LSI Logic Q3 2007 Earnings Call Transcript

LSI Logic Corp. (LSI)

Q3 2007 Earnings Call

October 24, 2007 5:00 pm ET

Executives

Sujal Shah - VP, IR

Abhi Talwalkar - President and CEO

Bryon Look - EVP and CFO

Analysts

Kaushik Roy

Romit Shah

Seogju Lee

Steve Zane

Shawn Webster

Sanjay Devgan

Paul Kim

Sumit Dhanda

Robert Mayna

Ed Ressan

Tayyib Shah

Craig Berger

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the LSI Corporation Investor Relations Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. Instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Sujal Shah, Vice President of Investor Relations at LSI. Please go ahead, sir.

Sujal Shah

Good afternoon and thank you for joining us. With me today are Abhi Talwalkar, President and Chief Executive Officer, and Bryon Look, Executive Vice President and Chief Financial Officer.

We will begin the call with opening remarks from Abhi and then Bryon will provide third quarter financial results and guidance for the fourth quarter. Abhi will then provide highlights on each of our businesses and we will open the call for your questions. Our press release is available on our website.

During this call, we will be mentioning non-GAAP financial measures, which we may refer to as results, excluding special items. Today's earnings release describes the differences between our non-GAAP and GAAP reporting. You can find reconciliations of our non-GAAP financial measures to corresponding GAAP amounts on our website at www.lsi.com/webcast.

I also want to remind you that today's remarks will include forward-looking statements. Our actual results could differ materially from those suggested by the statements made today. Information about factors that could affect our future results is contained in our 2007 quarterly reports on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2006.

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

Abhi Talwalkar

Thank you, Sujal. Good afternoon and welcome. I would like to begin by recognizing all of the employees here at LSI, not only for a solid quarter, but also for their hard work and diligence through our merger integration. While there were plenty of reasons to become distracted as we shaped the new company, our teams remained focused and continue to execute to drive the new LSI forward.

In the third quarter, LSI's revenue was $727 million, exceeding our guidance range. We saw strength across our entire business in the third quarter as end customer demand returned, aided by some inventory replenishment, after the second quarter.

As we look ahead to Q4, we are guiding for approximately 10% sequential growth net of mobility and consumer revenues. When we completed out merger with Agere Systems back in April, we promised you that we would move quickly to realize synergies, focus the newly merged company on markets where we can be leaders and begin to win new businesses on the strength of the combined organizations.

In the third quarter, our urgency was evident as we made significant progress in Phase I of our three-phase business acceleration plan. While there is still work to be done, we have successfully integrated LSI into Agere, accelerated synergies to reduce operating expenses and drove a number of strategic actions to build our business on two pillars, specifically: storage and networking.

Since the beginning of the third quarter, we have completed the sale of our consumer business to Magnum Semiconductor, initiated and completed the sale of our mobility business to Infineon. We sold our Thailand assembly and test facility, to STATS ChipPAC, and began a strategic initiative to transition the worldwide assembly and testing of semiconductor and storage systems products to contract manufacturers. We also purchased Tarari, a privately held company widely recognized as having best in class technology for deep packet inspection.

And finally, we delivered a significant reduction in quarterly operating expense.

As part of Phase I, we are evolving our new corporate strategy centered around two core businesses that form the pillars of LSI, storage and networking. In both these areas LSI provides high value through complex silicon, firmware, software, subsystems as deep customer relationships and have category scale for sustained leadership.

As we go forward, we see Phase II earnings growth and Phase III, which is revenue growth, having some overlaps. We will continue to drive improvements in gross margin and manage operating expense levels, while investing in storage and networking to provide a full portfolio of solutions and capabilities to our customers. We will strike a balance between driving improvements in near-term profitability and selectively deploying capital to ensure long-term revenue growth and long-term growth in earnings.

We are seeing very high levels of design win opportunities in customer engagements, particularly in storage, and are prepared to capitalize on these opportunities to drive long-term sustainable revenue growth.

In our last earnings call, we said that we believe that the June quarter represented the bottom and that we have a solid baseline from which to grow revenues. Our September quarter revenue, guidance for December, and design win momentum, provide proof points of the strength in our business.

We have a number of key design wins and initiatives that give us confidence that we will continue to grow our business. In storage systems, we continued to see strength in our mid-range systems and continue to ramp entry-level SAS/SATA systems through three tier one OEM engagements. We have further strengthened the full product line with the delivery of iSCSI connectivity. In hard disk drives, we have solidified our position with our lead customer and it has been successful in expanding our customer base for SoCs and preamplifiers. We also continue to grow and expand our SAS standard component business and win new component designs in Fibre Channel, SAN and in silicon segments. In networking, we continue to win designs in Gateway, Access and Enterprise Connectivity Applications.

We believe that the actions that we have taken increase our focus on the core markets of storage and networking, and position us for long-term growth of revenue and profitability. During the last quarter, we announced a new share buy-back authorization for $500 million. This authorization came on top of an earlier $500 million authorization that we completed in July.

I think you will all agree that we've been hard at work and have made tremendous progress in a short amount of time. We're confident that our plans will continue to move the company forward.

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

Bryon Look

Thanks Abhi. I'd like to begin with a few of the key financial highlights for the quarter. Growth on the top line, coupled with focused efforts to streamline costs, resulted in significant improvements in our financial results. Revenues were $727 million, an 8.6% sequential increase from the second quarter.

Consolidated gross margins excluding special items were 43.4%, a 2.5 percentage point improvement from the second quarter 2007.

Operating expenses excluding special items were $262 million, a reduction of $28 million from the prior quarter. Earnings per share excluding special items were $0.06 per share, an $0.08 per share of sequential improvement.

Let me take this moment to thank the employees at LSI for their dedication and focus on delivering a much improved quarter. Before providing additional details about our financial results for the quarter, I'd like to provide a brief financial summary of our recent strategic transactions.

On July 27, we completed the sale of our consumer business to Magnum Semiconductor and received $22.6 million in cash, along with the promissory note for $18 million due in 2010.

On October 2, we completed the sale of our assembly and test operations in Thailand to an affiliate of STATS ChipPAC Limited for approximately $100 million, $50 million of which was paid in cash at closing and $50 million of which was paid in the form of a note due over four years.

As we noted on our prior call, we expect the transaction to be margin neutral in 2007 and expect the longer-term to achieve greater cost efficiencies through the increased adoption of a variable cost structure and scalable capacity, reducing our capital expense requirements going forward.

We've also begun to transition our semiconductor and storage systems, assembly and test operations performed at company-operated facilities in Singapore and Wichita, Kansas, to third-party contract manufacturers. Transition of these operations is expected to be completed in the first half of 2008.

We expect the transition to be margin neutral in 2007 with longer-term benefits associated with a more variable cost structure, enhanced flexibility to scale and reduced capital expenditures.

On October 3, we completed the acquisition of Tarari, a maker of silicon and software that provides content and application awareness in packet and message processing, for $85 million cash.

Finally, today we announced the completion of the sale of the mobility products group to Infineon Technologies, AG, for $450 million in cash and a performance-based payment of up to $50 million.

Now moving on to our financial performance in the quarter and guidance for Q4. Revenues for the third quarter were $727 million, an 8.6% sequential increase from the second quarter.

Consumer revenue recorded in the third quarter prior to its sale was approximately $6 million compared to $21 million in Q2. Compared to the second quarter, our total semiconductor segment revenues increased 9.3% to $530 million, while our storage systems segment revenues increased 6.6% to $197 million.

In our storage systems business, we offer a broad range of open modular, RAID storage products comprised of complete storage systems, subassemblies and related storage protection and management software.

Storage systems segment represented 27% of LSI's total revenues in the quarter. The increase in systems revenue was driven by higher shipments in both our entry level and midrange product lines along with direct-attached RAID products.

Our storage semiconductor business includes hard disk drive silicon, SAS standard components and storage area network ICs. Our storage semiconductor revenues were $292 million, representing 40% of total revenues in the third quarter and a 14.5% from the second quarter. The increase was driven primarily by higher shipments of SoCs and hard disk drive controllers to one of our key customers.

Storage revenues continue to be a significant percentage of LSI's total revenues. Revenues from StoreAge Systems and Storage Semiconductors combined amounted to $490 million or 67% of LSI's total revenues in the Q3.

Now let me turn to our networking business. Our networking business includes standard and custom products for wireless, wireline and access applications, along with connectivity products for enterprise and PC applications.

Q3 revenues in our networking business were $134 million, representing 18% of total revenues for the quarter and a 19% sequential increase from the second quarter. We experienced increased demand for DSP products for wireless infrastructure, increased shipments of connectivity solutions and stabilization of supply chain buffer stocks which had impacted Q2 shipments.

Next, I would like to discuss the mobility business which includes a broad portfolio of cellular handset solutions for GSM-based technologies. As I mentioned, we just completed the sale of this business to Infineon Technologies.

Q3 revenues in mobility were $93 million, representing 13% of total revenues in the third quarter and a 2% sequential increase from the second quarter. As I mentioned earlier, our consumer business revenues were $6 million in Q3 and we completed the sale of this business to Magnum in July.

Now, I'd like to talk a bit about our IP business. As we noted during our Q2, 2007 earnings call, following the Agere merger we are not able to recognize revenues associated with the Agere IP contracts existing prior to the merger due to purchase accounting, even though we continue to collect cash due under those contracts.

Revenues recognized in our financial statements relate to pre-merger LSI agreements and new agreements entered into after April 2, 2007. Revenues for the IP business in the third quarter were $4.5 million. We continue to expect the sum of LSI’s 2007 IP revenue and Agere's March quarter IP revenues pre-merger to be approximately $60 million. And we expect IP revenues to increase overtime as we enter into new agreements.

Next, moving on to gross margin. Our consolidated Q3 gross margin, excluding special items, was 43.4%, which is within our guidance range. Semiconductor margins, excluding special items, improved approximately 2 percentage points from the second quarter to approximately 46%, primarily due to increased revenues and partially offset by inventory related charges and a less favorable product mix, as compared to the second quarter. We expect semiconductor margins to continue improving into the fourth quarter.

Storage systems margins, excluding special items, improved to 37%, a 2.4 percentage point increase from the second quarter, primarily due to our successful efforts in reducing mid and entry level system product costs along with reduced inventory charges. We expect to maintain or expand systems gross margins in the fourth quarter.

As I noted before, we continue to drive efficiencies in the organization and maintain tight controls on our operating expenses, which totaled $262 million excluding special items. This represented a decline of $28.3 million from the second quarter.

As we move forward, we expect to continue driving modest improvements to our operating expenses relative to our Q4 forecast. From the time we announced the mobility sale, we have acquired Tarari and seen a significant increase in the number of opportunities and customer engagements particularly in storage.

We continue investing in these and other key designs and development activities in our core businesses to deliver long-term growth, while continuing to drive further improvements in profitability.

Interest income and other net of interest expense, excluding special items, was $2.8 million for Q3. Since announcing our share repurchase program last December, we have spent $549 million, out of a total authorization of $1 billion, reproducing a total of approximately 67.3 million shares.

Now, let me turn to the special items we've recorded in the third quarter, which netted to $184.7 million. Special items, primarily non-cash, included $101.2 million in restructuring cost relating primarily to the sale of our mobility business and including charges associated with consumer and manufacturing and other restructuring, $70.6 million in amortization of acquisition-related items and $21.8 million of stock-based compensation expense.

The tax provision for the third quarter on a GAAP basis was $3.2 million, on a non-GAAP basis, the tax provision was $12 million. On a GAAP basis, third quarter net loss was $141 million, or $0.20 per share. Net income excluding special items was a profit of $44 million, or $0.06 per share.

Turning now to the balance sheet and cash flow. During the quarter, we reduced inventories by $67 million, operating cash flows for the third quarter was $99 million. Cash and short-term investments were $1.1 billion and our net cash position at the end of the quarter was $379 million.

Following is our guidance for the December quarter. Revenue in the range of $700 million to $730 million, which includes approximately $27 million of mobility related revenues. This represents approximately a 9% sequential increase from the third quarter net of mobility and consumer revenues. With respect to our businesses, we expect storage systems to be sequentially up, relative to Q3 along with networking and IP. We expect our storage semi revenues to be flat to Q3 coming off a very strong quarter.

Consolidated gross margin, excluding special items, in the range of 43% to 45%. Operating expenses in the range of $245 million to $255 million, excluding special items, which includes $8 million of estimated mobility expenses in the quarter along with the full quarter of expenses associated with Tarari.

Interest income and other net of interest expense of $2 million. Special items netting to approximately $55 million to $95 million. A GAAP tax provision of approximately $12 million, non-GAAP tax rate of approximately 25%. GAAP net income in the range of a loss of $0.09 to a profit of $0.03 per diluted share and EPS excluding special items in the range of $0.05 to $0.09 per diluted share. Diluted share count is expected to be approximately 700 million shares on a GAAP basis and 705 million shares on a non-GAAP basis.

In summary, we remain confident that the opportunities we have in each of our businesses will translate into long-term profitable growth. We continue to expect revenue growth in our businesses for the remainder of 2007 and expect to realize cost and expense savings resulting in gross margin and operating expense improvements.

Now, let me turn the call back to Abhi.

Abhi Talwalkar

Thanks, Bryon. As I mentioned earlier, we have established two pillars that form the foundation of LSI: storage and networking. I believe that our strength, strategy and leadership position in storage are well known, so I wanted to spend a few moments discussing the networking market and our strategy.

LSI will focus it’s networking solutions for the top ten global service providers who will drive innovation to deliver new IP-based services dominated by video content. We will partner with the top five OEMs in the service provider and enterprise markets to deliver scalable, multi service solutions with carrier grade real-time reliability. We already have strong positions with these OEMs and our new services in total solutions will allow them to deliver new value to service providers. We will focus our investment and development in three areas, each with $1 billion of silicon-served available market. These markets are access, business in media gateways as well as enterprise connectivity. We have the heritage, expertise and technical core competencies to execute this strategy, including DSP leadership delivering twice the channel density that have the power of any competitor which is vital to voice and video infrastructure.

Advanced network and packet processing enabling the creation and delivery of new services in the service edge which is vital for scheduling, quality service and service delivery. Advanced traffic management ensuring the delivery of real-time, high bandwidth IP-based services across the entire network. Our strategy included the recent purchase of Tarari, a privately held company widely recognized as having best in class technology for deep packet inspection. This is a critical capability for service providers in enterprise delivering services, like security, unified access and video over next generation networks, while also having applicability in storage.

The Tarari acquisition complements LSI’s strengths and advanced network and packet processing, advanced traffic management in digital signal processing by adding content inspection technology.

This strongly positions LSI to set a new standard for converged networking and security control. Tarari's current customer base includes: Cisco, Symantec, Alcatel-Lucent and others and we've engaged with numerous tier 1 data com and telecom equipment OEMs. We are unique in that, we have both a solid custom silicon capability as well as a higher level functional set of building blocks such as network processors, DSPs that are aligned to OEM needs.

Turning to highlights: our Networking business showed nice growth in the third quarter and we continue to generate key design wins in our focused segments of Gateway, Access and Enterprise connectivity applications. Earlier this year, we announced that Nortel has selected several SoCs, including our APP network processor, several link player processors and other networking ICs to power a new line of managed business services gateways. These systems are now in trials with leading US service provider.

In addition, we have won another tier one customer for a gateway application in the enterprise. Huawei selected LSIs pseudo wire solution for its new generation of access products. Huawei is expected to begin field trials with services providers this quarter. Our networking division also offers personal connectivity products and we are pleased to have been selected by Hewlett-Packard as the sole data card modem supplier for all Hewlett-Packard notebooks for 2008.

In addition, the new Apple iMac that was launched in August features LSI's 1394 controller for fire wire connectivity.

Turning to storage; we have three businesses that make up storage semiconductors. This is our hard disk drive business, our SAS standard components and storage area network ICs. In hard disk drives we continue to be successful in winning key designs at existing customers and expanding our business with new customers.

During the quarter, LSI was awarded a new notebook drive SoC with one of our largest customers. We set a new milestone in the industry by shipping over one billion of read channels to-date, this achievement represents approximately 30% of all hard disk drive shipped, since read channel technology was adopted in 1992. It is a tribute, not only to our strengths in hard disk drives, but also to our strategic relationships with the top hard disk drive manufacturers over many years. In addition, we have now sampled the industries first 65-nanometer iterative decoding read channel to all of our customers, reinforcing our technology leadership.

In preamplifiers, LSI announced the PA2500, strengthening our presence in mobile drives. The PA2500 enables a 25% reduction in power, while providing the increase and performance required for next generation drives. We continue to gain share in preamps, holding a strong position in desktop, while increasing our focus in enterprise and notebook spaces to drive further growth.

In the September quarter, LSI had strong revenue growth in SAS Solutions, including Raid-on-Chip controllers and Host Bus Adaptors. In July, we announced that we shipped more than 1 million SAS Raid-on-Chip ICs. We've reached this milestone after just 18 months indicating the popularity of the product and the rapid growth of SAS technology.

In Fibre Channel SAN silicon, we won a 65-nanometer design with the key SAN vendor for a solution targeted towards high performance, computing applications. We are the market share leader in 4-Gig Fibre Channel and have secured design wins to position us as the market leader for 8-Gig Fibre Channel generation.

During the quarter, we were pleased to see Brocade introduce a new series of products, which contain LSI's silicon technology. In storage systems, we saw both external and direct attached storage RAID grow in Q3, along with continued gross margin improvement driven by product cost, manufacturing efficiency and increased software sales. LSI was also named best-in-class supplier in Sun Microsystems 2007 Supplier Awards program. This program recognizes companies that make outstanding contribution to Sun's ability to deliver value to it’s customers.

We also announced iSCSI connectivity support across our complete line of Engenio external storage systems. We introduced our iSCSI based entry storage system for the small and medium business segment and we also certified select mid range Fibre Channel based storage systems with QLogic SANbox intelligent storage router, providing enterprise customers with multi protocol connectivity between servers and Engenio storage systems. iSCSI support further expands our industry, leading selection of interface options which now include iSCSI, SAS, Fibre Channel as well as InfiniBand.

With the iSCSI launch and availability of SATA disks, we now have released to our OEMs a full spectrum of products in our entry level storage system family. Our iSCSI products will enable us to participate in another fast growing segment of the network attached storage market, expanding our established position.

Finally, we announced that we are collaborating with IBM and Seagate to extend hardware base full disk encryption technology to enterprise class drives. Security of sensitive data is a major concern for IT administrators, and we believe that our silicon, systems and software expertise enables us to be a leader in making the data at risk much more secure.

Before we go to your questions, I want to conclude with some highlights of the business. First of all, we had strong revenue growth in storage and networking in the third quarter. We made significant progress in Phase I of our three-phase business acceleration plan, including the sale of our consumer business, the sale of our mobility business, significant transition to contract manufacturing, a new strategy focused on growing in storage and networking, as well as considerable reduction of operating expenses. We continue to see strong design win momentum and unprecedented levels of customer engagements, giving us confidence about future profitable revenue growth.

We are pleased with our third quarter performance, and expect this strength to continue into the fourth quarter. We believe that the progress you are saying today validates the strategic steps we've taking to position us for growth. What was a vision for the new LSI is translating into visible results that we believe will improve long-term shareholder value.

I would now like to hand it back to Sujal.

Sujal Shah

Thank you, Abhi. At this point we'll begin the Q&A portion of the call. Sue, will you please give the instructions for the Q&A session?

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Kaushik Roy. You may go ahead with your question.

Kaushik Roy

Thank you. Congratulations on the nice quarter. One clarification to begin with. Can you please go through your expectations for Q4 by the business units? The storage semis, do you expect it to be flat, up or down?

Abhi Talwalkar

We expect it to be flat.

Kaushik Roy

And then for networking?

Abhi Talwalkar

Networking slightly up.

Kaushik Roy

And what about systems, obviously up, right.

Abhi Talwalkar

Up, right.

Kaushik Roy

And you are only including $27 million of mobility in the guidance right?

Abhi Talwalkar

That's correct.

Kaushik Roy

So, my question is, can you comment on the seasonality for the March quarter? I've never followed Agere. So, combined with Agere, what's the usual seasonality for Q1?

Abhi Talwalkar

Seasonality, I think is best described by -- the seasonality is obviously associated with the consumption of our end markets, and if you look at the consumption of our end markets, which generally are PCs, with both consumers as well as enterprise spending, enterprise storage, servers historically and if you look back over time, those segments typically are seasonally down anywhere from 8% to 12% from the December quarter. And that's the seasonality that historically those segments have sort of experienced.

Kaushik Roy

Okay, that's helpful, and then one last question. IBM is still a 10% plus customer and they said that mid range storage was down 2% in Q3. Can you comment on how the 4000 and the 3000 series is doing? I mean, were there any issues with the product, or is net of cannibalizing some of the 4000 series?

Abhi Talwalkar

Well, I think you need to ask IBM for specifics, but what I can tell you, because IBM is a 10% customer, that obviously our relationship with IBM is very robust. They continue to launch new products based on our technology, both enhancing, existing, as well as, ramping the entry platform and our specific business with IBM was actually up year-over-year at 6%.

Kaushik Roy

Okay, great, thank you.

Operator

Thank you. Our next question comes from Romit Shah. You may go ahead with your question.

Romit Shah

Yeah, thanks. When would you expect the OpEx associated with the wireless business to roll off the P&L?

Bryon Look

We are estimating and this is built into what we've talked about going forward, is about $8 million worth of mobility expenses that we would have recognized here in the quarter, based on the close date.

Romit Shah

Let me ask it another way, Bryon. When would you expect the sale of this business to be accretive to EPS?

Bryon Look

So, if we go back to what we said when we talked about the transaction, we go to [Technical Difficulty] 2008 roughly in that position.

Romit Shah

Okay. And my follow-up is, at your Analyst Day, you guys talked about an operating margin target longer-term of 17%. Can you give us, now that wireless is gone, can you give us a revenue run rate to think about, in terms of getting to that 17% number?

Bryon Look

First of all, I think we are continuing to make strong progress towards that business model. You saw the improvements we made in the current quarter, and we expect to continue to make progress as we move to the quarters ahead, relative to that. We are not in a position of providing specific guidance relative to the revenues. But, as we have talked about, we will continue to make significant improvements to drive to the business model, not only through top line growth but also through continued efforts to tightly manage our spending. We are also seeing gross margin expansion with the number of the actions that we have taken, which also contribute to basically that progress towards the 17% OI business model target.

Romit Shah

But it's probably too aggressive to assume you could get there on a revenue run rate below $700 million?

Bryon Look

That's probably true.

Romit Shah

Okay.

Sujal Shah

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

Operator

Thank you. The next question comes from Seogju Lee. You may go ahead with your question.

Seogju Lee

Great. Thank you. Bryon, just in terms of the OpEx, just a follow-up on the last question. Beyond Q4, how should we think about that obviously the 8 million that's included comes off, but just in terms of the other activities that you have. And also in terms of taking out some of the cost related to mobility beyond the fixed cost, when should those start to kick-in as well?

Bryon Look

Yeah, what we are expecting to see is still continued modest improvement in our cost structure, as we go forward there are still benefits to be gained and we haven’t led about all in terms of the actions to drive continued efficiencies in our OpEx. And Abhi, you may want to comment a little bit in terms of the other elements of that?

Abhi Talwalkar

Yeah, I think, Seogju, clearly we’ve been very vigilant in terms of OpEx and OpEx reductions, roughly $28 million to $30 million of OpEx reductions quarter-over-quarter is certainly a strong signal to that point. We are not entirely done with Phase I, so we continue to look at our investments and make sure investments are going towards highest priority and highest probability of the best ROI returns. We will continue to focus on driving efficiencies and improvements around OpEx and we'll also balance that with the need to drive sustainable long-term revenue growth as well. We are seeing today really an unprecedented level of design win engagements but recognizing we want to serve those opportunities. We also need to continue to drive near-term profitability improvements.

Seogju Lee

Okay. And those investments are probably, what's offsetting the sort of OpEx levels that you expected to sort of drive to in Q4 and Q1?

Abhi Talwalkar

Well, there is some of that in Q4, obviously the results of the Tarari expense which is a full quarter and on top of that there is still some mobility but our goal will be to drive a modest improvement to that fourth quarter OpEx level as we move into next year.

Seogju Lee

Okay, great. Thanks, good luck.

Sujal Shah

Thank you, Seogju. Can we have a next question please?

Operator

Thank you. The next question comes from Arnab Chanda. You may go ahead with your question.

Steve Zane

Hi, this is actually [Steve Zane] for Arnab Chanda. I have a quick question about your networking storage. Your networking business, how much of that is still legacy? And how do see those segments breakout going forward and what are their growth rates? Thanks.

Abhi Talwalkar

Well. I think in our Analyst Day, we basically characterized legacy versus non-legacy somewhere around 50-50 and obviously the erosion of our legacy business, the erosion rate declining and we see that change, obviously, next year with our focused and growth business is starting to overtake that legacy component. Basically, to reiterate what we said at our Analyst Day we said that we expect networking to be sort of flat to modest growth next year in 2008, obviously dependent on how the legacy business does and erodes, but just based on our subsequent at this point?

Steve Zane

Okay. Thank you. I have a follow-up about your storage IC business. It seems like the PC channel, there has been talk that there have been double ordering and possibly weakness in terms of inventories. Did you see that shaping up at all for your demands for your product?

Bryon Look

No, not really. I mean we did say earlier, I think, when the question was asked that our overall storage semiconductor business was sort of flat quarter-to-quarter that's driven by a number of different things, obviously there was a very strong third quarter across these segments. I don't believe and certainly based on inventory checks, I'm talking to customers that there are any concerns relative to inventory. I believe even some of the hard disk drive vendors have alluded to inventory being generally on the lean side, but we've got a number of other moving parts, we've got the mix changes, as well as, the normal ASP erosion but overall first half to second half our Storage Semiconductor business as an aggregate will end up growing somewhere around 10%. So, we are very happy with the overall progress and growth of that business.

Steve Mills

Okay. Thank you.

Operator

Thank you.

Sujal Shah

Thank you, Steve. Can we have the next caller please.

Operator

Thank you. Our next question comes from Shawn Webster. You may go ahead with your question.

Shawn Webster

Great, thank you very much for taking my question. Abhi can you talk about the -- you touched on it briefly on the supply chain inventories for your communications in your storage chip segments and talk a little about where -- what your lead times are doing for your components? Do you see them coming out or going in for some of your various product families?

Abhi Talwalkar

No, lead times have not really changed in any kind of material fashion. And again, from an inventory standpoint inventories were generally lean in the third quarter so there's certainly some replenishment that did take place. Clearly, some of the strength in our networking business was a result of some inventory improvement, because inventories were lean, plus we know that certain networking or telecom companies that have gone through sort of their post merger activities that had stopped a lot of the supply chain activity, some of that was relieved and that's what lead to some of the growth that we're seeing as well.

Shawn Webster

Okay. And can you talk about how your order linearity progressed over the course of the quarter into October?

Abhi Talwalkar

In terms of --

Shawn Webster

Were you strong in the early part of the quarter and then it strengthened later or how did your orders progress?

Abhi Talwalkar

Well, I think I would just characterize it as orders and order raised in backlog and so forth obviously is very consistent with what we are guiding here today for the fourth quarter.

Shawn Webster

Okay. And can you list for us your 10% customers?

Bryon Look

Yeah, we have in the quarter three greater than 10% customers and that would be Seagate and IBM and Samsung.

Shawn Webster

Great. Thanks a bunch.

Sujal Shah

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

Operator

Yes. Our next question comes from Sanjay Devgan. You may go ahead with your question.

Sanjay Devgan

Congratulations guys on the great quarter. Just couple of quick questions. First off, on your storage systems business, you've done a good job kind of bringing the margins back up there. I was wondering, now you got them up to 37%. How much more headroom do we have there?

Abhi Talwalkar

Well, I think, we guided that those margins will certainly continue to improve into the fourth quarter. I think there remains quite a bit of headroom. We are just beginning an effort here over the past 9 to 12 months, really trying to drive a higher level of software attached to those building blocks into our OEMs, certainly the acquisition that we made last year around this time of StoreAge, which enhances our copy services solutions, is a good example of that. So, software is clearly one angle of that. We, obviously, I think have more opportunities in terms of improving the cost structure of our products, as well as with the move that we are driving in terms of outsourcing our assembly and test operation for systems that also will benefit in terms of gross margin improvement.

Sanjay Devgan

And one quick follow-up, if I may. You've done a great job in terms of -- in the enterprise storage space, in terms of the 2-gig to 4-gig Fibre Channel transition. And I just wanted to get your thoughts high level on how you see the 4-gig to 8-gig transition taking place. When can we expect to see some meaningful kind of transition shifts from one medium to the other?

Abhi Talwalkar

Well, I think, obviously you'd have to talk to all the different players in the ecosystem from the HPA vendors to the switch vendors to the storage systems vendors and we touched everyone of those in one shape or form,  whether it's our silicon or our systems. If I look at the 8-gig transition or when 8-gig will start becoming relevant in the marketplace and if I look at the conversations that I’m having with peers in this industry or ecosystem, it’s probably in the second half of next year when you start seeing some meaningful deployment activity and purchasing activity, at the same time qualification activities will start well ahead of that.

Sanjay Devgan

Thank you.

Sujal Shah

Thank you, Sanjay. Can we have a next question please?

Operator

Yes, the next question comes from Paul Kim. You may go ahead with your question.

Paul Kim

Hey, guys, how are you doing?

Abhi Talwalkar

Hi, Paul.

Paul Kim

Hey, just a couple of questions, one just to get back to the fourth quarter guidance, the midpoint suggest on the revenue line that is $715 million and I think if you just were to take the average of sell side from fourth quarter it’s $730 million. So, can you just, my guess is that the sell side is accounting for mobility for the whole quarter. So, can you just help us understand, kind of what this guidance really means, I know you said it’s 9% sequential increase, but at the own mobility throughout the fourth quarter what is kind of that, like-for-like number I think that would clarify lot things for a lot of people. My second question is on a balance sheet, what is the gross cash you have for all transactions that have been close, so far? And how does that relate to how you think about your share buybacks, because right now, it seems like the company has turned the corner every business line was fantastic, they just seems like an opportune time to kind of shrink the equity at this point. Thank you.

Abhi Talwalkar

Paul, relative to the revenue guidance we provided and the relationship to mobility right, we said that we’ve recognized, or approximately assuming $27 million of revenue based on the close date for the transaction. So, the way that we get to the sequential growth, if you factor that out of our Q4 numbers and take out the $93 million that we posted for that business in the second quarter, which you would see, I am sorry, in the third quarter what you will see is about 9% to 10% sequential growth there, that's how that's best to think about the growth that we have in our core businesses going forward.

Paul Kim

Okay, so lets just say for the fourth quarter your guidance for the fourth quarter 700 to 730 is it fair to say that like-for-like, if you owned it, there will be additional maybe $50 million in revenue in that number. If you were to own the mobility throughout the fourth quarter?

Abhi Talwalkar

But we wouldn't project I guess, since it's no longer our business.

Bryon Look

Yes, it's not easy for us to project fourth quarter revenue right. I mean it's not a question of easy; it’s someone else's responsibility now.

Paul Kim

But it would help if the street number out there at 730, that you know what I mean to…

Bryon Look

I think Paul, when we look at the various street numbers right. There is whole range on and based on different assumptions about the close date for mobility. So, now that we have actually closed it, and providing the actual number that we can use, that then correlate and therefore derive the sequential growth.

Sujal Shah

Hey, Paul this is, Sujal. Just what's reflecting on first call today would include mobility. So, I know, we've had a number of analysts that have adjusted post closure. But what's reflected in the first call number for Q4 includes mobility.

Paul Kim

Okay. And the balance sheet question?

Bryon Look

Okay, so we ended the quarter with $1.1 billion worth of cash and I did include cash that we received from the sale of our consumer business. We closed the transaction, relative to the sale of our assembly and test operations that's $100 million transaction, with $50 million of fund and in the fourth quarter. Just at the beginning of October, so that's not reflected in the cash balances.

Tarari acquisition closed in the fourth quarter as well. So that cash out is not also obviously reflected, we will be in projections as we move through the fourth quarter and look at yet the, upcoming cash. But, if you look overall, we are in a very strong position their relative to our cash. You can see that we have very strong cash flows in the quarter, and of course we would be, we will also factor in as we think about our share repurchase and our cash balances, the fact that we've got. The $450 million worth of cash from Infineon as a result of our closing of the mobility sale.

Paul Kim

Okay, great. Thank you.

Sujal Shah

Okay, thank you, Paul. Can we have the next question please.

Operator

And the next question comes from Sumit Dhanda, you may go ahead with your question.

Sumit Dhanda

Yes, hi. First, in terms of the outlook here. Abhi or Bryon, you mentioned that systems and networking would be up sequentially in the quarter driving the growth. Is it more skewed towards systems in the quarter in terms of the organic growth?

Abhi Talwalkar

Well, systems generally and historically Q4 is a very strong quarter. There's a tremendous amount of IT spending that occurs in our fourth quarter of the last two, three years has certainly been very strong. So, there is very strong growth in the fourth quarter. Obviously, we've got not only the IT spending and the seasonality, but we're in the midst of ramping more flavors to the entry product across our three tier one engagements.

So, yes that is correct, that's certainly more of the growth but networking is also growing, IP revenues were also growing as well.

Sumit Dhanda

And then on the storage component side in Q3 is the growth is more enterprise centric or client centric?

Bryon Look

It was across the board, certainly client driven growth driven by the very strong sales in terms of PCs, I believe PC shipments in Q3 are record number both desktops and notebook growth, especially, in the hard disk drive segment was significant. Servers were also very strong; I believe servers especially in terms of X86 server shipments also had record quarter shipments. So, that certainly drives a lot of our SAS component business as well which also pulls with it Fibre Channel business, so I would say it was across the board.

Sumit Dhanda

Okay. And then, Abhi, on the call you mentioned that in terms of the post merger opportunities within storage. Those had accelerated following the closure of the merger. Can you give us some more specifics around that in terms of exactly what you've seen?

Abhi Talwalkar

Well, we have, obviously refrained from discussing specific customers, at the request of our customers. But since the merger, we have been as specific as we can, relative to, for example, the hard disk drive activities and opportunities that we’ve had. Immediately post-merger we did announce a very significant enterprise SoC win, out in time which we are well in the development phase. We had also announced a new customer in terms of a SoC in the PC hard disk drive space just in this call, specifically we have announced a new win with one of our major customers in the notebook space. The preamp activity has also been very considerable as we penetrate into the notebook and enterprise segments. And so, we are growing our customer base. We generally never break out that business, but that business, first half to second half is seeing very strong growth as we grow market segment share.

Sumit Dhanda

And then, I guess, finally, when you are talking about the networking segment and the opportunities there, you mentioned enterprise connectivity. Can you detail the opportunities there and so the competitive landscape on how you think it’s back on?

Abhi Talwalkar

Well, a lot of our connectivity focus in enterprise is both a combination of the SAN connectivity that we are in today across the Fibre Channel fabric which we are a leader in. The other areas of connectivity has to do with LAN connectivity, and lot of that’s predominantly Ethernet and there we are working with, obviously the major players there, Cisco, HP, in terms of HP networking, Huawei, who is also offering a datacom networking product. So, that’s kind of the focus. Lots of that is custom silicon with a unique sort of value proposition that we have been able to bring to the table now, with the combination of that custom silicon capability but also a rich portfolio of higher level of building blocks that can be combined with customer IP to deliver very customized complex SoC's.

Sumit Dhanda

Okay, thank you very much.

Sujal Shah

Okay, thank you, Sumit. Can we have a next question please?

Operator

Thank you. The next question comes from Robert Mayna. You may go ahead with your question.

Robert Mayna

My question was answered. Thank you.

Operator

Thank you. The next question comes from Chris Medina. You may go ahead with your question.

Avery Son

Good afternoon, it’s actually Avery Son. Thanks for taking the question. I just want to clarify come back to the Q4 guidance and make sure I’m thinking about it right because I am sure there's going to be a lot of confusion tomorrow which is, if you take -- I think the consensus number, even though there is not an official number but if you average kind of the range of analyst that are out there. I think the mobility number from a revenue standpoint the people were looking for was around 100 million. So I take that 100 million I subtract out the 27 million that you reported in the Q4 number I come up with around 73 million, if I take that out of consensus I get to 660 and I think and I guess that's my question, is that the right way to think about the number that is comparable to the 700 to 730 guidance?

Sujal Shah

Avery, this is Sujal, that sounds about right. I think the thing to keep in mind is the consensus estimates today assume a full quarter of mobility.

Avery Son

I just wanted to make sure thinking about it at the right way. And then, as a follow-up can you help me think about the dilution that you would see in the fourth quarter as a result of the partial quarter, sort of moving parts?

Abhi Talwalkar

Okay, so there are a lot moving parts, we said that relative to the different transactions that we have going on, that mobility would be, to say, it would be initially slightly dilutive based. I am looking at the loss of the revenue contribution and also the fall off in the spending. I don't know if we can quantify any further beyond what we filed it in the actual guidance that we had given which is for $0.05 to $0.09 EPS for Q4.

Avery Son

Okay. Well I guess I'm trying to do the same math as we did for the revenues which is, if I take the residual revenues that we just talked about of $72 million to $73 million and apply kind of a below corporate average gross margin to that as you guys have talked about the mobility business historically. It seems like there is at least a couple of sense of dilution related to pulling the mobility business out for the quarter which obviously is not reflected in the consensus number or so. Can you guys provide a framework to think about the math there or does that sound roughly correct in terms of the dilutive impact?

Bryon Look

Probably in the range, I don't know that we can be more precise than that.

Avery Son

Okay.

Bryon Look

And it involves some expectations about what the spending would have been and what revenues would have been.

Avery Son

Okay. But a couple of cents is probably in the range?

Bryon Look

$0.01 to $0.02 maybe.

Avery Son

Okay. Alright, that's great. Thanks a lot guys.

Abhi Talwalkar

Hey Chris, let me just again clarify because I want to make sure that people get the numbers correct but if you really remove -- assume consumers out of the equation because the numbers for Q3 for consumer is very small. If you remove mobility, you basically are going from somewhere around $630 million in revenue to around $690 million in revenue from a mid point standpoint in Q4 excluding mobility. That's where we come up with roughly to 10%ish each growth quarter, 10% growth quarter-to-quarter on the go forward businesses.

Avery Son

Got it.

Abhi Talwalkar

Okay.

Avery Son

Okay. Thanks.

Sujal Shah

Alright. Thank you, Avery. Can we have the next question please.

Operator

Thank you. The next question comes from Tayyib Shah. You may go ahead with your question. Tayyib Shah your line is open. Please go ahead.

Tayyib Shah

Hi. Can you guys hear me?

Abhi Talwalkar

Yes we can.

Tayyib Shah

Hi, when you look at the networking business outlook for next year. Is there a target that you have in terms of how much of legacy revenue you need to replace over the next year to keep that business flat?

Abhi Talwalkar

Oh yeah, I mean to some degree it's probably less $100 million or so.

Tayyib Shah

Okay, and has the pipeline of new products and design wins in that business improved over the last couple of quarters, giving you more confidence as you can keep this business at least flat next year?

Bryon Look

We continue to feel confident relative to the guidance that we provided for '08 around this business which is flat to modest growth and that, obviously, is predicated on how the legacy business does but we believe we've done sufficient level of diligence and understanding all the elements of the legacy business and trying to project that forward. And then relative to the pipeline, the pipeline over the last three to six months across new design win activity in many of these segments have been very positive.

Tayyib Shah

Thank you.

Sujal Shah

Okay, thank you. I think we have time for one more question?

Operator

Thank you. Our last question comes from Craig Berger. You may go ahead with your question.

Craig Berger

Good afternoon, thanks for taking my question. Fist one on the housekeeping. Tax rate I think you guided Q4 to 25% is that what we should be using for the go forward or is 20 still a good number?

Bryon Look

Well, we're not again providing information going forward but you think about our tax rate, it’s going to vary quarter-by-quarter. We're in a position here where we are closing out the year with Q4 here and so that is a good number used for the fourth quarter. The variance is going to depend on the profitability levels that we have, as well as geographically. I think where we generate the profit Craig, so, but you got the range probably correct that 20% to 25%, that's the range.

Craig Berger

Okay. Thanks.

Bryon Look

We'll give further guidance as we go forward.

Craig Berger

Next question on the systems business, can you help us understand how much penetration into that one to three price band you have or how much of your systems business that price has been totals or any other color you can provide to help us understand how far long in the ramp of that product group we are?

Abhi Talwalkar

Craig, we started ramping that product line at the beginning of the year with a couple of our OEMs, others came on board. We've also been filling out the entire product line, whether it’s Fibre Channel host or SAS host, a support of SAS and SATA drives and then most recently, what we talk about in this call, is also the support for iSCSI. So, I would say that we are still very early in the ramp of that overall product line, clearly the ramp and the revenues this year versus last year very significant, a very-very large growth rates, we had very little to no business last year. So, we are in the front-end of that ramp and I think our customers are working very closely with us. They also drive an aggressive level of attached rate. There are servers to storage, so I think the opportunity continues to be very promising.

Craig Berger

Last question. Versus a quarter ago, it looks like the networking business has bounced back pretty hard. I know, there was just some supply chain disruptions over the summer on the party of your customers, and now it looks like that's over, perhaps the reselling of some of their inventory. Are you able to help us understand how much of the networking growth might be not repeated from some of these customers bouncing back?

Abhi Talwalkar

Yeah. There is probably some element of snapback, I don't know if I have an exact number or percentage of the growth to attribute to the snapback. We've also, obviously seen because of the PC strength. We have seen our connectivity products drive some of that growth, as well, some of our new growth areas are starting to show some revenue. We also have a fourth quarter of revenue from Tarari, which is also adding to some of that growth in the fourth quarter and certainly growth into 2008.

Craig Berger

Thanks a lot. Nice job.

Abhi Talwalkar

Thank you.

Sujal Shah

Okay, thanks Craig. I'd like to thank all of you for joining us this afternoon. If you have any additional questions, please call investor relation at LSI. Thank you and have a great day.

Operator

Ladies and gentlemen a telephonic replay of this conference will be available beginning today at approximately 5 o'clock pm pacific daylight time and we will run through midnight on October 27. The replay access numbers are 1-866-410-5843 within the US and 1-203-369-0645 for all other locations. The webcast will be archived at http://www.lsi.com/webcast. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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