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Broadcom (NASDAQ:BRCM)

Q4 2011 Earnings Call

January 31, 2012 4:45 pm ET

Executives

Chris Zegarelli - Director of Investor Relations

Scott A. McGregor - Chief Executive Officer, President and Director

Eric K. Brandt - Chief Financial Officer and Executive Vice President

Analysts

Ross Seymore - Deutsche Bank AG, Research Division

Glen Yeung - Citigroup Inc, Research Division

Uche X. Orji - UBS Investment Bank, Research Division

James Schneider - Goldman Sachs Group Inc., Research Division

Mark Lipacis - Jefferies & Company, Inc., Research Division

John Pitzer - Crédit Suisse AG, Research Division

Harlan Sur - JP Morgan Chase & Co, Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

Craig Berger - FBR Capital Markets & Co., Research Division

Craig A. Ellis - Caris & Company, Inc., Research Division

Sanjay Devgan - Morgan Stanley, Research Division

Romit J. Shah - Nomura Securities Co. Ltd., Research Division

David M. Wong - Wells Fargo Securities, LLC, Research Division

Ambrish Srivastava - BMO Capital Markets U.S.

Christopher J. Muse - Barclays Capital, Research Division

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Kevin Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Operator

Hello, and welcome to the Broadcom Fourth Quarter and Year 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Tuesday, January 31, 2012. I would now like to turn the call over to Chris Zegarelli, Director of Investor Relations. Please go ahead.

Chris Zegarelli

Thank you, and good afternoon, everyone. Today's call will include prepared remarks 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 which 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, which was furnished with the SEC today, and is available on our website, and on our 2011 10-K when it is filed. 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 the reconciliation between the 2 for the periods reported in the release. Please also see the Investor section of our website at www.broadcom.com/investors for a slide deck that includes additional information disclosed in accordance with SEC Regulation G.

Now it is my pleasure to introduce Broadcom's President and Chief Executive Officer, Scott McGregor.

Scott A. McGregor

Good afternoon, and thanks for joining us today. Broadcom performed well in the December quarter, with somewhat stronger revenue than we anticipated. Our quarterly revenue was $1.82 billion, above the guidance provided in December at our Analyst Day in New York.

At the outset of the year, we established a plan to outgrow the industry while delivering results within our target operating model. I'm pleased to report that we delivered on this goal. Broadcom's annual product revenue increased almost 9% year-over-year, significantly better than the overall industry, which grew in the low single digits.

2011 non-GAAP product operating margin came in at 20.9%, within our targeted range of 20% to 22%. As a result, Broadcom delivered record cash flow from operations of more than $1.8 billion, driving record cash balances of $5.2 billion.

At our Analyst Day, we talked about a few important competitive differentiators that we'll continue to highlight, IP strength, R&D scale, our complete system portfolio and our business model. Broadcom remains focused on enhancing our world-class IP portfolio. Ending 2011, Broadcom had more than 15,900 patents and applications. To put this in context, the U.S. Patent Office recognized Broadcom as receiving the 17th highest number of patents in the U.S. in 2011 among all industries and second among semiconductor companies, excluding memory. Looking forward, Broadcom will continue to leverage our leading IP portfolio into highly leveraged products that power communications from your handset, to the base station, through the network and back to devices in your home.

Broadcom's R&D scale and breadth of complete system solutions enables us to consistently gain share in our market, deliver solid profitability, reinvest in our businesses and return more capital to shareholders. In 2011, we nearly doubled the amount of capital return to shareholders in share repurchases and dividends. Today, we build upon that trend by announcing our second consecutive annual increase in our dividend to $0.10 per quarter.

I'll now turn the call over to Eric for details on the fourth quarter results and first quarter guidance, and then I'll go into details on our business units, and talk about our plans for strategic growth.

Eric K. Brandt

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

Moving to the financial overview, to summarize, for Q4, total revenue of $1.82 billion, including $1.76 billion in product revenue. Q4 total net revenue was down 7% sequentially and down 6.4% from prior-year levels. Both GAAP and non-GAAP product gross margin were down slightly from Q3 at 49.3% and 50.6%, respectively.

Q4 GAAP R&D plus SG&A expenses were down $30 million to $636 million. GAAP earnings per share for Q4 were $0.45 per share. Non-GAAP EPS was $0.68 or $0.03 above First Call Consensus of $0.65 per share. Cash flow from operations for Q4 was $482 million. Full year cash flow from operations was a record $1.84 billion. Our cash and marketable securities balance was $5.2 billion.

Moving to revenue and gross margin, in December at our analyst meeting, we said we expected Q4 total net revenue to be approximately $1.8 billion. Total net revenue ended at $1.82 billion. Our Broadband Communications segment was down 3% from Q3 due to a decrease in demand for our DTV and Blu-ray products. As anticipated, the Mobile & Wireless segment was down 7%, driven by softness in demand for our wireless connectivity solutions. Our Infrastructure & Networking segment was down 13%, with most lines of business down in the quarter.

Our Q4 GAAP product gross margin was down slightly at 49.3%, which translates to 50.6% on a non-GAAP basis, once again well within our target model. This was slightly below our expectations of roughly flat, driven by some unanticipated E&O charges.

Moving to operating expenses, total GAAP R&D and SG&A expenses for Q4 were down $30 million from Q3 levels, significantly below the guidance we provided in December of down roughly $5 million. This favorability to guidance was principally driven by lower mask cost, lower-than-expected legal fees and some non-recurring credits to R&D and SG&A in the quarter.

Moving to the balance sheet, as I mentioned earlier, cash flow from operations was $482 million for Q4, and a record $1.84 billion for all of 2011. Cash and marketable securities ended Q4 at a record $5.2 billion, benefiting from our strong operating cash flows, a successful debt offering of $500 million and roughly $200 million in net option proceeds. These were offset by approximately $860 million of capital returned to investors in the form of dividends and share repurchases, plus roughly $350 million in M&A in 2011.

For the full year, we repurchased 17 million shares of our stock. Our accounts receivable day sales outstanding was 34 days in Q4. In addition, inventory levels decreased $70 million from Q3, resulting in a strong 8.5 turns in Q4.

Moving to expectations, we currently expect net revenue in Q1 to be roughly $1.7 billion to $1.8 billion, the midpoint of which is about 2 points better than mix adjusted seasonality. Sequential revenue expectations for our Broadband Communications and Mobile & Wireless segments are expected to be down in Q1, while our Infrastructure & Networking sales are expected to be roughly flat. We expect Q1 GAAP and non-GAAP product gross margin to remain roughly flat versus Q4. We expect non-GAAP R&D plus SG&A expenses in Q1 to increase by approximately $55 million to $65 million, driven principally by our annual merit increases and Q1 fringe accounting step up totaling roughly $40 million. In addition, stock-based compensation will be up approximately $10 million, also associated with our annual merit process. The remaining increases can be mostly explained by the impact of the non-recurring credits in Q4, plus the modest expense increases related to headcount and additional masks.

Excluding legal upticks and the effect of M&A in 2012, we expect GAAP R&D and SG&A expenses to increase at a lower sequential rate for the rest of the year, consistent with what occurred in 2010 and 2011. Please note, none of these numbers reflect any impact from the potential closing of the NetLogic transaction.

Finally, as Scott mentioned, we announced an 11% increase in our dividend to $0.10 per quarter. We believe this reflects our powerful cash generation profile as a growth company, our strong balance sheet and our ongoing commitment to return capital to our investors.

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

Scott A. McGregor

Thanks, Eric. Starting with the Home Platform, our Broadband Communications revenues decreased 3% sequentially due to reduced demand for discontinued Blu-ray and DTV products. Over this summer, we announced the industry's first 1 gigahertz Full-Band Capture digital tuner in 3 new set-top boxes and DOCSIS 3.0 Gateway SoC solutions. These 40-nanometer devices deliver the tuner density and performance to accelerate IP-based video platforms, while reducing cost and power and footprint. In the fall, we announced an extension of that portfolio to our industry-leading satellite products, and today, I'm pleased to announce that we have production orders for these products and will ramp this innovative and disruptive technology in the middle of this year.

At the Consumer Electronics Show earlier this month, we introduced the industry's first integrated MoCA 2.0 system-on-a-chip portfolio, including 6 new set-top box and hybrid IP Gateway platforms. MoCA 2.0 more than doubles home network bandwidth, enhances video quality, enhances security and enables more efficient energy efficient systems. We also introduced our latest solutions for hybrid TV and over-the-top media players. These 40-nanometer devices feature a high-performance CPU, advanced software integration and dual transcoding. We expect revenue from our Broadband Communications business to be down slightly in Q1.

Moving to infrastructure, our Infrastructure & Networking business was down 13% sequentially, driven by softness in Ethernet Switches and PHYs, particularly in the enterprise and service provider segments. In 2011, our 10 gig BASE-T business grew more than 500%, reflecting Broadcom's market leadership.

During the quarter, we introduced our new EPON OLT solution that reduces cost and power by up to 50% and displaces several stand-alone ASSPs with one high-performance and low-power system-on-a-chip. This single-chip quad OLT works together with our aggregation switch solutions to combine proven carrier network -- or Carrier Ethernet technology, with feature-rich EPON to meet scalability, reliability, cost and advanced feature set requirements of our next-generation fiber deployments.

We also announced the formation of the One Pair Ethernet or OPEN Special Interest Group to drive adoption of Ethernet-based automotive connectivity. Membership has grown to 19 companies, including 3 major automotive manufacturers, 4 Tier 1 suppliers and 3 major semiconductor companies. We're seeing critical mass that continues to build in the automotive space around Ethernet in general, and our BroadR-Reach technology in particular.

As we look into Q1, we expect revenue from our infrastructure solutions to be roughly flat sequentially. We'll update you on NetLogic as more information becomes available. We have an enormous amount of work in motion on this front.

Moving to our Hand Platform, our Mobile & Wireless segment experienced a 7% sequential decline in revenue as growth in 3G baseband and continued strong market share in wireless connectivity combo chips was more than offset by softness in 2G baseband and multimedia solutions.

At CES, we unveiled the industry's first chip supporting an important new Wi-Fi standard, 802.11ac, the fifth generation of Wi-Fi. 5G Wi-Fi runs up to 3x faster than its predecessor and also provides significant improvements in reliability, range and coverage. 5G Wi-Fi is attractive to carriers who are looking to offload more content from their licensed spectrum, and to consumers who are streaming greater amounts of video content in the home and between devices. We have already received early production orders for our 5G Wi-Fi chips, and consumers will start to see products in the marketplace in Q3. We expect that by 2015, virtually all new Wi-Fi products will be based on 802.11ac. Also at CES, we demonstrated next-generation GPS technologies and NFC solutions and our emerging 4G LTE technology.

Earlier this month, we introduced a new 1 gigahertz HSPA baseband and reference design, the 21552G which includes an HSPA modem, a 1 gigahertz application processor, high-performance graphics and leading connectivity, including Wi-Fi Direct, Bluetooth low energy, advanced navigation and NFC. This reference design showcases Broadcom's ability to deliver smartphone features into a more cost-effective platform that can be quickly brought to market by a wide range of handset OEMs.

These innovations continue to drive momentum with new customers and new platforms. As one example, the Samsung GALAXY Y is a powerful smartphone, that's one of the top-selling smartphones in India. Additionally, we continue to see new 3G customers coming online, including ZTE, Foxlink and G'Five. We expect revenue from our Mobile & Wireless solutions overall to decline somewhat into Q1, but for both 3G basebands and wireless connectivity combo chips, to continue to increase sequentially.

In summary, Broadcom continues to benefit from powerful trends in the communications market. We see smartphones proliferating around the globe. We see increasing attach rates for a wide range of connectivity technologies across an ever-increasing number of products. We see 5G Wi-Fi coming to market and delivering a whole new level of wireless networking performance in the home and on the road. We see 10-gig Ethernet benefiting from server upgrades in the data center. We also see innovation in the home that's enabling content to be transmitted more quickly to and networked around the home. Broadcom remains firmly committed to creating outstanding communications products that make communicating and sharing that much easier, faster, more cost-effective and more power efficient.

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 Ross Seymore with Deutsche Bank.

Ross Seymore - Deutsche Bank AG, Research Division

A couple of questions on the top line side of things. First in wireless, Scott, your description of that business sounded like the headwinds are really coming from the 2G side. Can you talk about -- is that just seasonal, is it design-win based and if it's design-win based, when do you expect that 2G business to trough?

Scott A. McGregor

Ross, I expect our 2G business to fall off, and mostly be replaced by 3G business. So I don't consider that a trough. I think that will tail down over the next couple of years, not immediately, but in general, we will see most of our shares shift into 3G. So what you're seeing is, we have headwinds from the 2G business winding down a bit, as well as our video processor business declining at one large customer. And what we do see though is that we're growing in all the right places. We've got 3G basebands growing strongly in that space.

Ross Seymore - Deutsche Bank AG, Research Division

Great. And as my follow-up, switching over to the Networking & Infrastructure side of things, that guidance being flat sequentially, there's been a lot of different guidance up and down from some of your networking peers. And can you just talk a little bit from either a service provider enterprise or even a product type, what you see allowing that business to be flat going into the first quarter?

Scott A. McGregor

Yes, fair question. We see that the service provider business in particular was down recently. There's some anecdotal data that the service provider business is picking up, especially in China. We're seeing more RFQs in that space. So again, some anecdotal evidence that, that may be picking up a little bit. But we do see as part of our flat guidance there a variety of businesses both growing and still declining a little bit. So still some variability in that business.

Operator

Our next question is from Gene Yeung with Citi.

Glen Yeung - Citigroup Inc, Research Division

That's my brother Gene, it's actually Glen here. Question for you, first on what you're seeing in terms of an industry bottom, and I say this for 2 reasons, one, because your peers all seem to be calling a bottom. And then two, as I look over the history of Broadcom, I don't think I've ever seen 2 quarters of sequential -- more than 2 quarters of sequential revenue decline which would suggest the June quarter could be up. So maybe any thoughts around that.

Eric K. Brandt

Sure, Glen, it's Eric. As you know, as much as other people like to comment on the global economic side of things, we tend not to and notwithstanding the fact that sometimes people repeatedly call bottom. Having said that, I would say for Q1, we are feeling pretty good about the fact that we are better than seasonal, despite headwinds in the 2G space and with our business that we're discontinuing on DTV and Blu-ray. So I think as Scott mentioned, we're growing in the right places. And then if you sort of penetrate through the numbers, you can actually see pretty good strength in our business.

Glen Yeung - Citigroup Inc, Research Division

Okay, and then, I wanted 2 questions asked, I guess I'll ask a longer-term question about the ac market, and Scott, I understand -- I heard your comments about it, but I wanted to ask 2 questions there. One is, what do you think the ramp of ac will look like relative to the ramp of n or of g? And do you believe that you've got a competitive advantage in terms of product, but also in terms of time to market?

Scott A. McGregor

We expect the ramp of 5G Wi-Fi to be pretty significant. I would say will be comparable to n or perhaps even faster. I think the infrastructure partners, those who sell wireless access points and things like that will probably move the most quickly because it really provides a real benefit, and the extra performance, the extra range, extra coverage makes a real difference in a consumer household and will enable you to do things like stream HD video much more reliably around the house. So I would expect access points initially, very rapidly into PCs, laptops, into consumer devices, especially HD video-related devices. I think that will be a little different than what we saw in some of the previous generations of wireless LAN. We'll see more of a consumer electronics pickup as well. And then, I think probably into next year, you'll start to see pickup in the handsets. One of the advantages of 5G Wi-Fi is that it consumes less power for the amount of data transmitted. And for all of you who look around for power outlets in the middle of the day with your smartphones, I think that makes a big difference if you can get some battery savings on that. And so, it will not only be a better performance, but better battery utilization as well. I think in terms of -- you asked about our opportunity here. To my knowledge, Broadcom is the only the major semiconductor company with this technology available today. I think we've got a multi-quarter lead here, and our goal is to get that into as many customers' hands as possible.

Operator

Our next question is from Uche Orji with UBS.

Uche X. Orji - UBS Investment Bank, Research Division

Scott, let me just ask you about the comments you made about 3G replacing -- the headwinds in 2G. First of all, at what margins are those coming in relative to 2G? And also, most of your competitors have talked about selling an integrated Wi-Fi baseband as a processor into one of the low-cost handset market. How do you differentiate yourself within that market, given that you don't have such a triple combo product? And also if you can comment how much of it is coming from Android versus Windows platform?

Scott A. McGregor

Uche, there's a lot of questions there, but I think in terms of moving to 3G, I would certainly see a higher ASP in the 3G products and to the extent we put a lot of other features, there's potential for margin as well. We don't breakout the specific margins on our products. In terms of how do we differentiate, we differentiate in a number of ways. We provide a very cost-effective, very power efficient product that integrates both application processors and baseband, as well as video processing. I think we've done a tremendous job on video processing and generally have much better performance than our competitors in that space. So I think you'll see us provide some great solutions there, and as I said in the past, over the next year or so you'll see us close the gap with one of our other competitors in terms of just top end capabilities in application processors and baseband as well. So really providing some stronger competition in the high-end smartphone space as well.

Uche X. Orji - UBS Investment Bank, Research Division

And on the platform, Windows platform versus Android platform. When should we expect you to be active on the Windows side?

Scott A. McGregor

The biggest driver for us in the near term is certainly going to be the Android platform. To the extent there are 3 major platforms, including Windows, that's an important platform for us to support and you should expect that we would make an effort in that space, but we don't have any announcements today.

Operator

Our next question is from James Schneider with Goldman Sachs.

James Schneider - Goldman Sachs Group Inc., Research Division

I was wondering if you could talk a little bit about the wireless guidance for Q1. You called out combo chips is increasing in the quarter, but you didn't talk about the effect on discrete connectivity. Can you talk about what's going on? Is that just a function of more combo chips replacing discrete solutions? Or maybe you can talk a little bit about what's going on in the router and access point market as well?

Scott A. McGregor

So we're definitely seeing a shift to combo chips and in particular, we've got share gains in China where our combo chips are replacing discrete chips. The good news is they're somebody else's discrete chips. So that's a genuine share gain there. So we do expect to see -- into the first quarter, we do expect to see combo chip increase there. And then also, I mentioned we do expect to see 3G basebands grow as well into the first quarter, and then the tailwinds of course being 2G declines and also video processor declines.

James Schneider - Goldman Sachs Group Inc., Research Division

That's helpful. And then maybe one for Eric. Eric, I think you talked about the OpEx guidance and given your commentary, it sounds like compared to last earnings call, that maybe OpEx is going up a little bit more than you might have hinted at earlier. Is that just a function of the credits that we saw in Q4? Or is that also a function of maybe some higher confidence in the business going forward over the next few quarters?

Eric K. Brandt

So, Jim, let me break it into the buckets again, just because I think it's easier if I do that. So there's roughly $10 million of stock-based compensation, about $40 million of fringe and merit, and then about $10 million of this sort of credit not repeating. Beyond that, design and development prototyping, masks, et cetera, should be up between $5 million and $10 million. The other thing that you'll see when the 10-K comes out tomorrow is actually for the first time in a long time, the actual headcount at Broadcom went down about 100 people quarter-on-quarter. And so what you're seeing is in Q4, as we exited the digital TV and Blu-ray business, a drop in those resources and then a rehiring of targeted resources in Mobile & Wireless. And that's part of -- that's probably a couple million dollars just on the resourcing cost. So if that reflect confidence in the business, I think it reflects the same confidence we talked about at Analyst Day. I think there's naturally some timing of a couple of million dollars, but you can see it's pretty tight in terms of how we're managing it.

Operator

Our next question is from Mark Lipacis.

Mark Lipacis - Jefferies & Company, Inc., Research Division

First one is on the 3G side of the business, can you paint a picture of how -- where you guys are in the design win process and production ramp process? Is this going to come from Android phones in the U.S., in China? To what extent is this Tier 1 versus Tier 2 or Tier 3 OEMs?

Scott A. McGregor

So we're definitely seeing a lot of 3G design win traction. We're winning a lot of new designs right now. So I'd say, we see an acceleration in that business that should turn into revenue over the course of latter part of this year and next year. I'd say the majority of the business is Tier 1 customers. There certainly are some smaller customers, and I named a few of them earlier in my prepared remarks. So we're seeing more customer breadth as well in this space. It is primarily Android. I'd say the majority of it is outside the U.S., but we're starting to see U.S. opportunities as well.

Mark Lipacis - Jefferies & Company, Inc., Research Division

Great. As a follow-up, on the broadband business, at the Analyst Day, I think you described differences between the developed and the emerging markets. How big are the emerging markets or the BRIC markets for you guys on the broadband side? How should we think about the growth between the developed and -- versus emerging markets this year?

Scott A. McGregor

So Broadcom has the highest penetration into the U.S. and secondarily into Europe, less so into Asia and even less so into the BRIC markets. The BRIC markets are growing extremely quickly. There's estimates of doubling, tripling and so forth in South America and certainly, strong double-digit in places like India and China. And those are places where we have historically been underpenetrated. And so I would say that's a significant piece of the growth opportunity for us going forward, geographic expansion into those underpenetrated areas.

Operator

Our next question is from John Pitzer with Credit Suisse.

John Pitzer - Crédit Suisse AG, Research Division

Eric, quickly on the broadband business, on down revenue in the December quarter, it looks like OP margins were up pretty healthy. Can you just help us understand what's going on there? Was that just favorable mix in the quarter? Or is there something we can continue going forward?

Eric K. Brandt

Yes, the drop in Q4 can virtually, entirely be explained by the reduction in the consumer electronics business, the DTV and Blu-ray business. And so, that business -- one of the reasons we exited was that business was not particularly attractive from an operating margin or even a gross margin perspective. So as that business goes down, there is a tailwind to margins in broadband.

John Pitzer - Crédit Suisse AG, Research Division

And then guys, inclusive of the March guidance, you're now going to have a couple of quarters in a row where the 3G combo business is up, but overall Wireless & Mobile is down. I wonder if you could help me understand the relative sizes of the business within the Mobile & Wireless. And Scott, you talked about 2G winding down over time, but I'm just kind of curious as to when you think the maximum kind of headwind from that business is going to occur?

Scott A. McGregor

We don't typically breakout the details you're looking for there, but -- I mean, our hope is certainly the 2G stuff continues for a little while. But I think we're going to hit a crossover where we're primarily selling 3G roughly next quarter or in third quarter. So I think you'll see us continue to ramp 3G, and we should start to see it. A shift from headwinds to tailwinds in the latter part of this year.

Operator

Our next question is from Harlan Sur with JPMorgan.

Harlan Sur - JP Morgan Chase & Co, Research Division

In terms of the slight weakness that you're anticipating for the March quarter for your broadband business, Scott, can you just give us more color about the direction of your set-top and your modem segments within that? And then maybe some of the drivers that are responsible for the better seasonal trend there?

Scott A. McGregor

We certainly see an opportunity with our Full-Band Capture technology going forward. It's a real game changer. It really allows us to create some devices that our competitors aren't going to be able to deliver on, with multiple tuners and fast channel change and things like that. So that's an opportunity for us. It also allows us to do some nice things in the modem space as well. We definitely see customers continuing to deploy. As I mentioned to a question earlier, geographical expansion is a real opportunity for us in Q1 and going forward. And so those are the primary drivers there. We have a little bit of a headwind because of the discontinuation of our Blu-ray and DTV business. So that's the headwind on the business, but nevertheless, we still managed to drive that business strongly and expect over the long term to see that as a good growth opportunity as we penetrate those other areas.

Harlan Sur - JP Morgan Chase & Co, Research Division

And then the outlook for your combo connectivity business obviously looks pretty good this year. I mean, with forecast for 35% to 45% of shipment growth in smartphones and tablets. I think you mentioned earlier in the call about the increasing penetration rates of combo into the low-end and into the feature phone segment of the market as another driver here. Where are we today in terms of combo penetration in feature phones and low-end smartphones and where do you expect that to be exiting this year?

Scott A. McGregor

I think there's an opportunity for increased combo penetration, and also for combo chips to encompass more features. A great example of that is NFC. NFC is a new technology today that's basically 0% penetrated into the install base. And I would expect that to lag a little bit as people work out the business cases and the infrastructure to support it. But I would expect that to basically have the same kind of penetration levels we see for Bluetooth and get into even lower-end phones than you see today. I expect GPS still has some opportunity to go as we see that used for location-based services, emergency services and so forth. So I think, we're not in the latter innings yet on combo penetration into those devices. I think we'll see them both penetrate further down into feature phones, as well as broaden the features, things like NFC next year, things like 5G Wi-Fi that will give us an opportunity for ASP increase as well as selling more chips.

Operator

Our next question is from Vivek Arya.

Vivek Arya - BofA Merrill Lynch, Research Division

So Scott, for a number of quarters, a major investor concern has been that Broadcom's growth has been very dependent on combo connectivity and that the high 80%, 90% share that you have in smartphones and tablets is not sustainable. So my question is, how is the pricing and competitive situation in that connectivity business versus say, 6 months ago? Are you seeing any incremental competition from Qualcomm and others? And just fundamentally, how do you differentiate when you're all having to support the same 802.11 or ac or these other standards?

Scott A. McGregor

Broadcom's combo chips sell well because we have best-in-class technology for all of the components of the combo chip. We've seen some other competitors for the last years. We've always had these threats that competitors would come in there. But typically they come in where they might be good at one of the components, but they fall down in terms of the capabilities of the other components. And so, I think today, that's still true. We know of no other competitor who really can say they're best-in-class for all the components of these combo chips. And that's important for our customers. At the same time, we've really raised the bar by adding things like NFC, moving to 5G Wi-Fi next year, Bluetooth, low energy, a lot of the location capabilities we put in GPS. We really think have not yet been matched by competition. So I made this comment, I think, at our Analyst Day, and at some of our meetings at CES. But I think there's an opportunity for us to increase share in combo chips over the course of this year rather than to see any particular share loss. Does that mean that competitors aren't going to get any share at all? No, they're going to pick off some, and they each have opportunities and niches where they'll fit in. But I believe that we remain very strong in that business, and I think we'll show you that we probably hold or even gain share this year.

Operator

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

Craig Berger - FBR Capital Markets & Co., Research Division

Can you just provide us an update on your efforts in 4G baseband and any thoughts around timing and customer feedback?

Scott A. McGregor

I can't give you too much. I mean we have demonstrated, and if you came to CES and if you come to Mobile World Congress, you'll see maybe a little bit more. But we have some of our 4G products in the development phase, they're demo-able, we have them in carrier trials, we're pleased with the performance on those. And again, if you come to Mobile World Congress in Barcelona in February, we'll be happy to show you those and the performance they can do. We've said that you won't see them this year in terms of products, but we haven't said exactly when you'll see them. So we're going to stick with our usual model of, you'll see them when they start shipping. But please don't build any revenue in your model this year for 4G.

Operator

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

Craig A. Ellis - Caris & Company, Inc., Research Division

First, just a follow-up on the broadband business. Scott, when do you expect that the headwinds in the DTV and Blu-ray businesses are going to be behind you as a sequential growth dynamic?

Eric K. Brandt

Craig, it's Eric. I'll give you a little bit of information we don't normally give, mostly because it's a discontinued business. We did about $125 million in 2011 in that business. And in Q4, we did about $25 million. And so you can assume that, that $25 million over the course of 2012 will ramp eventually to 0 by the end of the year is our best guess or maybe low single-digit, and that's probably the best way to model, is draw that straight line from $25 million down.

Scott A. McGregor

Or maybe a little blip up in Q3, which is when they do the builds for consumers for the holidays.

Eric K. Brandt

But more or less that's sort of -- that is the headwind of the consumer electronics or DTV business.

Craig A. Ellis - Caris & Company, Inc., Research Division

Okay, that's real helpful. And since he let you off the hook, Scott, going back to your 5G Wi-Fi comments and the fact that you -- I think you're a couple of quarters ahead of your competition, what does that mean for share gain for Broadcom in applications like PCs, home access points and enterprise access points this year? And how sustainable do you think market share gain could be with that lead?

Scott A. McGregor

Well, I think it'll be definitely be positive towards market share gains. Certainly, when you're the only guy who's got the best technology, that's positive for your share gain opportunity. I think we've got a really great chip offering in 5G. It's performing really well. I think there are a few other things we'll do to make that proliferate and be available in a variety of different forms. I think it'll make it very challenging for competitors to really come at us on a broad base -- and one of the things we do is we provide software compatibility across our 802.11 a/b/g/n, and now ac platforms which really allows a customer to deploy a whole range of products with software compatibility. I think that'll be extremely attractive to a lot of customers, and so I would be optimistic in terms of our ability to both gain share because of 5G and probably sustain it as well.

Operator

The next question is from Sanjay Devgan.

Sanjay Devgan - Morgan Stanley, Research Division

Scott, one question on your Networking & Infrastructure business, you talked about a flattish outlook for Q1, but also towards the tail end of Q1, we also have the upcoming ramp of Romley and you guys have traditionally been very strong in the data center. I was wondering how should we view the upcoming Romley product cycle as kind of, how it bodes for you and is that more of a Q2 phenomenon, hence the kind of flattish guide or specifically I should say, how do you view Romley and how should we view that kind of going forward in terms of a product cycle for you guys on the data center?

Scott A. McGregor

We definitely see Romley as a driver for growth. And we'll start to see that in Q1. So we do model our data center business in infrastructure up in Q1, partly due to Romley and partly due to just a general acceleration as Romley rolls out. A lot of data centers were waiting for that to happen before they deployed additional capital. So I think that'll happen. I wouldn't model that as a sudden surge, but rather as something that will pick up over time. So we see that as having benefits into Q2 and Q3 as well and not sort of a blip in Q1 or Q2, but more a steady surge over the course of the year.

Operator

The next question is from Romit Shah with Nomura Securities.

Romit J. Shah - Nomura Securities Co. Ltd., Research Division

Scott, just along those lines, Juniper and Ericsson have indicated recently that carrier CapEx spending is still constrained. What's your outlook on that?

Scott A. McGregor

So they're certainly closer to the carriers than we are. So I can't really say more than that. We are hearing anecdotal data of China picking up with some of the carriers there. We see some of our Chinese customers showing more growth there. That would be less impactful to the U.S. networking guys you mentioned. But some of our Chinese customers are seeing some pickup as a result of Chinese carrier expansion. Maybe that's less true around the rest of the world.

Operator

The next question is from David Wong with Wells Fargo.

David M. Wong - Wells Fargo Securities, LLC, Research Division

Eric, last year, after the initial first quarter step up in OpEx, we saw R&D go flat and SG&A actually decline through the year. Would we expect a similar pattern this year? Are you continuing to try and drive down OpEx or will it begin to drift up as your revenues grow?

Eric K. Brandt

David, I think we're going to continue try to hold it reasonably tight. Having said that, I think that to the extent that things do begin to pick up and people are right in their call of the bottom, we would begin to spend a little bit more. I'm hesitant to predict it exactly. We tend to predict the number and then we underrun that number historically, mostly because the cost continue to push out -- people hire slower than we anticipate. But I would say, it's possible that we would see some growth in the spending. But I think for now, until we start seeing the kinds of revenue levels we saw in Q3 and beyond, we would be relatively tight in our management of our expense structure.

David M. Wong - Wells Fargo Securities, LLC, Research Division

Okay, great. And have handset baseband chips been growing as a percentage of the wireless division? And do you expect this percentage to grow through 2012 for -- or what's the pattern been?

Scott A. McGregor

So 3G, yes. 2G, no.

Operator

Our next question is from Ambrish Srivastava with BMO Capital Markets.

Ambrish Srivastava - BMO Capital Markets U.S.

You guys have done a good job on the dividend raise, albeit a small raise, a step in the right direction. A question for you, Scott. Last quarter, you talked about Nokia being in the plans for growth in 3G. Is that factored in your comments when you talk about in the back half of the year, you see 3G inflection point over 2G?

Scott A. McGregor

We said that we expect Nokia to ramp with us in 3G basebands this year. However, we have not given any color into the exact timing of that. And so, we would leave that as private to our customer, Nokia. So I can't give you any more color on exactly that. But it's certainly factored into our thinking and our guidance. But I can't give you color as to when exactly that happens.

Operator

Our next question is from C.J. Muse with Barclays Capital.

Christopher J. Muse - Barclays Capital, Research Division

I guess a question for Eric. As you think about the product cycles that you're seeing this calendar year, coupled with ramping 28-nanometer, I was hoping you could talk about there the trajectory of gross margin as you look through the year.

Eric K. Brandt

Yes, CJ, I'm actually cautiously optimistic about gross margin over the course of the year. We have been managing our gross margin despite a significant growth in our consumer business from 20%, 25% a couple of years ago to what was almost 48% this quarter. And our gross margins held rock-solid. I think as we introduce some of our new products, which we think are advantaged and beneficial and hopefully accretive to margin, we can see ourselves constantly sort of stay in the middle of that range. And hopefully, begin to drift up particularly as competitively we distance ourselves from the other companies. So I would hope that it would be sort of a, what I would call a slow tailwind kind of across the year and into next year.

Operator

Our next question is from Chris Caso with Susquehanna Financial.

Christopher Caso - Susquehanna Financial Group, LLLP, Research Division

I just wanted to ask a clarification on one of your earlier responses on the baseband business. You talked about the 2G being down as a percentage of revenue and 3G being up as a percentage of revenue. As you net all of that out, would you expect baseband as a whole to be up as a percentage of Mobile & Wireless revenue when you look at 2012 as a whole?

Scott A. McGregor

I would say definitely towards the end of the year, yes. In the middle of the year, it's a little hard to predict exactly how rapidly our 3G business will accelerate and how long our 2G business will hang in there. So the answer is, I don't know in the next few quarters. But towards the end of the year, and certainly next year, I would expect it to be a significant growth driver.

Operator

Our next question is from Stacy Rasgon from Sanford Bernstein.

Stacy A. Rasgon - Sanford C. Bernstein & Co., LLC., Research Division

Just for a second, just a quick question about the gross margin guidance for next quarter -- was flat, just a little bit lower than it was expected this quarter, mix seems to be a bit of a tailwind next quarter, where you have enterprise which is, from a relative basis is stronger. I was wondering if you can give us some puts and takes on gross margins both for this quarter and embedded in your guidance. After that one more, just a quick question, inventories are down a lot, your turns are looking good, but if you can give us a feeling with how lean is too lean, and then are you prepared to deliver demand in case -- deliver supply in case there is an uptick in the demand into next quarter into the first half of the year?

Eric K. Brandt

So Stacy let me start with the second one first. Yes I think 8.5 is probably tighter then we would typically want to run our turn. Historically, we have sort of said, 7 to 8, and I think as our hubbing business grows that sort of pulls that down a little bit, and probably it's closer to 6.5 to 7.5 is more of the right target. Having said that, I think that given our sourcing strategy, we are prepared if we need to, to ramp our inventory based on significant growth in demand. And I think we're in good shape rolling through Q1, and certainly based on what we project to order and delivery in Q1 or Q2. We have much tighter process. In fact, our turns have grown from the beginning of 2011 at about 6.4 to what you see the year-end number at 8.5. And so, it's almost over 2 full turns growth. And I think that's the product of really strong processes. Our operations group been much tighter communication and build plans. So it's given us that flexibility and provided the additional cash. In terms of the gross margin puts and takes as you look at Q4 versus Q1, let's start with Q4. In Q4, actually the standard margin was slightly favorable offset by 2 things. One was the E&O thing that I -- the E&O issue that I mentioned, which was a late quarter event as a particular customer lowered their forecast, and we have a fairly mechanical calculation on the way we take E&O reserve and the other thing being the absorption impact of the strong Q3 into Q4. As you roll to Q4, your observation is correct that there is some favorability in standard margin based on mix. That winds up being offset somewhat by 2 things. It's offset by absorption, again based on an assumption of a lower revenue number, relative to the number we did in Q4, and then secondarily, believe it or not, the OpEx issue that we have as it relates to fringe and merit takes place in ops as well and triggers an overhead jump in the operations area. Which triggers sort of this one-time, nonstandard cost effect in the numbers, which is how we get to flat. But I would say underneath that, if you look at the standard margins, which is really what -- the true product costing, it's actually modestly favorable both in Q4 and Q1.

Operator

Our next question is from Tristan Gerra with Robert Baird.

Tristan Gerra - Robert W. Baird & Co. Incorporated, Research Division

Could you give us a quick update on your design win momentum or any type of inflection point timing for VideoCore for your application processor business in general?

Scott A. McGregor

Our application processor business and our VideoCore business are generally bundled with our baseband, so we deliver a single SoC into the cellular market. So we don't offer today chips that separate those. We certainly could, but our strategy is to include all those together into an integrated SoC device. So every baseband we ship includes an integrated application processor and will include more and more of our VideoCore technology as well. So all of our baseband design win traction that I talked about before is also design win traction for apps processors and for our VideoCore products.

Operator

Our next question is from Daniel Amir with Lazard Capital.

Daniel L. Amir - Lazard Capital Markets LLC, Research Division

Can you comment a bit on the -- in your networking segment, about the 10 gigabit Ethernet? One of your competitors was talking about that as kind of a big opportunity that they're doing really well in. Can you maybe a bit expand where do you stand there and what do you see there here going forward for 2012?

Scott A. McGregor

I think 10 gig Ethernet is a tremendous opportunity for us, switches and PHYs and the data center in general has people in the Romley cycle upgrade there, server hardware that's going to put more demand for faster switches. We also see just the general trend of people running out of capacity on switching traffic, and so upgrading those as well. We expect to see 10 gig and then of course later 40 and 100 gig. But the 10 gig cycle over the next couple of years should play out well, and we believe we have the most competitive 10 gig switches and PHYs. And we believe that we should see pretty good traction, and that's a growth driver for our infrastructure group over the next couple of years.

Operator

Our next question is from Kevin Cassidy with Stifel, Nicolaus.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc., Research Division

Just on the 5G Wi-Fi, do you see that technology overlapping with small cell technology?

Scott A. McGregor

I don't see it overlapping per se. I see it as something where you would do both. Certainly with the 5G Wi-Fi, one of the real drivers for that is carriers who would like to offload a lot of the data traffic from their licensed spectrum onto wired lines using 5G Wi-Fi. So that's a driver there. I think they may also want to offer small cells and femtocells. Again they look for a variety of coverage on both licensed and unlicensed bands to drive an overall bandwidth equation for people. In general, when people do have Wi-Fi available, it's going to be a better choice. So I think we'll see a lot of interest there. But we also see small cells as a way to get much better capital utilization for deploying cellular coverage. So I see both of them as opportunities, and we'll certainly pursue both markets. But I can also imagine devices that would have both capabilities.

Operator

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

Scott A. McGregor

Thank you. Broadcom's completed another solid year of designing world-class communications products. We have gained market share, delivered solid profitability, and we're returning more capital to shareholders. I would like to once again thank all of our employees and partners for their innovations, their contributions and their ongoing support made this all possible. Finally, as reminder, we'll be hosting an open house at Mobile World Congress in Barcelona on February 27 at 3 p.m. local time. If you need any additional details on this event, please give Chris a call. With that, thank you very much, and have a good day.

Operator

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

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