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Executives

Linda Rothemund – Investor Relations

Dr. Bertrand Cambou – President and Chief Executive Officer

Dario Sacomani – Executive Vice President and Chief Financial Officer

Analysts

Daniel Amir – Lazard Capital Markets

Bob Gujavrty – Deutsche Bank Securities

Vijay Rakesh - ThinkPanmure

Betsy Van Hees – Caris & Company

Eric Reubel – MTR Securities

Shawn Webster – JP Morgan

Spansion Inc. (SPSN) Q2 2008 Earnings Call July 15, 2008 4:30 PM ET

Operator

Welcome to the Spansion second quarter 2008 earnings results conference call. (Operator Instructions) At this time, for opening remarks and introductions, I would like to turn the call over to Linda Rothemund, Investor Relations for Spansion.

Linda Rothemund

Welcome to Spansion’s second quarter 2008 earnings conference call. Joining me from Spansion is Bertrand Cambou, President and CEO, and Dario Sacomani, Executive Vice President and Chief Financial Officer. Bertrand will review key highlights for the quarter and as well share details on the overall vision for Spansion. Dario will provide more details on our financial performance in Q2, and then Bertrand will conclude the call with the business outlook for the third quarter and fiscal year 2008.

Before I begin today’s call, I will read the Safe Harbor Statement. During this call, we will make forward-looking statements that are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, including but not limited to, statements regarding future capital spending, anticipated positive free cash flow, expected third quarter and full year 2008 net sales, future 65-nm MirrorBit products, reduction of outside expenses, and expected net sales from SP1.

Investors are cautioned that the forward-looking statements in this conference call involve risks and uncertainties that could cause actual results to differ materially from the company’s current expectations. For risks that the company considers to be the important factors that could cause actual results to differ materially from those set forth in the forward-looking statements, the company urges investors to review in detail the risks and uncertainties in the company’s Securities and Exchange Commission filings, including but not limited to Spansion’s Quarterly Report on Form 10-Q for the first quarter fiscal year 2008 and the March 30, 2008.

This conference call, including audio and presentation slides, is also available on Spansion’s website at www.spansion.com. If you have not had an opportunity to review the second quarter 2008 financial press release, it is also available on our website. The audio replay of this call will be available through Friday, July 18, 2008. The replay number is 888-203-1112 and the pass code 3138421.

With that, I will turn over to Bertrand.

Bertrand Cambou

Second quarter results were above prior expectations. Revenue grew sequentially quarter-on-quarter and year-on-year. Manufacturing operations performed above plans improving efficiency and unit costs and days of inventory went down. Noticeable improvements in Q2 include a very strong revenue upside of our consumer CSID division where we are gaining market share, a wireless division hand revenue in a different market, and MirrorBit net sales of revenue hit an all time high at 80% of revenue. Our new SP1 facility is ramping up on track with $26 million in sales of 65-nm solutions in the quarter, up from $11 million in Q1.

Dario will go into more detail about our financial results. I would like first to spend a few minutes to describe some of our efforts to improve the fundamental business model of our corporation going forward. We are restructuring the corporation to improve our operating efficiency. As part of this strategy we are currently discussing with several of our partners opportunities to share R&D costs.

In the last few years we had to accelerate our migrations to new technology nodes and to escalate MirrorBit as an industry standard thus increasing R&D costs in the range of $450 million per year. Our new target objective is to reduce R&D spending to the $350 million to $400 million range.

We are also engaged in discussing with several partners ways to combine our test and assembly facilities. This will result in better economy of scale, reductions of capital needs and a better cost structure. In the area of material with the sub we successfully transferred JD1 and JD2 to Fujitsu last year. We are now considering other arrangements with other partners with existing material [to sub]. This strategy will allow us to concentrate on efforts to focus on leading edge manufacturing.

Today we are not in a position to announce specific engagements but we intend to give you regular updates at or before our next earnings call. As part of our general restructuring efforts, we reduced the number of Gruber positions by 500 in the second quarter and are actively transferring positions for industrialized regions to emerging regions such as China and Malaysia.

I would like also to make a second important point. In Q2 we announced a new memory technology called Spansion EcoRAM. This memory technology, based on MirrorBit, transcends existing memory architecture specifically addressed to specific needs of search engines for Internet servers. This multi-year effort is going to open the door for a market that is of considerable size and has a much higher margin than traditional memory segments.

EcoRAM provides much better power efficiency, higher capacity, and lower costs than existing solutions. EcoRAM also provides the feature that is very important to Internet companies, that is instant search, the feature out of reach for existing Flash technologies.

We intend to September or after a better server this year and revenue late this year, early or not. Our 300 mm SP1 strategy, in partnership with SMIC, is vital to this particular business in ramping up the Internet.

The last point I would like to make is concerning Saifun. In Q2 we positioned the Saifun team to accelerate our plants around the licensing business. Now, approximately 3,000 patents are available to the Saifun team. This is one of the broadest portfolios in the booming Flash industry and includes fundamental patents as well as important know-how for volume implementation. The Saifun team is now going full speed to build a very exciting licensing business that should impact all the large financial reserves in the years to come.

In summary, with this initiative around cost structure, the introductions of novel architecture like EcoRAM, and the licensing business, we intend to drive Spansion to the next level of success.

Now, Dario, please, talk to us about Q2.

Dario Sacomani

I will review a few specifics of our financial performance for the quarter. Net sales, as Bertrand mentioned, were $613 million, an increase of 7% compared to net sales of $570 million in the first quarter of fiscal 2008. And we showed slight growth from Q2 of 2007. Net sales from the consumer set top box and industrial division increased 14% sequentially.

Sales of our high-density MirrorBit product were the primary driver of the sequential net sales increase for our consumer business and we believe we continue to increase our lead over the next largest competitor in the consumer space. The continued success of our CSID business is positioning Spansion with a more diverse end customer base and reducing our exposure to the volatility of any one segment.

Net sales for the wireless business were flat, however, average density increased compared to the first quarter primarily due to the successful deployment of 65nm solutions out of SP1. Our Q2 2008 WSD revenue was constrained by supply of piece parts due to short lead time upside orders by several customers. Although the wireless business environment has been competitive we continue to expect to benefit in the second half of the year from industry consolidation as well as innovative product road maps such as Eclipse.

In Q2 2008 overall price per bit was down 15% versus Q1 of 2008. This was significantly influenced by an increase in high-density product shipments from SP1, which normally have a higher level of price degradation per quarter. Excluding these high-density sales the overall price per bit would have been down only 8% from Q1 2008. Overall blended ASPs were down 2% in the quarter.

Second quarter gross margin was 17.8% compared with 16.6% last quarter and 17.8% a year ago. The gross margin was about 120 basis points better than expectation. Pricing and volume accounted for a slight niche in gross margin of about 60 basis points, however, startup costs of SP1 were 100 basis points better than expected due to cost control and product qualification status.

Therefore, the effect of SP1 startup was only 200 basis points compared to our anticipated 300 basis points. And finally, we had about 80 basis points worth of one-time benefits. Our outlook for Q3 of 100 basis points to 200 basis points improvement, therefore, is actually more like 180 basis points to 280 basis points covering the Q2 2008 one-offs, which won’t repeat in Q3 2008.

Operating expenses were $186 million in the second quarter, including restructuring charges of $10 million. Excluding the charge, operating expenses were $176 million, which was in line with our prior outlook and reflects continued expense control.

R&D expenses were slightly favorable to expectation at $108 million, 18% of revenue, down $12 million from the prior quarter, primarily due to SP1 R&D which was down $14 million quarter-on-quarter and now sits at about $6 million in R&D. And that’s probably going to be the ongoing rate of SP1 costs in R&D. This decrease was partially offset by the consolidation of Saifun R&D, which was $6 million.

SG&A expenses of $68 million, 11% of revenue, in line with expectations and up $3 million from the prior quarter, due primarily to the consolidation of Saifun. Restructuring costs were $10 million for the quarter. Productivity improvements and targeted operating efficiencies resulted in the reduction of 500 regular and contract positions worldwide. We expect annual run-rate savings of approximately $20 million as follows: about 35% of the savings will be in cost of goods sold, 45% in R&D, and 20% in SG&A.

Our outlook for Q3 OpEx is approximately $176 million which is down $10 million from Q2, including the restructuring costs. While we do expect savings from the restructuring actions, the savings will be offset in the short term by several strategic initiatives.

Interest expense, net, was $25 million in the quarter, up from $18 million in Q1 due to the fact that our final capitalized interest adjustment for SP1 was made in Q1 of 2008.

We had a tax benefit of $2 million in the quarter due to benefits from our Japan subsidiary. We do not expect this credit to repeat and expect $3 million tax expense per quarter while in a loss position. Net income for the quarter was a loss of $101 million, or $0.63 per share, including the $10 million of restructuring charges, which were not included in our prior outlook.

One of our major financial objectives for 2008 is increased EBITDA and cash flow from operations, based on shifting the manufacturing supply from external supply to internal production, capitalizing on our SP1 investment. Therefore, the highlight of the quarter, from my perspective, is EBITDA at $88 million, which includes the restructuring charge of $10 million. Excluding the non-recurring $10 million of restructuring charges, we are close to a $400 million annual EBITDA run rate, which is driving the leverage ratio below 4%.

Although the Q2 2008 revenue and operating income, excluding restructuring, are similar to Q2 2007, so we’re very close in performance, Q2 2008 to Q2 2007 a year ago, however EBITDA is up approximately $27 million, to 16% of revenue, versus the prior year quarter at 12% as we continue to execute our 2008 financial plan.

Moving on to the balance sheet, DSOs were up slightly to 55 days from Q1 of 54. Days payable were also up to 111 days versus 91, as expected, primarily due to capital spending at SP1 and longer payable terms in Japan.

Inventory days were 115 for Q2 2008, down from 121 in Q1 2008. We made significant progress to reduce inventory days in the quarter despite an inventory build of approximately $30 million worth of 65-nm SP1 product in the quarter. The reductions came from the following. Successful reduction of assembly and test cycle times have allowed us to drop the finished goods percent of total inventory from approximately 30% in Q4 of 2007 to approximately 20% in Q2 of 2008. This reduces a significant amount of cash costs associated with packaging and overall inventory value. Additionally, this die-stage inventory allows greater flexibility to divert product to a larger customer base.

Secondly was the reduction of approximately $25 million of external foundry and subcon support, which also contributed to our inventory and cost control. We expect that inventory reductions through the second half of 2008 will contribute to our free cash flow goal and are working towards an inventory target of less than 100 days by year-end.

CapEx for the second quarter was $110 million, down from $227 million last quarter. The majority of the CapEx spend in the quarter was for 65-nm and 45-nm development at the 300 mm wafer diameter. Second quarter capital expenditures were lower than anticipated merely due to the timing of deliveries. These deliveries are now expected to occur in Q3, therefore we expect CapEx for Q3 to be relatively flat with Q2 2008 around $110 million. Our previous outlook for the full year CapEx, under $500 million, remains unchanged.

At the end of Q2 2008 our cash and short-term investment balances were $349 million and net debt increased $40 million. This $349 million included $109 million of auction rate securities. We decided to temporarily impair our auction rate securities of $122 million to about 89%, based on current valuations. We believe this valuation is temporary based on recent activity in the student loan/ARS market supporting redemption at par of approximately $3.4 billion, or 4% of the total market.

Revolver capacity at the end of the quarter was approximately $118.4 million, bringing total liquidity to $467 million. We did not do any incremental leasing activity this quarter as we did in Q1 2008, however, we may do some in Q3 of 2008.

In summary, I am pleased with our improved financial performance for the second quarter. Gross margin of 17.8% reflects solid internal manufacturing execution. At the same time, our strategy of increasing EBITDA by reducing external manufacturing and replacing with internal capacity is beginning to show the benefits. We are making progress towards achieving our 2008 operational and financial goals.

Bertrand Cambou

Let me now switch to the outlook for the next quarter and the remaining of the year.

We expect sales for the third quarter of 2008 to increase slightly from the prior quarter. Plus from major businesses have an opportunity to grow, leveraging or increasingly competitive offerings, at the high density with MirrorBit, with SP1, and an expanded customer base. Outlook for the full year is basically unchanged since last quarter. We expect 2008 revenue to be flat to slightly up compared with 2007.

In summary, in Q3 and Q4 we intend to pursue a vigorous effort around operational excellence, the ramp up of SP1 and the fundamental improvement of our business model, as described today.

Thank you for your attention and now we are open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Daniel Amir - Lazard Capital Markets.

Daniel Amir – Lazard Capital Markets

As you continue your restructuring efforts and your Spansion - 1, your gross margins outlook here for Q3 of 1% to 2% increase, what should we look at here for the remaining of the year and can we expect gross margins in the 20%s again, early next year?

Dario Sacomani

Yes. I think, as we’ve talked about before, getting over this startup period in Q2, I think once we get to a consistent output of at least 2,000 a week, which we should be at in Q3. I think that at 2,000 wafers a week, which is where we’re at today, I think ultimately we should be able to be driving our costs down. Assuming typical ASP patterns I think we should be moving into the mid-20s actually and I think we should make steady progress from Q3 forward.

Daniel Amir – Lazard Capital Markets

And this mid 20% is what, by the middle of next year, or earlier than that?

Dario Sacomani

I think we are going to make pretty steady progress. We’re talking about almost 200 basis points from where we’re at today, and honestly I think that as the factory ramps you are going to see a pretty steady pace of increased gross margin towards those mid 20%.

Daniel Amir – Lazard Capital Markets

Now in the end market, there has been a lot of talk about the handset market. What’s your visibility into the wireless segment? It was flat quarter-over-quarter, but it seems like you have done maybe better than others. Can you show what type of visibility you have there and what can we expect for the second half of the year?

Bertrand Cambou

Yes, we believe that the wireless system division has an opportunity to grow in the second half. And like you say, we have been pleased that in a very difficult Q2 we were able to hold our position. But in the second half of the year we have a portfolio that is stronger now. We have now a 65-nm lined up, which is starting to be effective.

And the other piece here is if you look at the market in the wireless, that it seems to suffer, it seems to be that this is the high end where essentially this is not the place we were currently in. Spansion is currently in the main stream of the wireless and as much as we can see this segment appears to be quite strong. With the strong portfolio that we have and an expanded customer base, we have an opportunity to increase.

Daniel Amir – Lazard Capital Markets

And any update on the competition front off of your major competitors. Are you seeing any difference in behavior following the changes in the industry?

Bertrand Cambou

Well, the first thing here that we are definitely seeing right now is on the pricing environment. In many cases we are getting to a much better balance here where you see a competition here that is more rational than what we have in the past. That is encouraging for us. Clearly we are gaining ground. We are improving our financial positions.

And this is the combination of an expanded customer base and a portfolio of technology that is more competitive that it was in the past. We are currently, in fact we have already started a 45-nm in our manufacturing area, and the first lot are currently running. We expect to sample that before the end of the year.

And then we are still on track for 32-nm MirrorBit sometime next year at the same time. This is definitely going faster than what you can read the competition is doing in volume productions. The competitive landscape appears to be rational and moving in the right direction.

Operator

Your next question comes from Bob Gujavrty - Deutsche Bank.

Bob Gujavrty – Deutsche Bank Securities

I understand the interest expense, quarter-on-quarter. Is there going to be another step-up function or should we think about it as a steady state from here on out.

Dario Sacomani

Steady state.

Bob Gujavrty – Deutsche Bank Securities

And also, looking at some of the working capital metrics, can you comment a little bit on the linearity in the quarter? Did you see some acceleration in the quarter and that might explain the payable and the receivables a little bit? And also, given the up side in revenues, I’m a bit surprised there wasn’t a more of a decline in the inventories. Can you just talk about that a little bit?

Dario Sacomani

At the end of the day, on all those, I wouldn’t say, by the way, that our linearity was significantly different from any other quarter. Quite frankly, I was disappointed with our days of sales outstanding performance and I think we have a lot of room to improve there in Q3 and Q4.

Like we talked about, as it relates to inventory, starting up SP1, we built $30 million worth of whip there, so just offsetting that build with a couple of the initiatives that I talked about regarding staging the inventory at die with improved cycle times in the back end, and reducing foundry, is what allowed us to really get where we got. So I think we did a good job on inventory. And, again, it’s all related to the fact that we’re right in the middle of starting up this big SP1 factory.

As it relates to days payable, like I told you last quarter, I expected them to go up just because of the percent of CapEx associated with SP1 in payables, which they have much longer terms in Japan. And I expect that those days payable will probably be close to the same in the third quarter and probably in the 105 range in Q4.

Bob Gujavrty – Deutsche Bank Securities

In terms of cash, I understand operating cash flow you are shooting for a positive. Can we try and understand some puts and takes in the second half? Do you have any significant contributions or significant sources of cash that maybe we’re not aware of?

Dario Sacomani

Well, the biggest sources of cash are actually tied up in working capital, as you just mentioned. I was pleased that we were able to decrease the inventory from 121 days to 115, but as I mentioned, we have a target of less than 100. And we do have a couple of initiatives associated with our sales channel, which I think are going to help us improve DSOs pretty significantly over Q3 and Q4. So I would say those two should not be used, they should end up to be a source over the second half.

Operator

Your next question comes from Vijay Rakesh - ThinkPanmure.

Vijay Rakesh - ThinkPanmure

It looks like you did $630 million but the guidance for Q3 was flat. Can you break it down, what you’re seeing in the wireless and CSID where you have the flat guidance pricing on units?

Bertrand Cambou

I think what we said was we guided Q3 to be up to Q2 and we believe that both business units have an opportunity to grow and like we say, we think that we have a broader customer base, on one hand, that we have stronger technology. And obviously we have to be a little bit cautious about the overall business environment and that is why we are making this guidance, because, quite frankly, we have to very carefully study what is going on around us and be sure that whatever we are committing our factory to run is in line to really stick up to.

Vijay Rakesh - ThinkPanmure

You are saying flat to up guidance for Q3, is that right?

Bertrand Cambou

We see Q3 being slightly up.

Vijay Rakesh - ThinkPanmure

And going back to the question on competition can you talk about, you said you are seeing a little bit more rationality. How are you seeing in Numonics, they have been talking about going to 45 and then going to 45-nm with Elpida? Does that pose a threat on pricing as you look out?

Bertrand Cambou

Actually, one of the things that they are going to have a big turnage because Elpida has built a DRAM factory and those DRAM factories are not very friendly to run NOR. Which means they will have to put a lot of expense, a lot of capital, to convert DRAM to NOR. And then the back and forward between the two capacities is not going to be very synergistic here. Which means what they elected to do, of course, they don’t have cash, and they have to find a solution here, but most likely this is not a very cost-optimized way versus our case where we have a very metric from the line factories.

There is another piece. They were announcing to start their product at 65-nm and to be in production sometime next year. Well, at that point they are going to get 45-nm and it seems to me that they are going to be about one year behind what they should be. Which means that we think that this announcement, of course it may or may not happen, because between AOI and MOU and the final agreement there is still a lot of negotiating which has to happen.

It seems to me, again, that validates the fact that the 300-mm is a must, that they are not capitalized to win, and that as a result they have to find band-aid solutions like that one to compete against us.

Vijay Rakesh - ThinkPanmure

And going back to the SP1, how much output, it looks like you had a nice pick up from Q1 to Q2, $26 million in Q2, where do you see Q3 output from the SP1.

Bertrand Cambou

It is going to increase.

Vijay Rakesh - ThinkPanmure

Same rate as Q1 to Q2?

Bertrand Cambou

Well, we may. That’s obviously a nice objective, to keep the pace, and I think that is achievable.

Operator

Your next question comes from Betsy Van Hees - Caris & Company.

Betsy Van Hees – Caris & Company

I was wondering if you could touch a little bit about some of the comments you made. In regards to CSID, can you give us a little more color as to where the strength was and the end markets and do you see that carrying on into Q3?

Bertrand Cambou

Yes. The CSID business, Betsy, the base of that business has been low-end commodity business where you have a lot of competition there. And our company has been pursuing a multi-year strategy to go to the high end of the segment with MirrorBit. And essentially we moved from being the new entrant and now we are the incumbent in the area. And what we have in Q2 has been very successful in the matter.

There was a interesting data point. If you look at the CSID divisions where essentially we grew from 274 to 312, it turns out that the growth is 100% based on MirrorBit. The floating gate into CSID, quarter to quarter, actually went down. Which means that all the upside has been for the MirrorBit, high density, and when we are talking about high density we are talking about 512, 1-gig, we are talking really some parts of the business where the MirrorBit technology is a differentiating factor.

Now, in the second half of the year, we are going to put, we have more design win in the matter, and then we are going to start to have a 2 gigabit in that segment with a MirrorBit 65-nm and SP1 and of course, we will go to even a higher density when we go to 45, which means that the strategy going forward is to keep up the same pace.

Now, we did double up a specific Eclipse architecture for the CSID business. The Eclipse architecture is an architecture that combines NOR and NAN together and for some segments, like automotive, in cabin guidance, some of the networking engines, some of the high end of the segment games and so on, the Eclipse is going to be a great solution.

In the CSID business we also now have an SPI, which is a serial port interface family, which is very popular. And again, on that strategy, it is a high-density SPI, 128 megabit, with MirrorBit and the revenue on that segment has been increasing and is going to go higher for the year. So you can see, Betsy, we have refreshed the portfolio of CSID and we intend to grow in that business with this new architecture and technologies and keep up the progressions.

Betsy Van Hees – Caris & Company

In regards to the wireless division, could you elaborate a little bit more on the comment about constrained byte piece parts and how you see that, has it been resolved as you look forward to Q3?

Bertrand Cambou

Well, the situation that you have, Betsy, the wireless segment is very much consumer-centric. And at the beginning of the quarter we may have an idea of what the consumer is going to buy, but guess what? They buy the phone they want to buy and it turns out that the configuration that is very popular right now is in our allocation. We are now going through a very painful process where we have many of our major customers adopting a particular configuration that is on our allocations and we are looking at the allocations being pretty hard in July and August. A waiver, we have been taking actions.

And we see us as closing the gap in the September month in such a way that as we are going to enter the holiday seasons we should be hopefully close to match the demand here. But to note this year that the segment is that is essentially short is the mid to high-end phone. This is the phone that uses a 512-mg of MirrorBit that is very popular right now and it turns out also that it is a bad business we have where we have a competitive position here. Which means we are sorry we have these constraints but again, we did not have the visibility at the beginning of Q2 that we had to prepare materials for that particular part.

Betsy Van Hees – Caris & Company

But from an ASP standpoint, that is a significantly higher ASP than what’s been normally shipping.

Bertrand Cambou

That’s right. This is a high density part.

Betsy Van Hees – Caris & Company

Going on to the question of blended ASPs. Did I hear you correctly, you said they were down 2%, is that correct?

Dario Sacomani

Correct, the blended ASPs.

Betsy Van Hees – Caris & Company

Could you give us a little bit of color as to how you expect the ASPs to be in Q3 and for the back half of the year I know that is pretty far?

Bertrand Cambou

We don’t know how to predict the future, but what we are assuming in our business plan is a 6% to 7% decline per bit. Which we are putting that into a manufacturing model. Now if the pricing environment is better, then it is going to be improving our margin. If it is worse it is going to be a bit less. But so far, as we are looking at the backlog and where we are, it seems that these assumptions appear to be quite accurate, as what probably is going to happen. Which means as we look at the remaining of the year, we look to stay on that curve.

Betsy Van Hees – Caris & Company

Can you please tell us, Saifun revenue, how that was in the quarter and if you’re separating that or putting that into a specific division?

Bertrand Cambou

Saifun has been visible in the past because we were reporting, a significant piece was actually spend [inaudible] that these appear and what we had in Q2 was a small number. But obviously with a new Saifun as a strategy, as we are figurated today, we expect to have significant upside in 2009. This year we’re not expecting that strategy to materialize. It will take some time, between a strategy and a reserve off. If you look at the Saifun reserve in the past, you can assume that approximately half of it was Spansion and half of it was the general market.

Operator

Your next question comes from Eric Reubel - MTR Securities.

Eric Reubel – MTR Securities

Dario, on the down tick in long-term obligations in capital leases, what was driving that?

Dario Sacomani

At the end of the day, what we paid was the GE facility in Japan, which is going to amortize at about $35 million a quarter, which started in Q2.

Eric Reubel – MTR Securities

And on, just to repeat, you said availability under all the revolvers stands at $118 million?

Dario Sacomani

That’s correct.

Eric Reubel – MTR Securities

Bertrand, if I can ask you on the wireless side, can you break out the sales between traditional NOR and the ORNAND piece of the product segments?

Bertrand Cambou

I essentially quoted that we did $26 million of 65-nm technology in the quarter and that was 100% ORNAND-based solutions. Now, the 19-nm was about the same amount in the quarter. Which means that we are having a transition right now where, and I would anticipate going forward, that the 19is going to be quickly replaced by the 65.

Eric Reubel – MTR Securities

You talked about better qualifications in the quarter that led to lower R&D costs for SP1. Could you talk about little bit about the better qualifications and how that translates to a revenue expectation for Q3?

Bertrand Cambou

This is always a very frustrating piece because some of our customers, it can take them as much as 9-12 months to qualify a new technology. And obviously we don’t want to take 9-12 months to ramp up SP1, which means we are currently engaged in a pretty intense qualification program. We have ORNAND has already qualified and has been qualified for six months.

We have essentially a general market, NOR, both 1.8 volt and 3 volt are doing very well. We have Eclipse that is also going very well. And we expect, actually, in Q3 either a significant customer ramp up or at least preparations of a ramp up that will happen in Q4. Which means that we are essentially where we thought we would be and this is a monumental task that we have to do. And the task is not that this is difficult to qualify.

The task is because we don’t want to have the usual 9-12 months. We have to find a way to work with our customer and to go faster than it was in the past. And that essentially is the challenge with the product of the 65-nm. So far we have, again, multi-architecture, multi-customer and things are progressing.

We think, like we said, that we are going to increase revenue in Q3 and then that we’re really going to have significant coverage for the SP1 volume in the Q4 time frame.

Eric Reubel – MTR Securities

If all of the 65-nm revenue in the quarter was ORNAND, is it fair to expect that there can be a 65-nm MirrorBit ramp up in the second half of 2008?

Bertrand Cambou

Absolutely, the fact is ORNAND is MirrorBit. You need to know that the way we are functioning right now as a company, we have the single technology in SP1. Every thing we are doing will be NOR, 3 volt, 1.8, wireless, CSID, ORNAND, and Eclipse, all are running through a single MirrorBit technology. Which means that MirrorBit, as we did it in 65-nm, is a platform.

And we worked so hard to top down the design in such a way that in many cases the [inaudible] are essentially one in the same and we are doing program platform type of things. And this is why we have multi-architecture at the same time. And this is a new method that is not what we did with the previous NOR. We did this a little bit different. And the reason we did it that way is essentially to multiply the opportunity to ramp up fast.

Eric Reubel – MTR Securities

What I was really meaning was when I think of ORNAND I think of the Japanese customers and I was talking about 65-nm MirrorBit NOR for non-Japanese customers.

Bertrand Cambou

If you say it that way, then so far this year we are, the bulk of the revenue was Japan, and in the second half of the year, obviously it is going to broaden to a world-wide implementation.

Eric Reubel – MTR Securities

If I look at just the changes in receivables, inventory and payables, the cash use in the quarter, and about $50 million cash use for the first half of the year, can you frame my expectations in terms of dollars, Dario, how much a positive cash inflow we could see from working capital in the back half of the year?

Dario Sacomani

Like I mentioned, I would model us to get below 100 days of inventory and I think that the DSOs should be more around 50-52 days. And then, like I mentioned before, I expect payables to stay at about 110 days in Q3 but probably drop to about 105 in Q4, as we start paying for the SP1 equipment.

Operator

Your last question comes from Shawn Webster - JP Morgan.

Shawn Webster – JP Morgan

In the context of the guidance that you gave, can you give us some color on what your book-to-bill ratio was? And also, in any quantitative way you can, can you tell us what your lead times are doing for your products? Are they going out, are they stable, are they coming in?

Bertrand Cambou

Right now the book-to-bill ratio is about one and we have, if I look at the backlog situations that we have in Q3, this is a satisfactory backlog. Of course, in Q3 is always a holiday quarter because this is the holiday season and you have procurement agents in many countries, Europe, China and so on, that are taking vacations and the visibility is not as good as it is in other quarters. There are seasonality issues. Usually when they are back from vacations, it becomes very hot and September is through the roof. Usually September, October, November is when we have the peak of the seasons.

Mid-July is always the time of the year where we are trying to extract as much information as we can from the market, but the backlog appears to be satisfactory, like I said, for increasing our revenue in Q3 and even greater in Q4 when we see some usual strength on the market.

As far as lead-time, and so on and so forth, like we said, we unfortunately are placing some of our customers right now on hard location and we don’t like that because it’s not good. But to some degree this is also an indication that some of our product portfolio right now is very, very much in high demand by the end customer that is being designed into [inaudible] products. What we are currently working, as a team, is on those devices and how to reduce the lead-time and that’s obviously very strategic for us, for of course, upside in financial reward but also for customer satisfaction.

Now, if we look at other indices like how distribution is doing and so on and so forth, actually in Q2 we saw reductions into the inventory into distribution here, which means that we feel that we are in a pretty healthy situation here in the quarter.

Shawn Webster – JP Morgan

Given the unexpected mix in some of your segments, like in the handset, it sounds like, and then when I look at the days of inventory, they’re still above your target range, is any of that inventory at risk, given the mix has moved in a different direction than you thought, or has the inventory in there fairly long-lived life and there’s not that much risk there?

Bertrand Cambou

No because actually the shortage we have is not in Flash. The shortage we have is essentially a piece part and just turning the customer and what they need. Which means as far as the Flash inventory we have, and that’s essentially at the die form right now, we don’t have anything committed of significance that has been assembled and then we have here the flexibility to essentially deploy whatever the customer needs.

Which on the contrary on the Flash situation, we are looking at inventory which is on the high side right now, as being a good asset, that should be ready during the holiday seasons to be opportunistic and to respond to a demand but is going to be pending to have all the logistics around to be in place and in some of these parts, the issue is the logistic around. But as far as the Flash is concerned, we feel that we have the flexibility in place to respond to the customer needs.

Shawn Webster – JP Morgan

And then your cost per bit, what did that do sequentially in Q2?

Dario Sacomani

We don’t normally give our cost per bit information, but as you probably know, Shawn, because we’ve talked about it before, to keep up with something in the range of 6% to 7% ASP degradation per quarter, we have to target something in the above 10% range. And if we do that you will see margin expansion, which you did. So that should give you an idea.

Shawn Webster – JP Morgan

Just given that Lexar was closing in the quarter, I was trying to figure out what was the native cost per bit production versus benefit from Lexar sequentially. Any way you can quantify that for us. I’m sorry you didn’t buy them, somebody else did, Saifun.

Dario Sacomani

Are you talking about Saifun? Yes, at the end of the day, Saifun adds something in the range of 25 basis points to the margin at the current level we’re at, so it’s not significant.

Shawn Webster – JP Morgan

And what was your cash flow from operations in the quarter?

Dario Sacomani

It was about $62 million, I think.

Operator

That concludes our question-and-answer session for the day and this also concludes today’s conference call. Thank you for your participation.

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Source: Spansion Inc. Q2 2008 Earnings Call Transcript
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