Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Peter Andrew - Vice President, Investor Relations

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

Eric K. Brandt - Principal Financial Officer, Senior Vice President

Analysts

James Schneider - Goldman Sachs

Uche Orji - UBS

Ross Seymore - Deutsche Bank

Craig Ellis - Citigroup

Sumit Dhanda - Banc of America

Tim Luke - Lehman Brothers

Randy Abrams - Credit Suisse

Shawn Webster - J.P. Morgan

Ruben Roy - Pacific Crest Securities

Daniel Berenbaum - Cowen & Company

Adam Benjamin - Jefferies & Company

Allan Mishan - Oppenheimer

Srini Pajjuri - Merrill Lynch

Shaw Wu - American Technology Research

Mahesh Sanganeria - RBC Capital Markets

John Dryden - Charter Equity Research

David Wu - Global Crown Capital

Craig Berger - FBR Capital Markets

Gary Mobley - Piper Jaffray

Quinn Bolton - Needham & Company

Krishna Shankar - JMP Securities

Gavin Duffy - Broadpoint Capital

Broadcom Corporation (BRCM) Q2 2008 Earnings Call July 22, 2008 4:45 PM ET

Operator

Welcome to the Broadcom second quarter and year 2008 earnings conference call. (Operator Instructions) Your speakers for today are Scott McGregor, Broadcom's President and Chief Executive Officer; Eric Brandt, Broadcom's Chief Financial Officer; and Peter Andrew, Vice President of Investor Relations. I would now like to turn the conference over to Mr. Andrew. Please go ahead.

Peter Andrew

Thank you, Jamie. During this call, we will discuss some factors that are likely to influence our business going forward. These forward-looking statements include guidance we will provide on future revenue, gross margin, and operating expense targets for the third quarter of 2008 and any other future periods, as well as statements about the prospects for our various businesses, potential market share, and the development status and planned availability of new products.

You should note that the guidance we provide today is based upon forecasts that require us to make certain estimates, judgments, and assumptions using the information that is available to us at this time.

It should be clearly understood that our actual performance and financial results may differ substantially from our forecasts and other forward-looking statements we make today.

Specific factors that may affect our business and future results including among other thing general economic conditions in the markets we address are discussed in the risk factors section of our annual report on Form 10-K for 2007 and subsequent SEC filings. A partial listing 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 except as required by law. Please refer to the investor section of our website for additional historical, financial, and statistical information, including the information required by SEC Regulation G.

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

Scott A. McGregor

Good afternoon and thanks for joining us today. Despite all of the recent economic concerns in the headlines, Broadcom had a very strong quarter. Total revenue for the second quarter came in at $1.2 billion, which represented year-over-year growth of over 30%. In addition, quarterly product revenue excluding royalties surpassed the $1 billion milestone for the first time.

We were able to keep operating expenses relatively tight, even with much stronger-than-expected revenue. Total operating expenses grew $54 million, or 13% year over year, while revenue grew about $300 million, providing positive earnings leverage. The combination of strong revenue and tight operating expenses enabled us to generate $247 million in cash flow from operations. Our total cash and marketable securities balance was over $2 billion, even after buying back $444 million worth of Broadcom stock in the second quarter.

As I prepared for this call, I tried to put my finger on exactly why, despite all of the recent economic concerns, that Broadcom was able to report such a strong quarter. After evaluating our product lines, part numbers, and customer ramps, at the high level the answer appears simple -- that communications products are playing a greater role within our lives, whether at home, work, or mobile.

Broadcom's traditional wireline businesses that address communication needs at home and work grew revenue at a double-digit percentage rate year over year, while our mobile and wireless businesses grew revenue more than 50% year over year. The market for communications, whether wired or wireless, are large and growing. This phenomena is occurring all around the world. Our recent strength, especially in networking, has been increasingly coming from Asia and Eastern Europe. We see worldwide Internet traffic growing strongly, driven by richer content, the deployment of broadband connectivity to new users, and the build-out of supporting network infrastructure. I’ll touch more on this in a few minutes but let me turn it over to Eric to talk in more detail about our second quarter results and third quarter guidance.

Eric K. Brandt

Thanks, Scott. Let me start with the financial overview. We are pleased to report our second quarter results. To summarize, record revenue of $1.201 billion, including a $35.6 million royalty in revenue from Verizon, was up approximately 34% from a year ago and well above the upper end of the range provided in our Q1 earnings call.

GAAP gross margin was 53.8%, up about 40 basis points from last quarter. Included in this number are a 140-basis point impact of the Verizon royalty and a 90-basis point negative impact of stock-based compensation and amortization of purchased intangibles.

Total GAAP operating expenses increased by $29 million over Q1; however, as noted in our Q1 results and guidance during last quarter’s conference call, there are a number of one-time/step-up elements in that quarter which I will detail in a moment.

GAAP earnings per share were $0.25. This number includes a one-time item associated with the revision to certain assumptions and methodologies relating to the accounting for expense reimbursements relating to directors and officers insurance, which resulted in approximately a $0.01 earnings per share negative impact on the quarter. Excluding this item and the acquisition related items from Q2 of 2007, roughly $0.02 per share, Broadcom experienced EPS growth in excess of 200% over Q2 of the prior year.

Stock-based compensation expenses in the quarter were $127 million, or roughly $0.24 per share, of which approximately $90 million or 7.5 points of revenue was in R&D, $31 million or 2.6 points of revenue was in SG&A, and $6 million or 0.5 points of revenue was in COGS. Cash flow from operations was a very strong $247 million.

Our cash and marketable securities on hand declined and stood at $2.04 billion at the end of the quarter, driven down primarily by $444 million in share repurchases settled in the quarter.

Moving to revenue and gross margin, in April we said we expected Q2 revenue could be approximately $1.075 billion to $1.125 billion, assuming a $35 million royalty from Verizon. We said we expected strong growth within our broadband and mobile and wireless targeted end markets and we expected enterprise networking to be roughly flat.

What occurred in Q2 was strong revenue across all of our targeted end markets, led by much stronger-than-expected growth in broadband communications and enterprise networking. The net result was that revenue for the second quarter came in above our prior estimated range.

With respect to broadband communication markets, the revenue increase was across the board with the greatest dollar increases in the set-top box and broadband modem areas. In the mobile and wireless market, as anticipated we experienced a bounce-back from seasonal declines in Bluetooth and wireless LAN products, as well as strong growth in our GPS product line.

Our enterprise networking market grew more than anticipated during Q2, principally driven by continued solid growth in switching, coupled with a much smaller than anticipated declined quarter over quarter in the gigabit ethernet controller segment. Please note that we define switching as switches plus software and [inaudible], whether they are optical or copper.

Revenue distribution for Q2 was as follows: broadband communications was 38% of total revenue; mobile and wireless, which included the Verizon royalty, was 35%; enterprise networking accounted for 27%.

Our GAAP gross margin increased 40 basis points to 53.8%, which was mostly driven by: one, product mix; two, increased demand for higher margin older products; and three, favorable cost control. Excluding the impact of the Verizon royalties, product-based gross margins were more than 100 basis points above our previously stated business model, as adjusted for the half point of FAS-123 expense and COGS of 49.5% to 51.5%.

Moving to operating expenses, GAAP operating expenses were up $29 million from Q1 levels. Excluding one-time settlement and acquisition adjustments called out in Q1, this number would be $54 million. Included in this amount are the negative effects of an $11 million expense related to DNO insurance associated with the shareholder and officer litigation issues, of which $9 million is a change in timing of recognition, an $11 million step-up due to our annual employee merit increase, a $4 million increase to the bonus accrual as operating results have been much better than planned, a $14 million increase in stock-based compensation, which was slightly higher than projected on the last call due to the movement in stock price following our last earnings call.

In addition, as mentioned last quarter, there was a $1 million step-up associated with the integration of Sunext Design and the non-recurring Q1 benefit from the Qualcomm reimbursement of San Diego legal expenses of roughly $9 million.

So the net effect of this was a $5 million increase in discretionary spending, well below our targeted increase of $13 million to $18 million.

All of the items I just mentioned were highlight in our Q1 earnings call, with the exception of the accounting change for DNO reimbursement. We made this change based on communications with our insurers with respect to potential coverage implications. The net effect of this change was to move to a cash receipt basis, under which we will record the expense offset only when cash is received from the carriers instead of offsetting a majority of the expenses in the quarter with a receivable from the carriers. We believe this to a be a more conservative approach, given the facts and circumstances.

R&D as a percentage of sales on a GAAP basis was 31.6%, a decrease of approximately 290 basis points. Included in this number is $90 million, or roughly 7.5 points of stock-based compensation expense. We continue to operate above our previous ranges as we continue to invest to deliver on recent design wins in a number of our emerging businesses. However, due to strong expense control, combined with better than anticipated revenue performance, we are seeing solid leverage in the R&D line.

We increased total company headcount by 168 people to a total worldwide headcount of roughly 6700. As I mentioned earlier, total cash and marketable securities were down slightly at $2.04 billion, as we generated very strong positive cash flow from operations of $247 million, which was offset principally by our share repurchase program.

Inventory increased in Q2 by approximately $35 million to $256 million. GAAP inventory turns remained strong at 8.7 times in Q2.

Our accounts receivable days sales outstanding were a solid 36 days, driven by good linearity in the quarter. As previously announced, last November a $1 billion share repurchase program was approved by the board of directors. The company repurchased approximately 17.7 million shares at a cost of roughly $444 million in Q2 at an average price of $24.87. Shortly following the end of the quarter, we completed the $1 billion share buy-back. We are currently evaluating our next potential repurchase program.

On a GAAP basis, diluted shares outstanding were down another 10 million shares to 530 million diluted shares outstanding at the end of Q2.

Moving to expectations, we currently expect solid growth in Q3, with total net revenue in the range of $1.25 billion to $1.3 billion. In looking at what we expect to happen in Q3 in broadband communications, we expect modest revenue growth driven by a seasonal pick-up in our Blu-Ray and digital TV product lines, while growth in the more traditional wireline business slows in the back half of the year.

In mobile and wireless, we continue to anticipate continued strong revenue growth driven by Bluetooth and wireless LAN. Our enterprise networking growth -- excuse me, our enterprise networking business should see solid revenue growth continue into Q3, as we expect strong growth in the switching area with a temporal up-tick in the gigabit ethernet controller market.

For GAAP gross margin, in Q3 we expect to see a decline in gross margin moving more in line with our historic range, which adjusting for our GAAP transition again would be 49.5% to 51.5% for product based gross margins excluding the effect of the Verizon royalty, driven principally by product mix and the ramp of several new products to new and existing customers in the quarter, and tighter supply conditions in our supply chain during the third quarter.

Just to repeat what we’ve said in the past, typically our newly introduced products have lower gross margins as we focus designs initially for quick time to market.

With respect to GAAP operating expenses in Q3, I would like to separate the discretionary elements from the usual Q3 FAS-123R step-up in option compensation, and the effect of moving to a cash basis for DNO recovery. We think it is useful to make this distinction to increase the transparency for the choices we are making. Let me start with the discretionary costs.

For the last three quarters, we have outperformed our guidance on expenses, which reflects the impact of our new processes and tighter controls, while at the same time we’ve seen significant upside to our revenue. We feel we have somewhat under-invested in the first half of the year and believe in light of additional revenue, we will release some strategic spending in Q3 to the tune of about $2 million to further support our competitive positioning. Based on this, we are providing a slightly higher operating expense range of $15 million to $20 million, of which roughly half will be in the legal area.

As I mentioned, we have been fortunate to do better than our guidance for operating expense growth over the last three quarters, and we will continue to work hard to do the same in Q3.

Moving to the FAS-123 step-up in DNO recovery accounting change to a cash basis, since we are using GAAP only, as we saw in Q2 you will need to include the stock-based compensation step-up due to the grant of new equity awards partway through Q2 in your Q3 projections. We anticipate this will be around a $9 million to $11 million step-up.

As we mentioned last quarter to help your modeling on stock-based compensation expense, it normally steps up in Q2 of each year due to the new grants made mid-quarter in connection with our annual employee review process, as well as in Q3 for a full quarter effect, and then it should drift back down in Q4 and Q1.

With respect to DNO recovery, as I mentioned we transitioned to a cash basis, which means we will offset outlays based on reimbursements actually received from our insurance carriers. To the extent that cash receipts are more or less than outlays in a particular quarter, we will have a delta in operating expenses, which we will highlight when we announce our results for that quarter, if they are material.

Cash flow from operations in Q3 is expected to remain strong.

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

Scott A. McGregor

Thanks, Eric. I’ll start off by talking about our wired end markets. Broadcom's enterprise networking business experienced a strong quarter of revenue growth, driven mainly by sales of our switching products, which grew almost 10% versus the first quarter and nearly 20% year over year. Much of this growth was driven by strength in Asian markets due to infrastructure build-outs and upgrades occurring in the region. Our deep and geographically diverse customer base and exposure across the service provider, enterprise, and small and medium sized business markets continues to benefit us.

For our switching products, just as last quarter, much of the growth was in the service provider space, followed by the enterprise market. We continue to see ethernet penetrating more of the metro market as service providers are rolling out more high bandwidth applications to their customers and migrating their older networks to an ethernet architecture.

From a product perspective, our second quarter announcements focused on low power, highly integrated 65-nanometer products. We are delivering a complete product offering to address our customers’ needs from low-end SMB switching to high-end carrier switch applications, running from 10-megabits per second all the way up to 10-gigabits per second. The ability of our customers to leverage Broadcom silicon and software across their entire product line is an important competitive advantage.

During the second quarter, we rolled out our new Strata XGS4 multi-layer switch product line for 1- and 10-gigabit applications, to address the switching needs in enterprise, data center, and service provider networks. These products continue to expand the merchant silicon opportunity in these markets by utilizing a low power 65-nanometer design with enough scalability necessary for data center applications, high levels of security required for enterprise networks, and a wide variety of protocols and quality of service features needed in next generation service provider networks.

In the 10-gig space, we also announced a 10-gig KR5 for back plane communications in blade servers and advanced telecommunications computing architecture equipment; a new 10-gig based T5 operating at over 100 meters of UTP cable for switch and controller applications; and a 10-gig ISCSI host bus adapter functionality that will be integrated into our future controllers for servers.

At the lower end of the switching market, to address the needs of the SMB customers, we also announced a family of five to 24-port switching solutions at price points to accelerate the adoption of gigabit switching into this market.

From a revenue growth perspective, typically our enterprise networking business slows down in the back half of the year but as Eric mentioned, we expect this growth to continue into the third quarter, driven primarily by continued broad-based strength in switching and strong demand for gigabit ethernet controllers for servers.

Moving on to our broadband communications businesses, we experienced a stellar quarter as every line of business experienced revenue growth on a sequential basis and all but one experienced very strong year-over-year revenue growth.

This broad-based demand highlights what I mentioned earlier about communications and connectivity playing a greater role within our lives. Growth in the second quarter was driven by sales to existing and emerging customers, service providers signing up more HD subscribers or broadband services, as well as perhaps a shift in consumer discretionary spending towards home entertainment.

As we mentioned last quarter, we experienced unusually strong demand in our set-top box business, driven by satellite operators continuing to promote HD services and strong set-top box sales driven by the cable card transition.

In our broadband modem business, we experienced much stronger than expected demand for both cable and DSL modems in the second quarter. We had record revenue in our cable modem business due to strong DOCSIS 2.0 demand and in DSL, we had record unit shipments, driven mainly by growth in the central office and increased deployment of VDSL 2.

We shipped our first cable modem product in 1997 and over 10 years later, the cable modem market is still generating strong revenue growth.

As we look into 2009, we see opportunity for growth within the cable modem business, driven by the emergence of DOCSIS 3.0 multi 100-megabit services for Internet access and IT video delivery.

Although broadband communications typically experiences muted demand in the back half of the year, we estimate that the revenue growth in our emerging product categories, such as digital TV and Blu-Ray disc, which are seasonally oriented product areas, will offset a decline in some of the transition-driven set-top box demand we’ve been experiencing, leading to modest overall growth for that business.

Moving to our wireless offerings, our mobile and wireless businesses grew 15% on a sequential basis and 56% year over year. This revenue growth in the second quarter was primarily driven by a seasonal rebound in our Bluetooth and wireless LAN product lines, along with strength in GPS for personal navigation device and cellular applications.

In the cellular area, our team remains focused execution. We’re making excellent progress toward each of the various process [gates] required to go to production with our customers. We remain excited about what we have to offer in the baseband area and more importantly on the entire cellular platform as it moves beyond a voice only device to incorporate multimedia and multiple forms of wireless communications.

We continue to invest in this area and once our customers begin shipping products incorporating our silicon, we’ll talk more about them.

In wireless LAN, revenue came in much stronger than expected in the second quarter, growing over 20% sequentially and over 40% year over year, driven by strength across numerous segments of the wireless LAN market.

Most of our growth in the quarter was driven by increased sales into client applications for both 802.11g and n, and growth within embedded applications. Our wireless line announcements in the quarter included expansion of our 802.11n wireless LAN product line into the enterprise access point market, leveraging our leading enterprise switch position and our fast-path networking software.

Lower cost 802.11n solutions to accelerate the adoption of n technologies into dual band routers and USB adapters for consumers to connect PCs, TVs, set-top boxes, personal video recorder and other devices to their home network.

We are also pleased to announce that you can now find our single chip n product, the BCM4322 in notebooks from leading PC manufacturers on sale today via the web.

Our Bluetooth revenue in the quarter grew over 20% sequentially, driven by strength in each of the target markets we participate in -- audio, embedded, mobile, and PC products.

Within the audio headset space, one of our tier one OEMs now has products incorporating Broadcom's BCM 2044 on store shelves. In addition, we started shipping production volumes of our BCM 2044 to Motorola for use in forthcoming products that will be available on retail store shelves in the coming months.

These designs are the result of our ongoing partnership with Motorola and are a good indication of the strong reception we are seeing for our line of dedicated headset solutions, which we launched in early 2007.

In the cellular phone market, we’ve achieved a significant milestone in the second quarter, with higher revenues coming from our combination Bluetooth plus FM part than from our standalone Bluetooth solutions. We believe this clearly shows how strong customer interest is for our converged communications products.

We hope to continue this momentum into the future as later this evening, you’ll see a press release from us announcing that we have commenced production shipments of our triple play part, which is Bluetooth plus FM plus wireless LAN for portable media and cellular handset applications, and then those applications will appear on retail shelves in the third and fourth quarters.

To date, we’ve shipped nearly a million units, as this product begins what we believe to be a very strong ramp.

Our leading position in Bluetooth, wireless LAN, GPS, and other communications features places Broadcom in an ideal position to benefit as the market for these converged communications products continues to expand.

With respect to our GPS product line, we experienced strong revenue growth in the second quarter, selling our solutions into personal navigation device and cellular applications. We are also proud to have ranked at the top of the latest GPS vendor matrix analysis from ABI. The vendor matrix is an analytical tool developed by ABI Research to examine vendors’ positions in specific markets.

Moving on to the legal front, with respect to events in the near-term related to Qualcomm, we have a pending motion against Qualcomm in the District Court of Santa Ana for what we believe are violations by Qualcomm of the District Court’s injunction.

Regarding SiRF, in May we filed four additional claims of infringement against SiRF Technology related to its Centrality Titan multimedia processors and SiRF Star 3 receivers. On June 13th, the ITC issued an initial determination that first, Broadcom did not infringe two of SiRF’s patents; and secondly, that certain claims of one of the patents were not valid.

And lastly, on August 8th, we should receive an initial determination from the ITC on whether SiRF is infringing on four of our patents relating to the improving global position system processing and sensitivity.

We’re now ready to take your questions. Jamie, may we have the first question, please?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from James Schneider from Goldman Sachs.

James Schneider - Goldman Sachs

Good afternoon and thanks for taking my question. I guess to start off, Eric, could you start off by giving us a little bit more color around the magnitude of gross margin decline you expect for Q3? I know you said more in line with the product’s historical range but can you give us a little bit more quantification on that, please?

Eric K. Brandt

We are a good solid point and change above our historical range. We believe that we will move back to that range in Q3, and that’s driven again principally by the fact that we had some very positive mix in Q2, and as we begin to ship more and more of our 65-nanometer parts, which as I think we’ve said in the past are really designed for time to market and not designed for lowest cost or margin, we will see some impact from that.

As those chips rev out cost and as we move forward, we’ll see that begin to bounce back but as we move that with new chips, as Scott mentioned, for instance, on the 4325, at least initially we’ll see some impact on that.

James Schneider - Goldman Sachs

So then going forward into Q4, would you expect directionally, which way?

Eric K. Brandt

We don’t provide any guidance for Q4 at this point in time. It really depends on how our mix fills up in the book for Q4 and I don’t have any visibility, really, sufficient visibility today to give you a picture on that.

James Schneider - Goldman Sachs

Okay, fair enough. And then just moving to the switching business, I know you talked about in the past the switching business being seasonally strongest in the first half. You talked about some of the factors that would allow growth in Q3, but if you look out into the back half in general, do you think you will see growth in the switching business?

Eric K. Brandt

We only give guidance for Q3, so I can’t comment on the full second half. But in general, the reason you get the first half increase and step-up in the growth is because the capital budgets are generally released and they tend to spend them in the first half of the year.

I think what we are seeing anecdotally from a number of customers is that increased Internet traffic due to applications like Facebook and YouTube, video going over the Internet, and just richer content, and potentially the increase of 3G phones is really gearing up a lot of the Internet traffic and we are seeing the build-out not only of the broadband links to support that but more importantly, the infrastructure in the backhaul in order to cover for that, and that’s what we believe is driving the growth.

James Schneider - Goldman Sachs

And then just lastly, what’s your expectation currently about the cable and satellite set-top box business in Q3?

Scott A. McGregor

Normally the second half does tend to be weaker than the first half seasonally, but we’re seeing a couple of things going on here. One is the cable card transition is driving a strong growth. As people see the commercials on TV, that their analog TV is going away, they can not only buy cable cards, which we are happy to provide the silicon for, but also if they move to cable or satellite, they can also avoid the transition. And so we believe that’s driving some of the demand in that space.

James Schneider - Goldman Sachs

Thanks very much.

Operator

Our next question comes from Uche Orji from UBS.

Uche Orji - UBS

Thanks. Scott, a couple of questions for you; you described your 10-gig controllers as performing well. Can you just talk abut what [inaudible] device, what device class is the majority of this demand? And any comments on what you are seeing on the competitive environment, that would be helpful, please.

Scott A. McGregor

I’m sorry, the last question?

Uche Orji - UBS

The competitive environment.

Scott A. McGregor

We’ve done really well with our 10-gig products. I would say we’re seeing a fair amount of deployment into data center and into the higher end server market. That’s where the 10-gig is going to initially pick up. Back plane applications are very strong and relatively short distance. Copper is not picking up as fast as optical KR and so forth, and we do expect copper to pick up over time but again, the optical seems to be leading the charge here.

But again, as people need higher connectivity and higher speed connectivity for their network servers, we believe that’s going to pretty rapidly increase the adoption rate of 10-gig.

In terms of competitors, you know, there’s always competitors out there. There’s start-ups and there’s a few larger players. We think our 65-nanometer products are very competitive in this space, and absolutely solid [FI] technology and other things, so we believe we are competitively in a strong position.

Uche Orji - UBS

You didn’t comment on your digital TV business. What are you seeing in terms of LCD TV demand? And if you can give any color, I know you are not going to give guidance for Q4 but in terms of how you expect the rest of the year to play out, this was an area that we expected to see some strong growth for you, so can you just tell us how that business performed then in terms of what you expect for the rest of the year on TV?

Scott A. McGregor

We previously identified digital television as a growth area for us in 2008 and I don’t see any reason that’s going to change. It’s a good area for us. We continue to get additional penetration into our existing customers and we have other customers coming online. I think also in the DTV market, we’re going to see more store branded products and we have an opportunity to penetrate those as well. So I think that’s a good market.

Also, just an interesting perspective from my history in the consumer electronics business, there’s often an interesting phenomena that happens in economic downturns, or times of uncertainty, is that people will sometimes cancel their family vacation and buy a new TV set instead, and so we’ll have to see if that bears out this time but it could also influence some of the overall industry.

Uche Orji - UBS

Right, and then just lastly on WiFi, can you just talk to me, or can you just let us now how the blended pricing trends were this quarter and in terms of how that will play out in Q3?

And in terms of g versus n, shipments to notebooks primarily g, or will n crossover soon?

Eric K. Brandt

We haven’t provided an exact timeframe in terms of when n is going to crossover with respect to g. As Scott mentioned in his script, we did see very nice growth in the quarter, mainly on the client side for both n and g, but I still think g as a total is larger than n for our total business.

In terms of ASP declines, I don’t have that at my fingertips. Give me a call on the inside afterwards and we could talk about that.

Uche Orji - UBS

All right, will do. Thank you.

Scott A. McGregor

I’ll just make one observation though that the single chip n we think is going to really drive demand for n going forward. We’re finally getting to the point where the penalty from a board space point of view and other things is getting negligible, and we believe that the PC companies will pretty much switch over to n, as they are doing right now, and I think there will be a pretty good transition over to n over the next year.

Uche Orji - UBS

Great. Thank you very much.

Operator

Our next question comes from Ross Seymore from Deutsche Bank.

Ross Seymore - Deutsche Bank

Eric, the color you gave on gross margin was helpful. Can you give us any sort of metric or idea on how we can think about new product versus old products, as that seems to be a primary driver in your mix for what happens with gross margin?

Eric K. Brandt

What typically happens, and let me just be clear on the gross margin, the range I gave excludes the impact of Verizon, so based on the revenue range, you’d be somewhere around 130 to 140 basis points needs to be added to that for Verizon, just so that I’m clear.

The way to think about it, if you remember back on analyst day, we showed a chart that typically as our revenue begins to ramp, we begin to see some pressure to the gross margin. And it can swing a point or change more related to that. There are other things, obviously, like fab capacity and other things that impact it as well. And as I said, as we sort of move to 65-nanometer and we see some additional new products, which are fairly large and haven’t been die-shrunk to the level we would like them to, there will be some margin pressure for those new products.

They are highly integrated devices. They are competitively advantaged and they are gaining market share, and as I said, we very much focus on getting them to market fast and then driving the cost out of them over time.

So I think we’ll see that effect in the back half of the year, certainly Q3 and again, I’ll have a better picture for Q4 when we get through Q3.

Ross Seymore - Deutsche Bank

Can you give us just an idea how to quantify that? Maybe just what 65-nanometer represented in say the first and second quarters and what you think it might represent in the third?

Eric K. Brandt

Well, it represents -- it comes off of a small base, so it’s sort of single-digit percentage in Q2 in terms of our revenue and it will probably double off of that, again off of a small base into Q3, so it’s moving fairly quickly. And obviously as I mentioned, we’ll be driving additional revisions of the chips to drive cost out of them to follow.

Ross Seymore - Deutsche Bank

Okay, and then one clarification on the OpEx side of things -- that increase of $15 million to $20 million sequentially that I think you said, is that inclusive or exclusive of the ESO step-up? And is that overall, no one-timers in addition to it?

Eric K. Brandt

It’s exclusive of the stock option expense, which is a normal rollover effect. And then in terms of one-times, I don’t know of any one-timers in Q3 that I would attribute to that. So what we tried to do is peel out all of the things that we mentioned again in Q1, with the one difference being the DNO impact, which swings wildly. It can have an expense one quarter and have a credit another quarter, based on the actual amount of expenditure in a quarter and reimbursement received. So we thought we would call that out so that you could see how that was swinging back and forth.

Great, and then the last question on the revenue line, this might be for Scott -- in your experience with Asia-based customers, especially in the enterprise and networking segment, does that revenue from that region tend to be choppier than other regions, more smooth than other regions? And I guess the core underlying question is the sustainability of Asian driven demand for enterprise networking equipment.

Scott A. McGregor

I don’t think it’s so much enterprise networking driven equipment. It’s more service provider, and so let me clarify that, and I don’t think we have that much track record of the service providers really deploying a broad base of new broadband customers. I think that’s a relatively new phenomena and I see that as something that is potentially ongoing here and should help us out. It’s hard to forecast in what the macroeconomic situation is going to be worldwide but I do believe the service provider deployment of broadband to customers around the developing world is going to be a big growth factor.

Ross Seymore - Deutsche Bank

Great. Thank you.

Operator

Our next question comes from Craig Ellis with Citigroup.

Craig Ellis - Citigroup

Thank you, and Scott, the TV comment on a slowing macro environment was truly a silver lining. As I look at the gross margin commentary, Eric, commenting on gross margins being up in the second quarter, you said there were some cost initiatives that were at play there. Can you go into more detail on what that was?

Eric K. Brandt

We have a variety of cost initiatives that we undertake which relate to -- they can relate to packaging, they can relate to the design of the individual chips, et cetera, things that we do in terms of negotiation with our fabs.

When we go into a year, we typically have a cost improvement target for our ops group and they execute against that cost improvement target and we saw the benefit from that. So that’s what I mean in terms of cost improvement for the quarter.

Craig Ellis - Citigroup

And Eric, is that a one-time item or does that provide some benefit against which you’d still see the 65-nanometer issue and therefore guidance for gross margins to be down about 100 basis points sequentially?

Eric K. Brandt

Well, again I didn’t give a specific number but be that as it may, it is an ongoing benefit. It continues. We have ongoing benefit that occurs this year, next year, et cetera, in terms of driving the cost of -- on the COGS side of things.

Craig Ellis - Citigroup

Okay.

Eric K. Brandt

I mean, again, we have been fortunate that our gross margins have been substantially higher, and -- meaningfully higher is probably a better way to say it than what our range has been, and what we are talking about is moving back to our historic range.

Craig Ellis - Citigroup

Okay, got it. Scott, you mentioned the triple play product. Can you provide some further color on how broad-based the design-in activity is there and any further color on how we can think about revenue potential?

Scott A. McGregor

Certainly. The product was originally designed to work in cellular phones, because it’s very low power, very compact, so the advantage to the customer is it’s a small product, low power consumption, and one of the things we’re finding that’s particularly attractive to customers is that it solves the integration problem of getting all the different radios to work between Bluetooth and wireless LAN and even FM Radio. It’s getting that not just from a single vendor but integrated on a single chip, pre-solves a lot of the radio integration issues you would have. And so as a result, we have seen a broad appeal of this product in a variety of spaces -- portable media players, into devices like PCs. It’s a very attractive device for PCs that incorporate both Bluetooth and wireless LAN. They don’t really need the FM radio. That’s not something they would normally spec but simply the fact that it pre-integrates wireless LAN and Bluetooth is quite compelling in that space as well, so a broad applicability there. It could also be applicable to game boxes and other things, basically any device that includes both wireless LAN and Bluetooth is going to be a target market for us on that.

Craig Ellis - Citigroup

And so do we see a meaningful impact on the revenue line in the second half of this year, or are you seeing design-ins that really lead more to material revenues for next year?

Scott A. McGregor

I think you will start seeing revenues on that the latter part of this year. I did mention that we’re just announcing the product today and we will have shipped over -- let’s see, about a million units of the product, so we believe there’s a pretty good ramp possible with that product.

Craig Ellis - Citigroup

Okay, thanks, Scott.

Operator

Our next question comes from Sumit Dhanda with Banc of America.

Sumit Dhanda - Banc of America

Eric, a question for you; in terms of just overall thinking about the incremental spending on the baseband side of things, how should we think about that? Is the pace of spending going to moderate going forward versus where you were at? And if you could help quantify that to some extent.

Eric K. Brandt

Sure. So we spend about 45% of our R&D on wireless technologies and about 55% on wired technology, give or take. We have said in the past about a quarter of our R&D spend is in the cellular base. It’s really mobile platforms, which includes mobile multimedia and some other things, and power management as well.

I think if you look at the R&D spending in terms of how it’s changed over time, and you were to take out the bonus accrual, you were to take out the stock-based compensation, and the annual merit increase, you would see that the step-up between Q1 and Q2 is sort of low- to mid-single-digit millions of dollars.

And so that gives you a sense of sort of the stabilization and cost control initiatives on the R&D line, which I think are quite good. So we expect those to continue and I think given where we are and sort of the performance on the revenue side and the fact that we’ve under-spent through the first half of the year relative to what we projected, there are some opportunities to drive additional revenue into next year that we thought were important enough to invest an incremental, depending on how you count it, point or 0.5% of the spend.

Sumit Dhanda - Banc of America

Okay, and then this description that you just gave encompasses any incremental masked cost flowing through the R&D line?

Eric K. Brandt

Yes, it does.

Sumit Dhanda - Banc of America

Okay. That’s all I have. Thank you.

Operator

Our next question comes from Tim Luke from Lehman Brothers.

Tim Luke - Lehman Brothers

Congratulations on the strong revenue in the quarter and the guidance. With respect to the revenue, was there any contribution there from the royalties from Qualcomm, or has that been finalized yet, Eric, as to what there may be there?

Eric K. Brandt

No, Tim, there’s been no finalization yet. It’s still hanging on the balance sheet. I think we’ve got another $9 million this quarter, $8 million or $9 million this quarter, which went up on the balance sheet.

Tim Luke - Lehman Brothers

And just to clarify, there seems to be some confusion on the OpEx guide -- could you just give what the total OpEx rise is likely to be, inclusive of the different elements that you had there, on a pro forma and on a GAAP basis?

Eric K. Brandt

I can’t do it on a pro forma basis. What I said was I think that there will be between $15 million and $20 million, so if we take the midpoint of 17.5, plus 9 to 11 related to the ESO piece on a GAAP basis, that would be 10, so -- you pick the midpoint of the two, that would be 27 on a GAAP basis for OpEx, of which we said about of that is legal expense.

Tim Luke - Lehman Brothers

And just to go to the gross margin line, the key catalyst for the gross margin decline, can you just define again how much you expect it to be down, including and excluding Verizon? It’s mix, essentially.

Eric K. Brandt

So take the Verizon piece out, the Verizon piece accounts for about 140 basis points of gross margin in this quarter, so you’d have to take that out, so I don’t count that. And so I’m just using product-based gross margin and the range that we had used before when we were using non-GAAP metrics was 50 to 52. If you assume about a half a point in there for stock-based compensation, give or take, that’s where you get the 49.5 to 51.5, because you have to take that out. So that’s the number we’ve used.

If you take the number that we had this quarter, 53.8, and you take out 140 basis points, you’re at 52.4, and so --

Tim Luke - Lehman Brothers

So you’ve got like a 200 basis point decline sequentially?

Eric K. Brandt

Again, remember what I said -- forget about Verizon for a minute, okay? So look at it excluding Verizon. So if you take 53.8, take out 1.4, you’re at 52.4. And what I’m saying is that instead of 52.4, we’re more likely to be in the range that we’ve typically seen of 49.5 to 51.5 on a GAAP basis.

Tim Luke - Lehman Brothers

But you’ve got stronger revenue -- I can’t recall you having such a strong gross margin decline for a while. Anything else, or more importantly, how do you think it shapes for the next few quarters? Is that the level we should think about?

Eric K. Brandt

Well again, I think we’ve always said that when our gross margin is above our targeted range, that we don’t view that that’s sustainable and that we benefit from certain periods of time where that’s the case. And then we said that our ongoing targeted range, again adjusting for the stock-based compensation, is 49.5 to 51.5, and we think that that’s what it is on an ongoing basis and we think it’s prudent to use that as a basis for how you’d think about the business.

If you look at last quarter, on a similar basis we were 53.4. We were about closer to 1.5 points, but you would take it out, we’d be 52 without Verizon last quarter. We thought the gross margin would come down a little bit. It actually went up, so the trend I think is sort of a pop-up this quarter and then back to what we thought it would do based on last quarter. So it looks a lot bigger than what it is, based on the movement in the positive direction this quarter perhaps than it might otherwise be.

Tim Luke - Lehman Brothers

Lastly, if I may, the shape of OpEx to plan for the next few quarters, should we think about similar metrics of 15 to 20, or --

Eric K. Brandt

No, not necessarily. I think that -- remember, we did 13 to 18 in Q4; we did 12, so we’re a million below the range. We did 13 to 18 in Q1; we did 11, so we were two below the range. And we did 13 to 18 in Q2, and we did five, so we were eight below the range. I think when you look at that trend below the range, and if you use the midpoint, obviously, that number goes up $3 million or $4 million off of that. I think we feel that we may have under spent a little bit and there are some significant opportunities for the new products we’re introducing that we want to take advantage of in light of the additional revenue and profitability that the company has.

Tim Luke - Lehman Brothers

Thanks so much.

Operator

Our next question comes from Randy Abrams from Credit Suisse.

Randy Abrams - Credit Suisse

Good afternoon. I wanted to see if you could elaborate on the additional spending for new product lines, maybe talk about what areas you are actually pulling in some of the expenditures?

Scott A. McGregor

There are a lot of opportunities across the company and we use that for basically acquiring additional customers for some of the products that we’ve already fielded here, so we’ve gotten very, very attractive customer pick-up on some of these and so it will just enable us to support some additional customers to support the demand we’re seeing. So this isn’t speculative investment. This will turn into a return in a fairly short period of time.

Eric K. Brandt

Interestingly enough, I mean, the investment probably is more centered in places we’ve seen the upside; places like broadband, like networking, and like wireless connectivity.

Scott A. McGregor

Yeah, a great example -- I’ll give you one example. I can’t detail it all for you but one example is we have seen unprecedented demand from customers for these combination chips and we are getting some new customers and some additional opportunities in existing customers. And frankly, we need some engineers just to help them get the product up and running and get it designed in and so forth. And so that’s some of the investment we’re looking at making here, and again we believe that’s a very prudent investment and delivers a fairly short return on investment -- a quick return on investment.

Randy Abrams - Credit Suisse

Okay, I wanted to ask a couple of questions on the wireless side -- what traction are you seeing with your video core product? And then the touch screen controller, there’s a notable win out there, but I want to see how meaningful a contributor you see it and how much you think design wins can [inaudible] at other customers?

Scott A. McGregor

I can’t really talk about that particular customer very much, so you’ll have to maybe ask them about their forecasts and get some more light on that.

In terms of the video core chip, it’s a fantastic solution. We have some major design wins with that chip and as they begin to come to market, we’ll certainly talk about them more. So we’re excited about that. I think the whole notion of video processors being able to do that quality of video processing at that low a power, I think to be able to turn a cell phone into an HD video camcorder is quite compelling, and so we do believe that will see adoption in a significant quantity of devices going forward. But again, I apologize; I can’t be more specific on that. Certainly as those products get closer to rolling out, or start rolling out, we can say more.

Randy Abrams - Credit Suisse

Okay, and one last question on DOCSIS 3.0, you touched on it. I want to see how meaningful you expect it to be as a replacement cycle, or an ASP cycle? And then how do you feel you’re positioned for that transition?

Scott A. McGregor

I think DOCSIS 3.0 is going to be more a next-year event. It’s just beginning to come up in some cable lab certifications. We have CMTS devices out there right now and working with the major players to do that. I think this year the growth is really going to be DOCSIS 2.0 driven; next year we’ll see DOCSIS 3.0 and yes, that’s a step up in silicon value as you go to hundreds of megabits per second, a much higher performance there, not that you can really get that. But we think DOCSIS 2.0 still has a fair amount of legs on it. Certainly for the balance of this year, it will be the bulk of the shipments.

Operator

Our next question comes from Shawn Webster with J.P. Morgan.

Shawn Webster - J.P. Morgan

Good afternoon. Thank you very much. Can you give us your sense when you look at the landscape of your customers how channel inventories are faring, if there’s any areas that are a concern or what your visibility is into your various channels that you sell into?

Scott A. McGregor

It’s certainly a question we ask. Broadcom generally doesn’t sell through distributors like some of our competitors do, and so we don’t see some of the surges and various things because of that. We have I think in the low, mid-teens percent of our revenue goes through distributors, and most of those are not even stocking distributors, so they are just fulfillment distributors.

So for our business, we do look closely at inventories. You know, it’s interesting -- we would say maybe there are a few customers that maybe are a little ahead of themselves, but there are also some customers that are just beginning ramps, and so we don’t see anything unusual in terms of inventory in the channel right now and in fact, it looks relatively lean out there. And I know we watch that very closely, given the economic uncertainty, but we see fairly normal inventories in our customers right now. We watch that carefully and to the best extent that is factored into our guidance for the third quarter.

Shawn Webster - J.P. Morgan

And have you experienced any particular product categories that have tightened up in terms of your ability to supply them, or any areas that are loosening up in terms of your ability to supply?

Scott A. McGregor

Well, we always have ebbs and flows in any product business. There was a PC cycle that was delayed, which caused some surge in demand for some of the older products, so we see some of that. There was some tightness in the foundry market for a little while, in the last few months but we see that easing up a bit.

So in general, I would say there’s no particular trend that’s driving our product business at this point. The primary influences in our business going forward are the product cycles and our customer product cycles.

Shawn Webster - J.P. Morgan

Okay, and did you have any 10% customers in the quarter?

Eric K. Brandt

We don’t discuss the 10% customers, except on an annual basis.

Shawn Webster - J.P. Morgan

Okay, and then last one, can you give us any guidance for your share count and tax rate, and also maybe share with us what you think your diluted share count excluding options were in Q2?

Eric K. Brandt

Excluding options in Q2 -- well, first of all, let me deal with tax rate. I can give you the answer on the share count in an second here. On tax rate, we have said on a pro forma basis to use 10%. In the quarter, we essentially had a zero tax rate, principally driven by the fact that what you do with tax rate is you estimate it every quarter for the full year, and if you’ve accrued more than you thought you needed, as we did in Q1, and principally driven by international mix, then in fact we actually had less.

So our cash tax typically runs in the 3% to 4% range, typically on a GAAP basis. On a pro forma basis, we have told everybody to use 10.

In terms of share count on a diluted basis, as I mentioned we were 530 million shares; on a non-diluted basis, on a basic basis, on a GAAP basis, we’re about 513 million shares. That number should be roughly constant on a basic basis because obviously that doesn’t account for treasury method, subject to any share repurchase the company might decide to do in the future. In fact since the high watermark of probably Q2 -- excuse me, Q4 of ’06, which is almost 550 million shares, we’re down 6% on a basic basis. On a diluted basis, which had some treasury method movement, since Q1 of ’06 we’re down almost 12% in share count on a GAAP basis.

Operator

Our next question comes from Ruben Roy from Pacific Crest Securities.

Ruben Roy - Pacific Crest Securities

Thanks. Eric, can you talk at all about lead times, what they were this quarter and how that compares to the historical mean?

Eric K. Brandt

It’s probably better of Scott were to --

Ruben Roy - Pacific Crest Securities

Okay.

Scott A. McGregor

You mean lead times from us to our customers or --

Ruben Roy - Pacific Crest Securities

Yes, yes.

Scott A. McGregor

I would say they had gone up earlier this year and while there was some tightness in supply for wafers in the foundries, but I think again that is probably softening up a little bit right now.

Ruben Roy - Pacific Crest Securities

Okay, and then Scott, you talked a bunch about 10-gig on today’s call, 10-gig ethernet. Is that becoming material in terms of your enterprise networking business? I.E., is it close to 10% of the revenues in that business?

Scott A. McGregor

No, no, it’s not. That’s going to be more of a phenomena next year, I think. Right now, it’s going to be in relatively small numbers in the higher end back planes and some of the customers who are just really -- speed and latency are really critical for them. Latency, it turns out, is an interesting driver where, for example, financial packages and other things, where they really care about shaving off those milliseconds to get a better [trade], but that’s going to be more of a phenomena next year as more customers deploy that into their mainstream boxes.

Ruben Roy - Pacific Crest Securities

Okay. Thanks a lot.

Operator

Our next question comes from Daniel Berenbaum from Cowen & Company.

Daniel Berenbaum - Cowen & Company

Thanks for taking my call. Just to go back to the litigation a little bit; on Verizon, if the Verizon acquisition of Alltel goes through, are there any adjustments to the royalty stream there?

And then, you’re obviously spending a lot of money on litigation in the upcoming quarter, a big step up there. Do you have any visibility on when you might see some of that royalty revenue from Qualcomm start to flow through the P&L?

Scott A. McGregor

So there were a few questions there. As Eric mentioned, we put the monies we received from Qualcomm on our balance sheet subject to questioning some of the accounting for that, and so I don’t have a specific answer on when that would fall into the P&L from the balance sheet, but presumably at some point it could.

In terms of the Alltel situation, I can’t really comment on that. Certainly it does increase the overall subscriber base of Verizon but I can’t comment specifically on the contract terms that might apply to that.

Daniel Berenbaum - Cowen & Company

Great. Thanks very much.

Operator

Our next question comes from Adam Benjamin from Jefferies & Company.

Adam Benjamin - Jefferies & Company

Thanks, guys. You saw some very strong growth, better than normal seasonality in the June quarter. As you look at those results, do you think that you benefited from share gains or do you potentially see some potentially pull-in from the typically normal, better seasonality of the September quarter? I was hoping maybe you could quantify that, maybe by specific segment.

Scott A. McGregor

Well, I think it would be hard to give you the specific detail you are looking for, but in general I would say we’ve definitely seen some share gains. We have an investment we’ve made over the last couple of years in technology and I believe we’re seeing some of the fruits of that, definitely. We’ve got very competitive products out there and it feels to me like we’re winning a lot more than we’ve won in the past. That’s just a personal observation but I think we’re definitely taking some share.

Certainly there are also some product cycles that are benefiting us; the cable card conversion is one. I mentioned the worldwide increase in ethernet traffic and Internet traffic certainly as something that we’re a strong beneficiary in. Richer content -- so you know, those are trends that are driving us here and I believe contributing to it, so it’s broad-based. I don’t see it as particular customers getting ahead of each other. That doesn’t feel like what’s going on to me right now.

Adam Benjamin - Jefferies & Company

So specifically on Bluetooth and wireless LAN, you saw sequential increases at 20%. Typically in terms of the normal seasonality, September is stronger. Should we expect that similar growth to continue?

Scott A. McGregor

I can’t give you specific numbers on that but we have said that we expect to see those grow going forward and that’s comprehended in our guidance number overall for the company.

Adam Benjamin - Jefferies & Company

But it wouldn’t be unreasonable to see the similar growth Q2 to Q3, as you just saw?

Scott A. McGregor

I can’t comment on specific numbers for those products, but we do have that overall factored into our company guidance for Q3.

Adam Benjamin - Jefferies & Company

And then just one last question, Eric, maybe for you, on the 65-nanometer -- as you look out as to what you’ve already spent en masse costs, can you give some rough percentage where you stand there? And then going forward, when do you really expect to see some benefit on the gross margin side from that big investment?

Eric K. Brandt

Well again, I’m not sure what you mean by -- maybe I can back up. What do you mean by the percentage of 65-nanometer? Are you talking about in terms of the masks that we’re doing?

Adam Benjamin - Jefferies & Company

The mass that you’ve already spent and what you need to spend going forward.

Eric K. Brandt

Well, I think we’re through much of the major R&D pieces and now we’re moving to more production cycle, as we would with additional combo chips. So I would say, as we said in the analyst day last year, we thought that we would see a bump this year and that it would normalize next year, in terms of mask costs. So I think we’re seeing some of that in terms of as we look at cost control across the year.

In terms of the 65-nanometer cost impact, remember that 65-nanometer is still fairly high up on the cost curve as it relates to mixed signal devices and the kind of devices we have, and as that moves down the cost curve, just as the FAS will benefit from that as well, and we track those costs as well. In addition, as we shrink the die sizes of a variety of these chips and make them more efficient, we’ll get the benefit of gross margin on that as well.

So again, I think that we are clearly designing these chips to get them to market, to gain market share, to remove socket from devices, as we have done with all of the businesses and create combo chips which increase our market share and revenue, and you are seeing it on the revenue line. And so I think the right way to think about this is that with revenue comes some pressure to gross margin and as we step up and stabilize again, the gross margin drifts back up. That is just a general, sinusoidal trend or delayed trend between the revenue and the gross margin line typically for our company.

So hard to give you an answer rolling into next year, et cetera, because it really depends on the mix of devices and which ones are new and which ones are sort of next generation of an existing device.

Adam Benjamin - Jefferies & Company

That’s helpful. Thanks a lot, guys.

Operator

Our next question comes from Allan Mishan from Oppenheimer Funds.

Allan Mishan - Oppenheimer

Nice job on the revenues. Can you help us understand the growth, specifically in Bluetooth that you experienced in Q2? Certainly there was some pressure on high-end handsets during the quarter but of course, you’re experiencing some share gain. So how much of that growth do you think was share related and how much is it just units for Bluetooth and handsets and so forth?

Scott A. McGregor

Well, it’s hard to say until we see everyone else report and we can get a good sense of what the total market looked like. But in general, I would say that we definitely -- it feels like we gained share, and partly that’s because we’re ramping still in some new customers. We’re not done ramping into a lot of those. We currently ship in four of the top five handset makers and quite a large number of the rest.

We’re beginning to ramp also into the headsets, which I mentioned earlier in the call, and I think that will be growth driver for us over the course of the next year. And then I think something that just benefits the whole market is that the penetration of Bluetooth in the cell phone space and in PCs is going up, so if that ratchets up say from 50% to 60% of the total units, that’s on such a large base, that can still drive significant growth, even if the handset growth is not as fast as it might be. You are certainly going to see still good Bluetooth growth.

Allan Mishan - Oppenheimer

Okay, great. And then for Eric, on the OpEx side, you’ve discussed some additional investments being made in Q3. What would you say is sort of the normal, discretionary increase that you would expect to add, excluding effects on stock options, excluding step-ups for bonus accruals? I think in the past you had once given sort of a $7 million to $9 million level. What is the level as you believe it today?

Eric K. Brandt

What I’ve said in the past was that the company historically has grown plus or minus a point or so about 5% to 6% sequentially in terms of OpEx, and that what we were going to do this year is try very hard on a discretionary basis to get that number down to 2% to 3%.

I think that we are pretty darn close to that. I mean again, excluding stock option expense, we’re spending about $400 million on a cash basis in SG&A and in R&D, and so 2% to 3% would be $8 million to $12 million. And I think that if you look at the last three quarters, that’s what you see.

Now, there’s been a bigger piece of increase on the legal side, certainly as it relates to the additional cases with SiRF and some of the ongoing things with Qualcomm, but I think we are seeing, and what we focused most on is the R&D line, and I think we’re seeing that kind of growth. Again, if we see sort of -- if you use again, excluding stock option expensing, you get down to a number that’s around $290 million in R&D. And that number, with a mid-single-digit growth rate in terms of discretionary spend, is a pretty good number. And I think that we would like to hold it in the 2% to 3% range. I think to the extent that we’ve been below that, we’ll take advantage of opportunities to drive additional revenue.

As Scott mentioned, the interest for a number of the parts we have that had customers is increasing and the applications related engineering work is important to actually drive additional revenue into next year. And we feel that given the performance we’ve had, it’s a smart investment, particularly given we’ve under spent in the first half of the year.

Allan Mishan - Oppenheimer

Okay, thanks very much for the color.

Operator

Our next question comes from Srini Pajjuri from Merrill Lynch.

Srini Pajjuri - Merrill Lynch

Thank you. Eric, just a couple of clarifications; first on the gross margin, as your new products ramp in the next few quarters, what’s the risk that the gross margins could call below your long-term range?

Eric K. Brandt

I have no basis to believe that that’s the case. I mean, this has been a normal phenomenon for the company. I don’t know and I haven’t been here long enough to know whether we’ve actually seen gross margins dip below that range for any period of time. So I think that it’s the normal -- again, it’s sort of the normal swing.

If I go back again to what we thought would happen in Q1, at 53.4 minus the Verizon piece, which was again about 1.4, 1.5, it would be 51.9, 52. And if the guidance range again including stock-based comp is 49.5 to 51.5, we were half a point above, and we thought that we would drop between Q1 and Q2.

Because we’ve seen the pop-up in Q2, and sort of talking about the range, I think this is a normal trend back to our range, which we have been talking about I think for almost a year, and I think as we see the new products begin to ramp, that’s when you begin to see it hit the gross margin line.

Srini Pajjuri - Merrill Lynch

Okay, got it. And then on the OpEx, you said you have some legal expenses going up this quarter. I’m just wondering if they are a one quarter, one-time issue or is this going to continue for a few quarters?

Eric K. Brandt

It really depends, right? I mean, we have a number of cases that go and they tend to be mix-centric related to what’s going to trial and what’s in front of a judge and they tend to increase in expense at that point in time.

The other thing is it depends on whether you can settle these cases. Our preference would be to settle these cases and make them go away. To the extent that that would be the case, we would actually see that expense fall off.

Srini Pajjuri - Merrill Lynch

Okay, got it. And then Scott, one for you; I guess especially in the broadband, given that that business has grown north of 50% sequentially, if you look at the history of that business, we are seeing these boom/bust cycles in the past. My concern is that obviously give the macro backdrop that there could be some potential inventory build somewhere, so my question is how much visibility do we have, especially at your customers that this is not a one-time or unusual order and that this is going to sustain into the next couple of quarters? Thank you.

Scott A. McGregor

We’re very sensitive to that. Certainly we’ve seen that happen in previous years, and so we constantly ask ourselves that and we work with our customers, and in many cases their customers as well to try and ascertain what the true underlying demand is. And overall, we need to be vigilant, we need to look at it, but it feels like a broader phenomena than that, and it doesn’t feel like one or two customers getting ahead of themselves. It doesn’t feel like that. It feels like a broader phenomena, a broader trend, a positive.

Certainly the cable card conversion is a factor, but that’s not a one quarter phenomena. That should continue for a while. Again, none of us have experience on that one so we’ll have to see how long that one plays out. But again, it doesn’t feel like some of the one-time events we saw in some previous years.

Srini Pajjuri - Merrill Lynch

Thanks.

Operator

Our next question comes from Shaw Wu from American Technology.

Shaw Wu - American Technology Research

Thanks. I would like to go back to your revenue guidance. So taking the midpoint of the range, it’s around 6% sequential growth. I’m just wondering if you could help us a little bit more in terms of your three reported business segments, which ones would be at or above or below that range? Thanks.

Scott A. McGregor

I think what I said was that I thought that broadband would be modest growth, and that we would see pretty good growth in enterprise networking and certainly in the mobile and wireless area, as we sort of get the seasonal growth. So I think with that qualitative backdrop, you can probably draw the conclusion.

Shaw Wu - American Technology Research

Okay, now what is seasonal growth in mobile and wireless? I mean, I look at -- I mean, specifically for Broadcom over the last couple of years, you know, the last year was very strong, up 13%; a year before it was down 10%, so just what is normal seasonal growth? Is it around the midpoint?

Eric K. Brandt

Last year, as I recall, we went from 898 to 950, so I don’t think that’s 13%. Q2 to Q3, is that correct, Peter? We’re just talking about wireless.

Shaw Wu - American Technology Research

Yeah, mobile and wireless, yeah.

Eric K. Brandt

We have the number. Hang on one second. If you go back over the last three years, not it does have a very large standard deviation around it, but over the last three year, on -- I’m sorry, the last five years, since 2003, the average growth in the third quarter from our mobile and wireless category has been around 19%, with a very large standard deviation, however. It’s ranged anywhere from down 8.2% to up 44.6%, so it’s a very, very broad range in there.

Shaw Wu - American Technology Research

Okay, and then just on your networking business, I guess specifically your switching business, could you help us with a little more color in terms of the type of applications that’s driving that growth? What types of deployments? Thanks.

Scott A. McGregor

I think if you look at the different spaces, enterprise, data center clients, service providers and so forth, I would focus on service providers as being the biggest growth factor in that. And we believe it’s due to backhaul and increased overall Internet traffic.

Shaw Wu - American Technology Research

Okay. Thank you.

Operator

Our next question comes from Mahesh Sanganeria from RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets

Thank you. Just a follow-up on the ethernet switching side; if I got it correctly, you identified the few factors that is driving the growth -- infrastructure build-up in Asia and your market share in SMB and a software component, which you are adding. Can you help us understand which part will be the growth driver in the second half into next year, and which part is kind of saturating?

Scott A. McGregor

I don’t think any of those three that you mentioned are saturating over the course of the next year and we’d expect all of those to contribute to growth.

Mahesh Sanganeria - RBC Capital Markets

Okay, and one quick question on the ethernet controller side, you said that server segment was strong but on the PC side, your market share decline, has that stabilized?

Scott A. McGregor

Yes, it has.

Mahesh Sanganeria - RBC Capital Markets

Okay. Thank you.

Operator

Our next question comes from John Dryden from Charter Equity Research.

John Dryden - Charter Equity Research

Thanks for taking my question. Scott, within GPS, can you discuss the long-term expectations for the attachment rate in cellular and PNDs? And do you expect the attachment rate to be significant enough to combine with your other connectivity products?

Scott A. McGregor

I would expect the attachment rate in PNDs to be close to 100%. In cellular, I think that will go up dramatically as we see a lot of the E911 kinds of applications do that, and also some of the -- also the location based services drive that. Those are things that the carriers are getting more and more interested in.

The thing that I think has also limited the GPS penetration has been cost, as well as just the readiness of some of those applications, so as the cost of GPS comes down, which it’s coming down at a fairly attractive rate, partly because of companies like Broadcom doing really competitive shifts in that space, we believe that the elasticity will pick up and we’ll see more penetration in that market.

Peter, do you have the current penetration of GPS into cell phone right now?

Peter Andrew

It’s fairly low right now. I don’t have --

Scott A. McGregor

It’s fairly small but I would expect that to follow a similar path that Bluetooth did going in there.

John Dryden - Charter Equity Research

And just a follow-up on enterprise control and the strength in server over client again -- within enterprise, is server controller now more than double client from that percent of total enterprise revenue?

Scott A. McGregor

Yeah, you are correct, the majority of our revenue from controllers for gigabit ethernet do come from server versus the client side.

John Dryden - Charter Equity Research

Thanks for taking my questions.

Operator

Our next question comes from David Wu from Global Crown Capital.

David Wu - Global Crown Capital

Good afternoon. Can I get some clarification on the Verizon royalty stream? If I assume that the rest of this year will be at the rate of the first two quarters, and by the end of the year, the limit on that $200 million, I think I believe it was, has been reached. Am I correct in that?

Eric K. Brandt

There will be some rollover into Q1, you know, depending on how you look at the number, whether you use 35, et cetera, it looks like it will be mid-20s, give or take, into Q1.

David Wu - Global Crown Capital

The last one will be Q1?

Eric K. Brandt

Yes.

David Wu - Global Crown Capital

Okay. I also have a quick one on your cost equation -- is the loosening up of capacity that you mentioned from the foundries, are those only 65-nanometer ones or the ones that have the older generation?

Scott A. McGregor

We generally don’t participate in the foundries that have the older generation technologies, so generally our parts are in the highest volume in 0.13-nanometer and moving more to 65, so that’s the part of the market that we have better visibility into.

David Wu - Global Crown Capital

I see. The rumor that these wafer, price per wafer is going up coming out of Taiwan is nothing but that?

Scott A. McGregor

I can’t speak to specific foundry and pricing, sorry.

Operator

Our next question comes from Craig Berger from FBR Capital Markets.

Craig Berger - FBR Capital Markets

Thanks for taking my question and congrats on the strong revenues. Just on the cellular piece, can you help us understand who are your 2G customers and 3G customers that you’ll ship to in 2008?

Scott A. McGregor

We’ve announced a partnership with Nokia on 2G but we don’t expect that to contribute significant revenues in 2008. That’s something we said would happen in 2009.

With Samsung, we’ve been working on Samsung in 3G. We’re shipping with Samsung today in 3G. We’re also shipping with Panasonic in 3G today in the market, and in relatively small quantities, but we have them as another 3G customer. And then we also have some legacy 2G business with some customers such as Palm.

Craig Berger - FBR Capital Markets

Based on the design wins that you are getting now, since cell phones do take 12 to 18 months to launch into production, do you have pretty good visibility into what things will look like next year, in the second half of next year? And can you share what you think your view is of that business in aggregate?

Scott A. McGregor

Well, we used to be in the business of forecasting market share in specific quarters, but we don’t believe that either we have good enough visibility to do that, nor do we want to disclose our customers’ launch plans. And so we’ve gone to a policy of we’ll talk about our customer design wins as they roll out in the market in the cellular space. I’m afraid -- I can tell you I feel like we’re making good progress. We’ve got some fantastic customers and some fantastic products and I eagerly await being able to say more about those.

Craig Berger - FBR Capital Markets

Last one for me -- can you help us understand the magnitude today of digital TV, the Blu-Ray, or even the cellular businesses?

Scott A. McGregor

We haven’t broken that out in specific numbers. We can maybe give a little more color at analyst day on that business.

Operator

Our next question comes from Gary Mobley from Piper Jaffray.

Gary Mobley - Piper Jaffray

If I’m not mistaken, normally when you guys sit here on your quarterly conference calls and you are giving the forward quarter guidance, you have pretty good visibility on that forward quarter, typically to the tune of 85% revenue coverage. Is that still the case this quarter?

And the second part of my question is how have orders trended so far in the month of July?

Eric K. Brandt

We clearly -- as we’ve said, we enter a quarter with about 80% to 90% visibility. I don’t think there’s really any difference to that. I think while we have 80% to 90% visibility, some things do change. We witnessed this last quarter where we gave guidance of 10.75 to 11 in the quarter and came in at 12, so things do change in a quarter but we have pretty good visibility on that.

In terms of order patterns in the quarter, we don’t comment on that on an ongoing basis.

Operator

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

Quinn Bolton - Needham & Company

This may be premature, but I just figured I’d ask -- when do you think you start to see a ramp-up in the 45-nanometer design expenses? Is that more of a 2009, 2010 expense?

Eric K. Brandt

Well, it’s interesting -- we’ve already been spending money in that area. We’ve actually been taping out chips at that -- more test chips, not production chips, but at that line width.

Scott A. McGregor

But also another perspective on that -- remember Broadcom essentially skipped 90-nanometer and so for us, 65-nanometer was a fairly broad initiative across the company where we took pretty much all of our planned future chips in one go in the 65-nanometers, and so that’s why you saw a significant cost for masks and for R&D in order to go do that.

I don’t think 45-nanometer or 40-nanometer is going to be the same kind of model. I think that will be -- we will start off in products that most benefit from it, which is going to be the products that are just so large, you need the benefit of the scale in order to do that, or specifically need the power or the speed you get from 40- or 45-nanometer that you wouldn’t be able to get from 65.

So I see that more as a gradual, rather than a big one go like we did for 65-nanometer.

Operator

Our next question comes from Krishna Shankar from JMP Securities.

Krishna Shankar - JMP Securities

Yes, for the next quarter, you had talked about $9 million to $11 million for BNO -- can you explain what is that and is that an ongoing expense?

Eric K. Brandt

No, what I said was that 9 to 11 associated with the step-up on employee stock option expense. We grant shares in the middle of Q2, so you get part of Q2 effect, which I think as $14 million, and then you get the other half, which really appears as it wrap around in Q3.

In terms of the DNO expense, which is directors and officers insurance related to the litigation we have, and it’s ongoing [into the shareholder suits], what happens is we incur expenses in a quarter. It can be anywhere between -- lately between $9 million and $13 million. We can receive reimbursements in a quarter, which could be greater than that because they carry the prior quarter, or they could skip a quarter, in which case you have an expense.

So all I wanted to do was highlight to you that as we go to a cash basis, as opposed to an accrual basis, there will be a lumpiness to that that we will try to call out if it’s meaningful. So that’s the difference, that’s all.

Scott A. McGregor

Eric, I think what happened here is basically we went to a more conservative form of accounting is really what the message is in the DNO front.

Operator

Our next question comes from Gavin Duffy from Broadpoint Capital.

Gavin Duffy - Broadpoint Capital

Just a two-part question on wireless, and one is are you guys trying to tighten your focus a little bit and just focusing on certain handset makers and kind of sharpening the focus of the R&D dollars?

Scott A. McGregor

Well, our strategy is to focus on the top five handset makers, and so that’s been our strategy for a while and that remains our strategy in that space. Not quite sure what you are referring to.

Gavin Duffy - Broadpoint Capital

Well, I’m just saying that, you know, some of the different -- either the handset makers or just different projects for wireless. Are you starting just to kind of tighten up the kind of things that you are investing the R&D dollars in?

Scott A. McGregor

I think what we are doing is focusing on execution and making sure we get our designs to market, and I think that’s important for us to demonstrate traction in that space and get a good return on that investment, so that’s absolutely what we’re focused on.

Operator

Thank you. That concludes the question-and-answer session.

Scott A. McGregor

Thank you very much. In closing, please join us for a couple more thoughts here. Before we conclude, I would like to reiterate a few things; first of all, Broadcom reported very strong second quarter results, driven by the increased role that communications is playing in our daily lives at work, home, and while mobile. The strength we experienced was across all of our targeted end markets, with growth on a year-over-year basis ranging between 16% and 56%. We have strong revenue growth and tight control of spending, and that enabled us to deliver leverage in our earnings. And finally, we do expect this growth trend to continue into the third quarter.

With that, thank you and good afternoon.

Operator

Thank you, ladies and gentlemen. This concludes the Broadcom second quarter 2008 earnings conference call. Thank you for participating and you may all disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Broadcom Q2 2008 Earnings Call Transcript
This Transcript
All Transcripts