Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Spansion (NYSE:CODE)

Q3 2011 Earnings Call

October 27, 2011 4:30 pm ET

Executives

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

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

Shubham Maheshwari - Investor Relations

Analysts

Daniel A. Berenbaum - MKM Partners LLC, Research Division

David Silverman - Unspecified Company

Hondo Sen - Cetus

Delos Elder

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

Krishna Shankar - ThinkEquity LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 Spansion Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. Shubham Maheshwari, Senior Vice President of Investor Relations. Please proceed, sir.

Shubham Maheshwari

Thank you very much, Jeremy, and welcome to Spansion's Third 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 a portion of today's call. You can download a copy of these slides from Investor Relations section of our website under Events and Presentations. There will be an audio replay of this call available by dialing 1 (888) 286-8010, and passcode 48457916. 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 expectations. We encourage you to review risk factors in our SEC filings. The company disclaims any duty to update forward-looking statements.

And with that, I will now turn the call over to John.

John H. Kispert

Thank you, Shubham. Good afternoon, and welcome to our fiscal year 2011 Q3 earnings conference call. I will first review our results, then update you on what we are seeing in the market and then outline the steps we are taking to strengthen our company for our customers, partners, employees and shareholders. Randy will then give you the financial details for the quarter and the outlook for the fourth quarter, and then finally, we'll field your questions.

To begin, Spansion remains the leader in the embedded Flash memory markets we serve, with an increasing number of design wins across our broad customer base and diverse end markets. During the quarter, we were not immune to the macroeconomic challenges facing the semiconductor industry. So later in the call, Randy and I will outline the steps we are taking in the midst of these challenging times.

Despite the difficult macro environment -- macroeconomic environment, we executed well in Q3 and achieved results within the revised guidance range provided in mid-September. Results of Q3 were primarily impacted by weakness in our more mature wireless business and the product decision by chipset suppliers primarily in China and other parts of Asia.

Given our strategy to place greater emphasis on areas of our business that we believe can provide a greater return on investment, we will continue to focus on products and segments that require high performance. And we have integrated our wireless business into our embedded segments, which already include wireless applications and infrastructure. We will continue to monitor the evolving smartphone and tablet market for future opportunities where we can add value, and we'll continue to support our existing customers with the inventory we have on hand, the IT and net technical know-how we possess, and of course, the dedicated folks we have in place working with the handset and tablet customers.

Going forward, our focus will remain on strengthening our leadership position in the embedded market, increasing licensing revenues, leveraging our proprietary MirrorBit technology and flexible fab-lite manufacturing strategy to create long-term value to our shareholders.

Moving to Q3 highlights. Our non-GAAP earnings were $0.48 per share. Non-GAAP adjusted net income was $30.3 million. Q3 revenues were $258 million, which was within the updated guidance range that we provided in mid-September, and represents a decrease of approximately 14% sequentially and 19% year-over-year as we were impacted by the global economic challenges and the rapid change in the China wireless and handset market.

Entering the September quarter, we anticipate the normal seasonal summer slowdown early in the quarter but also expected the usual improvement in the latter part of the quarter due to the typically seasonally strong September. Instead we faced strong demand headwinds, a tightening of inventory throughout the entire supply chain and overall caution from our customers and partners as forecasted. This impacted sales in all of our segments and channels.

All of the decline in the wireless and consumer segments was much more pronounced. In consumer, we experienced declines due to the weak global demand environment. The balance of our business performed pretty well, with absolute dollar sequential growth, quarter-on-quarter, in automotive, industrial and gaming segments.

The additional bright spot for the quarter was our licensing business, which got off to a good start with revenues of $30 million from the Samsung settlement in Q3. Randy will discuss the outlook going forward, but due to the continuing poor global economic conditions, we are forecasting a similar impact in Q4 as these macroeconomic challenges are adversely impacting our sales and the semiconductor industry in general.

We have a sound strategy and are taking a proactive measures to respond to the market challenges. Our goal is to manage through these challenges and focus on servicing our customer base generating profitability and cash generation, and of course, positioning Spansion for a bright future.

Let me now turn to the steps we are taking to improve our ability to deliver shareholder value and create a stronger company for our customers and our employees. As I mentioned earlier, we have begun actions that benefit the company and our stakeholders for the long-term. In the area of reducing cost and improving efficiencies, we are consolidating our 2 assembly and test facilities into one. We will transition production from our Kuala Lumpur facility to our Bangkok facility by the end of the quarter of 2012. We expect no impact to our customers from this consolidation, but we will be communicating with them frequently to address any questions or concerns.

We will also be reducing headcount by approximately a total of 20% with the majority of these reductions due to the closing of the Kuala Lumpur site. The areas outside of Kuala Lumpur, the reductions represent roughly 5%. Randy will talk more about the financial impact, but you can see from Slide 14 that there will be a financial implication for Q4 and some in 2012. Our goal is to have the bulk of the transition done in Q4, and thus, the realization of this financial benefits from the actions in Q1 of 2012.

On the technology and product front, our 65-nanometer product line continues to be strong, and it's the focus for sustained profitability. The blended wafer cost of our fab-lite strategy gives us an advantage and allows us to compete favorably on costs going forward. We continue to lead in mid to high density, and we have recently completed our first 45-nanometer silicone with our manufacturing partner, SMIC. That showed positive results. With our 45-nanometer technology, we'll continue to grow density and reduce costs.

As for our 65-nanometer products, in the fourth quarter, we'll be going into production with our new 4 gig Flash memory. We have over 10 customers who are currently evaluating the solution. In which, the fast random read performances ideal for systems featuring 3D graphics, interactivity and a dynamic user experience.

In the third quarter, we also announced our high-density serial Flash product, 65-nanometer, that fastest serial Flash memory product on the market. It delivers leading performance, automotive-grade temperature ranges, and in some applications eliminates the need for DRAM. Engineers are increasingly demanding these features for improving the user experience in designing innovative graphic-rich, stylish designs in next-generation electronics.

Our NAND efforts are progressing well, but we are not where we hoped to be at this point. Based on that -- what we see today our plan is to sample NAND in the first half of 2012 with production and revenue expected in the second half of 2012. We are still ahead of our competitors on any charge-trapping NAND projects, both in development and learning. And our strategy continues to bring to market a 1 gigabit through 8 gigabit NAND set of products. It solves specific needs for our embedded customers, who need a stable, long-term commitment of supply, and of course, high performance. This will allow Spansion to grow profitably over the long-term.

We continue to lay the foundation for our MirrorBit technology licensing business where we have the best mid- to high-density embedded technology in the industry and a technology easily scalable to future nodes of 1x nanometer or less. We have interest from several companies and are working the details with them. Given these are large-scale projects and involve technology that will go into production using nodes of 4x nanometer or less, we anticipate signing and announcing agreements in the first half of 2012.

With regard to patent licensing, we are moving forward in our efforts to receive compensation for use of Spansion IP. We've initiated conversations and hope to come to amicable solutions soon. As you know, it is our policy to not disclose any other details on ongoing negotiations.

We're also making good progress in our system-on-chip development, that we will initially target with a solution for the automotive market. Virtually, every major car manufacturer is interested in this technology, and we continue to work with them in our design and in our testing.

Turning to our design wins and future demand, we continue to see the momentum across all embedded segments. In consumer electronics, we maintained our leadership position in the consumer market with over 50 wins overall, 40 of these wins were for our mid- to high-density parallel NOR and serial Flash memory products in set top boxes, printers, and some home networking applications. We expect these to translate into revenue into the next 3 to 6 months. We continue to see new designs with our new 65-nanometer products at leading set-top box manufacturers, camera providers and printer and computing providers.

In communications, we secured over 35 designs, primarily for Ethernet switches, optical equipment and wireless base stations, which provide higher bandwidth and reduce costs for applications such as the Internet, video and multimedia interaction. We also saw a demand for our products supporting wireless and enterprise infrastructure, and it's growing much faster in Q3 than it did in Q4. We anticipate that to continue in Q4.

Automotive continues to be -- remains strong for us, with over 30 new design wins in Q3, 5 of these wins were for our new product set, for infotainment and advanced driver assistance services. We also had another thin-film transistor cluster wins, in which the design will go into cars made by a leading U.S. manufacturer.

In the industrial segment, we had over 70 design wins, approximately 20 of these wins were in emerging applications, many of which I spoke about last quarter like surveillance cameras and smart energy. We also see more medical devices require our Flash products for health monitoring and imaging equipment. At Spansion, we're focused on customers with market segments that require a high rate liability and high-value add products. This product category is a development priority, and as opposed to the more commodity-in-nature, lower margin products, which are often associated with our targeted consumer segment.

For this reason, as we steer away or limit our exposure to lower margin commodity businesses, we may, from time to time, experience a small share -- market share drop. This will generally be in the Asia-Pacific region, and again, the lower density consumer and/or wireless handset businesses.

Overall, we are well-positioned in our embedded markets, with over 400 design wins this past quarter and increasing market share in mid- and high-density products. We're focused on accelerating the adoption for our new NOR products in the embedded space in the short-term, followed by the release of more embedded memory solutions and charge-trapping NAND products next year. At the same time, we will reduce cost and balance our R&D investments and profitability. We expect to break even at the non-GAAP EPS level in the $210 million to $220 million range going forward, and to be above this in Q1 of 2012.

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

Randy W. Furr

Thanks, John. Again, let me start with the summary of our fiscal Q3 2011 operating results. Non-GAAP sales were $258 million, non-GAAP gross margin is 36.2%, non-GAAP adjusted operating income was $47 million, according to a margin of 18.1%, the non-GAAP adjusted EBITDA was $69 million.

On Slide 5 of the presentation posted to the Investor Relations section of our website, you'll see a breakdown of our sales by end market and geography.

Total net sales declined 13.7% from Q2 and 19.2% from Q3 of 2010. Embedded revenues accounted for $206 million or 80% of our total revenues. This compares to $240 million in Q2 and $246 million in our third quarter of last year.

In our third quarter, we saw a significant increase in our royalty revenue category. Revenues from royalties jumped from $2.1 million in Q2 to $30.8 million in Q3. One of the principal factors impacting our overall third quarter results was our wireless business.

For Q3, wireless revenues were $21.2 million. This compares to $56.3 million in Q2 and $73.3 million from Q3 a year ago. This is a sequential decline of 62% and a year-over-year decline of 71%. We are disappointed with our top line result. The weakness was due to 2 principal factors: one, the macro factors impacting our consumer business; number two, just as I mentioned, a decline in our wireless business. Of course, a major factor impacting Q3 is the one you're all familiar with and that is the macro global issues surrounding consumer confidence and spending. This is impacting our consumer business, which is done primarily in China.

As you can see from Slide 5, our consumer revenues dropped from approximately 29% or $87 million in Q2 to approximately 25% or $65 million in Q3, a sequential drop of 26%. And again as I mentioned, the second principal factor was our wireless business, which as you know, we have forecasted to be a smaller portion of our overall business over time. We saw our rate of decline accelerate due to the product transition by the chipset design suppliers. While we had hoped that our wireless products would've had a longer life, expanding, say, the next year or 2, we have excellent relationships with our customers and we will continue to support them in service the segment as our existing inventory gets worked down. Also contributing here is an overall surplus of supply of inventory in the market, which resulted in a negative impact on ASPs and resulting margins.

Just to clarify, by wireless here, we mean mobile handsets. We classify wireless infrastructure an area of focus for Spansion as part of our embedded business under computer and communications.

Turning to Slide 6. We'll review kind of our income statement highlights. Non-GAAP gross margin was 36.2%. This was essentially flat with Q2's 36.6% and up a bit from Q3 2010's 35.6%. Clearly favorable to Q3's gross margin was the incremental $30 million in royalties recognized from our Samsung patent dispute settled earlier this year. We had originally expected to recognize $25 million in Q3 and $5 million in Q4, but we received all $30 million in Q3, and revenue recognition accounting rules require that all $30 million be recognized in Q3. Thus, Q4 can only see $1.25 million in Samsung royalties and starting in Q1 of next year or Q1 of 2012, that number will be $6.25 million per quarter going forward.

The negatively impacting Q3 gross margin was lower volume to absorb to fixed cost, and a charge for writing down our wireless inventories to market value. This charge was $10.5 million. Also, there was an excursion in the fab that impacted yield related our 65-nanometer new product ramp amounting to approximately $4 million. Without these charges, Q3's non-GAAP gross margin would have been 41.6%.

As you can see, we did a good job at mitigating the top line weakness with expense control, as our operating expenses in Q3 come in at a level not seen for many, many years. The net result is non-GAAP operating income was $47 million, compared to last quarter's $50 million and last year's $51 million.

Benefiting, in part, from a lower interest rate on our term loan, we incurred $6.9 million in interest and other nonoperating items. Offsetting this benefit was an unusually high effective tax rate. This was due to 2 issues. First, up to $9 million in taxes for Q3, approximately $5 million was attributed to the $30 million in Samsung royalties as we recorded foreign taxes at 16.5% of this amount of Samsung royalties received. The other issue impacting our effective tax rate was the percentage of foreign income as a percentage of our total income was higher in Q3. This resulted in less benefits from our U.S. and California NOLs.

Adjusted EBITDA was a strong $69 million or 26.7% as a percent of sales. Our non-GAAP basic and diluted EPS was $0.49 and $0.48, respectively in Q3.

Let's turn our attention to column 2 on Slide 6, the one labeled Fresh Start Adjustments. This column lists the principal financial impact on our third quarter GAAP results from fresh start accounting. As we discussed on each of our quarterly calls post May 10 of last year, fresh start accounting has had a material impact on our operating results.

If you turn to Slide 7, titled Q3 '11 Results, GAAP to non-GAAP Adjustments. Here, we have further broken down items from fresh start accounting that impact revenue, gross margin, operating income and adjusted EBITDA. As you can see, there are only 2 remaining items related to fresh start, amortization of intangibles and inventory write-down. As I discussed in my comments last quarter, the inventory write-down is noncash, and this is the last quarter you will see it. In the future, the only impact remaining related to fresh start accounting will be the amortization of intangibles.

Now let's turn back to Slide 6. In column 3, we have broken out equity compensation by P&L category to assist you in reconciliation. And so still on Slide 6, column 4, takes the GAAP results listed in column 1, and that's the impacts of columns 2 and 3 to get non-GAAP results for Q2.

If you turn to Slide 8, you could see the Q3 results listed in column 4 on Slide 6 compared to the last 4 quarters.

Now I'd like to turn the conversation to the balance sheet, so 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 $301 million. During the quarter, we paid $11 million for capital purchases, also impacting the quarter was $30 million paid for the purchase and retirement of shares related to the Samsung bankruptcy claim. Finally, cash was impacted by higher inventory levels, which resulted from actual sales being less than originally anticipated for the quarter. I will point out that inventory in the channel is fairly low, averaging approximately 4 to 6 weeks, and again, Spansion recognizes revenue on sell through, not sell in, meaning that even inventory at our distribution partners is reflected on our balance sheet.

Now I'd like to focus on working capital. Trade accounts receivable was $106 million. DSO was down 3 days to 37 days. Inventory at Q3 was up, as I mentioned, to $211 million, and we ended with 104 days of inventory. Accounts payable, $105 million and this equated to 47 days.

Might I say, somebody needs to mute your phone out there.

Cash cycle days was 94 days in Q3 compared to 76 days at the end of Q2.

Now I'd like to turn to Slide 10, titled summary of Claims and Share Distribution. Again I know this whole claim and share distribution is a bit confusing, but again, there's a message here. And that message is we're doing a good job at managing the overhang of shares. This is both for shares that have been distributed, and our goal is to continue to do so for the remaining shares that are left to be distributed.

So in summary, as you can see in the middle part of Slide 10, we distributed 51.2 million shares. And the total -- or the net total number of basic shares that we anticipate eventually having outstanding is between 57.2 million and 57.9 million. Thus, we've already distributed approximately 89% of the eventual total basic shares.

To help you understand the math, we've included 2 different eventual total claims pool scenarios, one at $1.2 million 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, that being Spansion Japan, TEL, Silver Lake and Samsung. And the total number of basic shares will end up at approximately 57.2 million.

Under the $1.2 billion scenario, the total basic shares will be approximately 57.9 million as we will retire fewer shares, approximately 10.3 million total in this scenario. I'm sure many of you would like more detail in the remaining $236 million and remaining disputed claims.

Slide 11 provides you with that detail. And again per Chapter 11 plan of record, the responsibility for 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 reserves associated with each.

With that said, we're making progress, and we're optimistic that we will have the majority of these resolved by the end of this fiscal year. As we previously stated, where possible and where favorable to the company, we may acquire these claims for cash and retire the shares associated with the claim.

I would now like to turn the discussion to guidance for Q4. Please refer to Slide 13. As we incorporated into our earnings release for Q4, the range for net sales is $205 million to $225 million, and the range for GAAP net loss per share is $1.12 to $0.53. Included in this guidance, as outlined in column 4 on Slide 13, is a restructuring charge anticipated to range from $14 million to $44 million. We're taking a step to respond to the lower top line challenges by restructuring our operations to align our business with current market conditions and addressing the reduction in our top line from the wireless situation.

Please refer to Slide 14. As John mentioned, included in this restructuring is the consolidation of our final assembly and test operations resulting in the closure of our Kuala Lumpur site. The reason for the larger variance in the restructuring amount is the bottom end of the range does not include any additional write-down of inventories. The high end of the range includes a large inventory write-down. Even though at this point, we do not see a need for further inventory write-downs, we felt it prudent to provide you with a range with the potential Q4 restructuring charge.

What could drive additional inventory charges are: further erosion of ASPs in the wireless market and/or a reduction in the overall demand for Spansion's parallel NOR wireless products. Approximately $14 million of this Q4 charge will be cash and the balance will be noncash in the balance, if any. This is part of the larger restructuring program that will span four quarters with an additional $6 million anticipated for Q1 of next year, $3 million for Q2 2012 and $2 million in Q3 of 2012. Thus, the total anticipated range over the 4 quarters is $30 million to $56 million, with $24 million being cash and the balance, $6 million to $32 million, being noncash. Once completed, we expect future annual savings of approximately $30 million. As John mentioned, what this will do is drop or breakeven at the non-GAAP EPS level to $210 million to $220 million range, and going forward, we do expect to be above this number in Q1 of 2012.

Back to Slide 13. Without the restructuring charge, stock-based equity compensation and fresh start adjustments, we do expect to be essentially breakeven at the non-GAAP operating income level and non-GAAP EPS guidance would be in the minus or loss of $0.17 to a minus or loss of $0.07 for Q4. Again, Q4 will only see a small benefit from our restructuring efforts underway.

Slide 15 list our Q4 focus areas, which include growing our focused core embedded business, keep on track with our new product roadmap, continue to generate interest in licensing Spansion's IP and maintain profitability in this challenging market environment. Slide 16 is presented to help in reconciling historical non-GAAP to GAAP.

With that, I'd like to thank you for your time and to turn the call over to Jeremy, and we'll take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Daniel Berenbaum with MKM Partners.

Daniel A. Berenbaum - MKM Partners LLC, Research Division

I guess, John, I'd like to start with some of the market dynamics that you had talked about. You talked about walking away from some of the lower margin segments if I understood you correctly. So can you help me understand what size of your served market and how you view the size of your served market? And how we should think about your opportunity going forward?

John H. Kispert

Thanks, Dan, it's John. The way we to think about it is we are rolling out our new 65-nanometer low-density products here at the end of Q4 and right through the first half of next year. So today particularly with SPI low density, we're just at a competitive disadvantage happening for a long time. And we -- to answer your question directly, we compete in those consumer segments and just for everybody out there in set-top box, home networking, Digital TV, still digital cameras, camcorders, DVDs, TVs in general. Now all those markets have been softer recently, and there has been a deluge of more supply of low density -- lower density, and by low density, I mean, 16 and 32 megabit and below 16 megabit and below kind of range. And so, of course, prices have fallen mightily. So we have chosen not to support a bunch of that business. I'm not going to go into specifics. We consider all those customers key customers, and where we can support them, we will support them. But the key for us has been, and will continue to be, to get these new next generation products are -- which we think are going to be best in the industry too, not just from a cloud performance standpoint, the market over the next 6 to 9 months. And then, obviously, pick up more market share there. But I would suggest everybody that you look at the data we provided, particularly in consumer and it's the lower density portion of that. That in these kind of environment such as -- where it's not competitive, I don't think competitive for anybody and we're just not going to be in those businesses. And we're going to focus on the places where we create more value. I think that's it.

Daniel A. Berenbaum - MKM Partners LLC, Research Division

So it does, but then so, just sort of the -- of your guidance, kind of $215 million-ish, midpoint for the product revenue, how much of that is going to be into those segments or is there kind of 0 for those segments in Q4.

John H. Kispert

Oh, there is some in there. We will continue to support our customers in places where we can create value for our shareholders. It will be down, Q3 to Q4, is my feeling today, just because we don't have the products. We'll have a couple we're starting to ramp here shortly. So we'll continue to compete in that space but be very choosy on the deals that we close on.

Daniel A. Berenbaum - MKM Partners LLC, Research Division

Okay. And then just on the taxes, so what should we use and Randy, maybe you can answer this, what should we use for kind of ongoing normalized tax rate, including the, if you had the $6 million Samsung royalty revenue?

Randy W. Furr

Yes. Right now, I think, if I was modeling this out in the short term, I'd model somewhere around 18%.

Daniel A. Berenbaum - MKM Partners LLC, Research Division

18%. Okay.

Operator

And our next question comes from Raji Gill with Needham & Company.

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

Just trying to understand the -- how we should model the restructuring expenses in 2012. Should we view that as a non-GAAP type of number or we should include that in the expenses going forward or...

John H. Kispert

Well, that's a good question, Raji. What we're going to do is we're going to break those expenses out for you so you understand what they are. So when we present the financials going forward, we will present how much the charges is going to be, and then so you will understand. Like I said, the majority of this will be in Q4. It will be a small amount that spills over to Q1 and 2, but the majority is going to be in Q4, and we'll break this out for you see can understand it.

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

Okay. And if you're looking at being profitable on a non-GAAP basis in Q1 of '12 is going to...

Randy W. Furr

That's correct. But what we wanted to say here and what we wanted to communicate is that, look, we're taking some proactive actions based upon the combination of what's happening in our wireless business as well as what we're seeing in more of the macroeconomic situation out there, and we're taking costs out of the organization. We don't like doing it but we're doing it. And what that's going to do is that's going to drive our breakeven point. Q1 is historically one of the lower or it is easily the low point, seasonality-wise, for the company and what we communicated here on this call is that we expect to be above the breakeven point at the bottom line, not the non-GAAP operating income line but all the way down to the net income line for Q1.

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

And then how should we think about the wireless revenue? Is that -- there was $20 million in the third quarter, is that going to -- you might have mentioned this earlier in the call, I joined late, but is that going to 0 in the fourth quarter and then zeroing out all next year or...

Randy W. Furr

No. So it dropped, as I said on the call, from about $56 million to about $21 million in Q3. We expect it to drop further, probably dropping somewhere in the 25% range, but that will still put us, say, $15 million a quarter. Our goal is to do that, because we still have, as I mentioned earlier, wireless inventory here. We're still very -- even though the market is significantly less than what it was a couple of quarters ago, going forward, there still is a market for some of these products, and we still expect to be able to work our inventory down, granted it might take us 2 or 3 quarters to do that, but that's still the plan. So you will still see some wireless revenues but it will be somewhere between $10 million and $20 million a quarter.

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

For all 2012, or will it stop sometime...

Randy W. Furr

I'd certainly model it for the next 3 quarters, so let's say, Q4 in the first half of 2012 and we'll update you as we get to the midpoint of 2012. But as I said, we're pretty optimistic that we're going to be able to continue to work down our inventory in this space.

Operator

Our next question comes from Glen Yeung with Citi.

Delos Elder

This is Delos for Glen I just want to make sure I heard it right, the breakeven revenue point is $210 million to $220 million a quarter? Is that correct?

Randy W. Furr

Once the restructuring is completed, and based upon what we think we see today in terms of our ASPs going forward, our cost structure going forward, our standard margins, our absorption, what have you, we think that the break even is between $210 million and $220 million, yes.

Delos Elder

Got it. And just a follow-up, in terms of the end markets for Q4, which are -- can you maybe rank them in terms of strength or weakness?

John H. Kispert

Sure, Delos, it's John. I mean, I'll add on to Randy's last question too, but I'll answer your question first. Certainly, auto is a bright spot for us it's steadily recovering. Japan has worked its way through, and certainly we see strength across Europe, and the U.S. and there is picking up and I think people on the call all understand that the electronics strength in the future for cars with the security and safety really virtual requirements in every car. That looks very good to us and continues to be a strength, and that'll be up in Q4. I think that bleeds in to what we call industrial. And we've talked in the past about the Smart Grid applications, certainly, LED hasn't been as strong recently, but growing applications in and around those installations. It's kind of like time-of-use meters in production facilities is another growing place for us. So we see that quarter-on-quarter and strengthen to the next year really with the more automation, lower power and security needs, those guys are looking at. And the third one that's showing more and more strength is what we call gaming. We refer to it as entertainment. It's really the interactive data streaming business where these guys are looking for faster random read access to richer, better 3D data with lots of animation, lights and sounds, and that business is continuously picked up, and I think it'll be much stronger in Q4 and through next year. The question mark, as we just talked about, and I think to answer your question really is the consumer piece. And that's specifically in Asia, that happens to be -- that's where the manufacturing is taking place, so when you look at it regionally for us. That's where I would say the bigger question mark is. The -- our distributors -- with those guys we go through distributors for most of them, not all of them, but most of them, and the lead times that's certainly contracted there. The distributors inventory is, from everything we've heard and seen and measured, is less than it normally is. So we feel as though when things do turn around, that will have a nice hop in that direction, particularly with our newer products set. The timing of that, I think, is the real question. The other place of strength is the -- as I think about it, would be networking, what I would call networking, that's really the buildout of 3G and eventually, 4G. But also even 2G in the emerging markets, there's just more growth each quarter. Another spot that we see, inside that kind of networking space is the home power units. There's just so much power getting used in the home units, and people want instant access, instant on and deep sleep mode, and that plays very favorably to our technology in our product set. So that's growing pretty steadily and that'll go up in Q4 also. I wanted to add to Randy's -- the question that was asked Randy, I think the key for us is -- when you still look at Q4 and certainly Q3, there's a bunch of a onetime events. If you pull out the inventory adjustments for wireless, which is a business that we've talked a lot about, that is not a business that we invested at all, and in the last year and a half, and it is one that we going to stay in as long as we could, and drive cash flow. It's changed very quickly on us. It wasn't as much of a surprise. We built the inventory, because we know we're going to have the supply customers for a period of time. But if you take out that onetime charge, and you take out the -- the one yield issue we had that cost us $4 million. Our gross margin and our basic -- our base embedded business was over 40%. And I know, unfortunately, these are messy sets of numbers here. But it's -- I'd ask you guys look through it, because as most of you know, that has really been our -- our quest here is to establish ourselves in the higher return, higher margin steady businesses, and wean our way out of some of the more commodity-like businesses over time. And we continue to pull -- to do that. I think that'll become very clear as we get through Q4 with some of the consolidation that we're going to do inside the company. Delos, are you still with me?

Delos Elder

Yes, that was it. Thanks.

Operator

Our next question comes from Krishna Shankar with Bank Equity.

Krishna Shankar - ThinkEquity LLC, Research Division

Yes. Of the 25% of your business, which is consumer in Q3, what part of the business do you sort consider as core where you'll invest and grow, and where might the densities be somewhat lower and more commodity-like where you'd likely de-emphasize...

John H. Kispert

Very good, Krishna. It is a generality, but very -- I understand the question, I'd say half of it is more high-density, more where you think of digital TVs, home network and set-top boxes, digital cameras, those are the markets that we do well in. We have very competitive products, and that's a pretty steady business for us. It's everything else that is very crowded, and that's very well differentiated. And it's kind of as I said earlier, the 32 megabit and below range that we've tried to get to the company out of, piece-by-piece, over the last few quarters and we'll speed that up this quarter.

Krishna Shankar - ThinkEquity LLC, Research Division

Okay. And then regarding your comment about the core embedded business having gross margin, the 40%, 41% range. So will that sort of be the new baseline once we get through this restructuring issues? Sometime in 2012, should we be looking at sort of gross margins sort of fore handle on it maybe in the second half of 2012?

Randy W. Furr

Yes, so good question. In our longer-term model probably wouldn't quite get there. And the reason for that is in the second half of -- well, first off, in the first half of 2012, I think given our conservative approach here and again, the global issues that we're facing and the inventory situation we have, we're not going to be running as high of utilization in our facilities as we have for the last couple of years. I think that's going to negative impact the overall gross margin. With that said, the -- our expectation on standard margins especially for these focused areas like auto, industrial and gaming, which again require very high performance parts. In those areas, we don't expect -- we expect the margins to maintain is what I'm saying, but we do expect to be in a bit of an under fully observed kind of situation, which is going to negative impact gross margins. We'll probably have gross margins for the first half of the year, probably in the mid- to low-30s let's just say that. For the second half of the year, we -- as the new products come out, we do expect revenues to increase, we expect our absorption rates to improve and that's going to benefit margins, but we're going to be introducing a lot of new products. We've got a number of new SPI products coming out in the second half of next year. We have NAND coming out in the second half of next year. And I think as a result of these new product ramps, there are going to be a little bit of pressure on margins there. So I think our longer-term model at this point, has our gross margins more in the 34% to 37.5% or say, 34% to 38% range as opposed to something with a 4 on it. So -- but for the core embedded, like auto, industrial and gaming, clearly, the margins in that business we think will support that kind of number but we think there'll be a little drag on gross margins with these other things that I mentioned.

Krishna Shankar - ThinkEquity LLC, Research Division

Great. And then my final question, can you give us a little more elaboration on the issue, the delay in the embedded NAND technology development, is that something which you have a fix on or what's the nature of the issue? And how about how confident are you at about ramping up embedded NAND in 2012?

John H. Kispert

Hey, Krishna, it's John. Confident, we're quoting the customers and moving forward with dates. That was -- just for everybody, it's Single Level Cell, SLC NAND. And it's key for us, with this newer technology, the charge-trapping technology, which is never been done before. Very key for us to have these faster speeds with SLC for our customers, in particular, customers we're focused on. Very key for us to continuously lower the power consumption, and I think, most keys have high endurance, with the applications we're focused on there are going to be in more of those industrial and automotive kind of market, so the durability endurance is very key for us. We have product today, the key is for us, over the next couple of months, is to improve the durability, technically, improve it out. I have a lot of folks working on it. It's coming along very nicely. We could start shipping today into other markets, but we're choosing to stay focused on what we believe our core markets and making sure our product fits perfectly there before we actually introduce and bring it to the market. And we feel pretty good about early first half of 2012 to start ramping it and get revenue middle of the year to back half end of the year for 2012.

Operator

Our next question comes from Hondo Sen with Capital.

Hondo Sen - Cetus

I had a quick question, on the margins going into the fourth quarter, obviously, had the benefit of the licensing revenue dropping through, but when you look at the gross margins and sort of the EBITDA margins and the compression there, can you walk me through what's the impact? Is it purely just under absorption on the fixed cost? Is it depending on the channel, ASP compression? I mean, what's really driving that weakness and what's going to allow you to get back to those -- the early or low-30s in the first half of 2012 and potentially, a little better in the second half of '12?

John H. Kispert

Right. And so I think I heard a couple of questions here. The first one is could I help kind of bridge Q3 to Q4 guidance and -- is that part of your question?

Hondo Sen - Cetus

Yes, that'd be helpful.

Randy W. Furr

So we ended Q3 on a non-GAAP basis of 36.2%. And I think if you work through the guidance, you're probably going to come up in gross margins in the mid-20s. And I think, there is a couple of big moving parts in there. First off, as I mentioned in the call, we're going to have a total of $30 million less royalty in Q4 than we had in Q3. And I think if you do the math, that's about 8.5 points of margin. And then there's a number of other pieces, they're all pretty small but the net of the difference there, which is in the neighborhood of about 11 points, the net of the difference there is really going to be a combination of lower volume through our manufacturing operations, which means we're not as efficient, net against cost reductions that -- we're going to get some benefits by the restructuring activities that we have here. And quite honestly, we don't expect another $10.5 million hit with respect to our -- to the inventory. And if we do have an inventory, we'll certainly pro forma that out and explain that, which we really didn't pro forma that out this quarter. So the net of it is the bulk of it is just $30 million less revenues, a little less absorption in our fixed cost, offset by some cost reductions. And that's basically how you bridge to get from Q3 to Q4. Moving forward, there's 2 things that will help -- by the time we get to Q1 2012, 2 big things, one is we will have $5 million more a quarter or a total of $6.25 million of royalty revenue, which will all drop through the gross profit, gross margin line. And then secondly, we'll have the bulk of our restructuring activities done, which will reduce the overall cost, and that will help drive the margins up into the low-30s, to the low- to mid-30s kind of category.

Hondo Sen - Cetus

Okay, that is helpful. And I guess, obviously relative to Q3, understanding the royalties are the real driver, if you would take a snap from say, okay Q1 or Q2 versus the fourth quarter, is it just the macro headwinds that the company is facing particularly in the consumer that's driving that difference in margins?

Randy W. Furr

Right. It's -- well again, I think we're being very conservative of what we think is going to happen to our top line, I think. I mean -- and that's going to drive lower absorption there.

John H. Kispert

So Hondo, It's John. I think of 2 things. One is what we're announcing today, and we're -- what we've been driving over the last 2 weeks and we've announced internally and are executing on this consolidation of our back end final test facilities, which will lower the base assets for this absorption issue kind of mightily. And we'll be through that. And you'll see that in Q1, you'll see the benefits of that. So our footprint gets smaller and we have strong partners that we've developed with this strategy of being able to use both front-end manufacturing and back-end manufacturing that are not Spansion assets. And that'll improve the gross margin for Q1 and Q2. And lower that breakeven point was the point we're trying to make there. I think the second point is that we're actively steering away from this more commodity businesses that we've coined here wireless and the low-density consumer. And we've talked a little bit about that in the Q&A this afternoon. This -- it will be smaller, if not -- you won't even be able to notice them by Q1 or to Q2. And our base businesses should be bigger and stronger, so we'll have a mix going in favor. We're not really in a position to start trying to size 2012 and put numbers on margins and sizes and top line, but in this business, like many of the businesses that I know you cover, it really is about -- we'll have a very small asset base here, and it really is about them, just driving the top line with a higher gross margin businesses that will improve margins rapidly. Hard for us to size that, particularly in the macro economy we're right now. As we get into the 2010, we'll be talking more and more about it, with these new products and as this market start to develop more.

Operator

Our next question comes from David Silverman with Eagle Capital Partners.

David Silverman - Unspecified Company

I just wanted to follow up on that Q3 to Q4 margin bridge, and then next, I will have a question after that. So if you had $258 million in revenue, and if you -- so you backed out the royalties, you're at $228 million. And your adjusted EBITDA was $69 million so back out the $30 million, and you're adding about $40 million of adjusted EBITDA. So for the next quarter, you're guiding $205 million to $225 million. So from the lowest end you're about $20 million lower, but your adjusted EBITDA that you're guiding to is about $15 million lower, so I'm just trying to understand the decremental margins are or what's playing there?

Randy W. Furr

Yes. I think it's just -- it's, in essence, a mix of again how we get to those margins. So again the licensing revenue, which is going to drop quarter-over-quarter by $29 million that we disclosed is all impacting the EBITDA. We do expect there to be some other puts and takes in there, for example, as I mentioned, the wireless revenue being down another roughly approximately $5 million, based on what I said. And we expect the consumer business to be down another $10 million to $15 million, that's going to be offset by strengths in some of our other areas. So plus, we're going to have less absorption. We actually built more products in Q3, which is evidenced by the higher inventory levels than we plan on building during in Q4 and Q1. In fact, inventory levels, we expect to kind of go the other way. So in order words, we'll actually build less products than we shipped for the next couple of quarters, because we're going to work our inventories down, which will result, as John said, in unfavorable kind of manufacturing variance that hit the gross margin line. So it's really more of a function of the content of what goes into the profitability there and the resulting EBITDA, if that helps, it's the mix.

David Silverman - Unspecified Company

Well, I guess, sequentially at the high-end of your revenue guidance, it's basically flat to Q3 if you back out the royalties?

Randy W. Furr

That's correct.

David Silverman - Unspecified Company

So I guess, to that part, but in the range you gave, adjusted EBITDA is significantly lower even on the high-end?

Shubham Maheshwari

I think what Randy is also saying is that we are going to be working off of our inventory. So, David, what is happening here is that we build inventory in the September quarter, we got that absorption in the September quarter. And as you can see our balance sheet inventory was higher at the end of September. And so now we will be shipping this product but we will not be building new units of this product in the December quarter, so we would not be generating more absorption. And when we do not generate absorption, gross margins get impacted. So it is slightly disconnected from the revenue levels. Does that help you?

David Silverman - Unspecified Company

Yes. And maybe I'll follow up offline on that one. And then the second question in terms of the future share retirements. Are there any capital outlays that you have to make associated with that? Or to get to that 61 million dollars to 62 million shares, that's just going to happen through the settlement of the claims without capital required in your part?

Randy W. Furr

No, there's nothing else we need to make to get to there. We may choose to purchase some more shares from 1 or 2 of these settlements. In that case, then that 61 number would be a lower number.

David Silverman - Unspecified Company

I see. Okay. In your comment was that if it's favorable to the company. Can you just elaborate on what you'd be looking for in order to make a purchase of those shares?

Randy W. Furr

Yes. That on the day we do a transaction, and we look at the share price -- we look at the -- we look at what the stock is selling for on that day, and if we can buy it at a discount, then it's favorable is our view to that. It's favorable by 2 -- for 2 reasons. One is we get a discount to retire the shares. And secondly, we eliminate the overhang that could potentially be shares that would hit the -- a large number of shares that would hit the market from a buyer that would be a strategic buyer or an owner of the shares that would be a strategic owner.

John H. Kispert

David, in a word -- it's John, it's accretive.

Shubham Maheshwari

So it looks like we are out of time at this point. So I want to thank everyone for participating on the call today. Thank you very much, and have a great day. Bye-bye.

Operator

Ladies and gentlemen, that concludes the conference. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Spansion's CEO Discusses Q3 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts