LSI Corp (LSI) Management Discusses Q2 2013 Results - Earnings Call Transcript

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LSI (NASDAQ:LSI-OLD) Q2 2013 Earnings Call July 24, 2013 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

Vivek Arya - BofA Merrill Lynch, Research Division

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

Brian C. Peterson - Raymond James & Associates, Inc., Research Division

James Schneider - Goldman Sachs Group Inc., Research Division

Ryan Goodman - CLSA Limited, Research Division

Christopher Hemmelgarn - Barclays Capital, Research Division

Operator

Ladies and gentlemen, thank you for standing by, and 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 second quarter and guidance for the third quarter of 2013.

During this call, we'll 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 will 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. We also have an Investor Education Center on this site, which contains video presentations about each of our businesses. This may be particularly useful for new investors.

Today's remarks will include forward-looking statements. Our actual results could differ materially from those suggested by the statements made today. Information about factors that could affect our future results is contained in our Form 10-K for the year ended December 31, 2012, our first quarter 10-Q and today's earnings release.

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

Abhijit Y. Talwalkar

Thank you, Sujal. Good afternoon, and welcome. I will begin with a brief discussion of results for Q2 and our outlook for Q3, and will then provide highlights of our businesses.

We delivered solid results for the second quarter with revenue and EPS above the midpoint of guidance. We continued generating strong non-GAAP gross margin performance near our targeted business model while maintaining tight expense control. During the quarter, we saw higher-than-expected revenues in networking and flash, which both grew by double-digit percentages and drove our upside. Overall, product revenues grew approximately 6% sequentially in Q2.

Looking into Q3, our guidance reflects approximately 4.5% product growth from a strong Q2 baseline. Both our storage and networking semiconductor businesses are expected to be up in Q3, with new product cycles contributing to growth.

As we step back, we continue to be excited about new product cycles across all of our businesses and new product ramps at market-leading customers. We have been successful at expanding our customer base in PCIe flash and are pleased to be partnering with a leading social networking company to deploy our PCIe flash products to drive data storage, protection and acceleration across their applications.

In networking, we have begun ramping multiple custom switch silicon products at a leading data networking company while expanding our Axxia footprint in the wireless space into small cell base stations, which are being deployed by Verizon.

In hard disk drives, a new customer has gone into production using LSI SoCs. Also, we will be shipping into Seagate's recently announced Terascale enterprise drives through the second half of this year, with enterprise growth next year as we ramp new 28-nanometer SoCs to all HDD customers.

In servers, we are in a leadership position in SAS for the expected second half transition from 6-gig to 12-gig and also expect OEMs to launch shared storage solutions based on our Syncro technology.

LSI is centered in applications benefiting from strong secular growth in data and traffic. We are effectively positioned and focused on large and exciting market segments, including flash, data center, cloud and mobile networks. We believe our technology leadership and scale across storage and networking-focused segments will continue to generate a healthy design win pipeline to fuel strong top line growth and cash flow going forward.

Given our confidence in the future of the business, we are pleased to announce that we are initiating a quarterly dividend at $0.03 per share. The dividend will be part of our overall capital return strategy. And we also expect to maintain our share buyback program.

Now I'd like to briefly review additional product highlights and growth drivers for our businesses.

In flash, there is no other company that has LSI's breadth of products. Only LSI offers standard and custom flash controllers, PCIe flash adapters and caching software, positioning LSI to benefit from a multiyear growth cycle in flash-based storage adoption. This has proven to be an effective strategy and has enabled us to engage a broad base of customers, including vertically integrated NAND suppliers. Through our ability to offer customers either standard or custom flash controllers, LSI has established clear leadership in this market segment. Last month, market research firm, Forward Insights, ranked LSI #1 in worldwide SSD controller revenues, with 38% share in 2012. We expect to maintain revenue leadership in 2013 and going forward.

In addition to our standard product controllers, in custom products, we have 17 different custom flash controllers that are either in production or in development across 6 different SSD providers. Custom controllers are being used by vertically integrated NAND suppliers who want to differentiate by combining their controller technology with LSI IP for a complete solution. These custom products are a combination of client enterprise controllers supporting SATA, SAS or PCIe interfaces, enabling LSI to have the broadest design win exposure in the market to SSD OEMs. This year, the vast majority of client SSD shipments will be SATA-based, and LSI has the leadership position in this technology. We are beginning to see some early adoption of PCIe SSDs, and we expect to have the best product available at the point of mass adoption.

LSI is well-positioned with our third-generation of SandForce controllers that have been specifically architected from the ground up to bring out the full performance of PCI benefits. The 3700 is now in-house, with our evaluation running ahead of expectations. With our customers' samples expected later this quarter, we have increased the level of customer engagement and already have 5 major customers designing boards around the SF-3700. In enterprise SSDs, LSI has established new leadership in revenue share through a combination of standard and custom flash controllers, which can be found in enterprise SSDs offered by Samsung, SanDisk, Hitachi, Intel, SMART and others.

I'll now move to the PCIe flash market segment, where LSI is established as the #2 provider of merchant PCIe flash solutions and uniquely positioned as the supplier with the industry's broadest PCIe flash portfolio. We had a record revenue quarter in Q2 with rapid expansion and momentum of our engagements with a broad set of Web 2.0, cloud, financial and enterprise customers. As we noted in our last earnings call, this market is in the early stages of formation and involves a lot of discovery and evaluation by customers. We made considerable progress in the last few months in advancing our momentum for future growth. We are pleased to have consistently grown our funnel of engagements, with the number of trials doubling from Q2 and with new customers now contributing to revenue growth in Q3. We are excited to be partnering with a leading social networking company to deploy our PCIe flash products to drive data storage, protection and acceleration across their applications.

Building upon our success at Oracle, our Nytro WarpDrive solution continues to expand in applications with a broad range of customers. LSI also continues to be unique in offering its Nytro MegaRAID solution, which combines the benefits of flash acceleration and industry-proven MegaRAID data protection technology. We continue to see strong interest in this product's unique capability and have initial adoption by JPMorgan, Intel, Dell and others.

Leveraging our silicon and software expertise, along with deep customer relationships, LSI is now also broadening solution-selling with server OEMs and ISVs around big data, Hadoop, databases and virtual desktop infrastructure. For example, at Cisco Live, we showcased the Cisco and LSI partnership by demonstrating a jointly developed solutions bundle for big data.

To summarize our overall opportunity in flash, we remain very bullish about the growth prospects for LSI. We expect the size of our available market to go from over $1 billion today to over $3 billion in 2016 across our aggregate flash offerings. There is no other semiconductor company that is positioned as well as LSI to serve this large and growing opportunity.

In our SAS and RAID business, we continue to lead the market and are enabling the 6-gig to 12-gig transition with multiple Tier 1 OEM engagements and design wins. We were the first company to ship production level 12-gig SAS, RAID-On-Chip and I/O controller solutions and expect the shift to 12-gig solutions to accelerate over the second half of 2013.

We've also talked about expanding beyond our traditional SAS and RAID business with our Syncro product family. Last quarter, we announced our Syncro CS product, which operates on Microsoft Windows Server 2012 and enables sharing and scaling of storage across multiple servers. We expect to begin initial shipments this quarter.

In hard disk drives, the story continues to be around 2 strong suppliers in a consolidated marketplace. We feel good about our position given our product portfolio and design wins. We are well-positioned in the most resilient segments of the storage market. Nearly all of our SoC revenue is now driven by shipments in desktop, enterprise and nearline drives, which are collectively expected to be a driver of storage capacity for cloud and mega data center build-outs.

In the enterprise space, LSI has been designed into Seagate's recently announced Terascale drive, which is Seagate's lowest cost per gigabyte enterprise drive. Beyond this, we have secured design awards at all enterprise HDD OEMs in 28-nanometer technology, with all platforms expected to launch in 2014. This will enable future growth for LSI in enterprise SoCs.

In the notebook space, while we have very little exposure today to the traditional 2.5-inch hard disk drive notebook PC market, we have won all of Seagate's client solid-state hybrid drive platforms, which include both 500-gigabyte and 1 terabyte capacities for client applications.

Regarding customer expansion, we are pleased that a new customer has gone into production with drives that utilize LSI SoCs. We expect our volumes and revenues from this program to increase as we go forward.

Now I'd like to discuss our networking business where our products address the wireless mobile network, data center and enterprise market segments. In Q2, we experienced double-digit sequential growth as the products in our investment areas continue to ramp at market-leading customers. In fact, our investment areas in networking grew 14% year-over-year in Q2. Our key customers are increasingly looking to partner with semiconductor suppliers who can help deliver differentiation by offering a full suite of solutions and a roadmap that delivers increasing levels of integration and power efficiency. LSI is unique in meeting this challenge by providing a combination of custom silicon solutions and a growing family of Axxia multi-core standard products. We have already secured key design wins with leading Tier 1 base station OEMs who have selected both our Axxia standard products and custom baseband solutions. As new base stations from these Tier 1 customers come to market over the next several years, we expect our aggregate share for communication processors and baseband silicon in base stations to go from less than 15% today to over 40%.

Expanding our wireless footprint for Axxia, we have now introduced a solution which enables small cell base stations. The Axxia 3400 platform will be deployed in small cells by Verizon Wireless later this year and allows mobile network providers to add capacity in dense urban areas with high traffic while also providing best-in-class user-experience, including realtime services and mobile video. Earlier this year, we announced our first ARM-based multi-core processor, the Axxia 5500, which is targeted at next-generation base stations and combines 16 ARM cores with our specialized networking accelerators to optimize performance and power efficiency for advanced mobile broadband networks. We expect to start sampling the Axxia 5500 to customers this quarter, well ahead of any competitor for this class of solution.

Expanding beyond our wireless beachhead, we continue to make progress in data center and enterprise applications. Last quarter, we indicated design wins across 15 strategic sockets at leading data center and enterprise networking OEMs with custom solutions and Axxia products, and we have now begun ramping some of these programs into production. A leading networking OEM recently announced their next-generation of data center switches, which will use LSI custom silicon and Axxia processors, and we expect to benefit as these platforms ramp over the next few quarters.

To wrap up, we continue to demonstrate solid performance in an uncertain environment and have established product cycles to drive share gains and growth going forward. We're well-positioned to return capital to our shareholders, and we'll begin paying a dividend while at the same time retaining our share repurchase authorization.

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 few highlights for the quarter. Revenue at $590 million came in towards the high end of guidance. Non-GAAP gross margins were 54.5%, above the midpoint of guidance. Non-GAAP operating expenses were $234 million, just above the midpoint of guidance. Non-GAAP operating margin was 14.7%. Non-GAAP diluted earnings per share were $0.15, near the high end of guidance. Operating cash flows were very strong at $78 million. And we just announced the initiation of a quarterly dividend program.

Now turning to a more detailed discussion of our financial results for the quarter, beginning with revenues. Q2 revenues were $590 million, up 4% sequentially and down 11% on a year-over-year basis. Our server and storage semiconductor revenues, which include products from our server rate adapter and software, flash, SAS, SAN and HDD businesses, were $457 million, up 4% sequentially and down 14% on a year-over-year basis. The year-over-year decline is primarily due to our HDD revenues running at an elevated rate during the first half of 2012 following a snapback in demand at our primary customer as the HDD industry recovered from flooding in Thailand. The sequential increase in our storage and semiconductor revenues was primarily driven by growth in our server and storage connectivity businesses and our flash businesses. Server and storage semiconductors represented 77% of total revenues in the second quarter.

Q2 revenues in our networking business were $105 million, up 13% sequentially and up 6% on a year-over-year basis. We saw strong sequential growth from our investment areas, especially from the service provider end market, offset by declines in our legacy products. Networking represented 18% of total revenues for the second quarter.

Revenues for the IP business were $28 million, down sequentially by $10 million. Revenues for the first half of 2013 were higher than historic levels, driven by specific contracts. We expect IP licensing to return to its typical run rate going forward.

Moving next to gross margins. LSI's Q2 gross margin excluding special items was 54.5%, above the midpoint of guidance we provided in April, benefiting primarily from a more favorable mix. In terms of operating expenses, R&D, together with SG&A expenses excluding special items, totaled $234 million in Q2, just above midpoints of our guidance. Non-GAAP operating income for the quarter was $87 million or 14.7% of revenue. Interest income and other, net of interest expense excluding special items, was $2 million for Q2.

Now let me turn to the special items we recorded in the second quarter, which netted to approximately $59 million. Special items, primarily noncash, included $29 million in amortization of acquisition-related items; $22 million of stock-based compensation expense; and $8 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 discrete items. The tax provision we recorded for Q2 for both GAAP and non-GAAP purposes was $5 million. On a GAAP basis, second quarter net income was approximately $25 million or $0.04 per share. Non-GAAP net income was $84 million or $0.15 per diluted share, near the high end of guidance.

The diluted weighted average share count for the period for both GAAP and non-GAAP purposes was 562 million shares. This includes the weighted average benefit of purchasing approximately 9 million shares during the period under our share repurchase program. We utilized approximately $62 million in Q2 from our stock buyback authorization.

Turning now to the balance sheet and cash flows. We ended the second quarter with cash and short-term investments of approximately $673 million; operating cash flows for Q2 were $78 million; and we continue to operate with no debt on our balance sheet.

Finally with respect to Q2 results, depreciation and software amortization were $16 million and capital expenditures were $18 million.

Next is a discussion of our guidance for Q3 2013. Q3 revenues in the range of $590 million to $630 million were sequentially up approximately 3.5% at midpoint. We are expecting approximately 4.5% growth in product revenues, offset by declines in IP licensing as that business returns to its typical quarterly run rate. We expect both our server and storage semiconductor revenues and our networking semiconductor revenues to be sequentially up in Q3.

Gross margin, excluding special items, is expected to be 54.5% plus or minus 1%. Operating expenses excluding special items are expected to be in the range of $231 million to $241 million. Interest income and other and interest expense excluding special items is expected to net to income of approximately $2 million. Special items are expected to net to approximately $45 million to $65 million.

The GAAP and non-GAAP tax provision is expected to be approximately $11 million for Q3. We expect our non-GAAP tax rate to be between 10% and 12% for Q4.

We expect Q3 GAAP net income in the range of $0.01 to $0.11 per share and non-GAAP net income in the range of $0.13 to $0.19 per share. And the share count is expected to be approximately 563 million shares for both GAAP and non-GAAP purposes.

In addition, we expect depreciation and software amortization of approximately $15 million for Q3 and $60 million for the full year and capital expenditures of approximately $25 million in Q3 and $85 million for the full year.

In closing, we delivered a solid Q2, coming in towards the high end of guidance on revenue, non-GAAP gross margins, as well as non-GAAP EPS. We also announced today our decision to initiate a quarterly dividend at $0.03 per share, which reflects our continued confidence in the business, bolstered by our strong cash generation abilities and robust balance sheet. Returning capital to shareholders through a dividend will complement our ongoing share repurchase program and allows us to reward our shareholders with a consistent quarterly return. As a reminder, we ended the second quarter with approximately $356 million remaining in our stock repurchase authorization, and we anticipate continuing our repurchases under that program in the quarters to come.

Now let me turn the call to Sujal.

Sujal Shah

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

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Vivek Arya.

Vivek Arya - BofA Merrill Lynch, Research Division

Maybe the first one, Abhi, for you. Can you give us just what your perception is of demand trends in the second half? And if you could help us give color by the different market study on -- that you are in hard disk drive, server storage, flash and networking. And specifically, which of those segments are trending better or worse than what you thought maybe a couple of months ago?

Abhijit Y. Talwalkar

Okay. I mean, overall, the demand environment in Q3 is sort of consistent with what we expected several months ago, so nothing has certainly deteriorated. At the same time, nothing is on a rocket ship, but steady and steady growth. We're expecting obviously, the hard disk drives' TAM to grow comparable to what you might have heard from Seagate this morning, 135 million to 140 million units, certainly anticipated to grow above that in Q4. Server units are expected to have nice, decent growth Q2 to Q3, especially given a server cycle in the second half. The PCIe flash market continues to grow as well. SSDs overall for the full year grows, but has a number of dynamics that are factors, and I can speak to those briefly. And networking is also showing signs of decent growth, both in the enterprise space, as well as even in wireless CapEx space, where we are certainly starting to see indications of spending improvement in the second half. So that's kind of the color relative to the markets. Maybe I can offer some color relative to our specific sort of business as we go from Q2 to Q3. First of all, we were very pleased with the performance in Q2, with very strong 6% product level growth. On top of that strong growth, we're still forecasting product growth at about 4.5% Q2 to Q3. And that is implying growth across storage, as well as networking. Within storage, servers is up consistent with my TAM comment. HDD is up, again, reinforcing what we said earlier that Q1 would be a trough point for LSI's HDD business. So the puts and takes there, as well as modest TAM increase, has our HDD business up. Flash overall is sort of flat. Again, we came off a very strong Q2. We expect within flash, PCIe flash itself to be up as new customers are contributing to our revenue growth, as well as what we also commented in our prepared remarks relative to engaging and partnering with a leading social networking platform that will also be deploying our solutions. In the flash controller space, there are -- we have won everything that we can win relative to SSDs that will contribute to revenue profile in Q3. It's really ultimately a function of a number of factors: NAND availability, which certainly has been tight this year and has impacted some Tier 2 players; NAND pricing; as well as our customers' strategies and how they fare relative to market share. So that one's a little bit more difficult to call. Everything that's in our control, we have, I think, executed, too.

Vivek Arya - BofA Merrill Lynch, Research Division

Got it. Very helpful. And then maybe as a follow-up, good to see the initiation of the dividend. How should we think about the dividends and buybacks collectively as a percentage of free cash flow? I think over the last few quarters, it would have been slightly above your free cash flow, but how should we think about it going forward?

Bryon Look

Sure. I'll take that one. Well, first of all, let's step back and look at where the company is. We're certainly very confident in our business position, our business strategy and our outlook for revenue growth, and that translates into expanding profitability and continue to move towards that business model target of 20% to 22% operating income. So we continue to generate strong cash flow from operations, and that's given us the opportunity to be able to continue to return to investors, excess cash flow not needed to really grow the business. Specific to share buybacks and dividends, as we think about the return of capital to shareholders, share repurchases happen or continue to be, we believe, an attractive way to return capital to our shareholders. I'll remind you that we've returned over $2 billion to stockholders over the last 6 years, and we still have remaining over $350 million of authorization. So we expect to continue to be active with respect to buying back shares going forward. We view the dividends as giving us the opportunity to expand that return of capital program, initiating that $0.03 per quarter dividend as well. And so I think we're very comfortable that we're able to do what we set out to do, which is to return capital to our shareholders through the dividend, to complement the share repurchase program and to also reward shareholders in a more predictable and a more consistent way on a quarterly basis.

Operator

Your next question comes from Sujee De Silva.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

A couple of questions on the PCI Express win at the social networking customer. Was that a new program or a second sourcing with existing program or you displaced a competitor there, can you give us some color on that?

Abhijit Y. Talwalkar

We can't get into the specifics, Sujee, but obviously, very pleased with the progress that we've made there. That's been an effort that's been underway for well in excess of a year, and it's a focus across many different applications. And we're starting to see very solid traction where we'll be shipping into a number of different applications. That's about all I can say at this point.

Sujeeva De Silva - Topeka Capital Markets Inc., Research Division

Fair enough. For a large program like that, Abhi, would you expect lumpiness in the revenues in the PCI line as someone like that ramps up and then pauses before the ramping, or would it be steady?

Abhijit Y. Talwalkar

Yes, I mean, I think there's certain applications that can be steady. There are certain that are very bursty and that are linked to big data center build-outs and CapEx, highs and lows. So in general, this PCIe flash marketplace is going to be lumpy as it continues to grow. It still is very much in its infancy as an overall category. But what we alluded to the last quarter and again, reiterated this quarter, what we're focusing on -- obviously, ultimately, it's all about revenue and revenue growth, and we're pleased to see growth this quarter, growth going into the next quarter. But the other indicators that we look for is, obviously, the number of customers that we are engaging and the number of those customers that are spending real cycles, dollars, energy, engineers and trying our products out together and understanding how they can benefit their applications. And then our mission has been to convert those into revenue, which we're now starting to do. And there's a number of new customers that are contributing to our Q3 revenue in addition to the one that we discussed.

Operator

Your next question comes from Hans Mosesmann.

Brian C. Peterson - Raymond James & Associates, Inc., Research Division

This is Brian Peterson in for Hans. Just a question on your flash-related mix. How much of that is PCIe currently? And you mentioned that the NAND tightness might be impacting growth there at least sequentially. Are you guys still sticking to your growth forecast of kind of the 30% to 40% range for that business in 2013?

Abhijit Y. Talwalkar

Yes, I mean, I think -- first of all, relative to our performance Q1 to Q2, very pleased with solid double-digit growth in the second quarter across our aggregate flash, and we're not going to break out exactly what we did across the different product types within flash. Overall, aggregate business grew Q1 to Q2. We're certainly seeing PCIe flash grow in Q3 and have the funnel to continue growing that nicely into Q4. In terms of aggregate flash, as we think about flash controllers, we have won everything that there is to be won relative to sockets that are going to contribute to revenue in Q3 and Q4. And to a large degree, we're at the mercy of a bunch of variables that are outside of our control. NAND availability has been somewhat tight. It has had an impact on some of our Tier 2 customers in the first half of this year that couldn't get supply, whereas larger players were able to get supply. Pricing has certainly been a factor relative to penetration rates of SSD. And then ultimately, our customers have different strategies, different profitability objectives, and so that has an impact on overall ending share for us. But what I do feel confident about as we establish revenue leadership in our flash controller business in 2012, we expect to maintain that revenue share leadership in 2013. We have the most comprehensive offering with standard products, as well as custom controllers in client and enterprise, seeing significant share growth in enterprise SSDs. And most importantly, we're very excited about our next-generation SF-3700 SandForce controller that's in-house. It should be soon sampling, with a number of customers already engaged in design activity.

Operator

Your next question comes from the line of Jim Schneider.

James Schneider - Goldman Sachs Group Inc., Research Division

I was wondering, first of all, could you comment on -- obviously, good job on the gross margin execution and the cost controls. Can you maybe comment on your latest thinking on when you get to your operating margin targets and kind of reiterate what those are again, please?

Bryon Look

Sure. Our view remains unchanged. We're focused on driving towards that business model target, which, as you know, is 55% gross margin, 20% to 22% operating margins. The gross margin level, we've effectively been operating very close to that level. It will vary from quarter-to-quarter based on mix and the like. Relative to achievement, the overall business model, that's going to be a function largely of the revenue level. We're pretty excited about the growth prospects that we have as we move forward, translating again design wins to revenue, ramping with key customers in the right markets. We still believe that -- at revenue level, quarterly revenue level of approximately $700 million or so, we'd be at that business model target.

James Schneider - Goldman Sachs Group Inc., Research Division

Fair enough. And then moving to the networking business for a second, clearly, trends there are improving. Can you maybe talk to the profile of your expectations for that business as we go into Q3 and then into Q4, and whether you expect greater growth in wireless or wireline or enterprise?

Abhijit Y. Talwalkar

I mean, Jim, we're expecting the networking business to be up Q2 to Q3 at a very strong Q1 to Q2 growth profile, obviously, led by our investment areas, where we are seeing the benefits of a lot of hard work over the last several years in winning the right sockets at the right big players, which are now starting to go into production. I alluded to both progress in the wireless infrastructure space, specifically base stations, as well as in enterprise, where we focus on data center switches, as well as campus switches, all in the Ethernet space. And we talked about 15 strategic sockets there, of which a number of them are going into production now. So we are benefiting here in Q3 and expect to have the same benefit in Q4, assuming economic environment remains stable of both 2 things: one, an improving enterprise spending environment around networking, certainly signs and indications around improvement in mobile networks and CapEx associated with mobile networks; as well as a number of product cycles. So from that standpoint, the outlook certainly for Q3 is up, and we'll see how that materializes in the fourth quarter depending on sort of the economic environment.

Operator

Your next question comes from the line of Srini Pajjuri.

Ryan Goodman - CLSA Limited, Research Division

This is Ryan Goodman for Srini Pajjuri. I had a question on the next-gen solid-state -- the next-gen SSD controller, the SF-3700. Just curious if you could talk about some of the differences from the prior generation, just changes that might open up new markets or change -- enhance the strategy. I think you had talked a bit about a focus on PCI Express advantages of the new controller. So any color there?

Abhijit Y. Talwalkar

Yes, we can't provide too much color. Obviously, I don't want to help our competition any more than we need to. Obviously, very excited about this platform. The last platform, which is P-Pro, was highly successful, it ran and continues to run for a long time. It enabled us to establish revenue share leadership. This next-generation platform was really architected from ground up. That's a new architecture that will fully exploit the bandwidth offered by PCIe. A lot of our competition, at least currently, has not done that, and so we believe we are going to be ahead as we transition to this new class of product. And it's a platform by design, which means it will have a number of derivative offerings as well that will allow us to more effectively cover a growing number of segments that basically make up the SSD marketplace given its rapid growth. So we should be able to more effectively compete across a broad spectrum, which will allow us to maintain and grow share over the coming years.

Ryan Goodman - CLSA Limited, Research Division

Okay. Great. And then just a follow-up question. It looks like the strategy in SSDs is mostly going around the interfaces of like SATA, even MVME and then obviously, PCI Express. Haven't heard you talk much about SAS there. So I'm curious, one, why the decision not to go forward with any type of SAS SSD offering, if I'm correct? And two, how much of a risk do you view 12-gig SAS HDDs coming out maybe later this year into next year to the SSD offerings?

Abhijit Y. Talwalkar

Relative to the interfaces, no, we're covering all the interfaces. I mean, there's certainly choices that we made relative to SAS as it pertains to standard product, and our focus to participate there has been to participate via custom controllers. So LSI is, today, participating in SAS drives, and that's via our custom controller sort of engagements that we have. And, in fact, across the enterprise SSD space, where you look at SATA, which is still the predominant interface for SSDs in the enterprise space, but also SAS, as well as PCIe, LSI is by far the clear sort of unit share and revenue share player today. So we are participating. Relative to SAS 12-gig HDDs and what that might do relative to SSDs and their growth, we think there's a relationship there but it's a minor one. We don't think that, that is going to have an effect on 12-gig SAS adoption relative to the server space. Also, if you recall, LSI developed some very unique technology, where, if you're using LSI controllers on the server side, as well as LSI SAS controllers in terms of expanders that connect up all the drives, our customers can utilize 6-gig SAS while actually having the benefit of much higher performance and bandwidth that comes with 12-gig. And this is something all our OEMs will benefit from and we'll be able to differentiate against those few that do not use LSI silicon.

Operator

Your next question comes from the line of Blayne Curtis.

Christopher Hemmelgarn - Barclays Capital, Research Division

This is Chris Hemmelgarn on for Blayne. First off, could you just provide a little bit of color on the share breakdown within storage between HDD, servers and flash?

Abhijit Y. Talwalkar

In terms of just the storage business itself?

Christopher Hemmelgarn - Barclays Capital, Research Division

Yes.

Abhijit Y. Talwalkar

Roughly, our overall server business -- server SAS business is approximately 40%, HDD business is in the mid-40s and then what's left around 14%, 15% is flash.

Christopher Hemmelgarn - Barclays Capital, Research Division

That's really helpful. I guess, last question then is, any comments on just kind of the timing of hybrid drive ramp and when, I guess, you see regaining material share in the notebook space?

Bryon Look

I mean, in terms of hybrids today, as we said in the call, we've got all of Seagate's hybrid drives today at both the 500-gig and 1 terabyte. And we are shipping meaningful quantities and units into that space as of Q2 and expect that to grow in Q3. Still very small in the overall scheme of the total market. So this is really going to be a function of adoption across the PC OEMs and pricing strategies and how the value proposition plays between SSDs, hybrids, as well as what's referred to as dual drive, which is a combination of hard disk drives, as well as small capacity flash. And the positive is, LSI is participating in all of those.

Sujal Shah

Okay. Thank you. It looks like we have no further questions, so I'd like to thank you for joining us today. And if you have any questions, please contact Investor Relations at LSI. Thank you.

Operator

Ladies and gentlemen, a telephone replay of this conference call will be available beginning today at approximately 5:00 p.m. Pacific Daylight Time and will run through 9:00 p.m. Pacific Daylight Time on August 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 83885559. The website will be archived at www.lsi.com/webcast. That does conclude your conference for today. Thank you for your participation. You may disconnect.

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