Spansion Inc. (Form: 10-Q, Received: 11/07/2008 14:42:15)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended September 28, 2008

¨	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 000-51666

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		94088
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (408) 962-2500

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 x 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 x	Accelerated filer ¨	Non-accelerated filer ¨	Smaller reporting company ¨
		(Do not check if 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 x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the close of business on November 5, 2008:


Class		Number of Shares
Class A Common Stock, $0.001 par value		161,069,430

Table of Contents

INDEX


			Page No.

Part I.	Financial Information		3

	Item 1.	Financial Statements (unaudited)	3

		Condensed Consolidated Statements of Operations – Three and Nine Months Ended September 28, 2008 and September 30, 2007	3

		Condensed Consolidated Balance Sheets – September 28, 2008 and December 30, 2007	4

		Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 28, 2008 and September 30, 2007	5

		Notes to Condensed Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42

	Item 4.	Controls and Procedures	43

Part II.	Other Information		44

	Item 1.	Legal Proceedings	44

	Item 1A.	Risk Factors	48

	Item 6.	Exhibits	74

Signature			75

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
	Sep. 28 2008			Sep. 30 2007			Sep. 28 2008			Sep. 30 2007
Net sales	$	474,170		$	408,605		$	1,300,621		$	1,197,270
Net sales to related parties		156,690			202,464			513,231			650,742

Total net sales		630,860			611,069			1,813,852			1,848,012

Expenses:
Cost of sales (Note 7)		544,273			499,758			1,523,654			1,538,761
Research and development (Note 7)		106,845			111,248			335,469			324,139
Sales, general and administrative (Note 7)		64,094			59,192			197,122			179,379
In-process research and development (Note 3)		—			—			10,800			—
Restructuring charges (Note 13)		1,377			—			11,299			—

Operating loss		(85,729	)		(59,129	)		(264,492	)		(194,267	)
Other income (expense):
Other than temporary impairment on marketable securities		(14,518	)		—			(14,518	)		—
Loss on early extinguishment of debt		—			—			—			(3,435	)
Interest and other income (expense), net		1,432			6,835			7,347			30,873
Interest expense		(24,853	)		(23,628	)		(73,507	)		(65,316	)

Other income (expense), net		(37,939	)		(16,793	)		(80,678	)		(37,878	)

Loss before income taxes		(123,668	)		(75,922	)		(345,170	)		(232,145	)
Income tax (provision) benefit		(9,583	)		4,320			(7,195	)		18,163

Net loss	$	(133,251	)	$	(71,602	)	$	(352,365	)	$	(213,982	)

Net loss per common share:
Basic and diluted	$	(0.83	)	$	(0.53	)	$	(2.30	)	$	(1.59	)

Shares used in per share calculation:
Basic and diluted		160,687			135,049			153,216			134,805

See accompanying notes

Spansion Inc.

Condensed Consolidated Balance Sheets

(in thousands)


	Sep. 28 2008		Dec. 30 2007 ^(*)
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	152,107	$	199,092
Marketable securities		107,382		216,650
Trade accounts receivable, net		249,363		181,443
Trade accounts receivable from related parties, net ( Note 7 )		127,796		186,646
Other receivables		8,881		—
Other receivables from related parties (Note 7)		7,024		11,873
Inventories:
Raw materials		24,271		31,877
Work-in-process		485,289		421,765
Finished goods		105,157		130,227

Total inventories		614,717		583,869
Deferred income taxes		13,976		26,607
Prepaid expenses and other current assets		48,903		46,452

Total current assets		1,330,149		1,452,632
Property, plant and equipment, net		2,308,480		2,271,964
Deferred income taxes		43,240		29,957
Acquisition related intangible assets, net (Note 3)		57,761		—
Goodwill (Note 3)		18,506		—
Other assets		81,771		61,092

Total assets	$	3,839,907	$	3,815,645

Liabilities and Stockholders’ Equity
Current liabilities:
Notes payable to banks under revolving loans	$	130,411	$	—
Accounts payable		545,374		489,163
Accounts payable to related parties ( Note 7 )		46,046		56,929
Accrued compensation and benefits		76,960		60,778
Accrued liabilities to related parties ( Note 7 )		5,617		9,666
Other accrued liabilities		88,001		88,006
Income taxes payable		608		13,818
Deferred income on shipments		52,826		39,957
Current portion of long-term debt		104,191		68,705
Current portion of long-term obligations under capital leases		42,640		33,092

Total current liabilities		1,092,674		860,114
Deferred income taxes		4,260		186
Long-term debt, less current portion		1,233,477		1,258,616
Long-term obligations under capital leases, less current portion		44,769		40,920
Other long-term liabilities		22,429		23,361
Commitments and contingencies
Stockholders’ equity		1,442,298		1,632,448

Total liabilities and stockholders’ equity	$	3,839,907	$	3,815,645

*	Derived from audited financial statements at December 30, 2007.

See accompanying notes

Spansion Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)


	Nine Months Ended
	Sep. 28 2008			Sep. 30 2007
Cash Flows from Operating Activities:
Net loss	$	(352,365	)	$	(213,982	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization		468,440			387,709
Write-off of in-process research and development		10,800			—
Loss on pension curtailment		—			2,010
Loss on early extinguishment of debt		—			3,435
Provision for doubtful accounts		525			1,693
Benefit for deferred income taxes		(792	)		(43,537	)
Net gain on sale and disposal of property, plant and equipment, net		(19,910	)		(21,946	)
Other than temporary impairment on marketable securities		14,518			—
Gain on sale of marketable securities		(621	)		—
Compensation recognized under employee stock plans		15,493			12,084
Amortization of premium on floating rate notes and discount on senior subordinated and senior notes, net		1,693			1,745
Changes in operating assets and liabilities:
Decrease in trade account receivables from related parties		55,874			26,796
Increase in other receivables from related parties		(1,639	)		(6,177	)
(Increase) decrease in trade account receivables and other receivables		(55,467	)		27,700
Increase in inventories		(30,848	)		(76,558	)
Decrease (increase) in prepaid expenses and other current assets		1,121			(28,019	)
Decrease in other assets		(3,735	)		(1,361	)
(Decrease) increase in accounts payable and accrued liabilities to related parties		(113,085	)		34,938
Increase in accounts payable and accrued liabilities		163,330			75,981
Increase (decrease) in accrued compensation and benefits		16,182			(965	)
(Decrease) increase in income taxes payable		(13,210	)		18,984
Increase in deferred income on shipments		12,752			1,365

Net cash provided by operating activities		169,055			201,895

Cash Flows from Investing Activities:
Proceeds from sale of property, plant and equipment		6,333			188,525
Purchases of property, plant and equipment		(396,697	)		(964,666	)
Proceeds from maturity and sale of marketable securities		133,695			679,900
Purchases of marketable securities		(36,950	)		(822,075	)
Loan made to an investee		(4,125	)		—
Cash proceeds from Saifun acquisition		733			—

Net cash used in investing activities		(297,011	)		(918,316	)

Cash Flows from Financing Activities:
Proceeds from borrowings, net of issuance costs		250,559			810,840
Payments on debt and capital lease obligations		(162,278	)		(580,004	)
Proceeds from issuance of common stock, net of offering costs		—			60

Net cash provided by financing activities		88,281			230,896

Effect of exchange rate changes on cash and cash equivalents		(7,310	)		(13,323	)

Net (decrease) increase in cash and cash equivalents		(46,985	)		(498,848	)
Cash and cash equivalents at the beginning of period		199,092			759,794

Cash and cash equivalents at end of period	$	152,107		$	260,946

Non-cash investing and financing activities:
Equipment capital leases	$	50,474		$	—
Issuance of common stock and stock options to acquire Saifun		108,898			—

See accompanying notes

Spansion Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Description of Business

Spansion Inc. (the Company) is a semiconductor manufacturer headquartered in Sunnyvale, California, with research and development, manufacturing and assembly operations in the United States, Middle East, Europe and Asia. The Company designs, develops, manufactures, markets, licenses and sells Flash memory technology and solutions.

The Company’s Flash memory devices primarily address the integrated category of the Flash memory market and are incorporated into a broad range of electronic products, including mobile phones, consumer electronics, automotive electronics, networking and telecommunications equipment, data center servers, personal computers and PC peripheral applications. The Company licenses its Flash memory technology to semiconductor manufacturers who use this technology to develop and manufacture a variety of semiconductor solutions.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying condensed consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The condensed consolidated financial statements and notes thereto are unaudited. In the opinion of the Company’s management, these financial statements contain all adjustments (consisting of normal recurring adjustments) that are necessary for a fair presentation of the Company’s operating results, financial position and cash flows. Operating results for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent interim period or for the full fiscal year ending December 28, 2008.

The condensed consolidated financial statements include all the accounts of the Company and those of its wholly owned subsidiaries. All intercompany accounts and transactions have been eliminated.

The condensed consolidated financial statements do not include certain financial footnotes and disclosures required under U.S. generally accepted accounting principles for audited financial statements. Therefore, the unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and footnotes thereto for the year ended December 30, 2007 included in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission (the SEC) on February 28, 2008.

The Company uses a 52- to 53-week fiscal year ending on the last Sunday in December. The three months ended September 28, 2008 and September 30, 2007 both consisted of 13 weeks. The nine months ended September 28, 2008 and September 30, 2007 both consisted of 39 weeks.

Use of Estimates

The preparation of consolidated financial statements and disclosures in conformity with U.S. generally accepted accounting principles 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, the allowance for doubtful accounts, inventory valuation, valuation of acquired intangible assets, impairment of long-lived assets, income taxes, stock-based compensation expenses, product warranties and pension and postretirement benefits. Actual results may differ from those estimates, and such differences may be material to the financial statements.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Financial Statements Reclassifications

Certain prior period amounts in the condensed consolidated statements of operations and statements of cash flows have been reclassified to conform to the current period presentation. There is no material impact to the Company’s results from operations due to these reclassifications.

Inventories

Inventories are stated at standard cost adjusted to approximate the lower of actual cost (first-in, first-out method) or market. The Company records a provision for excess and obsolete inventory based on its estimated forecast of product demand. Demand for the Company’s products can fluctuate significantly from period to period. Historically, inventories in excess of forecasted customer demand over the next six months were not valued. However, beginning in the second quarter of fiscal 2008, as part of a strategy to efficiently manage its new production capacity and to maintain strategic inventory levels of certain products, the Company has built and valued certain inventory to meet estimated demand as much as twelve months into the future. Obsolete inventories are written off.

Goodwill

As a result of the Saifun acquisition, the Company recorded approximately $18.5 million of goodwill on its books . In accordance with FASB Statement No. 142 (Statement 142), Goodwill and Other Intangible Assets, the Company is required to review goodwill for impairment at least annually or more often if there are indicators of impairment present. The Company will perform its annual impairment analysis during the fourth quarter of each year, with the first impairment test related to Saifun goodwill to be performed during the fourth quarter of 2008.

Fair Value

The Company adopted FASB Statement No. 157 (Statement 157), Fair Value Measurements, effective January 1, 2008. Statement 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Statement 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date. Examples of the assets carried at Level 1 fair value generally are equities listed in active markets and investments in publicly traded mutual funds with quoted market prices.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the asset/liability’s anticipated life.

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

The availability of observable inputs can vary and is affected by a wide variety of factors, including, for example, the type of a security, whether the security is new and not yet established in the marketplace, and other characteristics particular to a transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. When observable prices are not available, the Company either uses implied pricing from similar instruments or valuation models based on net present value of estimated future cash flows, adjusted as appropriate for liquidity, credit, market and/or other risk factors. Fair value is a market-based measure considered from the perspective of a market participant rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, the Company’s own assumptions are set to reflect those it believes market participants would use in pricing the asset or liability at the measurement date. Please see Note 12 for fair value related to the Company’s marketable securities.

New Accounting Pronouncements

In February 2008, the FASB issued FASB Staff Position (FSP) FAS 157-2, “Effective Date of FASB Statement No. 157,” which provides a one year deferral of the effective date of Statement 157 for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. The Company has adopted the provisions of Statement 157 with respect to its financial assets and liabilities only.

In February 2007, the FASB issued Statement No. 159 (Statement 159), The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115 . Under Statement 159, a company may choose, at specified election dates, to measure eligible financial instrument and certain other items at fair value that are not otherwise required to be so measured. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. Statement 159 is effective as of the beginning of the fiscal year beginning after November 15, 2007. Upon initial adoption, this statement provides entities with a one-time chance to elect the fair value option for the eligible items. The effect of the first measurement to fair value should be reported as a cumulative-effect adjustment to the opening balance of retained earnings in the year the statement is adopted. The Company adopted Statement 159 at the beginning of its fiscal year 2008 on December 31, 2007 and did not make any elections for fair value accounting. Therefore, the Company did not record a cumulative-effect adjustment to its opening retained earnings balance.

In March 2008, the FASB issued Statement No. 161 (Statement 161), Disclosures about Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133 (Statement 133). Statement 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

entity’s financial position, financial performance and cash flows. The guidance in Statement 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This Statement encourages, but does not require, comparative disclosures for earlier periods at initial adoption. The Company is currently evaluating the impact on its derivatives disclosures upon adopting Statement 161.

In May 2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” The FSP will require convertible debt which may be settled in cash upon conversion including partial cash conversion to be separated into debt and equity components at issuance with a value to be assigned to each. The value assigned to the debt component will be the estimated fair value, as of the issuance date, of a similar bond without the conversion feature. The difference between the bond cash proceeds and this estimated fair value will be recorded as a debt discount and amortized to interest expense over the life of the bond. Although FSB APB 14-1 will have no impact on the Company’s actual past or future cash flows, it will require the Company to record additional non-cash interest expense as the debt discount is amortized which will increase expenses and adversely impact earnings per share. FSP APB 14-1 will become effective January 1, 2009 and will require retrospective application. In June 2006, the Company, issued $207.0 million of aggregate principal amount of 2.25% Exchangeable Senior Subordinated Debentures due 2016 (Exchangeable Debt). The Company’s accounting for the Exchangeable Debt will be impacted by the FSP as the related indenture provides the Company with the option to settle some or all of the instrument in cash. The Company is currently evaluating the impact of adopting FSP APB 14-1 on its consolidated financial statements.

In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets.” This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142 (Statement 142), Goodwill and Other Intangible Assets . The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (Revised 2007), Business Combinations , and other U.S. GAAP. This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. Early adoption is prohibited. The Company is currently evaluating the impact that this FSP will have on its operations, financial position and cash flows.

In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset in a Market That Is Not Active” which clarifies the application of Statement 157 when the market for a financial asset is inactive. Specifically, FSP FAS 157-3 clarifies how (1) management’s internal assumptions should be considered in measuring fair value when observable data are not present, (2) observable market information from an inactive market should be taken into account, and (3) the use of broker quotes or pricing services should be considered in assessing the relevance of observable and unobservable data to measure fair value. The guidance in FSP FAS 157-3 is effective immediately and the Company has adopted its provisions with respect to its financial assets as of September 28, 2008.

3. Acquisition of Saifun Semiconductors Ltd. (Saifun)

On March 18, 2008, the Company completed the acquisition of all of the outstanding shares of Saifun Semiconductor Ltd., a publicly held company headquartered in Netanya, Israel (the Acquisition). The Company has included the results of operations of Saifun beginning March 18, 2008 in its condensed consolidated statements of operations for the nine months ended September 28, 2008.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Saifun is a provider of intellectual property (IP) solutions for the non-volatile memory (NVM) market and licenses its IP to semiconductor manufacturers that use this technology to develop and manufacture a variety of non-volatile Flash memory based products including products that integrate Flash memory with logic as well as dedicated standalone Flash memory device. The Company believes that the acquisition of Saifun expands its product portfolio and enables its entry into the technology licensing business.

The aggregate consideration paid by the Company for all outstanding Saifun common shares consisted of approximately 22.7 million shares of the Company’s Class A common stock. In addition, the Company also assumed all of the outstanding Saifun stock options which were converted into options to purchase approximately 4.3 million shares of the Company’s Class A common stock. The total purchase price for Saifun was $117.0 million and is comprised of:


	In millions
22.7 million shares of Class A common stock	$	98.4
Fair value of vested options issued		10.5
Acquisition related transaction costs		8.1

Total purchase price	$	117.0

The fair value of the Company’s common stock issued was determined in accordance with Emerging Issues Task Force (EITF) Issue No. 99-12, “Determination of the Measurement Date for the Market Price of Acquirer Securities Issued in a Purchase Business Combination” which reflected the average of the closing prices of the Company’s common stock on the NASDAQ for the two trading days prior to and following December 13, 2007, the date that the number of issuable shares became fixed. The fair value of the Company’s options and restricted stock units was determined under FASB Statement No. 123R (Statement 123R), Accounting for Stock-Based Compensation . The vested portion of these options and restricted stock units was valued at approximately $10.5 million. The unvested portion was valued at approximately $6.3 million and will be amortized ratably over the future remaining service periods.

In accordance with EITF Issue No. 04-1, “Accounting for Pre-existing Relationships between the Parties to a Business Combination,” the Company reviewed its existing contracts with Saifun as of the date of the acquisition to determine if such contracts included terms that were favorable or unfavorable when compared to pricing for current market transactions for the same or similar terms which will result in a settlement gain or loss as of this date. A settlement gain or loss is measured as the lesser of (a) the amount by which the agreements were favorable or unfavorable to market terms or (b) the stated settlement provisions of the agreements available to the Company. The Company concluded that the terms in the pre-existing relationship were neither favorable nor unfavorable and, accordingly, the Company recognized no gain or loss relating to its existing contracts with Saifun as of the acquisition date.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Preliminary Purchase Price Allocation

The total purchase price was preliminarily allocated to Saifun’s tangible and identifiable intangible assets and liabilities based on their estimated fair values as of March 18, 2008, as set forth below:


	In millions
Net tangible assets acquired	$	24.2
Existing technology		42.8
In process research and development		10.8
Non-competition agreement		1.3
Customer relationships		18.0
Trade name		1.4
Goodwill		18.5

Total purchase price	$	117.0

As of September 28, 2008, the primary areas of purchase price allocation that have not been finalized relate to deferred taxes and the final quantification of direct acquisition costs which are expected to be finalized within fiscal 2008 and which may result in an adjustment in goodwill.

Management performed an analysis to determine the fair value of each tangible and identifiable intangible asset, including the portion of the purchase price attributable to acquired in-process research and development projects.

In-Process Research and Development

Of the total purchase price, approximately $10.8 million was allocated to in-process research and development (IPR&D) and was expensed in the first quarter of fiscal 2008. Projects that qualify as IPR&D represent those that have not reached technological feasibility and have no alternative future use at the time of the acquisition. These projects included development of top injection technology and Nitride-Read-Only-Memory (NROM) design projects.

The value assigned to IPR&D was determined using a discounted cash flow methodology, specifically an excess earnings approach, which estimates value based upon the discounted value of future cash flows expected to be generated by the in-process projects, net of all contributory asset returns. The approach includes consideration of the importance of each project to the overall development plan, estimating costs to develop the purchased IPR&D into commercially viable products.

The discount rates applied to individual projects were selected after consideration of the overall estimated weighted average cost of capital and the discount rates applied to the valuation of the other assets acquired. Such weighted average cost of capital was adjusted to reflect the difficulties and uncertainties in completing each project and thereby achieving technological feasibility, the percentage of completion of each project, anticipated market acceptance and penetration, market growth rates and risks related to the impact of potential changes in future target markets. In developing the estimated fair values, the Company used a discount rate of 20.8 percent.

Other Acquisition Related Intangible Assets

Existing technology represents Saifun’s core technology, Nitride-Read-Only-Memory (NROM) intellectual property. NROM technology doubles the storage of a Flash memory cell by creating two distinct and independent charges in a single cell. This technology asset was estimated to have a useful life of six years.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Customer relationships represent Saifun’s existing contractual relationships as of March 18, 2008, which were estimated to have an average useful life of seven years.

Trade names were estimated to have an average useful life of four years.

Non-competition agreements represent agreements with four key employees and were estimated to have a useful life of two years.

The Company determined the fair value of the above intangible assets using income approaches and based the rates on the most current financial forecast available as of March 18, 2008. The discount rates used to discount net cash flows to their present values was 17.8 percent. The Company determined these discount rates after consideration of the Company’s estimated weighted average cost of capital. The Company recorded the excess of the purchase price over the net tangible and identifiable intangible assets as goodwill.

The estimated useful lives for the acquired intangible assets were based upon Saifun’s historical experience with technology life cycles, product roadmaps and Spansion’s intended future use of the intangible assets. The Company amortizes acquisition related intangible assets using the straight-line method over their estimated useful lives.

The balances of acquisition related intangible assets as of September 28, 2008 were as follows:


(In millions)	Gross Assets		Accumulated Amortization			Net Book Value		Weighted Average Amortization in Months
Existing technology	$	42.8	$	(3.8	)	$	39.0	72
Customer relationships		18.0		(1.4	)	$	16.6	84
Trademarks and trade names		1.4		(0.2	)	$	1.2	48
Non competition agreement		1.3		(0.3	)	$	1.0	24
Goodwill		18.5		—		$	18.5	—

TOTAL	$	82.0	$	(5.7	)	$	76.3

The amortization expenses for the three and nine months ended September 28, 2008 were as follows:


(In millions)	Three Months Ended Sept. 28, 2008		Nine Months Ended Sept. 28, 2008
Existing technology	$	1.8	$	3.8
Customer relationships		0.6		1.4
Trademarks and trade names		0.1		0.2
Non competition agreement		0.2		0.3

Total	$	2.7	$	5.7

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Estimated future amortization expense related to acquisition related intangible assets as of September 28, 2008 is as follows:


	In millions
Fiscal Year
2008 (3 months)	$	2.7
2009		10.7
2010		10.2
2011		10.1
2012		9.8
2013		9.7
Thereafter		4.6

Total	$	57.8

Pro Forma Information

The following unaudited pro forma consolidated financial information gives effect to the Saifun acquisition as if it had occurred at the beginning of the fiscal periods presented. The pro forma consolidated financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each of the periods presented nor is it indicative of future financial performance.


	Nine Months Ended
	Sep. 28, 2008			Sep. 30, 2007
	(in thousands, except per share amounts)
Total net sales	$	1,816,382		$	1,861,909
Net loss	$	(357,914	)	$	(224,448	)
Basic and diluted net loss per common share	$	(2.24	)	$	(1.43	)

4. Stock-Based Compensation

Saifun Semiconductors Ltd. Employee Share Option Plans (Saifun Option Plans)

The Company assumed all outstanding option shares under the Saifun 1997, 2001 and 2003 plans (Saifun Option Plans), which were converted into options to purchase shares of the Company’s Class A common stock. Each option share assumed continues to have, and be subject to, the same terms and conditions of such options immediately prior to the acquisition date.

When Saifun implemented the Saifun Semiconductors Ltd. 2003 Share Option Plan (Saifun 2003 Plan), all Saifun shares that were then available for grant under the earlier Saifun share option plans were acquired by the Saifun 2003 Plan. At that time, Saifun stopped granting awards under the prior plans, and granted all subsequent awards under the Saifun 2003 Plan. The Saifun 2003 Plan provides that awards may be granted to employees, contractors, directors, and consultants of Saifun and Saifun subsidiaries, although certain option awards that are governed by specific Israeli tax rules may be granted to eligible employees and directors only.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

For options granted under the Saifun Option Plans, the exercise period may not exceed 10 years from the date of grant. Options are granted with an exercise price equal to the market price of the stock at the date of grant or at a lower price as may be determined by the compensation committee of the board of directors at the date of grant. Prior to the Acquisition, option awards vested over a period of up to five years; restricted stock unit and option awards granted after the Acquisition will vest over a period of up to four years. Awards granted under any of the Saifun Option Plans from the inception of the Saifun 2003 Plan through the Acquisition that are forfeited or cancelled revert to the Saifun 2003 Plan reserve. Future awards granted under the Saifun 2003 Plan that are forfeited or cancelled will also revert to that plan’s reserve.

Shares Available to Grant

The numbers of shares of Class A common stock available for grant under the Spansion Inc. 2007 Equity Incentive Plan (the 2007 Plan) and the Saifun 2003 Plan are shown in the following table:


Number of shares available for grant:
Shares reserved for grant ⁽¹⁾	12,126,424
Shares available under the 2005 Plan ⁽²⁾	506,413
Stock options granted through September 28, 2008, net of cancelled stock options	(6,754,003	)
RSU awards granted through September 28, 2008, net of cancelled RSU awards	(2,010,496	)

Shares available for grant under the 2007 Plan and Saifun 2003 Plan	3,868,338

⁽¹⁾	The 12,126,424 shares reserved for grant consisted of 6,675,000 shares approved for grant under the 2007 Plan, 920,523 shares transferred from the 2005 Plan and 4,530,901 shares from Saifun Option Plans.

⁽²⁾	The shares available under the 2005 Plan were related to stock options or RSU awards which were cancelled subsequent to the adoption of the 2007 Plan and thus available for grant under the 2007 Plan.

Valuation and Expense Information

The following table sets forth the total recorded stock-based compensation expense for the Spansion Stock-Based Incentive Compensation Plans (Spansion Plans and Saifun Option Plans) by financial statement caption, resulting from the Company’s stock options and restricted stock unit (RSU) awards for the three and nine months ended September 28, 2008 and September 30, 2007:


	Three Months Ended				Nine Months Ended
	Sep. 28, 2008		Sep. 30, 2007		Sep. 28, 2008		Sep. 30, 2007
	(in thousands)
Cost of sales	$	1,350	$	1,387	$	3,854	$	3,442
Research and development		1,699		1,202		4,522		3,268
Sales, general and administrative		2,505		2,153		7,117		5,374

Stock-based compensation expense before income taxes		5,554		4,742		15,493		12,084

Income tax benefit ⁽¹⁾		—		—		—		—

Stock-based compensation expense after income taxes ⁽¹⁾	$	5,554	$	4,742	$	15,493	$	12,084

⁽¹⁾	There is no income tax benefit relating to stock option expenses because all of the Company’s U.S. deferred tax assets, net of U.S. deferred tax liabilities, continue to be subjected to a full valuation allowance.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

No stock options were granted in the three months ended September 28, 2008 under either the Spansion Plans or Saifun Option Plans. The weighted average fair value of the Company’s stock options granted in the three months ended September 30, 2007 under Spansion Plans was $3.68 per share. The weighted average fair value of the Company’s stock options granted in the nine months ended September 28, 2008 and September 30, 2007 under Spansion Plans and Saifun Option Plans was $1.89 and $4.80 per share, respectively. The fair value of each stock option was estimated at the date of grant using a Black-Scholes-Merton option pricing model, with the following assumptions for grants:


	Three Months Ended				Nine Months Ended
	Sep. 28, 2008		Sep. 30, 2007		Sep. 28, 2008		Sep. 30, 2007
Expected volatility	54.13	%	45.32	%	48.66	%	48.50	%
Risk-free interest rate	3.06	%	4.12	%	2.67	%	4.73	%
Expected term (in years)	4.61		4.61		5.05		4.61
Dividend yield	0	%	0	%	0	%	0	%

The Company’s dividend yield is zero because the Company has never paid dividends and does not have plans to do so over the expected life of the stock options. The expected volatility is based on the Company’s historical volatility since its initial public offering in December 2005 and the volatilities of the Company’s competitors who are in the same industry sector with similar characteristics (guideline companies) given the limited historical realized volatility data of the Company. The risk-free interest rate is based on the yield from U.S. Treasury zero-coupon bond with a remaining term equal to the expected stock option life. The expected term is based on the “simplified method” provided in Staff Accounting Bulletin Topic 14, Share-Based Payment , for developing the estimate of the expected life of a “plain vanilla” stock option except for options granted to Saifun on the date of acquisition for which expected term was based on historical option exercise activity. Under this approach, the expected term is presumed to be the mid-point between the average vesting date and the end of the contractual term. The Company estimated forfeitures based on its historical forfeiture rates. Statement 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates in order to derive the Company’s best estimate of awards ultimately expected to vest.

As of September 28, 2008, the total unrecognized compensation cost related to unvested stock options and RSU awards under Spansion Plans and Saifun Option Plans was approximately $43.9 million after reduction for estimated forfeitures, and such stock options and RSU awards will generally vest ratably through 2012.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Stock Option and Restricted Stock Unit Activity

The following table summarizes stock option activity and related information under Spansion Plans and Saifun Option Plans for the period presented:


	Number of Shares		Weighted- Average Exercise Price		Weighted- Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value (in thousands)
Options:
Outstanding as of December 31, 2006	2,134,906		$	12.63	6.08	$	4,761
Granted	1,770,062		$	10.39
Cancelled	(363,000	)	$	12.45
Exercised	(5,000	)	$	12.00

Outstanding as of December 30, 2007	3,536,968		$	11.53	5.66	$	—
Granted ⁽¹⁾	6,806,119		$	1.48
Cancelled	(376,210	)	$	6.77
Exercised	(13,034	)	$	0.09

Outstanding as of September 28, 2008	9,953,843		$	4.85	6.67	$	6,428

Exercisable as of September 28, 2008	2,491,577		$	8.27	4.88	$	1,174

⁽¹⁾	The number of options granted in the nine months ended September 28, 2008 includes 4,364,829 shares of options granted in March 2008 under Saifun Option Plans in accordance with the provisions of the Acquisition Agreement.

The aggregate intrinsic value in the preceding table represents the total pretax intrinsic value, based on the Company’s closing stock price of $1.64 as of September 26, 2008, which was the last trading day prior to September 28, 2008, which would have been received by the stock option holders had all stock option holders exercised their stock options as of that date.

The following table summarizes RSU award activities and related information for the period presented:


	Number of Shares		Weighted-Average Grant-date Fair Value
Restricted Stock Units:
Unvested as of December 31, 2006	2,923,615		$	12.33
Granted	1,680,532		$	10.35
Cancelled	(303,430	)	$	11.95
Vested	(1,147,291	)	$	12.27

Unvested as of December 30, 2007	3,153,426		$	11.33
Granted	1,884,455		$	2.97
Cancelled	(313,158	)	$	9.06
Vested	(1,079,333	)	$	11.51

Unvested as of September 28, 2008	3,645,390		$	7.15

5. Net Loss per Share

Basic and diluted net loss per share is computed based on the weighted-average number of common shares outstanding during the periods presented.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

For the three and nine months ended September 28, 2008, the Company excluded approximately 25.3 million of potential common shares issuable upon exercise of outstanding stock options, upon vesting of outstanding restricted stock units and upon conversion of Spansion LLC’s 2.25% Exchangeable Senior Subordinated Debentures because they had an antidilutive effect due to net losses recorded in each of those periods.

For the three and nine months ended September 30, 2007, the Company excluded approximately 18.9 million of potential common shares issuable upon exercise of outstanding stock options, upon vesting of outstanding restricted stock units and upon conversion of Spansion LLC’s 2.25% Exchangeable Senior Subordinated Debentures because they had an antidilutive effect due to net losses recorded in each of those periods.

6. Comprehensive Loss

The following are the components of comprehensive loss:


	Three Months Ended						Nine Months Ended
	Sep. 28, 2008			Sep. 30, 2007			Sep. 28, 2008			Sep. 30, 2007
	(in thousands)
Net loss	$	(133,251	)	$	(71,602	)	$	(352,365	)	$	(213,982	)
Net change in pension plan, net of taxes		155			99			(442	)		293
Pension curtailment loss		—			—			—			2,010
Net change in cumulative translation adjustment		3,452			47,497			33,779			28,038
Net change in unrealized losses on marketable securities, net of $0 taxes		12,242			—			(515	)		—

Total comprehensive loss	$	(117,402	)	$	(24,006	)	$	(319,543	)	$	(183,641	)

7. Related Party Transactions

Upon the issuance of the Company’s Class A common stock to complete the acquisition of Saifun on March 18, 2008, Advanced Micro Devices’ (AMD) voting interest in the Company declined below 10 percent. AMD is no longer deemed to be a related party of the Company as its percentage of voting interest in the Company fell below 10 percent and it has no representation on the Company’s board of directors.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

The transactions with AMD for the period from December 31, 2007 to March 18, 2008, the closing date of the Saifun acquisition were not material. The following tables present the related party transactions and account balances between the Company and AMD for the three and nine months ended September 30, 2007 and as of December 30, 2007:


	Three Months Ended			Nine Months Ended
	Sep. 30, 2007			Sep. 30, 2007
Cost of sales:
Royalties to AMD	$	797		$	2,352
Service fees to AMD ⁽¹⁾ :
Cost of sales	$	15		$	(1,100	)
Research and development		(2	)		177
Sales, general and administrative		142			356

Service fees to AMD	$	156		$	(566	)

⁽¹⁾	Service fees to AMD are net of reimbursements from AMD, primarily for facility related charges.


	Dec. 30, 2007
	(in thousands)
Trade accounts receivable from AMD, net of allowance for doubtful accounts	$	2,976
Other receivables from AMD	$	6,488
Accounts payable to AMD	$	3,597
Royalties payable to AMD	$	1,629

The Company receives certain administrative services from Fujitsu, a holder of 10 percent or more of the Company’s voting securities. The charges for these services are negotiated annually between the Company and Fujitsu based on the Company’s expected requirements and the estimated future costs of the services to be provided. Fujitsu provides test and assembly services to the Company on a contract basis and also provides foundry and sort services to the Company since consummation of the JV1/JV2 transaction (the sale of the Company’s two wafer fabrication facilities located in Aizu-Wakamatsu, Japan) which occurred in the second quarter of fiscal 2007. The Company also purchases commercial die from Fujitsu, which is packaged together with the Company’s Flash memory devices.

The Company licenses certain intellectual property from Fujitsu in exchange for the payment of royalties to Fujitsu. These royalty expenses are recognized in cost of sales. The Company is required to pay Fujitsu semi-annual royalties based on net sales (minus the costs of commercial die). The royalty as a percentage of sales will decline to zero over a specified time. The term of the agreement expires in 2013.

Effective September 29, 2008, Fujitsu transferred its one share of Class C Common Stock to the Company. As a result of the transfer, Fujitsu no longer has a right to appoint any directors to the Company’s Board of Directors.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

The following tables present the significant related party transactions and account balances between the Company and Fujitsu:


	Three Months Ended						Nine Months Ended
	Sep. 28, 2008			Sep. 30, 2007			Sep. 28, 2008			Sep. 30, 2007
	(in thousands)
Net sales to Fujitsu	$	156,690		$	202,464		$	513,232		$	650,742
Cost of sales:
Royalties to Fujitsu	$	883		$	797		$	2,451		$	2,352
Other purchases of goods and services from Fujitsu and rental expense to Fujitsu		19,580			15,744			59,905			59,645
Subcontract manufacturing and commercial die purchases from Fujitsu		1,693			2,725			6,856			17,602
Wafer purchases, processing and sort services from Fujitsu ⁽¹⁾		56,588			63,274			186,329			122,236
Net gain recognized on sale of assets to Fujitsu on April 2, 2007 ⁽¹⁾		(8,192	)		(10,278	)		(25,238	)		(19,845	)
Reimbursement on costs of employees seconded to Fujitsu ⁽¹⁾		(7,454	)		(6,351	)		(21,483	)		(12,319	)
Pension curtailment loss ⁽¹⁾		—			—			—			2,010
Equipment rental income from Fujitsu ⁽¹⁾		(819	)		(1,884	)		(2,790	)		(3,914	)
Administrative services income from Fujitsu ⁽¹⁾		(93	)		(325	)		(1,180	)		(615	)

	$	62,186		$	63,701		$	204,850		$	167,151

Service fees to Fujitsu:
Cost of sales	$	9		$	77		$	28		$	660
Research and development		—			324			10			923
Sales, general and administrative		148			26			453			733

Service fees to Fujitsu	$	157		$	427		$	491		$	2,316

⁽¹⁾	These amounts relate to the JV1/JV2 Transaction which was consummated on April 2, 2007.


	Sep. 28, 2008		Dec. 30, 2007
	(in thousands)
Trade accounts receivable from Fujitsu	$	127,796	$	183,670
Other receivables from Fujitsu	$	7,024	$	5,385
Accounts payable to Fujitsu	$	46,046	$	53,332
Royalties payable to Fujitsu	$	914	$	1,629
Accrued liabilities to Fujitsu	$	4,703	$	6,461

8. Warranties and Indemnities

The Company generally offers a one-year limited warranty for its Flash memory products.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

Changes in the Company’s liability for product warranty during the three and nine months ended September 28, 2008 and September 30, 2007 are as follows:


	Three Months Ended						Nine Months Ended
	Sep. 28 2008			Sep. 30 2007			Sep. 28 2008			Sep. 30 2007
	(in thousands)
Balance, beginning of period	$	1,489		$	1,600		$	1,305		$	1,350
Provision for warranties issued		4,274			1,095			11,296			3,579
Settlements		(3,912	)		(446	)		(11,232	)		(1,554	)
Changes in liability for pre-existing warranties during the period, including expirations		(362	)		(649	)		120			(1,775	)

Balance, end of period	$	1,489		$	1,600		$	1,489		$	1,600

In addition to product warranties, the Company, from time to time in its normal course of business, indemnifies other parties, with whom it enters into contractual relationships, including customers, directors, lessors and parties to other transactions with the Company, with respect to certain matters. The Company has agreed to hold the other party harmless against specified losses, such as those arising from a breach of representations or covenants, third-party infringement claims or other claims made against certain parties. It is not possible to determine the maximum potential amount of liability under these indemnification obligations due to the limited history of indemnification claims and the unique facts and circumstances that are likely to be involved in each particular claim and indemnification provision.

9. Debt and Capital Lease Obligations

The Company’s debt and capital lease obligations consist of:


	Sep. 28, 2008		Dec. 30, 2007
	(in thousands)
Debt obligations:
Spansion China Bank Enterprise Cooperation Loan Facility	$	—	$	5,405
Senior Notes		232,425		230,628
Spansion Penang Loan		560		2,028
Exchangeable Senior Subordinated Debentures		207,000		207,000
Spansion Japan 2007 Credit Facility		272,031		256,503
Senior Secured Floating Rate Notes		625,652		625,757
Senior Secured Revolving Credit Facility		55,000		—
Spansion Japan 2007 Revolving Credit Facility		75,411		—
Obligations under capital leases		87,409		74,012

Total debt and capital lease obligations		1,555,488		1,401,333
Less: current portion		277,242		101,797

Long-term debt and capital lease obligations, less current portion	$	1,278,246	$	1,299,536

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

New Debt and Capital Lease Obligations and Activities for the nine months ended September 28, 2008

Debt Obligations

Spansion China Bank Enterprise Cooperation Loan Facility

In June 2008, Spansion China repaid the remaining principal balance of approximately $5.4 million and accrued interest under this facility and voluntarily terminated the facility.

Spansion Japan 2007 Credit Facility

In March 2008, Spansion Japan borrowed an additional amount of 5.6 billion yen (approximately $52.8 million as of September 28, 2008) under this facility. The drawdown period expired on March 31, 2008. The Company began to make quarterly principal installments in the second quarter of fiscal 2008. As of September 28, 2008, the total outstanding balance under this facility is 28.9 billion yen (approximately $272.0 million). The amount bears interest at approximately 2.8 percent and is scheduled to be repaid in quarterly principal installments through the fourth quarter of fiscal 2010.

Senior Secured Revolving Credit Facility

In February 2008, the Company borrowed $50.0 million under this credit facility. In June 2008, the Company repaid a principal amount of $6.0 million and accrued interest under this facility. In September 2008, the Company borrowed an additional amount of $11 million under this facility. As of September 28, 2008, the total outstanding balance under this credit facility was $55.0 million. This amount bears interest at approximately 4.6 percent to 5.0 percent as of September 28, 2008.

This credit facility provides a total borrowing capacity of $175.0 million and the Company may carry an outstanding balance of up to that amount, subject to certain borrowing base calculations derived from accounts receivable. The Company is required to maintain at least $35 million of availability under this credit facility if it fails to meet the minimum predetermined EBITDA (earnings before interest expense, income tax, depreciation and amortization) thresholds. As of September 28, 2008, the Company has not met the minimum EBITDA requirement. As such, after deducting the $35 million of availability required, the Company had approximately $38.4 million available under this facility as of September 28, 2008. This credit facility will expire on September 19, 2010.

Spansion Japan 2007 Revolving Credit Facility

During the quarter ended March 30, 2008, Spansion Japan borrowed 8 billion yen approximately $75.4 million as of September 28, 2008) under this credit facility. During the quarter ended June 29, 2008, the Company borrowed an additional 1 billion yen (approximately $9.4 million as of September 28, 2008). In September 2008, the Company repaid a principal amount of 1 billion yen (approximately $9.3 million as of the date of repayment) under this facility. As of September 28, 2008, the outstanding balance under this facility is 8 billion yen (approximately $75.4 million). This amount bears interest at approximately 1.2 percent as of September 28, 2008. Spansion Japan had approximately 5.3 billion yen (approximately $50.0 million) available under this facility as of September 28, 2008. This facility will expire on December 28, 2009 and is extendable at each anniversary with an extension fee 0.2% of the commitment amount.

Spansion China 2008 Revolving Credit Facility

In June 2008, Spansion China entered into a revolving credit facility agreement with a local financial institution, effective as of June 27, 2008, in the aggregate principal amount of up to 80 million Yuan RMB (approximately $11.7 million as of September 28, 2008). The borrowings must be used for working capital purposes. The interest rate for each drawdown denominated in RMB is a floating rate that

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

is benchmarked to the rate published by the People’s Bank of China for RMB loans with the same term and may, thereafter, be adjusted every month. The interest rate for each drawdown denominated in U.S. dollars is six-month LIBOR plus four percent and may, thereafter, be adjusted every six months. The last drawdown against this credit facility can be made on or before May 27, 2009.

As of September 28, 2008, the Company had not borrowed any amounts under this credit facility.

Obligations under Capital Leases

On March 26, 2008, the Company entered into an equipment lease agreement with a third-party financial institution. Under the lease agreement, the Company leased certain equipment for a period of 36 months, in the amount of approximately $52.1 million, beginning on March 27, 2008. The Company accounted for the lease transaction as a capital lease. The first rental installment of approximately $9.4 million was paid on March 27, 2008. The remaining payments under this lease are scheduled to be paid in 11 consecutive quarterly installments of approximately $4.0 million beginning July 1, 2008 and on the first day of each quarter thereafter. At the end of the lease agreement, the Company may elect to purchase the equipment at its then fair market value, renew the lease agreement with similar terms and conditions as the original lease agreement, or return the equipment.

10. Income Taxes

The Company recorded income tax expenses of $9.6 million in the three months ended September 28, 2008 as compared to $4.3 million of income tax benefit in the three months ended September 30, 2007. The income tax expense recorded in the three months ended September 28, 2008 was primarily related to tax provision in profitable foreign locations, of which $9.9 million was associated with profits in Japan. The income tax expense of $9.9 million associated with Japan is due to a $3.1 million reduction in income tax payable and a $13.0 million reduction in deferred tax assets. The income tax benefit recorded in the three months ended September 30, 2007 was primarily due to a decrease in the valuation allowance associated with deferred tax assets of the Company’s Japanese subsidiary, offset by tax provisions of its foreign subsidiaries. This decrease of the valuation allowance was made as the Company believed that it was more likely than not that these deferred tax assets would be realized.

The Company recorded income tax expenses of $7.2 million in the nine months ended September 28, 2008 as compared to $18.2 million of income tax benefit in the nine months ended September 30, 2007. The income tax expense recorded in the nine months ended September 28, 2008 was primarily related to a tax provision of $4.5 million associated with profits in Japan, and by tax provisions in other profitable foreign locations of $2.7 million. The income tax benefit recorded in the nine months ended September 30, 2007 was primarily due to the decrease in the valuation allowance associated with deferred tax assets of the Company’s Japanese subsidiary because the Company believed that it was more likely than not that these deferred tax assets would be realized, offset by tax provisions of its foreign subsidiaries.

As of September 28, 2008, the Company’s U.S. deferred tax assets, net of deferred tax liabilities, continue to be subject to a full valuation allowance. The realization of these assets is dependent on substantial future taxable income which at September 28, 2008, in management’s estimate, is not more likely than not to be achieved.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

11. Spansion Japan Pension Plan

The following table summarizes the components of the net periodic pension expense related to the Spansion Japan pension plan for the three and nine months ended September 28, 2008 and September 30, 2007:


	Three Months Ended						Nine Months Ended
	Sep. 28, 2008			Sep. 30, 2007			Sep. 28, 2008			Sep. 30, 2007
	(in thousands)
Service cost	$	1,592		$	909		$	4,863		$	3,547
Interest cost		444			273			1,357			1,064
Expected return on plan assets		(983	)		(596	)		(3,001	)		(2,325	)
Amortization of prior service cost		156			102			472			2,307

Total net periodic pension expense	$	1,209		$	688		$	3,691		$	4,593

On April 2, 2007, in accordance with FASB Statement No. 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits , the Company recorded a curtailment loss, which was included in the amortization of prior service cost for the nine months ended September 30, 2007, of approximately $2.0 million relating to the Spansion Japan Pension Plan as a result of entering into the Employer Secondment and Transfer Agreement with Fujitsu under the JV1/JV2 transaction.

12. Fair Value

As of September 28, 2008, the fair value measurements of the Company’s cash equivalents and marketable securities consisted of the following and which are categorized in the table below based upon the fair value hierarchy:


	Level 1		Level 2		Level 3		Total
	(in millions)
Money market funds	$	89	$	—	$	—	$	89
Auction rate securities		—		—		107	$	107

Total cash equivalents and marketable securities	$	89	$	—	$	107	$	196

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

The table below presents reconciliations for market securities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 28, 2008:


	Three Months Ended Sep. 28, 2008
	(in millions)
Beginning balance as of June 30, 2008	$	109
Other than temporary impairment		(2	)

Ending fair value as of September 28, 2008	$	107


	Nine Months Ended Sep. 28, 2008
	(in millions)
Beginning balance as of December 31, 2007	$	—
Transfer in		122
Other than temporary impairment		(15	)

Ending fair value as of September 28, 2008	$	107

Marketable Securities

The Company’s marketable securities at September 28, 2008 consist of $107.4 million of auction rate securities (ARS) valued at fair value which are backed by student loans and substantially all of which are guaranteed by the U.S. government Federal Family Education Loan Program (FFELP). These securities have credit ratings of AAA and Aaa. Prior to February 2008, these securities were publicly quoted and traded in auctions relating to such investments. The fair value of these securities approximated face value due to the frequent auction periods, generally every 7 to 28 days, which provided liquidity to these investments. However, subsequent to February 2008, all of these securities failed to be traded in these auctions. Given the failures in the auction markets, as well as the lack of any correlation of these instruments to other observable market data, there are no longer observable inputs available as defined by Levels 1 and 2 of the fair value hierarchy of Statement 157 by which to value these securities. Therefore, these auction rate securities are classified within Level 3 and their valuation requires substantial judgment and estimation of factors that are not currently observable in the market due to the lack of trading in the securities.

The Company has estimated the fair values of its ARS investments at September 28, 2008 using a discounted cash flow (DCF) methodology. Significant inputs used in the DCF models were the credit quality of the instruments, the percentage and the types of guarantees (such as FFELP), the probability of the auction succeeding or the security being called, and an illiquidity discount factor. The key assumptions used in the discounted cash flow analysis to determine the fair values as of September 28, 2008 were the discount factor to be applied and the period over which the cash flows would be expected to occur. The discount factor used was based on the three-month LIBOR (3.76% as of September 28, 2008) adjusted by 125 basis points (bps) to reflect the then current market conditions for instruments with similar credit quality at the date of the valuation. In addition, the discount factor was incrementally adjusted for a liquidity discount of 125 bps to reflect the risk in the marketplace for these investments that has arisen due to the lack of an active market. The Company applied this discount factor over the expected life of the estimated cash flows of its ARS with projected interest income of 3.48% per annum. The projected interest income is based on a trailing 12-month average 91-day T-bill rate at 2.28% as of September 28, 2008 plus 120 bps, which is the average annual yield of the Company’s ARS assuming auctions continue to fail.

The Company’s analysis indicated the fair value of its ARS investments was approximately $107.4 million, as compared to a face value of approximately $121.9 million as of September 28, 2008. The impairment in value, or $14.5 million, was considered to be other than temporary, and accordingly, was recorded as an impairment charge in the condensed consolidated statement of operations during the three months ended September 28, 2008.

In making the determination that the impairment was other than temporary, the Company considered (i) the current market liquidity for ARS, particularly student loan backed ARS, (ii) the long-term maturities of the loan portfolios underlying each ARS owned by the Company which typically range from 24 to 39 years, and (iii) the intent of the Company to hold its ARS investments until sufficient liquidity returns to the auction rate market to enable the sale of these securities or until the investments mature.

The Company continues to monitor the market for auction rate securities as well as the individual ARS investments it owns. The Company may be required to record additional losses in future periods if the fair value of its ARS deteriorates further.

The Company has classified its investments in ARS as current assets as it currently believes that it will be able to sell these securities and have the proceeds available for use in its operations within the next twelve months through a sale to a buyer outside of the auction process, a call on these investments, or a redemption by which issuers establish a different form of financing to replace these securities.

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

In October 2008, the Company received an offer to participate in an auction rate securities settlement from UBS, its broker, providing the Company the right, but not the obligation, to sell to UBS up to 100 percent of its auction rate securities at par, which was approximately $121.9 million as of September 28, 2008, commencing June 30, 2010. In addition, accepting this offer will allow the Company, pursuant to a no net cost revolving credit facility, to borrow up to 75 percent of the market value, as determined by the broker, of these securities. The credit facility will remain outstanding until the ARS are purchased by UBS commencing June 30, 2010, or sooner, to the extent UBS exercises its rights to call some or all of the ARS. However, certain provisions in the Company’s debt instruments may not allow the Company to make use of this borrowing provision. The Company is currently evaluating the offer.

The Company’s right to sell the ARS to UBS commencing June 30, 2010 represents a put option (i.e. right to sell) for a payment equal to the par value of the ARS. As the put option is non-transferable and cannot be attached to the ARS if they are sold to another entity other than UBS, it represents a freestanding instrument between the Company and UBS and which is separate from the ARS, which represents an investment security between the Company and the ARS Issuer. Therefore, in the accounting period in which the Company signs the auction rate securities settlement agreement with UBS, the Company will account for the put option as an asset, measured at its fair value, with the resultant gain recognized in earnings.

13. Restructuring Charges

In the second quarter of fiscal 2008, as part of its ongoing strategic effort to improve overall productivity, the Company eliminated regular and contract positions globally, through planned consolidations, attrition, and a reduction in regular, contract and temporary workers in manufacturing, engineering, management and administrative support functions.

Restructuring charges for the three and nine months ended September 28, 2008 were as follows:


	Three Months Ended Sep. 28, 2008		Nine Months Ended Sep. 28, 2008
	(in thousands)
Employee severance pay and benefits	$	1,351	$	11,093
Relocation of property, plant and equipment		20		132
Other		6		74

Total restructuring charges	$	1,377	$	11,299

Spansion Inc.

Notes to Condensed Consolidated Financial Statements-Continued

(Unaudited)

The following table summarizes the restructuring activity for the three and nine months ended September 28, 2008:


	Three Months Ended Sep. 28, 2008
	(In thousands)
Accrued restructuring balance as of June 29, 2008	$	8,345
Additional accruals		1,402
Adjustments		(54	)
Cash payments		(8,117	)

Accrued restructuring balance as of September 28, 2008	$	1,576


	Nine Months Ended Sep. 28, 2008
Accrued restructuring balance as of December 31, 2007	$	—
Additional accruals		11,324
Adjustments		(54	)
Cash payments		(9,694	)

Accrued restructuring balance as of September 28, 2008	$	1,576

The accrued restructuring balance was included in accrued compensation and benefits in the Company’s condensed consolidated balance sheet as of September 28, 2008.

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 regarding future events and our future results that are subject to the safe harbors created under Section 21E of the Securities Exchange Act of 1934 (the Exchange Act), particularly statements regarding the products that will represent the majority of total net sales, increases in sales of certain products, anticipated future cash flows and cash balances, planned capital spending, liquidity, our auction rate securities investments, the effects of our acquisition of Saifun Semiconductors Ltd., the reasonableness of our critical accounting policies and tax provisions, and the amount of liability exposure related to our indemnities, commitments and guarantees. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” “will,” “should,” “predict,” “potential” and variations of such words and other expressions indicating future results or expectations are intended to identify such forward-looking statements. In addition, any statements that refer to projections of our future financial performance, our anticipated growth and trends in our businesses, and other characterizations of future events or circumstances are forward-looking statements. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified in Part II, Item 1A, under “Risk Factors,” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. We undertake no obligation to revise or update any forward-looking statements for any reason.

Global Markets

In the U.S., recent market and economic conditions have been unprecedented and challenging with tighter credit conditions and slower growth through the third quarter of 2008. For the nine-month period ended September 30, 2008, continued concerns about the systemic impact of inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining real estate market in the U.S. have contributed to increased market volatility and diminished expectations for the U.S. economy. In the third quarter, added concerns fueled by the federal government conservatorship of the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association, the declared bankruptcy of Lehman Brothers Holdings Inc., the U.S. government provided loan to American International Group Inc. and other federal government interventions in the U.S. credit markets lead to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment have in recent weeks subsequent to the end of the quarter contributed to volatility of unprecedented levels.

As a result of these market conditions, the availability and cost of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has led many lenders and institutional investors to reduce, and in some cases, cease to provide

funding to borrowers. Continued turbulence in the U.S. and international markets and economies may adversely affect our liquidity and financial condition, and the liquidity and financial condition of our customers. If these market conditions continue, they may limit our ability to access the capital markets to meet liquidity needs, resulting in an adverse effect on our financial condition and results of operations.

Overview

We are a semiconductor device company exclusively dedicated to designing, developing, manufacturing, marketing, licensing and selling Flash memory technology and solutions. There are two major architectures of Flash memory in the market today: NOR Flash memory, primarily for code and data storage in mobile phones and automotive electronics and primarily for code storage in consumer and industrial electronics, and NAND Flash memory, which is primarily used for data storage in removable memory applications, such as Flash memory cards and USB drives, and applications such as MP3 players and high-end mobile phones.

The Flash memory market can be divided into two major categories based on application: the integrated category and the removable storage category. Within the integrated category, applications include portable, battery-powered electronics such as mobile phones, and consumer, industrial, telecommunications, computing and automotive electronics. Within the removable storage category, applications include Flash memory cards and USB drives. We focus primarily on providing NOR Flash memory solutions for the integrated category of the Flash memory market. Our Flash memory is integrated into a broad range of electronic products, including mobile phones, consumer electronics, automotive electronics, networking and telecommunications equipment, and personal computer peripherals.

Our total net sales for the three months ended September 28, 2008 and September 30, 2007 were approximately $630.9 million and $611.1 million, respectively. The increase in total net sales was primarily due to a three percent increase in blended average selling price (ASP) (defined as total net sales divided by total unit shipments) of our Flash memory products, partially offset by a one percent decrease in our unit shipments as compared to the corresponding period in fiscal 2007. The sales from products based on our MirrorBit technology continued to grow as a percentage of our total net sales, representing approximately 82 percent of our total net sales and approximately 63 percent of our total units shipped during the three months ended September 28, 2008, as compared to approximately 71 percent of our total sales and 47 percent of our total units shipped for the corresponding period in fiscal 2007.

Our total net sales for the nine months ended September 28, 2008 and September 30, 2007 were approximately $1,813.9 million and $1,848.0 million, respectively. The decrease in total net sales in the 2008 period compared to the 2007 period was primarily due to a three percent decline in blended ASP, partially offset by a one percent increase in unit shipments. The sales from products based on our MirrorBit technology continued to grow as a percentage of our total net sales, representing approximately 79 percent of our total net sales and 59 percent of our total units shipped during the nine months ended September 28, 2008, as compared to approximately 69 percent of our total net sales and 43 percent of our total units shipped for the corresponding period in fiscal 2007.

Our net losses for the three and nine months ended September 28, 2008 were approximately $133.3 million and $352.4 million, respectively, as compared to approximately $71.6 million and $214.0 million for the three and nine months ended September 30, 2007, respectively. Our net loss for the nine months ended September 28, 2008 was higher as compared to the same period of the prior year primarily due to lower net sales recognized for the first nine months of fiscal 2008, the inclusion of approximately $10.8 million related to the write-off of in-process research and development, $11.3 million of restructuring charges incurred in 2008, $14.5 million of other than temporary impairment of our marketable securities in the third quarter of fiscal 2008, and $13.1 million impact on gross profit related to our exit of the 90-nanometer content delivery business during the third quarter of fiscal 2008. The provision for income taxes included in our net losses for the three and nine months ended September 28, 2008 was approximately $9.6 million and $7.2 million, respectively, as compared to the tax benefit of approximately $4.3 million and $18.2 million for the three and nine months ended September 30, 2007, respectively.

Our cash, cash equivalents and marketable securities totaled approximately $259.5 million as of September 28, 2008 and consisted of cash, money market funds and commercial paper of approximately $152.1 million and auction rate securities of approximately $107.4 million. Our capital expenditures for the last quarter of fiscal 2008 will be significantly reduced as compared with recent prior periods. Our capital expenditures were approximately $1.1 billion in fiscal 2007 and approximately $396.7 million for the nine months ended September 28, 2008. We expect our capital expenditures to be approximately $40.0 million for the last quarter of fiscal 2008 depending on the timing of capital deliveries. Our ability to fund our cash needs over the short term and long term will depend on our ability to generate cash in the future, which is subject to general economic, financial, competitive and other factors. For a complete discussion of the risks facing our business, including our liquidity, please see Part II, Item 1A “Risk Factors.” Also see additional discussion under Liquidity and Capital Resources in Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Basis of Presentation

We use a 52- to 53-week fiscal year ending on the last Sunday in December. The three months ended September 28, 2008 and September 30, 2007 both consisted of 13 weeks.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts in our consolidated financial statements. We evaluate our estimates on an on-going basis, including those related to our revenues, inventories, asset impairments, income taxes and pension benefits. We base our estimates on experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. The actual results may differ from these estimates or our estimates may be affected by different assumptions or conditions.

Other than our accounting policies described below regarding inventories, deferred revenue, fair value, goodwill and business combinations, our critical accounting policies, which incorporate our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements, are the same as those described in Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 30, 2007.

Inventory Valuation

At each balance sheet date, we evaluate our ending inventories for excess quantities and obsolescence. This evaluation includes analysis of sales levels by product and projections of future demand. These projections assist us in determining the carrying value of our inventory and are also used for near-term factory production planning. Historically, we have generally used a six month demand forecast in assessing the salability of inventory on hand and did not value inventory in excess of six months of estimated demand. Beginning in the second quarter of fiscal 2008, as part of a strategy to efficiently manage our new production capacity and to maintain strategic inventory levels of certain products, we have built and valued certain product inventory to meet estimated demand as much as twelve months into the future. We write off inventories that we consider obsolete and adjust remaining specific inventory balances to approximate the lower of our standard manufacturing cost or market value. Among other factors, management considers forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value. If we anticipate future demand or market conditions to be less favorable than our previous projections, additional inventory write-downs may be required and would be reflected in cost of sales in the period the write-down is made. This would have a negative impact on our gross margin in that period. If in any period we are able to sell inventories that were not valued or that had been written down in a previous period, related revenues would be recorded without any offsetting charge to cost of sales, resulting in a net benefit to our gross margin in that period.

Deferred Revenue

We sell to distributors and provide such distributors certain rights of return, stock rotation and price protection as discussed below. We defer the recognition of revenue and related product costs on these sales as deferred income on shipments until the merchandise is resold by our distributors. We also sell some of our products to certain distributors under sales arrangements with terms that do not allow for rights of returns or price protection on unsold products held by them. In these instances, we recognize revenue when we ship the product directly to the distributors.

Rights of return are granted whereby we are obligated to repurchase inventory from a distributor upon termination of the distributor’s sales agreement with us. However, we are not required to repurchase the distributor’s inventory under certain circumstances, such as the failure to return the inventory in saleable condition or we may only be required to repurchase a portion of distributor’s inventory, for example when distributor has terminated the agreement for its convenience.

Stock rotation rights are provided to distributors when we have given written notice to the distributor that a product is being removed from our published price list. The distributor has a limited period of time to return the product. All returns are for credit only; the distributor must order a quantity of products, the dollar value of which equals or exceeds the dollar value of the products being returned. Some distributors are also offered quarterly stock rotation. Such stock rotation is limited to a certain percentage of the previous three months’ net shipments.

A general price protection is granted to a distributor if we publicly announce a generally applicable price reduction relating specifically to certain products, whereby the distributor is entitled to a credit equal to the difference between the price paid by the distributor and the newly announced price.

Price protection adjustments are provided to distributors solely for those products that: 1) are shipped by us to the distributor during the period preceding the price reduction announcement by us, 2) are part of the distributor’s inventory at the time of the announcement, and 3) are located at geographic territories previously authorized by us.

In addition, if in our sole judgment, a distributor demonstrates that it needs a price lower than the current published price list in order to secure an order from the distributor’s customers, we may, but we have no obligation to, grant the distributor a credit to our current published price. The distributor must submit the request for a reduction in price prior to the sale of products to its customer. If the request is approved and the sale occurs, the distributor must make a claim with the proof of resale to end customers for a credit within a specified time period.

Gross deferred revenue and gross deferred cost of sales on shipments to distributors as of September 28, 2008 and December 30, 2007 are as follows:


	Sep. 28, 2008			Dec. 30, 2007
	(in thousands)
Deferred revenue to distributors	$	90,185		$	75,010
Less: deferred costs of sales		(40,770	)		(35,053	)

Deferred income on shipments ⁽¹⁾	$	49,415		$	39,957

⁽¹⁾	The deferred income on shipments of $52,826 thousand on the condensed consolidated balance sheets as of September 28, 2008 included $3,411 thousand of defered revenue related to our licensing revenue that was excluded in the table above.

Our distributors provide us with periodic data regarding the product, price, quantity, and end customer when products are resold as well as the quantities of our products they still have in stock. We use estimates and apply judgments to reconcile distributors’ reported inventories to their activities. Error in our judgment could lead to inaccurate reporting of our revenues, deferred income and allowances on sales to distributors.

Fair Value of Marketable Securities

Our marketable securities at September 28, 2008 consist of approximately $107.4 million of auction rate securities (ARS) valued at fair value which are backed by student loans and substantially all of which are guaranteed by the U.S. government Federal Family Education Loan Program (FFELP). These securities have credit ratings of AAA and Aaa. Prior to February 2008, these securities were publicly quoted and traded in the auctions relating to such investments.

Historically, the fair value of our ARS investments has approximated face value due to the frequent auction periods, generally every 7 to 28 days, which provided liquidity to these investments. However, subsequent to February 2008, all auctions involving these securities have failed. The result of a failed auction is that these ARS will continue to pay interest in accordance with their terms at each respective auction date; however, liquidity of the securities will be limited until there is a successful auction, the issuer redeems the securities, the securities mature or until such time as other markets for these ARS investments develop. We cannot be certain regarding the amount of time it will take for an auction market or other markets to develop. Accordingly, we have concluded that the estimated fair value of the ARS no longer approximates the face value primarily due to the lack of liquidity.

We have estimated the fair values of our ARS investments at September 28, 2008 using a discounted cash flow (DCF) methodology. Significant assumptions considered in the DCF models were the credit quality of the instruments, the percentage and the types of guarantees (such as FFELP), the probability of the auction succeeding or the security being called, and an illiquidity discount factor. The key assumptions used in the discounted cash flow analysis to determine the fair values as of September 28, 2008 were the discount factor to be applied and the period over which the cash flows would be expected to occur. The discount factor used was based on the three-month LIBOR (3.76% as of September 28, 2008) adjusted by 125 basis points (bps) to reflect the then current market conditions for instruments with similar credit quality at the date of the valuation. In addition, the discount factor was incrementally adjusted for a liquidity discount of 125 bps to reflect the risk in the marketplace for these investments that has arisen due to the lack of an active market for these instruments. We applied this discount factor over the expected life of the estimated cash flows of our ARS with projected interest income of 3.48% per annum. The projected interest income is based on a trailing 12-month average 91-day T-bill rate at 2.28% as of September 28, 2008 plus 120 bps, which is the average annual yield of our ARS assuming auctions continue to fail.

Our analysis indicated the fair value of our ARS investments was approximately $107.4 million, as compared to a face value of approximately $121.9 million as of September 28, 2008. The impairment in value, or $14.5 million, was considered to be other than temporary, and accordingly, was recorded as an impairment charge in the condensed consolidated statement of operations during the three months ended September 28, 2008. The determination that this charge should be recorded was based on facts arising after October 15, 2008, the date our earnings release for the third quarter of fiscal 2008 was issued.

In making the determination that the impairment was other than temporary we considered (i) the current market liquidity for ARS, particularly student loan backed ARS, (ii) the long-term maturities of the loan portfolios underlying each ARS owned by us which typically range from 24 to 39 years, and (iii) our intent to hold our ARS investments until sufficient liquidity returns to the auction rate market to enable the sale of these securities or until the investments mature.

See additional disclosure in Note 12 of Notes to Condensed Consolidated Financial Statements.

Our auction rate securities have been classified as Level 3 assets in accordance with FASB Statement No. 157, Fair Value Measurements , as their valuation requires substantial judgment and estimation of factors that are not currently observable in the market due to the lack of trading in the securities. If different assumptions were used for the various inputs to the

valuation approach including, but not limited to, assumptions involving the estimated lives of the ARS investments, the estimated cash flows over those estimated lives, and the estimated discount rates, especially the liquidity discount rate, applied to those cash flows, the estimated fair value of these investments could be significantly higher or lower than the fair value we determined as of September 28, 2008.

Goodwill

As a result of the Saifun acquisition, we recorded approximately $18.5 million of goodwill on our books . In accordance with FASB Statement No. 142, Goodwill and Other Intangible Assets, we are required to review goodwill for impairment at least annually or more often if there are indicators of impairment present. The review of goodwill includes determining its fair value involving the use of significant estimates and assumptions. These estimates and assumptions include revenue growth rates and operating margins used to calculate projected future cash flows, risk-adjusted discount rates, future economic and market conditions and determination of appropriate market comparables. Fair value estimates are also based on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain. Actual future results may differ from those estimates. We will perform our annual impairment analysis during the fourth quarter of each year, with the first impairment test related to Saifun goodwill to be performed during the fourth quarter of 2008.

Business Combinations

In accordance with business combination accounting, we have allocated the purchase price of Saifun to tangible and acquisition related intangible assets acquired and liabilities assumed as well as to in-process research and development based on their estimated fair values. These valuations require us to make significant estimates and assumptions, especially with respect to acquisition related intangible assets.

We will review the acquisition related intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recovered.

We make estimates of fair value using reasonable assumptions based on historical experience and information obtained from the management of the acquired company. Critical estimates in valuing certain of the acquisition related intangible assets include but are not limited to: future expected cash flows from the sale of products, expected costs to develop in-process research and development projects into commercially viable products and estimated cash flows

from the projects when completed; the market’s awareness of the acquired company’s brand, market position and assumptions about the period of time the acquired brand will continue to be used in the combined company’s product portfolio; and discount rates. Unanticipated events may occur which may affect the accuracy or validity of such assumptions, estimates or actual results.

Results of Operations

Net Sales


	Three Months Ended								Nine Months Ended
	Sep. 28 2008		Sep. 30 2007		Variance in Dollars		Variance in Percent		Sep. 28 2008		Sep. 30 2007		Variance in Dollars			Variance in Percent
	(in thousands, except percentage)								(in thousands, except percentage)
Wireless Solutions Division (WSD)	$	319,817	$	316,598	$	3,219	1	%	$	912,016	$	1,040,704	($	128,688	)	-12	%
Consumer, Set Top Box and Industrial Division (CSID)		305,191		293,451		11,740	4	%		891,118		805,583		85,535		11	%
Other		5,852		1,020		4,832	474	%		10,718		1,725		8,993		521	%

Total net sales	$	630,860	$	611,069	$	19,791	3	%	$	1,813,852	$	1,848,012	($	34,160	)	-2	%

Total net sales for the three months ended September 28, 2008 increased three percent as compared to total net sales for the three months ended September 30, 2007 primarily due to a three percent increase in our blended ASP, which was partially offset by a one percent decline in our total unit shipments of Flash memory products.

Total net sales for the nine months ended September 28, 2008 decreased two percent as compared to total net sales for the nine months ended September 30, 2007. The decrease was primarily attributable to approximately three percent decline in our blended ASP, which was partially offset by a one percent increase in unit shipments. The decline in blended ASP was primarily the result of price declines in the overall Flash memory market.

Net sales in WSD increased approximately one percent for the three months ended September 28, 2008 as compared to the three months ended September 30, 2007. The increase was primarily attributable to an increase in blended ASP, which was partially offset by a slight decrease in unit shipments of WSD products as a result of an increase in shipments of higher density parts.

Net sales in WSD decreased approximately 12 percent for the nine months ended September 28, 2008 as compared to the nine months ended September 30, 2007. The decrease was primarily attributable to approximately 13 percent decline in blended ASP, which was partially offset by one percent increase in unit shipments.

Net sales in CSID increased approximately four percent and 11 percent for the three and nine months ended September 28, 2008 as compared to the three and nine months ended September 30, 2007, respectively. The increases were primarily attributable to a seven percent and 10 percent increase in blended ASP for the three and nine months ended September 28, 2008, respectively, primarily as a result of increased sales of our high density MirrorBit products, which were partially offset by a three percent decrease in unit shipments for the three months ended September 28, 2008.

For the three months ended September 28, 2008, our WSD accounted for approximately 51 percent of our total net sales, and our CSID accounted for approximately 48 percent of our total net sales, as compared to 52 percent and 48 percent, respectively for the corresponding period of fiscal 2007. For the nine months ended September 28, 2008,

our WSD accounted for approximately 50 percent of our total net sales, and our CSID accounted for approximately 49 percent of our total net sales, as compared to 56 percent and 44 percent, respectively for the corresponding period of fiscal 2007. The percentage shift between our two main divisions was primarily the result of the ASP decline in our WSD resulting in decreased net sales year-over-year and also of an increase in net sales for our CSID due to the increase in high density MirrorBit product sales.

Comparison of Gross Margin, Operating Expenses, Interest and Other Income, Net, Interest Expense and Income Tax (Provision)/Benefit

The following is a summary of gross margin; operating expenses; interest and other income, net; interest expense and income tax (provision)/benefit for three and nine months ended September 28, 2008 and September 30, 2007.


	Three Months Ended								Nine Months Ended
	Sep. 28, 2008		Sep. 30, 2007		Variance in Dollars		Variance in Percent		Sep. 28, 2008		Sep. 30, 2007		Variance in Dollars			Variance in Percent
	(in thousands, except for percentage)								(in thousands, except for percentage)
Net sales	$	630,860	$	611,069	$	19,791	3	%	$	1,813,852	$	1,848,012	$	(34,160	)	-2	%
Cost of sales		544,273		499,758		44,515