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LSI Corporation (NASDAQ:LSI)

Q1 2007 Earnings Call

April 25, 2007 5:00 pm ET

Executives:

Tom Tran - Director of Investor Relations

Abhi Talwalkar - President and CEO

Bryon Look - Executive Vice President and CFO

Analysts:

Craig Berger - Wedbush Morgan Securities

Shawn Webster - JP Morgan

Tayyib Shah - Longbow Research

Joseph Osha – Merrill Lynch

Seogju Lee - Goldman Sachs

Sumit Dhanda - Banc of America Securities

Romit Shaw – Lehman Brothers

Robert Maina - Cramer Rosenthal

Paul Kim – Omega Advisors

Harlan Sur- Morgan Stanley

Presentation

Operator

Welcome to the LSI Logic first quarter results conference call. At this time, participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during the call, please press the * followed by the 0. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Tom Tran, Vice President of Investor Relations at LSI. Please go ahead.

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Tom Tran

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. We will begin the call with opening remarks from Abhi, and then Bryon will provide first-quarter financial results and guidance for the second quarter. Abhi will then provide highlights for each of our businesses, and we will open the call for your questions. A replay of today's call and copies of our press release are available on our website.

During this call we will also be mentioning non-GAAP financial measures. You can find reconciliations of our non-GAAP financial measures to corresponding GAAP amounts on our website, at www.lsi.com/investors. I also want to remind you that today's remarks will include forward-looking statements. Our actual results could differ materially from those suggested by the statements made today. Information about factors that could affect our future results is contained on our annual report on form 10K for the fiscal year ended December 31, 2006.

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

Abhi Talwalkar

Good afternoon, and welcome, everybody. Today marks our first earnings call since we completed our merger with Agere Systems on April 2nd. The integration of the two companies is off to a running start. Internally there is genuine excitement as we come together to create a more competitive innovator of silicon, systems, and software building blocks for the storage, networking, and consumer electronics markets.

The response from our major customers has been very positive, and we are now functioning as a single entity as we execute our plans to drive the business forward. I am sure you have seen our press release this afternoon, where we reported strong financial results amid a seasonally challenging environment.

We also included guidance for revenues in the June quarter. Clearly we are in a challenging demand environment, as evidenced by recent announcements by our customers and peers. We have a significant amount of revenue directly or indirectly tied to IT spending, with half of this tied to US consumption. IT spending was soft in the March quarter and is expected to remain soft through the June quarter.

The June quarter is also expected to remain challenging for hard disk drives, driven by expected declines in desktop and notebook shipments. Market conditions, combined with inventory adjustments and supply-chain changes that are key customers, continue to hamper our business into this quarter. In addition, IP licensing revenues will be lower in the June quarter, due in large part to merger-related issues, including the effects of purchase accounting.

While June revenues will decline sequentially from our combined March results, we remain confident that our total business will grow as we move through the second half of 2007.

Over the past 18 months, both LSI and Agere have made tremendous strides in improving our respective businesses. However, there is still work to be done to get to the levels of consistent revenue growth and financial performance that are among the best in our peer group. These changes will not happen overnight or in a single quarter, but I assure you that we will be continuing to take bold steps to position the company for sustainable, profitable growth and unlock the value contained within the new LSI.

So looking ahead, we have sketched broadly a three-phase business acceleration plan for the new LSI to help you understand how we plan to move the company forward.

The first phase, merger integration, already is underway. In this phase we are executing our organizational integration and implementing a process to drive the cost synergies that we have identified. In addition, we have already launched an aggressive focus on our immediate, top ten cross-selling opportunities to drive near-term growth.

For the longer term, we are refining our corporate vision and strategy, and looking at ways to leverage our expertise. Also, as part of this phase we are undertaking an intensive portfolio evaluation to identify those products and markets that we will invest in and grow, those that we will manage for profitability, and those that we will exit for strategic reasons.

In our consumer business, we have taken steps over the past year to improve profitability and diversify our revenue base into new end markets. We are pleased that our new DoMiNo 8633 processor for DVD recorders recently won the 2006 EDN Innovations Award, and is featured in the latest DVD recorders offered in the US by Panasonic. In addition, we continue to see strong customer attraction around Domino[X] and ZEVIO products.

Even with this progress, we continue to believe that scale is necessary for long-term success in this segment. As a result, we are now actively exploring all strategic options for our consumer business. We believe there is a lot of value in this business, and are driving to optimize the value for our customers, employees, and shareholders. We expect to have a conclusion on our strategic options within the next one to two quarters. This is a significant milestone in Phase One of our plan.

Phase Two is the earnings acceleration phase. In this phase, we will be executing on cost and operating expense synergies to drive growth in operating income and earnings per share. As we have said earlier, the merger is expected to produce synergy-related cost savings of at least $125 million dollars in 2008.

As for 2007, our objective is to reduce total second-half 2007 operating expenses by $50 million dollars. This reduction will be composed of synergy savings, increased efficiencies, and portfolio rationalization, and does not include any additional savings we intend to realize in cost of goods sold.

As previously announced, the LSI board has authorized the repurchase of up to $500 million of the company's common stock, and we expect to begin repurchases in the near future.

In phase three, the steps that we are taking to focus our investments on building sustainable market-leading franchises, where we have strong differentiation and stickiness, is expected to translate into consistent top-line growth. It's our goal to achieve rates of revenue growth that are competitive with the industry and to draw a further growth in earnings. To provide a proof point of future growth, the combination has already secured a key enterprise hard-disk drive win, which I will talk about later in the call.

By design, these phases will overlap to some degree reflecting a mix of all elements in some quarters. Nevertheless, we expect to complete Phase One in the next several quarters, drive growth starting in the current year, and accelerate revenue earnings growth through 2008 in Phase Three.

To give you a more in-depth look at our plans to drive growth in our businesses, we have scheduled an investor day for June 13th in New York. We intend to provide further insights into our business model and progress at that event. Further details on the investor day will be available shortly.

Now, let me turn it over to Bryon, who will take you through our results and provide guidance.

Bryon Look

Thanks Abhi. With the close of the merger with Agere Systems, we are excited to now begin executing our integration plans and driving the many opportunities that we see in front of us as a new combined company. The transaction closed on April 2, at the beginning of our second quarter, so the first-quarter results that I will discuss reflect LSI's stand-alone performance prior to the merger.

While not part of LSI's financial results for the first quarter, I will also comment on Agere's revenues by business in the March quarter. Our guidance for June will be for the combined company.

Financial results for LSI in the first quarter were solid. Even with revenues at the low end of our guidance range, GAAP and non-GAAP earnings per share, gross margins, and operating expenses, all were better than guidance.

Some highlights of the quarter include GAAP operating income of $30.6 million and GAAP EPS of $0.07 per share. Non-GAAP operating income, which excludes special items, was $45.5 million, with EPS of $0.11 per share. Cash and short-term investments at the end of the March quarter were over $1 billion. And revenues for the March quarter were $465 million.

First-quarter revenue from our storage systems segment was $193 million, an increase of $16 million year-over-year, driven by growth of our mid-range products and the introduction of our new PriceBand 123 products. Storage system revenues in Q1 represented a significant portion of total revenue at 41%, and grew 9% year-over-year.

Now let me turn to the three markets that comprise our semiconductor segment. Our storage semiconductor revenues were $180 million, growing 13% over Q1 last year, and representing 39% of total Q1 LSI revenue. This growth was led by our SAS products.

Storage revenues continue to increase, as our percentage of LSI's total revenues. Combined storage semiconductor and storage-system revenues grew 11%, compared to the same quarter a year ago and combined storage revenues totaled 80% of LSI revenues in the first quarter, increasing from Q1 of the prior year.

Consumer revenues were $28 million in Q1, declining 54% from Q1 of the prior year, due primarily to lower shipments and to digital audio products.

Consumer semi-conductors represented 6% of total LSI revenue.

Q1 revenues and communication on other markets was $64 million, which was an 18% decrease from Q1 of the prior year and 16% decline sequentially.

In the March quarter we experienced lower demand due to excess inventory at several customers, supply chain changes at some customers, and lower overall IT spending.

For Q1 communications and other markets represented 14% of total LSI revenue.

Q1 gross margins, excluding special items was 43.3%, which was better than guidance.

Semi-conductor margins continued to improve to 49.9% up from 49.3% in Q4 due to product mix.

(Inaudible) systems margins declined in Q1 as expected due to new products start up costs and seasonally lower revenue.

We expect systems margins to improve in Q2 as start up costs are behind us and products continue to ramp and we expect margins to return to the high 30% range in the second half of 2007.

In Q1 we continued tightening operating expenses as they totalled $156 million excluding special items. This is an improvement of $4 million from Q4 and better than our guidance range.

Interest income and other net of interest expense was $6.6 million in the quarter.

Costs and expenses associated with special items for the quarter netted to $14.5 million.

Special items included $11.2 million of stock based compensation expense, $5.3 million in amortization of acquisition related items, $6.5 million write off of in process R&D related to our Q1 purchase of Silicon Store, and $2.3 million in severance and other restructuring costs offset by $10.4 million of gain on sales of real estate.

Stock based compensation expense was allocated as follows: $1.9 million to cost of sales, $4.8 million to R&D, and $4.5 million to SG&A.

The tax provision for the first quarter on a GAAP basis was $7.5 million. On a non-GAAP basis the tax provision was $7.8 million. On a GAAP basis first quarter net income was $30 million or $0.07 per share. This was up $0.04 per share from Q1 2006 and down $0.07 sequentially.

Net income excluding special items was $44 million or $0.11 per share. This was $0.01 per share higher than Q1 2006 and down $0.07 per share sequentially.

Turning now to the balance sheet and cash flow we had another strong quarter with operating cash flows of $56 million. Cash and short term investments are over $1 billion and our net cash position at the end of the quarter was $667 million.

Our inventory increased by $20 million from the prior quarter to $229 million due to end of life purchases and new product ramps.

So to summarize Q1, LSI remains financially strong. Our net cash position improved, operating cash flow is positive, semi conductor gross margin approached 50%, and operating expense declined from the previous quarter. Total revenues for the March quarter were $321 million.

The revenue break out in each business excluding IT licensing revenues was as follows: Storage $94 million, networking $93 million, and mobility $95 million.

Intellectual property licensing revenues in the quarter were $39 million.

Now if we look at our cycle going forward, our financials would look quite different.

For comparison purposes (inaudible) have been merged for the quarter ending March to combine product revenues by business would have been as follows. For the storage system segment, $193 million and for the semi-conductor segment, $554 million

For the businesses which make up the semi-conductor segment, stores semi-conductor $280 million which include the gears, our disc drive business and other businesses combined with LSI's storage semi conductors.

Networking, $151 million, which reflects the gears networking business combined with LSI's communications business.

Mobility, $95 million, and continues to reflect the gears former mobility business.

Consumer, $28 million, and continues to reflect LSI's former consumer business.

Note that these numbers exclude intellectual property licensing revenues.

Now I want to take a few moments to highlight the estimated impact of merger related accounting in the number variance including IT revenue, in process R&D, and gross margin.

Purchase accounting and merger related accounting effects will reduce the amount of IP revenue that LSI will be able to recognize by approximately $15 million in Q2 and will continue to be a factor for the next two years.

Note that because this revenue is high margin, consolidated gross margins will be lower than one might have expected based on a weighted average of the two companies.

Purchase accounting rules will also result in a one time charge associated with in process R&D of between $180 million and $220 million.

We will see the impact of purchase accounting on our gross margins in Q2 with a one time share market value write up of inventory of between and $45 and $55 million.

The ongoing amortization of acquisition related intangibles will be impacted by about $180 million to $220 million for the full year 2007.

We further expect to record restructuring expenses related to merger related activities as we combine facilities and gain operational efficiencies while moving to common systems and processes.

It is important to note that the required accounting treatment will not impact cash flow.

The following is our guidance for the June quarter: Revenue in the range of $715 million to $745 million, consolidated gross margin excluding special items in the range of 41-43%, and operating expenses in the range of $295 million to $305 million excluding special items.

To reiterate Abhi’s comments, our objective is to reduce total second half 2007 operating expenses by $50 million. This reduction will be composed of synergy savings, increased efficiencies, and portfolio rationalization. It does not include any additional savings we intend to realize in cost to goods sold.

Interest income and other net of interest expense for Q2 of approximately $5 million.

Special items in Q2 netting to approximately $320-380 million.

GAAP tax provision of approximately $6 million.

Non-GAAP tax rate, excluding special items is approximately 20%.

We had a GAAP net loss in the range of $0.40-0.49 per diluted share and EPS excluding special items in the range of break even to $0.03 per diluted share.

The diluted share cap per GAAP is projected to be 780 million shares and for non-GAAP, 800 million shares.

While the effective market conditions on our June revenue guidance is disappointing, we remain confident that the opportunities we have in each of our businesses will translate into long term profitable growth.

We expect revenue growth to occur through the second half of 2007 and expect to realize cost and expense synergies which will help to improve gross margins and drive down operating expense.

Now let me turn the call back to Abhi.

Abhi Talwalkar

Thanks Bryon.

Now I would like to review the highlights of some of our businesses as we will discuss them going forward.

For the benefit of those listeners who may not be familiar with the full line up of the new LSI, I will include a brief description of our businesses, the markets we serve, and our key competitive advantages.

First let me start by talking about our networking business.

Our networking business includes standard and custom products for wireless, wire line and access applications, as well as connectivity's standard products for PC applications.

Because of our rich technology and networking heritage, LSI possesses world expertise for delivering service providers, the enterprise, and small and medium sized businesses.

Highlights of the quarter include continued momentum with our portfolio of true one networking solutions. In a small and medium size business space we expanded our success with new designs for business services gateway solutions based on our network processors and LSI's network processor combined with link layer processor solutions continue to derive success in wireline access.

Our mobility business includes a broad portfolio of cellular handset solutions for GSM based technologies which serve more than 80% of the world's mobile phone subscribers. Our customers include Samsung and Amoi.

Key to success in this business has been our robust protocol software stack, proven on over 200 networks worldwide which enabled us to become the number one supplier to Samsung for GPRS.

During the quarter Samsung launched its new alternate addition to thin phones and we are experiencing strong demand from the acceptance of these phones. Our package on package technology enabled the thinness of these phone and we are pleased to be the sole source baseband provider for these GPRS edge handsets.

We continue to gain share and are now supplying over two thirds of Samsung's phones in this space by enabling high end features in mainstream phones. LSI's overall storage business consists of storage systems and storage semi-conductors which include hard disk drives, silicon fast, and fiber channel infrastructure silicon.

Notably within the quarter we surpass 2 million units shipped of Sass controllers, clearly establishing our market leadership in this key new standard.

In storage hard disk drives semiconductors, we enabled the world's largest disk drive manufactures to deliver innovative products by providing the broadest portfolio of storage solutions. Our customers include all the major hard disk drive makers including , Hitachi, Samsung, Seagate and Western Digital.

Our family of pre-amps, hard disk controllers, re-channel interfaces, and SOCs, are tailored to performance requirements of enterprise, desktop, mobile, and consumer drives. We help pioneer the market in hard disk drive ICs but the game has changed.

Developments scale unique and differentiated IPs such as rechannels, standards leadership suchs as Sass, and system level capabilities are key elements of a winning recipe.

By bringing LSI and a year's capabilities together combined with superior customer orientation we are uniquely positioned to win and have already had success with this approach in the hard disk drive enterprise segment with one of our customers. This win is a strong proof point of the value of the combination between LSI and a gear and the speed with which we have moved to quickly turn strong differentiation into a design win.

We are changing the playing field in enterprise storage and are actively engaged in many other discussions to increase our share and footprint in the hard disk drive space over the coming years. In the immediate term we are very excited to begin ramping 160 gigabyte per platter SOC with a key agent hard disk drive customer continuing the diversification of our hard disk drive customer base. This is a proof point of the strong relationship we have developed with this customer and we expect to broaden our footprint further. We are also pleased that we continue to grow our pre-amp business with all key players and game share expanding our design winds with Hitachi during the quarter.

Turning to storage systems, we offer a broad range of open modular external storage products comprised of complete storage subsystems, sub-assemblies, and related storage management software. This allows OEM customers to create highly customized storage systems that can be integrated with value at its software and services and delivered as a complete differentiated data storage solution to businesses. In addition we offer a wide spectrum of direct attach rate solutions for OEM and indirect channel customers. These customers include the like of IBM, SUN, Intel, and Dell.

We were very pleased with the first quarter performance of storage systems driven by the continued strong demand for our midrange fiber channel platforms as well as the ramp of our new line of entry level Sass and fiber channel platforms. With more than 7,000 of these new entry platforms shipped in the quarter, this represents the fastest ramp to volume of a new product we have experienced in this business in our history and we recently launched our third tier one customer with other customers that we are shipping to as well.

While market conditions present a near-term challenge, we are encouraged by the opportunities we have to drive the business forward to generate long term growth of revenues and profitability. If IT's spending is typical and consistent with last year's seasonality, we expect to see strong revenue growth in the second half of this calendar year based on our strong product position and strength.

Before we go to your questions I want to conclude with some of the key points from today's call. The June quarter revenues are being impacted by isolated and well understood items. We are well positioned for growth in the second half. We are executing to a three phase business acceleration plan and have started the process to ensure that our investments are aligned for our best opportunities going forward. We are committed to reduce total second half 2007 expenses by $50 million and we are confident in the future of our business and are fully committed to execute on our stock repurchase program. Now let me hand it back to Tom.

Tom Tran

Thank you Abhi. At this point we will begin the Q&A portion of the call. Mike will you please read the instructions for the Q&A session?

Question-and-Answer Session

Operator

Certainly. Ladies and gentleman at this time we will begin the question and answer session. To ensure that all participants have an opportunity to ask a question we ask that each person will be limited to one question and one follow up during this Q&A session. You may rejoin the queue if you need an additional follow up. If you wish to ask a question please press the "star" followed by the "one" on your touch tone phone. You will hear a tone indicating you have been placed in queue. You may remove yourself from queue at any time by pressing the "star" followed by the "two". If you're using a speaker phone, please pick up the handset before pressing the numbers.

Our first question is coming from Craig Berger with Wedbush Morgan. Please go ahead.

Craig Berger - Wedbush Morgan Securities

Good afternoon. Thanks for taking my questions. Just wanted to dig into this topline guidance. It certainly seems worse than I was expecting and I think worse than a lot of people were expecting. And I'm trying to understand how much of this is weak IT demand versus how much of this is working down excess inventory to customers or other factors?

Abhi Talwalkar

Well I think there are three factors Craig. One is, and Bryon sort of provided some visibility in this, the quarter to quarter decline especially with IP revenues because of largely margin related and accounting issues. The other drop that we're seeing quarter to quarter was associated with networking and what's happening there is that there are a number of merges that occurred in Q1 so the merges combined with some of the softening have put some pressure relative to supply change, inventory levels and so forth that are still working themselves through the system not only in Q1 but into Q2. And we expected some additional growth in our consumer business quarter to quarter and frankly that is not materializing to the level we expected.

Craig Berger - Wedbush Morgan Securities

So should we be modeling the networking business to bounce back as these combinations work themselves through and these customers begin ordering again?

Abhi Talwalkar

Well we're certainly not providing guidance beyond the June quarter but as I noted in my discussion earlier, if IT spending resumes which we expected it to as it typically does and is seasonally strong in second half, we're well positioned to grow based on our product positions and the fact that we're with all the right customers.

Craig Berger - Wedbush Morgan Securities

With respect to the cost savings on the merger, I know you guys said to $50 million combined in the back half. Is that all of it or should we expect more in 2008? Can you also address whether there's any facility closure or consolidation opportunities or what else you guys might be looking at?

Abhi Talwalkar

We're not going to be providing any more specifics at this time but we remain committed and we're off executing a number of plans and implementation activities relative to the $125 million for 2008 but we also wanted to provide more specificity relative to what we intend to do in the second half of 2007 which is the $50 million that is all outbacks but comprised of synergies, portfolio rationalizations as well as a number efficiency initiatives we've kicked off.

Operator

Our next question comes from Sean Webster with JP Morgan. Please go ahead.

Shawn Webster - JP Morgan

Good afternoon. Can you expand a little bit on the $50 million reduction in the second half? How should we think about that from a comparative sense? Is that down from the first half runway or should we think about that from a comparative sense? Is that down from the first half when the combined entities would have been separated and then I have a couple follow ups please.

Abhi Talwalkar

Yeah. We're talking about relative to whatever would have been in the plans for the second half. We are working towards the identifications. In any case, we have already identified savings that are all in the operating expense area against some of that would be coming from synergies that we could start to achieve either in the third or the fourth quarter. And of course you might expect that we have additional savings out into the 2008 timeframe that could take that number higher.

Shawn Webster - JP Morgan

Right. OK. And then on the gross margins, as your revenues were covered can you give us a sense of where you think your gross margins are going to move over the recovery trajectory in a sense of where your gross margins are going to go and what the drivers will be?

Bryon Look

Yeah I can do that and Abhi had some comments as well. We are intending to discuss more completely in our June analysis, day and target business model where we naturally speak to the gross margin targets as well as to our longer term spending margin targets as percentages of revenue. Clearly there are some activities that are one time in nature here that are affecting the gross margins. I alluded to a few of them. First of all there is the purchase accounting effect which is a one quarter effect on our gross margins. It's about a $50 million or so write-up of a year inventory that will flow through the manufacturing and therefore we'll see the recovery of the margin related to that particular item in the following quarter.

There are mixed changes going on with respect to the business. Our storage systems margins are roughly in the 34% range currently. It's a result of the exciting ramps that we're seeing with customers in particular. We have already implemented a number of actions which improve the margins in that particular business and would expect in the second half for those margins to turn to the high 30% range so that would definitely have a significant impact on the margins as we recover as well.

Operator

Thank you. Our next question comes from Tayyib Shah with Longbow Research. Please go ahead.

Tayyib Shah - Longbow Research

Hi guys. The weakness on the storage side in hard disk drive, is that more on the gear side of the business? And if that's the case is that going to be longer lived than the difficult ID spending seasonality?

Abhi Talwalkar

No, I think it's largely consistent with the fact that PC unit shipments quarter to quarter are down and range anywhere from 2–6%. Mileage varies whether it's a desktop segment or notebook segment. So I think that's largely part of it. In fact we are growing new customers in the hard disk drive business. And that growth is sort of offset by the quarter to quarter decline. And I think you've heard some of the customers in the market place are hard disk customers sort of allude to similar quarter to quarter characteristics.

Tayyib Shah - Longbow Research

OK and then the gear handset business. How do you see that tracking in the second quarter? And you said that you are now evaluating strategic alternatives for the consumer business but you haven't included the handset business for the same sort of evaluation. Should we take that as an indication that you are willing to keep the handset business for the longer term?

Abhi Talwalkar

Well you've got a number of questions there. First of all, relative to handsets, handsets into the June quarter here are up, and up consistent with what the gear management team had talked about, up based on our strong position in Samsung's line up and the strong acceptance that they've had with their ultra-two addition lines so we feel very good about that and excited about the acceptance of those phones.

Relative to that particular business, we recognize that the handset market place is a competitive market place. We have a very strong position within Samsung and are well positioned to drive growth in the second half of 2007. It's a contributor to the business and that's what we're focused on right now. As to consumer I think my comments were pretty clear. Scale is very necessary to succeed in that segment and we're evaluating a number of strategic alternatives.

Operator

Our next question comes from Joe Osha with Merrill Lynch. Please go ahead.

Joseph Osha – Merrill Lynch

Hi guys. Looking at 2008 you're talking about the $125 million savings. Is that off of the end of 2007 based or is that off of the current? I'm trying to figure out how to base this model.

Abhi Talwalkar

I think what we're saying is we certainly remain committed to the goals of the outline. When we announced the merger to $125 million of savings by 2008…and I think what we're trying to do here is to provide a little bit more clarity in terms of our ability to achieve some of that in 2007 in addition getting some other savings and operating expenses that our outside of what we would consider synergies.

Joseph Osha – Merrill Lynch

OK, so in other words, if another $75 million in improvement in 2008, so that $125 number is a cumulative number right?

Abhi Talwalkar

Well the $125 million was a number for the entire year in 2008. If you're asking Joe as to how does that $50 million that we talked about in the second half which is an aggregate reduction over the total second half spending relate to the $125, some of it contributes to that $125 but as Bryon alluded to we're driving several other activities around portfolio rationalization as well as other efficiencies that we consider non-synergy related that are contributing to that.

Joseph Osha – Merrill Lynch

OK. No I was not trying to...

Abhi Talwalkar

OK, no I wanted to, this was an important point. We want to make sure that it's clear.

Joseph Osha – Merrill Lynch

OK and just to follow along with that, it's certainly a step in the right direction, but you've got a company that's running $1.2–1.3 billion OpEx a year. You know I'll get companies that are undergoing mergers that are managing similar cross savings in '08. Why is this number not, to be honest, a whole lot bigger?

Abhi Talwalkar

Which number are you talking about?

Joseph Osha – Merrill Lynch

The reduction. You're talking about taking basically 10% out of the cost run rate, it's certainly a step in the right direction. But I'm just curious as to why it's not a substantially larger number?

Abhi Talwalkar

Well I think for a number of reasons. One is we want to execute to what we say we're going to execute to and commit to. Two, if you take a very close look at the two companies and their product lines and the markets they serve more so than product lines, the level of overlap between the product lines is actually very very limited. There is certainly an overlap in terms of some of the base foundational technology which will certainly contribute to some of those synergies of $125 million, but we have very little product overlap and I think that's a little bit different than maybe some of the other mergers and efforts that are underway out there.

Bryon Look

I think it's also important to note that we've been focused on describing at least some of the operating expense savings and we've alluded to some of the opportunities that we have in driving improved cost in sales also from the combination in scale that we have with combined company and we're already starting to see some of those benefits as we engage with suppliers and so forth. But there's a whole lot of category with the revenue growth that we can expect to see and the revenue opportunities we can expect to see from the combination. Some of the other synergies that we can start to identify and we're sharing that I think as we move forward here.

Abhi Talwalkar

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

Operator

Seogju Lee with Goldman Sachs has the next question. Please go ahead.

Seogju Lee - Goldman Sachs

Hi. Thanks. Just to clarify on the $50 million OpEx savings that are now in plan for the second of this year, how will that scale in as we go through?

Abhi Talwalkar

Not sure what you mean by scale in?

Seogju Lee - Goldman Sachs

So do you think it will be $25 million in Q3 and then $25 million in Q4?

Abhi Talwalkar

You know, Seogju Lee, we're not going to provide the details at this juncture. First of all you should assume it's distributed not all lump in one quarter. The reason we're not going to provide specifics at this time, we have a number of efforts underway, they have various times to execution, time to realization, timelines as well as risks with those timelines. So I think we'll certainly provide more clarity as we can at the June analyst call and in subsequent earnings calls as to how we're doing against that.

Seogju Lee - Goldman Sachs

OK, because clearly if you do, let's say, you'll have incremental savings in Q4 versus Q3, the run rate as you exit Q4 could get you to the $120+ million of savings that you're targeting for.

Abhi Talwalkar

Yeah. That's an accurate assumption.

Seogju Lee - Goldman Sachs

OK, great. Thank you. And then just in terms of the guidance for Q2, in terms of from a market standpoint, you had highlighted issues in networking as well as in consumer? And then also the (inaudible), should I assume that the other areas are expected to grow then?

Abhi Talwalkar

Well, I mean at a high level, we expect storage systems to be up, mobility to be up, consumers flattish, networking we’ve already discussed. It’s down and storage semi conductors is slightly down because of this office that we talked about, and some of the growth that we’re having in new customers and new products is sort of being offset by some of the softness we’ve alluded to.

Operator

Sumit Dhanda with Banc of America Securities, please go ahead with your question.

Sumit Dhanda - Banc of America Securities

Yes, hi, I have a couple questions. I guess the first one is, when you first outlined your cost saving associated with Synergy as opposed to the merger, my assumption here is that the revenue target you had in mind for the combined entity was a lot higher, and as I look through these numbers, it seems like the LSI standalone business will barely grow this year, if that, and the year is clearly going to decline this year. In other words, what I’m trying to get at is shouldn’t you be positioning yourself for taking a harder look at this and try to try figure out how to reduce operating expenses and even further for the combined entity given what the revenue run rate is?

Abhi Talwalkar

Well, I think this is one of the reasons why we have disclosed the $50 million in OpEx reduction which if you know, if you take a close look at it, a meaningful percentage of that is incremental to the OpEx savings in 2008 associated with that $125 million dollars. And we’ve also kicked off an intensive portfolio evaluation process as well. Then again, we continue to believe that we’re well positioned from a gross standpoint.

If you look at sort of the LSI, the old LSI business, about 80% of that business was associated with storage where we’ve clearly driven a strategy over the last year and a half, and increased our position across all the segments as well as our customer base. And we’ve demonstrated consistent double digit growth, year over year, both on the quarters as well as on an annual basis. Our objective is to get more of the new LSI’s business to that level of predictability and foundation.

Sumit Dhanda - Banc of America Securities

OK, let me just switch gears a little bit. You know you talked about the networking business being soft and persisting softness, you cited the merger related issues higher up in the supply chain, but it seems like it’s behind some of the other players who’ve reported within semi-conductors. This was an issue that a lot of people cited late in ’06 perhaps entering ’07, but that doesn’t seem to be a focal point of discussion for people exposed to that segment. So, are you seeing a delayed impact here?

Abhi Talwalkar

No, we may be talking about different things. I’m really referring to mergers such as Alcatel and Lucent, Nokia, and Siemens, there’s been some supply changes at another big, very large…

Sumit Dhanda - Banc of America Securities

That’s what I’m referring to.

Abhi Talwalkar

No, I mean you know we started seeing the effects of that in Q1 and clearly Agere saw it their business and we led to the pre-announcement and we’re seeing some of that definitely trickle into this quarter.

Operator

Thank you, our next question comes from Romit Shaw with Lehman Brothers. Please go ahead.

Romit Shaw – Lehman Brothers

Thanks. Just with respect to your storage business as you alluded to, there’s an incrementally more cautious commentary from some companies like IBM or EMC with respect to the North American enterprise market. Can you just share with us what your visibility is like today?

Abhi Talwalkar

Well, I mean I think pretty consistent with some of the other commentary across EMC, IBM, US IT spending was more cautious, we still saw growth year over year as reflected in our storage business, but that year over year growth, probably a little bit muted relative to what it was the prior year and each year over year. So there’s been that cautionary stance in the US market. The other markets have done really well.

We expect though as consistent with seasonality that that growth will resume. And IT spending is typically up and up strong in the second half of the year. We experienced it last year and the year before. I don’t believe that inventory levels outside of what we’ve discussed in networking, but inventory levels across our storage related business.

I don't believe that inventory levels outside of what we have discussed in networking, but inventory levels across our storage-related businesses are anything to be concerned about at this juncture.

Romit Shaw – Lehman Brothers

OK, and could you just elaborate again on your Enterprise Desktop One?

Abhi Talwalkar

Well, no, beyond the fact that it's a great proof point of the combination of these two companies bringing a very competitive line-up of IP and scale and a value proposition, it's a great, out-of-the-chute win for us on that particular business, as I've said before when we announced the merger, and subsequent to that, the hard-disk drive market is a big market. We're far from saturated. That is clearly going to be an area for us to grow, and we've got a number of accounts that we are working with closely to grow our footprint. And that is just one of more to come.

Operator

Robert Maine of Cramer Rosenthal, please go ahead with your question.

Robert Maina - Cramer Rosenthal

Yeah, good afternoon, guys. I just wanted to spend some time on other things, some of the consequences of your decision to exit the consumer business. Your cost savings goal of $125 million, can you share with us any insights as to how much of that comes out of the infrastructure, once the consumer business is exited? Thank you.

Abhi Talwalkar

Hey, Rob. We didn't say anything about exiting the consumer business. We talked about the fact that we're going to explore a number of strategic options, given the necessity for scale.

As to the $125 million, again, what that $125 million is associated with is synergies that come about bringing the two companies together, and has nothing to do with what we may choose to do or not to do, relative to the rationalization of product lines, markets, and the rest of the portfolio.

Robert Maina - Cramer Rosenthal

OK, and if I could ask one follow-up question, then. As it relates to the numbers that you've given for guidance this $715-745 million, the midpoint there is $730 million, if I could take your revenues in the first quarter of $465 million, (inaudible) the difference and the guidance, I come up with a $41 million delta. I know you alluded in the previous question to some of the breakdown where you'll see growth and where you'll see contraction. Can you share with us in terms of, maybe, a magnitude of how much we should assume networking is down, or how much we should assume storage and semi should be down? That would be helpful. Thank you.

Bryon Look

I'm just thinking through the math in your $40 million. You took sort of a pro-forma combined revenue base for the combined company in Q1, versus sort of center point, and you came out somewhere around $40-45 million, and your asking sort of the composition of that?

Robert Maina - Cramer Rosenthal

That's correct.

Bryon Look

OK, I'll give you some rough ranges. Clearly IP is probably in the $15+ million range, and obviously the majority of that, if not all of it, is merger-related, whether it's a large part of that being purchase accounting, as well as some sort of remnants of negotiations that have been delayed as a result of the merger, now we certainly hope are behind us.

Networking was a pretty significant portion of that $40 million, certainly north of $20 million, and then we certainly expected growth in our consumer business, probably in the order of 25%-30%, quarter-over-quarter, because Q2 is typically seasonally strong, and that that is not materializing.

Operator

Paul Kim with Omega Advisors has the next question. Please go ahead.

Paul Kim – Omega Advisors

Hey, guys, just a couple of questions on the balance sheet and share buybacks. So, pro-forma for the transaction I think your cash balance is probably going to be $1.5 billion. So that's roughly around 25% of your market caps. So, when you did the deal in December, you stock was trading, was approaching $11. Now it's going to be about $9.50 or so. So, the market has told you that you have basically destroyed value for this transaction. So if you disagree with that market, as a conclusion, then I don't see why you won't be really aggressive in buying back shares and increasing your share buyback program.

Abhi Talwalkar

Yes, I think we said on the call that we remain committed to that share repurchase program. We've had some limitations in terms of actually being in the marketplace, given the quiet period and getting through the actual close of the merger. And your numbers relative to the estimates on the balance sheet: yes, that's correct. We expect to have about $1.5 billion in cash here.

Paul Kim – Omega Advisors

So has your confidence in the business changed you announced the deal in December?

Abhi Talwalkar

No, not at all. If anything, our confidence and our long term strategic objectives and strategic rationale have only been reinforced, because what we continue to see as well as the fact that we’ve secured a pretty significant and meaningful win in an area of growth force. So, as we said earlier, now that we are beyond all the blackout periods, we have an opportunity to start exercising the repurchase program.

Operator

Our next question comes from Harlan Sur with Morgan Stanley. Please go ahead.

Harlan Sur- Morgan Stanley

Hi, good afternoon. First question on the entry level external raid products, Iknow you guys started the wrap in December, Abhi, you talked a little about it on the call. What are your expectations for the size of this business as we move through the year and the growth rate on this particular segment of the systems business?

Abhi Talwalkar

Well I’m not going to provide sort of overall expectations that we have for this business but clearly it’s an opportunity for us to expand our footprint not only from a customer diversification participate in a category, so it’s all upside, it’s all growth force. That segment itself is growing anywhere from 20-25% and in fact you could argue that because it sells into medium businesses and in some cases, sophisticated small businesses, it’s somewhat immune to some of the softness that we talked about as well because these down market segments certainly are of higher volume and I think move a lot of faster. So we’re excited to be in this pretty a good market. And we’ve got a great and diversifying customer base that will allow this product category to be very well distributed on a global basis.

Harlan Sur- Morgan Stanley

Is that the particular segment the majority of the incremental driver for the systems business in Q2?

Abhi Talwalkar

No. I mean it’s certainly contributing. We’ve got a very strong and healthy mid range business that still remains a pretty dominant percentage of the storage systems business.

Operator

Thank you. Next we have a follow up from Craig Berger with Wedbush Morgan. Please go ahead.

Craig Berger - Wedbush Morgan Securities

Good afternoon. Can you guys discuss your investment profile for the wireless business, the cellular base pan business, i.e. are you pursuing single chip product? Where are you with 3G, etc.?

Abhi Talwalkar

Well, Craig, I’m certainly not going to provide any investment transparency for obvious reasons, but I will comment on clearly our business today and what chips today and in the Samsung, there’s 2, 2 ½ G edge relative to 3G. We’re pretty much done with the product development inter-operability testing, field testing with a large spread of network providers. So, we’re working very closely with our customers to get those products out into the marketplace the second half of this year.

Craig Berger - Wedbush Morgan Securities

Can you comment on the single chip?

Abhi Talwalkar

No, I’m not going to comment on any roadmap related things that have not been disclosed publicly.

Craig Berger - Wedbush Morgan Securities

And then just real quickly here, the combined company revenues are down 17% for Q2 midpoint versus the Q4 ’06 number which seems like a lot. Is that surprising to you guys? I mean it seems like revenues are kind of evaporating more quickly than anticipated and just want to know your thoughts on that.

Abhi Talwalkar

Well, first of all, comparing Q2 to Q4 is not a good comparison at all. Q4 is the strongest quarter in the year and given the fact that we’ve got probably close to 85 - 90% of our business associated with IT related spending verses consumer spending, I just don't think that is the right comparison.

We have talked about what the isolated issues are that are driving our quarter to quarter drop and we remain very confident in terms of our product positions and the growth that we expect in the second half of 2007.

Operator

Next we have a follow up from Joseph Osha, please go ahead.

Joseph Osha – Merryll Lynch

It has been answered, thanks.

Operator

Alright, Tayyib Shah, please proceed with your follow up.

Tayyib Shah – Longbow Research

Can you tell me what are the chances of increasing share for hard disk drive SOC's on the gear side of the business maybe in 2007?

Abhi Talwalkar

Well, clearly as I alluded to earlier in the discussion that we are in the midst this quarter of ramping another customer relative to a SOC in the 160 gigabyte platter with a hard disk drive measure, so that is a very good example of customer diversification and new growth in the hard disk drive space.

As I said also we are in deep engagement across a number of other players in the market, now that we have combined the two companies and really are delivering a very different and more compelling value proposition to these players in the market.

Tayyib Shah – Longbow Research

OK, and a question related to the internal product growth map. When should we expect you to roll out products where you leverage both LSI's IP in the hard disk drive space as well as Agere?

Abhi Talwalkar

Well again I am not going to comment on specific timing relative to road map or make comments on unannounced products.

I see our goal as to expedite the opportunities that are in front of us as quickly as possible.

If there are no further questions, 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

Alright, thank you Ladies and Gentleman, our telephonic replay of this conference will be available beginning today approximately 5pm Pacific Day Light time. It will run through midnight on April 27th.

The replay access numbers are: 1 800 405 2236 within the US and 1 303 590 3000 for all other locations.

The pass code to enter is 11087195 followed by the pound sign. Again 11087195.

The web cast will also be archived at http:/www.lsi.com/investors

That concludes your conference for today. Thank you very much for your participation and have a pleasant day.

You may now disconnect.

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Source: LSI Q1 2007 Earnings Call Transcript
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