LSI Corp. Q4 2007 Earnings Call Transcript

Jan.23.08 | About: LSI Corp. (LSI)

LSI Logic Corporation (NASDAQ:LSI)

Q4 FY07 Earnings Call

January 23, 2008, 5:00 PM ET

Executives

Sujal Shah - VP, IR

Abhi Talwalkar - President and CEO

Bryon Look - EVP and CFO

Analysts

Craig Berger - FBR Capital Markets

Tayyib Shah - Longbow Research

James Snyder - Mercy Health Partners

Hans Mosesman - Raymond James

Christian Schwab - Craig-Hallum Capital Group

Kaushik Roy - Pacific Growth Equities

Romith Shah - Lehman Brothers

Suji De Silva - Kaufman Brothers

Mark Heller - Merrill Lynch

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the LSI Corporation Investor Relations Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Sujal Shah, Vice President of Investor Relations at LSI. Please go ahead.

Sujal Shah - Vice President, Investor Relations

Good afternoon and thank you for joining us. With me today are Abhi Talwalkar, President and Chief Executive Officer; 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 fourth quarter and full year 2007 financial results and guidance for the first quarter of 2008.

During this call, we will be mentioning non-GAAP financial measures which we may refer to as results excluding special items. Today's earnings release describes the differences between our non-GAAP and GAAP reporting. You can find reconciliations of our non-GAAP financial measures to corresponding GAAP amounts on our website at www.lsi.com/webcast. At that site you can also find a copy of the press release and a presentation which highlights the key points from today's call and provides an overview of our business. This may be particularly useful to new investors.

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

Abhi Talwalkar - President and Chief Executive Officer

Thanks, Sujal. Good afternoon and welcome. By now you have seen our press release announcing our results for the fourth quarter. Our revenues and non-GAAP gross margins, operating expenses and earnings were all better than we forecasted driven by the continued strong demand for storage fuelled by growth of digital content and information around the world. It's important to distinguish the strength that we are seeing in our business and the confidence that we have in our future from the broader events that are impacting the stock market.

There are several key takeaways that I would like you to get from this call. First, our results for the quarter continue to reinforce LSI's strategy to focus on storage and networking where we have deep incumbency and market leading customers that have a global presence.

We continue to see strong design-win momentum with key customers across the businesses that we expect to translate into future revenue growth. With $1.4 billion in cash, strong quarterly operational cash-flow and focus on expense control, we expect to continue to increase earning leverage as we go forward.

And finally we except to be active with our remaining share buy-back authorization at these price levels and anticipate that our cash generation will enable the opportunity to continue share repurchases into the future.

LSI ended 2007 on a strong note, exceeding our guidance for both revenue and non-GAAP earnings in the fourth quarter while also exceeding our design-win plan for the full year. LSI's revenue was $741 million in the fourth quarter with growth in storage systems, hard disk drives, SAS, SAN, multiple product areas in networking as well as IP licensing.

Excluding mobility, December revenues of our ongoing businesses increased over 12% sequentially. This strong performance which followed equally strong results in the third quarter capped the year in which we moved rapidly to align LSI for a long-term success.

The new LSI has come a long way in a short time to establish a silicon, systems powerhouse in storage and building a leadership position in networking.

Let me recap the 2007 highlights and then provide more clarity into Q4 business performance. After completing the merger with Agere, we quickly sold out mobility and consumer businesses avoiding significant future investments while eliminating our risk and exposure to those more volatile markets. We believe that storage and networking will provide a much higher return on our investments.

We are moving quickly to complete the transition of assembly and test operations to an outsource model using contract manufacturers which has the benefits of a variable cost model and lower future capital expenditures. We have reduced our operating expense run rate by approximately $50 million per quarter since the beginning of 2007 and drove gross margin improvement since the merger.

Now, I want to review with you the business highlights for the last quarter and for 2007 in storage and networking business. Our Storage systems business had an excellent quarter with 26% sequential growth. The quarter concluded the sixth consecutive year of growth and share expansion for our external storage systems business. Unmatched product breadth and delivering first-to-market on technology transitions combined with a unique OEM business model were at the core of LSI's storage systems' success.

Applying three of the top four server OEMs along with Teradata, a leader in data warehousing, we continue to see sustained growth in our mid-range platforms and strong demand for entry level storage systems.

In the fourth quarter we expanded our entry product line by adding support for SATA drives as well as high-SCSI host interface support fueling future revenue growth. We believe that exiting 2007 our combined OEM volume shipments make us the clear leader in this fast growing entry level external RAID segments.

LSI remains committed to delivering fast time to market solutions to address the challenges of managing and protecting growing digital content information in small and large enterprises. We have already deployed the first version of our next generation mid-range class platform with Oak Ridge National Labs with more than one terabyte of storage. In addition, as end customers deploy more data protections solutions, we expect continued momentum in software revenues for advanced replication features. We expect software attach rate to increase in 2008 as it did in 2007.

Our internal RAID storage business supplies 8 of the top 10 server OEMs and have strong demand across all of our customers and channels in the fourth quarter. We are now in full ramp of our latest generation of MegaRAID solutions based on LSI 1078 RAID-On-Chip standard product. IBM recently started shipping our RAID... internal RAID solutions which displays a previously entranced [ph] competitor.

In the December quarter, we also announced an extension of our relationship with Intel's server division that will expand our opportunities going forward.

Now, turning to Storage Semiconductor business. I will give some updates across our hard disk drives, SAS and SAN businesses. I am extremely pleased with the progress we have made in hard disk drive silicon as a result of the merger. LSI set a number of records for unit shipments in Q4 including SoC to Seagate and preamp shipments to Samsung and WD.

In 2007, LSI solidified its position as the leading hard disk drive supplier to Seagate. Beyond Seagate, we secured a desktop SOC win and a major new hard disk drive customer, where we now have provided sample silicon. We also significantly grew our preamp business in 2007; our share increased as we expanded our footprint in the desktop, notebook, consumer, as well as enterprise segments.

In SAS storage components, we grew 30% year-over-year, reflecting our SAS leadership position. In Q4, we announced an expanded SAS set of RAID agreement with Intel for its server and workstation channel products. This multi-generational alignment broadens the availability of LSI RAID-On-Chip and MegaRAID solutions.

Additionally, as noted earlier IBM is now using LSI's SAS RAID-On-Chip standard product in its xSeries server line.

LSI has been the number one supplier of SAS components since its inception. We believe that our strong portfolio of SAS components combined with our MegaRAID software will allow us to maintain our number one position through the SAS 2.0 transition in 2009.

For fiber channel storage area networks LSI continues to be the leading vendor with unmatched storage IP and custom silicon capability with approximately 70% share in 4 gig fabric silicon. We expect to continue this leadership position for the eight gig generation where we have secure design wins in our sampling silicon to all three HPA vendors and the leading switch provider. In addition, we have already started securing design wins for fiber channel over Ethernet.

Now I would like to review the networking business and its accelerated design win momentum. Our investments in networking are aimed at delivering technology and products that enable IP packet traffic management control and content processing all at faster data rates. These capabilities are enabling our networking customers to increasing add more intelligence into the network for traffic filtering, threat management, quality of service, Web 2.0 services as well as other emerging applications.

We continue to be viewed by many of our customers as the Company with the most comprehensive set of capabilities and portfolio of products. Just to share a few examples, in the December quarter LSI secured several network processor design wins with Nokia Siemens and a Tarari content processor win with Alcatel Lucent adding to our Tarari content processor win at CISCO, Juniper, Huawei, Symantec as well as a host of other networking companies.

In addition, we were awarded a significant custom gigabit Ethernet prime [ph] win at a major networking component provider wining business from a key competitor; we expect revenue from this program to be significant with our products beginning to ramp in 2009. We expect this particular engagement to develop into a broader business opportunity as we move forward. As you can see, we are entering 2008 with revenue momentum and a number of major design wins at new as well as existing customers.

With our Phase I of our business acceleration plan now complete, we are taking actions to increase earnings growth in Phase II. We have increased the efficiency of our R&D organizations and made further reductions to operating expenses to better align resources, to keep programs if we expect to generate revenue within the next two to three years. We also have been active in our share buy-back program, reducing our outstanding share count to add further earnings leverage.

Our goal remains to strike a balance between driving improvements to 2008 earnings, while making targeted investments to generate and acceleration of revenue in earnings growth in 2009 and beyond. We have already secured key wins in storage systems, storage semis and networking that give us confidence of growth. In addition, we continue to be successful in growing IP revenue. These wins and other key design engagements bode well for strong financial performance as production ramps.

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

Bryon Look - Executive Vice President and Chief Financial Officer

Thank you, Abhi. I'd like to begin with a few of the key financial highlights for the quarter and 2007. Continued revenue growth on the top line during the second half of the year, coupled with our continued efforts to reduce costs and streamline investments, resulted in significant improvements in our business results throughout the second half of 2007. Revenues for the fourth quarter were $741 million. Adjusting Q3 and Q4 for the sale of the mobility business, revenues improved sequentially by 12.2%. Revenues for full year 2007 were $2.6 billion.

Consolidated gross margins excluding special items were 46.7% for the fourth quarter, a 330 basis point improvement from the third quarter of 2007 and 43.7% for 2007. Operating expenses excluding special items were $244 million for Q4, a reduction of $18 million from the third quarter and approximately $46 million lower than Q2.

Earnings excluding special items were $0.13 per diluted share for Q4, a $0.07 per share sequential improvement from Q3 and $0.26 per diluted share for 2007. Operating cash flows for Q4 were $110 million and $295 million for the full year 2007.

Now turning to a more detailed discussion on revenues. Mobility revenues recorded in the fourth quarter before the completion of the sale were approximately $29 million. Eliminating the effect of the mobility sale on total revenues for Q3 and Q4 we experienced a strong growth quarter with total revenues going sequentially 12.2% from $634 million in Q3 to $712 million in Q4. In addition, net of mobility, semiconductor revenues increased 5.9% from $437 million in Q3 to $463 million in Q4.

Our storage semiconductor business includes hard disk drive silicon, SAS standard components and storage area network ICs. Our storage semiconductor revenues were $321 million representing 43% of total revenues in the fourth quarter and 9.9% sequential increase from the third quarter.

The strong performance in storage semiconductors was driven by increased demand in SAS standard components, storage and SAN custom ICs and preamps as well as revenues from shipments of SoCs and hard disk drive controllers to one of our largest customers which continued to be strong during the quarter.

Now let me turn to our networking business, Q4 revenues in our networking business were $133 million representing 17.9% of total revenues for the quarter and essentially even with levels from the third quarter.

Revenues for the IP business in the fourth quarter increased, increasing sequentially to $9 million as we continued to invest in our IP business and expect growth over time.

Turning next to our Storage Systems business, we experienced seasonally strong demand in our Storage Systems segment where revenues increased 26.2% sequentially to a record $249 million in Q4.

In addition this business also grew year-over-year recording revenues for 2007 of $825 million or an 8.7% increase from 2006. Storage Systems segment represented 34% of LSI's total revenues in the fourth quarter. The increase in systems revenues was driven by higher shipments in both our mid-range and entry level product lines along with growth in software and direct-attach RAID products.

Storage revenues continue to be a significant percentage of LSI's total revenues. Combined revenues from storage systems and storage semiconductors amounted to $570 million or 77% of LSI's total revenues in Q4.

Next, moving to gross margin. Consolidated Q4 gross margin excluding special items was 46.7% which was sequentially up 330 basis points from the third quarter. Semiconductor margins excluding special items, improved approximately 360 basis points from the third quarter to approximately 49.2% primarily due to higher revenues as well as a more favorable mix.

Storage systems margins excluding special items improved to 41.7%, a 430 basis point sequential increase from the third quarter, primarily due to increased revenues and a favorable product mix including increased software sales.

As I noted before, we continue to drive the efficiencies in the organization and maintain tight controls on our operating expenses which totaled $244 million in Q4 excluding special items. This represented a sequential improvement of $18 million from the third quarter. Interest income and other, net of interest expense, was $4.6 million for Q4 and $18.1 million for fiscal year 2007.

Now, let me turn to the special items, we recorded in the fourth quarter, which netted to $2.09 billion including a Q4 goodwill impairment charge. Current market concerns regarding macroeconomic conditions have severely impacted stock valuations. The resulting decline in LSI stock value to a level significantly below the value of the assets on our books has lead to a requirement that we measure and reassess the fair value of those assets including goodwill in accordance with standard accounting practices as outlined in FAS 142. The result upon completion of this assessment will be a write-down to our goodwill balance for our semiconductor business. This accounting charge is a non-recurring, non-cash charge. Based on our preliminary work, we recorded $2.0 billion estimated goodwill charge in Q4.

The company is in a process of completing the measurement of the impairment to goodwill and it is possible that this estimate could change within a range of $1.7 billion to $2.2 billion. The company expects to finalize the impairment charge and report it in the annual report on Form 10-K. Other special items, primarily non-cash, included $38.6 million in amortization of acquisition related items, $29 million in restructuring costs and other items relating primarily to asset write-downs and severance costs, $21.5 million of stock-based compensation expense and $6 million of acquired in-process R&D relating to our Tarari acquisition.

The tax provision for the fourth quarter on a GAAP basis was $12.0 million and on a non-GAAP basis, the tax provision was $12.3 million. On a GAAP basis, fourth quarter net loss was $2.0 billion or $2.88 per share. Without the goodwill impairment the loss would have been approximately $600,000 or essentially breakeven.

Net income excluding special items was a profit of $94.2 million or $0.13 per diluted share. For 2007, our net loss on a GAAP basis was $2.49 billion or $3.88 per share. Net income excluding special items was a profit of $168 million or $0.26 per diluted share.

And turning now to the balance sheet and cash flow, we reported yet another strong cash generating quarter completing 23 consecutive quarters of positive operating cash flows. As I previously highlighted operating cash flows for the fourth quarter were quite strong at $110 million. Cash in short-term investments were $1.4 billion and our net cash position at the end of the quarter was $680 million.

During the quarter inventories increased by $22.4 million as compared to Q3. This increase was primarily driven by inventory builds in preparations for planned factory shutdowns and replenishment of buffer stocks due to strong demand at one of our key customers in Q4.

For the full year 2007, depreciation and software amortization was $79 million and capital expenditures were $50 million. Included in our operating cash flow was approximately $56 million of cash receipts from IP licensing that was not reflected in the income statement due to purchase accounting.

Moving to share repurchase. Since announcing our share repurchase program last December, we have spent $771 million out of a total authorization of $1 billion, repurchasing a total of approximately 102.6 million shares. The following is our guidance for the March 2008 quarter.

Revenue in a range of $620 million to $650 million, which is in line with our previous expectation. In October we indicated that a typical seasonal decline for our businesses was 8% to 12% from Q4 to Q1. After netting our mobility revenues that we will not have in Q1 our guidance represents an approximate 11% sequential decline from a stronger than expected fourth quarter.

We expect the storage systems and storage semi businesses to be sequentially down from Q4 due to seasonality. However, we expect networking to be about flat and IP to be sequentially up. Continuing with guidance for Q1, consolidated gross margin excluding special items in the range of 44% to 46%. We expect semiconductor margins to be in the 48% range in the first quarter of 2008 and systems margins to be in the 38% range each excluding special items. Operating expenses in the range of $230 million to $240 million, excluding special items. Interest income and other net of interest expense of $3 million. Special items netting to approximately $70 million to $90 million and a GAAP tax provision of approximately $8 million with non-GAAP tax rates being approximately 15%. Longer term we expect our non-GAAP tax rate to be between 15% to 20%. This rate however varies quarter-to-quarter and is a function of profitability and different geographic tax jurisdictions, along with discreet items.

We will continue providing updates on this rate as we progress through the year and gain better visibility. Continuing GAAP net loss projected to be in the range of $0.01 to $0.09 per share, EPS excluding special items in the range of $0.05 to $0.09 per diluted share. And share count is expected to be approximately 660 million shares for GAAP purposes and 665 million shares for non-GAAP purposes.

In addition for the full year 2008, we expect depreciation and amortization of approximately $80 million, capital expenditures of approximately $50 million and IP cash receipts not reflected in net income of approximately $20 million. So, in summary we continue to make significant progress on our financials.

Throughout the second half of the year, we demonstrated strong revenue growth, non-GAAP gross margin expansion, non-GAAP operating expense reductions, strong operating cash flows along with improvements in earnings per share excluding special items.

And, now I'd like to turn the call back over to Abhi.

Abhi Talwalkar - President and Chief Executive Officer

Thanks, Bryon. Before we go to your questions, I wanted to provide some perspective on what we can expect in our business, going forward. While the uncertain economic environment gives us limited visibility, we are planning on typical seasonality in our end markets in 2008. Remember that our business composition has changed with data storage centered products now representing nearly 8% of our revenues.

In the storage market, the March and June quarters typically have seasonally lower demand and the September and December quarters tend to be stronger. We are expecting a consistent demand profile this year. Below the top line we are taking clear and definitive actions in Phase II of our business acceleration plan to improve our earnings leverage and deliver EPS growth in 2008 including gross margin expansion, operating expense control and expected share repurchases.

I would like to now turn the call back to Sujal.

Sujal Shah - Vice President, Investor Relations

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

Question And Answer

Operator

Thank you. Ladies and gentlemen, to ensure that all participants have an opportunity to ask a question, each person will be limited to one question and one follow-up during this Q&A session. You may rejoin the queue if you need additional follow-ups. [Operator Instructions]. The first question is from Craig Berger of FBR.

Craig Berger - FBR Capital Markets

Good afternoon and congratulations on the steady results here. Just a couple of questions. I guess the first is on the gross margins which are showing some considerable strength here, particularly in the chips. Are you able to isolate how much of that is due to the wireless mixing out of that over the last couple quarters or give any additional color on the strength there.

Bryon Look - Executive Vice President and Chief Financial Officer

Yes Greg, sure, this is Byron. And relative to the gross margin performance which is very strong in the quarter, 46.7% combined or consolidated, clearly one of the largest factors for that larger than expected gross margin was really the strength in revenues, right. We exceeded our own guidance over the top-end of our guidance by $10 million. So, our volume certainly enabled growth in that as we were able to get better absorption. We continue to drive manufacturing efficiencies that translate also to savings in terms of cost of sales. I mean I would say that for both the systems part of our business as well as the semiconductor part of our business we continue to remain focused on those type source of items. To break it out a little bit further for you, relative to the margin performance in semiconductor which is 49.2% in the quarter, that was driven again largely by the increased revenues, but also by some favorable mix. As you point to one of the elements of that as we had lower mobility within the quarter. But generally speaking we had strength in our storage business and benefited from volume.

On the systems side, the margin improvements which were substantial, from 400 basis points driving our margins to 41.7%, driven by volume, specifically strength again in our mid-range product-line as well as growth in our entry part of our product-line. We also had the benefit of increased software sales within that mix.

Craig Berger - FBR Capital Markets

On the Q1 OpEx, at midpoint 2.35, is that the bottom or do you think there's additional declines to be had there at any point in the year?

Abhi Talwalkar - President and Chief Executive Officer

Well Craig I'll give you my perspective, and then Bryon can add to it if he wants to. I mean we have been incredibly focused on improving our overall OpEx run-rate, we have demonstrated significant reductions over the course of 2007 to the tune of about $50 million per quarter. Q1 represents a reduction for that base as well. In sort of today's economic environment which has a level of uncertainties we are going to continue to exercise very tight expense control and we are going to watch that on a regular basis. We are not going to guide the full year at this point in time, but that is being watched very closely.

Craig Berger - FBR Capital Markets

Okay. Abhi, can you provide your perspective on the competitive landscape in the SAS server market. You have seen kind of like Zyrotech [ph] and Dot Hill [ph] getting in there and I guess Dell bought EqualLogic, and I think Dell could be an important customer for you guys if they are not already. So, just your perspective on the competitive landscape?

Abhi Talwalkar - President and Chief Executive Officer

Yes specifically on SAS systems which is what you are referring to. As you know we enabled our customers to get out in front of the market almost a year in advance of their competitors and as a result we have shipped thousands and thousands of systems throughout this year across a number of interfaces from iSCSI to fiber channel to SAS as well. So, we feel very good about what we've accomplished as well as the fact that we are a clear leader in terms of total volume shipments into the top three sort of storage OEMs that we have. So, I think there is a considerable advantage and lead as well as a breadth of product line that we have out there in the market.

Craig Berger - FBR Capital Markets

Thanks a lot.

Sujal Shah - Vice President, Investor Relations

Thank you, Craig. Could we have the next question please?

Operator

Tayyib Shah.

Tayyib Shah - Longbow Research

Hi, guys did you say that you would normally expect June to be seasonally weaker and if so are there any growth drivers like the entry level system or SAS related silicon that would negate that seasonality as we get to the middle of the year.

Abhi Talwalkar - President and Chief Executive Officer

I mean we've got... there's a number of puts and takes. As you also know, we've got a small legacy element in our business as well from a networking standpoint. But if I just look at overall seasonality of the end markets that we are in, this is everything from PCs to servers to external storage systems as well as all the disk drives that those segments drive and you can even look at networking expenditures in there. Typically Q1 and Q2 are depressed, are down, and you start seeing growth in Q3 and Q4. And, even historically some of these segments have been slightly have been flat to slightly even down in the Q2 or the June quarter. So that's why we are looking at the overall first half of this year sort of being flattish with growth system with seasonality in the second half.

Tayyib Shah - Longbow Research

Okay. And then networking business being flat, can you just give us some idea of how the legacy products are doing in that business and how rapid do you think will be the revenue decline in 2008?

Abhi Talwalkar - President and Chief Executive Officer

Well I think we have been pretty specific in terms of the magnitude of decline that we expect in 2008 to the tune of about $100 million.

Tayyib Shah - Longbow Research

Okay.

Abhi Talwalkar - President and Chief Executive Officer

We said that... historically we've said that in 2008, the growth elements of networking versus the legacy elements of networking to a large degree sort of... they cancel each other out to result in sort of flattish growth for our networking business. We believe we're doing a far better job than we did two, three quarters ago in terms of monitoring that legacy network and the business and I can confidently say that we have done a better job of predicting that within the quarter over the last two quarters.

Tayyib Shah - Longbow Research

Thank you.

Sujal Shah - Vice President, Investor Relations

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

Operator

James Snyder.

James Snyder - Mercy Health Partners

Hi, there. Good afternoon. If you look at the networking business and think about what kind of investments you need to drive future revenue growth there, how much would be organic in terms of new R&D adds versus what would you choose to do via acquisitions?

Abhi Talwalkar - President and Chief Executive Officer

Well we clearly don't comment on future acquisitions or potential acquisitions of that sort. Right now to a large degree we're very much focused on the organic investments that we have and making sure that we realize the benefits of those investments but that doesn't say we'll entirely rule out acquisitions. As we will look at potentially small technology tuck-ins; a good example is what we did with Tarari which is very significant in terms of leadership value, consistent with our networking strategy. But I would say we are more of centered around executing to our organic investments and realizing the return on those investments versus aggressive acquisition oriented moves.

James Snyder - Mercy Health Partners

Perfect. And just a follow-up. On the buyback program, I guess, you have about 200 and some million dollars left in that. Any thoughts of a renewal there that might be faster than you have done in the past and some kind of acceleration?

Abhi Talwalkar - President and Chief Executive Officer

Well, I think, at these pricing levels, as I said earlier, you can expect us to be aggressive and in the market, and clearly as we look forward and as we look at our plan modular [ph] the overall economic environment that we're all watching very closely, we believe that our cash generation capability that exists will absolutely afford us the opportunity to continue to revisit additional share repurchases into the future.

James Snyder - Mercy Health Partners

Great, thanks.

Sujal Shah - Vice President, Investor Relations

Okay, thank you James. Could we have the next question please?

Operator

Hans Mosesman of Raymond James.

Hans Mosesman - Raymond James

Thanks. Congrats guys. Most of my questions have been answered, but if you can give a little more detail on the storage systems software component. How much of the gross margin improvement on a sequential basis was driven by that component, and how should we look at that going forward?

Abhi Talwalkar - President and Chief Executive Officer

Hans, we... we haven't broken out this specific element although as we've discussed over the past year to almost five quarters, we are emphasizing software at that greater levels, have realigned some investments there, we have made one acquisition in the past, we've recognized that as not only a strategic opportunity, a customer need, as well as a significant sort of gross margin lever for our systems business to help it consistently execute to what was a pretty solid quarter in terms of gross margin. It is certainly starting to make a difference, and as we continue to grow it, it will be a major element of enabling us to consistently hit sort of the levels that we experienced in Q4.

Hans Mosesman - Raymond James

So, relative to your longer-term gross margin targets for the system businesses, is this going to take them up?

Abhi Talwalkar - President and Chief Executive Officer

Well there is number of detractors and attractors relative to the systems business. You got a standard level of sort of ASP erosion that you have to content wit, it's a hardware platform and that does bring with it some level of erosion. We've been compensating for that erosion by driving higher levels of software sales going to a variable manufacturing model. I think what we've said historically is that we want to consistently deliver margins for this business in the mid-to-high 30s. Certainly we have objectives that are probably more aggressive than that, but it will require very consistent and elevated performance and things like software. And that's something that we continue to work on.

Hans Mosesman - Raymond James

Okay. Thank you very much.

Sujal Shah - Vice President, Investor Relations

Okay, thank you Hans. Could we have the next question please?

Operator

Christian Schwab of Craig-Hallum Capital Group.

Christian Schwab - Craig-Hallum Capital Group

Thank you. Just on the networking business. What was your total revenue for 2008, I mean 2007 for networking back of the envelope? It just seems that... let me get to the question, it just seems that a $133 million for March will equate to a pretty measurable sequential follow-up in networking revenues at some point in the year, if that's going to be down a $100 million?

Bryon Look - Executive Vice President and Chief Financial Officer

Evaluating --

Abhi Talwalkar - President and Chief Executive Officer

It was $133 million from the March, I think you are referring to $133 million for Q4?

Christian Schwab - Craig-Hallum Capital Group

Right. But then you guys --

Bryon Look - Executive Vice President and Chief Financial Officer

We talked about specifically March.

Christian Schwab - Craig-Hallum Capital Group

Well you guys said in the Q4 guidance that you'd expect networking to be roughly flat, IP to be up slightly up and storage semis and systems to be down, just general direction-wise. So networking being flat at $133 million that would make three quarters of pretty solid revenue there. It doesn't seem like it's falling off any more. Should we... I mean could that expectation be conservative?

Abhi Talwalkar - President and Chief Executive Officer

We have got again some declining elements and some growth elements, right. So if I look at aggregate for the year 2007 versus 2008 what we sort of guided to at a high level is that we expected to be flat because the legacy declines are being offset by growth in sort of our go-forward focused areas.

Christian Schwab - Craig-Hallum Capital Group

Okay. So you would expect networking revenue year-over-year in 2008 to be flat?

Bryon Look - Executive Vice President and Chief Financial Officer

Just slightly down.

Christian Schwab - Craig-Hallum Capital Group

Okay.

Abhi Talwalkar - President and Chief Executive Officer

I mean it's hard to --

Bryon Look - Executive Vice President and Chief Financial Officer

I think it's very hard for us to really gauge the fall-off on that.

Christian Schwab - Craig-Hallum Capital Group

Right. But the... you are obviously feeling better about that business than you were six months ago?

Abhi Talwalkar - President and Chief Executive Officer

Yes, it's only related to our predictability of the legacy element. I think people will recall we had a very tough time predicting some of that and certainly the second quarter and even the first quarter of the year. So, I think we got better visibility and better determinants on that number. Again at the same time we don't necessarily, we don't control end markets and how our current customers will drive decisions around some of these products that over the course of time we'll get end-of-life [ph].

Christian Schwab - Craig-Hallum Capital Group

Great. And then, on the gross margin side being at almost 47%, which was your long-term model target here in the most recent quarter. A nice revenue but not what maybe some of us assumed you'd have to get to in order to put up that type of number. Does that 47%, potentially look like a conservative, long-term target, given the fact that we should see increased favorable product mix and hopefully over the next two years a significant increase in IP revenues?

Abhi Talwalkar - President and Chief Executive Officer

I think we're pleased with the progress that we are making there, it's always a challenge, not only the systems business but in the semiconductor business right with ASP pressures but I think we are working on the right kinds of things to do that. We had the benefit, we had a lot of things go in our favor in the quarter that drove those margins on both the systems as well as the semis side of the business.

Abhi Talwalkar - President and Chief Executive Officer

Yes, I mean, keep in mind, Q4 is our strongest quarter. We get the maximum revenue scale, the maximum cost scale; everything generally works in our favor and on our gross margins. Now, the challenge as well as the opportunity is to work on all the dimensions that get us to consistently perform at that level, right. We have got a number of elements that gravity-weigh against that as Bryon mentioned a few, and we've got a number of things, whether its software attached, whether its IP revenue, that will help us lift that up, so --

Christian Schwab - Craig-Hallum Capital Group

Fabulous, thank you.

Sujal Shah - Vice President, Investor Relations

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

Operator

Kaushik Roy of Pacific Growth.

Kaushik Roy - Pacific Growth Equities

Thank you and congratulations on the operating margin improvement. Your long-term operating margin is about 17%. So you are getting close to 14... I mean you got to 14% in December, but can you give us a timeline as to when you might get to that 17%, could it be end of this year or maybe sometime mid-next year. Can you just give us a timeline and then I have a couple of others?

Abhi Talwalkar - President and Chief Executive Officer

Kaushik at this point of time I think we are not going to provide a timeline. We are committed to continuously improving every dimension of our business performance to make meaningful progress towards that business model.

Kaushik Roy - Pacific Growth Equities

Okay. And then on seasonality just previous [ph] modeling June quarter up sequentially on the top line 3% and you are saying that it could be flat to down sequentially. Is that what it is or can you quantify in any way what the usual seasonality is, could it be down like 0% to 3% or in any way you can quantify it would be helpful?

Abhi Talwalkar - President and Chief Executive Officer

I think first of all, one caveat, there's clearly a lot of noise, lot of discussion around broader economic uncertainty and so forth, the U.S. and how much the U.S. factors in everyone's business. On one hand if we look at our customers and our top ten customers and their exposure to the U.S. versus non-U.S. that really does help us but at the same time there is uncertainty out there. I think what I would do is really say the things... we expect things to be seasonal in nature. We haven't seen anything that suggests we are going to see something dramatically different than seasonal and I think that would call for more of a flattish sort of outlook.

Kaushik Roy - Pacific Growth Equities

Okay great. And then going back to the macro question. Are you seeing any slowdown in the end demand or are you seeing any order push out or cancellations, are you seeing inventory builds up at your customers?

Abhi Talwalkar - President and Chief Executive Officer

Well it's interesting you asked because I wanted to listen to IBM and Seagate and a number of our peers as well as our customers. And I could have probably said some of the exact same things that they have said. Relative to order fill rates and demand signals and so forth, things look pretty good, right.

So some of the doom and gloom or the negative sentiment that's out there in terms of the overall economy and impact in demand signals, at least for this quarter we have not seen that materialize. Now we also have a very large percentage of our business which should not be news to anyone. It's something we've been talk about for quite some time that is turns oriented and probably 60%, 65% of our business is turns oriented, and there's a heavy element of it in the third month. So far things look good, demand signals certainly are there. Hopefully that stays the way throughout the quarter, right?

Kaushik Roy - Pacific Growth Equities

Okay, this is very helpful. Thank you.

Sujal Shah - Vice President, Investor Relations

Thank you Kaushik. Could we have the next question please?

Operator

Romith Shah of Lehman Brothers.

Romith Shah - Lehman Brothers

Yes, thanks Abhi. Just with this... little surprised with this seasonal decline in the storage business in Q1, do you expect storage ICs to grow in 2008?

Abhi Talwalkar - President and Chief Executive Officer

Yes we do, based on the drivers that we have and I think obviously it's dependent on end consumption. And if we look at our product positions across our customer base, across all the different storage [technical difficulty] segments as well as some of the catalysts, we do.

Romith Shah - Lehman Brothers

Right. I guess the end consumption part of the equation you can't control but are there any new customer ramps or new products that are going to ramp at existing customers that we should think about and can you give us a sense of timing?

Abhi Talwalkar - President and Chief Executive Officer

Well I mean there's a number of puts and takes in terms of just overall transition. I think it's hard to specifically say I think I will leave it at what I said relative to the overall year from a storage semi-standpoint. I think if I look... you started off your question relative to seasonality being worse in the March quarter. I think it's pretty consistent with what we expect. I think what you need to also make sure you factor in that some analysts that we recognize had not is the base that you should look at the seasonal drop from should be the Q4 sort of base less nearly $30 million in mobility.

Romith Shah - Lehman Brothers

Right.

Abhi Talwalkar - President and Chief Executive Officer

Right. So we are in that range, I wouldn't say we are seasonally worse or seasonally better, we are kind of right on, what we expect.

Romith Shah - Lehman Brothers

And you are expecting growth for the full year?

Abhi Talwalkar - President and Chief Executive Officer

I mean the... again based on the product positions, based on what analysts are saying relative to the end markets that we are in. But we are in January here and some very interesting dynamics across the overall marketplace U.S. in particular which even though is not a minority but it remains a 30% to 35% exposure for us.

Romith Shah - Lehman Brothers

Right. And I apologize if you answered this question earlier, but on the OpEx, you down to $235 million run rate, that's down pretty sharply from Q2. Is this a level of OpEx that you think is necessary to run the business or do you feel like you can take that number down and can you give us a little bit more guidance on where you think you can take it down to?

Abhi Talwalkar - President and Chief Executive Officer

Again, at this point I will just reiterate what I said earlier. We have taken a tremendous amount of OpEx out of our quarterly sort of run rate over the last two to three quarters. We are very aware of the overall sort of economic environment and so forth and we're going to be watching OpEx control very tightly. We did a pretty good job in Q4 relative to our guidance that was because we were like hawks around the OpEx control. We're going to continue to doing that, but we also need to make sure that we do a good job of balancing, not only delivering the right sort of EPS leveraging growth in '08 but also make sure that we're driving the right growth in just for '09 and beyond.

Romith Shah - Lehman Brothers

Okay. So then in terms of -- I mean you talked about on the last quarter about balancing, lower OpEx with all the design engagements that were in front of you, your thinking today versus three months ago hasn't really changed in terms of the scale balancing in one direction or the other?

Abhi Talwalkar - President and Chief Executive Officer

Our... the sentiment has not changed. That balance perspective is there and that's what drove us to some degree to go a little bit on the high side for Q4 in terms of guidance. And some of that because our synergies that we've been mapping as part of bringing the two companies together didn't line up perfectly to when we had the increase [technical difficulty] fairly significant sort of design win activity base.

Romith Shah - Lehman Brothers

Okay, thanks a lot. Nice quarter.

Abhi Talwalkar - President and Chief Executive Officer

Thank you.

Sujal Shah - Vice President, Investor Relations

Thank you Romith. Could we have the next question please?

Operator

Suji De Silva of Kaufman Brothers. Please check your mute button. Suji De Silva?

Suji De Silva - Kaufman Brothers

Hello, can you guys hear me?

Abhi Talwalkar - President and Chief Executive Officer

Yes, we can.

Suji De Silva - Kaufman Brothers

Hey guys, good job on the quarter. I think you are getting a lot of questions on the OpEx here because obviously in Phase II the goal is really earnings leverage. Can you elaborate maybe with OpEx in line kind of how you expect to achieve earning... drive earnings leverage as you think you can control an '08 play-out?

Bryon Look - Executive Vice President and Chief Financial Officer

Well I mean, I think earnings leverage everything from continued improvement in top-line to what we may choose to do in terms of share repurchase to continue to drive gross margin improvement. I mean, clearly one of the benefits that drove a healthy sort of gross margin level especially in semiconductors in Q4, with some of the synergies associated with bringing the two companies together and the purchasing scale that comes with that is also starting to materialize. So we've got gross margin as the lever, we've got revenue associated with our IP licensing business as another sort of gross margin lever, right, that which... that certainly will drive EPS leverage, and we have got a number of tools to work with.

Suji De Silva - Kaufman Brothers

Okay. And with the share re-purchase, what level of cash balance are you comfortable with for running the business?

Abhi Talwalkar - President and Chief Executive Officer

Well as we said, we've got a strong cash position, we've been operating with several hundred million debt positive cash. There's uncertainties in the economic environment. So we pay particular attention, I think, in these times to those sorts of things. But I don't think in any way that that causes us to have to cease what we have been doing which is being very active with respect to those share repurchases going forward.

Suji De Silva - Kaufman Brothers

Okay, that helps. And then on the gross margin side, I was interested to hear the guidance declining. As, Abhi, you've turned the company into a fabulous company with... should we see less gross margin volatility around revenue decline going forward, is that something we should expect?

Abhi Talwalkar - President and Chief Executive Officer

Yes, theoretically [multiple speakers] at least... certainly less volatility.

Suji De Silva - Kaufman Brothers

So what would vary [ph] we have from the theoretical sort of posture going forward, would be pricing perhaps or some other factors?

Abhi Talwalkar - President and Chief Executive Officer

In terms of gross margin.

Suji De Silva - Kaufman Brothers

Right. I mean gross margin coming down with lower revenue as seasonality hits.

Abhi Talwalkar - President and Chief Executive Officer

Pricing... types of capacity and what... our capacity looks and for us the overall foundry base and assembly test space.

Suji De Silva - Kaufman Brothers

Okay, that helps. And then lastly guys on the hard drive businesses like, you talked about some good momentum there. What do you think your share can do in the hard drive market versus where you are today?

Abhi Talwalkar - President and Chief Executive Officer

Up.

Suji De Silva - Kaufman Brothers

And can you --

Abhi Talwalkar - President and Chief Executive Officer

Just to continue to grow it. And I think we secured a lot of significant sort of wins and momentum in 2007 largely attributed to the merger, not only in sort of SSEs and other pieces of IP but also in preamps which is a higher margin profile sort of element of our hard disc drive business. We clearly are taking share from our competitors in 2009 when these additional gains will materialize in terms of production ramps.

Suji De Silva - Kaufman Brothers

Could you pace --

Abhi Talwalkar - President and Chief Executive Officer

I am not going to put out a specific number there. But, I can tell you that in the four storage segments that we participate in, we are number one in three of them and number two in the fourth and that's the hard disc drive space. We are focused at being number one in the markets that we participate in.

Suji De Silva - Kaufman Brothers

With facing contraction [ph] with customers you hadn't... usually had traction on that?

Abhi Talwalkar - President and Chief Executive Officer

You were breaking up... the question again?

Suji De Silva - Kaufman Brothers

Would you say you are seeing traction with customers you haven't traditionally seen traction at with the combined company?

Abhi Talwalkar - President and Chief Executive Officer

We have penetrated some new accounts, yes.

Suji De Silva - Kaufman Brothers

Okay great... for your time, guys.

Sujal Shah - Vice President, Investor Relations

All right, thank you Suji. Could we have the next question please?

Operator

Mark Heller of Merrill Lynch.

Mark Heller - Merrill Lynch

Yes, hi guys, good job. Just had a couple of questions, first of all what are your expectations for IP revenues in 2008?

Abhi Talwalkar - President and Chief Executive Officer

The overall IP revenues for 2007, let's say as a combined company for full year relative to the P&L put aside cash flow, but the P&L, was $58 million, okay. Our objective and what we stated historically is to certainly grow above that in 2008. In addition to that we will also have an additional $20 million or so in terms of cash flow from annuities prior to the merger itself. Right? And what we have been focused on is... post merger we have been developing entirely new revenue streams which means new licensing deals. Our focus has been very much in the short-term to get that engine going and to drive quarter-to-quarter growth which I am happy to say that we have been able to do. But, that's the color I would provide on IP revenues.

Mark Heller - Merrill Lynch

Okay. And, sorry to go back to it but again on the legacy business in networking. Is this a... is the decline expected to be pretty much a little bit every quarter or is there a specific quarter where it could drop off considerably?

Abhi Talwalkar - President and Chief Executive Officer

No, I would say it's more linear versus abrupt.

Mark Heller - Merrill Lynch

Okay. And last question. I guess you had mentioned you had a new desktop customer, I think you announced the win a few quarters ago, are you just sampling it right now? And if so when do you expect that win to ramp?

Abhi Talwalkar - President and Chief Executive Officer

The customer has not talked specifically externally about the ramp itself. But yes we are sampling it, it's probably one of our fastest sort of from design award to sampling of the SOC itself. Clearly our hope is that this thing starts to ship production at towards the latter part of this year, end of this year. But it's more of a 2009 benefit.

Mark Heller - Merrill Lynch

Okay. Thanks guys.

Abhi Talwalkar - President and Chief Executive Officer

Yes.

Sujal Shah - Vice President, Investor Relations

Okay. Thank you Mark, could we have the next question please.

Operator

Sumit Dhanda of Banc of America.

Unidentified Analyst

Hi, this is Gunaji [ph] for Sumit. Just one question on the seasonality that you have mentioned. If I look back at the other side historically, I understand Q1 being down from... for systems and storage components, but Q2 that actually showed higher seasonality relative to Q1 for instance storage systems up 3%, components up 7%, even comp up 6%. I just want to reconcile where the flattish outlook for June relative to what has been typically strong quarter for LSI, is it the fact that the consumer initiative business going to decline more than typical seasonal in Q2 or something else that has changed? Thanks.

Abhi Talwalkar - President and Chief Executive Officer

Well I mean, I think our composition has probably changed... it's changed considerably over the last several years. So I think I would say that for sure and clearly last year and definitely the year before we had consumer electronics in that composition, which typically Q2 and Q3 are the stronger quarters as well.

I think we have also had some product cycles that may have distorted that particular perspective, but if I just look at overall TAMs [ph] of hard disk drives and servers and PCs and sort of historically, it's been more of a flattish Q1 to Q2. And that's probably... those are probably good, very good markets in terms of proxies for how our business will behave.

Unidentified Analyst

And just two more questions on gross margins and for June, should we assume with flattish revenue obviously no chance for gross margins and then on systems gross margins, 41%... I mean what's normalized... I mean this... if my math is correct, this is probably the highest the company has achieved, what's the normalized levels for these margins going forward? Thanks.

Abhi Talwalkar - President and Chief Executive Officer

Well I think as we said earlier, there's puts and takes relative to the margins, volumes has a lot to do with that, we have programs underway. I think we are still comfortable with previous comments that we've made about gross margins for that business being in the mid to high 30s and again we have opportunities potentially longer-term to push that higher but just a lot of gives and takes.

Unidentified Analyst

And for Q2, no change I guess... should we assume flattish gross margin outlook for Q2, with flattish revenues or --

Abhi Talwalkar - President and Chief Executive Officer

I think we are not guiding it at segment level relative to Q2.

Unidentified Analyst

Thanks very much.

Sujal Shah - Vice President, Investor Relations

Hey, thank you. Could we have the next question please?

Operator

Kevin Rendino of Blackrock Capital. Please check in your button. Kevin Rendino of Blackrock Capital, your line is open.

Sujal Shah - Vice President, Investor Relations

Okay. I guess we have time for one more question.

Operator

Sumit Dhanda of Banc of America Securities.

Unidentified Company Representative

Do we have anybody else in queue Kelly.

Operator

Yes. Craig Berger of FBR.

Craig Berger - FBR Capital Markets

Hey guys thanks for the follow up. I just wanted to know if you could give us sense in your Systems business, how much is driven by the new SAS products versus legacy of SCSI products? Also if you have any 10% customers and if so, how much?

Bryon Look - Executive Vice President and Chief Financial Officer

Well, let's ask, the 10% customers as in for systems. Let me break out for systems. We do have two 10% customers for the Company and that is Seagate and IBM.

Craig Berger - FBR Capital Markets

Can you give us the percentages on those?

Bryon Look - Executive Vice President and Chief Financial Officer

No, we normally do not Craig. I don't believe we do. Relative to your systems question as how much is legacy versus new legacy SCSI, we really had no SCSI base RAID external systems, though the entire entry platform that we have launched in the various members of that family that we launched in 2007 was all new versus... there was no legacy element to it.

Craig Berger - FBR Capital Markets

Well can you give us a sense for how big that new... the new entry level stuff is as a piece of the systems? Which is the model of growth and kind of dig into the next layer there?

Abhi Talwalkar - President and Chief Executive Officer

I don't think we plan on providing that level of clarity. We'll... let us think about it and figure out how to help you get a better understanding of the different pieces within the systems business, and it's software as well within that.

Craig Berger - FBR Capital Markets

And then just one last question on the inventories. Why did the inventories go up again and is that build kind of the end of the build for that... for the transition?

Bryon Look - Executive Vice President and Chief Financial Officer

Yes actually I am very comfortable with... with respect to the inventory increases and understanding that, they were very discrete events, Craig, in the quarter. One specific situation was building just buffer stocks as we're transiting and shutting down the manufacturing. We've talked about our assembly and test operations in the past and the transactions around that. And the other one is really just stock replenishments due to very strong demand that we had with one of the storage customers that we had in the quarters. So, going... but we have done a great job I think relative to managing and taking the inventories down at the course of the year and my expectation is going forward again still would be able to improve relative to those inventory balances.

Craig Berger - FBR Capital Markets

Thank you.

Abhi Talwalkar - President and Chief Executive Officer

Thank you Craig.

Sujal Shah - Vice President, Investor Relations

In closing I would like to thank all of you for joining us this afternoon. If you have any additional questions please call Investor Relations at LSI. Thank you and have a nice day.

Operator

Ladies and gentlemen, a telephonic replay of this conference call will be available beginning today at approximately 5:00 PM Pacific time, and will run through mid-night on January 28th. The replay access numbers are 1-888-566-0639 within the U.S. and 1-203-369-3079 for all other locations. The webcast will be archived at http://www.lsi.com/webcast. That does conclude you conference call for today. Thank you for participation. You may disconnect at this time.

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