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Spansion (NYSE:CODE)

Q4 2012 Earnings Call

January 29, 2013 4:30 pm ET

Executives

Melanie Friedman

John H. Kispert - Chief Executive Officer, President and Director

Randy W. Furr - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Analysts

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Ada Menaker - MKM Partners LLC, Research Division

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Monika Garg - Pacific Crest Securities, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Spansion earnings conference call. My name is Stacy, and I'll be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to Spansion. Please proceed.

Melanie Friedman

Thank you, Stacy. Good afternoon, and thank you for joining us on today's call to discuss Spansion's fourth quarter and full year 2012 financial results. My name is Melanie Friedman from The Blueshirt Group. And with me today from Spansion are John Kispert, Chief Executive Officer; and Randy Furr, Executive Vice President and Chief Financial Officer.

We hope you saw our earnings press release issued today and posted to our website. Also on our website is a brief slide presentation that we will refer to during the call today.

Before we move on, please note the Safe Harbor statement on Slide 2 of today's presentation.

During the course of this meeting, we may make forward-looking statements regarding future events or the financial performance of the company. Such statements are based on assumptions as of the current date, and you're cautioned that these forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those statements.

We urge you to review in detail the risks and uncertainties discussed in our Securities and Exchange Commission filings, including our annual report on Form 10-K for the fiscal year 2011 and the Form 10-Q for the third quarter of 2012. The company disclaims any duty to update forward-looking statements.

Our agenda for the call today is as follows: John will discuss key highlights from the quarter and year, and then Randy will review these from a financial perspective and provide the forward-looking guidance. A Q&A session will follow.

Now I'd like to introduce John Kispert, CEO of Spansion.

John H. Kispert

Thank you, Melanie. Good afternoon, and welcome to our fourth quarter 2012 earnings conference call. In the fourth quarter, we executed well in what continues to be a challenging macroeconomic environment.

Going into the quarter, we expected a stronger quarter. And with the exception of Japan and, more specifically, our gaming business in Japan, the quarter unfolded largely as we expected, delivering another profitable quarter.

In aggregate, worldwide macroeconomic concerns, particularly in Japan, were more prominent at the end of the quarter with many of our customers, which resulted in revenue towards the lower end of guidance.

Overall, we were pleased with the Q4 results and are optimistic about 2013 with our continuing design win momentum, strong product positioning and innovation in our embedded markets.

My comments today will be organized as follows: First, I will summarize our Q4, and then I'll update you on what we're seeing in the market and on the latest developments across our various businesses. I will review your -- our design win progress. Finally, I will review 2012 fiscal results and what we are seeing for Q1 in 2013. Randy will then give you the fourth quarter financial details and the outlook for the first quarter. After which, I'll field your -- we'll field your questions.

Our focus and execution on delivering high-quality, differentiated products across our Flash product line and our programmable system solutions continued in the fourth quarter. In addition, we put tighter discipline on expense controls.

For the fourth quarter, we achieved revenue of $224 million, non-GAAP adjusted gross margin of 36.1%, non-GAAP adjusted operating income of $32 million or 14.3% of revenue, adjusted EBITDA of $46 million, non-GAAP diluted EPS of $0.34 per share and cash, cash equivalents and short-term investments of $314 million.

You can see from our segment and revenue breakdown on Slide 4: first, Consumer; and then, second, Transportation & Industrial were up and Communications & Gaming were down.

Across all segments, we continued to secure design wins with our newer products. Our strategy is to generate cash and to continue to improve our profitability are centered around 4 key areas: First, maintaining leadership in our Parallel NOR; second, growing our Serial Flash business; third, delivering and growing our NAND business; and, finally, driving momentum for our programmable system solutions, where we see continued benefit to our customers by combining Flash and Logic for value-added applications such as voice recognition.

Now I will highlight our progress in each of these areas in Q4. In Parallel NOR, we remain the market leader. And like the prior quarter, we saw adoption of our latest generation of products, as evidenced by the design wins in Q4 across all segments. We also announced the industry's first single-die 8 gigabit NOR product at 45 nanometer. It delivers high-quality, fast random-access read performance to enable a better user experience with interactive graphics, animation in video and games and in industrial applications. We have sampled the product to a number of customers over the past 2 months. We will continue to accelerate sampling in the -- to additional customers this quarter with mass production, and that means revenue starting in the second quarter. Thereafter, we expect revenue to ramp steadily through the year.

In the area of Serial Flash, we continue to aggressively drive migrations to newer high-density products and expand our offerings on lower densities for applications such as home network and equipment, e-Learning devices, white goods, printers and high-end computing peripherals.

Demand for our NAND product continues to grow. After announcing our new NAND offerings in late Q2 of 2012, we achieved revenue of $2 million within the first 90 days and finished Q4 with $10 million for the quarter, validating that NAND is a growth opportunity for Spansion.

In Q4, we also had more than 90 NAND design wins and engaged with customers on a number of different platforms, such as digital TVs, set-top box platforms, gaming consoles, cameras and a number of industrial and networking applications.

We recently secured a significant win with a new customer, who is a top-tier brand in Asia. We will become their NAND supplier for their new gaming system.

In the area of programmable system solutions, we integrated Spansion Acoustic Coprocessor with another leading chipset platform for the automotive market. The product is qualified in-production. It's is now being designed in by a number of Tier 1 automotive customers. We expect volume production by the end of the year.

Turning to our design wins, we had another year of strong design win momentum with approximately 1,900 design wins for the year. In particular, this quarter, we saw a new interest in our NAND products and continued to secure new design wins for our newer products to enable graphic-rich, intelligent and connected electronics in the embedded markets.

In Consumer, we secured approximately 200 design wins in the fourth quarter, with more than 1/2 of them for our high-density products. Our high-density products have seen design wins for home networking, factory automation and machine-to-machine applications. More and more consumer products require instant-on for their role in capturing, viewing, sharing and storing digital content. We are confident that the growth in the Consumer segment will continue.

In Transportation & Industrial, we secured approximately 180 design wins. In Transportation, these wins are primarily for instrument clusters, heads-up display and infotainment. There are also under-the-hood sockets. The 2 trends we have talked about before continue to drive future growth in automotive. First, in the area of driver-assisted cars, which require more advanced sensing technologies, such as cameras, lasers and infrared, all of which require more code, data and intelligence. And, second, increased connectivity in the car with the cloud. An example of that would be the car area network will become more congested and thus, new standards are -- will be needed to require more Flash memory to support complexity of the car network.

In Industrial, the second half of 2012, we saw a significant increase in demand, particularly driven by a variety of energy platforms and medical platforms like insulin pumps and defibrillators, aerospace and even some in military, as well as security surveillance. These applications increasingly require enhanced graphics, performance and longevity as they become more interactive and enable automation in control.

In the area of Gaming and Communications, although we were disappointed with how much production bias took place in the quarter, we still had more than 60 design wins. We had excellent results here in Q2 and Q3 of 2012. B but our Q4 and our current view of Q1 are colored by customers who are transitioning to new platforms and with our 8-gig 45-nanometer product squarely in their sweet spot, we believe, delivering higher performance for their gaming application needs, we're optimistic that, in the second half of 2013, we will drive higher revenues in this segment with this new product. We've already entered mass production.

Our Communications design wins were primarily for LTE platforms and enterprise systems to support the continued growth of the Internet of things. I will remind everyone that in the terms of translating design wins into revenue, Consumer and Gaming design wins will generally translate into revenue in the next few quarters. Transportation and Communications and Industrial could take longer, up to 15 to 18 months.

Turning now to our fiscal 2012 results. We delivered profitable growth, revenues of $916 million and maintained our leading market share position in the embedded market. Overall, and despite a very challenging market in 2012, Spansion performed relatively well, achieving 11% operating margin and earning roughly $1 per share.

We launched a total of 13 new industry-leading products, doubling last year's amount and surpassing our competitors' Flash memory offerings.

In addition, we entered new product categories and markets with the launches of our NAND and Acoustic Coprocessor products. All of this resulted in design win growth year-on-year of roughly 25%.

In summary, the milestones we achieved in 2012 position us well for the long term, with our strong product portfolio, design win momentum and strong customer relations.

For the first quarter, we are guiding conservatively. Historically, the first quarter is seasonally soft, typically down roughly 10%. The midpoint of our guidance this year for Q1 is closer to down 14%.

There are 2 reasons for the conservative guidance: First, we don't expect the gaming business to ramp their new products until the latter part of Q2. Second, Q1 is always characterized by a large amount of turns business that materials -- materializes in the latter half of the quarter. With that in mind, we're simply being cautious. So we've taken an overall conservative approach to Q1.

Many are predicting our research is starting in Q2, we believe we can benefit this -- from this more quickly than others due to our deep customer relationships, reach of more than 8,000 customers, our new product lines and increased demand for our 65- and 45-nanometer Flash products, as well as our new NAND offerings. Although we only guide 1 quarter at a time, I can say that we estimate Q2 to be at a run rate of -- at our just announced Q4 or better.

Overall, we are optimistic that Q1 is the bottom for fiscal 2013, as next-generation electronics become more advanced, addressing the need for connectivity, fast access to richer content, new user interfaces and more automation and control, we see demand for high-quality Spansion memory continuously increasing.

I want to thank our shareholders, employees, customers and partners for their ongoing commitment. Together, we can create more innovation for these embedded markets and long term value.

And with that, I'll turn the call over to Randy.

Randy W. Furr

Thanks, John. Let me start with the summary of our fiscal Q4 2012 operating results, which, as John indicated earlier, we are pleased to report we're generally in line with the guidance provided during our Q3 earnings call.

On a non-GAAP basis, sales was $224 million, gross margin 36.1%. Adjusted operating income was $32 million, equating to an operating margin of 14.3%. Adjusted EBITDA was $46 million. And non-GAAP diluted EPS come in at $0.34.

For the full year, net sales totaled $916 million. On a non-GAAP basis, adjusted operating income was $102 million; adjusted net income, $62 million; and adjusted EPS was a tick under $1, rounding down at $0.99.

As I discuss the financial results in more detail, I'll be referring to the presentation we have posted to our Investor Relations section of our website.

On Slide 4 of that presentation, you'll see a breakdown of our sales by end market and geography. As John mentioned, revenues come in at the lower end of guidance. Q4 saw sales particularly strong in the APAC region, which is primarily China. Again, this is ship-to location. In percentage of the total revenue turns, all other regions were up slightly or flat with the exception of Japan, where revenues were down approximately 6%. In APAC, we saw revenues grow in both percentage and absolute dollar terms, which was driven by continued strength in Consumer, as well as growth in Industrial.

In Japan, Gaming accounted for the majority of the decline. Again, our Gaming business can and will be lumpy from time to time. And right now, that business is going through a product transition, with the next generation of new products expected to begin shipping in Q2.

As John mentioned, our new 45-nanometer 8-gigabit GLT product, that we started sampling in Q4, is targeted for this sector. We're optimistic that you'll see revenue resume growth in this sector starting in Q2.

Turning the discussion to end markets. Consumer showed strength, increasing 2% quarter-over-quarter. This was driven by strength in both set-top box and digital TV.

Transportation & Industrial was up, driven by strength in Industrial. And in Industrial, we saw strength in medical, home energy and in surveillance, as surveillance revenues more than doubled quarter-over-quarter. In total, Transportation & Industrial was up 1% sequentially, coming in at 24% of total revenues.

We did see a bit of weakness in the Communications sector, with revenues being down sequentially in the 12% to 13% range. Combining this with my earlier comments on Gaming, and as you can see from Slide 4, the Communications & Gaming end market sector was down overall by approximately 21%, coming in at 27% of total revenues.

Turning to Slide 5. We will review the income statement highlights. Non-GAAP gross margin, again, driven by good capacity utilization in our internal operations and the migration from our 110- and 90-nanometer products to our newer 65-nanometer products remained above 36%, coming in at 36.1%.

In Q4, the percentage of 65-nanometer revenue grew from approximately 26% in Q3 to 31% in Q4, an increase of approximately 9% sequentially.

As we've previously mentioned, migration towards our newer products will continue to be a tailwind for margins.

Moving to operating expenses. R&D decreased from Q3. During the quarter, we released 3 new products. SG&A also decreased sequentially. And a laser-focus on spending is responsible for the decrease in both R&D and SG&A. We continue to show leverage on our model as evidenced by our increase in operating margin of 121 basis points this quarter. And we've accelerated our product introductions, while continuing to reduce spending relative to revenue.

The result is total operating expenses came in at $49 million, a decrease of almost $7 million or over 12% sequentially. This translated to non-GAAP operating income of $32 million compared to last quarter's $31 million. Non-GAAP operating margin increased sequentially from 13.1% in Q3 to 14.3% in Q4, fourth consecutive quarter of sequential operating margin improvement.

We incurred $7 million in interest and other non-operating items. Q4 was up sequentially only due to Q3 having an $800,000 in FX gains related to the cash proceeds from the sale of our KL facility in Malaysia.

For the remainder of 2013, we are looking at approximately $7 million to $7.4 million a quarter in other non-operating expenses. However, in Q1, we do expect to see a benefit or gain of approximately $1 million related to the sale of auction rate securities offset by higher estimated FX losses in Asia of approximately $200,000, resulting in other non-operating being in the $6.2 million to $6.6 million range. Again, this is for Q1.

Our income taxes in Q4 were $3.4 million. As mentioned last quarter, taxes in Q4 included a one-time charge of approximately $1.3 million or approximately $0.02 per share, as we released some existing deferred tax assets associated with a tax holiday for a foreign subsidiary that will benefit future periods to the tune of approximately $1 million to $1.2 million a year for the next 8 to 13 years. Obviously, if this one-time tax item had not flowed through Q4 earnings. Earnings would've been $0.36.

As a reminder, we have significant U.S. and California NOLs, and the $3 million in tax expense in Q4 represents foreign taxes. Going forward, we should see taxes in the $2.2 million to $2.7 million range each quarter.

Adjusted EBITDA was $46 million or 20.5% of sales. Our non-GAAP diluted EPS was $0.34 in Q4. So still, on Slide 5, this quarter we added Column 4 titled Reorganization. Now this is not restructuring, it's simply a place where we've separated and highlighted 2 items that netted to a credit or a profit that we needed to back out to get to non-GAAP.

Column 5 of Slide 5 takes the GAAP results listed in Column 1, and that's for the non-GAAP adjustments to get non-GAAP results for Q4. The Q4 results listed in Column 5 here relate to the financials depicted on Slide 6, which we have included to show a quarterly apples-to-apples comparison going back to Q4 of 2011.

Now I'd like to turn the conversation to the balance sheet. So please refer to Slide 7, and I'll start with cash. We ended the quarter with cash, cash equivalents and short-term investments of $314 million. Now this is down from Q3's $328 million. However, when you consider that we spent approximately $25 million to buy back shares and settle our dispute associated with the Tessera bankruptcy disputed claim, $3 million in Q4 cash cost for the term loan refinanced and $12 million on capital additions, ending with $314 million in cash is pretty positive.

We continue to focus on generating cash from operations and working towards a net cash position. Despite the Tessera settlement and refinancing costs, we essentially cut our net debt position in half by improving net debt by $85 million year-over-year.

With respect to working capital, trade accounts receivable was $107 million, down approximately $10 million from Q3. DSO, or day sales outstanding, dropped sequentially from 45 days to 43 days. Inventory for Q4 was up approximately $10 million quarter-over-quarter to $182 million, and we ended with 109 days of inventory, up from 97 days in Q3. The increase in inventory was driven by our production plan to reach the midpoint of our guidance from last quarter. Accounts payable was $86 million at the end of Q4, and this equated to 44 days. So the net is net cash cycle days was up a bit from 105 days in Q3 to 108 days in Q4.

Now I'll turn the discussion to guidance for Q1. So please refer to Slide 9. As we show in our earnings release, expected range for Q1 net sales is $180 million to $205 million. Without stock-based equity compensation and IP amortization, we expect non-GAAP gross margin to be 26.5% to 28.5%, translating to non-GAAP diluted EPS in the range of a $0.05 loss to a $0.06 profit.

Q1 is typically, seasonably weak for us. Historically, we see revenue decline of approximately 10% between Q4 and Q1. Our guidance implies that we're entering Q1 cautiously, as we see multiple challenges to include the macroeconomic environment is still not robust. U.S. consumers are absorbing the impact of higher taxes on their spending. Europe continues to have their issues and Japan's struggles are well documented. And finally, our APAC customers, we believe have taken advantage of some competitive pricing at year end to build inventories in advance of the Chinese New Years.

Slide 10 lists our first quarter 2013 focus areas, which include growing our core embedded business, growing our NAND business, getting design wins for Acoustic Coprocessor, staying on track with our new product roadmap, continue to migrate to our newer 65-nanometer products and aggressively increasing our operating efficiencies and lowering our operating cost.

Slide 14 is presented to help in the reconciliation of historical GAAP to non-GAAP.

So with that, I'd like to thank you for your time today and turn the call over to Stacy for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Raji Gill with Needham & Company.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

On the gross margin guidance, non-GAAP 26.5% to 28.5%, you didn't really talk too much about why that's dropping from 36%. What are the reasons why that's been dropping besides just lower volume? And what type of margin should we be looking for -- looking to going forward?

Randy W. Furr

Yes. So, Roger, it's Randy. Hey, good question there. So look, as usual, the thing that most impacts our gross margin is just the overall internal facility utilization. Obviously, we ended Q4 with a little higher inventory. And the plan is to dial back internal operations, work through some of that inventory and deal with the situation of lower revenues in Q1. So as a result, our overall internal utilizations will probably go from somewhere in the 90% utilization in Q4 down to probably 70% or maybe even slightly a tick under 70% in Q1. And that's what's bringing the gross margin back down into this, the midpoint of 27.5% range. We do expect the gross margins to pop back up into the mid-30s by Q2 on the higher revenue and the fact that we will be utilizing the facilities at a much higher utilization rates.

John H. Kispert

Hey, Ryan, I'll just add -- it's John. Let me just add that we feel is key to make sure we got the -- eventually, there will be a bounce-up. Lead times are just too short. And even within that, the customers are asking for shipments way within the lead times. So we wanted to build inventory. We think we're in the right position on inventory. We don't want to keep cranking that up. So the company is well positioned to be able to react if there's a bounce in different parts of the world or in different segments.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

I think, if I heard you correctly, you said about $10 million of SLC NAND in Q4?

John H. Kispert

That's correct, yes.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Where -- it's not really broken out in the revenue by segment -- slides. Is that -- are you going to identify that into a separate category, or is that kind of spread closer to the set -- on the consumer side with the set-top box or on the com side? How should we kind of categorize that?

Randy W. Furr

So, Raji, good question. We thought about this quite a bit. So we intend to disclose our NAND revenues. But again, I think it's important to understand that our NAND is sold to our existing embedded customer base. So the way we normally talk about our business, we break it down between embedded, historically what's wireless and we break out our royalties. But our NAND is part of our overall embedded customer base. So when we refer to embedded, that's a combination of Flash memory, which includes our NOR, both Parallel SPI as well as NAND. And we will just disclose for you, in the future, how much of that is embedded NOR and how much is embedded NAND.

John H. Kispert

So in Q4, Raji, we were -- we sold NAND into the Industrial segment, certainly into the Transportation segment, Consumer and Communications. So it's broad across the segments.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

Should we be looking at, kind of, a $10 million quarter run rate for NAND? Or is that, if you get more design wins, that could ramp further up?

John H. Kispert

Yes, I -- we think it's going to ramp continuously through the year. We think coming in and going into Q1 that we're in that run rate in the $10 million or more for Q1, and we'll see how it goes as the year goes on. But certainly, the design wins suggest that there is more growth through the year.

Rajvindra S. Gill - Needham & Company, LLC, Research Division

The OpEx for Q1, kind of implies another big step function down from Q4 or something like maybe the $44 million to $45 million range. I haven't finalized the numbers yet, but in that range roughly. So that's -- based on that run rate of OpEx, the -- we could see operating expense coming down pretty steeply, sharply in 2013. How do you look at kind of the OpEx structure? What are you doing in terms of the OpEx structure of why you're seeing such a reduction there? What steps are you taking?

Randy W. Furr

Yes. It's a really good question. So look, I think, part of it is we have really took the laser-focus on all of our cost, and we've taken steps to reduce our cost because of overall top line, kind of, situation here. So we're managing our business, and we're watching how much we have. So we've just done things like we haven't -- we put in some reductions in terms of hiring. We are now only hiring critical positions that we have going forward, and we're just really focused on trying to reduce cost. I do expect that we're going to be able to maintain that level or beat that level in Q1 that's coming up, again, in reaction to the overall top line. But throughout 2013, as our topline continues to improve, and we expect it to improve, we do also expect our operating expenses to flow up there with the top line as it increases too. Now we'll get some leverage on that, but we just don't want you to think that the levels that we're going to end up with in Q1 or Q4 are necessarily levels that we'll sustain as our revenues grow nicely throughout 2013. Our operating expense will grow in 2013 with the top line.

John H. Kispert

And we expect to get another 14, 15 new products out this year. There's no change to our execution. Our focus is still on our customers and these new products. We'll just keep squeezing. We'll find ways to lower the breakeven. You can count on that with this management team, in good times or bad times, to keep squeezing.

Operator

And your next question comes from the line of Daniel Berenbaum with MKM.

Ada Menaker - MKM Partners LLC, Research Division

This is Ada calling in for Dan. Could you talk a little bit more about the R&D trajectory for those new products you were just talking about and kind of how that looks like over the course of the year?

Randy W. Furr

Ada, it's Randy. We had a little bit of hard time hearing you. Are you asking about R&D, operating expenses and what the trend is going to look like throughout the year?

Ada Menaker - MKM Partners LLC, Research Division

Yes, please.

Randy W. Furr

Yes. So again, I think R&D to a function is related to our new product development roadmap. And at Spansion, we expense our mass sets, we expense our probe cards until the product goes into production. So R&D is not just fixed set of salaries and it's constantly going to be the same, it's going to vary from time to time based upon our new product roadmap that we have out there. In some quarters, it will be a little higher. In other quarters, we will try to make that guidance. I do think, again, with respect to the plan on the new products roadmaps that are coming out in Q1, it will be a number that will be probably a bit less than we reported in Q4. And the same with SG&A, it's going to be less as well, again, in reaction to the top line. But as John pointed out, we're not delaying our new products that are coming out. I think, by the time we get to Q2, as John mentioned, we expect our -- run rate of the company to be back up at numbers that we posted on the top line for Q4 or better. And I think, at that point, you'll see R&D start to grow again. And I would expect it to grow up to numbers that, by the end of the year, are probably somewhere between $25 million and $27 million a quarter.

Ada Menaker - MKM Partners LLC, Research Division

Great. And could you maybe talk a little bit about the inventory in the distribution channel right now, and what you think that's going to look like?

Randy W. Furr

Yes, I'll take a little bit of that. So again, just as a refresh, Spansion only recognizes revenue in terms of sell-through. So any inventory that's in the distribution channel for Spansion is already recorded on our books. But we monitor that in terms of weeks. We're right now probably at the lower end of that, as opposed to the midpoint or the higher end. And we try that -- we try to keep the inventory out there in the distribution channel fairly lean, and I think we did a relatively good job with that. I think -- what we think, and I made a comment about this, is that in advance of Chinese New Years, we think there was some pretty aggressive pricing that happened in -- late in Q4. Some of our customers took advantage of that, not necessarily from us, but from the competition, maybe some from us as well. And we kind of factored that into our guidance going there into Q1. So we're, again, a bit cautious there with our guidance.

Operator

And your next question comes from the line of Krishna Shankar with Roth Capital.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

How much of the revenue weakness in Q1 is due to the gaming platform transition in Japan?

Randy W. Furr

Yes. So a substantial part of it, I would say, the majority, but not all of it. The Gaming business -- and we've been saying this. And actually, if you look at history here, you will see the Gaming business tends to be lumpy. And the kind of the way that business works is that they design and qualify new machines, new systems. And that qualification is part of the overall government process that they go through, and they come out with more or less different model a year -- different new products, say, on a 12 to 18 months kind of a plan. If you noticed, Q2 and Q3 was relatively strong for us in this business. And we have a new product that's the industries only 8 gigabit and it's a single-die, that's based on 45-nanometer technology and it's designed for these new systems that's coming out there, that have very rich graphic as part of the systems. We expect those systems to be approved and to go into production, there's multiple customers and there's pretty detailed product roadmaps and schedules that go with them starting in Q2. Now I think the revenue that will come out of Q2 will certainly be quite a bit more than come out of Q1. But I think you'll really see pretty robust Q3 and Q4 in our Gaming business. With that said, it's not 100% Gaming. There -- as I mentioned in my prepared remarks, and it's pretty well documented, there's a number of challenges going on in Japan. The auto industry is being challenged today. They're not exporting as many autos, especially into other parts of Asia because of some...

John H. Kispert

This is Japan we're talking about.

Randy W. Furr

Yes. Japan's hot, because of some conflicts that are going on. And as such, there's softness in Japan -- throughout Japan, not just the Gaming, but throughout Japan. We're pretty confident that some of the stimulus programs that the government's talking about in Japan, we'll see some of that stuff come back. So we think Japan, in the second half of the year, is going to be strong, not only because of this Gaming business but also because of just the other segments that we have in Japan, includes consumer and auto that should be a far more robust second half than it was in Q4 and will likely be in Q1.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

Great. Then Just as a follow-up, on the gross margin, are you -- can you give us an update on, sort of, your fab-lite strategy? How much is the -- you have some capacity underutilization charges here in Q1, but can you tell us what you're doing with respect to your foundry commitments, and how you're balancing your outsourcing to SK Hynix and SMIC versus what you do in-house to try and stabilize your gross margins?

Randy W. Furr

Well, I'll take a stab at that. I mean, Krishna, it's -- first of all, with respect to the Hynix, they are our NAND partner. And we're -- as John pointed out, want to [indiscernible] NAND. And the NAND volumes that we have all comes from Hynix and they're our wafer foundry partner for NAND. So there's -- we just throttle that or we give them orders as we see demand, and there's no issues there. In terms of our internal fab, the -- to an extent, our internal fab has 65-nanometer capability along with 110 and 90, all the 110 and 90 products are built in our internal fab, and the 65-nanometer is built in our internal fab, as well as our partner, WXIC. So obviously, we think Q1 is the low watermark for Spansion. We cut back both in our internal fab and our external partner as -- because of demand that's out there. Our goal is continuing to be to keep our internal fab full. That's not happening in Q1. And we're going to continue to work on ways to minimize any underutilization of Fab 25 in the future. By the time we get to Q2, as I mentioned, Fab 25 is back up north of 90% utilization, and that's going to drive the improvement in gross margins for the balance of the year.

Krishna Shankar - Roth Capital Partners, LLC, Research Division

So we should get back to mid- to high-30s gross margins pretty quickly once the revenues recover in Q2?

John H. Kispert

That's correct.

Operator

Your next question comes from the line of Monika Garg with Pacific Crest Securities.

Monika Garg - Pacific Crest Securities, Inc., Research Division

My question -- it's more related to, kind of, the targets more that you talked during the Analyst Day in November. Now if you look at -- I mean, if you look at the NAND, that probably adds at least $40 million to $50 million on the top line, on top of 2012 revenues. So the question is, do you think you could do top line growth in that target more of 8% to 10% year-over-year?

Randy W. Furr

Yes. So, good question, Monica. I think, based upon what we observed in late December, I think that if I was modeling -- we don't give guidance for the full year. But if I was modeling, I would probably be under the low end of that for year-over-year growth right now. And we're saying that again because we're just not seeing some of the pickup that we have anticipated we would see after the election.

Monika Garg - Pacific Crest Securities, Inc., Research Division

Okay. And then, the question -- we've seen depreciation in yen recently quite significantly. So how do you think that impacts your feel [ph] in Japan. I understand it's a low percent of total rev, but...

Randy W. Furr

Yes. So fortunately, for Spansion -- well, let me just kind of give you an overview here. About 25% to 30% of our total revenue is just from Japan. Out of that, about 70% to 75% is yen-dominated. And we also have some natural hedge there. We have some expenses in Japan that naturally offset that. At the end of Q2, we implemented a Japanese yen cash flow hedging program to mitigate any volatility to revenue that could potentially cause -- that could be caused by Fx or foreign exchange fluctuations. Our program at Spansion qualifies for hedge accounting and therefore, we mark -- the mark-to-market for hedge is placed out of any quarter exposure and will not affect our current quarter P&L. It goes to other comprehensive income, as you know. This program allows us to hedge our -- our official program, allows us to hedge between 65% and 100% of forecasted annual exposure. As we get closer to the quarter, we forecast a higher percentage. Currently, we are 100% hedged for Q1 2013 forecasted Japanese revenue, and we're about 60% hedged for the balance of the year. And we continue to monitor this and adjust it accordingly. So fortunately for us, we're not impacted on a quarter-to-quarter basis. But obviously, with, right now, higher -- somewhat higher revenue than we have in expenses, we can clearly be impacted, either positive or negative, depending upon -- depending on how the currency goes into the future. But I want everyone to be comfortable that there won't be -- we understand, going in the quarter, so we factored that into our guidance. So there shouldn't be any surprises on a quarterly basis as a result of Japanese yen FX issues.

John H. Kispert

And, Monica, I mean, I think the bottom line answer is the way we look at it is the yen only helps our customers in Japan, whether they're Industrial, Consumer, some of the high-end computing guys, certainly some of our auto customers [indiscernible] they're going to be in a much better position for their business as the year goes on. So that's good news for us.

Monika Garg - Pacific Crest Securities, Inc., Research Division

Just the last one, I think, a couple of questioners before have had this question also. But you were talking about Q2 when the revenues ramp, margins to snap back to 35% level. And then, for Q3, Q4, if the revenue keeps ramping, we should expect -- we can expect that margins to go higher than that range as well.

Randy W. Furr

Well, good question. So again, as I pointed out in the past, the -- one of the biggest single areas impacting margins is the overall, internal utilization. And we do think it's going to be back up into the high 90s. So I think we're optimistic that we're going to get back up into that mid-30s by Q2. And I think, we don't really provide a forecast beyond that. But I think where you go from there is a function of a continued tailwind, as I call it, migration to our 65, and then, by then, our 45-nanometer products, offset by just the general mix of our products in terms of the geographies that we sell into, as well as the overall product mix between high-density Parallel and segment density SPI. So we'll probably be a little more comfortable at -- of guiding beyond, getting that mid-35s after we get into Q2 when we get a better look at how the product mix is going to be in the future.

John H. Kispert

Directionally, you're right, Monica. Obviously, if the mix is right, which we think it will be, as the company grows, the margins are going to expand.

Operator

[Operator Instructions] Ladies and gentlemen, that does conclude the presentation for today. You may now disconnect, and have a great day.

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