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ALTERA CORP - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(Edgar Glimpses Via Acquire Media NewsEdge)
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.
Executive Overview
Company and Market Overview
We are a global semiconductor company, serving over 12,500 customers within the
Telecom and Wireless, Industrial Automation, Military and Automotive,
Networking, Computer and Storage, and Other vertical markets. The Other vertical
market includes sub-markets of broadcast, consumer, medical and test. We design,
manufacture, and market a variety of products:
• Programmable logic devices ("PLDs"), which consist of field-programmable
gate arrays ("FPGAs"), including those that incorporate embedded
processors, and complex programmable logic devices ("CPLDs"), are standard
semiconductor integrated circuits, or chips, that our customers program to
perform desired logic functions in their electronic systems.
• HardCopy® application-specific integrated circuits ("ASICs") transition
customer designs from high-density FPGAs to low-cost non-programmable
implementations for volume production. HardCopy ASICs deliver performance
that can be an alternative to traditional ASICs, but with reduced
development costs and shorter production lead times.
• Pre-defined design building blocks, known as intellectual property ("IP")
cores, can be licensed by customers to add standard functions to their PLD
designs.
• Proprietary development software, which operates on personal computers and
engineering workstations, is used by customers to develop, compile, and
verify their designs, and then program their designs into our PLDs.
In 2012, sales of PLDs generated 93% of our net sales, with FPGA and CPLD sales
comprising approximately 84% and 9% of our net sales, respectively. The
remainder of our net sales is comprised of our HardCopy devices and
configuration devices used in conjunction with our FPGAs, as well as licensing
of IP cores and proprietary development tools.
Market Opportunity
Based on publicly available data and information derived from Gartner Dataquest,
an independent research firm, we estimate that the PLD market was approximately
$4.5 billion in 2012. We also estimate that the combined ASIC and ASSP market in
2012 was approximately $101 billion, comprised of the ASIC market at
approximately $21 billion and the ASSP market at approximately $80 billion. Due
to the low priced nature of some very high volume ASIC and ASSP applications,
including mobile phones and certain consumer applications such as PC-related
equipment, video games and portable media applications, we do not believe that
the entire ASIC and ASSP market is available for displacement by PLDs. As such,
we estimate that the PLD accessible ASIC and ASSP market was approximately
$50 billion in 2012 ($13 billion in accessible ASICs and $37 billion in
accessible ASSPs) and that this represents significant PLD growth potential.
In addition to the accessible portion of the ASIC and ASSP market of $50 billion
in 2012, we believe our recent and future embedded processor solutions,
including recently introduced FPGAs which integrate ARM®-based hard processor
systems, offers an additional available market of approximately $9 billion, and
that this additional market opportunity offers significant overlap with the end
equipment markets we currently serve. We believe our ongoing investments in
software programmer solutions, hard and soft processor-related IP, and licensed
cores for microprocessors and memory, as well as application-targeted FPGAs,
will allow us to capture a higher percentage of the semiconductor bill of
materials in an embedded system.
With the increasing tendency towards silicon convergence, the impact of "tipping
point" economics, and the ever-increasing need for programmability within an
electronic system, we believe that customers will increasingly turn to PLD
suppliers for not only logic functionality, but also system integration in both
prototyping and production quantities. With a combined $59 billion ASIC, ASSP
and embedded market replacement opportunity, our goal is that, over time, the
average growth rate of our revenue can double that of the total semiconductor
industry.
While we have had success winning customer designs against ASICs, ASSPs,
embedded processors and microcontrollers, the rate at which customers will adopt
the use of PLDs is unclear. Technological issues, including those related to
power consumption, performance specifications and design methodology, may limit
certain customers' broader adoption of PLDs. Despite having success in winning
new designs and a higher growth rate of PLDs relative to ASICs, ASSPs, embedded
processors and
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microcontrollers in recent years, our share gains relative to these alternatives
may take many years to become significant. This is due to the small size of the
PLD market when compared to the combined accessible revenue of ASICs, ASSPs,
embedded processors and microcontrollers. This is compounded by the fact that it
may take a long period of time for revenue from new designs to become meaningful
when compared with the existing legacy revenue stream.
Driving Operational Excellence
Since the PLD market emerged in the 1980s, the financial business models of the
leading PLD suppliers have generally been favorable when compared to most other
semiconductor companies. Fabless strategies, high barriers to entry, and
proprietary architectures have contributed to strong financial results for PLD
suppliers.
We regularly engage in a strategic review of our business to improve operations
and financial returns. We are focused on maximizing return on invested capital
by pursuing greater efficiencies in all aspects of our operations while seeking
balance with our commitment to continued investment in advanced technology for
the development of new products. In recent years, we have increased our focus on
enhancing our business model through process efficiency gains while also growing
PLD market share.
Our ability to maintain investment in the research and development of future
products has been aided by our early and ongoing cost savings initiatives, which
is a vital factor for our future sales and earnings growth. In addition, our
prior work in analyzing business processes has not only allowed us to
effectively identify and implement simplification and cost reduction
initiatives, but the concept of "workflow efficiency" has become a valued aspect
of our business culture.
Leveraging Our Global Structure
We believe that we have opportunities to further expand our position outside of
the U.S. Our organization and management structure integrates our U.S. and
non-U.S. operations and provides our management team with a global perspective
on our markets. We believe that this infrastructure provides opportunities to
develop and commercialize new products that meet global needs and can be rapidly
launched in multiple markets.
Competing for Design Wins
We compete with other PLD vendors to displace other semiconductor alternatives
and for market share within the PLD market. Competition between PLD vendors is
most intense in the "design-win" phase of the customer's design, when customers
select products for use in the customer's electronic system. Customers often
prefer to use the same PLD vendor in successive product generations. This
"incumbency advantage" is driven by a customer's investment in building
expertise with the PLD vendor's software and the re-use of portions of a design
from prior generations. In addition, because each PLD vendor's products are
proprietary, the cost to switch PLDs after a system has been designed and
prototyped is very high. Therefore, a design win can provide the PLD vendor with
a profitable revenue stream through the life of the customer's program.
From the time a design win is secured, it can be two or more years before a
customer starts volume production of its system. Typically, the customer selects
the PLD vendor relatively early in a customer's design process, but it may take
several years to complete system design, build prototypes, sample the
marketplace for customer acceptance, make modifications and manufacture in
volume. Thus, there is a delay between developing a competitive advantage and
experiencing a shift in the PLD market, meaning that market share is a lagging
indicator of relative competitive strength. Because it is extremely difficult to
forecast the success and timing of customer programs, and because the end
markets are highly fragmented (we have over 12,500 PLD customers), it is
difficult even for PLD vendors to gauge their own competitive strength in
winning designs at a particular point in time.
Developing Competitive Products
A PLD vendor's ability to secure design wins and to maintain or increase market
share is highly dependent on the cost and quality of its products, its ability
to provide tailored architectures, and the effectiveness and reliability of its
proprietary development software. Development software, working in tandem with
device logic architecture and features, creates the functionality desired by the
customer. We develop our software in parallel with our devices, and there are
schedule and integration risks between the two processes. If we fail to create
adequate software to support our new devices as they are introduced, we weaken
our competitive position, which can have long-lasting effects if customers
switch to competing solutions and become less familiar and less skilled with our
software.
Increasing our FPGA market share and the further success of our tailored
architectural approach in our new FPGA product families is important to our
long-term growth and profitability. Due to the higher integration density and
lower cost per function, the FPGA market has outgrown the CPLD market in recent
years, and industry participants and observers believe this trend will continue.
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Since the initial introduction of our Stratix and Cyclone FPGA families in 2002,
we have introduced several more FPGA families in the Stratix, Cyclone and Arria
series of products, including devices that incorporate hard embedded processors.
As a result of these product introductions, we estimate, based on publicly
available data and with information derived from Gartner Dataquest, that our
market share has increased as follows:
Market Share 2007 2012
PLD(1) 35 % 40 %
FPGA 33 % 39 %
CPLD 37 % 39 %
(1) Includes revenue from FPGA and CPLD sub-segments as well other products
including development software, intellectual property and HardCopy devices
Complementing our Stratix FPGAs is our HardCopy family of ASICs. The
availability of a HardCopy conversion path for high-density FPGA designs is a
competitive advantage. We first shipped HardCopy devices in 2001, offering
customers low-cost, non-programmable production devices that use our highest
density FPGAs as an integrated development vehicle. HardCopy devices are
targeted specifically at those applications and customers that have used PLDs
for prototyping and development and traditional cell-based ASICs from other
vendors for their volume production needs.
We have improved our CPLD offering with the MAX II and the MAX V families. MAX V
CPLDs offer pricing and features that we believe are competitively attractive,
with cost, performance, power consumption, and density that are superior to our
previous offerings.
An FPGA family typically reaches peak sales approximately five years after
initial product shipment. As a result, the Stratix IV and Arria II families,
introduced in the fourth quarter of 2008 and the second quarter of 2009,
respectively, comprised approximately 25% of our net sales in 2012, and may be
at or near peak sales. To improve or even sustain our growth rate, we must
successfully introduce successor generations of devices. The degree to which
other PLD vendors improve the competitiveness and execution of their products,
including the ability to support silicon convergence, may impair our ability to
improve our growth rate.
Within the next several quarters, we plan to ship newer FPGA families using more
advanced production techniques that will further improve product performance and
lower cost. Our foundry partner, Taiwan Semiconductor Manufacturing Company
("TSMC"), will manufacture these die using production processes that are new to
the industry. Given the extreme complexity of semiconductor fabrication, TSMC
may encounter difficulties that could delay our product launch or limit supply
so that we would be unable to meet customer commitments. We may discover
manufacturing errors after we begin shipping, which could harm customer
relations and cause us to incur additional unforeseen costs. Simultaneous
introduction of new PLD architectures and ramp of new technology processes are
inherently risky. Diagnosing failures, identifying root causes, and implementing
corrective actions in a production wafer fabrication facility are expensive and
time-consuming. We may not successfully commercialize our new products, or our
new products may not enable us to maintain or increase market share. Some of our
competitive offerings may be offered later than the competition, and it is
possible that our competitive offerings will be less effective, thus weakening
our market share.
It is also possible that our primary competitor may have secured design wins
that, when they enter production, will reverse some of our recent market share
gains. Our main competitor is larger in size with more sales and research and
development resources, and we may not enjoy the same success that we saw with
previous FPGA generations.
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 financial condition. 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.
32--------------------------------------------------------------------------------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 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.
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--------------------------------------------------------------------------------Results of Operations
Results of operations expressed as a percentage of net sales were as follows:
2012 2011 2010
Net sales 100.0 % 100.0 % 100.0 %
Cost of sales 30.4 % 29.6 % 29.0 %
Gross margin 69.6 % 70.4 % 71.0 %
Research and development expense 20.2 % 15.8 % 13.5 %
Selling, general, and administrative expense 16.3 % 13.5 % 13.0 %
Compensation expense (benefit) - deferred
compensation plan 0.4 % (0.1 )% 0.3 %
(Gain) loss on deferred compensation plan
securities (0.4 )% 0.1 % (0.3 )%
Interest income and other (0.5 )% (0.2 )% (0.2 )%
Interest expense 0.4 % 0.2 % 0.2 %
Income tax expense 2.0 % 3.8 % 4.3 %
Net income 31.2 % 37.3 % 40.1 %
Sales Overview
Net sales were $1.78 billion in 2012, $2.06 billion in 2011 and $1.95 billion in
2010. 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.
Net sales increased by 6% in 2011 from 2010, out-pacing the general
semiconductor, ASIC, ASSP and PLD markets by a wide margin. The significant
increase in net sales was primarily driven by strong growth in sales of our New
and Mainstream Products. In 2011, with design incumbency from our 40-nanometer
product success, our momentum continued in 28-nanometer, and our FPGA market
share improved.
Huawei Technologies Co., Ltd. ("Huawei"), an OEM, individually accounted for 16%
of net sales in 2012 and 13% in each of 2011 and 2010. No other individual OEM
accounted for more than 10% of net sales in 2012, 2011 or 2010. See Note 5 -
Accounts Receivable, Net and Significant Customers to our consolidated financial
statements.
Sales by Product Category
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® IV , MAX® V, and HardCopy® IV devices.
• 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™ and 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.
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--------------------------------------------------------------------------------Net Sales by product category were as follows:
Annual Growth Rate
2012 2011 2010 2012 2011
New 32 % 22 % 11 % 22 % 107 %
Mainstream 30 % 34 % 32 % (22 )% 11 %
Mature and Other 38 % 44 % 57 % (26 )% (18 )%
Net Sales 100 % 100 % 100 % (14 )% 6 %
Sales by Vertical Market
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
2012 2011 2010 2012 2011
Telecom & Wireless 44 % 43 % 44 % (12 )% 4 %
Industrial Automation, Military & Automotive 21 % 23 % 21 % (22 )% 12 %
Networking, Computer & Storage 17 % 17 % 14 % (11 )% 29 %
Other 18 % 17 % 21 % (10 )% (13 )%
Net Sales 100 % 100 % 100 % (14 )% 6 %
Sales of FPGAs and CPLDs
Our PLDs consist of field-programmable gate arrays, or FPGAs, and complex
programmable logic devices, or CPLDs. FPGAs consist of our Stratix, Cyclone,
Arria, APEX, FLEX and ACEX series, as well as our Excalibur and Mercury
families. CPLDs consist of our MAX, MAX II, and Classic families. Our other
products consist of HardCopy, HardCopy II and other masked programmed logic
devices, configuration devices, software and other tools and IP cores
(collectively, "Other Products").
Net sales of FPGAs, CPLDs and Other Products were as follows:
Annual Growth Rate
2012 2011 2010 2012 2011
FPGA 84 % 81 % 82 % (11 )% 5 %
CPLD 9 % 10 % 12 % (22 )% (11 )%
Other Products 7 % 9 % 6 % (27 )% 41 %
Net Sales 100 % 100 % 100 % (14 )% 6 %
Sales by 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.
35--------------------------------------------------------------------------------Net Sales by geography were as follows:
Annual Growth Rate
2012 2011 2010 2012 2011
Americas 18 % 19 % 19 % (18 )% 7 %
Asia Pacific 43 % 41 % 42 % (9 )% 2 %
EMEA 25 % 25 % 23 % (15 )% 17 %
Japan 14 % 15 % 16 % (18 )% (1 )%
Net Sales 100 % 100 % 100 % (14 )% 6 %
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 $4.3 billion and $4.0 billion for 2012 and 2011,
respectively. See Note 8: Deferred Income and Allowances on Sales to
Distributors to our consolidated financial statements. Average aggregate price
concessions typically range from 65% to 80% 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 $82.6 million and $127.6 million for 2012 and 2011, respectively. See
Note 8: Deferred Income and Allowances on Sales to Distributors to our
consolidated financial statements.
Gross Margin
2012 2011 2010
Gross Margin Percentage 69.6 % 70.4 % 71.0 %
Our gross margin rates are heavily influenced by both vertical market mix and
the timing of material cost improvements. While these variables will continue to
fluctuate on a cyclical basis, our gross margin target over the long term is
67%. We believe that the 67% gross margin target will enable us to achieve our
desired balance between growth and profitability. Our gross margin percentage
decreased in 2012 by 0.8 points when compared with 2011. The decrease was
primarily attributable to an unfavorable vertical market mix when compared with
2011.
Gross margin percentage decreased in 2011 by 0.6 points compared to 2010. The
decrease was primarily due to the change in the mix of revenue by vertical
market.
Research and Development Expense
Research and development expense includes costs for compensation and benefits,
development masks, prototype wafers, and depreciation and amortization. These
expenditures are for the design of new PLD and ASIC families, the development of
process technologies, new package technology, software to support new products
and design environments, and IP cores.
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We will continue to make significant investments in the development of new
products and focus our efforts on the development of new programmable logic
devices that use advanced semiconductor wafer fabrication processes, as well as
related development software. We are currently investing in the development of
future silicon products, as well as our Quartus II software, our library of IP
cores and other future products.
2012 vs. 2011 2011 vs. 2010
($ in millions) 2012 2011 2010 Change Change
Research and Development Expense $ 360.4 $ 325.7 $ 264.6
11 % 23 %
Percentage of Net Sales 20.2 % 15.8 % 13.5 %
Research and development expense for 2012 increased by $34.7 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.
Research and development expense for 2011 increased by $61.1 million, or 23%,
when compared with 2010. The increase was primarily attributable to a
$23.8 million increase in personnel-related costs due to an increase in the
number of employees, a $9.1 million increase in stock-based compensation driven
by an increase in the number of employees, and a $25.0 million increase in
product development activities.
Selling, General, and Administrative Expense
Selling, general, and administrative expense primarily includes compensation and
benefits related to sales, marketing and administrative employees, commissions
and incentives, depreciation, legal, advertising, facilities and travel
expenses.
2012 vs. 2011 2011 vs. 2010
($ in millions) 2012 2011 2010 Change Change
Selling, General and
Administrative Expense $ 289.9 $ 279.2 $ 254.5 4 % 10 %
Percentage of Net Sales 16.3 % 13.5 % 13.0 %
Selling, general, and administrative expense for 2012 increased by $10.7
million, or 4%, when compared with 2011. The increase was primarily attributable
to a $9.8 million increase in personnel-related costs due to an increase in the
number of employees, a $5.4 million increase in stock-based compensation driven
by an increase in the number of employees, an $8.4 million increase in
professional services and consulting fees. These increases were partially offset
by a $13.4 million decrease in variable compensation expenses based on lower
operating results in 2012.
Selling, general, and administrative expense for 2011 increased by $24.7
million, or 10%, when compared with 2010. The increase was primarily
attributable to an $8.3 million increase in personnel-related costs due to an
increase in the number of employees, an $11.1 million increase in stock-based
compensation driven by an increase in the number of employees, and a $6.3
million increase in professional services and consulting fees.
Deferred Compensation Plan
We allow our U.S.-based officers and director-level employees to defer a portion
of their compensation under the Altera Corporation Non-Qualified Deferred
Compensation Plan (the "NQDC Plan"). Since the inception of the NQDC Plan, we
have not made any contributions to the NQDC Plan and we have no commitments to
do so in the future. There are no NQDC Plan provisions that provide for any
guarantees or minimum return on investments. Investment income or loss earned by
the NQDC Plan is recorded as (Gain)/loss on deferred compensation plan
securities in our consolidated statements of comprehensive income. We reported
(gain)/loss on NQDC Plan assets of $(7.1) million, $2.0 million and $(6.8)
million in 2012, 2011 and 2010, respectively. These
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amounts resulted from the overall market performance of the underlying
securities. The investment (gain)/loss also represents an (increase) decrease in
the future payout to employees and is recorded as Compensation expense (benefit)
- deferred compensation plan in our consolidated statements of comprehensive
income. The compensation expense (benefit) associated with our deferred
compensation plan obligations is offset by (gain)/loss from related securities.
The net effect of the investment income or loss and related compensation expense
or benefit has no impact on our income before income taxes, net income, or cash
balances. See Note 16 - Employee Benefits Plans to our consolidated financial
statements for a detailed discussion of our NQDC Plan.
Interest Income and Other
Interest income and other consists mainly of interest income generated from
investments in bonds, money market funds and high-quality fixed income
securities. The increase in Interest income and other in 2012 compared with 2011
was primarily due to higher cash and investments and changes in our investment
portfolio elections during 2012 that generated higher investment income.
Interest income and other remained relatively flat in 2011 compared with 2010 as
neither returns nor invested balances changed significantly.
Interest Expense
The increase in Interest expense in 2012 compared with 2011 was mainly due to
the new long-term debt, which has a higher effective interest rate than the
former credit facility. See Note 17: Credit Facility and Long-Term Debt for
further discussion. In 2011, the year-over-year decrease in Interest expense
when compared with 2010 was due primarily to the slight decrease of the LIBOR
rate.
Income Tax Expense
Our effective tax rate reflects the impact of significant amounts of our
earnings being taxed in foreign jurisdictions at rates substantially below the
U.S. statutory rate. Our effective tax rates were 5.9% for 2012, 9.2% for 2011
and 9.8% for 2010.
The significant net decrease in our effective tax rate in 2012 when compared
with 2011 was primarily due to higher one-time tax benefits in 2012 compared to
2011, partially offset by the absence of a U.S. federal research and development
tax credit in 2012, due to its expiration in 2011. During 2012, the effective
tax rate includes the following net tax benefits associated with the release of
liabilities for uncertain tax positions: 1) a $24.4 million net tax benefit
primarily associated with the expiration of the federal statutes of limitation,
the reassessment and recognition of previously unrecognized federal tax
benefits, and the reversal of the related interest accruals; 2) a $6.9 million
net tax benefit as a result of a Statutory Notice of Deficiency received from
the IRS for 2005 to 2007; and 3) a $9.1 million net tax benefit as a result of
the expiration of the statutes of limitations for certain foreign jurisdictions.
In 2011, we reversed $4.3 million of liabilities for uncertain tax positions as
a result of a Statutory Notice of Deficiency received from the Internal Revenue
Service for 2002 through 2004. In addition, in 2011 we reversed $8.2 million of
liabilities for uncertain tax positions upon expiration of the statutes of
limitations and settlement with certain foreign jurisdictions.
Our 2011 effective tax rate was favorably affected by the higher benefit of the
2011 adjustments as compared to 2010. During 2011, we reversed $4.3 million of
liabilities for uncertain tax positions as a result of a Statutory Notice of
Deficiency received from the Internal Revenue Service for 2002 through 2004. In
addition, we reversed $8.2 million of liabilities for uncertain tax positions
upon expiration of the statutes of limitations and settlement with certain
foreign jurisdictions. In 2010, we reversed $19.4 million of liabilities for
uncertain tax positions, partially offset by an $8.2 million charge related to
the revaluation of our state deferred tax assets.
38--------------------------------------------------------------------------------Financial Condition, Liquidity, Credit Facility and Capital Resources
Overview
We derive our liquidity and capital resources primarily from our cash flows from
operations. We continue to generate strong positive operating cash flows. In May
2012, we issued 1.75% senior notes that will mature on May 15, 2017 (the
"Notes") in the aggregate principal amount of $500 million. We used the net
proceeds to repay our former credit facility. In June 2012, we entered into a
credit agreement that provides for a $250 million unsecured revolving line of
credit (the "Facility"), which is scheduled to mature in June 2017. As of
December 31, 2012, we had no borrowings under the Facility. As such, the $250
million available under the Facility represents a source of liquidity. See Note
17: Credit Facility and Long-Term Debt to our consolidated financial statements
for further discussion.
We currently use cash to fund dividends, capital expenditures and repurchases of
our common stock. Based on past performance and current expectations, we believe
that our current available sources of funds (including cash, cash equivalents,
short-term investments and the Facility, plus anticipated cash generated from
operations) will be adequate to finance our operations, cash dividends, capital
expenditures and stock repurchases for at least the next year.
Our cash and cash equivalents balance decreased by $495.3 million during the
year ended December 31, 2012. The change in cash and cash equivalents for 2012,
2011 and 2010 was as follows:
(In millions) 2012 2011 2010
Net cash provided by operating activities $ 587.2 $ 959.6 $ 856.7
Net cash used in investing activities (767.2 ) (170.9 ) (23 )
Net cash (used in) provided by financing activities (315.3 ) (181.9 ) 384.8
Net (decrease) increase in cash and cash equivalents $ (495.3 ) $ 606.8 $ 1,218.5
Total cash and cash equivalents accounted for 62% and 79% of total assets at
December 31, 2012 and 2011, respectively.
Operating Activities
In 2012, our operating activities provided $587.2 million in cash, primarily
attributable to net income of $556.8 million, adjusted for non-cash stock-based
compensation expense of $87.1 million (net of related tax effects), depreciation
and amortization of $36.9 million, deferred income tax expense of $8.8 million
and changes in working capital accounts. Significant changes in working capital
accounts (excluding cash and cash equivalents) included a $91.4 million increase
in Accounts receivable, net, a $30.4 million increase in Inventories, a $3.1
million increase in Other assets, a $50.6 million decrease in Accounts payable
and other liabilities, a $66.1 million increase in Deferred income and
allowances on sales to distributors and an $8.6 million increase in Income tax
payable.
Our sales to distributors are primarily made under agreements allowing for
subsequent price adjustments and returns, and we defer recognition of revenue
until the products are resold by the distributor. At the time of shipment to
distributors, we (1) record a trade receivable at the list selling price since
there is a legally enforceable obligation from the distributor to pay us
currently for product delivered, (2) relieve inventory for the carrying value of
goods shipped since legal title has passed to the distributor, and (3) record
deferred revenue and deferred cost of sales in Deferred income and allowances on
sales to distributors in the liability section of our condensed consolidated
balance sheets. Decreases in Accounts receivable, net associated with lower
billings are generally offset by corresponding decreases in Deferred income and
allowances on sales to distributors. However, timing differences between gross
billings, advances to distributors, discounts earned, collections, revenue
recognition and changes in the mix of sales to OEMs and distributors may result
in a temporary interruption to the normal relationship between these two
accounts.
The $91.4 million increase in Accounts receivable, net, and the $66.1 million
increase in Deferred income and allowances on sales to distributors principally
relates to increased gross billings to distributors and OEMs, associated with an
upward trend in demand for certain products in the fourth quarter of 2012
compared with the same period in 2011.
The $30.4 million increase in Inventories was attributable to increased
production of new products in the fourth quarter of 2012 compared with the same
period in 2011.
The $3.1 million increase in Other assets primarily resulted from the increase
in deferred financing costs as a result of the issuance of long-term debt,
offset by returns of advances from distributors and a decrease in prepaid income
taxes and other prepaids due to timing.
39
--------------------------------------------------------------------------------The $50.6 million decrease in Accounts payable and other liabilities was
primarily attributable to a decrease in the accrual for product development
activities due to timing and the accrual for sales incentives and variable
compensation as a result of lower operating results, partially offset by an
increase in other accrued liabilities.
The $8.6 million increase in Income tax payable was primarily attributable to
higher tax liabilities along with timing related to the payment of taxes.
In 2011, our operating activities provided $959.6 million in cash, primarily
attributable to net income of $770.7 million, adjusted for non-cash stock-based
compensation expense of $81.6 million (net of related tax effects), depreciation
and amortization of $31.9 million, deferred income tax expense of $15.7 million
and changes in working capital accounts. Significant changes in working capital
accounts (excluding cash and cash equivalents) included a $131.3 million
decrease in Accounts receivable, net, a $24.2 million decrease in Inventories, a
$54.7 million decrease in Other assets, a $32.5 million decrease in Accounts
payable and other liabilities, a $148.8 million decrease in Deferred income and
allowances on sales to distributors and a $31.1 million increase in Income tax
payable.
Investing Activities
During 2012, our investing activities resulted in a use of cash primarily for
the purchase of available for sale securities of $921.4 million. This included
$501.1 million used to purchase U.S. Treasury securities which provide an
approximate economic hedge of the interest rate exposure of our Notes. In
addition, we made purchases of property and equipment of $60.9 million and
purchase of intangible assets and other investment of $7.2 million, partially
offset by cash proceeds from the maturities and sales of available-for-sale
investments of $220.8 million.
During 2011, our investing activities resulted in a use of cash primarily for
the purchase of available for sale securities of $164.4 million and purchases of
property and equipment of $31.8 million, partially offset by cash proceeds from
the maturities and sales of available-for-sale investments of $25.0 million.
Financing Activities
During 2012, our financing included repayment of our former credit facility in
the aggregate principal amount of $500.0 million, a use of cash for the
repurchase of common stock of $229.1 million, dividend payments of $115.5
million, and minimum statutory withholding for vested restricted stock units of
$31.5 million, partially offset by cash proceeds of $500.0 million from the
issuance of long-term debt and cash proceeds of $49.7 million from the issuance
of common stock to employees through our employee stock plans.
During 2011, our financing activities resulted in a use of cash for the
repurchase of common stock of $197.0 million, dividend payments of $90.1
million, and minimum statutory withholding for vested restricted stock units of
$32.2 million, partially offset by cash proceeds of $120.0 million from the
issuance of common stock to employees through our employee stock plans.
Our dividend policy could be impacted in the future by, among other items,
future changes in our cash flows from operations and our capital spending needs
such as those relating to research and development, investments and
acquisitions, common stock repurchases and other strategic investments.
Contractual Obligations
The following table summarizes our significant contractual cash obligations as
of December 31, 2012, and the effect that such obligations are expected to have
on liquidity and cash flows in future periods:
40
--------------------------------------------------------------------------------
Payments Due by Period
Less than 1 More than 5
(In millions) Total Year 1-3 Years 3-5 Years Years
Operating lease
obligations (1) $ 33.4 $ 9.1 $ 9.2 $ 5.8 $ 9.3
Wafer purchase
obligations (2) 138.4 138.4 - - -
Long term debt 500.0 - - 500.0 -
Interest on long term
debt (3) 39.4 8.8 17.5 13.1 -
Obligations under
service award program
(4) 9.1 2.3 1.2 2.0 3.6
Electronic design
automation software
licenses (5) 5.8 2.9 2.9 - -
Total contractual cash
obligations $ 726.1 $ 161.5 $ 30.8 $ 520.9 $ 12.9
(1) We lease facilities under non-cancelable lease agreements expiring at
various times through 2017. Rental expense under all operating leases was
$10.6 million in 2012, and $8.1 million in each of 2011 and 2010.
(2) Due to lengthy subcontractor lead times, we must order materials and services from these subcontractors well in advance, and we are obligated
to pay for the materials once they are completed. We expect to receive and
pay for these materials in 2013.
(3) Interest is based on our $500 million aggregate principal amount of 1.75%
senior notes that will mature on May 15, 2017 (the "Notes") with an
effective interest rate of 1.91%. Interest on the Notes is payable semiannually in arrears on May 15 and November 15 of each year, beginning
on November 15, 2012. The Notes are governed by a base and supplemental
indenture between Altera and U.S. Bank National Association, as trustee.
(4) We offer to the majority of our U.S and non-U.S. employees participation
in the Service Award Program ("SAP"). The SAP provides employees with one
to four weeks of additional paid vacation upon their attainment of five,
ten, fifteen, twenty, twenty-five and thirty-year service anniversaries.
See Note 16: Employee Benefits Plans to our consolidated financial
statements.
(5) As of December 31, 2012, we had $5.8 million of non-cancelable license
obligations to providers of electronic design automation software and
maintenance expiring at various dates throughout December 2014.
Due to the uncertainty with respect to the timing of future cash flows
associated with our unrecognized tax benefits as of December 31, 2012, we are
unable to make reasonably reliable estimates of the period of cash settlement
with the respective taxing authority. Therefore, $272.0 million of unrecognized
tax benefits classified as Income tax payable- non-current in the accompanying
consolidated balance sheet as of December 31, 2012, have been excluded from the
contractual obligations table above. See Note 14: Income Taxes to our
consolidated financial statements for a discussion of income taxes.
In addition to the above obligations we enter into a variety of agreements and
financial commitments in the normal course of business. It is not possible to
predict the maximum potential amount of future payments under these or similar
agreements due to the conditional nature of our obligations and the unique facts
and circumstances involved in each particular agreement. Historically, payments
pursuant to such agreements have not been material. We believe that any future
payments required pursuant to such agreements would not be significant to our
consolidated financial condition or operating results.
Impact of Foreign Currency and Inflation
We have international operations and incur expenditures in currencies other than
U.S. dollars. For non-U.S. subsidiaries and branches, foreign currency
transaction gains and losses and the impact of the remeasurement of local
currency assets and liabilities into U.S. dollars in 2012, 2011 and 2010 were
not significant. We do not enter into foreign exchange transactions for trading
or speculative purposes.
Common Stock Repurchases
We repurchase shares under our stock purchase program announced on July 15,
1996, which has no specified expiration. No existing repurchase plans or
programs have expired, nor have we decided to terminate any repurchase plans or
programs prior to expiration. Since the inception of our stock repurchase
program through December 31, 2012, our board of directors has authorized 203.0
million shares for repurchase and we have repurchased a total of 190 million
shares of our common stock for an aggregate cost of $4.1 billion. As of
December 31, 2012, 13 million shares remained authorized for repurchase under
our stock repurchase program.
41
--------------------------------------------------------------------------------
Common stock repurchase activity was as follows:
(In millions, except per share amounts) 2012 2011
Shares repurchased 6.9 4.8
Cost of shares repurchased $ 229.1 $ 197.0
Average price per share $ 33.10 $ 41.05
No shares were repurchased in 2010.
Off-balance Sheet Arrangements
As of December 31, 2012, we did not have any off-balance sheet arrangements, as
defined in Item 303(a)(4)(ii) of SEC Regulation S-K.
Subsequent Events
On January 21, 2013, our board of directors declared a cash dividend of $0.10
per common share payable on March 1, 2013 to stockholders of record on
February 11, 2013.
The American Taxpayer Relief Act of 2012, which was enacted on January 2, 2013,
extends the federal research tax credit retroactively for two years from January
1, 2012 through December 31, 2013. The tax benefit from the extension of the
federal research tax credit of $10.6 million will be reflected in the income tax
provision in the quarter ending March 29, 2013.
On January 31, 2013, the IRS conceded an adjustment for certain inter-company
transactions in our litigation over the 2004 through 2007 tax years. The
concession only impacted our 2007 tax year. Our other inter-company transactions
continue to be subject to litigation for 2004 through 2007. As a result of this
concession, we expect to recognize a tax and interest benefit of $7.5 million
during the three months ending March 29, 2013 due to the release of certain tax
reserves.
New Accounting Pronouncements
The information contained in Note 2: Significant Accounting Policies to our
consolidated financial statements in Part II, Item 8 under the heading "Recent
Accounting Pronouncements" is incorporated by reference into this Part II, Item
7.
42--------------------------------------------------------------------------------
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