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Broadcom (NASDAQ:BRCM)

Q2 2010 Earnings Call

July 27, 2010 4:45 pm ET

Executives

Eric Brandt - Chief Financial Officer and Executive Vice President

Scott McGregor - Chief Executive Officer, President and Director

T. Andrew - Vice President of Corporate Communications

Analysts

David Wong - Wells Fargo Securities, LLC

Shawn Webster - Macquarie Research

Craig Berger - FBR Capital Markets & Co.

Mark Lipacis - Morgan Stanley

Mark McKechnie - Gleacher & Company, Inc.

Sumit Dhanda

Glen Yeung - Citigroup Inc

Stacy Rasgon - Bernstein Research

Daniel Amir - Lazard Capital Markets LLC

James Schneider - Goldman Sachs Group Inc.

Ross Seymore - Deutsche Bank AG

Mahesh Sanganeria - RBC Capital Markets Corporation

Adam Benjamin - Jefferies & Company, Inc.

Harlan Sur - JP Morgan Chase & Co

Srini Pajjuri - Credit Agricole Securities (NYSE:USA) Inc.

Christopher Caso - Susquehanna Financial Group, LLLP

Ruben Roy - Pacific Crest Securities, Inc.

Raj Seth - Cowen and Company, LLC

Craig Ellis - Caris & Company

Ambrish Srivastava - BMO Capital Markets U.S.

Timothy Luke - Barclays Capital

John Pitzer - Crédit Suisse AG

Operator

Welcome to the Broadcom Second Quarter 2010 Financial Results Conference Call. [Operator Instructions] 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 Peter Andrew. Mr. Andrew, you may begin.

T. Andrew

Thank you very much, Christine. During this call, we'll discuss some factors that are likely to influence our business going forward. These forward-looking statements include guidance we'll provide on future revenue, gross margin and operating expense targets for the third quarter of 2010 and any other future periods, as well as statements about the prospects for our various businesses, potential market share and the development status and planned availability of new products.

You should note that the guidance we provide today is based upon forecasts that require us to make certain estimates, judgments and assumptions using the information that is available to us at this time. It should be clearly understood that our actual performance and financial results may differ substantially from our 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 for additional historical, financial and statistical information, including the information required by SEC Regulation G. In addition, we have placed a slide deck, which is available now in the Investor Relations section of our website, that is on the right-hand side of the page under Q2 2010 Earnings Information. For increased transparency, we've incorporated additional tables, information regarding our future guidance, historical performance and segment operating income. With that, now let me turn the call over to Scott.

Scott McGregor

Good afternoon and thanks for joining us today. Broadcom continues to excel in both product leadership and financial discipline and we've performed particularly well in the June quarter, with better revenue and earnings than we originally anticipated, driven by upside demand in several of our largest businesses. Broadcom's quarterly total revenue of $1.6 billion and product revenue of $1.55 billion reached record levels. This is up more than 10% sequentially and over 60% from the strong sales growth quarter one year ago. Sequential revenue growth in the quarter was led by strength in our Broadband and Mobile & Wireless businesses, which were up 15% and 14% respectively. Our engineering investment in these areas over the last several years have enabled us to field an exceptionally strong product portfolio and we're now growing our market share. As a result of our solid cash flow from operations, Broadcom's cash position increased approximately $135 million sequentially to $2.5 billion, even after repurchasing over $120 million in stock and paying dividends of $40 million.

Broadcom is in the fast-growing wired and wireless communications markets, with cutting-edge solutions for a growing number of connected users who are demanding more content and bandwidth. Broadcom excels at silicon integration and our focus remains creating outstanding communication and connectivity products that enable us to grow our market share. We've also been extremely successful in generating profitable growth as both our Q2 and first half results delivered significant expansion in operating margin. Our outlook for Q3 indicates a continuation of this strong momentum going forward.

I'll now turn the call over to Eric for details on the second quarter financial results and our third quarter guidance.

Eric Brandt

Thanks, Scott. Moving to the financial overview. To summarize for Q2, total revenue of $1.6 billion, including $1.55 billion in product revenue. Q2 total net revenue was up 54% from prior year and 10% from Q1 level. Total gross margin increased 10 basis points from Q1 to 52.6%. Product gross margin in Q2 increased 30 basis points to 50.8% versus 50.5% in Q1. Q2 2010 GAAP R&D plus SG&A expense was $565 million compared to $554 million in Q1 of 2010. These expenses increased only $11 million over Q1 due in part to several takeouts sliding into the beginning of Q3.

GAAP earnings per share for Q2 were $0.52 compared to First Call consensus of $0.46 per share. Stock-based compensation dropped to 7.4% of net revenue to approximately $119 million and represented approximately $0.22 per diluted share. Cash flow from operations for Q2 was approximately $196 million. Our cash and marketable securities balance was up to approximately $2.5 billion at the end of the quarter.

Moving to revenue and gross margin. During April's conference call, we said we expected Q2 total net revenue to be between $1.535 billion to $1.635 billion. What occurred in Q2 was total revenue was above the midpoint of our range at $1.604 billion, up 54% from Q2 of '09. Our Broadband Communications segment, solutions for the home, showed solid growth, up almost 15% sequentially from Q1. This resulted from an increase in demand for digital set-top boxes, digital TV and broadband access equipment.

In the Mobile & Wireless segment, solutions for the hand, we experienced a revenue increase of approximately 14% compared to Q1, driven primarily by the strength in the wireless combo chip and ramping of our new GPS solution.

As anticipated, our Infrastructure and Networking segment, solutions for infrastructure, came in flat compared to Q1. Our Q2 GAAP product gross margin increased 30 basis points to 50.8%, up from 50.5% in Q1. This improvement relative to guidance was principally due to mix.

Moving to operating expenses. Operating expenses came in better than expectation. Total R&D and SG&A expenses for Q2 were up $11 million from Q1 levels versus guidance of up $20 million to $25 million. The increase was primarily related to an increase in headcount, full quarter effect of employee cost adjustments from our annual compensation review process in Q1 and growth in legal spending. Favorability to prior guidance came in the legal area as well as several takeouts related to late Q2, totaling roughly $3.5 million, which were delayed into early Q3. Legal spending continues to be both favorable and pushed to the right relative to estimates in April. Stock-based compensation was 7.4% of net revenue, down over 100 basis points from Q1.

Moving to the balance sheet. As I mentioned earlier, total cash and marketable securities were $2.5 billion despite $122 million in share repurchases, our dividend payout of $40 million and roughly $160 million used to pay the class action settlement into a settlement fund offset by equity proceeds of about $164 million. We repurchased approximately $4 million shares of stock in the quarter at an average price of $31.88.

Our inventory turns came in at 6.2x down from 6.9 turns in Q1 of 2010. About 60% of the sequential dollar increase in inventory came from our cellular baseband and mobile multimedia products, as we prepare for a number of new product ramps in Q3. Absent of cellular inventory build, our inventory turns would've been approximately 7x. Our days sales receivable outstanding were 39 days in Q2.

Moving to expectations, we currently expect net revenue in Q3 to be approximately $1.7 billion to $1.8 billion. We anticipate our Broadband segment to have solid sequential growth, the Mobile & Wireless segment to be up significantly over last quarter and the Infrastructure Networking segment, sales are expected to be roughly flat. We expect Q3 product gross margin to remain roughly flat to Q2. Inventory turns should return to our targeted range of about 7x based on growth in ramps of certain products at key customers. With respect to R&D and SG&A expense in Q3, we expect these expenses to increase approximately $25 million to $35 million, of which roughly half relates to growth in design and development costs as we continue to tape out more 40-nanometer parts. Also, as I mentioned, $3.5 million of Q2 mask slipped into Q3, which produces a $7 million swing in tapeout expenses quarter-over-quarter. The remainder of the growth is split roughly equally between legal expenses and employee costs.

On Analyst Day, we committed to grow operating expenses substantially slower than revenue while we were below our targeted operating model of 15% to 17% on a GAAP product basis. Digging a bit deeper, at the midpoint of guidance I just provided, it appears we should achieve our GAAP target product operating margin, net of acquisition and one-time costs in Q3, and be at or above the prior non-GAAP range for the third quarter in a row.

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

Scott McGregor

Thanks, Eric. Starting with our home platform, Broadcom's Broadband Communications business delivered the highest sequential growth rate in the second quarter, at approximately 15% with record sales from core set-top boxes and broadband modems. We expect the revenue growth momentum to continue in the September quarter, driven by new product cycles and dramatic increases in the global adoption of high-definition pay TV services and increasing consumer preference for HD content. We're benefiting from both share gains and mix in the connected home, as service providers increasingly deploy high-end devices, where our product portfolio is strong and product ASPs tend to be higher. In addition to our cable satellite and IP set-top box market share gains in Europe and Asia, we have an increased presence at service providers who are continuing their analog shut-off in bandwidths we capture programs to allow for increased HD and DOCSIS 3.0 deployments.

In our Broadband Access business, we're seeing strong sequential growth, driven by consolidation of market share during 2009, resumption of carrier network upgrades, including China, where carriers are rebuilding with new fiber-to-the-node networks and acceleration of VDSL [Very high bit-rate Digital Line Subscriber] deployments in North America and Europe. We also achieved a key milestone with initial shipments of VDSL2 products for deployment in AT&T's U-verse service.

In our Consumer Electronics businesses, both DTV and Blu-ray experienced good year-on-year growth. These businesses are benefiting from rapid adoption of Internet connectivity and the rendering and display of 3D video, which are natural strengths for Broadcom. According to a recent display search report, almost 26% of 2010 and 39% [Audio Gap] sold in North America will include connected TV capability.

Moving to infrastructure. Broadcom's Infrastructure and Network business in the second quarter was up more than 80% year-over-year and flat sequentially after three quarters of above seasonal growth. We continue to believe demand for video and data will outstrip expansion and capacity, resulting in a multi-year revenue growth for our largest business, Switches and Controllers. With the incredible growth of content that challenges data centers, networking infrastructures is moving to 10-gigabit ethernet solutions. We expect strong adoption of our high-throughput, energy-efficient, low-latency 10-gigabit products by data centers and enterprise customers to continue throughout 2010 and to be a secular revenue growth driver.

Based on order patterns and design wins, we're seeing strong customer demand for our new EPON [Ethernet Passive Optical Network] chipsets and high-end switch fabric products from our recently integrated acquisitions of Teknovus and Dune.

Moving to our hand platform. Within our Mobile & Wireless business, Broadcom experienced double-digit sequential revenue growth with dramatic expansion in sales across our wireless connectivity solutions, offset by some softness in our Cellular Baseband business. Based on our customers' order plans and solid traction in new product ramps, we expect substantial growth in the third quarter from both our wireless connectivity as well as our cellular baseband businesses.

Our Wireless Connectivity business did exceptionally well, with all of our target market segments up sequentially. Broadcom is specially pleased with the performance of our Wireless LAN and GPS businesses. The Wireless LAN portfolio delivered in excess of 30% sequential revenue growth in Q2 and we expect revenue growth above 20% sequentially in the September quarter.

In GPS, we're seeing excellent customer adoption across most of the leading cellular handset players combined with solid growth in PNDs [Personal Navigation Devices], enabling this business to be one of our largest percentage growth drivers in 2010.

In Bluetooth, the strength of our software and stack has created strong demand for our solutions in Android-based devices, which is one of the fastest-growing segments in the smartphone market.

We believe the market opportunity for our wireless connectivity devices will continue to grow as we leverage higher attachment rates in devices like smartphones, tablets, netbooks, digital TVs and Blu-ray players. Typically, we're able to augment our DTV and Blu-ray SoC design wins with incremental sales of Broadcom's wireless connectivity components.

To further advance our portfolio of leading wireless connectivity solutions, we expanded our position in Near Field Communications, called NFC, to our nearly completed acquisition of Innovision Technologies. We have great NFC technology and we'll accelerate its adoption into multiple areas, including simplifying the pairing of other connectivity technologies, electronic payment and security. We're working with multiple customers to use NFC as a point of differentiation in their future products.

In summary, Broadcom is focused on the most innovative technologies related to connectivity, bandwidth and content. Our platform solutions are enabling the cutting-edge products in the strongest growth markets of the semiconductor industry. This product leadership and Broadcom's solid financial performance and strong free cash flow generation model are the engines for our continued success. We believe we're extremely well positioned to deliver on our 2010 operating strategy of driving leverage and profitable growth.

This concludes our prepared comments and we're now ready for your questions. Christine, may we have the first question please?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from James Schneider from Goldman Sachs.

James Schneider - Goldman Sachs Group Inc.

Looks like you saw a pretty substantial operating margin expansion in both the Broadband and Wireless businesses in Q2 relative to Q1. Could you maybe comment on what you expect going forward? First of all, was most of that expansion just driven by the higher revenues? Was it also gross margins? And then going forward, will we expect more expansion in both those or mainly from just the Wireless business?

Eric Brandt

Both of the businesses saw some improvement in gross margin, as well as really, the growth in revenue and leverage of the R&D line, Jim.

James Schneider - Goldman Sachs Group Inc.

And going forward, will you expect growth in both?

Scott McGregor

All we can do is provide you one quarter's worth of guidance and I think if you plug in the numbers that we gave you, you can see that, overall, for the corporation our margins will expand, Q2 to Q3.

James Schneider - Goldman Sachs Group Inc.

On the inventory situation, I was wondering if you could just comment broadly on what you're seeing out there. I think some of your peers have commented on some inventory adjustments in emerging market handsets, maybe in the 2G area and possibly some inventory digestion in China broadband infrastructure. If you could comment on that, that would be great.

Scott McGregor

We're not seeing particular inventory in the various customers or channels that we look at. We've seen, generally, customers, we believe, are shipping what we ship them. We're not seeing any unusual situations in inventory.

Operator

The next question comes from Craig Ellis from Caris & Company.

Craig Ellis - Caris & Company

Scott, you mentioned that baseband was down a little bit in the second quarter. Can you provide some color on what you're seeing with design wins as the business evolves? Are you moving more to a 3G mix or is it staying pretty static at the EDGE and 3G mix that you have in the second quarter? And then as you look at the second half, do you think you'll be in some of the high render [ph] (23:45) models that your customers like you were last year?

Scott McGregor

We're seeing good design win traction. In Q2, we saw a little bit of softness, which we attribute to some shift between different models. We do expect to see a significant pick up in that business in the current quarter, though. So we'll see growth there. In terms of mix between 2G and 3G, in one of our large customers, we're shipping both 2G and 3G today, and we do see a mix towards 3G going forward there. One of our other large customers is still 100% 2G, though, and they're growing quickly and ramping. So probably, overall, you'll see an initial mix more towards 2G in the near term and then as 3G comes on in that second large customer and has 3G continues to pick up in the first large customer, we'll definitely shift more towards 3G.

Craig Ellis - Caris & Company

Eric, a question for you. Despite what looks like a revenue mix shift towards the Consumer businesses, in the third quarter, you are seeing gross margins increase. So is that intrasegment mix shift or is that really the benefit that the company's getting at a business, you're focusing on improving product level gross margins or another factor?

Eric Brandt

It's kind of all of the above, Craig. It is both an improvement in margins within the businesses. We're actually seeing margin improvements across virtually all of the businesses combined with just higher volume and lower absorption cost as you can imagine given how quickly our volume has ramped. I think if you mix adjust it just on a standard margin basis, you'd actually see a slight drop in the gross margin, which we would've expected seasonally as you see that shift to the consumer side. But it's being offset by improvements within the business and the absorption that we're seeing across the business.

Operator

The next question comes from John Pitzer from Credit Suisse.

John Pitzer - Crédit Suisse AG

Not A lot to pick on, but Eric, I was wondering if you could talk a little bit about the industry trends you're seeing in the Enterprise Networking space. I know flat revenue was expected in June. How do you think the industry performed? And I guess you saw a little bit of a degradation in op margin that business. I'm just kind of curious as to what's causing that.

Eric Brandt

So a little bit of two things. One is there's a mix shift a little bit within that business to some of the lower margin products, but only small. And then there has been a pick up in the R&D side of that business. Even with some of those tapeouts, it slipped out. They've actually increased their R&D, and on the flat revenue, that's what you see. So I think that's more noise than anything else. Beyond that, we're still working hard to meet the supply of our customers who are pushing for parts. I'll let maybe Scott comment further on that.

Scott McGregor

You need to put in perspective that we've seen an approximately 80% year-on-year growth in the Enterprise Networking business. So very, very strong growth over the last four quarters in that business. We see it consolidating at a pretty high level. In general, we're seeing very strong demand for things like switches, just a lot of people running out of capacity, a lot of new broadband deployments. So a lot of the broadband deployment we're seeing in our broadband business will translate into more capacity demand and we'll see that down the road in terms of driving more towards our Network Infrastructure business. It's interesting, something like 1 billion people in the last year or so have gotten an e-mail address for the first time, whether it's on a mobile device or a broadband platform at home. And all of those guys are going to start surfing the Internet. They're going to start downloading video content. And generally, we see after large increases in broadband, it's usually followed by an increase in infrastructure as people put the infrastructure in place. We're also seeing good traction from our Dune business. Excellent products in that space. Just tremendous ability to switch large numbers of ports at line speed, and we think that'll be very interesting for the end-of-row model. You think of the blades, the top of the rack and the end of the row. When you create these very large data centers, the end-of-the-row performance is really what drives the whole data center performance. And we've got, we think, the best products in the world in that space and so that should be a good driver going forward as we get the large cloud data centers deployed.

T. Andrew

This is Peter. One other little data point there is also if you look over the last couple quarters, we've been rather vocal in terms of how the service providers switching segments has been a nice driver for us. And the second quarter is really the Enterprise Business was looking up quite nicely for us.

John Pitzer - Crédit Suisse AG

Scott, as a follow-up, just going back to the wireless connectivity opportunity around combo chips, what's the rough split between smartphone and tablet currently and how do you expect that to trend for the balance of the back half of the year and then in the 2011? And when can we expect to see sort of multiple vendors that you're selling into on the tablet front?

Scott McGregor

The balance between smartphones and tablet, smartphones is just by far the larger volume by an order of magnitude. And so we see that there. We see tablets, obviously, as one of the fastest-growing areas. But as we see smartphones becoming a larger and larger percentage, and things like Bluetooth, which is now probably 60% or so penetrated into phones overall, and not just smartphones, we see wireless LAN probably approaching the same kind of penetration that Bluetooth has now over the next couple of years. And that represents a tremendous growth opportunity for wireless LAN. It'll be interesting to see how tablets develop and how rapidly that grows, how rapidly tablets cannibalize laptops or not. So there'll be some trends there. But in any case, our combo products are very well suited to that. You have to have competitors. We've been expecting competitors to show up in the combo space for years now, frankly, and we're still not seeing them drawing a lot of volume. I think, reflecting on two things. One is it's very hard to get a lot of radios working in one chip, number one. Number two, you can create a combo chip, but unless you have best-in-class components for all the components of a combo chip, if one of them is weak, then the combo chip itself isn't any good. And Broadcom has best-in-class in all the different areas. And the third point is we're now going on our third and fourth-generation combo chips. A lot of our competitors are still trying to get their first generation to work. So we believe we've got a significant lead there, and you'll see us pick up other technologies and look at ways to increase the value to our customers by adding additional components to those combo chips going forward.

Operator

[Operator Instructions] The next question comes from Glen Yeung from Citi.

Glen Yeung - Citigroup Inc

Scott, you mentioned a little bit earlier this concept of supply and customers scrambling for parts. I wonder when you look at your on business, what your sense is of the supply condition, particularly as we head into the second half of the year, obviously, looking for more growth. Are you comfortable with the availability of the chip supply?

Scott McGregor

We see a very tight situation in wafer supply, particularly in 65-nanometer, which is the bulk of our wafers which we procure. That being said, I think Broadcom has both done a good job working with multiple suppliers and creating a diversified supply base for our parts, and also our supply partners have really helped us out a lot. That being said, things are really tight and we're going to need to continue to work on that. You can see we've got very high growth rates over the course of this year; a challenge for us and our suppliers. That being said, today, any customer that orders within our given lead times will get product, and we've been able to deliver on those. Where we have challenge is where customer have upside on shorter notice. And because of the tightness in supply, there's not a lot of room for error and it's difficult to do what you would normally do, which is beat your lead times dramatically and get parts to them in a fraction of the normal time. The ability to maneuver and do that is difficult and so that's where the challenge is. But in general, where customers are giving us requested lead times on parts, we can get them basically all the parts we need. And on that basis, we believe we can grow strongly throughout the rest of this year.

Glen Yeung - Citigroup Inc

Do you have any visibility as to when you think that supply condition may ease?

Scott McGregor

That's a tough question. Folks like Broadcom are giving them a hard time because we're growing faster than they can add capacity in some areas. The foundry partners we work with are adding capacity at some point, that will come online and ease things. We will also begin migrating over to 40-nanometer and not just 65-nanometer. So there are a lot of factors there. Also depends on the economy and what some of our competitors do in terms of the overall wafer supply. So in summary, I don't think I can give you a good forecast there, but again, while things are very tight, we are working with our supply partners and I think we'll be able to procure the wafers we need to fuel our growth going forward.

Operator

The next question comes from Mark Lipacis from Morgan Stanley.

Mark Lipacis - Morgan Stanley

You talked about strength in the connectivity area. Is there -- I guess there's two parts to the question. You mentioned Wi-Fi and GPS. On the Wi-Fi side, was that Wi-Fi as part of access points that are going to PCs where you're taking share? Is it Wi-Fi as part of the combination chips? And on that same area, could you give us a sense of what percentage of your combo chips are shipping with Wi-Fi? And on the GPS side, are you guys, the growth that you're seeing there, is this an acceleration of a functionality that the OEMs, the handset OEMs are expecting in their cell phones or you guys think you're taking share?

Scott McGregor

So just a number of questions there. Let me try and a hit on them and I think Peter will probably try and give you a sense of the total split between wireless LAN and combo chips. In general, in wireless LAN, we believe we're taking share pretty much across all the different segments; everything from access points to handsets to all the consumer electronics, all the different markets we play in there. And again, driven by just really an exceptional product portfolio. The wireless LAN team have done a great job, I think building really competitive products in that space. Combo chips, in particular, offer our customers a real advantage in terms of space, power consumption. And something really important, which is the interoperability of the radios all running at the same time. They coordinate and even do fairly sophisticated things like allow streaming packets to go through and hold up the nonessential ones. In GPS, we see, we came from a relatively small share there, but our GPS products, we believe, are absolutely top notch. We offer them both in standalone configurations, as well as in combo chips. We have a Bluetooth GPS combo chip that's very attractive right now. There a lot of cell phones out there that both have Bluetooth for connectivity and headsets and GPS for the various government-mandated location programs. And so we think that's a perfect chip for phones that want to hit that market and they can use wireless LAN as an optional add-on to a design there. So definite strength in our GPS business in terms of just performance of the technology.

Mark Lipacis - Morgan Stanley

And the 30% growth in Wi-Fi sequentially, was that on standalone Wi-Fi products? Or do you group them somewhat together?

Scott McGregor

Yes, we group those together.

T. Andrew

Yes, so, Mark, the quick and dirty I think that you're looking for so we had growth on the Networking, the PC and the Embedded segments. So growth in all three of the major segments for our Wi-Fi business.

Eric Brandt

And then the only other thing you asked for is the what mix is shipping with Wi-Fi? About 75% of the combo chip shipped with Wi-Fi in it.

Operator

The next question comes from Tim Luke from Barclays Capital.

Timothy Luke - Barclays Capital

Scott, I was wondering, given the trends that you've seen, how are you beginning to think that the seasonality may shape as you go into the end of the year into the fourth quarter? Or to put another way, maybe you could just remind us what you've seen in terms of normal seasonality there? And what some of the different puts and takes maybe as you move through the year?

Scott McGregor

Tim, it's Eric. As you recall, we came out of Q1 given how strong relative to seasonal it was, in terms of it being multiple points better than seasonal. We were cautious about the seasonality going through the rest of the year. It looks like coming through Q2 and Q3, we are seeing, in fact, mix-adjusted seasonal-like growth. So Q2 sort of in the 9% range and Q3 at the midpoint of guidance is sort of 8%-9% range as well. In terms of Q4, we don't provide guidance. Normally, Q4 would be about flat relative to Q3. But surprisingly, we are seeing a more seasonal pattern this year on the back of a much stronger Q1 than we would normally see seasonally.

Timothy Luke - Barclays Capital

Scott mentioned that there was some mix elements that impacted the Baseband business in the quarter. Is that in for one of your customers there was more of a move to 3G from 2G where you'd had particularly strong position? And as you say that it's going to now ramp in the third calendar quarter, would you think that baseband might outpace connectivity now in the calendar third quarter?

Scott McGregor

I think the key message to take from that is we do expect the Cellular Baseband business to ramp in the third quarter significantly. We also expect our multimedia business to ramp as well in this current quarter. I think that's the key takeaway.

Timothy Luke - Barclays Capital

Just on MoCA, is that contributing yet to the second half, first half?

Scott McGregor

We are shipping MoCA-based products right now.

Operator

The next question comes from Adam Benjamin from Jefferies & Company.

Adam Benjamin - Jefferies & Company, Inc.

Just a first, to follow-up Eric on the gross margin, you typically talk about 65-nanometer as a percentage of the mix. You obviously guiding it flat, so that helps a little bit. So just curious, if you can give us a percentage of the mix in Q2 and going forward?

Eric Brandt

Q2 mix was north of 50%, and it will continue to grow. The older principal largest other piece of technology is at 130 [nanometer] and that's about 35% of our mix and going down.

Adam Benjamin - Jefferies & Company, Inc.

And then just a couple of follow-up questions for Scott, on the cellular business. First, one of your large customers has sort of had a disaggregation strategy with the baseband and the processor. You guys have not been really bumping up against that issue because you're sort of not at the high end of the 3G with that customer. So just curious as to how you see that playing out going forward and how you deal with that particular issue or how you address it.

Scott McGregor

I think disaggregation or the selling of separate chips for each of the different pieces in the cell phone is a factor in two areas. One is at the very high end of the market, where because of power or size or newness of the chips out there, you just do better with having separate chips, or where the technology is evolving very rapidly. Because basebands take along time to qualify, if you've got a something that's evolving a lot faster than a baseband, you don't want to incorporate it in, otherwise you'll end up shipping old technology by the time the baseband gets qualified. I think the long-term trend in this space is inevitably integration. You'll see integration of basebands and application processors and connectivity and power management and radios. It's just makes a lot of sense for cost reasons. There will always be a component of the business, generally, at the high end where it is less integrated. Broadcom is ideally suited for all of those different spaces. We have all the different separate pieces as well as the ability to integrate. A lot of our competitors are great niche players in one of the components or several of the components of the cell phone. Our strategy is really different. We've created a strategy to have all the different components from the cell phone, and we'll do whatever the customer wants. If they want them integrated, we're one of the only guys who can do that.If they want them separate, we can do that too.

Adam Benjamin - Jefferies & Company, Inc.

You mentioned a pretty significant ramp of your video core product as well as all the cellular into Q3. Can you just talk a little bit about how you see that product going forward? It seems sort of to be kind of a patch for one of your customers in the interim, and I'm just curious if the ramp is primarily one SKU that's ramping into the back half or it's more broadbase than that. And then just kind going forward, how we should be thinking about that product and handset adoption for that product?

Scott McGregor

I can't comment on particular customers. But in general, we see a separate video processor right now as being important, because it uses dramatically less power and provides more capability than a lot of the standalone processors, which -- a general-purpose processor is not a very good graphics processor. It's not a very good video processor for streaming, so it consequently uses a lot more power. Over time, the general-purpose processors will certainly be able to do that and will certainly absorb some part of the market. We see video processing and multimedia. Think about instead of the capability, and that capability is going to be integrated into basebands and other kinds of things. Not everybody wants to have a car battery attached to their smartphone just so they can watch a movie. Not everybody wants to pay the performance cost and power cost in terms of doing that. So we believe you're going to see dedicated video capabilities, dedicated multimedia capabilities in addition to [indiscernible] (43:28) processor capabilities in these devices, and again, it's just another example where Broadcom has a broader set of IP we can bring to bear on these markets. So we can offer our customers high-performance processors when they want them or low-power video capability when it makes sense to run the battery a long time so you can watch a movie on your smartphone without killing the battery.

Adam Benjamin - Jefferies & Company, Inc.

And Scott, is it more broadbase or video core ramp? Or is it just more of a couple of SKUs should be thinking about it?

Scott McGregor

Well, we've only announced one or two products in the multimedia space. So it's absolutely only a couple of SKUs. We haven't announced other products at this point. If other products become available, we'll certainly talk about them. But right now, we've only talked about two SKUs in that space.

Operator

The next question comes from Mahesh Sanganeria from RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets Corporation

Scott, quick question on Mobile & Wireless. Your guidance implies a pretty strong growth year-over-year over 40%. You have several new products here. GPS is growing and multimedia products is growing, but can you rank them on a year-over-year basis, which product is growing faster than -- and in terms of Wi-Fi, GPS and baseband?

Scott McGregor

We don't generally break that out, but I'll try to help you a little bit. I mean, certainly, from just overall dollar volume and clout and impact to Broadcom's overall business, wireless LAN and cellular are big movers in that space. From a percentage growth point of view, GPS is really doing strongly in that space. So that should give you a sense of what some of both the volume drivers and growth drivers or the percentage drivers.

Mahesh Sanganeria - RBC Capital Markets Corporation

Based on your forecast for the year, do you think you will have some customers getting close to 10% customers this year?

Scott McGregor

We probably will. We'll disclose that as we do normally on an annual basis, but our expectation is that we very well could.

Operator

The next question comes from Craig Berger from FBR Capital Markets.

Craig Berger - FBR Capital Markets & Co.

Eric, you said in your prepared comments that results were going to be ahead of your margin target in September. Is it time to start thinking about raising your long-term operating margin target? And is 18% too low?

Eric Brandt

So what I said was that from a GAAP perspective, we would actually be if you apply the midpoint of the range provided, you would come up with a GAAP number on a product basis that was between the 15% to 17%, and on a non-GAAP basis, would be above the old 20% to 22%. In terms of changing the margin targets, it's pretty clear that we are operating in a very quickly growing environment and to call what our business model is in this kind of environment or change it from six months ago when we met and we were just hoping to get to this number pretty much in 18 months to two years, I think it's too early to call. I think that we'll talk more about it on Analyst Day, but if we are certainly benefiting from above-target margin results excluding stock-based comp and even with stock-based comp running one to two points above the range we provided over the long term that we thought we'd get to, we still think we can get to the GAAP type of operating model in Q3.

Operator

The next question comes from Ambrish Srivastava from BMO.

Ambrish Srivastava - BMO Capital Markets U.S.

Scott, you touched a lot of end markets, I was wondering if you could share your perspective on what the end market should be doing in Q3 and particularly the PC market. And then I had a quick follow-up.

Scott McGregor

We don't play as much in the PC market as some other companies, but we do have some products in that space. I don't think I have anything to add other than other headlines you've seen. We certainly saw some softness in that before. There's probably some seasonal pickup going forward in that market. But again, that's not a huge driver for us as some of the other markets.

Ambrish Srivastava - BMO Capital Markets U.S.

And follow-up, Peter, maybe for you, you were talking about the difference in what drove second quarter for infrastructure and networking. What about the third quarter? Is it flipping around? or both the businesses is kind of acting the same?

T. Andrew

I think in the third quarter, we are looking for the revenue mix to stay roughly about the same as it was in Q2.

Operator

The next question comes from Sumit Dhanda from Bank of America.

Sumit Dhanda

The legal expenses ticking up in Q3, if you could just talk about what's driving that? And then, is the backlog coverage similar, more or less, than what you had last quarter?

Eric Brandt

So first, on the legal expense, as I mentioned in my prepared remarks, they continue to come in lower and shift to the right. As it turns out, next week, we actually have a court date on the derivative action, the last piece of the options-related litigation. If the court moves to summary judgment, then that will certainly be beneficial to us and because if they don't, it'll carry some legal expenses with it. Beyond that, I mean we've been running close to what I thought we could get to so far. I still think that there's an opportunity, particularly if -- even if we go to trial on the derivative action to be done some time next year. So I'm still cautiously optimistic on the legal spend. I can't predict exactly how the waves will come and go, but cautiously optimistic. On the backlog, we don't give guidance on backlog. But I can tell you that consistent with other quarters, we are entering the quarter 80% to 90% booked, even at least quite frankly. And we're trying to make sure that what we ship is going to underlying demand, and even in the face of that, we're still seeing strong growth, 7% to 9% sequentially, four quarters in a row now.

Operator

The next question comes from Raj Seth from Cowen and Company.

Raj Seth - Cowen and Company, LLC

Scott, I wonder if you could talk a bit more -- you made a couple of comments on integration trends, particularly in the baseband. I'm curious if you see conductivity functionality, maybe Bluetooth first, given the high attach rates. Do you see the industry beginning to integrate those into basebands within the next 12 to 18 months? Or is that further out?

Scott McGregor

I think the volume will certainly be further out. One of the challenges with Bluetooth is that there's a lot of new technology coming out in Bluetooth, Bluetooth low energy, a lot of the use of Bluetooth and wireless LAN together, so you get the higher performance over the wireless LAN fi [ph]. (51:18) So there's a lot of interesting innovation now happening in Bluetooth. And my guess is as long as that innovation moves quickly, that will work against integrating into the baseband and move instead to creating combo chips that would integrate Bluetooth with other things like GPS or wireless LAN that can move at a similar pace of innovation. So I don't see a lot of Bluetooth integration with basebands right now, but we're set up, we don't care. We're happy to do whatever our customers want. If they want Bluetooth integrated with baseband, we're delighted to do that. If they wanted it in combo chips, that's certainly a good solution for us as well.

Operator

The next question comes from Harlan Sur from JPMorgan.

Harlan Sur - JP Morgan Chase & Co

On the connectivity side, is most of the GPS growth you expect in the second half of this year going to be driven by standalone GPS products? Or are you seeing more adoption of your combo GPS solutions?

Scott McGregor

I don't know the mix on that, and we're certainly seeing significant growth in both areas. We have some customers who want the standalone. I think the trend in design wins going forward is for the Bluetooth-GPS combo, but maybe discrete is still the largest.

Harlan Sur - JP Morgan Chase & Co

And then maybe as a follow-up to the previous question on networking. I'm actually hearing very good feedback out there in the industry on your high port comp, that's the 64-port 10-gigabit ethernet switch solution from virtually all of your major networking equipment OEM customers, actually, some of them who haven't historically been very large customers for you in this area. Is this more of a 2011 timeframe when these products start to contribute in more meaningful way? Or are we going to see some of that at the end of this year? And maybe just your view on sort of what are the key differentiators versus the competitive solutions?

Scott McGregor

You'll definitely see a little bit of shipment this year, but the real volume is not in this year, it's going to be in subsequent years. The Trident product that we have, the 64-port 10-gigs switch, is a tremendous product. It's something over 2 billion transistors in 40 nanometers. We don't think competitors have products similar to that, so we think that's going to be a good share gain for us there as a lot of new customers will come over to get the advantages of that product. So that's an example of the kind of product we invested in over the last couple of years as we kept our R&D strong in 2009, was able to deliver products like that. We've got a lot more in the chute. I think some of the Dune-based products are also unmatched in terms of capabilities out there from competitors and should help us gain a lot of share in a very high performance end of the networking space.

Operator

The next question comes from Ross Seymore from Deutsche Bank.

Ross Seymore - Deutsche Bank AG

Scott, you mentioned earlier that your inventory was up in preparation for ramp in the cellular side. Is that kind of a normal seasonal ramp? Or is it share gains for you guys? And in that growth, would you expect your 2G or 3G mix to really shift in favor of one or the other versus what we've seen in the first half of the year?

Eric Brandt

So, Ross, it's Eric. Yes, about 50% of the inventory growth is related to product in the cellular space, split between, not quite evenly but close, between mobile multimedia and EDGE parts, principally some 3G, but based on product ramps that are occurring in the back half of this year. And so as you can imagine, we have to have the parts on hand. And in fact, because we are in a hubbing relationship with one particular customer, those parts not only have to be in hand but they have to be in their warehouses, which we own until they pull. And so it's just indicative of preparing for a fairly steep ramp on the part of the customer.

Operator

The next question comes from Ruben Roy from Pacific Crest.

Ruben Roy - Pacific Crest Securities, Inc.

Scott, when you mentioned strength out of DTV and Blu-ray as relates to your broadband business, you also talked about connectivity. Is the growth that you're seeing currently coming mostly from connectivity chips going into those applications? Or is this combination of connectivity and TV chips, Blu-ray processors? If you can comment on that.

Scott McGregor

It's both. But generally, when we talk about that business, we're referring to the underlying Blu-ray and digital TV chips. So the connectivity products we sell are not yet integrated into those chips, but certainly something we're considering in the future. But right now, they're not integrated in, so we talk about them as separate businesses. In general, we're seeing very good design win traction in digital television, in large part due to the stuff other people can't do. We can do a better job at connected TVs, providing a complete solution for a TV or a Blu-ray device that connects to the Internet, uses wireless LAN and Bluetooth to connect to remote controls, do things like DLNA, which is a network protocol for transmitting content in the living room. We're just much better set up to provide a complete solution versus a lot of our competition that either lacks the connectivity pieces or the Internet pieces or the overall combination of things to do, a Blu-ray or a digital TV in all of these areas.

Operator

The next question comes from Shawn Webster from Macquarie.

Shawn Webster - Macquarie Research

Just circling back to the supply constraints, over the last month, would you say that the tightness on the foundry side got better or worse? Or was it about the same?

Scott McGregor

I would say in 65 nanometer, it hasn't really changed much, and certainly, our rapid growth is probably contributing to why it's not easing up. In the other spaces, 130 nanometer and larger geometries, it probably is using up a little bit. You see a little less constraint there, but certainly in the smaller geometries, still very tightly constrained.

Eric Brandt

And just one follow-up on that, maybe just to give you a sense. I mean we are now running at about 500 million chips per quarter, of which -- excuse me, 400 million to 500 million, but approaching but getting very quick to 500 million, probably as we get to Q3. And with north of 50% of those chips in 65 nanometer, you can imagine we're putting a significant demand constraints or demand pressure on the fabs.

Operator

The next question comes from Daniel Amir from Lazard Capital Markets.

Daniel Amir - Lazard Capital Markets LLC

Can you expand a bit on kind of the product roadmap in terms of 40 nanometer? And kind of where you stand with some of the product in different categories?

Eric Brandt

Let me just give a statistic, and I'll hand it to Scott. I mean we are probably going to tape out in Q3 30% to 35% of our parts in 40 nanometer, if the tape outs will do in Q3. And that's a big tape-out quarter for us, so you can see us beginning to increase as we prepare to launch those products commercially. I'll hand it back to Scott.

Scott McGregor

Most of our new products are going to be 40 nanometer. That's the node that makes the most sense going forward. That's the performance cost, power utilization, so we'll definitely drive in that direction. We're shipping 40-nanometer products today to customers in small volumes, but that will ramp up over the course of the next couple of years. So we don't see that as particularly targeted for niches in our product portfolio. We see most of the product portfolio moving over to that, over time. It'll be different than our 65-nanometer ramp though. In 65 nanometers, we basically moved the entire portfolio over a very short period of time, and so you saw spike in our R&D cost because of that. We didn't expect that in 40 nanometers. It'll be more as the product evolve, as they come out with a next generation, they'll move to 40 nanometers.

Operator

The next question comes from Stacy Rasgon from Sanford Bernstein.

Stacy Rasgon - Bernstein Research

I got two questions on the OpEx. Number one, you, again, your commentary that in Q3 at the midpoint of your guidance on a GAAP basis, so you're essentially at the midpoint of your targets. What does that imply for OpEx growth relative to revenue growth, I guess, into Q4 and into 2011 and beyond? Is this the point where we should be thinking up more of a one-to-one kind of growth in OpEx versus revenue? And I have one follow-up on share-based comp after this.

Eric Brandt

So on OpEx, in the first six months of the year, I think OpEx was up about 4% and revenue is up about 20%. And the midpoint of our guidance is sort of 8%, 9%, and what I just gave you is probably in the vicinity of 5%, 6%. So we continue to ramp OpEx more slowly than revenue. We did say that when we got to the targeted range, they would ramp more closely. Having said that, it's easy to manage when you're driving a race car in a straightaway, and we want to make sure that we don't get too far out in front on an OpEx spend basis going forward. So we're going to try to hold it a little bit behind revenue in the event that sort of the revenue ramps slow, so we're not too far out in front of it. And good racecar drivers don't gain position on the straightaway, they do it on the curb, and so we just want to be prepared for the curb.

Operator

The next question comes from David Wong from Wells Fargo.

David Wong - Wells Fargo Securities, LLC

For your Enterprise and Networking division, flat in the June quarter and, again, sequentially in the September quarter. Is this what you consider a normal seasonal pattern? Or is there a softness in this end market or market share shifts, would you say?

Eric Brandt

It was substantially better than seasonal in Q1 and Q2. And then in Q3, it was flat, which is slightly lower than seasonal. I think seasonal is about 2% give or take, in Q3, so it's slightly lower. I think what I would go to is what Scott said, which is I think the business has ramped to a new run rate level. And as our customers sort of get their boxes out and the enterprise side picks up, in addition to the service provider side, we should see the cycle continue and drive growth as we go forward.

Operator

The next question comes from Mark McKechnie from Gleacher & Company.

Mark McKechnie - Gleacher & Company, Inc.

Couple of questions on your baseband, in your guidance, with baseband ramping up pretty significantly and your margins flat seems to indicate pretty good margins there, answering an age-old question. And then also, I wanted to ask, I don't know how you said it, but when would you expect or do you expect a 3G penetration at the second customer?

Scott McGregor

I think we've said for a number of quarters now that our baseband margins are better than people were probably giving us credit for. And so therefore, you do see us ramping those products, but it's not taking down the overall margin for the company. And I don't want to represent that they're better than average for the company by any means, but we're able to offset that with our overall portfolio mix, and that's really what we try to do is to maintain a balance in our overall gross margin within our target range. In terms of the second customer, when we expect 3G to ramp there, I can't really comment on that. That customer is specific there. I mean, certainly, we've won a number of designs there, and we work very closely with them. And we believe that's a pretty big opportunity going forward, but we don't have specific timing for when that'll kick in.

Operator

The next question comes from Chris Caso from Susquehanna Financial.

Christopher Caso - Susquehanna Financial Group, LLLP

Question for Eric. And, Eric, speaking to you over much in the last year, especially going into the second half of last year, you talked about some of the limited visibility you had because of your place in the supply chain. I just wonder if going into this year, if things have changed to give you a little more confidence. For example, you're ramping a couple of specific products at a couple of specific customers, product is a little tighter. What's kind of different as you go into the second half of this year?

Eric Brandt

I don't know. I mean, look, I think coming out of the downturn last year as things sort of turned around, it was hard to tell the difference between channel refill and true end demand and product ramp. I think we're past the point of channel refill given the strength we've seen in Q4, Q1 and Q2, and the guidance we've given for Q3. And certainly in a period of tight supply, we are seeing orders come in earlier, which gives us a little bit more comfort in terms of the demand levels and what's underlying. So I would say cautiously, we feel a little bit better and certainly feel better to see the kind of seasonality in Q2 and Q3, given we were expecting something much more muted earlier in the year. So a little bit better cautiously, I say.

Operator

There's time for one last question. The final question comes from Srini Pajjuri from CLSA.

Srini Pajjuri - Credit Agricole Securities (USA) Inc.

Eric, one clarification and one question. On the OpEx guidance, you said 25% to 35%. I'm just wondering how much of that is cash versus noncash. And then my question is about the seasonality that you talked about for Q4. I mean, historically, it's been flat in Q4, but given the

[Audio Gap]

and also one of your customers is notorious for cleaning inventory in Q4. Does that change the seasonality at all going forward?

Eric Brandt

So let's see. On OpEx, first of all, I guess to get to your question, you're asking about stock-based comp. Stock-based comp should be down $5 million or $6 million in the quarter. And so, when I said about half of that relates to the design and development, that's actually on a cash basis. So that gives you a sense of the magnitude of new products and tape outs coming out of the company in Q3. In terms of Q4, again, I don't want to provide guidance. We normally see again whatever is normal because the standard deviation is pretty wide or flat about Q4. We have had that customer that you're describing for certainly a couple of years as a large customer of ours, and we understand their strategy. So that would account for that just from the averages, overall.

Operator

Gentlemen, that concludes today's question-and-answer session. I'll now turn the call back to Scott McGregor for closing comments.

Scott McGregor

I like to leave you with a few thoughts today. Broadcom had a great Q2. We've grown faster than the industry. We've gained market share in both our core and our emerging businesses. We've significantly improved our operating profitability, and we've returned capital to the shareholders. And we're looking forward to additional market share expansion and profitable growth in the second half of 2010.

Thanks for joining us today, and have a good day.

Operator

Thank you for participating in Broadcom's Second Quarter 2010 Financial Results Conference Call. This concludes the conference for today. You may all disconnect at this time.

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