LSI Logic Q3 2007 Earnings Call Transcript

Oct.24.07 | About: LSI Corp. (LSI)

LSI Logic Corp. (NASDAQ:LSI)

Q3 2007 Earnings Call

October 24, 2007 5:00 pm ET

Executives

Sujal Shah - VP, IR

Abhi Talwalkar - President andCEO

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

Operator

Ladies and gentlemen, thank youfor standing by. Welcome to the LSI Corporation Investor Relations ConferenceCall. At this time, all participants are in a listen-only mode. Later we willconduct 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 theconference over to your host, Sujal Shah, Vice President of Investor Relationsat LSI. Please go ahead, sir.

Sujal Shah

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

We will begin the call withopening remarks from Abhi and then Bryon will provide third quarter financialresults and guidance for the fourth quarter. Abhi will then provide highlightson each of our businesses and we will open the call for your questions. Ourpress release is available on our website.

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

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

With that, it is now my pleasureto introduce Abhi Talwalkar.

Abhi Talwalkar

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

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

As we look ahead to Q4, we areguiding for approximately 10% sequential growth net of mobility and consumerrevenues. When we completed out merger with Agere Systems back in April, wepromised you that we would move quickly to realize synergies, focus the newlymerged company on markets where we can be leaders and begin to win new businesseson the strength of the combined organizations.

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

Since the beginning of the thirdquarter, we have completed the sale of our consumer business to MagnumSemiconductor, initiated and completed the sale of our mobility business toInfineon. We sold our Thailandassembly and test facility, to STATS ChipPAC, and began a strategic initiativeto transition the worldwide assembly and testing of semiconductor and storagesystems products to contract manufacturers. We also purchased Tarari, aprivately held company widely recognized as having best in class technology fordeep packet inspection.

And finally, we delivered asignificant reduction in quarterly operating expense.

As part of Phase I, we areevolving our new corporate strategy centered around two core businesses that formthe pillars of LSI, storage and networking. In both these areas LSI provideshigh value through complex silicon, firmware, software, subsystems as deepcustomer relationships and have category scale for sustained leadership.

As we go forward, we see Phase IIearnings growth and Phase III, which is revenue growth, having some overlaps.We will continue to drive improvements in gross margin and manage operatingexpense levels, while investing in storage and networking to provide a fullportfolio of solutions and capabilities to our customers. We will strike a balancebetween driving improvements in near-term profitability and selectivelydeploying capital to ensure long-term revenue growth and long-term growth inearnings.

We are seeing very high levels ofdesign win opportunities in customer engagements, particularly in storage, andare prepared to capitalize on these opportunities to drive long-termsustainable revenue growth.

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

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

We believe that the actions thatwe 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 thelast quarter, we announced a new share buy-back authorization for $500 million.This authorization came on top of an earlier $500 million authorization that wecompleted in July.

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

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

Bryon Look

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

Consolidated gross marginsexcluding special items were 43.4%, a 2.5 percentage point improvement from thesecond quarter 2007.

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

Let me take this moment to thankthe employees at LSI for their dedication and focus on delivering a muchimproved quarter. Before providing additional details about our financialresults for the quarter, I'd like to provide a brief financial summary of our recentstrategic transactions.

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

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

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

We've also begun to transition oursemiconductor and storage systems, assembly and test operations performed atcompany-operated facilities in Singaporeand Wichita, Kansas, to third-party contractmanufacturers. Transition of these operations is expected to be completed inthe first half of 2008.

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

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

Finally, today we announced thecompletion 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 $50million.

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

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

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

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

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

Storage revenues continue to be asignificant percentage of LSI's total revenues. Revenues from StoreAge Systemsand Storage Semiconductors combined amounted to $490 million or 67% of LSI'stotal revenues in the Q3.

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

Q3 revenues in our networkingbusiness were $134 million, representing 18% of total revenues for the quarterand a 19% sequential increase from the second quarter. We experienced increaseddemand for DSP products for wireless infrastructure, increased shipments ofconnectivity solutions and stabilization of supply chain buffer stocks whichhad impacted Q2 shipments.

Next, I would like to discuss themobility business which includes a broad portfolio of cellular handsetsolutions for GSM-based technologies. As I mentioned, we just completed thesale of this business to Infineon Technologies.

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

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

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

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

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

As I noted before, we continue todrive efficiencies in the organization and maintain tight controls on ouroperating expenses, which totaled $262 million excluding special items. Thisrepresented a decline of $28.3 million from the second quarter.

As we move forward, we expect tocontinue driving modest improvements to our operating expenses relative to ourQ4 forecast. From the time we announced the mobility sale, we have acquired Tarariand seen a significant increase in the number of opportunities and customerengagements particularly in storage.

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

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

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

The tax provision for the thirdquarter on a GAAP basis was $3.2 million, on a non-GAAP basis, the taxprovision 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 sheetand cash flow. During the quarter, we reduced inventories by $67 million,operating cash flows for the third quarter was $99 million. Cash and short-terminvestments were $1.1 billion and our net cash position at the end of thequarter was $379 million.

Following is our guidance for theDecember quarter. Revenue in the range of $700 million to $730 million, whichincludes approximately $27 million of mobility related revenues. Thisrepresents approximately a 9% sequential increase from the third quarter net ofmobility and consumer revenues. With respect to our businesses, we expect storagesystems to be sequentially up, relative to Q3 along with networking and IP. Weexpect our storage semi revenues to be flat to Q3 coming off a very strongquarter.

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

Interest income and other net of interestexpense of $2 million. Special items netting to approximately $55 million to $95million. A GAAP tax provision of approximately $12 million, non-GAAP tax rate ofapproximately 25%. GAAP net income in the range of a loss of $0.09 to a profitof $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 beapproximately 700 million shares on a GAAP basis and 705 million shares on anon-GAAP basis.

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

Now, let me turn the call back toAbhi.

Abhi Talwalkar

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

LSI will focus it’s networkingsolutions for the top ten global service providers who will drive innovation todeliver new IP-based services dominated by video content. We will partner withthe top five OEMs in the service provider and enterprise markets to deliverscalable, multi service solutions with carrier grade real-time reliability. Wealready have strong positions with these OEMs and our new services in totalsolutions will allow them to deliver new value to service providers. We willfocus our investment and development in three areas, each with $1 billion ofsilicon-served available market. These markets are access, business in mediagateways as well as enterprise connectivity. We have the heritage, expertiseand technical core competencies to execute this strategy, including DSPleadership delivering twice the channel density that have the power of anycompetitor which is vital to voice and video infrastructure.

Advanced network and packetprocessing enabling the creation and delivery of new services in the service edgewhich is vital for scheduling, quality service and service delivery. Advancedtraffic management ensuring the delivery of real-time, high bandwidth IP-basedservices across the entire network. Our strategy included the recent purchaseof Tarari, a privately held company widely recognized as having best in classtechnology for deep packet inspection. This is a critical capability forservice providers in enterprise delivering services, like security, unifiedaccess and video over next generation networks, while also having applicabilityin storage.

The Tarari acquisitioncomplements LSI’s strengths and advanced network and packet processing,advanced traffic management in digital signal processing by adding contentinspection technology.

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

Turning to highlights: our Networkingbusiness showed nice growth in the third quarter and we continue to generatekey design wins in our focused segments of Gateway, Access and Enterprise connectivityapplications. Earlier this year, we announced that Nortel has selected severalSoCs, including our APP network processor, several link player processors andother 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 tierone customer for a gateway application in the enterprise. Huawei selected LSIspseudo wire solution for its new generation of access products. Huawei is expectedto begin field trials with services providers this quarter. Our networkingdivision also offers personal connectivity products and we are pleased to havebeen selected by Hewlett-Packard as the sole data card modem supplier for allHewlett-Packard notebooks for 2008.

In addition, the new Apple iMacthat was launched in August features LSI's 1394 controller for fire wireconnectivity.

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

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

In preamplifiers, LSI announcedthe PA2500, strengthening our presence in mobile drives. The PA2500 enables a25% reduction in power, while providing the increase and performance requiredfor next generation drives. We continue to gain share in preamps, holding astrong position in desktop, while increasing our focus in enterprise and notebookspaces to drive further growth.

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

In Fibre Channel SAN silicon, we wona 65-nanometer design with the key SAN vendor for a solution targeted towardshigh performance, computing applications. We are the market share leader in4-Gig Fibre Channel and have secured design wins to position us as the marketleader for 8-Gig Fibre Channel generation.

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

We also announced iSCSIconnectivity support across our complete line of Engenio external storagesystems. We introduced our iSCSI based entry storage system for the small andmedium business segment and we also certified select mid range Fibre Channelbased storage systems with QLogic SANbox intelligent storage router, providingenterprise customers with multi protocol connectivity between servers andEngenio storage systems. iSCSI support further expands our industry, leadingselection of interface options which now include iSCSI, SAS, Fibre Channel aswell as InfiniBand.

With the iSCSI launch andavailability of SATA disks, we now have released to our OEMs a full spectrum ofproducts in our entry level storage system family. Our iSCSI products willenable us to participate in another fast growing segment of the networkattached storage market, expanding our established position.

Finally, we announced that we arecollaborating with IBM and Seagate to extend hardware base full disk encryptiontechnology to enterprise class drives. Security of sensitive data is a majorconcern for IT administrators, and we believe that our silicon, systems andsoftware expertise enables us to be a leader in making the data at risk muchmore secure.

Before we go to your questions, Iwant to conclude with some highlights of the business. First of all, we hadstrong revenue growth in storage and networking in the third quarter. We madesignificant 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 ongrowing in storage and networking, as well as considerable reduction ofoperating expenses. We continue to see strong design win momentum andunprecedented levels of customer engagements, giving us confidence about futureprofitable revenue growth.

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

I would now like to hand it backto Sujal.

Sujal Shah

Thank you, Abhi. At this pointwe'll begin the Q&A portion of the call. Sue, will you please give the instructionsfor the Q&A session?

Question-and-Answer Session

Operator

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

Kaushik Roy

Thank you. Congratulations on thenice quarter. One clarification to begin with. Can you please go through yourexpectations for Q4 by the business units? The storage semis, do you expect itto 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, obviouslyup, right.

Abhi Talwalkar

Up, right.

Kaushik Roy

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

Abhi Talwalkar

That's correct.

Kaushik Roy

So, my question is, can youcomment 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 bestdescribed by -- the seasonality is obviously associated with the consumption ofour end markets, and if you look at the consumption of our end markets, whichgenerally are PCs, with both consumers as well as enterprise spending,enterprise storage, servers historically and if you look back over time, thosesegments typically are seasonally down anywhere from 8% to 12% from theDecember quarter. And that's the seasonality that historically those segmentshave sort of experienced.

Kaushik Roy

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

Abhi Talwalkar

Well, I think you need to ask IBMfor specifics, but what I can tell you, because IBM is a 10% customer, thatobviously our relationship with IBM is very robust. They continue to launch newproducts based on our technology, both enhancing, existing, as well as, rampingthe entry platform and our specific business with IBM was actually upyear-over-year at 6%.

Kaushik Roy

Okay, great, thank you.

Operator

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

Romit Shah

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

Bryon Look

We are estimating and this is builtinto what we've talked about going forward, is about $8 million worth of mobilityexpenses that we would have recognized here in the quarter, based on the closedate.

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 goback to what we said when we talked about the transaction, we go to [TechnicalDifficulty] 2008 roughly in that position.

Romit Shah

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

Bryon Look

First of all, I think we arecontinuing to make strong progress towards that business model. You saw theimprovements we made in the current quarter, and we expect to continue to makeprogress as we move to the quarters ahead, relative to that. We are not in aposition of providing specific guidance relative to the revenues. But, as wehave talked about, we will continue to make significant improvements to driveto the business model, not only through top line growth but also through continuedefforts to tightly manage our spending. We are also seeing gross marginexpansion with the number of the actions that we have taken, which alsocontribute to basically that progress towards the 17% OI business model target.

Romit Shah

But it's probably too aggressiveto 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 thenext question, please?

Operator

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

Seogju Lee

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

Bryon Look

Yeah, what we are expecting tosee is still continued modest improvement in our cost structure, as we goforward there are still benefits to be gained and we haven’t led about all interms of the actions to drive continued efficiencies in our OpEx. And Abhi, youmay 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 interms of OpEx and OpEx reductions, roughly $28 million to $30 million of OpExreductions quarter-over-quarter is certainly a strong signal to that point. Weare not entirely done with Phase I, so we continue to look at our investmentsand make sure investments are going towards highest priority and highestprobability of the best ROI returns. We will continue to focus on drivingefficiencies and improvements around OpEx and we'll also balance that with the needto drive sustainable long-term revenue growth as well. We are seeing todayreally an unprecedented level of design win engagements but recognizing we wantto serve those opportunities. We also need to continue to drive near-termprofitability improvements.

Seogju Lee

Okay. And those investments areprobably, what's offsetting the sort of OpEx levels that you expected to sortof 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 topof that there is still some mobility but our goal will be to drive a modestimprovement 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 anext question please?

Operator

Thank you. The next questioncomes 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. Yournetworking business, how much of that is still legacy? And how do see thosesegments 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 andobviously the erosion of our legacy business, the erosion rate declining and wesee that change, obviously, next year with our focused and growth business is startingto overtake that legacy component. Basically, to reiterate what we said at ourAnalyst Day we said that we expect networking to be sort of flat to modestgrowth next year in 2008, obviously dependent on how the legacy business does anderodes, but just based on our subsequent at this point?

Steve Zane

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

Bryon Look

No, not really. I mean we did sayearlier, I think, when the question was asked that our overall storagesemiconductor business was sort of flat quarter-to-quarter that's driven by anumber of different things, obviously there was a very strong third quarteracross 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. Ibelieve even some of the hard disk drive vendors have alluded to inventorybeing 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 firsthalf to second half our Storage Semiconductor business as an aggregate will endup growing somewhere around 10%. So, we are very happy with the overallprogress and growth of that business.

Steve Mills

Okay. Thank you.

Operator

Thank you.

Sujal Shah

Thank you, Steve. Can we have thenext caller please.

Operator

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

Shawn Webster

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

Abhi Talwalkar

No, lead times have not reallychanged in any kind of material fashion. And again, from an inventorystandpoint inventories were generally lean in the third quarter so there'scertainly some replenishment that did take place. Clearly, some of the strengthin our networking business was a result of some inventory improvement, becauseinventories were lean, plus we know that certain networking or telecomcompanies that have gone through sort of their post merger activities that hadstopped a lot of the supply chain activity, some of that was relieved andthat's what lead to some of the growth that we're seeing as well.

Shawn Webster

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

Abhi Talwalkar

In terms of --

Shawn Webster

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

Abhi Talwalkar

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

Shawn Webster

Okay. And can you list for usyour 10% customers?

Bryon Look

Yeah, we have in the quarter threegreater 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 thenext question please?

Operator

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

Sanjay Devgan

Congratulations guys on the greatquarter. 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 waswondering, now you got them up to 37%. How much more headroom do we have there?

Abhi Talwalkar

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

Sanjay Devgan

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

Abhi Talwalkar

Well, I think, obviously you'dhave to talk to all the different players in the ecosystem from the HPA vendorsto the switch vendors to the storage systems vendors and we touched everyone ofthose in one shape or form,  whether it'sour silicon or our systems. If I look at the 8-gig transition or when 8-gigwill start becoming relevant in the marketplace and if I look at theconversations that I’m having with peers in this industry or ecosystem, it’sprobably in the second half of next year when you start seeing some meaningfuldeployment activity and purchasing activity, at the same time qualificationactivities will start well ahead of that.

Sanjay Devgan

Thank you.

Sujal Shah

Thank you, Sanjay. Can we have anext question please?

Operator

Yes, the next question comes fromPaul 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 onthe revenue line that is $715 million and I think if you just were to take theaverage 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 wholequarter. So, can you just help us understand, kind of what this guidance reallymeans, I know you said it’s 9% sequential increase, but at the own mobilitythroughout the fourth quarter what is kind of that, like-for-like number Ithink that would clarify lot things for a lot of people. My second question ison a balance sheet, what is the gross cash you have for all transactions thathave been close, so far? And how does that relate to how you think about yourshare buybacks, because right now, it seems like the company has turned thecorner every business line was fantastic, they just seems like an opportunetime to kind of shrink the equity at this point. Thank you.

Abhi Talwalkar

Paul, relative to the revenueguidance we provided and the relationship to mobility right, we said that we’verecognized, or approximately assuming $27 million of revenue based on the closedate for the transaction. So, the way that we get to the sequential growth, ifyou factor that out of our Q4 numbers and take out the $93 million that weposted for that business in the second quarter, which you would see, I amsorry, in the third quarter what you will see is about 9% to 10% sequentialgrowth there, that's how that's best to think about the growth that we have inour core businesses going forward.

Paul Kim

Okay, so lets just say for thefourth quarter your guidance for the fourth quarter 700 to 730 is it fair tosay that like-for-like, if you owned it, there will be additional maybe $50million in revenue in that number. If you were to own the mobility throughoutthe 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 toproject fourth quarter revenue right. I mean it's not a question of easy; it’ssomeone else's responsibility now.

Paul Kim

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

Bryon Look

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

Sujal Shah

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

Paul Kim

Okay. And the balance sheetquestion?

Bryon Look

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

Tarari acquisition closed in thefourth quarter as well. So that cash out is not also obviously reflected, wewill be in projections as we move through the fourth quarter and look at yetthe, upcoming cash. But, if you look overall, we are in a very strong positiontheir relative to our cash. You can see that we have very strong cash flows inthe quarter, and of course we would be, we will also factor in as we thinkabout 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 themobility sale.

Paul Kim

Okay, great. Thank you.

Sujal Shah

Okay, thank you, Paul. Can wehave the next question please.

Operator

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

Sumit Dhanda

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

Abhi Talwalkar

Well, systems generally andhistorically Q4 is a very strong quarter. There's a tremendous amount of IT spendingthat occurs in our fourth quarter of the last two, three years has certainlybeen 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 inthe midst of ramping more flavors to the entry product across our three tierone engagements.

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

Sumit Dhanda

And then on the storage componentside 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 notebookgrowth, especially, in the hard disk drive segment was significant. Serverswere also very strong; I believe servers especially in terms of X86 servershipments also had record quarter shipments. So, that certainly drives a lot ofour SAS component business as well which also pulls with it Fibre Channelbusiness, so I would say it was across the board.

Sumit Dhanda

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

Abhi Talwalkar

Well, we have, obviouslyrefrained from discussing specific customers, at the request of our customers.But since the merger, we have been as specific as we can, relative to, forexample, 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 anew customer in terms of a SoC in the PC hard disk drive space just in thiscall, specifically we have announced a new win with one of our major customersin the notebook space. The preamp activity has also been very considerable aswe penetrate into the notebook and enterprise segments. And so, we are growingour customer base. We generally never break out that business, but thatbusiness, first half to second half is seeing very strong growth as we growmarket segment share.

Sumit Dhanda

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

Abhi Talwalkar

Well, a lot of our connectivityfocus in enterprise is both a combination of the SAN connectivity that we arein today across the Fibre Channel fabric which we are a leader in. The otherareas of connectivity has to do with LAN connectivity, and lot of that’spredominantly Ethernet and there we are working with, obviously the majorplayers there, Cisco, HP, in terms of HP networking, Huawei, who is alsooffering a datacom networking product. So, that’s kind of the focus. Lots ofthat is custom silicon with a unique sort of value proposition that we havebeen able to bring to the table now, with the combination of that customsilicon capability but also a rich portfolio of higher level of building blocksthat 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 wehave a next question please?

Operator

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

Robert Mayna

My question was answered. Thankyou.

Operator

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

Avery Son

Good afternoon, it’s actually AverySon. Thanks for taking the question. I just want to clarify come back to the Q4guidance and make sure I’m thinking about it right because I am sure there'sgoing to be a lot of confusion tomorrow which is, if you take -- I think theconsensus number, even though there is not an official number but if youaverage kind of the range of analyst that are out there. I think the mobilitynumber from a revenue standpoint the people were looking for was around 100million. So I take that 100 million I subtract out the 27 million that youreported in the Q4 number I come up with around 73 million, if I take that outof consensus I get to 660 and I think and I guess that's my question, is thatthe right way to think about the number that is comparable to the 700 to 730guidance?

Sujal Shah

Avery, this is Sujal, that soundsabout right. I think the thing to keep in mind is the consensus estimates todayassume a full quarter of mobility.

Avery Son

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

Abhi Talwalkar

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

Avery Son

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

Bryon Look

Probably in the range, I don'tknow that we can be more precise than that.

Avery Son

Okay.

Bryon Look

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

Avery Son

Okay. But a couple of cents is probablyin 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 againclarify because I want to make sure that people get the numbers correct but ifyou really remove -- assume consumers out of the equation because the numbersfor Q3 for consumer is very small. If you remove mobility, you basically aregoing from somewhere around $630 million in revenue to around $690 million inrevenue from a mid point standpoint in Q4 excluding mobility. That's where wecome up with roughly to 10%ish each growth quarter, 10% growthquarter-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 wehave the next question please.

Operator

Thank you. The next questioncomes from Tayyib Shah. You may go ahead with your question. Tayyib Shah yourline 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 networkingbusiness outlook for next year. Is there a target that you have in terms of howmuch of legacy revenue you need to replace over the next year to keep thatbusiness flat?

Abhi Talwalkar

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

Tayyib Shah

Okay, and has the pipeline of newproducts and design wins in that business improved over the last couple ofquarters, giving you more confidence as you can keep this business at leastflat next year?

Bryon Look

We continue to feel confidentrelative to the guidance that we provided for '08 around this business which isflat to modest growth and that, obviously, is predicated on how the legacybusiness does but we believe we've done sufficient level of diligence and understandingall the elements of the legacy business and trying to project that forward. Andthen relative to the pipeline, the pipeline over the last three to six monthsacross new design win activity in many of these segments have been verypositive.

Tayyib Shah

Thank you.

Sujal Shah

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

Operator

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

Craig Berger

Good afternoon, thanks for takingmy question. Fist one on the housekeeping. Tax rate I think you guided Q4 to25% is that what we should be using for the go forward or is 20 still a goodnumber?

Bryon Look

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

Craig Berger

Okay. Thanks.

Bryon Look

We'll give further guidance as wego forward.

Craig Berger

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

Abhi Talwalkar

Craig, we started ramping thatproduct line at the beginning of the year with a couple of our OEMs, otherscame on board. We've also been filling out the entire product line, whether it’sFibre Channel host or SAS host, a support of SAS and SATA drives and then mostrecently, what we talk about in this call, is also the support for iSCSI. So, Iwould say that we are still very early in the ramp of that overall productline, clearly the ramp and the revenues this year versus last year verysignificant, a very-very large growth rates, we had very little to no businesslast year. So, we are in the front-end of that ramp and I think our customersare working very closely with us. They also drive an aggressive level ofattached rate. There are servers to storage, so I think the opportunitycontinues to be very promising.

Craig Berger

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

Abhi Talwalkar

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

Craig Berger

Thanksa lot. Nice job.

Abhi Talwalkar

Thank you.

Sujal Shah

Okay, thanks Craig. I'd like tothank all of you for joining us this afternoon. If you have any additionalquestions, please call investor relation at LSI. Thank you and have a greatday.

Operator

Ladies and gentlemen a telephonicreplay of this conference will be available beginning today at approximately 5o'clock pm pacific daylight time and we will run through midnight on October27. The replay access numbers are 1-866-410-5843 within the US and1-203-369-0645 for all other locations. The webcast will be archived athttp://www.lsi.com/webcast. That does conclude your conference for today. Thankyou for your participation. You may now disconnect.

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