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LSI (NASDAQ:LSI)

Q4 2011 Earnings Call

January 25, 2012 5:00 pm ET

Executives

Sujal Shah -

Sujal Shah - Vice President of Investor Relations

Bryon Look - Chief Administrative Officer, Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Abhijit Y. Talwalkar - Chief Executive Officer, President and Director

Analysts

Srini Pajjuri - CLSA Asia-Pacific Markets, Research Division

Craig Berger - FBR Capital Markets & Co., Research Division

Patrick McCartney

Srini Pajjuri - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Sanjay Devgan - Morgan Stanley, Research Division

Betsy Van Hees - Wedbush Securities Inc., Research Division

Parag Agarwal - UBS Investment Bank, Research Division

Sujeeva De Silva - ThinkEquity LLC, Research Division

Hans C. Mosesmann - Raymond James & Associates, Inc., Research Division

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Blayne Curtis - Barclays Capital, Research Division

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the LSI Corporation Investor Relations Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call 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 for the fourth quarter and full year 2011 and guidance for the first quarter of 2012.

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 the Investor section of our website at www.lsi.com/webcast. At that site, you can also find a copy of the earnings release and a presentation highlighting the key points from today's call and providing an overview of our business.

On January 3, we closed the SandForce acquisition, and our Q1 guidance will include this business. I would also like to remind you that LSI will be hosting an analyst day in New York City on March 14, and details and registration information are also posted on the website.

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 on our Form 10-K for the year ended December 31, 2010, our third quarter 10-Q and today's earnings release. With that, it is now my pleasure to introduce Abhi Talwalkar.

Abhijit Y. Talwalkar

Thanks, Sujal. Good afternoon, and welcome. I would like to begin by providing some highlights for 2011, a year in which we endured a turbulent macro environment but made significant progress as a company. Early in the year, we completed the transformation of LSI with the transition to a pure play storage and networking semiconductor company with the divestiture of our storage systems business. We ended the year with an announcement to acquire SandForce, positioning LSI to benefit from the growing adoption of solid-state drives and flash storage solutions. Throughout the year, we were successful in increasing design win momentum with industry leaders such as Seagate, Ericsson, Cisco, IBM, HP, Dell and many others. Our revenues grew 9% year-over-year and 16% from the second half of 2010 to the second half of 2011, illustrating acceleration of revenue growth driven by the share gains and [indiscernible] cycles. This is still the only first of several expected stages of new product ramps from design wins accumulated over the past 3 years. For the full year, we generated double-digit revenue growth in HDD SoCs, ServeRAID and networking investment areas. Our growth, which significantly outpaced our end markets and many of our peers’, would have been even higher, particularly in hard disk drives, were it not for the impact of the unfortunate flooding in Thailand which affected our fourth quarter 2011 revenues. Specifically for the fourth quarter, our revenues of $523 million were in line with the midpoint of guidance, and I credit our team for their efforts in assessing market dynamics and flood-related constraints to enable us to correctly call the quarter back in October. We saw roughly $40 million of revenue impact in Q4 from Thailand flood-related issues. Our operations team has done an excellent job on recovery, including the qualification of new suppliers, and we expect to have the capability to meet all customer demand in Q1. As we look forward to 2012, we are excited by the new product cycle ramps, accumulated share gains and new opportunities we have ahead of us in the areas such as SandForce flash storage processors, PCIe flash adapters, HDD SoCs, SAS for Romley and multicore processors and custom products for networking. The midpoint of our guidance for Q1 reflects 20% year-over-year growth and is composed of 16% growth in our organic business, plus the addition of SandForce revenues. In Q1, we are seeing outperformance driven by a snapback of HDD, SSD and preamp shipments, new product ramps and the addition of SandForce revenues. We're excited to have closed the SandForce acquisition and have the team integrated into LSI as a new business unit. The acquisition greatly enhances LSI's competitive position in the fast-growing PCIe flash adapter market segment and it catapults LSI into an industry-leading position for the rapidly growing high-volume flash storage processor market for Ultrabooks, notebooks and enterprise SSD and flash solutions. We estimate that LSI's available market for PCIe flash-based adapters and flash storage processors is growing at an annual CAGR of nearly 40% over time and will represent a greater than $2 billion TAM expansion for LSI in the next several years.

Going forward, we believe LSI is well positioned in large, exciting and fast-growing markets with solid fundamentals. We expect to benefit from growth in the deployment of server, storage and networking equipment for data centers, commercial and private clouds, and mobile networks, as well as the rapid adoption of flash storage.

Now, I want to review additional business highlights for Q4. I will begin with our networking business, where our products address the wireless mobile network, data center and enterprise market segments and where we expect revenue from new products to grow at a faster than market growth rates over the coming years as we gain share and displace competitors. Year-over-year, we saw double-digit growth in our investment areas in networking driven by growth in standard and custom products for wireless infrastructure and enterprise applications. Investment area revenues were $284 million in 2011, representing nearly 2/3 of our overall networking business. Over the past 5 years, our investment areas have seen a 5-year compound annual growth rate of 28% while participating in market segments that have rich gross margins. This is a strong proof point of a well-executed strategy in networking, and we're excited about the new product cycles we have in this business. We expect overall networking revenues to grow year-over-year in 2012 along with accelerated profitability.

We continue to be successful in increasing LSI's footprint in base stations and wireless backhaul infrastructure through a combination of our Axxia multicore communications processor and our custom silicon capability. With Axxia wins at Ericsson and strong progress at other wireless customers, we have now set a goal to exceed 50% share of data plane and control plane content in base station segments. Our network processors and now, Axxia , we are addressing a wireless data plane and control plane silicon TAM that is large and fast-growing with build outs of mobile networks. LSI solutions are increasingly being sought after based on superior performance and lower power consumption.

In addition to Axxia, we are increasing our footprint in base stations with custom silicon wins for the baseband function, which sits alongside the data plane and control plane devices, and implements DSP functionality. We're currently participating in baseband custom silicon business at 4 out of the top 5 OEM vendors. In the enterprise market segment, we are pleased with our progress in expanding our business with a leading data networking company. We are now in production on a custom switch solution and continue to make strong progress on additional custom opportunities. As it pertains to Ethernet PHYs, we are fully ramped on an integrated custom Gigabit Ethernet PHY for client applications at Intel and also expect to ramp a custom Gigabit Ethernet MAC PHY solution for Romley server platforms. We recently announced an expansion of our long-term strategic relationship with ARM. The agreement will lead to new product solutions designed to address needs to accelerate network performance as applications such as mobile video and cloud computing dramatically increase network traffic. LSI will gain access to the broad family of ARM processors, including the ARM Cortex-A15 processor and ARM on-chip interconnect technology for use in multi-core applications.

I'll now turn to server and storage, which includes 5 businesses: our new Flash business, SAS, ServeRAID adapter and software, SAN and HDD. In Flash, we are unique in offering standard product flash storage processors, or FSPs as we call them, as well as custom FSPs and PCIe flash adapters. FSPs manage the underlying flash memory and improve the endurance, reliability and performance of flash storage. In standard product FSPs, SandForce generated approximately $65 million in revenue in 2011 prior to our acquisition. For 2012, we expect solid growth at or above market rates based upon a very strong design win pipeline with industry leaders -- with leaders in the industry. The FSP industry has entered a rapid growth phase, and LSI is strongly positioned to benefit from this multiyear growth cycle. We continue to make progress at key customers with standard and custom FSPs in both client and enterprise segments. In the client market segment, we are in the final qualification with multiple flash manufacturers on our second generation of products and expect to start shipments in the first half of 2012. These customers target Tier 1 system OEMs in addition to expanding their footprint into the channel.

In the enterprise market segment, our SSD OEMs are in qualification with multiple Tier 1 server and storage manufacturers to provide both high-volume SSDs, as well as high-performance caching and workload SSDs. In PCIe flash adapters, we offer our WarpDrive family. We're expanding and increasing focus in storage and server application acceleration, bringing the performance advantage of the Flash to enterprise servers, storage and networking applications. We are pleased to be participating in the EMC Lightning program, which we expect to begin ramping this quarter, and a new program at Cisco in their custom blade products. We've also won multiple designs with our combined WarpDrive and host-based CacheCade software at a Tier 1 server OEM and expect our solution to begin ramping next quarter. Beyond this, we continue to build momentum with new server and large scale Web customers on the largest PCIe flash revenue opportunities based upon a superior architecture and our significant position in the server ecosystem.

We are now near production on our second-generation WarpDrive PCIe products, which use the latest generation SandForce FSP and integrate LSI CacheCade software for application acceleration. This second-generation WarpDrive supports SLC, cMLC and EMLC, enabling flexibility to optimize for performance, cost, high density and endurance.

In our SAS business, we expect to be shipping 6-gig SAS silicon to all top 10 server OEMs this quarter with the rollout of the Intel Romley platform. The next key inflection point in the SAS market will be the adoption of 12-gig SAS silicon. Server and external storage OEMs have already begun the evaluation and selection process. Our expectation is that the first usage will occur in 2012 with production in 2013. LSI began to sample next-generation 12-gig SAS ROCs, controllers and expanders to major customers in July, at least 6 months ahead of our competition, putting us in excellent position to grow share at this next transition.

We continue to make progress with External Storage Systems customers following the divestiture of our systems business. We estimate that our share in SAS for External Storage grew from 35% in 2010 to 40% in 2011. With our lead in 12-gig SAS, we expect to gain share in this upcoming transition.

In hard disk drives, we saw unit TAM decline by approximately 30% from Q3 to Q4 as a result of the situation in Thailand. However, we continue to gain share in Seagate’s enterprise platforms and ramp new SSCs into client drives. We're confident in our ability to support sequential growth in Q1 at our HDD customers.

Achieving a key milestone last year, LSI was the first supplier shipping SSCs for 1 terabyte per platter hard drives to customers, illustrating our technology leadership in this market segment. During the quarter, we also introduced the industry's first 28-nanometer read channel featuring a new LDPC architecture, enabling HD manufacturers to achieve increased areal density, higher yield and lower power consumption for HDDs. This is now the third consecutive technology transition where LSI has been ahead of the competition.

Customer-specific SSC samples built on this technology will become available in the first half of this year that will support notebook, desktop and enterprise HDDs. The enhanced low power management features in these SSCs are critical to extending battery life in notebooks and to reduce some energy costs in data centers.

To wrap up, we think it's time to take a new look at LSI. We're seeing the results of a multiyear growth strategy and are well positioned with share gain opportunities and new product cycles to enable us to outgrow the storage and networking markets we serve. Now let me turn the call over to Bryon who will take you through our results and provide guidance.

Bryon Look

Thanks, Abhi, and thanks, everyone, for joining the call today. I'd like to begin by providing a few highlights and perspectives on LSI's financial performance for the full year. As a reminder, we successfully announced and closed the sale of our External Systems business early in 2011. The financial results of the External Systems business have been classified as discontinued operations in LSI's financial statements. Our ongoing business is and has been referred to as continuing operations. The results we are covering for the full year 2011, as well as for Q4 and going forward, will be for continuing operations.

We closed 2011 with annual revenues of $2.04 billion, representing 9.3% year-over-year growth. Gross margins for the full year, excluding special items, were 51.5%. Operating expenses, excluding special items, were $794 million for the year as we remained focused on expense controls throughout the year, growing revenues at a rate higher than expenses. Operating income, excluding special items, was $258 million or 12.6% of revenues for the full year. In addition, one of our key focus areas has consistently been to maintain and grow our net cash position while driving efficient working capital management. In 2011, we delivered $247 million in operating cash flows and closed the year with $935 million in cash and short-term investments and no debt after having used approximately $499 million of cash to buy back stock. Finally, we successfully completed the SandForce acquisition in early January. Keep in mind, SandForce's business will be included in our guidance and results going forward as it closed on January 3.

Now on to Q4 results and the Q1 outlook. LSI delivered a solid quarter consistent with the guidance we provided in October despite the challenges associated with the floods in Thailand. Revenues were down sequentially by 4.3% to $523 million, in line with our guidance range. Non-GAAP gross margins were 49.5%, lower than our guidance, primarily due to inventory charges associated with the Thailand flood. We continued to carefully manage expenses with non-GAAP operating expenses of $203 million, just at the midpoint of guidance. And we delivered non-GAAP EPS of $0.13.

Now turning to a more detailed discussion of our financial results for the quarter beginning with revenues. Q4 revenues were $523 million, sequentially down 4.3% from $547 million. Our server and storage semiconductor revenues, which include products from our ServeRAID adapter and software, Flash, SAS, SAN and HDD businesses, were sequentially down $14 million or 4% to $389 million. As we noted earlier, this decline was driven by the flooding in Thailand and the related impact to the disk drive industry. Server and storage semiconductors represented 74% of total revenues in the fourth quarter. Q4 revenues in our networking business were $107 million or sequentially down 8% due primarily to softness in the wireless end market and, to a lesser extent, supply chain constraints generated by the flooding in Thailand. Networking represented 21% of total revenues for the fourth quarter. Revenues for the IP business were sequentially flat at $27 million.

Moving next to gross margins. LSI's Q4 gross margin, excluding special items, was 49.5% and below the 51% guidance midpoint we provided in October. Included in our results is an inventory charge of approximately $7.5 million or 140 basis points of gross margin, which relates specifically to inventory damaged at one of our subcontractors in Thailand during the flooding. In terms of operating expenses, R&D, together with SG&A expenses, excluding special items, totaled $203 million in Q4, just at the midpoint of guidance. Non-GAAP operating margin for the quarter was 10.7% or $56 million. Interest income and other, net of interest expense, excluding special items, was $8 million for Q4. Approximately 2/3 of this amount was related to income from transition services associated with the sale of the External Systems business.

We expect to see these service arrangements continue into Q1, but to a lesser extent, and to be completed by midyear.

Now let me turn to the special items we recorded in the fourth quarter which netted to $62 million. Special items, primarily noncash, included $29 million in amortization of acquisition-related items, $12 million of stock-based compensation expense and $21 million of restructuring costs and other items.

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 in different geographic tax jurisdictions and certain discrete items. We experienced such events in Q4, including both a shift in our geographic profit mix and the expiration of certain statutes of limitations, that resulted in a noncash tax benefit for the period versus the provision of $13 million we guided to in October. The tax benefit for Q4 was $8.8 million.

On a GAAP basis, fourth quarter income from continuing operations was approximately $11 million or $0.02 per share. Fourth quarter GAAP net income, which includes income from discontinued operations, was a loss of $2 million or approximately neutral on a per share basis. Non-GAAP income from continuing operations was $73 million or $0.13 per share. The diluted weighted average share count for the periods for both GAAP and non-GAAP purposes was 573 million shares. This included -- this includes the weighted average benefit of purchasing approximately 5 million shares during the period under our share repurchase program. In 2011, we repurchased a total of 72 million shares and utilized approximately $499 million of our current $750 million buyback program. Our share buyback program remains in place with $251 million remaining in our authorization.

Turning now to the balance sheet and cash flows. Cash and short-term investments ended the 2011 fiscal year at approximately $935 million. We continue to operate with no debt on our balance sheet. Operating cash flows were $55 million in Q4 and $247 million for the full year.

And finally with respect to Q4 results, depreciation and software amortization was $14 million for Q4 and $71 million for the full year, while capital expenditures were $14 million in the quarter and $61 million for the full year.

Next is a discussion of our guidance for continuing operations in Q1 2012. Q1 revenues in the range of $550 million to $590 million were sequentially up approximately 9% at midpoint. We expect our server and storage semiconductors revenues to be sequentially up in Q1. This includes approximately $20 million to $25 million of flash storage processor revenues associated with our recent acquisition, along with a snapback in HDD, SLC and preamp shipments following a soft Q4. In addition, we expect our server-related revenues to be sequentially down due to expected seasonality. We expect our networking semiconductor revenues to be relatively flat to down. Gross margin, excluding special items, is expected to be 51%, plus or minus 1%, as we experienced better absorption of fixed costs at higher revenues. Operating expenses, excluding special items, are expected to be in the range of $215 million to $225 million. Included in this guidance is approximately $15 million of operating expense associated with the acquisition. Interest income and other and interest expense, excluding special items, is expected to net to income of approximately $5 million, approximately half of which is related to transition services. Special items are expected to net to approximately $70 million to $90 million. This increase is primarily driven by an expected onetime charge of approximately $15 million in Q1 due to the purchase accounting effect on inventory assumed in the acquisition, along with expected increases in amortization of intangibles, stock-based compensation and other items primarily associated with the acquisition.

The GAAP and non-GAAP tax provision is expected to be approximately $9 million for Q1. We expect our non-GAAP tax rate to be approximately 12% for 2012. We expect Q1 GAAP income per share from continuing operations in the range of negative $0.07 to a positive $0.03 and non-GAAP income from continuing operations in the range of $0.09 to $0.15 per share. The share count is expected to be approximately 575 million shares for both GAAP and non-GAAP purposes. In addition, we expect depreciation and software amortization of approximately $18 million for Q1 and $70 million for the full year and capital expenditures of approximately $20 million in Q1 and $65 million for the full year.

In closing, we delivered solid revenues in Q4, despite the difficult environment. We remain focused on driving operating leverage and are excited about 2012 and our business prospects going forward. Now let me turn the call to Sujal.

Sujal Shah

Thank you, Bryon. At this point, we will begin the Q&A portion of the call. David, will you please give the instructions for the Q&A session?

Question-and-Answer Session

Operator

[Operator Instructions] And that question is from Daniel Amir of Lazard Capital Markets.

Patrick McCartney

This is Patrick McCartney calling on behalf of Daniel Amir. Could you quantify the opportunity for the PCIe flash adapter business this year?

Abhijit Y. Talwalkar

Well, we basically sized the market at approximately $500 million in 2011 in terms of our available market. We said about half of that was captive at the time because they were all first generation products that were developed internally by companies such as Oracle, Google, and so forth. The other half was available merchant market. That mix is starting to shift as we go into the second generation. Many of those captive players are seeking potential solutions outside to support. And we basically size that market to grow at approximately 40% sort of CAGR over the coming years. That gives you a sense for at least how large the market opportunity is for LSI in 2012.

Patrick McCartney

All right. And how does the service provider slowdown impact your communications business this year?

Abhijit Y. Talwalkar

Well, I think, clearly, it was well-publicized that there's a CapEx pullback relative to wireless infrastructure deployments in the second half of last year. We certainly experienced a decline in our business in Q3 and Q4. At the same time, keep in mind, we have product cycles where we are gaining some new sockets and do have share gains, but we also experienced that decline as well like many of our peers. As we come into Q1, there are still some small lingering effects of that. But that's how I sort of characterize it. We're guiding our networking business flat to down in Q1.

Operator

Your next question is from the line of Blayne Curtis of Barclays Capital.

Blayne Curtis - Barclays Capital, Research Division

Maybe just starting first with the hard drive market. Can you talk about what do you think the TAM is in Q1 and the kind of slope for the recovery for you guys and whether that extends into Q2?

Abhijit Y. Talwalkar

Yes. I mean, I think that it's difficult for us to call the TAM because we certainly don't have all the visibility into all of our customers, their supply chains and so forth. Certainly, there's lots of speculation and guestimates that are out there from analysts and so forth. But we certainly see our business growing strongly from Q4 to Q1, and we expect our HDD sort of business, which is approximately half of our storage and semiconductor business, which was $388 million in Q4, we expect the HDD part of that to grow approximately 20% to 25% quarter-to-quarter. And that's obviously both the recovery and growth in HDD SoCs, but also a pretty significant and strong recovery in preamps. Preamps for LSI was hit especially hard in Q4 because all of our preamps were assembled and packaged in Thailand. So we took a big hit, and that is seeing a very strong recovery now that we have our supply lines resurrected.

Blayne Curtis - Barclays Capital, Research Division

Great. And then maybe moving to SandForce that you talked about growing faster than market, maybe you can just talk about how you -- what kind of growth that you're thinking about for that opportunity and kind of where your best areas of opportunities are for the SandForce?

Abhijit Y. Talwalkar

Well, I mean yes. We're incredibly excited about SandForce, but the overall LSI strategy in Flash from a flash storage processor standpoint, where we've got a lot of engagements that are now starting to contribute also from a revenue standpoint in the form of custom flash storage processors, and then we obviously have the standard FSPs from SandForce as well. The SSD marketplace is expected to grow at approximately 100% in units from 2011 to 2012. And as I said earlier, we certainly have visibility in the pipeline to have confidence in our ability to grow at that rate or above that rate to be able to grow some share. And that's through the combination of our standard offering with SandForce as well as the custom silicon engagements that we have and will continue to grow.

Operator

Your next question is from the line of Craig Berger of FBR Capital Markets.

Craig Berger - FBR Capital Markets & Co., Research Division

Can you give any detail on design win traction with new top-tier hard drive guys and what the timing or magnitude of that stuff can be?

Abhijit Y. Talwalkar

Well, as we've said before, we've got engagements across all of them, and we continue to be very pleased that the progress of those engagements and execution has been incredibly well-regarded by these customers as well. We saw our share in SoCs grow from the low 20s to 30% last year, Craig, in 2011. We have every expectation to grow share again this year as well through share gains across a broad base of customers.

Craig Berger - FBR Capital Markets & Co., Research Division

Are you going to be achieving new customers this year? Or is that going to be more like 2013?

Abhijit Y. Talwalkar

Well, I'm not going to get into the specifics. But again, we are engaged across all customers and the development activities continue to progress very well, and we're excited about ramping those products and continuing to gain share this year.

Craig Berger - FBR Capital Markets & Co., Research Division

And then I'm sorry if I missed it, but did you guys say how much SandForce was in the Q1 guidance?

Abhijit Y. Talwalkar

We said SandForce would be approximately $20 million to $25 million in Q1.

Craig Berger - FBR Capital Markets & Co., Research Division

And do you have any expectations for the year on that?

Sujal Shah

I haven't given any for the year, but I certainly offered some color relative to our confidence in growing at the market unit growth rate of 100% or higher. And again, just a -- that's a unit growth rate. But we certainly have confidence based on the design wins that we have, engagements that we have, that we'll be ramping new ones that will be ramping here in the first half.

Operator

Your next question is from the line of James Schneider of Goldman Sachs.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

This is Gabriela Borges on behalf of Jim. You spoke about the investment areas in networking now being about 2/3 of the segment. How should we think about the ramp down of the lost legacy sales over the coming year?

Abhijit Y. Talwalkar

Well, the legacy business for us was roughly $100 million in 2011. And I think for modeling purposes, people should expect roughly a $30 million decline on that throughout the course of this year.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

That's helpful. And as a follow-up, if I could, I was hoping you could provide us with an update on your outlook for market share. I know someone asked this just now as well, but now that the merger of Seagate and Samsung is complete, how should we think about this cost for making adjustments to the sourcing agreements and the impact to LSI’s market share?

Abhijit Y. Talwalkar

Yes, I mean, I think it's still to be seen exactly how these mergers end up in terms of product rationalizations and roadmaps and so forth. I think a lot of that is probably put on hold as well just given everyone's focus on Thailand recovery and catching up the national demand over the next 2, 3 quarters. As we've always said, relative to the mergers themselves, we think the mergers are a good thing overall from an industry standpoint and certainly a positive aspect for LSI over the horizon. And again, to reiterate, our every expectation is to grow share this year on top of the share we grew last year.

Operator

Your next question is from the line of Stephen Chin of UBS.

Parag Agarwal - UBS Investment Bank, Research Division

This is Parag for Stephen. I just wanted to get an idea of the ARM licensing deal, what kind of products we would expect this to be in and what happens to your older products? I mean, is this a new category of products that you will be launching with the ARM microprocessors?

Abhijit Y. Talwalkar

Well, I wouldn't say it's a new category of products, and we're going to reserve disclosing too much of this at this time for competitive reasons, Parag. I expect us to shed more light on the ARM strategy and where that is headed at our analyst day. But clearly, our initial focus will be to leverage ARM in multi-core network processors for a wide variety of application areas. And what we're doing there is a natural expansion and extension of what we're doing today. It is an evolution of our overall strategy.

Parag Agarwal - UBS Investment Bank, Research Division

Perfect. And as you go forward, how should we think about your operating margins? Obviously, gross margins have done very well, and you have SandForce. So at the same time, you're gaining shares. So should we expect operating margin to expand or there could be any headwinds that would limit operating margin expansion going forward?

Bryon Look

Yes, we're very focused into driving continued expansion of our operating margins. Clearly, where we are in terms of seeing the returns on our years of investments, driving top line growth, and that will be a key driver of, I think, moving towards and achieving business model targets. So we'll have more color at our analyst day relative to even new targets for our business model. But clearly, we are very comfortable with the drivers that we have for being able to take us to significant higher levels of profitability.

Operator

Your next question is from the line of Hans Mosesmann of Raymond James.

Hans C. Mosesmann - Raymond James & Associates, Inc., Research Division

The Romley ramp is finally happening. Can you give us a sense of how important it's going to be in terms of volumes? Is this going to be an upgrade cycle or is it a dollar content move? Just a little more granularity there.

Abhijit Y. Talwalkar

Yes, I mean I think, Hans, it's happening, but it's still ahead of us in the sense that it's later this quarter, and there are several phases to it. But yes, I think confidence in the industry is pretty high. From an LSI standpoint, we're excited about Romley on a number of levels, everything from content increase, especially with an Ethernet PHY MAC combination solution chip that will be shipping onto the Romley platform with our engagement with Intel. We expect some share gains in SAS as we ship into all 10 of the top server OEMs as well. That will start with the Romley transition itself. We think some of our WarpDrive PCIe flash product cycles and opportunities that we have, some that we've won, some that we're pursuing will also, I think, align to the Romley cycle in the second half -- I'm sorry, second quarter. And so I think our sense is that it's going to be a pretty good upgrade cycle in the industry. There are clear value propositions, and from an LSI standpoint, we see share gains as well as increased content.

Hans C. Mosesmann - Raymond James & Associates, Inc., Research Division

Okay. And then as a quick follow-up, the Axxia, the multi-core product in base stations, just to clarify, you said you have 50% market share in terms of the design wins you're seeing?

Abhijit Y. Talwalkar

No. Let me -- that is an important point to clarify. We are seeing a lot of great success in our overall momentum with Axxia. Obviously, what we have publicized is Ericsson who we've worked, been working with for several years, that we'll be going into production with this year's RBS 6000 family. We're seeing strong engagements elsewhere. And given the strong pull that we've gotten and the confidence that we have in the architecture and its value proposition, we have set an internal goal to achieve 50% market share of the data plane and control plane content. Right? So that is a goal. That is not a statement of what we're shipping today.

Hans C. Mosesmann - Raymond James & Associates, Inc., Research Division

Okay. And then that goal over several years, is that...

Abhijit Y. Talwalkar

That's correct.

Operator

Your next question is from the line of Betsy Van Hees of Wedbush Securities.

Betsy Van Hees - Wedbush Securities Inc., Research Division

You mentioned the word snapback and then you also talked about the preamps. And I was wondering if there's any concern that your customers could potentially be building inventory, or what's your confidence level that this -- you're shipping to consumption?

Abhijit Y. Talwalkar

Our confidence level is pretty high. I mean, even with the 20% to 25% growth that is projected in terms of new hard drives that were built in Q1 by the industry, that is still far short of overall natural demand. So really the question is how are our HDD customers doing in terms of gathering all the parts that they need, as well as having sufficient capacity. And I think, at least based on the analysis that we've done and the visibility that we have, which isn't comprehensive to a point where we can call a TAM, we feel comfortable relative to our forecast.

Betsy Van Hees - Wedbush Securities Inc., Research Division

That was very helpful. And then I was wondering if we could talk a little bit more about the SandForce acquisition and some of the synergies that you're seeing maybe on the cost level for 2012.

Abhijit Y. Talwalkar

I mean we -- there are synergies with the combination of LSI and SandForce. Those synergies are at the revenue level, in terms of revenue opportunities just given the larger scale LSI, the ability to diffuse that technology across a broader base and take on more customers, and we're already seeing the benefits of that and the pull of that. And there certainly will be some benefits that we will see as we bring LSI's procurement scale across wafer and packaging technology that will benefit our competitiveness as well as our product margins for the SandForce product line.

Operator

The next question is from the line of Suji De Silva of ThinkEquity.

Sujeeva De Silva - ThinkEquity LLC, Research Division

In terms of the preamps snapping back here to some extent, can you tell us where it was in 4Q '11 or in the coming quarter relative to maybe prior peaks or prior normalized levels, how far below we still are for preamps?

Abhijit Y. Talwalkar

Yes. I won't give you absolute numbers, Suji, but I'll give you a sense. Because I think this is something that maybe people have missed a little bit because everyone's so focused on SoCs, and we have a pretty meaningful preamp business at roughly 40%, 45% share of preamps. And that business, that product line was hit very hard, and we shipped preamps across every HDD customer. And we saw revenues for that drop by 50%, Q3 to Q4, right, significantly more than what we saw in terms of HDD SoCs. So those are coming back pretty strong with the improvements that we’ve made on our supply line. And that is certainly a contributing factor to the growth that we have in Q1.

Sujeeva De Silva - ThinkEquity LLC, Research Division

And in the first quarter, will it be back to normalized levels or is this still below the prior?

Abhijit Y. Talwalkar

It's still a little bit below.

Sujeeva De Silva - ThinkEquity LLC, Research Division

Okay, great. And then on the SandForce acquisition, now that you've had a little time to kind of digest it, can you describe the competitive landscape and how you think SandForce will compete and have an advantage versus other people in that space?

Abhijit Y. Talwalkar

I mean, I think that, that's better responded with an overall LSI -- how does LSI compete? And I think the combination of the 2 where you've got a very superior flash memory management architecture that SandForce has and has shipped millions and millions of parts now as well, which means that there's been a lot of hardening and validation and qualification and so forth, combined with LSI's custom capability, because we still are seeing and I think we will continue to see, whether it's flash manufacturers or other companies that are building SSDs, will see a combination of using standard merchant market flash storage processors like SandForce or custom. And our ability to do both, we are already seeing a competitive advantage in being able to have that conversation and engage at whatever level of engagement is appropriate for a customer and their product strategies. So that combination is a strong competitive advantage. I think the other competitive advantage that we have certainly, we assess due diligence, but also what we're now experiencing is a solid firmware base as well that has been fully product-ized and fully validated and has the ability to also be customized across the customer base. And I think that's something that our competition doesn't have at least from our understanding, not to the extent of robustness and validation.

Operator

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

Sanjay Devgan - Morgan Stanley, Research Division

Abhi, a quick question on the -- you talked about your latest HDD SoCs and the LDPC and how they've kind of supplanted the competition and how they're driving increased yields for the -- for your customers. I was wondering, as you kind of move to these technologies that gave you better signal-to-noise ratios and improved yields for the customers, how does that help with the pricing? I mean, are you guys, as you kind of leapfrog the competition, is that helping on the pricing front or how should we think about that kind of go forward?

Abhijit Y. Talwalkar

Well, I mean, I think there's a couple of things. I want to make sure you appropriately grasp at least the data point on -- in the script relative to the 28-nanometer. What we noted there was we sampled -- we were the first to sample a 28-nanometer next-generation read channel technology and enhance the LDPC architecture. And that is the third time we've done that ahead of our competition. And every time we've done that ahead of our competition, that has led to share gains because it is all about time-to-market on that critical piece of technology. We did that at 65, we did that at 40, and we believe we're doing that again at 28. So from that standpoint, we feel very good about our ability to continue to grow share. In terms of pricing and pricing dynamics, I mean, it's still a very, incredibly competitive marketplace. You also have a consolidated customer base that's also playing out. So I don't think pricing has -- the environment has dramatically changed. The one thing that we don't have to contend with anymore is the alliance that we were straddled with before with another partner, where that did create some interesting pricing dynamics.

Sanjay Devgan - Morgan Stanley, Research Division

Okay. That's helpful. And then I guess just another question. You gave a little bit of color on the SAS side, on the market shares, roughly 35% in 2010, 40% in 2011. As you -- you have a couple of catalysts, one on the Romley side, but you also alluded to the 12-gig SAS as being the next inflection point. I was wondering, as you kind of look at those 2 catalysts kind of coming up, how do you think -- where do you think you guys can take your share kind of go forward for the second...

Abhijit Y. Talwalkar

Yes, I think -- but -- no, it's a great question. Let's break it into 2 pieces. There's all the SAS that goes into a server, right? And there are market shares considerably higher than the 35 to 40 that you mentioned, right? We're a very strong player in the marketplace there. And then the 35% to 40% growth that we mentioned in terms of share is specific to SAS that goes into external storage. This market has been forming over the last couple of years and continues to grow as more and more SAS is used by External Storage Systems. So if I can restate your question around, as that part of the SAS marketplace, where could our share go? It's going to go up, and we expect with our competitive advantage on the 12-gig, both in terms of performance and features as well as time-to-market, we expect it to go up. At the same time, there's no reason why we can't see our share in external storage start to migrate towards the higher share that we have inside of [indiscernible]. That might take a generation or 2, but we're certainly very focused on that.

Operator

Your next question is from the line of Srini Pajjuri of CLSA Securities.

Srini Pajjuri - CLSA Asia-Pacific Markets, Research Division

A couple of follow-ups. Abhi, first on the Seagate enterprise ramp, could you give us an update as to how far in that ramp we are and how long do you think it will take for it to complete? And along the same lines, one of your competitors, I guess, there is only one competitor, has been telling us that they have a design win at Seagate and that will ramp sometime this year. So I'm just wondering how do feel about your share on the client side and do you [indiscernible] any risk there?

Abhijit Y. Talwalkar

Yes, I mean, as we've said, right, every HDD vendor is working and executing on having dual sources. And that's also benefiting us as well as we have an opportunity to grow our share elsewhere. In terms of the enterprise business itself, that ramp continues. There's still more to go in that ramp. We're probably starting to approach or see the crossover point of 50% so we'll still have some more ramp up ahead of us as well over the next quarter to maybe 2. And then in terms of just Seagate overall, we expect our business to grow this year over last year.

Srini Pajjuri - Credit Agricole Securities (USA) Inc., Research Division

Okay, great. And then on the Axxia processors, I know you said that your target is to get to 50% market share. Could you help us maybe -- could you put some numbers around it as to what the market opportunity is and what your kind of run rate is and what -- if you get to 50%, what that dollar number will look like?

Abhijit Y. Talwalkar

Yes, I think the projections that we have relative to the market 2, 3 years out roughly is around $400 million a year of silicon opportunity associated specifically with the control plane and data plane functions, specifically, right? So that's in a base station product itself. And so our objective is to aim for that 50% share out in that horizon. I'm not going to break out for you today as to what our share is, but I will tell you and reiterate that what we said relative to Ericsson, which is the #1 player in the market today with 30% to 35% share, they will be ramping with Axxia in RBS 6000 this year.

Sujal Shah

There are no further questions. I'd 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 today beginning today at approximately 4 p.m. Pacific Standard Time and will run through 9 p.m. Pacific Standard Time on February 1. The replay access numbers are 1 (855) 859-2056 within the U.S. and 1 (404) 537-3406 for all other locations. The conference ID is 38812095. The webcast will be archived at www.lsi.com/webcast. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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