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SPANSION INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements This Quarterly Report on Form 10-Q, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements. These statements relate to future events or our future financial performance. Forward-looking statements may include words such as "may," "will," "should," "expect," "plan," "intend," "anticipate," "believe," "estimate," "predict," "potential," "continue" or other wording indicating future results or expectations. Forward-looking statements are subject to risks and uncertainties, and actual events or results may differ materially. Factors that could cause our actual results to differ materially include, but are not limited to, those discussed under "Part I, Item 1A. Risk Factors" in our 2012 Annual Report on Form 10-K, filed with the SEC on February 25, 2013. We also face risks and uncertainties associated with substantial indebtedness and its impact on our financial health and operations; fluctuations in foreign currency exchange rates; the sufficiency of workforce and cost reduction initiatives. Other risks and uncertainties relating to our business include our ability to: implement our business strategy focused primarily on the embedded Flash memory market; maintain or increase our average selling price and lower our average costs; accurately forecast customer demand for our products; attract new customers; obtain additional financing in the future; maintain our distribution relationships and channels in the future; successfully enter new markets and manage our international expansion; successfully compete with existing and new competitors, or with new memory or other technologies; successfully develop new applications and markets for our products; maintain manufacturing efficiency; obtain adequate supplies of satisfactory materials essential to manufacture our products; successfully develop and transition to the latest technologies; negotiate patent and other intellectual property licenses and patent cross-licenses and acquire additional patents; protect our intellectual property and defend against infringement or other intellectual property claims; maintain our business operations and demand for our products in the event of natural or man-made catastrophic events; and effectively manage, operate and compete in the current sustained economic downturn. Except as required by law, we undertake no obligation to revise or update any forward-looking statements to reflect any events or circumstances that arise after the date of this report, or to conform such statements to actual results or changes in our expectations. Overview We are a leading designer, manufacturer and developer of Flash memory semiconductors. We are focused on a portion of the Flash memory market that relates to high performance and high-reliability Flash memory solutions for microprocessors, controllers and other programmable semiconductors that run applications in a broad range of electronic systems. Our strategic emphasis centers on the embedded portion of the Flash memory market, which is generally characterized by long design and product life cycles, relatively stable pricing, predictable supply-demand outlook and lower capital investments. These markets include consumer, transportation and industrial, communications and gaming. Within this embedded industry, we serve a well-diversified customer base through a differentiated, non-commodity, service-oriented model that strives to meet the needs of our customer's for product performance, quality, reliability and service. Our Flash memory solutions are incorporated in products manufactured by leading original equipment manufacturers (OEMs). In many cases, embedded customers require products with a high level of performance, quality and reliability, specific feature sets and wide operating temperatures to allow their products to work in extreme conditions. Some embedded customers require product availability from suppliers for over a decade of production. We spent many years refining the product and service strategy to address these market requirements and deliver high-quality products that go into a broad range of electronic applications such as cars, airplanes, set top boxes, games, telecommunications equipment, smart meters and medical devices. 24 -------------------------------------------------------------------------------- The majority of our NOR Flash memory product designs are based on our proprietary two-bit-per-cell MirrorBit® technology, which has a simpler cell architecture, higher yields and lower costs than competing floating gate NOR Flash memory technology. While we are most known for our NOR products, we are expanding our portfolio in the areas of NAND and programmable system solutions to broaden our customer engagement and bring differentiated products to embedded markets. Our products are designed to accommodate various voltage, interface and density requirements for a wide range of applications and customer platforms. In addition to Flash memory products, we generate revenue by licensing our intellectual property to third parties and we assist our customers in developing and prototyping their designs by providing software and hardware development tools, drivers and simulation models for system-level integration. On April 29, 2013, we announced the execution of a stock purchase agreement with Fujitsu Semiconductor Limited (FSL) to acquire FSL's business of designing, developing, marketing and selling analog semiconductor and microcontroller products. Pursuant to the stock purchase agreement, we will acquire certain subsidiaries and assets, including approximately 1,200 patents, and assume certain liabilities of FSL. The purchase price for the business is approximately $110 million. The purchase price is denominated in currencies other than the US Dollar and we have entered into an economic hedge to mitigate the impact of foreign currency fluctuations on the purchase price. In addition, we have agreed with FSL as a condition precedent to closing of the transaction to negotiate an agreement to purchase existing inventory for approximately $65 million, subject to adjustment depending on the valuation and volume of inventory available at the time of closing. We expect that the transaction will close between July and September of fiscal 2013. Approximately 1,100 employees of FSL, who are primarily engaged in this business are intended to be transferred to the Company on or after closing. Consummation of the transaction will be subject to the satisfaction of customary closing conditions, including the absence of a material adverse effect on the business to be acquired, the absence of legal actions relating to the transaction, the accuracy of representations and warranties made by both parties, the receipt of certain regulatory and other consents and the execution of ancillary agreements. Critical Accounting Policies There have been no significant changes in our critical accounting estimates or significant accounting policies during the three months ended March 31, 2013 as compared to the discussion in Part II, Item 7 and in Note 2 to our financial statements in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 30, 2012. Recent Accounting Pronouncements In February 2013, the FASB issued guidance to provide enhanced disclosures related to reclassifications out of accumulated other comprehensive income. An entity will be required to disclose the net income line items impacted by significant reclassifications out of accumulated other comprehensive income if the item is reclassified in its entirety. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. The adoption of this guidance beginning in the first quarter of fiscal 2013 did not have an impact on our financial position, results of operations or cash flows. In December 2011, the FASB issued an accounting standard update requiring enhanced disclosure related to certain financial instruments and derivative instruments that are offset in the balance sheet or subject to an enforceable master netting arrangement or similar arrangement. In January 2013, the FASB clarified the scope of this guidance as being applicable to derivatives, repurchase agreements and securities borrowing and lending transactions that are either offset or subject to an enforceable master netting arrangement or similar agreement. The disclosure requirement becomes effective beginning the first quarter of fiscal year ending December 28, 2014. The adoption of this guidance is not expected to have an impact on our financial position, results of operations or cash flows. 25 --------------------------------------------------------------------------------Results of Operations Comparison of Net Sales, Gross Margin, Operating Expenses, Interest and Other Income (Expense), Interest Expense and Income Tax Provision The following is a summary of our operating results: Three Months Ended March 31, 2013 March 25, 2012 Variance (in thousands, except for percentages) Net sales $ 189,572 $ 218,758 $ (29,186 ) Cost of sales 143,717 159,560 (15,843 ) Gross profit 45,855 59,198 (13,343 ) Gross margin 24.2 % 27.1 % -2.9 % Research and development 22,777 26,041 (3,264 ) Sales, general and administrative 28,483 32,640 (4,157 ) Restructuring charges - 4,518 (4,518 ) Operating income (5,405 ) (4,001 ) (1,404 ) Interest and other income (expense) 962 1,505 (543 ) Interest expense (7,604 ) (7,681 ) 77 Provision for income taxes (2,388 ) (3,445 ) 1,057 Net Sales Net sales decreased by $29.2 million from $218.8 million for the three months ended March 25, 2012 to $189.6 million for the three months ended March 31, 2013. The decrease was due to a $15.9 million decline in embedded sales mainly in the Japan region due to lower sales volume and competitive pricing pressures in the first quarter of fiscal 2013. This decrease was partially offset by a $2.7 million ramp of revenues from 32nm NAND. Wireless sales decreased by $9.3 million and have been declining as we shifted our strategy to focus on the embedded market. Gross Profit Our gross profit decreased by $13.3 million from $59.2 million for the three months ended March 25, 2012 to $45.9 million for the three months ended March 31, 2013. The gross margin percentage declined from 27.1% in the three months ended March 25, 2012 to 24.2% in three months ended March 31, 2013. The decrease in gross margin was primarily driven by a reduction in product sales mix changes and licensing revenues. The decline was partially offset by a $12.0 million cost improvement associated with our internal fabrication facility utilization and efficiencies from consolidation of our two assembly, and test operations in Asia following the closure of our Kuala Lumpur (KL), Malaysia facility. 26 --------------------------------------------------------------------------------Research and Development (R&D) R&D expenses decreased by $3.2 million from $26.0 million for the three months ended March 25, 2012 to $22.8 million for the three months ended March 31, 2013. The decrease was mainly due to $2.4 million of lower employee compensation and benefits, and $2.0 million of lower development charges relating to NAND development. This was partially offset by $1.2 million higher stock based compensation expense due to new grants during fiscal 2012 and the first quarter of fiscal 2013. Sales, General and Administrative (SG&A) SG&A expenses decreased by $4.1 million from $32.6 million for the three months ended March 25, 2012 to $28.5 million for the three months ended March 31, 2013. The decrease was mainly due to $2.9 million of lower expenses relating to travel, marketing, sales commission, building maintenance and other outside services as we monitor our cost structure to align it with the global economic conditions and $2.3 million of lower employee compensation and benefits. The decrease was partially offset by $0.8 million of higher stock based compensation expense due to new grants during fiscal 2012 and the first quarter of fiscal 2013. Restructuring Charges There were no restructuring charges for the first quarter of fiscal 2013. Restructuring charges for the three months ended March 25, 2012 were $4.5 million, comprised of $5.4 million primarily relating to asset relocation and impairment charges in our KL facility which was offset by a $0.8 million credit as a result of us having prevailed in a labor-related lawsuit in conjunction with 2009 restructuring activities in Thailand. Interest and Other Income (Expense) Interest and other income (expense), decreased by $0.5 million from $1.5 million for the three months ended March 25, 2012, to $1.0 million for the three months ended March 31, 2013. This was primarily due to $1.0 million of lower preferential claim receipts in fiscal 2012 which was partially offset by $0.4 million lower realized and unrealized loss on foreign currency transactions. Interest Expense Interest expense decreased by $0.1 million from $7.7 million for the three months ended March 25, 2012 to $7.6 million for the three months ended March 31, 2013. This was primarily due to lower interest expense as a result of continued repayment of the Term Loan in fiscal 2012. Provision for Income Taxes Our tax expense decreased from $3.4 million for the three months ended March 25, 2012 to $2.4 million for the three months ended March 31, 2013. The decrease was primarily related to a decrease in operating income in the Company's foreign locations. As of March 31, 2013, all of our U.S. deferred tax assets, net of deferred tax liabilities, continue to be subject to a full valuation allowance. The valuation allowance is based on our assessment that it is more likely than not that the deferred tax assets will not be realizable in the foreseeable future. As of December 30, 2012, we had U.S. federal and state net operating loss carry forwards of approximately $992.2 million and $218.8 million, respectively. Approximately $490.6 million of the federal net operating loss carry forwards are subject to an annual limitation of $27.2 million. The federal and state net operating losses, if not utilized, expire from 2016 to 2031. We also have U.S. federal credit carryovers of $1.0 million which expire from 2020 to 2021. We also have state tax credits of $17.3 million, which includes California state tax credits of $16.5 million which can be carried forward indefinitely. If we were to undergo an "ownership change" for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, our ability to utilize the unlimited federal net operating loss carry forwards could be limited under certain provisions of the Internal Revenue Code. As a result, we could incur greater tax liabilities than we would in the absence of such a limitation and any incurred liabilities could materially adversely affect our results of operations and financial condition. 27 --------------------------------------------------------------------------------Contractual Obligations The following table summarizes our contractual obligations at March 31, 2013: 2018 and Total 2013 2014 2015 2016 2017 Beyond (in thousands) Senior Secured Term Loan $ 217,246 $ 1,120 $ 2,240 $ 2,240 $ 2,240 $ 2,800 $ 206,606 Senior Notes 200,000 - - - - 200,000 Interest expense on Debt 143,235 21,889 27,209 27,090 27,002 29,571 10,474 Other long term liabilities (1) 6,896 - 4,558 2,083 210 45 - Operating leases 10,448 3,420 3,449 1,910 1,449 220 - Unconditional purchase commitments (2) 199,724 23,657 118,831 28,796 28,315 125 - Total contractual obligations (3) $ 777,549 $ 50,086 $ 156,287 $ 62,119 $ 59,216 $ 232,761 $ 217,080 (1) Other long term liabilities comprise of payment commitments under long term software license agreements with vendors and asset retirement obligations. (2) Unconditional purchase commitments (UPC) include agreements to purchase goods or services that are enforceable and legally binding on us and that specify all significant terms, including fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. These agreements are principally related to inventory. UPCs exclude agreements that are cancelable without penalty. (3) As of March 31, 2013, the liability for uncertain tax positions was $18.9 million including interest and penalties. Due to the high degree of uncertainty regarding the timing of potential future cash flows associated with these liabilities, we are unable to make a reasonably reliable estimate of the amount and period in which these liabilities might be paid. 28--------------------------------------------------------------------------------Liquidity and Capital Resources Cash Requirements As of March 31, 2013 and December 25, 2012, we had the following cash and cash equivalents and short term investments: December 30, March 31, 2013 2012 (in thousands) Cash $ 253,305 $ 258,126 Money market funds 4,359 1,181 FDIC insured certificates of deposit 36,482 39,610 Commercial paper 14,984 14,980 Total cash and cash equivalents and short-term investments $ 309,130 $ 313,897 Key components of our cash flow during the three months ended March 31, 2013 and March 25, 2012 were as follows: Three Months Ended March 31, 2013 March 25, 2012 (in thousands) Net cash provided by operating activities $ 6,995 $ 14,933 Net cash provided by (used for ) investing activities (6,419 ) 70 Net cash used for financing activities (1,307 ) (12,631 ) Effect of exchange rate changes on cash and cash equivalents 286 (197 ) Net (decrease) increase in cash and cash equivalents $ (445 ) $ 2,175 Our future uses of cash are expected to be primarily for working capital, debt servicing, capital expenditures, contractual obligations, acquisitions and strategic investments. We believe our anticipated cash flows from operations, current cash balances and our existing revolving credit facility will be sufficient to fund working capital requirements and operations, debt service, and meet our cash needs for at least the next twelve months. Operating Activities Net cash provided by operating activities was $7.0 million during the three months ended March 31, 2013, which consisted of net loss of $14.4 million, and a net decrease in operating assets and liabilities of $5.3 million offset by net non-cash items of approximately $26.7 million. The net decrease in operating assets and liabilities was due to the decrease of $11.9 million in accounts payable, accrued liabilities, and accrued compensation and benefits, decrease of $4.8 million in prepaid and other current assets, increase of $5.3 million of other long term assets and increase of $2.5 million of inventories. Net non-cash items primarily consisted of $19.9 million in depreciation and amortization, and $8.6 million of stock compensation expense. Net cash provided by operating activities was $15.0 million during the three months ended March 25, 2012, primarily due to a net loss of $13.6 million and a net decrease in operating assets and liabilities of $4.5 million offset by net non-cash items of approximately $33.1 million. The net decrease in operating assets and liabilities was primarily due to the decrease of $12.9 million in accounts payable, accrued liabilities, and accrued compensation and benefits, the increase of $3.1 million in accounts receivable and the decrease of $14.4 million in inventories. Net non-cash items primarily consisted of $25.6 million of depreciation and amortization, $2.1 million of asset impairment charges, and $6.4 million of stock compensation costs. Investing Activities Net cash used for investing activities was $6.4 million during the three months ended March 31, 2013, primarily comprised of $24.0 million used to purchase marketable securities and $12.8 million used to purchase property, plant and equipment, which were offset by $28.0 million in proceeds from the maturities of marketable securities. 29-------------------------------------------------------------------------------- Net cash used for investing activities was neutral during the three months ended March 25, 2012, primarily comprised of $9.2 million of capital expenditures used to purchase of property, plant and equipment, $34.3 million of purchase of marketable securities, offset by a $4.1 million deposit received on the sale of the KL facility, proceeds from liquidation of auction rate securities of $1.1 million and $38.4 million proceeds from maturities of marketable securities. In the second quarter of fiscal 2012, we consummated the sale of the KL land and building for the remaining purchase price of approximately 112.0 million Malaysian ringitt ($36.5 million based on a currency conversion rate as of March 25, 2012). Financing Activities Net cash used for financing activities was $1.3 million during the three months ended March 31, 2013, primarily due to $1.5 million payments on debt, offset by $0.6 million of proceeds from issuance of common stock upon the exercise of stock options. Net cash used for financing activities was $12.6 million during the three months ended March 25, 2012, primarily due to payments of $13.6 million on debt, offset by $1.3 million of proceeds from issuance of common stock upon the exercise of stock options. Off-Balance Sheet Arrangements During the normal course of business, we make certain indemnities and commitments under which we may be required to make payments in relation to certain transactions. These indemnities include non-infringement of patents and intellectual property, indemnities to our customers in connection with the delivery, design, manufacture and sale of our products, indemnities to our directors and officers in connection with legal proceedings, indemnities to various lessors in connection with facility leases for certain claims arising from such facility or lease, and indemnities to other parties to certain acquisition agreements. The duration of these indemnities and commitments varies, and in certain cases, is indefinite. We believe that substantially all of our indemnities and commitments provide for limitations on the maximum potential future payments we could be obligated to make. However, we are unable to estimate the maximum amount of liabilities related to our indemnities and commitments because such liabilities are contingent upon the occurrence of events which are not reasonably determinable. As of March 31, 2013, we did not have any other significant off-balance sheet arrangements, as that term is defined in Item 303(a) (4) (ii) of Regulation S-K, promulgated under the Securities Exchange Act of 1934, as amended. 30-------------------------------------------------------------------------------- |