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Broadcom Corporation (BRCM)

Q2 2007 Earnings Call

July 19, 2007 4:45 pm ET

Executives

Peter Andrew - VP of Corporate Communications

Scott McGregor - President and CEO

Eric Brandt - CFO

Analysts

Alex Gauna - UBS

Shawn Webster - J.P. Morgan

Ross Seymore - Deutsche Bank

Gary Mobley - A. G. Edwards

Srini Pajjuri -Merrill Lynch

Seogju Lee - Goldman Sachs

Craig Berger - Wedbush Morgan

Quinn Bolton - Needham & Company

Shaw Wu - American Technologies

David Wu - Global Crown Capital

Presentation

Operator

Good afternoon, ladies and gentlemen and welcome to the Broadcom Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

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

Peter Andrew

Thank you very much Christine. I just want to remind everyone that during this call, we will discuss some factors that are likely to influence our business going forward. These forward-looking statements include guidance we will provide on future revenue, gross margin and operating expense targets for the third quarter of 2007, and any other future periods and statements about prospects for our various businesses, the development status, and the planned availability of new products.

It should be clearly understood that our actual results may differ substantially from the forward-looking statements we make today. Specific factors that may affect our business and future results are discussed in the risk factors section of our annual report on Form 10-K for 2006 and in our other SEC filings. A partial list of these important risk factors is set forth at the end of today's earnings press release.

As always, we undertake no obligation to revise or update publicly any forward-looking statement for any reason. Throughout this call, we will be discussing certain non-GAAP financial measures. Today's earnings release and the related current report on Form 8-K describe the differences between our non-GAAP and GAAP reporting and present a reconciliation between the two for the periods reported in this release.

Please see the investor's section of our website for reconciliations going back to the beginning of 2005, as well as for additional financial and statistical information, including the information disclosed in accordance with SEC regulation G.

Before I turn the call over to Scott, I would like to have everyone pencil in November 8th on their calendars as a date of our 2007 Analyst Day. We will be hosting this up in San Francisco, so please stay tuned for other details.

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

Scott McGregor

Thank you, Peter and good afternoon to everyone. Our revenue in the second quarter came in line with our expectations, even in the midst of a higher than normal level of variability in the ordering patterns of some of our larger end customers. While we worked through most of these issues in the second quarter, the good news is we believe the increasing diversity of our customer base and end market exposure, along with significant new products momentum, should enable Broadcom to increase revenues sequentially in the third quarter.

We will touch upon some of our new products in more detail in a few minutes. We kept spending tight in the quarter even with our annual compensation adjustments that took place in April. By combining this with tight asset management we were able to generate about a $158 million in cash flow from operations.

We've put some of our $2.5 billion in cash and marketable securities to work in the quarter, buying back shares of our Class A common stock and closing the acquisition of Octalica to help drive our future growth in areas of Multimedia over Coax or MoCA.

Earlier this month, we announced that we also completed the acquisition of Global Locate, a privately held GPS provider that offers assisted GPS semiconductor products and software.

With that let me now turn the call over to Eric to talk about the quarter from a financial perspective and provide our guidance for Q3.

Eric Brandt

Thanks, Scott. Overall, we are pleased with our Q2 results. Revenue of $897.9 million was down $3.6 million or 0.4% from Q1 2007, which is the middle of the range we provided on our last earnings call.

Non-GAAP gross margin of 52.4% was up 30 basis points from last quarter and remained slightly above our long-term model of 50% to 52%, and in consistence with our guidance.

Total Non-GAAP operating expenses increased $10.4 million over Q1 due principally to annual merit increases, as well as increase in headcount and prototyping costs, which were partially offset by lower legal and facilities expenses.

Non-GAAP earnings per share were $0.27, down from $0.29 in Q2 and equal to analyst's consensus of $0.27.

Cash flow from operations was $158 million. Our cash and marketable securities on hand decreased slightly by $82 million for the quarter to $2.48 billion driven primary by $216 million in share repurchases settled in the quarter.

Inventory for the quarter decreased by roughly $9 million to $191 million which equated to 8.9 tons. This is our fourth consecutive quarter with a reduction in inventory. This demonstrates the continued excellent work our operation's team has done to adjust our supply in an ever changing environment. The level of tons at 8.9 times remains well above our long-term goal of 7 to 8 tons.

Moving to revenue and gross margin. In our April call, we said that we expected Q2 revenue could be approximately $890 million to $905 million. We said we expected growth in both our cable and satellite set-top box businesses to be offset somewhat by softness in cable modems. In addition, we mentioned that our mobile and wireless businesses would be relatively flat as we anticipated that many of the new product lines will ramp in the second half of the year. And in enterprise networking, we expect the continued growth within our enterprise switching business offset by weakness in our Ethernet controller business. This is essentially what occurs.

With respect to our broadband communications market, all businesses were flat to up on a sequential basis, offset, in part, by one of our end customers' inventory reduction efforts in cable modems. In the mobile and wireless markets, businesses declined in Bluetooth due to issues at a particular customer and were offset by increases in wireless LAN, VoIP and mobile multimedia lines of businesses.

As expected, our enterprise networking business did grow modestly driven by the timing of customer requests for some of our gigabit Ethernet switch products, and the fact that our controller business did not fall off as sharply as we had previously anticipated. The customer in question pulled in some of its expected Q3 orders in to Q2.

The rest of the group was essentially flat on the quarter. In terms of revenue distribution for Q2 similar to last quarter broadband communications accounted for approximately 39% of total revenue, mobile and wireless for 30% and enterprise networking for 31%. But with respect to gross margin, as we forecasted in April, our gross margin rose 30 basis points to 52.4% driven by the strong efforts of our operations group.

Moving to operating expenses. Non-GAAP operating expenses were up $10.4 million from our Q1 levels due to increased personnel cost from our annual merit compensation cycle, investments in R&D and other staff costs, offsetting part by reductions and legal cost. We continue to see a temporary spike in R&D as a percentage of sale as we invest aggressively to secure future deign wins in our emerging businesses.

We continue to move forward with our 65 nanometer migration; roughly a quarter of our tape-outs in Q2 were in 65 nanometer with a number of additional tape-outs occurring just after the quarter end. As we said previously, by Q4, we expect almost 90% of our tape-outs will be in 65 nanometer. We continue to see 65 nanometer has given us the definite competitive advantage in a design win process in terms of offering low power and the ability to integrate features and functionalities into our designs.

In addition, the expanded use of MPWs and other efficiencies have allowed us to accelerate prototyping to customers. We increased our total company headcount from Q1 by 254 people, to worldwide total headcount of 5,827. This includes almost 4300 employees in engineering or 74% of our totaled headcount. This is increased from approximately 69% two year ago.

Moving to the balance sheet. As I mentioned, total cash and marketable securities decreased by $82 million to $2.48 billion driven principally by the share repurchase program approved in February of this year. We generated positive cash flow from operations of $158 million.

We also had some benefits from proceeds from employee stock sales of approximately $49 million net. This was more than offset principally by repurchases of our common stock, capital expenditures, which included expenditure to build out and move to our new Irvine campus and the acquisition of Octalica in the quarter.

We lowered our inventory further in Q2 by approximately $9 million to $191 million. Inventories were a very strong 8.9 times in Q2. The percentage of our sales made through distributors remained low at 15%. In addition, we began to provide more products to hubbing arrangements with our customers. As a reminder, we recognized revenue through distributors and hub on a sales out basis. Our accounts receivable day sales outstanding increased slightly from 37 days to 39 days, still at very good level.

As mentioned previously, we commenced a new share repurchase program under which we can purchase up to $1 billion of our Class A common stock over an 18 months period that commenced in February of 2007. During the quarter, the company repurchased $6.1 million shares at a cost of $190 million. The objectives of this program are to manage our net share dilution and to return capital to shareholders, while our first priority will always be to invest in our business. We believe that given our strong operating cash flow and the pace of our investments in future businesses and emerging areas, this is currently an excellent use of our cash.

Moving to the expectations. We continue to believe that Bluetooth, wireless LAN, and digital TV will be growth drivers this year. As Scott mentioned, we are seeing excellent customer traction in these businesses. We currently expect to return to sequential growth in Q3, and that revenue will be in the range of $915 million to $940 million in the quarter.

We are expanding our usual range of revenue as the increased use of hubbing arrangements creates slightly lower visibility for us, since revenue derived from those arrangements are more closely tied to our customers physical production schedules.

And looking at what we expect to happen in Q3 in our businesses, in broadband communications, we expect to see growth in our broadband modem and digital TV businesses. In fact we believe our digital TV business will be roughly doubled, as we ramped our new 65 nanometers 10 ADP products for the holiday season.

In mobile and wireless, we expect to see growth to come from Bluetooth and wireless LAN as the expected second half product ramp begins. In addition, with the closing of the Global Locate acquisition, we will begin to book revenue from our newest lines of business.

The enterprise networking group will be down slightly as compared to, Q2 partially driven by the normalization of the large customer switch order with some positives in the optical business and the controller business, due to recovery in the server market.

For non-GAAP gross margin in Q3, we expect to see a slight declining growth margin as compared to Q2, as we ramp a number of new products to new and existing customers in the quarter. Typically, our new products have lower gross margins because we focus design initially for a quick time to market.

For non-GAAP operating expenses in Q3, we expect continued investment in new products and our 65 nanometer migration, both of which we believe are critical to our revenue growth and gross margin in 2008 and later years.

In addition, in Q3 we expect to incur expenses associated with the acquisition of Global Locate. As a result, we expect the non-GAAP operating expenses in an absolute dollar basis to increase at a similar level as Q2, which is in the $8 million to $12 million range.

Historically, when our spending increases above our business model it is due to specific customer opportunities that we have a good track record of converting to revenue, which, as I mentioned, we will begin to see occurring in Q3. However, we remain very conscious of our long-term profitability model and we will take whatever steps we reasonably can, to assure that we operate within that model, while continuing to fund key growth opportunities and other priorities.

Cash flow from operations for Q3 is expected to remain strong. We also anticipate that we will continue to repurchase shares in Q3 based on the repurchase activity through the end of Q2. We have approximately $346 million remaining on our current buyback program.

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

Scott McGregor

Thanks, Eric. I’ll now provide some more details on our business, starting off with mobile and wireless. In Q2, our mobile and wireless revenue was down slightly quarter-over-quarter as growth in our wireless LAN, mobile multimedia and VoIP businesses were more than offset by a decline in our Bluetooth and cellular businesses.

We raised our wireless LAN revenue in Q2 in all segments of the 802.11n and g markets, including client, router and embedded G and both client and router in N. Despite numerous rumors of 802.11n market shares shifts at certain PC OEMs, we are seeing additional growth in our existing sockets. And we think we have the potential to gain additional market share.

We have orders on hand from Tier 1 OEMs where we had no presence in laptops today. These are orders for not only our 802.11n products on a discreet basis, but also for our platforms to combine our wireless LAN offerings with Bluetooth and take advantage of our state-of-the-art coexistence software.

Our ability to combine our leadership position in wireless LAN with a proven Bluetooth hardware and software solution is a definite competitive advantage. We are not only seeing demand for platforms to combine our discreet products, we are also seeing significant design activity around our industry's first 65 nanometer wireless LAN, Bluetooth and FM Single-Chip Solution as the 4325 and may start seeing revenue from that product as soon as Q4 of this year was successful.

In terms of news in the quarter, we welcome the Wi-Fi Alliance's 802.11n Draft 2.0 Certification Program, as our router, and client reference designs were among the first products to achieve this certification. The certification program will ensure that wireless LAN products from different manufactures will work seamlessly together.

In Q3 and Q4, we also expect growth in the older 802.11g router space and to see more of our cost-optimized EDGE products hit the market.

Bluetooth was down in Q2, driven by weakness in demand from one of our larger end customers. What we found very encouraging, however, was that the ramp up of our new Bluetooth plus FM products to a new Tier 1 handset customer came in significantly above our expectations in the quarter, and we look for stronger growth in Q3 and Q4 depending on the timing of new model introductions.

We are now shipping our Bluetooth plus FM solution to four of the top five Tier 1 handset manufactures, and end-products incorporating these solutions are available on store shelves today.

We had a very successful quarter securing additional Bluetooth design wins in the PC space, and we continue to make good progress in bringing our new line of mono handsets to market. Our first Bluetooth handset product should appear in Q4 with Tier 1 customers expected to start shipping products in the first half of 2008. We now have headset design wins at four of the top five headset OEMs.

From our new product perspective, we began shipping samples of our new Bluetooth device that can support the Bluetooth 2.1 standard, Enhanced Data Rate Technology or EDR and the Class 1 transceivers all in a single analytic device. The Bluetooth 2.1 specifications extend battery life, they simplify paring and enhance security. Our EDR technology provides greater bandwidth, so Bluetooth can handle more multimedia content and the Class 1 RF transceiver allows transmission of data over greater distances.

We also planned to expand our personal area networking portfolio to include new ultra-low power Bluetooth technology, which was formally known as Wibree. ULP is a version of Bluetooth that will exist along side the classic version of Bluetooth technology and enable new applications in the sports and wellness, healthcare, entertainment, mobile, office accessory and watch markets.

Moving on to cellular, in Q2, our cellular revenue was down as the decline in sales of our older GSM, GPRS and EDGE baseband platforms more than offset the continued growth in our wideband CDMA baseband sales. Going forward, we expect our baseband revenue to trend upwards.

On the customer and design wins front, we continue to make good progress in our strategy of developing and strengthening our relationships with the world leading cellular handset makers. While we have to be vague on details until the phones actually hit the market, we believe we are ahead of our expectations in our overall plan. As a result, we are going to be accelerating our investment in this area.

While this additional level of investment will increase our near term R&D cost somewhat, we believe that this is the right move to make for the long-term. Our goal remains the same, which is to reach the 10% to 15% market share by the end of 2009.

In Q2, we expanded our cellular design center in Taiwan and focused on a new generation of Microsoft Windows mobile smartphones based on our 3G chipsets. We also ruled out a new reference design platform for portable media players that include our Videocore applications processor, Bluetooth, FM tuner, wireless LAN and power management capabilities.

On the mobile multimedia front, a decline of our traditional portable device end market revenue was more than offset by initial shipments of the new product with new functions into a recently announced hot new cellular handset. As illustrated by numerous publicly available teardowns, the new touch screen controller demonstrates our ability to create innovative devices for our most cutting edge customers.

As Eric mentioned earlier, during the quarter we expanded our product offering into cellular portable navigation device, automotive, and notebook markets with the acquisition of Global Locate. Global Locate brings a proven GPS solution to the Broadcom product portfolio and enables product by TomTom, with the leader in the PND market.

In addition, to the PND market Global Locate is also shipping products into the smart and featured phone segments of the cellular handset market. We expect to grow our customer list in each of these areas.

We also look to integrate in bundle GPS functionality with a wide variety of our technologies such as application processors, Bluetooth, wireless LAN, cellular baseband and others. We are unique in the industry in that we are shipping products to Tier 1 GPS, Bluetooth and wireless LAN equipment centers.

You heard us talk about how we have one of the broadest communication portfolios for years. The conversion of multiple forms of communications into a single piece of silicon is happening now; it's a real trend. We are shipping products now, customers are asking for more of them and you will see more of this in the future.

Today, we are shipping our Bluetooth FM part. Later this year you will see our Bluetooth FM and wireless LAN parts and you will see more and more of these converged communications products in the future. We stand uniquely positioned to benefit from this trend due to our broad portfolio.

As we look into Q3 for mobile and wireless, we anticipate that both Bluetooth and wireless LAN will grow, even factoring-in potential continued weakness with one of our larger Bluetooth customers.

Moving to broadband, as Eric mentioned earlier, all lines of business within our broadband communications group grew in the quarter with the exception of cable modems, where we dealt with the temporary access inventory situation at one customer.

Growth in the quarter was led by set-top box businesses, as we experienced some of the catch up in demand for high-end cable set-top boxes, now that the transition to removable security, which is the FCC CableCARD initiative, is behind us.

Demand for our satellite and IP set-top box also grew in the quarter. To help IPTV operators enable higher quality voice data and video services at longer loop plans over an IP network based on either ADSL2+ or VDSL2, we announced the new impulse noise protection technology that we call PhyR.

Due to our DXP based architecture, we are able to future-proof our end customers' products, as all previously deployed Broadcom central office and consumer premise based solutions are upgradeable to this new error correction technology.

Longer term, we believe that growth in the set-top box markets will be driven by the emergence of the IP set-top box market, along with expansion outside the North American marketplace and growing demand for HD and PVR services from cable and satellite pay TV operators. All of these are important markets for us going forward.

In the broadband modem market, we believe that the customer’s specific inventory issue that we experienced in our cable modem business in Q2 is now behind us. In the DSL space, we believe that we have maintained our leadership position in this market driven by continued market share gains in China and bringing on another VDSL2 carrier win in Europe.

In Q2 we also expanded our portfolio of home networking technologies with the acquisition of Octalica. The Octalica team will accelerate Broadcom’s integration of MoCA or Multimedia Over Coax Alliance home networking technologies into our set-top box and broadband modem products.

Broadcom possesses the broadest array of communication technologies for the distribution of voice, video and data and throughout the home. We are going to quickly integrate this functionality in to set-top box and broadband modem solutions, providing MSOs and telecommunication operators with lower cost and higher performance technology for whole-home secure media distribution. As we look in to Q3, we expect growth in broadband communications to be driven by digital TV and broadband modems.

Moving to enterprise networking, revenue from our enterprise networking group grew slightly in Q2 as the follow up in our gigabit Ethernet Controller business for consumer and enterprise PCs was not as sharp as we had anticipated on the last conference call. As Eric mentioned earlier, we had an unusually large gigabit Ethernet switching orders shipment in Q2, though we had expected to ship on a more linear basis in Q2 and Q3.

On the new product front, the second quarter was a busy one. First, to enable flawless playback high definition video content in PCs and laptops we began shipping a new family of what we are calling: media PC solutions. Leveraging IP from our broadband communications group, we’re enabling the playback of HD content from Blue-ray or HD DVD disk for content that is downloaded or broadcast over the internet.

Our solutions enable this HD content to be viewed on PCs or laptops without intensive CPU processing or a discrete graphics processor with video hardware acceleration that drives up the cost. We began shipping this product to a top five laptop manufacturer in the second quarter.

Secondly, in the 10 gigabit Ethernet market, we rounded out our complete family of 10 gigabit Ethernet solutions with the introduction of our 10 gigabit Ethernet converged nic or C-NIC products. In our 10 gigabit Ethernet serial, transceivers were used in switch and play over the back play. We deliver the most complete family of 10 gigabit Ethernet solutions in the market today.

Finally, demonstrating our ability to continually bring additional features and functions in to our existing platforms we introduced two new products, Power over Ethernet, and broader reach physical layered technologies. Our PoE products support application such as enterprise phones, access points, residential gateways, surveillance cameras, point-of-sale readers and security card scanners.

According to Dell'Oro, PoE shipments will grow from 32 million ports in 2006, through 145 million ports in 2011. Today, we are shipping our PoE solutions to Delta Networks, Alpha Networks and Asante Technology. We are also successful in securing other direct Tier 1 data networking company wins in the second quarter.

Router reaches a breakthrough physical layer technology that extends the reach of standard Ethernet cables up to 500 meters, and can also work over existing and lower cost cables, which is important in networks maintained by hotels, colleges and universities, convention centers, airports, and train stations to name a few. In addition, broader reach works with our PoE solutions.

As we look into Q3, we believe that the Enterprise Networking Group will be down slightly, reflecting a large switching ordering in Q2 that we thought would be spread into Q3, along with relatively flat revenue from the rest of the business lines.

Moving on to our QUALCOMM litigation. First of all, I am pleased to announce that we had entered into a licensing agreement with Verizon Wireless, as described in the press release that was published in the last couple of hours. This will allow Verizon Wireless to offer cell phones that were banned by the ITC, and ensure continued delivery of new products to its customers. Besides payments to Broadcom, Verizon Wireless has agreed the cease its efforts to overturn the ITC order and to withdraw its motion to keep the ITC decision filed with the US Court of Appeals.

We, separately, announced that the two companies have entered into a strategic alliance involving new mobile device chipset another product including, Bluetooth, wireless LAN, optical networking, MoCA, GPS and DSL.

We are pleased to have reached this agreement with Verizon Wireless as it really brought to home the key messages that Broadcom has been discussing regarding QUALCOMM's pervasive infringement of our IP. First, this agreement shows that a commercial solution, not a political solution, is the proper way to settle this dispute. We've demonstrated that we are serious about making licenses available and reaching a viable commercial solution with other companies.

Second, this eliminates any argument regarding the appropriateness of the stay or veto of the ITC decision, and it makes it crystal clear that none of the wildly exaggerated claims that harm the consumers, public safety or economy will come to pass.

Third, this license agreement demonstrates the significant market value of Broadcom's IP. The greatest value of this agreement lies in the strategic alliance with Verizon Wireless. The revenue stream for use of Broadcom's IP is significant and we anticipate sharing this upside with our investors by accelerating emerging businesses and through additional earning. If executed properly, the value of this strategic business relationship could be worth many times of that amount over time.

Finally, as we stated numerous times in the past, we stand ready to negotiate with QUALCOMM or any other market participant to seek a commercial solution as we've done today with Verizon.

With respect to Broadcom's current litigation proceeding against QUALCOMM things are going very well. Our goals remain simple and two-fold. One is to gain proper recognition of the value of our IP, and the second is to achieve a level of competitive playing field.

At this time QUALCOMM has been found to infringe four of our patents, three of them willfully in two different forms. We also have additional patents that have not yet been addressed to trial. Please note that QUALCOMM has either lost or dropped all claims against Broadcom. There has not been any movement in our discussions with QUALCOMM, as it appears that they have bet their future and end customers' upcoming product launches on their political lobbying skills.

There are some near-term events to keep an eye on. From now until August 6th, is the Presidential Review of the ITC remedy. On July 26th, we'll be at a hearing in San Diego related to Broadcom's request for sanctions regarding withholding documents. Remember, in this case, QUALCOMM claims that Broadcom infringed two of its MPEG-4 patents. Broadcom was found not to infringe the patents, but the Judge and Jury both agreed that QUALCOMM had abused the MPEG-4 standard studying process.

We're also awaiting a decision from the judge related to QUALCOMM's standards abused. On August 14th, we will be in a District Court of Santa Ana asking for an injunction related to QUALCOMM's willful infringement of three Broadcom cellular baseband patents. Fourth, we began discovery on our suit alleging the QUALCOMM's conduct, before industry standards organization constitute unfair competition, fraud and breach of contract.

QUALCOMM's conduct includes improperly consuming its patents, reneging on license obligations, and exerting dominance to hidden affiliations. A trial date on that action has not yet been set. Other disputes outstanding, include the European Commission, Federal Trade Commission and our antitrust claim; no new dates have been set on these disputes.

We remain hopeful for these litigation matters and we will come to a positive resolution. We see the agreement announced with Verizon Wireless today as an important step in achieving this goal. We made fair and reasonable settlement proposals to QUALCOMM, which we hope they will consider.

So, in closing, we believe the increasing diversity of our customer base and end market exposure along with significant new product momentum should enable Broadcom to raise revenue sequentially in the third quarter. We continue to believe that we are a product cycle driven organization and we believe that we had a number of product cycles occurring in 2007 and 2008 to keep up excited about the future.

Exact timing and magnitude of these ramps in the early stages are difficult to predict, but we encourage that we are making excellent progress in bringing these solutions to market.

I'd like to thank everyone for joining us on this call and I'll turn the call now back to Peter for instructions on Q&A.

Peter Andrew

Okay. Thanks Scott. Now there obviously will be a lot of questions and so extend the duration of this call for a little bit longer than normal. I of course will be available for Q&A after the call this evening as well as tomorrow for additional Qs. Now please to enable us to handle as many questions as possible please keep your questions brief.

With that Christine, can you please ask for the first caller?

Question-and-Answer Session

Operator

Yes, thank you. We will now begin the question-and-answer session. (Operator Instructions). First question comes from Alex Gauna from UBS. Please go ahead.

Alex Gauna - UBS

Yes, thank you and congratulations on the agreement with Verizon, I was wondering if your guidance in corporate payments from that in the third quarter?

Eric Brandt

Alex, it’s Eric, no it does not. We are still finalizing the accounting for how it would actually run through our P&L. Typically these kinds of arrangements are recorded one quarter in arrears. We don't know the answer for sure but our expectation is that you will first see this in Q4 of this year obviously perhaps a quarter or Q3. Again we'll -- once we have a better picture that we sort of work through those details we’ll update you, but our belief currently is that probably would be one quarter in arrears.

Alex Gauna - UBS

And is the expectation that this process or however the accounting begins, is August 6th the date which this commences?

Eric Brandt

It commences today.

Alex Gauna - UBS

Today. Okay. And is this agreement, is it regardless of what happens with the presidential review -- meaning they have signed for your licensing, to license your IP regardless of what the White House might do?

Eric Brandt

Yeah, we can't comment on all the details in terms of the agreement, so I apologize Alex, we have to leave it there and you have to read what you read in press release.

Alex Gauna - UBS

Okay, fair enough. Could I ask also, is it reasonable to assume that others are interested or being extended similar type of terms, meaning other areas?

Scott McGregor

As I said in my remarks, we have made this offer available to others in the industry and we would be open to discussion with them.

Alex Gauna - UBS

Okay. And a question in terms of how this change is dynamic with QUALCOMM. It seems to me that there is now a green light for some of those phones to come in to the market. Does this alter your leverage with them in terms of trying to come to some agreeable WCDMA license with them?

Scott McGregor

Well I think there are a couple of observations on that. Number one, what’s happened here is that the end customers of QUALCOMM have seen that QUALCOMM is unwilling to protect them against IP, that it infringes and it’s so unfortunate that they had to take that into their own hands. My guess is that they won’t appreciate doing that and so I think there’s continued leverage on QUALCOMM from those customers. This was not a free license for example.

Another issue is that the importation of the phone in to the United States is not the only remedy that we were pursuing against QUALCOMM, and so there are other issues there. I think also this shows that Broadcom is rational and logical and willing to work out business arrangements with customers and other interested parties in the industry.

And so I think it sort of calls into question why QUALCOMM is being so recall strength here and why are they really digging in so hard. We have been pretty rational in terms of trying to settle this and we are hoping that they eventually get to that space as well.

Operator

The next question comes from Shawn Webster from J.P. Morgan. Please go ahead.

Shawn Webster - J.P. Morgan

Yes thank you. Quickly on Verizon, I know some of the details must remain confidential, but can you give us a sense, is there something that’s an annuity that keeps on going or does that 200 million lifetime cap really mean that there’s no renegotiation that happens for subsequent technologies? And then I have follow up, please.

Eric Brandt

Yeah I apologize for that. I think we really can’t go into the fees on that, but you can read what you have in the press release.

Shawn Webster - J.P. Morgan

Okay. Fair enough. Can you give us an update on how you see your channel and customer inventories, and then maybe could you go into a little bit more detail on what's going on with the hubbing and why and why that's causing some drop in visibility? Thanks.

Scott McGregor

Let me deal with the hubbing question first. What happens is, essentially we are carrying the production inventories for our customers and we record revenue as they sort of pulled the part into production. So what happens is we become sort of at the end of the change on the buffer stock, for their production cycles. So at the end of a quarter, depending on what their production looks like, or their particular inventory needs, it can sort of fluctuate a little bit.

So whereas, we sort of shipped to a schedule before and our customer is carried inventory and the buffering sort of adjusted between the two of us, now the buffering is entirely on our hands for these arrangements. So what happens is you literally get visibility on a day-by-day basis as the products are pulled, as apposed to sort of a build-to-order production schedule which occurs across quarter. When that happens, it does create some visibility that is lost to us.

And I think it’s prudent that we have essentially arranged a range which looks like 2.5% on our revenue is not unreasonable given the nature of these relationships and the fact that they will be expanding over time.

Eric Brandt

Yeah. I just think overall inventories in the channel feel relatively lean right now. I think customers across the board -- we don't see any particularly high levels of inventory and so consequently customers are asking for relatively short delivery times to meet production schedules. So I would characterize this as fairly lean inventory situation.

Scott McGregor

Also remember, if you are trying the distribution channel, the distributing channel is a very small percentage of our total sales, only around 15% last quarter. And recognize sales only on a sales-out basis.

Shawn Webster - J.P. Morgan

And with the customer's requesting the shorter delivery times, are you seeing your lead times going out for certain of your product categories?

Scott McGregor

Not particularly, there are one or two fabs that we’ve seen some lead times to move out. But in general things are relatively even keel. We have seen more expedites recently than we have in the past, though where customers are requesting parts and asking to fulfill in the orders.

Shawn Webster - J.P. Morgan

Okay. Thank you very much.

Operator

Your next question comes from Craig Ellis from Citi. Please go ahead.

Scott McGregor

Craig, you might be on mute.

Operator

Mr. Ellis, please go ahead with your question.

Scott McGregor

Okay. We'll try to pick him in the next round.

Operator

Thank you. The next question comes from Tim Luke from Lehman Brothers. Please go ahead. Mr. Luke, please go ahead with your question. We'll go to the next question. The next question comes from Ross Seymore from Deutsche Bank. Please go ahead.

Ross Seymore - Deutsche Bank

I guess one quick follow up on the Verizon deal. First of all, can you hear me okay?

Scott McGregor

Yes, Ross.

Eric Brandt

Yeah.

Ross Seymore - Deutsche Bank

Okay. Alright, one for three I guess out of those. On the Verizon deal overall, what about the workaround potential? Are there EV-DO revolutions that they could put into that? That gets them around $6 per handset if QUALCOMM gets to them some sort of workaround or how should we consider that potential?

Scott McGregor

Well, it's hard for us to assess that. We haven't seen any workaround. So, I don't know the details of what one might be. But, we would certainly be open to looking at it. I mean there are questions I would ask around it. I mean the goal of the technology we have is to save battery life, so what are the implications in battery life and what are the implications on overall network performance would be questions I would ask. And does it really avoid the five different claims of our patents. Those would be the questions that I would ask to somebody claiming to have a workaround.

Eric Brandt

The other thing that the operators have to consider is that potentially on August 14th there is a chance that we might be able to get a junction on three more patents. So, the question is which patent they are actually designing around today.

Ross Seymore - Deutsche Bank

Then a follow-up on the cellular SIM sales, Scott you mentioned about accelerating your investment in that area. To the extent can you go into a little bit more detail, if that’s due to customers asking for things that we should pull forward the timeframe when we might be able to see some of those design wins we have been waiting for? Or the flip side of it that you really need to invest more to get the products up to the competitive level?

Scott McGregor

I would say it's more of the former Ross. But, I wouldn't necessarily raise all your estimates at this point, it's still yearly days. I would love to give you more details on this, but I really can't. But, we are feeling good about our engagements with the top-tier customers. And one of the challenges when you engage with the top-tier cellular guys is, as you do get design wins you need to put bodies on it. And so, one other thing we are seeing is the need to deploy people who actually go execute on design win traction that we are getting, so that's the primary driver of that.

Ross Seymore - Deutsche Bank

Great. Then the final question for me, you mentioned about new product launches in the third quarter, and then the second half of the year really accelerating. Could you either go into some details on what those new products are? Or just talk about if you believe the new products ramp would be more impactful in the third quarter, so the first part of the second half or more in the second half of the second half?

Scott McGregor

I can't give you that kind of color. We probably don't even know that ourselves. What I would observe though is that Broadcom has announced quite a few new products recently, many of them in 65 nanometers, and we've accelerated the pace of our 65 nanometer tape-outs. As Eric said, we expect by the end of the year we'll have 90% of our products tapping out in 65 nanometer and really quite a few of them. And so that will be driven by obviously products we've already announced. It takes a little while before you start seeing revenue. But then a momentum going forward of additional products.

Ross Seymore - Deutsche Bank

Great, thank you.

Operator

The next question comes from Gary Mobley from A. G. Edwards. Please go ahead.

Gary Mobley - A. G. Edwards

Hi guys, now Verizon may be taking your baseband and Apps processor, but more seriously, how far are you guys away from perhaps having an offering that scope add on Verizon that worked?

Eric Brandt

I can't really comment on that, that would still be speculative at this point.

Gary Mobley - A. G. Edwards

And with respect to the alliance separate from -- so your products what is different about the strategic alliance versus like you were doing with them in the past, what is more beneficial now?

Scott McGregor

One of the things that came out of our discussions with Verizon on this is that we had our senior management meet with their senior management and their senior technical people meet with some of ours. And I think we really discovered that we have a lot of stuff and interests in common and so I see this as just an opportunity for far better communications between the companies. And just in our discussions, we observed that we have some common objectives and common technologies and markets of interest. And so, I believe it will facilitate a discussion that we haven't had very much before between a very large end customer and Broadcom in terms of developing technologies and working closely with them to get them the products they need, so they can do more competitive end products. So, I think it's the beginning of our stronger relationship where we didn't have much discussion in the past and now look forward to being able to do products and technologies much better tailored to what they see as opportunities for their customers.

Eric Brandt

And I think the other thing you can appreciate as a customer is we already have a relationship with Verizon in other parts of our business, and when faced with this uncertainty, you know, when a supplier steps up and sort of helps you address and I think it's important to them and whereas one supplier did, and one supplier didn't then I think that helps the relationship over the long-term. Christine?

Operator

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

Srini Pajjuri -Merrill Lynch

Thank you. Hi guys. Just a clarification first, then I have a couple of questions. It looks like the options expense jumped again this quarter, I mean, for some of those who care about GAAP. Well, how should we model as going forward?

Scott McGregor

Well, the options expense for the quarter was $134 million but I would suggest perhaps we take this one offline and we can sort of chat with Peter. We can sort of give you a little better picture of it but we just did our grants and those start to sort of roll their way through the P&L. I think as you look at this over time there are a couple of sort of broader points. One is there's a little bit of the pig and the python here, sort of some prior grants, and my guess is over the next two or three years that begins to sort of work its way out of the system, as we sort of migrate to a lower sort of net and even grow solution level. So, what I would suggest is enable with this we will deal with that offline, is that okay?

Srini Pajjuri -Merrill Lynch

Okay, that's fair. And then the sales and marketing expense looks like you are benefiting from some of the legal going away. Should we expect some of the claim going forward I mean, especially if you settle this QUALCOMM, should we expect that to come down further or do you think it's going to set at this level?

Scott McGregor

Well, we certainly benefited from it historically and a lot of that is driven by things that are actually going to try and what sort of spike for legal expenses up. We have a projection, I think through the next quarter and that's reflected in the guidance we've provided in terms of OpEx and you will see that it is fairly tight in terms of the growth. So assuming we can sort of work our way through some of these issues, we should be able to see some benefit from that. However, again we are firm believers in the value of our IP and we intend to defend it vigorously to the extent we have to.

Srini Pajjuri -Merrill Lynch

Okay, great. Then I have couple of product questions. Scott, you mentioned your baseband business growth starting in Q3. I am just wondering, I guess so far you announced Samsung and Panasonic for 3G wins. Are those the design wins that’s driving this growth or there any other ones that are impacting growth?

Scott McGregor

My apologies, I can't announce future products until they appear in the market, so I can't tell you the answer to that question. But you are right, those of the two that we have announced so far in the 3G space. What’s really going on here is that we had some old 2G business that was declining. It reached the end life with Sony Ericsson. And what we are now seeing is that we dropped, then we expected the trend up from here on our cellular baseband business.

Srini Pajjuri -Merrill Lynch

Okay. But is it primarily driven by 3G business?

Scott McGregor

Yes, it is.

Srini Pajjuri -Merrill Lynch

Okay. Fair enough. And then finally DTV, looks like that business is doing well. Could you put some numbers around there, at least can you give us some idea how big that business is and where do you hope to exit the year?

Scott McGregor

I am afraid now, we can't give you specifics on rather than to say that it did double in the quarter and double is going into Q3. We expect it to double going into Q3. But it's getting very good attraction there. We said that we would get design wins with Korea and Japanese and Chinese manufactures. We've done that, they are shipping. I think the opportunity for the rest of this year is to see products like our 3563 product and others, which offered 10 ADP. We expect that could hit the market in the later part of the second half of this year, which would drive the revenues even further.

So we are seeing great traction on our products and what people like about our digital television products is they really integrate more functionality than they are seeing from other suppliers. They are in 65 nanometers, they include basically all of the TV functions except for the tuner and the display driver pretty much, and so it really provides a totally integrated solution for TVs.

Srini Pajjuri -Merrill Lynch

Thank you.

Operator

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

Seogju Lee - Goldman Sachs

Hi, thank you. Just in terms of the business outlook, Scott, can we just delve into that a little bit deeper, it sounded like just in terms of put and takes, it sounded like obviously wireless is going to be things that are up, enterprise it’s done a little bit mix with one particular issue, but other being relatively flat.

And then broadband found it up, am I missing something -- and then you also have some seasonality and then contribution from Global Locate, so just that we could think about in the context of the guidance that would be very helpful? Thanks.

Scott McGregor

Yeah. There are a lot of moving parts and certainly when you have 20 semi-businesses they move a little bit on their own for each of those. In the enterprise networking space we are seeing a dramatic pick up in that business; that business is looking to be relatively flat. We haven't seen increased demand from customers in that space. Although, we believe eventually that business will get back to growing. But so far it still appears a little soft, so we are a little cautious on that business.

Our broadband good performers for the reasons we said. I think the star growth performer in the broadband areas is going to be digital TV, that's the one, that’s the biggest growth driver there. In the mobile and wireless space, Bluetooth and wireless LAN are going gangbusters and so we do see those as the primary growth drivers there. So if you ask me what are the three biggest growth drivers we see going in to Q3, it’s probably Bluetooth, wireless LAN and digital TV.

Seogju Lee - Goldman Sachs

Okay. But just conversely, the only thing I get sort of down is enterprise networking that -- how should we think about it?

Scott McGregor

Yeah, we don’t give an update on every business in exactly what it’s doing, but certainly from a top-level portfolio, I think you have got about the right view.

Seogju Lee - Goldman Sachs

Okay, great. Thanks. Good luck.

Scott McGregor

Thank you.

Operator

The next question comes from Craig Berger from Wedbush Morgan. Please go ahead.

Craig Berger - Wedbush Morgan

Good afternoon. Thanks for taking my questions. With respect to the hubbing arraignments, did you say which product areas those are in or which customers those are?

Eric Brandt

We haven't said. They are our largest customers. You need to be at a certain scale both from a standpoint of customer to make it work it from our standpoint, and I would leave it at that some times.

Craig Berger - Wedbush Morgan

Okay. Moving on to the set-top boxes. Has demand for the high-end set-top boxes caught up? Are we back to sort of more normalized pull relative to consumption there?

Scott McGregor

Well, we saw bit of a catch-up in the high-end set-top boxes after the FDC mandate. We believe that that market will continue to grow going forward, because the low-end of the market has basically moved up more to the high-end of the market. So, as time goes on we see capabilities like PVR, AVC and MPEG-4 as becoming more a normal set-top box functionality. So, the ratio of high-end set-top boxes to lower-mid we believe will go up and that will drive growth in that space.

Craig Berger - Wedbush Morgan

Thank you. Moving on the DSL modem. Has the issue being worked through there? Is that segment getting back to growth in the back half, or is there some more wood to chop?

Scott McGregor

Yes. Yeah, no, there is no inventory issue remaining in that space.

Craig Berger - Wedbush Morgan

Okay. And just quickly on DTV, I know you guys don't talk about specific customers or product. But you probably have a pretty good sense for how 2008 total is going to shape up at this point. Generally, 95 million to 100 million LCD TVs are expected to be sold. How many of those do you think you might be able to be in?

Scott McGregor

We don't give that specific guidance. What we will try to do at Analyst Day although in November is we'll probably give you a little more color on our products and you will get a chance to see some of them. And I think we can probably give you a better sense of where we are going there.

Craig Berger - Wedbush Morgan

Can you help us at least with any other design win traction for '08 without naming specific customers or products?

Scott McGregor

Well, I mean I can tell you that they are probably in China, Korea or Japan, but I don’t think I'll help you that much.

Craig Berger - Wedbush Morgan

Okay. Thanks a lot.

Operator

The next question comes from Quinn Bolton from Needham & Company. Please go ahead.

Quinn Bolton - Needham & Company

You guys mentioned starting to see I think more momentum on the IPTV set-top box front. Just wondering if you could expand on those comments. And then the second question, it sounds like you talked about a big switch order that you chipped in Q2 that sounds like you are going to see a pause in Q3 for that particular customer. But, outside of that customer, is the rest of the switch business sort of holding in?

Scott McGregor

Well, the switch business is holding on just fine and our share remains strong. We don’t see any share changes or whatnot there. We're just starting to see overall growth in the switch business, and so that’s why you get a big order and it can give you a little lumpiness between quarters. So, share-holding strong, don’t anticipate that changing. And we just looked to the switch business just catching up overall.

On your IPTV question. We believe IPTV will become more and more significant going forward. There were some big issues around content availability and other things that were limiting it. For example, we are shipping right now in the Verizon FiOS IPTV and a variety of ones in Asia and so forth. We do expect to see our design win traction in IPTV pickup. We have got some very compelling products in that space, and some new ones we have recently have done. And so IPTV products will become more and more important markets over the next year or so.

Quinn Bolton - Needham & Company

So is it more of an '08 rather that second half of '07 based on that?

Scott McGregor

The whole market is more of an '08 than an’07. If you look at the actual install rates, it's not so much in '07. That market will really come of age in '08 and '09.

Quinn Bolton - Needham & Company

Great, thank you.

Operator

The next question comes from Shaw Wu from American Technologies. Please go ahead.

Shaw Wu - American Technologies

Thanks. Just two questions if I may. Just a follow-up on the cable set-top box business. Obviously, there has been, you mentioned earlier the SEC mandate with the CableCARD initiative. We think the other players are going to see their business kind of soften, add a little more color in terms of why Broadcom has done well there despite the transition. And then second, just a little more color on digital TV obviously looking at that that, there will be a great growth opportunity. I am just trying to understand is that a function of gaining more share at your existing customers or is it more about gaining new customers? Thanks.

Scott McGregor

So in the DTV space -- if both gaining new customers and gaining additional models. The TV business is generally a risk of worst one and so they generally try you out in a model or two to see how it goes and sales and what your field call rate is and if there is anything breaking, so the customers don't like it, and if it goes well they expanded into multiple models. And so that really helps us there. So, we see our current 720T products doing fairly well in sort of the lower mid range or mid range products. In the 1080P product we have, that we announced at CES earlier this year enabled us to really do a good job there.

On the set-top box side you asked what's behind the strength in that business. We have just a great integrated product and one of the things that Broadcom has done is we have done a great job of taking a lot of different technology and putting it in a single piece of silicon. What that does is it eliminates sockets of competitors. It reduces the cost of the solution for our customers. And so it's really just executing on that for some of the larger customers that's given us that strength in set-top box.

Eric Brandt

Also remember Shaw, I think you've seen most of the churn really occur at the lower end of the market where we really have not had that much of a presence. If anything, one of the reasons for our growth in Q2, was the fact that the high end demand just returned back to the normal level.

Shaw Wu - American Technologies

Okay. Thanks. Just a follow-up on kind of the digital TV again, so do you see your gross, do you see as more just doing better, are your existing accounts -- would you say that's the bigger driver or just quantitatively or qualitatively that or versus over the new wins, I mean like new OEMs?

Scott McGregor

Shawn, it's really both. We have gotten additional designs wins and the customers that we already have, have gone from a handful of models to more model of the models that were in have ramped in terms of quantity, in one particular case the customer has put on additional capacity in their new facilities, now delivering products are based on our chips. And so it's really all of those things.

It's getting into the market that we have a better solution than many of the internal A6 solution that some other guys use, some of our competitors are internal A6. And we've also shown that we have better integrated solutions, so we are more cost effective than the internal A6. And better integrated and cost effective than the other merchant silicon out there. Again, I don't think there are other guys out there in 65 nanometers that have the level of integration we are looking at.

Shaw Wu - American Technologies

Okay. Great. Thanks.

Operator

(Operator Instructions) The next question comes from David Wu from Global Crown Capital. Please go ahead.

David Wu - Global Crown Capital

Yeah. Good afternoon gentleman, congratulations. I just want to have one clarification one simple question. The clarification is, I guess your relationship with Verizon, or the strategic relationship, would that bring you in to those CDMA, camp that is consolidated QUALCOMM, i.e. right now from my understanding you are going basically WCDMA and further down that path. With the deal that you strike with Verizon, does that entitle you to get in to the other side which is the EVDO side?

Scott McGregor

Well, Verizon certainly does use CDMA and EVDO technology today and there would be an opportunity for us to produce chips on those technologies, but we haven't made any announcements on that at this point.

David Wu - Global Crown Capital

I was wondering whether that’s got something to do with if you step up R&D spending.

Scott McGregor

Yeah, I can only say we haven't made any announcements at this point. And you should necessarily assume those are related.

David Wu - Global Crown Capital

Alright. The second question I have is really at this point to get to a 10% to 15% by December of 2009 on baseband, are there a couple of things we need to think about, or essentially the fact that you have all the IPs to give a pretty good SOC ultimately the key to you hitting that 10 to 15. In other words, the baseband itself is interesting, but that the way you get there is who really pretty comprehensive IP around and SOC for 3G.

Scott McGregor

I think you have got a good point there, it’s interesting the baseband market. I think in the future there is no baseband market. In the future there are cell phone chips, and they will happen to include a baseband. And if you think back in history we used to cell, microprocessor chip. And there are some companies that still do sell very high performance microprocessor chips and there are quite a few of them, but a lot of the companies that sold sort of embedded microprocessors -- it went from one chip back maybe 15 years ago, so now it’s small core in the corner of an SOC or maybe they are multiple in SOC.

I think the same thing is going to happen with baseband technology that today it may be a chip, but in the future it's part of an SOC. And so that's why the breadth of IP is very important. And a lot of these larger handset manufacturers, they are not going to switch base end suppliers to save a dollar today, that's just not as economical for them, because they have a big software investment and they make a long-term commitment to baseband suppliers.

So what we see is that we are able to offer an excellent SOC roadmap that includes baseband, includes wireless connectivity, it includes multimedia, it includes networking, it includes digital rights management, it now includes GPS, and a variety of these technologies. And so it gives us a very, very powerful SOC capability and that's definitely one of the things that excite our customers.

In terms of thinking about our business, I would encourage you to think of 2007 as the year that we have to get design win. And 2008 as the year that you are going to, you should expect to see those products start coming to market and in 2008 you should know the names of all big customers and how we are going to get our large market share, and 2009 is just a privation of that growing market share rolling out in multiple models then and again getting to that market share hold that we have.

David Wu - Global Crown Capital

Okay. Thank you very much.

Scott McGregor

Welcome.

Operator

This concludes the question-and-answer session for today. Gentlemen, please go ahead if any concluding comments.

Scott McGregor

Thank you very much. I appreciate you joining us today. As a reminder we are going to do our analyst day in November 8. We will be hosting this up in San Francisco stay tuned for further details on that. Thanks again for your attendance today and good afternoon.

Operator

Thank you for participating in the Broadcom conference call.

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Source: Broadcom Q2 2007 Earnings Call Transcript
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