Broadcom Q3 2007 Earnings Call Transcript

Broadcom Corp. (BRCM)

Q3 2007 Earnings Call

October 23, 2007 4:45 pm ET

Executives

Scott McGregor - President and CEO

Henry Samueli - CTO and Co-founder

Eric Brandt - CFO

Peter Andrew - VP, Corporate Communications

Analysts

Ross Seymore - Deutsche Bank

Craig Ellis - Citi Investment

Allen Mishan - CIBC World Markets

Srini Pajjuri - Merrill Lynch

Uche Orji - UBS

Quinn Bolton - Needham & Company

Sumit Dhanda - Banc of America Securities

Seogju Lee - Goldman Sachs

Shawn Webster - J.P. Morgan

Tim Luke - Lehman Brothers

Adam Benjamin - Jefferies & Company

Shaw Wu - American Technology

Daniel Berenbaum - Carris and Company

John Dryden - Charter Equity

David Wu - Global Crown Capital

Presentation

Operator

Welcome to the Broadcom Third Quarter Fiscal Year 2007 Earnings Call. During the presentation, all participants will be on a listen-only mode. Afterwards, we will conduct a question-and-answer session. As a reminder, this conference is being recorded Tuesday, October 23, 2007.

Your speakers for today are Scott McGregor, Broadcom’s President and Chief Executive Officer; Henry Samueli, Broadcom’s Chief Technical Officer and Co Founder; Eric Brandt, Broadcom’s Chief Financial Officer; and Peter Andrew, Vice President of Corporate Communications.

I would now like to turn the conference over to Mr. Andrew. Mr. Andrew, please go ahead.

Peter Andrew

Thank you, Jackie. During this call, we will be discussing 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 fourth quarter of 2007, and any other future periods and statements about prospects for our various businesses and the development status and planned availability of new products.

It should be clearly understood, that our actual performance and financial 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 subsequent SEC filings.

A partial list of these important risk factors is set forth at the end of today's earnings press release.

As always, we undertake no obligation to revise or update publicly any forward-looking statement for any reason. Throughout this call, we will be discussing certain non-GAAP financial measures. Today's earnings release and the current report on Form 8-K filed today, describe the differences between our non-GAAP and GAAP reporting and present a reconciliation between the two 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 we proceed, I'd like to remind everyone about our upcoming 2007 Analyst Day on November 8th in San Francisco. If anyone needs any information, please give me a call after our earnings call this evening.

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

Scott McGregor

Thank you, Peter and good afternoon to everyone. I am pleased to announce that Broadcom has achieved record revenue, with another quarter of strong cash-flow from operations. Revenue in the third quarter came in a bit stronger than expected, driven mainly by sales of our Bluetooth and Wireless LAN solutions, as this a seasonally strong time of the year for those lines of business.

Broadcom is a product cycle-driven company. We are benefiting from new customers product ramp, platform expansion within our existing customer base, and new technologies such as 802.11n and a combined Bluetooth and FM chip.

In the Enterprise Networking and broadband markets, Broadcom has already proven its ability to integrate an increasing number of features and functions onto a single piece of silicon, so much so, that many switches, set-top boxes, broadband modems and more recently digital TVs are now covered by converged single-chip solutions.

In Wireless end-markets such as Bluetooth Wireless LAN and Cellular, we're now entering a second phase of conversion, moving beyond integrating more features and functions, towards integrating multiple forms of communication onto a single chip. The convergence of communication, to be clear what we are talking about here, is not simply the ability to integrate pure digital radios with basebands and processors, as part of what we call the first phase of conversions.

The second phase of conversion is the ability to integrate other communication solutions, such as Bluetooth, Wireless LAN, FM receive and transmit, GPS, etcetera, onto the same chip, with the primary baseband its radio and associated processors.

As we integrate more and more of these capabilities onto a single piece of silicon, we believe that will enable our customers to create market-leading, cutting-edge products. We plan to invest aggressively throughout 2008 to accelerate the second phase of conversion, while at the same time we'll continue our R&D investments to enter and gain share in the larger and growing cellular handset market.

Last quarter, Broadcom and our customers made a number of announcements, highlighting the progress we have been making in both products and design wins. I'll talk more about these in a few minutes, but first I'll turn the call over to Eric talk about the quarter from a financial prospective and provide our guidance for Q4.

Eric Brandt

Thanks Scott. We are pleased with our Q3 results. To summarize as follows, revenue of $950 million was up $52 million or roughly 6% from Q2 2007, and with $10 million above the range provided on our last earnings call. Non-GAAP gross margin of 52.1% was down 30 basis points from last quarter, consistent with our guidance.

Total non-GAAP operating expense increased by $20 million over Q2. This was above the range provided by roughly $10 million, which I will detail in a moment. Non-GAAP earnings per share were $0.27, which was flat, with Q2 driven by the decrease in gross margin and growth in R&D and operating expenses, which offset the benefits of increased revenues. Cash flow from operations was a strong $212 million. Our cash and marketable securities on hand remained roughly flat for the quarter at $2.43 billion, driven primarily by $171 million in share repurchases settled in the quarter and the closing of our Global Locate acquisition which offset the strong operating cash flow.

Inventory for the quarter increased by roughly $22 million to $213 million, which equated to 8.5 times on a non-GAAP basis. This continues to demonstrate the excellent work of our operations team and what they have done to change; to address changing supply in an ever changing environment. The terms level of 8.5 times remains above our long-term goal of seven to eight turns.

In our July call, we said that we expected Q3 revenue would be approximately $915 million to $940 million. We said we expected growth in our broadband and mobile and wireless groups with Enterprise Networking slightly down. We anticipated this to be driven by strong growth in Digital TV due to the ramp of our new 65 nanometer 10 ADP products, as well as Bluetooth and wireless LAN with their second half of the year ramps.

In addition we expected modest growth in the Broadband modems controller and optical areas. What occurred was growth across all three of our lines of business, which in total exceed our range by about $10 million.

With respect to our Broadband communication markets, as we projected, Digital TV roughly doubled with growth also coming in the Broadband modem area. This was partially offset by a decline in the set-top box area, due a normal weaker back half of the year.

In the mobile and wireless businesses we benefited from strong growth driven by new product and customer ramps in Bluetooth and strengthen all wireless LAN segments offset by a decline in mobile multimedia business due to our product transition.

Finally, as you may have noticed, an increase in deferred revenue on the balance sheet which comes as a result of our Global Locate acquisition. Global Locate's legacy contracts included a service component with the chip sale related to its worldwide GPS reference network. As a result, we need to recognize that revenue radically over the estimated life. We are currently working on splitting this service from the chip such that we may recognize the chip revenue in the period shift which as you know is our ordinary practice.

Contrary to what we expected, our Enterprise Networking business did grow modestly, driven mainly by our timing issue in the controller segment caused by customer pull-ins due to delivery delays that at a particular competitor for designs won in the last cycle. The sequential decline in our switching business due to customer pull-ins in Q2, which we mentioned on our July call, was also not as great as we expected.

Revenue distribution for Q3 was as follows. Broadband communications accounted for approximately 38% in total revenue. Mobile and wireless were 32% and Enterprise Networking 30%. With respect to gross margins as we forecasted in July, our gross margin declined slightly to 52.1% driven by product mix and the ramp of a number of new customers and products. I recall that our product gross margins tend to be lower for new products which have not yet moved down the cost curve.

Moving to operating expenses, non-GAAP operating expenses were up $20 million from our Q2 levels or about double the increase we projected in July. Roughly half of the additional $10 million increase was due to dollar based R&D cost associated with opportunistic purchases of EDA tools and dedicated radicals prepared for productions of 65 nanometer products. And the other half, just higher than anticipated litigation cost during the quarter.

As a result, R&D as a percentage of sales on a non-GAAP basis, grew slightly to 27%. We continue to operate above our long-term targeted R&D range of 20% to 22% as a percentage of sales, as we invest aggressively to deliver on recent design wins in our emerging businesses as well as to pursue additional opportunities. This increased R&D percentage will continue until these design wins convert into revenue, especially in the cellular market. Roughly half of our tape-outs in Q3 were in 65 nanometer, where the number of additional tape-outs occurring just after the quarter end.

Looking to Q4, we expect that approximately 75% of our tape-outs will be in 65 nanometer or smaller process geometries. Recent product and customer announcements reinforced our view that 65 nanometer continues to give us a definite competitive advantage in the design win process in terms of offering lower power requirements and the ability to integrate features and functionality into our designs that many of our competitors either can’t integrate or will be much later in implementing. In addition, the expanded use of multi product wafers, and other efficiencies have continued to allow us to accelerate prototyping to customers.

We increased total company headcount from Q2 by 287 people to a worldwide total of 6,114 employees. This includes over 4,500 employees in engineering, where 74% of our total headcounts included nearly 500 Ph.Ds.

Moving to the balance sheet. As I mentioned, total cash and marketable securities were roughly flat at $2.43 billion, driven principally by the share repurchase program approved in February of this year, as well as the closing of the Global Locate acquisition. We generated strong positive cash flow from operations of $212 million.

We also had some benefit from proceeds from employee stock option exercise of approximately $65 million net. This was more than offset principally by the repurchases of our common stock, capital expenditures which moderated somewhat in the quarter, and the acquisition of Global Locate in the quarter.

Inventories increased in Q3 by approximately $22 million to $213 million. Non-GAAP inventory turns remained strong at 8.5 times in Q3. The percentage of our sales made through distributors remained low at 16%. In addition, we continue to provide more products through hubbing arrangements with our customers. As a reminder, we recognized revenue through distributors and hubs on a sales-out basis. Our accounts receivable day sales outstanding decreased slightly from 39 days to 38 days with good linearity.

As I mentioned previously, we continued our 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 $4.9 million shares at a cost of $163.9 million. We currently have $182 million remaining in this program.

The objectives of the program are to manage our net share dilution, 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 business and emerging areas, this is currently an excellent use of our cash.

Moving to expectations. We currently expect continued sequential growth in Q4 and that products revenue will be in the range of $960 million to $990 million, which at this point does not include any revenue associated with the patent license signed with Verizon in July. The reason it is not included, is because we have not yet received the counts of forms for which a $6 royalty would be payable during the quarter.

In looking at what we expect to happen in Q4 in broadband communications, we expect to see some growth across virtually all lines of our business. In Mobile and Wireless, we anticipate continued growth with all businesses likely to be up, and the strongest growth coming from Bluetooth.

The Enterprise Networking Group will be down slightly as compared to Q3, partially driven by a relatively flat quarter-on-quarter performance across the portfolio, and a normalization of the current quarters upside in the controller products.

For non-GAAP gross margin, excluding the margin impact from the Verizon license in Q4, we expect to see an additional decline in gross margin, slightly greater than what was experienced in Q3, as we continue to ramp a number of new products to new and existing customers in the quarter. Just to repeat, typically our new products have lower gross margins as we focus designs initially for quick time to market.

For non-GAAP operating expenses in Q4, we expect to continue investments in products and the migration of 65 nanometer, including more dedicated production-oriented math, both of which we believe are critical to our revenue growth and gross margin in 2008 and later years. As a result, we expect the no-GAAP operating expenses on an absolute dollar basis to increase slightly less than Q3 in the $15 million to $20 million range.

Cash flow from operations for Q4 is expected to remain strong. Also, we anticipate we will continue to repurchase shares in Q4. As noted early, we have approximately $182 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 with Enterprise Networking. Revenue from our Enterprise Networking business came in a bit better than we expected in Q3, driven mainly by better than expected sales of gigabit Ethernet Controllers and a smaller decline in switching revenue than we had originally expected.

Our gigabit Ethernet Controller business was stronger than anticipated, due to an overall strength in the PC market. Also on our last earnings call, we predicted some loss in market share and controllers, but this has happened more slowly than we have forecasted. The service base where we continue to hold an excellent market position remained relatively strong in Q3.

We do believe that we hit a peak in this business in Q3, and expect our gigabit Ethernet Controller business to be down in Q4, as our market share shifts and as the market comes to terms with some double ordering reportedly occurring in the PCs space.

Moving on to switching; our revenue generated from switch products was down in Q3 as we talked about the last quarter. But the decline was a bit less than we expected, due to a relatively robust end-market in the service provider, enterprise and SMP segment. Ethernet continues to reach deeper into the metro or Carrier Ethernet market, and we are finding additional opportunities to bundle more of our silicon together in our customer's products such as [Video Cell 2] which I'll touch upon later.

During the quarter Linley Group published a report noting that Broadcom's market share in the merchant silicon space for gigabit Ethernet reach the 70% level. To stride this leadership position with Enterprise Networking market, we began sampling our new highly-integrated line of 65 nanometer StrataXGS gigabit Ethernet switches, which were used in Enterprise networks enabling more intelligence at a lower cost and power dissipation.

Moving to our broadband business, broadband sales were up nicely in Q3, driven by growth in the digital TV, broadband modem and next generation high definition DVD player lines of business. As we expected, digital TV sales almost doubled from Q2 to Q3, driven by growth in our new 65 nanometer highly integrated 10 ADP products. No competitor has matched the levels of integration that we are bringing into this market, specifically our ability to integrate more of the front-end such as HDMI Channel B modulators today and in the future tuners, cable modems and ABC technology.

As we look into 2008, we plan to broaden our product line by developing products with additional picture enhancement features and to expand our business with additional Tier 1 customers.

Broadband modems were strong in the third quarter driven mainly by a rebound in our sales of voice enabled cable modems after a weak Q2 associated with customer inventory rebalancing. We had a very successful quarter with design wins for our VDSL2 solutions at both Ericsson and ZyXEL. While VDSL2 is still early in its deployment, we view this market evolution very positively as the increased bandwidth enabled by these networks is essential to telecommunications operators to broadly deploy IPTV services to compete with cable and direct broadcast satellite television.

As we look into the fourth quarter we expect to continue to experience strong growth in our broadband modems business. Set-top boxes were a bit weaker due to the downturn we normally experienced in the second half of the year as Eric mentioned. Within the set-top box space during the third quarter we announced our next generation 65 nanometer SoC solution for cable satellite and IP set-top boxes. This solution built upon Broadcom's widely deployed family of ABC and BC1 high definition solutions, and supports the latest in interactive features in a wide range of compression standards and offers support for a variety of digital rights management solutions.

The chip incorporates features to specifically address the needs of the IP set-top box market. A long history of shipping products that address the cable and satellite set-top box markets, along with our ability to lead the second wave of communications convergence with such functions as MoCA, wireless LAN, Bluetooth and other capabilities within the set-top box, places Broadcom in a very strong position to address the IPTV market opportunity going forward.

During the third quarter, we also began sampling a complete digital TV set-top box solution, targeted at the National Telecommunications and Information Administration, NTIA, digital-to-analog converter box program. This program is part of an FCC initiative that will assist your household in making an affordable transition from existing analog-to-digital terrestrial broadcasting, while preserving the large installed base of analog TVs.

Next generation DVD players experienced good growth, driven mainly by demand for high definition DVD playback for laptop PCs. In addition, both LG and Samsung are now shipping universal players, based on our solution that remove the confusion about which technology HD-DVD or Blu-ray is better, as they support both disc formats. As we look into Q4, we anticipate that growth in the broadband segment will be mainly driven by broadband modems, and to a lesser extent set-top boxes.

Moving to mobile and wireless. In Q3 our mobile and wireless revenue was up sharply as we benefited from seasonality, along with new customer ramps; expansion within existing customer platforms; and new product and technology ramps. The revenue growth in Q3 was driven primarily by our Bluetooth and wireless LAN lines of business.

Before I touch on these areas, I want to talk about the recent developments in the cellular baseband area. On the cellular baseband front, our baseband revenue was still small, but grew in the quarter. There were two important milestones for this business in the third quarter. First, there is now clear evidence of the customer traction Broadcom has been experiencing within the EDGE G3 markets. While it will take some time before this design wins turn into material revenue, we can point to clear customer progress in the cellular baseband space we are two of the largest cellular handset makers.

Nokia announced that it will be using our 65 nanometer single-chip baseband processor along with our power management unit in future EDGE phones. Our single-chip EDGE baseband integrates an RF transceiver or analog and digital baseband functions and multimedia. This is important, not only because Nokia is the world's largest provider of cell phones, but also because according to the market research firm iSupply, the EDGE segment of the mobile phone market is projected to grow from 245 million units this year to over 408 million units in 2009.

Also Samsung announced it has expanded it's deployment of 3G cell phones, incorporating Broadcom's 3G baseband, power management, Bluetooth, 3G protocol stack software, and M-stream technology. This is important as it highlights how Broadcom has been able to take a 3G baseband only solution and expand it to include more Broadcom products, including our software and protocol stack, and partner successfully with Samsung.

Secondly, Q3 was an important quarter because we announced a number of revolutionary new products with integrated features and functions, that no one in the industry has announced to-date, and that some simply aren’t able to do because they do not posses all of the necessary technologies to build such a product.

We announced a true 3G phone on a chip code named Zeus, which is the single-chip HSUPA mixed signal processor with voltage CMOS RF, rich multimedia, Bluetooth, FM radio and transmit, and more, all on one 165 nanometer dot.

We are proud of our team for pulling off this amazing achievement. No one in the world has announced a product with this level of integration and this announcement highlights why we believe we have an opportunity to be a significant participant in the cellular handset market. We believe that handsets incorporating our Zeus chip will be available in the mid to late 2009 timeframe.

We also announced the new Multimedia Processor that enables HD video camcorder and playback, 12 megapixel camera and 3D gaming, all in one chip. And at low power suitable for cell phones and other portable devices, we believe this is a great product for the cellular handset and portable media customers.

It offers the following features: first of all it has five hours of high-definition video playback or 3 hours of HD recording using a standard cell phone battery. It has support for a 12 megapixel camera with on-chip image signal processing capable of on-the-fly photography of up to 12 pictures per second, and 3D gaming, capable of 32 million triangles per second, which is higher than PlayStation 2 class gaming performance.

These are very important customer and product announcements, but due to the long design cycle of getting a chip in the multiple phone models and then getting the phones into mass production, we don't envision any substantial revenue contribution from our cellular baseband efforts in 2008. We do expect potentially to double the size of our cellular baseband revenue in 2008, but that’s also a relatively small base, and most of the growth will be backend loaded.

Our goals in cellular baseband solution have not changed. We are expecting 10% to 15% unit market share by the time we exit 2009. 2007 has been the year of design wins, and you have seen some of those recently. 2008 is the year to get the products of phones done, and 2009 is the year to grow share and generate significant revenue.

Moving onto our Mobile Multimedia line of business; revenue was down sharply as sales of an older solution in the MP3 space ended, and this fall-off more than offset growth in the sales of our new products for portable phones and MP3 players. In the GPS market, we closed the acquisition of Global Locate in July and then quickly rolled out our next generation Single-Chip GPS Solution for mobile application called Barracuda.

GPS is a technology that we look to integrate with other Broadcom technologies such as Bluetooth, wireless LAN, and our cellular processors to help drive the adoption of this technology faster in to personal navigation device in cellular phone applications.

Our GPS shipments grew nicely in Q3. Wireless LAN had a very strong quarter, up over 20% sequentially as we experienced growth in all segments: client, retail and embedded and in both protocols g and n. The strongest growth in the wireless business was on the client side, but we had excellent growth in both g and n client applications, especially in N, where our revenue nearly doubled on a sequential basis. We clearly gained share in the client segment.

During the quarter, we pushed the integration envelop in the 802.11n space as we introduced a 65 nanometer true single-chip solution to not only lower the cost for existing client and gateway applications, but to also enable the solution to go into other consumer electronic products that have never included wireless LAN functionality before, such as TVs, set-top boxes and camcorders.

Also during the quarter, we made excellent progress in securing customers design wins for 2008 in the cellular and MP3 phases with our triple play products. This ultra low powered device combines 802.11a and g, Bluetooth and FM together on a single 65 nanometer die.

We are seeing strong interest from our customer base in these and other forth coming Converged Communication Solution. Finally the HomeRun line of business in the quarter was Bluetooth. Revenue was up strongly in the quarter at all segments of this line of business. Mobile, PC, audio and embedded experienced growth.

The strongest growth was in the mobile and PC areas, where new rams were combined with additional expansion within our existing customer base. Our Bluetooth plus FM single-chip solution for cell phones more than doubled in the quarter, and our Bluetooth solutions for the PC market grew by nearly 50% as the penetration rate of Bluetooth and the PCs space grew and we gained market share within this segment.

While early in it's evolution, we did begin shipping our Mono Bluetooth headset solutions to Tier 2 vendors, and we expect to ship to the Tier 1 vendors in the first half of 2008. We look to garner significant market share in the Mono headset space in 2008. So, in total, it was a very strong quarter for Bluetooth, and we expect continued strong growth in Q4 in all segments.

On the litigation front we had another good quarter in terms of stopping QUALCOMM's pervasive infringement of our intellectual property. On the positive side, Number one, European Commission decided to continue it's investigation regarding QUALCOMM's licensing and competitive practices.

Number two, the Third Circuit Court of Appeals reversed the lower court's dismissal of the Federal Antitrust claims Broadcom brought against QUALCOMM. Our claims of monopolization and attempted monopolization are moving forward once again in the district court. And number three, in early August, the San Diego Federal court ruled that QUALCOMM engaged in aggravated litigation misconduct and standards abuse for two QUALCOMM patents that relate to digital video technology.

With respect to standards abuse, the court discovered "Carefully orchestrated plan and the deadly determination of QUALCOMM to achieve its goal of holding hostage the entire industry." The court ruled that QUALCOMM thereby waived its right to enforce all claims related to the two Broadcom patents in question. The court also ordered QUALCOMM to pay Broadcom's attorney's fees in the litigation.

With respect to the aggravated litigation misconduct, QUALCOMM and its outside counsel are currently waiting a decision regarding sanctions for their misconduct. On the negative side, after the Bush administration decided to uphold the ITC Patent Remedy, a U.S. Court of Appeals granted a stay of the ITC's exclusion order, pending appeal by third parties to cellular phones containing QUALCOMM's infringing chips were subject to exclusion.

The Appeals Court made no findings questioning the validity of the patent or it's infringement by QUALCOMM. Importantly, the appeals court ruling does not affect the ITCs Cease and Desist Order against QUALCOMM, or its order barring QUALCOMM from bringing infringing chips into the United States.

Finally, as we've stated numerous times in the past, we stand ready to negotiate with QUALCOMM or any other market participants that seek a reasonable solution. We have made fair and reasonable settlement of proposals to QUALCOMM, which we hope it will consider and embrace.

In all this litigation, our goals remain simple. Number one, to gain proper recognition of the value of Broadcom’s significant intellectual property, specially in the wireless space. And number two, to achieve a level for competitive playing field in the cellular chip market. To date, QUALCOMM’s been found to infringe four of our patents in two different forms. We have additional patents, antitrust and unfair competition claims that have not yet been addressed to trial.

By comparison, QUALCOMM has either lost or dropped all claims against Broadcom. Unfortunately, however our settlement discussions with QUALCOMM have not yet borne fruit, as QUALCOMM appears to have bet its future and its end customers upcoming product launches on the patents appeal process.

Some near-term events to keep an eye on includes the following. Number one, the Santa Ana case, where we have requested an injunction against QUALCOMM’s infringing product support, and new product development activities, among other things. And number two, a ruling on QUALCOMM’s misconduct in San Diego.

We remain hopeful that these litigation matters will come to a positive resolution, and we see our agreement with Verizon Wireless, announced in the third quarter, as an important forward step in achieving that goal.

So, in closing, Q3 was a good quarter, where new product cycles enabled Broadcom to once again reach record revenue levels, and generate strong cash flow from operations. As Eric mentioned, we are looking for continued revenue growth in Q4. We are going to continue to invest aggressively in 2008, to keep this momentum going.

We are now ready to take your questions. Jackie, may we have the first question, please?

Question-and-Answer Session

Operator

Sure, thank you. We will now begin the question-and-answer session. (Operator Instruction). Our first question comes from Ross Seymore from company, Deutsche Bank. Please go ahead.

Ross Seymore - Deutsche Bank

Thanks guys, that’s Deutsche Bank. Eric, a question on the Verizon royalties. Give us a little idea when we should expect those to come in?

Eric Brandt

We should hear from Verizon at the end this month on the number of phones that earn the $6 royalty. And then once we have a picture of that, then hopefully we can provide you an update on Analyst Day. Those royalties we will book once we know how much they are and we collect the money. So that would occur in the middle of this quarter and would be booked in this quarter.

Ross Seymore - Deutsche Bank

If we think about it going forward, is it more like a two quarter arrears that you have to wait or is it something that will little bit more timely as we go forward?

Eric Brandt

It's a one quarter arrears. So basically what it is, is that we signed the contract in the third quarter, so we started collecting royalties about half way through the third quarter. And then they have 30 days provide us a tally sheet on the number of phones that have earned the royalty. So that rolls into the following quarters, so it's literally as one quarter in arrears.

Ross Seymore - Deutsche Bank

Okay. Then a bigger picture question for Scott. From your end customer perspective, are you seeing any of the gyrations you thought that you saw before from the customers being weak whether that be their own issues or end market weakness? And on that second point on end market weakness, any commentary you would like to give on either inventory of your parts in the channel or demand creating inventory of your customer's final parts in the channel?

Eric Brandt

Well a few comments in that regard when you talk about gyration from our customers I am not exactly sure what you mean there. I mean we are seeing some macro economic challenges I think between housing and other things and it makes us all nervous for the overall economy which obviously affects our business.

On the other hand we are seeing very-very strong design win traction right now, which I think is very positive, so I am feeling really good about that. I don't see any particular inventory issues that I am concerned about I don't think they are always some places where there is a little too much or not enough and there are always some customers who are expediting and some customers who maybe have a little more than they need, but I say its fairly normal from our perspective from an inventory situation out there right now.

Ross Seymore - Deutsche Bank

And then the final question, with that macro environment happening are you getting the sense that your customers are incrementally bringing their orders on you down from where they were before or are they remaining unchanged arriving?

Eric Brandt

We are not seeing any significant trend either direction there again we have some customers who order late and so are expediting and have seen pick ups in there their demand and then they are you always get a mix and there is always some order and some push up, but I don't see a trend there I think what you are trying to get at is do we see a push out trend and I don't see that right now.

Ross Seymore - Deutsche Bank

Great thank you.

Operator

Our next question comes from Craig Ellis from Citi Investment please go ahead.

Craig Ellis - Citi Investment

Thanks guys. First clarification on the operating expense guidance, I would have thought it wouldn't have been up so much given the absence of what I would expect to be a one time impact on the EDA tools in the third quarter can you just provide a little bit more color on what's happening in the fourth quarter with OpEx Eric?

Eric Brandt

Yeah sure, it's principally the conversion from multi products wafers to dedicated wafers for production preparation which is driving the MOSFET costs up. Typically what happens is as you know we have targets in terms of trying to get to the end of the year and we have lot of people who would like to get their products taped-out between now and the end of the year, so that happen always, no, but I think its prudent of us to assume that that's the plan and that's what we are doing. That's principally the driver of the increase as we move for multi-product wafers to more dedicated radicals for production preparation.

Craig Ellis - Citi Investment

Okay. So it's staffing related and more just related to product?

Eric Brandt

There is headcount in there as well but there is a lot of MOSFET costs that's sort of driving that.

Craig Ellis - Citi Investment

Okay. Fair enough. And then secondly on the gross margins a little bit more of a step down sequentially as 65 nanometer increases. How should we think about the trend that's developing there. Is that going to somewhat stabilize after we get to the fourth quarter or is that something that could increase sequentially as we think about early 2008?

Eric Brandt

Interesting if you look at the business, as the business is grown faster, when you are seeing the greatest pressure on the gross margins. So, what typically happens is as we are growing fast we've new products and new customers as we price for time to market and the gross margin inspite of in the space that's when we think the latest pressure in gross margin. So, my expectation would be that we are seeing some drop as we continue to grow and sort of move to newer products which are little tighter and we price really for time to market or sort of design for time to market. And I think as we roll into 2008 which you will probably see something a little bit more in the middle band of our range and above our range for gross margins. So, more in the middle band above 50 to 52 I suppose to above the 52.

Craig Ellis - Citi Investment

Okay, that's helpful. And then lastly for you Scott, it's always helpful to get perspective on expected growth drivers I am wondering if you can take a longer term view and just talk about what you think the key growth drivers will be for '08?

Scott McGregor

We have a lot of growth drivers across our business and I think last year in the Analyst Conference we showed I think 15 different growth drivers and those are still in place. If I had to handicap the various businesses I would guess the top three growth drivers in terms of dollar content for 2008 would probably be Bluetooth, wireless LAN and digital television. I would say those three are looking really strong. We've been surprised in the past where others will come out of the blue and perform really strongly and that's the way it's possible. But based on our projections I'd say those three are very likely to be certainly our top growth drivers going forward.

Craig Ellis - Citi Investment

Okay and then just as a follow-up there any thought on what a reasonable market share expectation is exceeding next year on the baseband side.

Scott McGregor

It's going to still be fairly small single digit probably, well I won't speculate further than that. It will depend how quickly some of our customers can deploy. There's a little bit of uncertainty in terms of how fast they get the models to market, which models are popular ones in terms of the style and so forth and which operators. So that makes a little hard to predict there and we are taking a bit of a conservative view. But I think 2009 is where we are really focused on driving the market share.

Craig Ellis - Citi Investment

Okay. Thanks.

Scott McGregor

I wanted to follow-up back a little bit on the 65 nanometer in terms of cost. It's certainly a cost. It's like almost $1 million when you do a 65 nanometer MOSFET. But that's generally a very positive event for us because it entails a new competitive product coming to market and when we see some of the most competitive products we have out there these 65 nanometer products we have where our competitors haven’t yet moved into 65 nanometers those are looking really strong and we are seeing very strong customer demand for that. So, yeah it's always bad whenever you spend $1 million to do a MOSFET but I would view that as a leading indicator for our future business because it generally means we are reaching a higher level of competitiveness when we get those products out.

Craig Ellis - Citi Investment

Okay. Thanks again.

Operator

Our next question comes from Allen Mishan from CIBC World Markets. Please go ahead.

Allen Mishan - CIBC World Markets

Hi. You mentioned in your talk about the enterprise business that you had heard about, or had seen some potential double ordering in the PC area. Do you worry about the wireless LAN and Bluetooth businesses, that they perhaps, grew too fast and may see a correction in the PC area in Q4?

Scott McGregor

You know that’s always possible and when I hear an anecdotal evidence of some double ordering, I put back from a number of other industry players and also we’ve seen the sale of PC products accelerate fairly rapidly. I do believe there is probably some inventory buildup going on in the PC channels based on those kinds of data. We, first of all, watch that pretty closely, so we plan in our own forecast pretty carefully for the Bluetooth and wireless LAN spaces. So I think we understand that business pretty well and account for that. And also, certainly for Bluetooth, it’s not our largest business for Bluetooth by any means. So, it would not be a major factor on the overall growth there, handsets continue to dominate the PC space for Bluetooth by quite a large margin.

Eric Brandt

We also have some important product cycles going on in the Bluetooth and the Wi-Fi space, so its Bluetooth processor and its 802.11n. So, we have additional drivers in those areas that we don’t have in the Gigabit Ethernet Controller space

Allen Mishan - CIBC World Markets

Okay. Great. And then, did I hear you say earlier that mobile multimedia would actually grow in Q4 versus Q3?

Scott McGregor

Yes. We do expect that area to grow in Q4.

Allen Mishan - CIBC World Markets

Okay. So the product transition effect completely took place during Q2 to Q3?

Eric Brandt

Pretty much. Yes.

Allen Mishan - CIBC World Markets

Okay. Thanks very much.

Operator

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

Srini Pajjuri - Merrill Lynch

Thank you. Hi, Eric, as you look past the current quarter, how should we think about the R&D expense as we look into the next several quarters in 2008?

Eric Brandt

Well, Srini, you know that we don’t provide guidance beyond one quarter. So we should have given you a picture of what we think will happen in Q4 in OpEx, and principally that’s an R&D expenditure. However, what we did say, Scott said and I said, I think is that the way to think about the R&D expenditure is that the discount rate has changed. So while we were investing very heavily in the baseband area and in the mobile phone area trying to win customers, we had now won a number of those customers and are winning others and in other parts of our business as well. So, now we are sort of transitioning that investment from a pure R&D developer product and win a customer to now delivering on that product, putting the field test engineers in place and driving that forward. So, the way to think about the risks is different and so there needs to be continued investments to continue to do that and bring these products to markets and drive the revenue forward, however, the risk profile is substantially different.

I think we’ll continue to invest to do that as Scott mentioned and drive these products to market and the real leverage will come as the revenue appears associated with that, principally in the cellular space and then some of the other spaces as well. So that’s the way we are thinking about the business. Actually, Scott said on the 65 nanometer products, we are thinking very positively that, we we’ve actually made this, we’ve turned the corner quite frankly with respect to the product performance and new products availability. And now we are sort of moving much more, I would say, perhaps into in a development stage or delivery stage of R&D.

Srini Pajjuri - Merrill Lynch

Okay. And then, just one clarification on the royalty payments. I am guessing it will pretty much flow through to the bottom line. Is that a fair statement or is there anything else I am missing here?

Eric Brandt

Well our royalty payment has no by inherence, its inherent cost rather than the fact that we spend a fair amount on the legal side to generate that benefit. But at the end of the day, it does go to the bottom net of what we choose to invest back in the business.

Srini Pajjuri - Merrill Lynch

Okay. And then Scott for you. You just reiterated the target to get to 10% to 15% by I guess end of 2009. My question is, with the announced design wins, do you think you'll get there or you think you need more designs wins to get to the kind of market share?

Scott McGregor

It's certainly possible to get there with the designs wins we have, but we certainly like to have more designs wins and I am working on them, and believe we will get additional design wins beyond the ones announced so far.

Srini Pajjuri - Merrill Lynch

Thank you.

Operator

Our next question comes from Uche Orji from UBS, New York, please go ahead.

Uche Orji - UBS

Hi Scott. Just a question for you, I appreciate you don't want to give guidance for much longer than next quarter, but let me go back a bit to R&D. In your prepared comments you talked about 65 nanometers and small [processor geometries]. But I assume you are doing some work on 45. Is there any point when should be reasonably expect 45 nanometers to be in production from you, and what type of products will there be for?

Scott McGregor

Yeah we are certainly working on 45 nanometers, and we have done test checks so far on 45 nanometers. And I would expect based on the industry roadmaps that 45 nanometers probably doesn't go into production until 2009, sometime in that time frame. So that be probably the best guess for when that would start to see our production ramps.

Operator

Our next question comes from Quinn Bolton from Needham & Company please go ahead.

Quinn Bolton - Needham & Company

This is just for Eric, but first a quick clarification on them. To extent that you do recognize Verizon royalties, you've talked in past about potentially reinvesting some of that back in to the business. I am assuming that any reinvestment you have already included in the OpEx guidance that you gave early on the call?

Eric Brandt

Yeah. For Q4 we've provide you our view of what the OpEx number would be.

Quinn Bolton - Needham & Company

Okay. So, to extent that the royalty that you give us and updated the Analyst Day whatever you gave would pretty much flow through to the bottom line.

Eric Brandt

Yeah that is mathematically correct.

Quinn Bolton - Needham & Company

Okay, great. And then second just on the DTV business. I know you guys sort of nearly doubled in the September quarter right, I might have missed it but was just wondering if you would give us an update what you see sequentially in to December quarter?

Scott McGregor

We don't breakout guidance for particular businesses going forward. So I can't do that. But over the course of the next year we do expect that business to grow as we get additional top tier and second tier design wins in that space. We are bullish on the business overall for growth.

Quinn Bolton - Needham & Company

Can you comment perhaps I mean typically in the business since September is a big quarter, would there be new product ramps either customers or models that might allow you to offset normal seasonality?

Scott McGregor

Yeah, I prefer not to comment on that. We'd like announce those as we get them and the customers are comfortable talking about that.

Quinn Bolton - Needham & Company

Okay. And then lastly just can you talk a little bit about IPTV, I know you've got some new products there, but just sort of any color you can give on IPTV, set-top box [direction]?

Scott McGregor

Well the IP set-top box market does mean a lot of different things to different people, and we've been shipping so far. We've been shipping product into the FiOS network and we've been shipping Linux-based IP set-top boxes for a while. We've also recently announced our 7405 product, which is specifically designed to address the needs of the IPTV set-top box market and I talked about that a little bit.

And I think the key thing is, when you combine those kind of things with MoCA, wireless LAN, Bluetooth, Ethernet etcetera, we think we've got an excellent opportunity in all segments of IP set-top box market, including the Microsoft certified segments.

Operator

And our next question comes from Sumit Dhanda from Banc of America Securities. Please go ahead.

Sumit Dhanda - Banc of America Securities

Yes. Hi Eric. I just wanted to follow up again on your comment regarding maintaining a high level of R&D as a percentage of sales until the design converts to revenue. So is it fair to assume that this is generally going to hang around at this level, until the cellular revenues kick in which is mainly a '09 phenomenon based in what you said in the call today?

Eric Brandt

Yeah, what I would say is that, the way to think about it is that the leverage in the R&D line comes principally from revenue growth. And as the business continues to sort of drive growth forward and grow faster than it has over the last several quarters, you should see some leverage beginning to appear in the R&D line.

But the point we are trying to make is, is that, we've now got these design wins in hand, we now have these customers that we need to serve, and the single worse thing we could do right now is to not provide the support to deliver the products and get the products into the market. So what we are trying to do and we have made some choices in terms of what we are doing in our business. What we are really trying to do is to drive that forward.

So having said, the big revenue ramp that we've been talking about is the cellular space, and as those products and that significant investment in the cellular business and I will more about this on analyst day and explain the economics a little better. But as that investment begins to generate the kind of revenue we believe it will generate, that's when you will really see the R&D line begin to move back towards the targeted range of 20% to 22%.

Operator

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

Seogju Lee - Goldman Sachs

Right. Thanks. Eric, during the quarter at a competitor's conference, you characterized this sort of Verizon royalties as expecting that. You would likely be booking, sort of the quarterly maximums on a quarterly basis. I guess this quarter potentially, there is a bit of a stop because the contracts have closed during third quarter. But, in terms of your understanding of the Verizon phone shipments, has anything changed that you would think differently.

Eric Brandt

No. I think, I wouldn’t think anything is substantially different. You are right that this quarter is a stop period, so we don’t know. There is certainly a seasonal aspect to cell phones, as you have said of the holiday season. So there could be some little bit of swing between, sort of heading in the front part of the year, versus the back part of the year. But to be honest with you, we don’t sell cell phones. So I don’t know for sure. But given what their total number of cell phones were, we expected that we would probably hit to catch across the quarters in ’08.

Operator

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

Shawn Webster - J.P. Morgan

Yeah. Good afternoon. Thank you for taking my question. Can you, I hate to keep beating up on the OpEx thing, but can you define invest aggressively as we go forward, should we expect $10 million to $20 million kinds of R&D growth or do you have any kind of initiative to maybe stop the inflow of headcount?

Eric Brandt

Yeah. I would say, we are on the process of sort of going through our budgeting process now, and really beginning to prioritize is what we are doing. I can’t give you specific numbers quarter-to-quarter, as we go forward. But suffice is to say that we are aware in cognizant of the burn associated with the operating expense. And are doing what we can to manage that while still delivering on the commitments we have got for our customers.

You know, in some respect, and I think Scott’s tried to sort convey this and I will reiterate the point that he made, which is, we are winning a lot of design wins out there. And if anything, we are trying very hard to make sure that we have right resources to deliver on those commitments, and are very excited about the up, the revenue side of the business. So, that’s the message we are trying to convey to you.

Having said that, I think we are much more dollar-focused, we are much more portfolio-focused, and trying very hard to make sure that we maximize the opportunity dollar, and the opportunity benefit for every dollar in R&D investments.

Scott McGregor

Yeah. Let me comment on that a little bit. I think it's a fair question to be beat us up on OpEx, because our R&D number is certainly running higher than model. We are running about 27% and our model is 20% to 22%, and we are very cognizant of the overage there and its effect on earnings per share. There’s different kinds of R&D, there is the R&D where you invest and you create a product and you hope that somebody will buy it, and that’s what's traditionally done in the semiconductor industry.

Broadcom is often in a situation, where we win a design and then on the basis on that design win, we go create the chip for that customer, which then sells a lot. And a lot of this is in that latter category, which for me is a lower risk category, and as Eric would probably say has lower hurdle rate, which you would assigned to that as a result. And so when we have these situations and we are winning designs, we have a choice, we say well, let’s tell the customer no, and not hire to people and get closer to our model R&D or let’s hire to people, go fulfill the design with the customer and then get the revenue down the road a year or so.

And I think that’s the dilemma we face, and our belief is that we want to invest in the long-term value for the shareholders. And we think the right answer here is when you get these designs, you should go for it and you should go deliver on them. So that’s the basis that’s what going on here.

I apologize we can’t share all of the design wins and some of other things that we have won here that underscore and underlie this investment, but we hope to do that. You have seen the Samsung and Nokia announcements so far. We believe there will be more over the course here, that hopefully will give you a little more confidence that we are investing in the right kinds of things. And we'll try and refine that a little bit at Analyst Day and give you more of a feel for that.

Operator

Okay. (Operator Instructions). Our next question comes from Tim Luke from Lehman Brothers, please go ahead.

Tim Luke - Lehman Brothers

Thanks so much. Eric you mentioned in the third quarter of the R&D was a little high higher than you expected, partially reflecting some of the litigation cost. Is that where litigation expenses largely reside, and is there any framework you gave us for how much that’s impacting that expense line? And may be separately just with respect to Verizon, is there as you move forward this outline date that you suggested with Santa Ana, is there anything in that, that impacts the recognizing of revenue from Verizon as you go through the next several quarters?

Eric Brandt

Well Tim let me start with the first one. I apologize if it wasn't clear. What I felt was that we were $10 million above the range, half of that was driven by R&D and the other half by legal. Legal is in the SG&A line actually it's in the [SG&A] line. And the right way to think about it is just look at the SG&A percentage. I mean between last quarter and this quarter it's down a percentage a tenth of a point so marginally.

But between last year and this year it's down from 9.7 and 9.2. So we continue to get leverage in that line. In fact the greatest investment in the company in the SG&A line has been in the S part of that line, subject to sort of puts and takes and swings in the legal cost, depending whether cases are on trial or not which when they are at their highest cost. So one of the issues that we had, we actually we had a number of court appearances over the past quarter in Q3 and that sort of drove some of the costs in the SG&A line, so that's part of it. The second piece of it is with respect to Santa Ana we have assigned contracts with Verizon, really what we are just waiting for is to find out what the number is from them. They certainly have their ability as we mentioned in the 8-K under certain circumstance determinant contract but we have no reason to believe at this point in time that that's in they are contemplating at.

Operator

Our next question comes from Adam Benjamin from Jefferies & Company. Please go ahead.

Adam Benjamin - Jefferies & Company

Thanks. Just to continue this cellular theme. You guys have been investing pretty significantly on the R&D side obviously to get the wins that you've achieved now with Nokia and Samsung. Now that you have got those and obviously you are going to have more going forward can we expect there to be a shift from the R&D investment to the SG&A as you add FAE engineers going forward and then in term to that if there is a shift can you quantify the investment in terms of what you've done so far and what you expect to continue invest in '08 in '09 in terms of a percentage rate or whether that should start declining as the majority of the investment has been made or some percentage there to give us some ideas to where you stand on that front?

Eric Brandt

Yeah, that's fair. I would say that the phase were in of course as you point out as first win the designs and then you actually have to deploy on them and what not. And that does increase the number of FAEs we have and also people who do various kinds of adoption for the phones and customization and helping the customers get the things done. That is relatively easier from an R&D point of view than the other aspects, still very-very important of course but it’s a little easier to find some of the people who do that. We want to keep our standard high but we'll continue to invest more in those areas, we think we're in a very good shape on the technology point of view. As you can see now we've pretty much announced every chip in the cell phone and every capability in the cell phone except for perhaps standalone memory. And so, I think we are definitely at a critical math on the raw technology side and so the R&D investments going forward are to help our customers to deploy different phones. FAEs are accounted as R&D for us and so that wouldn’t increase the SG&A. So, the increase is again pretty much in there. We are running at about 27% now and I think that's probably the highest we would go on a percentage basis. I don’t expect much more than that and then as we get more revenue then it would start to come down.

Operator

Our next question comes from Krishna Shankar from JMP Securities. Please go ahead.

Krishna Shankar - JMP Securities

Yes. I was wondering if you could -- I am trying to think about the royalty stream and how we should be sizing that for 2008 and what happens to the royalty stream in case you reach an agreement with QUALCOMM?

Eric Brandt

Well I think it's premature to sort of discuss that. Let's see what happens with respect to QUALCOMM because I don’t want to speculate one way or the other. When we have something to say about that we will. At this point we just have the relationship with Verizon. Can I just make a comment on what Scott mentioned on the R&D side? We will continue to invest to the extent there is some seasonal effect in the first half of the year relative to some of the consumer oriented products. You could see some movement up on a percentage in first part of the year which will then come back down as the year progress sort of on the consumer side pick up in the back half of the year.

Operator

Okay. Our next question comes from Shaw Wu from American Technology. Please go ahead.

Shaw Wu - American Technology

Yes, just a little more color on your digital TV business. You mentioned that the business doubled. I was just wondering if that was spread across your various OEMs? Or was it that concentrated towards one or two or any comment on ramping of new ones there. Thanks.

Scott McGregor

It’s spread across a number of OEMs. It’s not concentrated in any one particular OEM, to answer your question there. We have announced and in the market today, we have LG, and Sharp and Haier and some of the other Chinese based customers. So, that’s what we have announced in the market today and we do expect new customers there over the course of the next year.

Operator

Our next question comes from Daniel Berenbaum from Carris and Company. Please go ahead.

Daniel Berenbaum - Carris and Company

Yeah. Hi, thanks for taking my call. I need a follow-up on a couple of questions ago. We talked about R&D maybe going up as a percentage of revenue in the first half due to normal seasonality. Can you really help us to understand what normal seasonality is for your businesses and what piece of your business, or what percentage of your business is affected by seasonality versus your new product cycle?

Eric Brandt

Most of it is new product cycle. I think that as we have seen strength, and growth and new products in consumer oriented products, which you go into the holiday season, you naturally get a pickup in those businesses. I think as Peter has mentioned repeatedly, much of the capital equipments components of our business like what you would find in the broadband business, or in the enterprise networking business, capital equivalent tends to be a little bit stronger in the front half of the year. I think what we are seeing is, given the strength and the new product cycle, we have seen in wireless LAN and Bluetooth, and things have sort of like PCs, cell phones and those sorts of things. I think we are just being prudently cautious relative to the strength of Q4 vis-à-vis sort of the front half of next year.

Operator

Our next question comes from John Dryden from Charter Equity. Please go ahead.

John Dryden - Charter Equity

Yeah. So a question for Eric. Could you just update us on the hubbing arrangements during the quarter, and did that play out as you expected, with any quarter readjustments or any increase in overall inventory. And then, question for Scott, if you could just update us on the 43/25, any customer sampling feedback based on the quarter’s success you had in Bluetooth plus FM?

Eric Brandt

I think on the hubbing side, we are proceeding as we projected, I think we are managing it well, I think our ops team does a tremendous job in terms of managing our inventory and projecting those sorts of things. So, I think we have done quite well and in fact some of the growth in the actual inventory dollars was in the face of product ramp growth and the growth we saw in this quarter and potentially in the next quarter as well as some tenders that we went after etcetera.

Having said that, I think that it is possible that you could see some impact from hubbing. However, we’ve been operating well above our range on inventory at 8.5 times. So I think we feel comfortable that the 7/8 times is quite achievable even in the face of these hubbing arrangements.

Scott McGregor

In regard to your question on the 43/25, we have seen very-very strong customer enthusiasm for the 43/25. There is nothing else like it in the market. And I think it's been a game changer in that, in the past many of our customers were thinking about separately buying Bluetooth or wireless LAN. And they have now moved to think of combo as a category and to look for that as a preferred way to get Bluetooth and wireless LAN, if they want both of those in the same devise. We are seeing a lot of interest, especially in the cell phone handset makers as you would expect, but also in the various MP3 customers as well. If sampling today a number of customers are designing in it as we speak. I feel, you really going to start see a revenue contribution for that starting in 2008.

Eric Brandt

We are actually seeing a pretty a normal supply situation there. There are always spot shortages and ease in other places. I don’t see any unusual situation in the market right now, over the long-term we are able to get both the front-end and back-end resources that we need and don’t foresee any problems or issues with deliver on our revenue as a result of that.

Operator

There is time for one more question, the final question comes from David Wu from Global Crown Capital. Please go ahead.

David Wu - Global Crown Capital

Sneaking underway, thanks for taking may call. I just want some clarification on the gross margin issue and also given that on a gross margin you were also talking about the going into calendar '08 in the 50% to 52% pro forma gross margin range and I wonder would that had us included those the royalty income from Verizon in that guidance. And on GIG-E do you see any growth in calendar '08 on the enterprise segment and when should we expect any revenue contribution from 10 gig at least for the switch side?

Eric Brandt

Just to answer your question quickly the gross margin comment I made does not reflect Verizon we are focused on product oriented gross margin which was what the basis of my comment was.

Scott McGregor

On your GIG-E question yes we do see growth as we see the gig penetration in the enterprise space continued goal of 48% to 66% for some of the analyst forecast out there. In terms of 10 gig switch was started if some of that coming out over the next few quarters and that'll certainly increase starting from a fairly small base but eventually that'll become a significant part of business more likely in 2009.

Eric Brandt

Okay I'd like to conclude now, I'd like to thank everyone for joining us on the call this afternoon and then just one more reminder on November 8th we'll be hosting our 2007 Analyst Day in San Francisco looking forward to seeing everyone there. Thank you very much for joining us today and good afternoon.

Operator

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

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