Randy Furr - Chief Financial Officer, Principal Accounting Officer and Executive Vice President
Shubham Maheshwari - Investor Relations
John Kispert - Chief Executive Officer, President and Director
Rajvindra Gill - Needham & Company, LLC
Atif Malik - Morgan Stanley
Krishna Shankar - ThinkEquity LLC
Daniel Berenbaum - MKM Partners LLC
Unknown Analyst -
Spansion (CODE) Q2 2011 Earnings Call July 27, 2011 4:30 PM ET
Good day, ladies and gentlemen, and welcome to the Second Quarter 2011 Spansion Inc. Earnings Conference Call. My name is Francine, and I am your operator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Mr. Shubham Maheshwari. Please proceed, sir.
Thank you, very much, and welcome to Spansion's second quarter 2011 earnings conference call. On the call with me are John Kispert, CEO; and Randy Furr, CFO of Spansion. We will be referencing a slide deck during the portion of today's call. You can download a copy of these slides from Investor Relations section of our website at www.spansion.com, under Events and Presentations. There will be an audio replay of this call available by dialing 1 (888) 286-8010, and passcode 36022600. A webcast replay will be available on the company's website for the next 30 days.
Before we begin, please note the following Safe Harbor Statement. 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 may differ materially from our current expectation. We encourage you to review risk factors in our various SEC filings. The company disclaims any duty to update forward-looking statements.
With that, I will now turn the call over to John.
Thank you, Shubham. Good afternoon to everybody, and welcome to our fiscal year 2011 Q2 earnings conference call. I'll begin by highlighting our results and update you on the -- then I'll update you on the market and then finally, our strategy. Then Randy will give you the financial details for the quarter and the outlook for the third quarter, which ends in September. And then finally, we'll field your questions.
To begin, we continue to execute against our strategic priorities and maintain our leadership in embedded markets. At a high level, we achieved GAAP earnings of $0.40 per share and non-GAAP diluted earnings of $0.54 per share. We expect positive GAAP earnings per share -- we expect a positive GAAP earnings per share and for it to continue to improve the next couple of quarters.
Revenues of $299 million represented an increase of approximately 2% sequentially, and year-over-year with our core embedded business increasing about 12% over last year. We also achieved improved gross margins. And our cash from operations at the end of the quarter was approximately $48 million.
To date, we have spent $156 million of cash for approximately 11 million shares, at an average price of approximately $15. We also continue to have strong design win momentum, which I will cover shortly.
However, in Q2, we began to see some demand weakness due a few factors. First, in our consumer segment, we saw demand slowing and we attribute that to the macro-global issues surrounding consumer confidence. And thus, spending in our consumer segments. These are segment such as digital TVs, digital cameras, home gateways, all these were impacted, particularly in China for us, which is where most of the manufacturing for our customers takes place.
Second, in wireless, we saw a supply surplus developed throughout the second quarter, which impacted our margins. And finally, with the Japan earthquake, there was a lower automobile production due to shortages of electronic parts across the industry and an inventory correction happened towards the latter part of the quarter.
Currently, we are forecasting that these trends do not abate in the September quarter. I would add that although we anticipate the supply demand issues in the auto supply chain correcting soon, we don't anticipate seeing that business picking up till the end of September or maybe early October.
Overall, we have a clear strategy and are focused on continuously developing a track record for executing. We will leverage our strength as the leading memory provider for embedded and will be aggressive in our new product introductions.
Our market share continues to grow in embedded, gaining over 1 point from last quarter at approximately 38%, an increase of 8% market share from a year ago. We have a broad base of about 6,500 customers worldwide. I will now touch on some of the strategic announcements we made in the quarter in both our core specialty memory and in our licensing businesses.
In core specialty memory, we extended our foundry relationship with SMIC to expand our 65-nanometer capacity and to include the manufacturing of Spansion's 45-nanometer flash memory. This supports our strategy to meet customer demand for all of our flash products and our expanding roadmap.
And in licensing, as you know, we have put the Samsung litigation behind us. This was a significant milestone. Now that we have demonstrated the value of our IP, we intend to aggressively pursue additional opportunities to grow our licensing revenue by offering licensing to our patents, as well as to certain technologies.
For example, foundries are using various embedded flash technologies, which have limited scalability. We have a competitive and scalable technology that meets their needs.
Moving to new product development, which has been a big focus this year for defining our future product lines, we are starting to gain momentum with our new product platform. The GL-S flash memory. We entered production last quarter with the 1-gigabit and the 512-megabit products.
Now, we are sampling 128-megabit and 256-megabit, which is critical for customers in Europe and Japan for consumer and automotive applications. With these products, we also expect good traction in the second half, especially in the aforementioned consumer segments, which typically have much shorter design cycles and -- for design wins.
In addition, we will also start sampling the industry's first 4-gigabit NOR at 65-nanometer in August. We're also progressing well with our NAND development and we already have customer NAND from our embedded customers. We will offer a portfolio of Single Level Cell or SLC NAND products targeted at applications such as set-top boxes, printers, digital TVs and point-of-sales kiosks.
We anticipate our first product will start sampling later this year and we'll follow on products introduced next year. These will focus on high reliability, durability, quality and performance. The kind needed for the applications I just mentioned.
Turning to our design wins and our future demands, we continue to seek momentum across all embedded segments. In consumer electronics, we have maintained our leadership position with over 30 wins. We expect additional demand for GL-S and with the rise of network home applications and gateways.
In gaming, we secured key design wins including for the first time, 2 of the leading providers of home entertainment gaming controllers. This demonstrates the value new customers are placing on the performance and reliability of our flash products.
In telecom and networking, we had approximately 45 design wins driven primarily by more switches required for the growth of cloud computing. In automotive, while timing uncertainty still exists from the Japan earthquake and the ensuing supply and demand challenges, the latest designs all require more flash.
Digital thin-film-transistor clusters, infotainment and safety applications are some of the key areas that we're focused on for growth. This quarter, we secured about 30 new design wins.
Lastly, in industrial, we have over 30 new designs. Mostly from emerging applications ranging from surveillance cameras and point-of-sale kiosks to smart meters and solar panels. Let me quickly highlight the flash requirements for a couple of these applications.
Surveillance cameras are transitioning from analog to digital cameras. These requires sophisticated digital signal processing, leading to large code sizes that require a high density flash. Approximately 15 million IP-based security cameras are expected to be sold worldwide in 2014. These cameras require sound or motion to be detected by the camera, with the ability to respond instantly to an event and start the recording process instantly.
We'll also capturing the wide dynamic range, which requires complicated algorithms for video motion analysis, instant-on capability and a high read performance that only Spansion flashes can provide.
We secured another 5 design wins for smart meters this quarter. These meters require our high reliability in performance and are on their first phase of smart grid investment by utility companies worldwide.
Another emerging area is in solar panels, where we are generating interest in our flash products for solar inverters to store their program code for the microprocessors performing the power management, as well as in the data logging modules for the efficient control of the solar plants.
To sum it up, we are all well-positioned across all these markets, as evidenced by our design win momentum in our core specialty memory markets. Virtually all of our products sit next to a microcontroller, a microprocessor, a field programmable gate array or an application-specific processor, where it is fundamental to the operation of the processing logic in our customers' end products. We are focused and our executing against our strategic initiatives.
Going forward, we are placing even more priority on superior service, quality and delivering products on time, and of course, expense management. Accountability and efficiency will continue to be driven throughout this entire organization. I remain optimistic about the future as we maintain our embedded market share leadership, continue to introduce new flash products in the second half and expand our licensing business, a brand new revenue stream for the company.
The ultimate metrics we're still focused on are growing profitability, EBITDA and cash generation.
And with that, I'll turn the call over to Randy.
Thanks, John. Let me start with the summary of our fiscal Q2 '11 operating results. Non-GAAP sales were $299 million, non-GAAP gross margin was 36.3%, non-GAAP adjusted operating income was $45 million according to a margin of 15% and non-GAAP adjusted EBITDA was $74 million.
As I am sure you are familiar with by now, we are presenting non-GAAP financial information in addition to GAAP, in order for you to better understand the operating results of the company. We believe this is important due to the significant impact of fresh start accounting requirements. In accordance with my comments from past quarter's call, our plan is to discontinue with this format going forward.
So I'll start with Slide 6. After adjusting for fresh start accounting, net non-GAAP sales come in at approximately $1 million below the bottom end of our guidance at $299 million. Revenue was up 1.6% from Q1 and our second quarter of this year 2011, embedded revenues accounted for $243 million or 81% of total revenues. This compares to $238 million in Q1 and $218 million in our second quarter of last year. So we are up a healthy 11.6% year-over-year and up 2% sequentially in our core specialty embedded business.
With that said, our revenue did not get to a point we expected. We are seeing weakness due to several factors. First, clearly, there are macro-global issues surrounding customer confidence in spending. This has impacted our consumer business, which is done primarily in China. Secondly, we are seeing an impact on our automotive business due to parts shortages related to the Japanese earthquake and tsunami.
Finally, we are seeing weakness in our wireless business as 90% of our wireless business is low-featured phones manufactured and consumed in China. As we exited our second quarter and reviewed our order backlog situation for Q3, it is clear to us that we will be impacted in Q3 with a customer inventory correction.
However, looking beyond Q3 into Q4, we do see a healthier backlog situation at this time. I should point out that our current belief is that the parts shortage situation flogging the auto industry should be fixed by the beginning of Q4.
Non-GAAP gross margin was 36.3%, this was up sequentially from Q1's 35.6% and up 240 basis points from Q2 2010's 33.9%. The reason we were up is mostly due to the favorable mix with our low-density embedded consumer business being down sequentially in the quarter, and with the incremental top line revenue increase.
Also contributing to the improvement was operational efficiencies achieved by both our fabrication and our final manufacturing operations. This was partially offset with lower ASPs due to pricing pressure, most prominent in our wireless business.
As you can see, we did a good job at mitigating the top line weakness with expense control as our operating expenses in 2, came in at the low end of guidance. The net result is non-GAAP operating income was $45 million, an increase of 11.4% from Q2's $40 million last year. Non-GAAP operating margin was 15%. This represents 130-basis point increase from Q2 2010's 13.7%. So even though we were just below the bottom end of our guidance with respect to revenue, we did end up at the midpoint with respect to our operating margin guidance.
In line with expectations, we incurred $9.1 million in interest and other nonoperating items in Q2 and our tax rate was 6.4%, which was also in line with the 5% to 10% guidance.
Adjusted EBITDA also posted a year-over-year gain coming in at $74 million. This represents 24.6 as a percent of sales. Our non-GAAP basic and diluted EPS was $0.55 and $0.54, respectively, in Q2.
Let's turn our attention to Column 2, the one labeled "Fresh Start Adjustments." This column was the principal financial impact on our second quarter's GAAP results from fresh start accounting.
As we discussed in each of our quarterly calls post May 10th of last year, fresh start accounting has had a material impact on our operating results.
Let's turn to Slide 7, titled "Q2 GAAP to Non-GAAP Adjustments." Here, we've further broken down items from fresh start accounting that impact revenue, gross margin, operating income and adjusted EBITDA.
Given that we've covered each of these in detail during prior quarters' earnings calls, and the format is the same and that the Q2 fresh start numbers were generally in line with the guidance provided during last quarter's call, I will not do a deep dive into each line item.
However, there's one difference I would like to discuss, and that is the depreciation roll off that occurred on the first anniversary of fresh start, which was on May 10th of this year, 2011. On that date, there was a significant reduction in depreciation expense and inventory was revalued using normal depreciation levels on a go-forward basis.
On Slide 7, this is the line item titled, "Inventory Write-down." And in total, the chart was approximately $25 million, of which $12 million was recorded in Q2 and $13 million will be recorded in our upcoming Q3. Since this is a non-cash, nonrecurring and not representative of our normal business economics and similar to our other fresh start accounting related charges, we are excluding it here from business results and separately outlined this amount for Q3 in our guidance for Q3.
Now let's turn back to Slide 6. Column 3 was the impact on our financials of our Samsung litigation. By now, I'm sure you are all aware of our recently announced settlement with Samsung. As Spansion had accrued future litigation expenses in connection with our dispute with Samsung and now that, that dispute is settled, we must reverse that accrual. This equated to approximately $26 million in benefit with respect to our GAAP financials, but we carved it out here for non-GAAP. We will not be breaking out Samsung litigation expenses in the future, nor do we anticipate any future expenses over and above the small accrual that remains.
Just still on Slide 6, Column 4 takes the combined GAAP results listed in Column 1, and that's the impacts from Columns 2 and 3 to get non-GAAP results for Q2. If you turn to Slide 8, you can see Q2 results listed in Column 5 on Slide 6 compared to the past 4 quarters.
We would now like to turn the conversation to the balance sheet. Please refer to Slide 9 and I'll start with cash. We ended the quarter with cash and cash equivalents and short-term investments of $314 million after paying approximately $1 million for bankruptcy-related disbursements. That's after paying that.
Going forward, disbursements related to bankruptcy should be less than a total of $8 million and the majority will likely be paid out over the next 1 to 2 quarters.
In addition, here in Q1, we had 2 other unusual or higher than normal cash disbursements. During the quarter, we purchased for $29 million and we'll retire the shares associated with Silver Lake's claim against the bankruptcy estate of Spansion.
Also during the quarter, we made a $20 million prepayment to our foundry partner SMIC Wuhan. This was in line with our May 16 announcement.
Finally, during the quarter, we paid $15 million for capital purchases and we paid $5 million down on our debt. So $49 million in unusual cash-related disbursements and $20 million in disbursements normally associated with our business for a total of $69 million and cash still rose by $6 million. Thus, we had a pretty good quarter with respect to cash generation.
Now I'd like to focus on working capital. Trade accounts receivable was $131 million, DSO was down 9 days to 40 days. Inventory for Q2 was down slightly from Q1 to $175 million and we ended with 72 days of inventory. Again, a very impressive number for the industry. Accounts payable was $96 million at the end of Q2 and this equated to 36 days.
Let's turn to Slide 10 titled, "Summary of Claims and Share Distribution." Let me start off by saying, I know this whole claim and share distribution thing is a bit confusing to many of you, but there is a message here. And that message is, we are doing a good job at managing the overhang of the shares. This is both for the shares that have been distributed and our goal is to continue to do so for the remaining shares that are left to be distributed.
In addition, to the accretive benefit of buying and retiring shares at a price of less than market, by our buying the larger claims, we ensure that any material amount of shares that gets distributed go to either financial investors like you or to Spansion.
So in summary, as you can see, from the middle part of Slide 10, we have distributed 49.5 million shares. And the total net number of basic shares we anticipate eventually having as outstanding is between $57.1 million and $57.8 million. Thus, we have already distributed approximately 86% of the eventual total basic shares.
To help you understand the math, we've included 2 different eventual total claim pool scenarios, one at $1.2 billion and one at $1.15 billion. The point here is under the $1.15 billion total claims pool scenario, we will be able to retire approximately 11 million shares related to the 4 claims we purchased. And again, that was in Spansion Japan, TEL, Silver Lake and Samsung. And the total number of basic shares we will end up at approximately $57.1 million. Under the $1.2 billion scenario, the total basic shares would be approximately $57.8 million as we will retire fewer shares, approximately 10.3 million, in this scenario.
I'm sure many of you would like more detail on the remaining 238,000,000 of the remaining disputed claims. Slide 11 provides you with that detail. Again, for a Chapter 11 plan of record the responsibility through the majority of these claims is with our claims agent. We will not be periodically reporting or discussing the status of any individual claim, but we felt the information provided on Slide 11 will help you understand what claims remain and the reserve associated with each.
With that said, we are making progress and we do hope to have the majority of these resolved by the end of this fiscal year. As we've previously stated, where possible and where favorable to the company, we may acquire these claims for cash and retire those shares associated with that claim.
For the quarter, we've added Slide 12. What we've done here is outlined the detail of our full claims purchases. In summary, we will have spent a total of $156 million and we expect to retire between 10.3 million and 11 million shares in total. This equates to an average share purchase price of between $14.18 and $15.15.
This also outlines how many shares have already been retired and how many more are expected to be retired as we finalize the disputed claims and make future distributions. The point here is our basic share should continue to decline in the future, as the remaining shares are distributed.
I would now like to turn the discussion to guidance for Q3. Let me again say that the challenges of reporting and understanding fresh start accounting is, quite simply, pretty hard. We wish it could be easier and we wish we were totally through it and we're getting close, but we're not quite there.
As we incorporated into earnings release for Q3, the range for adjusted net sales is $285 million to $325 million, and the range for diluted GAAP EPS is $0.42 to $0.54 per share. Included in Q3's net sales is $25 million cash and is part of our Samsung settlement.
Also included in our Q3 GAAP guidance is $19 million or about $0.29 related to fresh start accounting. This $19 million breaks down by $6 million, related to amortization of intangibles established at the time of fresh start accounting, and $13 million in expense related to a onetime write-down of inventory related to fresh start accounting. And this is the part that's in Q3 that I discussed earlier.
This write-down is to revalue our inventory to lower standard costs as a result of the depreciation roll off from the asset write-up at the beginning of fresh start. Again, this is related to fresh start accounting that has to do with the May 10 roll off. In other words, they'll have much lower depreciation component to our standard costs, and we lower the value of our inventory accordingly.
After Q3, the only fresh start accounting adjustments will be the ongoing $6 million per quarter amortization related to the intangibles. We have added the table in our earnings release providing guidance of non-cash charges anticipated for Q3. Without the non-cash charges related to fresh start and stock-based compensation, EPS would be $0.81 to $0.93 for Q3.
Also related to guidance, we previously guided our fiscal 2011 capital expenditures to be approximately $100 million. We now see the total 2011 capital spending to be approximately $75 million.
Slide 13 is presented to help in reconciling historical non-GAAP to GAAP.
With that I'd like to thank you for your time, and turn the call back over to Francine for your questions.
[Operator Instructions] Our first question comes from the line of CJ Minh [ph] from Barclays Capital.
Unknown Analyst -
I guess, first question is really just a point of clarification. You talked about Samsung and $25 million cash. Should we pull that out to get non-GAAP revenues?
Yes, this is Randy. So as I have put into my prepared text here, we're kind of going forward without that concept of the same format of GAAP and non-GAAP, now that Samsung is behind us. But certainly, the $25 million is a onetime item that we will see in Q3 that we will not see in future quarters. However, I do want to point out, it is an item that will be cashed. So a lot of the things in the past that we've put into kind of this non-GAAP area has been non-cash. This will be actual cash we will receive in Q3. But you can certainly, if you wanted to pro forma that out or put it in a non-GAAP category, that could be your call going forward.
Unknown Analyst -
Okay. Just trying to understand the moving parts here. So if we pull that out, take the midpoint then down a little bit sequentially, maybe you could discuss, I guess, some of the moving parts across the various subsegments with embedded, where you might see a little strength and where you're seeing the downtick? I guess in more detail than what you've already provided on the consumer auto side?
Well, I'll take another stab at it and if I don't do it here, then you're welcome to come back at me. So look, as we progress through Q2, what it was clear to us is that especially in our consumer segment these products were primarily made and consumed in -- or consumed and sold and consumed in China, I should say. Not made, but sold and consumed in China. That there were softness and with the backlog just didn't progress as we expected in that business. Also, what we kind of observed is that at the beginning of the earthquake, many of our customers panicked -- I shouldn't say panicked, but accelerated their orders for work with some product that clearly, they were worried about getting in the parts supply. And they're, in our opinion, setting on that inventory today. They have that inventory here. So we've talked to many of our big customers about that, about consuming that inventory. And they think they'll consume it in Q3. But it will impact, overall, what we expect to ship into our end customers in Q3. So the combination of not shipping as much auto because of the part shortages related to the auto industry, our consumer business being down and many of our customers having going into Q3 with the higher than normal inventory situation, clearly, we've factored that into our forecast in our plans. So, yes, if you back out the $25 million from Samsung, clearly, you get to a midpoint of that to where we're going to be down in the 5%, maybe slightly over that range. And what we're doing is we're factoring in this inventory correction going forward.
Again -- I'll take the second part of your question, CJ, it's John. The places where we continue to see what we have kind of predicted for the year as far as strength, I'd say much more in the industrial segments, industrial control, automation. Medical instrumentation continues to go very nicely for us. Energy management. A lot of the medical, particularly the newer devices, machine-to-machine, the net would be the area that we kind of halfway through the quarter definitely didn't seem to slowdown. Particularly in the low end, the low-density side, would be consumer things around digital TVs and digital cameras, game consoles. Absolutely some of the areas I think that stayed a little bit stronger are areas that we're really not interested in competing in, that's more on the PC or the computer side of business, which is real low density. So that seemed to be a little bit stronger as the quarter went on, but not an area that we're very focused on right now.
Unknown Analyst -
Sure, it's very helpful. Just one quick follow-up. You made great traction post-bankruptcy in terms of recapturing share and embedded. I believe your share prior to bankruptcy is around 41%, you indicated 38%. Given some of the new products that you're coming out with, given your discussion with your top customers, when do you think you can get back to that kind of market share where you always were?
Yes, that's absolutely 100% of our focus, is the new product. We definitely have a product set that has performance advantages and form factor advantages, it's faster read, you'll see it give us a bunch of advantages. The trick there is getting a design win as quickly as possible. So it's going very well in auto, very well in the industrial space that I just talked about. I think in the consumer side, it's a much quicker design to kind of production cycle with the softness there, it's been a little bit frustrating. We feel very good about Q4, that's filling out very nicely. It's the Q3, where we're obviously conservative in thinking if we see a pickup in folks wanting to make that transition quicker, rather than waiting a little bit longer with their current design, which would have our older product set in it, or our competitors' product set in it.
Our next question comes from the line of Krishna Shankar from ThinkEquity.
Krishna Shankar - ThinkEquity LLC
Yes. Going into the September quarter, can you talk a little bit about orders, backlog coverage, and what you need in the form of turns business to hit the midpoint of guidance?
That was going into the third quarter, is that what's your question?
Krishna Shankar - ThinkEquity LLC
So our third quarter, from the guidance that we give, the percentage that we're booked is not that dissimilar to any other quarter. Obviously, if you do back out the Samsung, we're guiding to the numbers being down to 5%, 7% kind of numbers. And when you really look at it, our embedded business is booked fairly well throughout the quarter. I won't say it's fully booked, there then needs to be a lot of turns business in the embedded business. The wireless business is down at the bottom end of that spectrum, which is pretty traditional. So you can do the math, you can see we ended last quarter roughly 18%, 19% wireless business. That's business that traditionally we go in there as booked anywhere between 10% and 30%, which means you have to do a lot of turns. And it happens that way every quarter, and it's not any dissimilar this quarter. The wireless -- the embedded business, though, is usually booked somewhere between 60% and 90%, usually in the midpoints of that, and we are in that range again this quarter, entering into the quarter. So there's a lot less turns business that needs to be done in the embedded business. And the percentages aren't a whole lot different than normal. It's just that, obviously, with the guidance down a bit, the numbers are lower.
Krishna Shankar - ThinkEquity LLC
So I guess -- so the weakness here in Q3 would be macro-related relating to consumer automotive and some of the wireless feature phone business, would that be some of the 3 areas?
That's exactly it. Again, I could cite them, and you guys know them very well, high unemployment, the high fuel prices. The stuff -- the debt crisis going on in Europe. If you look at the 3 largest economies consuming for consumer products, it's the U.S., Japan and China. Clearly, all 3 of those today, they're having something going on in terms of consumer confidence. So unfortunately, it just impact us at a greater level than we anticipated. The good news is, if there's a silver lining through all of this, and I think we're focused a lot on the top line, is that if you do look at within the mix of business that we have, the automotive is very good, and we've kind of indicated it's down. But the majority of this is consumer and pricing impact on our wireless business. So if you really think through that, and our consumer business was down, impact on our wireless pricing and some of our automotive, yet the company continued to improve, hit the midpoint of its guidance in terms of its margin, continued to improve in terms of profitability. That's telling you that the real core embedded stuff that's the mid- and high-density products is really continuing to perform pretty well for the company.
Krishna Shankar - ThinkEquity LLC
And my last question, can you remind us again, what was the percent of embedded in Q2, again, for the company?
Our next question comes from the line of Daniel Berenbaum from MKM Partners.
Daniel Berenbaum - MKM Partners LLC
Randy, maybe you can go over some of the other moving parts in the model. If we exclude the Samsung royalty revenue, it looks to sort of get to the midpoint of guidance. It looks like gross margin is going down a bit. Can you talk a little bit about gross margin, and could you talk about where the moving parts are on OpEx?
So if you exclude the Samsung -- so there are a lot of moving parts, unfortunately, and I wish we were one more quarter down the path. So there's 2 things that impacting. The gross margins aren't going to be significantly different, but they will be sequentially down, because the revenue is going to be down. So to think that to bear in mind in terms of our GAAP guidance we had is $25 million for Samsung, but we also had $19 million associated with fresh start. And if you just -- if you said -- first just group those 2 together that's impacting Q3, and you said, okay, think of it in a way away as we had $25 million of incremental revenue and we had $19 million of incremental costs, a lot of that cost is in cost to goods sold. Therefore, it actually, from a GAAP point of view, it's going to pull down our margins going forward. Because it's the way to think of it as the $25 million of revenue with $19 million of cost, so you're going to have a pretty well gross margin contribution as a result of those two items. So if you back those 2 items out, you're actually going to have a non-GAAP, if you wanted to back them both out, you would have in theory, a non-GAAP higher gross margin than you would in terms of GAAP. With that said, these margins are going to be in the neighborhood of, for Q3, of 35%. And it's down a little bit from where we ended up this quarter, but that's to kind of be anticipated if the volume is going from roughly $200 million or $300 million down to roughly $275 million.
Daniel Berenbaum - MKM Partners LLC
Right. So that 35% would compare to the 36.3% this quarter?
Daniel Berenbaum - MKM Partners LLC
Okay. And then, just while you're on that topic and you're talking about it, so when you sort of net out, if you net out the $25 million royalty revenue and the $19 million charges, it sort of gets to a $6 million negative impact, which I get as being sort of 60-plus million shares kind of around a $0.10 net negative impact to the GAAP guidance. Does that make sense?
That make sense. Now I'm not trying to get cute here at all. But again, I think one way to think about this is that the accrual reversal, clearly, is something you should non-GAAP out. But one can make an argument that the $25 million that we get from Samsung, it is pure cash. Now, granted you're not going to see that repetitively, so you probably want to highlight that. But I would look at that as a little bit different than some of these non-cash charges that's associated with the fresh start accounting. So the problem or the situation -- I shouldn't say problem, situation here in Q3, is you can run these numbers a number of different ways. You can include Samsung, exclude fresh start. You could just look at GAAP. You could exclude both Samsung and fresh start and non-cash equity-based compensation. So what we've tried to do here in our table is to have you -- provide you enough details so that you could fully understand the business and the expectations that we have for Q3. But, clearly, if you back all this out, I think it's where you're headed here that what we're saying is that there's an inventory correction situation going on in Q3. We think Q4 is looking better, because we do get backlog at this point but in Q3, we are going through this inventory correction situation. Our revenues will be lower, therefore, we will -- our gross margin overall will take a hit. It's not huge, I mean, that's the good thing about Spansion is that there will be ups and there will be downs. But what we've shown you here is that we can manage this very well through the challenging times. But anyway, hopefully, that helps. By the way, we presented the information in the earnings release.
Daniel Berenbaum - MKM Partners LLC
Yes, absolutely, that helps. And then just one more question on that product revenue. John and Randy, I mean you guys have been around the semiconductor industry for a while, and given that kind of environment we're in, the midpoint of the product revenue would seem to be down about 15% from your peak quarter, which was Q4 of last year, so 3 quarters ago. Does that sort of 15% top to bottom, I mean, does that feel like a top to bottom correction? Does that feel like maybe there's a little bit more to go?
That's a great question, Dan. I hadn't thought of it in those terms. We saw the end of Q3 was -- end of Q2, I'm sorry. June was relatively quiet. It certainly felt like a bottom. But we've been around the semiconductor industry long enough to know it could last for a while. We don't think that, that's the case, as we've said a couple of times, Q4 is filling out very nicely. Particularly in what I'll call the more industrial markets, we see a very nice lift up there. The question is, it'd be more the consumer kind of segments that we keep focusing on here, and I'm thinking particularly the wireless. How long does that last? And we're not experts at that. Obviously, we're going to run the business in a way that we're going to continue to kind of put up those 35%, 36% gross margin businesses at any level. That's how we're thinking about it. I don't see another big stair step down from the guidance we just gave you. Having said that, we've been around it long enough to know that we're going to be prepared for that. And we'll just keep running our business at these levels and focus on growing the company in the segments that do show growth.
Our next question comes from the line Atif Malik from Morgan Stanley.
Atif Malik - Morgan Stanley
John, on the last call, you guys said you guys were on the pace for a 5% to 7% top line growth, and now the global GDP environment has changed since then, and you guys do sound bullish on the fourth quarter. So my question is, are we still on track for the 5% to 7% growth given your bullishness on the fourth quarter? And what is driving your bullishness in the fourth quarter, and which segment?
Yes, Atif, everything we talk about here is really just looking at our sales funnel, which is with 6,000 customers, you can imagine, it's relatively complicated. But we do put a great deal of time into it and focus into it. So when we have comments on Q4, it's not us using economics to figure out, it's literally looking at backlog. Looking at orders on the books, by segments, et cetera, by region. And when we put our guidance together for Q3, as Randy said earlier, we do all the bottoms up work. As Randy said it, there's history here. Also, we know that there's an x percent that generally gets booked before the quarter starts, in each segment, each business, and we focus on that. As far as Q3 is concerned, if we did see consumer, what I'm going to call more consumer kind of markets that I articulated earlier started to pick up. And there are people that say that, that could happen in the September time frame or even sooner. Obviously, we're going to react to it and get every bit of that business we possibly can. We just don't want to be in the business of trying to predict that. So what we're giving to you guys is our analytical bottoms up of our sales funnel for the next 6 months when we talk through this.
Atif Malik - Morgan Stanley
Yes. And the second question, you mentioned that there's an oversupply in the wireless segment and I just want to understand the severity of that oversupply. And does that change the company's view of staying in that wireless segment, cater to the Chinese handset market?
Yes, very good question. It hasn't changed our strategy one bit, I think we could have done some things a little bit better this last quarter, I don't like those gross margins at all. We actually did meet our, or close to meet our revenue goals for the quarter and what we thought was the right kind of businesses for us to get. We did see at the end of the quarter an influx of more supply. And I think that's attributable to other folks in the MCP business who had more supply. That they were able to get into that, into markets that we were more focused on. I think we're in much better shape going into Q3, for a variety of reasons I don't want to go over on this call. And we still like this business. We think we have different -- we think it particularly helps us as we grow in the kind of the machine-to-machine markets. And so we're going to stay focused on it. And I think we'll, margin perspective, we'll show improvement in that Q3, Q4 timeframe.
Atif Malik - Morgan Stanley
And one last one, John, you mentioned expanding the licensing on the NAND side to foundries. I'm just curious in terms of the revenue timing from NAND licensing, is it still kind of in the middle of last year -- I mean, middle of next year, the revenue timing?
I would say that's about right. We have -- if you're going to think of licensing kind of in 2 flavors, one is technology licensing, where we're in deep conversations with a number of different folks. It does take time because you have to prove out the technology in working with somebody else's technology. We're being -- we're pushing it on, we're resourcing it. I'm very hopeful that it will happen sooner rather than later, but I think we have the right set of expectations. There's another side of the business, which is really patent licensing, which is what we learned a lot with the Samsung litigation. The phrase I'm using is, is that we now have battle-tested IP. We know it's valuable. We know that it's not just valuable with nonvolatile memory, but it's valuable with -- in other semiconductor technologies. So on that side of the business, I think it might take a little bit longer. We want to focus on it in a way that there's not litigation. Not that we're afraid of litigation, obviously, but that we go after it in a way that we can move quickly, create the right business model for the company going forward. And you'll hear more about that portion, I would say, that's probably a little bit behind the technology licensing efforts that we've been working on for the last couple of months.
Our next question comes from the line of Glen Yeung from Citi.
This is Delos for Glen. Just a few quick questions, housekeeping related. Do you expect any more accrual reversals in the third or fourth quarters?
No more, we don't expect any more accrual reversals in the third or fourth quarter. No.
And then for OPEX, what are we thinking for the back half?
I think, essentially, it will be flat from if you take the $26 million that we had and add it back to operating expenses. I think you can look at essentially flat operating expenses going forward.
And then one last thing. As far as the fourth quarter of the core business, it sounds like you're expecting that to grow. Do you think it was a matter of some of your customers maybe pushing out to that quarter or not?
I think it's a variety of a couple of things. One is, I know I personally talked to a couple of our larger customers about the forecast because it was decent in Q2, it's down in Q3 and it's pretty big in Q4. And they walked me through that, just as we told you, it's an inventory correction situation. When the unfortunate stuff happened in Japan, they decided to accelerate a bunch of orders and they can see now that there's really not a worldwide disruption that's impacting their business. There were some in the automotive business, but for the most part, not impacting their business. And they're working through this inventory and it's not 6 months, it's a couple of months of inventory, and we'll be back to normal. Secondly, as we've said, I think it's pretty widely known that the microcontroller for the auto industry was pretty significantly damaged in the Japan earthquake and tsunami. That is coming back online. There's a lot more supply in Q3 than there was in Q2, but by Q4, it's expected to be fully back in production. Generally, orders of micro-controllers, as John said, there's a piece of NOR with it. And because there's just some companies have made up for, some had been more -- that had more damage are down. Companies that didn't have the damage are obviously up. That's why you're seeing some semiconductor companies doing well and some not, because it just varies. But overall, it's impacted the number of automobiles worldwide. And we're in a fair amount of these automobiles and it's impacted us. So we feel pretty confident by Q4, that part shortages will be fixed, and demand -- and certainly from the forecast that we get and usually our automotive customers are pretty good at that -- demand will be back up. So again, we're -- we did not provide guidance for Q4, and what we're saying is we do expect it will be back up closer to the kind of the situation that will be past this inventory correction situation. But as John said and as I've just confirmed, where we feel comfortable here is the forecast and the order backlog that we're seeing from our customers for Q4 at this time.
Our next question comes from the line of Raji Gill of Needham & Company.
Rajvindra Gill - Needham & Company, LLC
Just to follow-up on some of the previous questions. In the kind of annual guidance, you had talked about kind of 5% to 7% top line growth, including in that was a $15 million to $30 million impact because of the Japan disaster. I wanted to see if that disaster has accelerated that revenue number. And on that, if I look into fourth quarter, it would imply a pretty big sequential ramp to get to net 1% or 2% growth in 2011. So pretty big growth and a big recovery in auto quarter-over-quarter, and a recovery in consumer and gaming. So maybe if you can help me -- do you think you guys will grow this year? Given what's happening with all the several segments that you're experiencing.
So when we, obviously, we provided that guidance not that long ago, it's unfortunate, but at that time, it looked like good guidance. And but clearly, there's been, as we've alluded to, a number of macro-global economic things that's impacted our business. And I think, when we referred to the roughly $15 million of $30 million of impact as a result of the Japan earthquake, I think that's still a pretty good range. Clearly, I think we're at the higher end of that range. But I think that range is pretty good. We're not -- the area that we've seen the greatest impact here, in terms of pure top line revenue, has been in our consumer segment. And if you look at the pie charts that we provided as part of our presentation, you can see that our Asia Pacific percentage of revenue is down pretty significantly, that's where the greatest part of that is. And also in our consumer segment that we have, you can see it's down as well. So again, fortunately for us, it tends to be a bit of our lower margin segment, but that's where we're seeing that's soft. I certainly would model Q4 to get you to a 5% to 7% year-over-year growth, given that we're at the low end or just missed the bottom of the range here in Q2, we're guiding down in Q3, I certainly wouldn't guide, if I -- we're not providing guidance, but I certainly wouldn't be that high to get us back into that range. So short of me giving you a another full year estimate, or Q4, there's not much other way I can answer this question. So...
Rajvindra Gill - Needham & Company, LLC
Yes, I understand. I'm just, I mean, the consumer gaming scene is going to be persistent, it's not temporary. Especially if 40% of your sales is coming in from Asia Pacific, there's kind of rising inflation going on in China that's going to affect -- that's going to be a long-winded situation, consumer and gaming. And then, I don't know if the oversupply in wireless in China is also temporary. The only thing that could reverse itself potentially is in the auto industrial in the fourth quarter.
Yes. So but clearly, the overall end markets have been resaddled down. I think it's going to be this way for everybody. There's been mixed results, I mean, we've had people report before for us, and they're not too dissimilar from what we're saying out there and what we're seeing. With that said, I do want to emphasize that I do think there is an inventory correction going on. I don't think that what we're guiding to in Q3 is reflective of what we're going to see in Q4. And I think once we're past this inventory correction, Q4 will certainly be higher than Q3.
So with that, it looks like we're out of time, and I want to thank everyone for participating on the call today. Thank you very much, and have a great day.
Ladies and gentlemen, thank you for your participation in today's conference. I want to thank you for your participation. You may now disconnect, and have a great day.
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