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LSI Corporation (NASDAQ:LSI)

Q1 2009 Earnings Call

April 29, 2009, 5:00 pm ET

Executives

Sujal Shah – Vice President of Investor Relations

Abhijit Y. Talwalkar – President and Chief Executive Officer

Bryon Look – Executive Vice President and Chief Financial Officer

Analysts

Sumit Dhanda – Bank of America

Craig Berger – FBR Capital Markets

Sukhi Nagesh – Deutsche Bank

Hans Mosesmann – Raymond James

Christian Schwab – Craig Hallum Capital Group

Romit Shah – Barclays Capital

Daniel Amir – Lazard Capital Markets

Kaushik Roy – Wedbush Morgan

Suji De Silva – Kaufman Brothers

Blayne Curtis – Jefferies & Co

James Snyder – Goldman Sachs

Shawn Webster – JPMorgan

Operator

Good day everyone and welcome to the LSI Corporation investor relations conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Mr. Sujal Shah, Vice President of Investor Relations. Shah, please go ahead sir.

Sujal Shah

Good afternoon and thank you for joining us. With me today are Abhi Talwalkar, President and Chief Executive Officer and Bryon Look, Executive Vice President and Chief Financial Officer. Abhi will begin the call with some opening remarks and highlights from our business, and then Bryon will provide first quarter 2009 financial results and guidance for the second quarter of 2009.

During this call we will be mentioning non-GAAP financial measures, which we may refer to as results excluding special items. Today’s earnings release describes the differences between our non-GAAP and GAAP reporting. You can find reconciliations of our non-GAAP financial measures to corresponding GAAP amounts on our website at www.lsi.com/webcast. At that site, you can also find a copy of the earnings release and a presentation, which highlights the key points from today's call, and provides an overview of our business. This may be particularly useful to new investors.

I also want to remind you that today's remarks will include forward-looking statements. Our actual results could differ materially from those suggested by the statements made today. Information about factors that could affect our future results is contained in our annual report on Form 10-K for the year ended December 31, 2008.

With that, it is now my pleasure to introduce Abhi Talwalkar.

Abhijit Talwalkar

Thank you, Sujal. Good afternoon and welcome. While the economy continues to uncertain I’m pleased with our execution in a difficult environment and the dedication that our employees continue to demonstrate. Both our revenues and non-GAAP earnings per share exceeded the midpoint of our guidance range, with the storage, semi and networking businesses showing strength towards the end of the quarter.

We also effectively managed our spending with total non-GAAP operating expenses decreasing 8% sequentially and below our guidance range. We continue to do a good job of managing our balance sheet ending the quarter with 1.1 billion in cash. Before we talk about our business and financial performance, I want to acknowledge that investors now face some interesting challenges in evaluating investment opportunities in the tech sector.

Ultimately it is about gauging future potential performance among the peer group and it’s deciding which companies are structured to play offense through these economic challenges and grow at above market rates coming out of the downturn.

With that in mind here are the key take aways I would like you to get from this call. First LSI is structured for success. Over the past couple of years, we have made substantial changes in our business strategy and cost structure. Second, we have driven our non-GAAP operating expense level significantly lower over the past two quarters and expect to maintain tight cost controls in the second half of 2009. And lastly, we are positioned to grow at above market rates due to the significant 2007 and 2008 design win closures, many of which are nearing production.

Two years ago, we began transforming LSI into a storage and networking company while solidifying our cost structure. Today, we are accompanied with a strong balance sheet that has reduced operating expenses by 25% over two years, divested volatile businesses and outsourced manufacturing. Unlike many other companies, we didn’t wait for the downturn to drive changes to our business composition and cost structure. While others are going through this risk assessment now, we’ve remain solidly focused on execution of key programs and winning more business in our targeted markets. We expect to continue gaining share of wallet in market leaders across our segments through this challenging environment.

Although IT purchases have temporarily contracted to conserve cash, this situation for businesses can’t persist for long. Growth and digital information and additional drivers such as growth and video traffic, proliferation of broadband and rich mobile services and the greater adoption of IT by the healthcare industry are examples of what will further push demand for capacity and network bandwidth enabling the end product segments we serve to fare better as economic conditions improve.

Now I want to review with you the business highlights for last quarter in our Storage and Networking businesses. I would like to begin with storage systems and storage virtualization software for our time to market transitions on new technology offerings combined with our no conflict channel model and lower total cost of ownership software, makes us a key partner for the leaders in the industry.

We have expanded our customer base with Tier-1 customer such as HP and emerging OEM’s such as Huawei while also gaining significant share in entry-level platforms. Last quarter, we began ramping our flagship XBB2 mid-range platform at IBM under the DS5000 product line. We are pleased to announce that Sun is now ramping the XBB2 under the Sun Storage 6780 product family.

Last week, we announced enhancements to the XBB2 platform that include 8-gig Fibre Channel host interface support, SafeStore security software providing encryption services as well as capacity expansion to 448 drives. This week, IBM announced a new version of the DS5000 series with these new features and we expect other OEM partners to make follow-on announcements soon, with production ramping in the near future.

Earlier this week, Oracle and LSI announced a breakthrough achievement in file system performance with Oracle Secure Files, utilizing the LSI Engenio 7900 storage system, which is also based on our XPB2 architecture. The combination of Oracle Secure Files running on LSI Engenio 7900 delivers performance and scalability, beyond traditional file systems and offers a leading solution to customers for unstructured data management.

In addition to the XPB2, we expect to release a new volume midrange platform in the second half of the year that will provide further enhancements to our current offering and drive a very meaningful product cycle in the volume midrange space.

In storage virtualization, HP began shipping LSI’s storage virtualization manager software, which has been received favorably by IT managers in this difficult environment where our total cost of ownership and an immediate ROI is paramount. Our SVM software allows HP to deliver SAN Virtualization and advanced data management functionality for their mid-range EVA product line.

Lastly, LSI continues to strengthen its position in the storage market. Last week, we acquired the 3ware RAID Adaptor Business from AMCC. The addition of the 3ware business positions LSI to provide an unmatched breadth of storage solutions through worldwide network of channel partners including leading storage distributors, as well as system builders.

I’ll now turn it to storage semiconductors, which includes SAS, SAN as well as HDD. In our SAS and SAN server products where LSI is the clear share leader, we offer the broadest family of server to storage standard product solutions and a proven server software stack with our MegaRAID offering. For 6-gig SAS, our customer base continues to expand. Taiwan server industry leaders including Acer, Asus, Gigabyte and Quanta have selected LSI as a 6-gig SAS technology partner for their next generation servers.

We also announced that our SAS ICs, HBAs, and MegaRAID software products will enable more than 80 new server and workstation models based on the new Intel Nehalem processor. Industry leading OEMs incorporating 6-gig SAS technology from LSI include Dell, Fujitsu, IBM, Intel, NEC and Sun who are all bringing LSI’s solutions to market in their latest server offerings based on these new processors.

With our performance and power advantage and roadmap acceleration, we continue to expect that we will provide 6-gig SAS solutions to all top 10 server OEM’s. To further add to our momentum in SAS, we have now won a key 6-gig SAS storage processor design at the largest volume external storage OEM for a next generation platform.

Furthermore, we also expect to capitalize as SAS sees greater adoption in external storage systems and expect this to be a new multi $100 million market over the coming years. In SAN, all our 8-gig Fibre Channel HBA and switch customs silicon components are now shipping in production and we continue to grow share. First generation of fully integrated custom silicon for converged network adapters is expected to ramp into production with our customers during the summer of 2009.

In Q1, we also won additional custom silicon designs in next generation Fibre Channel over Ethernet, as well as native Fibre Channel protocols with existing and new customers.

Turning to hard disk drives, our business saw an upturn in demand in March and our Q1 HDD revenues exceeded our expectations. Contrary to some of the myths in the HDD space, LSI is in an excellent position to gain share at existing customers and further expand our customer base. The fact is that the HDD market is consolidating, not only from a customer standpoint but also from a semiconductor supplier perspective. At roughly 20% share in SoCs, LSI is far from saturated. In fact we expect to benefit significantly, as all customers work to implement a dual supplier strategy.

With Seagate, we previously secured two generations of SoC designs for enterprise drives, and were also solely awarded multiple mainstream desktop and notebook hard disk drive SoC design wins for platforms expected to ship in 2010 and 2011 timeframes respectively.

With Hitachi, we also previously secured next generation SoC wins across multiple platforms representing new business growth in 2010 and 2011. With these wins, we expect our share to grow in HDDs. WD, Samsung and Toshiba Fujitsu remain sole sourced and represent a significant and attainable growth opportunity for LSI as they move away from sole source technology and pricing.

LSI took the technology lead in 2007 by introducing the world’s first 65-nanometer iterative decode read channel. Capitalizing on this transition enabled us to regain the next several generations of enterprise SoCs at Seagate, as well as win numerous SoCs at Hitachi.

Now I’m pleased to announce that we have extended our lead by tapping out the world’s first 40-nanometer full LDPC read channel. LDPC is a new type of coding scheme that is required to reach the next level of aerial density. With time to market and cost per area being key factors for HDD competitive position, we expect to gain more ground with customers by being first in this critical technology transition.

In preamps, we gained share in 2008 as reported by IDC. Based on our designs and competitive product offering, we expect to continue to grow our share in 2009 as well. Shifting to our efforts in solid state drives, during the quarter we announced a new release of our MegaRAID software with features that include enhanced management and data protection capabilities for solid state drives.

Earlier this month we achieved a significant milestone by being the first company to achieve more than one million input/output operations per second with 6-gig SAS on a single server demonstrating the ability to leverage-SSD performance levels. In SSD Silicon, we are deep in the development of enterprise SSD controllers with three major server and and storage OEM’s and we expect these solutions to go into production in 2010.

Now I would like to review the Networking business, where we grew over 35% year-over-year in our investment areas in Q1. We continue to make excellent progress across our three focus segments, which are wireless, wireline and enterprise infrastructure. Across all three segments, we are seeing rapid growth in data traffic driven by content such as streaming video and news services delivered through endpoint such as the iPhone. These any-to-any communication services and usage models require new capabilities in the network such as rich media processing, content awareness and quality of experience.

We continue to displace competitors and gain share in our focus segments as we partnered with our top customers on driving roadmaps that address these new requirements. We expect to secure major new product wins at Cisco, Intel and HP leveraging our differentiated solutions.

I'll now provide some examples of our progress in each of our three focused segments. First the wireless infrastructure space remains resilient despite the broader economic climate because telecom operators continue to expand their deployments in 2G and 3G networks to service the rapid expansion in mobile traffic. We are benefiting from this build out across our multi-core media and communication processing products. Nokia, Siemens networks is using our network processors in their IPA2800 3G wireless platforms.

Also Huawei is now in mass production with our newest generation DSP in their wireless base station products. In the Chinese market, telecom operators are expected to expand CapEx spending to tens of billions of dollars as they extend their 3G net infrastructure. All of the primary equipment providers for this build out in China are using LSI networking products. Tatung has also selected our network processor and multi-server processors for their 3G base stations as well.

The wireline segment, which services wireless infrastructure is also benefiting from the rapid growth in mobile traffic. All the market leaders in this space are LSI customers and already utilize our multi-core communication processing elements. For example, our multiservice and network processors, which are number one and number two respectively in share, are in production today at Ericsson as well as Nokia Siemens networks.

Finally, in our third focus segment, enterprise networking, we continue to expand our footprint and success in high-volume platforms. The world’s volumes leader in enterprise networking selected our DSP media processors for multiservice router platforms, which we expect to go into production at the end of 2009. The success of our DSP as a result of its market leading multicore architecture, which enables faster voice and video processing at a fraction of the cost and power consumption.

Also in the enterprise space, the combination of our unique custom networking silicon capabilities in deep IP portfolio has enabled us to win several high volume gigabit Ethernet designs with the leading provider of PCN server chipset.

We expect the first of these programs to begin ramping into production in the second half of 2009. As these programs ramp, we expect to generate more than $70 million of annual revenue. The technology we acquired from Tarari also continues to generate strong momentum and success in the enterprise space. We expect to announce a strategic engagement with the major server OEM to use Tarari technology to accelerate enterprise software applications that will significantly improve enterprise database performance while reducing operating costs. We expect revenues to begin in the second half of 2009 for this product.

I'll now turn the call over to Bryon, who will take you through our results and provide guidance.

Bryon Look

Thanks. Reinforcing what you just heard from Abhi, we’ve remained focused on driving long-term market leadership, but we also delivered our significant reductions in our cost structure. Our revenues exceeded the midpoint of our guidance, while our operating expenses excluding special items continued to show significant improvement dropping another 8% sequentially to approximately $214 million.

Our cash position remains strong at approximately $1.1billion, and our net cash position or cash in short-term investments, net of debt closed the quarter at $479 million. Some additional key financial measures for Q1 2009 include the following.

Revenues were $482 million. Consolidated gross margins, excluding special items were 42.7%. Net loss excluding special items was $17.6 million, or $0.03 per share. And we closed the quarter improving inventory levels by 9% to $201 million. In addition, we announced and closed in April, the acquisition of the 3ware business from AMCC. As noted previously, the acquisition is expected to be neutral to non-GAAP EPS in 2009, and the financial impact of the transaction is included in our guidance going forward.

And now turning to a more detailed discussion on revenues. Revenues for Q1 were $482 million, which is sequentially down $128 million, or 21%. Semiconductor revenues for Q1 were sequentially down $49 million, or 13% to $325 million. Our storage semiconductor revenues, which include hard disk drive silicon, SAS standard components and storage area and network ICs were sequentially down $32 million, or 13% to $207 million, and represented 43% of total revenues in the first quarter.

Sequential decline in revenue was primarily due to the continued softness in end-market demand for PCs and servers and related storage products. Q1 revenues in our networking business were $96 million, representing 20% of total revenues for the quarter. And down $18 million, or 16% sequentially, primarily due to declines in our legacy products, partially offset by increased revenues in our gross networking products. Revenues for the IP business in the first quarter were $22 million, sequentially up 9%.

And turning now to our storage systems business. Business revenues were $157 million in Q1, sequentially down $79 million, or 33% from a seasonally high Q4 2008. We experienced lower than expected systems revenues, primarily due to soft end-market demand for mid to high levels storage solutions. Storage system segment represented 33% of LSI’s total revenues in the first quarter.

Moving next to gross margins. LSI’s consolidated Q1 gross margin excluding special items was 42.7%, which was sequentially down 250 basis points from Q4 2008. The sequential decline in gross margin was driven primarily by a margin decline in our systems business along with lower absorption of fixed costs. Semiconductor gross margins excluding special items decreased from the fourth quarter to approximately 48.8%, primarily due to lower absorption of fixed costs.

Storage Systems gross margins excluding special items were lower than expected at 30%. This decline was primarily driven by mix shift to lower end, lower margin products along with lower overall absorption of fixed costs. Going forward, we expect to realize margin improvements driven by a higher percentage of total systems revenues associated with our mid to high levels storage solutions. In addition, we expect higher total systems revenues, which typically drives, better absorption of fixed costs.

And now, moving to operating expenses, R&D together with SG&A expenses, excluding special items totaled up to $214 million in Q1, beating the midpoint of our guidance by $11 million. Operating expenses excluding special items, declined approximately $18 million, or 8% sequentially. These results are a reflection of our continued commitment and focus on reducing our cost structure where possible, while continuing to stay on course with respect to our strategic direction. Interest income and other net of interest expense, excluding special items, was a loss of $1.4 million for Q1.

Now, let me turn to the special items we recorded in the first quarter, which netted to $86 million. Special items, primarily non-cash, included $43 million in amortization of acquisition related items, $25 million of net restructuring costs and other items, and $18 million of stock-based compensation expense. The tax provision for the first quarter on a GAAP and non-GAAP basis was $8 million. On a GAAP basis, first quarter net loss was $104 million, or $0.16 per share. Net loss excluding special items was $17.6 million, or $0.03 per share.

Turning now to the balance sheet and cash flows. First quarter operating cash flows were negative $10 million, coming off very strong Q4 operating cash flows of $98 million. Our cash and short-term investments remained solid, ending the March quarter at approximately $1.1 billion. And as I mentioned earlier, our net cash position at the end of the quarter was approximately $479 million. We continue to carefully manage cash and our goal remains to drive positive operating cash flows to the full year 2009.

Our large cash balance puts us in a solid position to support our businesses, invest in our future and optimize our capital structure. Finally, with respect to Q1 results. Depreciation and software amortization was $23 million and capital expenditures were $10 million.

The following is our guidance for Q2. Revenues in the range of $470 million to $530 million. Sequentially, we expect our networking semiconductor business be flat to slightly down relative to Q1, with new product growth, partially offsetting legacy declines. In addition, we expect our storage semiconductor business to be approximately set out flat. We expect storage systems to be sequentially up, due to expected seasonality, as Q1 tends to be our low point on revenue for the year.

In addition, we’ve included in the guidance for storage systems, the revenues we expect to record from the 3ware business. We expect IP revenues to be roughly flat compared to the March quarter. Consolidated gross margin excluding special items is expected to be in the range of 41% to 43%. Semiconductor gross margin is expected to be approximately 47%, and systems gross margin is expected to improve to approximately 33%, and each excluding special items.

Operating expenses excluding special items are expected to be in the range of $213 million to $223 million, which is essentially flat to Q1, as we are including within our guidance with the operating expenses associated with 3ware.

In addition, we expect interest income and other and interest expense to net to an expense of $2 million. Special items netting to approximately $65 million to $85 million. GAAP and non-GAAP tax provision to be approximately $6 million for Q2, and for modeling purposes $6 million to $8 million per quarter for the balance of 2009 for both GAAP and non-GAAP.

As a reminder, our tax provisions can vary quarter-to-quarter based on our profitability and different geographic tax jurisdictions, and certain discrete items. We expect Q2 GAAP net loss per share in the range of $0.19 to $0.09. EPS, excluding special items in the range of negative $0.06 to positive $0.01 per diluted share. Share count of approximately 650 million shares for GAAP and non-GAAP purposes. In addition, we expect depreciation and software amortization of approximately $20 million and capital expenditures of approximately $15 million.

Summary, we’ve remained focused on our key objectives resulting in significant progress in our design win activities and product investments, a solid foundation in our cash position and substantial improvements in our cost structure while consistently meeting and or exceeding our key interim and customer milestones.

And now let me turn the call back to Abhi.

Abhijit Talwalkar

Before going to your questions let me offer some very quick closing comments. Our goals are to extend our competitive lead in key product areas, maintain and elevate our design win momentum and effectively manage our cash through this challenging period. Our cash position is strong, enabling us to play offense and continue to invest at levels needed to capitalize on the opportunities we have ahead of us.

This should help us to emerge as a stronger company as economic conditions improve. At the same time, we’ve continued to drive expenses lower and this is reflected in our guidance and results thus far.

Now let me hand it to Sujal for questions.

Sujal Shah

Thank you Abhi. At this point we will begin the Q&A portion of the call. [Rufus], will you please give the instructions for the Q&A session.

Question-and-Answer Session

Operator

Thank you sir. Ladies and gentlemen, to ensure that all participants have an opportunity to ask a question each person will be limited to one question and one follow-up during this Q&A session. You may rejoin the queue if you need to ask any follow-up questions. (Operator Instructions) And for our first question, we go to Sumit Dhanda with Bank of America.

Sumit Dhanda – Bank of America

Yes, hi, good afternoon guys. Couple of questions. First on the gross margins, Bryon, I think last quarter, you had said that storage would finish around 36% and semis would be down a little more than you actually printed at 46%. Help us to understand, why there was a reversal, since your revenues came in little better than expectations in terms of what you printed on gross margins versus the expectations into the quarter?

Bryon Look

Yes, sure Sumit. So, overall gross margins for the Company were down relative to the lower revenue levels and of course that leads to a lower fixed cost absorption, whether that’s on the semiconductor side of our business or the system side of our business. In the quarter, our semiconductor gross margins actually held up quite well. And overall again, we exceeded the midpoint for our guidance in terms of consolidated gross margins. But, clearly on the system side, we had lower than expected gross margins and that was due to two primary factors. One, the lower revenue levels, which drove lower fixed cost absorptions as well as a mix shift in our systems business from the mid to high levels storage systems to more of the entry level systems and I’ll let Abhi comment a little bit further on that.

Abhijit Talwalkar

Yeah, I mean relative to the system gross margins, there are number of contributors that led the gross margins down, first and foremost the overall lower revenue base at roughly 33% decline quarter to quarter, which is consistent with what we’ve seen with companies such as EMC, who had about a 35% decline in their product or their hardware revenues; IBM, in terms of their System Technology Group, had a decline that was close to almost 40% quarter to quarter. So, the decline is consistent with what others have experienced and the current challenging economic environment has definitely brought more pressure to the higher end of the product line, not only for LSI but I think our customers as well as many of our peers and that’s what has driven some of the mix shift. So the lower revenue base driven by the economic environment as well as the mix shift together contributed to also an absorption problem and the lower margins. We believe and as we said in our guidance, we expect to drive improvement in these margins as we go into Q2, driven by a number of factors that will contribute to that.

Sumit Dhanda – Bank of America

Okay, maybe just a let me ask this a different way. On your systems gross margins, where your revenues a lot lower than anticipated because it was 6 point delta versus your initial forecast or was that delta really driven by much more adverse mix than you had forecast during the quarter?

Abhijit Talwalkar

I would say probably revenues were softer but mix was probably the bigger contributor. And again driven by sort of a greater, sort of deferral of some of the higher end systems and what we’re hearing from resellers and business partners and our customers that IP budgets generally remain intact but, there was certainly a level of pause and level that deferral in some of the higher end larger deployments, which impacted the mix, more so than we anticipated coming into the quarter.

Sumit Dhanda – Bank of America

Okay. And then for my follow up, I don’t know if this is important or not but, your quarter ended on was at March 31 or April 5? I mean did you have a couple of extra days in the quarter I was a little, I was not able to make that out from the press release because your prior quarter ended on the 31 of December?

Abhijit Talwalkar

Yes you’re right, the quarter ended on April 5, and so there were a few extra days compared to prior. It’s just a function or here we always end our fiscal year on December 31 and which happens to be sort of mid week and so you end up carrying either carrying a half a week one way or the other in terms of that first quarter.

Sumit Dhanda – Bank of America

And then in Q2, do you have the other half extra week or how does that workout?

Abhijit Talwalkar

In Q2 I believe we also go into July, whatever that Sunday is that would be in the first week of July.

Sumit Dhanda – Bank of America

Okay. And then you’re normalized out for the back half of the year?

Bryon Look

I think we have all that that is going forward on same pattern.

Sumit Dhanda – Bank of America

Okay.

Sujal Shah

Okay. Thank you Sumit. Could we have the next question please?

Operator

And we go next to Craig Berger with FBR Capital Markets.

Craig Berger – FBR Capital Markets

Hey guys nice job, thanks for taking my question. I guess first on the gross margins, why do you expect semiconductor gross margins to fall sequentially?

Bryon Look

Well, if you look at a revenue guidance for Q2, overall in terms of semiconductor, we would expect those revenues to be flat to slightly down. If you broke that out by the different sort of product groups or market areas, our networking is expected be flat to slightly down that does have a somewhat negative effect relative to mix on the gross margin. Also, if you look at where the growth areas are in overall for the company in Q2, we’ve got our systems business growing in Q2 and while the gross margins in that business are expected to improve still as a function, as a percentage of the total, it’s going to have a more of a negative effect in terms of the consolidated gross margin.

Craig Berger – FBR Capital Markets

Next question, I’m a little surprised that storage semis isn’t expected to do better in the second quarter that the PC build seem to be tracking up sequential. It seems like you guys were potentially under shipping and consumption on the first quarter. So why isn't that going to be better than flat?

Bryon Look

Well I mean that this is what our current data tells us Craig based on discussions with customers based on the sort of our current fill rates and booking rates. So we’re watching this very closely and we certainly did end the quarter with strength in terms of where we are right now relative to bookings and fill rates in the quarter, we are actually doing fairly well to just sort of historical times in the quarter.

Craig Berger – FBR Capital Markets

Well last question. Can you just comment on whether you guys were shipping below in consumption rates? Does your current guidance get you back in line within consumption rates? And also can you just help us understand how much of your networking business is legacy versus newer product? Thank you.

Bryon Look

Well, it’s very difficult to answer your first question more so because I don’t know if anyone has a good handle on end consumption rate and what end demand is actually doing, net of all the inventory correction that’s taking place Craig. So I don’t know if you want to rephrase that question or help us understand exactly what you’re asking?

Craig Berger – FBR Capital Markets

Have you seen any inventory replenishment happening among the drive makers?

Abhijit Talwalkar

Yeah, I would absolutely believe our large part of some of the stability that we saw in Q1 was driven by inventory replenishment because inventories were dramatically decreased and probably overcorrected in the fourth quarter. All right, and so we certainly saw that happening definitely in the desktops, which led sort of the strength that we saw in HDD. We’re starting to see some aspects of that in notebook also benefiting from some share gains that we believe, Seagate is experiencing in notebook. So, and that’s why we commented that we exited the quarter with relatively good strength in the HDD business.

Craig Berger – FBR Capital Markets

And the last question was legacy networking versus non-legacy?

Abhijit Talwalkar

Yeah, we don’t break that out at a quarterly level, but I think as we said in the last call, relative to for the year, we expect legacy decline to be somewhere South of $100 million in total for the year.

Craig Berger – FBR Capital Markets

How much of that is already reflected?

Abhijit Talwalkar

Again, we don’t breakout the quarterly numbers.

Craig Berger – FBR Capital Markets

Okay, thanks guys.

Sujal Shah

Thank you Craig. Could we have the next question please?

Operator

And for our next question, we go to Sukhi Nagesh with Deutsche Bank.

Sukhi Nagesh – Deutsche Bank

Yeah thank you. Nice year on the OpEx line there. My question pretends to the storage systems side. Moving towards the end of this year or full year here, how do you guys look at that business, especially given all the turmoil in the market now, with Broadcom a bid on Emulex and a lot of people talking about QLogic and Brocade, maybe disappearing by the end of the year?

Abhijit Talwalkar

Yeah, well none of those potential deals and acquisitions have really any relevance to our storage systems business so, are you questioning our storage systems business and its impact or?

Sukhi Nagesh – Deutsche Bank

Yeah, yesterday or the day before yesterday, Brocade announced exclusive deal with IBM and I’m wondering if?

Abhijit Talwalkar

The deal that Brocade announced with IBM has to do with IBM reselling and rebranding Brocade switches for both Ethernet as well as Fibre channel and converged Ethernet and Fibre Channel, so that again has no impact because those are very different products, different segments of the market.

Sukhi Nagesh – Deutsche Bank

Okay and then..

Abhijit Talwalkar

But relative to our systems business and we continue to believe that, we will be able to drive meaningful growth on that business over the course of the coming quarters here as well as improved from current levels of gross margins, and see gross margins improve, driven by several significant product cycles that we are in the midst of today, as well as new cycles of next generation volume midranges that are coming in the second half.

Sukhi Nagesh – Deutsche Bank

Got it.

Abhijit Talwalkar

By the way the other comment that I can add as well is we have seen an increased level of stability relative to Sun and Sun resellers, since the announcement that Oracle made. In fact, that was a factor to some of the revenue softness that we saw in the first quarter where there was a lot of instability so.

Sukhi Nagesh – Deutsche Bank

Okay. Abhi, you are pretty close to this enterprise storage overall business here. Do you get a sense at this point that maybe for the second half you might see a stabilization of these in the enterprise side?

Abhijit Talwalkar

That’s certainly our expectation and as I said we’ve got a number of additional elements that will give us more confidence and our ability to grow that systems business, again back to the number of product cycles that we expect to drive over the next three quarters.

Sukhi Nagesh – Deutsche Bank

Great, one last question I had, on the hard disk drive side, what are your expectations in terms of total share for your hard disk drive at the, Hitachi for this year or next?

Abhijit Talwalkar

We are not going to breakout specific share but I can’t tell you that we expect our share at Seagate to continue to grow this year and in the next year and in aggregate, we expect our share for SoCs in HDD to continue to grow. And that is based and predicated on the design wins that we have won over the past two years that are at various stages of development and a number of them will start to shipping in the second half of ’09 and then definitely more so in 2010.

Sukhi Nagesh – Deutsche Bank

Great. Thank you.

Sujal Shah

Thank you Sukhi. Could we have the next question please?

Operator

And we go to Hans Mosesmann with Raymond James.

Hans Mosesmann – Raymond James

Thanks. Just a clarification on the previous caller regarding Emulex and the deal potentially here with Broadcom, how do you identify that as friend or foe or neutral? Is Emulex, I guess can be viewed as a customer, as a supplier? Can you go through that process a little bit for us Abhi? Thanks.

Abhijit Talwalkar

Yeah I mean, we generally don’t like to comment and or speculate on what’s happening in the industry especially the deals that have not been consummated, at the same time I mean, Emulex we enjoy a very good very relationship with Emulex, it goes back a long time. Emulex is one of three customers that we have for the Fibre Channel SAN market. Our overall Fibre Channel SAN revenues are 5% or less of the total company of which Emulex is one of three customers. We don’t believe that there would be any immediate impact if such a transaction were to materialize.

Hans Mosesmann – Raymond James

Fair enough. Thank you.

Sujal Shah

Okay, thank you. Could we have the next question please?

Operator

And for our next question we go to Christian Schwab with Craig-Hallum Group.

Christian Schwab – Craig-Hallum Capital Group

Great, thank you. Just on the disk drive storage business followed up on the person’s questions earlier on flat unit demand. Seagate took a number of drives today in finished goods from 21% of future shipments in December to 13% in March and our checks also suggests a possible material share gain at Seagate over the course of this year as they move away from another provider. Would you suggest that flat guidance is conservative?

Abhijit Talwalkar

Well you’re talking about flat guidance. First of all we didn’t guide at the HDD level per se. We’re more so trying to guide at the overall storage semi level. I think what I would go as far as saying that we feel very good about our position and our relationship with Seagate. We also feel very good about the actions that they’ve been taking over the past quarter to increase our overall competitiveness, improve their overall execution and that is starting to materialize in some share gains especially in area of notebook, which is going to continue to grow favorably this year versus the other segments.

Christian Schwab – Craig-Hallum Capital Group

Great I would agree. As we look to the second half of this year, and if we can mean, it kind of looks like that we can return to some very favorable positive earnings and do you think it’s likely as we exit the June, if we just experience modest typical seasonality that the blended gross margins of your business, can return North of 45%?

Abhijit Talwalkar

It’s probably too early for us to guide to specific numbers, but I think our expectations would certainly be at with revenue growth, and we be able to take our margins back, and I think our target still remains for our overall gross margins to be 47%, and for a semiconductor margins to be in the high 40’s, if not better end for our systems margins to recover into the mid to high 30’s. So if it is a kind of a function of not only the revenue recovery here but also the mix of products across each of those bases.

Christian Schwab – Craig-Hallum Capital Group

Okay, thank you. I’m sorry, go ahead.

Operator

For our next question, we go to Romit Shah with Barclays Capital.

Romit Shah – Barclays Capital

Thanks for taking my question. Could you guys just share with us the contribution from 3ware in Q2?

Bryon Look

Yeah, I can comment on that. So relative to the transactions, we closed the transaction on April the 21st, and so we’ll get in terms of our P&L, some additional operating expenses, which we have already factored into our guidance, so on that level basically, we are saying OpEx is basically flat plus the absorption of that spending. On a revenue level, I won’t come I’ll wait for AMCC to comment on the historicals, I don’t think they’ve done that yet for the March quarter and one in fact is they do want to put out there though for everybody is the fact they’ve given the way that business recognizes revenue, which is selling into the channel. There is inventory in the channel so, we won’t see sort of a normal four quarters worth of revenue as we record in our P&L for Q2. But certainly going forward, we are very comfortable with that overall transaction and I'd like to reiterate the fact that we’re also comfortable that should be neutral to our EPS for the full year 2009.

Romit Shah – Barclays Capital

Would you characterize the revenue contribution as being immaterial in Q2?

Abhijit Talwalkar

I would also I mean you can look back historicals, I believe that there were some reported numbers to that business. I think the last reported quarter is roughly $9 million or so revenue in the quarter and that was going back to the December quarter. So it’s an environment where clearly I think a lot of folks are experiencing some softness based on the economy. I think we’ll just kind of wait for further information to come out with the formal reports.

Sujal Shah

Okay thank you Romit. Could we have the next question please?

Operator

We’ll go next to Daniel Amir with Lazard Capital Markets.

Daniel Amir – Lazard-Capital Markets

Thanks a lot. Can you comment a bit on, what’s your visibility a bit on the networking side considering your guidance here on the networking segment and what type of driver should we be looking in that segment, or in terms of new products here for the next 12 months?

Abhijit Talwalkar

Well, I mean in terms of new products and our new investment areas, we continue to be very pleased with that, I think we’ve reported in our prior quarter that we had 2008 revenues grow at 35% over prior 2007 and just this quarter alone in Q1 in a very difficult environment, we saw a growth of again in the 30 to 35% actually higher year-over-year comparison. We’re very happy with the overall ramp of the new products into new segments and new categories that are helping to certainly offset a part of the legacy that we’re experiencing. In terms of what to look for going into the next 12 months, there are number of new products that we expect to continue to support the ramp of this sort of investment area, we have as we talked about in the earnings just a few minutes ago, we’ve got DSP design wins at Huawei, multiple DSP design wins, that are ramping in the production now in terms of wireless, which is benefiting from a strong demand and build out in China that would be fairly relevant this year and probably burst in nature, but nonetheless, it's happening, we have also won a significant DSP win and multiple wins in the volume leader in terms of integrated service routers that we expect to start shipping at the end of this year that will contribute certainly in the next 12 months. We’ve also talk about winning or a 1-gig Ethernet custom sort of multiple solutions in fact across the number one PC and server chipset provider that business we expect to ramp in the second half of this year, as the first of numerous programs begin to ship. So there is a number of new drivers that will continue to help us drive growth for our investment areas in networking at this 30% to 40% level. Relative to visibility, I mean visibility in this environment continues to be limited. The best visibility we have right now is sort of our bookings level coming into the quarter for networking, which generally is high coming into the quarter and we’re very happy with where it is at and certainly supportive of the guidance that we provided.

Daniel Amir – Lazard Capital Markets

Okay, and on the cash side, you obviously have a pretty good balance sheet here and your net cash position is close to $0.5 billion. What is kind of the usage of cash? I mean is there a thought of consolidating in the industry or areas that you feel that you need, your under representative currently in the market that you feel that you need to strengthen it?

Bryon Look

Well, we need to continue to carefully manage our cash as we go through 2009, I think there is still a fair amount of uncertainty there relative to the overall economy. So we are going to be conservative with respect to the use of our cash. There are things that we are looking at relative to the M&A. We don’t generally comment in that area, relative to other purposes for the cash. We do have a convertible notes, which come due in the month of December 2009 so, that certainly one of the things that I’m looking at pretty closely in terms of the right timing with respect to cash going out to a service bad debt.

Sujal Shah

Thank you Daniel. Could we have the next question please?

Operator

We’ll go next to Kaushik Roy with Wedbush Morgan.

Kaushik Roy – Wedbush Morgan

Thank you. Abhi, can you comment on the linearity for Q1, and what do you expect for Q2. I mean April is almost over. What are you seeing now in the inventories in the channels and the OEMs?

Abhijit Talwalkar

We are starting to see linearity return to what we’ve sort of experienced historically, going into Q coming into Q1, the booking levels across our different businesses and sort of fill rates where I would say more so suppressed in the early part of the quarter and came on fairly strong as we saw strength in the last, I would say six weeks or so notably in segments such as hard disk drive as well as the networking. If I look at Q2 and coming into the second quarter, I would say that bookings and fill rates are starting to get back to if not in the number of segments back to sort of our historical experience, which would suggest that inventory supply line and end demand have reached or starting to reach a point of equilibrium, right and so that the big question that remains I think for all us and we are hopeful that there are positive signs out there that end market demand is starting to stabilize but, that’s the unknown still for I think every one of us.

Kaushik Roy – Wedbush Morgan

Right, okay great. Bryan for Q2 do you expect cash flow from operations would be positive?

Bryon Look

Well, we haven’t been providing cash flows on a quarterly basis but I would like to reiterate again our target is to drive positive operating cash flows for 2009 and as I said number of times, we are going to continue to very carefully manage our cash flows and I caution everybody the timing of our working capital can happen in effect on just quarter-to-quarter so, you should really be think about on a little bit broader basis than that. But clearly that will be our focuses continue driving towards that the positive operating cash flows.

Sujal Shah

Okay thank you Kaushik. Could we have the next question please?

Operator

We go next to Suji De Silva with Kaufman Brothers.

Suji De Silva – Kaufman Brothers

Hi guys good afternoon. You guys normally guide to about 55% turn, can you talk about what the turns expectation is? Yeah I think heard Abhi you mentioned that bookings were filling in higher than historical averages?

Abhijit Talwalkar

I mean I don’t know if we've guide the turns we sort of given some color relative to turns level for our different businesses. All right.

Suji De Silva – Kaufman Brothers

And I guess what I am getting at is are you guiding more conservative than difficult in this environment?

Abhijit Talwalkar

We are guiding as we always have guided using the information that we’ve always used in the past to help triangulate on the best possible guidance with the best possible intelligence we have at the time.

Bryon Look

I would say the business still is such that you don’t have a lot of backlog going into any particular quarter and that’s especially issue on the system side of our business so, whether its conservative or not we really don’t know, we don’t have a good handle on that until you really get well into the quarter probably into the towards the end of the second month of the quarter.

Suji De Silva – Kaufman Brothers

Okay that color helps. And then on the storage systems business I think about what gets your guys the gross margin backup towards the target, how are you comfortable on the second quarter in the mix returns from the low end that you saw in the first quarter would give me that [confidence]?

Abhijit Talwalkar

There is number of drivers that give us confidence that we are going to able to improve above Q1 right, recovery back to Q4 levels are going to take longer than that but, we definitely have confidence that we have the ability to improve over Q1 both in terms of top line as well as in terms of gross margin, if I look at top line we have contributors such a new product cycle in our XBB2 class platform, a release of new features on that with 8-gig Fibre Channel which we believe is out there ahead of many of the competitors enabling our customers to be out there first. We also have Sun that started to ramp of that XBB2 platform in the first quarter that will start contributing. I very much believe based on all my sort of touch points with sort of our reseller base and our sales force out that touches end-customers, that there is incrementally more stability today in the Sun reseller base in Sun sales force than there was 4 to 8 weeks ago, and we believe that will contribute to improvement over Q1 and all of these things will also have a factor in terms of gross margin improvement because, revenue levels will be higher and we believe we’ll see some improvement in mix.

Sujal Shah

Okay, thank you Suji. Could we have the next question please?

Operator

And we go next to Blayne Curtis with Jefferies.

Blayne Curtis – Jefferies & Co

Good afternoon guys, couple of questions on your hard drive business Abhi you previously talk about the next gen wins at Seagate is being sole sourced. I was just curious if that's still your understanding and if you've seen other platforms with new suppliers now?

Abhijit Talwalkar

Yeah, I think when we first of all we’ve had a numerous set of wins with Seagate over the past 18 months that we’ve been talking about. The initial ones came back in fact in the first half of 2007, which were the enterprise SoC wins and those as you can imagine by this time are way down the development path and in fact, we continue to believe that will, those will start shipping in the first half of or early part of 2010, which will allow us to meaningfully participate and grow our business in the enterprise space. Relative to comments that we’ve made in terms of sole awards, those were in reference to desktop and notebook wins that we secured in the second half of last year actually sort of mid summer to Q3 timeframe, where Seagate had elected to and decided to, sort of terminate the terminate the ST LSI lines. Right now something that we were involved in this well and that alliance has not received any SoCs for joint development, joint ownership since that point in time, we don’t expect any into the futures that alliances now sort of ended relative to new programs, and those are sole source wins. Relative to the latter part of your question, in terms of any new competitors, I mean here is my simple view on this and this is based on experience over the last four years of development cycles. If a competitor was awarded a an SoC in the second half of 2008, as Seagate started driving a different strategy that particular SoC, would not see the light of day in terms of production revenues for likely at least a minimum of two years. Right and that would be pushing very, very hard and probably on the shorter end of things Right. So, and while that is happening we continue to grow our position across these notebook and desktop and enterprise and that's why we continue to reiterate that we expect our business level with Seagate from here on out to continue to grow and our share to grow.

Blayne Curtis – Jefferies & Co

Great. And then on the enterprise controller you kind of touched on it but, that business has come down as the Marvel SoC has ramped. When that inflection point you said you should start to see first half of ’10 maybe your SoC ramp back in, is that business kind of a very low state today or is there still more to go to come down as you go through the year.

Abhijit Talwalkar

It's at a low state. So, we see that as very meaningful upside in 2010.

Sujal Shah

Okay, thank you Blayne. Could we have the next question please?

Operator

And we go next to James Snyder with Goldman Sachs.

James Snyder – Goldman Sachs

Good Afternoon, and thanks for taking my question. I was wondering to get start off on the systems business for a moment. Could you talk what percentage of your systems business was low end systems in the quarter and what you expect for that next going forward I think you talked about high-end coming back-end but, if you could just provide some more color on that that will be great?

Abhijit Talwalkar

Hey we don't breakout the mix across the different segments, so difficult for me to give you that granularity and answer that question.

James Snyder – Goldman Sachs

Okay. Well then I guess maybe could you address it by talking about. How you expect the mid range in high-ends that systems business profiles would go as we move through out the year?

Abhijit Talwalkar

Well I mean certainly our goal and our desires to continue to grow that sort of high end of product line as well as the volume mid range and get it back to sort of historical mix levels and we believe that will occur through a number of contributors, one is certainly improvement in the overall economic conditions, as we’ve said earlier, we believe that the IT projects and budgets are there, and the pipeline is there and we see the visibility, but there has been some deferral of these high-end sort of systems. While all this is happening, we've seen tremendous growth in the entry product line as we’ve been selling that to three or four major OEMs, and in fact we saw unit growth from a year-over-year standpoint that was in the 50 to 75% range so we’ve seen terrific growth there. But back to the midrange in the high-end, it’s going to be driven through improved economic conditions, significant new product cycles both in our XBB2 flagship platform. As well as refreshing our volume midrange platform, that is well over three years old. And that's going to bring a lot of new technology, and will also allow us to improve our ASPs.

Bryon Look

The revenues in the entry and the midrange, they are both very meaningful and they both expected to grow as we move forward here and it’s baked into the guidance that we provided.

Sujal Shah

Okay, thank you Jim, I believe we have time for one more question.

Operator

And that question will come from Shawn Webster with JPMorgan

Shawn Webster – JPMorgan

Great thanks for squeezing me in guys. Abhi you spent some time in the beginning talking about some of the tailwinds, a lot of folks in the industry have in terms of wireless infrastructure build out and others, and I was wondering, if you could us a sense either for Q1 specifically or maybe for 2008, what percent of your revenues were from the wireless infrastructure market?

Abhijit Talwalkar

Hi Shawn, we don't break that particular number out, but we do have quite a bit of content in wireless infrastructure both a legacy but, also new content and its in the form of baseband solutions both legacy as well as new, it’s in the form of network processors that’s in that wireless sort of infrastructure. And as I’ve said earlier, we also benefit from wireless growth because there is a whole bunch of infrastructure that has to connect up to that wireless, kind of the back end of that and we are participating there across most of the players again through things like network processors and through DSPs that will be used in sort of media gateways within that infrastructure.

Shawn Webster – JPMorgan

Okay.

Abhijit Talwalkar

And clearly some of the strength that we saw in Q1 was because of our participation in wireless.

Shawn Webster – JPMorgan

Okay. Thanks. And then separately on the restructuring charges, the $25 million can you give us a sense of how much was cash? What was the composition of that? It sounds like it’s going to be similar in Q2 and maybe give us a sense on when the restructuring charges will be done with?

Abhijit Talwalkar

Sure, relative to the restructuring charges $25 million for Q1 cash, non-cash since I don’t have in front me that’s probably roughly about half you got more than half of that actually is non-cash. The lion share of that has to do with some software terminations and software contract terminations. So effectively, non-cash item and of course there is some cash related to the headcount reductions that occurred in the course of Q1.

Sujal Shah

Okay, thank you Shawn. I would like to thank all of you for joining us this afternoon. If you have any additional questions please call investor relations at LSI. Thank you and have a nice day.

Operator

And ladies and gentlemen, a telephonic replay of this conference will be available beginning today at approximately 6:00 PM Pacific Time, and will run through 10:00 PM Pacific Time on May the 6th. The replay access numbers are 1-888-203-1112. Again that’s 888-203-1112 within the United States and Canada or at 1-719-457-0820. Again that’s 719-457-0820 for all other locations. The replay passcode is 6379491 that is 6379491. The webcast will be archived at www.lsi.com/webcast.

That does conclude your conference for today. Thank for your participation. You may now disconnect.

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Source: LSI Corporation Q1 2009 Earnings Call Transcript
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