Altera Corporation Q1 2008 Earnings Call Transcript

Altera Corporation (ALTR) Q1 2008 Earnings Call April 16, 2008 5:00 PM ET

Executives

John Daane - President, Chief Executive Officer, and Chairman of the Board.
Scott Wylie-Vice President, Investor Relations
Timothy R. Morse-Senior Vice President and Chief Financial Officer

Analysts

Tim Luke-Lehman Brothers
Glen Yeung-Citigroup
John Dryden-Charter Equity Research
Christopher Danely-J.P. Morgan
Ruben Roy-Pacific Crest Securities
James Schneider-Goldman Sachs
Uche Orji-UBS
David Wu-Global Crown Capital
Gary Mobley-Piper Jaffray
Hans Mosesmann-Raymond James
Sumit Dhanda-Bank of America
Mark Lipacis-Morgan Stanley
Tim Luke-Lehman Brothers
Sidney Ho-Merrill Lynch

Operator

Good afternoon everyone and welcome to the Altera First Quarter 2008 Earning Results Conference Call. (Operator Instructions) At this time, I’d like to turn the call over to Mr.

Scott Wylie, Vice President of Investor Relations for Altera Corporation. Mr. Wylie, please go ahead.

Scott Wylie

Good afternoon. Thank you for joining this conference call, which will be available for replay telephonically and on Altera’s website, shortly after we conclude this afternoon. To listen to the webcast replay, please visit Altera’s investor relations web page where you will find complete instructions. The telephone replay will be available at 719-457-0820 and use code 251712.

During today’s call we will be making some forward-looking statements and in light of the Private Securities Litigation Reform Act, I would like to remind you that these statements must be considered in conjunction with the cautionary warnings that appear in our SEC filings. Investors are cautioned that all forward-looking statements in this call involve risks and uncertainty and those 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 over view 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.

Timothy Morse

Thank you, Scott. I’ll begin today with an overview of first quarter results set against the backdrop of our on going operational themes of growth, efficiency, and shareholder value. To recap the long-term framework we established in 2007, our primary financial targets are 10 to 15% annual revenue improvement, 30% or better operating margin rates and 30% or better return on equity. In 1Q we made progress toward all three of these goals, revenue grew 1% versus prior year, OM rate expanded to 28%, excluding some one time favorability I’ll describe more fully in a moment and ROE improved to 26%. Transitioning to a specific discussion of the elements of growth efficiency, and shareholder value, I’ll start with the top line.

First quarter revenue of $336 million was 4% higher than fourth quarter, exceeding our guidance range of 0 to 2% sequential growth. John will provide details and co-commentary on product and market segment performance following my over view.

Moving now to the broad topic of efficiency, first up is gross margin. This quarter, our GM rate improved by one point sequentially to 65.1%, driven primarily by the mirror image of market segment and customer mix dynamics that depressed our rate in the second half of 2002. As revenue results in the industrial segment exceeded our expectations with 8% sequential growth, so too did gross margin exceed the high end of our 64 to 65% guidance for 1Q. Operating expenses were similarly favorable. On a reported basis, OpEx landed at $119 million, roughly $11 million ahead of guidance.

However, 5 million of that under run is attributable to losses in our NQDC or non-qualified deferred compensation plan. Although the company doesn’t ultimately participate in gains or losses on the underlying assets, accounting standards prescribe mark-to-market treatment for those changes in value. In this case the losses are recorded as favorability to OpEx with an equal and off setting entry made to other income. As described in the past, the net of these entries obviously creates no earnings impact at all.

Nonetheless, on a reported basis, our operating margin rate benefits from this accounting by 1.5 points. It can reasonably be expected, however, that this benefit will be reversed in the coming quarters as the financial markets improve. In the meantime, we view our OM rate as 28% for the quarter, not the more favorable 29.6% reported basis.

Excluding the NQDC affect then, operating expenses were $124 million, $6 million below guidance and 4% below last year. On that XNQDC basis, R&D was $61 million, 4 million less than guidance, but up 6% from last year. Of the favorability versus guidance, about half is timing and half should fall through for the year. As a result, I’d now update our full year R&D guidance to be $268 million versus our earlier $270 million guidance. As previously communicated, we expect a slightly second half weighted spending pattern. Rounding out XNQDC operating expenses, SG&A was $63 million, $2 million less than guidance and 11% below last year. The favorability versus guidance was spread evenly among a variety of line items, with the biggest single chunk being $0.5 million of advertising timing. The remaining $1.5 million should fall through for the total year, so the updated 2008 guidance for SG&A will now be approximately $259 million versus prior guidance of $260 million. With this small adjustment, we continue to see the spending pattern essentially even across the remaining quarters.

Before proceeding, it’s important to note, once again, that the updated OpEx guidance number of $527 million assumes that the 5 million first quarter NQDC favorability reverses itself over the course of the year. It’s impossible to forecast that reversal by quarter, however, so all the forward-looking numbers we provide are on an XNQDC basis. To the extent NQDC doesn’t reverse itself, OpEx will be lower than $527 million. In either case there is no impact on earnings and we will continue to report the NQDC affect as we move forward.

Returning to first quarter results, on the operating margin level, excluding NQDC, Altera earned roughly $94.5 million, up 32% from 1Q07. The resulting 28% OM rate compares favorably to 23% in 1Q07 , 22% for total year 2007 and 24% for total year 2006. On just 10% year-over-year revenue growth for the quarter, these improvements demonstrate the strength of the Altera financial model.

Turning now to our shareholder value metrics. Other income for the quarter was just shy of $1 million on a reported basis and $6 million excluding NQDC. The decline versus all comparison periods is attributable to three dynamics: declining cash balances related to our share buy back activities, falling interest rates on our investments and increased interest expense as we draw down on our credit facility. The effective tax rate for 1Q08 was 16.5%, right at the mid point of our 16 to 17% guidance. We expect that underlying rate to be stable in the 16 to 17% range for the full year. If and when the US R&D tax credit is passed, it will reduce the full year rate to the previously communicated range of 14 to 15%.

On the net income line: Altera generated roughly $84 million or $0.27 per diluted share. That result was up 12% from last year in dollar terms and 31% in EPS. In a related item, we have now completed the $1.5 billion repurchase program committed this time last year. At final tally, we repurchased 73.5 million shares at an average cost of $20.44 and three months ahead of schedule. Consistent with prior communications, going forward we intend to repurchase shares for anti-dilutive and opportunistic purposes. We do not, however, feel the need to telegraph specific events or timing in advance, so as not to impair the economic effectiveness of our actions. We will, of course, continue to provide diluted share count guidance for each coming quarter.

With regard to the balance sheet: cash and investments were $995 million, roughly flat with 4Q. Our investment portfolios contain no special investment vehicles, adjustable rate notes, variable rate demand notes, mortgage backed securities, asset backed securities, nor asset backed commercial paper. At $150 million, our cash flow from operating activities this quarter was extremely strong.

Accounts receivable on shipments into distribution rose $32 million, to $231 million at quarter end. The change was attributable to a $41 million increase in March versus December monthly distributor billings, partially offset by an anticipated improvement in collection activity. As a reminder, we recognize revenue upon shipment out of distribution, so increased billings into distribution create no impact on our income statement.

Inventory levels across the supply chain were similarly unaffected. Altera MSOH declined 1/10 of a month to 1.8 months, while distributor MSOH increased 1/10 of a month to 1.2 months. In total, three months supply on hand for 1Q was consistent with 4Q and at the low end of our three to four month desired range.

On the right hand side of the balance sheet, long-term debt increased by 100 million to $350 million. As planned, we’ve subsequently brought the full draw down on our credit facility to 500 million, in conjunction with the now completed 1.5 billion repurchase program. Pricing wise it was slightly advantageous to wait until April to take on that final $150 million of funding.

As previously noted, the combination of operating results in capital structure improvements have yielded 26% return on equity this quarter, up from 21% in 2007 and 23% in 2006.

Concluding with one final item on shareholder value, effective with the June 2 payment, Altera’s board of directors has authorized an increase in the quarterly cash dividend to $0.05 per share from the previous $0.04.

Moving to our outlook for the second quarter, we expect to see revenue in the 1 to 4% growth range with times in the mid to high fifties, a touch below 1Qs 60%. We enter 2Q off a book-to-bill ratio greater than one last quarter and a new high in backlogs since 3Q06. Gross margin rates will continue to be segment mix dependent in the 65% range.

Second quarter operating expenses should be in the 128 to $132 million range, split between 65 to $67 million in R&D and 63 to 65 million in SG&A. We anticipate having $3 million of other income and an effective tax rate of 16 to 17%, unless the US R&D tax credit is renewed during the quarter. Additionally, we expect our diluted share count to be in the 305 to 310 million-share range. The final implication of second quarter guidance on total year results is an adjustment in expectations for other income to $15 million for the year from the prior $30 million, primarily as a result of lower interest rates.

With that, I’ll turn the call over to John.

John Daane

Thank you, Tim. The 4% sequential Q1 revenue increase surpassed the top end of our forecast as a result of very strong new product growth derived from continued ASEC and ASSP replacement. By end market communications was solid with double-digit growth in networking and an improvement from our Asian customers and industrial has strong broad base growth in each of its six sub segments. In a more detailed view, our new products, which total 40% of our revenue, grew 14% sequentially and 77% year-over-year. All of our FPGA and CPLD new products grew double digits sequentially. Cyclone III was up 73%, Cyclone II up 15%, Stratix III up 18%, Stratix II and Stratix II GX up 21% and MAX II up 17%. Mainstream products increased 2% and mature products declined5% sequentially. In total, our CPLD and FPGA products performed very well in the quarter, CPLDs increased 6% sequentially and 10% year-over-year and FPGAs increased 6% sequentially and 12% year-over-year.

In our Q3 2007 conference call, I had forecast hard copy to be flattish through mid 2008 as we experienced program transitions. Hard copy decreased 27% in Q1 after increasing 12% in Q4 and with forecasted growth this quarter, the product line is roughly on track of flat through mid year.

We still expect second half 2008 growth for hard copy. By vertical market for Q1 we had forecast consumer to be down, for computer to be flat and for industrial and communications to be flat to up slightly. Consistent with the forecast, computer we flat with storage a little down and computer a little up. Consumer declined 2%, less than we had anticipated, as new design ramps partially offset the seasonal decline. Both broadcast and consumer sub segments declined.

Communications increased 4% sequentially, with telecom down and wireless up. Networking grew double digits driven by new product ramps where we displaced Asix. Also, late in the quarter, our Asian communications business showed robust orders and growth after two quarters of a lull. Industrial grew 8% sequential with broad based growth across medical, military, test and measurement, automotive and the broad industrial customer base. Certainly from the results, it is apparent that we have not seen a significant impact from the slowing global economy.

There are a few points about Altera’s business I would like to highlight. First over 90% of our revenues are derived from infrastructure and markets and as yet there has been limited changed in Cap Ex plans for the major markets that we serve. Additionally, over the last five years we have grown over two times faster than our end customers through the replacement of Asix and ASSP products, a trend we expect to continue. We also have new market opportunities such as automotive and military in our industrial sector, which are ramping programs and should continue to do so independent of market conditions. We are satisfied with our Q1 results, but we’ll continue to take it one quarter at a time.

Moving to Q2, we are forecasting revenues to increase 1 to 4% sequentially. In Q4 of 2007 and Q1 of 2008, we were cautious with our guidance due to the economic uncertainty and both quarters we out performed.

For Q2 we are adopting a different forecast methodology with a wider range that is higher at the top end than the previous two quarters, to cover a broader set of scenarios. By vertical market for Q2, both industrial and computer should be flat to down. Communications should grow this quarter across each of the three sub segments with continuing new program ramps and strength in Asia. We expect consumer and broadcast to grow based on new program ramps. As Tim noted, our book-to-bill was solidly above one for Q1 and the terms rate required to meet the mid point of guidance is below historical norms.

Introducing innovative new products, developing an efficient cost structure and creating an effective capital structure remains our central focus. In Q1 we made solid progress on all fronts with 10% year-over-year revenue growth and significant increases in operating margin and return on equity.

On the product front we have, in my view, the best-designed software platform, and industry leading programmable solutions spanning blue logic through a single chip system integration. With our 40-nanometer product introductions this year, we’ll be in the strongest competitive position certainly since I have been with the company. The growth opportunity for programmable logic comes from replacing Asix and ASSPs and I believe we are very well positioned to continue to capitalize on this secular trend.

Let me now turn the call back to Scott.

Scott Wylie

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

Question-and-Answer Session

Operator

(Operator Instructions) We’ll go next to Glen Yeung with Citigroup.

Glen Yeung-Citigroup

Thanks and hi guys, good quarter. I wonder if you could talk a little bit about the linearity you saw in this quarter. You know we’ve heard from one of your, well your competitors, a distributor that they saw some weakness at the end of the first quarter. Maybe give us a sense as to how that played out for you guys.

Timothy Morse

Business was a little stronger for us towards the end of the quarter. As I mentioned by vertical market, obviously industrial did very well for us, communications did very well and in particular, towards the end of the quarter, we saw our Asian communications business start to come back after a two quarter lull and also consumer was down less than we had anticipated, as we had some new program ramps over the quarter. So a very good linearity although we did see strength at the end and obviously the final result was above both the original guidance as well as the update that we had provided at the beginning of March.

Glen Yeung-Citigroup

Yes, clearly. Then, John, when you think about the second, I mean outside of just the obvious guidance that you gave, I’m trying to think of how the revenue can ramp between Q2 and then looking into Q3, only from the perspective of, often times this infrastructure business can be pretty lumpy and you can see big pockets of orders dry up reasonably quickly, through no fault f your own, it’s just the way the orders are placed. Is your sense that that’s the kind of business that you’re looking at now, or do you feel like it’s, looking into your backlog, that maybe it’s not that lumpy kind of business?

John Daane

Well so as Tim has pointed out, I mean generally we have business that has terms in the low to mid sixties. It would be rare for us to have backlog that goes out six months or more, or if we do, it’s not very significant. So, as I mentioned before, in this environment and as has been our historical practice, we really want to take it one quarter at a time, at this point Glen, so we provided a 1 to 4% sequential increase in revenue guidance for Q2 and we’ll just have to see how Q3 develops.

Glen Yeung-Citigroup

Okay, fair enough, thanks.

John Daane

Thank you.

Operator

We’ll take our next question from John Dryden-Charter Equity Research.

John Dryden-Charter Equity Research

Hi, thanks for taking my questions and Tim for all the color up front. Specifically to you, lower out backs each of the last six quarters, can you comment, continuously conservative or expedited savings due to the plans instituted in ’07 and then how much runway is left in cost counting, or is the bulk of the remaining operating margin gains left to improvements in revenue?

Timothy Morse

Yes, I would say we’ve underperformed at least slightly each of the last few quarters I think. Last year I characterized that as being slightly ahead of our plans and that was great. We were working hard to get on this new kind of glide path for our cost structure. I see this year, I think things have tightened down more. I’m very pleased to have under run the guidance and OpEx for the quarter, but I don’t necessarily see that as being an ongoing trend.

We’re trying to hit this mark right where we think it’s going to be. It will fluctuate from quarter to quarter; you saw that in my script. Some of the stuff that benefited us this quarter undoubtedly will time against us in the coming quarters, but that said, we have an awful lot of action going on here across the company in a wide variety of ways across our entire cost structure to continue to make things better. I think, really, we’re just at the very beginning stages. 2007 was a good start, it was a solid start, but as I said before, it was just a start. I think the culture of the company is really starting to come around and, like I said, lots and lots of people in a wide variety of areas working on improving our profitability. So I see a lot of impacts still to come in operating margin.

John Dryden-Charter Equity Research

Then one follow up. Can you provide some additional insight into the 25% increase in deferred income to distributors? Was that due to a lot of the selling late in the quarter or is that due to a higher mix of new products on the Stratix III end?

Timothy Morse

It’s a mixture of those things. I mean really deferred income is essentially the balance sheet reflection between what we bill our distributor’s and when we ship to them, and what we ultimately recognize in revenue when the product goes to the end customer. So, effectively it’s the inventory and to some extent the margin that’s waiting to be sold through to end customers. So in a period of rising sales, you’d expect that number to go up. So what you want to kind of do, I think, is look at that number in conjunction with, or just the SMOH inventory number, which at 1.2 months the channel was holding inventory at levels consistent with the 1.1 to 1.3 month ranged that we’ve seen for the last 6, 7 quarters.

John Dryden-Charter Equity Research

Thanks for taking my questions.

Timothy Morse

Sure, thank you, John.

Operator

Thank you. We’ll go next to Christopher Danely with J.P. Morgan

Christopher Danely-J.P. Morgan

Hey, thanks guys. I just wanted to ask you a quick question, just to take a step back on usage of cash. You know for what it’s worth, I think it’s a great idea to use buy backs a little more strategically just buying back shares of recorded. But John and Tim, did you guys take a look at your cash balance; it’s starting to creep up? I mean where you see your cash going from a broad look in terms of trying to find some more revenue growth versus the shareholders and especially now that the buy backs going to be more strategic. Should we expect a microchip type of dividend, which certainly your margins could afford that? Or will you start pumping some more cash into finding some new growth or new products?

Timothy Morse

Hi, Chris, this is Tim. It’s obviously, on the one hand, tough to say about finding other uses for the cash. Certainly we search for watts in many different ways to grow the business. I think when you look at the dividend specifically, as I’ve described before, you know you’re really pretty much constrained to paying that out of US cash and what we’ve done, as we’ve already articulated, is really run our US cash pretty much down to a workable minimum that is a formula for us of having a certain amount of US cash on hand. The target for us is now to continue to grow not only total cash, to give us options to grow in a variety of ways, but also specifically to grow US cash, to generate more US cash, to give us more flexibility on buy backs, on dividends, along the whole spectrum. So it’s very tough to say with any precise nature what we’ll be doing with the cash in the future, but we’ll continue to look for growth opportunities, we’ll continue to look for ways to enhance our capital structure and we do that obviously in the conjunction with the Board of Directors. I do think one of the important things to highlight is that we have ultimately, even through the $1.5 billion share repurchase that we’ve executed over the past 15 months, we’ve been opportunistic, so we didn’t do that all at once. We tried to buy at as low prices as possible. I think that resulted in an average repurchase price of about 20-44, so I think that sort of strategy makes a lot of sense. It certainly has paid of, I think much better for us than a lot of other companies who did structured deals and took out a lot of stock all at once and that will continue to be our sort of strategy. So you may see us in some quarters heavy and you may see us in some quarters light. Clearly we’re not going to exactly telegraph what we do. But that will continue to be a strategy, because I do think it has paid off very well for us.

Christopher Danely-J.P. Morgan

Yes, I think it has been a good idea. Then last question, Tim can you tell us how much cash is a US versus non-US or how much you have available for a dividend?

Timothy Morse

At this point, the vast majority of our cash is international.

Christopher Danely-J.P. Morgan

What like 75%, 90%?

Timothy Morse

Yes, probably closer to the 75.

Christopher Danely-J.P. Morgan

Gotcha, all right, thanks guys.

John Daane

Thank you.

Operator

We’ll take our next question from Rueben Roy with Pacific Crest Securities.

Ruben Roy-Pacific Crest Securities

Thanks. Hi., John. I was wondering if you can provide some more detail on your communications commentary. When you talk about the Asian based customers coming back towards the end of the quarter, was that strength towards your customers in China or was that spread across other Asiapac countries and then also it sounds like the end of quarter strength continued through into Q2. Is that a correct assumption? Thanks.

John Daane

Yes, the strength for Asia and particularly I’m commenting around China, because if you look at it Japan has broken out as a separate geography or us. Communications biggest customers are in Korea and China. Specifically what we had talked about for the last couple of quarters is our Chinese communications business was low; I think a lot of people had seen that as well and talked about it from an industry perspective. I had forecasted that it was going to continue to be low for a while. Two reasons behind that: one is with the Olympics coming up, there, in my mind, wasn’t a lot of need to deploy a lot of additional equipment for the Olympics; number two, the carriers are going through a recombination government mandated and so I had discounted the forecast that we were seeing from the customers and assumed that our business would continue to be weak through the first half in Asia; It has picked up, we’re seeing a lot of wireless and some wire line builds particularly around their existing networks and so that’s good news, because obviously it’s picked up earlier than I would have thought. That strength will continue into this quarter as I did mention.

Ruben Roy-Pacific Crest Securities

Okay thank you, John and just a quick follow up. The networking double-digit growth, was that specific to any geography?

John Daane

It’s a couple of geographies. I’d hate to break it down because in this particular area people start translating to customers and I’m always wary to do that. We had said, about a year and a half ago, that we did expect to see some very strong gains in networking late last year or this year and I’m very pleased that we’re seeing them. These are predominantly gains that we’re getting against former Asix sockets and so that’s something that I do want to highlight.

Ruben Roy-Pacific Crest Securities

Okay, thank you.

John Daane

Thank you.

Operator

We’ll go next to James Schneider with Goldman Sachs.

James Schneider-Goldman Sachs

Hi, good afternoon. John, maybe just to start off, within the coms business, if you look forward do you see pretty much sequential growth within all of the three sub segments? Within that, broadly speaking, if you look at business that’s levered to carriers versus the enterprise, do you see any kind of relative strength or weakness there?

John Daane

Carriers are, I think, going to be stronger than enterprise, generally for calendar quarter Q2 in our forecast.

James Schneider-Goldman Sachs

Okay and do you see that all changing through out, in terms of what you’re hearing from your customers for the yearlong forecast?

John Daane

I haven’t seen as yet any significant CapEx change from any of the carriers. I think in the enterprise sector, what I have heard and what I’m sure you’ve heard is the banking and automotive industries are a little bit slower in terms of CapEx spend. There are other sectors around the world that I think are, particularly geographies like Chine and India that are making up for some of that slack. But in this quarter we do expect the carrier side to be a little bit stronger than the networking side, both for wireless as well as wire line service provider equipment.

James Schneider-Goldman Sachs

Great and one quick follow up for Tim. You talked about some of the opportunities you saw. Can you maybe just flesh out a little bit where you think the biggest levers are in terms of future cost reductions?

Timothy Morse

Yes. We did some of that back on December 11, in New York City. In terms of the R&D side, certainly new design methodologies, on the infrastructure sort of side, consolidating all of our various computer farms and the like. I think in a wider sense, we’ve got, as I said, teams of people across the company looking at all of our fundamental business processes to find ways of simplifying and streamlining them, to make them more efficient, to cut out all the stuff that’s non value added, focus on what’s important and rid ourselves of any unneeded bureaucracy, frankly, that will enable us to be more efficient in every single job and be able to grow faster. So I see just tons and tons of opportunities along really the whole gamut of the income statement to overall be more productive and enable us, as we talked about, in December 11, to if costs have to go up year-over-year, than they’re going to go up far far less than revenue is.

John Daane

You know I think, one important thing to realize is that this year Altera is 25-years-old and as a 25-year-old company, we have accumulated a lot of policies, procedures and systems which, quite honestly, no longer match the business and it’s time to go back and peel the company apart and look at what we are doing today and develop new systems and really streamline a lot of what we do in order to redeploy the existing resources that we have around areas that add value. So ultimately through that redeployment we can continue to invest in the areas that are important to the company without necessarily having to significantly increase our overall operating expense.

James Schneider-Goldman Sachs

Great, thanks very much.

John Daane

Thank you.

Operator

Thank you. We’ll take our next question from Uche Orji with UBS.

Uche Orji-UBS

Thank you very much. Can you hear me?

John Daane

Yes, sure Uche.

Uche Orji-UBS

Two things, first of all you know if I look at the guidance you’re giving for next quarter, if I look back historically, it’s been somewhat higher than that. Are there any surprises that we have seen historically that is not embedded in the current guidance? So any undated terms kind of being [indiscernable] but can you talk about what this guidance means in the context of the historical legend with that other thing that could be a potential upside in your ability to count the current guidance?

John Daane

I think as Scott has pointed out repeatedly to our investor base, you can get a historical average percentage increase for each quarter, but the deviation around that number is actually larger than the number itself and that’s because the last several years there has been different patterns that have developed either because of market segments or inventory or allocation that we’ve been on or different impacts to end markets because of a combination of companies or other one time events. So, as Scott has, I would really caution anybody from looking at historical patterns. The only pattern that we have seen, which we believe would continue to be true, is our third calendar quarter tends to be a little bit more weaker than the others, a little bit more back end loaded associated with communications in the summer periods in North America, particularly also in Europe and Japan. So generally I think the one to four guidance, in this environment, is actually pretty good and we’re quite happy with that. And again, I would caution you from trying to draw any conclusions from a piece of history.

Uche Orji-UBS

That’s fair enough and let me just ask you, in industrial can you talk about some of the dynamics within that segment? Specifically if you can talk about tests and equipment and medical and also if you can let us know what progress you’ve made in military when you were in New York in December, you talked about military and maybe a way you were going to make some progress. So can you just talk about those three segments please?

John Daane

Absolutely. Military, test and measurement, medical, the broad industrial base and automotive were all up. They were all up about similar percentages in the quarter. A couple things that I’d peel apart is while industrial looks to be up strongly, with an 8% sequential growth, in reality it’s only up 5% year-over-year, so it’s up, but it’s not up at level where you’d feel uncomfortable with it in the current macro economic environment. Number two, we are forecasting for that segment to be flat to down this quarter, after the growth and in particular, I would say segments which we expect to be lower are in the test and measurement and in the medical field. Also, one last thing I’d like to point out is if you look at industrial, as we did say earlier, there are some segments like military and automotive where we’re ramping a lot of new programs and we would expect those numbers to grow independent of what happens to the economy, simply because we’ve got so many programs that are going into production this year and really nothing that exists for us to tale off that we feel would hurt us in any way in those market segments.

Uche Orji-UBS

Okay and then just another question. Japan was very strong. I know last quarter we talked about all the deployment of next generation, that sort of thing in Japan. How much more sustainable is this strength going to be in Japan? I know you talked about Asia in general, but I like to zero in on Japan please.

John Daane

Yes, the reason I pointed out Asia is because I had forecasted Asia to continue to be weak. We did forecast Japan to be strong in communications and obviously it was both around wireless and wire line, those were both consistent with our forecast. We also saw some growth in Japan and some of the other set market segments, so not all of the growth was attached to communications. We do expect that the NGN deployments will continue through out the year. Wireless deployments are certainly continuing this quarter and we’ll see how that continues to go through the rest of the year, it probably will continue. As I mentioned last quarter, around the 800 MHz band which is being reclaimed fro PDC. So ultimately in Japan we see, at least in the near term, continuing to be strong for us in communications as well as some of the other market places.

Uche Orji-UBS

All right and then lastly, let me just ask you about 45 nanometer, can you update us as to what progress you’re making there and if you have any updates to the timing of deployment that would be helpful. Thank you.

John Daane

So our 40 nanometer and it is 40 not 45. We did call it 45 earlier, only because TSMC had not announced that it was really 40 nanometer. They did a few weeks ago, so we can tell you that we are the lead customer on the 40-nanometer process technology with them, it has been a joint development program for quite a few years, and it’s absolutely on schedule. We have not announced specifically the product or the dates for both the software and chip releases, all I would tell you is exactly what I’ve told you previously, is that both software as well as components will be shipped this year and we will obviously announce those as time goes on.

Uche Orji-UBS

Great. Thank you very much.

John Daane

Thank you very much.

Operator

Thank you. We’ll go next to David Wu-Global Crown Capital.

David Wu-Global Crown Capital

John, well congratulations, great quarter. Maybe you can help me on two things. On the subject of 40 nanometer products, would the low cost Cyclone come out ahead of the high performance Stratix or would it be the other way around? And the other question I had was, on the subject of visibility. I remember the December meeting in New York we talked about that and it appears that it’s difficult to forecast four quarters ahead for POD Company. How comfortable are you feeling today that you can forecast 90 days ahead with a great degree of accuracy?

John Daane

So, David, I will start with the first question on 40 nanometer. Since we have not announced whether it’s going to be Cyclone, Stratix , Arria or MAX or some other product, I don’t want to be in a position where I pre-announce the product line, so as we have in the past, I will continue to say let’s wait until we’ve formally announced the product. In terms of the visibility, as we’ve talked about before, typically we turn in the mid 60s about 65% of our business in a quarter. Obviously that means that visibility is low. You do get forecasts from you major customers, but the accuracy of the forecast is extremely low and so therefore it is difficult to forecast beyond one quarter. There are changes in inventory positions, success that our customers have with winning programs, changes in their end customer’s deployment plans, all of which can change things through out the year. So we’re going to take it one quarter at a time. We have been, I would say, fairly accurate historically in forecasting the trend or directions on a sub market like communications. Whether it’s going to be up or down, up down a little bit or a lot, but we’ve never been extremely accurate overall. I think we’ve been one of the best, but not 100% and that just speaks to the fact that we need to book and ship 65% of the business to make whatever midpoint of guidance that we’re providing. I think that trend is permanent for PLDs. We’ve turned 60% plus all the way into low 70s percent for the last five or six years, so I don’t see visibility necessarily improving for the PLD industry, I see it staying limited.

David Wu-Global Crown Capital

Yes. John, one question, and then I might ask a follow up on the Chinese Telco business, Telco customer orders. It seems that the less that we use, they do it in bunches and then it sort of died for a while and then back into the bunches. I guess they don’t have the fiscal system of take-outs. Do you see that pattern changing?

John Daane

I would say generally there is not really much pattern that you can discern from most of our customers in terms of their buying habits. They provide us forecast, we obviously go through that and make our own judgments on those forecasts. Most of the time our judgments are actually far more accurate than our customer’s inputs, and ultimately our sales forecasts. Sometimes they’re wrong, obviously, I was wrong last quarter. But I would hate to say that one customers good and another customer is bad, I would say all customers equally have trouble being accurate and it’s simply the environment that their in. Many times their lead times are a couple weeks and so they will literally want to buy product from you and have it shipped the next day so that they can build it and meet that in order to minimize the amount of inventory that they carry, or for that matter the amount of inventory that a contract manufacturer carries. So ultimately within that environment, I think all customers are going to come up or down on any given quarter and I wouldn’t say there is any difference or pattern that I discern from some of our Asian customers versus some of our North American customers.

David Wu-Global Crown Capital

Okay, thank you.

John Daane

Thank you, David.

Operator

Thank you. We’ll go next to Gary Mobley with Piper Jaffray.

Gary Mobley-Piper Jaffray

Hi guys. I was hoping that maybe you could give some commentary on trends in Logic unit growth or perhaps pricing in per Logic unit?

John Daane

I do not; you know I haven’t looked at that data in awhile, so I don’t know that there is necessarily a new trend developing. I guess at a high level I’d probably take you back to the gross margins of the PLD industry, I think they’ve been fairly good and fairly stable for a while. One company might go up or down, but I think generally the industry itself has been very stable for quite a few quarters, so I don’t see anything new as a trend that’s necessarily developed recently. Pricing is always aggressive to win new platforms. The advantage of the PLD world is none of the products from our competitors, they’re incompatible with our products; therefore I think there is a vigorous competition up front to win the socket. Once you win it you are sole source and therefore pricing tends to stabilize over the life of the program.

Gary Mobley-Piper Jaffray

Yes I have a follow up as well. Whether you divide it up according to the vertical end market that you serve or divide it up by CPLD or FPGA, are there any dramatic shifts taking place on the gross margin front for any way you divide it?

John Daane

I wouldn’t say that there are, no.

Gary Mobley-Piper Jaffray

Okay, thank you guys.

John Daane

Thank you.

Operator

We’ll take our next question from Hans Mosesmann-Raymond James.

Hans Mosesmann-Raymond James

Thanks. John, a question about the cadence of moving to new process nodes; It’s my understanding that you never wanted to be a leader in going to the next node like your top competitor. Is the move to 40 nanometer a normal cadence? Are you going to that node as you would expect or are you accelerating your progression? The other way to look at this is, is your competitor going to the next node on a lagging basis or are they delaying their migration? Thanks.

John Daane

I cannot speak for our competitor and shouldn’t Hans, so I’ll just talk about us. In fact, we are accelerating our 40-nanometer deployment. We’re taking advantage of the fact that we’re working with PSMC; PSMC is obviously the leader in the foundry business. I believe they have a well over 55% market share and I think in the newer process nodes, like 90 nanometer, 65-nanometer, their market share is significantly higher than that.

Obviously they have the resources to be able to invest in developing new process technology nodes. We decided to accelerate some of the 40-nanometer development with them, through a joint development program, in order to be sort of a leader, not only in software and architecture, but also be a leader in process as well.

I would tell you at the same time, that we have not changed our design methodology, so I believe what is unique to Altera is we actually do test chips along the development to prove out individual modules to make sure that they are working, so this would be the Logic fabric, this is the memories, PLL, audio structures, EST structures, to make sure that independently they all are performing exactly as we thought and then when we start putting them together in larger test chips, that they also behave as we thought.

And the reason that we do that is that many times through simulation in today’s EDA tools, what you simulated isn’t exactly what you get back. And this is a methodology that we’ve used for quite a few process generations. It allows us to know that the first chip that we end up developing will work, it allows us to get to market very quickly with that chip, it also allows us to subsequently tape out all of the members of the family and get those in the volume production very quickly.

So we’re using the exact same design methodology, we did accelerate the process development with TSMC, we’re doing it because the two of us can do it and we think this actually puts us in a strong competitive lead. Strong because we’ll have 40-nanometer early, strong because we also have, I believe, the best fabric for density performance today, also we’ve addressed the power issue that you have with high end FPGAs because of the high transistor counts and also the advance process technologies where leakage is a major concern, through our programmable power technology both in hardware and software architecture that we developed in 65 nanometer. So I think hands down we’ve got, in my mind, today, across the board, the best product line up this year and should see our overall design lines accelerate off of our historical rate over the last few years.

Hans Mosesmann-Raymond James

Okay, thank you and congratulations for the quarter.

John Daane

Thank you very much, Hans.

Operator

Thank you. We’ll go next to Sumit Dhanda with Bank of America.

Sumit Dhanda-Bank of America

Hi, Tim I had a follow up on the comment on the comment on deferred income. I guess I was trying to reconcile your comment on month’s sales on hand with the distributors versus a more significant increase in the deferred income. The only logical explanation seems to be that you’re carrying a different profile of products from a margin perspective. But tell me if there’s something else that will help me to connect the dots here.

Timothy Morse

Yes, what it really is, Sumit, is it’s, if you look at MSOH, it’s just a matter of, that helps you check the deferred margin increase. So if you’ve stayed in the same range of inventory, than those dollars at deferred margin went up would make sense. You know, if those two start to disconnect, there are other things going on The high level Summit, business in the quarter was stronger than we had originally anticipated and business is good this quarter.

Obviously that meant we had to build more product and ship it into distribution for our customers and that results in a little bit more of a back end loaded quarter for shipments into distribution, which results in the change of the metrics that Tim mentioned. I mean the math on that whole thing is really kind of a mess.

I think, as Tim points out, we recognized revenue only when distribution ships the product to the end customers, so ultimately the real important metric here is does distribution have the right amount of inventory we targeted them to have, about a month to 1.3 month supply on hand, their right in there, so we’re not over building on inventory in the short term and then at a high level, recognize that we only recognize on revenue when distribution ships it. So, we’re not trying to game it by shipping more inventory into distribution in order to make our revenue number.

Sumit Dhanda-Bank of America

I understand. John a follow up for you. You noted that you’re bounding the low end of your range and introducing some more flexibility at the high end of the range. What’s the catalyst for that? Are you feeling better that you might see some upside because the turn’s requirement is lower or pick up in the business or some other factor?

John Daane

I think it has been because the last two quarters we’ve been low, so we decided this time we’d be better off to do a range; however, if we change our methodology and we don’t tell you that we have, you’re probably going to look at our past pattern and assume that we could be like that. So we just wanted to be completely transparent and have you understand we are broadening our range and we’re doing that, it’s a change of methodology so that you don’t look at the last two quarters and assume that we’re doing the same thing.

Sumit Dhanda-Bank of America

Last question for you Tim, on the gross margins a nice bump up this quarter. Obviously you’re industrial mix helped you out as you entered the back half of the year. Do you think there is a conversion back to a lower level or is there something else that should help you sustain something closer to 65% going forward?

Timothy Morse

You know I just go back to the comments we have made consistently, basically since I’ve been with the company and I know these guys said the same thing before is it really depends on mix and you’ve seen it play out from into 2Q last year, into 3Q, 4Q, sequentially the swings in our market segments have all made sense. We’ve put a range on it between 64 and 66 or in other wards 65% plus or minus a point, just because you will see some swings. You’ll see industrial up a quarter, you’ll see consumer up a different quarter and those all have impacts on the total rate. But so in general, as I said in the call just a few months ago, I wouldn’t put a top end on 65, the top end is 66, low end of 64. We’ll continue to work all the levers mix, especially as we’ve said, we expect the industrial businesses segment to bounce back this year, that’s very good for mix. Consumer won’t be as strong in all likelihood as it was last year as we’ve walked from some low margin business, that helps the mix and we continue to work on all manner of the cost of goods sold to our products as well, to improve the profitability in a more natural way that way too. So I can’t really help you on second half because it’s related to sales and we don’t really want to go beyond the current quarter, second quarter.

Sumit Dhanda-Bank of America

I understand. Thank you very much.

Timothy Morse

Thank you.

Operator

We’ll go next to Mark Lipacis with Morgan Stanley.

Mark Lipacis-Morgan Stanley

Thanks for taking my question. You talked about strength in communications and in part by strength in Asia, two questions on this; one did you see growth in your communications vertical excluding Asia, that’s part one and part two, John, I apologize if I ask you to repeat yourself on this, you may have answered this, but the comps business can be lumpy, we all know that. Can you tell us to the extent you think the trends you’re seeing in communications fall into the lumpy bucket or the more sustainable bucket? Thank you.

John Daane

Well Mark, to answer that, what I said is that the Asian communications business came back towards the end of the quarter. If you take out that business, communications still would have up and so we’d also talked about the fact, that for instance in Japan both NGN as well as spend on wireless was happening; you see our Japanese geographical numbers are up, so communications really would have been up anyway. It was up a little bit stronger than we had forecasted, I think because we had some Asian business start to fall in towards the tail end of the quarter. In terms of communications, we’re going to take it, like every one of our markets, one quarter at a time. We do think this quarter that all three of the sub segments with three being networking, wireless, and telecom, all three will be up this quarter. It’s hard for me to predict what’s going to happen the quarter after that simply because of the volatility in our customers forecast, so again we’ll just take it one quarter at a time.

Mark Lipacis-Morgan Stanley

Okay fair enough, thank you very much.

John Daane

Thank you, Mark.

Operator

We’ll go next to Tim Luke with Lehman Brothers.

Tim Luke-Lehman Brothers

Thanks so much. Nice quarter John. With respect to the wireless side, are you beginning to see and I’m saying the Asian call was better and it sounds like it’s the carrier side, if that principally relates into 3G in Wallace or are you beginning to see some trials in either LTE or the wireless helping the Wallace business or maybe you can give some sense of when you might expect to see that. And then secondly, I was just wondering, could you just clarify the timelines for 40-nanometer in terms of when you expect that to start gaining subtraction in terms of volumes and how long do you think that your lead is likely to be with respect to that node?

John Daane

To your last question Tim, I do not know how much of a lead we have over our competition. I’d hate to even guess. We feel very strongly that we will be early. I don’t know that we will be the first to announce, but I do think that we will be in a very strong position, much stronger than we’ve been certainly in the last three nodes, in terms of the product line as well as the introduction date. At least that’s my expectation for this.

Tim Luke-Lehman Brothers

So what are the expectations on the introduction date, exactly?

John Daane

As we talked about earlier, Tim, we’re not announcing, in this production, date and I am not even, at this point, providing forecasts on revenues. We’ll sort of wait until the product-marketing people announce the product and then we’ll come back and give you an update as to what we’re doing there. In terms of the question on communications, business is good in both 3G as well as in 2G, we are seeing, for instance, continued a MSM deployments as well as wide band and then additionally we are seeing prototype opportunities for and some actual deployments for YMAX so for instance Taiwan is dong a fairly aggressive build with YMAX today, there are a lot of other trials going on around the world and then seeing prototyping today for LTE, I think you’re really going to see some trials start a little bit later than now and so it’s more than just 3G, it’s also 2G, YMAX as well as some LTE business flowing.

Tim Luke-Lehman Brothers

Just one last thing for Tim; just in terms of shaping your OpEx through the calendar year and maybe some longer term expectation for how you think your rate of R&D investment is going to grow going forward, maybe into next year.

Timothy Morse

Yes, as I mentioned in the script, we started seeing R&D would be a bit second half weighted. If you were to do the math now on first quarter actuals and 2Q guidance, you will see that their second half weighted. I also said in the script, SG&A the trailing three quarters here should be pretty even so nothings really changed in any of the patterns we’ve indicated before for 2009, I really can’t say. R&D we’re going to continue to target kind of 18% of sales, we think that’s right and that’s do able, over the long term there will be some oscillations within that certainly, but in general that’s our target there. I couldn’t tell you much else about ’09, although we are now later on this month, officially kicking off our planning process for ’09 cost structures, so we’re starting early there.

John Daane

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

Operator

Thank you, we’ll go to Sidney Ho with Merrill Lynch.

Sidney Ho-Merrill Lynch

Thanks, guys and nice quarter. From a high level, you mentioned you have not really seen the impact of the slowing global economy, there are a few other companies are saying the same thing. Frankly, that’s a little bit surprising. But if we do go into a recession, which our economists are saying that we are, what do you think is a good leading indicator in terms of end markets on geography or maybe just tourist business. In other wards, what kind of signs do you look at to become more optimistic or more cautious or will you be just giving out a wider range for the guidance?

John Daane

Sidney, this is John. I think first of all, for a lot of companies the US market is a much smaller piece of the overall revenues than it was 10 to 20 years ago, and so where you have even a slowing China or Indian market, still could mean very strong growth for a lot companies. So, I think where a lot of people are, obviously we live in the US, we feel what’s happening in the US, I think you have to take a global view and look at the fact that even if the global economy slows it still grows.

Secondly, as I highlighted, a lot of our revenue, over 90% comes from infrastructure. I would expect in the US if this is a slow down led by the slower consumer spending that the consumer areas would get hit harder than infrastructure sides, which would impact others perhaps more than it would us. We could and very well could see slow downs in pieces or all of our business, that’s not impossible. What we are saying is, currently we haven’t seen anything material that you can point at and say okay, I can draw the conclusion that this is because of a macro economic slow down. We are very cognizant of it. We think about is as we’re providing the forecast and information to you. We are obviously staying very well tuned to our customers and our customer’s customer to watch what happens, but so far, so good for Altera.

Sidney Ho-Merrill Lynch

Okay, thanks.

Timothy Morse

Thank you, Sidney. As we wrap up today, let me note that during the second quarter we will attend the UBS semi-cap conference in Chicago on May 15 and on the 20^th we will participate in the JP Morgan Technology Conference in Boston. This concludes Altera’s conference call. Thank you for your participation and interest.