LSI Corporation Q1 2010 Earnings Call Transcript

Apr.28.10 | About: LSI Corp. (LSI)

LSI Corporation (NASDAQ:LSI)

Q1 2010 Earnings Call

April 28, 2010 5:00 PM ET

Executives

Sujal Shah – Vice President, Investor Relations

Abhi Talwalkar – President and CEO

Bryon Look – Executive Vice President and CFO

Analysts

Kaushik Roy – Wedbush Securities

Blayne Curtis – Jefferies

Craig Berger – FBR Capital Markets

Sukhi Nagesh – Deutsche Bank

Parag Agarwal – UBS

Daniel Amir – Lazard Capital Markets

Allan Mishan – Brigantine

Hans Mosesmann – Raymond James

Harlan Sur – JP Morgan

Mark Heller – CLSA

Sanjay Devgan – Morgan Stanley

Mark Delaney – Goldman Sachs

Operator

Ladies and gentlemen, thank you for standing by. 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. 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, Sujal Shah, Vice President of Investor Relations at LSI. Please go ahead.

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 results and guidance for the second quarter of 2010.

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 copies 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 investors who are new to LSI.

I 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, 2009.

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

Abhi Talwalkar

Thank you, Sujal. Good afternoon and welcome. I continue to be pleased with our execution and progress we are making across our businesses. Just last month, we held an event with analysts and investors where we talked about the successful transformation of LSI and the strong opportunities we have for growth as we move forward.

We appreciate all of the positive feedback we’ve received from analysts, existing holders and potential new shareholders following this event. I will reinforce some of those highlights today and also provide further updates in each of our businesses.

For Q1, revenues were at the high-end of the upwardly revised guidance range that we provided in mid-March. We grew 9% sequentially in our semiconductor business driven by increases in networking standard and custom products, SAN and IP licensing.

We also have revenue significantly above typical seasonality in our storage systems, HCD and SAS businesses reflecting improving end demand. Our first quarter non-GAAP operating margins were 11.7%.

LSI generated a double-digit operating margins in the first quarter of the calendar year, which is typically our weakest seasonal quarter, demonstrating the operating leverage we have created to the transformation of the company. During the quarter, we also repurchased $26 million worth of stock under our $250 million share repurchase authorization.

Before I talk about our businesses, here are the key takeaways that I would like you to get from this call. First, we continue to secure significant design wins with industry leaders across our businesses.

Second, we are positioned to grow faster than the markets we serve and third we are executing for our business and financial milestones and our focus on delivering solid progress, against our business model this year.

At our Analyst Day event last month, we showed the transformation at LS -- that has occurred at LSI over the past several years. This included focusing on fewer and larger end markets going after established and growing applications and narrowing our focus to market-leading customers.

This focus, combined with product leadership has resulted in a design win pipeline that is unprecedented in value and robustness for LSI. Our annual design win values over the past few years in our semi segment have been in the range of 1.5 to 2 times higher than our reported annual revenues in that segment.

Additionally, in our networking business, our strategy is resulting in an improved design win conversion rate, which is percentage of design win value that we expect to reach production and materializing the revenue. All of this gives us great confidence in the future revenue growth.

I’m very pleased that we are successfully executing on design win milestones we outlined. Last year, we had told the investment community that we would expand our customer base and HCD and growing SAS. Last month, we indicated that we had one SoC’s across all five HCD OEMs and that two of the top three server OEMs chose LSI SAS RoC and ServerRAID solutions for the 2011 [Intel RAM] server generation.

We also successfully intercepted the solid state drive market at the right time and continue to win with market leaders in networking, where we announced our first major Axxia network processor win at one of the top two wireless infrastructure players.

We are also solidly positioned in markets that have strong growth projections and low volatility. Overall, we believe our end markets have recovered considerably from the economic downturn and, supply and demand continue to be in balance. While the supply chain has been tight, we have managed to meet customer demand requirements.

In fact for Q1, we believe that LSI’s performance was in line or better than our served markets. Our external storage and HCD businesses performed roughly in line with IDCs estimates of end market performance for the first quarter. We believe that we out grew the market in our server and storage connectivity businesses and in networking standard and custom products for Q1.

Now I want to review with you the business highlights for last quarter in our storage and networking businesses. I’ll begin with storage systems, which includes both external storage systems and server RAID adapters and software.

In our storage systems business, our first quarter revenues was highest ever for the first quarter of the year, building on Q4’s record results, we now have two quarters in a row of record revenue performance.

Going forward, we are expanding our opportunities for continued growth. Healthy storage demand drivers are expected to fuel strong capacity growth and these industry trends are aligned with our core capabilities.

Based on our analysis of IDC’s storage systems tracker, we are the number one provider of entry-level external storage systems to our OEM customers. Entry-level is the fastest levels storage systems segment and in the second half of this year, we expect to ramp a new platform that will help us extend our leadership in this space.

The new platform is based on LSI’s highest performance 6 gig SAS storage processor and will offer up to four times the performance and twice the capacity compared with our current industry-leading platform. It brings mid-range performance, connectivity and functionality to entry price points.

A key expansion opportunity in entry-level systems is in a white box market. IDC estimates that 42% of entry units are supplied by non-Tier 1 OEMs. This is a substantial opportunity for LSI to pursue a $1.6 billion year market that we are not currently serving through our traditional OEM customers.

Through our MegaRAID and 3ware products, we already serve much of this segment and our goal is to expand our presence by adding non-branded entry-level storage systems building blocks to our offerings in this channel. Whitebox system builders will be able to integrate these storage building blocks into their branded product offerings.

We’re also pleased with our competitive position at Oracle. Oracle recently posted a PDF on their website to address their partnership with Hitachi Data Systems. We believe there have been positive developments for LSI, including determination of the HDS relationship. This will give LSI more room to grow and Oracle also mentions support for technology partners associated with the 6780 system and 6000 series, which is all leveraging LSI’s storage system technology.

In our ServeRAID business, we continue to raise the bar relative to our competition by leveraging our leading SAS silicon and adding advanced data management capabilities. During the quarter, we announced four new data management offerings that will be released throughout this year and that addressing key end-user paying points. These were fast pass for boosting SSD I/O performance, safe store for data security, cascade for SSD data sharing and data snapping recovery, which is similar to snapshot and recovery available on external storage systems today.

I’ll now turn to storage semiconductors, which includes SAS, SAN and HDD. In SAS, we have the broadest portfolio solutions and continue to extend our leadership. Since the inception of SAS, LSI has shipped nearly 20 million SAS-based products across our full portfolio, which is over 10 times more than the units shipments of our nearest competitor.

By offering best in class SAS technologies, assured interoperability and single vendor support, LSI is the silicon systems supplier of choice for top OEMs. In fact that S&W, we demonstrated 1 million input outputs per second with our PCIe Based Solid State Storage Solution in a single server, further demonstrating our performance leadership in the space.

Based our broad portfolio and technology leadership, market leading customers continue to choose LSI solutions. Our next generation SAS RoC and RAID software have already been chosen by two of the top three x86 server OEMs for their 2011 [Intel RAM] regeneration servers. These wins position us well to secure [RAM] regeneration wins at other top server OEMs.

We have announced new products to further our growth in SAS. Our PCIe Based Solid Stage Storage Solutions are under evaluation at 10 customers and we have already secured the first design win.

In addition, we sampled the industry’s first series of 6 gig SAS Switches to customers which significantly extend the capabilities of SAS and direct attached storage environment. In external storage, we expect to gain share as SAS replaces fiber channel as the distant host interconnect. Over five customers are using LSI SAS bridge an Expander Solutions in external storage applications including Dell, Oracle, IBM, NetApp, as well as Dot Hill.

Turning to hard disk drives, we are executing on all the milestones we have set and are clearly positioned to grow SoC share as our solutions are increasingly deployed by customers.

Our competitive position is dramatically improved since we accelerated our regional development cadence and hit the market inflection point with the industry’s first 40-nanometer LDPC solutions. The net result is that over the past several years we’ve gone from being an SoC supplier to one customer to expanding our customer base with SoC wins at all five HCD OEMs.

Our HCD team is now focusing on successfully executing on all of these new wins and key development programs. In fact, we’ve already taped out the first SoC for one of our new HCD customers.

Now I would like to review the networking business where LSI is bringing strong differentiation to customers. The wireless segment in particular is a key focus area for LSI, for traffic levels are increasing dramatically driven by smartphones and portable PCs.

Mobile data traffic is forecast to grow at a compound annual growth rate of 100% between 2009 and 2014. This traffic management challenge becomes even more complex with increasing levels of video content across the wireless network. To meet this challenge, carriers have to deploy new base station and media gateway architectures that deliver significantly higher capacity and far greater capability at lower system costs and power.

Last quarter at Mobile World Congress, we announced and sampled our end-to-end next-generation wireless architecture and platform with three multicore solutions for wireless applications.

The Axxia Communication Processor which paves the way for single multi-radio access network, StarPro Media and Baseband for DSPs, which provide higher performance for video streaming, enabling higher traffic loads at lower cost and a new Link Communication Processor that allows network traffic to be easily and efficiently migrated from existing networks to next-generation Ethernet and IP networks.

This portfolio of multiprocessor cores is based on a scalable and unified architecture which enables customers to drive common investments resulting in more efficient development efforts. This foundational approach is creating multigenerational design wins for LSI key customers.

All of the five top wireless infrastructure OEMs are currently using LSI products and we expect this new portfolio of products to extend our footprint within these customers. Last quarter, one of the top two wireless infrastructure OEMs shows our recently introduced Axxia processor for their next-generation multi-radio base stations and wireless gateway platforms.

Now, let me hand the call over to Bryon, who will take you through our results and provide guidance.

Bryon Look

Thanks, Abhi. Let me start by saying we had a very strong Q1 2010. Seasonal buying patterns by enterprises typically cause a sequential decline in our first quarter revenues. However, we delivered first quarter revenues, which were sequentially flat to Q4. First quarter revenues also represented a significant improvement relative to Q1 of 2009 when we were all experiencing the effects of the economic downturn.

On a year-over-year basis, consolidated revenues were up 32%. Consolidated gross margins excluding special items were up 500 basis points. Operating margins, excluding special items went from negative 1.7% to a positive 11.7%. Operating cash flows improved $116 million going from negative $10 million to positive $106 million. Our net cash balance was up 39%, as compared to Q1 2009. In addition, we will be debt free before the end of Q2.

During the downturn, we maintain a consistent focus on product development in support of a strong pipeline of design wins while prudently managing expenses and sustaining a strong cash position.

In addition to significantly beating the original Q1 guidance we provided in January, we met or exceeded the revised guidance we provided in March on revenue, gross margin and EPS.

And now some highlights from the recent quarter. Revenues were $637 million, exceeding the midpoint of our increased guidance by $7 million and sequentially flat from Q4 2009.

Consolidated gross margins excluding special items were 47.7% improving sequentially by 30 basis points. Operating expenses, excluding special items were approximately $229.5 million.

Non-GAAP earnings were $0.14 per share, which is above the high-end of our revised guidance range. We recorded a net tax benefit of $19 million in Q1, which included a favorable $28 million tax item related to the exploration of statute of limitations. If not for this item, we would have reported non-GAAP EPS of approximately $0.10 per share, which is above the midpoint of our revised guidance.

Operating cash flows were very strong at $106 million. And finally, total cash and short-term investments increased to slightly over $1 billion and net cash or cash and short-term investments net of total debt increased to $666 million.

And now turning to a more detailed discussion on the quarter beginning with revenues. Semiconductor revenues for Q1 were sequentially up $35 million or 9.2% to $416 million significantly stronger than normal seasonality. In addition, revenues were up 28% as compared to Q1 2009.

Our storage semiconductor revenues, which include hard disk drive silicon, SAS standard components and storage area network ICs, were sequentially up $12 million or 4.4% to $286 million. Storage semiconductors represented 45% of total revenues in the first quarter.

Q1 revenues in our networking business were $114 million, sequentially up $19 million or 21% and represented 18% of total revenues for the quarter. Revenues for the IP business were up in the first quarter at $16 million.

And turning now to our storage systems business, which includes both external storage systems and server RAID adapters and software. Storage systems delivered a record Q1 in terms of revenues at $221 million. On a sequential basis, revenues for the systems business were down $36 million or 14% from Q4 2009, primarily due to seasonality. This represented, however, a 40% improvement in systems revenues, as compared to Q1 2009. The storage systems segment represented 35% of LSI’s total revenues in the first quarter.

Moving next to gross margins, LSI’s consolidated Q1 gross margin, excluding special items was 47.7%, which was sequentially up 30 basis points from Q4 ‘09. Semiconductor gross margins, excluding special items, sequentially increased 10 basis points from the fourth quarter to 52.0%. Storage systems gross margins for the first quarter, excluding special items sequentially declined 80 basis points to 39.8%, primarily due to seasonally lower revenues.

Moving to operating expenses, R&D together with SG&A expenses, excluding special items totaled $229.5 million in Q1. The sequential increase in Q4 is primarily due to the reinstatement of compensation and benefit programs we suspended early in 2009, along with lower relative spending in Q4 due to the vacations and shutdowns we had during the final quarter of 2009.

Non-GAAP operating income as a percentage of total revenues for the quarter was 11.7%, or $74.7 million. Interest income and other net of interest expense, excluding special items was a loss of $1.1 million for Q1.

And now, let me turn to the special items we recorded in the first quarter, which netted to $70 million. Special items, primarily non-cash included $40 million in amortization of acquisition related items, $16 million of stock-based compensation expense and $13 million of net restructuring costs and other items. Included in the $13 million of net restructuring costs and other items was a $12 million write-down of equity securities.

Moving next to tax, our tax provision on both a GAAP and non-GAAP basis can vary significantly quarter-to-quarter, based on our profitability and different geographic tax jurisdictions and certain discreet items. Such a discreet item occurred in Q1, which related to the expiration of statutes of limitations. This release was included in the net tax benefit of $19 million we recorded in the quarter versus the $8 million tax provision we guided to in January.

As noted earlier, if not for this item, we would have reported non-GAAP EPS of approximately $0.10 per share, above the midpoint of our revised guidance.

On a GAAP basis, first quarter net income was $23 million, or $0.03 per share. Net profit excluding special items was $92 million, or $0.14 per share. Keep in mind that both the GAAP and non-GAAP results recorded in Q1 include the above mentioned $19 million tax benefit.

Share count for the period for GAAP purposes was 664 million shares and 690 million for non-GAAP purposes. The reported non-GAAP share count was higher than GAAP due to the exclusion of 26 million shares related to our outstanding convertible debt. When calculating non-GAAP EPS for the period as a result of the non-GAAP profitability level.

And turning now to the balance sheet and cash flows. We continue building a solid cash position. First quarter operating cash flows were quite strong, coming in at $106 million. Positive operating cash flow was driven primarily by operating performance coupled with a continuous focus on efficient management of working capital.

Our cash and short-term investments increased ending the March quarter at just over $1 billion. Relative to the $250 million share repurchase program we announced in March, we utilized $26 million to repurchase 4 million shares during the first quarter. LSI’s net cash position at the end of the quarter improved sequentially by approximately $54 million to $666 million.

Finally with respect to Q1 results, depreciation and software amortization was $26 million and capital expenditures were $15 million.

The following is our guidance for Q2 2010. Revenues in the range of $635 to $665 million, at the mid-point this is sequentially up approximately 2%. We expect our storage systems business along with our storage and networking semiconductor businesses to be sequentially up in Q2.

Consolidated gross margin, excluding special items is expected to be between 46.7% and 48.7%. We expect gross margins, excluding special items to be approximately 52% for the semiconductor segment and approximately 38% for the systems segment.

Operating expenses, excluding special items are expected to be in the range of $228 million to $238 million as we continue to invest supporting our strong design win pipeline.

Interest income and other net interest expense is expected to net income of approximately $1 million. Special items are expected to net to approximately $50 to $70 million. The GAAP and non-GAAP tax provision is expected to be approximately $9 million for Q2. We expect Q2 GAAP net income per share in the range of negative $0.03 to positive $0.06, and EPS excluding special items to be in the range of $0.08 to $0.14.

The share count is expected to be approximately 664 million shares for both GAAP and non-GAAP purposes. In addition, we expect depreciation and software amortization of approximately $26 million and capital expenditures of approximately $15 million. Also we will repay the $350 million of outstanding convertible notes when they mature in May after which LSI will be debt free.

In conclusion, we are emerging from the economic downturn well-positioned and excited about our prospects to drive growth going forward. Our focus for 2010 remains consistent. Deliver sustainable top and bottom line growth to drive continued progress toward our business model. Continue to drive cash generation and maintain a solid balance sheet and drive continued design win momentum for future growth.

And now, let me turn the call back to Abhi.

Abhi Talwalkar

Thank you, Bryon. Before we go to your questions, let me just reinforce that the management team is focused on making solid progress towards our business model. We have a number of catalysts for topline growth, initiatives gross margin expansion and expect to grow operating expenses at a lower rate than both revenue and operating income growth.

Let me hand the call back to Sujal.

Sujal Shah

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line of Kaushik Roy with Wedbush Securities.

Kaushik Roy – Wedbush Securities

Thanks and congratulations. Two questions and both are on gross margins. Bryon, you said that systems gross margins will be down to 38%. Can you help us understand why?

Bryon Look

Yeah. Sure. If you, first of all, let me reinforce everybody, in terms of our Q1 gross margin performance, which is very strong, we’re already operating at or above our business model targets. Q1 was strong and what was typically, a seasonally low quarter.

As we think about the progression to Q2, we see a few minor mix changes as well as some benefits that we had in [period] costs in Q1, which revert back to more normal levers. For example, we had a lower than normal warranty cost in Q1, which drove significant gross margin performance in the quarter. We’ll have more typical levers Q2.

But let me reiterate, the Q2 gross margin guidance we have for systems at that approximately 38% range, we would consider to be very good for that level of revenue and at this point of time of the year and we’d expect to kind of build from that point.

Kaushik Roy – Wedbush Securities

And my follow-up is also on gross margins. At Analyst Day you said, for the full-year you are expecting 47%. Now it seems like two consecutive quarters, I mean Q1, Q2 were -- usually your gross margins are the lowest, you are above that range. So should we consider more than 40% for the full year or we should think of it differently?

Bryon Look

Well, we’re not providing updated guidance for full year gross margins, but clearly given our performance in Q1, we are in a very strong position. We continue to maintain strong focus in terms of driving improvements in terms of our productivity and cost structure and so forth. And we are pleased with the fact that we are currently operating at or above the overall gross margin target. So we’ll keep -- and that will be a function, of course, volume levels, product mix and continued improvements in terms of our period expenses.

Kaushik Roy – Wedbush Securities

Great. Thank you.

Bryon Look

Thank you, Kaushik. Can we have the next question, please?

Operator

Your next question is from the line of Blayne Curtis with Jefferies.

Blayne Curtis – Jefferies

Hey, guys. How’re you doing?

Bryon Look

Very good. Thank you.

Blayne Curtis – Jefferies

The networking business that you have been fighting, when are trying to get above $100 million. You finally did. Can you maybe give a little color as two where the strength came from, growth areas versus legacy?

Bryon Look

Well, we saw overall strength across both the go forward as well as legacy. I think the overall networking markets that we participate in saw growth Q4 to Q1 because of the build out, a lot of it in wireless. And I think some of our networking centric peers also demonstrated good growth. We had even better growth because of the strength of our go forward networking business, which is both benefiting from end demand environment improvements but also share gains, as more of our design wins kicking the production. We also had better than anticipated legacy strength, as some of the phase-out plans were delayed, as people were chasing support for the wireless build out that’s been taking place. I mean those are the two major contributors to the strength of our business. But we’re very happy with the progress in our go forward networking areas.

Blayne Curtis – Jefferies

Yes. And I know you get asked this every quarter, but as far as the falloff, I know it’s hard to predict that business, but are you still expecting that legacy business to falloff this year?

Bryon Look

Well, we had been saying at the beginning of the year that people should think about a $50 million to $71, sort to drop over the course of the year, not necessarily providing quarterly guidance. I think given where we are at this point of time of the year, it’s likely going to be on the lower end of that range. But very difficult to say at this point in time but I think that’s what you should still be thinking about.

Blayne Curtis – Jefferies

Got you. And then just one, quick one for Bryon. Did I miss something in the gross margin? Did IP gross margin fall down in the quarter?

Bryon Look

Our overall semiconductor gross margins, which include the IP, would be strong.

Blayne Curtis – Jefferies

In the March quarter, with 52% semi and 39%.

Bryon Look

We did have an increase in terms of our IP revenues in the quarter, so that was posted at $16 million of revenue for Q1

Blayne Curtis – Jefferies

Got you. Okay. Thanks, guys.

Abhijit Talwalkar

Thanks, Blayne. Can we have the next question, please?

Operator

Your next question is from the line of Craig Berger with FBR capital markets.

Craig Berger – FBR Capital Markets

Hey, guys. Thanks for the question and nice job on the results. I guess one question I had is just also on the IP. What’s the kind of forward outlook there? Is 16 the new baseline?

Bryon Look

No. I say we maintain a strong pipeline in terms of our IP opportunities. We have a good capability there. It’s going to vary from quarter-to-quarter. We remain committed to the goal of driving IP revenues on a year-over-year basis to be higher. And I think we are very comfortable that how we’ve begun the year here.

Craig Berger – FBR Capital Markets. I see. I guess I’m just asking because you guys used to do in the 20s sometimes in that business. I’m just trying to figure how to model that line item this year.

Bryon Look

I think, Craig, as we have talked in several past calls. We have had challenges over the prior three, four quarters, relative to the IP business just given the overall economic environment. And the incremental challenge that that’s presented in terms of getting value for our licensing activity. We are happy with what we started out this year. We said that we would grow this year relative to last year and we feel pretty good about being able to do that. And so we’re guiding that up into the next quarter as well.

Craig Berger – FBR Capital Markets

I see. Thank you. And just a follow-up on the storage IC business you guys used to do, in a kind of 3 to 330 range, a quarter in 2008, your guidance can get you back up towards 300. When do some of these new design wins start to kick in that take us back to prior peak or potentially even better? How long before we see some of that contribution? Thanks.

Bryon Look

Well, I think we’re going to start to see that contribution here fairly soon. Storage ICs, the number you alluded to, also included some of the older enterprise, hard disk drive revenues that had been declining on us, which, that headwind has completely gone and is behind us now. And with the design wins that we secured over the past two years and those starting to come into production, as we speak and certainly into the second half, we we’ll continue to see solid growth in this business, across all segments within storage segments.

Craig Berger – FBR Capital Markets

And so last question, we’ve had a stronger than seasonal first-half. Should we be thinking about a muted second half, given that elevated base or do you think we can continue to maybe track towards seasonal growth in the second half? Obviously, it’s still kind of far away.

Bryon Look

I’m not going to give you guidance relative to the second half, by I will give you my perspective and color. The second half for us, given the enterprise centric sort of composition has generally been historically, much stronger in the first half and we are on the 10% to 12% sort of range. If I look at the second half at this juncture, what I would go by is overall economic indicators are generally positive. Tech demand has certainly been recovering. Corporate spending relative to enterprise has still yet to really kick in. And then from an overall supply demand standpoint, I’d say the supply line relative to demand has sort of aligned itself nicely. I’m not concerned about inventory. So all of those things bode towards growth in the second half, but I’m not going to place a percentage number on that for you at this time.

Craig Berger – FBR Capital Markets

Thanks for the color.

Abhijit Talwalkar

Hey. Thank you, Craig. Can we have the next question, please?

Operator

Your next question is from the line of Sukhi Nagesh with Deutsche Bank.

Sukhi Nagesh – Deutsche Bank

Hi, guys. Thanks for taking my question. Nice results, by the way. If you look back in history, your second quarter has grown on an average of about 10%. I’m just trying to figure out, given your current guidance of flat up 4%, can you just walk us through why we are kind of maybe below your historical average here?

Bryon Look

Our historical average if you go back over five years, it wouldn’t be 10%. Certainly there has been years here and their relative to just different cycles of product cycles and customer inventory situations, but if you really normalized those one-time things out, our Q1 to Q2 sort of growth has been sort of in the range that we are guiding Q2.

And I think if you look at all the other proxies relative to PC and server growth, Intel being a good proxy, you look at our customers in the form of the Seagate and WD, in fact our guidance is a little bit better than what those proxies are guiding for the second quarter.

Sukhi Nagesh – Deutsche Bank

Okay. And for the June quarter guide in the top line, you said, both the storage semi business as well as systems is as close to grow q-on-q. What do you expect to decline? Do you expect any metrics in our IP to decline or?

Bryon Look

No. We’re not expecting anything to decline. Certainly the growth rates across these businesses vary, but all business are expected to grow Q1 to Q2.

Sukhi Nagesh – Deutsche Bank

Okay. Thank you.

Abhijit Talwalkar

Thank you, Sukhi. Can we have the next question, please?

Operator

Your next purchase from the line of Parag Agarwal with UBS.

Parag Agarwal – UBS

Hey. Thanks for taking my question. I just wanted to build down on the gross margin for semis. It feels that your networking business is growing very fast and like your design wins, it should continue to grow. So as that business grows and you have an additional design wins sampling in the second half. How should we think about your semiconductor gross margin?

Bryon Look

Well, Parag, our objective as we discussed at the analyst event is, is to continue to drive our semiconductor gross margins higher. We should be driving to higher levels in the 52% that we demonstrated in Q1. We’re not going to put a timetable or a particular, watermark out there that we’re driving two. But the confidence that we have, I think, stems from the fact that we will have increasing scale with our semiconductor business, as SoC share gains continue to add to our revenue.

Our SAS business continues to grow, as well as you’re point, our networking business. At this point of time of the year, we actually expect our networking business in aggregate, inclusive of legacy to be positioned to grow as well in 2010. So all those things bode for improving semiconductor gross margins and I think we should be able to continue to drive that growth into 2011.

Parag Agarwal – UBS

Okay. And coming to OpEx, at Analyst Day you said that OpEx is going to grow 1 to 2% for the quarter in 2010. Given the current outlook, you are still maintaining that target or is there any update to that?

Bryon Look

We’re still very comfortable with what we said last month relative to operating expense growth in the course of the year. A key part of that was our commitment to drive topline, our revenue growth as well as operating income growth, substantially ahead of OpEx. So yes, we definitely remain committed to that.

Parag Agarwal – UBS

Thank you.

Abhijit Talwalkar

Thank you, Parag. Can we have the next question, please?

Operator

Your next question is from the line of Daniel Amir with Lazard Capital Markets.

Daniel Amir – Lazard Capital Markets

Hi. This is Lorraine for Daniel. Can you guys comment on the backlog in your visibility right now?

Bryon Look

Visibility for the second quarter is a certainly good. Backlog in terms of both backlog and turns is sort of consistent with -- I would say past Q2s. In terms of visibility in the second half, certainly less visibility from that standpoint. But I’ll go back to the comments that I made to Craig Berger relative to our second half perspective.

Daniel Amir – Lazard Capital Markets

Very good. And then just to be clear, you expect networking IP’s and storage semis and semi to all be up, next quarter?

Bryon Look

That’s correct.

Daniel Amir – Lazard Capital Markets

Okay. Thank you.

Abhijit Talwalkar

Okay. Thank you. Can we have the next question, please?

Operator

Your next question is from the line of Allan Mishan with Brigantine.

Allan Mishan – Brigantine

Hey, guys. Nice job. And I just wanted to clarify some of the comments you made in your prepared remarks about storage semis. So did you say that the SAN components was higher sequentially, but that HDD and SAS were down but above seasonal, or were the latter to actually up as well?

Abhijit Talwalkar

No. We said that HDD and storage systems were sort of above seasonal, right? Basically all segments were above seasonal. But in terms of HDD and storage systems, we said that they were in line with sort of end market growth. Whereas our storage and service components, which is inclusive of sand, actually outgrew the market, Q4 to Q1.

Allan Mishan – Brigantine

Okay. Great. That’s helpful. And then in your Q2 guidance, do you include a ramp of any new enter projects, C programs or is that something that could be upside if it takes place?

Bryon Look

It’s insignificant.

Allan Mishan – Brigantine

Okay.

Bryon Look

No. It’s small, yeah.

Allan Mishan – Brigantine

Okay. Thanks for a much.

Abhijit Talwalkar

Okay. Thanks, Allan. Can we have the next question, please?

Operator

Your next question comes from the line of Hans Mosesmann with Raymond James and Associates.

Hans Mosesmann – Raymond James

Thanks, congratulations. A couple of questions. Abhi, can you give us a sense of what you’re seeing in the channel and at OEMs in terms of inventories and what is your opinion on your current inventory position and how you would expect that to trend here over the next quarter? Thanks.

Abhijit Talwalkar

Yeah. I would say inventories are in pretty good shape. Still probably, not quite at modeled but there was some further inventory replenishment that took place throughout the quarter. But I would say across, most of our product lines and the visibility that we have in the customers, I’d say inventories is still not quite at modeled relative to a lot of the different segments. That’s why we’re confident that we don’t have an inventory situation. And then in terms of channel and when I think about channel, I think about sort of the white box-channel that services 20%, 30% of the server market. There we’ve seen great sell through and they’re I would say that we are right about at modeled for inventory, so no concerns there from an inventory standpoint.

Hans Mosesmann – Raymond James

Great. Thank you and congratulations.

Abhijit Talwalkar

Thank you.

Bryon Look

Thank you, Hans. Can we have the next question, please?

Operator

Your next question is from the line of Harlan Sur with JP Morgan.

Harlan Sur – JP Morgan

Thank you, good afternoon. And thanks for taking my question. Within your storage systems business, you are doing quite well on the entry-level side. I think Abhi, you said your number one in market share now. Just curious as to how the margins for these products compare with the margins for your mid-range systems?

Abhi Talwalkar

Well, I mean the margins, it depends because we’ve got different business models with our different customers. Some take complete systems, some take just controllers and so forth. We’re not going to break out the margins in particular for those, software attached also is a factor. So it’s a bit of a complicated question and it’s not something we’re going to provide a level of granularity on.

Now I want to also comment that are midrange business has done very well also. The last three quarters, especially relative to our combined efforts between LSI and IBM, we have seen solid midrange growth, grow faster than the market. Share gains in this particular space. If I look at our high-end midrange product and in terms of its mix in Q1 of 2010 versus 2009, significantly higher, significant year-over-year units growth. It also tells me that in customers are starting to buy up again. And it’s a pattern that we’ve now seen for several quarters.

Harlan Sur – JP Morgan

I guess on those, just sort of feeding on top of that. So of the incremental growth that you seen in your midrange systems business, how much of that is just enterprise and IT spending and server capacity build-outs versus sort of the success that you’re seeing and market share gains with the midrange platforms?

Abhi Talwalkar

Well, it’s both. Certainly, the demand around the world has been up in storage, but we’ve also seen incremental benefits from share gains.

Harlan Sur – JP Morgan

Okay. And one last question. Again on the storage systems business, you guys have done a pretty good job of improving margins, actually in the overall business in the past few years. Just curious what kind of activities you guys have in place to be able to kind of further pick up margin share going forward?

Abhi Talwalkar

Well, I think it’s some of the same things that we talked about before. Software attached continues to be a big focus. We’ve started to see very good traction in the marketplace with our relationship with HP, where they sell our storage virtualization and advance sort of copy services solutions for EPA. We’ve seen great traction there. That’s largely a software oriented sale that comes with very nice margins. So software certainly has been a big push as we continue to scale and grow our overall revenue, that helps in terms of absorption rates and improves gross margins as well. And where we can, we are certainly looking at just evolving the overall business model where we increasingly shipped more of the RAID controller, the fiberglass and silicon software versus necessarily a lot of sheet metal, if you will, right. So those are the different things that we’re working on relative to gross margin and initiatives to improve our systems gross margin.

Harlan Sur – JP Morgan

Thanks, Abhi.

Abhi Talwalkar

Thank you. Thank you. Can we have the next question, please?

Operator

Your next question is from the line of Mark Heller with CLSA.

Mark Heller – CLSA

Hi, guys. Thanks for taking my question. I much recovered it, but by inventories go up 10% in the quarter on the balance sheet?

Abhi Talwalkar

Yeah. So the inventories are up, but if you look at that compared to historical levels compared to a year ago, if you look at what that represents in terms of turns, we are very comfortable with the inventory levels that we have. There may be a few cases where we wanted to it ensure supply to make sure that we could service our customers. But I think we’re accountable not only with the performance that we drove in the first quarter, but really our position as we move through the year 2010.

Bryon Look

Inventory levels are far below what the prior -- the peak prior to the downturn. We continue to have best in class turns in our inventory. It’s not a concern whatsoever.

Mark Heller – CLSA

Okay. And can you update us on the -- I know that you have been talking about an enterprise when ramp in the hard drive space. Can you just give us an update on that?

Abhi Talwalkar

The specificity of that really needs to be -- that question really needs to go towards our customer. But in terms of what we said where initial units would start shipping in the first half and then a ramp starting towards the latter part of the first half and drawing strength in the second half. We continue to believe that will be the case.

Mark Heller – CLSA

Okay. Great. Thanks.

Sujal Shah

Okay. Thank you, Mark. And we have the next question, please?

Operator

Your next question is from the line of Sanjay Devgan with Morgan Stanley.

Sanjay Devgan – Morgan Stanley

Hey, guys. Thank you so much for taking my question. Just two brief questions. I guess the first pertains to given the better than normal seasonality we’ve seen from a broad-based of semiconductor companies, I guess the biggest question on most people’s minds are kind of the type of capacity both from the foundries as well as from attachment some on the perspective. I just wanted to get your thoughts given that the second half of the year normally is as I think you pointed out is up 10% to12% in aggregate relative to the first half year, how come are you able to source the product both from a foundry and test and assembly perspective?

Abhi Talwalkar

That’s a great question. I would say that if I was to measure the tightness of the supply chain over the past three or four months, it still remains very tight. But the level of a number of escalations and so forth has certainly been reduced. But we still continue to see that. We have been working very closely with our major suppliers to ensure sufficient capacity and sufficient allocation of the capacity throughout the rest of this year. And at this point in time, we feel like we are generally in good shape to be able to meet all demand.

Sanjay Devgan – Morgan Stanley

And then I guess just as a follow-up, Abhi. You know, you talked about the growth in networking businesses last quarter. Being broad-based across focus products as well as the legacy products. I was wondering, as we look at the legacy products, if you could remind us what end markets those products cater to today. I’m assuming there mainly a six, but if you could just help us understand what and marks there Q2, that would be helpful.

Abhi Talwalkar

I’d say there’s a decent concentration and wireless and that’s one of the reasons that we saw better than expected strength. Some of the older products just continue to ship as people as and carriers had to respond dose not carriers, telecom equipment companies had to respond to carriers demands to build a more capacity, especially in the strange sort of wireless networks. A large part of it is also in sort of the backhaul, which is also in area that has been of focus in terms of improving the overall capacity and bandwidth out there for wireless networks that are under a lot of strain given things like the iPhone. So it’s many different parts across a lot of different designs and applications and customers. But I would say there is certainly a piece of it that was driven by wireless and that’s why we saw the upside.

Sanjay Devgan – Morgan Stanley

By wireless you mean GSM GPRS?

Abhi Talwalkar

Yeah. Yes.

Sanjay Devgan – Morgan Stanley

Okay. Okay. That’s helpful. Thank you very much.

Sujal Shah

Thank you, Sanjay. Can we have the next question, players does please?

Operator

Your final question is from the line of Jim Schneider with Goldman Sachs.

Mark Delaney – Goldman Sachs

Hi, guys. This is Mark Delaney calling for Jim Schneider. Thanks so much for taking the question. I guess starting up first with respect to your hard drive customers, are you guys getting any near-term benefits from the ways in program transitions, specifically maybe your comment that Seagate, if you’re able to pick up any share there from STMicro?

Abhi Talwalkar

Well, I mean as we have said and I will just go back to the color we provided relative to our Seagate relationship. We are the largest supplier today and we expect our business at Seagate to grow and we also expect our share to grow there. And lot of this also stems from the fact that we started winning sole SoC wins that get back now over 18 months. And some of these are going to start coming into production.

Mark Delaney – Goldman Sachs

Okay. Great. If you follow up -- you guys have talked a lot about supply demand being in a pretty healthy balance generally. I was wondering if you could drill down into the storage adapter. I think maybe some of your customers have been reporting mixed results and I was just wondering what your thoughts are on component levels in that segment, specifically? Thanks so much.

Abhi Talwalkar

Yeah. I think you are probably referring to Emulex and referring to Fiber Channel adapters, to be specific. I assume that’s what you’re referring to. You know, inventory situation there, it seems to be consistent with sort of past patterns. There is a bit of a phase shift that occurs now and then there is also a transition a four gig to eight gig that is occurring, nothing that weren’t necessarily concerned about. In the case of the customer that you alluded to, I think their results also were reflected based on sort of on IBM’s Power Systems or pSeries business which did drop year-over-year by 17%. But that’s relatively a small part of our overall Fiber Channel SAN business. So it’s nothing that we’re concerned with.

Sujal Shah

Okay. Thank you, Mark. 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

Ladies and gentlemen, a telephonic replay of this conference will be available beginning today at approximately 5:00 p.m. Pacific Daylight Time and will run through 9:00 p.m. Pacific Daylight Time on May 5th. The replay access numbers are 1-800-642-1687 within the U.S. and 1-706-645-9291 for all other locations. The webcast will be archived at www.lsi.com/webcast. That does your conference for today. Thank you for your participant. You may now disconnect.

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