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ALTR > SEC Filings for ALTR > Form 10-K on 14-Feb-2014All Recent SEC Filings

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Form 10-K for ALTERA CORP


14-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes thereto included in Item 8 and the Risk Factors included in Item 1A of this Annual Report on Form 10-K.

Our Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is provided in addition to the accompanying consolidated financial statements and notes to assist readers in understanding our results of operations, financial condition, and cash flows. MD&A is organized as follows:

• Overview - Discussion of our business and overall analysis of financial and other highlights to provide context for the MD&A

• Critical Accounting Estimates - Accounting estimates that management believes are the most important to understanding the assumptions and judgments incorporated in our financial results and forecasts

• Results of Operations - An analysis of our financial results

• Financial Condition, Liquidity, Credit Facility and Capital Resources - An analysis of changes in our balance sheets and cash flows and a discussion of our financial condition and potential sources of liquidity

Overview
                                      Three Months Ended                                       Years Ended
(In thousands,
except share and        December 31,       September 27,                      December 31,       December 31,
per share data)             2013               2013             Change            2013               2012           Change
Net sales             $      454,367     $       445,945     $    8,422     $    1,732,572     $    1,783,035     $ (50,463 )
Gross margin          $      310,343     $       304,420     $    5,923     $    1,185,836     $    1,241,512     $ (55,676 )

Operating cash
flows                 $      130,759     $       245,406     $ (114,647 )   $      590,208     $      587,214     $   2,994
Total cash, cash
equivalents and
investments           $    4,705,711     $     3,820,895     $  884,816     $    4,705,711     $    3,722,343       983,368

Diluted shares               322,018             323,505         (1,487 )          323,018            324,497     $  (1,479 )
Diluted net income
per share             $         0.31     $          0.37     $    (0.06 )   $         1.36     $         1.72     $   (0.36 )

Dividends per
common share          $         0.15     $          0.15     $        -     $         0.50     $         0.36     $    0.14

Our net sales for 2013 were down 3% from 2012 as we were impacted by reduced demand in certain vertical markets, particularly in Telecom & Wireless, driven by the lack of demand in the Telecom sub-vertical. Of our eleven sub-vertical markets, seven grew during 2013 as we had continued success in penetrating new markets and displacing ASICs in existing markets. Our Industrial Automation, Military and Automotive sub-vertical markets each grew in 2013. Our Networking, Computer & Storage sub-vertical markets also increased as we are in the early stage of FPGA adoption in data center applications. The Telecom & Wireless sub-vertical markets each decreased, with Telecom down significantly, as carriers redirected spending to Wireless. Wireless was down slightly due to an ASIC conversion partially offset by an increase in Long-Term Evolution (LTE) related growth in China that positively impacted our second-half revenue. Our gross margin percentage for 2013 decreased from 69.6% to 68.4%, due to an unfavorable mix in vertical markets along with an unfavorable customer and product mix within the sub-vertical markets.

Our fourth quarter net sales of $454.4 million increased 2% sequentially from the third quarter of 2013 as a result of improved demand in certain vertical markets, particularly in Networking, Computer & Storage, with the Computer sub-vertical market up sharply. The Telecom & Wireless sub-vertical markets were flat. Industrial Automation, Military and Automotive decreased slightly, although the Industrial sub-vertical market had growth for the third consecutive quarter. Our gross margin percentage increased slightly to 68.4% when compared to the third quarter gross margin percentage of 68.3%.

Our 28-nanometer and 40-nanometer product families continue to be the most significant contributors to revenue, driving the 10% sequential and 31% annual growth in our New Product category.


During 2013, we made significant strategy and product announcements. During the first quarter, we announced that we had entered into an agreement with Intel for the future manufacture of certain Altera FPGAs on Intel's 14 nm Tri-Gate transistor technology. This established us as the only major FPGA company with access to this technology, which we believe will significantly strengthen our next-generation competitive position. During the second quarter, we announced our Generation 10 FPGAs and SoC FPGAs, which will offer system developers higher levels of performance and power efficiency. During the fourth quarter, we released a new version of our Quartus II Software that supports our Arria 10 FPGAs, making us the first FPGA supplier to offer publicly available software support for 20 nm FPGAs.

We continue to generate strong operating cash flows, with $590.2 million in cash flows from operations for 2013. We returned $361.5 million, or 61.3%, of the cash flow from operations to our stockholders during the year in the form of dividends and repurchases of common stock. During the fourth quarter of 2013, for the second time in two years, we capitalized on the continued low interest rate environment, issuing $1 billion in senior notes for general corporate purposes including future common stock repurchases. We ended the year with $4.7 billion in cash, cash equivalents and investments. On January 20, 2014, our board of directors declared a cash dividend of $.0.15 per share for the first quarter of 2014.

We continue to evaluate strategic business acquisitions and, during 2013, we made two key acquisitions to enhance our product offerings. During the first quarter, we acquired TPACK. TPACK's FPGA-based optical transport network (OTN) IP and expertise will enable us to accelerate and expand our OTN solutions road map. During the second quarter, we acquired Enpirion, Inc., a leading provider of high-efficiency, integrated power conversion products known as PowerSoCs. We believe the combination of our FPGAs with Enpirion's PowerSoCs offers customers higher performance, lower system power, higher reliability, smaller footprint and faster time-to-market.

We believe that we are well positioned in many of our vertical markets to see growth that will primarily be driven by our New Product category.

Critical Accounting Estimates

The preparation of our consolidated financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America ("U.S. GAAP") requires our management to make certain judgments and estimates that affect the amounts reported in our consolidated financial statements. Our management believes that we consistently apply these judgments and estimates and the consolidated financial statements fairly represent all periods presented. However, any differences between these judgments and estimates and actual results could have a material impact on our consolidated statements of comprehensive income and our consolidated balance sheets. Critical accounting estimates, as defined by the Securities and Exchange Commission ("SEC"), are those that are most important to the portrayal of our financial condition and results of operations and require our management's most difficult and subjective judgments and estimates of matters that are inherently uncertain. Our critical accounting estimates include those regarding (1) revenue recognition; (2) valuation of inventories; and (3) income taxes.

Revenue Recognition

We sell the majority of our products to distributors for subsequent resale to OEMs or their subcontract manufacturers. In most cases, sales to distributors are made under agreements allowing for subsequent price adjustments and returns. We generally defer recognition of revenue and costs until the products are resold by the distributor. Our revenue reporting is highly dependent on receiving pertinent and accurate data from our distributors in a timely fashion. Distributors provide us with periodic data regarding the product, price, quantity and end customer when products are resold as well as the quantities of our products they still have in stock. We maintain system controls to validate distributor data and to verify that reported data is accurate. At times, we must use estimates and apply judgments to reconcile distributors' reported inventories to their activities. This reconciliation process requires us to estimate the amount of in-transit shipments (net of in-transit returns) to our distributors. In-transit days can significantly vary among geographies and individual distributors. We also apply judgment when estimating the total value of price concessions earned by our distributors but not claimed by the end of the reporting period. This is because there is a time lag between the price concessions earned and claimed by the distributors for any underlying resale of products. Any error in our judgment could lead to inaccurate reporting of our net sales, deferred income and allowances on sales to distributors, and net income.

Valuation of Inventories

Inventories are recorded at the lower of cost determined on a first-in-first-out basis (approximated by standard cost) or market. We routinely compare our inventory against projected demand and record provisions for excess and obsolete inventories as necessary. We establish provisions for inventory for technological obsolescence or if inventory levels on hand are in excess of projected customer demand. Such provisions result in a write-down of inventory to net realizable value and a charge to cost of sales. Historically, it has been difficult to forecast customer demand. Actual demand may materially differ from our projected


demand, and this difference could have a material impact on our gross margin and inventory balances based on additional provisions for excess or obsolete inventory or a benefit from inventory previously written down. Many of the orders we receive from our customers and distributors request delivery of product on relatively short notice and with lead times less than our manufacturing cycle time. In order to provide competitive delivery times to our customers, we build and stock a certain amount of inventory in anticipation of customer demand that may not materialize. Moreover, as is common in the semiconductor industry, we generally allow customers to cancel orders with minimal advance notice. Thus, even product built to satisfy specific customer orders may not ultimately be required to fulfill customer demand.

Income Taxes

We establish a tax provision for the anticipated tax consequences of the reported results of operations. Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, and for operating losses and tax carryforwards. We record valuation allowances, when necessary, to reduce our deferred tax assets to the amount that management estimates is more likely than not to be realized. If, in the future, we determine that we are not likely to realize all or part of our net deferred tax assets, an adjustment to the deferred tax asset valuation allowance would be recorded as a charge to earnings in the period such determination is made.

We measure and recognize uncertain tax positions in accordance with U.S. GAAP, whereby we only recognize the tax benefit from an uncertain tax position if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the merits of the position.

The calculation of our tax liabilities involves the inherent uncertainty associated with the application of U.S. GAAP and complex tax laws. We are subject to examination by various taxing authorities. We believe we have adequately provided in our financial statements for additional taxes that we estimate may be required to be paid as a result of such examinations. If the payment ultimately proves to be unnecessary, the reversal of the tax liabilities would result in tax benefits being recognized in the period we determine the liabilities are no longer necessary. If an ultimate tax assessment exceeds our estimate of tax liabilities, an additional charge to expense will result.

Results of Operations

Results of operations expressed as a percentage of net sales were as follows:

                                                     2013          2012          2011
Net sales                                            100.0  %      100.0  %      100.0  %
Cost of sales                                         31.6  %       30.4  %       29.6  %
Gross margin                                          68.4  %       69.6  %       70.4  %
Research and development expense                      22.2  %       20.2  %       15.7  %
Selling, general, and administrative expense          18.5  %       16.3  %       13.5  %
Amortization of acquisition-related intangible
assets                                                 0.3  %        0.0  %        0.1  %
Compensation expense (benefit) - deferred
compensation plan                                      0.6  %        0.4  %       (0.1 )%
(Gain) loss on deferred compensation plan
securities                                            (0.6 )%       (0.4 )%        0.1  %
Interest income and other                             (0.7 )%       (0.5 )%       (0.2 )%
Interest expense                                       1.0  %        0.4  %        0.2  %
Income tax expense                                     1.8  %        2.0  %        3.8  %
Net income                                            25.4  %       31.2  %       37.3  %

Net sales were $1.73 billion in 2013, $1.78 billion in 2012 and $2.06 billion in 2011. Net sales decreased by 3% in 2013 from 2012. The decrease in Net sales in 2013 was mainly due to a typical decline in Mature and Other Products coupled with a moderate decline in Mainstream Products as our new technologies are being adopted. Sales of New Products had strong growth in 2013 as we continued to experience growth in our 28-nm and 40-nm products. Net sales declined in the Telecom & Wireless vertical market, partially offset by slight increases in the Industrial, Automation, Military & Automotive and Networking, Computer & Storage vertical markets. We experienced a decrease in net sales in 2013 in Asia Pacific, offset by modest growth in Japan and EMEA.


Net sales decreased by 14% in 2012 from 2011. The Net sales decrease in 2012 was due to a decrease in customer demand across all vertical markets and in all geographies. We saw strong growth in sales of our New Products while there was a decrease in our Mainstream and Mature Product categories.

Huawei Technologies Co., Ltd. ("Huawei"), an original equipment manufacturer ("OEM"), individually accounted for 11% of net sales in 2013, 16% in 2012 and 13% in 2011. No other individual OEM accounted for more than 10% of net sales in 2013, 2012 or 2011. See Note 7: Accounts Receivable, Net and Significant Customers to our consolidated financial statements.

Product Categories

We classify our products into three categories: New, Mainstream, and Mature and Other Products. The composition of each product category is as follows:

• New Products include the Stratix® V, Stratix IV, Arria® V, Arria II, Cyclone® V, Cyclone IV, MAX® V, HardCopy® IV devices and Enpirion PowerSoCs.

• Mainstream Products include the Stratix III, Cyclone III, MAX II and HardCopy III devices.

• Mature and Other Products include the Stratix II, Stratix, Arria GX, Cyclone II, Cyclone, Classic™, MAX 3000A, MAX 7000, MAX 7000A, MAX 7000B, MAX 7000S, MAX 9000, HardCopy II, HardCopy, FLEX® series, APEX™ series, Mercury™, Excalibur™ devices, configuration and other devices, intellectual property cores, and software and other tools.

The product categories above approximate the relative life cycle stages of our products. New Products are primarily comprised of our most advanced products. Customers typically select these products for their latest generation of electronic systems. Demand is generally driven by prototyping and production needs. Mainstream Products are somewhat older products that are generally no longer design-win vehicles. Demand is driven by customers' later stage production-based needs. Mature Products are yet older products with demand generated by the oldest customer systems still in production. This category also includes sales of software, intellectual property and other miscellaneous devices.

Net Sales by product category were as follows:

                                           Annual Growth Rate
                 2013    2012    2011       2013         2012

New               43 %    32 %    22 %      31  %         22  %
Mainstream        27 %    30 %    34 %     (14 )%        (22 )%
Mature and Other  30 %    38 %    44 %     (22 )%        (26 )%
Net Sales        100 %   100 %   100 %      (3 )%        (14 )%

Vertical Markets

The following vertical market data is derived from data that is provided to us by our distributors and end customers. With a broad base of customers, who in some cases manufacture end products spanning multiple market segments, the assignment of net sales to a vertical market requires the use of estimates, judgment and extrapolation. As such, actual results may differ from those reported.


Net Sales by vertical market were as follows:

                                                                       Annual Growth Rate
                                             2013    2012    2011      2013         2012

Telecom & Wireless                            41 %    44 %    43 %     (9 )%         (12 )%
Industrial Automation, Military & Automotive  22 %    21 %    23 %      4  %         (22 )%
Networking, Computer & Storage                19 %    17 %    17 %      6  %         (11 )%
Other                                         18 %    18 %    17 %     (3 )%         (10 )%
Net Sales                                    100 %   100 %   100 %     (3 )%         (14 )%

FPGAs and CPLDs

Our PLDs consist of field-programmable gate arrays, or FPGAs, including those referred to as system-on-chip FPGAs ("SoC FPGAs") that incorporate hard embedded processor cores, and complex programmable logic devices, or CPLDs. FPGAs consist of our Stratix, Cyclone, Arria, APEX, FLEX and ACEX 1K, as well as our Excalibur and Mercury families. CPLDs consist of our MAX and Classic families. Other Products consist of our Enpirion PowerSoCs, HardCopy ASIC devices, configuration devices, software and other tools and IP cores.

Net sales of FPGAs, CPLDs and Other Products were as follows:

                                         Annual Growth Rate
               2013    2012    2011      2013         2012

FPGA            83 %    84 %    81 %     (4 )%         (11 )%
CPLD             9 %     9 %    10 %     (4 )%         (22 )%
Other Products   8 %     7 %     9 %      9  %         (27 )%
Net Sales      100 %   100 %   100 %     (3 )%         (14 )%

Geography

The following table is based on the geographic location of the original
equipment manufacturers or the distributors who purchased our products. The
geographic location of distributors may be different from the geographic
location of the ultimate end users.

Net Sales by geography were as follows:
                                       Annual Growth Rate
             2013    2012    2011       2013         2012

Americas      18 %    18 %    19 %      (1 )%        (18 )%
Asia Pacific  40 %    43 %    41 %     (10 )%         (9 )%
EMEA          26 %    25 %    25 %       4  %        (15 )%
Japan         16 %    14 %    15 %       5  %        (18 )%
Net Sales    100 %   100 %   100 %      (3 )%        (14 )%

Price Concessions and Product Returns from Distributors

We sell the majority of our products to distributors worldwide at a list price. Our distributors resell our products to end customers at a very broad range of individually negotiated prices based on a variety of factors, including customer, product, quantity, geography and competitive differentiation. Under these circumstances, we remit back to the distributor a portion of its original purchase price after the resale transaction is completed and we validate the distributor's resale information, including end customer, device, quantity and price, against the distributor price concession that we have approved in advance. To receive price concessions, distributors must submit the price concession claims to us for approval within 60 days of the resale of the product to an end customer. Primarily because of the uncertainty related to the final price, we defer revenue recognition on sales to distributors until


our products are sold from the distributor to the end customer, which is when our price is fixed or determinable. Accordingly, these pricing uncertainties impact our results of operations, liquidity and capital resources. Total price concessions earned by distributors were $4.6 billion and $4.3 billion for 2013 and 2012, respectively. See Note 10: Deferred Income and Allowances on Sales to Distributors to our consolidated financial statements. Average aggregate price concessions typically range from 70% to 85% of our list price on an annual basis, depending upon the composition of our sales, volume and factors associated with timing of shipments to distributors or payment of price concessions.

Our distributors have certain rights under our contracts to return defective, overstocked, obsolete and discontinued products. Our stock rotation program generally allows distributors to return unsold product to Altera, subject to certain contract limits, based on a percentage of sales occurring over various periods prior to the stock rotation. Products resold by the distributor to end customers are no longer eligible for return, unless specifically authorized by us. In addition, we generally warrant our products against defects in material, workmanship and non-conformance to our specifications. Returns from distributors totaled $88.1 million and $82.6 million for 2013 and 2012, respectively. See Note 10: Deferred Income and Allowances on Sales to Distributors to our consolidated financial statements.

Gross Margin
                         2013     2012     2011

Gross Margin Percentage 68.4 %   69.6 %   70.4 %

Our gross margin rates are heavily influenced by both vertical market mix and the timing of material cost improvements. While these variables will continue to fluctuate on a cyclical basis, our gross margin target over the long term is 67%. We believe that the 67% gross margin target will enable us to achieve our desired balance between growth and profitability. Our gross margin percentage decreased in 2013 by 1.2 points when compared with 2012. The decrease was primarily attributable to an unfavorable mix within vertical markets along with an unfavorable customer and product mix within certain of the vertical markets when compared with 2012.

Our gross margin percentage decreased in 2012 by 0.8 points when compared with 2011. The decrease was primarily attributable to an unfavorable vertical market mix when compared with 2011.

Research and Development Expense

Research and development expense includes costs for compensation and benefits, development masks, prototype wafers, and depreciation and amortization. These expenditures are for the design of new products, the development of process technologies, new package technology, software to support new products and design environments, and IP cores.

We will continue to make significant investments in the development of new products and focus our efforts on the development of new programmable logic devices that use advanced semiconductor wafer fabrication processes, as well as related development software. We are currently investing in the development of future silicon products, as well as our Quartus II software, PowerSoCs, library of IP cores and other future products.

                                                                                2013 vs. 2012     2012 vs. 2011
($ in millions)                        2013           2012           2011           Change            Change

Research and Development Expense   $    385.2     $    359.6     $    324.2              7 %           11 %

Percentage of Net Sales                  22.2 %         20.2 %         15.7 %

Research and development expense for 2013 increased by $25.6 million, or 7%, compared with 2012. The increase was primarily attributable to a $24.4 million increase in personnel-related costs due to an increase in the number of employees to support product development and from our recent acquisitions, a $6.9 million increase in depreciation expense, a $6.2 million increase in variable compensation expense, a $2.7 million increase in rental and license costs in connection with our product development activities, a $2.6 million increase in professional services, and a $0.9 million increase in stock-based compensation expense due to an increase in the number of employees. These increases were partially offset by an $18.8 million decrease related to timing of external costs for product development activities.


Research and development expense for 2012 increased by $35.4 million, or 11%, compared with 2011. The increase was primarily attributable to a $27.4 million increase in personnel-related costs due to an increase in the number of employees, a $12.4 million increase in product development activities, a $6.8 million increase in rental and telephone expense, a $5.2 million increase in stock-based compensation driven by an increase in the number of employees and a $4.8 million increase in depreciation and maintenance and repair expenses. These increases were partially offset by a $24.4 million decrease in variable compensation expenses based on lower operating results in 2012.

Selling, General, and Administrative Expense

Selling, general, and administrative expense primarily includes compensation and
benefits related to sales, marketing and administrative employees, commissions
and incentives, depreciation, legal, advertising, facilities and travel
expenses.
                                                                             2013 vs. 2012     2012 vs. 2011
($ in millions)                    2013           2012           2011            Change            Change

Selling, General and
Administrative Expense         $    320.1     $    289.9     $    279.2           10 %                  4 %

Percentage of Net Sales              18.5 %         16.3 %         13.5 %

Selling, general, and administrative expense for 2013 increased by $30.2 . . .

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