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Spansion, Inc. (SPSN)

Q3 2006 Earnings Call

October 18, 2006 4:30 pm ET

Executives

Dr. Bertrand Cambou - President and CEO

Dario Sacomani - Executive Vice President and CFO

Bob Okunski - Director of Investor Relations

Analysts

Michael Masdea - Credit Suisse

Glen Yeung - Citigroup

Alex Gunn - UBS Financial

Prenna Lahariah - Deutsche Bank

Shawn Webster - JP Morgan

Daniel Amir - WR Hambrecht

Darren Hudson - Morgan Stanley

Presentation

Operator

Good day and welcome to the Spansion Third Quarter 2006 Conference Call. Today's call is being recorded and now for opening remarks and introductions I will turn the call over to Bob Okunski, Director of Investor Relations. Please go ahead.

Bob Okunski

Thanks, Matt. Good afternoon everyone and welcome to Spansion's Third Quarter 2006 Earnings Conference Call. This is Bob Okunski, Director of Investor Relations here at Spansion. Joining me are Bertrand Cambou, President and CEO; as well as Dario Sacomani, Executive Vice-President and Chief Financial Officer.

As for procedure on this call, Bertrand will start out with a high level view of the quarter followed by Dario who will give some additional color on the performance and then turn it back to Bertrand for guidance. We will then open up the call for questions.

Before being today's discussion I need to spend a few minutes reminding you of the Safe Harbor limitations of our discussions. 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 future deployment of MirrorBit technology including MirrorBit Quad, ORNAND and 65-nanometer products, expected fourth quarter sales and future facilities and capacity plans and foundry supply expectations.

Investors are cautioned that the forward-looking statements in this script and conference call involve risks and uncertainties that could cause actual results to differ materially from the companies 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, the company urges investors to review in detail the risks and uncertainties in the company’s Securities and Exchange Commission filings including but not limited to the company's annual report on Form 10-K for the fiscal year ended December 25, 2005 and periodic reports on Form 10-Q. Most recently our 10-Q report filed for the quarter ended June 30, 2006; and our registration statement on Form S-1 filed October 10, 2006.

Finally a copy of this press release is available on our website and this live call is being recorded for replay purposes and can be accessed on our investor relations website at www.spansion.com. A telephone replay will be available for seven days following this call and can be heard by dialing 888-203-1112 with the pass code 4759139.

With that I'd like to turn the call over to Bertrand Cambou, Spansion's President and CEO. Bertrand.

Bertrand Cambou

Thank you, Bob. Good afternoon and thank you for joining us. I'm going to focus my comments on the status of the business, accomplishments during the quarter and then Dario will go to the financials.

Revenue for the third quarter was a record for the company at $675 million. This is up 31% versus Q3 last year. We had growth in Korea, Europe and the Americas. Unique shipments, average density and blended ASP were all up quarter-on-quarter and we gained further market share against our largest competitor.

In total, Spansion MirrorBit product was well accepted and rose to 53% of net sales in Q3 driven by greater sequential demand for high density solutions, in particular a 256 mega-bit and 512 mega-bit which were up more than 15% in units compared with last quarter. We reduced sequential operating loss to $10 million from $27 million last quarter, almost 90% pull through. We essentially reached a goal of operational breakeven when considering that we successfully switched last quarter our Japan-Asian distributors to a deferred revenue model earlier than expected, which resulted in higher deferred revenues reported in the quarter. This was a one-time non-cash event that will further improve the way we serve our customer going forward.

Our reported results were also affected by 12,000 marginal roll wafers received from one of our suppliers. These wafers significantly impacted yield and gross margin. However, as we speak, we are back to normal. All of these materials are behind us. Yields are strong, including the 90 nanometer technology node that we plan to switch 75% of our wafer starts at fab 25 in mid-November.

Our cash positions increased much more than forecasted in the quarter, $40 million dollars. Cash flow from operations increased as well, and we generated approximately $30 million in free cash flow. Dario will detail this very important point later on.

Concerning cash management, the key focus for the enterprise; we announced the very significant sale of our trailing edge technology facility JV1 and JV2 to Fujitsu for approximately $150 million in cash, payable in 2Q07. Our loan term planning indicated that due to our cost reduction program, using advanced manufacturing, we will not need these two fabs down the road. The agreement included a foundry relationship, enabling us to continue to meet the future need of our customer with JV1 and JV2 while we are switching to new, more cost effective technologies.

During the quarter we also announced the first silicon 4-bit per cell technology, MirrorBit Quad. This technology gives us twice the density of traditional technology, with up to 30% smaller cell size than any other supplier. We plan to produce this technology this quarter and ramp up at the beginning of Q1. We intend to leverage this technology in our primary focus market, the integrated solution.

Let me now give you a bit more detail on our two major business segments. Both of them grew sequentially quarter on quarter. The wireless business remains strong. Our current estimate now increased to 950 million to 975 million phones to be shipped in 2006. This is more than 17% higher than 2005.

We see particular strengths in Korea, Europe and the Americas. In this environment, it is crucial for Spansion to increase flash memory revenue per handset. By leveraging the MirrorBit Solutions in the 256-megabit and 512-megabit range, we achieved higher revenue per handset in Q3 over Q2 on flat handset unit shipments of 96 million. This trend will continue. We are now ramping our new multi-dock MirrorBit solution, combining NOR and ORNAND. This architecture has been very well accepted in the marketplace and will become a significant portion of the revenue going forward.

On the embedded side, our second business, the beginning of the quarter was weak due to an inventory correction in Asia in consumer applications. Despite this, we were able to grow revenue in this business quarter on quarter, benefiting from the adoptions of our high-density MirrorBit. Quarter on quarter, MirrorBit grew double-digit in both dura and unit in that segment.

Going forward, the embedded market fundamentals remain strong and we anticipate the inventory level to be quickly reduced during the holiday season. In many segments of this embedded space we are already observing the business picking up.

During the quarter, we also elected to establish a new business unit called the media storage division to capitalize on the possibilities of MirrorBit quad, the world's first nitrite-based, four bit per cell flash technology. This division will strengthen our capability in the integrated portion of the Internet market that now require massive amounts of memory.

65 technology node is on track in Fab 25 and [Semper] is expected this year. We already have working silicone at 65 nanometer, and volume production is now scheduled mid-2007. And, we are still online to have our company producing 300mm wafers at 45 nanometer in Spansion’s new factories mid-‘08.

During the quarter, we also received first volume shipments of 110 MirrorBit wafers from TSMC, and this is allowing us to free up Fab 25 for more advanced technology. We also extended the agreement of TSMC to include 300mm 90 nanometer wafers that we expect to receive mid-2007, allowing us to free up 65 nanometer in-house. This strategy will greatly improve cash management, as well using our own capital on new technology.

I'd like now to turn the call over to Dario to detail our financial performance.

Dario Sacomani

Thanks, Bertrand, and good afternoon everyone. With Bertrand hitting a lot of the P&L highlights, I'd like to start out discussing the significant improvement in our cash management performance for the quarter. For the quarter our hard work on improving capital efficiency continued to pay off and I'm very pleased with our results.

On a cash flow basis, we significantly increased our cash flow from operations to approximately $210 million for the quarter. That's up from $108 million last quarter and a minus $35 million in the first quarter of the year. We also recorded approximately $30 million in free cash flow for the quarter. We saw improvement across all our cash metrics as DSO declined to 56 days from 62 in Q2 of '06 due to a $30 million reduction in accounts receivable which is primarily due to improved terms in relation to our distributor model change in Asia.

Days of inventory declined to 80 from 85 in Q2 '06 primarily due to cycle time improvement initiatives in assembly and test. Days payable was up slightly to 63 days. These improvements have resulted in an overall improvement in our cash conversion cycle from 99 days in Q1 '06 to approximately 75 days for Q3 '06 and I expect these balance sheet metrics to remain relatively stable for Q4 of '06.

CapEx for the quarter came in at approximately $180 million as we continue to fund our next generation test strategy and the node migration to 90 and 65 nanometer. Our CapEx guidance for the year remains unchanged at $650 million to $800 million, primarily focused on leading edge technology. We estimate that maintenance CapEx is approximately 15% of the trailing last 12 month depreciation or approximately $120 million per year which is easily covered by cash flow from ops.

In relation to our recently announced 45-nanometer 300 millimeter fab in Japan called SP1, we will continue to pace this investment based on market demand. We have been reviewing various structured finance alternatives and have recently received solid ratings for a secured term loan option we are evaluating. With this potential loan, internal cash flow from operations and the sale of our JV1 and JV2 facilities, we're well-positioned to find our SP1 facility at low cost and will continue to evaluate business conditions in order to appropriately time the investment.

At the end of Q3 2006 our cash and short term investment balances were $378 million, up $14 million. Debt for the quarter was $605 million, down $14 million, holding debt to equity at 33%. Net debt decreased approximately $28 million versus $255 million last quarter due to improved cash management. We do have approximately $280 million of unused borrowing capacity in our credit facilities.

EBITDA for the quarter was approximately $125 million, up from $115 million in the second quarter and $84 million in Q3 of last year. Year-over-year quarterly EBITDA was up more than 48% on an increase in revenue of 31%, showing significant improvement in our overall operating performance during the period.

I'd now like to review the specifics of our P&L performance for the quarter. Again, Q3 total net sales were strong as we recorded solid year-over-year and sequential growth, specifically net sales for the quarter of $675 million was up 31% or $159 million versus Q3 of 2005 and up 3% versus Q2 of '06.

It should be noted that during the quarter the company switched our non-Japan Asian distributors to a new distribution model to provide better visibility to the business and better manage customer relationships. During this transition these customers were shifted to our standard deferred revenue or sell through model which negatively impacted the P&L reporting in Q3 of '06 although, as I previously mentioned, improving our DSOs.

Blended ASP for the quarter was up 2% compared with the last quarter, slightly higher than our forecasts and compares with a decline at 3% for Q3 of last year. This stabilization of prices is the result of strong market demand, the increase in higher density solution sales, and rapid customer acceptance of our new products. We anticipate that ASPs will be flat to slightly up for the fourth quarter.

Gross market for the quarter was 21% compared with 20% in Q2 and a 14% gross margin in Q3 in ’05. The increase in gross margin was directly related to our increased sales of higher density MirrorBit reaching 53% of total net sales for the quarter.

As Bertrand previously mentioned, gross margin would have been higher but was impacted by lower than planned yields early at fab 25 related to 12,000 marginal raw wafers received from one of the suppliers. This issue has since been corrected and yields have returned to planned levels.

For Q4 we believe that given the return to planned yields at fab 25, the increase in MirrorBit revenue and overall improvement in manufacturing efficiencies, gross margin will be in the 23 to 24% range.

Research and development expenses were $90 million compared to $92 million last quarter. The decline in R&D was primarily related to less labor and depreciation costs associated with our 14-week quarter in Q2. These reductions were partially offset by higher spend related to continued development activity on 45 nanometer 300 millimeter. As a percentage of total revenue, R&D expenses were down 70 basis points sequentially to 13.3% of sales. We anticipate that Q4 R&D expenses will be up slightly on an absolute basis.

Q3 sales, marketing, general and administrative expenses were $62 million and compares to $67 million in the previous quarter. SG&A cost declined, primarily as a result of the Q2 ’06 completion of our IT transition. As a percent of total revenue SG&A expenses were down 100 basis points sequentially to 9.2%. We anticipate that Q4 SG&A expenses will be up slightly on an absolute basis.

Our Q3 operating loss was $10 million, including $6 million of option expense, a year-on-year reduction of $39 million or an 80% improvement over Q3 of ’05 and a 63 % improvement over Q2 on higher sequential sales. This quarter on quarter improvement represents an 88% fall-through on incremental sales despite the fab 25 yield issues and the change in our Asia sales model.

Net interest expense for the quarter was $9 million, primarily resulting in improved cash management, taxes of $3 million, leading to a Q3 net loss of $22 million, including option expense, compared with a loss of $49 million in the second quarter of 2006, a sequential improvement of 55%. Q3 loss per share for the quarter comes in at $0.17.

With that I’d like to turn it over to Bertrand to discuss our expectations for Q4.

Bertrand Cambou

Thank you, Dario. For Q4, we anticipate revenue to be up and in the range of $710 million to $740 million as we see a traditional strong Q4 seasonal pattern. We expect MirrorBit product to be approximately 60% of total revenues, again driven by high density in the general market and the increase MirrorBit shipment into next generation phones. We anticipate in fact that revenue from these solutions will reach 5% to 10% of the company’s net sales for the quarter. Current backlog is strong and we have the capacity in place to meet our revenue forecast. We anticipate reaching bottom line profitability in the quarter.

In summary, in addition to progress made in improvement revenues and bottom line, the enterprise is now focusing more than ever on continuous improvement of the balance sheet. The selling of JV1 and JV2 agreement, TSMC and prudent cash management through the entire organization are helping us to deliver on our commitment to grow Spansion as a technology leader in the exciting flash memory business.

This concludes our prepared remarks and we would like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from Michael Masdea - Credit Suisse.

Michael Masdea - Credit Suisse

Good progress in the quarter. Can you give us a little more quantification of the impact of the 12,000 wafers and also the distribution inventory change on the revenue and growth margin?

Bertrand Cambou

Sure. First to the 12,000 wafers. We are caught here by some kind of unknown. We have specifications for the raw materials. Those materials were essentially within our specs but different than any type of wafers we had seen in the past. When we find the problem, that we have the 12,000 wafers all ready in the line and that many affected the mature technology, but also leading edge technology.

As a result a high scrap rate of those wafers increased testing to be sure that we screened all the qualities and as we were doing this work we had essentially empty tester waiting on the back end and delinquency to the customer.

We showed the impact of those 12,000 wafers was quite massive for us and unexpected. Since then the following has been done: All raw materials is out and either processed or scrapped. All materials in line are is currently to our specifications and we have changed our incoming spec now to incorporate the learning that we had and are looking at the opportunity to tighten our spec to better manage our supplier going forward.

The yields as we speak are back to normal and the 90 nanometer yield are above our expectations, essentially reaching maturity and this is why we decided to essentially switch hard fab 25 like we did.

On the revenue distribution model, this is kind of great news because we have ties to a previous agreement that was forcing us to sell to a buy/sell program through an Asian distributor. I think as I said we're able to have revenues on the spot because as quickly as we are shipping them material we are able to recognize revenues. But that model was essentially weak as far as giving us visibility of what the customer really needs.

We essentially were pushing for a long time to go and sell direct like we do across the board. To give you a magnitude here, this is about 35 million to 40 million sales per quarter. That's pretty significant for us. It's turned out that we had the agreement in place in such a way that it was fully impacting Q3 ahead of our schedule. We knew that by doing that, that we'll change the reporting structure, but this is the right thing to do for the company. This is a one-time event and now that this is behind us, we are starting off Q4 on a clean sheet of paper. We don't have any recognized revenues in that channel anymore but the one that has been consumed.

Dario Sacomani

If I could just add one thing to that. You know Bertrand mentioned we did in fact shift like 35 to 40 million. Now of course, some of that did sell through in the quarter so we still had an impact. Between the two issues that we had in the quarter, the change on reporting and the wafer scrap issue. It's about 100 to 200 basis points of gross margin just to try to calibrate you from a quantification perspective.

Bertrand Cambou

And that's also, the gross margin is being impact but the top-line revenues are being impacted. Now, like we announced, if you look at our cash situations it actually was the opposite because we received the money from the customer in the quarter. The receivable was better. The new agreement with the distributor is actually allowing us to receive cash sooner than we had in the previous model, and if you look at the balance sheet progress quarter-on-quarter that's definitely ahead of what we committed. What you see here is we did what we think is right for the business and believe that going forward we are now in a stronger position again on all those issues.

Michael Masdea - Credit Suisse

That's really helpful. Maybe one quick follow-up on that number 35 to 40. You said some of it did sell through in the quarter. How much of it do you think is flowing through into the upcoming quarter when we look at that?

Bertrand Cambou

It is very hard to quantify but we can say that two-thirds were sold through and one-third was deferred, approximately. This is because we had to put another [inaudible[ in there. We had to essentially get the sell through which I think was very positive for us as far as understanding the customer need and better serve them. But to your answer about two-thirds was baked in the quarter and one-third was not.

Michael Masdea - Credit Suisse

Great. Thanks. I appreciate that. On the Intel front, they seem to be at least getting their house a little bit in order. Are you seeing any change in the dynamic there especially as they change their manufacturing demands from the processor? Any sort of impact at all?

Bertrand Cambou

Well it seems that in Q3 they had a very tough quarter. They just announced yesterday a huge drop in Flash and that kind of surprised us because this huge drop does not incorporate NAND. Which is they are not only going down in total number but which means in the NOR spaces that we're in, it seems that they are ineffective, it seems that they have kind of been switching the capacity away from chipset, building an inventory of Flash and that is essentially sitting on their shelf.

At the end of the day the customer is not stupid, he's not going to be opportunistic here. In particular, the strategy customer which is a Spansion focus. They intend to have a supplier that on Monday have chipset issues and Tuesdays have inventory and on Thursdays it's something else. Spansion is committed to customer satisfaction as a big account and we have been extremely successful to grow market share against them last quarter in both of our markets which means that, you know for more details ask them, but that's the way we read it.

Operator

Moving on , we'll hear from Glen Yeung - Citigroup.

Glen Yeung - Citigroup

Thanks. Bertrand I wonder if you were to look at what you saw from your handset customers in the third quarter and maybe your view on the fourth quarter. Do you feel comfortable that handset demand is where you want it to be?

Bertrand Cambou

Absolutely. Right now we see the handset demand being in fact higher than we thought last quarter. Last quarter we kind of saw a bit of inventory in China. Some of the tier 3 low player had a difficult time to survive in a fight against the big guy, and they have to move inventory. And right now the situation in the handset business in the handset business has kind of been, quite frankly ahead of our expectations. In particular the value phone, you know very well accepted, the main player all together, some of them are winning, some of them are losing, but you know aggregate the big player are kind of gaining ground and we look at the environment as being pretty solid.

As we reported, Spansion is definitely right now to move the flash per phone. Market share in the 40% to 45% range in unit, but we like to have stronger participation in the high-end phone and this is what we are currently pushing. That gives us an opportunity to guide you to an upside in Q4, in particular by the flash content per phone. We are betting on a pretty steady, but richer opportunity for us to serve the market. To remind you that the only decision is usually the time of year where fancy phones are being sold. You know people like to buy phone as a gift and blah, blah, blah. We think that higher flash per phone and for expansion; higher market share on those high-end phones is giving us an opportunity.

Now on the general market on the consumer space, it seems that the inventory overbuild, this has been happening in the first half of the year was the result of perhaps the OEM was a bit too optimistic of the entire year and at the start of Q3, you know quite frankly was a wait and see mode. We observed in many cases some areas where they had a difficult time to move the end product. Right now we are seeing that situation to be again, to clear up.

We see a pocket of vibrant demand. And this is the time of year again where the consumer product that usually doing pretty well in the general market, Our strategy, like in wireless is to go after high densities and that gives us also we believe an opportunity to gain ground in Q4. That the way we see the environment right now.

Glen Yeung - Citigroup

Okay. Last question is just looking at gross margins, I think implication here is 100 to 200 basis points of impact from some one-time charges in the third quarter, so 21.2% maybe is 22% or 22.5% and then you're guiding for 23% to 24%, so call it 100 basis point increase. While that increase is good with the mix shifting to now greater than now 60% MirrorBit, I would have expected to see gross margins a little bit higher.

I wonder if you could tell us if you're seeing the kinds of margins or the kinds of cost downs from MirrorBit that you thought you would see and are you not seeing it on price or is there some other issue there?

Bertrand Cambou

No I think the cost reductions that we are achieving is as expected and definitely some of our customers on the high-end phones, they are trying to pack in more for less if I can say. It is very, very important to price competitive on the high density in general, but all together like we said, we see blended ASP to go up, unique shipment to be [steady], which means that now the margin that we're announcing here, this is obviously our best estimate right now and I heard your comment about higher expectations and this is what I say to my people, I want more.

Glen Yeung - Citigroup

Okay, well thank you.

Bertrand Cambou

Thanks.

Operator

And moving on we will hear from Alex Gunn - UBS Financial.

Alex Gunn - UBS Financial

Hi guys, thank you. I was wondering if you could go over what you think your progress on in ramping with customers and maybe share progress with other major OEMs besides your lead customer, Nokia?

Bertrand Cambou

On the customer front right now, we have, I would say there is definitely opportunity for Spansion in Japan and Korea. This is a scenario where traditionally other solutions were prevailing and quite frankly now we have the technology, with in particular this multi-die [inaudible] that allow us to play where we had no position in the past. You know those phones are -- content per phone is really huge. For us we're looking at $20, $30 per phone. That's really nice and we think that in this particular area we are moving from being a low player to being a player.

Like I was alluding to during my prepared remarks, our strategy right now is definitely on revenue per phone. The key for us is 65 nanometer because at 65 nanometer we really have a really nice cross-structure here and we already have our 65 nanometer ORNAND in fab 25 right now. First silicone, on test sheets it's extremely promising. We already had that out of fab 25 and we expect to essentially, in '07, to have an offering with extremely small die size, 65 nanometer and we expect to bundle with a NOR which will be again best in class at that point. I would say that on that particular area here we have an opportunity here to go above and beyond our existing territory.

That being said I want to make it very clear that, as I said at the mid to low end phone, we currently have a very, very strong offering that is selling very well and we are keep pushing that line of product with a lot of vigor.

Alex Gunn - UBS Financial

Still on the vein of new platforms, new customers including these $20 to $30 phone applications, is there any opportunity that some of this or visibility that some of this is layering in to offset normal seasonality that we would expect going into early '07?

Bertrand Cambou

We think that this is the opposite. What you have is a fundamental shift in the industry toward higher functionality phones. This has been happening now for many years. In '07 we clearly see -- and I'm talking about the design socket win that we are currently engaged with. Currently we are preparing the 2007 model and they all are requiring more flash, which means that if you have a Q4 which is traditionally kind of a bit higher as a trend, you know Q1 will be slightly less; but then the fundamentals are going to kick again in '07 to be for our company an opportunity to increase revenue pro phone.

Alex Gunn - UBS Financial

You already touched on the gross margin impact of the bad wafers, what about the top line? How much revenue do you estimate was missed and is some of this catch-up now in Q4 or did you satisfy all customer demand through your efforts in the lower gross margin line?

Bertrand Cambou

Obviously the backlog we have right now is as I refer to as huge, we have a very strong backlog and we have some execution issues that has to tightly managed and we think that we are in a position of being more supply-constrained then demand-constrained in Q4 which means that as a result the guidance that we are giving you, 710 to 740 represents our best estimate of our ability to deliver in the current market environment that we think we have in place. You know the entire supply chain to deliver those numbers. That is why we essentially give you such positive outlook for Q4.

Alex Gunn - UBS Financial

All right. Thank you.

Operator

Our next question comes from Prenna Lahariah - Deutsche Bank.

Prenna Lahariah - Deutsche Bank

Can you talk about how much wireless was up and how much non wireless was up in the quarter? What within the non-wireless business was notably strong or weak?

Bertrand Cambou

Interestingly enough, both businesses grew at 3%, which means they grew at the same rate and for different reasons. I was alluding to the market position in the wireless space, in general very strong core product and our goal was putting more flash per phone.

In the embedded general market, the market was weaker but our ability to gain share into the high density has been stronger than the business environment. Going forward, we see trajectory to help us in Q4, which means that we see both businesses.

In general wireless is very strong in Q4 and we see that which means most likely wireless is going to grow a bit more than the general market in Q4. But then it could be the other way around. You know again, a conditional pattern here. Q3 was remarkably, both businesses grew at the same rate for different reasons.

Prenna Lahariah - Deutsche Bank

What was the revenue contribution from ORNAND and TSMC wafers for the quarter?

Bertrand Cambou

That was another significant -- TSMC was very small. The bulk of those two is going to be Q4. In Q4 this is where you are going to see the significant volume of TSMC and the significant volume of our multi-die ORNAND. Like I say, it is going to be so strong that we see between 5% and 10% of Spansion revenue on those combos which means that the full impact is definitely looking forward. You do notice we have sold a significant amount of double die ORNAND in the quarter. Then we had some high density 512- megabit out of TSMC for the general market that is being produced. But again Q4 is the big --

Prenna Lahariah - Deutsche Bank

Okay, and then lastly with Intel building inventory of NOR flash I have to imagine they will get very price competitive in the very near term. Suddenly with your strategic customers there may not be so much allowance for them to frame those customers, but can you maybe highlight where you expect them to be very, very price competitive and how soon?

Bertrand Cambou

The outlook we have for the quarter, we think that Intel is currently aiming at the support market; an area where we do not participate. Our strategic accounts, this is all business that is multi-quarter in advance. It is not a business where you go on Monday and leave on Tuesday type of thing.

The spot market that Intel is going to probably go with some of the little players and their trying to grow their turf, you know in an area we are playing. By the way, I do not believe that they are going to be able to go very far there. Because let's just say if they sell below their costs, if you look at the fact this is a business, you have to assume that if they were to do that their senior management will congratulate them for a bigger loss. Which means, I don't think that they are going to go to far with that but that will be up to them.

Definitively we do not see on the custom OEM situation here of them being successful -- in Q3 they actually went very, very little. In some cases we know that we gained away from them in their own turf in accounts that are very significant.

Operator

And now we will hear from Shawn Webster - JP Morgan.

Shawn Webster - JP Morgan

Yes good afternoon. Can you talk a little bit about your backlog/ Was it up sequentially in dollars?

Bertrand Cambou

Currently the backlog that we have is above our ability to serve and we are kind of managing our company to try and be sure that we don't over commit. We are very prudent on that particular are which means that we are definitively right now in the mode of tightening in such a way that we build for order. You know most of this we did in the past. On that particular area, the visibility for the quarter right now is extremely high and we think that the number or the growth that we quote to you is a very high ability to introduce. Right now in some of our product family, the growth is absolutely above expectations here. In particular those new accounts, which are currently gaining ground right now that all of you know.

Shawn Webster - JP Morgan

Okay so it sounds like book-to-bill is above 1 then?

Bertrand Cambou

The book-to-bill is around 1 right now but could be higher if we take the order.

Shawn Webster - JP Morgan

How about your lead times? Can you talk about what your lead times did on average basis in Q3 and what you expect they'll do in Q4?

Bertrand Cambou

As you saw in our report we are successful to reduce our inventory and we are definitely putting pressure on the organization on the cycle time. Right now we essentially gained about a week of cycle time on our factory, on the front end. The back-end is taking the same challenge. The lead-time right now that we are building toward more and more, is essentially constrained by your cycle time. We are pushing the enterprise for cash management, customer service and so on and so forth to reduce cycle time.

Again in Q3 we had made some progress on the cycle time or lead time that is compressed by inventory reasons. We don't have inventory sitting that allow us to do a lot of churn business because we are dedicating our capacity to the strategic account.

Shawn Webster - JP Morgan

Okay and so on your utilization rates are you 100% utilized or are there any changes?

Bertrand Cambou

100% booked up and ramping up as we speak. JV3 is currently performing a marvelous job in increasing the run rate. And of course we currently are going to a strategy to eventually redesign our JV1 and JV2 product into advanced technologies. Which means that as a result of the strategy, JV1 and JV2 are going to become obsolete.

Obviously in Q2, as we are going to finalize the transactions, we're going to -- Fujitsu having an opportunity to have capacity for their own needs and that's obviously exciting for us because JV1 and JV2 right now is pretty expensive still and in this models we believe that we are going to go to a improving our metrics in the right direction.

Shawn Webster - JP Morgan

Thanks. And then, Dario, maybe just one last question. What was your depreciation in Q3?

Dario Sacomani

$135 million.

Shawn Webster - JP Morgan

Okay. What do you think it will be in Q4?

Dario Sacomani

I think it will probably come in a little bit higher than that, but nothing substantial. Probably in the range of $140 million.

Operator

And our next question comes from Daniel Amir - WR Hambrecht.

Daniel Amir - WR Hambrecht

I had a question, as we're looking forward to the guidance that you provided on the revenue, can you give us your expectations of between the wireless business and CSID, what percentage you expect to see in both businesses growing?

Bertrand Cambou

I expect to have the wireless business growing faster, because again this is the time of the year where we cannot redo that. I expect CSID to have a smaller growth. It will probably be in the same trajectory as Q3.

Daniel Amir - WR Hambrecht

When listening to the prepared comments you mentioned that you had strength in particular areas and one of the areas you didn’t mention was Japan and Asia. You also mentioned that you didn’t see that happening in Q4, if I heard correctly. I was wondering if you could give us a little bit more color on what was happening in those areas?

Bertrand Cambou

Yes. Japan first. What’s happened in Japan is the big Japanese company did a bit of an overbuild. They had an outlook for the year that was really too optimistic and they built a lot of product in the first half of the year. Right now they are correcting that a bit. They are looking at 2007, you see a lot of new models coming that is going to renew the demand. Which means that Japan right now is essentially looking at the second half that is softer than the first half.

In Asia the issue we had here is a lot of in the same scenario. A lot of the tier 2 and tier 3 players are losing market share to the big guys; the big Motorola, Nokia, Samsung are very effective to be the low cost phone. A lot of the local companies had an overaggressive plan. They are readjusting that as well and that is creating the fact that we do not include Asia for the second half of the year.

If you look at the consumer cell phone in China is actually growing very strongly. The fundamental of the business over there in Asia becomes great and we see that as a possibility for the big player. But the big player are going to be in Europe or Korea or in the Americas.

Daniel Amir - WR Hambrecht

One last question. In regards to the particular growth in the new account that you were mentioning, can you give us an idea, a little bit of color as to what you expect your market share was in Q3 and what you expect it to grow to in Q4?

Bertrand Cambou

I cannot give you the number. All I can tell you here is we have a couple of exciting new accounts where we were a non-player in the past and now we are a significant player. And as you do that, as you know, we have to go through stages. In the first stages, they give us a seat on the row which is the second row and we have to deliver to that and as we make them happy then we expect to move up to the front row. But that big guy don’t change without having experience with you multiple times. Right now we are very happy to be on the bus and enjoying a revenue that is significant. The way we are modeling those two accounts right now is gradual progress and that is going to be clearly a function of how we can please them and serve them and we intend to work very hard at that.

Operator

Okay your next question comes from Darren Hudson - Morgan Stanley.

Darren Hudson - Morgan Stanley

I was wondering on ORNAND, can you can quantify roughly how many handset models you were designed into so far for the 2007 launch season? And then I’ve got a couple of follow ups.

Bertrand Cambou

If I was to give you a number of how many handsets, I think we have probably a dozen, would be a speculation of handsets, 10 to 12. We are already switching to several OEM accounts and this phase of the technology that is really encouraging it was a multi die approach. We are able to reduce the cost for the customer and as we are going to migrate on into 65-nanometer, which we intend to do as quickly as possible, we're going to build an incredibly competitive situation. Because in many cases, as you know, in the NAND space right now they are more closer to 90 and you're only talking about 70 being used for cell phone; and it is going to open up to a much bigger penetration.

Darren Hudson - Morgan Stanley

Is that the sole focus for ORNAND is these multi-die solutions? Or do you see it also as a stand-alone opportunity where it was going with someone else's NOR or just in a different configuration?

Bertrand Cambou

We have to be focused and we currently have an incredibly strong position in NOR and the ability to build a wireless solution is so attractive at the enterprise here at that point, which means that we have kind of a mania focus here, we want to have a 65-nanometer combos going to 45-nanometer combos just after that and to be perceived as the industry leader for cellular phone applications.

Now along the way, an opportunistic standpoint, if we find low-hanging fruit, we're going to do it. But I don't have time to – I don't believe that we want to defocus the enterprise right now in all directions.

Darren Hudson - Morgan Stanley

Then just as you were talking about the weakness in the Tier 2 and Tier 3 handset OEMs, can you quantify what percentage of your wireless sales you think could go to those Tier 2 and 3 OEMs? Or take it the other way and say what percentage of your wireless business goes to the top five vendors roughly?

Bertrand Cambou

That's a good question here. What we have right now is that Spansion has a predominant position in China. Our market share over there is really big. We're talking about 65% of every handset or 17% of the function. Calculate that, and in this part of the world, you have actually some emerging power hubs in the cellular phone. They are focused. A company like Lenovo right now is a number one player.

In China right now, we are getting a lot of people upset because we are not serving the little guy and they don't understand. Why are you not serving us? The reason is because we're extremely focused in China on the top guys. Because we feel that in China, at the end of the day, you have too many handset players. We have been kind of watching very, very carefully here how to play there and that has been to our advantage because by and large, how we sit at a top account in China, if it is the top five, we probably have 80%, 85%, I'm shooting from the hip here, but in the little guy we don't serve at all.

But now if you go outside this territory, Spansion is only working with the big OEMs. We are not working with the Tier 2 players. We're essentially focused on the top 10 and that's it.

Bob Okunski

Thank you everybody for joining us. I look forward to speaking with you in January on our Q4 call. Thanks. Have a great day.

Operator

This does conclude today's conference call.

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Source: Spansion Q3 2006 Earnings Call Transcript
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