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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

Altera Corporation (ALTR) Q3 2007 Earnings Call October 23, 2007 5:00 PM ET

Operator

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

At this time, for opening remarks and introductions, 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 before turning the call over to John. After John concludes his remarks, we will take your questions.

Prior to the Q&A session 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

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

Beginning with third quarter results, revenue declined by 1% from second quarter to $316 million. That result 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 total for 3Q our largest customers comprising just over 60% of our revenue grew modestly, but the broad based declined 4%.

New products continued to gain momentum registering 13% growth on a quarter-over-quarter basis, and 52% growth versus 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%. CPLD revenue was up 1% sequentially, led by13% growth in MAX II. HardCopy declined by 7% in the third quarter following a 58% sequentially jump in 2Q.

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

Continuing down the income statement, 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 $8 million from second quarter as we continued our successful 65 nanometer product launch with $4 million of favorability versus guidance due to better than anticipated yields and spending for both Stratix III and Cyclone III. SG&A declined $2 million from second quarter and also under ran guidance by the same amount. We remain slightly ahead of pace with regard to our cost out commitments for 2007 and therefore are building better than plan momentum heading into 2008.

Other income was $16 million for the third quarter including $2 million benefit from favorable returns in our non-qualified 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 in both periods $14 million of other income in 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 remained unchanged versus 2Q and versus the midpoint of guidance.

At quarter end, cash and investments were approximately $1.2 billion a reduction of $93 million driven by $255 million of share repurchase activity in the third quarter. 3Q year-to-date we have repurchased $717 million or 32 million shares. That leaves us with a little less than $800 million to repurchase over the next three quarters in order to fulfill our previously announced repurchase plans of 1.5 billion by June 2008. Elsewhere on the balance sheet 52 day sales outstanding in third quarter declined by two days from second quarter levels. Pipeline inventory ended third quarter at 3.3 month supply on hand, essentially unchanged versus 2Q.

Distributor inventory dropped to tenth of a month to 1.1 months, while Altera inventory increased as expected from 2 months to 2.2 months.

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

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

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

In 2007, we continue to invest strongly in new products and technologies, while greatly improving our spending efficiency. The resulting $539 million of operating expense will be down low single digits from 2006, as well as 10% favorable to original 2007 guidance. We are well positioned to leverage these initial cost out, simplification efforts for the benefit of 2008 and beyond. Once again, more detail will be forthcoming in our December 11th event.

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

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

With that, I will hand it over to John.

John Daane

Thank you, Tim. Revenues in Q3 decreased 1% sequentially, softening of our communications business late in the quarter was the primary reason for our shortfall to guidance, as I will detail on them.

By product classification, we typically expect the new category to grow, Mainstream to be flat to down, and mature to decline. Our new products grew 13% sequentially and 52% year-over-year and continue to outpace our major competitor. Cyclone II was up 34% 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 a larger than normal 9% caused by Stratix and Stratix GX which combined were down 21%. Cyclone increased 4%. Mature products declined 7% sequentially.

The shortfall in the original 130 nanometer Stratix series was due to lower revenues in our industrial and communication segments and the conversion of some high volume devices to HardCopy where 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 in the Wireline Access and Wireless center cell applications offset slow declines in older storage and communications areas.

By vertical market for Q3, we had forecasted computer to be down, industrial to be flat with a rebound in test and measurement offsetting a decline in medical. For communications to be up on growth in wireless and networking and for consumer to grow in a traditional strong consumer quarter.

Computer declined 3% as forecasted with server revenue up and storage down. Industrial declined 8% with medical down as expected but the test and measurement market decreased significantly for the second straight quarter instead of the rebound we had forecasted.

The declines here are both industry and account specific and we believe this sector has bottomed. The communications segment declined 1% instead of growing as forecasted. Telecom declined, Wireless grew very slightly and Networking declined with overall communication shipments tailing-off in late September.

Consumer grew 14% far stronger than forecasted with upsides in flat panel TVs and set-top decoder boxes. The upside in consumer offset the decline in test and measurement and midst to guidance was the weakening of the communications business towards the tail-end of the quarter.

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

Moving to our Q4 forecast, we are guarded with negative pre-announcements from several major communications equipment manufacturers and are forecasting revenues to be flat to down 4%. We expect Consumer, Industrial and Computer to each be flat to down and for the Communications segment to decrease. Note that our Communications customers are forecasting our business with them to roughly flat and we are taking a cautious position.

Within the markets we expect broadcast to be flat, digital entertainment flat to down as the holiday ramp tails, 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 be approximately 56% lower than our typical mid-60s and lower than Q2s 61%.

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

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

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

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

At Altera we continue to focus on innovation, execution and customer service, we are completing our 65 nanometer Stratix III and Cyclone III rollout, where these products have significantly lower power consumption than competing devices. And we are well into design of 45 nanometer products that will begin to ship next year putting Altera in a strong position to take maximum advantage of the ASIC and ASSP replacement cycle.

Let me now turn this call back to Scott.

Scott Wylie

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

Question-and-Answer Session

Operator

Thank you. 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 Glen Yeung. I wanted to ask about, you talked about large customers growing modestly versus the broader base not growing. Could you give us some sense or can you also help us understand that versus your longer term growth rate it looks like your year-on-year growth rates are inflecting pretty much though you are down quarter-on-quarter, is year-on-year growth rates inflecting? Can give us some view of '08 and how your large customer growing modestly now or may you being a little bit stronger relative, would make you any more or less comfortable with that longer-term growth rate?

John Daane

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

We would expect actually all product categories or customer categories to go both big and small over the long term. We would note that a lot of the small customers represent the industrial sector. Bigger customers are aggregated more around consumer communications; some of the computer and storage area medical, military as examples. So, we would hope that all of our customer categories grow over the long term, continue to believe as we talk about few moments ago that few of these will continue to replace ASICs and ASSPs for years to come, simply because it is becoming very expensive to design forward and newer process notes.

For those companies that are trying to use existing older generations of process technology, because they are cheaper to design with. I think their fundamental problem is as we move forward and write Moore's Law we can make our programmable devices even now they are slightly bigger than ASIC, because they incorporate technology to allow them to be programmable. We will be able to under cut the costs.

So for those that want to stand 0.13 micron as we move in the 65 nanometer and 45 nanometer, we will have a more cost effective solution, and therefore can continue to replace ASIC and ASSP solutions. We had also outlined that the servable market in both the ASIC and 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 we need to look at something else to continue strong growth.

Operator

And we'll go next to Seogju Lee at Goldman Sachs.

Jim Schneider - Goldman Sachs

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

John Daane

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

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

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

Operator

Our next question goes to Tristan Gerra at Robert W. Baird.

Tristan Gerra - Robert W. Baird

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

John Daane

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

Operator

Next question goes to Chris Danley of JP Morgan.

Venk Natirmani - JP Morgan

Hi, good afternoon this is [Venk Natirmani] sitting in for Chris Danley. John, I have a question for you. You talked about the various applications that could lead to sustained growth in the PLD end market. But on flip side do you see anything that could perhaps slow 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 company about five or six years ago and I think its fairly well accepted now, around the industry, our comment at the time was really only programmable types of technologies can take advantage of Moore's Law. Naturally, if the cost to do a design increases with each node, that means you have to achieve a higher revenue source or flow for each product that you introduce. The advantage of programmable products as we can take one ship and sell it to lots of customers in lots of different markets and through the aggregation of volume justify the continued investment moving forward. So, we would see that as we write Moore's Law, we can make our devices more cost effective, move them into higher volume applications, so that we can take more market share that way. Increase the density so that we can also play more in the higher end of the ASIC industry, where we were not able to compete previously and therefore take market share based on those two vectors.

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

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

Operator

We go next to Steve Elisku at UBS.

Steve Elisku - UBS

Yes. This is Steve Elisku for Uche Orji. 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 sacrificing your 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 of the mix right now. The GM, the only good thing I could say about gross margin rates right now it is behaving very, very consistently with how we've been articulating it, and therefore it's fairly a simple message on how it will get back into that round. We are as we said before actively managing our business to that 65% target. Right now we are a little bit light on industrial, which is above the corporate strike zone of 65%. We see terrific growth opportunities in those segments to get us back in the range. We see a lot of the key dynamics in the other segments playing in our favor as well.

We will continue to evaluate many of the consumer opportunities and as John had mentioned in the last call, we've walked from a couple of those that haven't had satisfactory margins. So I think when you couple the mix that will rebound, we've had a couple of quarters here in 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 the work that we are doing in our cost out simplification initiatives will actually have a nice impact on cost to goods sold as well. We are evaluating a wide range of fairly big projects that will help our gross margin rate. So we are actually pretty optimistic in that regard.

John Daane

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

Operator

And we'll go next to Gurinder Kalra at Bear Stearns.

Gurinder Kalra - Bear Stearns

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

Tim Morse

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

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

So we're being aggressive. We are unquestionably driving the message throughout the entire organization. I think the entire organization is grasping it well, and again we feel good about where we're going with this. So, I wouldn’t call it a problem forecasting, I am delighted with the progress and I just want to continue to build on that momentum.

Operator

And we go next to Arnab Chandra at Deutsche Bank.

Arnab Chandra - Deutsche Bank

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

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

John Daane

So I guess there is multiple components within that question and so I'll try to break it down. In terms of process generations we are as aggressive as we've ever been, perhaps more aggressive in adopting process generations, as we mentioned we'll shipping 45-nanometer products next year. I think but you have to take a step back and appreciate is the fact that what we heard from customers and feedback couple of years ago as power was starting to become a major issue for them, particularly in the infrastructure equipment area, you’ve now heard that out of companies like Intel and AMD for servers. It is very much so if not a bigger issue within the communications industry. And so we wanted to do something different on power.

We could make our devices bigger to lower power that would have impacted the cost; we didn’t want to do that. We could make our devices slower to lower power we didn’t want to do that, because that then would limit our ability to reach some of the market. So we came up with an innovative programmable power technology, it required a lot of tools development and a lot of architectural development, which was different than what our competitors decided to do. Ultimately we have a much better product line, which we can not only deploy in 65-nanometer, which answers the power issue, but also take that forward into 45-nanometer.

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

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

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

And again, it’s a portfolio of business. We plan to manage this as a portfolio. We will try to grow the top-line as quickly as possible. We are also cognizant that at the end of the day we want to grow earnings. And so if a piece of business has strong top-line growth that actually hurts our earnings that's something that we're just flat not going to pursue.

Operator

And we will go next to Mark Lipacis of Morgan Stanley.

Unidentified Analyst

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

John Daane

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

Now, overall, Japan the reason that it’s declined this year, we had a really strong growth in Japan the prior two years because both NTT as well as KDDI were going through a very large build-out of 3G wireless technology. That is obviously gone through a pause 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 extremely well positioned there both in terms of high end FPGAs, as well as, HardCopy at the two major suppliers into that segment and we would expect that our Japanese revenues will grow probably sometime beginning next calendar year as that deployments starts to take-off.

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

Operator

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

Tim Robinson - Buoyant Advisors

Hi guys. Thanks for taking my call. I apologize if I miss this, but what was your quarterly cash from operations?

John Daane

CFOA for the quarter was $116 million.

Tim Robinson - Buoyant Advisors

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

Tim Morse

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

John Daane

Yeah. Typically, we build into an assumption that we are going to have to potentially respend some of the early devices that we prototype. Mask sets are running around $3 million and so as you can imagine, if you have to respend a device that can be very expensive and again if you have to respend here for several devices, you can multiply that up.

This year, we are doing both the Cyclone and Stratix family, so you can imagine that you have quite a few. Altera has executed really almost flawlessly, since 0.13 micron 90-nanometer and 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 a stellar record of bringing the products out on schedule, as well as, being able to achieve volume. So, we certainly have that going in our favor this year. And as Tim mentioned, we usually plan wafer purchases and yield work to improve yields and 65-nanometer yields that are well ahead of schedule, so we are saving money also within that side of the business.

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

So, it is nothing to do with our product schedules, a number of products that we are doing as much as it just have been. We've executed much better than I think any other company normally does, PLD or semiconductor period and that efficiency has led the lower overall R&D cost.

Operator

(Operator Instructions). And we will go to Tim Luke of Lehman Brothers. Please go ahead. Mr. Luke your line is open, we are not hearing you. Mr. Luke are you there sir. (Operator Instructions). 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 taking another question. Could you view in the past you have mentioned a desire to refocus on the military business. Can you give us an update of what you are doing there? Thank you.

John Daane

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

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

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

In area that we have done quite well is for instance in SDR. And the reason that we have done well within these new communication systems is because the government has mandated programmable technology for radios in order to upgrade algorithms to be able to change the equipment. So that they can ultimately upgrade the crypto algorithms to stay one step ahead of either the enemy or the terrorist and that has been mandated to be done on programmable logic devices, because we have both the logic fabric as well as the DSP capability.

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

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

Operator

And we do have a follow up question in the queue this is from Steve Elisku at UBS. Your line is open please go ahead.

Steve Elisku - UBS

Yeah, this is a follow up to your comments on being optimistic regarding a rebound especially in industrial. Can you 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 would be very helpful? Thank you.

John Daane

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

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

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

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

Operator

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

Scott Wylie

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

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Source: Altera Q3 2007 Earnings Call Transcript
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