Spansion Inc. Q2 2010 Earnings Call Transcript.

| About: Spansion Inc. (SPSN)

Spansion Inc. (SPSN) Q2 2010 Earnings Call. July 21, 2010 4:30 PM ET


John Kispert – Chief Executive Officer.

Shubham Maheshwari - Investor Relations

Randy Furr - Executive Vice President and Chief Financial Officer


[Jen] – Unknown Company

Atif Malik - Morgan Stanley

Joseph Stauff - Susquehanna

Daniel Barenbaum - Auriga USA

John Evans - Edmunds White Partners


Good day ladies and gentlemen and welcome to the Spansion Inc second quarter 2010 earnings conference call (operator instructions) and as a reminder, this conference is being recorded. And now your host for today’s conference, Shubham Maheshwari. Please begin.

Shubham Maheshwari - Investor Relations

Thank you and welcome to Spansion second quarter 2010 earnings conference call. On the call with m today are John Kispert, CEO and Randy Furr, CFO of Spansion. We will be referencing a slider during the portion of today’s call. You can download a copy of these slides from our investor relations section of website at under events and presentations.

Our call will be approximately 60 minutes in length. There will be an audio replay of this call. You may access that by dialing 1-8-00-642-1687 and the conference ID is 87909802. This replay will run through July 24th. A webcast replay will be available on the company’s website throughout this year. Please note the following Safe Harbor statement. During the course of this meeting, we may make projections or other forward looking statements regarding future events or the future financial performance of the company or the industry.

We wish to caution you that such statements are predictions and that actual events or results may differ materially. For this, that the company considers to be important factors that could cause actual results to differ materially from those set forward in the forward looking statements. We urge you to carefully review risks and uncertainties described in our SEC filings including but not limited to Spansion’s quarterly report on Form 10Q for the fiscal quarter ended March 28th, 2010 and annual report on Form 10Q for fiscal year 2009. The company disclaims any duty to update forward-looking statements.

With that I will now turn the call over to John.

John Kispert – Chief Executive Officer.

Thank you Shubham. Good afternoon and welcome to our Q2 earnings conference call. This is the first time we’ve been able to share results with you since emerging from our reorganization process. Throughout the process we have maintained a laser focus on our customers and the specific needs of their markets which include automotive, computing and communications, gaming and mobility.

I believe that with this focus it’s been a significant contributor for us getting through the reorganization and will provide increasing benefits now that we have emerged. On today’s call I will discuss our progress and update you on the market and also highlight our product focus and strategy. Then Randy will give you the financial details and Q3 outlook and then we’ll have time to field your questions.

To start at high level, we delivered strong results this quarter with the third consecutive quarter or revenuer growth in our core embedded markets. This was across all of our embedded segments and we were also able to increase our gross margins and improve our operating profit and cash flow. Of course fresh start accounting makes this harder to understand on a GAAP basis so shortly randy will cover the fresh start accounting impacts to our income statement and balance sheet as a result of our merging and restructuring in May.

You will see on slide four our revenue breakdown. We saw growth in all of our embedded market segments with the two largest being consumer and gaming and automotive and industrial. We also saw a solid growth in our three largest regions which are Asia Pacific, Japan and Europe. You can also see breakdowns in technology and density as well in the presentation.

In May we were able to reengage with all of our customers throughout all of our segments and regions. With new customer designs went to roughly doubling over the last couple of months. We are focused on and poised to win market share. By providing our customers with superior service, technology and quality, we have identified areas where technology advancements could give customers a market advantage. For example the gaming segment requires high density NOR with fast programming speeds.

Our MirrorBit technology is well suited for this application and we are developing products that will lead to increased revenue in this segment. We’ll also be applying these feature set and capabilities to all our applications in other markets. In automotive and some industrial segments, the need for flash memory is growing in telematics and in next generation dashboards. Expansion products are enabling bi-directional communication for vehicle tracking and recovering, [concierge] services and remote diagnostics.

We’re also working with chipset vendors and automotive customers to bring more value to next generation dashboards and enable instant on. For example in infotainment applications, radio applications and also the monitoring of screens. On the product execution front we continue to make steady progress toward our previously stated goal of introducing eight new products over the next 8 moths. In June we introduced a 256 megabyte multi IO SPI device which is the highest density SPI product in the market with applications primarily in communications and consumer.

We’ll keep you updated on our new product development progress going forward. The September ending quarter is a very key quarter for us in regards to product introductions and we’ve made great strides internally in getting these new technologies and products to markets. We look forward to talking more about it. Our MirrorBit charged trapping technology is the foundation for developing the NOR and end products our customers require.

Today we announce with Elpida a NAND strategic alliance which includes the new NAND [inaudible] services agreement. This builds upon an existing alliance for joint development of NAND processed technology and products. Elpida is license expansion NAND IP based on MirrorBit charge trapping technology and it’s on a non-exclusive basis. Elpida will produce the new advanced NAND products at its’ leading edge, 300 millimeter Hiroshima wafer fab.

We’ll each separately market products to customers with Spansion focused on the embedded market. Joint development in technology transfer activities for NAND products are well underway in Hiroshima. We’ve been working on this for a couple of months. This alliance with Elpida is an example of how we can do three things. One, monetize our technology with little investment. Two, meet our customer demands in an affordable way and three, expand our total addressable market.

Moving forward we will continue to focus on customers and markets where we can add substantial value. Over the next two quarters, we will remain laser focused on one, driving operational excellence, two, getting closer and closer to our customers engineers and three, product execution against aggressive plan we laid out months ago. In closing, we’re optimistic about the opportunities in all of our segments, our ability to lever in our future, and with that I’ll turn it over to Randy.

Randy Furr - Executive Vice President and Chief Financial Officer

Thanks John. Last month on June 16the we held a conference call to explain both the accounting expansion now that we’ve emerged from chapter 11as well as the impact of fresh start accounting. During the call, we walked you through the need to combine two income statements to get to a combined consolidated result for Spansion and the need to reconcile GAAP to NON-GAAP to appropriately obtain and analyze our second quarter and full year’s results.

I will start with slide six. Similar to the commentary on our June 16th call, I will first explain the slide. Column 1 is Spansion’s GAAP results for the first part of the quarter before adoption of fresh start accounting. Spansion emerged from chapter 11 on May 10th and as March 29th to May10th was a stop period for Spansion and the GAAP results for those six weeks are presented in column 1 and labeled as predecessor.

Again to properly analyze Spansion’s second fiscal quarter, you need to add the subsequent seven week period from May 11th to June 27th. The GAAP results for that period are presented in column two and labeled successor. Column three is the combination of columns 1 and 2 and reflects the results for the full 13 weeks of the quarter on a GAAP basis. However, as you can see the GAAP results reflect accounting adjustments for fresh start accounting and the numbers still need further explanation for reconciliation.

The goals of column 4 and 5 are to help with that explanation and reconciliation. Column 4 labeled fresh start adjustment lists the principal financial impact on our second quarter GAAP results from fresh start accounting. Now let’s turn to slide seven titled Q2 10 results GAAP to non-GAAP adjustments. Here we have further broken down the items from fresh start accounting that impact revenue, operating income and EBITDA. Let me take these one at a time.

Channel revenue lost. As we discussed on our June 16th call, this is revenue that was in the distribution channel on May 10th. Spansion’s accounting policy for products sold through the channel is to bill the distributor upon shipment to the distributor. However the revenue and income from those products sold through the distribution channel is not recognized until those products are sold through, in other words sold by the distributor to the end customer. The way fresh start accounting rules work, preferred revenue on the predecessor’s books is lost forever. Either the predecessor, more the successor it’s to record this revenue nor the profit associated with the revenue.

The loss in GAAP revenue is completely non-cash in nature and given that we will still collect the cash from the distributors, for us to get a quarter to quarter comparison, we have to provide the impact of this which is 37 million in revenue lost and 9 million of operating income and EBITDA lost for Q2. The next item listed on slide 7, higher depreciation cost due to asset write up.

Fresh start requires that we re-value all of our assets and liabilities to market value. This equated to a property plant and equipment being written off by approximately $86 million. The impact here is higher depreciation and this will show up in higher cost of goods sold and if this flows through to the operating income line where the impact in Q2 was 12 million negative. Obviously there’s no impact on EBITDA as it is part of the depreciation that is excluded in the calculation.

In tangibles, amortization is the next item listed. Like the write up and property plan equipment for a start also required a write up of intangibles and given intangibles was near to zero prior to fresh start, the 200 plus million in write up of intangibles now equate to Spansion incurring a period charge for amortization; the impact is 2 million in Q2 at the operating income line and again no impact on EBITDA.

The next item on the list is inventory markup to market value. As I previously mentioned fresh start is similar to purchase accounting which requires that on the date of purchase, the fresh start date in our case, inventories could be written up to essentially the market value less the cost of completion. This is obviously going to impact gross, operating and net margin until the entire inventory on hand, and again, no matter what stage the inventory was in [indiscernible] to expense. The impact to gross and operating income in Q2 was 19 million negative as a result of this item.

The next item on slide seven is other miscellaneous, and the net was 4 million favorable so instead of adding it to get to Non-GAAP results we deducted it. This was made up of some items related to fresh start as well as some items not related to fresh start accounting for example; we had a gain related to our transaction with PTI on the sale of our final manufacturing operation located in Suzhou, China, since that sale included a procurement contract. That gain is spread over many quarters. We felt it was not appropriate to count that benefit and that’s why we are moving that benefit to get to Non-GAAP results.

Also we sold some used tools in Q2 before the fresh start date and we were going to gain from those sales as well, again, to get a more comparable results.

Now lets turn back to slide six. As you can see in column four, the line item impact on the income statement of the fresh start accounting items and column five was the impact on the financials of our Samsung litigation.

Essentially, here we are disclosing that during Q2, we expensed 5 million on litigation in connection with Samsung. We discussed this issue on our June 16th call but to summarize, we had three pieces of litigations with Samsung. We’re disclosing to help you reconcile previously disclosed financial plans which did not contemplate this litigation.

Column six takes the combined GAAP results listed in column three and that’s for the impact of columns four and five to get the Non-GAAP results for Q2.

If you turn to slide eight, you can see the Q2 results listed in columns six on slide six compared to the past five quarters.

Our second quarter saw a 5.8% sequential increase in Non-GAAP revenue to 293 million. As John mentioned, in our focused embedded business revenues increased for the third straight quarter by 7.7% to 212 million. This increase is reflective of the general strength of our NOR embedded market and inline with the guided set during the June call.

Non-GAAP gross profit rose 99 million equating to a gross margin of 33.9% which is 120 basis points sequential improvement from Q1. Clearly a large portion of this improvement came from higher revenue, but also adding to the improvement was greater operating efficiencies and cost control in our Austin fab and our sort and final manufacturing operations.

I’d like to spend some time on gross margin and gross margin trends. If you look at slide eight, you can see that despite the decline in revenue, which again was expected, the four quarter period from Q2 2009 forward has shown a steady progression in gross margin improvement; the reasons for improvement in operating efficiencies, cost reduction and improved product mix.

We continued with the improvement in Q2 of this year, and now contributing to that improvement is top line growth leverage as we are relatively high fixed cost, low variable cost business.

In addition to volume leverage, we should see future gross margin improvement as a result of continued improvement in operational efficiencies, improved product mix, selected price increases and most importantly the new products John mentioned in his prepared comments. These new products primarily utilize advanced technologies targeted at growth margins and should drive improved margins.

Non-GAAP operating expenses were both inline with guidance as well as pretty consistent with Q1. Quarter-over-quarter R&D was up approximately 2 million, reflecting our focus in delivering the eight new products John referred to. SG&A was down about 4 million; reflecting our continued focus on cost reductions and efficiencies. In Q2, we made significant progress in reducing IT related expenses company wide given the top line growth, SG&A fell from 13.4% of sales in Q1 to 11.6% in Q2.

Adjusted operating income was 40 million on a Non-GAAP basis, the high end of our June 16th guidance. This equated to a nice sequential improvement and operating margin up from 11% in Q1 to 13.7% in Q2, certainly a record for Spansion as a public company.

Taxes for GAAP and Non-GAAP were $1 million for Q2. This was due to a large amount of carry forward NOLs available to offset any income prior to May 10th. For the post May 10th period we have annualized prorata NOL benefit of 23 to 28 million to offset income generated. 1 million in Q2 was mostly for foreign jurisdiction taxes.

Q2 was a difficult quarter for any discussion regarding EPS as we had two different sets of outstanding shares; one set for pre-emergence and one set for post-emergence. On a Non-GAAP basis, if we simply take the full quarter Q2 Non-GAAP net income and divide it by the outstanding shares as of June 27th, this equates to an EPS of $0.46 a share.

Adjusted EBITDA on a Non-GAAP basis come in at 68 million; about 3 million over the top end our guidance, from an adjust EBITDA perspective again, we’re making nice progress with Q2 of 68 million. Clearly revenue growth and gross profit improvement will be primary drivers of future EBITDA growth.

However, we believe we’ll also have opportunities for improvement as result of G&A cost reductions. One example is last quarter we changed our data center service provider. This was an initiative started over a year ago and will drive down IT cost by approximately 10% year-over-year.

I would now like to turn the conversation to the balance sheet. I will start with cash, and please excuse me for a bit for bouncing around here, as you can see we listed the balance sheet summary on slide nine. Return to the slide after that, slide ten labeled ‘Capital Structure’, we will use that for the discussion here of cash.

We ended the quarter was cash and cash equivalence of 254 million. This is after paying approximately 25 million for planned reorganization disbursements netted against the redemption of approximately 51 million in option rate securities proceeds during the quarter.

Note slide ten depicts a delta of 15 million in ARS proceeds for the period May 10th to June 27th. During the period of March 29th to May 810th, we redeemed an additional 36 million to get to the total of 51 million for the quarter. Additional items impacting cash during the quarter include our 13 million purchase of the Kawasaki distribution business in Japan, capital expenditures of approximately 10 million and the sale of approximately 9 million in surplus used tools.

As you can see, we still have approximately 59 million left to go out of our plan of reorganization disbursement and 28 million and proceeds coming in from the redemption of the auction rate securities.

We have provided some guidance for the September quarter and as you can see there is likelihood that some of the POR related disbursements will get pushed out to October or even later. We are assuming the remaining 28 million in ARS proceeds will be redeemed by September, leaving our next cash position between 230 and 260 million.

Now let’s turn back to the balance sheet trend slide or slide nine. Trade accounts receivable was 140 million, DSO 47 days using adjusted NON-GAAP revenue -- 293 million. The related party accounts receivable and the related party accounts payable are balances with Spansion Japan. These balances are down significantly from the prior quarters as we settled the due to and due from accounts with Spansion Japan.

The current balances reflected at the end of June are more representative of the expected balances going forward. As mentioned above, we closed on the transaction with Spansion Japan and transferred over approximately 125 employees, primarily connected with our Japanese sales effort, who are based in Kawasaki near Tokyo.

Inventory for Q2 was 245 million, and this reflects not only the impact of higher standard cost due to asset write-up but also includes writing inventory up to its estimated market value less the cost to sale. Had we used cost standards in place from the predecessor company inventory would have been approximately 152 million, equating to a write-up of approaching 93 million.

We do expect that the majority of the written up inventory will flow through in Q3 and the balance in Q4, thus we expect the inventory levels will come down from the Q2 levels, but will still be somewhat higher than historical levels due to the asset write-up driving higher standard production or standard product cost.

However, this should only persist through the first half of 2011 as we are accelerating depreciation from this asset write-up. We discussed the property plant and equipment write-up as well as intangibles. As you can see, we also put 162 million of goodwill on the books as a result of fresh start accounting, and an additional 4 million of goodwill due to the purchase of Kawasaki’s distribution business.

This is an appropriate time to talk about Spansion’s asset life strategy. Slide four brought down our Q2 revenues by technology. As you all know that almost 60% of our Q2 revenues were 110 nanometer and above, the cornerstone, a real engine in Spansion’s asset life strategy is our Austin fab facility. Completed in 1995, it’s a state-of-the art microprocessor facility. This facility today is slightly depreciated and has excellent capacity and flexibility.

We can do 110 nanometer, 90 nanometer and 65 nanometer technology, and we can adjust wafer priorities literally on a daily basis. In addition, we have same product families on all 3 nodes. In other words, we have fab flexibility in our product portfolio was hoping to even greater flexibility.

As you know Spansion spent over 1.2 billion in R&D for the period 2006 through 2008. The majority of these R&D was for process development. We had process development 4 nodes pass the 65 nanoometer node, in which we are in production today and as you can see represents only about 2% of our revenues. Our asset life strategy takes advantage of this past process technology investment, and leverages that investment with partners for advanced node wafer fabrication. By using our technology and processes, we were able to derive competitive wafer pricing from our partners. When we combined our partner’s capabilities with the Austin fab’s cost competitiveness and flexibility, we believe we have a very competitive asset life strategy that will serve us well into the future.

Accrued liabilities increased from 128 million to 196 million due to accrual of payments to bankruptcy professionals, substantial claim payments and legal fees.

By comparing the Q1 and Q2 balance sheet, you will see some pretty significant changes, we discussed the related party accounts receivable and accounts payable as well as the fixed assets. I’d like to discuss a couple of other changes to our balance sheet. The change in quarter-over-quarter restricted cash was for 450 million debt and equity rights offering proceeds being held in escrow, which was earmarked to pay the secured creditors per our plan of reorganization. The secured debt of 633 million that was paid off was part of the 1.7 billion included in liability subject to compromise. You can see that after emergence from chapter 11 and the adoption of fresh start accounting, liabilities, subject to compromise, is now zero.

Finally, you can see that after fresh start, we ended Q2 with common shareholder equity of 658 billion.

Let’s turn to slide 11; total summary of claims and share distribution. In summary as you can see, we distributed about 44% of the total 59.2 million shares. Additional distributions will come as our claims agent settles or litigates the disputed claims that, including reserve, total approximately 1.76 billion. We do expect additional distribution of shares to occur later during the current quarter.

I would like to turn to slide 13 titled ‘Q3 10 forecast GAAP and Non-GAAP’. We You’re probably familiar with the concept by now, but column one is a GAAP guidance, column two is guidance for fresh start accounting and impact on Q3. In column three is our guidance for Samsung litigation and impact on Q3. and column four presents a Non-GAAP guidance for Q3.

The range for adjusted revenue is 300 to 320 million, gross profit is 105 to 120 million and operating income is 35 to 50 million.

Some R&D material slated to be received in Q2 got delayed to the early part of July. Due to this reason and the continued hiring in R&D, we expect Q3 R&D will go up by a few million dollars. EPS guidance is $0.40 to $0.60 an adjusted Non-GAAP EBITDA to 65 to 80 million.

Slide fourteen helps in the understanding of the fresh start accounting adjustments guidance that was included in column three of slide thirteen.

With that, I’d like to thank you. Thank you for your time, good day and turn the call over to [Ty Wilhelm] for questions.

Question-and-Answer session


Thank you Sir. Ladies and gentlemen, (Operator instructions). Our first question is from Tim Luke, your line is open.

Unidentified Company Representative

Hey, Tim are you there?


Please check this your [indiscernible]

Unidentified Company Representative

[Jen] - Unknown Company


Unidentified Company Representative

Hallo, well we can here you.


Hi, this is Jen [indiscernible], thanks for taking my question. Just one quick question on the last earnings call, you had mentioned that you lost about 10 to 12% market share during the bankruptcy procedure, and I was wondering just how much of that do you think that you have gained back in the quarter? And how much more market share would you need to gain to get back do you think to get to the midpoint of your guidance through the third quarter? Thank you.

John H. Kispert - Chief Executive Officer

Thanks for the question. We did say that, and we are sticking to it. Remind you we got out of Chapter eleven midway through May and it was amazing how quickly customers were wanting to re-engage at engineering level force to focus on next generation products. So we feel like we gained a point or two in Q2 -- of market share back and again, we were in chapter eleven for most of the quarter, and I think Q3 in that guidance is gaining back another -- roughly three points, just rough math, to get us on way to our target, which is to get half of it back this year


Okay, great. Thanks so much.

John H. Kispert - Chief Executive Officer

Thank you.


Our next question is from Atif Malik of Morgan Stanley. Your line is open

Atif Malik – Morgan Stanley

Hi, thanks for taking my questions and nice guide on Gross margins, 35 to 38%. Questions on the Elpida lines, the NAND products that Elpida foundry is going to make for expansion, are those NAND products going to be used for embedded NAND, for handsets or for multichip packages

John Kispert – Chief Executive Officer.

Good question Atif, thank you, it’s John. It’s single level cell that we’re focused on. It’s, although we are not growing out MCP our applications right now, that certainly not the focus I think in the focus coming out early next year will being in more of the consumer type devices, industrial markets, set top boxes where there is a we believe a market that compliments real well the markets that we are in today that we can in line with our soft ware and with our NOR products, but focused on those embedded segments

Atif Malik – Morgan Stanley

Sure. And then can you tell us what geometry Elpida will be using for non-starting off and the timing of that NAND production?

John Kispert – Chief Executive Officer.

Yeah we are fairly long, fairly far along at 43 nanometer with them in Hiroshima. But we’re also working on 32 nanometer and so like any product will be a transition there but coming out of gates will be a 43 nanometer for our embedded segments

Atif Malik – Morgan Stanely

John and how should we think about the royalty contribution to the model. Should it be like standard, like high single digit percentage of the revenue stream and sometime in second half of next year?

John Kispert – Chief Executive Officer.

Yeah I think you could think about it in the mid between 0 and 10% and of course a big piece there is what is shipments that Elpida is going to have given the I think much larger multilevel sale markets that they are going after. That you should you should ask Elpida [inaudible] about that, obviously I’m not focused on that. But I am very hopeful, I mean the technology looks great and I think both companies are excited that this Elpida that can quickly move into a larger market with NAND and compete, that will be a nice royalty stream for us.

Atif Malik – Morgan Stanley

John, one last one. If you could reminder us about the next milestone on the Samsung mitigation, what’s coming next and how you think this [camel] is going to fit?

John Kispert – Chief Executive Officer.

Yeah, very good. I think just for us to start with we’re not going to comment on litigation, it’s public that the decision from the ITC will be September 17th or September 19th, something in that range, I might have the date wrong but it’s in the high teens inSeptember. Beyond that I don’t think it helps anybody

Atif Malik – Morgan Stanley

Okay thanks, nice quarter.

John Kispert – Chief Executive Officer.

Yeah, thank you


Thank you. Our next question or comment is from Joseph Stauff of Susquehanna. Your line is open

Joseph Stauff- Susquehanna

Good morning, no I’m sorry good afternoon, it’s been a long day. Can you help me out regarding visibility and in the context of your business model, how far you can see in the context of your guidance and that level of conviction that you have expect to hitting a little high end of your range. You crossed second quarter relative to your previous guidance and so I was just trying to understand that

John Kispert – Chief Executive Officer.

Yeah Joe it’s John Kispert. I guess I can give you a bunch of data points. We don’t do any thing abnormal here; we are looking at a sale funnel just like everybody else. What can get, what’s in Q3 and then what’s in Q4. Q3 were -- as far as back log of bookings were concerned, we are drawing near 100% right now throughout the guidance just gave you.

If you look at weeks of inventory which is something we focus on also that’s out there because we’re always focused on any sort of correction, it’s still in that 4 to 5 week time frame which is very healthy from out standpoint and we certainly focus on a by region, by distributor, by customer. So we feel really good about that, for folks out there when it gets up to that 6, 7, 8 week time frame is when we get we get concerned and so it’s still I’d say very healthy.

IA as far as Q4 is concerned it’s filling out nicely. I’d say at this point in Q3 we are better off now for the following quarter, IEQ4 than we were 90days ago for this quarter. So despite, I think obvious nervousness with the overhang and certainly some consumer and market gyrations, business has been relatively steady for us and strong for us by region, an overall correction in any where the regions or by segment. Hope that helps.

Joseph Stauff- Susquehanna

Yeah, that’s helpful and then you had comments regarding your design wins doubling.

Can you help us reconcile that obviously through the guidance and the earlier question that your efforts obviously to kind of regain lost market share as a result of bankruptcy and kind of where you are and how we gauge that in terms of that comment in particular?

John Kispert – Chief Executive Officer.

Yeah, I think it’s a very positive data plan, we are tracking it very closely worldwide by every one of our opportunities which are many. It’ -- unfortunately Joe when you’re in chapter eleven you are unfortunately not allowed by customers to compete for some of the sockets and that’s certainly has had a slash share, we’ve done everything we possibly can to kind of work through that. But always given I’ve never done this before what was interesting was almost from the moment we exited reorganization, we were invited in, asked in very quickly by large embedded application customers who were not letting us compete and we were asked to come in quickly and start competing for sockets and we saw a big jump and it’s continuing right through July here.

We are trying to stay away from giving out those numbers because it’s just after a while, but the key is not just winning the design but then carry them through into production and we are not missing that point either. This is about disappointed focus and so we’ve seen a nice jump and we plan on turning that into revenue sometime in the next 6 or 9 months

Joseph Stauff-Susquehanna

Great.. One final question if I might. With respect to how do measure that appetite as relates to your comments? Are people happy to see, are people happy to re-engage with the various engineering constituencies, is that a function of just the overall markets being that tight, is it a function of manufactures and so forth wanting to do a force, how do you read that?

John Kispert – Chief Executive Officer.

I read it that we’re more focused on their needs. I think very clearly that our strategy is to focus on their needs and then it’s hard for them to find another supplier. They can’t find another supplier who is going to focus on them like that, and when I say focus I mean having a flexibility around the design, the specific design of the application software for that application, the ease of use in the interfaces and those are things that we continue to invest in expansion over the last year and customers know that and that’s why they are quick to try to try to get us back in and get us to sign into any one of these segments because they know we‘re going be there for them because that’s the market that we’re focused on

Joseph Stauff-Susquehanna

Beautiful, thanks very much

John Kispert – Chief Executive Officer.

Thanks Joe.


Thank you. Our next question or comment is from Daniel Barenbaum of Auriga USA. Your line is open.

Daniel Barenbaum - Auriga USA

Yeah hi guys, thanks for taking my call. Few questions, I’m sort of staring at slide 13 with varying degrees of comprehension. As we move through the course of the next couple of quarters, when do non litigation extraordinary items, how long does it take for all of this to roll off and when do we get to what you would consider to be sort of a more normalized business model and we won’t have to worry about some of the other charges, that happened just over the next two quarters?

Randy Furr - Executive Vice President and Chief Financial Officer

Yeah, this is Randy. I think you’ll probably see us supporting this non-GAAP or reporting in this basis through the rest of this calendar year. We will have moved through inventory, most of the inventory that was written up and we’ll get down to where your GAAP was also much closer to or very close to what it would be on an non-GAAP basis. So probably the March quarter of next year you won’t see this kind of format here going forward.

John H. Kispert - Chief Executive Officer

Hey Dan, John. I’ll add one thing but to state the obvious, but we believe that IP is the process technology we are talking about in this particular case is fundamental demand and fundamental deploring gate and we haven’t even started talking about Mirror, but we’re not planning, we are going to do what it takes to win on a legal budget. So we are not – I wouldn’t plan on disappearing at some date just because we think it’s over with. We are planning to win.

Daniel Barenbaum - Auriga USA

Right and I'm actually less concerned about that sort of litigation because I think you see a quitter go on that and more just understanding but more just sort of pure accounting type adjustments over law. But since you started about that litigation and you being in it to win I mean should we think about that actually ongoing litigation expenses and my question is more related to -- I mean I do understand that some of the patents are really fundamental to a lot semiconductor processing maybe even beyond just the technology or around floating gate around NAND. Should we -- if this litigation is successful with Spansion should we expect to see some sort of ongoing litigation expense and maybe royalties become a larger part of your business.

Randy Furr - Executive Vice President and Chief Financial Officer

Yeah, that’s a good question. One thing I want to point out what we've listed in column 3 here on slide 13 is a range is just litigation expenses related to Samsung. We do have other litigation expense; if you refer to our Q&K you will see that. That’s part of our normal legal expenses that we are not adjusting to a Non-GAAP basis. What we are doing here is we are signaling out Samsung in itself as additional litigation expense. Primarily again back to reconcile just some of the plans we have out there. If you feel it is more appropriate to put that into our numbers you are welcomed to do that.

We do think there is an end date to this particular litigation and that will end. Now your point is very good that in the future part of the company strategy in Germany I want to add on here is to monetize the company’s IP Portfolio and as part of that effort, there may be similar kind of expenses that are ongoing expenses that at that point we clearly wouldn't proforma out. But we would also hope that we have a revenue stream that well offsets those expenses going forward.

Daniel Barenbaum - Auriga USA

And so you are strategically -- is there a way for me to think about how to value your IP Portfolio?

Unidentified Company Rep

Yeah Dan I don't think you can do that today. I think it's stated owned, we feel very good about the technology position and we are just at this point rolling out a strategy to go monetize that and as you know and most people listening know there is plenty of ways to go do that.

Daniel Barenbaum - Auriga USA

Ok Thanks very much


Our next question or comment is from John Evans of Edmunds White Partners. Your line is open.

John Evans - Edmunds White Partners

Can you help us understand with your asset light strategy I guess just how you think about CapEx and CapEx requirements maybe over the next couple of years especially if you keep gaining share back etc. I'm just trying to understand that.

Randy Furr - Executive Vice President and Chief Financial Officer

Good question So we've guided to future CapEx expenses being between about 15 and 75 million. About 40% of that is kind of making CapEx for our facilities. About another 15% or so were IT related expenses and the balance we are reserving for specialized equipment and it’s primarily associated with new technology, advanced node technology that we think we might purchase and put into our partners to protect some of our proprietary processes that we have.

As I mentioned on the call, expansion has spent over a little over 400 million a year for the last 3 years 2006 to 2008 in terms of R&D. The majority of that expense was for process development and it drove a lot of capital spending in this company as this company followed a strategy of basically trying to focus on or servicing wireless customers who were needing this advanced node type manufacturing. Going forward we have on the shelf, we were already into 65 nanometer production. We have on the shelf 43 nanometer process developed and we have well down the path in the 3X node process development.

So we feel today what we needed to do was to focus and we have process technology that’s going to take us well into the future. As I showed you on a base slide forward the earlier slide there , the majority of our customers today are 110 and above. So we are moving them to 90 and 65 now. That is going to last 2 years, maybe 3 years then we will move them to the 4X technology for which we already have the process done and eventually the 3X technology for which we’re substantially there. So we don't need to be investing heavily in terms of equipment or in terms or in terms of R&D to meet the needs of our customers for the next many years.

So what we are doing with R&D is we are forcing on product development and taking certain sub segments as John mentioned earlier and we are really focusing on the needs of those sub segments and that's why you are seeing a capital budget in the 50 to 75 because that’s all we need to spend and why you are seeing R&D in the neighborhood of 10% because that is what we need to do and in fact we are spending more this year on products than we've spent historically on products. We've actually increased our spending in terms of products but we are just not spending near as much on terms of process because we already have those processes on the shelf.

John Evans - Edmunds White Partners

So just to understand if you continue on this track of the market stayed strong and you continued to take share obviously your business would get better and I guess what I’m trying to understand is, you can stay at these low levels of CapEx even as revenues. Can you give us a sense -- I mean if revenues go down, what kind of level do you think you need to bump up CapEx, because that seems like that's one of the real (inaudible) in your model.

John H. Kispert - Chief Executive Officer

Sure John, it’s John. Let me try to help with numbers. So today about 65% of our output is from assets we own. We do have a 65 nanometer partner, we have an 110 nanometer partner, we have a 90 nanometer partner and we just talked at length about our 45 nanometer partner. A little bit of this ties to Dan's earlier question just a product question on strength of IP because a lot easier here to get partners when the IP that is important to them and will work with them. So I would expect that 65% -- we were adding capacity to our assets too and that number I think Randy just explained that. So there is a lot more external capacity at our fingertips with these partners by node.

But in addition to that every quarter we will be adding 10,000 wafers starts or so to the assets that we own. So there is upside, plenty of upside, not something I'm losing sleep over right now.

John Evans - Edmunds White Partners

And then the last question I have for you is and I know that this sounds kind of funny just coming out of the place that you were, but if that if it is true, you guys are going to generate a lot of free cash flow and so what do you do with it? Do you just put it on the balance sheet for now and just let it sit? Is that kind of the thought process?

John H. Kispert - Chief Executive Officer

I don't think that is funny, I think that is brutal that question given where we were two months ago. I think we got execute and I think you asked a very good question, one that we hope to answer repeatedly in the coming months and quarters. We do have thoughts, we do have some strategies that we want to roll out. But what we are focused on right now I think next quarter for at least the next 6 months which is executing on this business and proving to you all that we are doing what we say we are doing.

John Evans - Edmunds White Partners

Ok Thank you for your time.

John H. Kispert - Chief Executive Officer

Thanks John.


And I'm sorry no further questions or comments at this time. Ladies and gentleman, thank for you for your participation in this conference. This does conclude the program. You may now disconnect. Have a wonderful day.

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