January 28, 2008

Research Analyst: Payal Jalan, M. Fin.

Sr. Editor: Ian Madsen, imadsen @zacks.com:1-800-767-3771:x 9417

N. Canal Street, Suite 1101  Chicago, IL 60606

Spansion Inc. / (SPSN –NASDAQ) / $3.38

Note: This report contains substantially new material. Subsequent reports will have new or revised material highlighted.

Reason for Report:4Q07 & FY07 Earnings Update Prev. Ed.:December 5, 2007; Minor Changes in Estimates

Brokers’ Recommendations: Neutral: 57.1% (4 firms); Positive: 42.9% (3); Negative: 0.0% (0) Prev. Ed.: 5; 3; 0

Brokers’ Target Price: $7.67(↓$4.33 from last edition; 3 firms) Brokers’ Avg. Expected Return: 126.9%

Recent Events

On January 22, 2008, SPSN released its financial results for 4Q07. As reported, total revenue increased 7% q/q to $652.8 million. Net loss in the quarter was $0.37 per share versus loss of $0.53 in 3Q07.

On December 20, 2007, Saifun Semiconductors Ltd. announced that its shareholders approved the acquisition of the company by SPSN.

Overview

Analysts have identified the following factors for evaluating the investment merits of SPSN:

Key Positive Arguments / Key Negative Arguments
Share Gains: Improved MirrorBit penetration and easing competition in the marketplace are helping SPSN gain shares.
Strong Leadership: The opportunity presented by ORNAND (a new memory technology), combined with the barrier to entry created by the Company’s 300mm commitment, strengthens the existing leadership position of Spansion in the NOR market.
Advanced Technology in Code Storage: SPSN is a technology leader with its innovative MirrorBit and ORNAND technologies. / Volatility in the NOR Market: Spansion is a supplier of commodity NOR flash memory, and is subject to seasonal and cyclical ups and downs of the NOR spot/contract market.
Excessive Dependence: With revenues split between wireless sales and embedded flash sales, the Company’s performance is dependent upon the mobile handset and consumer electronic end markets. A downturn in these markets or a widespread adoption of other technologies, such as embedded NAND flash, could erode profitability.

California-based Spansion, Inc. (SPSN or the Company) engages in the design, development, and manufacture of flash memory products and systems in the United States, Japan, Malaysia, Thailand, and the People’s Republic of China. Its wireless product family primarily includes the PL family, used for a range of mobile phones; the WS family, used for mobile phones with capabilities; the GL family, which enables code and data applications in mobile phones; and the MS family products for data applications in higher-end mobile phones. The Company’s embedded products include the AL and GL product families that address consumer, networking, and telecommunication applications; the CD product family of automotive engine and transmission control applications; and the FL product family that addresses personal computers and peripheral applications, and consumer applications. More information about SPSN can be found at its website

Note:SPSN’sfiscal references coincide with the calendar year.

January 28, 2008

Revenue

Provided below is a summary of revenues as compiled by Zacks Research Digest:

Total Revenue
($ in million) / 4Q06A / 2006A / 3Q07A / 4Q07A / 2007A / 1Q08E / 2Q08E / 2008E / 2009E
Digest High / $687.3 / $2,579.3 / $611.1 / $653.0 / $2,501.0 / $620.0 / $641.9 / $2,670.9 / $3,058.3
Digest Low / $687.0 / $2,579.0 / $611.0 / $652.8 / $2,500.7 / $594.0 / $584.0 / $2,500.0 / $2,720.2
Digest Average / $687.3 / $2,579.3 / $611.0 / $652.8 / $2,500.8 / $607.9↓ / $626.4↓ / $2,606.7↓ / $2,849.9↑
YoY Growth / 28.8% / -9.4% / -5.0% / -3.0% / -3.2% / 2.8% / 4.2% / 9.3%
QoQ Growth / 1.9% / 0.3% / 6.8% / -6.9% / 3.0%
Zacks Consensus / $610.0 / $625.0 / $2,637.0 / $3,058.0

According to the Digest average model, total revenue in 4Q07 was $652.8 million, falling in the Company guidance range of $640 million to $700.0 million but below the consensus estimate of $660.1 million. Results were down 5.0% y/y but up 6.8% sequentially. Pricing environment was strong in the quarter and book-to-bill ratio was at 1.3, the highest in two years.

The Company outperformed the overall NOR industry in FY07 with revenue declining by just 3.0% y/y to $2,500.8 million. Company’s NOR industry segment share increased to 33% from 31% in FY06.

SPSN’s Wireless Solutions Division (WSD) reported net sales of $322.0 million in 4Q07, up slightly from $317.0 million 3Q07. Worldwide unit shipments were up in the quarter and blended ASPs were flat sequentially. The book-to-bill ratio for WSD was particularly strong due to gains at the top 5 handset OEMs. Consumer, Set Top Box and Industrial Division (CSID) achieved record net sales of $324.0 million for 4Q07 versus $294.0 million in 3Q07, reflecting continued segment share gains. Growth wasattributable to strong sales of the Company's high density MirrorBit(R) solutions across multiple geographical regions. Blended ASPs for CSID in 4Q07 rose 9% sequentially and unit shipments reached a record, up 3% sequentially. Newly established Media Systems Division (MSD) revenue was at $7.0 million in 4Q07.

Outlook

For 1Q08, SPSN expects total revenue to be in therange of $580.0 million and $640.0 million, consistent with seasonaltrends. CSID net revenue is expected to decline sequentially and WSD net revenue is expected to increase sequentially driven by gains at top tierhandset customers. For FY08, SPSN expects y/y improvement in total revenue and believes financial performance will improve versus 2007.

One brokerage firm (Cowen) believes the Company’s revenue guidance, especially for WSD might prove to be too optimistic in the light of macroeconomic concerns.

Please refer to the Consensus tab of the SPSN spreadsheet for revenue estimates.

Margins

Provided below is a summary of margins as compiled by Zacks Research Digest:

Margins / 4Q06A / 2006A / 3Q07A / 4Q07A / 2007A / 1Q08E / 2Q08E / 2008E / 2009E
Gross / 18.8% / 20.0% / 18.1% / 19.8% / 17.5% / 15.6%↓ / 18.8%↓ / 20.5%↓ / 26.5%↓
Operating / -2.5% / -3.5% / -9.6% / -7.0% / -9.5% / -11.4%↓ / -7.6%↓ / -5.1%↓ / 1.1%↓
Pre-Tax / -4.3% / -5.7% / -12.3% / -8.5% / -11.4% / -14.8%↓ / -10.9%↓ / -8.4%↓ / -2.0%↓
Net / -3.7% / -5.6% / -11.6% / -7.5% / -10.4% / -14.9%↓ / -10.8%↓ / -8.4%↓ / -2.1%

According to the Digest average model, gross profit margin was 19.8% in 4Q07, representing an increase of 100 basis points (bps) y/y and 170 bps q/q. Results were driven primarily by lower manufacturing costs in the quarter. Gross profit was at $129.4 million in 4Q07 and $437.4 million in FY07.

SG&A representing 9.5% of 4Q07 total revenue decreased 3.2% y/y and increased 7.0% q/q to $62.1 million. R&D expense at $112.7 million in 4Q07 increased 36.5% and 1.5% y/y and q/q, respectively,andrepresented 17.3% of total revenue.

Operating margin in 4Q07 stood at a negative 7.0% versus negative margins of 2.5% and 9.6% in 4Q06 and 3Q07, respectively. Operating loss in 4Q07 stood at $45.4 million and $237.5 million in FY07. Interest income was$10.3 million in the quarter with pre-tax loss at $55.7 million.

Outlook

For 1Q08, SPSN expects gross margin to decline due primarily to non-cash charges of $25.0 million related to the full conversion of its SP1 facility to production. R&D expensesare expected to be approximately $105.0 million as SP1 costs are moved to cost to goods sold and SG&A to be approximately flat on a dollar basis. Net interest expense is expected to be approximately $20 million to $23 million in Q1. Taxes are anticipated to be approximately $3 million to $5 million expense.

Management anticipates further improvements in product mix over the next two quarters, being partially offset by additional costs of the ramp of SP1 in Japan. By 4Q08, 90nm production is believed to be fully internal, saving approximately $50 million in costs.

One brokerage firm (J.P. Morgan) expects gross margin in 1Q08 to decline to 14.0% based on lower revenue and higher factory start-up costs.

Driven by expectation of increase in fixed costs from new fab ramp, one brokerage firm (MorganStanley) believes that gross margin will reach its bottom in 1Q08. Similarly, another firm (Citigroup) expects gross margin to fall to 15.8% in 1Q08 and thereafter improve into the mid-20s with production ramps at the SP1 facility.

As per Zacks Digest, COGS is expected to increase by 0.7%, 3.3% and 5.8% y/y in FY08, FY09, and FY10, respectively, as against total revenue increase of 4.2%, 9.3%, and 10.8% y/y in FY08, FY09 and FY10, respectively. SG&A is expected to increase by 1.5% in FY08 and 0.7% in FY09 but to decline by 2.8% in FY10. R&D is expected to decline 3.5% in FY08 and 1.3% in FY10 while is expected to increase by 1.6% in FY09.

Please refer to the Consensus tab of the SPSN spreadsheet for margin estimates.

Earnings per Share

Provided below is a summary of EPS as compiled by Zacks Research Digest:

Proforma EPS / 4Q06A / 2006A / 3Q07A / 4Q07A / 2007A / 1Q08E / 2Q08E / 2008E / 2009E
Digest High / ($0.19) / ($1.14) / ($0.53) / ($0.37) / ($1.95) / ($0.54) / ($0.32) / ($0.99) / $0.37
Digest Low / ($0.19) / ($1.15) / ($0.53) / ($0.37) / ($1.96) / ($0.93) / ($0.82) / ($2.87) / ($1.69)
Digest Average / ($0.19) / ($1.15) / ($0.53) / ($0.37) / ($1.95) / ($0.67)↓ / ($0.50) ↓ / ($1.63)↓ / ($0.38)↓
YoY Growth / 72.3% / -211.8% / -94.7% / -69.9% / -20.4% / -0.9% / 16.3% / 76.5%
QoQ Growth / -11.8% / -6.0% / 30.2% / -82.2% / 25.2%
Zacks Consensus / ($0.72) / ($0.58) / ($1.36) / ($0.19)

According to the Digest average model, pro forma EPS in 4Q07 was a negative $0.37, down 94.7% y/y and up 30.2% q/q. Results were above the Street consensus of a negative EPS of $0.54 per share primarily due to lower costs and taxes.

Outlook

Management has not provided any EPS target for 1Q08.The Digest model projects EPS of ($1.63) for 2008, ($0.38) for 2009, and $0.70 for 2010, representing a y/y increase of 16.3% in 2008, 76.5% in 2009, and 282.6% in 2010.

Highlights from the EPSestimates are as follows:

  • 2008 forecasts (7 analysts) range from ($2.87) (MorganStanley) to ($0.99) (Cowen); the average is ($1.63).
  • 2009 forecasts (3 analysts) range from ($1.69) (J.P. Morgan) to $0.37 (Deutsche Bank); the average is ($0.38).
  • 2010 forecasts provided by one analyst (Citigroup) is $0.70.

Following 4Q07 earnings release, most of the analysts covering the stock have decreased their EPS estimatesfor FY08 primarily due to FY07 results and lackluster management guidance.

Please refer to the EPS tab of the SPSN spreadsheet for further details.

Target Price/Valuation

Of the 7brokerage firms covering the stock, 3 gave positive ratings and 4 gave neutral ratings. None of the firms provided a negative rating. The average Zacks Digest price target is $7.67 (↓ $4.33 from the previous Digest report; 126.9% upside from the current price). The price targets range from $7.00 (107.1% upside from the current price) (Citigroup and Deutsche Bank) to $9.00 (166.3% upside from the current price) (FTN Midwest Res.).The firm (Deutsche Bank) quoting the lowest target price rated the stock Buy and used 4.0x forward EV/EBITDA valuation method to derive its target price. Thefirmquoting the highest price target has rated the stock Buy and used EV/S and EV/EBITDA method for calculating its price target.

Following 4Q07 earnings release,three firms reduced their price targetestimates.

Provided below is a summary of valuation and ratings as compiled by Zacks Research Digest:

Rating Distribution
Positive / 42.9%
Neutral / 57.1%
Negative / 0.0%
Digest High / $9.00
Digest Low / $7.00
Avg. Target Price / $7.67↓
No of Analysts with Target Price /Total / 3/7

Risks to target price include: a)excess dependence on the handset end market, b) decreasing trend in ASPs, c) NOR flash market following cyclical/seasonal trends, d) changes in investors’ sentiment, e) product obsolescence, f) rapidly changing competitive pressures, g) continuing development of industry standards, and i) macroeconomic risks.

Metrics detailing current management effectiveness are as follows:

Metrics (ttm) / Company / Industry / S&P 500
Return on Assets (ROA) / -7.2% / 12.8% / 8.7%
Return on Investment (ROI) / -9.1% / 15.3% / 12.7%
Return on Equity (ROE) / -15.2% / 17.7% / 21.3%

ROA, ROI, and ROEof the Company are all lower than the overall market averages (as measures by S&P 500) of 8.7%, 12.7%, and 21.3%, respectively.

Please refer to the Valuation tab of the SPSN spreadsheet for further details.

Capital Structure/Solvency/Cash Flow/Governance/Other

Balance Sheet

Exiting 4Q07, SPSN had cash, cash equivalent and marketable securities of approximately $415.7 million. Accounts receivables were approximately $380.0 million, with DSO flat at 53 days. Days payable increased to 90 days from 85 days. Inventories stood at roughly $583.9 million with days of inventory at 102 days from 97 days. Company’s long-term debt and capital lease obligations stood at $1,299.5 million.

Cash Flow

Cash flow from operations in FY07 was approximately $195.0 million. Capital expenditure for the full year was approximately $1.1 billion, of which 70% was for 300 millimeter production on 65 and 45 nanometer.

Management expects capital expenditure for FY08 to be approximately half of the amount spend in FY07. The Company expects this expenditure to be highly front-end loaded with approximately 80% delivered in 1H08 primarily to increase SP1 capacity to 2,000 wafers a week as soon as possible. SPSN expects to finance capital expenditure with increased cash flow from operations, existing credit lines, and strategic leasing opportunities.

Foundry Agreement

On October 23, 2007, SPSN announced thatit intensified its focus in the China market by partnering with foundry leader, Semiconductor Manufacturing International Corporation ("SMIC"). SPSN will transfer its 65nm MirrorBit(R) technology to SMIC for foundry services on 300mm wafers in China. SMIC and SPSN also signed a preliminary memorandum of understanding, which would allow SMIC to enter selected segments of the Flash memory market with a license to manufacture and sell 90nm and 65nm and potentially future SPSN MirrorBit(R) Quad products for the China content delivery market. Through the foundry agreement with SMIC, SPSN will have wafer manufacturing capabilities in China.

Acquisitions & Mergers

On December 20, 2007, Saifun Semiconductors Ltd. (SFUN) received shareholders approval of the acquisition of the company by Spansion and all other transactions contemplated under the October 7, 2007, merger agreement (which was amended on December 12, 2007), including the cash distribution. The merger remains subject to satisfaction of customary closing conditions that include Israeli court approval and other regulatory approvals and is expected to close in the first quarter of 2008.

The acquisition will help SPSN to consolidate all MirrorBit IP, design and manufacturing expertise into a single company. The combination will enable SPSN to expand operating margins, diversify its product portfolio and drive the Company’s entry into new markets.

Upon closing, Saifun will operate as a wholly owned subsidiary, and will be responsible for driving the new IP licensing and royalty business for SPSN. Under the terms of the agreement, each Saifun shareholder will receive 0.7429 shares of SPSN common stock, and approximately $6.05 per share in cash for each share of Saifun common stock. The cash distribution will be funded solely from Saifun's existing cash on hand concurrently or before the closing of the transaction.

January 28, 2008

Potentially Severe Problems

There are none other than those discussed in other sections of this report.

January 28, 2008

Long-Term Growth

The long-term growth rate for the Company is 15.0% (FTN Midwest Res.).The Company's long-term financial model is supported by the acceleration of the Company's 300mm strategy, which is expected to result in lower cost per bit. Most analysts’ long-term outlooks depend on how successfully the Company can make the transition; over the near term, research surveys reveal that added costs can be more than offset by continued positive fundamentals in the NOR market. The MirrorBit Eclipse architecture that combines MirrorBit NOR, ORNAND, and Quad Flash memory on a single die can enable handset OEMs to save up to 30% or more on their handset memory subsystems bill of materials costs, while experiencing more flexibility in their designs.

Spansion announced it has started production of MirrorBit technology at 65nm on 300mm wafers at its Spansion 1 (SP1) facility in Japan. The Company also announced its MirrorBit NOR Flash memory was pre-qualified on MediaTek’s reference design platforms for mainstream handsets in China.

January 28, 2008

Upcoming Events

April 16, 2008: SPSN is expected to release 1Q08 earnings results.

Individual Analyst Opinions

POSITIVE RATINGS (42.9%)

Citigroup – Buy (Target Price – $7.00) – (1/23/08): The brokerage firm maintained a Buy rating and lowered the target price to $7.00 from $13.00 per share based on lower estimates.

Deutsche Bank– Buy (Target Price – $7.00) – (1/22/08):The brokerage firm maintained a Buy rating,but decreased the target price to $7.00 from $11.00.

FTN Midwest Res. –Buy (Target Price – $9.00) – (1/23/08):The brokerage firm maintained a Buy rating, but lowered the target price to $9.00 from $12.00per share. INVESTMENT SUMMARY: The firmexpects improvements in product mix in the coming two quarters partially offset by SP1 ramp. The firm continues to recommend the stock to patient investors and expects customer diversification and design wins to be important catalysts for the stock going forward.

NEUTRAL RATINGS (57.1%)

Lazard– Hold – (1/23/08): The brokerage firm maintained a Hold rating. INVESTMENT SUMMARY: The firm contends investors should stay on the sidelines due to the following factors: (1) continued improvement in NOR pricing, (2) SP1 results in gross margin expansion, (3) a positive impact from Intel-STMicro joint venture merger, and (4) better market for memory stocks.

Cowen– Neutral – (1/23/08): The brokerage firm maintained a Neutral rating. INVESTMENT SUMMARY: The firm contends investors should remain on the sidelines untila reduction in inventory levels, gross margin expansion, continued improvement in cost efficiencies, and the ramp into production of 65nm MirrorBit at SP-1.

J.P. Morgan– Neutral – (1/23/08):The brokerage firm maintained a Neutral rating. INVESTMENT SUMMARY: The firm prefers to be cautious due tothe lack of margin expansion, high capital requirements, and overhang from the Fujitsu/AMD ownership stake.

MorganStanley–Equal Weight – (1/22/08): The brokerage firm maintained an Equal Weight rating.

NEGATIVE RATING (0.0%)

None

Research Associate: Payal Jalan

Copy Editor:Sudipta Mukherjee

Content Ed.: Shalu Saraf

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