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Broadcom Corporation (NASDAQ:BRCM)

Q3 2013 Earnings Call

October 22, 2013 4:45 p.m. ET

Executives

Chris Zegarelli - Senior Director, IR

Scott McGregor - President and CEO

Eric Brandt – EVP and CFO

Analysts

Joe Moore - Morgan Stanley

Ross Seymore - Deutsche Bank

Harlan Sur - JPMorgan

Stacy Rasgon – Sanford C. Bernstein

John Pitzer - Credit Suisse

Srini Pajjuri - CLSA Securities

Mark Lipacis - Jefferies

Samuel Meehan - Citi

Craig Ellis - B. Riley

Ruben Roy - Mizuho Securities

Kevin Cassidy - Stifel

Patrick Wang - Evercore

David Wong - Wells Fargo

Doug Freedman – RBC Capital Markets

Christopher Rolland – FBR Capital Markets

Alex Gauna - JMP Securities

Brian Nugent - William Blair

Operator

Welcome to the Broadcom Quarter Three 2013 Earnings Call. My name is Sharon and I will be your operator for today's call. (Operator instructions) Please note this conference is being recorded.

I will now turn the call over to Chris Zegarelli. Chris, you may begin.

Chris Zegarelli

Thank you very much, and good afternoon everyone. Today's call will include prepared remarks by Scott McGregor, our President and Chief Executive Officer; and Eric Brandt, our Executive Vice President and Chief Financial Officer.

This call will include forward-looking statements which are subject to risks and uncertainties that could cause Broadcom's results to differ materially and adversely from management's current expectations. We encourage you to review the cautionary statements and risk factors contained in the earnings release, which was furnished with the SEC today and is available on our website and in our 2012 Annual Report on Form 10-K. We undertake no obligation to revise or update publicly any forward-looking statements to reflect future events or circumstances.

Additionally, throughout this call, we will be discussing certain non-GAAP financial measures. Today's earnings release and the related current report on Form 8-K describe the differences between our non-GAAP and GAAP reporting and present a reconciliation between the two for the periods reported in the release. Please also see the Investors section of our website at www.broadcom.com/investors for a slide deck that includes additional information disclosed in accordance with SEC Regulation G.

Now it is my pleasure to introduce Broadcom's President and Chief Executive Officer, Scott McGregor.

Scott McGregor

Good afternoon and thanks for joining us. On today’s call, we’ll discuss Broadcom’s results for the September quarter. We’ll also talk about long term trends in the business and some near-term headwinds for which we are taking actions to lower our expense growth.

For the quarter, Broadcom delivered better than expected results across the board. Revenue came in at $2.15 billion, ahead of Wall Street consensus. Gross margins were stronger than expected. Operating expenses came in below guidance.

Resulting GAAP and non-GAAP EPS exceeded consensus by $0.15 and $0.07 respectively. Looking at the Q4, we see some near term headwinds to sequential growth, including softness in wireless connectivity, intense competition for M3G platforms without our 4G LTE revenue until 2014, softness in broadband access and roughly seasonal decline in our infrastructure business. While these trends affect the near term outlook, Broadcom has multiple paths for growth in 2014, including LTE in early 2014, continued strength in data center, 5G Wi-Fi and multiple technology transitions that are broadband proven. I’ll go into each of these items in more detail later in the call. But I first like to turn the call over to Eric for details on the third quarter results and fourth quarter guidance.

Eric Brandt

Thanks Scott. As Chris mentioned, please refer to the data breakout in Investors section of our website for additional information that will supplement my financial commentary.

Moving to the financial overview. To summarize, total revenue came in at $2.15 billion, up 2.7% sequentially and up 0.8% year-over-year. Excluding Qualcomm royalties which ended in Q2, product revenue was up 4.8% from 2.9% respectively. Q3 non-GAAP product gross margin was up 150 basis points from Q2 to 53.6%. Q3 GAAP product gross margin was 51.4%.

Q3 non-GAAP R&D plus SG&A expenses were up $8 million sequentially while GAAP R&D plus SG&A expenses were down $3 million. Q3 non-GAAP EPS was $0.76 or $0.07 above first call consensus of $0.69 per share. Q3 GAAP EPS was $0.55, which included $0.03 of acquisition related and restructuring charges, a settlement gain and a charitable contribution. Cash flow from operations for Q3 was $672 million. Our cash and marketable securities balance at the end of the quarter was $4.34 billion.

Moving to revenue and gross margin. In September, we guided our – we updated our guided range for Q3 product revenue to between $2.075 billion and $2.175 billion. We delivered revenue slightly above the mid-point of that range of $2.15 billion. Our Broadband Communication segment was roughly flat sequentially from Q2 consistent with our expectations at $567 million.

Revenue from our Infrastructure and Networking segment came in meaningfully ahead of expectation and increased 11% sequentially to $564 million, driven by continued strength in Ethernet switches and PHYs across all major markets.

Our Mobile and Wireless segment increased 5% sequentially to $1.02 billion, driven primarily by stronger than anticipated sales of our cellular SOCs and other technologies including touch controllers.

Our Q3 non-GAAP product gross margin came in ahead of revised expectation was up 150 basis points from Q2 to 53.6%. Gross margin benefited from both stronger than expected mix and higher than expected decreases in excess and obsolete inventory.

Our Q3 GAAP product gross margin was up from Q2 to 51.4%. As discussed on last quarter’s call, product gross margins now include ongoing and recurring licensing revenue, which added roughly 20 basis points to the product gross margin calculations in Q3, which is relatively consistent with prior periods.

Moving to operating expenses, total non-GAAP R&D and SG&A expenses for Q3 were up $8 million from Q2 levels, which is meaningfully below the updated guided range provided in September driven by lower than anticipated accruals for incentive compensation and lower [mask] and related development spending. On a GAAP basis, R&D and SG&A expenses for Q3 were down $3 million from Q2 levels.

Moving to restructuring costs. During the quarter we initiated a global restructuring plan and recorded restructuring costs of $12 million. We put this plan in place to reduce expenses while investing in areas of strategic focus.

The restructuring impacts roughly 1,150 employees split roughly into third, Renesas, Broadcom baseband and other efficiencies. We anticipate that we will record approximately $20 million in restructuring charges in Q4. For further discussion please see our 10-Q that we anticipate filing today.

Moving to the balance sheet, cash and marketable securities ended Q3 at $4.3 billion. This reflects cash flow from operations of $672 million, our dividend payment of $63 million and stock repurchases of $378 million in the quarter. We ended the quarter with $2.1 billion in U.S. cash, down roughly $280 million from the prior quarter.

Our accounts receivable day sales outstanding were 36 days in Q3. In addition, net inventory turns were 7.7 in Q3. During the quarter we repurchased 14 million shares bringing total repurchases year-to-date to 20 shares well ahead of our target for the year.

Moving to expectations, we currently expect net revenue in Q4 to be $1.79 billion to $1.975 billion plus or minus 3%. From a segment perspective, we expect all segments to be down with ING down less than the other segments.

We expect Q4 GAAP and non-GAAP product gross margin to be down roughly 50 to 100 basis points, driven principally by the non-recurrence of the non-standard cost benefits reported in Q3 and lower absorption. In addition we expect non-GAAP and GAAP R&D and SG&A expenses in Q4 to be up $40 million to $60 million.

Recall that when we announced the acquisition of Renesas’ LTE assets, we expect us to take on an incremental $75 million of operating expenses in Q4. Due to executing on synergies between the teams sooner than anticipated we now expect that incremental operating expenses related to the Renesas transaction will be closer to $65 million in Q4.

Given the overall guidance for non-GAAP R&D and SG&A expenses into Q4, this means that core organic expenses are expected to be down sequentially by roughly $15 million in Q4.

And now I’d like to turn the call back over to Scott to talk more about the state of the business.

Scott McGregor

Thanks, Eric. Starting with the home platform, our Broadband Communications revenue came in consistent with our expectations at $567 million, roughly flat sequentially. Looking into Q4, we expect our Broadband business to be down sequentially driven principally by our access business.

Set top box continues to be a key driver of growth for our Broadband business. In developed markets, we see increasing content driven by transcoding, MoCA, and HEVC which is the key enabler for ultra HD. In developing countries, we continue to gain share. For example, we've seen good traction with multi-choice on a terrestrial set to[inaudible]p box offering as being deployed throughout Africa and we continue to see strength across the BRIC countries.

The combination of our unparalleled IP portfolio, best in class and broad scale to support customers around the globe continues to cement our leadership position in this dynamic market. We continue to see meaningful design traction in broadband access. In PON, we're seeing accelerating revenue growth in the second half of 2013 and we've reached production with our latest multi-PON CPE solution.

We also continue to lead the industry to videocell and vectoring and expect to see continued growth from these technologies as service providers upgrade infrastructure and deploy the latest gateway platforms to subscribers. Looking forward, we expect new technologies such as DOCSIS 3.1 and G.fast to set the stage for future growth. Moving to infrastructure, we saw a recent strength continue with the September quarter with revenue up roughly 11% sequentially to $564 million.

To strengthen the quarter was broad-based with all major in-marks showing sequential growth. As we look into Q4, we expect our infrastructure and networking business to be down slightly sequentially but up double digits year-over-year. Our data center business continues to be an outstanding driver of growth. This segment grew an excess of 20% year-over-year in 2012 and is on track to grow more than 20% again in 2013.

This growth is being driven primarily by our leadership in high density Ethernet switch particularly our Trident series of switches. Our latest generation Trident II is now in volume production and sets the stage for continued momentum for this business growing into next year. Our service provider business continues to grow in Q3 driven by our customers fulfilling tender activity across multiple carriers.

We also continue to see progress in emerging growth areas, for example BMW is now in production with our broader reach technology in the BMW 2014 X5. Moving to our hand platform, our mobile and wireless revenue came in at $1.02 billion, up more than 5% from Q2. Sequential growth was driven by a better-than-expected sales of 3G cellular SOCs and solid growth in the sales of touch controllers.

Looking into Q4, we see mobile and wireless revenues down sequentially driven by a continued customer inventory adjustments and near-term product mix. Our wireless connectivity sales came in roughly flat sequentially driven by channel inventory correction and mix. We saw a growth in Wi-Fi combo sales and NFC offset by declines in discreet connectivity.

In Wi-Fi combos, we saw almost 15% sequential growth in units, but a mixed shift towards 802.11n due largely to the launch of a new leading Smartphone. We believe this mixed shift is short term and that our customers remain firmly committed to 5G Wi-Fi over the longer term making that a growth driver for us into 2014. Our wireless connectivity strategy is the focus on technology leadership targeting the leading edge devices and new market segments.

As the case in point, the competitive analysis of our 5G Wi-Fi versus the competitor's 802.11ac solution show that Broadcom's solution delivered up to twice the data rate. This level of unmatched performance has kept Broadcom's connectivity as the solution of choice for high-end devices. We also announced targeted 5G Wi-Fi combos for the automotive entertainment market.

In low cost and mid-tier devices, we see customers increasingly leverage complete platform solutions. Our strategy here centers on the complete Broadcom cellular platform which includes the base stand, RF, connectivity and power management. We accelerated our expected 4G market entry with the acquisition of LTE-related access from Renesas which closed earlier this month.

The dual core multi-mode Cat 4 SoC from Renesas will enable us to sell the complete 4G platform to customers in early 2014. Our goal is to introduce a quad core LTE platform next year and the driver LTE technology toward the leadership platform to enable us to cover the complete spectrum of LTE devices.

In summary, since we're seeing some softness in the business towards the end of this year, we're taking the difficult position necessary to tightly manage our cost structure. Broadcom remains positioned for long-term success. We're poised to gain share in 4G LTE starting in early 2014. We expect the penetration of 5G Wi-Fi to continue to grow in 2014. We're at the very early stages of an industry transition to HEVC and ultra HD in our broadband division.

And we continue to see growth in our data center that contributed to our infrastructure business growing double digits in 2013.

This concludes our prepared remarks and we are now ready for your questions. Sharon, may we have the first question please.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from Joe Moore of Morgan Stanley.

Joe Moore - Morgan Stanley

Great. Thank you. I wonder if you could qualify some of the factors that you talked about in mobile and wireless in the fourth quarter, maybe on year-over-year basis, it looks like you are tracking down year-over-year. How much of that is sort of combo pricing and maybe give us some idea of leveling pricing year-on-year and then also how much of that is baseband?

Scott McGregor

Well, pricing is actually holding up relatively well. We’re seeing less ASP decline this year than in previous years. So that’s not so much a factor. I think one other thing we are seeing is that the growth of smartphones particularly in the low-end is growing faster than the growth of smartphones in the high-end where we have proportionally high share.

So that’s one of the factors I think in the overall numbers there. Particularly in China we’re seeing a platform approach where we are neither able to get a stronger connectivity penetration in another markets.

Joe Moore - Morgan Stanley

Okay. Thank you. And then, in terms of Renesas timing, you said early next year, is that still, is that potentially Q1 or once I know, you said by early Q2 at latest and then what is status of the quad-core chip from Renesas?

Scott McGregor

So we’ve said early next year, we haven’t change that, early next year is January to April, in my view first part of the year and we are on track with that. And in terms of the quad-core we do expect to have that out and we do expect to get revenue for the quad-core next year as well.

Joe Moore - Morgan Stanley

Great. Thank you.

Operator

Thank you. And then our next question comes from Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank

Hi, guys. Going again into the wireless side of things, Scott, you mentioned two things, I wanted to get some more color on. One in inventory adjustment, anymore color on that? And then two, you mentioned one customer going to the end generation or sticking with it rather than going to AC. I think that customer made that same decision today in their tablet strategy? So can you talk a little bit about what you believe is behind that and what you can do to get them up or others up to AC? Thank you.

Scott McGregor

So in terms of the inventory question, I think you saw that we shipped a little more than we expected on basebands in Q3 and I think there’s a little bit of an inventory build in that. We also have a large customer who typically does it pretty significant inventory correction or inventory adjustment in the fourth quarter to exit the year with very low inventory and so we believe that’s a factor in our Q4 numbers.

I can’t comment on particular numbers but I did comment that we do believe that 5G WiFi will be a growth driver and I expect our unit counts to grow into next year on that, so it should be growth driver for us overall in the business.

Ross Seymore - Deutsche Bank

And then one clarification for, Eric, now that the Renesas cost is $65 million instead of $75 million, any sort of update as far as how we flow the cost in and timing of accretion, et cetera for 2014 as a whole?

Eric Brandt

No change to what we said prior. I would remind you that obviously Q1 has that normal fringe and merit step up that we see, and that number runs, including stock base comp $45 million to $55 million. But relative to the Renesas plan I believe we’re on track to get to the point what I talked about earlier up $30 million a quarter as we exit 2014.

Operator

Thank you. And then our next question comes from Harlan Sur of JPMorgan.

Harlan Sur - JPMorgan

Great. Good afternoon. Thanks for taking my question. In Broadband, if recall last year your business would have been up sequentially in Q4 if it went for the ramp down of your DTV and Blu-ray business? I know this year you mentioned Broadband access as an area of weakness, is the weakness more PON related, is it DSO related or cable modem driven, is it an inventory correction, is it pricing, is it demand related, any color here would be helpful and then I have a follow up?

Scott McGregor

In the overall Broadband business, we are definitely seeing us strengthen the business relative to peers. So while the growth of that business isn’t as strong as we would like, we are definitely believe we are gaining share as m any of our peers are falling off there. I did mention how we're seeing strength in the PON space and so the softness is in the rest of the access business. We're just not seeing the strength there. As to whether it's inventory or share or just softness in demand, we're not sure yet on that and we'll see how that develops. But we've got some new products coming out in that space and we're going to see if we can try to drive a little more sales there.

Harlan Sur - JPMorgan

Great. And then the Renesas team already had an ongoing dialogue with a number of Tier-one smartphone customers. I think, Scott, you mentioned you're still on track to see LTE revenues early next year. So is it fair to assume that the Broadcom-Renesas team has been able to convert the customer interest sort of pre-acquisition into design wins (inaudible) acquisition and would this be design wins with multiple Smartphone customers?

Scott McGregor 

Good question, and we'll definitely cover that more at Analysts Day coming up. I would give you more visibility on our overall LTE plan, some milestones, where we are with some customers, and progress on development. So we're planning to share a bit more with you at Analysts Day. I think for the main point of your question though, you can probably assume that it is in a cold start with the Renesas team and that we're able to leverage a lot of what they were able to do in ongoing conversations with discussions that they had and translate that into revenue in early 2014.

Harlan Sur - JPMorgan

Great. Thank you.

Operator

Thank you. Our next question comes from Stacy Rasgon of Sanford C. Bernstein.

Stacy Rasgon – Sanford C. Bernstein

Hi, guys. Thanks for taking my questions. I wanted to dig into the restructuring a little bit. Can you give us a trajectory of how big are the savings going to be, how are they going to ramp in I guess through Q4 and into 2014, what does this further restructuring cost look like? I mean it sounded like you were still guiding effectively OpEx up in the first quarter due to fringe, but I would expect it to be coming down as that cost comes out. So any sort of call you can give us on how we should be modelling the trajectory of those restructuring savings going through the income statement over the next few quarters would be very helpful.

Scott McGregor

So Stacy, first on the $12 million versus $20 million, the $12 million that booked reflects the other efficiencies that I mentioned, roughly about one-third of the 1,100 heads, 750 people that I mentioned that is part of Broadcom. This decision was made in Q3, the remaining $20 million due to accounting in terms of it being contingent upon the completion of the Renesas transaction. And then ultimately the synergization, if you will, of the two teams, that's why that happened in Q4 because it was a contingent decision on the closing of this transaction.

The first $12 million, you'll see in the Q, that we anticipate reduction in growth of expenses in the vicinity of about $50 million in next year. On Analysts Day, I'll put the pieces together in terms of how they come together. But you've got sort of a wrap of expenses that we've added during the course of this year. You've got the fringe and merit set-up that normally happens that wouldn't show up in the current run rate.

You've actually got a benefit on the Renesas cost coming down across the rest of the year in inflation. Net, net, net, it's going to be pretty tight. So the right way to think about it is probably to start working off the run rate, add the fringe and a little bit of inflation, and we'll manage pretty tightly. But I'll provide more clarity on that on Analysts Day.

Stacy Rasgon – Sanford C. Bernstein

So are you telling us that OpEx in 2014 is not going to be down from 2013 even though you're taking out 1,150 heads?

Scott McGregor

I do not believe it will be down year-over-year, no, because remember the way that you got to think about it is take the number that we're running at even in Q3, let alone Q4. And if you take the Renesas cost which are at $65 million in Q4, assume they ramped down, let's just pick an average of a round number of $50 million, that number multiplied by four, it would be $200 million of costs next year just associated with the Renesas transaction that we've got. So again, I'll provide more details on that on Analysts Day.

Stacy Rasgon – Sanford C. Bernstein

But the Renesas cost is supposed to cut in half anyway by the end of next year. When are you supposed to reach – you're supposed to take half that cost out.

Scott McGregor

So if you take $65 million to $30 million, okay so it's $45 million.

Stacy Rasgon – Sanford C. Bernstein

Got it.

Scott McGregor

If you got about 1,200 people over from Renesas, and so that's the number we started with. And then the reductions that we made take that number down.

Operator

Thank you. Our next question comes from Srini Pajjuri of CLSA Securities.

Srini Pajjuri - CLSA Securities

Thank you, Scott. What kind of visibility do you have into your design wins and connectivity and how should we think about your market share as we look into the next 6 to 12 months?

Scott McGregor

I think we have good visibility into the major phones out there, certainly over a six-month period and it declines after that. But generally, we believe that our connectivity portfolio remains quite strong. I think we have more challenges with the platform designs of competitors in the lower end space that I mentioned particularly in China where we don’t have as much visibility or as much ability to penetrate those.

Certainly that’s been the fastest growing part of the market in last quarter or so. And so that’s I think where we have more challenge in the market. But at the high end, I think we continue to see very good technology and strength. And we believe we’ve got a good line of sight to win the majority of those sockets going forward.

Srini Pajjuri - CLSA Securities

Okay. And then as a follow-up to that China comment, obviously you’re focusing a lot on the high end in LTE on the Baseband side. And then 3G, I’m not sure what’s your progress so far in China but do you think you can make sustainable profitability in this business without being a part of that whole China and 3G market because that’s a fairly big market today, even if some of the market goes to LTE, I think that will remain a fairly big market. So I guess, my question do you have enough confidence that you will get enough share in LTE to purchase further investments?

Scott McGregor

I agree with you on the importance of China market. And our strategy in China is to initially go for Chinese handset makers for their export market. So some of them -- a good example is ZTE do a substantial part of their business exporting phones from China to the rest of the world and making them in fact, one of the top phone makers for the United States in terms of overall device shift.

And so we’ll initially focus on the export market for Chinese makers. And then as our platform continues to mature and expand then we’ll go more for the Chinese indigenous market. So that’s our strategy in China and we believe that China will be an important platform for us and market for us going forward.

Srini Pajjuri - CLSA Securities

Thank you.

Operator

Thank you. And our next question is from John Pitzer of Credit Suisse.

John Pitzer - Credit Suisse

Good afternoon guys. Thanks for letting me ask the questions. Scott, my first question, I think in your prepared comments, you talked about a competitive pricing environment for 3G. I wonder if you could elaborate a little bit. Is that transitory? Do you think it’s just part of what of where we are in the life cycle and importantly as we move to LTE except for the fact that you guys might have second mover advantage, why shouldn’t we expect that to be as competitive environment overtime as this 3G market has become?

Scott McGregor

So the competitive and pricing environment on 3G is fairly ferocious. And I think people are pricing aggressively to win share there. And that’s certainly has contributed to some of the softer top line we’ve seen. And I think you’re going to see that show up for other players in the market as well as that’s not limited to us. That’s across the market at this point.

Good question. This also applies to LTE. I think to some extent it will and so that’s why it’s important to do a number of things. One, it’s important to have a broad range of LTE products. I think it’s going to be more significant price pressure in the low end of LTE where there are more competitors. And I think towards the higher end of LTE, we don’t see as many competitors. In fact, there may only be two or three players in that market. And so I think that will do -- that will fare better than the low end part of LTE.

The other significant thing that we’ve done is part of our reason for acquiring the Renesas team and the modem that they did is that it has a very small die size. And so I think it gives us certainly a better competitive position than we had with our original modem which was focused on some other areas. But they’ve done a great job in terms of creating a small die size. And if you do believe, it’s going to be a challenging pricing environment in LTE having a small die size is very important and taking advantage of the fact that this team has been working on that for many, many years.

It’s not their first generation LTE. They have had lot of time to tune that and optimize that for die size which I think is going to translate into cost advantages for us in that space. And I think some of our competitors are not going to share.

John Pitzer - Credit Suisse

That’s all for Scott. And then Eric in my follow-up, I just want to make sure I understand the genesis of the restructuring. It sounds like kind of a natural action that you are taking relative to the Renesas acquisition and not necessarily a change in view of the markets you addressed or your structural position. One, is that correct? And if it is, given the considerable investment you guys are making in Baseband now, what kind of profitability milestones you would be thinking about before just potentially other kinds of cost structure or restructuring actions you can take?

Scott McGregor 

John, there is no question that there is part of this which is the synergizing of the two teams between the Broadcom-Baseband team and the Renesas team. And then what we did is, as we normally do over the course of the year, is we went through an analysis of our business and tried to refocus our resources where we thought made the most sense, and that's the last third.

In terms of the profitability of the business, the way to think about it, right there, is there's the large investment in cellular which adds healthy new ramps you get meaningful leverage on the back of that. And we should see that over the course of next year. But if you look at the other two businesses, and this is sort of the reason why we cut as little as we did in the other parts of the business, if you look at the profitability of broadband and ING, they're near record highs in terms of their profitability.

So the strength of those businesses would suggest that there is a meaningful cut in terms of driving additional profitability you'd want to do in those two businesses. And so that's how we've decided what to do and how we've put those pieces together.

Unidentified Analyst

Thank you, guys. I appreciate it.

Operator

At this time, we're asking everyone to limit themselves to one question. Our next question comes from Jim Schneider of Goldman Sachs.

Jim Shneider – Goldman Sachs

Good afternoon. Thanks for taking my question. I was wondering if you could give us some color on your expectations for Q4 in terms of customer inventory levels on the wireless side. Specifically, are you expecting all the customer inventory reductions to be done on both the combo and Baseband side? And then do you expect combo or Baseband to be down more?

Unidentified Participant

Jim, I think we've got it as we see it. I mentioned that there's one of our customers who traditionally tries to execute four with a very low inventory, and that's a factor. And I believe across some of our large customers, there may be some inventory build-up in some of their models. And so it's a combination of those factors that are really driving it there into Q4.

To the extent it is inventory, we think that results in Q4. To the extent it's really demand manifesting this inventory, that could linger into Q1. But for now we believe certainly that one effect of the one customer is truly in inventory are effective than closing their year. And the rest, we'll see if that sorts out in terms of demand versus inventory. But to a large extent, we believe that that's inventory-related.

Jim Shneider – Goldman Sachs

Thank you.

Operator

Our next question is from Vivek Arya of Bank of America Merrill Lynch.

Vivek Arya – Bank of America Merrill Lynch

Thanks for taking my question. Scott, I have a longer than strategic question. From what we can see, it's clear that the wireless segment, you're seeing a very sharp deceleration in growth, a lot of concentration risk, lower pricing, high competition. At what point will Broadcom make a decision whether it makes strategic sense to stay in wireless or to just focus on broadband and infrastructure segment where your profitability is 2x to 3x what your leverage have derived in the wireless segment. Why should 2014 in wireless be any better than what we saw this year? Thank you.

Scott McGregor

Broadcom is committed to the wireless segment. We believe we've got a number of things working in our favour for next year. You'll see the deployment for our LTE solutions which we've been working on for a long time here and really trying to make that come to pass. One of the side benefits of launching our LTE products is that it'll allow us to reclaim some share in the connectivity side as some of the LTE products we wean back will have connectivity that goes along with it. So that should be a helpful factor for our connectivity share as well as that LTE business growth.

We also believe our connectivity business, all by itself, has a number of interesting areas that I think are going to help drive growth. One is we do believe that customers are committed to 5G Wi-Fi going into next year. And so that has an advantage of an ASP increase into existing or successor model, and so it should drive dollar count up on that business and give us some strength there.

We also see a number of other emerging markets. Automotive is one where we launched a series of products now for the automotive entertainment market and believe we've really got a competitive product there that should get a very large share. And we also see emergence of other markets such as wearables [ph] and other things. So long term, I believe this business is pretty vibrant and yet there is some near term headwinds. But we believe we’ve got some good things going on next year and we’ll share more about some of those specifically at Analyst Day. So you can get a sense of some of the milestones that we look at for tracking our success in this business and give you a little more comfort that we are on track here.

Operator

Thank you. And then our next question comes from Mark Lipacis of Jefferies.

Mark Lipacis - Jefferies

Thanks for taking my question. Question for Eric. Actually, Eric I looked up the word synergization in the Merriam-Webster online dictionary. It’s not there by the way. But I believe if we write about it you can get put into the next version. Question on the gross margins, can you remind us where the historical target for your gross margins are? Seems like these are higher than your historical targets and Eric, you’ve made the argument in the past that the industry is trending towards higher R&D intensity and that necessarily should lead to higher gross margins for the industry. I’m wondering if this is where you guys are at right now. Thank you.

Eric Brandt

Yeah. Mark, we have trended up. We were probably before the NetLogic acquisition, running in the 50, 51s range. We’ve moved up into the 52s after we did the acquisition. And I think this year, with the added strength of some of the other businesses on the infrastructure side as we said we’ve sort of augmented our high gross margin businesses. We’ve moved up into the 53 range. I think it’s too early to call that we’ve changed the growth margin of the company.

I mean part of this was strategically to create a gross margin lift as we ramped significantly on the wireless side. I think as the wireless ramps certainly on the base stand has been a little slower than we anticipated, we’ve actually seen the benefit of that gross margin strategy actually playing through the P&L. So, I don’t think that it changes things.

In terms of R&D intensity, certainly in the markets where we have differentiated products, we are seeing strength in gross margin. We are seeing strength in gross margin. On the broadband side of things, we are seeing strength in gross margin just on mix as we see good growth on the infrastructure side. And to the expense of that process, I think we could see some favorability in gross margins.

Operator

Thank you. And then our next question is from Ambrish Srivastava of BMO.

Unidentified Analyst

Hi. This is Gabriel calling in for Ambrish. Thanks for taking my question. I actually have a follow-up on the connectivity on the ac. Can you remind us what the ASP increase versus [NAND] and also given the decline -- year-over-year decline, what gives you confidence that your connectivity business will grow?

Scott McGregor

So, we don’t give specific ASPs for our different businesses. But the ac business, the ac products have a pretty significant ASP adder versus the end product. And by the way, they are different flavors of all of these. There is one by one, two by two and so it really depends on the number of channels as well on these products.

In terms of why do we believe our connectivity business will grow next year, I think one of the biggest factors is going to be the increased penetration of 5G WiFi into next year in terms of adding ASP increase for a larger piece of the smartphone market. We think that’s going to be one of the big growth drivers for that market.

Operator

Thank you. And then our next question comes from Glen Yeung of Citi.

Samuel Meehan - Citi

Thank you. This is Samuel Meehan on behalf of Glen. If we can revisit the inventory adjustment in this once smartphone customer, was wondering if you get the sense that this customer is pushing out their flagship builds or you think they are working through inventory because they are seeing weakness in a particular segment of the market.

Scott McGregor

That’s a bit hard for us to judge and we don’t comment on specific customers. But it is traditional for that customer to cutback inventory in the fourth quarter, beyond that I can’t comment.

Operator

Thank you. And our next question comes from Craig Ellis of Riley.

Craig Ellis - B. Riley

Hi. That’s Craig Ellis from B. Riley. Thanks for taking the question. A quarter ago you had indicated that you thought baseband would return to sustainable growth in the second half of next year. With the Renaissance Technology acquisition and the traction that you are seeing on the product side there, has that changed and related to that when do you think mobile and wireless will return to year-on-year growth?

Scott McGregor

I think the 3G business is a little bit odd for us to predict. It’s going to depend a bit on exactly the sales of models and what not. We do have some quad designs coming out and some new customers to talk about, over the course of the next couple of quarters. And so some things will happen there but the 4G business is really the growth vector for us there and we do see 4G growing from basically zero to we believe material business for us over the course of next year. And again based on designs and the products that we talked about.

Operator

And then our next question comes from Chris Cathill [ph] of Next Financial.

Unidentified Analyst

So just a bit of a longer term strategic question and I guess do you feel that your continued success in connectivity requires you to be successful in base band. You talked about some of the bundling that your competitors are doing on the low end. They are obviously trying to move that higher up in the stack. Does that require you to be successful in baseband and to defend the connectivity business?

Scott McGregor

I would say the business is definitely synergistic. To the extent that we have a baseband business, every time we sell a baseband there is about 100% chance that we win the connectivity. And if we don’t win the baseband and somebody else wins it, it ranges – our chances to win are sometimes good, sometimes weaker. In the lower end part of the market, we have less of an opportunity to win the connectivity, because a lot of our technological differentiation that doesn’t apply and they’re just looking for a low cost solution, or they just want to go with the easy path of using the platform supplied by the baseband provider.

In the higher end space, where differentiation and quality and technology is more important, we have an increasing, as you go up in the market, opportunity to win on the connectivity business. If we didn’t have baseband at all, hypothetically we would still have a strong connectivity business, although it would impact our ability to win some of that platform sale in the more mid-range where we believe the baseband opportunity will give us a connectivity opportunity as well.

Operator

And then our next question comes from Timothy Arcuri with Cowen & Company.

Timothy Arcuri – Cowen & Company

Just questions, Scott, on 5G WiFi, what’s going to be the tipping point next year because certainly the big customer did not adopt this for the phones or for the iPad. So what’s going to be the thing that pushes the industry to really adopt it more next year?

Scott McGregor

I can’t comment on specific customers which I think is the gist of your question. But we do believe that the 5G market will continue to expand. We believe the 5G WiFi technology is very compelling. It’s twice the performance, it’s significantly better range and it’s lower power. In many of these devices, power is an important consideration if you look at tools for bit transmitted, the 5G WiFi is significantly more efficient for that. So it may use more power per second bit of tone but it uses less power per bit transmitted. And so that’s a valuable feature as well. So it’s compelling across all fronts and we believe over time we will see additional customer adoption of that and we believe that’s a driver for us over the course of next year.

Operator

And our next question comes from Steven Chen of UBS.

Steven Chen – UBS

First one is on related to the headcount reduction you guys announced today. In terms of the reductions on number of the Broadcom size [indiscernible], how does that affect your ability to execute in terms of producing new products, different variants for different markets and also your ability to potentially address your customer schedules if they see a lot of interest towards your products?

Scott McGregor

So net-net it helps us. I think you should view our acquisition of Renesas as acquiring a complete second team that works in the baseband space. And the synergization of those two teams puts us in a better stead because I think we are able to pick the best of both teams, we are able to choose one modem product. So we don’t have to merge architectures or anything like that. We just chose one of the two and went forward with it. And so I believe it puts us in better stead in order to deliver customers the products earlier than we would have had we had stayed our course and speed as of prior to the Renesas acquisition.

Operator

Our next question comes from Ruben Roy of Mizuho Securities.

Ruben Roy - Mizuho Securities

Yes. Thanks. Scott, sorry if I missed this on the infrastructure side but the decline in Q4, would you say that, that’s a seasonal decline. I know it’s going to be down slightly but you had a nice quarter on the Ethernet side in Q3, so is this just sort of a normalization there. And then also in terms of service provider, can you give us a rough idea of how much that was up this year and where you are exposed in the service provider market and what your outlook is for next year? Thank you.

Scott McGregor

I would characterize the infrastructure decline in Q4 as purely seasonal. We had a great Q3 and so a little bit of decline there, I don’t see as anything worrisome and view that as seasonal. In terms of the breakout of our business that you probably know we’re about 40% service provider and 30% data center and enterprise each. The service provider business was up over the course of this year -- year-over-year and the data center though was up strong, very strongly.

That was up 20% last year and again 20% up year-to-date this year. So very, very excellent strength in the data center and the Tridents which is for example being one of the key drivers of that. I think the softer spot is the enterprise in SMB market. And I believe that were more macro related. That’s flat or slightly down year-over-year and so that’s the market that I think is still hanging in there with some economic overall drag on that business.

But service providers are good. There are a lot of tender activities right now. China is releasing more of their CapEx for the large LTE rollout they are doing there. They are also doing a number of broadband rollouts and then data center of course because of the considerable traction we have on switch there, doing the best of the three segments and sub-segments in our infrastructure business.

Operator

Thank you. And then our next question comes from Kevin Cassidy of Stifel.

Kevin Cassidy - Stifel

Thank you. I just wanted to get a little more details about your mobile strategy. You said that China handset manufacturers export to the U.S. is an example. What is it that uniquely qualifies you for fitting into that market. I guess why would your customers choose Broadcom?

Scott McGregor

The reason customers choose Broadcom for export from China to the rest of the world is because of the quality of our technology. The Chinese market is much more forgiving in terms of whether you actually meet spec and is primarily focused on price. I think a lot of our technology where we solidly meet spec, our connectivity products, excellent technology.

I think that’s more valued in markets like United States and Europe. And so for those markets where the Chinese handset makers export and South America as well, by the way, another good market for us, I think those markets again take more advantage of what we bring. And so it’s a better market for us. Our products are more appreciated.

Operator

Thank you. And then our next question comes from Patrick Wang of Evercore.

Patrick Wang - Evercore

Yes. Hi Scott. I think you said that you have got pretty good visibility in components design over the next couple of quarters. And it sounds like you are pretty confident Broadcom maintain these key designs over that period. So I am just wondering if I interpret that correctly. And then also on 3G, I think you saw a price pressure in Q2. I am just wondering how much lower pricing can go on these 3G modems as we look ahead or are we ready pretty close to another price curve? Thanks.

Scott McGregor

It’s hard to predict the future on 3G pricing. It’s certainly down pretty low now, my guess is people are probably reluctant to sell below costs. So that -- I guess that’s a limit on that. But the margins for 3G I don’t think are particularly good for anybody in the industry right now. And my guess is that others report their quarters, you will probably see some impact from that as well. The 4G business, we do see as a growth driver next year and believe that will continue to provide some fuel for us in terms of growth next year.

Operator

Thank you. And then our next question comes from David Wong of Wells Fargo.

David Wong - Wells Fargo

Thanks very much. With your restructuring are you actually exiting any businesses or shutting it down, any particular divisions or is it general across the board set of cuts?

Scott McGregor

Nothing significant that we have announced this. It has been mostly across the board. There has been a couple of places we have been deeper than others in terms of where we are making investments but nothing specifically that we have announced.

Operator

And then our next question is from Doug Freedman of RBC Capital Markets.

Doug Freedman – RBC Capital Markets

And Scott, can we focus little bit on one of the brighter spots and that is the infrastructure. You offered that there are some LTE buildouts that you are starting to see happen. How should we think about the magnitude of that trajectory over this quarter – fourth quarter and into next year? Is this something that goes up and goes sideways from that level? Or is it a ramp that we see continuing throughout the year? What are your expectations then?

Scott McGregor

My expectation on the China LTE infrastructure ramp is that it will continue over the course of the year. It takes a while to deploy all of that and build it. And I think as you are probably aware the government has – and guys like China Mobile have issued the tenders to a variety of players, something like five different makers. And we’re going to need to see exactly, as they start pulling as those – that allocation turns into actual orders for those customers. But I don’t think of it as a blip at all. I think it’s probably a year long, or maybe a two year long, sort of increasing in CapEx spending will result in more sales to our service provider channel.

So I see this as a positive trend and Broadcom is increasingly participating in the infrastructure market in a variety of ways. We have switches, we have back-haul of microwave and fiber in terms of how we participate there and increasingly imposters [ph]. And as you know, with our NetLogic acquisition costs, there is an increasingly important part of our business. And for those who might actually question on that, we did see a very good quarter in Q3. It was a record quarter for us on NetLogic revenue for the businesses we acquired from that. It was also a record quarter for processors. And you may have also seen the announcement we made some pretty impressive processor course that we announced and also new architecture for a 64-bit our architecture in that space. So there is a lot of investment in that space and those things are slow to rollout and slow for the customers to ramp. But I think you are going to see some very significant and interesting product in that space over time. So we are pretty bullish on that.

Operator

And then our question is from Christopher Rolland of FBR.

Christopher Rolland – FBR Capital Markets

So really nice gains in your networking op margin this year. Second sort of big quarter in a row here of expansion. Can you talk about those gains and where you think they may settle out? I mean, is this a level that it could settle out at particularly once Trident II fully ramps and starts costing?

Scott McGregor

Chris, we’ve always said that the infrastructure business was highly levered towards revenue growth and if the revenue growth came back, you’d see meaningful expansion in the operating margin. What you are seeing now is that effect. In prior periods where the business has been strong like this we have seen margins in this range sort of in the low to mid-30s for a couple of quarters in a row. I think it really does depend on the strength of the revenue of the business but we continue to hold the spending relatively tightened to the extent that the revenue continues to perform well. You could see margins in this range.

Operator

And then our question is from Alex Gauna of JMP Securities.

Alex Gauna - JMP Securities

Two part question if I could around mobility environment. On the processing side, what’s your opportunity to get to a 64 bit importance of that as you go after that market and can you use any of the progress in R&D you are making in your networking side to get to about – and then also, Scott, you mentioned on the opportunity that LTE brings to with the bundling the Wi-Fi to address some of the share losses for the mass market. Do you have a line of sight on SKUs or kind of volume SKUs could make that a reality in 2014 or is that a longer term thing that we should think about for 2015 and beyond? Thanks.

Scott McGregor

So on the latter part of your question, I think it’s a 24 effect. In terms of the exact SKUs and exact timing of that, I think it’s a little early to have solid views of that. But we have a sense of it and we do believe that there are some SKUs that will achieve with that product – that baseband product that will take connectivity share away from competitor that they’ve previously acquired, again reversing the platform one with a win that they have achieved.

In terms of 64-bit mobile, we haven’t announced any product in that space. Will it come eventually? Yes. But the timing is not that clear. In terms of whether we can use the architecture that we announced for our infrastructure business, I don’t think so. Those are 100 watt devices and so very impressive and unless you want to warm your pockets substantially with your phone, that’s probably not a good design fit in that architecture. Are we capable of doing 64-bit architectures for mobile? Absolutely, yeah. But we haven’t announced any products in that space.

Operator

Thank you. And then our final question comes from Anil Doradla of William Blair.

Brian Nugent - William Blair

Hi guys. This is Brian Nugent for Anil. On the combo business, I know you sound pretty confident on your share, at least in the high end. But I just wonder if you can talk about changes in the pricing environment in the last two months either, relative to historical trends or relative to what you are seeing in 3G baseband?

Scott McGregor

I think the connectivity, ASP environment has held up much better than baseband at much better. Normally, there is a 10% annual price decline in semiconductors, that’s sort of the rule of the thumb in industry. And we have done better than that in the connectivity meaning we’ve declined less than 10% in terms of ASP’s year-over-year there.

So, we’ve been able to hold that up with new technologies and basically very strong competitive products. So that’s been a bright spot and I think that is a strength of Broadcom. It demonstrates that we really do have good technology in that space. And for me, convinces me that that business is pretty sustainable.

Brian Nugent - William Blair

Thank you.

Operator

And then at this time, we would like to now turn the call back to Scott McGregor for closing remarks.

Scott McGregor

I would like to thank everyone for joining us today. In summary, Q3 was a strong quarter for Broadcom with revenue and earnings head of expectations. And even though we are seeing some softness in the business as we exit 2013, Broadcom is taking the necessary steps to position the company for long-term success in the communications semiconductor markets.

We look forward to seeing many of you at our Analyst Day in New York City on December 10th. If you need any additional details on that event, please contact, Chris or Sameer. With that, thank you very much and have a good day.

Operator

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

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