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Broadcom Corporation (NASDAQ:BRCM)

Q1 2009 Earnings Call Transcript

April 21, 2009 9:00 am ET

Executives

Peter Andrew – VP of Corporate Communications and IR

Scott McGregor – President and CEO

Eric Brandt – SVP and CFO

Analysts

Randy Abrams – Credit Suisse

Tim Luke – Barclays Capital

Jim Snyder [ph]

Uche Orji – UBS

Ross Seymore – Deutsche Bank

Shawn Webster – JPMorgan

Sumit Dhanda – Banc of America

Craig Berger – FBR Capital Markets

Ruben Roy – Pacific Crest Securities

Mark McKechnie – Broadpoint Securities

Adam Benjamin – Jefferies

Mahesh Sanganeria – RBC Capital Markets

Dan Morris – Oppenheimer

Srini [ph] – CLSA

Edward Snyder – Charter Equity

Quinn Bolton – Needham & Company

Gary Mobley – Noble Financial

Steve Smigie – Raymond James

Suji De Silva – Kaufman Brothers

David Wu – Global Crown Capital

David Wong – Wachovia

Alex Gauna – JMP Securities

Operator

Welcome to the Broadcom First Quarter Earnings Conference Call. (Operator instructions) As a reminder, this conference is being recorded on Tuesday, April 21st, 2009. Your speakers for today are Scott McGregor, Broadcom’s President and Chief Executive Officer; Eric Brandt, Broadcom’s Chief Financial Officer; and Peter Andrew, Vice President of Corporate Communications and Investor Relations.

I would now like to turn the call over to Mr. Andrew. Please go ahead.

Peter Andrew

Thank you very much, Lorraine. Before I turn the call over to Scott, I would like to discuss some factors that are likely to influence our business going forward. These forward-looking statements include guidance we will provide on future revenue, gross margin, and operating expense targets for the second quarter of 2009 and any other future period, as well as statements about the prospects for our various businesses, potential market share and the development status and planned availability of new products and statements about potential benefits of the proposed acquisition of Emulex as described in our announcement earlier today.

You should note that the guidance we provide today is based upon forecasts that require us to make certain estimates, judgments, and assumptions using the information that is available to us at this time. It should be clearly understood that our actual performance and financial results may differ substantially from our forecast and the other forward-looking statements we make today. It should also be understood that such guidance does not take into account the effects of the proposed acquisition of Emulex announced today.

Specific factors that may affect our business and future results, include among other things, general economic conditions, are discussed in the risk factors section of our 2008 Annual Report on Form 10-K and subsequent SEC filings. A partial list of these important risk factors is set forth at the end of today’s earnings press release. As always, we undertake no obligation to revise or update publicly any forward looking-statement except as required by law.

Please reference the Investors section of our website at broadcom.com for additional historical, financial, and statistical information including the information required by SEC Regulation G. In addition, we placed two slide decks, which are available now in the Investor Relations section of our website. They are on the right hand side of the page under Q1 2009 Earnings Information. The first deck incorporates additional tables and information regarding our historical performance and our future guidance. And the second deck contains additional information regarding our proposed acquisition of Emulex.

With that, let me now turn the call over to Scott.

Scott McGregor

Good morning and thank you for joining us today. Regarding today’s Emulex announcement, we’ll say more on that later. But first I’d like to touch upon our operating results for the quarter, provide some commentary on our specific end markets, and then allow Eric to discuss our financials in greater detail.

Revenue of $853 million in the first quarter came within the range we provided and represented a decline of 24% sequentially and 17% year-over-year. On a peak-to-trough basis, this represents a 34% decline from our peak revenue in Q3 2008. Clearly [ph], the economic downturn and our customers adjusting their business to the new economic reality had negative impact to our first quarter results.

The decline was broad-based as each of our targeted end markets declined by about the same amount in Q1. The good news is that business strengthened throughout the quarter and we experienced more customer-requested expedites than we did cancellations in the last few weeks of the quarter. Most of these expedite requests were on mobile and wireless end markets for Wireless LAN or Wireless Combo products and our Single-Chip EDGE-based bands.

We also saw expedited orders related to infrastructure projects in China. These orders were due mainly to upcoming new product ramps along with overly lean customer inventory. If you look at our top customers and the revenue they reported in Q4 and what they are expected to reported in Q1 according to First Call, we ship significantly less to them than they shipped or plan to ship out. In other words, Q1 revenue was likely below end market demand and we expect that inventories being reduced in our sales channels.

We intend to take advantage of this downturn to widen the distance between us and our smaller competitors. We are hearing of competitors cutting future product development and believe that this downturn could delay their transition to 65 nanometers. The 65-nanometer investment is largely behind Broadcom and we continue to generate meaningful cash flow from operations, which will allow us to continue to fund our product development roadmap.

Moving to the end markets we serve, I’d like to start by talking about enterprise networking end market where revenue was down both sequentially and year-over-year across all segments as our customers adjusted their order and inventory levels due to the economic slowdown.

During the last quarter, we did see some areas of strength, specifically related to infrastructure projects in China and their government’s stimulus efforts beginning to drive demand. At this point though, we are not as comfortable with the timing of the rebound in IT related businesses as we are with our consumer and quasi consumer related businesses, and we are taking a conservative approach to our forecast. We believe the rebound in IT oriented businesses will take longer given the capital budgeting cycle and the lack of credit availability.

From a product perspective, as we look into 2009 and beyond, our investments will continue to focus on driving 10 gigabit Ethernet deeper into servers, switches, and the metro space, as well as new markets like the embedded security and point-of-sale markets.

Moving on to the broadband communications end market, sales were also down on a sequential and year-over-year basis as a revenue decline in modems and set-top boxes more than offset minor revenue growth in our other consumer related businesses. It seems that modem and set-top box customers pulled back substantially in Q1, resulting in significant supply chain contraction, compounded by an accelerated product ramp of our cable DTA solutions in the prior quarter.

As we look into Q2, it looks like this inventory correction maybe largely behind us as customers have resumed more normal ordering patterns. We are also seeing increased activity in DTV and consumer electronics as companies prepare new products for the upcoming holiday season.

Opportunities for Broadcom going forward to drive growth and additional market share gains are the following. First, as we mentioned last quarter, the continued expansion of pay-TV and Internet access services internationally. We continue to see significant growth in China for cable and India for satellite and have optimized low-cost solutionship into both countries. We also see both market share gains and strong demand for DSL products in the China market.

Second, the convergence of communications and consumer electronics driving Internet and device connectivity in the home. This enables operators, studios, and content providers to offer additional value-added services. And third, we’ve been getting good traction in our consumer broadband products. In particular, recent reviews have ranked Broadcom-powered Samsung and LG Blu-ray players at the top two as they not have rich feature sets, but also super video performance.

I would also like to highlight the recent DOCSIS 3.0 certification of our customers’ products in both Europe and North America. With these certifications, Broadcom has the world’s first and only fully-compliant modem solution, meeting the stringent interoperability requirements of both the DOCSIS 3.0 and Euro-DOCSIS 3.0 specifications.

As MSO deployment plans solidify, we believed we are well positioned as the Broadcom solution offers cable operators twice the download performance of competing solutions by bonding up to eight versus four for the competitor downstream channels together. Broadcom has already begun shipping the Broadcom 3380 and in total, we’ve now shipped more than 3 million silicon solutions in the channel bonding applications.

Moving to mobile and wireless, in our mobile and wireless end market, revenue was down on both the sequential and year-over-year basis. We did experience continued dramatic growth in the wireless combo solution area where we continued to see expedite requests as our customers prepared for upcoming product ramps.

We also experienced significant year-over-year growth in wireless LAN on a combo and stand-alone basis. And we expect revenue growth in Q2 driven by increased adoption in handheld portable devices. One of the reasons Broadcom is able to fair better than our peers in this economic environment is our stand-alone leadership position combined with our proven ability to integrate the discreet functions into wireless combo connectivity solutions. We now have four different wireless combo chip sampling are in production and is shipped over 250 million units to date. Customer demand for our wireless combo chips continues to exceed our shipments.

As we look into Q2, we expect both revenue and units for our Triple-Play parts incorporating wireless LAN to approximately double sequentially. Based up on our current outlook for 2009, we believe that our wireless combo solutions in total could represent more than 10% of our total sales.

In the cellular area, we’re starting to see our EDGE and 3G baseband products ramping. And in Q2, we expect to ship millions of EDGE and 3G chips primarily to Samsung. Nokia, we believe will remain on track to begin deployment of our EDGE products in 2009. At the request of our customer and in order to protect their confidentiality, going forward, we will no longer provide any further updates on our deployment plans or schedule until products become generally available in the market.

We continue to engage in both EDGE and 3G with the top handset makers that supply the majority of the market and believe we’re well positioned to establish a meaningful presence in the handset space.

Let me now turn the call over to Eric, who will talk more about our fourth quarter and 2008 results, along with providing guidance for the first quarter.

Eric Brandt

Thanks Scott. As Peter mentioned, please refer to the breakout data on the Investors section of our website for additional financial information that will supplement my financial commentary. We’ve included additional data to reconcile gross margin and operating expense and accounting changes in addition to detailed breakouts we provided last quarter.

Moving to the financial overview, to summarize, revenue in Q1 of $853 million, including $19 million in royalty revenue from Verizon, was down approximately 17% from a year ago and down 24% from the prior quarter.

GAAP gross margin, including Verizon royalties, was 47.7%, down about 280 basis points from last year. The 280 basis point decline is approximately 130 basis points below the estimate at 49% we provided in January. This is principally driven by adverse mix and additional inventory reserves taken during the quarter. I will provide further detail on this in a moment.

In Q1, GAAP operating expense was $510 million, which includes a $7 million restructuring charge associated with our cost reduction program initiated in Q1. Q4 GAAP operating expense was $734 million. You will recall that this included an impairment charge and a charge for in-process R&D of approximately $201 million. Excluding these charges in their respective periods on a comparable basis, operating expense decreased $30 million over Q4 versus our guidance of an $8 million to $10 million increase, nearly a $40 million favorability. Again, I’ll talk about this more in a minute.

GAAP earnings per share for Q1 were negative $0.19. This includes approximately $0.01 associated with the restructuring charge I just mentioned. Stock-based compensation represented approximately $124 million or $0.25 per share. Cash flow from operations for Q1 was $91 million. Our cash and marketable securities balance increased $64 million through a balance of $1.96 billion at the end of the quarter.

Moving to revenue and gross margins, in January, we said we expected Q1 revenue could be approximately $800 million to $875 million. What occurred in Q1 was an overall revenue decline consistent with the guidance. With respect to our broadband communications, we saw a sequential revenue decline was the largest declines coming in the broadband modems and set-top boxes, offsetting part by growth in Blu-ray. In the mobile and wireless market, we experienced broad based sequential decline driven by seasonality and by lower consumer demand, reduced Verizon royalties, and normal Q1 seasonality weakness.

Our enterprise networking target market also declined across the board due to controller and switching customers adjusting their demand levels downward due to the current economic downturn and apparent buildup of channel inventory.

Revenue distribution for Q1 was as follows. Broadband communications was 37% of total revenue. Mobile and wireless which includes Verizon royalties was 37% of revenue. Enterprise networking accounted for 26% of revenue.

Our Q1 GAAP gross margin decreased 280 basis points to 47.7%, which is 130 basis points below the estimate (inaudible) earnings call. In January, we guided GAAP gross margin to be approximately 49% which anticipated we would be – we would have a 150 basis points sequential decline comprised of the following. 75 basis points for the reduced Verizon component, 50 basis points from fixed cost spread over a lower base, and adverse mix of roughly 25 basis points.

While Verizon and the fixed cost impact were roughly as expected, mix and an increase in the E&O reserves caused a greater negative impact of 155 basis points more than projected. This was due to a shift in product demand relative to inventory planning assumptions at the beginning of the quarter. Net-net, core Broadcom gross margin excluding the Verizon royalty of 120 basis points was 46.5%. Going forward, this is the relevant comparator number.

Moving to operating expenses, during the quarter, the company booked $7 million associated with restructuring we announced on our last call. The following commentary on operating expenses focuses on recurring cost and as such excludes these amounts. Once again, we had much better than expected performance in controlling our operating expenses in the first quarter.

Total operating expenses excluding the restructuring charges mentioned before for Q1 were down $30 million from Q4 levels, less than the $8 million to $10 million increase we expected in January. Over half of this favorability came as a result of tight cost control programs instituted over the last six months. Specifically favorability to our estimate came from three principal areas.

Our ongoing efforts to control the growth in headcount and other operating expenses including stock-based compensation benefits greater than projected generated approximately $23 million in favorability. Timing of legal expenses and additional D&O recovery generated approximately $10 million of favorability. Please recall, we have said that this is somewhat unpredictable. Timing – and third, timing benefit of approximately $7 million associated with mask and prototyping, which should manifest itself from the next quarter or so.

Our efforts over the last year to manage control to operating expenses are clearly paying off. We’ve made excellent progress over the last year with our Q1 2009 spending lower than any other quarter since Q1 2008, despite having absorbed the expenses associated with the AMD DTV business in Q4 2008. We decreased total headcount in Q1 by 217 people to a worldwide total of 7185.

Moving to the balance sheet, as I mentioned earlier, total cash and market securities were $1.96 billion as we generated positive cash flow from operations of $91 million. As we indicated in January, we expect inventories to decrease and turns to improve. Based on the strong work of our operations team, we’re able to reduce the inventories by roughly $100 million and improve turns to 6.7 times. Assuming no further shocks to the industry, we anticipate turns will improve next quarter. Our accounts receivable, day sales outstanding, returned to a more normal level of 38 days due to roughly flat linearity.

Moving to expectations. I will be providing guidance net of the transaction as there is too much uncertainty as to timing and accounting the treatment at this point to project financial impact. We currently expect Q2 revenue to increase to roughly $900 million to $975 million and looking to at what we expect to happen in Q2, in broadband communications, we expect strong growth across all target markets. In mobile and wireless, we anticipate sequential growth virtually across the board, driven by new product ramps and normal seasonality.

Our enterprise networking business should decline somewhat as we remain cautious about the IT infrastructure/capital equipment market somewhat slower rebound out of the current economic downturn. We expect overall GAAP gross margin to improve slightly by roughly 25 basis points to 50 basis points off of the 46.5% we saw in Q1 excluding Verizon. This is driven by a benefit to overhead absorption, partially offset by mix and anticipated E&O level. Typically, E&O reserve as a percentage of total inventory peak about one quarter after the trough.

With respect to GAAP operating expenses, we expect core business operating expenses to be roughly flat to up $5 million, driven principally by timing of tape-outs/prototyping and some IT and lab related costs. Beyond that, with the options litigations picking up and unknown further reimbursement from our D&O carriers were estimating legal expenditures increasing in the range of $10 million to $15 million.

To reiterate, this is very difficult to forecast these expenses and reimbursements as they are largely out of our control. Net-net, we anticipate total operating expenses will grow approximately $10 million to $20 million over Q1, which would put us – put operating expenses at or below year-ago levels. Again, this is after integrating roughly 500 people in the AMD DTV acquisition.

In closing, I would like to reiterate our operating strategy for 2009. We are targeting managing our business to share gain and generate positive quarterly cash flow from operations in 2009. As you can see read in our proxy statement and 8-K, we’ve aligned our incentives accordingly. Specifically, we’ve built our plan including cost saving’s targets to target running the business above $75 million positive quarterly cash flow from operations and have done so in Q1 and project to do so in Q2. We believe this will allow us to leverage our cash strength to emerge from the downturn into stronger market position as we enter. Again, the guidance provided does not contemplate the transaction announced this morning.

And now, I’d like the call back over to Scott to talk more about the announcement this morning.

Scott McGregor

Thank you, Eric. I would now like to highlight some key points in our proposal to acquire Emulex. As many of you know, Broadcom has proposed to acquire all of the outstanding shares of Emulex common stock for $9.25 per share, payable in cash. I think it’s important to highlight that this proposal is not subject to any financing conditions and provides significant immediate value for shareholders as it offers considerable premiums to current and historical valuations, specifically a 40% premium over Emulex’s closing price yesterday, April 20th, a 62% premium over the last 30 days average trading price, and an approximately 85% premium over their enterprise value.

Financially, this transaction is beneficial to Broadcom as it’s immediately accretive to both margin and EPS upon close. Please note that in my previous statement, EPS does not include any purchase accounting related adjustments and fair value measurements.

From a technology standpoint, this is an important transaction because it accelerates the time to market for next-generation converged networking solutions and provide significant benefits to customers, the industry, and employees. From a customer and industry standpoint, this deal would combine Broadcom’s expertise in Ethernet and fabulous system-on-a-chip or SoC development with Emulex’s similarly impressive expertise and leadership in fibre channel storage networking. This is important because we believe customers desire persistent consolidation is driving a greater and greater need for converged networking solutions where multiple traffic types such as network, storage, and clustering are all carried over a single network infrastructure.

We believe the combination of Broadcom and Emulex will enable our combined company to accelerate the development and adoption of the converged networking solutions that represent the future and ensure that we meet the needs of our customers in the rapidly evolving data center and networking space.

In joining Broadcom, Emulex employees will be able to take part in this exciting industry transition with a Fortune 500 leader in technology execution and conversion is just a few miles away.

In closing, we look forward to hearing from the Board of Directors of Emulex regarding our proposal as our preference would be to engage with the company directly. We’re confident if they were given the opportunity to engage directly with Emulex, we’ll be able to negotiate a mutually acceptable merger agreement and close in a timely manner.

Finally, as many of you know, Broadcom has a rich and successful history, integrating approximately 40 acquisitions over the last 15 years with a large number of employees from those transactions still with us to date. As such, we are confident we have the skills and resources to integrate this transaction quickly and effectively.

That concludes our prepared comments and now, we’re ready for your questions. Lorraine, may we have the first question please?

Question-and-Answer Session

Operator

Yes. Our first question comes from Randy Abrams from Credit Suisse. Please go ahead.

Randy Abrams – Credit Suisse

Yes, thank you. I wondered if you can elaborate on the gross margins. Just talk about the potential or what the moving parts would be to get back towards the 50% plus range? And then as baseband starts to ramp in second half, do you anticipate any initial drag from the baseband revenue?

Eric Brandt

Well, so Randy, I’ll reiterate what I’ve said in the past. It’s hard to draw conclusions about systemic gross margins in this kind of downturn. There are a couple of things going on. One is we have – with the significant drop in revenue you have the overhead absorption issue. The other thing that happens is we actually get an increase in excess and obsolete inventory and in fact, if you look at prior periods and prior downturns, whether you look at 2001 or 2004 or even today, that number, which is currently running at around 21% can get as high as 30% or 40%. So, as that number moves up and as you are adjusting for what’s being demanded versus what you’ve actually got, and remember we are doing inventory planning off of the forecast, you do get that – you do get a hit from that.

In addition, I think we’re in a very exciting cycle to optimize our chips. I’ve give examples on the road of chips where we have actually on second and third-generation 65-nanometer chips taking the same chip with the same functionality and cut die-size almost in half. And so, as we go through that I think that all of those will be benefits to the gross margin and as we sort of come out of the back half of the E&O increase, we get a bit of a tailwind that follows off of that. So I would say looking forward I’m cautiously optimistic depending on what happens in the rest of the market, but it’s hard to draw a conclusion of that at this point in time. More on that I think as we go through the year.

Randy Abrams – Credit Suisse

Okay. And if we were to take the OpEx space, what’s your projecting, there is a bump-up OpEx lower base into next quarter, but if you could talk about your target beyond that? If revenue continues to grow, do you expect to still hold OpEx flat through the year or as now that revenues are starting to come back up, is there any potential for core operating expenses starting to increase?

Eric Brandt

Yes. Randy, we are actually watching the cash flow component here. I would say as a company, we’ve built a plan off of a cash flow assumption. We originally assumed, when we announced last quarter, savings off of our originally expected cost basis for 2009 of in excess of $100 million. We are now close to $200 million savings off of that number.

We are managing this tightly from a, what I’ll call, ex-legal standpoint because we – again, the legal piece is not predictable. So, I don’t that think showed a real comfort that the markets return to levels that look like 2008, that you will see any substantive change to our spending other than timing elements associated with masks and prototyping.

Randy Abrams – Credit Suisse

Okay. Last question. You mentioned a bit of gap or inventory is coming down in your under-shipping customers. Based on the outlook for second quarter, do you think that closes the gap or do you think there is still some areas where you could close the gap further into second half?

Eric Brandt

Randy, I’m not sure I understand the question. I mean in terms of –

Randy Abrams – Credit Suisse

I mean you are guiding – well, for second quarter you are guiding a bit of an acceleration in growth and I was just wondering is that implying that you’re now catching up to your customers’ run rates or is there further catch-up to do in second half where you could accelerate even further relative to the market.

Eric Brandt

No, it’s hard to tell Randy. I go back to my analogy of the parade of elephants at the circus, right? We are three elephants back and you know what the elephant sees, right? So, we are sort of at a point where we are trying to judge what we think is or what we hope is a sufficient inventory draining back to the normal demand. So, we are optimistic, I think you see good solid growth in Q2. The range is between 5.5% and 14% sequentially, which we think is quite strong. It’s early to call Q3, but I think if Q3 remains strong, then hopefully the concept of a W won’t occur and we’ll actually recover out of it.

Operator

(Operator instructions) And our next question comes from Tim Luke from Barclays Capital. Please go ahead.

Tim Luke – Barclays Capital

A question to Scott. Just, if you could provide a little bit of the context on the Emulex proposal? It looks from your letter to them that you initially approached them in December and they weren’t particularly receptive on the need to hide these a little to their poison pill provision. Can you talk about the context as you moved into this transaction and how you perceived their response to date?

And separately, I just want to get back to the gross margin side. It sounded like you were saying there were some issues associated with inventory and some mix issues, but should we continue to model a longer-term 50% gross margin or how should we be thinking about that? Thank you.

Scott McGregor

I’ll turn the gross margin over to Eric. But first let me comment on your first question. We did approach Emulex in December and frankly we were disappointed that they weren’t interested in talking with us and basically just (inaudible) said the company isn’t for sale and as a potential acquirer, that was obviously disappointing.

We believe that there is a very compelling value in putting the two companies together. When we look across the server space at what our trends that are going to drive that business going forward, we see the customers are very interested in finding ways to bring together Ethernet and fibre channel solutions and so, we believe it’s a great opportunity to put those technologies together, offer customers a smooth migration to the Fibre Channel over Ethernet technology and it enables Broadcom going forward to offer a complete set of technology for those customers. Let me turn the other question over to Eric.

Eric Brandt

So, Tim, again on the gross margin side of things, you are right. There is some inventory mix relative to planning in terms of what we’ve actually pulled as we got pull-ins from the quarter and what actually we have projected and that triggers some additional increase and E&O levels, in fact they went up significantly, probably on a projection basis in the range of 200 basis points of a hit to gross margin.

In terms of going forward, eventually that stuff does turn around and we will be happy at some point to show you the chart just historically of how that behaves. But you can see that there was a confluence of events that drive gross margin down in a downturn. One is the physical downturn and the overhead absorption issues and the second relates to the E&O as it creeps up and then eventually winds its way off.

Going forward, as I said I’m consciously optimistic. I believe that those things begin to wind their way off and then we get the benefit of some of our more cost-optimized chips beginning to hit the market towards the back half of this year. So I – we don’t provide guidance beyond one quarter, but I would say that 2008 was a year we focused on OpEx and clearly, 2009 is a year we’re focusing on gross margin. So, more on that over the course of the year as we report.

Tim Luke – Barclays Capital

Thank you.

Operator

And our next question comes from Jim Snyder [ph]. Please go ahead.

Jim Snyder

Maybe you could start on the baseband business for a moment. Now that you are shipping that in volume, could you give us any kind of sense about when you might expect that baseband business to be essentially on par with one of your larger businesses, such as Bluetooth?

Scott McGregor

Well, Bluetooth is one of our largest businesses, so that will certainly take a little bit of time. We are not guiding that specifically, but we are encouraged very much by the initial shipments we have in our new baseband chips and we’ll give you a little more visibility over the next few quarters, but I’m going to decline to the state-specific goals for that. We did that a while back and that didn’t work out so well for us. So, I think we’ll just share the market data as we get it.

Jim Snyder

I understand. Then I guess my second one would be – maybe Scott, you – I think you talked about some of the very strategic reasons why you are interested in Emulex, but could you talk a little bit more about some of the specific assets there and what was most attractive to you, was it the fibre channel software stack or was it the converged network adapters? What was it exactly that in terms of assets that made you interested in that?

Scott McGregor

The variety of assets in the company. There is certainly a very robust and hardened software stack that takes a fair amount of time to do. We can certainly do it, but working with Emulex gives us one that is already proven and that has a high degree of customer acceptance today. Certainly, their adapters are well entrenched in the market.

One of the things I like is their relationship with customers and also their distributor channel. They have a large distributor channel and one of the potentials for us at Broadcom is that well, maybe some of our other Broadcom products would be appropriate to a VAR channel as well and so, it gives us an opportunity in the future to look for expanding existing products into new customers through some new opportunities.

So, it’s a variety of things, it’s technology, both hardware and software, it’s a talented team, customers and channel, together it’s a good package and I think putting the companies together will allow us to really take advantage of the strength of both companies and create a lot of value going forward for both sets of shareholders and the customers, both of our customers today.

Jim Snyder

Fair enough. Thanks.

Operator

Our next question comes from Uche Orji from UBS. Please go ahead.

Uche Orji – UBS

Thank you very much. Scott, can you just talk about pricing environment. I know you talked about getting some expedited orders. But if you just walk me through some of the major product types in any areas where you’ve seen more aggressive price action by your competitors or just also from the OEMs demanding more aggressive price cuts? And if you also can put that for me in context of your ships to 65 nanometers? What products have yet to move to 65 and are you seeing any opportunity to use that (inaudible) by your competitors as a way to either drive margins or hold up the price pressure?

Scott McGregor

I would say the pricing environment is very competitive. That’s not something new recently. I mean, we’ll fit a pretty competitive industry in that respect. I think we said on previous calls that a lot of times when our competitors find that they can’t compete on features such as in the wireless combo chips, they resort to price and in some cases, that makes their solution more attractive than it would be otherwise and in some cases, that doesn’t work because for example in the combo chips, we offer lower power and a smaller footprint and price doesn’t fix those kind of things. It might make you feel better about an inferior part, but it doesn’t really address all of the customer desires in that space. So, we have a variety of opportunities there.

I think that our move to 65 nanometers is, as you alluded to, has increased our competitiveness and we use that competitiveness in two ways. One of course is to drive additional features and functionality. It does reduce our cost of the die’s as we can get more things on them and what not. But we’ve also used that to penetrate new markets and so, you see us using 65 nanometers in cellular basebands, in a lot of the broadband consumer areas where we are going after new markets. We are also pushing to gain share in some of the network spaces, small and medium business and what not. I would say at this point we have a large part of our product portfolio moved over to 65 nanometers.

There is still a few parts left in 130 nanometer or other feature sizes that are doing just fine. We’ve generally moved the ones that get the biggest benefit to 65 nanometers already, we will continue to move a few more, but right now and alluding to the cost factor, I think a lot of a – the cost of moving to 65 nanometer is behind us.

We’ll start to tape out our first 40 nanometer chips later this year, but we don’t expect it’s going to be the wave like we did for 65 nanometers. There will be some parts that immediately benefit from 40 nanometers because of speed or die-size, defect density, kinds of factors. But again, it’s not going to be the massive swell towards 45 nanometers and therefore, we won’t see the cost lift that we saw when we moved to 65 nanometers.

Uche Orji – UBS

All right, great. And just one big follow-up, can I ask you about IPTV? What are your expectations for IPTV set-top box growth in 2009? You are talking about cable and satellite, any color as to the ramp plan for IPTV? That will be great, thanks.

Scott McGregor

IPTV, we definitely see as an important factor going forward and Broadcom intends to participate there as strongly as we do in any other space. We’ve already got some initial traction with customers. We will be making some more comments on that over the next couple of quarters, but we do see that very much as a growth area for Broadcom and certainly our goal is to be number one in that space and we’ve got an aggressive set of products, we are working very closely with Microsoft in that space and deploying a lot of very interesting technology.

Broadcom has the advantage that we have such depth of technology from our satellite, from our cable areas and we also leverage a lot of the capabilities from our other businesses. So, it enables us to feel very strong products in that space and we believe there is no reason why we couldn’t see a good share in there.

Operator

Our next question comes from Ross Seymore from Deutsche Bank. Please go ahead.

Ross Seymore – Deutsche Bank

Thanks guys. A question on the gross margin, you talked about mix being a negative factor. Can you give us an idea of what are the positive drivers to the mix and negative drivers to mix and maybe a general range of the gross margins of your products please?

Eric Brandt

Yes, we haven’t been that specific, but I think you know that enterprise segment products typically are higher-margin type of products than consumer products and as we’ve seen that mix shift, we’ve been hurt a little bit by that. I think that as that segment recovers, we’ll see some benefit from that going forward.

Operator

Our next question comes from Shawn Webster from JPMorgan. Please go ahead.

Shawn Webster – JPMorgan

Yes, thank you very much. Can I just clarify on the inventory write-down, Eric? I think you said it was 200 basis points worth of incremental hit in Q1.

Eric Brandt

Yes, it’s not a write-down Shawn. In every quarter you evaluate your inventory relative to demand and you take a reserve under the presumption that you won’t sell if, if you don’t have immediate demand for something. And so, relative to what we thought would happen, we thought it would be flat to actually down slightly, it actually went up and it was in the range of 200 basis points. And so, the way that works is part by part.

Now, as you can imagine that, when you wind up in that situation, one of the things we will do because of the way accounting works is you write that part down to zero, because you don’t take partial reserves on parts. You take partial reserves on the amount of inventory, but an individual product gets written to zero is that we will then make every effort to sell that part aggressively if we can and that gives us – that’s what gives us the tailwind in the future as you reduce those number of parts you are carrying and you sell them at a deal going forward. So, that’s what happened.

Operator

Our next question comes from Sumit Dhanda from Banc of America. Please go ahead.

Sumit Dhanda – Banc of America

Yes. Hi Eric, just a follow-up on that question again. So, there was a 130 basis point miss on gross margins versus initial expectations and you said reserves and mix were the factors, but are you suggesting that the reserves were a total of 200 basis points? Could you just clarify the math on that?

Eric Brandt

Yes, the reserves actually swung about 130 basis points, we had actually hoped for some positive benefit. Actually our ops team did a good job and we had some positive purchase price variance offsetting the E&O impact. That would get the net 130, really 150 of the number, but that includes the mix.

Operator

Our next question comes from David Wu from Global Crown Capital. Please go ahead. David Wu, your line is now open. If you are on the speaker phone, can you please pick up your handset? Okay. And our next question comes from Craig Berger from FBR Capital Markets. Please go ahead.

Craig Berger – FBR Capital Markets

Hi guys. Just on the gross margins, I mean if you took 130 BPs of E&O write-downs, I mean why don’t we get that back at some point in the future?

Eric Brandt

You do actually, but it takes time, right? So, it rolls up over time and rolls down over time. It just doesn’t come back in any given quarter unless you are selling the exact inventory you wrote down, which means you shouldn’t have written it down to being with.

So, what happens over time is it does come down and you do get a tailwind from that as revenue begins to pick up. So, you get a double tailwind when revenue picks up. You get the tailwind of the E&O beginning to come down to a lower percentage of the mix, as well as the overhead absorption and then as I mentioned, we are expecting some improvement in terms of the products themselves.

Operator

And our next question comes from Ruben Roy from Pacific Crest Securities. Please go ahead.

Ruben Roy – Pacific Crest Securities

Thank you. Hi Scott, you touched on this, but I was wondering – you said you could potentially build fibre channel products in-house. I know Broadcom has been hiring engineers with fibre channel experience over the past year. Just wondering kind of what drove the buy – potentially buy Emulex at this point versus build it in-house. Was it something your customers were pushing you to do and specifically, I was just wondering if this goes entrance recently into the service market it’s accelerating how you are looking at the transition of Fibre Channel over Ethernet? Thank you.

Scott McGregor

Certainly customers have motivated us in this space. They certainly would like to see expertise on Ethernet and fibre channel from the same supplier. One of the challenges, I think, customers face is that today in the market there are people who are really good at fibre channel and then people who are really good at Ethernet and no one who is good at both.

And so this will create Broadcom to be the one supplier that can provide a comprehensive set of products and help customers who deploy fibre channel or deploy Ethernet or want to go to the future of hybrid Fibre Channel over Ethernet. So, that’s we think something that offers a great opportunity for our customers. In terms of why this, why now? We look across all of the different opportunities for Broadcom. We focus on opportunities in the hand, looking at wireless and portable technologies, we focus on opportunities in the living room, and you see a lot of the broadband efforts we do there.

We also believe and are very positive about infrastructure, the enterprise networking space, we believe that’s a great opportunity, will continue to be a good opportunity going forward, and this is a way to strengthen our portfolio in that space. So, a combination of those things, thinking about it from an overall portfolio point of view, we believe this is both an attractive acquisition for Broadcom from a portfolio point of view, but also very attractive for our customers.

Operator

Our next question comes from Mark McKechnie from Broadpoint Securities. Please go ahead.

Mark McKechnie – Broadpoint Securities

Great, no, thanks. On Emulex, I mean it does sound like they’re fighting the takeover a little bit, not quite sure why they are not seeing the same synergies, but I would appreciate if you could try to articulate how hard do you fight here to get this with the Broadcom assets. And the price, I guess I’m starting to hear the synergies, but can you kind of help articulate how it’s super-important strategically or is this just a nice adder to your P&L or how you look at that? Thanks.

Scott McGregor

Well, first of all, I wouldn’t characterize it as a fight. I mean, we made an initial entry into Emulex and we asked their Chairman whether they would be open to a discussion and they basically said, no, the company isn’t for sale and that was the end of the discussion until today, so I wouldn’t characterize it as a fight.

We have amicable personal relationships between the companies and so, we have every reason to hope that this isn’t a fight at all, that this will be something we can work out together and we very much await hearing from the Board of Directors of Emulex on this proposal, and hope to be able to engage with them shortly.

In terms of strategic value, we see the enterprise and service space as a very important area, infrastructure really is the plumbing that makes all the rest of these things we know will not work, I mean we love how our connected living room connects to the Internet and we love the ability to get e-mail and search the web and make phone calls on our new phones.

But we have to remember that it’s the infrastructure that really enables that and Broadcom is the largest player in the infrastructure space. We believe that as video and 3G and 4G and as your living room sort of wakes up, talks to not only all the different devices there, but starts talking across the Internet, so that’s going to drive a lot of bandwidth across infrastructure.

And so for us, we look at what are the things in infrastructure that are going to benefit from this. Certainly, storage and the whole – how do you access data and devices is very important and fibre channel is a very important play in that today in the enterprise space and certainly the large server farms that we have out there.

We see the whole trend towards increased bandwidth on the infrastructure side as something that will play very well with our ability to expand Broadcom’s footprint from just Ethernet, which we have today into Ethernet and fibre channel, broadening our storage opportunities and providing that complete solution to customers. So, it’s very synergistic to what we do, it’s a logical add-on. It’s absolutely strategic for us in the sense that it expands our footprint in infrastructure, which we believe in very strongly going forward.

Operator

And our next question comes from Adam Benjamin from Jefferies. Please go ahead.

Adam Benjamin – Jefferies

Thanks guys. You talked about seeing revenue and units up double digits sequentially for your combo chips. I wonder if you can give some more color as to the number of tier-one OEMs you’d be shipping to, not only for June, but for the rest of the year and material volume, i.e., millions of units, as you move across the rest of the year. Thanks.

Peter Andrew

Yes, and this is Peter. If you look at the combo parts, I assume you’re referring more to our Triple-Play parts of 4325 and the 4329. We will be shipping those parts to multiple tier-one OEMs. I think it’s the quick answer to your question. Do you have another one, if you want to dig into a little bit more? Adam, you are still there?

Operator

He is back in queue. (Operator instructions)

Peter Andrew

Okay. Lorraine, let’s go to the other one and we’ll come back to Adam.

Operator

Adam is back on the line.

Peter Andrew

Okay. Go ahead, Adam.

Adam Benjamin – Jefferies

Thanks. Thanks guys. Just on – you talked a lot on gross margin, but you previously talked about gross margin mix on the 65-nanometer starting at 10% early in the year and finishing 40%. Just wondered if you can give an update on where that stands as we are now in April here and where do you expect that to go? And then more importantly as you look out, are you going to expect to see any benefit the rest of this year from those – from that mix or is it really 2010 as you kind of previously talked about? Thanks.

Eric Brandt

So Adam, I think we said north of 20% exiting the year, but I’ll – I’ll go double check my notes. But we’re north – we were – on a revenue basis, I believe we’re north of 15% in Q1. And as we roll across the year and that increases as a percentage of our mix, we will see a benefit. And the reason we’re going to see a benefit as I mentioned is, there are second and third-generation parts, which are substantially smaller in die-size, providing similar and in some cases, greater functionality than what was being provided before.

So that’s a win-win to the customer in a sense if the BOM price comes down and we are able to hold margin, essentially reduce the cost structure of the chip faster than the ASP decline of the chip. So we expect to see some tailwinds on that on the back part of the year with the sweet spot probably rolling into 2010 as we originally said I believe at your conference.

Operator

Our next question comes from Mahesh Sanganeria from RBC Capital Markets. Please go ahead.

Mahesh Sanganeria – RBC Capital Markets

Thank you. Scott, just some more on Emulex acquisition. It looks like you are making several exception in this case, you usually acquire smaller companies and this time you are going for a much bigger company and Emulex is more of a systems company and rather than chip company. So I would suggest you are – must be really, really convinced that this is a strategically the best way to go. And so, if you can give us little bit more color on that and what options – other options have you looked at the QLogic and why did you choose Emulex over QLogic?

And one more thing I want to figure out also in terms of your portfolio management. Looks like enterprise networking has been lower than what it has – as a percent of the revenue and could it be that you are trying to get your gross margins back up by basically matching all three segments so that you can get the gross margin back to 50% plus?

Scott McGregor

You asked a lot of questions in there, but I think they’re really good ones. So let me hit as many as I can. This is definitely an atypical acquisition for Broadcom. It is our first public company and so, as such it had to pass maybe a higher bar than normal for (inaudible) and is it financially attractive. So these are very important things for us.

When we look at companies for acquisitions, we look at a number of different areas, we look at strategic fit, it’s a good strategic fit, it allows us to participate in the architectural transition to Fibre Channel over Ethernet. And it creates a broad server product line and best-in-class networking solutions for us. We also look at is the team Broadcom quality, we look at competitive advantage, we look at potential synergies, financial criteria, does it enhance revenue growth for us, does it have the opportunity to increase gross margins. And yes, in this case it does increase gross margins.

Some people ask us, well, why would you be interested in a company that has a substantial board business. A lot of people are allergic to board businesses because they think of them as low margin, but Emulex has done a great job creating a very high margin, a high value board business that consolidates a lot of technologies ranging from the chips themselves to the complete solution.

We look at valuation obviously, we look at risks and we look at accretion dilution. This is an accretive investment for us. So we believe financially it’s very attractive. So you asked another question of why Emulex, there were other opportunities? Let me answer that sort of in four or five different areas. Principal technology, Broadcom focuses on Ethernet to date; we certainly have some fibre channel investments we’ve made, but certainly not to the depth of Emulex. Emulex has very, very strong fibre channel resources and combining the two, we think creates really good complementary technologies.

We look at product lines, Broadcom has switches, controllers, processors, and PHYs. Emulex has host bus adapters, embedded fibre channel switches and bridges and what not. The combination of those again, very complementary going forward. We look at our primary customers in this space and there are customers like Cisco and HP and IBM, Dell, ZT, Huawei, those are some of our key customers in the space. Emulex key customers are HP, IBM, EMC, again a very high overlap and complementary value there.

Another interesting thing is sales channel. We are primarily a direct sales channel. Emulex is both direct, but also through distribution. And in particular, they’ve got a very interesting VAR network they’ve created and we see that as a complementary opportunity. Some of it will be the same in that we already talked to some of the same customers. But again it also gives us an opportunity to take Emulex technology through the much broader OEM networks that we have at Broadcom and vice versa, we can take a lot of the Broadcom technology potentially through the VAR channel over the future going forward there.

So again very complementary, we think Emulex fits particularly well in that space and we see there is a positive opportunity for us.

Operator

Our next question comes from Dan Morris from Oppenheimer. Please go ahead.

Dan Morris – Oppenheimer

Thank you. Could you comment on your backlog coverage relative to guidance? And also how would you characterize visibility in terms of returns?

Eric Brandt

Yes, we don’t provide book-to-bill. I would say that certainly there is much better visibility than when we entered into Q1. We say repeatedly that 80% to 90% of what we enter quarter worth is what we shipped, I don’t think that’s changed at all. The interesting thing in every quarter is when you get to what I call pull and push-out season, which is the last three weeks of the quarter.

I think in Q1, we saw probably an equal mix, maybe a little bit more on the pull-in side on Q1, which caused some of the inventory issues I mentioned. But I would say, we are not entering Q2 with any different assumption relative to mix than we’ve had in the past and feel that Q2 has a more of a normal feel than certainly Q1 and Q4 has.

Scott McGregor

One observation on top of that is that a lot of our customers and the channel in general has been trying to lean itself out, meaning to try and get as lean as possible. And one of the things I think we and a number of other companies in our industry are seeing is that when customers start to run low on parts, the ability of the supply chain to respond quickly is hampered a bit. In other words, there isn’t extra inventory of parts lying around for people who have sudden increases in demand. And so, that’s caused some of the expedite situations we see where customers do have successful products and they want more parts and it’s not as easy to supply them on short supply as they request.

Operator

And our next question comes from Ross Seymore from Deutsche Bank. Please go ahead.

Ross Seymore – Deutsche Bank

Hi Eric, just one quick question, a follow-up on the gross margin question I asked earlier. When you mentioned about – a little bit about mix and the enterprise and networking side being the higher gross margin contributor, I’m a little confused if that business dropped as it did the least amount in the first quarter in your segments, why was gross margin impacted negatively on mix and then I guess in the second quarter as well that supposed to become a smaller part of your mix, but yet the gross margin guidance is up because of mix?

Eric Brandt

Okay. So let me answer the Q2 piece first, okay? So relative to the Q2 piece, the benefit we’re seeing in Q2 is principally driven by overhead absorption and I said this mix in E&O that pushes the other way. But the real benefit is the overhead absorption on the quarter. In terms of Q1, it’s really mix relative to what we had anticipated going into the quarter and so it’s off of our what our initial assumptions were, which the networking group is lower than what we had thought when we had done our forecast. There are some other mix issues in other parts of the business, in other business units as well in terms of higher and lower gross margin lines of business. But that’s basically the description.

Operator

Our next question comes from Srini [ph] from CLSA. Please go ahead.

Srini [ph] – CLSA

Thanks, guys. Scott, I guess the combo products seem to be doing really well. My question is obviously you are a dominant player in Wi-Fi, as well as in Bluetooth. And as you move to combos, how much of that is you think is incremental versus some sort of cannibalization? And also, how should we think about the ASP difference between the combo versus in a stand-alone Wi-Fi and Bluetooth? Thank you.

Scott McGregor

Yes, thanks Srini [ph], that’s a good question. I think it depends in different spaces. For example in the Bluetooth space, we’ve seen a move from a stand-alone Bluetooth to Bluetooth plus FM. So in a sense that’s cannibalization, but I would characterize it is very positive cannibalization because we were able to add more value and offer an opportunity for increasing our ASP by offering the addition of Bluetooth plus FM tuner.

In the wireless LAN space, I would say that that’s largely incremental, because it’s primarily going into smartphones and it represents the penetration of wireless LAN into the smartphone space. And so as somebody who has an existing smartphone wants to go beyond Bluetooth and other capabilities and add wireless LAN, it’s very, very compelling for them to do that with a combo chip. And again I think you probably understand this, but the advantage of a combo chip for the customer is smaller footprint, lower power, and very importantly, pre-integrated RF. So they don’t have to worry about the compatibility and co-existence of wireless LAN and Bluetooth. We automatically handle that, we prioritize on a packet-by-packet basis whether it’s asynchronous data or – example streaming music or headphones or whatever.

And I think as we see, smartphones additionally add GPS and wireless LAN, the various combo products we offer are going to become even more attractive because again the more radios you put in the device, the more challenging it is from an engineering point of view to get them all to play nice together. And by pre-integrating a lot of those and having a set of products that pre-integrate the various wireless combinations, we really simplify the task for the handset designer.

We do see a lot of other spaces beginning to pickup for incremental growth. Wireless LAN is moving increasingly into consumer devices. I think Bluetooth moving into consumer devices such as TV sets, other kinds of things we think will be incremental growth.

So I would say there are tremendous opportunities for incremental growth and we don’t view it as a cannibalization thing primarily. The cannibalization we see will likely be where we cannibalize one of our own products with a higher value increased functionality product and so both positive, incremental as well as the increased functionality cannibalization if you will.

Eric Brandt

Yes, and just to add quickly on that, one proved point to that is – I mean probably the best example is wireless LAN. You can see wireless LAN is increasing its market, right? It’s expanding where it’s going. And as a result, for a large business like that in the face of the current economy, it’s one of – it’s one of our businesses that actually grew year-on-year, because it’s penetrating new markets and creating new uses for its product and being the first people there and bring the interoperability has put us in a very nice position.

Scott McGregor

In fact, I’d say wireless LAN is a great candidate for one of the strongest products – product families for us this year. We see wireless LAN growth as a significant growth driver for us in this year.

Operator

(Operator instructions) And our next question comes from Edward Snyder from Charter Equity. Please go ahead.

Edward Snyder – Charter Equity

Thank you very much. I want to go back to wireless if you can a bit here, your product is starting to shift with you no longer to be named main customer in the EDGE platform and that should ramp through the rest of this year and I know you have been – it’s been announced that you will be doing a 3G chip there. What can we expect in terms of the profile from the revenue, margin, and investment point of view? Obviously you’re going to have to put a lot of time and energy and resources into developing a 3G chip for this product.

Should we expect this business as a whole, should be accretive, dilutive to gross margins and from a OpEx point of view versus a revenue, is it something that’s going to be a big driver overall or you see as a cost center for the next year or so before we start getting enough volume that you can either board to other OEMs or just from your main customer to see a net return that’s more positive than what you’re investing?

Scott McGregor

We don’t break out all of the detail you are asking for, but let me try and help you on a few other points. We’ve assembled a very strong team in our cellular area and we believe that that team is adequate to deliver 2G and 3G products to our two primary customers that we’ve announced today.

And so, as such, we wouldn’t expect to ramp that team over the cost of this – over the course of this year and so we wouldn’t expect the cost of that to go up. I mean our goal on our cellular investment at this point is to start getting some leverage on the investments that we’ve made and to see moving towards the return on those.

If we were to get significant new customers or dramatically expand the footprint versus what we’ve talked about, yes, that would possibly entail additional cost, but we would only do so if we saw that we had those design wins and a compelling opportunity there. So I think we’ve got a pretty good discipline and cost model on our cellular space. We do expect that to begin to ramp this year. I wouldn’t set high expectations on a large amount of revenue this year. I think 2010 is where we’re going to see more of the volume ramp in that space and yes, we are looking to see a return on the investments we’ve made there.

Operator

Our next question comes from Quinn Bolton from Needham & Company. Please go ahead.

Quinn Bolton – Needham & Company

Hi, just wanted to clarify one point and then ask about the GPS business. The clarification, it sounds like you’re starting to see replenishment activity in your consumer business, but you’re still seeing de-stocking in the enterprise networking. Is that the right way to be thinking about the two businesses?

Scott McGregor

I guess, I wouldn’t – I would say that the in the enterprise networking space, we are just not seeing a pickup of demand. I don’t think there is an unusual stocking situation there or a lot of inventory in that channel at this point certainly from what we can see. But it’s just that the demand isn’t picking up yet and we attribute that to low corporate enterprise spend.

And generally, when people are doing layoffs at companies or they’re downsizing their companies, they’re not thinking about building new datacenters, okay? And that’s what drives a lot of that growth. Certainly there is replenishment, certainly people do expand on projects and add new capabilities.

One of the things that we do see as an opportunity in the enterprise space is people are replacing older equipment with newer equipment that has as lower power and cooling footprint or where they can get more capabilities in the same rack. And so that’s an opportunity and we do see that going on, because generally the IT organizations can justify that financially within one year, it pays for itself very quickly. Our return on investment is very good. But we just don’t see a pickup in the enterprise space and so that’s why our more muted comments there versus seeing more of a pickup in the wireless space and in the broadband space where we do see a pickup.

Operator

And our next question comes from Gary Mobley from Noble Financial. Please go ahead.

Gary Mobley – Noble Financial

Hi guys, I have a couple of questions for Scott. Emulex has an ecosystem of various ASIC and ASSP vendors that help supply for board and box level solution. Just wondering if you are successful in acquiring Emulex, how that ecosystems impacted? And then my second question relates to MoCA, you didn’t mention MoCA in your prepared comments. I’m just curious, having seen your main competitor in MoCA announced some alliances with different cable MSOs as well as what’s existing at Verizon. Just wondering if that penetration by the competitor is sort of blocking you out for a period of time.

Scott McGregor

Your first question on the Emulex ecosystem, it’s a little premature for us to have sorted all that out yet. We look forward as we get closer to concluding a transaction, we’ll look into that. I mean generally I ascribe to the principal, if it isn’t broken, don’t fix it. So we certainly wouldn’t go in and dramatically change anything if it’s already working well. Obviously overtime, we would look to improve and optimize and so forth. But again, I wouldn’t expect any fast changes in the ecosystem. It’s working pretty well right now. We think we can improve it overtime, but we don’t envision radical changes there.

On MoCA, we didn’t say anything specifically about MoCA, but that doesn’t in anyway diminish our enthusiasm for it. We’ve done really well with MoCA, we’re integrating that into a variety of products, we’ve announced those, we’ve deployed those with customers. We believe that the primary interest for us in MoCA is integrating that capability into a variety of set-top boxes and other devices where they communicate within the home over the cable infrastructure.

And so, all of those different products, whether it’s TV or set-top box or cable modems or other kinds of things, we will deploy that as part of our SSCs there and we’ve had very good success with customers and we believe that we’ll be able to provide a significant part of that market going forward.

Operator

And our next question comes from Steve Smigie from Raymond James. Please go ahead.

Steve Smigie – Raymond James

Great, thank you. I was wondering if you could comment on cash management, post an Emulex deal, is there still plenty of cash for a potential buybacks, other acquisitions, et cetera? Thanks.

Eric Brandt

Yes, absolutely. I mean as you can see, the transaction is in a $800 million range, they have about $300 million in cash. So, we anticipate it uses about $500 million of our net cash off of a balance of nearly $2 billion. That leaves us an extra $1.5 billion plus whatever cash we generate over the course of the year. So this transaction doesn’t substantially change our cash position really at all.

Operator

Our next question comes from Suji De Silva from Kaufman Brothers. Please go ahead.

Suji De Silva – Kaufman Brothers

Hi, good morning, guys. Two questions, one for Scott, perhaps one for Eric. On Emulex Scott, I’m just having trouble seeing the revenue synergies one to two years out, Emulex had the fibre channel assets and you’ve had your C-NIC vision for a while, Ethernet storage over Ethernet. Does Fibre Channel over Ethernet have to kick in for this to work or is there some way that the revenue synergies manifest without that?

The second question is on gross margin. It just sounds like you guys are more excited in the second half about some of the consumer, new products into the holiday season. I’m wondering if that’s the case how gross margin could have sort of an uplift from a mix perspective if that’s the case?

Scott McGregor

I’ll let Eric speak to the gross margin question. But in terms of Emulex on revenue synergies, we don’t see fibre channel as something that happened suddenly. We see that as something that’s going to roll out gradually over the next few years. And so, as such, we aren’t expecting or building into our models dramatic revenue synergies. We believe we can optimize the Emulex existing businesses going forward a little bit, see a little bit of opportunity there as we can introduce them to more customers and take advantage of that.

And likewise, we do see an opportunity for Broadcom products moving forward with their channels. But I think the real key thing for the next few years is that this will enable Broadcom to uniquely be able to go to customers and say, we can cover you completely in fibre channel with the world’s best, most solid, robust technology in fibre channel, we’re already known for having the best Ethernet technology, and together we can create a mixture of those products and satisfy the needs of these enterprise customers where they want to mix and match, maybe migrate slowly or quickly or do whatever.

It enables Broadcom to be the supplier that will work with them regardless of what their strategy is and provide all the solutions they need to know that they’ve got compatible products and a solid set of functionality and a robust and reliable system, which is absolutely critical to those enterprises suppliers.

Eric Brandt

Just on the gross margin question. Remember gross margin is a product of a couple of different things. One being the actual overhead absorption and to the extent that volume and the economy recovers or at least our business recovers consistent with what people are talking about. We pick that up. I think in addition, it’s a product mix and price and with some additional products that are coming, we believe that are more efficient in size will benefit from that.

And then lastly, as we listen to our customers with some hope that the enterprise segment begins to pickup in the back half of the year, we should see some mix benefit on that as well. So I think there are a variety of different things which give us bit of an optimistic view. Certainly the roll-off, if it follows its historic pattern, will give us a tailwind as well to get down to a more normalized level.

Operator

And our next question comes from David Wu from Global Crown Capital. Please go ahead.

David Wu – Global Crown Capital

Yes. Can you help me on two things? Number one is on the gross margin. When these write-offs or perhaps excess and obsolete charges you took in Q1 on enterprise carrier, I assume that if the business comes back, those – you recover those charge-offs so to speak and you get extra gross margin. Is that some of the – some of the push and takes that would help the gross margin in the second half assuming some left in enterprise demand?

The other one I was wondering is for Scott, is really if this Emulex decide to be stay independent and that really doesn’t amount to anything, what’s your backup plan if you – would you do other deals in that areas or do you have a plan that you want to have an offering in – if Fibre over Ethernet and you either it internally or look at other possible deals?

Eric Brandt

Well, with the respect to the gross margin, the E&O reserve is not exclusive to enterprise networking. We’ve taken E&O reserve on a part level and it cuts across all of our business units. So to the extent that combo parts were accelerating in the quarter and we had low inventory and we had pull-ins on combo parts, that doesn’t help E&O. And so, while we have in a variety of different places.

The accounting for E&O, excess and obsolete, as we look at our demand pattern, we can’t see a reasonable demand pattern to sell the parts that are in finished goods that we have on our books at that time, we take a reserve against us. If it turns out later in the year that we are able to sell those parts, because we’ve taken a reserve at the full cost of those parts, those parts essentially sell with zero gross margin, zero cost of goods and a 100% gross margin against them. So one of the things that happens as E&O cycles up and down in down cycle is you do get a headwind as it goes up and then you get a tailwind as it comes down as demand picks up and that’s across the entire business.

Operator

Our next question –

Scott McGregor

On your second question there, you asked about backup plans and stuff like that. Do we have backup plans? Yes of course, we do. Are we open to listening to other deals and opportunities? Of course, we are because we are pragmatic business people. On the other hand, let me be very clear, we are very focused and we are very determined on closing this transaction with Emulex and so that’s where our focus is.

Operator

And our next question comes from David Wong from Wachovia. Please go ahead.

David Wong – Wachovia

Thanks very much. Can you tell us roughly how many DTV units ship a quarter with Broadcom content in them? And then roughly what do you – do you normally get the DTV and what’s the maximum you could get?

Scott McGregor

David, today our market share in the digital TV space is still relatively small. I haven’t seen a good independent researcher like this place or is there anyone really come out some hard numbers on us, but I’ll go back and check and see if I can find anything more there. But in terms of the ASP for digital TVs, I mean remember following the acquisition of the Digital TV assets of AMD, we now have a complete product line ranging anywhere from the low end to the very high end, as well as the panel processor product line. So these solutions for Digital TVs can run anywhere from the mid-to-high single-digit all the way to the high-teens depending on the (inaudible) that the various products have.

Operator

And our next question comes from Alex Gauna from JMP Securities. Please go ahead.

Alex Gauna – JMP Securities

Hi, thank you, Scott. I’m wondering if you’ve seen in the past when communications semiconductor companies including Broadcom has moved into the storage space. Any lessons that can be taken from that that will help you going forward Emulex (inaudible)? And I’m also curious your internal C-NIC and other storage area networking convergence efforts, how large are they relative to what you would be bringing on with Emulex?

Scott McGregor

So on your first question, absolutely, there are lessons that we learned from doing other things before. Both Eric and I have experience doing public company acquisitions and you learn a lot about doing those both how you execute the transaction, but more importantly how you execute the integration afterwards. So a lot of lessons learned there.

Also I think Broadcom has looked at many of these areas in the past and we haven’t always seen the right opportunities. But for us, Emulex, we believe is a great combination for the principal technology. Reasons, product lines, primary customers and sales channel reasons that I mentioned before, so all very positive signs there and I believe the entire Broadcom team will use the depth of its experience both here and elsewhere to make this a very positive transaction.

Eric Brandt

You also had a question about the server exposure for our controller business and actually though [ph] the controller business today the majority of the revenue actually has been for the last couple of quarters is coming from products that we sell on to the server market, so the server market for us today is a very large piece of our total controller revenue.

Operator

And our next question comes from Craig Berger from FBR Capital Markets. Please go ahead.

Craig Berger – FBR Capital Markets

Thanks for taking the follow-up. Can you guys just walk we through what you expect for operating expenses I guess three components, core, legal and stock comp expense?

Eric Brandt

Yes, we –

Craig Berger – FBR Capital Markets

For Q2.

Eric Brandt

Yes we put – we put the guidance on the website. We think the core Broadcom, excluding the legal component, okay, will be flat to up principally driven by the timing of some of the tape-outs and IT spending that I mentioned that we did not spend in Q1.

In terms of headcount expense, et cetera, we actually believe that that will be flat to down in those numbers since we resolved. With respect to legal, we said up 10 to 15, mostly because we cannot anticipate, we’ll project really what the options related expenditures will be and what D&O reimbursement we will receive – we’ll receive some this quarter.

We’d actually received some in Q1 and we’re already received some in Q2. But since we’re on a cash basis, we don’t project that going forward. So I think that covers the core components. We do expect stock-based compensation to come down in Q2 and probably come down across the year as we continue to modify our equity granting practices and migrate that number to a more normalized number in the industry as we discussed on Analyst Day.

Scott McGregor

And Craig, I’ve sort of just remember another data point there is in Q4, remember, we added about 500 people. And so even with that addition of all those people, we’re still keeping a very tight reign in OpEx.

Operator

And I am showing no further questions at this time Mr. Andrew

Peter Andrew

Okay.

Scott McGregor

Okay in closing, I would like to thank everyone for joining us on the call this morning. Before we conclude, I would like to reiterate a few points. In spite of economic environment, our revenue, operating expense and cash flow from operations were in line or better than guidance. Customer orders strengthened throughout the first quarter and we experienced a number of expedite request and continued to see robust growth especially in our wireless combination products and particularly those incorporating wireless LAN.

We see signs that Q1 2009 may be a trough revenue quarter, as our consumer oriented businesses in the broadband and mobile and wireless end markets are showing signs of recovery. We remain prepare to address further deterioration in the broader economic environment should it appear.

The proposed acquisition of Emulex will help Broadcom accelerate our network convergence and it’s immediately accretive to gross margin and EPS on a cash basis on the conclusion of the transaction. We continue to believe that Broadcom is well positioned in the economic downturn. We have truly integrated product offerings and a scalable business model. As a result, we see this economic slowdown as a longer-term opportunity to emerge in an even stronger position at the end of the down cycle.

Thank you very much and have a good day.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. Thank you for participating. You may now disconnect.

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Source: Broadcom Corporation Q1 2009 Earnings Call Transcript
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