code20131023_10q.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


 

Form 10-Q


 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 29, 2013

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to

 

Commission File Number 001-34747


 

SPANSION INC.

 (Exact name of registrant as specified in its charter)


 

Delaware

 

20-3898239

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

915 DeGuigne Drive

Sunnyvale, California

 

94085

(Address of principal executive offices)

 

(Zip Code)

 

(408) 962-2500

 

(Registrant’s telephone number, including area code)


 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes       No 

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes       No 

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   

 

Accelerated filer 

 

Non-accelerated filer   

 

Smaller reporting company  

 

  

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes      No  

 

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.          Yes      No

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the close of business on October 28, 2013:

 

Class

 

Number of Shares

Class A Common Stock, $0.001 par value

Class B Common Stock, $0.001 par value

 

 58,860,754

 1

 

 
1

 

 

Table of Contents

 

INDEX

  

 

 

 Page No.

Part I.

Financial Information

3

 

 

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

 

 

Condensed Consolidated Statements of Operations – Three and Nine Months Ended September 29, 2013 and September 30, 2012 (Unaudited)

3

 

 

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) – Three and Nine Months Ended September 29, 2013 and September 30, 2012 (Unaudited)

4

 

 

 

 

 

 

Condensed Consolidated Balance Sheets – September 29, 2013 (Unaudited) and December 30, 2012

5

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 29, 2013 and September 30, 2012 (Unaudited)

6

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

30

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

40
       

 

Item 4.

Controls and Procedures

42

 

 

 

 

Part II.

Other Information

43

 

 

 

 

 

Item 1.

Legal Proceedings

43

 

Item 1A.

Risk Factors

44

 

Item 6.

Exhibits

44

 

Signature

46

 

 
2

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

Spansion Inc.

Condensed Consolidated Statements of Operations 

(in thousands, except per share amounts)

(Unaudited) 

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29,

2013

   

September 30,

2012

   

September 29,

2013

   

September 30,

2012

 
                                 

Net sales

  $ 273,378     $ 239,747     $ 658,020     $ 691,945  

Cost of sales

    217,209       161,281       498,640       480,370  

Gross Profit

    56,169       78,466       159,380       211,575  

Research and development

    38,341       27,407       84,666       83,078  

Sales, general and administrative

    54,544       35,228       117,441       103,485  

Net gain on sale of Kuala Lumpur land and building

    -       -       -       (28,434 )

Restructuring charges

    6,264       1,862       6,264       5,650  

Operating income (loss)

    (42,980 )     13,969       (48,991 )     47,796  

Interest and other income (expense)

    3,578       1,267       7,658       2,216  

Interest expense

    (7,351 )     (7,339 )     (22,333 )     (22,924 )

Gain on acquisition of Microcontroller and Analog business

    8,205       -       8,205       -  

Income (loss) before income taxes

    (38,548 )     7,897       (55,461 )     27,088  

Provision (benefit) for income taxes

    (1,644 )     2,757       (891 )     9,572  

Net income (loss)

    (36,904 )     5,140       (54,570 )     17,516  

Less: Net loss attributable to the noncontrolling interest

    -       -       -       (503 )

Net income (loss) attributable to Spansion Inc. common stockholders

  $ (36,904 )   $ 5,140     $ (54,570 )   $ 18,019  
                                 

Net income (loss) per share

                               

Basic

  $ (0.63 )   $ 0.09     $ (0.93 )   $ 0.30  

Diluted

  $ (0.63 )   $ 0.08     $ (0.93 )   $ 0.30  
                                 

Shares used in per share calculation

                               

Basic

    58,785       60,139       58,506       59,932  

Diluted

    58,785       60,820       58,506       60,775  

 

See accompanying notes.

 

 
3

 

 

Spansion Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

(Unaudited)

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

   

September 29, 2013

   

September 30, 2012

 

Net income (loss)

  $ (36,904 )   $ 5,140     $ (54,570 )   $ 17,516  

Other comprehensive income (loss), net of tax:

                               

Gain on auction rate securities reclassified into earnings

    -       -       (1,200 )     -  

Net foreign currency translation gain (loss)

    117       305       (1,420 )     259  

Net unrealized gain (loss) on cash flow hedges:

                               

Net unrealized hedge gain (loss) arising during the period

    (391 )     (1,639 )     13,669       (1,422 )

Net gain reclassified into earnings for cash flow hedges (ineffective portion)

    -       -       (2,415 )     -  

Net loss (gain) reclassified into earnings for cash flow hedges (effective portion)

    (3,113 )     538       (7,701 )     538  

Net unrealized loss (gain) on cash flow hedges

    (3,504 )     (1,101 )     3,553       (884 )

Other comprehensive income (loss), net of tax

    (3,387 )     (796 )     933       (625 )

Total comprehensive income (loss), net of tax

    (40,291 )     4,344       (53,637 )     16,891  

Less: Comprehensive loss attributable to noncontrolling interest

    -       -       -       (503 )

Comprehensive income (loss) attributable to Spansion Inc. common stockholders

  $ (40,291 )   $ 4,344     $ (53,637 )   $ 17,394  


See accompanying notes.

 

 
4

 

 

Spansion Inc.

Condensed Consolidated Balance Sheets

(in thousands, except par value and share amounts)

(Unaudited)  

 

   

September 29, 2013

   

December 30, 2012

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 193,025     $ 262,177  

Short-term investments

    35,367       51,720  

Accounts receivable, net

    155,206       106,864  

Inventories

    257,600       182,192  

Deferred income taxes

    3,811       8,699  

Prepaid expenses and other current assets

    64,914       28,531  

Total current assets

    709,923       640,183  
                 

Property, plant and equipment, net

    186,211       176,728  

Intangible assets, net

    177,207       149,153  

Goodwill

    166,584       166,931  

Other assets

    66,961       39,171  

Total assets

  $ 1,306,886     $ 1,172,166  
                 

Liabilities and Stockholders' Equity

               

Current liabilities:

               

Accounts payable

  $ 99,454     $ 85,542  

Accrued compensation and benefits

    65,606       26,080  

Other accrued liabilities

    97,896       29,913  

Income taxes payable

    1,673       2,618  

Deferred income

    27,099       9,135  

Current portion of long-term debt

    5,380       5,382  

Total current liabilities

    297,108       158,670  
                 

Deferred income taxes

    4,408       9,393  

Long-term debt, less current portion

    413,789       410,913  

Other long-term liabilities

    34,688       31,416  

Total liabilities

    749,993       610,392  
                 

Commitments and contingencies (Note 15)

    -       -  

Stockholders’ equity:

               

Capital stock:

               

Class A common stock, $0.001 par value, 150,000,000 shares authorized, 58,828,662 shares issued and outstanding (57,267,409 shares as of December 30, 2012)

    59       58  

Class B common stock, $0.001 par value, 1 share authorized, 1 share issued and outstanding

    -       -  

Preferred stock, $0.001 par value, 50,000,000 shares authorized, 0 shares issued and outstanding

    -       -  

Additional paid-in capital

    739,646       690,891  

Accumulated deficit

    (182,261 )     (127,691 )

Accumulated other comprehensive income (loss) (Note 5)

    (551 )     (1,484 )

Total stockholders' equity

    556,893       561,774  

Total liabilities and stockholders' equity

  $ 1,306,886     $ 1,172,166  

 

See accompanying notes.

 

 
5

 

 

Spansion Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

 

   

Nine Months Ended

 
   

September 29,

2013

   

September 30,

2012

 

Cash Flows from Operating Activities:

               

Net income (loss)

  $ (54,570 )   $ 17,516  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

               

Depreciation and amortization

    62,630       74,390  

Gain on liquidation of auction rate securities

    (1,200 )     (1,059 )

Gain on recovery from impaired investment

    (9,592 )     -  

Provision for deferred income taxes

    (3,728 )     1,826  

Net gain on sale of Kuala Lumpur land and building

    -       (28,434 )

Net gain on sale and disposal of property, plant and equipment

    (3,084 )     (5,326 )

Gain on acquisition of Microcontroller and Analog business

    (8,205 )     -  

Costs relating to partial repurchase of 7.875% Senior Unsecured Notes

    2,280       -  

Asset impairment charges

    -       2,070  

Compensation recognized under employee stock plans

    23,324       24,176  

Changes in assets and liabilities, net of effect of acquisition

    56,938       (961 )

Net cash provided by operating activities

    64,793       84,198  
                 

Cash Flows from Investing Activities:

               

Proceeds from liquidation of auction rate securities

    1,530       1,059  

Proceeds from sale of property, plant and equipment

    3,206       44,357  

Proceeds from recovery of impaired investment

    9,592       -  

Proceeds from maturities of marketable securities

    116,888       99,381  

Purchases of property, plant and equipment

    (39,238 )     (30,753 )

Purchases of marketable securities

    (100,535 )     (80,135 )

Acquisition of Microcontroller and Analog business , net of cash acquired

    (148,144 )     -  

Net cash provided by (used for) investing activities

    (156,701 )     33,909  
                 

Cash Flows from Financing Activities:

               

Proceeds from issuance of common stock due to options exercised

    2,303       1,358  

Refinancing cost relating to Revolver

    (282 )     -  

Repayments on debt and capital lease obligations

    (2,105 )     (30,390 )

Proceeds from issuance of Senior Exchangeable Notes

    150,000       -  

Cost relating to issuance of Senior Exchangeable Notes

    (4,506 )     -  

Purchase of capped call for the Senior Exchangeable Notes

    (15,375 )     -  

Partial repurchase of 7.875% Senior Notes including costs

    (106,779 )     -  

Acquisition of noncontrolling interest

    -       (4,024 )

Cash settlement of hedging activities

    (268 )     (799 )

Net cash provided by (used for) financing activities

    22,988       (33,855 )

Effect of exchange rate changes on cash and cash equivalents

    (232 )     358  

Net increase (decrease) in cash and cash equivalents

    (69,152 )     84,610  

Cash and cash equivalents, beginning of period

    262,177       194,850  

Cash and cash equivalents, end of period

  $ 193,025     $ 279,460  
                 
                 

Non-cash investing and financing activities:

               

Liabilities recorded for purchases of property, plant and equipment

  $ 10,448     $ 7,629  

Unpaid issuance costs relating to the Senior Exchangeable Notes

  $ 460     $ -  

Restricted cash relating to employee compensation and benefits received from FSL

  $ 32,086     $ -  

 

See accompanying notes.

 

 
6

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Unaudited)

 

1. Basis of Presentation

 

The unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and notes required by U.S. GAAP for annual financial statements. In the opinion of management, the unaudited interim financial statements reflect all normal and recurring adjustments considered necessary for a fair statement of the financial position, results of operations and cash flows for the periods presented. The December 30, 2012 condensed consolidated balance sheet data were derived from audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 30, 2012, but does not include all disclosures required by U.S. GAAP for annual periods.

 

These condensed consolidated financial statements and related notes should be read in conjunction with the Company’s audited financial statements and related notes included in its Annual Report on Form 10-K for the fiscal year ended December 30, 2012 as filed with the SEC on February 25, 2013. The results of operations for the nine months ended September 29, 2013 are not necessarily indicative of the results that may be expected for any other interim period or for the full fiscal year.

 

The Company operates on a 52- to 53-week fiscal year ending on the last Sunday in December. The additional week in a 53-week fiscal year is added to the second quarter to realign the Company’s fiscal quarters more closely to calendar quarters. Fiscal 2013 and fiscal 2012 are comprised of 52-week and 53-week periods, respectively.

 

Principles of Consolidation

 

On August 1, 2013, the Company acquired the Microcontroller and Analog business (AM Business) of Fujitsu Semiconductor Limited (FSL). The unaudited condensed consolidated financial statements include the results of operations of the Company, the AM business commencing as of the acquisition date and all of the Company’s other wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. The fiscal 2012 financial statements also include a variable interest entity (VIE) for which the Company was the primary beneficiary through March 31, 2012. The VIE’s financial statements were not significant to the Company’s condensed consolidated financial statements for the periods presented. On April 1, 2012, the Company acquired substantially all assets and assumed certain liabilities of the VIE under an asset purchase agreement and the entity ceased to be a VIE as of the acquisition date.  

 

Use of Estimates

 

The preparation of the Company’s consolidated financial statements and disclosures in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of commitments and contingencies and the reported amounts of revenues and expenses during the reporting periods. Estimates are used to account for the fair value of certain marketable securities, revenue adjustments, the allowance for doubtful accounts, inventory write-downs, valuation of intangible assets, impairment of long-lived assets, legal contingencies, income taxes, stock-based compensation expenses, the fair value of long-term debt, and product warranties. Actual results may differ from those estimates, and such differences may be material to the Company’s condensed consolidated financial statements.

 

2. Recent Accounting Pronouncements

 

In July 2013, the FASB issued an accounting standard update permitting the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to US Treasury interest rates and the London Interbank Offered Rate (LIBOR). This guidance is effective prospectively for qualifying new or redesignated hedging relationships, entered into on or after July 17, 2013. The Company does not expect the adoption of this guidance to affect its consolidated financial position, results of operations, or cash flows.

 

 
7

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

In July 2013, the Financial Accounting Standards Board (FASB) issued an accounting standard update that resolves the diversity in practice regarding the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The unrecognized tax benefit should be presented as a reduction to a deferred tax asset. This guidance is effective for the first annual period beginning after December 15, 2013. The Company does not expect adoption of this guidance to affect its consolidated financial position, results of operations, or cash flows.

 

In February 2013, FASB issued an accounting standard update to provide enhanced disclosures related to reclassifications out of accumulated other comprehensive income (AOCI). An entity will be required to disclose the effect of significant reclassifications out of AOCI on the respective line items in net income if an amount in AOCI 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 the Company’s 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 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 for the Company beginning the first quarter of fiscal year ending December 28, 2014. The adoption of this guidance is not expected to have an impact on the Company’s financial position, results of operations or cash flows.

 

3. Acquisition         

 

On August 1, 2013, the Company acquired the AM Business of FSL for a purchase consideration of $158.5 million, ($149.9 million, net of cash acquired). Of this amount, the Company had a liability of $1.8 million as of September 29, 2013, to be paid towards the purchase consideration. Pursuant to the terms and conditions of a Stock Purchase Agreement (SPA) with FSL, the Company acquired certain subsidiaries and assets and assumed certain liabilities of FSL for purposes of acquiring FSL’s business of designing, developing, marketing and selling, microcontroller and analog semiconductor products. The primary reason for the acquisition was to expand the Company’s embedded market leadership and support its customer base with a broader product line including Flash memory, microcontrollers, analog, mixed signal and system-on-chip solutions. The acquisition was accounted for using the purchase method of accounting. During the three and nine months ended September 29, 2013, approximately $6.2 million and approximately $11.2 million were incurred as acquisition expenses and were included in the sales, general and administrative expense line in the Condensed Consolidated Statement of Operations.

 

 
8

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The table below represents the provisional allocation of the purchase price to the net assets acquired based on their estimated fair values as of August 1, 2013:

 

   

Fair Values

 
   

($ in thousands)

 

Cash

    8,595  

Restricted cash

    32,086  

Accounts receivable

    1,534  

Inventory

    104,300  

Property and equipment, net

    12,143  

Intangible Assets

       

Developed technology

       

Automotive microcontrollers

    10,500  

Consumer microcontrollers

    5,900  

Analog

    12,700  

In-Process technology

    500  

Customer relationships

    18,800  

Trademarks

    2,700  

Tradenames

    1,400  

Deferred tax liability

    (3,739 )

Japan Pension related underfunded liability

    (23,923 )

Liability to FSL for excess pension related cash received

    (8,163 )

Japan employees compensation and benefits liability

    (8,585 )

Gain on acquisition of Microcontroller and Analog business

    (8,205 )

Total Purchase Consideration

    158,543  

 

The purchase price has been allocated to the assets acquired and liabilities assumed based on estimated fair values as of the acquisition date. The Company has not finalized the purchase price allocation for this acquisition.

 

Gain on acquisition

 

The accounting guidance requires that economic gain resulting from the fair value received being greater than the consideration paid to acquire the net assets be recorded as a one-time gain included in earnings on the acquisition date. The Company recorded a gain on acquisition of $8.2 million, which is disclosed as a separate line in the accompanying Condensed Consolidated Statement of Operations.

 

The Company was able to acquire the AM Business for less than the sum of the fair value of its net assets largely as a result of its long-standing and on-going relationship with FSL, including the existing and future distribution and supply agreements between the Company’s core flash memory business, the AM Business and Fujitsu’s continuing business in the semiconductor space. Additionally, the Company believes there is a significant difference in the market participant approach it used to value the business compared to the way Fujitsu valued the business due to the differences in each company’s method of running the business. Historically, Fujitsu operated the AM Business as a fully integrated manufacturer owning substantially all of the manufacturing facilities in the supply chain. In recent years, the high fixed cost nature of this business model contributed to its substantial losses. The Company, conversely, valued the business using the income approach based on an outsourced business model where the Company mainly incurs only the variable cost of manufacturing in sourcing products for the AM Business going forward.

 

 
9

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

Identifiable intangible assets

 

Developed technology relates to FSL’s automotive microcontroller, consumer microcontroller and analog technologies that have reached technological feasibility. Developed technology was valued at the individual product level under each of these categories. The income approach, specifically the multi-period excess earnings method, which calculates the value based on the risk-adjusted present value of the cash flows specific to the products, net of all contributory asset returns was used. The estimated economic lives of the underlying developed technologies were based on the estimated product lifecycles of the current automotive, consumer, and analog products. A discount rate of 24.0% was used to discount the cash flows to the present value. The Company will amortize the fair value of the acquired developed technology on a straight line basis.

 

In-process research and development (IPR&D) relates to research and development for products that have not yet reached technological feasibility. A discount rate of 26.0% was used to value the research and development projects, adjusted to reflect additional risks inherent in the acquired projects. Acquired IPR&D assets are initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. Accordingly, during the development period after the acquisition date, these assets will be subject to periodic impairment testing. If a research and development project is terminated, the associated IPR&D asset will be written down to zero in the period in which the project is terminated. Upon successful completion of the development process for an acquired IPR&D project, determination of the useful life of the asset will be made; at that time, the asset would be considered a finite-lived intangible asset and the Company would begin to amortize the asset into earnings. Management estimates that it will take approximately three months to three years to complete the on-going projects, depending on whether these relate to the analog, consumer or automotive microcontroller markets, and that the acquired assets will then be amortized using the straight line method over the estimated useful lives for developed technology in each of these markets.

 

Customer relationships represent the fair value of future projected revenue that will be derived from sales of products to existing customers of the AM business. As a result of the acquisition, the Company entered into an agreement with Fujitsu for the distribution of its microcontroller and analog products in Japan and acquired several non-Japan customer relationships. Customer relationships were valued using the with-and-without-method, a form of the income approach, which captures the opportunity cost associated with the theoretical loss of the customers existing as of the valuation date. The method involves a comparison of the cash flows as if the customer relationships were in place versus as if the customer relationships were to be created "from scratch". This method also assumes that all other assets, know-how and technology were easily available in both scenarios.

 

Customer relationships, trademarks and trade names were fair valued using a discount rate of 24.0%. The estimated fair values of these intangibles will be amortized on a straight line basis.

 

Liability relating to underfunded portion of Defined Benefit Pension Plan

 

The majority of the transferred employees were participants of the Fujitsu Corporate Pension Fund and Retirement Allowance Plan (together, “the Pension Plan”). In accordance with the SPA, these employees will remain in, and will continue to participate in the Pension Plan through the acquired subsidiaries in Japan. All pension related costs will be billed by Fujitsu to Spansion periodically, and related assets will continue to be managed and invested by the Pension Plan.

 

 
10

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The Pension Plan had unfunded and underfunded liabilities as of August 1, 2013 which the Company assumed. Fujitsu agreed to pay the Company for the total amount of the unfunded and underfunded liabilities and transferred the cash on August 1, 2013. The cash transfer amount was calculated based on the present value of the projected defined-benefit obligation less the fair value of Pension Plan assets at the period end, allocated from the Fujitsu Pension Plan for the transferred employees. The fair value of the Pension Plan assets was derived from balances reported by the financial institutions that manage these assets. The projected defined benefit obligation was computed by an independent actuary in accordance with the terms of the SPA. This cash of $23.9 million is treated as restricted cash and is recorded in Other Current Assets and the unfunded and underfunded liabilities are recorded under Accrued Compensation and Benefits in the Condensed Consolidated Balance Sheet.

 

The Company also received additional cash pending the actuarial estimation of the underfunded portion of the pension liability. This amount of $8.2 million has also been recorded as restricted cash and a liability payable to FSL.

 

Other liabilities taken over as part of the acquisition

 

The Company also took over certain other liabilities of $8.6 million relating to employee compensation and benefits in Japan for which it was reimbursed in cash by FSL.

 

Pro Forma consolidated results of operations

 

The following unaudited pro forma consolidated results of operations for the three months and nine months ended September 29, 2013 and September 30, 2012 assume the acquisition had occurred as of December 26, 2011. The pro forma results of operations are presented for informational purposes only and are not indicative of the results of operations that would have been achieved if the acquisition had taken place on December 26, 2011 or of results that may occur in future. For the purpose of this pro forma financial information, adjustments were made in all periods to include the depreciation of the acquired property and equipment, the amortization of the acquired intangible assets and the income tax effects relating to such adjustments. Adjustments were also made to exclude gain on acquisition, acquisition related costs, amortization of fair market value of inventory markup and the income tax effects relating to such adjustments for the three and nine months ended September 29, 2013 and to include these items for the three and nine months ended September 30, 2012.

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

   

September 29, 2013

   

September 30, 2012

 
   

(in thousands, except per share amounts)

 

Net sales

    314,701       386,786       947,551       1,163,123  

Net income (loss)

    (24,106 )     (46,075 )     (159,988 )     (169,905 )
                                 

Net income (loss) per share

                               

Basic

    (0.41 )     (0.77 )     (2.73 )     (2.84 )

Diluted

    (0.41 )     (0.77 )     (2.73 )     (2.84 )

 

The AM Business acquired contributed net sales of $92.9 million from the acquisition date of August 1, 2013 through September 29, 2013. It is impracticable to determine the earnings for the AM Business as the Company does not allocate non-operating items to its various product groups.

 

4. Balance Sheet Components

 

The Company’s cash balances are held in numerous locations throughout the world, with the majority in the United States. As of September 29, 2013, the Company had cash, cash equivalents, and short-term investments of $206.1 million held within the United States and $22.2 million held outside of the United States. As of December 30, 2012, the Company had cash, cash equivalents, and short term investments of $303.1 million held within the United States and $10.8 million held outside of the United States.

 

 
11

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

All securities other than the Federal Deposit Insurance Corporation (FDIC) insured certificates of deposit were designated as available-for-sale. FDIC insured certificates of deposit are held to maturity. Gross unrealized gains and losses on cash equivalents and short term investments were not material as of September 29, 2013 and December 30, 2012. Gross realized gains and losses on cash equivalents and short term investments were not material for the three months and nine months ended September 29, 2013 and September 30, 2012.

 

   

September 29, 2013

   

December 30, 2012

 
   

(in thousands)

 
                 

Cash and cash equivalents

               

Cash

  $ 188,118     $ 258,126  

Cash equivalents:

               

Money market funds

    4,844       1,181  

FDIC insured certificates of deposit

    63       2,870  

Cash and cash equivalents

  $ 193,025     $ 262,177  
                 

Short-term investments

               

Commercial paper

  $ -     $ 14,980  

Time Deposit

    14,035       -  

FDIC insured certificates of deposit

    21,332       36,740  

Short-term investments

  $ 35,367     $ 51,720  
                 

Account receivable, net

               

Accounts receivable, gross

  $ 155,578     $ 107,127  

Allowance for doubtful accounts

    (372 )     (263 )

Account receivable, net

  $ 155,206     $ 106,864  
                 

Inventories

               

Raw materials

  $ 11,673     $ 8,647  

Work-in-process

    177,029       149,722  

Finished goods

    68,898       23,823  

Inventories

  $ 257,600     $ 182,192  
                 

Property, plant and equipment, net

               

Land

  $ 45,168     $ 45,168  

Buildings and leasehold improvements

    61,601       59,807  

Equipment

    366,951       341,129  

Construction in progress

    25,910       11,694  

Accumulated depreciation and amortization

    (313,419 )     (281,069 )

Property, plant and equipment, net

  $ 186,211     $ 176,728  
                 

Other Long Term Assets

               

Long Term License

  $ 33,210     $ 10,002  

Others

    33,751       29,169  

Other Long Term Assets

  $ 66,961     $ 39,171  
                 

Accrued Compensation and Benefits

               

Accrued Vacation

  $ 10,372     $ 9,404  

AM business underfunded pension related liability

    23,923       -  

Others

    31,311       16,676  

Accrued Compensation and Benefits

  $ 65,606     $ 26,080  
                 

Accrued Liabilities

               

Short Term License Liability

  $ 17,948     $ 3,377  

Others

    79,948       26,536  

Accrued Liabilities

  $ 97,896     $ 29,913  

 

 
12

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

5. Accumulated Other Comprehensive Loss

 

The following table summarizes the activity related to accumulated other comprehensive loss, net of tax:

   

Foreign

Currency

Translation Adjustment

   

Net Gains and

Losses on Cash

Flow Hedges

   

Unrealized Gains

and Losses on Available-for-Sale Securities

   

Total

 
   

(in thousands)

 
                                 

Beginning Balance, December 30, 2012

  $ (2,685 )   $ 1     $ 1,200     $ (1,484 )

Other comprehensive income before reclassification, net of tax

    (1,420 )     13,669       -       12,249  

Amounts reclassified to earnings (ineffective portion)

    -       (2,415 ) (2)   -       (2,415 )

Amounts reclassified to earnings (effective portion)

    -       (7,701 ) (1)   -       (7,701 )

Amounts reclassified on sale of Auction Rate Securities

    -       -       (1,200 ) (2)   (1,200 )

Net other comprehensive income

  $ (1,420 )   $ 3,553     $ (1,200 )   $ 933  

Ending Balance, September 29, 2013

  $ (4,105 )   $ 3,554     $ -     $ (551 )


(1) Reclassified into Net Sales line item of the Condensed Consolidated Statement of Operations. Please see Note 11 for further details.
(2) Reclassified into Interest and Other Income line item of the Condensed Consolidated Statement of Operations. Please see Note 11 for further details on the ineffective portion of cash flow hedges.

 

6. Equity Incentive Plan and Stock-Based Compensation

 

Equity Incentive Plan 

 

The Company’s 2010 Equity Incentive Award Plan (2010 Plan) provides for the grant of stock options, stock appreciation rights, restricted stock units, restricted stock, performance awards, and deferred stock to its employees, consultants and non-employee members of its Board of Directors.

 

In the first half of fiscal 2013, the Company granted performance-based restricted stock units (PSUs) to certain senior executives. The PSUs have vesting percentages ranging from 0% to 100%, calculated based on the relative Total Shareholder Return (TSR) of the Company’s common stock as compared to the TSR of its peer companies. These awards are divided into two equal tranches, each with an 18-month performance period. The first performance period is from February 1, 2013 through July 31, 2014 and the second performance period is from August 1, 2014 through January 31, 2016. The grant date fair value for these grants is estimated using the Monte-Carlo option pricing model. 

 

 

 
13

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The numbers of shares of common stock available for grant under the 2010 Plan are shown in the following table:

 

   

Shares Available

 For Grant

 

Balance as of December 30, 2012

    1,103,450  

Additional shares issuable under 2010 Plan (annual increase for 2013)

    2,577,033  

Stock options granted, net of forfeitures/cancellations

    (317,562 )

RSU awards granted, net of forfeitures/cancellations

    (693,310 )

PSU awards granted, net of forfeitures/cancellations

    (340,332 )

Balance as of September 29, 2013

    2,329,279  

 

Stock-Based Compensation

 

The following table presents the total stock-based compensation expense by financial statement caption resulting from the Company’s stock options and RSU awards:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

   

September 29, 2013

   

September 30, 2012

 
      (in thousands)  
                                 

Cost of sales

  $ 1,384     $ 1,713     $ 4,235     $ 4,747  

Research and development

    1,952       2,350       7,420       6,045  

Sales, general and administrative

    3,692       4,698       11,669       13,384  

Stock-based compensation expense before income taxes

    7,028       8,761       23,324       24,176  

Stock-based compensation expense after income taxes(1)

  $ 7,028     $ 8,761     $ 23,324     $ 24,176  

 

(1) There was no income tax benefit related to stock-based compensation because all of the Company's U.S. deferred tax assets, net of U.S. deferred tax liabilities, continue to be subject to a full valuation allowance.

  

 
14

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The weighted average fair value of the Company’s stock options granted is as follows:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29,

2013

   

September 30,

2012

   

September 29,

2013

   

September 30,

2012

 
                                 

Weighted average fair value of stock options granted

  $ 3.68     $ 5.30     $ 4.69     $ 4.19  

 

 

The fair value of each stock option was estimated at the date of grant using a Black-Scholes option pricing model, with the following assumptions for grants:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

   

September 29, 2013

   

September 30, 2012

 
                                 

Expected volatility

    41.84 %     51.24 %     47.06 %     51.23 %

Risk-free interest rate

    1.14 %     0.50 %     0.94 %     0.67 %

Expected term (in years)

    4.35       4.35       4.35       4.35  

Dividend yield

    0.00 %     0.00 %     0.00 %     0.00 %

 

  

As of September 29, 2013, the total unrecognized compensation cost related to unvested stock options and RSU awards was approximately $32.5 million after reduction for estimated forfeitures. These stock options and RSU awards will generally vest ratably through 2016.

 

The fair value of each PSU award granted in fiscal 2013 was $7.40 using a Monte-Carlo pricing model and was estimated with the following assumptions:

 

   

Three and Nine Months Ended

 
   

September 29, 2013

 
         

Stock price on grant date

  $ 11.50  

Expected volatility

    50.90 %

Risk-free interest rate

    0.21 %

Dividend yield

    0.00 %

 

 
15

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

Stock Option and Restricted Stock Unit Activity

 

The following table summarizes stock option activities and related information under the 2010 Plan for the periods presented:

 

   

Number of

Shares

   

Weighted

Average

Exercise

Price

   

Weighted

Average

Remaining

Contractual

Life (in Years)

   

Aggregate

Intrinsic

Value

 
                           

(in thousands)

 

Outstanding stock options as of December 30, 2012

    6,641,892     $ 13.06       5.34     $ 15,228  

Granted

    630,000     $ 11.45             $ -  

Cancelled/Forfeited

    (312,438 )   $ 13.46             $ -  

Exercised

    (234,924 )   $ 9.81             $ 550  

Outstanding stock options as of September 29, 2013

    6,724,530     $ 13.00       4.69     $ 609  

Total vested and exercisable as of September 29, 2013

    4,608,375     $ 13.53       4.29     $ 307  

 

 

No income tax benefit was realized from stock option exercises for the three and nine months ended September 29, 2013.

 

The following table summarizes RSU award activities and related information for the nine months ended September 29, 2013:

 

    

RSU

 
   

Number of

Shares

   

Weighted Average

Grant-date

Fair Value

 

Outstanding as of December 30, 2012

    2,518,916     $ 13.72  

Granted

    990,343     $ 12.41  

Cancelled/Forfeited

    (297,033 )   $ 12.75  

Vested

    (891,868 )   $ 11.66  

Outstanding as of September 29, 2013

    2,320,358     $ 14.07  

 

  The following table summarizes key executive RSU and PSU award activities and related information for the nine months ended September 29, 2013.

 

   

Key Executive RSU

   

PSU

 
   

Number of

Shares

   

Weighted Average

Grant-date

Fair Value

   

Number of

Shares

   

Weighted Average

Grant-date

Fair Value

 

Outstanding as of December 30, 2012

    1,792,171     $ 12.02       -     $ -  

Granted

    -     $ -       376,000     $ 7.40  

Cancelled/Forfeited

    (11,668 )   $ 10.25       (24,000 )   $ 7.40  

Vested

    (781,049 )   $ 11.52       -     $ -  

Outstanding as of September 29, 2013

    999,454     $ 12.43       352,000     $ 7.40  

  

 
16

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

7. Net Income (loss) Per Share

 

Basic net income (loss) per share is calculated by dividing net income (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share represents the earnings attributable to each share of common stock after giving effect to all potentially dilutive securities which were outstanding during the period. The dilutive effect of outstanding options and RSUs is reflected in diluted net income (loss) per share by application of the treasury stock method. Under the treasury stock method, the amount the employee must pay for exercising stock options, the amount of compensation cost for future service that the Company has not yet recognized, and the amount of tax benefits that would be recorded in additional paid-in capital when the award becomes deductible are assumed to be used to repurchase shares. On August 26, 2013, Spansion LLC, a wholly-owned subsidiary of the Company, issued $150.0 million of Senior Exchangeable Notes due 2020 (“the Notes”) in a private placement. The Notes can be settled either by cash or shares of common stock of the Company, or a combination of both at the discretion of the Company. The potential dilution impact of the Notes is computed using the if-converted method. The if-converted method is used for convertible securities that have a potential for sharing in earnings as common stock. Thus, the interest expense less income tax effects applicable to the Notes are not recognized in net income(loss) to determine basic and diluted net income (loss) per share and the weighted–average number of shares is adjusted to reflect the assumed conversion as of the beginning of the year or actual date of issuance if later.

 

The following table presents the computation of basic and diluted net income (loss) per share:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September

29, 2013

   

September

30, 2012

   

September

29, 2013

   

September

30, 2012

 
   

(in thousands except for per-share amounts)

 
                                 

Numerator:

                               

Net income (loss)

  $ (36,904 )   $ 5,140     $ (54,570 )   $ 18,019  

Denominator:

                               

Denominator for basic net income per share, weighted average shares

    58,785       60,139       58,506       59,932  

Effect of dilutive RSUs and Options

    -       681       -       843  

Denominator for diluted net income per share, weighted average shares

    58,785       60,820       58,506       60,775  
                                 

Basic net income (loss) per share

  $ (0.63 )   $ 0.09     $ (0.93 )   $ 0.30  

Diluted net income (loss) per share

  $ (0.63 )   $ 0.08     $ (0.93 )   $ 0.30  

Potentially dilutive shares excluded from the diluted income per share computation because their effect would have been anti-dilutive

                               

- RSUs and Options

    4,441       6,704       4,555       7,367  

- Conversion of Senior Exchangeable Notes

    3,996       -       1,352       -  

Total antidilutive shares

    8,437       6,704       5,907       7,367  

 

 
17

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

8. Intangible Assets and Goodwill

 

Intangible Assets

 

The following table presents the balance of intangible assets as of the dates indicated below:

 

   

September 29, 2013

   

December 30, 2012

 
   

(in thousands)

 
   

Gross Amount

   

Additions

   

Accumulated Amortization

   

Net Amount

   

Gross Amount

   

Accumulated Amortization

   

Net Amount

 

Developed technology

  $ 111,376     $ 29,100     $ (48,451 )   $ 92,025     $ 111,376     $ (35,386 )   $ 75,990  

Customer relationships

    92,080       18,800       (33,781 )     77,099       93,264       (25,191 )     68,073  

Trade names

    8,252       1,400       (4,711 )     4,941       8,374       (3,284 )     5,090  

Trademarks

    -       2,700       (58 )     2,642       -       -       -  

In-process technology

    -       500       -       500       -       -       -  

Total Intangible Assets

  $ 211,708     $ 52,500     $ (87,001 )   $ 177,207     $ 213,014     $ (63,861 )   $ 149,153  

 

On August 1, 2013, the Company acquired the AM Business of FSL for a purchase consideration of $158.5 million ($149.9 million, net of cash acquired). The Company recorded intangible assets of $52.5 million as of the acquisition date. Please see Note 3 for further details relating to the intangible assets recorded as part of the acquisition.
 

The actual amortization expense and estimated future amortization expense for intangible assets are summarized below:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29,

2013

   

September 30,

2012

   

September 29,

2013

   

September 30,

2012

 
   

(in thousands)

 

Amortization expense

  $ 9,514     $ 6,813     $ 23,140     $ 20,792  

 

   

Estimated Future Amortization

 
   

(in thousands)

 

Fiscal 2013 (remaining 3 months)

  $ 10,135  

Fiscal 2014

    40,193  

Fiscal 2015

    38,920  

Fiscal 2016

    32,550  

Fiscal 2017

    21,069  

Fiscal 2018 and beyond

    33,840  

Total

  $ 176,707  
  

Goodwill

 

The following table presents the balance of goodwill as of the dates indicated below:

 

   

September 29, 2013

   

December 30, 2012

 
   

(in thousands)

 
                 

Goodwill

  $ 166,584     $ 166,931  

 

 
18

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The changes in the carrying amount of goodwill and gross balance of intangibles assets since December 30, 2012 resulted from foreign currency translation adjustments.

 

 

9. Financing arrangements

 

The following table summarizes the Company’s debt:

 

   

September 29, 2013

   

December 30, 2012

 
   

(in thousands)

 

Debt obligations:

               

Term Loan

  $ 214,496     $ 216,295  

2.0% Senior Exchangeable Notes

    110,609       -  

7.875% Senior Unsecured Notes

    94,064       200,000  

Total debt

  $ 419,169     $ 416,295  

Less: current portion

    5,380       5,382  

Long-term debt

  $ 413,789     $ 410,913  

 

2.00% Senior Exchangeable Notes

 

On August 26, 2013, Spansion LLC, a wholly-owned subsidiary of the Company, issued $150.0 million of Senior Exchangeable Notes due 2020 in a private placement. The Notes are governed by an Indenture, dated August 26, 2013, between the Company and Wells Fargo Bank, National Association, as Trustee. They are fully and unconditionally guaranteed on a senior unsecured basis by the Company and Spansion Technology LLC. The Notes will mature on September 1, 2020, unless earlier repurchased or converted, and bear interest of 2.0% per year payable semi-annually in arrears on March 1 and September 1, commencing on March 1, 2014. The Notes may be due and payable immediately in certain events of default.

 

The Notes are exchangeable for an initial exchange rate of 72.0929 shares of common stock per $1,000 principal amount of the Notes (equivalent to an initial exchange price of approximately $13.87 per share) subject to adjustments for anti-dilutive issuances and make-whole adjustments upon a fundamental change. A fundamental change includes a change in control, delisting of the Company’s stock and liquidation, consolidation or merger of the Company. Prior to June 1, 2020, the Notes will be exchangeable under certain specified circumstances as described in the Indenture.

 

The Notes were issued at face value, resulting in net proceeds of approximately $145.5 million after related offering expenses. In accounting for the Notes at issuance, the Company separated the Notes into debt and equity components according to the accounting standards for convertible debt instruments that may be fully or partially settled in cash upon conversion. The carrying amount of the debt component, which approximates its fair value, was estimated by using an interest rate for nonconvertible debt, with terms similar to the Notes. The excess of the principal amount of the Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The debt discount is accreted to the carrying value of the Notes over their term as interest expense using the interest method. The amount recorded to additional paid-in capital is not to be remeasured as long as it continues to meet the conditions for equity classification. Upon issuance of the Notes, the Company recorded $110.2 million as debt and $39.8 million as additional paid-in capital in Stockholders’equity.

 

The Company incurred transaction costs of approximately $5.0 million relating to the issuance of the Notes. In accounting for these costs, the Company allocated the costs of the offering in proportion to the fair value of the debt and equity recognized in accordance with the accounting standards. The transaction costs allocated to the debt component of approximately $3.6 million were recorded as deferred offering costs in other non-current assets and are being amortized as interest expense over the term of the Notes. The transaction costs allocated to the equity component of approximately $1.3 million were recorded to additional paid-in capital.

 

 
19

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The net carrying amount of the liability component of the Notes consists of the following:

 

   

September 29, 2013

 
   

(in thousands)

 

Principal amount

  $ 150,000  

Unamortized debt discount

  $ 39,391  

Net carrying value

  $ 110,609  

 

The following table presents the interest expense recognized on the Notes:

 

   

Three Months Ended

 
   

September 29, 2013

 
   

(in thousands)

 

Contractual interest expense at 2% per annum

  $ 290  

Amortization of debt issuance costs

    50  

Accretion of debt discount

    432  

Total

  $ 772  

 

 

Capped Calls

 

In connection with the issuance of the Notes, the Company entered into capped call transactions with certain bank counterparties to reduce the risk of potential dilution of the Company’s common stock upon the exchange of the Notes. The capped call transactions have a strike price of approximately $13.87 and a cap price of approximately $18.14, and are exercisable when and if the Notes are converted. If upon conversion of the Convertible Notes, the price of the Company’s common stock is above the strike price of the capped calls, the counterparties will deliver shares of the Company’s common stock and/or cash with an aggregate value approximately equal to the difference between the price of the Company’s common stock at the conversion date (as defined, with a maximum price for purposes of this calculation equal to the cap price) and the strike price, multiplied by the number of shares of the Company’s common stock related to the capped call transactions being exercised. The capped call expires on September 1, 2020. The Company paid $15.4 million for these capped calls and recorded the payment as a charge to additional paid-in capital.

 

7.875% Senior Unsecured Notes

 

On August 26, 2013, the Company used proceeds from the issuance and sale of the Notes to repurchase $105.9 million of the 7.875% Senior Unsecured Notes.

 

Revolving Credit Facility

 

On September 27, 2013, the Company amended its revolving credit facility (the “2012 Revolving Credit Facility”) with Morgan Stanley Bank, N.A and other financial institutions to increase the revolving loan commitment from $50 million to $70 million. The amendment to Revolving Credit Facility contains additional covenants requiring: (a) the consolidated quick ratio as determined on the last day of any fiscal quarter to not be less than 1.25 to 1.0, and (b) the amount of consolidated cash, cash equivalent and other short-term marketable investments to not be less than $150 million.

 

 
20

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The Company is in compliance of all the covenants under its existing debt arrangements as of September 29, 2013.

 

10. Fair Value Measurement

 

The Company measures its cash equivalents, marketable securities, foreign currency forward contracts and interest rate derivative contracts at fair value. Fair value is an exit price, representing the amount that would be received on sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:

 

Level 1—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—Include other inputs that are directly or indirectly observable in the marketplace.

Level 3—Unobservable inputs that are supported by little or no market activities.

 

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

Cash equivalents, auction rate securities and marketable securities are classified within Level 1 or Level 2. This is because the Company values them using quoted market prices or alternative pricing sources and models utilizing observable market inputs. The foreign exchange forward contracts and interest rate derivative contracts are classified as Level 2 because the valuation inputs are based on quoted prices and observable market data of similar instruments. The Company principally executes its foreign currency contracts in the retail market in an over-the-counter environment with a relatively high level of price transparency. The market participants and the Company’s counterparties are large money center banks and regional banks. The valuation inputs for the Company’s foreign currency contracts are based on quoted prices and quoted pricing intervals from public data sources (specifically, spot exchange rates, LIBOR rates and credit default rates) and do not involve management judgment. In determining the fair value of the Company’s interest rate swap, the Company uses the present value of expected cash flows based on observable market interest rate yield curves and interest rate volatility commensurate with the term of each instrument.

 

 
21

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The fair value measurements of the Company’s financial assets and liabilities consisted of the following types of instruments categorized in the table below based upon the fair value hierarchy:

 

   

September 29, 2013

   

December 30, 2012

 
   

Level 1

   

Level 2

   

Level 3

   

Total

   

Level 1

   

Level 2

   

Level 3

   

Total

 
   

(in thousands)

 
                                                                 

Money market funds

  $ 4,844     $ -     $ -     $ 4,844 (1)   $ 1,181     $ -     $ -     $ 1,181 (2)

Commercial paper

    -       -       -       - (1)     -       14,980       -       14,980 (2)

Foreign Exchange Forward Contracts

    -       5,199       -       5,199       -       3,032       -       3,032  

Auction rate securities

    -       -       -       -       -       1,530       -       1,530  

Total financial assets

  $ 4,844     $ 5,199     $ -     $ 10,043     $ 1,181     $ 19,542     $ -       20,723  

Interest rate swaps

  $ -     $ -     $ -     $ -     $ -     $ 514     $ -     $ 514  

Foreign Exchange Forward Contracts

          $ 22             $ 22     $ -     $ 296     $ -     $ 296  

Total financial liabilities

  $ -     $ 22     $ -     $ 22     $ -     $ 810     $ -     $ 810  

  

(1) Total cash and cash equivalents, short-term investments of $228.4 million as of September 29, 2013 includes cash of $209.5 million held in operating accounts, $4.8 million in money market funds and $14.0 million held in time deposit accounts.

(2) Total cash and cash equivalents, short-term investments of $313.9 million as of December 30, 2012 includes cash of $297.7 million held in operating accounts, $1.2 million in money market funds and $15.0 million in commercial paper.


Fair Value of Other Financial Instruments Not Carried At Fair Value

 

The Company’s Term Loan, 7.875% Senior Unsecured Notes and Senior Exchangeable Notes are traded in the market and the fair value is Level 1, and is based on the quoted market price as of September 29, 2013 and December 30, 2012. The carrying amounts and estimated fair values of the Company’s debt instruments are as follows:

 

   

September 29, 2013

   

December 30, 2012

 
   

Carrying

Value

   

Estimated

Fair Value

   

Carrying

Value

   

Estimated

Fair Value

 
           

(in thousands)

                 
                                 

Debt traded in the market:

                               

Term Loan

  $ 214,496     $ 215,568     $ 216,295     $ 217,917  

2.0% Senior Exchangeable Notes

    110,609       107,014       -       -  

7.875% Senior Unsecured Notes

    94,064       97,591       200,000       201,000  

Total Debt Obligations

  $ 419,169     $ 420,173     $ 416,295     $ 418,917  

 

In connection with the issuance of the Notes, the Company purchased capped calls from certain counterparties. The initial fair value of the capped calls of $15.4 million was recorded within stockholders’ equity which approximated their carrying value. The fair value of the capped calls is not remeasured each reporting period.

 

The fair value of the Company’s cash equivalents, accounts receivable, accounts payable and other current liabilities approximates their carrying value.

 

 
22

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

11. Derivative Financial Instruments

 

Beginning in the second quarter of fiscal 2012, the Company entered into multiple foreign exchange forward contracts to hedge certain operational exposures resulting from movements in Japanese yen (JPY) exchange rates. The Company’s hedging policy is designed to mitigate the impact of foreign currency exchange rate movements on operating results. Some of these foreign currency forward contracts were considered to be economic hedges that were not designated as hedging instruments while others were designated as cash flow hedges. Whether designated or undesignated, these forward contracts protect the Company against the variability of forecasted foreign currency cash flows resulting from revenues and net asset or liability positions designated in currencies other than the U.S. dollar and are not speculative in nature.

 

Cash Flow Hedges

 

The Company’s foreign currency forward contracts that were designated as cash flow hedges are carried at fair value and have maturities between three and eight months. As of September 29, 2013, the Company had outstanding forward contracts to buy USD for $30.9 million. Over the next twelve months, the Company expects to reclassify $3.6 million from accumulated other comprehensive gain to earnings as the related forecasted transactions occur.

 

The following table summarizes the activity related to derivatives in accumulated other comprehensive loss, net of tax:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29,

2013

   

September 30,

2012

   

September 29,

2013

   

September 30,

2012

 
      (in thousands)  
                                 

Beginning Balance

  $ 7,058     $ 217     $ 1     $ -  

Net (gain) loss reclassified into earnings on cash flow hedges (effective portion)

    (3,113 )     538       (7,701 )     538  

Net gain reclassified into earnings on cash flow hedges (ineffective portion)

    -       -       (2,415 )     -  

Net unrealized hedge gain (loss) arising during the period

    (391 )     (1,639 )     13,669       (1,422 )

Ending Balance

  $ 3,554     $ (884 )   $ 3,554     $ (884 )

 

Non Designated Hedges

 

The Company hedges net receivables and payables denominated in Japanese yen and expenses incurred in Thai baht with foreign exchange forward contracts to reduce the risk that its earnings and cash flows will be affected by changes in foreign currency exchange rates. These forward contracts do not subject the Company to additional material financial statement risk due to exchange rate movements because gains and losses on these derivatives are intended to offset gains and losses on the monetary assets and liabilities and underlying transactions being hedged, assuming that the derivative counterparty performs. The notional principal of foreign exchange forward contracts outstanding to buy USD was $38.4 million as of September 29, 2013 and $32.8 million as of December 30, 2012. In the second quarter of fiscal 2013, the Company also recorded a gain of $2.4 million from the mark to market on certain JPY hedges which were previously designated as cash flow hedges, as the Company concluded that the related forecasted transactions were probable to not occur during the hedge period or the additional two months thereafter.

 

On August 1, 2013, the Company acquired FSL’s AM Business. In the second quarter of fiscal 2013, the Company had entered into an economic hedge using foreign exchange forward contracts and options to mitigate the impact of foreign currency fluctuations on the purchase price which was denominated in currencies other than U.S. dollar. These contracts were settled during the third quarter and were no longer outstanding as of September 29, 2013.

 

These forward contracts were not designated hedges and were carried at fair value with changes in the fair value recorded in interest and other income (expense) in the accompanying Condensed Consolidated Statements of Operations.

 

 
23

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

Interest Rate Swap

 

The Company entered into a series of interest rate swaps to manage the interest rate risk on its Senior Secured Term Loan (the Term Loan) in the third quarter of fiscal 2010. The swap agreements expired on May 17, 2013. The mark-to-market of the swap has been reported as a component of interest expense because it does not qualify as a cash flow hedge.

 

The effect of derivative instruments on the Condensed Consolidated Statements of Operations for the three and nine months ended September 29, 2013 and September 30, 2012 was as follows:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

   

September 29, 2013

   

September 30, 2012

 
   

(in thousands)

 

Derivatives Designated as Hedging Instruments

                               

Foreign Exchange Forward Contracts

                               

Net unrealized gain (loss) recognized in OCI (1)

  $ (391 )   $ (1,639 )   $ 13,669     $ (1,422 )

Net (gain) loss reclassified from accumulated OCI into income (effective portion)(2)

  $ (3,113 )   $ 538     $ (7,701 )   $ 538  

Net gain reclassified from accumulated OCI into income (ineffective portion) (3)

  $ -     $ -     $ (2,415 )   $ -  

Derivatives Not Designated as Hedging Instruments

                               

Net gain (loss) recognized in income

                               

Swap interest expense (4)

  $ -     $ (16 )   $ (8 )   $ (134 )

Foreign Exchange Forward Contracts (5)

  $ (1,053 )   $ 1,221     $ (813 )   $ 1,464  

Foreign Exchange Options Contracts (5)

  $ (197 )   $ -     $ -     $ -  

 

(1) Net change in the fair value of the effective portion classified in other comprehensive income (OCI)

(2) Effective portion classified as net product revenue

(3) Classified in interest income and other (expense)

(4) Classified in interest expense

(5) Classified in interest and other income (expense)

 

The gross fair values of derivative instruments on the Condensed Consolidated Balance Sheets were as follows:

 

   

September 29, 2013

   

December 30, 2012

 

Balance sheet location

 

Derivatives designated as

hedging

instruments

   

Derivatives not designated as

hedging

instruments

   

Derivatives designated as

hedging

instruments

   

Derivatives

not

designated as

hedging

instruments

 
      (in thousands)  

Prepaid expenses and other current assets

                               

Foreign Exchange Forward Contracts

  $ 2,626     $ 2,573     $ -     $ 3,032  
                                 

Other accrued liabilities

                               

Interest rate Swap

  $ -     $ -     $ -     $ 514  

Foreign Exchange Forward Contracts

  $ -     $ 22     $ -     $ 296  

 

 
24

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

12. Pension and Post-Retirement Benefits

 

On August 1, 2013, the Company acquired the AM Business of FSL. Pursuant to the SPA, certain transferred employees from the AM business were enrolled in the Pension Plan. The Company by agreement with Fujitsu, is required to fund the proportional benefit obligations attributable to the Company’s employees enrolled in the Pension Plan. The benefits provided by the Pension Plan are based on employee’s years of service and compensation levels. The Company accounts for its participation in the plan as a multiemployer plan wherein the expense recorded for the Pension Plan is equal to the annual cash contributions. The Company recorded pension expense of $1.0 million for the quarter ended September 29, 2013 and had an unpaid pension liability of $0.5 million as of September 29, 2013. The Company has also recorded $23.9 million as Restricted Cash and $23.9 million in Accrued Compensation and Benefits in the Condensed Consolidated Balance Sheet for the underfunded portion of the plan. Please see Note 3 for further details of the acquisition.

 

The Company may also be subject to additional liabilities imposed by law as a result of its participation in the Pension Plan. The Pension Plan imposes certain liabilities upon an employer who is a contributor to a multi-employer pension plan if the employer withdraws from the plan or the plan is terminated or experiences a mass withdrawal. These liabilities include an allocable share of the unfunded vested benefits in the plan for all plan participants, not merely the benefits payable to a contributing employer’s own retirees. As a result, participating employers may bear a higher proportion of liability for unfunded vested benefits if other participating employers cease to contribute or withdraw, with the reallocation of liability being more acute in cases when a withdrawn employer is insolvent or otherwise fails to pay its withdrawal liability.

 

13. Income Taxes

 

The following table presents the Company’s income tax expense (benefit):

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

   

September 29, 2013

   

September 30, 2012

 
   

(in thousands)

 
                                 

Income tax expense (benefit)

  $ (1,644 )   $ 2,757     $ (891 )   $ 9,572  

 

The Company recorded an income tax benefit of $1.6 million and an expense of $2.8 million for the three months ended September 29, 2013 and September 30, 2012, respectively. The Company’s income tax benefit was $0.9 million and income tax expense was $9.6 million for the nine months ended September 29, 2013 and September 30, 2012, respectively.

 

The tax benefit for the three months and nine months ended September 29, 2013 was primarily attributable to pre-tax income in foreign jurisdictions and withholding taxes related to Samsung licensing revenue. This was offset by the release of reserves for uncertain tax positions in foreign locations and the tax impact from the Microcontroller and Analog business acquisition.

 

The tax expense for the three and nine months ended September 30, 2012 was primarily attributable to pre-tax income in foreign jurisdictions, withholding taxes related to Samsung licensing revenue and the impact from the sale of land and building in Kuala Lumpur offset by the release of reserves for uncertain tax positions in foreign locations.

 

As of September 29, 2013, all of the Company's 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 the Company's assessment that it is more likely than not that the deferred tax assets will not be realizable in the foreseeable future.

 

 
25

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

As of December 30, 2012, the Company had U.S. federal and state net operating loss carry forwards of approximately $989.9 million and $218.8 million, respectively. Approximately $489.7 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. The Company also has U.S. foreign tax credit carryovers of $1.0 million which expire from 2020 to 2021 and research and development credits of $1.2 million which expire in 2032. The Company also has state tax credits of $17.6 million, which includes California state tax credits of $16.8 million that can be carried forward indefinitely.

 

If the Company were to undergo an “ownership change” for purposes of Section 382 of the Internal Revenue Code of 1986, as amended, its ability to utilize its federal net operating loss carry forwards could be limited under certain provisions of the Internal Revenue Code. As a result, the Company could incur greater tax liabilities than it would in the absence of such a limitation and any incurred liabilities could materially adversely affect the Company’s results of operations and financial condition.

 

14. Restructuring and Others      

 

Fiscal 2013 Restructuring Plan

 

Beginning in the third quarter of fiscal 2013, in an effort to lower its expense levels, given the competitive pricing pressures and slower than expected growth in Japan revenues from Flash products, the Company implemented a reduction in force to rationalize its global workforce.

 

The following tables present a summary of restructuring activities related to 2013 restructuring plan described above:

 

   

Three Months Ended

 
   

September 29, 2013

 
   

(in thousands)

 

Accrued restructuring balance, beginning of period

  $ -  

Provision:

       

Severance and others

    6,264  

Restructuring charges

    6,264  

Non-cash adjustments (1)

    (230 )

Cash payments

    (4,351 )

Accrued restructuring balance, end of period

  $ 1,683  

 

(1) Non cash adjustments mainly relate to intangibles written off.

 

Fiscal 2011 Restructuring Plan

 

Beginning in the fourth quarter of fiscal 2011, the Company initiated a restructuring plan as part of a company-wide cost saving initiative aimed at reducing operating costs in light of global economic challenges and rapid changes in the China wireless and handset market. In the interest of reducing costs and improving efficiencies, the Company announced reduction of headcount in several locations and the closure of its assembly, test, mark and pack facility in Kuala Lumpur, Malaysia (the KL facility), which was completed in the first quarter of fiscal 2012. Total costs incurred under the fiscal 2011 restructuring plan were $22.6 million.

 

 
26

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

The following tables present a summary of restructuring activities related to 2011 restructuring plan described above:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

   

September 29, 2013

   

September 30, 2012

 
   

(in thousands)

 

Accrued restructuring balance, beginning of period

  $ 30     $ 785     $ 538     $ 8,087  

Provision:

                               

Gain on sale of equipment

    -       -       -       (3,798 )

Asset relocation fees

    -       854       -       4,686  

Asset impairment charges

    -       -       -       2,070  

Severance and others

    -       1,009       -       3,550  

Restructuring charges

    -       1,863       -       6,508  

Non-cash adjustments (1)

    -       (43 )     (75 )     1,557  

Cash payments

    (30 )     (344 )     (463 )     (13,891 )

Accrued restructuring balance, end of period

    -     $ 2,261     $ -     $ 2,261  

 

(1) Non cash adjustments relate to gain on sale of equipment, asset impairment charges and foreign currency translations.

 

Fiscal 2009/10 Restructuring Plan

 

In fiscal 2009 and 2010, the Company implemented certain restructuring measures including workforce reductions and the sale of its plant in Suzhou, China. The Company incurred restructuring expenses related to employee termination benefits and fixed asset relocation, depreciation and disposal. During the first quarter of fiscal 2012, there was a restructuring credit of $0.8 million as a result of the Company having prevailed in a labor-related lawsuit in conjunction with the 2009 restructuring activities in Thailand. Total costs incurred under the 2009/10 Restructuring Plan were $43.2 million.

 

The Company does not expect to incur further restructuring charges under the 2011 and 2009/10 Restructuring Plans.

 

15. Commitments and Contingencies

 

Purchase Commitments

  

The Company had $141.4 million of purchase commitments with certain suppliers, primarily for inventory items as of September 29, 2013.

 

Guarantees

 

In the normal course of business, the Company is a party to a variety of agreements pursuant to which it may be obligated to indemnify the other party. It is not possible to predict the maximum potential amount of future payments under these types of agreements due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. Historically, payments under these types of agreements have not had a material adverse effect on business, results of operations or financial condition.

 

 
27

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

Income Taxes

 

The Company is subject to audit by the Internal Revenue Service (IRS) and various other tax authorities. The Company has reserved for potential adjustments to the provision for income taxes that may result from examinations by, or any negotiated agreements with, these tax authorities, and the Company believes that the final outcome of these examinations or agreements will not have a material effect on the Company’s results of operations. If events occur which indicate payment of these amounts is unnecessary, the reversal of the liabilities would result in the recognition of tax benefits in the period the Company determines the liabilities are no longer necessary. If the estimates of the federal, state, and foreign income tax liabilities are less than the ultimate assessment, a further charge to expense would result.

 

Product Warranties

 

The Company generally offers a one-year limited warranty for all its products. Changes in the Company’s liability for product warranty were as follows:

 

   

Three Months Ended

   

Nine Months Ended

 
   

September

29, 2013

   

September 30,

2012

   

September 29,

2013

   

September 30,

2012

 
   

(in thousands)

 

Balance at beginning of period

  $ 1,127     $ 3,860     $ 2,124     $ 2,537  

Provision for warranties issued

    760       404       1,360       2,991  

Settlements made

    (827 )     (1,205 )     (2,412 )     (2,305 )

Changes in liability for pre-existing warranties during the period

    106       (89 )     94       (253 )

Balance at end of period

  $ 1,166     $ 2,970     $ 1,166     $ 2,970  

 

 

Legal Matters

 

              In the Matter of Certain Flash Memory Chips and Products Containing the Same, Investigation No. 337-TA-893, filed on August 1, 2013 and instituted on September 9, 2013.

 

On August 1, 2013, Spansion LLC, a wholly owned subsidiary of the Company, filed a complaint pursuant to Section 337 of the Tariff Act of 1930, as amended, 19 U.S.C. § 1337 (“Section 337”), to request that the U.S. International Trade Commission (“ITC”) institute an investigation relating to the unlawful importation into the United States, the sale for importation, and/or the sale within the United States after importation of certain Macronix flash memory chips (“Macronix Chips”) that infringe the Company’s valid patents, and/or are made, produced or processed under, or by means of, a process covered by the claims of the Company’s patents, and products containing the Macronix Chips.

 

On September 9, 2013, the Commission instituted its investigation. Other than the Company, the principal parties, or respondents in the investigation are Macronix International Co, Ltd., of Hsin-chu, Taiwan; Macronix America, Inc., of Milpitas, CA; Macronix Asia Limited of Kanagawa Pref., Japan; Macronix (Hong Kong) Co., Ltd., of Sa Tin, N.T., Hong Kong; Acer Inc. of New Taipei City, Taiwan; Acer America Corporation of San Jose, CA; ASUSTek Computer Inc. of Taipei, Taiwan; Asus Computer International of Fremont, CA; Belkin International, Inc., of Playa Vista, CA; D-Link Corporation of Taipei City, Taiwan; D-Link System, Inc., of Fountain Valley, CA; Netgear Inc., San Jose, CA; Nintendo Co., Ltd., of Kyoto, Japan; and Nintendo of America, Inc., of Redmond, WA.

 

Through this investigation, the Company seeks a general exclusion order to exclude from importation all infringing Macronix Chips and downstream products containing such chips. In the event that the ITC is unwilling to issue a general exclusion order, the Company seeks that a limited exclusion order be entered against each named Respondent and its subsidiaries and affiliates in order to remedy the Respondents’ violation of Section 337 and to prevent such future violations by Respondents. The Company has also asked the ITC to issue a cease and desist order to ensure compliance with the requested exclusion orders.

 

 
28

 

 

Spansion Inc.

Notes to Condensed Consolidated Financial Statements - (Continued) (Unaudited)

 

Spansion LLC v. Macronix International Co., Ltd. et. al., U.S. District Court, Northern District of California.

 

On August 1, 2013, Spansion LLC filed a complaint in the U.S. District Court, Northern District of California (San Jose Division), case no. 3:13-cv-03566-JST, against Macronix International Co., Ltd., Macronix America, Inc., Acer Inc., Acer America Corporation, ASUSTek Computer Inc., Asus Computer International (America), Belkin International, Inc., D-Link Systems, Inc., NETGEAR Inc., Nintendo Co., Ltd., and Nintendo of America, Inc. for patent infringement. Spansion has asked for monetary damages as well as permanent injunctive relief to prevent further infringing activity.

 

On August 29, 2013, the Company amended its original complaint to delete certain defendants, resulting in the eleven party defendants identified above (“Defendants”), and to make certain additional allegations.

 

On October 8, 2013, pursuant to 28 U.S.C. § 1659, each of the Defendants asserted its statutory right to a mandatory stay of all proceedings in the Northern District of California action until the determination of the ITC becomes final (see In the Matter of Certain Flash Memory Chips and Products Containing the Same,, Investigation No. 337-TA-893, U.S. International Trade Commission, above). Because the requested stay is mandated by statute, the Company does not oppose the motion.

 

Macronix International Co., LTD. v. Spansion Inc. et. al., U.S. District Court, Eastern District of Virginia.

 

On October 2, 2013, Macronix International Co., Ltd. filed a complaint in the U.S. District Court, Eastern District of Virginia, case no. 3:13-cv-679-REP, against Spansion Inc. and Spansion LLC for patent infringement. The Company has not filed an answer or otherwise responded to the complaint. The complaint seeks unspecified monetary damages as well as injunctive relief.

 

Besides the above, the Company is a defendant or plantiff in various legal actions that arose in the normal course of business. In the opinion of management, the aggregate liability, if any, with respect to these matters will not have a material adverse effect on the Company's financial condition, result of operations or cash flows.

 

16. Ongoing Bankruptcy Related Matters

 

In connection with the Company’s emergence from Chapter 11 bankruptcy proceedings in May 2010, a claims agent was appointed to analyze and, at its discretion, contest outstanding disputed claims totaling $1.5 billion. As of September 29, 2013, the Company had resolved all of these claims with the exception of potential preference claim reserves of $7.2 million.

 

 
29

 

 

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

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 on the embedded Flash memory, microcontrollers, mixed-signal and analog markets; 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 global leader in embedded systems solutions. We are focused on a portion of the semiconductor market that relates to high performance and high-reliability Flash memory, microcontrollers, analog and other programmable semiconductors that run applications in a broad range of electronic systems. Our strategic emphasis centers on the embedded portion of the semiconductor 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 predominantly differentiated, non-commodity, service-oriented model that strives to meet the needs of our customers 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.

 

 
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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.

 

On August 1, 2013, we completed the acquisition of the Microcontroller and Analog business (the AM Business) of Fujitsu Semiconductor Limited (FSL) for a purchase consideration of $158.5 million ($149.9 million, net of cash acquired). Pursuant to this acquisition, we will also deliver a broad embedded line of products which includes microcontrollers, analog and mixed-signal semiconductors, in addition to flash memory.

 

In addition to product sales, 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.      

 

Critical Accounting Policies

 

There have been no significant changes in our critical accounting estimates or significant accounting policies during the nine months ended September 29, 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 July 2013, the FASB issued an accounting standard update permitting the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes, in addition to US Treasury interest rates and the London Interbank Offered Rate (LIBOR). This guidance is effective prospectively for qualifying new or redesignated hedging relationships, entered into on or after July 17, 2013. We do not expect the adoption of this guidance to affect our consolidated financial position, results of operations, or cash flows.

 

In July 2013, the FASB issued an accounting standard update that resolves the diversity in practice regarding the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The unrecognized tax benefit should be presented as a reduction to a deferred tax asset. This ASU is effective for the first annual period beginning after December 15, 2013. We do not expect adoption of this guidance to affect our consolidated financial position, results of operations, or cash flows.

 

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 the first quarter of fiscal 2013 did not have an impact on our financial position, results of operations or cash flows.

 

 
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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.

 

Results of Operations 

 

Comparison of Net Sales, Gross Margin, Operating income (loss), Interest and Other Income (Expense), Interest Expense and Income Tax Provision

 

The following is a summary of our operating results:

 

   

Three Months Ended

 

Nine Months Ended

 
   

September 29,

2013

   

September 30,

2012

   

Variance

   

September 29,

2013

   

September 30,

2012

   

Variance

 
   

(in thousands, except for percentages)

 

Total net sales

  $ 273,378     $ 239,747     $ 33,631     $ 658,020     $ 691,945     $ (33,925 )

Cost of sales

    217,209       161,281       55,928       498,640       480,370       18,270  

Gross profit

    56,169       78,466       (22,297 )     159,380       211,575       (52,195 )

Gross margin

    20.5 %     32.7 %     -12.2 %     24.2 %     30.6 %     -6.4 %

Research and development

    38,341       27,407       10,934       84,666       83,078       1,588  

Sales, general and administrative

    54,544       35,228       19,316       117,441       103,485       13,956  

Net gain on sale of KL land and building

    -       -       -       -       (28,434 )     28,434  

Restructuring charges (credits)

    6,264       1,862       4,402       6,264       5,650       614  

Operating income (loss)

    (42,980 )     13,969       (56,949 )     (48,991 )     47,796       (96,787 )

Interest and other income (expense), net

    3,578       1,267       2,311       7,658       2,216       5,442  

Interest expense

    (7,351 )     (7,339 )     (12 )     (22,333 )     (22,924 )     591  

Gain on acquisition of Microcontroller and Analog business

    8,205       -       8,205       8,205       -       8,205  

Provision (benefit) for income taxes

    (1,644 )     2,757       (4,401 )     (891 )     9,572       (10,463 )

 

Net Sales           

 

Net sales increased by $33.7 million from $239.7 million for the three months ended September 30, 2012 to $273.4 million for the three months ended September 29, 2013. The increase was mainly due to the inclusion of $92.9 million of August and September revenues from our newly acquired AM Business and $12.5 million of revenue from patent sales. The increases were partially offset by $67.0 million of decline in embedded sales and $2.5 million decline in wireless sales. The decrease in embedded sales was mainly due to lower gaming revenues in Japan due to timing of orders as the majority of our customers are in product transitions moving to newer product platforms. In addition, we also had a downward pressure on selling prices with increased competition.

 

Net sales decreased by $33.9 million from $691.9 million for the nine months ended September 30, 2012 to $658.0 million for the nine months ended September 29, 2013 primarily due to $117.5 million lower embedded sales relating to lower gaming revenues in Japan and increased pricing pressures. In addition, wireless sales decreased by $14.9 million as we shifted our strategy to focus on the embedded market. The decrease was partially offset by the inclusion of $92.9 million of revenues for August and September from our newly acquired AM Business and $12.5 million revenue from patent sales.

 

 
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Gross Profit

 

Our gross profit decreased by $22.3 million from $78.5 million for the three months ended September 30, 2012 to $56.2 million for the three months ended September 29, 2013. The gross margin percentage declined from 32.7% in the three months ended September 30, 2012 to 20.5% in three months ended September 29, 2013. The decrease in gross profit and margin was primarily driven by $27.1 million amortization of a purchase accounting markup on the AM inventory purchased from FSL as a part of our acquisition and lower utilization from our manufacturing facilities, and was partially offset by $12.5 million of gross profit from patent sales. In addition, we had lower margins from revenues in the embedded market, primarily driven by downward pressure on selling prices due to increased competition and a less favorable product sales mix in Japan. The decrease was partially offset by additional gross profit on our newly acquired AM Business revenues.

 

Our gross profit decreased by $52.2 million from $211.6 million for the nine months ended September 30, 2012 to $159.4 million for the nine months ended September 29, 2013. Our gross margin as a percentage of sales decreased from 30.6% in the nine months ended September 30, 2012 to 24.2% in the nine months ended September 29, 2013. The decrease was mainly due to lower margins from revenues in the embedded markets as discussed above, $27.1 million amortization of a purchase accounting markup on the AM inventory purchased from FSL as a part of our acquisition and lower utilization from our manufacturing facilities. The decrease was partially offset by additional gross profit from our newly acquired AM Business revenues and $12.5 million of gross profit from patent sales in the third quarter of fiscal 2013.

 

Research and Development (R&D)

 

R&D expenses increased by $10.9 million from $27.4 million for the three months ended September 30, 2012 to $38.3 million for the three months ended September 29, 2013. The increase was mainly due to $14.8 million of R&D expense relating to the AM Business incurred post acquisition, and was partially offset by $2.5 million of lower employee compensation and benefits due to the reduction in headcount with the restructuring activity in the third quarter of fiscal 2013, and $1.7 million of lower material costs on certain projects.

 

R&D expenses increased by $1.6 million from $83.1 million for the nine months ended September 30, 2012 to $84.7 million for the nine months ended September 29, 2013. The increase was mainly due to $14.8 million of AM Business related R&D expense incurred post acquisition, and was partially offset by $7.6 million of lower employee compensation and benefits due to the reduction in headcount with the restructuring activity in fiscal 2013, $3.5 million of lower development charges relating to NAND development and $2.7 million of lower material costs on certain projects.

 

Sales, General and Administrative (SG&A)

 

SG&A expenses increased by $19.3 million from $35.2 million for the three months ended September 30, 2012 to $54.5 million for the three months ended September 29, 2013. The increase was mainly due to $9.2 million of SG&A expenses relating to the newly acquired AM Business incurred post acquisition, $5.6 million of AM Business integration costs, and $9.0 million of higher legal expenses due to the Macronix patent infringement litigation. The increase was partially offset by $3.5 million of lower employee compensation and benefits and $1.0 million of lower sales commission expenses. Lower employee compensation and benefits were driven by the reduction in headcount with the restructuring activity in the third quarter of fiscal 2013 and lower incentive accruals. Lower sales commission expenses were driven by lower sales and cost reduction efforts.

 

SG&A expenses increased by $13.9 million from $103.5 million for the nine months ended September 30, 2012 to $117.4 million for the nine months ended September 29, 2013. The increase was mainly due to $10.7 million of AM Business integration costs, $9.2 million of SG&A expenses relating to the newly acquired AM Business incurred post acquisition, and $9.0 million of higher legal expenses due to the Macronix patent infringement litigation. The increase was partially offset by $9.9 million of lower employee compensation and benefits, $4.4 million of lower travel, rental expense and other outside services and $1.0 million of lower sales commission expenses. Lower employee compensation and benefits were driven by the reduction in headcount with the restructuring activity in the third quarter of fiscal 2013 and lower incentive accruals. Lower sales commission expenses were driven by lower sales and cost reduction efforts.

 

 
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Restructuring Charges

 

Beginning with the third quarter of fiscal 2013, in an effort to lower our expense levels, given the competitive pricing pressures and slower than expected growth in Japan revenues, we implemented a reduction in force to rationalize our global workforce.

 

Restructuring charges increased by $4.4 million from $1.9 million for the three months ended September 30, 2012 to $6.3 million for the three months ended September 29, 2013. Restructuring charges for the three months ended September 29, 2013 mainly comprised of $5.8 million of severance expense and $0.4 million of intangibles written off due to closure of a design service facility. Restructuring charges for the three months ended September 30, 2012 mainly comprised of $0.9 million severance costs and $0.9 million asset relocation costs.

 

Restructuring charges increased by $0.6 million from $5.7 million for the nine months ended September 30, 2012 to $6.3 million for the nine months ended September 29, 2013. Restructuring charges for the nine months ended September 29, 2013 mainly comprised of $5.8 million of severance expense and $0.4 million of intangibles written off due to closure of a design service facility. Restructuring charges for the nine months ended September 30, 2012 mainly comprised of $7.9 million asset relocation and impairment charges relating to closure of our assembly, pack, mark and test facility in Kuala Lumpur, Malaysia (the KL facility) and $1.9 million of severance and employee related costs, offset by a $1.9 million gain on the sale of equipment in the KL facility, a $1.9 million gain on sale of equipment in Thailand, and a $0.9 million credit as a result of our prevailing in a labor-related lawsuit in conjunction with the 2009 Restructuring Plan in Thailand.

 

Gain on acquisition

 

Gain on the AM Business acquisition of $8.2 million was recognized net of tax of $3.7 million in the three and nine months ended September 29, 2013. We did not have a similar event in the three and nine months ended September 30, 2012.

 

Interest and Other Income (Expense)

 

Interest and other income (expense), increased by $2.3 million from $1.3 million for the three months ended September 30, 2012, to $3.6 million for the three months ended September 29, 2013. This was primarily due to $9.6 million of gain on recovery of a previously impaired investment, and $0.9 million foreign exchange gain mainly from economic hedges relating to the AM Business acquisition purchase consideration. The increase was partially offset by $7.6 million of costs relating to partial repurchase of the 7.875% Senior Notes.

 

Interest and other income increased by $5.4 million from $2.2 million for the nine months ended September 30, 2012 to $7.7 million for the nine months ended September 29, 2013 due to $9.6 million of gain on recovery of a previously impaired investment, $2.4 million of gain on ineffective cash flow hedges and $2.6 million foreign exchange gain including the gain from economic hedges relating to the AM Business acquisition purchase consideration. The increase was partially offset by $7.6 million of costs relating to partial repurchase of the 7.875% Senior Notes. The gain on ineffective cash flow hedges related to certain JPY hedges on which we concluded that the related forecasted transactions were probable not to occur during the hedge period or the additional two months thereafter.

 

 
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Interest Expense

 

Interest expense increased by $0.1 million from $7.3 million for the three months ended September 30, 2012 to $7.4 million for the three months ended September 29, 2013. Increase in interest expense, including amortization of debt discount, of $0.8 million due on the 2.0% Exchangeable Senior Notes (the Notes) issued on August 26, 2013 was offset by $0.8 million lower interest expense due to partial repurchase of the 7.875% Senior Unsecured Notes.

 

Interest expense decreased by $0.6 million from $22.9 million for the nine months ended September 30, 2012 to $22.3 million for the nine months ended September 29, 2013 primarily due to lower interest expense on the Term Loan and the 7.875% Senior Unsecured Notes, partially offset by the additional interest expense recognized in the third quarter of fiscal 2013 on the issuance of Notes.

 

Provision for Income Taxes

 

The Company had a benefit of $1.6 million and an income tax expense of $2.8 million for the three months ended September 29, 2013 and September 30, 2012, respectively. The Company’s income tax benefit was $0.9 million and income tax expense was $9.6 million for the nine months ended September 29, 2013 and September 30, 2012, respectively.

 

The tax benefit for the three months and nine months ended September 29, 2013 was primarily attributable to the release of reserves for uncertain tax positions in foreign locations and the tax impact from the AM Business acquisition. This was offset by tax expense on pre-tax income in foreign jurisdictions and withholding taxes related to Samsung licensing revenue.

 

The tax expense for the three and nine months ended September 30, 2012 was primarily attributable to pre-tax income in foreign jurisdictions, withholding taxes related to Samsung licensing revenue and the tax impact of gain from the sale of land and building in Kuala Lumpur, offset by the release of reserves for uncertain tax positions in foreign locations.

 

As of September 29, 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 $989.9 million and $218.8 million, respectively. Approximately $489.7 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. foreign tax credit carryovers of $1.0 million which expire from 2020 to 2021 and research and development credits of $1.2 million which expire in 2032. We also have state tax credits of $17.6 million, which includes California state tax credits of $16.8 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.

 

 
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Contractual Obligations

 

The following table summarizes our contractual obligations at September 29, 2013:

 

   

Total

   

2013

   

2014

   

2015

   

2016

   

2017

   

2018 and Beyond

 
   

(in thousands)

 

Senior Secured Term Loan

  $ 216,686     $ 560     $ 5,765     $ 2,240     $ 2,240     $ 2,800     $ 203,081  

Senior Notes

    94,064       -       -       -       -       94,064       -  

Exchangeable Senior Notes

    150,000                                               150,000  

Interest expense on Debt

    115,700       6,674       21,917       21,748       21,659       24,228       19,474  

Other long term liabilities (1)

    12,234       -       3,771       7,191       1,228       44       -  

Operating leases

    18,243       2,529       8,203       3,641       2,730       1,140       -  

Unconditional purchase commitments (2)

    141,401       6,856       80,248       26,148       28,024       125       -  

Total contractual obligations (3)

  $ 748,328     $ 16,619     $ 119,904     $ 60,968     $ 55,881     $ 122,401     $ 372,555  

 

 

(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 September 29, 2013, the liability for uncertain tax positions was $16.4 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.

 

2.00% Senior Exchangeable Notes

 

On August 26, 2013, Spansion LLC, our wholly-owned subsidiary, issued $150.0 million of Senior Exchangeable Notes due 2020 in a private placement. The Notes are governed by an Indenture, dated August 26, 2013, between us and Wells Fargo Bank, National Association, as Trustee. They are fully and unconditionally guaranteed on a senior unsecured basis by us and Spansion Technology LLC. The Notes will mature on September 1, 2020, unless earlier repurchased or converted, and bear interest of 2.00% per year payable semi-annually in arrears on March 1 and September 1, commencing on March 1, 2014. The Notes may be due and payable immediately in certain events of default.

 

The Notes are exchangeable for an initial exchange rate of 72.0929 shares of common stock per $1,000 principal amount of the Notes (equivalent to an initial exchange price of approximately $13.87 per share) subject to adjustments for anti-dilutive issuances and make-whole adjustments upon a fundamental change. A fundamental change includes a change in control, delisting of the Company’s stock and liquidation, consolidation or merger of the Company. Prior to June 1, 2020, the Notes will be exchangeable under certain specified circumstances as described in the Indenture.

 

The Notes were issued at face value, resulting in net proceeds of approximately $145.5 million after related offering expenses. In accounting for the Notes at issuance, we separated the Notes into debt and equity components according to the accounting standards for convertible debt instruments that may be fully or partially settled in cash upon conversion. The carrying amount of the debt component, which approximates its fair value, was estimated by using an interest rate for nonconvertible debt, with terms similar to the Notes. The excess of the principal amount of the Notes over the fair value of the debt component was recorded as a debt discount and a corresponding increase in additional paid-in capital. The debt discount is accreted to the carrying value of the Notes over their term as interest expense using the interest method. The amount recorded to additional paid-in capital is not to be remeasured as long as it continues to meet the conditions for equity classification. Upon issuance of the Notes, the Company recorded $110.2 million as debt and $39.8 million as additional paid-in capital in Stockholders’equity.

 

 
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We incurred transaction costs of approximately $5.0 million relating to the issuance of the Notes. In accounting for these costs, we allocated the costs of the offering in proportion to the fair value of the debt and equity recognized in accordance with the accounting standards. The transaction costs allocated to the debt component of approximately $3.6 million were recorded as deferred offering costs in other non-current assets and amortized as interest expense over the term of the Notes. The transaction costs allocated to the equity component of approximately $1.3 million were recorded to additional paid-in capital.

 

The net carrying amount of the liability component of the Notes consists of the following:

 

   

September 29, 2013

 
   

(in thousands)

 

Principal amount

  $ 150,000  

Unamortized debt discount

  $ 39,391  

Net carrying value

  $ 110,609  

 

The following table presents the interest expense recognized on the Notes:

 

   

Three Months Ended

 
   

September 29, 2013

 
   

(in thousands)

 

Contractual interest expense at 2% per annum

  $ 290  

Amortization of debt issuance costs

    50  

Accretion of debt discount

    432  

Total

  $ 772  

Capped Calls

 

In connection with the issuance of the Notes, we entered into capped call transactions with certain bank counterparties to reduce the potential dilution to our common stock upon exchange of the Notes. The capped call transactions have a strike price of approximately $13.87 and a cap price of approximately $18.14, and are exercisable when and if the Notes are converted. If upon conversion of the Notes, the price of our common stock is above the strike price of the capped calls, the counterparties will deliver shares of our common stock and/or cash with an aggregate value approximately equal to the difference between the price of our common stock at the conversion date (as defined, with a maximum price for purposes of this calculation equal to the cap price) and the strike price, multiplied by the number of shares of our common stock related to the capped call transactions being exercised. The capped call transactions expire on September 1, 2020. We paid $15.4 million for these capped calls and recorded a payment as a charge to additional paid-in capital.

 

7.875% Senior Unsecured Notes

 

On August 26, 2013, we used proceeds from the issuance and sale of the Notes to repurchase $105.9 million of the 7.875% Senior Unsecured Notes.

 

Revolving Credit Facility

 

On September 27, 2013, we amended our revolving credit facility (the “2012 Revolving Credit Facility”) with Morgan Stanley Bank, N.A and other financial institutions to increase the revolving loan commitment from $50 million to $70 million. The amendment to Revolving Credit Facility contains additional covenants requiring: (a) the consolidated quick ratio as determined on the last day of any fiscal quarter to not be less than 1.25 to 1.0, and (b) the amount of consolidated cash, cash equivalent and other short-term marketable investments to not be less than $150 million.

 

 
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We are in compliance of all covenants under our existing debt arrangements as of September 29, 2013.

 

Liquidity and Capital Resources

 

Cash Requirements

 

As of September 29, 2013 and December 30, 2012, we had the following cash and cash equivalents and short term investments:

 

   

September 29, 2013

   

December 30, 2012

 
   

(in thousands)

 
                 
                 

Cash

  $ 188,118     $ 258,126  

Money market funds

    4,844       1,181  

FDIC insured certificates of deposit

    21,395       39,610  

Time deposits

    14,035       -  

Commercial paper

    -       14,980  

Total cash and cash equivalents and short-term

investments

  $ 228,392     $ 313,897  

  

 Key components of our cash flow during the nine months ended September 29, 2013 and September 30, 2012 were as follows:

 

   

Nine Months Ended

 
   

September 29, 2013

   

September 30, 2012

 
   

(in thousands)

 
                 

Net cash provided by (used for) operating activities

  $ 64,793     $ 84,198  

Net cash provided by (used for) investing activities

    (156,701 )     33,909  

Net cash provided by (used for) financing activities

    22,988       (33,855 )

Effect of exchange rate changes on cash and cash equivalents

    (232 )     358  

Net increase (decrease) in cash and cash equivalents

  $ (69,152 )   $ 84,610  

 

 On August 1, 2013 we completed the acquisition of the AM Business from FSL for a purchase consideration of $158.5 million ($149.9 million, net of cash acquired). We financed this transaction from our existing cash reserves. Our future uses of cash are expected to be primarily for working capital, debt servicing, capital expenditures and contractual obligations. 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.

 

 
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Operating Activities

 

Net cash provided by operating activities was $64.8 million during the nine months ended September 29, 2013, which consisted of net loss of $54.6 million and net increase in operating assets and liabilities of $56.9 million and net non-cash items of approximately $62.5 million. The net increase in operating assets and liabilities was due to an increase of $87.6 million in accounts payables, accrued liabilities and accrued compensation and benefits, a decrease of $27.1 million in inventory and an increase of $18.0 million in deferred income, offset by an increase of $45.8 million in accounts receivables and an increase of $28.0 million in other long term assets. Net non-cash items primarily consisted of $62.6 million in depreciation and amortization, $23.3 million of stock compensation expense $9.6 million gain on recovery from impaired investment and $8.2 million gain on the acquisition of the AM Business .

 

Net cash provided by operating activities was $84.2 million during the nine months ended September 30, 2012, which consisted of net income of $17.5 million, and a net decrease in operating assets and liabilities of $1.0 million offset by net non-cash items of approximately $67.6 million. Net non-cash items primarily consisted of $74.4 million in depreciation and amortization, a $28.4 million gain on the sale of the Kuala Lumpur facility and $24.2 million of stock compensation expense.

 

Investing Activities

 

Net cash used for investing activities was $156.7 million during the nine months ended September 29, 2013, primarily comprised of $148.1 million used for acquisition of the AM Business net of cash acquired, $100.5 million used to purchase marketable securities and $39.2 million used to purchase property, plant and equipment, offset by $116.9 million in proceeds from the maturities of marketable securities.

 

Net cash provided by investing activities was $33.9 million during the nine months ended September 30, 2012, primarily from $44.4 million of proceeds from the sale of property, plant and equipment, and $99.4 million in proceeds from the maturities of marketable securities, which were offset by $80.1 million used to purchase marketable securities and $30.8 million used to purchase property, plant and equipment.

 

Financing Activities

 

Net cash provided by financing activities was $23.0 million during the nine months ended September 29, 2013, primarily due to $145.5 million of proceeds from the issuance of Notes, net of costs, offset by $106.8 million of partial repurchase of 7.875% Senior Unsecured Notes and $15.4 million of purchase of capped call for the Notes.

 

Net cash used for financing activities was $33.9 million during the nine months ended September 30, 2012, primarily due to $30.4 million payments on debt and $4.0 million acquisition of a non-controlling interest.

 

 

 

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 September 29, 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.

 

 
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

 

Interest Rate Risk

 

Our exposure to market risk for changes in interest rates relates primarily to our cash deposits, invested cash and debt. As of September 29, 2013, we had $188.1 million held in demand deposit accounts, $4.8 million held in overnight money market funds, $21.4 million invested in certificates of deposit fully insured by the FDIC and $14.0 million held in time deposits. Our cash and short-term investment position is highly liquid. Approximately $193.0 million have maturity terms of 0 to 30 days, $2.1 million have maturity terms of 91 to 180 days, and the remaining $33.3 million have maturity terms of 181 to 365 days at the time of purchase. Accordingly, our interest income fluctuates with short-term market conditions, but our exposure to interest rate risk is minimal due to the short term nature of our cash and investment position.

 

On August 26, 2013, we completed an offering of $150.0 million aggregate principal amount of Notes in a private placement. The Notes will mature on September 1, 2020, unless earlier repurchased or converted, and bear interest of 2.0% per year. In accounting for the Notes at issuance, we separated the Notes into debt and equity component according to the accounting standards for convertible debt instruments that may be fully or partially settled in cash upon conversion. As of September 29, 2013, 49 percent of the aggregate principal amounts outstanding under our third party debt obligations were fixed rate, and 51 percent of our total debt obligations were variable rate, comprised of the Term Loan with an outstanding balance of $214.5 million as of September 29, 2013. The Term Loan has a LIBOR floor of 1.25 percent. While LIBOR is below 1.25 percent, our interest expense will not change along with short-term change in interest rate environment. When LIBOR is above 1.25 percent, changes in interest rates associated with the Term Loan could then result in a change to our interest expense. For example, a one percent aggregate change in interest rates would increase/decrease our contractual interest expense by approximately $2.1 million annually.

 

Default Risk

 

We intend to actively monitor market conditions and developments specific to the securities and classes of securities in which we invest. We take a conservative approach to investing our funds. Our policy is to invest only in highly-rated securities with relatively short maturities, and we do not invest in securities we believe involve a higher degree of risk.

 

Foreign Exchange Risk

 

Our sales, expenses, assets and liabilities denominated in Japanese yen and other foreign currencies are exposed to foreign currency exchange rate fluctuations. For example,

 

 

some of our manufacturing and operating costs are denominated in Japanese yen, and other foreign currencies such as the Thai baht and Malaysian ringgit;

 

sales of our products to Fujitsu are denominated in both U.S. dollars and Japanese yen;

 

our purchase price to acquire a portion of FSL’s business is denominated in Japanese yen and other foreign currencies (See Note 11 to the Condensed Consolidated Financial Statements for further details); and

 

Some fixed asset purchases and sales are denominated in other foreign currencies.

 

Consequently, movements in exchange rates could cause our net sales and our expenses to fluctuate, affecting our profitability and cash flows. We use foreign currency forward contracts to reduce our foreign exchange exposure on our foreign currency denominated assets and liabilities. We also hedge a percentage of our forecasted revenue denominated in Japanese yen with foreign currency forward contracts. We also entered into an economic hedge using foreign exchange forward contracts and option contracts for the purchase consideration payable to FSL. The objective of these contracts is to mitigate the impact of foreign currency exchange rate movements to our operating results. We do not use these contracts for speculative or trading purposes.

 

 
40

 

 

We recognize derivative instruments from hedging activities as either assets or liabilities on the balance sheet and measure them at fair value. Gains and losses resulting from changes in fair value are accounted for depending on the use of the derivative and whether it is designated and qualifies for hedge accounting. To receive hedge accounting treatment, all hedging relationships are formally documented at the inception of the hedge, and the hedges must be highly effective in offsetting changes to future cash flows on hedged transactions. We record changes in the intrinsic value of these cash flow hedges in accumulated other comprehensive loss in the Condensed Consolidated Balance Sheets, until the forecasted transaction occurs. When the forecasted transaction occurs, we will reclassify the related gain or loss on the cash flow hedge to revenue.  In the event the underlying forecasted transaction does not occur, or it becomes probable that it will not occur, we will reclassify the gain or loss on the related cash flow hedge from accumulated other comprehensive income (loss) to interest and other income (expense) in our Condensed Consolidated Statements of Operations at that time.

  

We evaluate hedge effectiveness at the inception of the hedge prospectively as well as retrospectively and record any ineffective portion of the hedging instruments in interest and other income (expense) on our Condensed Consolidated Statements of Operations.

 

We do not anticipate any material adverse effect on our consolidated financial position, results of operations or cash flows resulting from the use of these instruments in the future, including the impact of counterparty non-performance. However, we cannot assure you that these strategies will be effective or that transaction losses can be minimized or forecasted accurately. In particular, we generally cover only a portion of our foreign currency exchange exposure. We cannot assure you that these activities will eliminate foreign currency exchange rate exposure. Failure to eliminate this exposure could have an adverse effect on our business, financial condition and results of operations.

 

The following table provides information about our foreign currency forward contracts as of September 29, 2013 and December 30, 2012:

 

   

September 29, 2013

   

December 30, 2012

 
   

Notional

Amount

 

Average

Contract Rate Per USD

 

Estimated Fair

Value

   

Notional

Amount

   

Average

Contract Rate

Per USD

   

Estimated Fair

Value

 
   

(in thousands, except contract rates)

 

Non-Designated hedges

                                         

Foreign currency forward contracts

                                         

Buy JPY / Sell USD

  $ -  

JPY 0.00

  $ -     $ 12,258    

JPY 83.92

    $ (296 )

Sell JPY / Buy USD

  $ 38,353  

JPY 91.61

  $ 2,551     $ 45,059    

JPY 80.21

    $ 3,032  
                                           

Designated hedges

                                         

Sell JPY / Buy USD

  $ 30,903  

JPY 89.80

  $ 2,626     $ -     $ -     $ -  

 

 
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ITEM 4. CONTROLS AND PROCEDURES

 

Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the Exchange Act)) are effective at the reasonable assurance level to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the three months ended September 29, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 
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PART II. OTHER INFORMATION

 

 

ITEM 1.

LEGAL PROCEEDINGS

 

In the Matter of Certain Flash Memory Chips and Products Containing the Same, Investigation No. 337-TA-893, filed on August 1, 2013 and instituted on September 9, 2013.

 

On August 1, 2013, Spansion LLC, a wholly owned subsidiary of the Company, filed a complaint pursuant to Section 337 of the Tariff Act of 1930, as amended, 19 U.S.C. § 1337 (“Section 337”), to request that the U.S. International Trade Commission (“ITC”) institute an investigation relating to the unlawful importation into the United States, the sale for importation, and/or the sale within the United States after importation of certain Macronix flash memory chips (“Macronix Chips”) that infringe the Company’s valid patents, and/or are made, produced or processed under, or by means of, a process covered by the claims of the Company’s patents, and products containing the Macronix Chips.

 

On September 9, 2013, ITC instituted its investigation. Other than the Company, the principal parties, or respondents in the investigation are Macronix International Co, Ltd., of Hsin-chu, Taiwan; Macronix America, Inc., of Milpitas, CA; Macronix Asia Limited of Kanagawa Pref., Japan; Macronix (Hong Kong) Co., Ltd., of Sa Tin, N.T., Hong Kong; Acer Inc. of New Taipei City, Taiwan; Acer America Corporation of San Jose, CA; ASUSTek Computer Inc. of Taipei, Taiwan; Asus Computer International of Fremont, CA; Belkin International, Inc., of Playa Vista, CA; D-Link Corporation of Taipei City, Taiwan; D-Link System, Inc., of Fountain Valley, CA; Netgear Inc., San Jose, CA; Nintendo Co., Ltd., of Kyoto, Japan; and Nintendo of America, Inc., of Redmond, WA.

 

Through this investigation, the Company seeks a general exclusion order to exclude from importation all infringing Macronix Chips and downstream products containing such chips. In the event that the ITC is unwilling to issue a general exclusion order, the Company seeks that a limited exclusion order be entered against each named Respondent and its subsidiaries and affiliates in order to remedy the Respondents’ violation of Section 337 and to prevent such future violations by Respondents. The Company has also asked the ITC to issue a cease and desist order to ensure compliance with the requested exclusion orders.

 

Spansion LLC v. Macronix International Co., Ltd. et. al., U.S. District Court, Northern District of California.

 

On August 1, 2013, Spansion LLC filed a complaint in the U.S. District Court, Northern District of California (San Jose Division), case no. 3:13-cv-03566-JST, against Macronix International Co., Ltd., Macronix America, Inc., Acer Inc., Acer America Corporation, ASUSTek Computer Inc., Asus Computer International (America), Belkin International, Inc., D-Link Systems, Inc., NETGEAR Inc., Nintendo Co., Ltd., and Nintendo of America, Inc. for patent infringement. Spansion has asked for monetary damages as well as permanent injunctive relief to prevent further infringing activity.

 

On August 29, 2013, the Company amended its original complaint to delete certain defendants, resulting in the eleven party defendants identified above (“Defendants”), and to make certain additional allegations.

 

On October 8, 2013, pursuant to 28 U.S.C. § 1659, each of the Defendants asserted its statutory right to a mandatory stay of all proceedings in the Northern District of California action until the determination of the ITC becomes final (see In the Matter of Certain Flash Memory Chips and Products Containing the Same,, Investigation No. 337-TA-893, U.S. International Trade Commission, above). Because the requested stay is mandated by statute, the Company does not oppose the motion.

 

 
43

 

 

Macronix International Co., LTD. v. Spansion Inc. et. al., U.S. District Court, Eastern District of Virginia.

 

On October 2, 2013, Macronix International Co., Ltd. filed a complaint in the U.S. District Court, Eastern District of Virginia, case no. 3:13-cv-679-REP, against Spansion Inc. and Spansion LLC for patent infringement. The Company has not filed an answer or otherwise responded to the complaint. The complaint seeks unspecified monetary damages as well as injunctive relief.

 

Besides the above, the Company is a defendant or plaintiff in various legal actions that arose in the normal course of business. In the opinion of management, the aggregate liability, if any, with respect to these matters will not have a material adverse effect on the Company’s financial condition, results of operations or cash flows.  

 

ITEM 1A.

RISK FACTORS

 

In addition to the cautionary information included in this report, you should carefully consider the factors discussed in “Part I, Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 30, 2012 filed with the SEC on February 25, 2013 and the additional factors in our Quarterly Report on Form 10-Q filed with the SEC on August 5, 2013, which could materially adversely affect our business, financial condition and/or results of operations. These risk factors do not identify all risks that we face—our operations could also be affected by factors that are not presently known to us or that we currently consider to be immaterial to our operations.

 

ITEM 6. EXHIBITS

 

Exhibit

Number

 

Description of Exhibits

10.1*

 

AM Product Foundry Agreement between Spansion LLC and Fujitsu Semiconductor Limited, dated as of August 1, 2013.

     

10.2*

 

AM Product Sort Services Agreement between Spansion LLC and Fujitsu Semiconductor Limited, dated as of August 1, 2013.

     

10.3*

 

AM Product Assembly and Test Services Agreement between Spansion LLC and Fujitsu Semiconductor Limited, dated as of August 1, 2013.

     

10.4*

 

AM Product Distribution Agreement between Spansion LLC and Fujitsu Semiconductor Limited, dated as of August 1, 2013.

     

10.5*

 

Transition Services Agreement between Spansion LLC and Fujitsu Semiconductor Limited, dated as of August 1, 2013.

     

10.6*

 

Intellectual Property Assignment between Spansion LLC and Fujitsu Semiconductor Limited, dated as of August 1, 2013.

     

10.7*

 

Intellectual Property License Agreement between Spansion LLC and Fujitsu Semiconductor Limited, dated as of August 1, 2013.

     

10.8

 

Indenture, dated August 26, 2013, between Spansion LLC, the Guarantors and Wells Fargo Bank, National Association, as trustee, including the form of 2.00% Senior Exchangeable Notes due 2020, filed as Exhibit 4.1 to Spansion's Current Report on Form 8-K dated August 26, 2013, is hereby incorporated by reference.

     

10.9

 

Letter Agreement, dated August 20, 2013, between Barclays Bank PLC, Spansion LLC and Spansion Inc., regarding the Capped Call Transaction, filed as Exhibit 10.1 to Spansion's Current Report on Form 8-K dated August 26, 2013, is hereby incorporated by reference.

 

 
44

 

 

10.10

Letter Agreement, dated August 20, 2013, between Citibank, N.A., Spansion LLC and Spansion Inc., regarding the Capped Call Transaction, filed as Exhibit 10.2 to Spansion's Current Report on Form 8-K dated August 26, 2013, is hereby incorporated by reference.

   

10.11

Letter Agreement, dated August 20, 2013, between Jefferies LLC, Spansion LLC and Spansion Inc., regarding the Capped Call Transaction, filed as Exhibit 10.3 to Spansion's Current Report on Form 8-K dated August 26, 2013, is hereby incorporated by reference.

   

10.12

Letter Agreement, dated August 20, 2013, between Wells Fargo Securities, LLC, Spansion LLC and Spansion Inc., regarding the Capped Call Transaction, filed as Exhibit 10.4 to Spansion's Current Report on Form 8-K dated August 26, 2013, is hereby incorporated by reference.

   

  31.1**

 

Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

   

  31.2**

 

Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

   

  32.1***

 

Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   

  32.2***

 

Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

   
   

  101.INS**

 

XBRL Instance Document

   

  101.SCH** 

 

XBRL Taxonomy Extension Schema Document

   

  101.CAL**

 

XBRL Taxonomy Extension Calculation Linkbase Document

   

  101.DEF**

 

XBRL Taxonomy Extension Definition Linkbase Document

     

  101.LAB**

 

XBRL Taxonomy Extension Label Linkbase Document

     

  101.PRE**

 

XBRL Taxonomy Extension Presentation Linkbase Document

 

_____________________________

 

*

 

Confidential treatment has been requested with respect to portions of this exhibit.

     

** 

 

Filed herewith.

   

*** 

 

Furnished herewith. Exhibits 32.1 and 32.2 are being furnished and shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liability of that section, nor shall such exhibits be deemed to be incorporated by reference in any registration statement or other document filed under the Securities Act of 1933, as amended, or the Exchange Act, except as otherwise specifically stated in such filing.  

 

 
45

 

 

SIGNATURE

 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

       

 

SPANSION INC.

   

          

 

Date: November 1, 2013

By:

   /s/Randy W. Furr

 

 

 

Randy W. Furr

 

 

 

Corporate Executive Vice President

and Chief Financial Officer

 

 

 

46