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Executives

Peter Andrew - VP, Corporate Communications

Scott McGregor - President and CEO

Eric Brandt - CFO

Analysts

Sumit Dhanda - Banc of America

Craig Berger - FBR Capital Markets

Craig Ellis - Caris & Company

Adam Benjamin - Jefferies

Ross Seymore - Deutsche Bank

Uche Orji - UBS

Tim Luke - Barclays Capital

Jim Schneider - Goldman Sachs

Ruben Roy - Pacific Crest

David Wong - Wells Fargo

Allan Mishan - Brigantine Advisors

Edward Snyder - Charter Equity Research

David Wu - GC Research

Suji De Silva - Kaufman Brothers

Srini Pajjuri - CLSA

Brian Blair - Wedge Partners

Broadcom Corp (BRCM) Q4 2009 Earnings Call February 3, 2010 4:45 AM ET

Operator

Welcome to the Broadcom fourth quarter and year 2009 financial results conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session.

As a reminder, this conference is being recorded, Wednesday, February 3, 2010. 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. I will now turn the call over to Mr. Peter Andrew. Mr. Andrew, you may begin.

Peter Andrew

Thank you very much, Monica. During this call we will 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 first quarter of 2010 and any other future periods as well as statements about prospect for our various businesses, potential market share, and the development status and planned availability of new products.

You should know 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 forecasts and the other forward-looking statements we make today.

Specific factors that may affect our business and future results, including among other things general economic conditions, are discussed in the risk factors section of our 2009 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 refer to the Investors Section of our website at www.broadcom.com for additional historical, financial and statistical information, including the information required by SEC Regulation-G.

In addition, we've placed a slide deck, which is available now in the Investor section of our website that is on the right hand side of the page under the Q4 2009 Earning Information. For increased transparency we have incorporated additional tables and information regarding our future guidance, historical performance and the last three years of segment operating income.

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

Scott McGregor

Good afternoon and thanks for joining us today. Broadcom continues to execute well in a difficult economy and executed particularly well in the fourth quarter with substantially better results than we originally anticipated, driven by upside demand in several of our businesses.

For the fourth quarter, we reported net revenue of $1.34 billion, which is up over 7% from our third quarter. Broadcom's quarterly revenue reached a record level and is up 57% from the tough quarter in Q1 2009. Sequential revenue growth in the quarter was a result of overall strength in our broadband and enterprise businesses, which were up 14% and 18% respectively offset by an expected seasonal decline in our mobile and wireless business.

The upside in revenue was driven by new product ramps, normal customer order patterns, and a better than expected holiday season along with strong demand from customers in Asia. Broadcom far surpassed our 2009 financial goals of gaining market share, while at the same time generating strong cash flow from operations.

Broadcom's annual revenue declined approximately 4% year-over-year significantly better than the overall industry decline of 9 %. We generated $987 million in cash flow from operations in 2009, far surpassing our $300 million goal for the entire year and reached a record level for Broadcom, despite the difficult market environment entering the year.

Broadcom's goal remains to create great products that enable us to grow our market share and deliver better than industry revenue growth. Broadcom has also been successful in generating strong sequential growth and operating margin leverage and is committed to returning to our financial model as outlined on our Analyst Day last December.

We believe we can achieve all of these objectives while at the same time initiating return of capital through our investors and confidence in our business is the foundation for the announcement we made this afternoon to initiate a quarterly dividend.

I will now turn the call over to Eric for details on the fourth quarter results and first quarter guidance.

Eric Brandt

Thanks, Scott. As Peter mentioned, please refer to the segment breakout data on the Investor Section of our website for additional financial information that will supplement my financial commentary. We have included data to reconcile product gross margin and operating expense as well as modified the presentation of our income statement to further breakout revenue and income related to our intellectual property licensing.

Moving to the financial overview, to summarize for Q4, total revenue of $1.34 billion including $1.28 billion in product revenue. Q4 total net revenue was up approximately 19% from prior year and 7% from Q3 levels. Total gross margin improved 220 basis points to 53.1%. Product gross margin in Q4 increased 240 basis points to 50.9% versus 48.5% in Q3.

Q4 2009 GAAP R&D plus SG&A expense was $481 million. This included a net recovery of legal expenses of $63 million. On a comparable basis, excluding this recovery, these expenses increased $10 million over Q3. Earnings per share for Q4 were $0.11. This includes approximately $0.33 per share negative impact associated with certain settlement costs, primarily related to our proposed class action settlement.

It also includes $0.12 per share positive impact associated with the recovery of legal expenses discussed above. Excluding these non-recurring items, earnings per share were $0.32 compared to a first call consensus of $0.22. Stock-based compensation dropped to 9% of net revenue to approximately $121 million, and represented approximately $0.23 per diluted share.

Cash flow from operations for Q4 was a record $332 million, or 25% of net revenue. Full year cash flow from operations was also a record of $987 million. Our cash and marketable securities balance was flat sequentially at $2.4 billion at the end of the quarter despite $215 million in share repurchases and a $166 million used primarily for the acquisition of Dune Networks.

Moving to revenue and gross margin. In December at our Analyst Meeting, we said we expected Q4 total net revenue to increase approximately 5% sequentially over Q3.

What occurred in Q4 was that Broadcom generated stronger total sequential net product revenue growth of approximately 7%, thus the total revenue of $1.34 billion.

Our broadband communication segment, also known as solutions for the home, came in stronger than we had expected with growth in broadband cable modems and digital Set-Top box target markets. In the mobile and wireless segment, also known as solutions for the hand, we experienced modest seasonal revenue decline as we had anticipated due to the significant strength in Q3 ahead of the holiday season.

Our Enterprise Networking segment, otherwise known as solutions for infrastructure, also came in stronger than we had anticipated, driven principally by the continued improvement in customer order patterns in the Ethernet switching area.

Our Q4 GAAP product gross margin increased 240 basis points or 170 basis points net of E&O to 50.9%, up from 48.5% in Q3, which is above the improvement estimate of a 100 basis points net of E&O provided at our analyst meeting in December. This was primarily due to favorable changes in product mix and continued focus on cost improvements.

Moving to operating expenses, once again we had better than expected performance in controlling our R&D and SG&A expenses. Total R&D and SG&A expenses for Q4 were up $10 million from Q3 levels, excluding the non-recurring D&O insurance receipt of $63 million compared to the increase of $20 million we expected in October.

The favorable under run to guidance in Q4 was principally driven by lower than anticipated employee costs. Legal expenses actually increased beyond our original guidance due to costs associated with the trial in the quarter. During the quarter, the company also recorded settlement costs of $176 million, of which $161 million is related to our proposed settlement of our securities class-action and $12 million related to a post acquisition technology transfer fee to the Israeli government, related to our acquisition of Dune Networks.

Moving to the balance sheet, as I mentioned earlier total cash and marketable securities were $2.4 billion as we generated positive cash flow from operations of $332 million. We repurchased approximately 7 million shares of our stock in the quarter, an average price of roughly $29 per share as part of our ongoing goal to offset dilution associated with our annual equity grant. For the full year, we repurchased 15 million shares as part of this program.

In addition to the record cash flow from operations for the quarter, Broadcom also produced record cash flow from operations from operations of $987 million for the full year, in the face of one of the toughest economic environment since the depression, reflecting our alignment and focus on the key cash flow metric we outlined just over a year ago at our 2008 Analyst Day. As we projected in December, inventory turns came in at seven times. Our accounts receivable day sales outstanding decreased from 39 days in Q3 two 35 days in Q4, driven by strong collections at the end of the year.

Moving to expectations, we currently expect revenue in Q1 to be flat to up 5% to Q4, which would be up over 50% versus Q1 a year ago. Sequential sales expectations for our segments of broadband commutations, mobile and wireless, and enterprise and networking, will roughly follow the overall guidance of flat to up somewhat. We expect decline of approximately 100 basis points in Q1.

This is almost entirely driven by the temporal distortions associated with (inaudible) and acquisition accounting. Excluding acquisition-based charges of amortization and inventory step up, and our basic function of zero you know, product gross margin would be essentially flat to Q3 and be comfortably within our targeted model. We note this guidance does not contemplate any impact from the transaction announced today.

With respect to R&D and SG&A expenses in Q1, we're expecting expenses to increase by approximately $10 million, excluding the effects of the net recovery of $63 million of legal fees received in Q4. This will be driven principally by employee costs adjustments from our annual compensation review process, and our Q1 [fringe] accounting step up which reduces across the year, with seasonal spending on trade shows et cetera.

Legal spending is expected to drop by approximately $15 million as an anticipated options related to Q1 was canceled. Tapeout and prototyping expenses are anticipated to be roughly flat.

Before I turn the call back to Scott, let me comment more broadly on the anticipated legal spending for 2010. We are pleased to have the favorability in Q1, but for now are cautious about additional favorability throughout the year. We still have exposure to legal fees in the remaining derivative action, and there continues to be some sun certainty around the options matter that was dismissed last quarter. We anticipate being able to provide a better picture when we report in Q1 in April 2010.

Finally, as Scott mentioned, we announced today our decision to initiate a dividend at $0.08 per quarter. We believe this reflects our powerful cash flow generation profile as a company supports our commitment to financial discipline, and we'll provide our investors an additional opportunity to return on their investment in Broadcom.

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

Scott McGregor

Thanks Eric. Starting with our home platform, our Q4 revenue from Broadband communications grew almost 14% sequentially driven by growth within the set top box and broadband access quarter lines, and with flat revenue from our consumer electronics product line following the typical peak third-quarter quality shipments.

We made several important broadband product announcements. First was a new line of HD cable set top boxes as SSB solutions with Integrated MoCA(R) for the North America and European markets. Our Integrated MoCA(R) products are built on a very successful line of set top box silicon solutions for the cable service provider markets. Second was a new crystal HD solution that brings highest definition to netbooks alongside Intel's Atom Microprocessor.

Our HD video accelerator is a companion chip to the CPU, providing a cost effective and powerful solution for the netbook market that leverages our portfolio of video intellectual property. Third, we're the first to ship, single chip Blu-ray disc solution integrating proven optical front-end and backend video decoding and displaying technologies on a single die. Independent industry analysis now confirms that Broadcom has become the leading provider for silicon solutions for Blu-ray disc players.

We believe that the connected home provides a number of large and long-term opportunities given our broad video processing wired and wireless connectivity portfolio. For those of you who attended the consumer electronics show, I'm sure that you walked away with a better understanding of our horizontal integration strategy and the increased penetration of wireless connectivity and Ethernet capabilities into broadband communications products. We believe the breadth and depth of our product portfolio is a long-term strategic competitive advantage for the digital home market.

Moving to infrastructure, Broadcom's enterprise networking business delivered the highest sequential revenue growth rate in the fourth quarter at approximately 18% with record sales of switches and phi. Growth in the quarter was broad-based as our customers in the enterprise and service provider markets continue to increase their demand and rollout new platforms. In particular, our switching and phi products are used extensively by OEMs to build switches and routers for 3G and broadband infrastructure in Asia. We also experienced a strong increase in demand for 10 gigabit products throughout 2009 from enterprise and data center customers.

To further advance our competitive position; today, we announced we are sampling several new 10 gigabit Ethernet products. The first of these is the industry's first example 40-nanometer lowest power and G-based T5 in both dual and quad configurations. Mg BASE-T enables connections up to 100 meters over inexpensive UTP cables to enable wide scale deployment of 10 gigabit Ethernet with backup compatibility to gigabit Ethernet installed infrastructure at approximately 3.5 watts per port, OEMs will be able to design cost effective high density mg BASE-T switches and adapters to bring down the total cost of ownership.

The second announcement we made this afternoon was our third generation dual port 10 gigabit Ethernet converged net with a number of cutting-edge features including bidirectional line rate performance across both ports and greater than 1 million IOPS of storage engine processing capability for both FCoE and iSCSI. This is the only off-load chip in the industry that supports iSCSI, FCoE and TCP Chimney simultaneously over a single Ethernet port. And it truly delivers on the vision of a converged data center network for the enterprise crowd at financial markets.

The new device supports a complete set of virtualization features and is the world's first 10 gigabit controller supporting the energy efficient Ethernet, or EEE standard. Broadcom switch products have achieved wide adoption across the world for DSL on deployment. To further enhance our portfolio of industry-leading platforms supporting the rapid build out of broadband networking in Asia, we've decided to enter the EPON market and participate in the service provider build out in the region. And that's why today we announced the acquisition of Teknovus, which is a major player in the EPON market.

Moving to our hand platform within our mobile and wireless business, Broadcom experienced a sequential product revenue decline of approximately 4%, as growth in the wireless LAN and VoIP were offset by declines in other connectivity products after about seasonal growth in both the 2nd and 3 quarters of 2009.

Within the cellular market, we are pleased with the performance interaction we are receiving from current tier one customers, Samsung and Nokia. And we are excited about our road map and customer diversification opportunities and other handset OEMs and ODMs. We announced a new multimedia coprocessor solution during the quarter in 40 nanometers which delivers a 1080p camcorder and high-performance one gigapixel per second 3D graphics all of the power envelope of a mobile phone. We look forward to displaying this and our other cellular platform solutions at Mobile World Congress in weeks. We hope you can join our open house on February 15.

Wireless compass solutions continue to exceptionally well. The rollout of our leading industry-leading products were timed for market acceptance of multiple integrated conductivity radios as proven by our shipments of approximately 500 million wireless combo devices today.

For the full year 2009, wireless combo product revenue exceeded 10% of Broadcom's total sales. We believe our combo portfolio is a competitive advantage that will extend in 2010 as the majority of large designs, in our piece in the mobile phone market now require three or more connectivity radio versus standalone for dual radio designs in previous years.

We are designed into a number of key android hand sets today and our elite connectivity s supplier into four of the five significant smartphone operating systems. Finally, one of our newest triple-play combo parts, the BCM2075 which integrates Bluetooth, GPS, and FM has been named as the 2009 product of year from Electronic Products, China.

We are also seeing increased adoption of Broadcom's wireless connectivity chips in the consumer electronic devices such as digital television, Blu-ray, and set-top boxes which are on retailer shelves today. Wireless LAN provides internet connectivity which enables access to video services like Netflix and Skype. Bluetooth enables a new generation of user friendly remote control devices with QWERTY keyboard, streaming audio and connectivity to mobile handsets.

In summary, Broadcom is benefiting from some very powerful long-term trends entering 2010. We have momentum building with acquisitions in the data center and broadband access base, new competitive 40-nanometer parts, increased addressable market opportunities through our home platform integrating connectivity in Ethernet, upcoming third generation combo products and the ongoing ramp of our cellular base band products.

These products combined with a strong free cash flow generation model are the engine for Broadcom's continued growth and give us the confidence to introduce a dividend to return capital to our shareholders. That concludes our prepared comments today and we are now ready for your questions. Monica, may we have the first question, please?

Question-and-Answer Session

Operator

Certainly, we will now begin the question-and-answer session. (Operator instructions). Our first question comes from Sumit Dhanda of Banc of America.

Sumit Dhanda - Banc of America

On the legal expense front, Eric, is the understanding that the $15 million sequential decline you're seeing this quarter, that was up again or it will stay static at this level sending more clarity?

Eric Brandt

Sumit, all I can give you is guidance for Q1. As you know, the company has moved down the path to resolve its legal matters and there remains open the derivative action and potentially we still don't know what the SEC and the DOJ is going to do in terms of appeals. So until we have a better picture of that, we are remaining cautious. But we are quite pleased to give you the $15 million at least in Q1 and we will have a better picture when we get to April.

Operator

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

Craig Berger - FBR Capital Markets

You seem to shipping above seasonal and some businesses in the first quarter. Is that because your customers need product to meet their demand or are they trying to replenish a little bit here in the seasonally slower part of the year? Can you just give us any color around what you see with your customers?

Scott McGregor

What we see is a scenario where Christmas happened, but seasonality doesn't appear to be happening. We see a very strong first quarter. There are many theories people have. Is it budget flush? Is it inventory building or is it just genuine strength from our customers? We certainly see the latter. We see the customers definitely selling through and building a lot of strong products.

And we have some very strong product ramps that are contributing to our growth. We don't see particular inventory in the channel. We had a discussion of this over the last week. There are always a few pockets here and there, but we don't see any abnormal inventory building up and I can't comment on the budget flush, but certainly we do see strength in our customers and strength in the product ramps.

Craig Berger - FBR Capital Markets

How do we think about your wireless combo chip opportunity this year? How do we think about growth there and new product generations, what are your plans for a number of new product launches this year?

Scott McGregor

You can certainly expect we will introduce some new products, but we have some great products out there right now. I think the triple-play parts, the 4325, 4329 and the latter in particular are really strong. We are seeing design wins just across a lot of different markets and very, very good strength there. As I said in my prepared remarks, we are also seeing a move away from the discrete parts and the two component parts to triple component parts. And that's also a very good timing as we launch our GPS products. GPS is definitely a pickup, both wireless LAN penetration and GPS penetration I think are going to drive good growth for our wireless combo products across the year.

Operator

Our next question comes from Craig Ellis of Caris & Company.

Craig Ellis - Caris & Company

Eric can you just talk about some of the gives and takes on the gross margin line? As we look ahead how much benefit from 60-nanometer mix shift progress is there and are there any headwinds out there that we should be aware of as we think about 2010?

Eric Brandt

So in general, I would say we are certainly quite pleased with the performance this quarter being up a 170 basis points net of E&O. I would say about a quarter to a third of that is mix related and about two thirds to three quarters of that is actually related to cost improvements. Cost improvements embody two things.

They embody actual good work on our ops group to get lower costs on the wafer side, but it's also the ramp of some of our newer and lower cost products which will ramp across the year. So the reason why I made the comment that in Q4 and in Q1, net of E&O and acquisition related charges were comfortably back in our targeted model and probably pretty much right in the center of it. I can't give long-term guidance, but as I mentioned earlier, last year, our focus on gross margin is paying off and you're seeing it now.

Craig Ellis - Caris & Company

One on the dividend, how did the company settle on $0.08 a share? And two, as we think about the company now being a dividend payer, what does that mean for the acquisition prospects for the company?

Scott McGregor

So [Craig], I would say, we thought about the dividend a lot and talked about it a lot internally, and you've heard of sort of you've been thinking about it out loud to some degree. As we thought about $0.08, we wanted to make sure that we selected a number which was meaningful in terms of the dividend yield, and in our view as we looked at the company, that were growth companies, the growth and income companies, that number is typically around 1% or slightly above that.

I don't think Broadcom is ever really going to be a yield company. We are a growth and income company and so as we set our targets for the dividend and for our plan, we thought very much about growing revenue fast in the market, growing profits faster than revenue, and being able to deliver cash back to the shareholders.

As we looked at our cash flow, you can see again, in one of the worst economies since the Depression, we hit record cash flow from operations, and we look at our plan going forward we believe we have sufficient cash flow to pay a dividend, to buyback shares to offset dilution, and to make acquisitions. And that's how we balance it and we will continue to balance that on an annual basis as we think through it.

Operator

Our next question comes from Adam Benjamin of Jefferies.

Adam Benjamin - Jefferies

Just a continuation on gross margin. I know the E&O has gone back and forth a little bit here with the downturn in 2009. I know you don't want to give guidance for Q2 specifically, but as it relates to that charge, does that go back in your favor as you get into Q2?

Eric Brandt

The reason why I gave you the number net of E&O is because I want you to understand what the underlying gross margin of the company is, excluding these swings back and forth. Between Q4 and Q3, we have had about a 150 to 160 basis points of release in E&O, part of which in Q3 was masked by the DTV impairment.

So I think we are actually consuming the excess E&O that we had on our book. I think there might be some marginal favorability across the year. But I do think the right way to look at is to wash it out of the number and understand what the underlying gross margin of the company is, net of these E&O swings, and net of any of these acquisitions related charges.

Adam Benjamin - Jefferies

Just on the better than normal guide, given some seasonality we see in the mobile and wireless business, obviously with ramps elsewhere, can you just comment, regarding just how we should be thinking about what's going on out there? I know there is a lot of back-and-forth. Cisco seems to be indicating that business has improved dramatically and they build some inventory.

But at a pretty significant guidance for the next quarter or so it would seem to justify where business trends are going. But you know Scott, I wonder if you can comment on commentary with your customers about that inventory discussion. I know that you guys have typical shied away from saying we are convinced there is no double ordering or there isn't inventory out there because you typically don't know for sure. But I was curious if you just give some commentary with your recent discussion you mentioned last week, Scott.

Scott McGregor

I'm happy to do so. First, just want to clarify we believe that all three of our segments are in the range of flat to up slightly. So I think as you had said at the beginning, that you thought out mobile and wireless might be down and offset. So I just want to correct that.

Adam Benjamin - Jefferies

No. I'm just saying typical seasonality would be that way.

Scott McGregor

Okay, fine. In terms of the conversations we have with customers, frankly we have a number of customers expediting parts and they are absolutely shipping to end users. So we see a lot of customers where if we could supply more parts, we could ship more. So we see a little bit of that going on. We don't believe they are building inventory. We do believe they are shipping through. I'm certain there must be some customers somewhere building inventory as Eric point out. But generally we don’t see atypical environment out there. We looked at distributor inventories. We've looked at a variety of things. We just don't see a story for inventory buildup at this point.

Adam Benjamin - Jefferies

Just a follow-up on that. You mentioned you would ship more parts if you could. Are you constrained, and if you are, any specific of your three main end markets, some perspective there would be helpful and when you think you could be less constrained going forward would be helpful to know?

Scott McGregor

Our constraints are not coming from inability to get silicon. We believe we can get access to all the silicon we need now and going forward this year. The constraints are coming more from very short order lead times from customers where they are hoping to get parts substantially within our lead time, typically because they have gotten orders within a short lead time for them.

So that's where typically the expedites are coming from. So it's hard to predict how that will trend throughout the year, so I will decline to do that. But right now we do have some customers who wish they could get parts faster than we can deliver them.

Eric Brandt

I just add to that, Adam, I mean you can see that we have taken our inventory from the normal eight turns down to seven turns and I think part of that is in light of the strength we saw in Q4 rolling into Q1. And part of that was just in light of the fact that we understand the capacity is relatively tight. And we want to make sure we have sufficient inventory on some of the new parts that are ramping. So we are doing our best to make sure that we have supplied. I think our customers are pleased that we are able to supply them, and to the extent their (inaudible) we will do our best in management.

Operator

As a reminder, participants are asked to limit the sales to one question. Our next question comes from Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank

Hi, guys. Congrats on the strong quarter. Last quarter you gave some helpful color on what Baseband revenues were. Could you give us an idea of what they did in the fourth quarter and may be 2009 as a whole?

Scott McGregor

I'm glad you are pleased we gave that guidance last quarter. But we're not going to do that every quarter. But we do believe and I will certainly reiterate that we do expect our Basebands to be a growth driver for us, a significant growth driver for us in 2010. We see new models ramping from both of our major customers and we believe that will drive significant growth in that business over the quarter. And generally, we are pretty pleased with both the quality of the models and the quantity of the models we are seeing and the revenue we believe will come from that.

Eric Brandt

Also the next changing from 2G over to more 3G.

Ross Seymore - Deutsche Bank

Got you. And completely changing gears, now that the legal expenses side a lot of it is behind you, I think we have all seen in the press something about the founders of the company wanted to come back. Does that in any way impact anything on the managerial structure or strategy that you guys are putting into place?

Scott McGregor

No, it doesn't.

Operator

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

Uche Orji - UBS

Scott, just a couple of quick questions. One is Teknovus, can you just give me an idea of what the annual revenue is and the headcount and also how the margins for that business are compared to your EPON product?

Eric Brandt

Sure. Its Eric. The Teknovus revenue was sort of in the tens of millions of dollars. There are about 100 people, maybe a little bit more, about 140, about 100 or so in the engineering side of the house. Was there another question in there?

Uche Orji - UBS

I just want to have your margins for a moment compare but if you can (inaudible)?

Eric Brandt

As a business, often what we find is when we buy smaller companies, our pricing is better than smaller companies. And as I think as we look at our enterprise business, as we look at Teknovus business that is consistent with our enterprise business. Over time, we work through that.

Uche Orji - UBS

That's great. A different question on crystal HD. Scott, you talked about that in the opening remarks. Let me just ask you this. What kind of a tax rate are you seeing with that product along with ATOM and in the marketplace? One will want to see that products against NVIDIA [high end] you know what is the feedback you're getting us to the cost benefit of crystal HD versus any other competitive solution out there?

Scott McGregor

I don't have the specific number for you, but we are seeing very good reception for that product. It's a great product in that it hits a very good price point. It's exactly the future, components that people want, and it's very low power. So compared to some of the other solutions out there, it generally provides substantially better battery life, and it's substantially cheaper. And it gets the job done beautifully to playback 1080P HD video, which is really the sweet spot for that product. And so we are seeing a lot of interest, and a lot of designs from OEMs all over the world.

Uche Orji - UBS

And just finally, I know, I'm not asking for guidance, say for 2010, but if one were to look down through 2010 and one had to say is the top five revenue drivers for Broadcom in 2010, how would you describe that? They are just so much confident in macro so I know it's difficult to kind of give that much of a view, but how would you kind of guide us into thinking about how revenues or what products and areas will drive revenue through 2010? That's my last.

Scott McGregor

It's hard to predict exactly which ones are going to do that, but I can give you a list of a handful that I think are going to be significant drivers. Certainly as I mentioned already, we believe that cellular Baseband will be a significant growth driver for us in this year. And I think many people also underestimate the overall multimedia products that we have, and so those into cell phones and other products, I think are also going to be a significant growth driver.

In the combo space, GPS space, GPS and wireless LAN are very strong. I believe the increased penetration rates of those features will drive very strong revenue for us over the course of the year. The consumer electronics space, digital TV and Blu-ray and over the top services we enable with some those services I think are going to give us a growth driver in that space.

And then in the enterprise space, certainly the 10 gig transition. We have seen a multi- fold increase in products in 10 gig over the course of the last year. I expect that is going to continue. Those have higher ASP's. They add a lot more value for customers and so a 10 gig should be a driver as it manifests in phis and switches and other related products. So those would be my best guess as to the strongest growth drivers for us. But we always have one or two surprises. And there may be others as well.

Operator

Our next question comes from Tim Luke of Barclays Capital.

Tim Luke - Barclays Capital

Scott, often the beginning of the year in areas like wireless can be seasonally lower and it sounds like your expecting all of the business to be flat to higher in the beginning of the year. Do you have a feel of what you see now as to how you think the rest of the year may shape given the business drivers? Do you anticipate that you would see some modest sequential procession through year?

And then separately, if you could just clarify, you said that the OpEx, the legal spending is going to be down $15 million but overall the OpEx is up $10 million. What are the factors with that? And it sounds as if you are inferring that there is some ongoing legal uncertainty on the options case that might bring back legal expense. Can you just frame at all as to why that would be the case that you would have to have incremental spending on a case that seems to have been dismissed and how material we think we should think about that?

Scott McGregor

So let me start with the last one which is on the legal side. And essentially Tim as you know, I tend to be fairly conservative. So I don't want to count my chickens before they hatch. The criminal case was dismissed, although it’s unclear whether there will be an appeal on that. In the process of clearing the criminal case and settling the class action, it accelerates the derivative action which could go to trial in Q2, which could cause additional costs. Our hope is that it will get settled and resolved which will save the company a lot of money. But at this point I don't want to count on that until it happens.

Moving to the OpEx, just to give you a sense, you are right. Legal is down 15 and I set up about 10. There are some odd accounting things that occur in Q1, just to give you a sense. Between the fringe step up I mentioned and vacation accrual which reverses from the holiday season, it doesn't really reverse but it steps up from people taking a lot of vacations during the holiday season. That hits us about $20 million. Then the other thing is between the focal, both the salary and stock-based comp, you are talking $5 million to $10 million as well.

So there are just a couple of natural step ups and so our annual merit increase which occurs every year except in 2009 sort of feathers its way in Q1 and Q2. It used to be Q2 and Q3. This year it will be Q1 and Q2. So from my perspective, I think from an OpEx point of view, although we are adding some resources to key areas in the company, I don't think it's a big OpEx jump as much as a lot of it is driven by some accounting factors.

Moving to the revenue piece, which you asked where you started, I think in the first half of 2009, seasonality was out of the window as everything went down. And then in the second half of 2009 seasonality further went out of the window or exaggerated in the second half of the year in 2009 and into the first quarter of 2010. And again, just to remind you on a mixed adjusted basis, Q1 is typically down 5% to 5.5% for us.

So we're seeing somewhere between 5.5% and 10.5% swing on seasonality. I hope that normal seasonality continues through the rest of the year. But I just don't know. I think we're in uncharted waters. I hope that we can see the back part of the train starting to move. I just hope that the economy, which is the engine of the train is starting to move on the front part of the train.

Operator

Our next question comes from Jim Schneider of Goldman Sachs.

Jim Schneider - Goldman Sachs

I guess if you look at the mobile and wireless business, in the 10-K you just filed, it looks like you posted an operating income of just under 7% for that business relative to double-digits and much better for the rest of the businesses. Could you talk about what your target is for that business? What we might expect it to be in 2011, whether you think the target would be still lower than the rest of the business or not as (inaudible) growth?

Scott McGregor

Tim, we don't give targets for the particular businesses, but I think what you're seeing there is the nascent cellular business where we still have a significant R&D cost and we're still in the early phases of ramping up. So do I expect that number to go up? Absolutely, yes. But I hope it came as a positive surprise to most people that overall our mobile and wireless business is profitable today.

Operator

Our next question comes from Ruben Roy of Pacific Crest.

Ruben Roy - Pacific Crest

Scott, I was wondering if you would comment a little bit around the Teknovus acquisition, recently the Dune acquisition and you guys came out with a split in the enterprise networking group of network infrastructure technologies group. Is that going to be a separate segment? Can you characterize the revenues to date of that area and how that plays out over the next several years as growth driver for Broadcom?

Scott McGregor

The infrastructure segment we discussed pretty much lines up with our enterprise networking group today. So think of those as approximately synonymous. What we call the divisions internally, we are trying to separate that a little bit from how we view that there are three primary platforms that we attack, the (inaudible), the home, and the infrastructure. You can think of those as roughly synonymous.

In terms of the acquisitions, we are definitely looking for ways to grow in the enterprise space, in the infrastructure space. We see there's a lot of opportunity. It's a good market, the [pawn] opportunity, the cloud computing opportunity, we saw those as both areas that we wanted to accelerate our participation in. As you know, we often do things organically and we always look in the market for are there really great teams and great companies that we could acquire that would be eventually very accretive to the company and would accelerate our penetration into those areas?

And we found those in Dune and Teknovus. They are both very talented technical teams, they have done impressive things in the market place. Dune has some fabulous high end switch products and are really going after the scale of the cloud computing. Frankly, we haven't put as much attention towards it and as we see cloud computing accelerate, that's very attractive for us. Teknovus, I think you are probably aware, we have some GPON products and we are making great progress in the space.

A lot of Asia is focused on EPON. So GPON being more US and European-centric, EPON really giving us the Fiber-to-the-Home, Fiber-to-the-Curb coverage that we wanted worldwide. So we believe that completed our fiber portfolio and really gives us access to the worldwide market now for that.

Operator

Our next question comes from Stacy Rasgon of Sanford Bernstein.

Stacy Rasgon - Sanford Bernstein

Just a quick question on gross margins. So you had cost improvements that were driving most of the improvement this quarter. You're guiding flat next quarter, but you've got revenues going up, you may even have mix maybe helping you a little bit there. I'm just curious why the flat product gross margins excluding the E&O impact, what might be some of that that will stop that from actually going up?

Stacy Rasgon - Sanford Bernstein

There’s normal ASP declines that go on in the business. There is a combination of effects that go across the two quarters. As we look into Q1, we begin with some of the new pricing that we have with our customers as we start our annual schedule of negotiation, but I think there will be continued cost benefit in Q1 by some of the new products, and reductions in some of the pricing we're getting from on our wafers.

And maybe greater as a percentage than the mix benefit we got in Q4 with obviously with the mobile & wireless sector down slightly and the enterprise space up a fair bit. So as mobile & wireless begins to grow in the beginning part of the year, there could be some less mix benefit.

Operator

Our next question comes from [Pranav Chandra] of Roth capital.

Unidentified Analyst

Scott, if you could talk a little bit about what your situation is in terms of share and something you have been very successful, Bluetooth and combo chips, and maybe something that you’ve not been so successful as in digital TVs?

Scott McGregor

We don't generally estimate shares. We leave that to the third parties to do that, but I believe the third parties are showing that for Bluetooth and combo chips, we are a clear number one in both of those areas. In digital TV, I think we got off to a slower start there than we had hoped for. I think that the economy really took a dive just as we were getting into that market and so for a while people weren’t buying so many digital TVs. That was a headwind for us. We also saw our customers losing a little bit of share to a competitor that we didn't have chips in and we saw some situation in designs.

We believe that's back on track and that's why I listed that as a growth driver for Broadcom this year. We think our team has done a great job there of getting that back on track. We have won a bunch of new designs. At CES, you saw us demonstrating some of the coolest newest TVs.

I think the real strength we have in the digital TV space going forward is something we do really well at Broadcom, which is combining all of the different technologies into single SSCs. So TVs have really moved away from being just traditional TV functionality to far more things like internet and wireless connectivity and other things and that's a real strength of Broadcom. We are bringing those capabilities so that you have over-the-top services and connectivity.

Things like DLNA, those are really things we can add a lot of value to and many of the traditional legacy TV chip makers just really don't have that capability. So I think long-term, it's an area for us to shine and it will certainly be a growth driver for us this year.

Operator

Our next question comes from David Wong of Wells Fargo.

David Wong - Wells Fargo

In terms of your inventory growth, was that fairly even across your various product segments and end market segments or are there some end markets where there is a greater need to build inventory to make sure that you have got plenty for increasing demand?

Eric Brandt

Yes. In fact, there are a couple of new products that are ramping and I don't want to be specific, but there are a couple of new products that are ramping where we wanted to make sure an example, just generally speaking, would be some of the combo chips. Where we wanted to make sure we had sufficient supply to meet the demands of our customers particularly to the sense that they see some upside and given the strength again that we were seeing coming out of Q4 and into Q1.

Operator

Next question comes from Allan Mishan of Brigantine Advisors.

Allan Mishan - Brigantine Advisors

Hi. You mentioned that the merit increases were feathering over Q1 and Q2 this year. So does that mean that there will be a step up from that portion of your OpEx into Q2 or does that just mean that it's taking the step up in Q1 and sustains in Q2?

Eric Brandt

So the way the merit increase is working, is that the actual salary piece goes in, in the third month of the quarter, and the equity goes in at the second month of the quarter. So typically, on the cash component, the salary component, it runs in the $10 million a quarter range. We had dissipated Q1 that we will see about $3 million of it. So somewhere in the vicinity of four, five, six will step up into Q2.

Operator

Our next question comes from Edward Snyder of Charter Equity Research.

Edward Snyder - Charter Equity Research

Thank you. A couple here if I could. Your Baseband was strong, I'm sorry your broadband is strong across all customers or did you see that concentrated in one or two? Because given Motorola's comments about relatively weak performance in its set-top business, I am just wondering what checks you have that you are not growing inventory of some of your customers versus say end market demand? And then also Eric, in the drivers for Baseband growth this year, you highlighted and increased mix in 3G. Is that going to be based on new products coming out or are you expecting traction in existing products say beyond Samsung which is now I am using it??

Eric Brandt

As two broadband, which really see that broad-based. And we don't comment on specific customers. But we see that broad-based across customers and not a specific thing with one or two customers.

In terms of your baseband question, we certainly see revenue in the near-term from products that we have already announced, and you'll have to just see down the road. We generally don't announce new products until they are at least sampling the shipping so hard for me to comment on that. You'll have to wait and see it the year develops on that. But we do expect growth in 3G. for sure increasing as a percentage versus the mix with 2G and 3G.

Operator

The next question comes from David Wu of GC Research.

David Wu - GC Research

I was wondering whether you could shed some light on a couple of things that we saw at the show. A lot of these handheld products are kind of arm-based. I guess can see as an arm license, architecture license. What part of your business do you think will migrate towards the arm architecture and would that effect any of the existing No Space product? And the other thing, how do you see Andriod as an operating system. There are a lot of links is out there. But is Andriod really getting the (inaudible) not only for smart phones but also for things like set top boxes and other consumer electronic products?

Scott McGregor

I will answer both questions their. In terms of handheld products and the use of arm, we use in MIPS, we use arm, we use a variety of other processors. And we consider ourselves agnostic in terms of which is better. We have a flexibility to even change our mind, some of our products have been MIPS and arm another year and we'll move that around. Quite often for embedded applications, the customer doesn't really care what the instruction set is. We find that typically consumer electronics products and a lot of infrastructure products where they really care about basically performance per watt and cost performance for the major drivers. And what instruction set it is fairly moot. We are and arm licensee we expect to continue to be an arm licensee. We are also a MIPS licensee expect to continue to be a MIPS licensee and I don’t think I can have a particular color their.

In terms of your question on android, we see a lot of interest for android, especially in the handheld space. As I think I have said to a few of you it has really captured the imagination of a lot of consumers and a lot of customers, and so we have a significant effort on android. I think I mentioned that we do have a lot of handset design wins, android -based, with a variety of our wireless products. And so we do expect that to be a growing operating system as a percentage of the total operating systems we support in the course of this year. And we think it's a significant new driver going forward in terms of gaining share in the operating system space.

Operator

Our next question comes from Suji De Silva of Kaufman Brothers.

Suji De Silva - Kaufman Brothers

Hi, guys. You showed at your Analyst Day some smart feature phones. When do those ramp-up? Is there an inflection point coming in and when do those do ramp? Are they going to be a large enough to be something of a head wind on margins versus the larger business?

Scott McGregor

The smart feature phones are ramped today. In fact, if you look at the Samsung Star phone is shipping many millions of units a month, I would say that's quite ramped. In fact, Samsung told us it was the fastest ramping of phone in their history. So smart feature phones are ramped today. And therefore, does it change our margins or anything, I think is good. It's already factored into really excellent margins we reported in Q4.

Suji De Silva - Kaufman Brothers

And if anything, as the mix improves, that should also help out on the margin side.

Scott McGregor

Smart feature phones are definitely going to get us better return than lower end 2G phones. Absolutely, the more smart features we put in there, the higher the patch rate for GPS, for wireless LAN, and for other capabilities multimedia, other capabilities we could add, so both smartphones and smart feature phones are very good for Broadcom, and they drive additional (inaudible).

Operator

Our next question comes from Srini Pajjuri, CLSA.

Srini Pajjuri - CLSA

Just a clarification, Eric. It's good to see you guys paying a dividend. My question is, does it change your buyback or M&A policy going forward? My question is does it rule out a larger potential acquisition in the future?

Eric Brandt

It does not. I think again, in one of the world's worst economies ever, we had record cash flow from operations. And operations you can see in Q4 and Q1, we had record quarters. We think our cash flow will continue to grow, we think we have enough room to pay dividend, buy back shares, offset solutions, and make meaningful acquisitions. So I think as a company, the dividend is just a sign of the true financial strength of the company's cash flow and acquisitions.

Operator

The next question comes from Brian Blair of Wedge Partners.

Brian Blair - Wedge Partners

You talked a bit about the connected TV market, and I just wanted to know if you could give a little more color on what your expectations are, as we get towards the holiday season at the back of this year in terms of what percentage of overall TVs might be connected and you always make your own numbers, but can you just give us a sense for how you see the opportunity as we're getting into this holiday season and maybe provide a little color on what you see beyond that?

Scott McGregor

That's a hard question to estimate, and I think you put your finger on the recent. We don't determine that. If we could you determine it'd be a 100% that really depends on what the consumers are interested in buying and how our customers prices are products to market. The good news is we're seeing some very aggressive pricing and promotion of the features. That 3D are also things I think are driving new consumer interest and a lot of the TV sets. So I apologize. I can't give you an exact number, but we do see that is becoming a must-have feature summer -- certainly in other midrange and high-end TV sets. And that will drive the penetration further into the other's going forward.

Eric Brandt

Also remember, it is not just wireless. It's also Bluetooth Ethernet another technologies we are able to incorporate in those products.

Operator

We have no further questions at this time.

Scott McGregor

Thank you all for coming today. I have just a couple of thoughts I would like to leave you with the for signing off here. Broadcom really had a great Q4 and we believe we have grown faster than the industry, we have improved our operating leverage. As we said we would. We are looking forward to additional market share expansion and increased financial leverage across 2010. One final reminder, we'll be hosting an open house at mobile world congress in Barcelona on February 15 at 4:30 pm local time. If you need any additional details or an invitation to this, please give Peter a call. With that, thank you again for joining us today and have a good day.

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Source: Broadcom Corp Q4 2009 Earnings Call Transcript
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