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Executives

Eric Brandt - Chief Financial Officer and Executive Vice President

Scott McGregor - Chief Executive Officer, President and Director

Chris Zegarelli -

Analysts

Emily Scudder

David Wong - Wells Fargo Securities, LLC

Craig Berger - FBR Capital Markets & Co.

Uche Orji - UBS Investment Bank

Glen Yeung - Citigroup Inc

James Schneider - Goldman Sachs Group Inc.

Stacy Rasgon - Sanford C. Bernstein & Co., Inc.

Ross Seymore - Deutsche Bank AG

Sumit Dhanda - Citadel Securities, LLC

Harlan Sur - JP Morgan Chase & Co

Romit Shah - Nomura Securities Co. Ltd.

Christopher Caso - Susquehanna Financial Group, LLLP

Ruben Roy - Pacific Crest Securities, Inc.

Craig Ellis - Caris & Company

Vivek Arya - BofA Merrill Lynch

Timothy Luke - Barclays Capital

Quinn Bolton - Needham & Company, LLC

Arnab Chanda - Roth Capital Partners, LLC

John Pitzer - Crédit Suisse AG

Doug Freedman - Gleacher & Company, Inc.

Broadcom (BRCM) Q1 2011 Earnings Call April 26, 2011 4:45 PM ET

Operator

Hello and welcome to the Broadcom First Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded, Tuesday, April 26, 2011. Your speakers for today's call are Scott McGregor, Broadcom's President and Chief Executive Officer; Eric Brandt, Broadcom's Chief Financial Officer; and Chris Zegarelli, Director of Investor Relations. I would now like to turn the call over to Mr. Zegarelli. Please go ahead.

Chris Zegarelli

Thank you, Manisha. During this call, we will discuss some factors that are likely to influence our business going forward. These forward-looking statements include guidance we will provide on future revenue, gross margin and operating expense targets for the second quarter of 2011 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 forecast and the other forward-looking statements we make today, as well as statements about the prospects for our various businesses, factors that may affect our business and future results, including, among other things, general economic conditions that are discussed in the Risk Factor section of our 2010 annual report on Form 10-K and subsequent SEC filings. A current list of these 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 statements to reflect future events or circumstances.

Throughout this call, we will be discussing certain non-GAAP financial measures. Today's earnings release and the related current report on Form 8-K describe the differences between our non-GAAP and GAAP reporting and present a reconciliation between the two for the periods reported in the release. Please see the Investors section of our website at www.broadcom.com for any reconciliations going back to the beginning of March 2009, as well as for additional financial and statistical information, including the information disclosed in accordance with 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 Q1 2011 Earnings Information. For increased transparency, we have incorporated tables and information regarding our future guidance, historical performance and segment operating income.

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

Scott McGregor

Good afternoon, and thanks for joining us today. Broadcom had a solid March quarter with slightly better revenue and profitability than we originally anticipated. Broadcom continues to benefit from powerful long-term trends in all 3 of our business segments. We see increasing attach rates for our wireless connectivity devices in phones, tablets, connected home and consumer electronics products. Data Center buildouts are continuing at a rapid pace and service providers are upgrading their networks to manage the explosive growth in mobile data.

In the Home, international growth and the migration to HD continue to drive demand for our highly integrated and cost-effective solutions. You can see the momentum building around Broadcom from our design win traction. Following record design wins in 2010, we achieved record design wins across all 3 of our business units in Q1. Our focus remains to create innovative communications products that enable us to grow our market share while maintaining strong profitability.

Financially, we remain focused on running our business within the operating margins we outlined on Analyst Day. To that end, we are maintaining a tight rein on our overall spending growth as shown by our Q1 results and Q2 guidance for R&D and SG&A spending.

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

Eric Brandt

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

Moving to the financial overview. To summarize for Q1, total revenue of $1.82 billion, including $1.75 billion in product revenue. Q1 total net revenue was up approximately 24% from prior year and down 7% from Q4 levels. Q1 total GAAP gross margin declined 20 basis points to 50.7% from Q4. Product gross margin decreased 50 basis points to 48.9% from Q4, principally due to acquisition-related charges. Q1 GAAP R&D plus SG&A expense was up $36 million to $677 million. GAAP earnings per share for Q1 were $0.40 above First Call Consensus of $0.35 per share. Cash flow from operations for Q1 was $334 million. Our cash and marketable securities balance was $3.9 billion, down slightly from Q4, principally due to share repurchases in the quarter.

Moving to revenue and gross margin. In February, we said we expected Q1 total net revenue to be approximately $1.75 billion to $1.85 billion. Total revenue ended at $1.82 billion. Our Broadband Communications segment was down as expected, principally due to a modest channel inventory build that was mentioned on our Q4 call. The Mobile & Wireless segment was seasonally down as anticipated as weakness in our cellular business was offset somewhat by growth in GPS and wireless LAN. Our Infrastructure & Networking segment had another record quarter which was stronger than we had anticipated, principally driven by growth in sales of Ethernet Switches. Our licensing business was up as well in the quarter, driven by an IP sale during the quarter.

Our Q1 GAAP product gross margin decreased 50 basis points to 48.9%, slightly better than our guidance. This was primarily due to acquisition charges associated with inventory step up and increased amortization of 60 basis points. Non-GAAP product gross margin, which excludes these effects, was actually up 20 basis points in the quarter.

Moving to operating expenses, total R&D and SG&A expenses for Q1 were up $36 million from Q4 levels, which is well below the guidance provided in February, about $45 million to $55 million. This benefit was principally driven by favorability in legal spending due to the pending settlement of the derivative action associated with the stock options litigation. During the quarter, the company also recorded a nonrecurring GAAP charges of $9 million associated with the impairment of acquisition intangibles offset by a settlement gain of $5 million.

Moving to the balance sheet. As I mentioned earlier, cash flow from operations was $334 million for Q1. Cash and marketable securities ended Q1 at $3.9 billion. We returned a record $470 million in capital to shareholders in the quarter in the form of dividends and share repurchases. Including the pending completion of the accelerated share repurchase program, we estimate having repurchased approximately 11 million shares in the March quarter.

Our accounts receivable day sales outstanding was flat at 38 days in Q1. In addition, net inventory levels decreased by approximately $50 million in the quarter.

Moving to expectations. We currently expect net revenue in Q2 to be roughly flat to Q1 and within the same range provided for Q1 at $1.75 billion to $1.85 billion. Sequential revenue for our Broadband Communications segment is expected to be up. Our Mobile & Wireless segment is expected to be down in Q2, principally driven by market softness at some of our key customers, while Infrastructure & Networking sales are expected to be flat to slightly down.

We expect GAAP product gross margins to be up about 50 basis points and on a non-GAAP basis, product gross margins should be up slightly again and within our target model. We expect GAAP R&D and SG&A expenses to be approximately flat in Q2 excluding the accounting for the pending derivative settlement, which is expected to be recorded in Q2. Lower expense growth is driven by anticipated favorability in legal spending, offset by a significant sequential increase in tapeout spending as more 40-nanometer products move to dedicated masks. Please recall, as we mentioned in our release at the time it was announced, that the derivative settlement was expected to be roughly neutral to earnings, with nonrecurring cash and shares coming in, matching payments to plaintiff's counsel and the contribution to Broadcom Foundation going out. Additional information on the derivative settlement is provided in our Form 10-Q.

Yesterday, we announced the closing of the Provigent transaction. The guidance provided above does not include the effects of the Provigent transaction on our Q2 financial statements. While we anticipate the combination to be roughly neutral to non-GAAP earnings in full year 2011, quarterly GAAP results may vary due to acquisition-related step up and amortization costs, plus the assumption of their operating expenses in Q2. GAAP share count is expected to be roughly 575 to 580 million shares.

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 revenue declined 15% sequentially, in line with our expectations, driven by excess channel inventory entering the quarter. During the quarter, we announced our standardized Ethernet over Coax platform solution to accelerate network conversions, increase quality of service and enable more cost-effective services in China. Broadcom's complete DOCSIS-based Ethernet over Coax cable infrastructure solution enables our customers to leverage established technologies like DOCSIS and EPON to cost effectively upgrade their network infrastructure and support new devices such as telephony, high-speed Internet access and HDTV. We believe the opportunities for Broadcom to drive growth and additional market share gains with our highly integrated SoCs are, first, the continued expansion of pay-TV and Internet access services internationally with growth in China for cable and India for satellite using our optimized low-cost solutions. Second, the convergence of communications and consumer electronics driving Internet and device connectivity in the home and enabling operators to offer additional value-added services. As an example, several pay-TV operators have announced plans to offer live TV via video streaming to popular tablets. Third, surging demand for online video content will drive growth in next generation, high-speed modems utilizing DOCSIS 3.0, VDSL and PON access technology. And finally demand for greater bandwidth throughout the home will drive adoption of Gigabit Ethernet 802.11n, MoCA and power line high-speed home networking technology. As we look into Q2, we expect sequential revenue growth in the Broadband segments as the inventory correction is now largely behind us.

Moving to Infrastructure, our Infrastructure & Networking business was up 2% sequentially to a new high, driven by record sales of switches. We continue to see strength in our Switching portfolio from new products adoption, service provider packet transport and broadband rollouts and the increased adoption of 10-gigabit in the Data Center.

Revenue from service provider solutions, including China deployments increased in the March period as operators globally migrate to Ethernet backhaul over traditional time division multiplexing networks. The Data Center business was also strong sequentially for us.

Broadcom's Ethernet solutions continue to outpace the industry, driven by our ability to leverage our broad IP portfolio to deliver solutions for each of our markets and enable our customers to deploy scalable and high-performance products. Our latest carrier, Ethernet Backhaul Switch solution, allows carriers to seamlessly migrate existing networks to 4G with the capability of delivering much higher bandwidth and faster connectivity to the growing number of smartphone and tablet users. The BCM56440 Switch provides the industry's highest integration in its class, combining the functionality of up to 7 standard parts into 140-nanometer device, dramatically lowering the bill of materials cost and reducing the service provider capital expenditures. This latest switch solution combines -- continues our tradition of delivering the industry's broadest and most interoperable standards-based edge-to-core portfolio, all working together to enable higher reliability and superior quality of service over Ethernet.

Yesterday, we announced the closure of our acquisition of Provigent. With the addition of Provigent's engineering expertise and microwave radio products, Broadcom expanded its robust portfolio to address the large microwave backhaul equipment business. Broadcom is uniquely able to offer service providers a complete platform of system solutions as they upgrade legacy mobile networks to 4G and manage the exponential growth in wireless data traffic. As Eric mentioned, we expect the Infrastructure revenue to be flat to slightly down sequentially in the second quarter.

Moving to our Hand Platform. Broadcom experienced a 6% sequential decline in revenue in its Mobile & Wireless segments, with strength in wireless connectivity solutions offset by weakness in cellular products. Broadcom's performance in wireless combo solutions was strong. In Q1, Broadcom announced its newest wireless combo chip. This is our third generation Bluetooth Wi-Fi FM combo device and significantly reduces both power consumption and board area. The solution size is more than 40% smaller than its predecessor, while significantly advancing the feature set, particularly in terms of peer-to-peer media transfer. Our combo chip success is broad based, with wins in nearly every major handset OEM and across nearly every operating system.

Our GPS solutions experienced strong sequential growth in the March period, with broad-based traction across the leading handset and tablet OEMs. During the quarter, we refreshed our most advanced discrete and combo GPS solutions to include support for the GLONASS system. Our chip can take full advantage of the GLONASS Satellite Constellation, which results in significant improvement in position accuracy, particularly in deep urban areas. As consumer use of location-based services grows, we're seeing an increased level of interest from our customers in the cellular and personal navigation device markets for GPS and Assisted GPS technologies.

Progress on our NFC business continues to accelerate. We see strong demand in multiple market segments, including cellular handsets for NFC technology in future products. Expect to hear more from us in the future, but, suffice it to say, we see solid opportunity in NFC as part of our larger connectivity business.

During the quarter, we announced 2 new 3G cellular SoCs. The BCM21654 integrates an HSPA baseband, an ARM Cortex-A9 processor with high-end 3D graphics support, advanced processing and dual SIM capabilities for mass market Android handsets with a focus on converting predominantly feature phone markets to smartphones. The BCM28150 integrates an HSPA+ baseband, Dual ARM Cortex-A9 processors with high-end 3D graphics, full 10edp VideoCore IV video and a high-end image signal processing for up to 20 megapixel camera support. This device is targeted at smartphones with high-performance requirements. Both new cellular SoCs are part of Broadcom's complete reference platforms that include Broadcom design cellular RF, PMU, Wi-Fi, Bluetooth, GPS, NFC and FM, making it easier and faster for OEMs to bring to market all the features people want in affordable handset designs. Broadcom is 1 of the few technology companies that can bring together all the key advance wireless technologies required for smartphones.

Getting back to financial performance, we expect our Mobile & Wireless segment revenue to decline in Q2 due to softness at some of our key customers. In summary, we're focused on the most innovative technologies related to connectivity, bandwidth and content. Our products are in the strongest growth markets of the semiconductor industry. We're benefiting from the product leadership and consumers' increasing demand for data in the home, at work and on the go. Our goal remains to create great products that enable us to grow our market share and deliver strong profitability and robust cash flow from operations. We'll remain focused on managing operating expenses to drive growth within our operating model. We believe we can achieve all of these objectives while at the same time providing a solid return of capital to our shareholders.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Vivek Arya with Bank of America.

Vivek Arya - BofA Merrill Lynch

Scott, could you talk a little bit more about the second quarter sales outlook? Over the last 5 years, the average sequential growth has been 8% to 9% or so, from my calculation. Other than cellular, where are you seeing perhaps softer trends or you think this is just a transitional issue?

Scott McGregor

I think you're right. If you go back over a number of years, you see a seasonal increase on our revenue, typically in the second quarter where about the numbers you said. As I mentioned earlier, we are seeing growth in our Broadband business. We said in our last call that we expected the business to rebound in the second quarter and we still believe that will occur. So we feel comfortable on that. In the Infrastructure business, it's roughly flat, maybe down a little bit. The softness is really coming from the wireless -- Mobile & Wireless space, and we see that both in the combo products area as well as the cellular baseband area due to softness at a number of our larger customers. And what's interesting is we believe that we're holding share or even gaining share. And so we don't see this as a share-related issue, but more of an issue with these key customers in terms of some of what they've guided to in the quarter and what they expect for their products in the quarter.

Vivek Arya - BofA Merrill Lynch

Got it. And just as a follow-up, how do you expect -- maybe for Eric, how do you expect the operating expense and gross margins to trend through the rest of the year?

Eric Brandt

Yes, we don't provide guidance past the current quarter. I think I said last quarter that we expected that our operating expense growth would be more moderate than what we saw last year. I think you're seeing that already, certainly in Q1 and in Q2. And we'll keep a tight rein on it, as Scott was alluding to, over the course of the year. But I think we're running favorable to what most people had in their models already and I suspect that we will probably run at roughly the same rate as what I said last time, which is slightly attenuated from last year.

Operator

Our next question is from James Schneider with Goldman Sachs.

James Schneider - Goldman Sachs Group Inc.

Scott, if you look at your overall connectivity business, the outlook for the full year today for you versus what it was a quarter ago when you last reported, is it higher or lower today? And could you maybe talk about whether that's just a market issue, whether it's a customer issue or there is some kind of impact of pricing there? You mentioned there wasn't a share issue.

Scott McGregor

Yes, we don't guide for the full year, so a little hard to say there. Overall, though, I do believe we're picking up share. We're already very strong share in the larger customers and very few that we're missing at this point. We are picking up share with a number of the Chinese handset makers though as they move from discrete solutions more to combo solutions, so we actually see share gain. As to how that compares for the full year, it's hard to say. We don't guide that in general, but it would be hard to say what that would be anyway. We'll have to see how the year plays out.

James Schneider - Goldman Sachs Group Inc.

Okay. Then second question on the baseband side, I believe on the last call, you talked about your expectation for EDGE baseband sales to still grow for you this year on a year-over-year basis. Do you still think that's the case or do you think there is customer specific issues at work that might not -- make that not the case this time?

Scott McGregor

Well, it's hard to speak for particular customers, and we'll have to see how they do. There is still market growth expected. I mean we do expect to see some share gains as we continue to roll out across some of our major customers. But the exact number for the year, we'll have to see how that plays out, and again we don't guide that.

Operator

Our next question is from Uche Orji with UBS Bank.

Uche Orji - UBS Investment Bank

First of all, Scott, let me just probe a little bit more back on this cellular question. What is the mix of your cellular business that is split between feature phones and smartphones? And I know you don't guide for the full year, but some of the factors that one will hope to have in the feature such as the low-cost Android phones, I think that we believe might play into the kind of areas that Broadcom is very strong at. So any updates you can give us as how you see that market playing out beyond the current guidance you gave for Q2 and how you're positioning for this lower cost feature phone markets, that would be helpful. Thanks.

Scott McGregor

Let me see if I can help you a little bit there. The connectivity tends to be biased towards the high end of the cellular market towards the smartphones. Typically the smartphones will have the features like wireless LAN and GPS. Bluetooth is pushing down more into the feature phone space. It's got 100% penetration in the smartphones and then as you move down into the lower tiers of phones, it tends to have lower penetration. So our connectivity business is disproportionately in the high end of the space. Broadcom's baseband business tends to be more in the mid-range space. We don't play in the very low end and we're not playing at the very high end today. And again as you mentioned, we are targeting things like cost-effective Android solutions and we're still optimistic on that and believe that will be a good business for us going forward.

Uche Orji - UBS Investment Bank

Let me just follow up a little bit then on the application processor markets, when you look at the opportunity for the market since you have now launched a standalone application processor, what is the reception for Broadcom solution in that market, and when should we expect that to start to contribute? And if you can just talk to what makes your product special and what is a very competitive space as it stands?

Scott McGregor

Broadcom believes that application processors will be integrated typically with basebands. At the very high end, that's probably not true. I think they'll remain discrete for a while, but we believe for the volume part of the smartphone market and the high-end feature phone market, we're going to see an integration of processors and basebands and other capabilities. And that plays very well to Broadcom as we have the IP portfolio to be able to do the integration of lots of different things and create very cost-effective cellular SoCs. And so for us, we've announced a number of chips and I mentioned a few of those in my earlier remarks. I believe you'll see revenue coming from those primarily next year. I don't think -- you might see a little bit this year, but it's primarily a next year effect when you'll see revenue driven from that.

Operator

Our next question is from Ross Seymore with Deutsche Bank.

Ross Seymore - Deutsche Bank AG

Scott, can you talk a little bit on the Broadband segment? Where was the inventory as far as application markets and was it specific to a handful of customers or broad based?

Scott McGregor

So in our last call 3 months ago, we mentioned that there was an inventory issue and it was limited to a very narrow set of the customer base. We believe that 1 or 2 customers got ahead of themselves there and probably ordered more than they turned out that they needed. And so that's why we have the confidence to say that we thought it was a 1 quarter inventory effect and that we would rebound in the second quarter and indeed, that's what we believe has happened today, and we think that's behind us at this point.

Ross Seymore - Deutsche Bank AG

So was it in the set-top box side, the cable modem side?

Scott McGregor

I'm going to decline to comment on that. I don't particularly want to identify the customers on that, but it was in our Broadband -- it was in our Broadband space.

Ross Seymore - Deutsche Bank AG

Got you. And then Eric, one for you. A little more accounting-wise, sorry if it's a little boring, but the tax rate going forward, how should we think about GAAP versus pro forma on that?

Eric Brandt

So if you look at our GAAP tax rate, what I've said in the past on the GAAP tax rate is our cash tax is relatively constant. It sort of runs from $20 million to $30 million a year and that's pretty much where it is. Recall back, when I joined the company, we moved away from non-GAAP, didn't spend a lot of time thinking about it and focused purely on GAAP. As we continue to do more acquisitions and purchase accounting begins to affect our financials where we're sort of at a point now where I think we need to look back at the non-GAAP financials a little bit more so you can see the underlying economics of the business. And as we drilled in and looked at the tax rate, I think the GAAP tax rate is pretty stable, at least for the foreseeable future. And I don't know why we would use a tax rate above that. I don't have any substantiation for a tax rate. We've been running 2% to 3% versus tax rate on a pro forma basis, which has been 10%. So from our perspective, I think you can use the GAAP tax rate. It's pretty stable and for the foreseeable future, I don't see it changing.

Operator

Our next question is from Harlan Sur with JPMorgan.

Harlan Sur - JP Morgan Chase & Co

Scott, I know you've addressed this several times, but it continues to be a concern for the market and that's your sort of medium to long-term partnership and design win traction with 1 of your large cellular customers as this customer moves to the Windows Phone 7 operating system. So can you just provide us with your view on how it does or does not impact Broadcom this year and next year, and when should we expect Broadcom to be in the market with a mobile platform that supports Windows Phone 7?

Scott McGregor

Thanks for asking that question. I believe there is some misconceptions in terms of our position and how that customer's strategy affects our business prospects. Nokia has really separated into 2 businesses and they have a high-end phone business, which they've said will move over time towards Microsoft Windows. And then they have a feature phone business, which is primarily S40 based today, Symbian 40 based today. And that business will stay with S40 and that's the business where we have the majority of our EDGE design wins that ship over the next year or so, and our 3G wins as well. So the part of Nokia's businesse thats moving to Windows is where we don't have particular cellular baseband penetration today, and frankly becomes more of an opportunity for us going forward if we can provide Windows-based solutions for Nokia. That's up to them, of course, but we would certainly like to view that as an opportunity for us going forward. Meanwhile, the main volume part of Nokia's business, where they said they will increase their investment, is the part of the business where we have baseband exposure. And so we believe our share remains intact with that business for the foreseeable future. Obviously, Nokia will decide on suppliers over time, but basically the move to Microsoft Windows does not affect our primary baseband business at Nokia.

Harlan Sur - JP Morgan Chase & Co

Okay, got it. Thank you for that. And then in your Broadband segment, you've got some new set-top box product cycles, I think, ramping here starting in the second quarter. Can you just give us a sense on what's happening in the China market? I know the cable triple play in China was a solid growth driver for the team last year. Is that a contributor to the growth in Q2 and beyond, and outside the U.S. and China any other color on drivers for the Broadband business going forward?

Scott McGregor

We absolutely see China as an opportunity continuing to go forward, both the triple network convergence that you alluded to there. There's a cable opportunity in China. There is DSL opportunity. There is DSLAM opportunity. A variety of things there as the government encourages a lot of the carriers in China to populate broadband connections into their population. A very strong push for that as they push to get the population on the Internet. In India, we see more opportunities in the satellite space. So that's another opportunity I would highlight there. And then Europe in general, that's been an area where we have lower market share than, for example, the United States. And so that's an opportunity for us going forward with some of the Sky properties and other carriers there. So I would say a good percentage of our growth over the next couple of years will come from international expansion, but don't discount the ongoing SD to HD conversion that's going on as not only do we see some of the cable operators move more towards HD but reclaim some of their analog spectrum and move to digital, which triggers a replacement cycle across not only the set-top boxes in people's homes but also the infrastructure side as well.

Operator

Our next question is from John Pitzer with Credit Suisse.

John Pitzer - Crédit Suisse AG

I have 1 question on revenue and then 1 on cost. So on the revenue side, Scott, was Japan at all an impact on the June guidance? And when you talk about some of your key customers in wireless kind of having a pause here, what's the confidence level that this is a 1 quarter pause versus maybe not having competitive product in the market?

Scott McGregor

I don't see it as a competitiveness issue for us. And in terms of Japan, I believe that Broadcom with the hard work of our operations team and our engineering team, we've managed to find alternate sources for supply and locked down enough supply. We're pretty comfortable with our ability to supply parts. I think the challenge for us and I think many of our peers on the Japan issue is that if our customer gets all but 1 of the parts they need to build a box, even if we're able to supply, there is a risk that they aren't able to ship the box. And so that's where I have concern, not so much on our ability to supply our competitiveness. I think we're fine there and it will be a question of whether all the box makers can find all the parts they need over the next couple of quarters. I think Japan is probably a 1 or 2 quarter issue for the industry, and I think by fourth quarter that should all be resolved. People will either have qualified other sources or moved on in the design, so I believe it's a relatively short-term effect.

John Pitzer - Crédit Suisse AG

And then, Eric, on the OpEx side, I know you said you don't give full year guidance, but I guess it was my understanding that there was some step-up costs in the first half of the year that might not repeat in the second half like fringe and legal and it sounds like in Q2, some 40-nanometer tapeouts. So are we supposed to model kind of those costs going away in the back half but other costs coming in? Or help me understand how I should think about that.

Eric Brandt

So, John, actually there is favorability of legal in Q1 and Q2 as it begins to step down as we don't have those expenses further. Fringe does step down, but it begins to step down at a lower rate. So probably the best way to do it, just absent additional guidances is to take what we said in Q1 and Q2, step it down and run it off the same slope you have in your model because I can't provide additional guidance. I think with that, absent further information, I think that's a reasonable number to start from and then we can talk more as we have more information over the course of the year. But so you've got to step down of Q1 and Q2 as favorability in absolute spending. Don't assume that we're going to try to make that up in the back half of the year so that, that favorability will carry its way through. And we'll see how the rest of the year plays out. But I do think that there are some benefits and some other things that go into expenses over the course of the year and to the extent that we can drive more tapeouts of 40-nanometer products that would be good for the business.

Operator

Our next question is from Craig Berger with FBR Capital Markets.

Craig Berger - FBR Capital Markets & Co.

Just looking at the cellular business, I know there's been a lot of questions there, but big picture, do you think that business is tracking to plan? I know you guys have talked about potentially ramping a third or more customers this year. Can you give us an update on that and kind of how big might that business be able to grow for you guys over time?

Scott McGregor

Craig, over time we expect that to be a pretty significant business. It's our goal to be a major player in the cellular SoC space, including basebands and integrated application processors and other technologies. We've said in earlier calls that it is our goal at this point to broaden our customer base beyond the 2 large ones that we've announced, and we believe we are making progress in that area. We've focused on a variety of customers and on China in particular, and we have a number of additional design wins. As to our normal fashion, we don't generally announce those until they ship. There is 1 customer in Japan that has begun shipment, but we haven't done an announcement on that yet. But we're just beginning to see those products coming to market. So we believe we will be successful broadening our customer base on our cellular business and it's natural as you'd expect with application processors and connectivity and the full solution I mentioned, which includes radios and power management and NFC and a whole range of technology. We've got a great set of solutions that we believe will be attractive to a wide range of customers increasingly over time.

Craig Berger - FBR Capital Markets & Co.

Just as a follow-up, within your Mobile & Wireless segment, can you help us understand the composition of that business? How much, say, is combo connectivity products versus discrete Bluetooth or discrete Wi-Fi versus other? Any additional detail would be helpful.

Scott McGregor

In the connectivity space, the combo products have been extremely popular and now outsell the discrete components in that space. And we don't give a breakout of the specifics there, but our highest volume chips in all of Broadcom tend to be our combo products right now like the 4325, 4329 and probably the 4330 going forward. Those are extremely high-volume chips for us.

Operator

Our next question is from Glen Yeung with Citi.

Glen Yeung - Citigroup Inc

Apologies if this has been asked because I got on a little bit late, but I wanted to get an update on where you stand on LTE now. How Beceem has helped you and what you feel like your progress has been?

Scott McGregor

Broadcom is very interested in LTE. We supplemented the organic development in LTE we had ongoing with the acquisition of Beceem . Beceem is a company that was doing both WiMAX and LTE development, and we will continue the WiMAX with the existing WiMAX customers, but the team will primarily focus on LTE going forward. We believe we'll be able to provide very interesting LTE solutions. And again, as is our norm, we don't announce products generally before they go to market, but you can count on us being focused on delivering LTE products to the market.

Glen Yeung - Citigroup Inc

Okay, Scott, and maybe as a follow-up, I wonder if you could address the networking business in general, give us your sense of what's going on there. And also maybe address what you think the opportunity is for Broadcom to take share in the captive silicon market networking with the merchant solution?

Scott McGregor

So networking, that's a pretty broad area, but let me try and help you out there. I mean there's a lot of phenomena that are contributing to growth in networking. One is just the amount of data that every -- that all of us are consuming and the amount of video data is really driving up the overall bandwidth in the world infrastructure. And that plays really well to all our switches and optical networking and Broadcom really is the backbone for the Internet and the backbone for a lot of the infrastructure connections for cellular, for all the wired connections and so forth. So that's a great opportunity there. And that's upgrading to -- in the Data Centers to 10 gig and beyond, backplanes upgrading, switches, fabric. We're now seeing cloud computing really come into play. And as people create the cloud data centers, they have need for extreme scalability on switches and fabrics. And we believe Broadcom is really the only company out there that has the products that can really deliver for that kind of scale in that space. In terms of the ability to go after the captive markets, whether it's in networking or other areas, I think over time, there's a real advantage for merchant silicon. Our ability to integrate a lot of different IP, our ability to support and aggregate the needs of lots of different customers and provide those capabilities, we believe over time, we will be able to gain share in the captive market and move towards merchant silicon. We don't have anything specific to announce there, but we believe we are making ongoing progress in that space.

Operator

Our next question is from Craig Ellis with Caris & Company.

Craig Ellis - Caris & Company

I know Provigent is excluded from the second quarter guidance, but can you help us with some parameters? How many folks did you pick up with that deal and can you provide us some revenue and maybe even expense parameters for them?

Eric Brandt

So we picked up probably right around 100 people, maybe a little less. I think that given the nature of the inventory they're carrying and the purchase price, you could see north of 100 basis points impact just on acquisition charges to the gross margin line on a GAAP basis. Interestingly, on a non-GAAP basis, it will be accretive to gross margin. So these things will wash their way out and then the gross margin will bounce down -- will come down and bounce right back up, well not right back up but will bounce back up over time. In terms of operating expenses, we haven't given more details on the parameters. I'll provide that later, probably -- certainly next quarter. But it's a reasonable sized business and you could probably back into what their expenses are with roughly 100 people or so.

Craig Ellis - Caris & Company

And anything on the revenue side there?

Eric Brandt

I would say right now for Q2 upper single-digit millions. And that's for the 2 months we'll have it.

Operator

Our next question is from Doug Freedman with Gleacher.

Doug Freedman - Gleacher & Company, Inc.

Scott, you answered sort of the Japan effect really from a supply side. What are you and your customers seeing from the demand side? I mean we've heard that 1 of the supply issues is the LCD TV. If you could give us the impact you're seeing on that market as well.

Scott McGregor

You mean demand from end customers or do you mean demand from our customers in terms of their ability to sell to Japan?

Doug Freedman - Gleacher & Company, Inc.

The demand coming out of Japan, so your customers' ability to sell into that market.

Scott McGregor

We see that continuing without a huge impact there. You have to remember that Japan is a fairly large country and not all of Japan was affected by the quake, even though very serious impact to the northeastern part there. So we do continue to see orders from our Japanese customers. They do continue to build product. And so we see that continuing there. Will there be some effect? Probably. Broadcom's exposure to Japan is in the low single-digit percentage. So I expect that our impact will be less than perhaps many others. But we do see that business ongoing.

Operator

Our next question is with Ruben Roy with Pacific Crest Securities.

Ruben Roy - Pacific Crest Securities, Inc.

Scott, i wanted to clarify, when you talked about Q1 and Mobile & Wireless business, you talked about weakness in cellular offset by GPS and wireless LAN. Were you talking about discrete chips or was the combo chip business weak in Q1 as well? And then secondly, do you have an assessment of what channel inventory specific to your combo devices might be at this point in time?

Scott McGregor

Let me clarify there. When we look at our combo chips, we apportion the revenue of combo chips into wireless LAN and Bluetooth and GPS, et cetera. So when we say that wireless LAN improved, we mean that both the combo, the combined combo and discrete part of wireless LAN improved. We don't separate the 2 there. So GPS, we are moving more towards combo there. We still have a relatively higher percentage discrete in GPS, although moving rapidly to combo. In wireless LAN, the majority of our business is combo. And so when we say that improved, you can probably assume that combo improved from that statement. In terms of channel inventory, we don't see any unusual channel inventory for our combo chips. People consume those fairly quickly, and we're not aware of anybody inventorying large numbers of those. So I would say we have healthy inventory situation in our combo chips.

Operator

Our next question is with Chris Caso with Susquehanna Financial.

Christopher Caso - Susquehanna Financial Group, LLLP

I wondered if you could talk a bit about your market share in wireless combo going forward. And I guess I think one of the concerns maybe that the share at this point is so high, what do you do going forward to hold onto that share and grow the business going forward. I wonder if you could address that.

Scott McGregor

We do have a high market share in our combo chips and we believe that's because we have really good solutions there, and we are absolutely keeping up the R&D on that. We're coming out with a variety of new combo chips. It's interesting a lot of our competitors will announce a combo chip as their sole product in that space. And we, at this point, have quite a few different combo chips that are tuned for different market segments. And one of the important things in the connectivity space is giving the customer a full matrix to choose from. So for example, some of our customers want Bluetooth and GPS, and they want to buy the wireless LAN separate from that because in the low-end phones they want to put a basic b/g wireless LAN and the high-end phones they want to put either 1 by 1n or a 2 by 2 in the very high-end devices and tablets. And so, Broadcom, unlike a lot of our competitors, is able to provide a complete matrix plug-and-play across the matrix. Common software, common test frameworks, common drivers that allow a customer to basically field their entire connectivity set of products with minimal rework. And I believe that will be a sustainable advantage for quite some time going forward. We also keep pushing the technology. I mean here's a great example. Our GPS supports GLONASS, as I mentioned, as well as the U.S. Satellite System. But unlike some of our competitors, we support both at the same time. And if you're in an urban canyon, it's critical that you be able to see at least 3 satellites to get a fix or 4 to get motion. And so if you can only look at GLONASS or the U.S. independently, you're not going to really get the number of satellites up. But if you can look at both constellations simultaneously and mix and match, you have a dramatically better product. And so, for example, our GPS products today are dramatically better than competitor GPS products because of that simultaneous GLONASS and U.S. satellite constellation. So we'll continue to push technologies there. We've talked about some of the technologies in the wireless LAN space. There is other opportunities. Certainly NFC is an interesting opportunity going forward and there are many more. So we believe we have by far the highest R&D in the combo space and a great team, and we're doing a great job integrating them. And we don't promise to get 100% market share going forward, but we're not going to cede any of that share easily.

Operator

Our next question is from Sumit Dhanda with Citadel Securities.

Sumit Dhanda - Citadel Securities, LLC

Yes, a couple of questions. Scott, maybe the first one for you. Last quarter, as it relates to the Broadband business, my recollection was you expected that to be up strongly in Q2. Seems like Q1 may have been at tad weaker on that segment versus your expectations, and is the implication that Q2 is going to be up, but not quite as strongly as you had initially anticipated?

Scott McGregor

I would say that Broadband was down in Q1 approximately as we anticipated and is coming back in Q2 approximately as we anticipated, so I don't think there's anything unusual there. I think that business is on track with expectations. I think the softness is really coming from the Mobile & Wireless business for the reasons we've mentioned.

Operator

Our next question is Arnab Chanda with Roth Capital Partners.

Arnab Chanda - Roth Capital Partners, LLC

Scott, I'm not going to be unique here, but I still want to ask a little question on that Mobile & Wireless business. Really one things, one is what you're experiencing here, is that because you need a new customer or new sort of 4G transition for you to get reinvigorate the cellular business because EDGE, I mean, people are talking about 4G and EDGE is 2.5 or is there an inventory correction that's come late in the Mobile & Wireless or is it a combination?

Scott McGregor

I would say none of the above. I'd say that our top customers have reported softness in the second quarter and that's what this is all about. So to the extent that they no longer have soft quarters in the future, I don't see any share changes. I'd say we pick up when they pick up. So in the longer-term future, there are a lot of opportunities to grow with additional baseband customers, increasing application processor sales. There's a lot of great opportunities going forward. But in the near term, we believe it's simply softness in some of the key customers as we mentioned.

Operator

Our next question is with Stacy Rasgon with Sanford Bernstein.

Stacy Rasgon - Sanford C. Bernstein & Co., Inc.

I had a question on Near Field Communication, so obviously you're pointing to this as a longer-term growth opportunity. Do you see that growth opportunity coming primarily as discrete unit demand or do you see that primarily as a combo solution where perhaps it helps to support combo ASPs without necessarily driving further unit demand or is it some combination of both? If you could you give us some color on, I guess, the growth outlook and where it's coming from, if from NFC, that'd be helpful.

Scott McGregor

Sure, let me try to help you on that. I think that the market overall for the industry in NFC is going to start off as discrete devices simply because they'll come to market sooner, they're easier for people to just add in to existing products and it just makes more sense. Over time, we believe the NFC is a technology that will naturally make sense to go into connectivity combo chips. It has some similarity with some of those in terms of antenna requirements and other things, and so there's some advantages including it in combo chips. Broadcom has a very strong combo strategy, so it's a natural for us to think of it going into combo chips over time. So I would expect in the long run, I'd expect a lot of the NFC reader business to be in combos. Now the NFC tags are very low-cost things that could be in posters or other kinds of things. I expect that to remain discrete for the foreseeable future, so you really need to differentiate between the reader market and the tag and of course in NFC you can be both a reader and a tag simultaneously. For reader tag combinations, that's a natural thing to put into combo chips. Readers make sense in combo chips and the tags themselves could be in combo chips, but again, if you're trying to get something in a poster, you're really driving ultra low cost and you're going to try and drive that price down to $0.10 or something like that. And so that probably makes sense to keep discrete. Broadcom hasn't announced our particular chips and how we plan to serve that market, but as I've said in my remarks, we're very interested in this market, and we believe it could be a good adder going forward. We see it as adding to the ASP of combo chips and to the extent we do discrete chips, it would be discrete separate revenue.

Operator

Our next question is from Romit Shah with Nomura Securities.

Romit Shah - Nomura Securities Co. Ltd.

Sorry to beat a dead horse, but trying to get some more color on what's happening in Mobile & Wireless. Scott, I hear that -- I hear you saying you're not losing share, but I'm having a hard time reconciling the numbers versus some of the other guys like Qualcomm which grew units in Q1 and guided units flat in Q2. If you're not losing share, to me it would seem that either your customers are losing share or there's an issue with ASPs. And if the answer is that it's customer specific, in other words, your customers are losing share, that would seem like it's a multi-quarter issue. So the first question is would you agree with that conclusion? And then second, if the wireless market is weak, should we be mindful of your wireless margins, which I think have held up pretty well actually coming under pressure at some point?

Scott McGregor

You've got a lot of questions embedded in there. Let me try and help you the best I can. I believe QCT guided flat to slightly down for the second quarter. They have some overlap with us on customers and some customers that we have that they don't and vice versa, so there's certainly some effects there. ASP is always a factor, but that's not the predominant factor that we see. I would go back and say, we can't elaborate a lot, but based on the significant customers we have, we're seeing that they have some softness in the next quarter and that's what's reflected in our revenues. And I don't see it as a particular ASP issue. In terms of margins, we don't see any particular unusual thing going on in margins there. We've been able to balance our portfolio and as you can see in our financials, we try and maintain our margins within the range we talked about at Analyst Day, and I don't see why we wouldn't be able to do that going forward.

Operator

Our next question is from Quinn Bolton with Needham & Company.

Quinn Bolton - Needham & Company, LLC

Scott, just wanted to ask on the PC business, Intel sort of surprised, I think, a lot of folks with its guidance for Q1 and Q2. They have a lot of Bluetooth and wireless LAN products going in PCs. Can you just give us a sense what you see happening in the PC for Q1 and Q2?

Scott McGregor

We see the PC market as maintaining. The Bluetooth and wireless LAN sales we have in there, we continue to do well. We believe we're approximately holding share in that space. I think to the extent that tablets take over netbooks and notebooks, that will be beneficial for us because we generally have a higher share in tablets than we do in the PC market. We have a very high share in the tablet market with our combo chips, and so any trend moving from PCs to tablets should be beneficial for us.

Operator

Our next question is from Tim Luke with Barclays Capital.

Timothy Luke - Barclays Capital

Just with respect to your OpEx guide, Eric, how do you see that going forward for the year in as much as with a tempered revenue outlook? It seems that some of the OpEx spend have been tempered as well. How do you see the puts and takes as you go into the back half of the year? And I don't know, Scott, how you generally perceive the broader outlook for the year. Do you have any broader commentary on your expectations? Do you think that you're in, for example, a seasonal environment for the back half of the year given the broad demand trends you're seeing or is it just too uncertain to say?

Eric Brandt

So, Tim, just a little data. I mean if you look at Q1, we were up $36 million, $37 million. Fringe and vacation accrual is $36 million of that number and stock-based comp is $15 million. So that means that we were actually up $50 million between those 2 numbers together, $52 million, and then we actually posted up $36 million, $37 million, which means that we were managing our expenses reasonably tight, and some of that quite frankly is a normal seasonal shift, seasonal down in tapeouts in Q1 as people rush to get their tapeouts done for their MBOs in Q4. As we look at the rest of the year, I think you can -- again, we don't provide guidance for the rest of the year, but I would say, probably the best thing to do at this point in time is take your model, step it down based on Q1 and Q2 results and run the same slope. Having said that, we remain committed to run our business between 20% and 22% non-GAAP, which is what we said at Analyst Day, and we will manage our business as best we can to do that, bearing in mind that we have very significant fixed costs. But we're committed to run our business fiscally correctly and consistent with what we communicated to our investors on Analyst Day. And to the extent that revenue in the industry is a little bit weaker, we'll manage costs a little bit tighter and to the extent that revenue picks up in Q3 and those couple of customers that are sort of a little soft in Q2 begin to pick up in Q3. We'll probably turn on some spending. But again as we said on Analyst Day, we'll try to keep the spending rock behind the revenue curve as best we can from here.

Operator

Our next question is from David Wong with Wells Fargo.

David Wong - Wells Fargo Securities, LLC

Could you give us some idea as to what the percentage of your baseband sales of 3G as opposed to lower levels?

Scott McGregor

We don't break out the specific numbers on that, but I would say that our EDGE products still outnumber our 3G products. Over the course of next year, I'd expect that trend to reverse and sell more 3G than 2G. And then the following years, I'd expect to migrate increasing 3G and start to sell some 4G.

David Wong - Wells Fargo Securities, LLC

Great. And what do you reckon your connectivity market share is in smartphones and the market share you think you have for connectivity in the overall addressed phone market?

Scott McGregor

I don't know the exact number on that, but I would say the overwhelming majority of smartphones and tablets basically design our combo chips in at this point. We're in almost everyone of the top 20 customers across all the different operating systems. And so we have pretty good share, and again we will, as I mentioned on an earlier question, we will fight very hard to keep that.

Operator

Our next question is from Ambrish Srivastava with BMO.

Emily Scudder

This is Emily calling in for Ambrish. Thanks for taking my call. Just 1 quick question, can you comment on the target level for inventory as we exit this quarter and whether or not you're seeing any front-end or back-end constraints?

Eric Brandt

So you can see our inventory levels came down about $50 million. Our turns went up about 0.1 of a point. We'll try to manage our inventory reasonably tight around where it is on a turns basis, perhaps a little bit better. Interestingly over the last year, the amount of hubbing inventory we are carrying for customers has doubled, so that does affect our turns to some degree. In terms of constraints, as Scott mentioned, a relatively small amount of our business is exposed with some constraints going into Q2. I can't speak for Q3 at this point, but I think our operations team has done an excellent job at making sure that we've secured supply and that we are really leveraging the strength of our engineering organization to rapidly and on an expedited basis qualify second sources, which I think is a unique capability to a company of our size.

Scott McGregor

So I would expect that there are probably some smaller companies and competitors of ours that are going to have some trouble in front-end and back-end sourcing, but I believe we've done a great job and I don't expect that we will.

Operator

We have no further questions at this time. I'd like to turn the call back over to Scott McGregor for closing remarks.

Scott McGregor

Thank you, Manisha. In closing, I'd like to leave you with a few thoughts. Broadcom is in the fast-growing wired and wireless communications markets, and our cutting-edge solutions are enabling more content and bandwidth and these are strong, long-term trends. We have strong design win momentum. I mentioned earlier that we had, not only record design wins last year, but record design wins in the first quarter. And so we believe that momentum is building for our products going forward. We're rapidly deploying new competitive 40-nanometer parts, which we think differentiate us from a number of our competitors. We excel at silicon integration. Our focus remains on creating outstanding communications products that enable us to grow our market share. Thank you very much, and have a good day.

Operator

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

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