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Executives

Eric Brandt - Chief Financial Officer and Executive Vice President

Scott McGregor - Chief Executive Officer, President and Director

Chris Zegarelli - Director of Investor Relations

Analysts

Shawn Webster - Macquarie Research

Craig Berger - FBR Capital Markets & Co.

Uche Orji - UBS Investment Bank

Sandeep Shyamsukha - Auriga USA LLC

Glen Yeung - Citigroup Inc

Sanjay Devgan - Morgan Stanley

Daniel Amir - Lazard Capital Markets LLC

James Schneider - Goldman Sachs Group Inc.

Christopher Muse - Barclays Capital

Edward Snyder - Charter Equity Research

Ruben Roy - Mizuho Securities USA Inc.

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

Ross Seymore - Deutsche Bank AG

Harlan Sur - JP Morgan Chase & Co

Srini Pajjuri - Credit Agricole Securities (USA) Inc.

Mark Lipacis - Jefferies & Company, Inc.

Christopher Caso - Susquehanna Financial Group, LLLP

Craig Ellis - Caris & Company

Vivek Arya - BofA Merrill Lynch

Romit Shah - Nomura Securities Co. Ltd.

Quinn Bolton - Needham & Company, LLC

Arnab Chanda - Roth Capital Partners, LLC

Ambrish Srivastava - BMO Capital Markets U.S.

John Pitzer - Crédit Suisse AG

Broadcom (BRCM) Q2 2011 Earnings Call July 25, 2011 4:30 PM ET

Operator

Welcome to the Broadcom Second Quarter 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded, Monday, July 25, 2011. I would now like to turn the conference call over to Chris Zegarelli, Director of Investor Relations. Please go ahead.

Chris Zegarelli

Thank you, and good afternoon, everyone. Welcome to Broadcom's Second Quarter 2011 Earnings Conference Call. I'm joined today by Scott McGregor, our President and Chief Executive Officer; and Eric Brandt, our Executive Vice President and Chief Financial Officer.

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

Additionally, throughout this call, we will be discussing certain non-GAAP financial measures. Today's earnings release and the related current report on Form 8-K describe the differences between our non-GAAP and GAAP reporting and present a reconciliation between the 2 for the period reported in the release. Please also see the Investors section of our website at www.broadcom.com for a slide deck that includes additional information disclosed in accordance with SEC Regulation G.

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

Scott McGregor

Good afternoon and thanks for joining us today. Broadcom performed well in the June quarter with revenue consistent with the guidance provided in April. Our total quarterly revenue was $1.8 billion which, on a product basis, was up almost 13% year-over-year. I'm also pleased to report stronger earnings than we anticipated due to solid product cost improvements and expense discipline that delivered significant growth in operating results. With a boost in profitability, we had record cash flow from operations that surpassed 27% of revenue. Our strong free cash flow enabled about $350 million in acquisitions and about $300 million in share repurchases and dividends with minimal impact to our cash balance. This demonstrates our ability to pursue strategic objectives while at the same time returning capital to shareholders.

I'll now turn the call over to Eric for details on the second quarter results and third quarter guidance, and then I'll go into the details on our highlights and discuss the trajectory for continued growth with our customers.

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 Q2, total revenue of $1.8 billion including $1.74 billion in product revenue. Q2 total net revenue was up approximately 12% from prior year and down 1% from Q1 level. Q2 total GAAP gross margin increased 40 basis points to 51.1% from Q1. GAAP product gross margin increased 70 basis points to 49.6% and non-GAAP product gross margin increased 60 basis points to 51.1%. Q2 GAAP R&D plus SG&A expenses were up $9 million to $686 million, which includes a nonrecurring legal fee of $25 million related to the derivative settlement. Net of this nonrecurring item, R&D and SG&A expenses were down $16 million sequentially.

GAAP earnings per share for Q2 were $0.31 per share, including a negative $0.14 of onetime items. Non-GAAP EPS was $0.72 per share, above First Call Consensus of $0.63 per share. Cash flow from operations for Q2 was a record $489 million. Our cash and marketable securities balance was $3.8 billion, down slightly from Q1.

Moving to revenue and gross margin. In April, we said we expected Q2 total net revenue to be approximately $1.75 billion to $1.85 billion. Total net revenue ended at $1.8 billion. Our Broadband Communications segment was up slightly less than expected, principally due to weakness in consumer electronics and some continued inventory issues in set-top box. The Mobile & Wireless segment was down as anticipated due to some softness at a number of key customers. Our Infrastructure and Networking segment was roughly flat as expected.

Our Q2 GAAP product gross margin increased 70 basis points to 49.6%, which is significantly better than our expectations, including the impact of Provigent. This translates to 51.1% on a non-GAAP basis. This increase was primarily due to cost improvements as we continue to increase our mix of 65-nanometer optimized products.

Moving to operating expenses. Total R&D and SG&A expenses for Q2 were up $9 million from Q1 levels, which, if normalized for the $25 million of nonrecurring legal fees related to the derivative settlement, is actually down $16 million relative to the flat sequential guidance provided in April. This benefit was principally driven by favorability in legal spending, offset by increases in design and development costs.

During the quarter, the company also recorded nonrecurring GAAP charges of $74 million associated with the impairment of acquisition intangibles and $25 million in charitable contributions, offset by settlement gains of $45 million, principally associated with the termination of the derivative action. These items are discussed in more detail in our Form 10-Q filed today.

Moving to the balance sheet. As I mentioned earlier, cash flow from operations was a record $489 million for Q2. Cash and marketable securities ended Q2 at $3.8 billion. We returned roughly $300 million in capital to shareholders in the quarter in the form of dividends and share repurchases, as well as acquired Provigent and SC Square for approximately $350 million. Year-to-date, the company has repurchased approximately 17 million shares of its stock. Our accounts receivable days sales outstanding improved to 35 days in Q2. In addition, net inventory levels decreased slightly in the quarter.

Moving to expectations. We currently expect net revenue in Q3 to be roughly $1.9 billion to $2 billion. Sequential revenue will be up across all segments, and our Mobile & Wireless business will rebound sharply, up double digits driven by strength across all lines of business. We expect Q3 GAAP product gross margin to be flat to up slightly and within our GAAP targeted model. We expect GAAP R&D and SG&A expenses to be roughly flat to down $10 million with Q2's $686 million.

Excluding the $25 million settlement related nonrecurring legal fee in Q2, expenses would be up roughly $15 million to $25 million sequentially in Q3. Expense growth is driven by anticipated increases in 40-nanometer masked spending and employee cost as well as some increase in litigation spending as certain IP cases come to trial.

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

Scott McGregor

Thanks, Eric. Starting with the Home Platform, our Broadband Communications revenue increased 5% sequentially with solid sales from core set-top boxes and broadband modems offset by a decline in our consumer businesses. Broadband revenue growth would have been roughly doubled sequentially, excluding the soft sales of our consumer electronics products. We are benefiting from Digital subscriber growth in emerging markets along with the a global increase in HD broadcasting, providing strong orders for set-top box silicon solutions.

Our broadband modem business continued to show solid growth, driven by an increase cable modem volume for DOCSIS 3.0, strong VDSL2 Central Office and CPE shipments and continued strength in ADSL2+ revenue. During the quarter, we announced a major innovation in full band capture, the industry's first 1 gigahertz full band capture digital tuner integrated into 3 new IP set-top box and DOCSIS 3.0 gateway SoC solutions. These 40-nanometer devices deliver the cable turner density and performance that operators need to convert current cable systems to IP-based video platforms while significantly reducing the bill of materials, power and footprint.

Residential gateways have become the fastest-growing segment of broadband CPE devices as more hybrid IP-based solutions provide content delivery and services throughout the home as well as to connected devices. We expect broadband revenue growth to continue in the September quarter driven by new product cycles and increases in the adoption of high-definition pay TV services and content across the globe.

Moving to Infrastructure. Our Infrastructure & Networking business was stronger than expected with record revenue driven by our industry-leading switching and PHY solutions. We continue to see strength in our switching portfolio from new product adoptions and service provider broadband network upgrades in Ethernet access, mobile backhaul and packet transport. With the rapid growth of content that challenges data centers, networking infrastructure is moving to 10 gigabit Ethernet solutions. We expect the strong adoption of our high-bandwidth, energy-efficient and low latency 10-gigabit products will be a revenue growth driver over the next few years.

In Q2, we introduced our latest EPON solutions designed to address China's fastest-growing broadband technology. These single-chip solutions are highly integrated 1 gigabit EPON SoCs and includes switch, PHY, MAC and CPU. They allow carriers to quickly deploy solutions with the fewest possible components at lower power and reduced system cost.

We began to ship our latest fully interoperable FCoE offload solutions on converged network adapter platforms with performance speeds of up to 1.7 million IOPS, which is more than 80% faster than our nearest competitor. This solution has been fully qualified by industry-leading OEMs such as Cisco, Dell and EMC.

Finally, we announced that Alcatel-Lucent utilized our Premier Custom IC Program to develop and deploy the industry's first 400 gigabit-per-second network processor, leveraging our advanced design methodology, extensive IP library and over 100 customized libraries. Broadcom is an important player in ASIC, as well as merchant silicon. For the September quarter, we expect strong sequential revenue growth across all of our Infrastructure end markets.

Moving to our Hand Platform, our Mobile & Wireless segment experienced a 5% sequential decline in revenue, which was in line with our expectations. We expect our Mobile & Wireless segment revenue to increase by double digits sequentially in Q3, with strong growth across all lines of business. Growth in Q3 is driven by seasonal strength in wireless connectivity, combo chips, baseband and multimedia core processors in cellular handsets, tablets and other consumer devices.

In Q2, we announced our newest Bluetooth wireless LAN single-die combo chip, expanding the opportunity for OEMs to deliver innovation in PCs supporting next-generation Windows and Android systems. This powerfully integrated 40-nanometer device provides a significant reduction in footprint, a lower bill of materials and a 40% reduction in power consumption. By extending our leadership in wireless connectivity to 40 nanometers, we're delivering the most cost-effective and industry-proven integrated solutions for the wireless handset, tablet and PC markets.

Our innovative solutions continue to drive the most advanced wireless LAN and Bluetooth features into a broadening range of phones, tablets, consumer electronics and PC devices, leveraging our differentiated architecture, software and other enhancements to unleash the creativity of device-makers.

In summary, we're seeing increasing attach rates for our wireless connectivity devices and phones, tablets and a number of connected home and consumer electronic products. We have new competitive 40-nanometer parts, strong momentum in switching and increased addressable market opportunities all across our business. Broadcom excels at silicon integration and our focus remains creating outstanding communications and connectivity products that enable us to grow our market share while maintaining strong profitability. Our Q3 guidance is a strong and reflects significant sales expansion across our strategic business segments.

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

Question-and-Answer Session

Operator

Our first question comes from Romit Shah of Nomura.

Romit Shah - Nomura Securities Co. Ltd.

Scott, given what we're hearing broadly across other regions in terms of GDP, and then, if you look at some of the company specific results from microchip and in Qualcomm not being that great in their outlook, what would you highlight as the biggest company-specific drivers for Broadcom here in the third quarter? Because the guidance does looks pretty good.

Scott McGregor

The guidance is good and I can't speak for those other companies, but we're certainly seeing our markets rebound nicely to give us the guidance that we do have. I think we were sub-seasonal in the first quarter and so we certainly get some benefit, maybe, from rebounding a bit there. But Broadcom has very strong products right now and we do see an opportunity to grow our market.

Romit Shah - Nomura Securities Co. Ltd.

Do you think in the second quarter that you burned inventory in the wireless channels? And is that helping you at all?

Scott McGregor

I don't think we burn inventory. The question is, did some of our customers bleed off inventory? I think we'll know more on that as the year goes by, but we said earlier that we were seeing some pickup and some share gains in our connectivity. We said that in our last earnings call, so I think that growth certainly helps us a little bit here and others might not seeing that.

Romit Shah - Nomura Securities Co. Ltd.

Okay, great. And then just a last question for me. In terms of Provigent, can we get the revenue contribution for the June quarter? And if any, for September?

Eric Brandt

It's Eric, Romit. I can only give you what we did for the June quarter broadly, which would be roughly -- would be single-digit millions, so limited to no impact to the revenue in Q2.

Operator

[Operator Instructions] Our next question comes from Vivek Arya of Bank of America.

Vivek Arya - BofA Merrill Lynch

Scott, a major investor question has been competitive changes and your very high growth connectivity in business, especially from the likes of Qualcomm, Atheros. Our next deal in Qualcomm is turning to launch a 28-nanometer product. My question is where can Broadcom be surprised in the connectivity side? And what specifically are you doing to maintain your edge in this market?

Scott McGregor

Broadcom has very strong connectivity products and I think the key elements of that is made up of a few things. One is we have best in class IP and each of the things that go into our connectivity combo products. And like a chain, if you have one link that's weak, then the whole chain is weak. And we've got extremely strong links in our chain. We've moved to 40-nanometer. And also our concept of integration is a little different than others in that we include all the analog and radio as well as the digital pieces. Some of our competitors are including all the digital stuff within digital chips and not including the analog pieces. So you got to be a little careful when you hear what some of the competition says. It's not always an apples-to-apples comparison.

Vivek Arya - BofA Merrill Lynch

So as you look out at the design win activity for the next few quarters, how is the market share playing out in terms of design wins for major products?

Scott McGregor

Well, we typically can see about a year ahead in terms of the designs that are being done now and awarded and give us visibility over that period, and we don't see anything that would represent any significant challenge to our market leadership in combo chips over that period of time. We have very, very strong technology. And again, in our last earnings call, we said we even expected we would gain a little bit of share as some of the people who are using still discrete products more towards our combo chips.

Vivek Arya - BofA Merrill Lynch

And then lastly, on the cellular basement side, I think you had mentioned a couple of drivers in the past, for example, 3G ramp that Nokia, some socket wins at Chinese handset players and just the mass market Android opportunity. Where are we in those ramps? Are they progressing per your expectations? And when can we see the baseband business start picking up?

Scott McGregor

[indiscernible] baseband business picking up in Q3, again one of the segments we said would grow. But in general, we believe that our 3G business with Nokia will start in 2012 as we've said for quite a while, and we're looking at Android opportunities in China and elsewhere. And we've begun to ship those in small quantities, but most of that volume growth is ahead of us.

Operator

The next question comes from James Schneider of Goldman Sachs.

James Schneider - Goldman Sachs Group Inc.

Scott, I was wondering if you could provide a little more color on the baseband business? In terms of the uptick you're expecting in Q3, is that coming from basically existing customers in existing platforms? Or is there mix of new customers coming in there as well?

Scott McGregor

It's a mix but primarily existing customers.

Operator

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

Craig Ellis - Caris & Company

Eric, following up on the point on some improvement in gross margin on cost reduction and cost improvement. Is that really 40 nanometer that's starting to show through? Or are those other initiatives that are bearing fruit?

Eric Brandt

It's really other initiatives. 40 nanometer is still only about 1% of our revenue. It's in the vicinity of 50% of our tape-outs today and more and more of the dedicated tape-outs. It's second- and third-generation 65-nanometer part. Strong work on the part of our ops team. And I think as we roll into Q3 certainly some absorption benefit of nonstandard cost as we grow meaningfully off of Q2.

Craig Ellis - Caris & Company

Okay, and then, just a bigger picture question. Nice outlook across the board. As we look at the Mobile & Wireless guidance especially given all the share shift amongst tablet and smartphone OEMs, how do you ensure that your wafer starts and builds are on track with what will probably be consumption for those types of products?

Scott McGregor

We spend a lot of time talking with our customers and working with our operations team to do our best to get that number right. I think one of the advantages we have is because we do have high share and good spread across all the customers is that we're relatively insulated from share shift between the customers. And so the number of units that sell if 1 customer gains or loses share, we'll typically pick it up on other customers. And so that gives us a little more predictability in the market. But that's obviously something we spend a lot of time in conversations with customers to get that right, and we're talking many hundreds of millions of chips we have to develop for these customers. And so it's important to get that right.

Operator

Next question comes from John Pitzer of Credit Suisse.

John Pitzer - Crédit Suisse AG

Scott, a couple of questions. First any way to quantify how big the tablet opportunity was in Q2 or expected to be in Q3? In addition, any 10% customers in June are expected in September? And then my last question, when you talk about 10-Gig E [10-Gigabit Ethernet] opportunity, can you help us size that opportunity and I guess how quickly you would expect that to develop?

Scott McGregor

So on the tablet market, I don't know that number off on top of my head, but we do see the tablet market growing and diversifying. There are quite a few tablet OEMs out there, some a lot more successful than others, but we still a lot of people innovating and coming out with new solutions there and overall growing that market. But I don't have a specific number for you. On 10% customers, we only break that out on an annual basis, so I can't give you any news on that one. 10 Gigabit Ethernet, we do see that as a long-term trend over the next few years. Certainly, in the data centers, it's become extremely important as just the video demand has gone up. We can probably get you some numbers and point you to some third-party analysts to look at the forecast for that. If you follow up with Chris or John, we can get you those numbers.

Operator

Our next question comes from Craig Berger of FBR.

Craig Berger - FBR Capital Markets & Co.

Can you just describe what you see as the primary cellular baseband opportunities in 2012 and also give us an update on your 4G traction?

Scott McGregor

So the largest opportunities for us certainly are 3G expanding at Nokia. That's been a number of years in coming, and so we do expect that to happen in 2012. Probably one of the other biggest drivers for us is Android as smartphones based on Android hit new low cost points that we think will really drive volume. And that's both a China phenomena and an outside of China phenomena. So I think those are two things that are important there. On 4G, we continue to work on LTE. We've got a pretty good-sized team on that and we expect to go to carrier trials this year but I can't say much more about the timing there. We'll announce those chips when they're ready to go for customers.

Craig Berger - FBR Capital Markets & Co.

And just as a follow-up, looking at the broadband business, I guess set-top boxes have some inventory issues. When do you see that resolving and getting back to a growth path?

Scott McGregor

Hard to say. The inventory we saw last quarter was very specific to 1 or 2 customers, and we're seeing it sort of scattered a little more broadly, and that's dampened the growth a little bit. Although equally dampening the growth in our broadband business has been just the extreme weakness in the consumer electronics, in particular, digital television market. I think you're seeing cries of pain from a lot of the players in that space, but we do believe it's up in Q3. So we definitely see a path forward for that business growing in Q3.

Operator

Our next question comes from Harlan Sur of JPMorgan.

Harlan Sur - JP Morgan Chase & Co

Scott, to an earlier point that you made, I mean the team is constantly ramping new products. And so of the incremental growth that you're expecting in the third quarter, how much of it is from new products that you've launched over the past several months? You've got things like the fourth generation 4330 combo connectivity product. You've got the 2157 Android 3G baseband reference platform, and you also have things like your Data Center 10 gigabit switching solutions as examples?

Scott McGregor

It's a fair question. I don't have the percentage at my fingertips, but certainly, the 4330 will probably be our highest-volume product for all Broadcom in the next 12 months. So that's certainly a big product there and, some of the others you mentioned important as well. Some of the 40-nanometer products we have in broadband, and certainly, some of the switch products are doing very well in our Infrastructure group. So I don't have that number. But generally, most of our revenue is products launched over the last 18 months, and so give you a sense that we tend to be an innovation and product cycle-driven company rather than a macroeconomics-driven company.

Harlan Sur - JP Morgan Chase & Co

Yes, got it. And then on the broadband side, can you just give us a sense of what are the moving parts that are contributing to the growth in Q3 from a geographical perspective? Is it China triple play? Is it the SD to HD and advanced services migrations in the U.S? Is it India? Any color there would be great.

Scott McGregor

Sure, I can help you a little bit there. We certainly see the SD to HD trend as a long-term trend and helps us a little bit in that space. We've seen good growth from the Satellite side. China continues to be something that drives there especially in the Infrastructure side and DSL side, but we see some benefit there. And I think the move to home gateways is something we see as a broader trend. Home gateways really allow us to put a lot more silicon into the boxes and drive the ASP there. So those are some of the things that drive that on a broader sense.

Operator

The next question comes from Uche Orji from UBS.

Uche Orji - UBS Investment Bank

First of all, Eric, can I just understand how we should think about OpEx? You'd done a great job keeping it down, but specifically, are there any, beside bonus and major awards, accruals first quarter just so that we don't see it catch-up on the OpEx, somewhere? Any comments you can make as to how we think about OpEx especially around accruals for some major works?

Eric Brandt

I don't think there are any abnormal accruals. So this quarter, there's that $25 million payment that was made to the derivative attorney, which is what causes this OpEx to actually be down $16 million quarter-on-quarter on a GAAP basis. And that's principally driven by favorability in legal -- some favorability in employee costs.. Obviously the fringe rate [ph] steps down. As we look forward, the guidance we gave you is really 3 things. It's design and development, which is tape-outs as more and more tape-outs go to 40-nanometer particularly on dedicated. Some employee cost benefits, the fringe thing pretty much just washed itself out by Q3 and a little bit of pickup in legal basically due to some of the IP cases come in trial, like the Emulex [ph] trial. But even in the face of all of that, we still think probably flat to down $10 million on a GAAP basis as we roll through Q3. We don't guide more than 1 quarter out. And so we said that we would be more attenuated across the year. We think we have -- and I don't think that changes as we look at Q4 either.

Uche Orji - UBS Investment Bank

A follow-up question for Scott. Scott, when I look at your comments around Infrastructure and I look back to some of the comments made by the wireless, by some of the carriers in terms of second half CapEx, it's a little less bullish than what your guidance will imply. Can you just kind of walk me through, either by geography or by specific programs, where you're seeing these trends in the Infrastructure business that you have?

Scott McGregor

Infrastructure is made up of carriers but also data centers, and we do see opportunity for data center growth, as well as carriers, but we're definitely seeing China as remaining a driver on that and we're seeing people generally upgrade bandwidth in that space. And so it was quite broad-based, and we expect our growth is broad-based into Q3. So in some cases, we are taking share. And again, as you probably know, one of the overall objectives for Broadcom is to grow faster than the market and take share. And so this is one of the ways we do it and evidence of us being successful at doing that.

Operator

Our next question comes from Glenn Yeung of Citi.

Glen Yeung - Citigroup Inc

I guess two questions here. First off, we're now kind of removed from the Japan earthquake, but we still had some companies suggest that there's some volatility in the supply chain because of that. I wonder if you could just discuss in 2 ways: one, are you seeing still any volatility from your customers because of the earthquake? And then secondly, are you -- is there volatility in your own orders to the supply chain as a result of what happened there? And the second question I have is specifically in the networking side. We're picking up that you're gaining some share from in-house ASICs, and I wonder if you can address that, give us a sense as to how much that opportunity is and how sustainable it might be?

Scott McGregor

So the Japan quake, I would say at this point things are beginning to normalize. We still see spot shortages of things like substrates and we often have to jump through hoops to get some of the product out the door because of some spot shortages. But in general, we don't believe that's impacting revenue at this point. There's still a few customer issues that we need to work, but so lots of activity below the surface, but at the surface, all is calm on that front. So I think we're through the Japan quake. I don't expect going into Q3 that will have any revenue impact or major customer disruptions. That being said, I think our ops team is still struggling and working really hard to make sure it all looks smooth like that because, again, we do see some supplier issues remaining but that'll sort out, I think, as we go through the rest of the year. In terms of gaining share versus in-house ASICs, Broadcom has for a long time said that we believe it's a major trend from in-house ASICs to merchant silicon across the board on Infrastructure at the remaining large OEMs who still use internal ASICs. We believe that's a long-term trend. There's still, if you look at the market size for internally done ASICs, there's a very large opportunity for us. And I think you can see we work in a number of different models. The Alcatel announcement we made is a great example of partnering with someone to do a semi-merchant silicon custom ASIC where we combine a lot of the libraries and technology we have into an ASIC, so it's much more than an ASIC. It's a much closer partnership. And then, we also see other customers moving more towards that merchant silicon. I can't be specific in terms of customers other than that, but we do see it as a growth opportunity going forward.

Operator

Our next question comes from Ambrish Srivastava of BMO.

Ambrish Srivastava - BMO Capital Markets U.S.

Quick one for you, Eric. Operating income or operating margins looking at Mobile & Wireless down versus higher revenues in the year-over-year basis. And then I have a longer-term follow-up for Scott, please.

Eric Brandt

Yes. So the reason you'd see that is because we've been adding resources to that business over the course of last year and to this year. And so as you get the back half of last year's as wrap-around for this year on flat to down 5% growth sequentially, you would see the effect to operating margins. I think we've said pretty clearly that differentially we've been adding resources to that side of the business and I think that's all you're seeing. There's nothing else meaningful behind that at all.

Scott McGregor

Plus acquisitions.

Ambrish Srivastava - BMO Capital Markets U.S.

Okay. And Scott, we, all of us, including me, we spend so much time on your Mobile & Wireless business. And maybe because, and I'll be the first one to admit, I don't understand the Infra, all the moving parts. Could you please help us understand not just next quarter, just kind of longer term, maybe a few quarters out, what are the big drivers that you see in the Infra and the Networking business?

Scott McGregor

So if I look across all of our businesses, in the broadband business, we see the continued trend there towards things like gateways, like moving more towards SD to HD and really adding additional silicon content in the devices is our opportunity there. In the Infrastructure and Networking side, certainly the migration to 10-Gigabit Ethernet is a positive one for us. It's an upgrade cycle across the industry, drives higher silicon values. Switching overall is a growth driver for us, the switching business doing extremely well. And then we've also made some acquisitions in that space that are doing well. A great example is the Provigent microwave business, which is a rapidly growing business as cellular infrastructure is deployed. Now all of it can be hooked up with optical fiber and so a lot of the rural deployment of infrastructure is deployed via microwave. And our acquisition there and our business there is the number 1 merchant silicon provider in that space. And then of course in the Wireless business, as you said, you follow that. But certainly, Wireless LAN and Cellular and GPS in the future NFC, those are drivers in that space.

Operator

Our next question comes from Chris Caso of Susquehanna.

Christopher Caso - Susquehanna Financial Group, LLLP

I guess I'll go back to the part of the business that we spent 80% of our time on, on the Wireless. And really two questions there with respect to the Wireless Combo business. I wonder if you could be more specific with regard to -- what's changing with regard to the technology either on your side or with the industry standards that will help you to maintain your market share and your lead in that combo business? And then as we look into next year, that business -- the wireless combo business, obviously getting -- gotten very large. What's your confidence that, that continues to be a growth business over the next year or 2 years?

Scott McGregor

So let me take those in turn here. Combo technology is something that's moving very quickly. And if you look each of the components that we put in the combo chips, each one of them is moving quickly. So for example, Bluetooth moving to Bluetooth, low energy moving to other additions to that technology, also moving to lower power 40-nanometer, things like that. We see GPS evolving very rapidly as there are new constellations of satellites that are going up, certainly GLONASS from the Russian Federation. The Japanese have put up a handful of satellites that kind of figure-eight orbit over Japan. China is putting a constellation in place and the European Union is putting up a constellation, and each one of those has very different requirements and different needs there. Also, location-based services and homologation data where you take not just the GPS data but you take data from Wireless LAN and cellular towers and FM radio stations and all kinds of things, sensors, all kinds of things to create location, that's a very rapidly moving area. Wireless LAN moving to technologies like AC and AD. AC technology, a channel bonding technology that gives you dramatically higher bandwidth; AD technology moving to 60 gigahertz, which would give you extremely fast data transfer at relatively short distances but allow you to transfer un-encoded movies and rapidly download media between devices. So we're excited about that. NFC, a new technology coming out, and then there are a variety of other technologies we will be adding to combo chips over time. So with a lot of moving pieces and a lot of moving parts, it goes back to that "You need to have best in class in each one of the areas," and we see a number of our customers coming out -- or competitors coming out where they'll maybe have an okay Bluetooth but they're short in Wireless LAN or their GPS doesn't support all the constellations or other kinds of things. And I think being on top of all of that and being the company best at integrating all the analog and digital components for that, we think we've got a very strong technology lead versus our competition, and that's the fundamental basis for our leadership position today, and we think we can keep that.

Operator

Next question comes from Daniel Amir of Lazard Capital Markets.

Daniel Amir - Lazard Capital Markets LLC

A couple of questions. First of all, can you comment a bit about where the inventory situation stands in kind of different end markets? Do you feel it's normal for this time of year in terms of seasonality? And then the follow-up question is, what needs to happen in your opinion in order for the broadband set-top box business to kind of return to a more normal level as it used to be historically? It seems like it's been multiple quarters where this business has been under pressure?

Scott McGregor

Inventory, in general, I think inventories are okay. We mentioned a little of inventory we see in the broadband space and we've seen some of our competitors talk about inventory in some of their wireless markets but we haven't seen that with our customers. And so we think inventory is approximately normal with the usual spots here and there where we get some. In terms of the broadband business overall, if I look at that business, it grew so rapidly last year. I think it probably overshot a little bit, and so you need to take that into account when you look at that business. But I think getting through some of the inventory, we do see that business growing again in Q3 and so hopefully getting back to a growth path. It would be nice if the digital TV industry will recover a little bit. So let's hope the consumer confidence goes up and please go out and buy a Broadcom-based DTV.

Eric Brandt

Dan, just to add to that, as Scott mentioned, had you taken out the Consumer Electronics business? The growth rate for the broadband segment would have been almost double. And in fact, probably some of the strongest-growing businesses in Q2 with set-top box businesses.

Operator

Our next question comes from Sandeep Shyamsukha of Auriga USA.

Sandeep Shyamsukha - Auriga USA LLC

My first question, I wanted to get a sense of how big emerging markets are for your set-top box business? And then also if you could provide color on your high-end set-top box that you announced last year? What level of traction are you seeing for that? And how does it compete with products which have been announced with Intel's processors in this market?

Scott McGregor

Emerging markets are becoming increasingly important for us. I think we got into those markets using products that were primarily intended for the U.S. or European markets. And so we're not particularly cost-optimized for those, and that had some margin impact in that business. We've put out a number of products that are targeted specifically for emerging markets and so we see an opportunity to both improve margin as well as take additional share in those markets. So are they important to us? Absolutely, yes. In our high-end set-top boxes, we're seeing very good traction with those products there. Yes, I've seen announcements from some competitors and so forth. But generally, those deployments are fairly small. There's about 200 million set-top boxes shipped per year, and I think you're seeing at best single-digit kinds of shipments from some of these other guys. So we are seeing strong traction and good products. We've dramatically increased processor performance in a lot of those chips, and a lot of our competitors come from a processor-centric design point and don't have the broadcast decoders and all of the content projection and just the range of other things we put into set-top box chips that really provide an integrated solution.

Sandeep Shyamsukha - Auriga USA LLC

Can you also provide some feedback on your GPS business? There's talk about competitors integrating baseband and GPS together on the same chip and those chips becoming a bigger part of the market. How do you see your GPS revenue going forward in 2012 and beyond?

Scott McGregor

We see our GPS opportunity as quite strong. I think maybe one competitor you're referring to has been integrating the digital piece of GPS with their digital baseband for a long time. Many, many years. And so that's really nothing new. We integrate all of the analog and radio components as well, as well as the power management components, and so a much more comprehensive solution. And I think we've been able to get the lead on our competition in terms of driving technology, support for multiple constellations support for all the different technologies for homologation and location-based services. And so that's a good opportunity. And for us, we do see growth of that business going into Q3 in longer term.

Operator

Our next question comes from Mark Lipacis of Jefferies.

Mark Lipacis - Jefferies & Company, Inc.

A couple of questions. On the cellular side, can you give us a sense of how big is this 3G portion of that business and how that ramps over time?

Scott McGregor

The 2G business is the largest part of our business today. We ship only 2G with Nokia, for example, and that will move to 3G next year. We're certainly shipping more 3G with some of our existing customers. And then, our new customers are generally all 3G. And so we definitely see a transition from primarily 2G today to primarily 3G over the next couple of years.

Mark Lipacis - Jefferies & Company, Inc.

Okay, thanks, that's helpful. And then, on the broadband side, I think in the past you mentioned China, Internet cable and India, satellite as opportunities. Could you provide a little bit more color on those?

Scott McGregor

Well, certainly, and there's also the opportunity for multiple devices within a house. That's another trend that I probably should've added before where you see where they'll put one installation and then they'll support satellite rooms based off the same set-top box using dongles or using other forms of transmission. So all those are opportunities -- certainly, China triple play is important. The government's sponsoring a number of efforts there, and that's sort of ebbs and surges between the quarters, but overall, very strong traction there. India is another market that's growing rapidly on the satellite side. We also see the continued trend from SD to HD and again, the analog reclaim of bandwidth for the U.S. cable MSOs where they do the same thing the FCC did across the airwaves where they want to compete with satellite guys to provide more digital channels. And so they do an upgrade cycle for the head-ins, the CPE, the consumer equipment, as well as set-back boxes for your existing TVs, analog TVs and other things you might have. So all of those tend to be drivers in that space.

Operator

The next question comes from Arnab Chanda from Roth Capital Partners.

Arnab Chanda - Roth Capital Partners, LLC

I just have one question. Let's see if I can say this without offending anybody. There's a very poorly kept secret of a Californian OEM that will release a new product in the second half of the year that potentially impacts your wireless business. If you excluded that hypothetical possibility, would you have -- what kind of qualitative growth do you think you would see in your Wireless business? In other words, is it broad-based or not?

Scott McGregor

I'm afraid I don't quite understand your question. Maybe you could rephrase it.

Arnab Chanda - Roth Capital Partners, LLC

Well, I've heard [indiscernible] phones and some type of tablets in the second half of the year. You're obviously very well-leveraged towards that. If you leave that out, are you seeing the growth in Mobile & Wireless business from other areas also? Or is it just mostly because of this new product launch?

Scott McGregor

I can't comment on that specific customer. And so I would say, though, that when we look across our business, we certainly see growth in a broad range of customers and not any one specific customer, so hopefully that's helpful.

Operator

The next question comes from Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank AG

A question, Eric. You went into a lot of detail about the Broadband segment and how the growth was going to be doubled what you delivered if not for the consumer side. Can you give us any idea of how that segment breaks down, just roughly how big is the consumer segment?

Eric Brandt

It's a small part -- it's certainly a smaller part today actually. But it's a small part of the business. We've typically said to people it's 10 percent-ish.

Scott McGregor

It's less than 10%.

Eric Brandt

Yes, or less now.

Operator

Our next question comes from Shawn Webster from Macquarie.

Shawn Webster - Macquarie Research

In terms of the supply chain, are there any areas where you're seeing your order lead times go out or where you're seeing component tightness? And I was wondering separately if you could give us an update on what your dollar content per tablet is running today and how you expect that to evolve over the next year?

Scott McGregor

So the lead times I would say are generally normalizing. If you looked about a year ago when things were extremely tight, we would see bookings well, well in advance of the quarter and we're seeing things move more towards normal right now. So I would say after many years of the downturn in 2009 and the craziness in 2010, I'd say we're finally getting back to, well, whatever normal is in the semiconductor industry, but more characteristic lead times. So I'd say lead times are relatively healthy. We see fab loading is still tight in some areas but generally reasonable. Assembly and test, generally reasonable. Again, the Japan situation has created some spot shortages and issues with substituting parts and qualifying new parts. But other than that craziness, I think there is a pretty normal -- moving more towards normal view of the industry there. In terms of dollar content per tablet, for us, we have most tablets today shipped with our connectivity solutions. So we see that as continuing and we're looking to add additional content there as we move the wireless LAN technology more towards AC and AD adding NFC, getting GPS into more of those devices. We have an opportunity for a cellular baseband and application processors in tablets going forward. So we see tablets as fertile growth opportunity for us.

Operator

Our next question comes from Stacy Rasgon of Sanford Bernstein.

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

Given the outlook that you have for increasing penetration into the ASIC market in switches, what impact does Intel's recent acquisition of Fulcrum have on that long-term outlook? And also just an accounting question, I noticed obviously your OpEx was better than expected, your gross margins were up. But your operating margins and the bulk of your businesses at least in, I guess, in Enterprise and Mobile & Wireless look like they were down quarter-over-quarter. How do we just reconcile that in the half?

Scott McGregor

So on Intel's acquisition, we noticed that. Fulcrum is a relatively niche player, and so we don't see that as having a significant impact. I think they do, what, $30 million a year, and so not a broad-based impact for us. Intel, we've competed with for many years so we do pay attention to what they do and we'll make sure our products stay competitive in that space.

Eric Brandt

And then Stacy, there are a variety of onetime items going in and going out. When we get off the call, we can got to -- we can discuss it. But the impact of those businesses is small in terms of what they changed and we're benefiting obviously for the improvement in the gross margin. But we can talk about it when we're done with the call.

Operator

Our next question comes from CJ Muse from Barclays Capital.

Christopher Muse - Barclays Capital

I guess, first question, Scott, you talked about digital TV and expectations for that to grow sequential in Q3. Curious whether that's broad-based or whether that specific to any one geography. And then second question, Eric, I know you guys don't guide out beyond the quarter for gross margin, but I was hoping you could kind of talk us through the puts and takes in terms of node transitions, absorption, any onetime items that we should be taking in [indiscernible] beyond the September quarter?

Scott McGregor

Your first question on digital television, we do see that business growing from Q2 into Q3, and it's not specific to any one customer. It's across our customers. It tends to be seasonal. Q3 is the big season for DTV leading into the Christmas build. A DTV weighs a lot more than a tablet or phone and so they tend to be shipped by boat rather than by airplane. And so those tend to peak of little earlier than some of other products.

Eric Brandt

On the gross margin side, certainly, as revenue comes up, we pick up on the absorption. And depending on how Q4 revenue plays out, that'll sort of move absorption one way or the other. We are certainly benefiting from improved costs, second- and third-generation parts. I think mix-wise, as you know, consumer products tend to be somewhat lower than enterprise products in terms of their margin. And to the extent the consumer product mix picks up in the company, we do see some headwinds. And as you can see, as we mentioned in Q3, with the strength of the Mobile & Wireless business, we're seeing that with some offset both in terms of cost and absorption. And depending on how that mix plays out in Q4, and obviously into next year, will sort of drive gross margin. But as we said last year, going into last year, we have very high degree of focus on gross margin. We're paying very tight attention to it. We are clearly designing products for better margin so that we manage this mix shift as it goes to our business.

Operator

Our next question comes from Ruben Roy of Mizuho securities.

Ruben Roy - Mizuho Securities USA Inc.

Scott, just a little on the consumer side of broadband business . At less than 10% of revenues, and I don't want to say it's a lumpy business, but perhaps maybe a little disappointing relative to your expectations for things like Blu-ray and digital TV. What's the focus for Broadcom from an R&D perspective for that business going forward? And what are your growth prospects if you look out into 2012?

Scott McGregor

So the business is below our expectations on that, and certainly, part of that is due to just the industry not doing particularly well on DTV right now. We do participate in the high-end part of that market with the over-the-top the Internet-connected TVs and 3D TVs and we expect as consumer sentiment were to pick up, we would see some growth in that space. Going forward, we see it as a strategic business because it ties into set-top boxes and it's alternative for how you get content in the living room. That being said, it's less R&D for us than for most of our competitors because it leverages off the set-top box investment that we already make. And so we will continue to drive that business again as an alternative for how people will get content and the emphasis, we'll make in that is not doing vanilla digital televisions, for example, but rather the over-the-top devices and highly connected devices that leverage Broadcom's breadth of IP. Same for Blu-ray devices. I think Blu-ray devices will become increasingly niched over time as people look to download movies and content directly over the Internet rather than physical media. But there'll always be a place for physical media. People like it. They don't always have Internet connectivity and sometimes want to watch Blu-Ray movies. So we don't see that going away. But that's not going to be a huge growth business going forward.

Operator

Our next question comes from Sanjay Devgan of Morgan Stanley.

Sanjay Devgan - Morgan Stanley

Just 2 quick questions, one on the combo connectivity side. There's been a lot of debate around new entrants in this space and the competitive landscape getting increasingly tougher. I was wondering if you could just give us a sense of as you look at connectivity in general, what portion of the market today is kind of discrete versus combo? Just to give us a sense of what the potential upside is as you kind of take away those discrete sockets.

Scott McGregor

So today, I think it's about 60% Bluetooth penetration and 30% WiFi penetration. There's an opportunity to increase the penetration there, so it's not just the discrete products moving to combo chips. It's also the broader penetration of the technologies into devices. Phones, if they're already 60% Bluetooth can that go 80%? Yes, Wireless LAN can match Bluetooth in penetration and so that's a great opportunity there. GPS moving up.

Eric Brandt

Low 30s will go or 50% near term. That's mostly discrete today.

Scott McGregor

So again, both discrete to combo as well as increased penetration of the 2 drivers you should look at.

Operator

Our next question comes from Quinn Bolton of Needham & Company.

Quinn Bolton - Needham & Company, LLC

Scott, I was just wondering if you could give us some sense of the relative strength within Mobile & Wireless for basebands, combo chips, media processors, all be at double digits or is one area leading growth? And then just last quarter, you thought your sort of slowdown in Mobile & Wireless was just sort of time to some of your key customers. Now that you have another quarter in your belts, you're obviously projecting a strong rebound. Do you think this is just your customers getting stronger as you get into the back half of the year? Do you think this is some of the share gains in wireless combo chips starting to kick in?

Scott McGregor

I think it's a combination of all of those. When I look across the different segments in that business, they're all up strongly. There are none that aren't up significantly in that space. We're seeing a combination of things that drive that. We've got some share gain. We've got some of our customers in that space who have gotten more aggressive in the marketplace to drive share on their part. And so that helps us pick up some gain there as well. So -- and we have new products coming out with new technologies. So I think those are all factors that are driving that space and I don't see -- looking across at the businesses, I don't see any that aren't showing a significant pickup in Q3.

Operator

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

Edward Snyder - Charter Equity Research

A couple of things. When will 40-nanometer reach something more significant, say, 35% of revenue? Any general idea on the timing on that given your rollout? And then your Mobile & Wireless guidance is good. You did say the growth of existing customers especially baseband. Is that purely seasonal or is that new models? And then how does that apply to the connectivity? Is that mostly seasonality or are you talking about the share gains of those customers or new products? I'm just trying to get a feel for what's driving all that.

Eric Brandt

It's Eric. I'll answer the 40-nanometer. I think that if you look at 65, which is pretty instructive, it took about 3 years for 65 to cross over 50% from the time we started taping out. We're really shipping products and we began shipping 40 products this year really sort of the end of last year. Our tape-outs are probably half today in 40-nanometer and lower, probably going to 80% by the end of the year. So you can get a pretty good picture of that. The entire new product portfolio as we roll into 2012 is going to be pretty 40 or smaller. There'll be some other things that are power management, et cetera, that are higher and probably some legacy 65s. So probably assume about 3 years for it cross over 50%.

Scott McGregor

On your baseband question, there are multiple drivers to that and certainly in the existing customers, as I mentioned previously, they're getting more aggressive in their market. There is a seasonal component to it, as you mentioned. We are seeing new models and we all are picking up some additional customers to drive some growth there, but it's a mix of all of those that drives our growth quarter-on-quarter.

Operator

Our last question comes from Srini Pajjuri of CLSA securities.

Srini Pajjuri - Credit Agricole Securities (USA) Inc.

A couple of follow-ups. Scott, you talked about baseband opportunity at Nokia and also in Android smartphones. And historically, you've had a very strong position in 2G at Samsung. I'm just curious as to how we should think about the opportunity at Samsung. And then if you can touch about the tablet processor opportunity? You mentioned your content will grow over time, but when should we expect the processor to contribute meaningfully to the revenues?

Scott McGregor

So on your baseband question, I can't talk about specific customers but we do see our 2G business continuing. We're not looking for new 2G customers at this point. We're focused primarily on 3G and 4G, but we do expect that we'll get additional models at some of our existing 2G customers, and so that helps us in that regard. In terms of tablet processors, you may have seen that at the consumer electronic show, we announced an integrated device that included a processor for tablets. I would say probably you'll see us penetrate more in the lower end of tablets or the purpose-built tablets that are for user interface devices or other kinds of things initially. And then as we get our processor performance up and get more competitive in that space and narrow the gap with some of the other guys, you'll see us reach more into the mid and high end of the processors. So I would model relatively small processor component for tablets over the next year. But beyond that, I think we could do more.

Operator

We have no further questions in queue. I will now turn the call back over for closing remarks to Scott McGregor.

Scott McGregor

Thank you very much for joining us today. In closing, I'd like to reiterate that Broadcom's goal remains to be to create leading communication platform solutions that enable us to grow our market share and deliver strong profitability and robust cash flow from operations. Our delivery of cutting-edge solutions and the solid financial discipline that you've seen should result in significant revenue and operating margin improvements in the September quarter.

Finally, one last reminder. We'll be hosting our 2011 Analyst Day, this time in New York on December 14. And if you need any more details on this event, please give Chris or John a call.

With that, thank you very much for joining us today, and have a good day.

Operator

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

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