Broadcom Q3 2006 Earnings Call Transcript

Oct.20.06 | About: Broadcom Limited (AVGO)

Broadcom Corporation (BRCM) Q3 2006 Earnings Call October 19, 2006 4:45 PM ET

Executives

Peter Andrew – IR

Scott A. McGregor - CEO

Bruce E. Kiddoo – CFO

Analysts

Michael Masdea - Credit Suisse

Ambrish Srivastava - BMO Capital Markets

Ross Seymore - Deutsche Bank

Chris Caso - Friedman, Billings, Ramsey

Arnab Chanda - Lehman Brothers

Seogju Lee - Goldman Sachs

Mark Edelstone - Morgan Stanley

Shebly Seyrafi - Caris

Alex Gauna - UBS

Bill Lewis - JP Morgan

Ruben Roy - Pacific Crest

David Wu - Global Crown Capital

Srini Pajjuri - Merrill Lynch

Charlie Glavin - Needham

Shaw Wu - American Technology Research

Operator

Good afternoon, ladies and gentlemen, and welcome to the Broadcom third quarter results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session.

Please note that this conference is being recorded.

I will now turn the call over to Mr. Peter Andrew, Vice President of Investor Relations. Mr. Andrew, you may begin.

Peter Andrew

Thank you very much, and good afternoon, everyone.

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 anticipated revenue for the fourth quarter of 2006, financial information for earning periods, and statements about prospects for our various businesses and the development status and planned availability of new products.

It should be clearly understood that our actual results may differ substantially from the forward-looking statements we make today.

Specific factors that may affect our business and future results are discussed in the risk factors section of our 2005 Form 10-K and subsequent 10-Qs and 8-Ks, and in our other SEC filings. A partial list of these important risk factors is set forth at the end of today's press release.

As always, we undertake no obligation to revise or update publicly any forward-looking statement for any reason.

On July 14th and September 8th, we provided preliminary reports on the voluntary review of our equity award practices. As we announced previously, as a result of that review, we had to limit the scope of the financial information that we released today. In addition, on this call we will not be able to provide any specifics about our gross margin or operating expenses for the third quarter or year-to-date because we cannot determine those amounts in accordance with GAAP until we have completed our ongoing review, and the expected restatements of our historical financial statements.

In today's call, we will provide you some information and guidance about the general trends for these metrics, but cannot provide any greater detail than what we state on the call.

We will, of course, make every effort to provide you with more detailed information as soon as we can, which will be when we have completed all of our required SEC filings and amendments. You should note, however, that this will likely take a number of weeks to accomplish.

Because of the pending restatement of our financial statements, all financial numbers for the third quarter discussed on this call are not final and should be considered estimates.

In addition, any guidance we provide for the fourth quarter of 2006 does not take into account the effects of the pending restatement, which we believe will result in significant adjustments to our results of operations on a GAAP basis, but will not have any material effect on our non-GAAP results.

To the extent we discuss any non-GAAP measures, please refer to the 8-K we have filed with the SEC on April 20, 2006, that contains additional information regarding why Broadcom believes that these non-GAAP measures provide useful information to investors, the specific manner in which management uses these measures, and some limitations associated with the use of these measures.

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

Scott A. McGregor

Thank you, Peter. Good afternoon, and thanks for joining us today. I am sure everyone has seen our press release by now and, as we noted in our prior quarter conference call, we are a bit limited in terms of financial metrics that we are able to report.

What we are able to disclose at this time is our revenue and some limited balance sheet items.

Revenue came in at $902.6 million, which is above our guideline of $900 million, and represented a decline of 4.1% quarter to quarter, but growth of nearly 30% year over year.

The decline in Q3 revenue versus Q2 was primarily driven by our enterprise networking and mobile and wireless end markets, while the broadband communications end market was up slightly on a quarter-to-quarter basis.

We had another strong quarter of cash generation, as total cash, cash equivalents, short- and long-term marketable securities came in at just over $2.55 billion, which represented net growth of over $177 million quarter to quarter.

As for inventory, we said we would decrease our inventory in Q3 back to Q1 levels, and we did. Inventory decreased by over $54 million to $223.5 million, which is below our Q1 inventory level. The ability to adjust inventory quickly illustrates the strength of our fabulous business model and our ability to shift production quickly as demand changes.

Now I will turn the call over to Bruce Kiddoo, our Acting Chief Financial Officer, to talk about Q3, and give guidance for Q4.

Bruce E. Kiddoo

Thanks, Scott. Before I discuss the financials, with respect to our equity award review, we have nothing new to report on our analysis today, but we continue to make good progress. We are making every effort to complete our analysis and file our restated financial statements as soon as possible after the completion of our review. With that in mind, we are very limited in what we can say while our equity review process is ongoing.

Knowing that, I will give a financial overview of revenue, gross margin and operating expenses, and then provide as much color as I can.

Overall, Q3 came right in line with our guidance. Revenue of $902.6 million was down $39 million, or 4.1% from Q2. Revenue was up more than $207 million, or 30%, from Q3 2005.

Non-GAAP gross margin was down from last quarter, and within our long-term model of 50% to 52%, consistent with our guidance.

Total non-GAAP operating expenses increased by less than a third of the rate of increase in Q2, again consistent with our guidance.

Our cash and marketable securities on-hand increased by $177 million for the quarter, leaving us with a balance of $2.55 billion.

Inventory for the quarter decreased by over $54 million to $223.5 million, which is below our Q1 inventory level.

Going into more detail on revenue and gross margin, in our July call, we said that we expected Q3 revenue would be approximately $900 million, and that three principle lines of businesses would be the major contributors to the expected temporary decline in Q3, and they were:

  • In DSL, we predicted that Q3 would be down, as our rapid ascent into the leadership position, combined with a tight supply chain, resulted in an excess inventory situation. DSL was down in Q3 a bit more than we had previously expected;
  • Gigabit Ethernet switching was down in Q3, as we continued to work through some small pockets of excess inventory built across a broad set of our customers; and finally
  • Cellular was the third area of expected decrease in Q3. In Q2, some of our GSM and GPRS models for our largest customer in that market, reached the peak of their volume lifecycle.

In addition to the above three businesses mentioned in our July call, our wireless LAN business declined in Q3. This decline was driven by different items, depending on the technology:

  • With respect to 802.11g, we had two customers change their supply chain logistics, which caused a temporary slowdown in shipments for a few weeks. Now that this adjustment is behind us, we do expect to rebound in G, plus some potential seasonal strength in Q4;
  • For 802.11n, in Q3 we transitioned from selling N-based routers in Q2 to client-based products for PC OEMs, which have significantly lower ASPs. In addition, as we mentioned last quarter, our growth in the near-term was going to be dependent on how aggressively the PC guys pushed 802.11n in their notebooks and desktops. So far, we have only seen Dell and Acer ship products. Sell-through is in line with our expectations in July. We expect to see other large PC OEMs announce its N-based products in Q4.

These issues were partially offset by the initial ramp of our wireless LAN solutions into the Nintendo Wii platform, which uses both our Bluetooth and wireless LAN solutions.

Offsetting these sequential declines in Q3 were increases in areas such as:

  • Digital TV, where our revenue generated from this business doubled from Q2 to Q3 as we began our ramp with our first tier-one customer;
  • Cable set-top boxes and modems both increased, driven by growth in units combined with continued growth in high-definition and DVR-enabled set-top boxes and voice-enabled modems;
  • Our mobile multimedia business benefited from a seasonal build for portable media players; and finally
  • Bluetooth increased, due to growth in the PC space and the Nintendo Wii platform.

In terms of revenue distribution for Q3, broadband communications accounted for approximately 40% of total revenue, mobile and wireless for 28%, and enterprise networking for 32%.

In Q3, we once again had two customers, each of whom accounted for 10% or more of our revenue -- Motorola and Cisco.

As we guided to in July, our gross margin fell back into our long-term targeted gross margin range of 50% to 52% in the third quarter. This decline was mainly due to our inventory buildup in Q2, resulting in Q3 shipments at Q2 foundry prices, and due to product mix and product transition issues.

Looking at operating expenses, consistent with our guidance, total non-GAAP operating expenses were up only slightly from last quarter, as we remain conscious of our long-term profitability model.

We increased our total company headcount from Q2 by only 185 -- the lowest level of increase in over a year -- to worldwide total of 5,039 employees. Importantly, engineers comprised approximately 72% of this total headcount. This percentage has increased from approximately 67% two years ago.

Our annualized revenue per employee was $716,000, down from $776,000 in the previous quarter, but up from $695,000 reported in 2005.

Moving on to the balance sheet, we continue to generate strong positive cash flow, increasing total cash and marketable securities by $177 million, to an all-time high of $2.55 billion. The positive cash flow was generated primarily from operations, as proceeds from employee stock option exercises were negligible.

As we stated in July, our goal was to bring our inventory levels down by approximately $50 million, and we were able to bring them down just over $54 million to $223.5 million, which is more than the amount of increase in Q2. As demonstrated in prior periods, we were once again able to quickly identify pockets of excess inventories and take immediate corrective action.

Our accounts receivable day sales outstanding, or DSOs, increased from 39 days to 43.

Our linearity of shipments was still quite good, shipping 33% of the quarter in the third month. Compared to Q2, we had a higher percentage shipped in the second month than we did in the first.

Looking at expectations for Q4, in July we indicated the decline in Q3 was temporary, and that we expected Q4 revenue to be higher than Q3, and even higher than what we reported for Q2. We still expect to see an increase in Q4 over Q3, but not as high as we had previously predicted. Specifically for Q4, we expect revenue to be slightly up, to up approximately 1% above Q3.

The main reasons for the difference from our prior expectations for Q4 revenue are:

  • In DSL, we had anticipated that the inventory correction was going to take one quarter to correct itself, and now it appears it will take two quarters. Our view of the potential in this market has not changed -- the correction just took longer than we had originally anticipated;
  • In Gigabit Ethernet switching, while we expect growth in Q4, the bounce-back is not as strong as we had predicted;
  • We are also seeing minor pockets of softness in other segments of the enterprise market that we had not anticipated at the time of our July conference call;
  • For wireless LAN, while we expect growth in Q4, we anticipated a bigger ramp in the client and access point areas for 802.11n.

Looking at what we expect to happen in Q4 versus Q3, in Q4, we expect revenue growth to be led by our mobile and wireless group. We expect growth in almost all major businesses, including cellular, driven by growth in both 2G and 3G phones, and Bluetooth and wireless LAN, due to ramp of the Nintendo Wii.

Other areas of expected growth include digital TV, as existing tier-one accounts continue to ramp and new accounts begin their ramp.

In satellite set-top boxes, where we expect to see an increase in our satellite business offset by a temporary decline in our cable set-top business, as a major customer purposely built up inventory in Q3 due to a manufacturing transition.

For gross margin, we have consistently stated that our long-term model is to be in the range of 50% to 52% on a non-GAAP basis, and reported Q3 was within this range. We have begun to see the supply chain capacity opening up, resulting in a more favorable pricing environment. We expect Q4 gross margin to be above Q3, but still within our long-term model.

For Q4, we do expect to see operating expense continue to increase, primarily due to increased mass tooling costs related to 65-nanometer products, critical to our revenue growth and gross margin in 2007 and later years.

We are also investing aggressively in new product areas that have the potential to drive our revenue in 2007 and beyond. To put this level of investment into perspective, approximately 30% of our research and development spending is in markets from which we generate little to no revenue today. However, we remain very conscious of our long-term profitability models and we will take whatever steps we reasonably can to assure we operate within that model, while continuing to fund our growth opportunities.

Cash flow from operations for Q4 is expected to remain strong.

Finally, as a reminder, our guidance for the fourth quarter of 2006 does not take into account the effects of the pending restatements, which we believe will result in significant adjustments to our results of operations on a GAAP basis, but will not have a material effect on our non-GAAP results.

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

Scott A. McGregor

Thanks, Bruce. At a high level, I would like to start off by observing that Broadcom is well positioned to lead the communications and convergence wave, due to our broad and diverse product offering that covers a large number of large and growing end-markets.

We have over 20 lines of business focused on three separate end-markets, that we classify as broadband, mobile and wireless, and enterprise networking. Another way to look at it is do Broadcom solutions touch an individual at home, work and while mobile?

These lines of business change from time to time, but none represented over 13% of revenue in Q3, and only three are about 10% because of sales, which is a testament to the diversity of our revenue stream, and in fact, we are not being driven by any single end-market product technology or customer.

For our 20-plus lines of business, we saw a TAM opportunity of approximately $64 billion in 2005. Looking out to 2008, we see this growing to $95 billion.

Our served addressable market, or SAM, is a more accurate view of our opportunity, and it is expected to grow from $24 billion in 2005, with a 40% compound annual growth rate, to $67 billion by 2008.

The key take-away here is that there are large and fast growing opportunities ahead of us.

Moving on to our product lines, our broadband communications was up slightly in Q3, with all but one of our businesses achieving sequential growth.

In DSL, while we see inventory and product transitions at specific end customers, the overall DSL market demand and our market share remains strong year over year, and relative to an outstanding first-half of 2006. We have previously been under pressure to keep up with supply in the DSL space over the last few quarters, as we have been successful in capturing a number of design wins, that have since driven us to the number one position in this market. It is clearly a positive.

As we signaled in Q2, we believe that we have more than fulfilled those shortages, leading to an excess inventory situation and therefore, a decline in our Q3 DSL revenue. We now see DSL revenue being down slightly into Q4, and then growing again in 2007.

Overall, we expect to finish 2006 with more than 100% unit growth in DSL, and market share greater than 40%.

Our funnel and production qualified design wins indicates that we have further increases in market share possible in 2007.

We see excellent opportunities to grow our broadband modem business longer term, driven by additional units, ASP increases -- as we had voice switching and wireless LAN in these platforms -- and our expansion into the VDSL2 market. We believe we can achieve a share position in VDSL2, similar to what we have today in ADSL2+. We will talk more about our VDSL2 solution at our upcoming analyst day on November 9th.

In set-top boxes, Broadcom continued to experience a high level of demand for our HD and PVR solutions for both the cable and satellite set-top box markets.

Within the cable set-top box market, during Q3 we experienced strong unit demand across both our high- and low-end units. Part of this growth was the result of customers transitioning manufacturing supply chain from one location to another. We anticipate that in Q4, this customer will order more, similar to the first-half of this year. Based upon recently reported results from this customer, demand for set-top boxes remains strong.

In the satellite set-top box market, we successfully expanded our customer engagements for AVC and MPEG4-based set-top boxes, beyond our relationship with EchoStar and DirecTV. Not only are we expanding our customer base, we are also looking forward to expanding our strong DBS2 back-end offerings into the front-end.

In Q3, we took a significant step into the digital TV space and began shipping our solutions to our first tier-one customer in Korea. As we mentioned last quarter, we have tier-one design wins in Korea, Japan and China, and expect more of these to begin shipping over the next two quarters.

We achieved excellent revenue growth in Q3, albeit from a small base, as DTV revenue is now in double-digit millions, and revenue grew over a 100% from Q2 to Q3.

Customers are choosing our DTV solutions because of the following reasons:

  1. Picture quality -- we have been able to leverage our 15 years of experience in the cable set-top box market. Tier-one OEMs will not even consider an integrated solution without having world-class picture quality;
  2. Single chips solutions at analog integration -- we are able to integrate things like CPU, MPEG-2, HD and audio decoders, BTSC, A2 analog, audio decoders, deinterlacer scalers and imagers;
  3. Extensive turn-key software support -- many of these are software-based solutions, and are sold on that basis;
  4. Roadmaps for future development -- we are able to leverage of lot of our cable technology and other broadband technology, such as OCAP, cable modems with DOCSIS3, cable cards, security and AVC into the TV marketplace.

Digital television is one of many examples where our customers are demanding a more complete solution from their technology partners, and Broadcom is well-positioned to meet this need.

According to a recent IDC report, the TAM for the IC content in digital TV space is expected to be $4.7 billion in 2006, and grow to $7.7 billion by 2010.

In the mobile and wireless space, we saw revenues down sequentially, driven by the correction in our cellular business, as well as a mixed shift within our wireless LAN business.

These declines more than offset the sequential growth we saw in our mobile multimedia and Bluetooth lines of business.

As we discussed on our Q2 call, the Q3 decline in revenue in our cellular business was driven by end-of-life sales of a few GSM and GPRS models to our largest customer in this market.

On the positive side, earlier this week, we announced that Panasonic, our second 3G customer, is shipping a new handset with our wideband CDMA processor. Also, our cellular solutions were chosen by Palm in the new Treo 680 product.

Our cellular baseband solutions are now qualified in over 75 countries, and on a 150 carrier networks. We are truly laying the foundation for our future success in the cellular market.

With respect to our single-chip HSDPA solution, we have seen a high degree of interest in this product. We continue to experience very good progress while taking the product through testing and qualifications, so please stay tuned for more updates here.

Make no mistake -- this is a competitive market and design wins take time, but we believe we are well on our way to our stated goal of 10% to 15% share in basebands by 2009.

As Bruce mentioned, wireless LAN was down sequentially because of a supply change in the 802.11g space, and a mixed shift in the 802.11n space, but we do expect to see an up-tick in Q4.

We have multiple design wins into top tier-one PC OEMs, such as Dell and Acer, and others that will be announced shortly. This is a nice complement to our retail access point design wins with Buffalo, Linksys, NETGEAR and US Robotics.

To date, we have shipped more than 2 million units of draft 802.11n solutions. We are seeing a strong interest in draft 802.11n connectivity in both desktop and notebook applications, as well as in other content distribution opportunities.

As we look into 2007, we expect draft 802.11n units to represent approximately 20% to 30% of total units shipped.

As we look at our wireless LAN roadmap going forward, we expect to have low-power wi-fi in integrated wi-fi Bluetooth FM chips, as well as other products in this line of business. We will have more news on these initiatives soon.

A great example of our ability to offer complete solution to our customers is the Nintendo Wii, which is expected to be released on November 19th.

This platform incorporates a complete wireless solution from Broadcom. We have the embedded wireless LAN and Bluetooth in the console, as well as Bluetooth in the controller.

The Wii highlights our customer-centric solution approach, where we add tremendous value to our customers' products and work with them to create a strong a value proposition.

As expected, our Q3 revenue from Bluetooth recovered from the impact of a customer rebalancing issue in Q2. We expect to grow again in Q4, driven by growth in each of the segments of the Bluetooth market -- cellular, PC, headset and embedded.

Our leadership position in the handset market has been driven not only by our success in capturing the right design wins, but also our software and roadmap integration with the other functions, such as FM radio, wireless LAN, and some additional technologies that we have not highlighted to date.

Enterprise networking was down in the quarter, driven primarily by expected weakness in Gigabit Ethernet switching, as we worked through the second quarter of our anticipated inventory correction. We have no doubt that the Gigabit Ethernet market will grow, and that we are still in the early stages of its adoption.

When you combine that with our leading market share position and new product momentum, we see growth out of this line of business going forward.

This inventory situation was being driven by supply shortages in the second-half of 2005 and Q1 of 2006, combined with product transitions at our end customers as they ramped down production of their older boxes and cleared out any remaining inventory using our StrataSwitch II product, before they begin to roll out their new boxes using our StrataSwitch III.

As anticipated, we experienced a drop in Q3 in Gigabit Ethernet switching, but expect growth in Q4. However, it appears that the inventory situation has broadened across other business lines, with minor adjustments expected to occur in Q4 in other areas of the enterprise networking market.

Our optical business had a good quarter. We are seeing a faster-than-expected adoption of 10-gigabit Ethernet, primarily being driven by the server and blade server markets, as well as by switches and other data center equipment markets. We do not believe this diminishes our expectation for 10GigE over copper, but merely represents early adoption of this technology.

In closing, we are encouraged by our continued design win momentum and favorable product cycles across our diverse set of businesses. We have been managing through a challenging period, and will continue to invest in the future to remain at the forefront of new technologies that enable our customers' new products.

Before we turn the call over to your questions, I would like to anticipate one of the questions, and highlight a few of the areas that are shaping up to generate strong growth in 2007.

The first one of these is digital television, driven by shipping additional tier-one customers.

The second is Bluetooth, as our customer base expands and we begin to penetrate mono-headsets.

The third one is wireless LAN as 802.11n and embedded applications grow.

The fourth is network switching, as gigabit continues and we begin to penetrate the metro space.

With that, let me turn the call over to your questions. Operator.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Michael Masdea from Credit Suisse. Please go ahead.

Michael Masdea - Credit Suisse

Yeah, thanks a lot. I think a lot of us doubt a lot less your opportunities, and I guess more of us are concerned about some of the volatility, both from last quarter and this quarter and what we've seen in the last couple of years. What are you doing or what can you do to try to get this out of there, especially like for when you look at the fourth quarter? For example, we have a couple of things like the Wii and some of the handset stuff and some of this cable customer that is transitioning the supply chain, will that cause the same sort of volatility going into Q1?

Scott A. McGregor

Well, certainly, some volatility is good when you get a new customer, you see a surge in sales. So I don't think you're complaining about that.

Michael Masdea - Credit Suisse

No, that's fine.

Scott A. McGregor

I think what you're concerned about is what can happen in the semiconductor industry where we get shortness in product deliveries, customers over-order and then we have an inventory correction. And that's very hard to correct in the industry and has been something with us for 50 years. If you have a solution to that though, please, Michael, let us know.

Michael Masdea - Credit Suisse

So what's going on with the customers right now, because it sounds like maybe even during the quarter some of their outlook has changed a little bit or maybe some of the guesswork was a little bit off it? Is something changing with the customer base right now?

Scott A. McGregor

Well, we've seen pretty consistent order – pretty consistent end user shipments from our customers. So that's what leads us to believe this is largely an inventory issue. You know, we had 20-week lead-times for substrates and stuff like that in the first half of this year, and with the wisdom of 20-20 hindsight we believe that a lot of those customers did double order. So that's what we're working off now.

So we believe that’s the primary issue here, and, again, that's very difficult to tell our customers that we're not going to ship them the product they want.

Michael Masdea - Credit Suisse

That makes sense. Last question, options strategy, just talk us through what your thinking going forward? Is it the same as what we heard at your last quarter Analyst Day and conference call? Are there any changes in the way you’re thinking about granting options and restricted stock units going forward?

Bruce E. Kiddoo

Yes. So this is Bruce Kiddoo. At this point, we're not looking for any changes in our policy going forward. We still believe that equity is an important component of our business and that to motivate the engineers as we like to say, to do the impossible, they like that, the equity component.

But clearly we understand from a dilution point of view that we have to manage that. And I think the program that we had in place for the last year, while we're targeting 5% to 6% gross dilution and then a stock repurchase program of 2% to 3% is still going to be our plan going forward.

Scott A. McGregor

That gets us into the low single-digit net dilution, which we think is reasonable given the growth we can deliver as a company.

Michael Masdea - Credit Suisse

Thanks a lot.

Operator

The next question comes from Ambrish Srivastava from BMO Capital Markets. Please go ahead.

Ambrish Srivastava - BMO Capital Markets

Hi, guys. Can you give us some details on bookings, backlog coverage and what kind of turns do you need to make your numbers for the fourth quarter?

Bruce E. Kiddoo

We don't normally provide that detailed level of information. Historically, we go into a quarter at 80% to 90% booked and I think that would be consistent looking forward.

Ambrish Srivastava - BMO Capital Markets

Okay. And then second question is on the receivables. Up quite a bit year-over-year; up 50% your sales are up 30%. What’s going on there?

Bruce E. Kiddoo

We have a slight uptick in our DSOs from 39 to 42 days in Q3 over Q2. That was really just a slight change in our linearity. The third month of the quarter was still the same at about 33% but we shipped a little bit more in the second month than the first month and when you have 45 to 60 day payment terms, that sort of pushes out the receivables.

We're not concerned about this. We continue to manage this very closely and are comfortable that it will stay at these levels, which compared to other benchmarks are at very, very strong levels.

Ambrish Srivastava - BMO Capital Markets

So we should expect it to stay at what level, around 40 days?

Bruce E. Kiddoo

Yes. I think that would be reasonable.

Ambrish Srivastava - BMO Capital Markets

Okay. Thank you.

Operator

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

Ross Seymore - Deutsche Bank

Thanks, guys. Scott, one question about the 2007 growth drivers you talked about. I was writing them down fast but I seem to believe you did not mention cellular handsets given the stressing of 3G, can you either correct me or describe why that wasn’t mentioned?

Scott A. McGregor

We see the 2G business declining a bit into next year in the 3G business ramping. So if I just look at 3G cellular then yes, that would be a growth area for us next year. But we shifted most of our R&D to 3G instead of 2G and so we're seeing some roll-off of those products. In aggregate, I wouldn't classify that as a strong growth driver in 2007. It certainly is a major growth driver for 2008 and 2009, but not so much in 2007 again, because 2G declining while 3G ramps.

Ross Seymore - Deutsche Bank

Okay. Fair enough. And as we think about seasonality in general for you guys, you gave us a lot of great granularity from the bottoms up and so it might be different in each year, 22 product lines. But generally if you're shipping under demand in the fourth quarter, how do we think about seasonality in whatever way you want to determine it for the first quarter?

Bruce E. Kiddoo

We don't give guidance for Q1. However, you're right, we certainly have some product lines that will show seasonality, some of the wireless business, some of the consumer products will show seasonality. We also have some that we sort of call quasi-consumer businesses that sometimes have reverse seasonality and are actually stronger in Q1 than they are in the other quarters. So exactly how that balances, we haven't given guidance on that yet, but there will be a mix of that going on in Q1.

Ross Seymore - Deutsche Bank

Okay. Finally, the last question you mentioned about the wafer prices starting to decline a little bit. Do you believe we're at the beginning of that trend? How should we think about the cost side of the equation proceeding for the next few quarters given what you're seeing from some of your wafer suppliers?

Scott A. McGregor

Well, certainly our long-term model of 50% to 52%, we still believe is the right way to model us in the long term. As we gave in our guidance, we expect gross margins to be up slightly in Q4 over Q3, and at this point we're not giving guidance for 2007.

Ross Seymore - Deutsche Bank

Great. Thank you.

Operator

Next question comes Chris Caso from Friedman, Billings, Ramsey. Please go ahead.

Chris Caso - Friedman, Billings, Ramsey

Yes. Thank you. I wonder if you can comment a little bit on pricing environment and maybe obviously focus on some of those areas where the pricing is typically more volatile, say the wireless LAN and Bluetooth side. Seeing anything there as a result of, you know, some of the pockets of inventory that you guys talked about?

Scott A. McGregor

I think if you look at it on a multi-quarter trend, we saw some issues where we had relatively flat wafer pricing and increasing assembly and test pricing over certainly the first half of this year, and the latter half of last year. That made it painful for us as customers wanted their price reductions and we were actually seeing price increases.

There is actually a significant amount of gold in our chips with the little wires that connect them and the price of gold going up was a problem for us, as customers wanted price reductions. And so that contributed to some of the margin pressures that we saw, up until now.

Now, we see that gold is going back down. We see wafer prices easing and we see a relatively normal pricing environment in terms of price erosion on the chips. So I think net that puts us into a more favorable environment going forward.

Chris Caso - Friedman, Billings, Ramsey

So if I look, what you're selling now both in wireless LAN and Bluetooth, margins actually, I guess it sounds like you're implying they actually improved Q2 into Q3?

Scott A. McGregor

No, I didn't mention that specifically for those products. We do see a significant decline in 80211n pricing, as expected. You introduce new technology when it first comes out at higher and then, the price declines faster than normal for the overall chip market. But that will get back under the normal curve at some point here.

Chris Caso - Friedman, Billings, Ramsey

Okay. Just a follow-on with regard to your production, you've made good progress in bringing inventory levels down. How would you characterize that versus your targets? And as a follow-on to that, what do you expect in terms of your production levels and wafer starts and that as we go forward now?

Scott A. McGregor

So from inventory point of view, we've historically said we kind of target seven or a little bit better turns. Going forward, I think you should model at that same level. Of course, until we refile our financial results we can't calculate the term for you.

Chris Caso - Friedman, Billings, Ramsey

Does that imply from here, that we would start to see production level start to rise again, or is that probably more an early '07 event?

Scott A. McGregor

I would say we're happy with our level of inventories right now. And so wafer starts will begin to match our production going forward. But, by the way, be careful, we've seen some things out in The Street where one or another of our foundries or assembly and test centers will talk about our business or other business. Remember, we have five or six foundries we work with and about the same number of assembly and test centers. We constantly move load around based on pricing and performance. So one can go up or down and it may not necessarily reflect our business, but rather how we view them in terms of their pricing and performance.

Chris Caso - Friedman, Billings, Ramsey

Understood. You guys keep us on our toes. Thank you.

Operator

The next question comes from Arnab Chanda from Lehman Brothers. Please go ahead.

Arnab Chanda - Lehman Brothers

Thank you. I have couple of questions which are product related. First, basically for Scott, you talked about when 2G is declining and 3G is growing. From what point on should we assume the 3G growth is going to characterize the growth of say, your handset business?

Scott A. McGregor

I would expect us to trough early next year or even a little sooner. And then, after that the 3G growth should dominate the equation there.

Arnab Chanda - Lehman Brothers

Thanks. A question about Bluetooth. Do you think this year that you have in the market is that relatively stable, there have been talk of new entrants in handsets. Where are you with that? Or are you gaining share, losing share, maintaining, are there new customers that you are gaining? Obviously, Nokia is one that you don't have as a big player, if you could talk on that little bit?

Scott A. McGregor

We nearly 100% market share with a very large player in the cellular space and that's not sustainable, and we have discussed that before. Certainly, we understand why they would want to go with a multi-source strategy for Bluetooth.

However, as we said, I believe in our last call, we expect that our adoption rate into new customers will more than offset any declines we see in that customer. So yes, we are picking up additional large customers and we believe that Bluetooth remains a strong grower for us going forward in the next few quarters and in the next few years.

Peter Andrew

We haven't really attacked the headset space and I believe in 2007 you'll see renewed effort on our getting a very nice market share within the headset space for Bluetooth.

Arnab Chanda - Lehman Brothers

Thanks Peter and Scott. And just a last question please. A couple of the markets you've talked about, you know, it seems like there are new market transitions going on, for example in wireless LAN, there's obviously big opportunity in embedded you haven’t participated in. And certainly for VDSL, is there a danger specifically to DSL that, you know, at some point DSL markets are in decline and you need to get the right share in VDSL? If you could shed some light on that? Thanks.

Scott A. McGregor

Well, actually, we expect our share in VDSL2 to be certainly in the same ballpark as our current share. And the other opportunity for us is to add additional functionality in these solutions. So you don't just sell a modem. You sell a wireless LAN with it, voice capability and other things. So once we get into that platform, then we have the opportunity to bring our whole portfolio to bear and so that's how we're able to enter a market, take share and grow in that market, and then continue to increase ASPs into those platforms going forward.

We've done that successfully in the cable modem area, which we've been in for a long time. We have a high share in the cable modem space and yet we've able to increase revenue there not by increase in share and not by the market growing spectacularly but rather by adding additional functionality. And that formula we believe applies to quite a few markets including the ones you mentioned..

Peter Andrew

Also, Arnab, please make sure you show up at our Analyst Day. We hope to have more news for you on our VDSL2 efforts.

Arnab Chanda - Lehman Brothers

I'll be there as long as I'm doing this job, so no problem with that. Thank you.

Operator

The next question comes from Seogju Lee from Goldman Sachs. Please go ahead.

Seogju Lee - Goldman Sachs

Thanks. Scott, just if we can touch on the ongoing litigation with Qualcomm. There has been some updates there but just, if you could give us your thoughts on the latest ruling and then, additionally how we should look at the milestones going forward? Thanks.

Scott A. McGregor

Well, I apologize, since that's ongoing litigation I can't say too much but we were very pleased to see that the ITC has ruled that our patents are valid and that Qualcomm does infringe on our patents. There is the usual appeal and review processes and what not, but we believe that this is the first time that Qualcomm has ever been challenged in court on infringing on other people's IP and lost. So we think that's very significant.

Long-term, our goal is two-fold; one is to get paid for our IP, so this is a very significant step forward. And the second is to create a level playing field in the 3G space. And those are our goals and those drive where we are going forward.

As they say, all wars come to an end and we will eventually settle this. We are not sure how long that will take, but we believe that having our IP proven as something that is a fundamental to what Qualcomm uses in their chips, that is a very important first step in getting that settlement.

Seogju Lee - Goldman Sachs

Okay. And just a follow up on that, in terms of the comment of Qualcomm coming to you with a more favorable sort of offer, can we look into that or think that this should be settled at some point here in the near-term? Or how should we think about that?

Scott A. McGregor

Yeah, I'm sorry, I can't comment on that.

Seogju Lee - Goldman Sachs

Okay. And just lastly on a product side of things. Broadband, when you went into this quarter you had expected all three product segments to be down. Broadband was up sequentially and you did mention DSL was a little bit worse than you had expected. Help us think about what helped offset that?

Scott A. McGregor

So the first part was that we've talked about before was digital TV was up. As we started to ramp with one of our first tier 1 customers there. In addition, we saw strong sales in our cable TV business, as I talked about in my opening remarks, as we saw both increased sales from a unit's point of view and increased sales in the PVR -- and in the PVR higher-end HD boxes.

Also another contributor was our cable modems. Remember there was a great transition going on there from data-only devices to true gateway devices that are integrating not only data but also voice which has a nice incremental ASP boost for us.

Seogju Lee - Goldman Sachs

Okay. Great. And you talked about some correction in terms of supply chain on the cable set-top box next quarter but satellite remains strong and you see that continuing here?

Scott A. McGregor

That's a correct comment for Q4.

Seogju Lee - Goldman Sachs

Great. See you at analysts' day. Thanks.

Scott A. McGregor

See you there.

Operator

The next question comes from Mark Edelstone from Morgan Stanley. Please go ahead.

Mark Edelstone - Morgan Stanley

Thanks a lot, guys. Good afternoon. I had two questions; the first one was for you, Scott, if I could. Could you give us your sense as to what you think your SAM growth looks like in 2007? Just conceptually, how you see the year playing out for you guys as you go through and recover from this inventory correction and get back to growth?

Scott A. McGregor

Mark, I don't have those SAM numbers in front of me. We can certainly get that for you after the call and we can talk about it at analysts' day where we cover the different markets there. But we do definitely see growth in 2007; certainly you get recovery from inventory correction just you get back to normal ordering patterns. We've won a number of important designs and those are going to start ramping and so, you know those will drive a lot of a growth. I've mentioned a few of them but we'll cover that in more depth on the 9th.

Mark Edelstone - Morgan Stanley

And then for Bruce, you guys have highlighted here in the press release that you do not expect to file your Q on time. Can you just give us an update as to where you stand now in the option review process? Has most of the work been done internally and now you're just waiting on outside auditors to confirm data for you or where do we stand in the process?

Bruce E. Kiddoo

Sure. As we mentioned upfront, we continue to make good progress in our investigation. I think until it's completely done, I don't think we want to give details as to where we're at. But we're comfortable that we're moving forward and we're making good process. We understand what needs to be done and are confident we'll get this done in a timely manner.

Mark Edelstone - Morgan Stanley

Can we assume that happens before the end of the year?

Bruce E. Kiddoo

You know, at this time I don't think that we can give you an exact date. As you know, this does involve working with outside parties and that makes it very difficult to, you know, give an exact date when we'll get it done. Rest assured this is our top priority and we know what we need to do and we will get it done as soon as we can.

Scott A. McGregor

Mark, with that being said I would personally be very disappointed if we didn't get it done before the end of the year.

Mark Edelstone - Morgan Stanley

Okay. Sounds good. Thanks a lot guys.

Operator

The next question comes from Shebly Seyrafi from Caris & Company. Please go ahead.

Shebly Seyrafi - Caris

Good afternoon. You know, so, I guess I'm confused by the numbers. Mobile wireless segment is about 30% of revenue, it has a lot of positive drivers here. The iPod should grow well for Apple and that should help your mobile multimedia segment. Wireless LAN is going to grow, Bluetooth should be helped by Nintendo Wii. And then, we're also talking about offset being DSL, which I estimate to be only 6% of revenue, which can't really do a lot of damage, according to my models.

So I'm wondering why you're not more optimistic about the fourth quarter in light of the drivers in the mobile and wireless segment?

Scott A. McGregor

Well we do expect all of those businesses to grow and the question is just how much? We'll need to see how those markets develop. It's a little hard to predict how strong the Christmas season is going to be.

Shebly Seyrafi - Caris

Okay. Also, at the end of the June quarter, you had noted that your customers had excess inventory. Would you say that over half of that excess inventory has been worked off so far?

Bruce E. Kiddoo

Yes. Shelby, we can't go to that level of detail, because, remember, it's in different areas and it's happening at different times, for example, in Q2 we had one customer that we went through a supply adjustment within the Bluetooth space, and then there is different things happening at different times. So it's hard to put an exact number on where we are through the overall inventory correction process.

Shebly Seyrafi - Caris

Okay. Finally for me, any comments on the state of wireless LAN inventory for N? Has that been reduced meaning fully?

Scott A. McGregor

I think what you're referring to is access points in the retail side. And what we believe is very important to that is getting the clients shipping. Because once the client ship, it creates a natural demand to pull that inventory on access points. So I think the things to look to there, are how many of the PC OEMs are shipping 802.11n. So far we have Dell and Acer announced. There is another PC company shipping already. There was a tear-down on that with our product. And we know our number of others beginning.

We expect over time the price of the retail cards will go down and we may even see some of the PC OEMs begin to bundle at some point and replace G. So those are the things that are really going to drive the access point business and I think there is a bit of an overhang still in the retail market.

But for us, unlike many of our competitors, we sell both access points and we sell the client cards, and so our business has shifted a bit from retail to the client side, and we expect the client side will now pick up the ramp and then the access point in retail will follow on probably a quarter or two later as that overhang goes away.

Shebly Seyrafi - Caris

Thank you.

Operator

The next question comes from Alex Gauna from UBS. Please, go ahead.

Alex Gauna - UBS

Yes. Thank you. I was wondering does guidance incorporate 100% coverage of shippable backlog in the quarter? And if so, what are some the key areas where you might expect some variance meaning I would think that consumer areas like the wee, there might be some turns expected that could go one way or the other. Can you go over that please?

Bruce E. Kiddoo

So as we indicated earlier, generally going into fourth quarter, we have about 80% to 90% coverage on backlog so our guidance doesn't reflect 100% of that. I think as Scott mentioned, there are a number of areas where we're looking for growth and it's just a question of how much of that growth is going to be, and we can't project that right now until we understand how strong of a Q4 and the consumer season is going to be.

I mean areas such as digital TV, areas such as Bluetooth and as you said in some of the either MP3 or gaming areas, as well. Until we get an understanding of what the end demand is, we won't be able to provide an accurate estimate of our Q4 forecast.

Scott A. McGregor

But guidance is just that. It's management's best estimate based on the data we have of what we think the pluses and minuses are going to be in the quarter. And you know you can certainly get more pluses than we counted on and, you know, Christmas might not come and that would reduce it. That's our guess and our estimate, based on the numbers we know.

Alex Gauna - UBS

In the satellite set-top box area, is there enough flexibility in the supply chain that you can get significant turns there, or is the manufacturing cycle too long to do much within the quarter?

Bruce E. Kiddoo

I think as we've discussed before, we have a very strong operations team, and to the extent that the customers need product, we will work to do everything we can to get that. We certainly have the ability to do a certain level of turns within the quarter. It's really a question of when the customers identify that requirement to us and our ability to meet that.

Scott A. McGregor

We do a good job staging product in the different stages of manufacturing. So, we stage a die, we stage wafers, we stage actual product in our own inventory, in addition to what the customers have. And, so if there is a sudden pickup or sudden change in demand, we're usually pretty good at being able to capture that.

Alex Gauna - UBS

Okay. One specific question it is fair, it might be too granular. I recently checked with DirecTV found out that they're backlogged some three weeks in there new MPEG-4, HD PVR set-top-boxes, they cited strong demand. I'm wondering are there any manufacturing bottlenecks here or are you seeing some of the pickup, because if I'm not mistaken that's an area where you're dominant?

Scott A. McGregor

We can't comment on particular customer situations. You have to ask them that question.

Alex Gauna - UBS

Okay. One more if I could, looking out at 2007, based on the kind of design win profile you've got at this point in time with digital television, how sizeable an opportunity is that starting to look like?

Scott A. McGregor

Well, we do identify it as one of our, you know, significant growth drivers. I think it's a little uncertain for us. It is a huge market and we have great products. And the real question is how fast we can ramp and how many models with how many different customers? So I think the gating item for us is not our products and not the market. I think the gating item for us is just how many design wins we're able to support going forward.

So that's what I think also will drive it. But we have a lot of irons in the fire there and it's just a question of how rapidly they roll-out.

Alex Gauna - UBS

Very good. Thank you.

Operator

The next question comes from Bill Lewis from JP Morgan. Please go ahead.

Bill Lewis - JP Morgan

Great. Thank you. It sounds like from your commentary about inventory and target turns that this quarter you're kind of where you want to be. So from here you don't really need to radically adjust your own internal inventories. But in terms of the customers, at the OEMs, contract manufacturers, where do you anticipate inventories are going to be kind of cleaned up and at appropriate levels by the end of the quarter?

And I guess more importantly, where do you see some areas where there still might be some lingering overhangs as we think about your growth in the first half of next year?

Scott A. McGregor

You're correct that we are happy with our own inventory situation. And, you're right the issue is what is the customer's inventory? I think it's really hard to generalize on that, because some of the guys are going to be seasonal the consumer product kinds of things, others are driven more by capital cycles with the carriers, and what not. So I don't think I can give you a simple answer on that. It will vary quite a bit in each of our segments.

Bill Lewis - JP Morgan

I guess are there any specific segments where there will be kind of lingering inventory impacts that you would point out to us to think about as we look at the first half of next year?

Scott A. McGregor

I don't anticipate any.

Bill Lewis - JP Morgan

Okay. And then, a second question, if I could, just kind of putting everything together on your outlook for the fourth quarter, do you anticipate that net income would be down sequentially just given the increase in operating expenses?

Bruce E. Kiddoo

We can't give that level of guidance at this point in time.

Bill Lewis - JP Morgan

Okay. All right. Thanks.

Operator

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

Ruben Roy - Pacific Crest

Hi, thank you, Bruce, I just wanted to clarify something, I'm sorry, on the bookings comments you made a couple of times now you've said, specifically you have 80% to 90% backlog coverage, but are you saying that's where we are entering Q4?

Bruce E. Kiddoo

We didn't give that specific item. I would say, historically, that's the level we have going into quarters.

Ruben Roy - Pacific Crest

Okay. And then, Scott, on that end – I'm sorry, if I missed this, but are you expecting 802.11n to grow, revenue growth in Q4?

Scott A. McGregor

It will depend a little bit on the sell-through in the retail side and how rapidly some of the PC OEMs pick up. We haven't given specific guidance on that but those would the factors that drive growth on N in Q4.

Ruben Roy - Pacific Crest

Thank you. And then a final one for you, Scott, on the digital TV, question came up on the market out there for merchant components, I guess. But you have taken a stab at market share for base band. Would you care to maybe take a stab at where you would like to be in terms of market share in 2007, within the digital TV market for merchant components?

Scott A. McGregor

Well, 2007 is going to be hard to predict because it's really going to depend as I said on the ramp there. But make no mistake, our ambition is to become number one in the space. So it might take us a few years to get there but that’s our ambition in the digital TV space.

Ruben Roy - Pacific Crest

Great. Thank you very much.

Operator

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

David Wu - Global Crown Capital

Yes, good afternoon, gentlemen. I wonder if you could help me get some clarity on the fourth quarter outlook that was described? Number one, that the mobile and wireless is the main driver for sequential revenue growth of 1%, right? What about broadband? How does that look in Q4 relative to Q3?

The last thing is on the enterprise side you mentioned while Gigabit Ethernet switch business should be turning up in Q4, that there were other businesses, smaller businesses that would have problems? Could you clarify what kind of businesses are we talking about in the other category?

Bruce E. Kiddoo

So for broadband communications, we mentioned that we still saw some very modest weakness in DSL and we also mentioned that there was a manufacturing transition in our cable TV with one of our largest customers there where they purposely build up inventory in Q3 to support a manufacturing transition in Q4. And so that's going to result in kind of a temporary decline in that business in Q4 as well.

David Wu - Global Crown Capital

Okay. What about the enterprise networking side, XT Gigabit Ethernet switch?

Bruce E. Kiddoo

Sure, within that category, we're just seeing small pockets of weakness in a couple of different categories, mainly associated with the enterprise space, more of the controllers, security, those types of issues. It's fairly small in terms of total size.

Scott A. McGregor

But we did see our switch business trough in Q3, and we do expect renewed growth in Q4.

David Wu - Global Crown Capital

If I were to look at these three categories, I assume broadband will be down sequentially and enterprise may be off slightly. And the net-net is the mobile and wireless would carry the day for Q4. Did I get it correct?

Bruce E. Kiddoo

Yeah, that's approximately correct.

David Wu - Global Crown Capital

Okay. Thank you.

Operator

The next question comes from Srini Pajjuri from Merrill Lynch. Please go ahead.

Srini Pajjuri - Merrill Lynch

Thank you. Most of my questions have been answered. Scott, one longer-term question. I guess one of your biggest competitors recently acquired a wireless business. I am just wondering if you look at your wireless business and given the small scale and if you don't get your 10% to 15% market share target in the next year or two, would you consider acquiring another business or, you know, do you think you're good on your own?

Scott A. McGregor

Our target for 10 to 15% market share in base bands is 2009. I would say a year ago, we would have been open to acquiring a business there. Over the last year, though, we've built up our own technology in this space and actually based on customer feedback, we are ahead of most of the people that are for sale right now, which is probably one of the reasons they are for sale and got bought.

But we've seen just an incredible push on our own technology. So I would say the things that gate us on the cellular side are no longer technology and no longer customer access. We believe we have the access to all of the customers we need to get to and the products that are of interest to them.

I think the thing that is going to gate us is just how many designs simultaneously we can support. For us to support many of the top ten customers doing multiple designs, that's where we'll need the staff and that's where we'll need the scale going forward. Now, we could get that by buying one of those people you're referring to, but that would be a very expensive way to buy that capability and there are easier ways to do that.

Srini Pajjuri - Merrill Lynch

Fair enough. Thank you.

Operator

The next question comes from Charlie Glavin from Needham & Company. Please go ahead.

Charlie Glavin - Needham

Hey, guys. I had a question, Scott, if you could give a little bit more granularity by geography? You mentioned by the product areas, but certainly the weakness in terms of the trough rolling in terms of by geography, as far as Europe may have recovered in certain aspects, maybe not in DSL, whereas low-end phones little bit better but the high-end, particularly from the CDMA being weaker. Could you give us a little bit more clarity in that.

Scott A. McGregor

Charlie, we're rifling through our papers looking at the geography. We don't see any real geographical trends. So we don't see anything jumping out at us in terms of one geography or another.

Charlie Glavin - Needham

And you mentioned in terms of having the various foundries and balancing them off overall. In terms of the costs though, as we start to see the wafers' prices coming down as more of the wafer guys shift from over from 8 over to 12, can you give better granularity in terms of where you seeing the cost? Is it more back end, front end in terms of the relief?

Also, how much of this is also in regard to some of the migration or some of the product you've taped out and are now bundling together? And a quick follow-up on that last question.

Scott A. McGregor

So two issues here, first is whether costs are driven by wafers or back end. The answer is we're seeing reductions in both, as those factories become less loaded the suppliers become more reasonable on pricing.

And again we went from -- usually assembly and test is not the gating item. But we just saw a very difficult situation there, you know, a year ago or nine months ago that now has abated both with the overall demand in the industry coming down a little bit, but also with additional supply coming on-stream. For example, PBGA factories in China coming on stream to off load some of the shortness in Taiwan. So you know both of those are factors.

Then you also mentioned the integration of different technologies and whether that was driving things. Certainly moving to 65 nanometers as we're doing aggressively and our general strategy, which is to integrate as much technology we can on single chips, helps us achieve the margin and competitiveness that we do have. So that's just part of our normal strategy and that isn't anything unusual going on right now.

Charlie Glavin - Needham

I guess that last question maybe this is something for the analysts meeting, but in terms of your bundling on the supply side, were those constraints in the substrate more relative to the complexity of your designs? That is, are more of your designs having go in packages that are higher end and was that part of the problem?

And then the second part of that, Scott, is as much as you have ever estimated, what percentage of the products now would you say are bundled? That is, as opposed to selling data-only access product now, now you have got it bundled with voice or other products. And if that is the case, is there really a relevancy in product breakdowns since there is so much overlap now?

Scott A. McGregor

It's an interesting question. I don't, to be honest I don't know how to quantify it. Why don't you let us think about that one and at the Analyst Day maybe we can help you out more on that? But, certainly our strategy is to continue to additional functionality and to integrate thing into single chips. Sometimes that is a single chip and sometimes it's sort of the fast-food equivalent of the Happy Meal, I guess, where we want to sell a variety of chips altogether as part of the solution. So, I have to think about how to characterize the difference between those two and how that affects that.

Charlie Glavin - Needham

Maybe, a way to quantify it on your terms, Scott, is you take a look at the R&D function, assuming that your SG&A, at least the sales and marketing aspect is somewhat related to your top line. Your R&D seems to be growing at a pretty good clip and in not only third quarter, fourth quarter and given the number of designs you have. How should we take a look at your R&D, not only through the end of the year, but do you have any particular goals in terms of next year?

You're certainly hiring a lot of software and app engineers, but given the bundling and also the migration how can we kind of look at that?

Scott A. McGregor

We model having about 20% R&D in terms of our overall business model. And we try to stick to that. You know, it is interesting at the beginning of 2005, we said that we would deviate from that and move above that, because of, you know, known designs and opportunities that we saw. We said that we would then see subsequent growth, it would take us back to correct that.

And in the course of 2005, the beginning we were significantly over the 20% on R&D and by the end of the year we brought that back down to less than 20%. So, that shows that, you know, we are able to go capture those.

To the extent that we see design opportunities that are firm and convincing, we will increase our R&D above 20%. But if you see us increase R&D above 20% deliberately, that's usually because we see unusually high growth opportunities we want to go capture and that is why we do it.

Broadcom typically does not develop products just for hypothetical customers. We tend to develop products for specific customers and so we have a very effective capture rate on return for R&D. I think that's important because it means if you do see R&D creep up, it's because we see particular growth opportunities that's targeted for.

Charlie Glavin - Needham

Well, Scott, since you're already over 20% , you were in third quarter and fourth quarter. Is that given the design opportunities certainly the ones that you listed in your prepared remarks for '07, should we anticipate that this will stay above 20% in '07?

Scott A. McGregor

You clearly must have some form of ESP, because we haven't given the R&D numbers out. But, anyway, to the extent as I said, we would deviate from the model it would only be because we saw great opportunities ahead of us that would accelerate our growth.

Charlie Glavin - Needham

All right. Thanks, Scott.

Bruce E. Kiddoo

Before we take the next question I forgot to mention one important data point to Arnab's question earlier about VDSL2, which was that in this quarter, we did begin shipping our standards compliant VDSL2 solution to carriers this quarter. So I just want to follow-up and then make sure I answered Arnab's question properly. Christine?

Operator

Thank you. And the final question comes from Shaw Wu from American Technology Research. Please, go ahead.

Shaw Wu - American Technology Research

Sure. Thanks. Just a follow-up on a question that was asked earlier, where do you think you are in terms of the inventory flush, in terms of your markets?

Second, based on your revenues now they're going to be somewhat depressed for the next two quarters, and how does this relate to potential seasonality, whether you're going to be seasonal or not seasonal, in terms of the first half of '07? Thanks.

Scott A. McGregor

We haven't given guidance for Q1, and as I mentioned on a previous question, the inventory is highly dependent on particular markets and especially the seasonality. We see some that are counter seasonal. For example, some of our set-top box business, you think of that as a consumer business, but actually it's a anti-seasonal, because a lot of the capital infusions into that business are heavy in the first quarter and so you see a bigger flush there in the first quarter than you would in the fourth quarter.

Other business like some of the wireless business or MP3 players, we expect to be traditionally seasonal. And we haven't at this time, given guidance and to be honest, we don't have any surety of the mix of those two going forward into the first half of the year.

Shaw Wu - American Technology Research

I mean, these are pretty depressed revenues. Is there a good chance you could see above seasonal or you prefer not to talk about that yet?

Scott A. McGregor

Well, if you told me how good and strong the Christmas sales are going to be, I can tell you how strong the seasonal products are going to be. That's part of the problem is it's hard to understand that market and we'll just have to wait and see how the store sales are later in the year. But certainly if you see that consumer demand is strong, that's going to be positive for those corresponding businesses that we have.

Shaw Wu - American Technology Research

Okay. Thanks.

Scott A. McGregor

Okay. I'd like to just follow-up with one parting thought here. When we gave guidance originally at the end of our Q2 conference call for Q3, and we gave guidance for the declining quarter, we certainly had some moments of introspection in the team and we wondered, my God, is Broadcom losing share or is something going on? Because other companies at the time were talking about a very robust second half.

Subsequently, we saw that many other companies also saw some similar inventory issues as we did. We felt a bit vindicated there. But we also believe that we tend to be a leading indicator on some of this and see it earlier than many other companies.

Since that time we've gone back and looked at our market shares and looked at our product design wins, and we believe, we are holding share or gaining share in our principal markets. We believe we're executing well. And, so, that's why we believe that Broadcom should continue to outgrow the semiconductor industry overall here going forward.

So with that parting thought, let me end the call. Thank you very much and I hope for the analyst community, you can join us on November 9th and we'll talk to you then. Thanks.

Operator

Thank you for participating in the Broadcom third quarter results conference call. This concludes your conference for today.

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