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Altera Corporation. (NASDAQ:ALTR)

Q4 2007 Earnings Call

January 31, 2008 5:00 p.m. ET

Executives

Scott Wylie - Vice President of Investor Relations

Tim Morse - Chief Financial Officer and Senior Vice President

John Daane - President and Chief Executive Officer

Analysts

John Dryden - Charter Equity Research.

Glen Young - Citi.

James Schneider – Goldman Sachs

Tim Luke - Lehman Brothers.

Chris Danley - JP Morgan

David Wong - Wachovia

Uche Orji - UBS.

Ruben Roy - Pacific Crest Securities

Glen Young - Citigroup

Mark Lipacis - Morgan Stanley.

Tristan Gerra - Robert Baird

Sidney Ho - Merrill Lynch

Zumeth Danda - American Securities

Operator

Stand by. We are about to begin. Good day everyone and welcome to the Altera Fourth 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.

Scott Wylie - Vice President of Investor Relations

Good afternoon. Thank you for joining this conference call which will be available for replay telephonically and on Altera's website shortly after we conclude this afternoon. To listen to the webcast replay, please visit Altera's Investor Relations webpage where you will find complete instructions. The telephone replay will be available at 719-457-0820, and use code 258712.

During today's call, we will be making some forward-looking statements and in light of the Private Securities Litigation Reform Act, I would like to remind you that these statements must be considered in conjunction with the cautionary warnings that appear 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, 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 - Chief Financial Officer and Senior Vice President

Thanks Scott. Altera generated $323 million of revenue in fourth quarter 2007, up 2% versus both prior quarter and prior year. This result exceeded the top end of our guidance range of flat to down 4% sequentially. The favorability primarily resulted from stronger--than-anticipated demand in communications, broadcast and military applications. For the quarter in general, however, demand growth was fairly broad-based in terms of customers, geographies and market segments.

Turning to a few product specifics, our new category grew 9% sequentially in 4Q and 56% versus the same period last year. For the full year 2007, new products registered 65% growth. In terms of product family performance, FPGAs grew 4% sequentially and 3% versus prior year, while CPLDs declined 1% versus both comparison periods. This quarter we registered record revenue highs in our Stratix II high-end FPGAs, Max II CPLDs and HardCopy devices. With respect to gross margin, the 64.1% rate for the quarter was fractionally above our 63% to 64% guidance range in three tenths of a point better than 3Q. The sequential improvement in GM rate was entirely consistent with the market segment mix model we have previously articulated. John will provide more details on market segment performance following my overview.

Farther down the income statement, operating expenses were $142 million in total including $5 million in previously announced restructuring charges. Excluding restructuring, operating expenses were $137 million with a split of $71 million for R&D and $66 million for SG&A. Compared to guidance, both of those results were slightly favorable driven by spending discipline across a wide variety of line items. Noteworthy, however, that none of the R&D underrun was attributable to development schedule push outs. As planned, we are now shipping our high-density Stratix III device as well as all eight members of the Cyclone III family.

For the year in total, operating expenses were down 3% versus 2006 on a reported basis and down 4% or $21 million excluding restructuring. Within that total, R&D increased 6% or $15 million on the back of our 65 nanometer product roll out. SG&A is where we made our biggest improvements reducing spending levels by 12% or $36 million compared to last year. These results coupled with our fourth quarter restructuring actions form a strong foundation for improvements in 2008 and beyond. In the quarters and years ahead, we will continue to actively simplify, streamline, and innovate our cost structure to achieve superior operating margins and shareholder returns. Returning to the income statement, other income of $11 million with inline with updated guidance on December 5th and consistent with our plan to capital structure transformation. Net income with $65.5 million or $0.20 per share for fourth quarter and $290 million or $0.82 per share for the full year. Total year 2007 effective tax rate was 14.1% right at the midpoint of the guidance range we’ve been communicating.

At UN the cash and investments were approximately $1 billion down roughly $190 million from third quarter levels. Third and fourth Q, we repurchased $26 million shares for $509 million and drew an initial $250 million from our credit facility. Through the year, we repurchased 58 million shares for $1.2 billion and now we expect to complete our 1.5 billion repurchase program by late 1Q or early 2Q 2008 roughly three months ahead of schedule.

With regard to working capital, accounts receivable increased by 4 days in fourth quarter to 56 days sales outstanding, driven by $50 million in payments received just past our December 28 fiscal yearend. Our geographic terms remain unchanged and we anticipate continuing to collect AR on a weighted average 50-day basis in the future. Inventories on the other hand, decline from 3.3 months’ supply in third quarter to an even three months’ supply at yearend. Distributor inventory was flat at 1.1 months while Altera inventory dropped from 2.2 months to 1.9 months. Capital expenditures were $9.5 million for fourth quarter and $31 million for the year. Prior guidance was for $27 million with the excess spending attributable to acceleration of 2008 and 2009 outlays, in order to take advantage of favorable pricing.

Moving to our outlook for the first quarter, we expect to see revenue in the flat to up 2% range in terms consistent with 4Q’s 59%. We enter 1Q off a book-to-bill ratio of roughly 1.0 last quarter and the highest backlog level in over a year. Gross margin rates will continue to be mix dependent in the 64% to 65% range. First quarter operating expenses should come in at roughly $130 million evenly split between R&D and SG&A. We anticipate having $7 million other income in an effective tax rate of 16% to 17% until the US R&D tax credit is renewed. Additionally, we expect our diluted share account to be approximately $315 million shares, CapEx to be in the $8 to $12 million range, and pipeline inventory to remain in the low end of our 3 to 4 month desired band. For 2008 in total, our previously communicated guidance is unchanged.

In closing, I would like to reiterate the overarching themes and objectives we set for our Fair this past December 11th in New York City. We remain committed to a financial framework focused on driving growth, efficiency and shareholder value. Going forward, I will provide updates each quarter against our goals of 10% to 15% revenue growth greater than 30% operating margin rate on a GAAP basis and greater than 30% return on equity. We are confident that we have the right people, products, cost culture and capital structure to make substantial progress on these metrics in 2008. With that, I will turn the call over to John.

John Daane - President and Chief Executive Officer

Thank you Tim. We are pleased that Q4 revenues increased 2% sequentially based on a large part on a recovery of our communications and industrial business. December’s terms were particularly strong with unforced casted upside from customers in the military and broadcast segments as well as Japanese wireless and telecom customers. By vertical market for Q4, we had forecasted industrial consumer and computer to be flat to down and communications to decrease based on softness at the tail end of Q3 and numerous pre-announcements by communications equipment companies.

At final tally, communications increased 4%. Telecom was down but both wireless and networking were up double digits. In communications, Japan was strong as previously noted, Asia-Pacific weak and North America and European customers were mixed with some up and some down. Consumer was down 8% as displays ramped down from holiday bills and one of our set-top decoder box customers reduced inventory. Industrial was up 6% with growth in military…past and computer was up 2%.

In Q4, new products grew 9% sequentially. Stratix II and Stratix II GX were up 20%, HardCopy up 12%, and Max II up 8%. Cyclone II declined in tandem with our consumer revenues and was down 9%. Mainstream products declined 5% sequentially which our products increased 3%. Overall, FPGAs increased 4% sequentially and CPLD decreased 1%.

A few notes on products. Max II is now our largest CPLD family by revenue and as a revenue starting point for a 65 nanometer products, Cyclone III was $1.5 million and Stratix III was $500,000. Shifting the full-year 2007 results our sales revenue declined 2% but slightly better than the PLD industry. By vertical market, communications revenue declined 6% due to wireless CapEx reductions in Japan and equipment vendor consolidation in North America and Europe.

After 20% growth in 2006, industrial grew 1% in 2007 affected by the slow down in medical, caused by a change in US government reimbursements, and a significant decline in the test in measurement equipment market. Computer declined 11%. Consumer was the bright spot in 2007, growing to 13% after a flat 2006 with displaced and set-top decoder boxes leading the increase.

By product category for 2007, our new products dominated by 19 nanometer FPGAs grew 65% faster than our major competitor both in dollar and percentage terms. Mainstream products declined 15% and mature and other products declined 19%.

For the full year, FPGAs decline 1% HardCopy increase 13% and CPLD has declined 5%. I believe we held market share in CPLDs but increase market share in both FPGAs and the combined PLD sector for the 5th straight year. Cyclone III in March and completed the rollout in December. Cyclone III is the industry's only low cost 65 nanometer FPGA product and coupled with a low power process technology results in 75% less power consumption than competing devices. We introduced MAX IIZ, the industry's lowest power CPLD for the fast growing portable electronics market. We also shipped the Arria GX Series of mid range FPGA with transceivers.

Moving to our Q1 forecast we expect the seasonal decline in our consumer business and remain guarded on our industrial and communications business to the economic environment. We are forecasting a flat to up 2% sequential quarter. We expect consumer to decline, computer to be flat, and for industrial and communications to be flat to up slightly.

In summary, while 2007 was a challenging revenue year, it was fruitful from an execution standpoint particularly in product development and as Tim described capital structure and cost management. We have positioned the company for long term 10% to 15% compound annual growth, the ability to achieve greater than 30% operating margins.

Now let me turn the call back to Scott. We would now like to take questions. Please limit your questions to one at a time so that we give as many callers as possible the opportunity to ask questions during the call.

Operator, would you please provide instructions and call for questions.

Question-and-Answer Session

Operator

(Operator Instructions)

We will go first to John Dryden with Charter Equity Research.

John Dryden

Hi and thanks for taking my questions. John with the low exposure to defense, can you discuss the M-market strength in North America because you outlined Japan to be the strength there for communications.

John Daane

That’s a good question. Maybe we can ask somebody ask another question and we will go back and we will get our data and see if we can answer that. I just do not have off the top of my head, John, I am sorry.

So, if we could ask for another question and while we are asking for another question we can go back and look and see if we can answer that.

Operator

We will go next to Glen Young with Citi.

Glen Young

Obviously, we have got concerns of the macro environment here and now you have given us in advance relatively healthy guidance for the first quarter and to be fair, and so is your competition. I wonder if you have a lot of confidence in the way you are looking at first quarter, how it is started and if this gives you a sense of confidence. Secondarily, how would you characterize your feasibility this first quarter versus what might be a typical first quarter.

John Daane

A couple of data points. First of all, as Tim pointed out we expect turns to be in the 59% range that is lower than typically where we have operated. Historically, we have been in the mid-60s that is attributable to the fact that we have a strong backlog going me into this quarter. The first week of January was a short week because of the New Year holidays. Even with that first week short week, business was strong in January and we are basically on target to meet our guidance and our book to bill so far this quarter has been just above 1. So, again we are being somewhat cautious looking at some of the trends and the market place and industry but so far we have not seen any changes to any of the major carriers CapEx and rates. We have not seen any inventory build from any of our customers and so far business has been good.

Glen Young

John, have any of your customers reacted to low level of inventory that you have which also seems quite so low. Do you sense the customers are responding to the low inventory situation?

John Daane

No, not at all. In fact, the inventory is low for two reasons. One is, we have been driving to get the inventory down to about three months supply in hand. Our typical range in the past has been 3 to 4 but we have had an internal program to try to drive that to the lower end of the range, and that has been a consistent program for a period of time and if you note last quarter our inventories were also in the low 3s. Number 2, we had strong business strong business towards the end of the quarter and that naturally is going to pull the inventory down just a little bit. I cannot think of any products that are really on any sort of major allocation or allocation at this point in time nor am I aware of any customers that went and procured product trying to build inventory. In general, my assumption is at this point, most company’s management will look at the current environment and tell their purchasing departments to try to minimize the amount of inventory that they hold.

And so we have been assuming that our customers are trying to minimize inventory and certainly from nothing that we have seen, have we seen anybody want to establish a buffer stock or buffer position of our inventory so no impact due to that.

John Dryden

Thank you.

Tim Morse

Just to add to John’s comment there, the MSOH for inventory has been in this low end of the 3 to 4 range, 3.3, 3.2, 3.0 over the last three quarters, so it is not something that just happened in the fourth quarter. It has been there for a little while.

John Dryden

Perfect. Thank you very much.

Tim Morse

And just to answer John Dryden’s question for North America, the main driver (inaudible) broadcast area, military was up and some of the test areas were also up and so a number of product areas. I would not say that there is any one thing that jumped out and really drove the North American increase. Next question please.

Operator

Over next to James Schneider – Goldman Sachs

James Schneider

Good afternoon. With respect to the coms business, can you talk a little bit about any changes you are seeing as you move from Q4 into Q1 in terms of the order patterns you are seeing either geographically or with respect to wireless or wire line and can you specifically what you are seeing from Chinese customers.

John Daane

As we mentioned in the script, China for communications was weak in Q4, was also weak in Q3 (inaudible) from those customers as they expect their business to strengthen as we move through the year particularly in the communication side of the business. Other segments within China are doing just fine. In terms of the communications business, generally, we do expect the business to be flat to slightly up this quarter. I would say wireless is going to do okay. In Japan what you have seen is NTT-Docomo and also KDDI have been doing an additional build about last quarter and extends into this quarter as they add additional capacity in 3G in Japan so that is going a strong last quarter continues also this quarter and we will see how it goes throughout the rest of the year. NGN has been picked up in Japan in Q4, will continue. We expect some accounts to be up and some accounts to be down sort of trend in other geographies. I am not sure if that totally answers your question. If it does not please feel free to follow up and ask something a little bit more specifically. Thank you very much. Next question please.

Operator

(inaudible) next with Tim Luke with Lehman Brothers.

Tim Luke

John, just to follow on from that. In the last quarter your networking was up double digit along with the wireless by the sound of things. Do you see that up and do you see the telecom wireline was low or should that be lower again? In the consumer area, it looked like your (inaudible) has seen some strength in the display area. Your consumer area was a little low and sequentially maybe that was audio-visual, perhaps you can give some color on what the dynamics was there and then slightly lower in the calendar first quarter and if I may just pretend in guiding the lower expenses, should we think about you keeping the full year guidance being as SG&A is going to be flattish for the next of the year.

Tim Morse

Flattish versus first quarter you mean, Tim. I guided the 2006 back in December and said at that point that it would be roughly even throughout the year. I do not have any reason to expect something different at this point.

John Daane

Tim, this is John. In terms of communications, we did as you note have strength both in the enterprise area networking as well as wireless last quarter. We do not expect both to continue at the current growth although we would expect those to be the two segments that will be still strong again this quarter. I think if you look at some of the announcements out of the communication industry the data that we provided is consistent with some of these and communications companies are reporting in terms of revenue. In terms of consumer, we did see the ramp down of the 2007 models. It is a little bit ahead of the 2008 late ramp so we do expect a seasonally, typically fine that Q4 is flattish, slightly down and Q1 is down and then you see a build starting in the late Q2 Q3 again for the consumer cycle. Please note also that we had one customer where they take many products from us and have many setup decoder box models. One of the models ended up with an over-inventoried situation. They worked down last quarter. They will continue to work this down this quarter and we would expect them to start ordering again on that particular model, probably late this quarter or Q2. So, that affects the number as well.

And also, I would like to stress X3 had slightly better traction. Do you have any color there on the on the design wins?

John Daane

Yes, Stratix III has been strong. We put the software out early that has been our typical model as to put the software out early, follow up with the chips. We have two chips that we are shipping in Q4. Both were shipped about a month earlier to schedule. That includes the 340 which is the industry’s largest chip. As Tim pointed out, we’ve got about five more chips that we will ship this quarter and then finish Stratix III with five additional chips in the second calendar quarter and then, as we have alluded, we will very quickly be following that up with 45 nanometer that we will ship both software and product on this year. So we are very, very quickly transitioning from 65 nanometer and do 45 nanometer. The design wins are strong. The main reason for Stratix III’s success is power as I alluded to. Power is a huge issue in the industry. It is probably a little bit hard for you to appreciate but our largest chip that we ship, it is also the largest chip in the PLD industry that we put out in December has 1.3 billion transistors. I noted that Jensen Wong in Wachovia or in his video said that their largest GPU has 1 billion transistors, and I went also online and looked at Intel’s microprocessors on a single buy, they look to have about 400 to 500 million transistors. So you see, you could see that our devices are far larger than anything in the industry; and therefore the power issues that come with Moore's Law, we are far more susceptible to than merely any other product. And I think by doing the re-engineering work that we did, which was not just hardware architecture, it was a significant investment in software as well. To really re-do everything that we had previously done as an industry has resulted in us having a much lower power consumption device with higher performance; higher density. And that is exactly what customers are interested in, because power is limiting their ability to develop and deliver higher density products in existing chassis. So, we sold off of our road map, customers bought in to that because of our on-time historical execution. We are ramping the products very quickly and, from here, we had in the 45-nanometer, I think, with what looks like to be a good competitive advantage.

Thank you very much, Tim. Next question please.

Operator

Well, the next to Chris Danley with JP Morgan.

Chris Danley

Thanks guys. Nice quarter. Hey, John. You gave your relative in-market facts for Q1. Could you just give us your thoughts on the relative in-markets growth rates for 2008, and also a full-year revenue growth rate?

John Daane

Thank you very much Chris for the comment on the quarter. We have typically, as you know, just sort of taken it one quarter at a time. I would like to stay with that at this point because I think that many of our customers are, obviously, as concerned about the economic environment as we are. We feel comfortable with our guidance for this quarter, but we would rather just stay with one quarter at a time and see how the over-all industry develops. I would say that we do expect our industrial segment to be stronger this year than it was last year, but that is probably about where it stops.

Chris Danley

Okay, and then just to, I guess point to a clarification if I may?

John Danne

Sure.

Chris Danley

You expect the gross margins to remain in the 64% to 65% range for the rest of the year. How are we going to jump to that?

John Danne

Oh no, no. This is Tim. Hi Chris. My guidance back in December was 64% to 66% and, first quarter 64% to 65%, but for a lot of reasons, including the industrial strength that John just referenced, I think that for the whole year, again it is that broader range. I would not put a top end at 65%, no.

Chris Danley

Okay, so it is slowly trailing up after Q1?

John Danne

Yeah, again mixed dependent but, yeah that is the general feel.

Chris Danley

And then the last question is, when do you guys have a Stratix III GX coming out? Is that Q1 or Q2?

Tim/John Danne

We are moving to the 45 nanometer devices for that.

Chris Danley

Okay, great. Thanks.

Operator

We will go next to David Wong with Wachovia.

David Wong

Thanks very much. Two clarifications; one is you talked about $5 million for the past year or so. Is this ahead of your expectations for the year or that is in line with the $270 million that you guided for the full year?

John Daane

Perfectly in line, David.

David Wong

Great. Thank you. And the second thing is you talked about 45. You sort of answered this in just the previous question but 45-nanometer chips, they will be the Stratix III to three families. Will you be doing a refresh of the first Stratix III 45-nanometer of the string or will it just be new variation of Stratix III or 45-nanometers?

John Daane

I will prefer to kind of wait until we announce the products rather than to get into a breakdown of whether it is Stratix or Cyclone or Arria or something else or which portion on Stratix it might be for competitive reasons. So, I would like to just kind of beg off that question for now if I could.

David Wong

Great. Thanks very much.

John Daane

Thank you very much. Next question please.

Operator

We will go next to Uche Orji with UBS.

Uche Orji

Thank you very much. Let me just ask you, John about the prospects for Stratix III. I know you have kind of said the design wins to rate about some. If I will put this in context that you are coming in late behind Xylinks on 65-nanometers. How much more head room do you think there is for basic contingencies and why?

John Daane

Because, a lot of the design wins have been. You would realize that we put the software out in the first half of last year. And so you would have customers who have been designing with the software and are now procuring components to do the prototyping effort. I think it is important to recognize that you high in platforms typically customers, you are now doing what were historically million plus gate ASIC designs to takes the customers to awhile to implement the design before they need their devices to start the prototype and process. So, we have got a lot of businesses that are already won and it is going to ramp into the process technology.

So, we do expect the product to grow. We do expect it to be a strong product for us. We did recognized that we and working with TSMC had potentially competitive advantage as we talked about the last year and as we also highlighted in our December analyst meeting, and that we decided strategically to pull in the 45-nanometer technology to be one of the earliest implementers in the industry. Be one of the first in the FPGA world, and implement what is I think the best architecture and best software at this point as early as possible in order to produce I think the best product to the industry. Not only it be our architectural leaders but also be process technology leaders.

And so, we are exactly following what we wanted to do. We wanted to create the best Stratix architecture. We executed that exactly on schedule, actually early. We have decided to aggressively move to 45-nanometer. That is going extremely well for us at this point.

Uche Orji

I'm just going to ask Tim about operating expense. You have done very well in coding or taking down. I know last year you launched into this program to call in OpEx. Is there any more headroom for you to continue to squeeze OpEx down to the rest of 2008?

Tim Morse

Yes, 2008 and more to the point beyond, I think there is still a quite a bit of headroom here. First, the principle of productivity and infinite probability to improve everything that were really kind of spreading throughout the culture. There are parts of the culture already in the R&D ranks especially that really get that and are really absorbing it well and the other functions are catching up quick. So, we got a ton of opportunity really all across our PNL whether you are talking logistics or you are talking support functions, or how we do R&D, our design methodologies, our infrastructure in terms of IT, and continuing in terms of facilities. There is just a ton of work that is going on throughout the company that just opens a whole new horizons and we are really focusing especially on really looking a lot of our fundamental business processes in simplifying everything we possibly can. Cutting out all the waste, the non-value added work, the bureaucracy, and that will free us up to grow faster in a more efficient operating margin rates. So, there is still a ton of opportunity.

Yes in 2008 sure but I am more excited about the years out.

Uche Orji

But in terms of how you quantify, in terms of target of OpEx to sales ratio you are working to us. Can you just remind us what that is?

Tim Morse

I think more in terms of operating margin rates and getting our big objective there is North of 30%. I think will take a substantial step in that direction here in 2008 and we will keep driving it. And note that I did not say 30% operating margin, I said greater than 30% operating margin. I am not going to put a ceiling on that. We will keep driving it as high as we can. And like I said, we see a lot of opportunities to do that.

Uche Orji

That is fair enough. Just finally one last constituting question. I wondered (inaudible) share cost for first quarter.

Tim Morse

$3.15.

Uche Orji

Thank you.

Tim Morse

Somewhere right around there.

Uche Orji

Thank you.

Tim Morse

Yeah. No problem.

Operator

Over next to Ruben Roy with Pacific Crest Securities.

Ruben Roy

Thanks. John, I have a question on hard copy. You mentioned record levels of revenues in Q4 and I was just wondering if you can give us an idea as to where hard copies is now, the percentage revenues and also hard copy revenues have been lumpy through the year and I was just wondering looking forward if you expect that to continue or if you think revenues will smooth out in 2008 and finally any update on hard copy too as it relates to potential Stratix to replace some business in 2008. Thanks.

John Daane

Ruben. This is John. I think it was 4.5%. Hard copy was about 4.5% of revenues in counter quarter Q4. As we talked about last quarter, we do expect that there is going to be some transitions this year where some of our older hard copy business ramps down as customers’ end-of-life, products that have those hard copy products in them and we do have a number of new hard copy programs ramping up right now particularly in communications as one of the strongest sectors. Hard copy will grow this year but not as strong as I expect it to ultimately grow in 2009 as we have more and more of these designs flow in. Q4 was also a record quarter for us in terms of takeouts, and so the program continues to be very strong and continues to build for us. So, we do expect that it is going to continue to ramp over time and be a very successful product.

In terms of thinking of any major program that is going to transition from Stratix II into hard copy and therefore impact Stratix II revenue I cannot think of anything off the top of my head. We will look at that and if I can come up with anything, I do not think there is, we will certainly try to include that in the next quarter script.

Ruben Roy

That’s great. Thanks John.

John Daane

Thank you very much. Next question please.

Operator

We will go to Glen Young, Citigroup.

Glen Young

Thanks. I guess for Tim. In a good level of buy back, it has been getting better, billing and cash, what level of cash do you feel comfortable with?

Tim Morse

We really have to talk about it in two parts, Glen. The US cash and the international cash because as we all know, to do anything meaningful with the international cash in terms of buy back or dividend you would have to repatriate it and thereby incur 35% tax on it. The split of our cash right now, the majority of it, 60% or more is off shore. Increasingly the minority is US cash. We work on the US side to a formulated minimum that includes a year of interest, a year of dividend, three quarters of US operating expenses, some on-demand payable, a little bit of strategic fund there. We are working down toward that minimum and that is the way we look at it and whatever we do I want to grow the international cash and that is pretty much permanently invested outside of the US.

Glen Young

I guess ultimately why I am asking is you are going to run out on your buy back relatively early as you suggested and it is the intention to continue to buy back as aggressively as you have been.

Tim Morse

We will as we have previously talked about, we will use the buy back program to counter dilution of our equity programs. We will be opportunistic in terms of share price, in getting to the certain ranges but we are going to balance that out obviously also with the need to use that same demands of cash for the dividend. So, there are a lot of things at play here. I would say we will finish the 1.5 billion by March or April. We will continue to be in the market certainly in the trailing quarters but I really could not tell you at this point any definitive plans other than countering dilution and just looking for slots to be opportunistic.

Ruben Roy

Okay, fair enough. You mentioned this R&D program that you have with TSMC and it comes in conjunction with an aggressive plan by the company to manage operating expenses and I wonder if that work with TSMC is enabling you to better manage this OPEX. Is it a more aggressive plan than normal?

Tim Morse

It does not change the way that we have looked at R&D as there are certain programs that we are going to find in order to be a successful company. So we have never looked at it and said, "Let us go and kill this product that we are in development with because we cannot afford it anymore." We have always said we want, if the program makes sense to fund because it is going to have a strong return, we are going to fund that no matter what the industry is doing.

What we are looking for in terms of R&D efficiencies is to improve productivity of the engineers. So as we highlighted in December, Tim talked a little bit about the fact that for 32 nanometer we are going to be implementing a new design methodology with new tools in order to improve the productivity of the engineers that we have as one way in order to, again, through higher productivity lower the amount of spend that you have to develop any particular generation product. So I would not say that we are doing anything that would hamper our long-term competitiveness. We are really looking for ways to improve the productivity and to simplify a lot of the tasks that we do at the company in order to become more efficient.

Ruben Roy

And John, one last question. You seem to have a lot of confidence that industrial will get better and I have heard you say in the past that your consumer mix will go down if you walked away with some unprofitable business and so, more or less profitable and so we get that improvement in gross margin due to mix, but what gives you the confidence to say that industrial is actually going to be better in 2008?

John Daane

Well we expect military to be a strong growth engine for us this year. We have had a lot of design wins in military as you probably can appreciate. We are a distant number 2 in the market having exited it probably twelve years ago. A lot of design wins over the last 3 to 4 years that are rolling into production. We did have a strong military quarter in Q4 so we expect that to be up. And then there are other spots within the industrial sector which we expect to have a better year. We do expect that, for instance, the medical industry is going to come back. That has been hampered because of the change in the US reimbursement. There has been a lot of used medical equipment put under the marketplace that is getting absorbed with an aging population around the world. We do expect the diagnostic equipment is going to continue to sell. So that should be up for us as well as some of the test of measurement area which really was quite down for us Q2, Q3 and still at a very low run rate although it was up in Q4 simply because there is a number of new standards that have been developed or are being developed: YMax, LTE. There is obviously the need for R&D testers and production testers in those areas as well as the fact that I think semiconductor tests have been tight and probably is an area that even in a weak economy some people are going to have to do some upgrades. So those are examples of areas within industrial that I think would grow even if the environment was well.

In the broad base of industrial, it was actually a very good grower in 2007 and 2006 as well, but 2007, and we first continued to see the trends there in the factory automation, security, et cetera, so a lot of things actually to be pretty positive about in that segment.

Ruben Roy

Okay thanks. Thank you very much.

Operator

We are going next to Mark Lipacis with Morgan Stanley.

Mark Lipacis

Perhaps a question for Tim. You talked about taking the cost structure down by over a thousand basis points which is impressive and I guess the way I understand it, you are thinking about you doing your business planning in under assumption of 10% to 15% top line growth this year the OpEx is kind of tracking flattish sequentially. As you think about that 10% to 15% top line growth, in your mind, are you thinking that at some point you still have to, you said, to grow the OpEx as you go into 2009 at some slower rate than revenue or can you actually keep that OpEx flat even going to '09. Thanks.

Tim Morse

Yeah. Thanks for the question Mark. It is a good question. I don't know. As I articulated back on December 11th, you get a ton of leverage out of this model even if you grow your OpEx at half of whatever you grow your revenue at. It is a part of the strength of our model given especially the high gross margins we have. Do I know? I really am not, honestly, in a position to know what will happen. I don't really have too many inklings, even on what will happen in 2009 and 2010. But right now, to enable me right now to say it will be up 2% or it will be down 2%, I don't know. I know it will grow at the very least I can tell you it will grow substantially less than our revenue grows. Could it go down in 2009? Yeah I think it depends on again, how much more traction we get? What big things did we uncover? Could you go one fold a bit yeah it could go up a little bit too but it will definitely grow less than the revenue growth rate and we are very confident with that.

Mark Lipacis

And then if I could just follow up, that in your mind, this is the target goal for at least 30% operating margins. That is not a 5-year plan in your mind. Right, that is something like a 2 or 3-year plan, is that fair characterization?

Tim Morse

Definitely not a 5-year plan, we talked to put a timing on it without talking the revenue side to the equation as well because you will get to see through some of this IS 15% of SG&A percentage of sale and 18% percent of R&D as percentage of sale, some of that will come through some volume leverage, some growth in the top line while holding spending much less in terms of growth rate. So it is tough to say the exact time frame but definitely it should be much earlier or later than 5 years.

Mark Lipacis

Fair enough. Thank you.

Tim Morse

Thank you. Next question please.

Operator

Well the next Tristan Gerra with Robert Baird

Tristan Gerra

Hi guys. This is just a followup to previous questions, Stratix III ramp is a little bit late and at the time you were developing a low-power architecture which you believe give you the advantage. In comparison, 45 nanometers seems to be ahead, what makes the execution differences? Is 45 nanometers more for a shrink; is that basically benefiting from what you developed with Stratix III or any other color that you could provide on this?

Tim Morse

Well as I think as we talk about Stratix III, we made the decision to do a completely new architecture and software development around that in order to lower power but keep very high performance in density. Density equals both the ability to take on higher or larger ASICS, it also means the higher the density, the lower the cost structure. So all of those vectors are important, we decided not to sacrifice any of them and therefore needed to do something completely different, a revolutionary and accomplish that. Obviously from a scheduled perspective, we could have had 65 nanometer out a long time ago as we just ported an existing architecture but we would have not had achieved the advantages that we have today and I think it is important to remember Tristan, that the opportunity is not to swap market share back and forth between POV vendors, the opportunity for growth is to take more ASICS market share and more ASSP market share, and in order to do that, you really have to have the right products. In terms of 45 nanometer, that was a complete change in our overall strategy, we started a joint R&D program with a TSMC to develop the process early as well as to develop chips early, and so that required that we put a team together in order to do that development in conjunction with our overall Stratix III development. So, it really called for us doubling up, it called for a lot of work out of the team and things have gone extremely successfully. We’d also tell you that we are not sacrificing any other reliability that we’ve had in the past by moving to the 45 nanometer process technology note early. We have continued to do the test chip development that we have always done in the past to verify parts or substantial portions of our designs, the memories, the IOs, the PLL, the basic fabric structure in order to make sure that each is right. We have continued to do that work. We have continued to program, manage and maintain schedules and we expect that product to execute as every other product generation has for us.

Tristan Gerra

Great then. A quick followup in terms of HardCopy, you mentioned that there was going to be a ramp in communication this year based on design wins you have, any significant change in the end market distribution for HardCopy that you expect what it is to the distribution in ’07.

Tim Morse

Yeah we talked about that in the Q3 conference call. We do expect that communications in particular is going to pick up more as the percentage this year which also means that the computer and storage area will decrease as a percentage of this year. And in particular, we talked about in that conference call, if I am not mistaken, that areas like enterprise, networking, wireless and some of the access programs were very strongly ramps for us for HardCopy this year.

Tristan Gerra

Great. Thank you.

Tim Morse

Thank you very much. The next question please.

Operator

Our next with Sidney Ho, Merrill Lynch.

Sidney Ho

Hi. Thanks for taking my question. Following up to Mark’s question regarding operating margin target, first the classification if that is of GAAP basis or is it options based and second if there is no specific time frame, is there a revenue level that…

Tim Morse

Yeah hi Sydney this is Tim. Definitely on a gap basis go back and look the text of the script I just read as well I make that clear the definitely gap basis.

The second part of your question had to do with revenue?

Sydney Ho

If there is no specific time frame shift the 30% margin targeted bill like a revenue level that we should be looking at?

Tim Morse

You know, I guess, you know we are coming dangerously close in our line that we really do not want to cross here in terms of that kind of gains. I just encouraged you to do a little math on your own. I shared certainly some of that math back in December 11 because I, you know, wait out a couple of different scenarios of revenues and growth. You can get there (inaudible) substance and get there pretty easily. It is a step not rocket size.

Sydney Ho

Okay, fair enough.

Tim Morse

I would not do it for a living if it were.

Sydney Ho

Sure. Switch the subject for a second. If you have talked about this earlier I must have missed it. In Q4 new products were administering products were down both depending expected but I would expect this base products to keep going down. Can you talk about what is driving that in Q4 and what should we think about that in Q1?

Tim Morse

Well, typically you are right. We called them mature products should decline, which our products were actually up in the quarter, and it is really because we had some business in the industrial sector that came up. And some areas like test of measurements and medical, some areas of industrial we very really weak for two quarters. So we are seeing customers sort of come back to what is more natural run rate, and therefore, that carried the momentum up. If you look at the actual product lines that are in the mature category, there are a lot of them, most of them were down. And so, we would expect that mature category to continue to decline on a sequential basis going forward.

Sydney Ho

Thank you very much.

Tim Morse

Thank you.

Operator

And our last question from Zumeth Danda with American Securities

Ian for Zumeth

Hi guys. This is Ian for Zumeth. A couple of questions if I could. Will the beginning backlog up again? Would you say it is up about the same more or less as the Q4 backlog was up over Q3?

Tim Morse

Why don’t you ask your second question and I will…

Ian

Second question is, I think last quarter you felt it prudent to exercise some caution with respect to the (inaudible) forecast. Is the environment such that prudent is still about the same or has that change any?

John Daane

We are still assuming that customers are not going to exactly hit our forecast. We have some customers who are talking about some large forecasted increases this quarter. We are still putting some windage on that as well as some of the industrial forecast we are getting. And there is some volatility of course and so, we will just have to see how it ends.

Ian

Okay. And then just one last one on the military strength. Would that really do the just timing or maybe the magnitude of that business was a surprise, or was it the combination of both? If you could just talk to what was the surprise for you?

John Daane

It was up stronger. It was unforecasted demand in the military segments, North America predominantly some in Europe. We do expect that military is growing to grow for us this year and be a strong growing marketplace for us this year. I can not really comment down to any particular programs or things of that nature at this point. And maybe if we go back to Tim.

Tim Morse

The backlog answer is it is up less than it was. But that is really not surprising given the seasonality typically kind of Q3. We enter Q3 with a little bit lower to see expected build back up for 4Q, if there is a seasonal quarter history queue. It naturally enter a little bit lighter into that one so it is of last you also expect that. I think the important point is a group.

Ian

Okay thanks.

Tim Morse

Are there any last questions?

Operator

We have no further questions.

Tim Morse

Bye. Thank you, operator. I will just a final word before we conclude today. For those of you who might be interested on March 5th, we will participate in the Morgan Stanley Technology Conference in Dana Point, California.

This concludes Altera's Conference Call. Thank you for your participation and interest.

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Source: Altera Corporation. Q4 2007 Earnings Call Transcript
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