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LSI (NASDAQ:LSI)

Q1 2012 Earnings Call

April 25, 2012 5:00 pm ET

Executives

Sujal Shah - Vice President of Investor Relations

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

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

Analysts

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Blayne Curtis - Barclays Capital, Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

Sujeeva De Silva - ThinkEquity LLC, Research Division

Arnab Chanda - Fitch Ratings Ltd.

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

Christian D. Schwab - Craig-Hallum Capital Group LLC, Research Division

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

Harlan Sur - JP Morgan Chase & Co, Research Division

Betsy Van Hees - Wedbush Securities Inc., Research Division

Stephen Chin - UBS Investment Bank, Research Division

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the LSI Corporation Investor Relations Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

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

Sujal Shah

Good afternoon, and thank you for joining us. With me today are Abhi Talwalkar, President and Chief Executive Officer; and Bryon Look, Executive Vice President and Chief Financial Officer. Abhi will begin the call with some opening remarks and highlights from our business, and then Bryon will provide results for the first quarter and guidance for the second quarter of 2012.

During this call, we will be mentioning non-GAAP financial measures, which we may refer to as results excluding special items. Today's earnings release describes the differences between our non-GAAP and GAAP reporting. You can find reconciliations of our non-GAAP financial measures to corresponding GAAP amounts on the Investor section of our website at www.lsi.com/webcast. At that site, you can also find a copy of the earnings release and a presentation highlighting the key points from today's call and providing an overview of our business. Also on the site, we have posted a full video replay of our March 14 Analyst Day event, along with slides, which provide an in-depth information about each of our businesses.

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 future results is contained in our Form 10-K for the year ended December 31, 2011, and today's earnings release.

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

Abhijit Y. Talwalkar

Thanks, Sujal. Good afternoon, and welcome. I would like to begin by providing some highlights for the first quarter. Our revenue of $ 622 million represented 19% sequential growth and over 30% year-over-year growth, driven by 3 main components: a snapback in HDD business, better-than-expected strength in our newly acquired SandForce flash business, and growth in networking investment areas. We are demonstrating strong operating margin expansion and attained over 16% non-GAAP operating margins in Q1, showing progress towards our new business model target of 20% to 22%.

We also continue to increase momentum with leaders in the industry, with SandForce flash storage processor wins at Intel and SanDisk, PCIe flash adapter and software wins at Oracle and IBM, and Axxia multi-core processor wins at 2 top base station OEMs and 12-gig fast wins at 2 top server OEMs.

At our Analyst Day event last month, we talked about our company being a new LSI, with all ingredients now in place to drive the expanding shareholder value. This is an exciting time for our industry, and we have centered LSI within the key secular trends of data and traffic growth. We're effectively positioned and focused on large and exciting market segments, including data center cloud, mobile networks and flash.

Our increasingly connected world is generating data and traffic faster than the current IT investments can keep up, which we believe will generate increased demand for our solutions. These data and traffic generators include social platforms, the growth of the mobile Internet with the rise of smartphones and tablets, rapid proliferation of video, collection and real-time analysis of massive amounts of data and growth of cloud services.

LSI is well positioned to respond to these trends with a broad portfolio of storage and networking solutions that uniquely leverage intelligence to help accelerate access to data, improve application performance and enable highly efficient network utilization. As we move through 2012, we're excited by new product cycles, accumulated share gains and new opportunities that we have ahead of us across our businesses.

Now I want to review additional business highlights for Q1. I will begin with our networking business, where our products address the wireless mobile network, data center and enterprise market segments, and where we expect revenue from new products to grow faster than market rates over the coming years as we gain share and displace competitors with designs we have won in the last few years.

We continue to make progress to increase our content in base stations through a combination of our Axxia multi-core communications processor and our custom silicon capability. Specifically, our solutions address an estimated $2 billion in wireless SAN opportunity in 2015 that encompasses data plane, control plane switch, base band and digital front-end functions. LSI has already secured wins, which we expect will enable greater than 50% share of data plane, control plane functions and 40% share of base band functions.

LSI solutions are strongly differentiated with superior performance and low power consumption. The Axxia architecture integrates purpose-built acceleration engines for functions such as traffic management, packet classification and security, which off-load these functions from the main CPU, thereby boosting performance. In fact, one key customer demonstrated that Axxia has twice the performance per watt of a competing multi-core processor in wireless transport processing. Moving forward, we are excited with our partnership with ARM that will bring the benefit of multi-core ARM to our industry-leading Axxia architecture.

We are now turning Axxia loose in the enterprise market segment, where we are focused on an enterprise, data center TAM we expect to be over $2 billion in 2015 for processor, switch and PHY functions. Earlier this week, we announced the expansion of our Axxia communication processor portfolio to target enterprise applications. Today's enterprise and cloud data centers are dealing with both massive data growth and the impact of virtualization, creating bottlenecks and switching. The Axxia communication processor delivers intelligent acceleration to help data center architects cope with traffic growth. As a proof point, Axxia has been chosen for a leading data center switch platform.

Also in enterprise, we have won custom solutions for layer 2 and layer 3 switching and routing at a leading data networking customer with revenue ramps beginning before the end of this year. We are fully ramped on an integrated custom Gigabit Ethernet PHY for client applications at Intel. We expect that this device will also be integrated into the upcoming Ultrabook launch. We have also begun ramping a custom Gigabit Ethernet Mac/PHY solution for Romley server platforms.

I'll now turn to server and storage which includes 5 businesses: our flash businesses, SAS, ServeRAID adapter and software, SAN and HDD.

In flash, we are unique in offering 3 product families: standard product flash storage processor or FSPs, custom FSPs and PCIe flash adapters with caching and tiering software, strongly positioning LSI to benefit from a multi-year growth cycle in flash-based storage solutions.

In FSPs, our Q1 revenues were above expectations, and we continue to build momentum with key leaders in the industry and believe we are positioned to be the share leader in 2012. LSI delivers better performance, and we also enable customers by providing, not only flash storage processor silicon, but also firmware, manufacturing and test tools and SSD OEM designs. In addition, we continue to support in production all 6 major flash vendors and are well positioned to support the latest generation of flash at the earliest time to market for our customers.

This unique model of providing key ingredients to produce SSDs continues to drive our momentum in both client and enterprise applications. In client, we have a displaced the competition by securing wins with Intel for their 520 and 330 series SSD, and we have also won 15 additional SSD models that were announced in the quarter at other suppliers. We are also well positioned for the ramp of Ultrabooks, both in systems, where the SSD is used as SAS main storage; and in dual-drive systems, where smaller capacity flash is used as a cache in conjunction with high-capacity HDDs.

Our enterprise momentum is also increasing as we released production firmware for our second-generation FSP in the first quarter. We expect volume production in enterprises system OEMs this quarter and new platforms to launch throughout the rest of the year.

In PCIe flash adapters, we are expanding and increasing focus in storage and server application acceleration, bringing the performance advantages of flash to enterprise storage, server and networking applications. We recently introduced our Nytro product line, which encompasses Nytro WarpDrive, Nytro XD and Nytro MegaRAID. This is a family of solutions that combines PCIe flash technology with intelligent caching and management software to achieve accelerated application performance. We also expanded our offerings to include MLC-based solutions, as well as a wider range of capacity points. Nytro solutions will have data centers and enterprises to contend with massive data growth and speed the ability of databases and other applications to access data and provide real-time analytics and reporting.

Building on the established LSI SAS and MegaRAID infrastructure, the Nytro portfolio represents a strategic inflection, enabling broader adoption across enterprise and data center workloads. LSI has not only developed solutions to address early adoption of PCIe flash, but we now offer a full range of flash capacity coupled with seamless caching and acceleration software, which is unique in the industry. A prime example of this new approach is Nytro MegaRAID, which combines MegaRAID, high performance flash and intelligent caching software onto a single PCI card, enabling an end user to use the solution where they use MegaRAID today and achieve up to 30x performance improvement.

Nytro MegaRAID uses the same tools, standard OS drivers and management as MegaRAID, enabling OEMs and end users to deploy it with minimal effort. This is a breakthrough in usability and is the key to expanding flash to ultimately become an every-unit item in servers. The Nytro product line will go into production this quarter utilizing the industry's best-in-class SandForce flash storage processors, another clear differentiating feature. Our leadership position has enabled us to secure a new PCIe flash adapters wins with Oracle and IBM, which are proof points of the benefits of the Nytro architecture and also significant position in the server ecosystem.

In our SAS and RAID business, LSI solutions will power more than 200 new server models based on the recently introduced Intel Romley platform. Server market leaders, including Dell, IBM, Intel and others, have selected LSI 6-gig SAS and MegaRAID solutions for new data center servers. We have a shipped more than 30 million SAS ICs and close to 5 million SAS storage adapters, establishing LSI as the SAS provider of choice for the world's leading server manufacturers.

In addition, key customers in China and Taiwan has elected LSI's 6-gig SAS and MegaRAID solutions for their Romley platform rollouts. These include Huwawei, Lenovo, ZTE, Acer, ASUSTeK, Inventec, Quanta and many others. As why the adoption of our 6-gig SAS technology continues, LSI is in a position to support customers at the next critical inflection point, the 12-gig SAS rollout. LSI is at least 6 months ahead of our competition, and we have already been awarded the industry's first 12-gig SAS ROC design wins at 2 top-tier server OEMs.

In hard disk drives, we are seeing near-term benefits from a snapback following Thailand flood-related issues. We set a new record in Q1 for SoCs shipped to our largest customer, and we expect further growth in Q2 in line with increase in demand. Our HDD team has done an outstanding job on recovery from flood-related issues, which has enabled us to meet elevated demand and allowed our key customers to be successful in the marketplace.

Beyond the near-term upside, the underlying fundamentals of our HDD business are solid. We expect to grow revenues and the share year-over-year in 2012 with continued ramp of enterprise SSCs, increased demand for high-capacity 3.5-inch drives driven by cloud deployments and shipments of SoC and preamps into all 3 HD OEMs by the end of this year.

To wrap up, we think it's time to take a new look at LSI. We are seeing the results of our multi-year growth strategy and are well positioned with share gain opportunities and new product cycles to enable us to grow our business in excess of the markets that we serve.

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

Bryon Look

Thanks, Abhi, and good afternoon, everyone. LSI delivered a solid first quarter, meeting or exceeding the update we provided in March at our Analyst Day.

A few of the highlights are as follows: Revenues increased sequentially by 19% to 200 -- to $622 million. Non-GAAP gross margins expanded to 52.4%. We continue to carefully manage expenses with non-GAAP operating expenses of $224 million, and we delivered non-GAAP diluted earnings per share of $0.20. Moreover, the company grew at the top line by approximately 32% year-over-year, while expanding year-over-year non-GAAP operating margins from 12% to 16.4%. We're pleased with our financial performance in the first quarter, which represents the strongest first quarter non-GAAP operating income percentage we've had in several years and demonstrates significant progress towards our new business model target of 20% to 22%.

Now turning to a more detailed discussion of our financial results for the quarter, beginning with revenues. Q1 revenues were $622 million, sequentially up 19% from $523 million. Q1 revenues in our networking business were $107 million, flat sequentially and represented 17% of total revenues for the first quarter. Our investment areas grew sequentially but were offset by declines in our legacy products.

Moving next to our server and storage semiconductor revenues. As a reminder, we will be including revenues from standard and custom flash storage processors, along with our PCIe flash adapter and software products within this category as we discuss the results and provide guidance. In the aggregate, server and storage semiconductor revenues will consist of our ServeRAID adapter and software, flash, SAS, SAN and HDD businesses.

Revenues for server and storage semiconductors were sequentially up $100 million or 26% to $488 million and represented 78% of total revenues in the first quarter. This upside was primarily driven by a snapback in demand in our HDD business, along with better-than-expected strength in our newly acquired SandForce flash business, and partially offset by typical seasonality in other product areas. Revenues for the IP business were $27 million.

Moving next to gross margins. LSI's Q1 gross margin, excluding special items, was 52.4%. Gross margins increased sequentially by approximately 290 basis points, primarily due to the recovery from the effects in Q4 relating to the Thailand flood, along with improved absorption of fixed costs with higher revenues. In terms of operating expenses, R&D, together with SG&A expenses, excluding special items, totaled $224 million in Q1, primarily driven by the addition of SandForce.

Non-GAAP operating margin for the quarter increased sequentially to 16.4% or $102 million. Interest income and other net of interest expense, excluding special items, was $9 million for Q1, approximately half of which was related to income from transition services associated with the sale of our external systems business last year.

Now let me turn to the special items, which we recorded in the first quarter, which netted to $42 million. Special items, primarily non-cash, included $31 million of stock-based compensation expense, $30 million in amortization of acquisition-related items, $15 million of restructuring costs and other items, $14 million from the purchase accounting effect on inventory relating to the SandForce acquisition, offset by a $43 million tax benefit reported in Q1 relating to the SandForce acquisition and a $6 million investment gain related to the acquisition.

Moving next to tax. Our tax provision on both a GAAP and non-GAAP basis can vary significantly quarter-to-quarter based on our profitability in different geographic tax jurisdictions and certain discrete items. The non-GAAP tax benefit we recorded for Q1 was $6 million compared to the $9 million provision we guided to in March. This favorability of approximately $15 million or $0.025 per diluted share was primarily due to discrete items associated with the exploration of statutes of limitations, along with the change in profitability across our geographic tax jurisdictions. The GAAP tax benefit we recorded for the period was a favorable $49 million, primarily due to the onetime tax benefit associated with the SandForce acquisition we mentioned in March.

On a GAAP basis, first quarter income from continuing operations was approximately $75 million or $0.13 per diluted share. Non-GAAP income from continuing operations was $117 million or $0.20 per diluted share. The weighted average share count for the period for both GAAP and non-GAAP purposes was 591 million shares. This includes the weighted average benefit of purchasing approximately 4.6 million shares during the period under our share repurchase program.

The majority of the sequential increase in our reported share count used to calculate earnings per share was the result of our stock price increasing and subsequently increasing the dilutive effect of outstanding options and RSUs on reported shares. Relative to our existing share repurchase authorization, we have repurchased a total of 77 million shares and utilized approximately $537 million for our current $750 million buyback program.

Turning now to the balance sheet and cash flows. Cash and short-term investments ended the March quarter at approximately $623 million. Within the quarter, we acquired SandForce, primarily for cash, as well as capital purchases of property, plant and equipment, including a new headquarters facility in San Jose. We're excited about the opportunity to consolidate into one facility in the Bay Area, which we expect will drive efficiencies and lower our costs.

Operating cash flows for the first quarter were $50 million, and we continue to operate with no debt on our balance sheet. Finally, with respect to Q1 results, depreciation and software amortization was $15 million, and capital expenditures were $65 million.

Next is a discussion of our guidance for Q2 in 2012. Q2 revenues in the range of $630 million to $670 million were sequentially up about 4% at midpoint. We expect our server and storage semiconductor revenues to be sequentially up in Q2, and our networking semiconductor revenues to be roughly flat. Gross margin, excluding special items, is expected to be 53%, plus or minus 1%.

Operating expenses, excluding special items, in a range of $225 million to $235 million, with the increase primarily driven by annual salary merit increases, which take effect in the second quarter.

At midpoint, our guidance represents further expansion in non-GAAP operating income to approximately 17.5% for Q2, which is above our prior business model target of 17%, and demonstrates further progress towards reaching 20% to 22%.

Interest income and other and interest expense, excluding special items, is expected to net to income of approximately $3 million. This sequential decline is primarily due to the completion of transition services relating to the sale of our external systems business.

Special items are expected to net to approximately $50 million to $70 million. Included in these special items is approximately $24 million of expected of stock-based compensation for Q2.

The GAAP and non-GAAP tax provision is expected to be approximately $11 million for Q2. We expect Q2 GAAP net income per diluted share in the range of $0.03 to $0.13 and non-GAAP net income in the range of $0.15 to $0.21 per diluted share. The share count is expected to be approximately 600 million shares for both GAAP and non-GAAP purposes. In addition, we expect depreciation and software amortization of approximately $16 million and capital expenditures of approximately $20 million.

In closing, we delivered solid expansion of revenues, gross margin and operating income in the first quarter as we continue demonstrate significant progress towards our new business model targets.

Now let me turn the call to Sujal.

Sujal Shah

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Daniel Amir.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

A couple of questions here. First of all, on the networking segment, it seems like you had a solid Q1. You're guiding for flattish Q2, but then it looks like there's some big opportunities here in the wireless base station side and on the enterprise side as well. So can you kind of give us a little more visibility about the trends and what's going on the networking segment? And then I have one follow-up.

Abhijit Y. Talwalkar

Yes, I mean, on the networking side, tactically speaking relative to the quarter, I think everyone has been watching the inventory burn that's been taking place over the last 2, 3 quarters in wireless infrastructure, in particular, less so in enterprise. And I think people are starting to call the bottom at this point in time. If we look at our networking investment areas, we expect that to grow in Q2, kind of consistent with what some of our peers are also saying. At the same time, we've got some legacy declines. Longer term, we're very excited about our networking strategy and the success that we've had with Axxia, also combined with our custom silicon capability, not only in wireless infrastructure, as we alluded to in our Analyst Day, where we've got some very significant wins that will enable us to have 50% share in the control and data plane and even 40% share in baseband functions with next generation systems, which have just now started beginning in the development phase. And as we also discussed in prepared remarks, we're starting now to take Axxia and expand that into enterprise, in particular, data center switching that can really leverage the architecture's benefits.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Okay. And the follow-up on the SSD side. There's been some commentary from other companies that this quarter, that there was a buildup a bit post-Thailand flood to the SSD market. And then towards the end of Q1, there has been some inventory decline a bit after a basically building up of inventory in the SSD market. I mean, so what are you seeing a bit on the client SSD side? I mean, are you seeing that trend or are you bucking the trend because you're gaining share? I mean, how would you look at that business?

Abhijit Y. Talwalkar

Well, a, we're definitely gaining share. We've displaced a number of competitors, and we've been working with a number of our customers the last 3 to 6 months. And a lot of those products are now coming to market. They were introduced in February, March and more will be introduced here in Q2. So we definitely are benefiting from share gains. I don't know if we've completely experienced what you've described. There's certainly been some discussion around inventory. But I think that's more on consumer NAND versus really SSD, which we expect to continue to grow at the exciting growth rates we've projected coming into the year.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

And would this business be up in Q2?

Abhijit Y. Talwalkar

Yes, it should be contributing to our growth.

Operator

And your next question comes from the line of Jim Schneider.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

This is Gabriela Borges on behalf of Jim. I want to follow up on your comment on having leading share in the flash control market. Could you talk a little bit more about the competitive environment here and perhaps quantify roughly how much they have told?

Abhijit Y. Talwalkar

Well, I mean, our comment around leading share is really tied to 2012, although we do believe we're probably tied for #1 or an incredibly close #2 in 2011. But in terms of 2012, just based on our tops-down, bottoms-up analysis and looking at all the design wins that we've had and where we've displaced some of our competitors, we feel pretty good about our ability to achieve a #1 unit share in 2012. And that's obviously a result of a broadening of the customer base but also a superior product performance, a firmware stack that is heavily tested and product ties more so than what some of our competitors are offering as well. I think the combination of LSI and SandForce has also driven a lot of synergies as all of the sudden now, this great technology is supported by the wherewithal of LSI.

Gabriela Borges - Goldman Sachs Group Inc., Research Division

Great. That's very helpful. And then as a follow-up, if I may. Following the snapback in 1Q with HDD revenues, what's your sense of how your HDD customers are progressing with their recovery post Thailand. For example, when we look to 2Q, do you think customer TAM levels will be back at pre-flood levels?

Abhijit Y. Talwalkar

I think, in terms of what's out there, and we would agree with some of the numbers that are out there obviously. Some of our biggest customers but also analysts are projecting a TAM of about 160 million units in Q2. That's up from about 143 million, 144 million in Q1. That still is not back up to probably full natural demand, but I think we agree with some of the comments that have been made. Notebook is pretty much all caught up. Enterprise is almost caught up. Desktop or 3.5-inch drives are not completely caught up, likely will catch up in Q3. We don't anticipate any inventory replenishment in Q2 either as output is still probably lagging demand, in particular, in the areas that I've discussed. But the recovery has been certainly good and at faster pace than anticipated coming into the year.

Operator

And your next question comes from the line of Blayne Curtis.

Blayne Curtis - Barclays Capital, Research Division

Maybe just following up on the hard drive market. Obviously, you've seen a tailwind with the recovery, maybe on a more normalized basis, SSD share. And obviously, your main competitor is ramping. Your main customer, I think you've talked about wins at their main customer. I was wondering if you could net all these out, where you see your share going forward after we get the recovery?

Abhijit Y. Talwalkar

Well, for the full year, we definitely expect our share to be up. So we're very confident in that happening, and we're 4 months in the year and continue to feel very good about that. Right? We also continue to expect our share to grow in preamps as well, where we grew a nice share last year.

Blayne Curtis - Barclays Capital, Research Division

Got you. And then a question for Bryon. I mean, the gross margin takes a step-up in Q2. Is this the new level? And obviously, you're long-term model is higher than this, but is this the new base we're operating off through there?

Bryon Look

Yes, I think we're continuing to focus on continuing to improve our gross margin levels. We had our Analyst Day just a month or so ago and provided a new business model target there for gross margins at approximately 55%. So as revenues continue to grow, as we continue to focus on managing our costs and so forth, I think we do expect to be expanding gross margin.

Operator

Your next question comes from the line of Vivek Arya.

Vivek Arya - BofA Merrill Lynch, Research Division

Two questions, actually. One is the design wins with Western Digital. I think you have had the design wins for some time. Why are you more confident that you can translate those into revenues this year and how meaningful can that be in the second half?

Abhijit Y. Talwalkar

Well, first of all, we're not going to discuss any specific customer or customer designs just out of respect for confidentiality expressed by our customers. But we feel very good about our ability to ship SoCs across all 3 customers. And keep in mind, development cycles typically for a brand-new hard drive and a brand-new SoC can be anywhere from 2 to 3 years.

Vivek Arya - BofA Merrill Lynch, Research Division

All right. And a separate topic, what is the impact of small cells as they start getting used more in wireless infrastructure? Is your opportunity impacted in any way?

Abhijit Y. Talwalkar

No. In fact, we have an architecture that scales down into various segment within small cells. Keep in mind, when people around the word small cell, there's actually multiple segments within small cells, pico, femto and so forth. Our product line, today, in our customer's platforms actually supports aspects of small cell as well, and we've got a very scalable architecture in Axxia. So we think we're going to be positioned very well as that market develops. It's still a very small percentage of the overall base station volume and TAM and will probably be so for several years.

Operator

Your next question comes from the line of Suji De Silva.

Sujeeva De Silva - ThinkEquity LLC, Research Division

First of all, Abhi, as you look at the second half of the year, how would you rank order some of the growth opportunities that you guys have in front of you?

Abhijit Y. Talwalkar

Rank order in terms of just percentage growth, obviously, not absolute growth. We still feel very good about, obviously, flash just given the growth rates in the flash market or the markets that we're in relative to flash, growing at 40% to 50%. So that's certainly going to -- the upturn in terms of growth, we expect to start seeing meaningful contribution with our Nytro product line or PCIe flash. So I would put our flash-related businesses at the upper end, if you will. I think networking in terms of investment areas, we'd also expect good growth as we continue to ramp new products as well. And I think we're fairly optimistic as long as economic environment stays stable that we'll see nice growth in data centers and in the pull of servers, especially with Romley, which has a pretty decent proposition. And we're well-represented there in Romley and also have some incremental share gains and revenue footprint as well. And then hard disk drive, kind of in that order.

Sujeeva De Silva - ThinkEquity LLC, Research Division

Great. And then on specifically network infrastructure on the investment side, in wireless, I know you're starting to ramp at the second of the top 3 customers. How far along are you with that second customer? Is that already underway or is that on the come?

Abhijit Y. Talwalkar

Well, let's make sure the questions are clear. First of all, we're shipping some form of silicon or multiple pieces of silicon into at least 4 out of the 5 wireless infrastructure guides today. Right? And it could be in the form of multiple custom silicon chips. It could be in the form of Axxia. When we talked about the incremental wins at the Analyst Day and we talked about basically winning 2 of the wireless infrastructure players with Axxia, those developments are just now getting into the development -- they're in development about 3 to 6 months. So that will add to our ability to achieve and really surpass this 50% goal that we have for control plane and data plane. But along the way, we'll continue to ship into the wireless infrastructure space with the business that we have today.

Operator

Your next question comes from Arnab Chanda.

Arnab Chanda - Fitch Ratings Ltd.

A couple of questions for you, Abhi. First of all, if you look at your wireless infrastructure wins, I think that was fairly unexpected because you were not a player there except maybe in some more legacy area or ASICs. Can you talk a little bit about when do you see that sort of growth in the investment areas, especially in wireless infrastructure, be able to offset the legacy declines? Is it going to be this year or next year? And then one question about the hard drive business. I think this was asked, but I'm going to ask you a different way. There's sort of 3 factors that you have. One, obviously, is the supply chain bonds snapback; two, your share gain is probably accredited late in the year; but then, three, there's an offsetting factor where you're no longer going to be single-sourced probably at your major customer. Do you think you can grow hard drives with those 3 factors all through this year or do you think there will be kind of a pause before it comes back with the new customer end?

Abhijit Y. Talwalkar

All right. Couple of big questions there. Let's take the networking one. First of all, our networking investment areas have been consistently growing at CAGR of about 25-plus percent over the last 5 years, and we've been very much focused on wireless infrastructure and obviously, a number of segments in enterprise through a standard product, as well as a custom silicon sort of strategy. And they go hand-in-hand as well. We are in production with Axxia today at a major wireless infrastructure provider today. So we're already now in the production and will expect that to grow as we bring on more customers, and we announced the second customer out of the major players as well. And that has now just started development. And we expect our networking investment areas, which again comprise wireless networks, as well as enterprise, custom and standard, to continue to outpace our legacy declines. And we still expect, assuming CapEx returns in the wireless space, as I think everyone is expecting, exiting Q2 and into the second half, that in aggregate our networking business should grow this year. Okay? In hard disk drives, lots of moving parts, obviously, both TAM increases, post-merger product road map rationalization and decisions as well, ramps of new products. Very, very difficult to really call how things play out in the second half, but we very much we'll be gaining share for the full year. And we will be very much growing our business very nicely in 2012 over 2011, both on the SoC side, as well as the preamp side.

Operator

Your next question comes from the line of Craig Berger.

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

Just wanted to understand SandForce and the solid-state drive business a little bit better. What kind of revenue target should we still be expecting for the year? I think that was around $125 million. What's the gross margin profile of that business? And within the revenue, sort of how much is client, how much is enterprise, controllers and how much is flash that's part of the packaged deal that you're passing on?

Abhijit Y. Talwalkar

Okay. Let's see if I can hit those, Craig. First of all, there's no flash in any of our content or what we sell. In terms of gross margins, let's say, gross margins are north of our average. Okay? In terms of growth of SandForce or our SandForce flash processors, we have not specifically provided a growth for that part of the flash business for 2012. But I'll reiterate what I have said around our flash business, which is, if you assume SandForce was part of LSI all of 2011, the aggregate flash-based revenues or flash-oriented revenues at LSI would have been about $70 million in 2011. And I've been on the record to say that we expect our aggregate flash business to grow 100% to 150% this year, and we're on track to do that. Did I answer all your questions on SandForce?

Christian D. Schwab - Craig-Hallum Capital Group LLC, Research Division

Yes. Client versus enterprise?

Abhijit Y. Talwalkar

Client versus enterprise, we were more exposed to client because that's where the focus had been relative to SandForce. That focus now has expanded to enterprise as we discussed in the prepared remarks. We're also starting to ship in the enterprise space in Q2. We're already shipping today, but we'll see improvement in share gains this year in enterprise. Keep in mind, number of the enterprise opportunities have also been cuffed, and we've been working on those. And some of those are in production today as well. So in aggregate, LSI has pretty good representation in enterprise, and we expect it to keep growing.

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

And then just as a brief follow-up. First of all, did you guys say what's actually driving the margins higher? And then, b, when I talked to investors, kind of the biggest fear is that your hard drive customers are overbuying controllers relative to consumption. And so what kind of checks and balances do you have that, that's not the case or what are you saying to make yourselves feel comfortable that this is a sustainable base from which we can apply growth and seasonality?

Abhijit Y. Talwalkar

Yes, let me tackle the second question, and we'll go back to Bryon on the gross margin question. Yes, I've seen some of the analysis that was done around LSI potentially overshipping or shipping ahead of customers. I've looked at it and it's grossly inaccurate and is missing a number of elements as well. Just a number of facts. First of all, in Q4, let me back up, we have a hub-based supply chain model with our customers, so we have complete visibility into that inventory that we maintain. And our customers have no incentive to order more than they need because they order and they pull from the hub. They build the drive, and they ship it. So we have very good visibility from that standpoint. Just some other facts. We undershipped our customers in Q4 because our customers leveraged what they had from an inventory standpoint, so we probably undershipped to the tune of 4 million units in Q4. As it pertains to Q1, there were a number of factors that drove our performance, and I think one factor that is not well understood is our preamp business. Our preamp business was decimated in Q4 because that's where the Thai floods hit us the hardest. And we saw our preamp business grow almost 100% from Q4 to Q1, which is also part of the growth that we experienced. In addition to that, some of the other factors, we are growing share in enterprise and so we saw a nice growth Q4 to Q1 in the enterprise space. And aside from that, we see our units track very nicely to our customers in Seagate and Hitachi.

Bryon Look

Yes, and then just very quickly on your gross margin question, right. It's pretty simple. Our gross margins were affected in the fourth quarter significantly from the Thailand flooding situation, so there's some recovery of that. We have the expansion about 290 basis points quarter-over-quarter. And of course, we have significantly higher revenue levels as well, which helped with the better absorption of our fixed costs.

Operator

Your next question comes from the line of Hans Mosesmann.

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

Another question on flash, just to kind of beat this dead horse, if you don't mind. Can you comment, Abhi, on the competitive dynamic in client and enterprise going forward, not what happened last year, but who were the main players and what are the advantages and excessive value add that LSI brings to these 2 market, clients and enterprise?

Abhijit Y. Talwalkar

Yes, I mean, I think from an architectural standpoint, we've got a very good solution that delivers, I think, great performance across a broader base of workloads and real world applications that's demonstrated. If you look at all the different test labs out there to do benchmarks and takeoffs, SandForce-based solutions are typically always the top 5. If not, they're 4 out of the top 5. So we've got, I think, a good coverage of the segments and good performance across a broad base of application environment. Some of the technologies that we have around where management and so forth, such as our DuraClass technology is another example. I think the other key to the success that SandForce has had which has enabled many players in the marketplace has been the fact that we have a very complete, comprehensive firmware base, as well as the ability to provide a level of customization as well, as we do see that required across a lot of the major players as well as they personalize that something that we do extensively and are also building up support to take on more of that. Because we think that is going to be a differentiator in terms of support as well. And then we've been providing reference designs to enable more players into the marketplace. And then I think the other element, which is not well understood by a lot of people, is the custom capability. Because we also are now experiencing some of the large SSD players as they try to cover a very broad base of SSD segments, and that market is going to continue to bifurcate. They have a strategies in certain areas where they want to do full custom to drive different levels of differentiation, and were doing that today because of our great custom capability in a number of areas they are going to use standard products, which are going to be SandForce-based. That comprehensive capability is something that really only LSI has. And as a result, we're really elevating our value proposition into who we think are going to be the major players in this market as the market grows and develops.

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

Yes, Abhi, if you don’t mind, if you can just mention who your key competitors are in each one of those segment or maybe they're the same?

Abhijit Y. Talwalkar

Well, I think there's competitors obviously such as Marvell. There are competitors in sort of the lower-end segments like Phison, and there's several others. There's also some that are doing internal. But in those internal situations, in some cases, we're participating because we're doing the custom silicon. Samsung is a major player in SSDs today. Their flash storage processors are all internal and their own silicon as well. So that's not an opportunity really today for any of us that are in the merchant market, but maybe that opens up here as the market continues to grow in segment.

Operator

Your next question comes from the line of Harlan Sur.

Harlan Sur - JP Morgan Chase & Co, Research Division

Abhi, your largest SSD customer, I think, estimated TAM growth of about 12% to 13% for the second quarter. Is that -- how much of your HDD business is expected to grow in June? And it also sounds like you expect SoCs to continue to grow, as well as your preamp business. What's happening with your ServeRAID and your SAN businesses in the second quarter?

Abhijit Y. Talwalkar

Maybe I'll expand and give you a little bit more color and maybe focus this around the growth into Q2. If you look at our midpoint, we're going at about 4%. And then obviously, at the upper end, it's roughly 7.5% to 8% growth. But if you kind of focus on midpoint, the assumption is that we have -- obviously, we've got some contribution in terms of growth with our flash-oriented business. We're assuming about a high single-digit growth in HDD, which is kind of in line with our largest customer, especially if you look at their organic sort of hard drive and the growth of the organic hard drive business. And then from a server standpoint, expecting seasonality and expect that growth to be somewhere around 2% to 3%. Networking, generally flattish, however, investment area is growing while we're offsetting some declines in legacy. So that's kind of the makeup of Q2, with a few exceptions there.

Harlan Sur - JP Morgan Chase & Co, Research Division

Great, and I appreciate that. And then on the SAS for your external storage business. This is -- I'm talking about next-generation 12 gig. Any updates on any market share gains on some of this next-generation platforms where you currently have, let's say, very little footprint. My understanding is that the bake-offs are happening now. Wondering if the team in LSI is starting to see the benefits given your lead on 12 gig?

Abhijit Y. Talwalkar

Yes, I believe we are, and we do participate in external storage today. Our share is not as strong as it is in the server side. Our share is probably in the 35% to 40% range. This is, today, in terms of what's shipping. In the last 1 to 2 earnings calls, we have announced 2 external storage systems vendors that have chosen LSI 12-gig SAS. We were public about one of them, that's Dot Hill. I don't believe we're public about the second one. And you're absolutely right, the bake-offs, the evaluation, all that is underway now. And we anticipate to make progress and grow share. 12-gig SAS in external storage is really a 2013, probably mid-2013 start. Right, a little bit lagging that of server.

Operator

Your next question comes from the line of Betsy Van Hees.

Betsy Van Hees - Wedbush Securities Inc., Research Division

I know there's a lot of questions that have been asked on SandForce, but I do have a couple. You, in your last quarterly call, said that you thought revenue from SandForce is going to be about $20 million to $25 million. So given the commentary, I would imagine that it was -- it exceeded that. I was wondering if you could tell us how much it exceeded by or give us a percentage as we try and model this business.

Abhijit Y. Talwalkar

We're probably not going to give you that level of clarity. But you're correct in it exceeding $25 million.

Betsy Van Hees - Wedbush Securities Inc., Research Division

Okay, fair enough. And then when we're looking at your business in Q3, I know you don’t want to give any type of guidance. But what can we assume for a typical seasonality as we look at the different businesses?

Abhijit Y. Talwalkar

We're all hoping for a typical seasonality cycle for once, as the last 2 years certainly have not provided it, given the national disasters and other factors and so forth. If you think about our composition, 75%, 80% of our composition is still on the order -- is still oriented around enterprise IT infrastructure and service provider IT infrastructure. If service providers start to see CapEx spending loosen up into the second half, which certainly that's what the sentiment is out there, that, combined with what's expected in terms of server and data center growth and just enterprise cycles, second half is up from the first half in aggregate. Right? But that's probably as far as I would go. And then I'd say, historically, we've seen a 3% to 5% sort of growth in Q2 to Q3 and higher growth in the Q4 time frame. And if you look at from HDD TAM standpoint, what people are projecting in terms of TAM is 160 million units in Q2, moving to 180 million units in Q3 to 185 million, 190 million units in Q4. So there's certainly going to be growth that will come with that.

Operator

Your next question comes from the line of Stephen Chin.

Stephen Chin - UBS Investment Bank, Research Division

Couple of questions for me on the networking side of the business. I know that you guys mentioned that investment areas grow in Q1 and you expect it to grow again in Q2. I was wondering if you could provide a little more granularity on whether it's existing products that maybe has been on the market for more -- that was launched for more than a year that -- before you saw growth or is it actually from just new programs ramps over the last quarter and then current quarter where you're experiencing the growth?

Abhijit Y. Talwalkar

Yes, it's hard to break that out but I'd say, more new product ramps that we've launched in the last couple of quarters or recent quarter. Right?

Stephen Chin - UBS Investment Bank, Research Division

Okay. And I guess also for -- in terms of what your customers might be seeing in terms of the CapEx trends and spending at security level? I know a number of them have already been reported it. But it does seem like Q1 was relatively weak for a number of these equipment OEMs and the expectations that Q2 in the second half would improved and then see growth? But I guess in terms of the conversations you've had, what is the underlying actual spending trends and budget as they're opening up already that your customers might be seeing? If you can talk to that.

Abhijit Y. Talwalkar

Yes, I think that's certainly the hope. I mean that North America will start to see a lift here in Q2 some time. Europe will probably continue to be a bit problematic, and China will continue to do well, and particularly, in the second half though. So at least what we're hearing, some of that maybe a hopeful expectations from customers or at least service providers and equipment companies that sell to them. But I think everyone is of the same opinion that networks are incredibly oversubscribed and there needs to be spending growth to keep up with the challenges that exist. And so with most of that inventory now burned off, we do hope and anticipate things to start improving from here on out.

Stephen Chin - UBS Investment Bank, Research Division

Okay, got it. And then for the ARM-based Axxia products that you mentioned earlier, I was curious as to when you might see revenues for that product line? Is it 1 or 2 years off and also what kind of feedback have you gotten from customers regarding a second micro-architecture that you may need to support or re-compile the software for -- in order to support that?

Abhijit Y. Talwalkar

Yes, I mean I think -- let me take the second question first because that's an easy one. We obviously work hand-in-hand and collaborated with a number of our lead customers around this and there's strong pull for this, which means they completely understand and have assessed the software porting activity but see tremendous benefit in making that happen and doing that, so really good support there on the customer side. In terms of revenues relative to the ARM-based Axxia product line, that's not something that we've put out there. And I just out of concerns of sharing too much with our competition, I probably won't answer that today. But we'll keep you posted on progress on that front. We're very excited, and I think that is absolutely a key differentiator and has been part and parcel to the success that we were able to announce at the Analyst Day relative to future share in wireless infrastructure.

Stephen Chin - UBS Investment Bank, Research Division

All right, great. And just one last quick one on your storage business. Just given some of the online storage, sort of cloud storage service offering that have come out recently. I was curious as to whether or not you think there will be a lot of pent-up demand in the second half given that both enterprise storage, it's not growing terribly fast. In terms of the TAM side and also on the desktop side, the 3.5-inch side, that has yet to fully recover. So I was wondering given the types of drives that these cloud service providers might utilize, if there might be continued strong demand and potentially, better-than-expected demand in the second half because of that?

Abhijit Y. Talwalkar

Yes, I mean all the trends are very supportive of just continued build-outs. And we're very well positioned there, especially if you look at our HDD business, which has a heavy exposure to enterprise drives with Seagate and Hitachi, who are really -- and now WD, obviously, with the enterprise business from Hitachi, we're leaders in the marketplace. And then we also have a very strong market share position in desktop for 3.5 inch, and those are going to be probably the greater mix in terms of cloud oriented deployments. And then don't forget our PCIe flash, our Nytro product line, a lot of that is also aimed at these web 2.0 companies and those that are also offering cloud services. So we think all of that is a great opportunity for us throughout the year.

Sujal Shah

Okay. Thank you, Stephen. It looks like there's no further questions, so I'd like to thank all of you for joining us this afternoon. If you have any additional questions, please call Investor Relations at LSI. Thank you, and have a nice day.

Operator

Ladies and gentlemen, a telephonic replay of this conference will be available beginning today at approximately 5 p.m. Pacific Daylight Time and will run through 9 p.m. Pacific Daylight Time on May 3. The replay access numbers are 1 (855) 859-2056 within the U.S. and 1 (404) 537-3406 for all other locations. The conference ID number is 66912997. The webcast will be archived at www.lsi.com/webcast.

That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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