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LSI (NASDAQ:LSI)

Q3 2012 Earnings Call

October 24, 2012 5:00 pm ET

Executives

Sujal Shah - Vice President of Investor Relations

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

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

Analysts

James Schneider - Goldman Sachs Group Inc., Research Division

Srini Pajjuri - CLSA Asia-Pacific Markets, Research Division

Blayne Curtis - Barclays Capital, Research Division

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

Vivek Arya - BofA Merrill Lynch, Research Division

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

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

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

Harlan Sur - JP Morgan Chase & Co, Research Division

Betsy Van Hees - Wedbush Securities Inc., Research Division

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the LSI Corporation Investor Relations Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Sujal Shah, Vice President of Investor Relations at LSI. Please go ahead.

Sujal Shah

Good afternoon, and thank you for joining us. With me today are Abhi Talwalkar, President and Chief Executive Officer; and Bryon Look, Executive Vice President and Chief Financial Officer. Abhi will begin the call with some opening remarks and highlights from our business, and then Bryon will provide results for the third quarter and guidance for the fourth 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 and providing additional information about our business. Today's remark 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 Form 10-K for the year ended December 31, 2011, our second quarter 10-Q in today's earnings release. With that, it is now my pleasure to introduce Abhi Talwalkar.

Abhijit Y. Talwalkar

Thanks, Sujal. Good afternoon, and welcome. While there continues to be challenges in the macro environment and softness in certain end markets impacting near-term revenue, I'm pleased with our execution and results for the third quarter and the progress we have made over the past year.

For Q3, revenue was within our guidance range but below our midpoint, driven largely by a weak PC market leading to declines in our HDD business. However, revenues grew 14% year-over-year driven by growth from new products, including SandForce FSPs, Nytro PCIe flash adapters and Axxia multi-core communications processors. Even the revenue softness, non-GAAP gross margin and EPS came in at the midpoint of our guidance as we lowered variable expenses to be in line with lower revenue and earnings levels.

On a year-over-year basis, non-GAAP operating margin expanded from 15% to nearly 18%, illustrating the structural improvements we've made as we work towards our business model target for 20% to 22%.

Going forward, our guidance for Q4 reflects a cautious outlook due to uncertainties in the macro environment and softness in PC demand. While we did see reductions in our HDD business in Q3, we expect further reductions in component shipments in Q4 tied to ongoing softness in the PC end market. We also expect reductions in both our custom and standard product, flash storage processors in Q4. This is driven by several factors including ongoing weakness in the PC market, elevated shipments in Q3 in support of new product launches, and SSD PC enabled rollouts being rollouts being lower than previous expectations.

As we look beyond the near-term environment, LSI is centered in applications benefiting from strong, secular growth in data and traffic. We continue to benefit from the rapid adoption of flash-based products and the penetration of our products into large web and cloud data centers.

We believe we have the broadest and most competitive lineup of flash-based solutions and expect to have a #1 share in flash storage processors this year, emerging as the #2 player in merchant PCIe flash adapters. We continue to expect our total flash revenues to grow over 200% year-over-year in 2012, well ahead of market growth rates.

Even with the revenue softness in the second half, we expect to grow over 20% year-over-year in 2012 while the semiconductor market and many peers are expected to decline. This year, our design win momentum is tracking ahead of expectations, giving us confidence in our ability to grow more than our served market segments and our semiconductor peer group. As we look ahead, we expect to benefit from new product cycle ramps, including PCIe flash adapters at Oracle, Cisco, IBM and a new win at a leading social networking company. We have a broad footprint of FSP designs and are well positioned as FSPs get increasingly adopted in client, as well as enterprise platforms. We also began shipping FSP to a new ACD customer this quarter, and we'll benefit as this program reaches full production in 2013. In addition, Axxia revenues are expected to grow as we continue ramping at the leading base station OEM.

In the management team, we continue to drive improvements to what we can control. Our efforts have led to improvement in financial results and solid positioning in growing markets, reflected by new product cycles and share gains.

I'd like to review additional business highlights for Q3. We will begin with our server and storage business, which includes flash-related businesses, SAS, ServeRAID adapters and software, SAN and ACD. 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. In Q3, we saw further growth in standard product SandForce FSP revenues reflecting our broad footprint with market leaders such as Toshiba, Intel, Hynix, ASUS and others. Our power-optimized hardware and firmware were specifically engineered to meet the very aggressive power and performance specifications of new Ultrabook platforms. Our solutions are now qualified and shipping to 6 PC OEMs in Ultrabooks and notebooks, and we're excited about the upcoming Intel Haswell platform launch. In Q3, we also saw our growth in custom and standard FSPs targeted to enterprise applications with shipments to Intel, SanDisk, Kingston, SMART Modular and Toshiba.

I'll now move to PCIe adapters where we are bringing the performance advantages of flash to enterprise server storage and networking applications. Earlier this year, we introduced the Nytro product family, our second generation of PCIe flash adapters that incorporate our SandForce FSPs and enable acceleration across a broad spectrum of enterprise and data center applications. We are pleased to announce that Oracle Exadata platform is leveraging and shipping LSI's Nytro flash acceleration technology.

With Oracle and other key wins, we believe LSI is emerging as the #2 provider of merchant PCIe flash solutions worldwide, behind Fusion I/O. We were recently awarded business at a leading social networking company where Nytro is being used to accelerate webpage access. We also expect to release Nytro solutions in the production for IBM and Cisco. 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. We anticipate that customers will begin to migrate servers from 6-gig SAS to 12-gig SAS in the second half of 2013. Given LSI's early market leadership position and value proposition, we believe that many of those server platforms will leverage LSI solutions.

Beyond the traditional markets for SAS, we are now sampling our high-availability, direct-attached storage, or HA-DAS solutions for Microsoft Windows Server 2012. Our solutions deliver the benefits Of traditional SAN and shared storage capabilities in a much lower cost, easy-to-use, DAS environment. LSI solutions are expected to be generally available in the first quarter next year, in conjunction with the rollout of Microsoft Windows Server 2012 and will add to future SAS RAID growth, enabling us to grow above server market growth rates.

In hard disk drives, we saw declines of over 20% sequentially driven by lower PC sales affecting ACD demand and resulting inventory adjustments by key customers. We expect demand to remain soft due to weakness in the PC market segment resulting in lower component shipments in Q4 and this is reflected on our guidance.

We continue to execute well on the factors we can control, which we believe will lead to share gains over the long term. We have now begun shipping one terabyte per platter desktop SSCs to new customer and expect to benefit as this program ramps into full production. In 2.5-inch notebook drives, we have been selected to provide SSCs into a 500-gig per platter hybrid drive targeted at Haswell-based Ultrabook platforms. Lastly, we have secured 2 additional wins for 500-gig per platter notebook designs and these SSCs will enable our customers to achieve even higher areal density points.

I would now like to discuss our networking business where our products address the wireless mobile network, data center and enterprise market segments.

In the wireless space, we began ramping our standard product Axxia multi-core communications processor at the leading base station OEM during the past quarter. We also secured our second data plane and control plane design win at another leading OEM, displacing an incumbent competitor in a future generation with our Axxia solution.

We now have multi-generational engagements with leading system OEMs in the wireless space that will enable LSI to have access of -- in excess of 50% share in control and data plane silicon a few years out. Our previously mentioned custom silicon wins in the base band section of base stations with multiple system OEMs further adds to LSI's footprint in base station infrastructure.

A year ago, we added an enterprise focus to our Axxia effort. We reported on a beachhead win in a leading data center switch platform and now have another key win to add to this. Additionally, 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've also expanded our footprint in the Gigabit Ethernet space by sampling a low-power Gigabit Ethernet PHY targeted for Ultrabook platforms.

Lastly, we're very excited about our efforts with ARM to extend LSI's differentiation with ARM-based Axxia solutions. We are working closely with ARM on interconnect technology that will enable Axxia to be the industry's first, many-core ARM SSC targeted to wireless and enterprise networking infrastructure.

To wrap up, I am pleased with the execution that we're delivering as a company, LSI's is well positioned with share gain opportunities and new product cycles to enable us to outgrow the storage and networking markets we serve. 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. I'll start with a discussion of our financial results for the quarter beginning with revenues. Our Q3 revenues were $624 million, up 14% on a year-over-year basis and down 5% sequentially. Q3 revenues in our networking business were $106 million, down 10% on a year-over-year basis, and up 7% sequentially. Networking revenues represented 17% of total revenues for the third quarter.

Moving next to our server and storage semiconductor business, which consists of our ServeRAID adapter and software, flash, SAS, SAN and HDD businesses. Revenues for server and storage semiconductors were $493 million, up 22% on a year-over-year basis, and down 8% sequentially. The sequential decrease was primarily driven by a reduction in demand for our HDD products, partially offset by increased demand for our flash products. Revenues from server and storage semiconductors represented 79% of total revenues in the third quarter. Revenues for the IP business were approximately $25 million.

Moving next to gross margins. LSI's Q3 gross margin, excluding special items, was 53.9%. Gross margin decreased sequentially by approximately 10 basis points. In terms of operating expenses, R&D, together with SG&A expenses, excluding special items, totaled $226 million in Q3. This was sequentially down $7 million from Q2, as variable compensation expenses were lowered in the quarter.

Non-GAAP operating income for the quarter was $111 million or 17.7% of revenue. This represented a sequential decrease of 90 basis points and a 250 basis point increase from a year ago. Interest income and other net of interest expense, excluding special items, was $3 million for Q3.

Now let me turn to the special items which we recorded in the third quarter, which netted to approximately $59 million. Special items, primarily noncash, included $30 million in amortization of acquisition-related items, $28 million of stock-based compensation expense and $4 million of restructuring costs and other items, offset by a $3 million gain on the sale of investments.

Moving next to tax. The tax provision on both the GAAP and non-GAAP basis will vary significantly quarter-to-quarter based on our profitability in different geographic tax jurisdictions and certain discrete items. The tax provision we recorded for Q3 for both GAAP and non-GAAP purposes was $15 million. On a GAAP basis, third quarter net income was approximately $40 million or $0.07 per diluted share. Non-GAAP net income was $99 million or $0.17 per diluted share.

Weighted average share count for the period for both GAAP and non-GAAP purposes was 572 million shares. This includes the weighted average benefit of purchasing approximately 7 million shares during the period under our stock repurchase program. On a cumulative basis, LSI has repurchased a total of 102 million shares and utilized approximately $725 million of the $750 million stock repurchase program the Board authorized last year. In addition, in August, the Board authorized a new $500 million stock repurchase program.

Turning now to the balance sheet and cash flows. Cash and short-term investments ended the third quarter with $643 million, and we continue to operate with no debt on our balance sheet. Operating cash flows for the third quarter were $112 million. Finally, with respect to Q3 results, depreciation and software amortization was $15 million and capital expenditures were $26 million.

Next is a discussion of our guidance for Q4 2012. Q4 revenues in the range of $570 million to $610 million were sequentially down about 5% at midpoint. This would represent about 13% growth on a year-over-year basis. We expect our server and storage semiconductor revenues to be down sequentially in Q4. We expect declines in our flash and HDD businesses and a slight growth in our server-related products. We expect the declines in our flash and HDD businesses are tied to soft PC market conditions, as mentioned by Abhi earlier. We expect our networking semiconductor revenues to be slightly down sequentially in Q4.

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 $223 million to $233 million. Operating expenses for Q3 and Q4 reflect lower variable compensation expenses and tied to lower revenue and profitability levels. 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 $55 million to $75 million.

The GAAP and non-GAAP tax provision is expected to be approximately $9 million for Q4. We expect Q4 GAAP net income per diluted share in the range of negative $0.02 to positive $0.07, and non-GAAP net income in the range of $0.11 to $0.17 per diluted share.

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 $27 million.

In closing, we delivered solid results in Q3 in spite of a difficult business environment. We continue to demonstrate solid year-over-year progress across key areas including revenues, which grew sub 14%; non-GAAP gross margins, which expanded by 170 basis points; non-GAAP operating income which grew by 250 basis points, and non-GAAP EPS which increased by 21%. We continue with our stock buyback program, which the Board extended in August 2012, with the announcement of a new $500 million authorization.

Now let me turn the call back to Sujal.

Sujal Shah

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of James Schneider with Goldman Sachs.

James Schneider - Goldman Sachs Group Inc., Research Division

If you could address the inventory situation at your customers, especially in the PC supply chain. Clearly it sounds like there are some inventory reductions continuing into Q4. What are the chances that extends into Q1 as well or do you think it will be cleaned up in Q4? And maybe, as part of that, you can just remind us about how we should think about normal seasonality for Q1 in your business?

Abhijit Y. Talwalkar

Yes, I mean, Jim, very difficult to say as to where inventory adjustments go beyond Q4 because that's certainly dependent on the market and what the market does in Q4. But if the market TAM is sort of what is expected out there relative to PC consumption and at least what one major HDD customer shared in terms of their view on the TAM, I think we would conclude that the inventory adjustments that remain will get addressed in Q4. Not all of it got addressed in Q3, there are some remnants of inventory adjustment that are taking place going into Q4 and that's obviously factored into our guidance. Relative to seasonality, I mean, we haven't had a normal Q4 to Q1 in a number of years, given natural disasters and a number of other factors. But if you go back to when we had stability in our lives, seasonality, typically for our business, Q1 is down from Q4, given there is a budget flush for enterprise in Q4, and obviously there's the holiday season associated with consumer products and PCs, so that's typically what we've seen, is that Q1 being down from Q4.

James Schneider - Goldman Sachs Group Inc., Research Division

That's helpful, thanks. Then maybe following on the enterprise SSC, specifically the Nytro opportunity for 2013. I think you've laid out some primers in terms of how you the see the market size there and you talked about some of your customer design wins in that space. Can you maybe lay out for us, or bracket, what the revenue opportunity might be for you in 2013 at this point, based on what you're seeing from your customer design wins?

Abhijit Y. Talwalkar

Yes, we're finally starting to register tangible revenue. We said in Q3 we we're going to have double-digit millions and then start growing from there. Then we certainly executed against that, as we said we would. Relative to the market, the market is growing at around 40-plus percent per year from a revenue standpoint. We have every bit of confidence that we can grow at least that rate in our objective is certainly to grow above that. We have numerous pilots that are in progress, our pilot activity continues to increase, and the adoption as well as the excitement around our products and the breadth of our products continues to be very exciting.

James Schneider - Goldman Sachs Group Inc., Research Division

Yes, but just a quick clarification. Can you clarify whether you expect Nytro to grow sequentially in Q4, even as flash, overall, is declining?

Abhijit Y. Talwalkar

Nytro is expected to grow slightly.

Operator

Our next question comes from the line of Srini Pajjuri with CLSA.

Srini Pajjuri - CLSA Asia-Pacific Markets, Research Division

Just a question on flash. Abhi, do you expect the decline in Q4 to be a one-quarter correction, or do you see that continuing into Q1 as well?

Abhijit Y. Talwalkar

You're talking about flash, you cut out there a little bit.

Srini Pajjuri - CLSA Asia-Pacific Markets, Research Division

Yes.

Abhijit Y. Talwalkar

Yes, as we sort of alluded to in the prepared remarks, there are several factors that are contributing to the Q3 to Q4 decline. We had a number of our customers launch new products, a number of them obviously for SSDs integrated into thin and light sort of notebooks or Ultrabooks, as well as a number of SSDs that were launched for after market adaptation in the PCs and so forth. So revenues in the third quarter were elevated and supported those new product launches and then as we said, on top of that there's certainly a weak PC market that is also affecting SSD based PCs. And lastly, I think relative to expectations that many of us had in the industry in terms of Ultrabooks 3 months back as to where they're now performing, those are coming in lower. And your question is to -- as to Q1, certainly not going to guide into Q1, but a number of these factors that we discussed are sort of onetime. You know that the PC industry is caught between product transitions as well. A lot of this will depend on how the PC market does in Q1, once Windows 8 starts to get rolling, as well as new Intel platforms and ultimately how Haswell does in April.

Srini Pajjuri - CLSA Asia-Pacific Markets, Research Division

Okay, great. And as a follow-up, the $10 million or double-digit millions that you mentioned in Q3 for enterprise, that's pretty impressive, given that this is probably first or second quarter of ramps. But my understanding is that you're procuring the NAND as well for your customers. And the question is, as you look out to the next 1 to 2 years, what's the risk that at some point, that business model changes, i.e., what's the risk that your customers would start to procure NAND instead of you procuring, and what are the implications from that?

Abhijit Y. Talwalkar

I don't think there's any negative implication. I mean, there may be some implication certainly from a top line standpoint, but as you probably can conclude, gross margins are generally going to be better if we don't have to carry a lot of NAND flash in the products. So we're flexible in terms of business models and we've got a number of ways to engage our customers around the core value that we bring to the table, which is around flash management, caching software and integrating all of those into a very robust enterprise solution. But we'll engage customers across different business models. That's not a concern to us.

Operator

Our next question comes from the line of Blayne Curtis with Barclays Capital.

Blayne Curtis - Barclays Capital, Research Division

You mentioned in your script that you did start shipping that one terabyte platter platform. I was wonder if you could give any color as to, I think, the perception is that there'll be a smaller drive. Is there way that you could frame that opportunity for us?

Abhijit Y. Talwalkar

As we said before, we believe that's a meaningful piece of business and we're not going to provide any more specifics to that. We're very excited about that opportunity and we think it's going to lead to more opportunities.

Blayne Curtis - Barclays Capital, Research Division

Got you. And then on the networking side, it was up in September, if you could talk about what the drivers there where? And then talk about the timing of the ramp there with your lead customer. I know it'll take time to ramp, but what are some of the puts and takes that are getting you the down guidance?

Abhijit Y. Talwalkar

I mean, I think first of all, in terms of the overall backdrop for networking, and in particular wireless, which is more than a majority of our networking business, probably 60%, 70% of our business is influenced by wireless infrastructure spend, as I think everyone knows, that continues to be weak. Carriers around the world continue to hold CapEx spending very tightly and we have not seen much life there and certainly hope to, towards sometime next year. Because the networks are very saturated and we're very well positioned to benefit from that when that starts to take hold. In terms of Q3, we'll definitely starting to see contributions from our Axxia ramp at the very early stages of that particular ramp. Obviously, very excited to see that. That's been a program that's underway for quite some time, and we believe it's the start of many exciting sort of opportunities with Axxia across wireless. But also, as we've noted in the prepared remarks, in enterprise data center switching as well. I think the other thing to keep in mind, there is a lot of different puts and takes in networking. If we look at our overall networking business this year, we will decline. Now our legacy business will have declined approximately $50 million year-over-year. But if we put aside our networking sort of legacy business and just focus on our investment areas, our investment areas this year will grow. And this will grow despite many of our peers, a vast majority of our peers actually declining in networking and the overall market being down. So this is a strong sort of testament to the product cycles that we've been alluding to over the past year to 2 that we'll start benefiting from.

Operator

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

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

I guess on the hard disk drive business, I mean, do you -- is your view that, that is temporarily depressed right now? Are we sort of shipping at consumption levels with this $140 million TAM for the fourth quarter? And how does that impact your future growth rate assumptions and investment allocation decisions?

Abhijit Y. Talwalkar

Well, there's a lot in those questions, Craig. I mean, I think as -- if the TAM ends up being around $140 million or so, we are slightly under shipping because we believe there's still a little bit of inventory that needs to get worked off. And again, as I said earlier in the prior question, there's only so much visibility as to how Q4 plays out relative to the PC market. But assuming all of us are projecting that correctly, the inventory situation will be cleared up in Q4, and then hopefully we'll be on to a number of new industry product cycles that are ahead of us in the first half of next year. Relative to sort of growth rates and our outlook for growth rates in the ACD space, obviously PC growth rates that are being forecasted here for the next 3 to 4 years have come down, given what has transpired this year and some of the challenges around tablet and mobile sort of cannibalization lease in terms of share of wallet, we still expect the ACD market to grow. The question is whether it's 3%, 4% or 5% CAGR. There are projections that are even higher. Keep in mind that 40% of the HDD sort of products have nothing to do with PCs and are growing in the teens from that standpoint. Relative to your last part of your question in terms of investment allocations, I mean clearly, I think it's safe to conclude that we're going to make sure that we're investing for growth in where we have high growth opportunities. Flash in particular obviously is getting a lot of attention and a lot of investment, given 40% to 50% growth rates sort of opportunities. That doesn't mean we're losing focus on HDD. It's a multibillion-dollar market. We're only in the high-30s in terms of share, markets have been consolidating, and our customers are going to a dual supplier strategy and we've won a number of designs this quarter, as well as we'll be ramping into a new customer. So we expect our share there to continue to grow as well.

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

Thanks for that. And then since that was a long one, I'll make my second one short, which is did you guys disclose how big the flash revenues were this quarter? I think you did last quarter. And can you also help us size the server storage connectivity piece?

Abhijit Y. Talwalkar

Let me give you the second part. I think what you're asking for is the $493 million that we had in server storage sort of semi, about 46% of that was HDD, 16% tied to server, about 17% tied -- sorry, 16% tied to ServeRAID, about 17% to SAS, 5% Sand, and then 16% flash.

Operator

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

Vivek Arya - BofA Merrill Lynch, Research Division

Abhi, let's assume the PC market sort of stays very muted next year, say flattish or so. What levers do you have to stay on track towards your goal for achieving more than 20% operating margins?

Abhijit Y. Talwalkar

Well I mean, I think clearly, as a management team, we remain very focused in driving to our business model. We've -- over the course of this year, we've seen the company now at a much more elevated profitability level, and we certainly hope to do that as we look into 2013. Very much dependent on what consumption is next year, which is tied to macroeconomic environment, which is probably anyone's guess at this juncture. We have a number of growth drivers, right, that we're excited about. Flash is obviously significant growth driver for the company. We are very underrepresented in the PCIe flash adapter space. There's no reason why we can't significantly outpace the market. The opportunity is there, the product line is there and the customer interest in pool is there for us as well, and we're certainly aiming to drive much higher growth rates. So I think that is a pretty sizable lever. Another lever that we certainly hope to benefit, even in maybe a weak macro environment next year is the huge design win pipeline that we've been accumulating across all our product lines over the last 3, 4 years, which has had very high conversion rates, which has helped us deliver a CAGR over the last 3 years in the teens. And that will also contribute to next year's growth. Ultimately, OpEx is a factor as well, and is a controlled point. And as we've demonstrated over the last 2, 3 years in very similar situations where environments can be tough, we'll take the right action to balance long-term and short-term, and continue to focus on driving earnings growth while we also drive top line growth as well.

Vivek Arya - BofA Merrill Lynch, Research Division

And as a follow-up, recently Altera has spoke about the conversion of FPGA back to an ASIC, I think they mentioned at a specific customer. Is that a trend you see also? And would that be a positive or negative for your networking segment?

Abhijit Y. Talwalkar

Well I mean, I think first of all, our custom silicon focus is incredibly targeted and very surgical around 3 or 4 customers and 3 or 4 applications. We're not a broad-based ASIC sort of player. We're just very much focused in the networking space and a certain set of applications. What you are alluding to -- and I don't have specific insight as yet, certainly some guesswork on my side at this juncture, we will certainly validate this further. But there are certain applications in the wireless base station space where FPGA technology, as we look forward, is likely going to fall short. Fall short in terms of performance, fall short in terms of power requirements. And these are areas that we're focused on as well. So yes, I think some of the trends that you're seeing there, again very isolated, it's not broad-based. But in our space, are beneficial to LSI.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. And just last one. So PCI adapter opportunity, that sounds like a long-term growth area. How are you positioned versus Fusion I/O? I think you mentioned a win at a social networking customer. So what's your key selling proposition versus Fusion I/O when you go against them? And how are sort of the wins and losses shaking out?

Abhijit Y. Talwalkar

Well, I mean, they've done a great job creating a category, and it's great when someone else sometimes does that heavy lifting and then you come in behind as a fast follower and you benefit from that. And we believe we have a broader product line in the form of 3 different products that make up our Nytro family. The third one that was just recently announced, which leverages our leadership position in ServeRAID or DAS RAID, so we're combining the benefits of our RAID position along with flash to provide accelerated sort of application performance in DAS environments. And then we also have the very high-end Nytro product member which is called WarpDrive, which is for flash being used as primary storage. And so the breadth of our product line is certainly, I think, will be an advantage. I think the fact that we're using proven driver technology and firmware that all of the server vendors -- basically, everyone is used to and has been using for many, many years, and hardened [ph] technology is another advantage. In a number of the workloads, we also have performance advantages as well. And lastly, we do believe for a broad spectrum of workloads and usage models, the fact that we have what we refer to as an offload sort of architecture, which minimizes consumptions of CPU cycles, we think that's also a big benefit as well. And I could probably go on longer, but we feel very good about our competitive position. And frankly, the industry is looking for a strong alternative. Right now, I think LSI's clearly emerging as that second alternative. And I think we've distanced ourselves from the other players.

Operator

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

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

[indiscernible] ask a question. Abhi, in terms of the ARM effort, you mentioned that you're focused on wireless infrastructure. Does that mean you're not focused on the data center?

Abhijit Y. Talwalkar

No. I mean, our Axxia product line is, initially, was targeted for wireless. But from an architecture standpoint, also had data center switching and other sort of enterprise networking applications in mind, and we've been able to start proliferating that architecture into other variance, other products on the roadmap. And as I noted in the remarks, we've already made progress in data center switching relative to ARM. And what we're doing there, we have product versions that will also be targeted for enterprise, leveraging our work with ARM.

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

Great. And then as a follow-up, any sense for us to understand when you would have volume shipments of this product?

Abhijit Y. Talwalkar

It's not something we're going to disclose for obvious competitive reasons, but we feel very good about our time-to-market leadership.

Operator

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

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

Abhi, a couple of questions. It seems like you have some of the things that you promised you have started to get design wins and even getting into production in a lot of different markets, but your -- the end market is not cooperating. Now if you look at the flash market, is there any desire to do things like NVMe or in the tablet market to go into a lower end technology like MLC where it seems like there's a lot of unit growth occurring? And then I have a question about -- similar type of question in networking. Obviously, you're doing pretty well with Axxia and design wins. There's also a transition, it seems like, in some parts of the adjacent markets to 64-bit ARM. Is that something you are -- you think is necessary in this market, or do you think that this is something you're working on? If you could clarify those points, that'll be great.

Abhijit Y. Talwalkar

Yes, relative to your first question, Arnab, I mean, we are working and supporting NVMe. As to whether we are looking at ways to take our flash management IP and potentially finding ways to participate in tablet and handsets, and that could be through various different models, yes, that is absolutely an opportunity for the company, and that's something that is -- something that we're going to be -- we have been looking at and we'll continue to look at. So right now, it's a matter of focus, and we've been focused on enterprise and client FSPs. And as we get time to breathe and start looking at where else do we aim this IP, that is clearly an opportunity given the size of the market in terms of units at least. You're second question, I think what you're really alluding to there is 64-bit for ARM relative to a server-oriented offering. Is that where your question was going?

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

Not necessarily, but you've answered that, too. But I was asking whether you want to do -- if you need 64-bit ARM in your wireless or networking. But yes, feel free to answer...

Abhijit Y. Talwalkar

Yes. I mean, I -- yes, I mean, right -- yes, I think 64-bits is going to be important. I would say the pressure for 64-bits in server-related workloads is more so than in many of the networking applications that we're focused on. But there are a number of networking from a switch standpoint, especially higher end switches that want 64-bit capability. Relative to some of the initial penetration that we have planned, as well as now committed through customers in the wireless space, 32-bits is sufficient for the initial generation and eventually will evolve to 64-bits.

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

And then if I can, just a follow-up question, more of a overall strategy question. Given your level of R&D and the level of execution in new product introduction is pretty outstanding [ph] in the semiconductor industry so far. Is there a risk that you are -- maybe you were never asked -- someone asked this question, but you're underinvesting? I mean, you're not -- you are going to this market with lots of large players, lots of technological change. Is there a risk that you actually need to invest more to get to where you need to be, to be really successful in some of these markets?

Abhijit Y. Talwalkar

No, I mean, I don't think we're underinvesting. I think if I look at all of our products categories, we're at scale in the HDD space from an investment and revenue standpoint ability to compete, we're at scale in our SAS and RAID business, so we're #1 there by a large margin, a very comfortable position in terms of ability to compete. In flash, we're certainly investing ahead of revenue, but that market's growing 40% to 50% per year. We're delivering 200% year-over-year growth as well. Networking, we are investing ahead of revenue, but our investment areas, aside from this year, which has been tough for everyone, has demonstrated 25% CAGR. So I think we're investing sufficiently, and yes, we are waiting for end markets to behave a bit better and consume more which, I do believe that will happen. And when that happens, we're going to be incredibly well positioned because I think we're in all the right sockets in the applications.

Operator

Our next question comes from the line of Daniel Amir.

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

A couple of questions. First, can you give us an update a bit about what's going on in the SAS market for next year with the transition to 12-gigabyte SAS. And also, a bit of an update on the server market with the Romley upgrade cycle. I mean, there's obviously been mixed reviews on what's going on currently in the server space, and you did comment in your prepared remarks that you do believe you're outgrowing the server market.

Abhijit Y. Talwalkar

Yes, relative to the 12-gig transition, I think we'll start seeing SKUs offered by server OEMs in the second half of '13 when the rest of the ecosystem is there in terms of 12-gig SAS based either SSDs or hard drives. So I think we'll start -- we'll see the front edge of that transition in the second half of '13, and then we'll see more of that occur in 2014. And we've got a very strong lineup for that and obviously have been engaged with customers for quite some time across that product line. Relative to Romley, I think Romley is a good platform. Certainly doesn't have the ROI benefits that the prior [indiscernible] and platform did but Romley, nonetheless, is -- got great value proposition. But also has been launched and introduced in what has been generally a tough environment. Server unit growth rate, which is projected to be around 3%, 4% this year, probably is closer to 1% or 2%, so that has come down and that has impacted certainly the full potential of Romley. But we're still probably in the early phase of the Romley cycle in itself. We are seeing growth and we said that we do expect server-related businesses to be up in Q4, but certainly well below seasonality just given a muted enterprise environment. We continue to see fairly good activity in our sort of data center cloud-oriented customers that we've got great positions with.

Operator

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

Harlan Sur - JP Morgan Chase & Co, Research Division

I'm sorry if you guys have been asked and answered this question, but within your networking business that you guided down for the fourth quarter, I guess down slightly, can you just help us understand the moving pieces why this infrastructure enterprise legacy?

Abhijit Y. Talwalkar

Well, legacy is actually up given some additional last-time buys, I mean that's something that we experienced last year this time as well. And then we've got, obviously in our networking business, what we referred to as our PCS or PC connectivity business. And you can imagine given the PC market, that's down and down quite a bit, and then our sort of investment area business is down slightly. Obviously, it would've been down quite a bit more had we not had a number of new product cycles. So we definitely are benefiting there, and let's just say declining less than a large percentage of our peers because of the product cycles.

Harlan Sur - JP Morgan Chase & Co, Research Division

Yes, got it. Okay, thanks for that. And then we've been waiting for your customers to rollout hybrid drive solutions, I think maybe hopefully towards the end of this year, first half of next year. I believe you've got the lead position here with your largest HDD customer. Abhi, sort of what's your sense on how big hybrid drives could be as a percent of the total mix maybe next year? And how do you compare your dollar content per hybrid drive relative to your dollar content in a typical HDD or typical SSD configuration?

Abhijit Y. Talwalkar

Harlan, and just so we're talking about the same thing, I mean, there is dual drive, which I believe you're not talking about...

Harlan Sur - JP Morgan Chase & Co, Research Division

No, I'm talking about -- yes, I'm not talking about dual drive.

Abhijit Y. Talwalkar

So hybrid drive. Yes, hybrid drive. I think from what we've seen in the labs and so forth, they have a great value proposition. Small incremental premium, the resume time and performance almost close, not quite to SSDs, and obviously great capacity. So we think they have a lot of promise. And a number of the HD -- all the HDD OEMs are now starting to aggressively focus on this. We do believe that it's really around the Haswell platform that we'll see more uptake with these hybrid drives because they're going to be of the smaller sort of form factor, the 7-millimeter form factor. There may or may not be 5-millimeter products in production at that time. I think they're going to come later in '13. And you're correct, we do believe we're ahead here by a meaningful sort of margin, and this initial product has a 500-gig per platter hybrid product. As to projections for the year, Harlan, I don't know. I hope they're widely successful because we're in a great position. But that's going to be a function of what PCs they make it into and what price points they hit, right? And I don't have visibility yet on that.

Harlan Sur - JP Morgan Chase & Co, Research Division

Okay, great. We'll certainly be monitoring that pretty closely. And then just as my final question. So as it relates to the 6- to 12-gig SAS transition you talked about second half of next year, and obviously you guys have a leadership position in the server space. On the SAN systems part of the market, do you have anything to report on in terms of share gains at some of the Tier 1 OEM, like an EMC for example?

Abhijit Y. Talwalkar

Yes, we continue to make good progress there on that front, and we announced several wins a couple of quarters back relative to Zyrtax [ph] and Dot Hill. And we've done well across a number of EMC's product lines. And the design win opportunities there continues to be opened because we expect the SAS 12-gig transition for storage to really start sometime in 2014. It'll lag servers. We'll keep you posted.

Operator

Our final question is a follow-up from the line of Craig Berger with FBR Capital Markets.

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

Follow-up. Two things. First, can you just give us a feel for how desirable more buyback is to you and how much more powder you have there?

Bryon Look

Sure. Craig, I think you've realized we're and have been in a very strong cash position, we expanded cash again this quarter. We have no debt on our balance sheet. Operating cash flows are very strong, another quarter of over $100 million in operating cash flows. And so when we look at the utilization of our cash, we're trading capital to shareholders high amount of [ph] list, given also that we're pretty well [indiscernible] to investments that we need to make to grow our top line. We've been pretty aggressive, I would say, relative to the authorizations that we have had. About $225 million of the authorizations spent just in 2012. And you did see the notification that our board has authorized a new share repurchase authorization in the amount of $500 million, which was done in August. So our expectations are we're in a strong position to be able to utilize our cash, this is [ph] good use of our cash. And depending on market conditions, we may continue to be very active in terms of those share repurchases.

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

Okay. Next question on ramping top tier other OEM customers. Is that still -- I know you mentioned it, but is that still on track for this year? And kind of what's the diffusion rate as we look forward and how will we know when you're acting [ph] with that customer?

Abhijit Y. Talwalkar

I think -- yes, Craig, just to clarify, you're talking about HDD new customer, correct?

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

Yes.

Abhijit Y. Talwalkar

Yes, we did say on this call that we've begun shipments, production shipments. And we'll certainly benefit from that ramp in 2013.

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

Lastly, the percentages you gave out for flash, so pretty amazing growth in the fourth quarter. Was PCIe flash almost $20-ish million this quarter?

Abhijit Y. Talwalkar

I'm not going to break out. I think -- were you talking about Q3 growth in terms of flash, Craig? Or are you talking about Q4?

Bryon Look

I think Craig was referring to Q3...

Abhijit Y. Talwalkar

Yes, we had contribution [ph] for both product categories, both FSPs standard and custom, as well as PCIe flash adapters.

Operator

Our final question comes from the line of Betsy Van Hees with Wedbush Securities.

Betsy Van Hees - Wedbush Securities Inc., Research Division

I just wanted to follow up on Craig's question about the flash. It was great that you gave us all the information in terms of what percent of what was in server and storage. I was wondering if you could tell us in Q2, what percent of flash was server and storage so we can just kind of have a reference point to what the quarter-on-quarter growth was? Because last quarter [ph], you just gave us SandForce. That's my first question.

Bryon Look

I don't -- Betsy, I don't think we've broken out the different pieces of flash in Q2, at least we certainly don't plan to in this quarter. As a percentage of total, it was certainly smaller than it was in Q3.

Abhijit Y. Talwalkar

Relative to Nytro.

Bryon Look

And in Q3, we saw growth across all our flash products. So PCIe flash adapters grew, we saw growth in our standard product SandForce FSPs and we also saw growth in our custom FSPs that are targeted to the enterprise space.

Betsy Van Hees - Wedbush Securities Inc., Research Division

One last thing [ph], you break it out by each group, you said it was 16%, if I heard correctly. In Q3, flash was 16% of overall server and storage, and I just was wondering, overall, what it was in Q2 flash was, as a percent.

Bryon Look

Yes, well, I think -- yes, I think all we would say at this point is it was up as a percentage of the total of what we report out as server and storage semi [ph] revenues.

Betsy Van Hees - Wedbush Securities Inc., Research Division

Okay, thanks. And then when we look at your flash business and we look at what you're doing in the consumer space, in the enterprise space, you have a total system solution with WarpDrive. And then in the consumer space, you guys are just shipping, if I understand correctly, just a controller from SandForce. Are you looking to provide more value to your customers by providing an entire solid-state drive consumer for your -- that business, or you're going to continue to just support the flash controller business?

Abhijit Y. Talwalkar

Yes. No plans, no intent to provide the complete SSD solution. Now one of the reasons LSI does really well in this market and has been winning is in addition to our flash storage process or silicon, we provide a very robust and fully productized firmware stack that our competitors really don't to the level that we do. We provide tremendous amount of support around manufacturing and test and test programs and so forth. But we have no intent in selling an SSD. Those are our customers, and we'll be shipping flash storage processors to them. And then keep in mind though, we do that also for enterprise SSDs. We sell flash storage processors there as well. So in enterprise, we're participating 2 ways: PCIe flash adapters with lots of different software, caching software, to be specific; and then we also sell flash storage processors for companies that are developing and selling enterprise flash SSDs.

Sujal Shah

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

Operator

Ladies and gentlemen, a telephonic replay of this conference will be available beginning today at approximately 4 p.m. Pacific Daylight Time and will run through 9 p.m. Pacific Daylight Time on November 1. The replay access numbers are 1 (855) 859-2056 within the U.S., and 1 (404) 537-3406 for all other locations. The conference ID is 37349309. The webcast will be archived at www.lsi.com/webcast. That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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