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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

Blayne Curtis - Barclays Capital, Research Division

James Schneider - Goldman Sachs Group Inc., Research Division

Steven Chin - UBS Investment Bank, Research Division

Sujeeva De Silva - ThinkEquity LLC, Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

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

Philip Lee - Lazard Capital Markets LLC, Research Division

Betsy Van Hees - Wedbush Securities Inc., Research Division

Arnab K. Chanda - Avian Securities, LLC, Research Division

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

Harlan Sur - JP Morgan Chase & Co, Research Division

Cheng Cheng - Pacific Crest Securities, Inc., Research Division

LSI (LSI) Q2 2012 Earnings Call July 25, 2012 5:00 PM ET

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 call 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 second quarter and guidance for the third 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 Relations 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. Also on the site, we have posted a full video replay of our Analyst Day event along with slides, which provide 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, our first quarter 10-Q and today's earnings release.

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

Abhijit Y. Talwalkar

Thanks, Sujal. Good afternoon, and welcome. While we are in an environment with broad macro challenges, our strong results for the second quarter are a testament to our sound strategy, the contribution from our new product cycles in exciting and growing market segments and solid execution.

Our revenue of $660 million was above the midpoint of guidance and represented 32% year-over-year growth and 6% sequential growth, driven by increases in our HDD business and better-than-expected growth in our newly acquired SandForce flash business. We continue to make progress towards our new business model target of 20% to 22% non-GAAP operating margins.

In Q2, we obtained 18.6% non-GAAP operating margins, along with non-GAAP earnings per share of $0.21, which is at the high end of our guidance range.

Going forward, our guidance for Q3 reflects a cautious outlook due to the macro environment and declines in shipments of SoCs and preamps for hard disk drives. Based on recent industry trends and revenue revisions by our largest customer, we believe that demand eroded faster than industry supply in the month of June. Therefore, we expect to see reductions in demand for our components in Q3, as our customers adjust inventory to bring supply back in line with lower demand levels. We expect this to be a single-quarter inventory adjustment and expect to see higher HD-related shipments in Q4, provided that the PC market experiences some level of normal seasonality.

While we expect our third quarter to be impacted by the macro environment and anticipated inventory adjustments in the HDD market segment, as the management team, we are driving improvements to what we can control. Our efforts have led to significantly better financial results and solid positioning in growing markets reflected by new product cycles and share gains. Year-over-year versus 2Q '11, revenues have grown over 30%; and on a non-GAAP basis, gross margin has expanded by 210 basis points; operating margins have grown from 12.4% to 18.6%; and EPS has doubled, from $0.10 a share to $0.21 per share.

As a company, LSI is centered in applications driving strong secular growth in data and traffic. We are rapidly building momentum in the fastest-growing sectors in technology, such as flash oriented storage and mega data centers.

As flash storage adoption increases in notebooks and data centers, LSI is in a leading position to deliver significant growth. We focused our strategy on hitting the inflection point of flash adoption, and as a result, have achieved key design wins that we believe will enable LSI to be the leader in this emerging, high-growth market segment. We believe we have the broadest and most competitive lineup of flash-based storage solutions.

While end-demand environments remain challenging, we expect to benefit from a number of new product cycles that will be ramping into production in the coming months. In addition to our ramps of our SandForce FSPs, Q3 will be the first quarter of initial production ramps for our Nytro PCIe flash adapter products and Axxia multi-core standard products, and we remain on track to be in production with all HDD customers by the end of this year.

Now I'd like to review additional business highlights for Q2. I will begin with our server and storage business, which includes flash-related businesses, SAS, ServeRAID adapter and software, SAN and HDD.

In flash, we are unique in offering 3 product families: Standard product flash storage processors or FSPs, custom FSPs and PCIe flash adapters, strongly positioning LSI to benefit from a multiyear growth cycle in flash-based storage adoption. We had previously indicated that our flash businesses would grow 100% to 150% in 2012 from a rough base of $70 million in 2011. Based upon strong customer momentum and new design wins, we are seeing in SandForce, FSPs and Nytro PCIe solutions, we now believe that our revenues will exceed 200% growth year-over-year in 2012.

In Q2, our standard product SandForce FSP revenues were above $45 million, representing 42% sequential growth and continued market share gains. Growth is being driven by increased penetration into the notebook market segment, with key wins at Toshiba, Intel, Hynix, Asus and others. According to IDC, flash-enabled notebooks are expected to be the fastest-growing segment of the PC market for years to come in contrast to the overall HDD-enabled notebooks space. LSI has focused on developing FSPs that hit this inflection point, as ultrabooks and other flash-enabled notebooks take a growing foothold in the marketplace.

LSI FSPs are the core of many of the most popular solid-state drives, sell for significantly higher prices than equivalent HD SSDs and have enhanced for more value. Our recent wins in the flash-enabled notebooks give us confidence that LSI will be the leader in this high-growth market segment in 2012.

In FSPs -- for enterprise SSDs, our momentum and share are also increasing. We are now shipping to 6 enterprise SSD OEMs, enabling us to gain significant share year-over-year in this space. Relative to the competition, we believe our FSP solutions deliver better performance, and that we provide not only flash storage processor silicon, but also firmware, manufacturing and test tools and turnkey SSD reference designs, improving our customers' time-to-market. In addition, we continue to support in production all 6 major flash vendors and are well-positioned to support the latest generation of flash.

In PCIe flash adapters, we are bringing the performance advantages of flash to enterprise server, storage and networking applications. We are focused on transparent acceleration of applications, and we encourage you to visit our website, thesmarterwaytofaster.com for additional information.

Last quarter, we introduced the Nytro product family, our second generation of PCIe flash adapters that incorporate our SandForce FSPs and offer a high performance with low latency, accelerating a broad spectrum of enterprise applications. Nytro is now in production, and we expect double-digit million revenue contribution from PCIe flash adapters in Q3, driven by ramps in high-performance data warehouse applications.

Last quarter, we announced that we were working with Cisco and EMC to bring the application acceleration benefits of PCIe flash cache and technology to Cisco UCS Blade Servers. We expect initial shipments in Q4.

In our SAS and RAID business, we continue to benefit from the ramp of Intel's Romley platform in addition to continuing to supply existing 6-gig SAS solutions to leading server OEMs. As customers begin migrating servers from 6-gig SAS to 12-gig SAS technology in the second half of '13, LSI is in the leading position to drive this transition. We are now sampling customers with our production 12-gig SAS rocks and has expanded our design win footprint to include 4 out of the top 5 server OEMs.

In external storage, Zyrtax [ph] has fully adopted our 12-gig SAS controllers and expanders, and we expect to begin initial shipments later this year.

In hard disk drives, we saw further growth in Q2, as a result of increased SoC and preamp shipments. However, we did see signs of industry softness in June and believe that HDD builds exceeded demand in the quarter. Because of uncertainty in the macro environment, expected inventory adjustments and lower PC sales affecting HDD demand, we believe it is prudent to assume a lower component shipments sequentially in Q3, and this is factored into our guidance. As I previously mentioned, we believe the inventory adjustments will take place in Q3, and we should return to a more normalized supply-demand environment as we exit the quarter.

Hard disk drives represent a large market segment with only 2 major SoC suppliers, and we continue to make progress in winning new platforms and positioning for additional share gains in SoCs.

We have gained traction in next-generation notebook platforms and are well-positioned for 5-millimeter hybrid drives, which are expected to be a volume platform for ultrabooks. We also expect to be ramping SoCs and preamps Toshiba this quarter and remain 100% on track to be shipping SoCs in production to all ACD customers prior to the end of this year.

I would like to discuss our networking business where our products address the wireless mobile network, data center and enterprise market segments. We are increasing LSI content in base stations through a combination of our Axxia multi-core communications processors and our custom silicon capability. As we previously communicated, Axxia has been selected by 2 top base station OEMs for next-generation systems. We're expecting to begin ramping Axxia into these base stations during this quarter. Axxia processors use industry-standard cores in a clearly partitioned architecture that provide the flexibility to seamlessly integrate ARM processors into our solutions and develop robust roadmaps for customers. We do not use customized cores that are heavily integrated with accelerators, so we expect to capitalize as competitors work to re-architect their solutions.

We are winning Axxia designs and enterprise applications as well. Last quarter, we mentioned that Axxia has been chosen for a leading data center switch platform. These design wins translate to a robust pipeline for next year and beyond. Also in enterprise, we have won both high-volume and high-end switch platforms with custom products at a leading data networking customer with revenue ramps in 2013. We have also expanded our design win footprint in the Gigabit Ethernet space by securing a custom supply win in a switch application at this same customer.

To wrap up, I'm pleased with the execution that we're delivering as a company and as progress shows in our financial performance. LSI is well-positioned with share gain opportunities and new product cycles to enable us to outgrow the storage and networking markets we serve. We're growing revenues in new, high-growth market segments, expanding margins and aggressively driving to higher levels of profitability in our new business model targets. We remain debt-free with strong operating cash flows, with the opportunity to continue to return capital to our shareholders.

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

Bryon Look

Thanks, Abhi, and good afternoon, everyone. In Q2, LSI delivered a strong quarter of financial performance and met or exceeded the guidance we provided in April.

A few highlights for the quarter are as follows: Revenues were $660 million, increasing 6% sequentially and up 32% year-over-year; Non-GAAP gross margins expanded to 54%; we continue to carefully manage expenses with non-GAAP operating expenses of $233 million for the period; non-GAAP operating income expanded 220 basis points to 18.6%; we delivered non-GAAP diluted earnings per share of $0.21; and operating cash flows were $117 million.

Now turning to a more detailed discussion of our financial results for the quarter, beginning with revenues. Our Q2 revenues of $660 million were sequentially up 6% from $622 million, and $10 million above the midpoint of our guidance. Q2 revenues in our networking business were $99 million and represented 15% of total revenues for the second quarter. The networking business was sequentially down approximately 8%, primarily due to declines in our legacy products along with continued softness in wireless infrastructure spend.

Moving next to our server and storage semiconductor revenues. As a reminder, server and storage semiconductor revenues consist of our ServeRAID adapter and software, flash, SAS, San and HDD businesses. Revenues for server and storage semiconductors were sequentially up $46 million, or 9%, to $535 million, and represented 81% of total revenues in the second quarter. This upside was primarily driven by continued strength in HDD, along with increased demand for our flash products. Revenues for the IP business were $26 million.

Moving next to gross margins. LSI's Q2 gross margin, excluding special items, was 54.0%. Gross margins increased sequentially by approximately 160 basis points, primarily due to continued focus on cost reductions along with the product mix.

In terms of operating expenses, R&D, together with SG&A expenses, excluding special items, totaled $233 million in Q2. This was sequentially up from Q1, primarily due to compensation in benefit costs, reflecting annual merit increases which go into effect at the start of Q2.

Non-GAAP operating income for the quarter increased to $123 million or 18.6% of revenue. This represented a sequential improvement of 220 basis points and a significant increase from 12.4% a year ago.

Interest income and other net of interest expense, excluding special items, was $10 million for Q2, approximately 1/2 of which represented payments received for insurance claims covering a portion of our losses that resulted from the Thailand flooding of late last year.

Now let me turn to the special items, which we recorded in the second quarter, which netted to approximately $62 million. Special items, primarily noncash, included $30 million in amortization of acquisition-related items, $26 million of stock-based compensation expense and $6 million of restructuring costs and other items.

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 tax provision we recorded for Q2 for both GAAP and non-GAAP purposes was $12 million. On a GAAP basis, second quarter net income was approximately $59 million or $0.10 per diluted share. Non-GAAP net income was $121 million or $0.21 per diluted share.

The weighted average share count for the period for both GAAP and non-GAAP purposes was 581 million shares. This includes the weighted average benefit of purchasing approximately 18 million shares during the period under our share repurchase program. We have now repurchased a total of 95 million shares and utilized approximately $675 million of our current $750 million buyback program.

Turning now to the balance sheet and cash flows. Cash and short-term investments ended the second quarter at approximately $601 million. Operating cash flows for the second quarter were $117 million, and we continue to operate with no debt on our balance sheet.

Finally, with respect to Q2 results, depreciation and software amortization was $15 million, and capital expenditures were $13 million.

Next is a discussion of our guidance for Q3 2012. Q3 revenues in the range of $620 million to $660 million were sequentially down about 3% at midpoint. This would represent, however, about 17% growth on a year-over-year basis. We expect our server and storage semiconductor revenues to be sequentially down in Q3. We expect HDD declines in the quarter due to inventory adjustments to be partially offset by growth in flash and server-related products. In addition, we expect our networking semiconductor revenues to be slightly up.

Gross margin, excluding special items, is expected to be 53%, plus or minus 1%. Operating expenses, excluding special items, are expected to be in the range of $228 million to $238 million, were essentially flat to Q2 at midpoint.

Interest income and other and interest expense, excluding special items, is expected to net to income of approximately $3 million. Special items are expected to net to approximately $50 million to $70 million.

The GAAP and non-GAAP tax provision is expected to be approximately $12 million for Q3. And we expect Q3 GAAP net income per diluted share in the range of $0.02 to $0.11, and non-GAAP net income in the range of $0.14 to $0.20 per diluted share. The share count is expected to be approximately 570 million shares for both GAAP and non-GAAP purposes. In addition, we expect depreciation in software amortization of approximately $15 million and capital expenditures of approximately $25 million.

In closing, we delivered strong sequential expansion of revenues, gross margin and operating income in the second quarter, as we continue to demonstrate significant progress towards our new business model targets. Despite the recent HDD correction, along with the challenging macroeconomic environment impacting our sequential guidance, the midpoint for Q3 reflects 17% growth on a year-over-year basis. We're well-positioned as the leader in our served markets and expect to benefit from new product cycles in the quarters ahead.

And now, let me turn the call back to Sujal.

Sujal Shah

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

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Blayne Curtis with Barclays.

Blayne Curtis - Barclays Capital, Research Division

Maybe some clarity on the hard drive business. I think there was concern for a while that you were over-shipping your markets. I mean, is this more a factor of that the OEMs are adjusting their inventories, or is it inventories of your chips? And then as you look to Q4, you indicated and you thought that came back. Is that really the TAM coming back, or is that the share gains that you're talking about?

Abhijit Y. Talwalkar

Well, Blayne, I mean I think the over-shipping our customers, that was back in Q1, and we never believed that to be the case and certainly wasn't the case. I think we're talking about relative to the Q2 to Q3 -- and adjustment in Q3 and linearity associated with it. It's just a simple fact that, I think, we all saw demand erode in the early parts of June and sort of accelerate in erosion through the latter part of June. And supply lines just can't correct that fast. And as a result, we do believe HDD drives were built, didn't all entirely get shipped, and we ended up with a little bit of a component inventory out there in the channels, if you will. And that has to get worked up in Q3. I believe, it's a one-quarter adjustment.

Blayne Curtis - Barclays Capital, Research Division

And I guess the second part was, into Q4, you seem to indicate you felt like the business would come back with the driver there. Is it just the hard drive market coming back, or is it the share gains or what?

Abhijit Y. Talwalkar

I think there's lots of different moving parts. But certainly, there's -- it will come back assuming that the latter part of the year sees the typical or even some level of seasonality, which is up relative to PC, as well as the other segments going into the holiday season.

Blayne Curtis - Barclays Capital, Research Division

Got you. And then I think -- I don't know if it was last call or the call prior to that, you indicated that your long-term goal in networking and base stations was 50%. It seems like looking at your slide deck that you feel pretty good about that target. If you could just elaborate as to what you're seeing as far as design traction?

Abhijit Y. Talwalkar

Yes, I think if we look at the markets that we're going after, applications that we're going after and base stations. Let's first take the control plane and data plane, which we saw as roughly to be a $400 million SAM in 2015. Based on the design wins that we have achieved and the schedules around those around those and when they're going to ramp and so forth, we're in the position to achieve 50% share of the control plane and data plane in that time period. The other areas that we've also been focused on has been in base band, which is even a bigger market, roughly $800 million in size. And we believe we've secured wins that will help us achieve 40% share out in that timeframe as well.

Operator

Your next question comes from the line of James Schneider of Goldman Sachs.

James Schneider - Goldman Sachs Group Inc., Research Division

I guess a follow-up on -- maybe longer range on the hard drive space. If you look at your unit share of the overall hard drive TAM today and you compare that with what you're expecting maybe, say, at the end of 2013, what's your level of confidence that your market share, that TAM, is going to be higher than it is today? It's good to maybe put any kind of estimate around how much share you could expect to gain, that will be helpful.

Abhijit Y. Talwalkar

Well, I mean, I think, Jim, it's -- obviously, there's lots of moving parts, but here's the way we think about it. At a full year level in 2012, we'll certainly see a very meaningful growth in our share position from 2011, driven by a number of factors, but also very strong products and design wins that we accumulated in prior years. This is a market that really is down to 2 suppliers on the SoC side, 2 suppliers on the preamp side. On the preamp side, we've gotten into a point of probably nearly 50% share or close to, up from 15% share, 3-plus years ago. That's proved positive around our ability to grow share in the hard disk drive space, and we pretty much doubled our share in SoC over the last 3, 4 years as well. We're very focused on continuing to grow our share in a market that's really down to 2 suppliers. We got great technology, and that's what we're focused on. In the prepared remarks, I also commented on traction that we've made relative to notebook designs, as well as positioning ourselves to be a heavy player in the 5-millimeter hybrid drive space as well. So our goal is to keep growing share from the current levels we're at.

James Schneider - Goldman Sachs Group Inc., Research Division

Okay. And then as a follow-up, on the gross margin, you seem to be guiding them down. I think it's about 100 basis points sequentially. I would have thought that given hard drives kind of decreasing as a percentage of mix and server-based that's going up, and TAM's going up, that those margins might actually improve somewhat. So can you maybe give us some color what's going on there?

Bryon Look

Yes, sure. I'll take that one. Yes, there are many factors that drive the gross margin. Yes, mix is one of those things, but it also depends on things like obviously, the absolute volume levels. And so given the guidance we're providing, we expect to see that to be one of the factors that has our margins a little softer. But relative to where we're operating compared a year ago, we're pleased with the expansion we have. We've got great opportunities moving forward. We've been making progress towards that new business model and target of approximately 55% gross margin. And our confidence in that remains the same.

Operator

Your next question comes from the line of Steven Chin with UBS.

Steven Chin - UBS Investment Bank, Research Division

First one I have is on the hard drive business. I guess in reference to some of the upcoming 5-millimeter -- 2.5 inch drives that are coming out, was curious if the pricing structure or strategy for those products, if it's any different from your SoC products historically. And I asked this mainly because I imagine that some of your customers for these products might overlap with your flash storage processor business, where the ASPs are a lot higher. So I'm just kind of wondering if you guys are looking at the price of different products in a different way compared to your historic trends?

Abhijit Y. Talwalkar

No. I mean, I think this is probably a question that probably needs to start with the HDD customers themselves and what their pricing strategy is going to be around hybrid, as it's going to be one option for ultrabooks in addition to pure SSD implementations as well. It may materialize into a slightly higher SoC SAP versus a non-hybrid drive SoC. And then, obviously, we've got a very strong participation level with the SSDs themselves. We believe we're the market leader today, and will be by the time the year's over as well. And those ASPs generally run quite a bit higher because of just enhanced firmware value. And the volume economics are very different in SSDs than HDDs.

Steven Chin - UBS Investment Bank, Research Division

Okay. And just one quick one on your enterprise and end cash business. So the revenues in your Nytro business, that's currently ramping. Could you give some color on how long ago those design wins -- I guess the development and qualification of those products when that first began, like 1-year or 2-year sort of a development timeframe leading up to revenues this quarter?

Abhijit Y. Talwalkar

Yes, that's a great question. I mean, from a development standpoint, the product development cycle for this class of product is probably in the order of 9 to 12 months or so. But maybe the real question you're asking is, from the time we engage a customer to the time we can generate revenue on a product that's already been developed, and that really is highly dependent on the customer and the application environment, at what level a specific optimization has to be done for that customer's environment. And we're going to have a full spectrum. We're going to have some that may take up to 6 months to 9 months of optimization qualification, and we're going to have some that are going to go into production within a month to 2 months of engaging a customer. So it's very application- and customer-dependent.

Operator

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

Sujeeva De Silva - ThinkEquity LLC, Research Division

All right. So first question on the networking in the third quarter being up, is that more design win-driven or end market-driven? And, Abhi, are you comfortable that with the design wins you see in front of you, that you can have steady sequential growth in networking the next several quarters?

Abhijit Y. Talwalkar

Yes, we are. I mean, I think clearly, relative to Q2, Q2 was down largely driven by legacy, obviously, with a backdrop of a soft wireless environment that certainly did not recover to, I would say, many people's expectations. As we go into Q3 and Q4, we've got a number of product cycles that will allow the certainly the networking investment business, as well as the aggregate business to grow quarter-to-quarter, even with the soft backdrop.

Sujeeva De Silva - ThinkEquity LLC, Research Division

Okay. And then on the server side, there's been a lot of noise about how Romley has been tracking versus perhaps expectations, can you talk about your perspective on that, and whether there's any color in different segments, traditional servers, Internet servers and such and your participation?

Abhijit Y. Talwalkar

Well, I mean, I think we definitely have seen very strong demand around Web and data center environments. And we've got a couple of different sort of points of visibility or advantage on that. One, we've got a channel business that sells a lot of our ingredients through distributors into baby Web companies, if you will, to mega Web companies. And that has continued to be fairly active, and we've seen very good demand there. And I think that demand has outpaced general enterprise sort of pickup in demand, which I would say has been there. And certainly, we've seen growth, but I would say, a modest growth, if you will, relative to a whole new server cycle. But our server-related business, which is SAS, as well as RAID, was up in Q2, and we're forecasting it to be up in Q3. It's just not as big as we might have anticipated 6 months ago, just given cautious orientation in the macro environment.

Operator

Your next question comes from the line of Vivek Arya of Bank of America.

Vivek Arya - BofA Merrill Lynch, Research Division

Abhi, a very strong growth in flash. I was wondering if you could talk more about what's driving that? And also, importantly, what is the competitive landscape in that business, because there seem to be a number of captive and merchant solutions out there? What is your share like? And do you see the pricing -- how should the pricing trend in this kind of a very competitive market?

Abhijit Y. Talwalkar

Okay. I think you asked a lot of questions there, but I mean let's start with the growth. We absolutely are outpacing the market from a unit standpoint. Market is expected to grow about 100% in units this year. We're still forecasting the SSD market, comprised of both enterprise and client to probably be in the 35 million units sort of range this year. And we're seeing our share grow considerably this year from probably in the 30% non-captive sort of share level last year to certainly higher levels in terms of non-captive share. Aggregate share will also be a leader. But what's driving that growth is just the number of design wins that we've had, as well as the design wins that we've had with the much larger players as this market becomes bigger. And we noted a number of those in the prepared remarks. We talked about Intel, Toshiba and so forth. And these are the companies now that are starting to really be the big players of SSDs. We also are benefiting from a unique strategy that I think we're the only ones that have today, which is a great line of the standard SandForce processors that has a fantastic firmware stack and a number of other value elements, but also a full-custom capability. And this combination has allowed us to do really well across even the NAND flash companies that have some captive capability as well. We've been able to augment what they're doing. And as a result, our share is even higher, given the custom capability. Enterprise is a great example, where we have 6 different enterprise SSDs that are shipping now. A number of those are custom in nature. So that's a bit what's been driving our growth. And the market's certainly continues to do very well in terms of adoption of flash. And then pricing dynamics, as the market continues to grow, we'll certainly see ASPs move in the direction -- all technology does as the market grows, but the ASPs are very, very healthy ASPs and significantly higher than HDD SoCs as well a large part because of the volume dynamics being very different than HDD, but also a very rich firmware stack that we saw with our flash word processors.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. And as a follow-up, Abhi, the networking market is sort of been a mixed bag. I think some of your -- somewhat peer, like a Broadcom are all there -- have relatively positive things to say about spending on telecom products as others have been more cautious. What's your general read? Does this market come back? Are you assuming the market comes back in Q3, or is it more of a Q4 timeframe then we see more spending? Because if you look at some of the U.S. carriers, for instance, they have not changed their CapEx guidance for the year. So they're certainly expecting higher capital spending in the second half.

Abhijit Y. Talwalkar

Yes, I mean, I think it's relative to those of us that supply, it can be a mixed bag, because you got everything from differences in geographic CapEx spend to the number of -- to the 5 players that are providing system infrastructure to who you're in and not in. But I don't think anyone can dispute the fact that the overall backdrop is a soft backdrop, and not certainly recovering at the rate and pace that we all anticipated. We are seeing some modest growth. We are expecting growth in our networking business in the third quarter. We are expecting our networking investment areas to grow for the full year as well, albeit not at the levels we anticipated at the beginning of the year, but very healthy growth nonetheless for our investment areas. And a lot of that is obviously driven by the fact that we've got a number of different product cycles and new customer ramps.

Operator

Your next question comes from the line of Craig Berger with FBR Capital Markets.

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

I wanted to ask on the enterprise flash side. How big do you think that market can grow? I think you said you were going to ship more than 10 million in the September quarter, and kind of what's your share or who do you compete with in that market?

Abhijit Y. Talwalkar

Yes, I think, Craig, you're talking about our Nytro product line, right? So not enterprise SSDs, but enterprise PCIe flash, which is our Nytro product line, correct?

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

Yes.

Abhijit Y. Talwalkar

Okay. Yes. No, I mean, we're just getting started. I mean our rough guesstimate relative to the market last year is about $0.5 billion market, 1/2 of it was captive, 1/2 of it was merchant, but which much of it was the guys that really get credit for creating the category of Fusion I/O. This year, we believe the market's growing at least 40%. And we see now estimates that suggest the markets even bigger over the next 2, 3 years, exceeding I think comfortably $2 billion, 2, 3 years out. And we're just getting started. And we think we've got a fantastic product line, and we've engaged very aggressively, really around the globe, across big Web guys and enterprise companies. And so we have very high expectations for this business and our share in the marketplace over the next 1 to 3 years. This is one of our biggest growth opportunities.

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

Got it. And then on the hard drive side, I mean, it's been asked a little bit. But we're coming up on Win 8 that seems like there's some pauses in buying, pauses in production. It seems like European demand is weak. There's some inventory contractions. So how should we be thinking about sequential trends in the fourth quarter and the first quarter, given some of these factors and share gain opportunities?

Abhijit Y. Talwalkar

Well, I'm not going to go out in the first quarter. And relative to the Win 8, your guess is as good as mine. I've heard all kinds of different views and so forth around the potential for Win 8 to really start and catalyze another PC cycle, as well as there's a lot of promise around ultrabooks, as well as a combination Ultrabook platforms as well. So as we said earlier in our remarks, we do anticipate growth in our HDD business in the fourth quarter, assuming some level of modest seasonality, which certainly assumes PCs see some life going into the holiday season. I don't think that necessarily equates to Windows 8 having been a big driver because I think that's going to be a latter part of the year, and really more of a question of what it's going to do to the 2013 PC cycle.

Operator

Your next question comes from the line of Daniel Amir with Lazard Capital Markets.

Philip Lee - Lazard Capital Markets LLC, Research Division

This is Philip Lee on behalf of Daniel Amir. I just want to go back to Axxia processor. Are you seeing additional traction outside of the existing OEMs that you have previously mentioned?

Abhijit Y. Talwalkar

You can be rest assured that we're engaging every one of them, and we've got a very strong value proposition here in terms of delivering just greater performance at a much lower power sort of envelope. So let's just suffice it to say that we're having great dialogue and great discussions, and we're working aggressively to expand our position in wireless base stations.

Philip Lee - Lazard Capital Markets LLC, Research Division

Okay. And how is the Axxia moving along on the enterprise side?

Abhijit Y. Talwalkar

Also very good there. I mean we just -- that effort has been a recent one, I'd say, over the past 6 to 12 months or so. Axxia was always designed to enable it with minor derivatives to move into enterprise applications, in particular, switching platforms starting with data center. And a couple of quarters ago, we did announce that we had won a data center switch platform, in particular, in the line card, which is where the volume is with Axxia. And we're working to use that as a beachhead and start expanding beyond that. We also think Axxia is going to be a very interesting play for us in software-defined networking over the next 2 to 3, 4 years as that develops in the marketplace.

Operator

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

Betsy Van Hees - Wedbush Securities Inc., Research Division

I was wondering -- just wanted to go back to the HDD, when you started to see that demand in June drop off, as well as you had concern over inventory correction, can you -- and you look at your guidance, how much of that, if you can gauge, is driven by demand? And how much is derived driven by inventory? That's my first question. And then my second question is, did you see any pricing pressure as you started to see this aloofness happen in the June quarter? I mean, the month of June, sorry.

Abhijit Y. Talwalkar

Yes, let me -- Betsy, let me take your second question first. No pricing [indiscernible] as that took place. As we've noted before in the past, we generally have volume pricing agreements, and they're generally locked in for a generation or at least for a full year and so forth. So there's usually there's never any quarter-to-quarter pricing dynamics from that standpoint. And if there are, they're already planned and part of our forecast and so forth, as part of just quarter-to-quarter drops. Relative to your first question, I'm not quite sure how to frame that question. But I think the simple way to think about it is, in sort of the middle of June, as demand started dropping, and as we all know, PCs in particular, in the consumer retail space and so forth, started softening. That, in itself, started driving demand signals that, to us, late in the quarter. Right? And it's just -- you just can't correct that supply chain fast enough between our customers and LSI as well to track to exactly what's happening to demand. Right? So demand dropped faster than supply chains were able to correct themselves. As a result, you have a pocket of inventory that has to get adjusted in Q3. And that's really the entire factor relative to our guide being 3% down in the quarter. The rest of our businesses are growing as we expected them to.

Betsy Van Hees - Wedbush Securities Inc., Research Division

And then I have one more question in networking. I believe you guys guided, I think, for the Q2, that networking was going to be flat to up. Was that correct? Is it -- and was it the softness that we saw in the legacy -- decline in legacy products that really was the kind of a surprise in terms of that quarter-to-quarter decline?

Abhijit Y. Talwalkar

Yes, well, I think from Q1 to Q2, networking did decline with the vast majority of that really being legacy declines. Relative to the color that we've provided for Q2 to Q3, we're expecting our aggregate networking business to grow, which obviously, is being driven by our networking investment areas.

Operator

Your next question comes from the line of Arnab Chanda with Avian.

Arnab K. Chanda - Avian Securities, LLC, Research Division

A couple of questions. First, Abhi, if you could talk a little bit about -- if you just focus on SSD controller business because you obviously [indiscernible] SSDs in many different ways. If you get a replacement on notebooks hard drives with SSDs, taking into account your share, do you think that would be a net dollar and margin as positive? Or do you think it would be neutral or negative for you?

Abhijit Y. Talwalkar

No, it's a net positive. I mean, if you're saying, we sell an HDD -- or sorry, an SSD FSP instead of an HDD SoC, it's positive on all dimensions, if that's the question you asked.

Arnab K. Chanda - Avian Securities, LLC, Research Division

Okay, great. Yes, that is the question. Great. And then second question is, if you look at your networking share gains, at what time frame do you think that, that those businesses start to accelerate and kind of offset -- they offset the legacy decline. In other words, the growth rate of your networking business will be characterized by the share gains that you have in the investment areas.

Abhijit Y. Talwalkar

Yes, I mean, I think our investment areas in networking have been up until -- up through 2011 had been growing in excess of a 25% CAGR for the prior 5 years, right, which is really demonstrating an effective strategy and execution. Relative to this year, as we came into the year, we had said that we expect our aggregate networking business to grow. Right? We're 6 months in the year, not necessarily at a point where we can really call that for the full year because there's still 6 months to go and/or 5 months to go, and there's still a lot of different moving parts. We can definitely confirm that our networking investment areas are absolutely growing this year, but probably not to the level of a 25% CAGR that we've historically experienced. But nonetheless, growing very respectably for the full year.

Operator

Your next question comes from the line of Hans Mosesmann with Raymond James.

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

Abhi, a question regarding Axxia and the roadmap and positioning between the current PowerPC version of that product and the ARM-based solutions. I just want to understand where each of these has a position in market with the customers.

Abhijit Y. Talwalkar

Hans, I don’t know if I can go into a lot of detail. Obviously, what we're ramping here in the third quarter, as well as the design wins that we've alluded to around enterprise, those were all power PC-based today. Right? And then in the beginning of the year, we announced a deeper collaboration with ARM and that LSI would be developing and introducing, and really, we believe, leading the marketplace in terms of offering multi-core communications, networking processors, based on ARM in wireless infrastructure. And we believe that absolutely remains the case and has been pivotal to a lot of our design win momentum that we've talked to. Yes, I'm not going to tell you who's where. Yes, there are some positioning aspects, but we're going to do various variants on ARM-based Axxia that scale across on the number of cores, if you will. And we're going to be supporting both architectures, because every customer has a bit of a different strategy relative to their thoughts on transition, when that transition might be, how they're going to manage their installed base and so forth. So it really varies. I think at a high level, we were supporting both architectures and providing a level of flexibility to work very closely with our customers to meet their needs...

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

Okay. And as a quick follow-up, it looks like the ITC that came out with the determination that LSI and ST did not illegally use Rambus' patent technology. Can you remind us what that case was all about, and what the implications were for you guys in this case versus Rambus?

Abhijit Y. Talwalkar

Yes, I think that's a positive outcome for us. I will just leave it at that, Hans.

Operator

The next question comes from the line of Harlan Sur with JPMorgan.

Harlan Sur - JP Morgan Chase & Co, Research Division

On the SSD front, I'm seeing a lot of Ultrabook form factors with dual drives sort of cash configurations. I've been expecting the hybrid drive market to kind of bridge the gap between HDD and SSD, but have yet to see many products out in the market. Abhi, I know you talk about the traction here. When do you expect hybrid drives to become more pervasive in the notebook market? And then secondly, what type of dollar content uplift do you see, given that the controller solution is obviously a little bit more complex?

Abhijit Y. Talwalkar

Okay. So first of all, let's talk about hybrids. I mean, hybrids, I think, are still out in time. I'm going to refrain from telling you exactly when because I think the HDD customer should be providing that. But hybrid drives need to get to a level of acceptable resumed performance, as well as hit sort of this magical 5-millimeter form factor. Because I think that's when that becomes a very interesting and solid alternative or let's say an option for ultrabooks in the hierarchy of what storage is going to be used across a full segmentation of ultrabooks. Right? So I think that's what has to happen. And I very much believe and know that hard drive companies are working around those types of form factors and have roadmaps and obviously, I alluded to engagement traction on that front. Right? And then relative to dual drive, we're participating in dual drive as well. And there, you've got a separate flash subsystem supported by a separate flash controller in addition to a hard drive as well. And we're participating there. We've got a number of dual drive design wins with our SandForce product line. So we're going to be positioned really well in pure SSD environments, in dual drive, as well as hybrid. And at the end of the day, it's going to be impossible for us to influence the mix as to how people purchase things and how PC vendors price things, but we think we've got a very competitive lineup to participate in all of those.

Harlan Sur - JP Morgan Chase & Co, Research Division

Great. And then on the guidance for your networking segment to grow in Q3, can you just, at a high level, just give us more color on whether this is going to be more driven by your service provider segments or your enterprise/data center segments?

Abhijit Y. Talwalkar

I think it's both because we've got new product cycles across both. We've got product cycles on the enterprise Ethernet side as well.

Operator

Your next question comes from the line of Cheng Cheng with Pacific Crest Securities.

Cheng Cheng - Pacific Crest Securities, Inc., Research Division

Just a question on the flash side, given kind of the strong growth in Q2, guys, I'm assuming that's all FSP. And depending on how aggressive your are on the PCIe side, I'm just wondering if you think the FSP momentum's going to carry you in -- carry on into Q3 and Q4?

Abhijit Y. Talwalkar

Yes, absolutely. I mean, based on our design wins, from a bottoms-up standpoint, and then just based on the continued adoption of flash.

Sujal Shah

If there's no further questions, 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 great day.

Operator

Ladies and gentlemen, a telephonic replay of this conference will be available beginning today at approximately 4 p.m. Pacific daylight time and will run through 9 p.m. Pacific daylight time on August 2. The replay access numbers are 1 (855) 859-2056 within the U.S., and 1 (404) 537-3406 for all other location. The conference ID is 96422042. The webcast will be archived at www.LSI.com/webcast. This does conclude your conference for today. Thank you for your participation. You may now disconnect.

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