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Executives

Chris Zegarelli - Director of Investor Relations

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

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

Analysts

Harlan Sur - JP Morgan Chase & Co, Research Division

Ross Seymore - Deutsche Bank AG, Research Division

John Pitzer - Crédit Suisse AG, Research Division

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

Uche X. Orji - UBS Investment Bank, Research Division

Glen Yeung - Citigroup Inc, Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

James Schneider - Goldman Sachs Group Inc., Research Division

Christopher J. Muse - Barclays Capital, Research Division

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

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

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

Sumit Dhanda - ISI Group Inc., Research Division

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

Ambrish Srivastava - BMO Capital Markets U.S.

Daniel A. Berenbaum - MKM Partners LLC, Research Division

Raj Seth - Cowen and Company, LLC, Research Division

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

Doug Freedman - RBC Capital Markets, LLC, Research Division

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

Broadcom (BRCM) Q1 2012 Earnings Call May 1, 2012 4:45 PM ET

Operator

Welcome to the Broadcom First Quarter Earnings Call. My name is Jackie, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. And I will now turn the call over to Mr. Chris Zegarelli. Mr. Zegarelli, you may begin.

Chris Zegarelli

Thank you very much, Jackie, and good afternoon, everyone. Today's call will include prepared remarks by Scott McGregor, our President and Chief Executive Officer; and Eric Brandt, our Executive Vice President and Chief Financial Officer.

This call will include forward-looking statements that involve risks and uncertainties that could cause Broadcom's results to differ materially from management's current expectations. We encourage you to review the cautionary statements and risk factors contained in the earnings release and our 10-Q, which were furnished and filed respectively with the SEC today and are available on our website.

We undertake no obligation to revise or update publicly any forward-looking statement to reflect future events or circumstances. Additionally, throughout this call, we will be discussing certain non-GAAP financial measures, today's earnings release and the related current report on Form 8-K describing the differences between our non-GAAP and GAAP reporting and present a reconciliation between the 2 for the periods reported in the release.

Please also see the Investors section of our website at www.broadcom.com/investors for a slide deck that includes additional information disclosed in accordance with SEC Regulation G.

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

Scott A. McGregor

Good afternoon, and thanks for joining us today. Broadcom delivered solid Q1 results in addition to successfully completing the acquisition of NetLogic Microsystems in February. Q1 total revenue was $1.83 billion. Excluding NetLogic, revenue would have been $1.79 billion, which is at the high end of the guided range and ahead of mix-adjusted seasonality for our business.

We also reported stronger earnings and gross margins than we anticipated due to solid product cost improvements and expense discipline. We're off to a strong start in 2012.

We have many exciting business updates to talk about later today. We've extended our lead in 5G Wi-Fi, and we've seen solid growth in 3G basebands and Wi-Fi combos. We introduced new broadband platforms for international and developed markets and also meaningfully expanded the addressable market for our infrastructure solutions. These accomplishments led to record design wins across all 3 segments in Q1, which is an important sign of strength for our business.

Before we get into specific updates, I'll turn the call over to Eric for a discussion of first quarter results and second quarter guidance. Eric?

Eric K. Brandt

Thanks, Scott. Given the mid-quarter closure of the NetLogic acquisition and our guidance -- and that our guidance in January did not reflect it, we will provide a little more color on the revenue contribution of NetLogic. Please note that we do not anticipate breaking out this information in the future. As Chris mentioned, please refer to the data breakout in the Investors section of our website for additional financial information that will supplement my financial commentary.

Moving to the financial overview, to summarize for Q1, total revenue of $1.83 billion; total product revenue of $1.77 billion, including $33 million from NetLogic; Q1 total net revenue, excluding NetLogic, was down 1.4% sequentially and down 1.2% from prior year levels. Q1 non-GAAP product gross margin was up 150 basis points from Q4 to 52%; Q1 GAAP product gross margin was 48.1%; Q1 non-GAAP and GAAP R&D plus SG&A expenses were up $54 million and $89 million, respectively, from Q4 levels; Q1 non-GAAP EPS was $0.65 per share or $0.10 above first call consensus of $0.55; Q1 GAAP EPS was $0.15, including $0.13 of acquisition-related charges and $0.12 of onetime adjustments outlined in our earnings release; cash flow from operations for Q1 was $368 million; our cash and marketable securities balance at the end of the quarter was $2.1 billion.

Moving to revenue and gross margin. In January, we said we expected Q1 total net revenue to be between $1.7 billion and $1.8 billion. Excluding NetLogic, we delivered revenue near the top end of that range. Total net revenue ended at $1.83 billion, of which NetLogic contributed $33 million. On a standalone basis, NetLogic total revenue for the first quarter of 2012 would have been $83 million, meaning $50 million pre-acquisition period revenue was not recorded in Broadcom's financial statements.

As anticipated, our Broadband Communications segment was down 3% from Q4, which was better than our normal Q1 seasonal decrease in demand for broadband. Our Mobile & Wireless segments was flat sequentially from Q4 as strength in 3G, basebands and Wi-Fi combos was offset by anticipated softness in 2G baseband and multimedia coprocessors.

Including NetLogic, revenue from our Infrastructure & Networking segment increased 6% sequentially. Excluding NetLogic, this segment was down 3% due to a weakness in the service provider market and a decrease in our controller products.

Our Q1 non-GAAP product gross margin was up 150 basis points to 52%. This was better than our expectations of roughly flat, driven principally by lower costs and a decrease in the E&O provision during the quarter. Our Q1 GAAP product gross margin was 48.1%, driven primarily by an increase in acquisition-related charges of roughly $45 million.

Moving to operating expenses. Total non-GAAP R&D plus SG&A expenses for Q1 were up $54 million from Q4 levels, including NetLogic, which is favorable to the guidance provided in January, principally driven by lower employee costs and lower-than-expected legal fees in the quarter. On a GAAP basis, R&D and SG&A expenses for Q1 were $89 million, up from Q4 levels, approximately $24 million related to the NetLogic stock-based compensation assumed in the quarter.

During the quarter, we recorded settlement costs of $86 million related to patent infringement claims, as well as an impairment of acquisition intangibles of $28 million. We also recorded a onetime non-cash benefit for income taxes of roughly $46 million related to the purchase price accounting associated with the NetLogic transaction. These items are discussed in more detail in our Form 10-Q filed today.

Moving to the balance sheet. As I mentioned earlier, cash flow from operations was $368 million for Q1. Cash and marketable securities ended Q1 at $2.1 billion. This reflects the net cash payment for NetLogic of $3.4 billion and our quarterly dividend payment of $55 million. Our accounts receivable days sales outstanding was 38 days in Q1. In addition, net inventory levels increased $54 million from Q4 resulting in 7.7 turns in Q1.

Moving to expectations. We currently expect net revenue in Q2 to be roughly $1.9 billion to $2 billion. Sequential revenue for our Broadband Communications and Infrastructure & Networking segment are expected to be up in Q1, while our Mobile & Wireless sales are expected to be roughly flat. We expect Q2 non-GAAP product gross margins to remain roughly flat versus Q1. We expect non-GAAP R&D and SG&A expenses in Q2 to increase by approximately $35 million to $50 million, of which $35 million comes from the full quarter impact of our annual merit increase and operating expenses from our NetLogic and BroadLight acquisitions. Meaning, Broadcom organic expenses are projected to be flat to up $15 million. In addition, stock-based compensation should decrease by $5 million to $10 million.

Finally, despite meaningful revenue estimate revisions to the industry and NetLogic peers since September, much of which, NetLogic experienced as well. We currently estimate accretion on a non-GAAP basis for full year 2012 to be between $0.07 and $0.08 per share, helped by improved cost synergies and favorable financing.

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

Scott A. McGregor

Thanks, Eric. Starting with the Home Platform, our Broadband Communications revenue decreased 3% sequentially, which is ahead of our normal Q1 seasonal decline in this segment, driven by strength in sales of broadband access solutions. We continue to see solid growth opportunities for our portfolio of broadband products outside of North America. During the quarter, we announced several partnerships in China to deploy Ethernet over Coax, which unites PON and DOCSIS to enable service providers to deploy cost-effective triple play services. We also introduced our latest generation of entry-level cable set-top box platforms to fuel the global migration to HD.

In developed markets, we see network set-top box and personal content viewing via tablets and smartphones, driving demand for next-generation features. During the quarter, we introduced the industry's first platform enabling secure convergence of pay TV and Internet applications for hybrid gateways. We also announced NAGRA certification for our latest 40 nanometer set-top box platforms, enabling secure delivery of premium content and services to multiple TVs in the home. Our MoCA attach rate continues to rise as customers roll out next-generation network set-top boxes in hybrid gateways.

We also announced the acquisition of BroadLight, a provider of highly integrated end-to-end GPON solutions. BroadLight's solid engineering team will extend our successful broadband access business in the fastest-growing segment, which is PON. Over the next few years, PON subscriber growth is forecast to the above 20% per year. Broadcom is now strongly positioned to offer service providers complete solutions across the access spectrum from DSL to cable to PON. The BroadLight acquisition closed in April, and we'll include it in our Q2 results. We expect revenue from our Broadband Communications business to be up in Q2, driven by strength in our IP set-top box and broadband access portfolios.

Moving to Infrastructure, our Infrastructure & Networking business was up 6% sequentially in Q1. Excluding the $33 million revenue contribution from NetLogic, this segment was down 3% sequentially, better than most of our peers. Softness in the quarter was due to reduced demand for service provider products, partially offset by strength in data center solutions.

On a full quarter basis, NetLogic's processor revenue grew sequentially in Q1. The acquisition of NetLogic more than doubles our addressable market in infrastructure, while being accretive to non-GAAP gross margins. We're excited about the combination and the integration is off to a great start. NetLogic employees are actively collaborating with their Broadcom colleagues, and they've jointly completed multiple tape outs, including one in 28 nanometers. I'm also pleased to report that as of this morning, the NetLogic business has completed the transition to our administrative systems.

Over the last few months, we meaningfully expanded our footprint in the service provider market by announcing several powerful new products, including a small cell backhaul switch that integrates up to 4 components to drive down system cost and power consumption for next-generation LTE networks; a highly-integrated microwave RF chip, which doubles our addressable market in microwave radios; and the industry's first fully programmable 100 gigabit per second full duplex network processor that delivers more than twice the throughput of any other network processor on the market today.

This week, we also made 2 important announcements: the world's highest density scalable 100-Gigabit Ethernet switching solution, which enables the design of switching platforms with densities up to 4,100 gigabit Ethernet ports for data center and service provider applications. We also announced our next-generation high-performance stackable enterprise switches with integrated application level visibility and mobility features.

In the data center, our customers started shipping the latest generation of Romley servers, using Broadcom 10-Gig controllers. We expect to see continued strong demand for 10-gig, 40-gig and now 100-gig switching products throughout the data center, which is a multi-year secular trend for our infrastructure business.

Looking into Q2, we expect our infrastructure revenues to be up, driven by a full quarter of NetLogic and broad strength in Ethernet Switches and FI's [ph], particularly in the service provider and data center markets.

Moving to our Hand Platform, our Mobile & Wireless segment was flat sequentially from Q4, ahead of both seasonality and guidance, driven by strong performance in 3G basebands and Wi-Fi combos. Strength in 3G basebands drove both 3G volume and revenue to crossover 2G in the first quarter, which is ahead of our prior expectations.

Broadcom extended its leadership in 5G Wi-Fi. We were the first to sample in Q4 2011, we were the first announce it at CES in January, the first the demonstrate it over the air, and we were the first to ship production volume to lead customers. Last week, Netgear announced the industry's first 5G Wi-Fi router, powered by Broadcom and available later this month. We are pleased to see 5G Wi-Fi coming to market even earlier than we anticipated and even more pleased to see growth in our ecosystem as we deliver real innovation to the market.

We also broadened our 5G Wi-Fi portfolio in Q1 by introducing solutions for enterprise, cloud, network and carrier customers. We expect to see wide adoption as 5G Wi-Fi is 3x faster, twice the range and 6x more power-efficient than its predecessor. We believe we're 2 to 3 quarters ahead of our competition and look forward to seeing this technology ramp into a broad range of products over the course of the next year.

Finally, we see continued momentum around our NFC solutions. Since we announced our tag and reader solutions for smartphones, we have won numerous designs, have received production orders, and we expect to ship to lead customers this quarter. We expect Mobile & Wireless revenue to be roughly flat sequentially in Q2. Our 2G baseband and multimedia coprocessor business will be soft in Q2, without which, our Mobile & Wireless business would be up sequentially.

In summary, we see strength across our portfolio in both near-term demand and longer-term design win traction. We are seeing solid growth in 3G, which now represents the majority of our baseband business. We see a broadband business fueled by subscriber growth in international markets and network set-top boxes in developed markets. We see an infrastructure business that can now serve a much larger addressable market. Broadcom has a strong and broad communications portfolio, and our record design wins in Q1 demonstrate that customers continue to value our ability to lead with innovation.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Harlan Sur with JPMorgan.

Harlan Sur - JP Morgan Chase & Co, Research Division

Within your Mobile & Wireless division, in Q2, Scott, can you just give us a little bit more detail about the moving pieces? So you said that excluding the 2G ramp and -- 2G ramp down and multimedia coprocessor decline, are your -- within that, are your 3G baseband processors and combo solutions both going to grow in Q2?

Scott A. McGregor

Yes, we -- let me put a little more color on that. We originally said that we expected 3G to cross over 2G some time mid-year of this year. And instead, what we saw is considerable strength in our 3G baseband business, and they crossed over in the first quarter. We do expect them to continue to grow in the second quarter. So that's one of our growth drivers in the second quarter. We still see some softness in our 2G business, and we expect that to continue to decline over the course of the year. But I think after the second quarter, the headwinds are pretty much gone, and we don't expect to see headwinds in Q3 or Q4. With some customers, for example, like Samsung, we're primarily 3G today. At Nokia, we're 100% 2G, and at this point, we don't expect material revenue from Nokia 3G this year. We expect that will be a 2013 event at this point.

Harlan Sur - JP Morgan Chase & Co, Research Division

Okay, great. And can you just talk about, at a high-level, customer and channel inventories exiting the first quarter in your 3 segments, and then just give us a sense in terms of how much of the growth you're seeing in Q2 is the inventory replenishment versus end demand pull and/or new product ramps?

Scott A. McGregor

I think inventories are generally in pretty good shape. You can see that we exited Q1 with 7.7 turns. So our inventory is in incredibly good shape and if anything, we'd probably like to even increase it a little to have more parts on hand. We do have customers, in some cases, still having a little bit of inventory they need to work down. But in many other cases, and becoming more common, we have customers expediting parts and trying to pull in orders. So I'd say it's a fairly normal inventory situation at this point. We see some customers with more or less, but looks pretty normal. I don't think it's driven so much by inventory replenishment, but more natural demand that we're seeing from customers.

Operator

Our next question comes from Ross Seymore with Deutsche Bank.

Ross Seymore - Deutsche Bank AG, Research Division

On the baseband side of the business, and even to a certain extent on the connectivity side, one of your competitors has made a lot of noise with their fully integrated solution that they're having a little bit of difficulty manufacturing now. What impact does that lack of ability to manufacture having on your business? Is that opening up opportunities? What sort of threats are you seeing or even opportunities you're seeing on the combo and baseband side of things?

Scott A. McGregor

Well, first of all, I have to comment that the fully integrated solution doesn't use any fewer chips than our solution. So that's more of a marketing phrase than I think a reality out there. But anyway, we have heard rumors from customers that they are struggling with manufacturer of that part and a little hard to determine whether it's a allocation issue, or whether it's a product issue or other things. We hear various rumors along those lines. But I think one of the messages that's clearly come out is that customers are hesitant to bet on Qualcomm that has not worked well as a strategy for those who put all their eggs in one basket, which is very favorable for us. So I'd say we're seeing much more interest from customers, especially as we get our own more advanced 3G and 4G solutions better to market. So I'd say, overall, we see an improving interest in customers, in our products and contributing to design wins going forward.

Ross Seymore - Deutsche Bank AG, Research Division

Great. And then as my one follow up, on the gross margin side of things, Eric, you guys had a nice beat to the upside in the first quarter. Your guidance for flat in the second quarter, can you go through a little bit of the puts and takes there? Because from the end market mix and your growth drivers on the revenue side, it seems like mix would be a positive.

Eric K. Brandt

It actually is, Ross. Half -- so we guided flat. We were up 150 basis points. Roughly half of that is standard margin, and roughly the other half of that is what I'll call other cost of sales, principally a release on the E&O line. We don't forecast that as an ongoing trend. So if you think about it and you assume that, that reverts back the way it was, then really, the underlying gross margin was up about half of that 150 basis points. And going into Q2, it's up the other half of that 150 basis points on the flat guide given that we've sort of reversed the benefit -- or in our forecast of that E&O side. Now we don't know. We just -- that's just the way we forecast it. In addition, there's another -- there's a couple of other headwinds on the other cost of sales like picking up some additional royalties from patent trolls and things like that from some of the settlements we've got. But fundamentally, the margin trend is favorable as I mentioned last quarter, and we are cautiously optimistic as that goes across the year.

Operator

Our next question comes from John Pitzer with Credit Suisse.

John Pitzer - Crédit Suisse AG, Research Division

Scott, you mentioned that the June quarter would be sort of a lap of the headwind on the 2G business. I'm wondering if you could help us just size that business as a percent of the overall Hand business today? And kind of your comfort level that June is sort of the maximum headwind in that business? If you'd give some color, that'd be great.

Scott A. McGregor

Sure, I can. And we think of the legacy business as both the 2G baseband and the multimedia coprocessors. And they did decline meaningfully in Q1, and we expect them to decline again in Q2. By the time we get to Q2, the total amount of those businesses will be low tens of millions. And so we expect them to still decline over the course of the year, but it won't be meaningful in our overall numbers and don't expect it to really provide a headwind. They'll decline eventually to 0 over the course of the year into the first part of next year. But again, just the magnitude of them is small enough that it won't provide the headwind. And because they're relatively small in magnitude, that gives us the confidence that the headwind will abate. We're not just sort of hoping they hold up. It's really that they're small, and so, are dwarfed by the numbers that we see for the 3G business.

John Pitzer - Crédit Suisse AG, Research Division

And then, Scott, as a follow up, just on the 802.11ac portion of your business, wondering if you can kind of give some expectations as how you see this product cycle ramp relative to the end product cycle ramp? Do you think this is going to be slower, quicker and...

Scott A. McGregor

Slower or quicker compared to what?

John Pitzer - Crédit Suisse AG, Research Division

The 802.11n.

Scott A. McGregor

To 802.11n. Thank you. I'd say it'll be probably a little bit faster. Unlike 802.11n, the infrastructure part typically leads. People want to have base stations before they connect the clients. So for us, the announcement of the Netgear client that will ship this month is very important. We see a number of other customers also launching quickly. So we believe the infrastructure will be out there pretty quickly. We expect clients -- you could begin to see those towards the latter part of this year, but that's mostly a next year event. Think of it this year, for infrastructure; next year, for clients. That's typical with 802.11. But we think that this is a pretty compelling solution, just in terms of the kind of performance improvements you get. So expect it to go fairly quickly with the infrastructure in place.

Operator

Our next question comes from Romit Shah with Nomura.

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

Guys, you mentioned that NetLogic contributed about $33 million in Q1. I was hoping you could break it out for us in Q2 so we can get a better sense of how the business is performing on an organic basis.

Eric K. Brandt

So again, NetLogic was $33 million on our P&L in Q1 and $50 million in the pre-acquisition period. For cumulative Q1 for NetLogic of $83 million in Q1. We won't break it out in much more detail, Romit. What I will tell you is, the growth rate sequentially of NetLogic Q1 to Q2 is consistent with the guidance we provided for the overall corporation.

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

Okay, that's helpful, Eric. And then, Scott, just on baseband, I understand there's some puts and takes with 3G and 2G. But overall, do you expect the Baseband business to grow this year?

Scott A. McGregor

We're pretty happy with the 3G business that we've seen, and I think it's quite likely at this point that it will grow. It's a little hard to predict how popular some of the models will be, and so I'm not committing to that. But I think, certainly, versus prior calls and conversations we've had, I think things are looking rosier for our 3G business. We've got a lot of good design wins. Our customers are getting good traction with the products, they're selling well, they look good. We're seeing good traction on future products. So I'm feeling significantly better about our 3G business.

Operator

Our next question comes from Uche Orji with UBS.

Uche X. Orji - UBS Investment Bank, Research Division

Scott, maybe just ask you about some of the foundry-related issues that you discussed a little bit earlier in one of the questions. What is your roadmap for 28 nanometers in terms of products? Have you announced any plans for products at that load? And as GSMC has alluded to capacity issues on that node, is that in any way influencing 40 nanometers or 65, any products you have there in terms of how much you're having to pay for that?

Scott A. McGregor

So we definitely have a roadmap on 28-nanometers. And, by and large, we chose to use what's called the HPM process, which came out a little later than some of the processes that other people are using. But we waited because the HPM process tends to have a better figure of merit than the HP or the Poly/SiON processes that some of our competitors are using. So when we do come out with 28-nanometer products, they should have better specs, better power performance and whatnot. We have already taped out a number of 28-nanometer chips. We believe we'll see some 28-nanometer revenue this year, but it will be relatively immaterial. Primarily our revenue is on 65 nanometer moving to 40-nanometer. Most of our tape-outs are still 40-nanometer. And next year, you'll start to see the 28-nanometer revenue ramp, but it will still be a minority of our business. And so we are less subject to some of the initial ramp problems that some of our competitors have had with 28-nanometer in some of the foundries. We do see that 40-nanometer and 28-nanometer, often used on shared equipment, which drives a little bit of tightness in the 40 nanometer side of the business as people look to get 28-nanometer capacity. But we don't see that as impacting our business. We've been able to get the wafers we need by and large because we have excellent relationships with our foundry partners. And so for us, access to wafers or pricing or other terms have not been a limiting factor for our business right now.

Uche X. Orji - UBS Investment Bank, Research Division

Fantastic. Let me ask you a different question. As I look at some of the comments provided by some of your customers in the wireline segments, generally, the results have been actually not very positive in terms of some of the comments we've heard. As you look at the NetLogic business and, of course, as you expand your service provider business, what is your sense as to when, in aggregate, spending will resume? and in trying to answer that, if you can also provide some additional color as to what's happening now in terms of spending and what you think will happen as the year progresses?

Scott A. McGregor

Absolutely. In my prepared remarks, I did talk about service provider revenues being weak and certainly, a number of our peers have seen the same thing. We do see those stabilizing, and I think it does have some regional variation. I think certainly China came in weaker than expected, but anecdotally, that's said to improve. I think recent press releases from 2 of the largest service providers in North America recently have talked to increased capital spending as they rollout a variety of their both wireline, as well as wireless infrastructure. So we do see service providers stabilizing and believe that will be an improving trend over the course of the year, where it has been weak for the last couple of quarters.

Operator

Our next question comes from Glen Yeung with Citi.

Glen Yeung - Citigroup Inc, Research Division

Actually, the first question is a clarification on 3G. If 2G is dropping to double digits, is 3G now or very close to triple digit revenues? And is that coming from -- I hear you when you say share gain, but is it coming from share gains specifically within Samsung? Do you see it there as well?

Scott A. McGregor

I'm a little reluctant to break things out in quite the detail you're looking. But let me try to be helpful. We see the 3G business as not just a little bit bigger than the 2G, but significantly bigger than the 2G business at this point. So it will be the predominant driver for us going forward, which also reflects on the headwind comments I made before so -- which I think is a very good trend. And again, we were expecting originally that would happen sometime mid-year and to have it happen in the first quarter is very positive news. In terms of customers, Samsung is certainly our largest customer for 3G basebands, but we do have other customers and we expect to grow across all of our customers and add a few new customers over the course of the year.

Operator

Our next question comes from Vivek Arya with Bank of America.

Vivek Arya - BofA Merrill Lynch, Research Division

Scott, I have 2 questions. First is when you say baseband, I think in the past year, you have referred to it as cellular. So is it baseband standalone? Is it the integrated part with apps processor? Because I was under the impression you are selling an integrated part. And if I'm right about the integrated part, do you see growth in 3G as being on that integrated part, or on the standalone baseband, or both?

Scott A. McGregor

So, I said baseband and use that for short [ph] . We only sell integrated devices. So every single one of our basebands comes with application processors. And so, when we sell a baseband chip, it includes sufficient application processors that they don't need to buy one from anyone else. So that is our strategy going forward. And in fact, frankly, I believe that the concept of a standalone baseband chip is pretty much obsolete over the next couple of years, and people will largely buy an integrated SoCs that cover the combination of baseband and application processor and some other functions, certainly, some of the graphics. And we can debate about how much else it includes. But certainly, those pieces, I think, will become very, very popular to be integrated. And so the answer to your question is, yes, that's an integrated baseband plus application processor that completes the need for those functions for those customers. And it also includes a graphics processor and in many cases, an image processor that handles all of the camera aspects as well.

Operator

Our next question comes from James Schneider with Goldman Sachs.

James Schneider - Goldman Sachs Group Inc., Research Division

I was wondering if you could talk a little bit about the opportunity for your discrete Wi-Fi sales in 2012. I know that's not been a huge contributor previously, but with the 5G Wi-Fi rolling out, do you expect that could be a material contributor to sales by the end of this year? And maybe if you can give some metrics in terms of what share you might be able to achieve, that will be helpful.

Scott A. McGregor

Well, we certainly sell both Wi-Fi in combos and Wi-Fi discrete. And for example some of our cellular customers will buy an integrated Bluetooth FM and FC combination or something like that to put a Wi-Fi as a discrete to go along with it. And one of the reasons customers do that is because they want to have different SKUs, and they want to have like a low-end Wi-Fi, a mid-range Wi-Fi and a high-end Wi-Fi. And by -- because all of our software is compatible and we provide a really broad solution for customers. Many of them do choose to do Wi-Fi. Also, we have a number of customers like automotive customers or other things where a discrete Wi-Fi makes sense for the kind of product they want to ship. So we very much have both, a combo business and a Wi-Fi business. That being said, the combo business is larger than our discrete business, but we do expect good growth opportunities in both.

Operator

Our next question comes from C.J. Muse with Barclays.

Christopher J. Muse - Barclays Capital, Research Division

I guess Scott, I was hoping to probe your vision for what the ramp for a combo chip will look like in the second half? Considering the product cycles that you're levered to, improving leverage into China, I was hoping you could talk what typical seasonality looks like and how I would imagine you would expect to surpass that going into the second half?

Scott A. McGregor

I would say seasonality is, while it's a factor, I think attach rate and penetration of new technologies is more significant. In China in particular, we originally saw a discrete marketplace and sometimes with our competitor products. And we see that moving more towards our combo chips. So that's a combination share gain for us there and penetration. We also see that smartphones are becoming more popular. And so smartphones, as a percentage of total phones, are going up dramatically, which has a drag-along effect of bringing our combo chips into play there. And so I think those are more important factors than the seasonality overall. Generally, the seasonality is favorable in the second and third quarters, a little falloff in the fourth quarter as people in the third quarter really push hard to build for the holiday season. So that would be a seasonal effect. But again, I believe that the penetration and the attach rate will be a more significant driver.

Operator

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

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

Eric, if you could just take a step back and provide some commentary on operating expense, is there potential from here to reduce any of the operating expense associated with the acquired NetLogic business? And on the other hand, as the business is showing fairly broad-based growth here, how do you think about hiring and adding on an organic basis to R&D as we look out over the back half of the year?

Eric K. Brandt

Over the course of the year, we certainly pick up some additional cost synergies associated with the transaction to just give you a sense. On the non-GAAP EPS we reported, the NetLogic contribution in Q1 was neutral. So that $0.65 was really all native Broadcom business or organic Broadcom business. As it plays out for OpEx over the course of the year, and one of the reasons why I broke out the OpEx the way I did, is that we are talking about basically organic OpEx growth of flat to $15 million. If you take the midpoint of that and you look at what we actually performed on the organic component of the Broadcom business, actually, we would probably be below from a Broadcom perspective what many of have in your models in Q2. Having said that, I think we are becoming a little more comfortable with the spending pattern over the course of the year based on some of the growth trends we're seeing in the business. So broadband's growth into Q2, which is actually stronger by the fact there's a decline of the Consumer Electronics business and it will actually show some growth, including a decline in the Consumer Electronics business. The fact that Mobile & Wireless was flat in Q1 despite the drop in 2G and seasonally typically being down also reflected some strength in our minds. And again, using some of the guidance or qualitative aspects associated with NetLogic going into Q2, you can see the underlying ING business is also growing into Q2. So we're trying to remain relatively tight. We want to run our business on a product operating margin north of 20%. We were 19.1% this quarter. We'd like to pick that back up. But having said that, I think we're beginning to see some signs where we may be able to spend a little bit higher than we originally anticipated entering this year.

Operator

[Operator Instructions] Our next question comes from Craig Berger with FBR Capital Markets.

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

I guess just within wireless, can you help us understand sort of the makeup of the business? How big is the combo piece of it? How big is the baseband piece of it? How big is discrete Bluetooth, Wi-Fi? And then also can you just address profitability which seemed to be down on a pretty good revenue performance this quarter?

Eric K. Brandt

Let me start with -- I assume, Craig, you're talking about the aggregate profitability. Normally, Q1, we are seasonally down from a revenue perspective. We were better than seasonal. Typically, we were down about 4.5%, 5%. We were down 1.5% excluding NetLogic. It is the quarter when we do our annual merit increase, et cetera. So it is the normal annual low point, barring some sort of secular trend in the industry. It is the annual low point of our operating margin. And even despite the annual low point of our operating margin, we were still north of 19% which is why I think we're beginning to get more comfortable as the year goes along in terms of our operating margin. So what's the second question?

Scott A. McGregor

He wanted us to break out the different businesses?

Eric K. Brandt

No, we don't break apart the different businesses. I would say as you probably know, the majority of what goes on in Mobile & Wireless in the wireless connectivity and principally in the combo side. Beyond that, Craig, we just haven't provided additional detail other than some of the qualitative things Scott said about 2G and 3G.

Operator

Our next question comes from Daniel Amir with Lazard.

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

Can you expand a bit on the networking side, a bit what you're seeing on the enterprise space? You talked a bit about the kind of the service provider, but a bit more on the enterprise and kind of the 10 gig opportunity there as well?

Scott A. McGregor

Certainly. We have quite a few new announcements of new products in the fabric space, network processors, all kinds of things. So I would say our competitiveness of products is probably higher than it's ever been. The Romley rollout has basically standardized on 10 gig. And so we see that driving servers to 10 gig, and so we believe the people will move quickly to 10 gig and in aggregation, use 40 and 100 gig as well. So it's a multi-year secular trend, I think, to move towards the faster networking speeds. And we're very well set up to have best-in-class products for both the enterprise customers and the data centers, as well as the service providers who are going to take advantage of a lot of that. So it's a good secular trend. I think you'll see a shorter-term benefit from the Romley roll out. But overall, we see that as a growing business as people have a demand for much more bandwidth.

Operator

Our next question comes from Sumit Dhanda with ISI Financial Group.

Sumit Dhanda - ISI Group Inc., Research Division

So a quick question on mask [ph] costs. How should we think about that, Eric, especially heading into the back half of the year?

Eric K. Brandt

We expect mask [ph] costs to grow in Q2 and -- after sort of some growth in Q1. I think it's relatively steady across the year, although on a dollar basis, it will drift up as more dedicated 40s are coming out and some of the 28s move to production mode.

Operator

Our next question comes from Stacy Rasgon with Sanford Bernstein.

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

Just briefly on gross margins, 52% this quarter, next quarter, so that's kind of above the high end of the range that you typically guided to, which I think topped at around 51.5% I assume you have some accretion in there for NetLogic. But can you give us some idea or color on drivers of gross margins, I guess, through the rest of the year? Do you anticipate them coming back down into the more typical-guided range? And just briefly on housekeeping, do your Qualcomm royalty revenues actually start to come down next quarter? I think at some point, they do.

Eric K. Brandt

Yes. So let me deal with the Qualcomm one first. Qualcomm royalties will drop to $48 million next quarter, and then drop to $43 million and stay at $43 million a quarter through the middle of next year, through the second quarter of next year. On gross margins, as I mentioned, half of the gross margin outperformance this quarter were the underlying product cost base, and the other half was based on E&O reversal. And that the flat gross margin in this quarter removes that benefit of the E&O. And so you actually get some standard margin benefit going into Q2. Depending on the mix of the business, Stacy, over the course of the year, we're not changing our range, which is 50 to 52. But I wouldn't be surprised to see us riding around this range and maybe drift up at the end of the year once we wash out some of the older NetLogic parts that were manufactured under their contracts and moved to our contracts. So there are some tailwinds certainly for NetLogic as it grows over the course of the year. It was only about 20 basis points of tailwind to gross margin this quarter, and it will drift up, we think, closer to the 100 basis points end of this year, beginning of next year.

Operator

Our next question comes from Ambrish Srivastava with Bank of Montréal.

Ambrish Srivastava - BMO Capital Markets U.S.

Scott, on Nokia, I'm just a little bit confused, and correct me if I'm wrong. Last couple of quarters, you had highlighted Nok as a ramp this year. And it's -- something's happened. It got pushed out. But -- so I'm wondering why are you still optimistic about basebands? Clearly, you seem to have more design wins. But then just staying with Nokia, what gives you the confidence that it will show up in 2013?

Scott A. McGregor

So it does represent a change from our previous calls. And that's why I felt the need to mention it before. We no longer expect material revenue from Nokia 3G basebands this year. But what I also said is that we're very bullish about our baseband business overall and expect it to grow significantly in 3G with other customers. Why do we expect to see it in 2013? Well, our conversations with the customer lead us to believe that. But we can't say much more about that at this point. You'd have to talk to Nokia, and we protect their confidentiality. So a very, very positive trend on our 3G basebands. We will grow perhaps even faster than we originally thought without that customer. And we hope to add that customer next year.

Operator

Our next question comes from Daniel Berenbaum with MKM Partners.

Daniel A. Berenbaum - MKM Partners LLC, Research Division

On going back to OpEx real quick, I think I got confused by some of the piece and parts of different answers. So Eric, should we expect OpEx to sort of trend down because of the synergies with NetLogic, or you're going to be adding costs that would sort of offset the synergies that you're gaining as we go through the rest of the year?

Eric K. Brandt

So costs come up in Q2 because of the -- because basically, we got 40% of the revenue and 50% of the costs. So we'll pick it up in Q2. And then costs, I would say, would be -- as we said earlier in the year, grow at a much more moderated rate. So I don't expect costs to come down, but I don't expect them to grow meaningfully, certainly, until we feel that we're comfortably running above 20% OI.

Operator

Our next question comes from Raj Seth with Cowen and Company.

Raj Seth - Cowen and Company, LLC, Research Division

Scott, can you comment briefly on your ambition at the top of the handset stack? You've talked previously about a bit of a gap between some capabilities that exist in that processors versus your own. Is that an area that we'd expect to see Broadcom address in the short term, or is that something that comes later?

Scott A. McGregor

That absolutely is a goal of the company. I think, historically, Broadcom has had excellent integrated products that focus more on the mid-range of smartphones and of feature phones. And what we've said is that to the extent that, historically, we had a gap on processor performance or on modem capabilities, we will eliminate that gap. And we've been working hard on that, and we believe we've got great products in the pipe. And you'll be seeing those roll out. As is our typical style, we generally don't announce those products until they ship. So I can't tell you much more about them. But I think based on what I know about our products and the customer reaction we've had, we have no apologies to make in our future products.

Operator

Our next question comes from Steve Smigie with Raymond James.

Jonathan Steven Smigie - Raymond James & Associates, Inc., Research Division

I was hoping you could update us a little bit on your thoughts on LTE? I believe you said last quarter that you thought you wouldn't generate any revenue or not significant revenue this year. Just wondering if that timing pulled forward at all, or even if it's still next year, is it still going to ramp roughly when you thought, or did they get pushed out a little bit as well?

Scott A. McGregor

I'm afraid all we've said is that we don't anticipate revenue from LTE in 2012. But we haven't really given any more color beyond that. So, sorry, I can't say more than that at this point. But as those products roll out and become visible, we'll certainly talk about them.

Operator

Our next question comes from Doug Freedman with RBC Capital Markets.

Doug Freedman - RBC Capital Markets, LLC, Research Division

You guys were nice enough during your analyst day to show us your own internal rankings of your individual product lines. Can you give us a rundown of how you view your business internally right now and any -- which businesses are running in the red possibly?

Eric K. Brandt

So what I would say to you is the ranking you saw is actually pretty consistent. What's interesting is with the strength we're seeing in some of the cellular side, I would probably say that's moving up. Broadband, now that we've sort of removed the Consumer Electronics business, I think it's also beginning to move up in some of the businesses inside of broadband. So I would say that there is some internal movement. Certainly, we are not terribly excited about the aggregate change in the NetLogic business from the middle of last year to now, but I think strategically, all the reasons we bought the business remain, and we're encouraged by the fact that it appears to us that as much as they've experienced some of the things their peers have, it looks like less, in fact, than many of your peers, which would indicate to us that they are, in fact, gaining share of the markets that they're in. So that would be sort of the best qualitative picture I can give you.

Operator

Our next question comes from David Wong with Wells Fargo.

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

Just a clarification of something you said earlier. Wireless, you expect to be up in June, excluding the 2G business. Is that both the connectivity side of things as well as 3G basebands?

Scott A. McGregor

Well, I didn't say specifically, but the answer is yes.

Operator

And at this time, we have no further questions. Is there any closing remarks, Mr. McGregor?

Scott A. McGregor

Yes, thank you. In summary, this quarter saw Broadcom bring to market innovative products across our entire portfolio. They expand our addressable market, they push the leading edge of technology and position us for success in the fastest-growing markets in the semiconductor industry. We're excited about this year, great design win traction. We look forward to talking with you on our next call. Thanks, and have a good day.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for your participation. You may now disconnect.

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