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Executives

Ken Tinsley - Director of Investor Relations

Bertrand F. Cambou - President, Chief Executive Officer, Director

Dario Sacomani - Chief Financial Officer, Executive Vice President

Analysts

Daniel Berenbaum - Cowen & Company

Shawn Webster - J.P. Morgan

Bobby Gujavrty - Deutsche Bank Securities

Betsy Van Hees - Caris & Co.

John Pitzer - Credit Suisse First Boston

Spansion, Inc. (SPSN) Q3 2008 Earnings Call October 15, 2008 4:30 PM ET

Operator

Welcome to the Spansion third quarter 2008 earnings results conference call. (Operator Instructions) At this time for opening remarks and introductions, I would like to turn the call over to Ken Tinsley, Director of Investor Relations.

Ken Tinsley

With me here today are Bertrand Cambou, CEO, and Dario Sacomani, our CFO.

Before we begin today’s discussion I’d like to remind you that during this call we will make forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 including but not limited to statements regarding expected fourth quarter and fiscal 2008 operating results, anticipated capital expenditures and reductions of costs, expected net sales from SP1, expected inventory declines, efforts to improve the company’s capital position and long-term cost structure, expected benefits from our EcoRAM technology, expected benefits from potential strategic transactions including the anticipated joint venture with ASE.

Investors are cautioned that forward-looking statements in this conference call involve risks and uncertainties that could cause actual results to differ materially from the company’s current expectations. For risks that the company considers to be important factors that could cause actual results to differ materially from those set forth in the forward-looking statements, we urge you to carefully review the risks and uncertainties listed in the company’s Securities and Exchange Commission filings including but not limited to Spansion’s quarterly report on Form 10Q for the fiscal quarter ended June 29, 2008. The company disclaims any duty to update forward-looking statements.

With that let me turn it over to Bertrand.

Bertrand F. Cambou

We had a solid Q3 in spite of the challenging environment for the memory industry. Revenue grew to $631 million up quarter-on-quarter and year-on-year. These results were achieved through market share gain. We now command nearly 40% market share compared to 33% last year and meet 20% of the formation of Spansion.

Even though our prices are relatively stable, we were impacted in the third quarter by overhead pricing pressure in the memory segment. To mitigate this ASP drop we are focusing on the highest margin part of the business, raising prices for select segments and exiting non-profitable product lines.

As part of this strategy we decided to exit the 90 nanometer content delivery card business in the third quarter comprised of our 4 bit [preserved] flash memory device built in our mature fab 25 factory. As a result of the set of actions that we taken, total inventories are down significantly quarter-on-quarter and fab 25 is essentially full. We are dedicating most of this factory to profitable business that we have.

In the third quarter revenue generated from product built in our 300 millimeter SP1 factory was lower than expected for the two following reasons.

First, the Japan cell phone business that consumed the majority of our 2 gig ONAND devices out of SP1 dropped in the third quarter to less than half our expectation. This decline was due to changes in regulation in Japan which has cut subsidies to subscribers.

Second, the qualifications of our 112 volt wireless NOR device to our biggest customer was a couple of months behind schedule. As a result revenue from SP1 was in the low double-digit millions of dollars for the quarter.

Please note that we were able to mitigate any potential sales impact of those delays by continuing shipments of the 90 nanometer NOR.

Progress on customer qualifications across the board in SP1 to a full range of customer including our biggest NOR customer allowed us to build inventory ahead going into Q4. We are now on track with our SP1 factory quals including 1.8-volt wireless NOR in our market, 3-volt customer NOR devices, MirrorBit clips and EcoRAM solutions. At this rate we are planning to realize full revenue from Sp1 productions around Q2 of 09 at which time we expect to add further capacity by ramping up these products at SMIC to meet customer demand.

Now let me switch and explain the performance of our two main business divisions. The wireless system division or WSD had a strong revenue upside to $320 million driven by share gain at our largest OEM accounts. In fact the third quarter rate was the second highest quarter on report for our largest wireless account. Particularly strong for that division were sales in the US, Europe and then both Korea and China went up. Why? Japan was down for reasons already discussed.

I’d like to mention that quarter-on-quarter the number of units shipped in wireless went up by 10 million from 85 million in Q2 to 95 million in Q3. Interesting enough the low density least profitable segment in wireless went down in units quarter-on-quarter while 256 megabit and 512 megabit revenue was up by 33%. WSD expects significant 65 nanometer NOR revenue from Sp1 in Q4.

For the consumer, set top box and industrial division or CSID revenue was slightly down to a respectable $305 million. We are again very pleased with the performance of this division.

Year-to-date CSID has enjoyed very large segment share gain leveraging high density MirrorBit devices. Quarter-on-quarter revenue from high density MirrorBit product in that division greater than 128 megabit went up 7% while the last profitable commodity floating gate product went down.

CSID is now going also full speed in qualifying 65 nanometer NOR from SP1. We expect revenue for that division this quarter as well.

The deployment of our newly-announced EcoRAM technology for data center and search engine is right on time. We now have our first server in the hand of our customer and expect firm orders this quarter. EcoRAM will be built in SP1 first and also SMIC for additional capacity.

Also note that last month we announced the extension of our agreement with SMIC to include our new 43 nanometer MirrorBit ORNAND2 out of the Wuhan XinXin Semiconductor company to serve value-added NAND portion of the integrated market.

Before I let Dario describe our financials in detail, I’d like to give a brief update on cost-cutting and restructuring efforts. This morning we announced a very significant MOU, Memorandum of Understanding, for the creations of a joint venture with ASE group to jointly own and operate Spansion’s flagship Suzhou factory. This factory has 1,100 employees dedicated to assembly and test mainly for cell phone memory multichip modules. The purpose of the alliance is to leverage ASE’s expertise and economy of scale to further accelerate our cost advantage over our competition.

We are currently in discussions with other potential partners to create similar arrangements for other final manufacturing facilities and material with the fabrications. We are also making progress in forging alliances with other leading corporations to reduce our R&D costs.

Altogether we are now on the path to create a focused Spansion while leveraging our high valued $2.3 billion of fixed assets that we own as well as our very strong intellectual property, which approximately count 3,000 patents and patent applications.

To notice that short-term we are taking more actions to rapidly cut all spending and reduce the need for cash. This includes salary reductions, cutting capital expenditures, freezing headcount and reducing administrative expenses. In manufacturing we are engaged in a relentless race to cut subcon and foundry expenses and push for productivity in all areas. As a result costs went down in Q3 and I expect them to decline further this quarter and beyond.

Now I’d like to turn the call over to our CFO, Dario Sacomani.

Dario Sacomani

I’ll review a few specifics of our financial performance for the quarter and then I’ll provide some detail on our outlook.

As Bertrand mentioned, Q3 was solid in light of the overall memory segment. Net sales in Q3 were $631 million, up 3% compared to Q2. Overall pricing was stable in the third quarter which contrasts sharply with the rest of the flash memory industry. Sequentially from Q2 ASP per megabit declined approximately 10%. However in our core NOR business it was only 8% to 9% ASP per megabit decline. Therefore, overall I’m pleased with the relative stability in our core NOR business.

The biggest impact on margins this quarter was from our 90 nanometer content delivery business which we decided to exit in Q3. Even with these lower ASPs we were able to grow the top line. As for gross margin, there were three primary drivers regarding third quarter margin of 14%.

The core NOR pricing decline of 8% to 9% I mentioned caused about a 150 basis point incremental gross margin decline.

During the third quarter Spansion elected to exit the 90 nanometer content delivery business as Bertrand mentioned by monetizing the inventory and writing down certain related assets. With mainstream NAND price declines of over 40% since the third quarter alone, we made the decision to exit this business which cost us about 200 basis points of gross margin.

Finally, gross margin was also impacted by approximately 150 basis points due to lower-than-expected SP1 utilization as explained previously by Bertrand.

Due to the volatile economic environment our outlook for Q4 gross margin is uncertain. Our current expectation is that gross margin in Q4 will be up but could be flat depending on how demand for Q4 and Q109 affects factory utilization through the quarter.

On the expense side, excluding restructuring charges, op ex totaled $171 million down $6 million sequentially and slightly better than our expectation. Our outlook for the fourth quarter for ongoing operating expenses is a further decline of approximately $10 million reflecting the impact of cost reduction measures implemented in the third quarter as Bertrand discussed.

If we are successful with certain partnerships and restructuring activities, we may have additional expenses associated with those transactions. We expect to see additional savings from restructuring initiatives next year.

Moving on you’ll note an uptick in our income tax provision in Q3 due to more profit in our Japan subsidiary. We expect future provisions to be in the range of $3 million to $5 million per quarter.

Net loss for the quarter was $119 million or $0.74 a share and included $13 million in charges related to our exit of the 90 nanometer content delivery business. EBITDA for the quarter was $76 million and included the $13 million of exit costs and a small restructuring charge of $1 million.

Moving on to the balance sheet, DSOs were up slightly to 57 days from 55 in Q2. Days payable declined to 104 from 111. Inventory days were 103 down from 115 in Q2 reflecting results from our overall inventory reduction plan including continued reduction of external foundry and subcon support of approximately $15 million. We expect the inventory to decline slightly in Q4.

At the end of Q3 our cash and short-term investment balances were $259 million. This amount included $107 million of auction rate securities which we temporarily impaired from $122 million or 88% of PAR. Last week UBS offered to buy-back these securities at 100% of PAR in June of 2010. From now until then we might be able to receive 75% of the PAR value of these notes in the form of a short-term loan against these securities at the same interest rate we are currently earning on these securities. We are currently working with UBS to realize this liquidity.

In addition to our cash and investments, revolver capacity at the end of the quarter was approximately $100 million bringing total liquidity to $359 million. The ASE transaction discussed by Bertrand should result in cash proceeds to Spansion, and we have several other similar opportunities that we are pursuing.

Cap ex for the third quarter was $110 million, flat from last quarter. The majority of the cap ex spend in the quarter was 65 nanometer and 45 nanometer 300 millimeter development. Now that the initial investment in SP1 is complete we’re significantly reducing our capital spending to maintenance levels. For Q4 we expect capital expenditures to be roughly $40 million. Our previous outlook for 2008 was cap ex to be under $500 million so with this reduction we are now expecting approximately $435 million of capital expense for the year. That excludes the $50 million lease in Q1 bringing full year to $485 million.

In summary, our sales growth in the quarter was impressive considering the memory market conditions, our inventory levels are moving in the right direction, we remain cautious in this environment and are taking aggressive actions to align our operations accordingly to ensure our long-term success.

With that I’ll pass it back to Bertrand to wrap up.

Bertrand F. Cambou

Let me wrap up and come back again on our guidance. We are very confident in our ability to solidify our segment market share position in Q4 as we are ramping up a new wireless account and pushing high density MirrorBit across all businesses. However we have to carefully consider the uncertainty in our business. The size of the total available market may actually shrink and we will offset this reduction somewhat by gaining share. Altogether we are now thinking about a slight reduction of revenue in Q4. Dario has already said gross margin at that point to be flat to up and all of our expenses to go down.

Let me assure you that the primary objective of management in this difficult environment is: First, cash preservation and the relentless cost-cutting effort. Second, we are pursuing a successful commercial strategy to gain share, a strategy to count. And third, we are focused on a flawless execution at SP1 to fully leverage this strategic asset.

Spansion’s competitive position significantly improved again in Q3 and our factory had outstanding performance. It is time now to get the job done and deliver on our commitment.

With that, let’s open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Daniel Berenbaum - Cowen & Company.

Daniel Berenbaum - Cowen & Company

You mentioned about your total liquidity. Do you think that cash balance has bottomed in this quarter? Do you expect to have to tap the revolver? As far as any leasing agreements for equipment that you might have or other financial arrangements in the fab, how has the ongoing credit crisis affected that and could there be any issues with actually operating the fab because of tightening credit requirements?

Dario Sacomani

The credit crisis obviously affects everybody, but the truth is even before the credit crisis at single B there wasn’t a lot of credit available to us anyway. Since there really is no credible financing sources for alternatives given our stock price and yield rates on our bonds, we’re really focused more on the fundamentals to start with, which as Bertrand enumerated significant amount of cost-reduction activities, capital spending reductions to maintenance levels, inventory control, improved DSOs and vendor terms. If you assume looking forward that in Q4 we get our days of inventory at around 103, DSOs of 53, and DPOs of 111, that should drive us to free cash flow in Q4.

Obviously we spend a lot of time focused on the auction rate security liquidity options and there are to your question alternative leasing opportunities to us.

I think one of the benefits of Spansion is we do have a global footprint so we aren’t tied to only being able to obtain credit in the US, and we’re leveraging that global footprint all the time.

I think on top of that the ASE, the alliances for manufacturing in R&D we’re focused on and we’re also focused on continuing to pursue other non-strategic asset sales. That’s kind of how we’re addressing liquidity.

Bertrand F. Cambou

I’d like to rebound on Dario here. I have to say that I am very, very pleased by the overall trajectory that we have as a company right now. With cost-cut reductions, capital cost reduction everywhere and we are already seeing some tangible and if I look at our results you see things that has been worrying like the inventory of tough control six months ago, that is fixed. The spending that we had that was high, done. We’re not spending any more. R&D costs are going down. SG&A is going down.

Now to add on what Dario said, we currently have very, very [inaudible]. I was quoting here this $2.3 billion and that’s a prime asset. The Suzhou factory that we had the transactions is currently the largest MCP factory in the world, the most modern one and a factory of very advanced, very well run, very well kept and we think that right now this is a perfect timing to join forces with a leader like ASE to retransform Spansion into a smaller Spansion, more focused on our core competencies and to leverage that asset into improve our liquidity.

Dario Sacomani

I just want to make sure you guys are clear. I answered that and I talked about alliances as it came up in liquidity, but like Bertrand talked about earlier this is a long-term strategy. This is not something that we did just for liquidity. We expect costs from someone who does this for a living to go down significantly in the long term. So I mentioned it in the context of liquidity but I think Bertrand had previously talked about the fact that from a long-term perspective this is going to be a cost advantage for Spansion.

Daniel Berenbaum - Cowen & Company

On the op ex cuts, you said you expect Q4 to be down about $10 million. How much of that’s R&D and how much is SG&A and how much more can you cut both of those if you have to? And obviously I’m particularly concerned about R&D. That trajectory’s been down. What’s your minimum R&D level to support some of the Eclipse development, the charge-trapping development?

Bertrand F. Cambou

On the R&D we actually have two opportunities there. First, a lot of the 65 nanometer 300 millimeter SP1 development is behind us. We had a lot of costs in [inaudible] six months ago that we don’t have to incur anymore. It’s fundamentally now our cost is lower than what we used to and our technology is very focused. We are essentially walking on MirrorBit, one technology it is very much focused here and we think that we have an opportunity to further reduce it and not that it will result in any compromise whatsoever on pursuing our technology leadership.

We have a second opportunity on cutting R&D which is alliance. There are currently some companies that we are discussing with and of course this is not the right time to disclose what it is but there is opportunity there as well to do some R&D sharing at that point, which means that between the fact that the fundamentally we are currently going down because of R&D. We are going to accelerate that and find a true alliance to go even lower here. Like I was saying to my previous discussion in the last quarter, this is a priority. That has to go down.

We are taking actions. You are going to see a significant piece of this $10 is going to be R&D and going forward this is an area that you can assume here that we like to be at the $100 million ladder or so for R&D costs in Q4 and then to go way sub $400 next year; way sub [inaudible]. The train has left. We are now in an efficiency mode and we’re not going to compromise our leadership position.

Dario Sacomani

I’ll just comment a follow on to what Bertrand said. He talked about R&D and I’ll just talk a little bit about SG&A because we talked about it last quarter. Again we have a very global footprint and in addition to salary cuts and discretionary spending cuts as it relates to SG&A overall efficiency in administration, we’re also doing a significant amount of movement of centralized functions to low-cost regions. That’s going to give us a lot of leverage as it relates to SG&A.

Additionally we talked a little bit about ASE. That’s a lot of employees and at the end of the day there’s a lot of SG&A associated with the maintenance of those kinds of facilities that having joint ventures like we’re proposing are also going to allow us to reduce the amount of SG&A we spend.

Operator

Our next question comes from Shawn Webster - J.P. Morgan.

Shawn Webster - J.P. Morgan

I’d like to ask some questions on your restructuring initiative, but first can you share with us what your book-to-bill is and how lead times are progressing? You mentioned one of your factory’s utilization rates was low, but can you talk about your total utilization rate trends this quarter and next?

Bertrand F. Cambou

I was actually mentioning that our utilization is high. The factory [inaudible] right now is totally full. Our JV3s is also full which mean we don’t - absolutely we have a great situation here in our factory. We currently have an installed capacity that is lower than our current revenue rate, which means that we are on the contrary in a very, very good position as far as being able to like Dario said further cut inventory going forward and we have monitored here because let us say six to nine months ago a big portion of our capacity was coming from foundry which means that we think we have on the contrary the asset being well in line to the alignment.

Shawn Webster - J.P. Morgan

So your utilization rates were full in Q3 and you expect them to remain full in Q4?

Bertrand F. Cambou

We absolutely are currently running, not only that we are full but with the current revenue outlook, we are not able to produce demand. The SP1 I went in growing detail explaining the SP1 situation here and we think that this is a situation of wrapping up all the qual but as quickly as they are, we’re going to be short and we need to use SMIC as quickly as we are massively qualifying.

On your questions on the book-to-bill, interesting enough in the environment our backlog is not bad at all. The month of September that was supposed to be a catastrophe in the industry as far as we are concerned, we had a very strong September. Our book-to-bill technically is slightly below one and that obviously we anticipate that to be the case because the customer lead time right now has been reduced. Our customers in general are more prudent. They place their order at the last minute but if we actually grow and as we are doing monitoring the true demand of our product on the run rate, again the backlog that we have right now has been pretty strong. September was a good month in all aspect.

Dario Sacomani

Just to add to that if I could real quick, as it relates to factory utilization what I said about gross margin was really that when we start to understand the full demand; there is some uncertainty; but a lot of what we build in the fourth quarter is associated with the first quarter. So seeing what happens in the fourth quarter as well as starting to feel out where we think the first quarter is going is really what’s going to help us determine what kind of utilization rate we’re going to have in Q4. That’s why I said our gross margin could be flat because it’s unknown at this point in time.

Shawn Webster - J.P. Morgan

Did you write down inventory in the quarter?

Dario Sacomani

No we didn’t really write it down. We actually got out of the quad 90 business, which had a significant amount of inventory. We didn’t get a whole lot of revenue for it but we actually tried to monetize as much as we possibly could. Every quarter we have inventory write-downs you guys don’t know about called standard changes but there was nothing really significant. The significant impact in the quarter was exiting the 90 nanometer business.

Shawn Webster - J.P. Morgan

When you say you monetized that line of business, do I read that as you sold it for really low prices?

Dario Sacomani

That’s why we said in the NAND business, the price declined by 40%. I think considering holding on and expecting prices to go up was the wrong thing to do.

Bertrand F. Cambou

What we had is the fab 25. We have been kind of using some of this card delivery business as an early way to set up the technology right because with this ORNAND technology in general is easier to ramp up. And when we started we had some ASP assumptions and we had some kind of a piece of the fab 25 use. Obviously the factory right now is running very well. We don’t need that type of thing anymore and that’s why we elected to essentially sell at whatever market price was there to write off. We had [inaudible], [taxiture], some things around it and we elected to clean all of that up and then to start fresh for Q4.

Shawn Webster - J.P. Morgan

Do you see pricing pressure from any particular competitors out there or geographies?

Bertrand F. Cambou

Now we’re talking about the main NOR business. In the NOR business Dario was turning to you here but on average the price decrease per bit was around 8% or so, which is a bit higher than what we model because we essentially were modeling 6% to 7% and that’s in all this 150 basis point that Dario was eluding to.

In the overall grand scheme of things if you look at what is going on in the memory segment, we’re pretty pleased that the prices are holding pretty well. In some cases, in particular in some of the Asian markets, we raised price in Q3 with success. In other cases we are holding price firm, which means that on average we see an average selling price a bit more intense than the model but nothing compared with what’s going on in the memory segments right now in the mainstream device.

Going forward we are still back to the same things; high density MirrorBit is solid because we have less competition there. We have a competitive edge on our technologies and when you go to the low end commodity, then that’s where you have a lot of pressure right now all across the board because the entry level is so low that it is hard to stick with a price in the current environment.

Dario Sacomani

I just want to add one point of reference to what Bertrand said if I might, and that is just that the environment has actually been pretty stable for a while but back in Q1 and Q2 of ’07 we were talking about 12% and 18% price declines per megabit. It’s definitely less volatile than it was.

Shawn Webster - J.P. Morgan

For the ASE initiative Dario, what is the kind of depreciation associated with that that’s running through your P&L right now?

Dario Sacomani

Actually we can’t talk about the details of the deal at this point. It’s a little too early.

Shawn Webster - J.P. Morgan

Can you talk to us about what you expect your debt requirements to pay down your debts in the next six months are? I see you had about the $277 million on your balance sheet but maybe you could walk us through what the actual paybacks you have to do for the next let’s say three to six months for your debt.

Dario Sacomani

The only thing that’s actually debt amortizing right now is what was about a $360+ million facility in Japan, which now we’re already down to about $260 million on. We started amortizing that in Q2 and it’s at about approximately $30 million a quarter. Between the leases that we have and the GE deal in Japan, those are the only two things that really are amortizing in the upcoming period. It’s not until really 2013 and 2016 that the floating rate notes or the senior notes or anything significant happens. So you have to count on about $30 million a quarter.

Operator

Our next question comes from Bobby Gujavrty - Deutsche Bank Securities.

Bobby Gujavrty - Deutsche Bank Securities

You mentioned that you’d like to bring inventories down. What do you think is a reasonable number of inventory level to run your business given that revenue like you mentioned [inaudible] might actually decline this year?

Bertrand F. Cambou

The current inventory that we have right now is not bad at all. We were at 120 days six months ago and now we bring it to 103. That’s almost a 20% drop in six months, which is good. We have in this business 15 weeks of lead time. Between the time we start the materials to the time we ship it, our manufacturing cycle time is 15 weeks. If you do the math of what that will mean, the optimum build of inventory I really like to be at 85. That would be kind of awesome. 95 is not bad at all. With one or three we perhaps would have a slight [inaudible] but quite frankly the inventory reductions.

Let me say it differently. The increase of inventory we had a year ago was due to foundry. We bought foundry. We had a big contract on foundry but now that we don’t have any foundry that the manufacturing is actively running below our rate of sales, we think that we’re in a pretty good position. To add on that topic of [financially] here, don’t forget on the current inventory now that we’re still carrying a bit heavier inventory in SP1 because this is kind of in a startup mode. If you take the non-SP1 situation here right now, we are actually pretty good.

Dario Sacomani

I would just [inaudible] where that die can go with respect to what customer.

Bobby Gujavrty - Deutsche Bank Securities

Did you have any asset sales in the quarter, maybe older equipment or something like that?

Dario Sacomani

No. Nothing significant. We had some sales of scrap wafers but nothing significant in relation to equipment.

Bobby Gujavrty - Deutsche Bank Securities

It sounds like your op ex cuts you’re implementing in 4Q, they’re sustainable through ’09 and you might even see further declines in each of the categories both R&D and SG&A then.

Bertrand F. Cambou

I can tell you that not only are the cuts sustainable but this is just the first step. We’re currently looking at cutting much, much deeper and there was a lot of opportunity for cutting now like I was explaining to a colleague and friend Daniel here early on. We are on the R&D suite used to have a lot of investment to start up SP1 300 millimeter. That’s done. The 65 nanometer is done. Our 45 nanometer is looking extremely done. We have now a focused organization. We can spend less. We are going to have alliances going forward which means that we are currently thinking about how to go much, much lower than where we are right now.

Operator

Our next question comes from Betsy Van Hees - Caris & Co.

Betsy Van Hees - Caris & Co.

In the past you have provided us with the revenue breakout for ORNAND and MirrorBit or maybe percent of business. I was wondering if you could tell us how much ORNAND shipped in the quarter and MirrorBit?

Bertrand F. Cambou

On the MirrorBit we did very high; higher than 80%; between 80% and 85% if my memory is good. The reason that we don’t keep reminding everybody on that one here is because it’s so high that when you get to this level here, the floating gate at the end of the day for us right now is left to some of the CSID business. We essentially don’t have any significant in the wireless.

If you look at the slide number three in the package we sent you, you can see here that that information has been provided. MirrorBit revenue was $511 million which is an all-time high on the graph for the quarter which is probably almost 85%. 81% Dario said.

Concerning the ONAND, obviously what we had, the plan was to sell in the $50 million range in ONAND for Japan. What we have has been a collapse of that market here and it has nothing to do with ONAND. What you had in Japan is essentially the authority elected to discontinue subsidies for cell phones. In Japan the cell phones are very expensive. In the past people were just buying the phone and paid back on the subscription and not exchange. As a result the renewal rate just went down the tube and this year, in particular in the second half of this year, the entire wireless Japan is cut.

That has been impacting our ONAND sales this quarter as being low. We expect that number to stay pretty low right now in the short term because the ONAND has been excellent to startup SP1 but very soon Sp1 is going to be totally full with NOR and then the next time we are essentially going to do ONAND is at 45 nanometer and to notice that we already have are walking 45 nanometer ONAND as we speak are going to essentially offer it to the customer pretty soon and use it as a debugger of the 45 nanometer six to nine months ahead of NOR.

Betsy Van Hees - Caris & Co.

You did a great job of explaining what happened to your gross margins and why they were so much lower than I think everyone’s expectations were going to be. I’m just trying to understand as I look at Q4 and you’re saying that gross margins are going to basically be flat to slightly up. What are we looking for that’s going to contribute to that because we’re not going to have the write-off that you had of the 90 nanometer content delivery business?

Bertrand F. Cambou

What Dario has been alluding to is we think that the margins actually are going to go up a couple of hundred basis points in Q4 unless we take the decision to slow down some of our factory because the outlook of Q1 will turn out to be bad. We all our watching the financial meltdown and the consumer spending and all these type of things, and if it turns out in the quarter that we have a softening of Q1, we are going to then take actions to cut our run rate as we should because like we say we are committed to control inventory, and by doing that it’s technically going to reduce our gross margin. And in this case the gross margin will be approximately flat which would be essentially the result of first taking action if the economy was to go down.

But like Dario was eluding to, the most likely if everything is moving okay, then we assume now that the consumer is eventually going to somewhat recover a bit, not great, and we keep getting share, then we have an opportunity to actually increase a couple of percent the margin in Q4.

Betsy Van Hees - Caris & Co.

Switching gears a bit, could you give us a little bit of an update on how things are going with MirrorBit Eclipse in terms of design wins and when we can expect revenue contributions from that?

Bertrand F. Cambou

In the case of Eclipse we have two families of Eclipse. The family that was essentially going to use as a way to upgrade our NOR performance by offering a much faster NAND like writing performance. Right now this technology’s mature is in the customer hand, multi-customer which means that is moving on track.

Then there is a second version of Eclipse which is the EcoRAM, and that one is actually moving extremely well. Like I was saying on my prepared remarks, we have [alpha] server that has been tested by customers. The performance we’re getting with EcoRAM for [inaudible] is actually as expected; way superior to any other memory technology in existence. We are expecting a firm order this quarter and revenue either this quarter or next quarter which means this is moving. That’s a 2 gig Eclipse type device for server application.

Operator

Our next question comes from John Pitzer - Credit Suisse First Boston.

John Pitzer - Credit Suisse First Boston

Bertrand, just as a follow on to that EcoRAM. Is that multiple customers or is this a single customer? And can you help me understand; is EcoRAM usable both within an AMD server environment and an Intel or just an AMD?

Bertrand F. Cambou

The customers that we have are multiple and we have actually layers of customers. What you have here is the first customers to use it are going to be final Internet companies in Asia. First customer to use it.

Then there is a second layer of customers which are a little bit more conservative but are the big box makers. That one essentially built the server and they’re not going to sell it across the board. Those people are also evaluating our technology very successfully right now but we don’t think that those people are going to place firm orders in the near term because they have their own quality process and then that’s a bit longer here which means that we see the first order to come from the Asian Internet company to be followed early next year by the big boxes, and then we see the Internet companies in the US to place orders as well in the late Q1 type of schedule.

As far as the implementations, we’re not at that point disclosing what CPU is to be used. Obviously our strategy is to support the two but the timing and the road map has not been made public at that point.

John Pitzer - Credit Suisse First Boston

Bertrand as you try to look inside this market for ’09, what kind of numbers do you think are appropriate to use?

Bertrand F. Cambou

This type of business is very big, which means that for us definitely as a company we’re going to reassess at the right moment here, but we are thinking about the triple digit millions of dollars revenue for ’09. And the way we’re going to plan for it is obviously because there’s a lot of unknowns, this is a new technology, could be much bigger, who knows?

What we have right now is we have dedicated a piece of SP1 for it, and then we’re going to essentially use external manufacturing as a valuable way to support it which means that we are currently qualifying it in the two areas, which is the SP1 or SMIC, to put some flexibility into the system as a function of the size of the business.

Back to your question here, for us we’re thinking about a hundred million dollar type of number here for ’09, and of course a much higher number after that.

John Pitzer - Credit Suisse First Boston

I’m sorry if I missed this or if you talked about this, but just relative to the outlook of the Japanese handset market into December, what’s the view? It was clearly disappointing in September. Do you think that it continues to be a disappointment?

Bertrand F. Cambou

We think it’s going to be very low. What you have right now is the handset company in Japan has been kind of building inventory the first six months of the year and their shelves are just full and the phones are not selling which means the inventory right now that we have in Japan is essentially in the form of a phone already built. We don’t have any flash inventory in the system but their phone has been overbuilt. Now there are some new models that essentially are going to create some revenue in Q4 which is not going to be zero but definitely with Japan right now, it has to sort out that situation.

As you know things can change. In Japan you may have tomorrow morning a new minister policy that essentially is going to reverse the things to try and reactivate the national cell phone industry, and that business would just explode around the holiday season. It is not up to me to guide you on that one, but as far as Spansion is concerned right now we are planning no recovery whatsoever in the next six months.

John Pitzer - Credit Suisse First Boston

When you look at the market share gains, which have been impressive, how much of the near-term market share gain would you attribute to disruption around [Pneumonics] integration and how worried do we have to be that once those two entities kind of iron out things and get up and running that the competitive environment gets a little more difficult again?

Bertrand F. Cambou

We believe that actually the market share gain is the beginning because the way we’ve been gaining has been to get deep engagement with the strategy customer. And with those strategy customers when you are in, you are in. They’re not going to play. In those places, Spansion was not there. Now we have a big foot in the door and where we are now we’re going to put the second one and then we have an aggressive technology and we are aggressive people. We like that business. We like those customers and we’re going to make [Pneumonics] like [inaudible]. That is a beginning.

Now in the CSID business, this is a bit of a more fragmented business indeed here but right now we are so much ahead we are like twice as big as they are. They’re currently suffering because obviously now it has been published by our supply that [Pneumonics] is so much smaller than us. They don’t have our economy of scale. They don’t have a company that is focused like we are. They are still worrying about the integrations, and the integrations task is not done, it is not behind them. They will now have to go and it is going to take them some time before they can be effective.

That is definitely our strategy right now to delight our customer. We enjoy about 40% market share compared with 33% last year and we have a big ambition and appetite to keep pushing it to the higher number.

Operator

That does conclude the question and answer session. I’ll turn the conference back to management for any additional or closing remarks.

Ken Tinsley

Thanks everybody for joining and hope you have a great evening.

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Source: Spansion, Inc. Q3 2008 Earnings Call Transcript
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