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Broadcom (NASDAQ:BRCM)

Q3 2012 Earnings Call

October 23, 2012 4:45 pm ET

Executives

Chris Zegarelli - Director of Investor Relations

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

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

Analysts

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

Harlan Sur - JP Morgan Chase & Co, Research Division

Glen Yeung - Citigroup Inc, Research Division

James Schneider - Goldman Sachs Group Inc., Research Division

John W. Pitzer - Crédit Suisse AG, Research Division

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

Christopher J. Muse - Barclays Capital, Research Division

Ross Seymore - Deutsche Bank AG, Research Division

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

Emily Scudder

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

Daniel A. Berenbaum - MKM Partners LLC, Research Division

Srini Pajjuri - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Vivek Arya - BofA Merrill Lynch, Research Division

Anil K. Doradla - William Blair & Company L.L.C., Research Division

Alex Gauna - JMP Securities LLC, Research Division

Doug Freedman - RBC Capital Markets, LLC, Research Division

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

Steven Chin - UBS Investment Bank, Research Division

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

Shawn R. Webster - Macquarie Research

Ruben Roy - Mizuho Securities USA Inc., Research Division

Operator

Welcome to the Broadcom third quarter earnings call. My name is Anthony, and I will be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the call over to Chris Zegarelli. Mr. Zegarelli, you may begin.

Chris Zegarelli

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

This call will include forward-looking statements 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 describe 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. We're pleased to report quarterly revenue -- record revenue, record cash flow from operations and model profitability in the September quarter. Revenue came in at $2.13 billion, which was up 8% sequentially and at the high end of the guided range. Q3 was the first quarter in the company's history exceeding $2 billion. Non-GAAP earnings per share of $0.79 were up 10% over Q2, and cash flow from operations was a record $621 million.

All 3 of our businesses grew in Q3. Mobile and Wireless grew almost 14% sequentially and crossed $1 billion of quarterly revenue for the first time. We continue to see strong demand for connectivity solutions, while our 3G baseband business continues to grow with the ramp of our latest 40-nanometer platform.

Despite a challenging economic environment, we're benefiting from multiple attractive secular themes, including increasing WiFi attach rates, exponential growth in network traffic and strong adoption of high-definition cable and satellite solutions in emerging markets.

This quarter, we introduced the industry's highest density, [indiscernible] Bragg switch and the industry's first 28-nanometer multicore communications processors. Broadcom's technology innovation has created a product portfolio that's stronger than ever and drives growth from new product cycles going forward.

I'll discuss these trends and announcements later in the call. But first, I'd like to turn it over to Eric for details on the third quarter financial results and fourth quarter guidance. Eric?

Eric K. Brandt

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

Moving to the financial overview. To summarize for Q3, total record revenue of $2.13 billion, including product revenue of $2.08 billion. Q3 total net revenue was up 8% sequentially and 8.7% year-over-year. Q3 non-GAAP product gross margin was 52.1%. Q3 GAAP product gross margin was 48.8%. Non-GAAP and GAAP R&D plus SG&A expenses were up $28 million and $21 million, respectively, from Q2 levels. Q3 non-GAAP EPS was $0.79 or $0.02 above First Call Consensus of $0.77 per share. Q3 GAAP EPS was $0.38 per share, including $0.21 of acquisition-related and non-recurring adjustments outlined in our earnings release. Cash flow from operations for Q3 was a record $621 million. Our cash and marketable securities balance at the end of the quarter was $3.2 billion.

Moving to revenue and gross margin. In July, we said that we expected Q3 total net revenue to be $2 billion to $2.15 billion. We delivered revenue at the upper end of the range at $2.13 billion. The Broadband Communications segment was up a bit less than expected, increasing 2.6% from Q2 principally driven by growth in sales of set-top box platforms. Revenue from our Infrastructure & Networking segment was a bit stronger than anticipated, increasing 5.2% sequentially, driven principally by stronger-than-expected sales of switching products. Our Mobile and Wireless segment was up 13.7% from Q2 to a record $1.02 billion, which was slightly higher than anticipated driven primarily by strength in wireless connectivity.

The non-GAAP product gross margin was down 10 basis points from Q2 to 52.1%. This was consistent with our expectations of roughly flat. Our Q3 GAAP product gross margin was up 210 basis points from Q2 to 48.8%, consistent with our expectations, driven primarily by a decrease in inventory step-up of $36 million resulting from the sell-through of inventory assumed in our acquisition of NetLogic.

Moving to operating expenses. Total non-GAAP R&D and SG&A expenses for Q3 were up $28 million from Q2 levels, which is above the high end of our guidance provided in July principally due to a true-up accrual for incentive compensation as a result of the company's improved relative performance versus our peers. On a GAAP basis, R&D and SG&A expenses were up $21 million from Q2 levels.

Moving to the balance sheet. Cash and marketable securities ended Q3 at $3.2 billion. This reflects our quarterly record cash flow from operations of $621 million, the net proceeds of our debt offering of $492 million, our quarterly dividend payment of $56 million and a small amount of share repurchases in the quarter. For the quarter, our accounts receivable days sales outstanding was 37 days in Q3 and net inventory turns were 7.6.

Finally, moving to expectations. We currently expect net revenue in Q4 to be roughly $1.95 billion to $2.1 billion. Sequential revenue is expected to be roughly flat to Q3 for the Broadband segment, down for our Infrastructure & Networking segment and down slightly for our Mobile and Wireless segment. We expect Q4 GAAP and non-GAAP product gross margin to be flat to up slightly with GAAP gross margin improving slightly more due to the continued reduction in acquisition-related inventory step-up. In addition, we expect GAAP and non-GAAP R&D and SG&A expenses in Q4 to be flat to up $15 million.

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

Scott A. McGregor

Thanks, Eric. Starting with the Home Platform, our Broadband Communications revenue increased 3% sequentially driven by growth in our set-top box business. Solid secular trends and Broadcom innovations continue to fuel our set-top box business. In developed markets, we see increasing content for platform as customers ramp next-generation products with more tuners, more transcoding and additional networking technologies, including MoCA, powerline and WiFi. For example, our MoCA attach rate to cable set-top box platforms has more than quadrupled over the last year.

In September, we strengthened our security and content protection offerings with the announcement of NAGRA OpenTV 5 support across cable, satellite and IP set-top boxes and gateways. When this is combined with integrated NAGRA On-chip Security, operators can securely deploy complementary, over-the-top services to more devices throughout the home.

Outside of Europe and North America, we see share gains and continued growth in pay TV subscribers. For example, we recently announced the industry's first dual ISDB-T chipset for digital terrestrial TV in Latin America. This 40-nanometer solution enables our customers to reduce board space and lower costs to address the large and rapidly expanding digital terrestrial TV market in Latin America.

Moving to our broadband access business, we've seen meaningful growth across DSL, PON and cable modem over the past year. Our DOCSIS 3.0 mix has grown by over 40% year-over-year and now represents more than 2/3 of our cable modem business. We also announced the integration of 5G WiFi on our DOCSIS 3.0 and VDSL gateway platforms, enabling our customers to accelerate their ramp of whole home coverage for subscribers. In DSL, we're driving vectoring technology for central office deployments, which doubles capacity by removing cross-talk interference. As announced by Belgacom and Alcatel-Lucent last week, we look for large-scale customer trials with VDSL2 vectoring technology by the end of this year.

Looking into Q4, we expect our Broadband Communications revenue to be flat as strength in set-top box is being offset by the nearly concluded rollout of our legacy Blu-ray and DTV businesses.

Moving to infrastructure. Our Infrastructure & Networking revenue was up 5% sequentially in Q3 driven by growth in Ethernet switch, PHY and multicore processors. During the quarter, we extended our leadership in Ethernet switching for the data center with the introduction of Trident II, which is the world's highest-density switch chip. With 4.8 billion transistors on a single chip, Trident II delivers more than 110-gigabit Ethernet ports or up to 32 40-gigabit ports and is optimized for software-defined networks and cloud-scale data centers, supporting tens of thousands of servers and virtual machines. Trident II is sampling now and will be adopted in data center networks in 2013.

We also expanded our product portfolio with the introduction of the world's first 28-nanometer communications processor family. The XLP 200-Series delivers best-in-class core performance enabled by quad issue, quad threading and 2-gigahertz out-of-order execution with security acceleration technologies. By moving to 28-nanometer, the XLP 200-Series delivers up to 400% greater performance while, at the same time, consuming up to 60% less power. The XLP 200-Series is sampling now and expected to ramp next year.

Finally, our announcement with Hyundai is the most recent example of a major automotive manufacturer engaging with Broadcom to deploy Ethernet in advanced driver assist systems, telematics and infotainment. Building on our relationship with industry leaders like BMW, our BroadR-Reach technology has been standardized and promoted by the OPEN Alliance, which has grown to more than 80 members over the last year. While we're still in the early stages of this opportunity, automotive is expanding the addressable market for Ethernet.

We expect our Infrastructure revenue to be down sequentially in Q4 driven by softness in data center and enterprise spending as well as continued softness in service provider capital expenditures.

Moving to our Hand Platform, our Mobile and Wireless revenue grew by almost 14% sequentially to a record $1.02 billion driven by solid growth in wireless connectivity. Our connectivity business grew faster than our overall Mobile and Wireless business and came in ahead of our expectations. Upside in the quarter was driven by customers building a broad range of new devices in advance of the holiday season.

Sequential growth in connectivity was driven by both improved mix and share gains in China. Amazon launched the Kindle Fire HD, which introduced 2x2 WiFi in tablets to increase connection speeds up to 40%. New smartphones are also increasingly embracing dual-band WiFi to leverage the 5-gigahertz band for higher speed and improve signal reliability.

In China, our combos are increasingly being found in cost-effective smartphones. This richer mix and broad geographic footprint highlights the value of a complete portfolio of connectivity products.

We also saw strength in 5G WiFi, GPS and NFC. We're pleased with the ramp of 5G WiFi across multiple device categories. We have more than $100 million of orders for our mobile 5G WiFi solutions today, and production orders have just begun to ship.

Our 3G baseband business also grew sequentially in Q3 driven by our highly integrated SoCs that address the growing global demand for affordable smartphones. T-Mobile introduced the Conquer smartphone, which is the first 3G smartphone based on the complete Broadcom platform selling in the North American market. Samsung also announced new Android Ice Cream Sandwich devices based on our latest single-core, 40-nanometer platform. When compared to our prior generation, this new solution includes enhanced multimedia acceleration and doubles the processor performance. We expect to see more products coming to market through the rest of the year, including powerful smartphones leveraging our 40-nanometer dual-core HSPA+ platform.

Looking into Q4, we expect Mobile and Wireless revenue to be down slightly due to seasonality and some better-than-expected sell-in as a result of customer product launches during Q3.

In summary, our product roadmap and design win traction are stronger than ever. We continue to bring best-in-class products to market while delivering fully integrated platforms to help customers get to market quickly. While we may see some variation in our business in the short term due to macroeconomic conditions, Broadcom is extremely well positioned for the future. Our relentless engineering focus, combined with our leadership position in the fastest-growing segments of the semiconductor industry, continue to position us well for meaningful, long-term outperformance.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Romit Shah of Nomura.

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

Eric, just a question on seasonality. If I look at some of the companies that have reported thus far in the third quarter and giving guidance, they're guiding, on average, anywhere from 5 to 10 points below normal seasonality. You guys are closer to, I guess, what you consider to be normal seasonal. Is that mainly because of Mobile and Wireless?

Eric K. Brandt

Yes. So our normal seasonality would be down 1% to 2%, and I think the midpoint of our guidance is roughly down 4% or 5%. Basically, what you see is the Mobile and Wireless is roughly seasonal, being down slightly; and Broadband is roughly seasonal, being roughly flat. The principal deviant from seasonal would be the Infrastructure group, which is consistent with what a number of companies have said both about data center and enterprise as well as service providers. So that's really why I think we are much closer to seasonal than other people are as our business continues to perform well and we pick up market share in broadband and in Mobile and Wireless.

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

Okay. And then just on gross margin, flat to up in Q4. I would assume that mix is -- was working against you. So what are the offsets?

Eric K. Brandt

Interestingly during the quarter, in Q3, we were about 60% 55-nanometer, about 15% 40-nanometer. As we grow more in 40-nanometer, we'll pick up some margin benefit as we have some more margin-optimized product. And so they are giving us a bit of a tailwind. Mix is a bit of a headwind just related to Mobile and Wireless. But we think we're overcoming that with some of these more cost-optimized parts, which is what's giving us the benefit of being flat to up slightly in Q4.

Operator

Our next question comes from Harlan Sur of JPMorgan.

Harlan Sur - JP Morgan Chase & Co, Research Division

In Q3, the team started production and shipments of your 40-nanometer single- and dual-core baseband platforms into customers like Samsung. I assume this 40-nanometer 3G baseband business probably continues to go for the team in Q4 as you ramp into some mid-end smartphone platforms. So I guess, number 1, is that true? And then number 2, what other subsegments are responsible for the overall down outlook for the entire segment here in the December quarter? Is it combo connectivity that is the offset here? You obviously saw the benefits of your combo ramp with many of your customer introductions in the third quarter, but I'm just wondering if things like, for example, 802.11ac rollout with some of your router-based customers are taking a slight pause here as well.

Scott A. McGregor

I think the biggest factors are, as Eric said, we see some seasonality in the business. And normally, our customers give us the largest quarter in Q3. And if you think about our connectivity business, a lot of that goes through modules. And so our total cycle time is longer than a lot of our competitors'. So it'll typically be shipped by us in Q3, assembled into modules and delivered to customers late Q3 and into Q4. So that tends to shift our peak a little more into Q3 than you would see from others. So that accounts for some of the seasonality. We also have a little bit of our 2G business continuing to fall off. That's a little bit of a headwind. That's becoming fairly small, and that will essentially go to near 0 next year. So that'll diminish fairly quickly. On the positive side, we have things like 5G WiFi continued penetration and new 3G basebands coming out. So I'd say those are the puts and takes in the Wireless business in terms of driving the overall seasonal outlook.

Harlan Sur - JP Morgan Chase & Co, Research Division

Great. And then broadband was obviously good growth in the third quarter, kind of flattish here in Q4, kind of more in line with kind of the seasonal trends. Still seems like demand, though, for advanced set-top boxes in the developed countries, like here in the U.S. as the service providers aggressively transition their subscribers to advanced services, is going well. And so maybe you can just articulate what subsegments within broadband are responsible for driving more of a flattish profile. Is it kind of the low- to mid-end set-top boxes going into emerging markets and maybe a slight pause in some of your broadband access rollouts?

Scott A. McGregor

I think that's possibly true. We certainly see strong demand for the higher-end set-top boxes and for a lot of the new capabilities. A lot of the higher end, higher speeds on modems are helpful. Latin America is a good growth driver for us. I think one of the things that we believe is going to be a challenge is that some of the modem business has taken a little bit of a pause going into Q4. So I don't see that as a long-term effect but more of a quarter fluctuation.

Eric K. Brandt

Then there's a normal seasonality to the remaining consumer electronics business, which is now in Q3 down around $10 million, which will go down to sort of mid-single digits. So that does provide a little bit of a headwind as well.

Operator

Our next question comes from Glen Yeung of Citi.

Glen Yeung - Citigroup Inc, Research Division

Glen asking a question. Either one can answer it. If you look at the low end of our guidance for the fourth quarter, that would put the fourth quarter sequential decline in the bottom 10% of your historical performance. Is the environment that bad, particularly because it sounds like the only real meaningful downside here, at least variance from seasonality, is just Networking? And for it to account for that kind of a bad outlook would mean Networking would have to fall apart. So I guess I I'm asking you, is the down 9% really a reasonable expectations? Or if it is, where would you see the risk coming from?

Scott A. McGregor

We call the guidance like we see it. So we look at our business, and we try to provide a reasonable range and give you guys our best view on it. That's what we try to do.

Glen Yeung - Citigroup Inc, Research Division

Okay, fair enough. Second question is thinking about some of the bottlenecks that we're seeing in the supply chain for a variety of products, but we see it in some baseband products, we see it in screen technologies. Do those bottlenecks do anything to smooth out the performance between Q4 and perhaps, well, Q3, Q4 and Q1? Or do you feel like those things are not affecting your business at all?

Scott A. McGregor

The implication of your question is, is there some sort of pent-up demand being created by sort of [indiscernible] elsewhere?

Glen Yeung - Citigroup Inc, Research Division

Well, kind of.

Scott A. McGregor

I don't really think so. We haven't seen, for our own products, really supply issues like some of our competitors have. But I think a lot of that is all sorted out this quarter, and I don't think there's anything ongoing into Q1 that would cause sort of a push of demand from Q4 in Q1.

Operator

Our next question comes from James Schneider of Goldman Sachs.

James Schneider - Goldman Sachs Group Inc., Research Division

Scott, I think you touched on the fact that you're going to -- you're expecting some of your customers to ramp more mid-range and higher-end smartphones with your dual-core products over the next several quarters. Can you give us a little bit of a sense of whether you expect a bigger -- an impact in Q4? Or that’s going to be into next year before we start to see some of those ramps?

Scott A. McGregor

The dual-core products that we're shipping are pretty high-end 3G smartphones. So those would move us up a bit in terms of where we participated to date. So moving us up market and giving us a broader market footprint. I think we'll ship some of those by the end of this year, but it'll be a fairly small number. I think the ramp's really going to be next year. I wouldn't expect a meaningful revenue contribution from that in this quarter but would expect meaningful revenue contribution next year.

James Schneider - Goldman Sachs Group Inc., Research Division

That's helpful. And then following on the baseband side for a little bit more, maybe thinking about the customer diversification you have. Clearly, Samsung is a very large customer for you, your main customer. But how do you think about the China handset vendors out there? You've obviously gotten some penetration right now. How do you think about the composition of the customer set within baseband and how big the China customer set could be for you within either the next year or next 2 years?

Scott A. McGregor

I think right now, we have excellent success with a small number of customers, and our goal is to grow that excellent success with a larger number of customers. And China is an important part of that. We have increasingly picked up Chinese customers, some small and also some top 5. So we're able to grow that. And I expect as we develop more competitive products over the course of the next year, we'll be able to increase that. We've really tried with cost-effective products in China, and we've had some traction there, not as much as I'd like to see. I think we can do better. And I think the dual-core products are very competitive. They have a lot of capabilities that our competition in China doesn't have with things like HSPA+ 21 megahertz, which is being rolled out by now a lot of the Chinese carriers. So I think we've got an opportunity to grow there. And certainly, as we continue to move upstream in terms of processor performance and more advanced modems, I think our competitive position gets stronger not only in China but the rest of the world. And that'll help us with the customer diversity.

Operator

Our next question comes from John Pitzer of Crédit Suisse.

John W. Pitzer - Crédit Suisse AG, Research Division

Scott, in the prepared comments, you talked a little about how connectivity was kind of migrating down more into the mid and low end of the smartphone range. I wonder if you could just help us just size that market and where your penetration is today. At what price point at the platform level are you seeing the traction? And at what point does having an integrated sort of connectivity baseband product become necessary to get into that end of the market, and I guess, Eric, maybe with the margin implication as that begins to happen?

Scott A. McGregor

At the very lowest end of phones with very low end, discrete Bluetooth is probably the place where we play the least. As you start moving up where the phones include NFC or WiFi and start combining those things, that's where we start to get meaningful traction. That's in the high-end feature phone space and certainly all smartphones. So I would define that as our playing field. And the discrete Bluetooth-only phones at the low end tend to be lower margin, but that's not a place we play as much. As you move up into the higher-end smartphones, we see more of the full-featured, wireless LAN, the cutting-edge technologies in both Bluetooth, wireless and GPS that I think we're really good at. And that's really our heartland space, and I think we've got absolute best-in-class products there. And if you look, for example, across all LTE phones, Broadcom has the vast majority of all connectivity on LTE phones today. And even where we see competition trying to create SoCs and things to put connectivity with baseband, we finally still have the majority of the connectivity in that space. And frankly, I think it's going to increase over the course over the next few quarters as we get additional design wins.

Eric K. Brandt

Yes. And John, in terms of the gross margin, even on the what I'll call lower end, we've done a pretty good job of optimizing the products that we sell into that space and shrinking the die size to make them reasonably competitive from a margin perspective. And the margin impact is not dramatic, I think, to the overall margin on the connectivity business.

John W. Pitzer - Crédit Suisse AG, Research Division

As then guys, as my follow-up Scott, can you talk a little bit about any update on the LTE baseband? Any milestones you can share with us? And when do you think you'll have sort of volume product in the marketplace?

Scott A. McGregor

;

I think the milestone that you need to look for on LTE is when we announce that with a customer that is shipping. So I apologize, we're going to be in stealth mode until then. But we're certainly working hard on the technology. I stated a number of times that that’s important and believe that's very important for our success going forward. We've got quite a few people working on that, and we think we've got some great products in the chute. And we'll talk about them as they come to market.

Operator

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

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

Scott, you mentioned connectivity is benefiting from increasing WiFi attach rates. Can you size the smartphone and tablet part of that business versus the non-smartphone and tablet part of the business and compare the growth rates of the 2 businesses as you look out over the next year or 2?

Scott A. McGregor

I would say the smartphone business is the vast majority of our connectivity business. And it's growing quickly and that certainly drives a lot of the top line growth we've seen. There are other markets that WiFi is penetrating into, all kinds of things like consumer and automotive and devices in the house, thermostats. I mean some of those have higher growth rates. But in terms of what's going to drive the top line, I'd really look at the mobile and tablet market as the primary driver of that. And it is a high-growth market, and it's both increasing in terms of the number of technologies we can put in there. We're certainly adding new capabilities, like 5G WiFi which helps us offset some of the ASP decline you would otherwise see, and then looking to just increasingly move the bar with new technologies in that space.

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

And then switching gears, Eric. I know you're not guiding to the first quarter, but as we think about the first quarter next year and think about the adverse environment that we're in, we're naturally thinking about how companies are managing operating expense. How should we think about some of the seasonal dynamics to be aware of as we look at operating expense in the first quarter of next year?

Eric K. Brandt

Yes. I mean, remember in Q1, we have our natural merit increase and fringe step up that we get for the fringe costs. Last year, that number was about $50 million on a GAAP basis and about $40 million on a non-GAAP basis. But you can presume that we are managing things pretty tightly. I mean, if you just look at the current quarter, the true-up of the incentive compensation was probably half to 2/3 of the total operating expense increase that we saw in the quarter. We would have been solidly in the middle of the range, maybe even the bottom half to some degree. So I think that what we're doing is we're trying to manage the business pretty tightly. We're making, I think, good and prudent choices on where we're going to invest. I suspect as long as things stayed tight for next year, the nature of what we would invest in incrementally will be fairly limited and pretty tight in terms of the things that are most strategically important to the business.

Operator

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

Christopher J. Muse - Barclays Capital, Research Division

I guess first question, Scott, can you talk about what typical seasonality looks like for mobile wireless in Q1?

And then, as part of that, when you think about new form factors, design wins and product cycles, including NFC 802.11ac, how you think we should think about your business into the new year?

Eric K. Brandt

It's Eric. On seasonality, which I'll take, is typically down about 5 for Mobile and Wireless in Q1 typically coming out of the holiday season.

Scott A. McGregor

And in terms of product cycles for a lot of these technologies, I'd say it's running anywhere from 6 months to a year in that range depending on the technology and how new it is. It's definitely shorter than, for example, a baseband, which would be a longer product cycle by the time you factor in all of the tests and acceptance testing. So it runs at a different cadence than some of the other pieces of the Mobile business.

Christopher J. Muse - Barclays Capital, Research Division

And I guess as a follow-up, as you think about what you're seeing in Mobile and Wireless in Q4, are you embedding in your guide any sort of inventory flush from any of your customers, i.e., showing some conservatism on your part?

Eric K. Brandt

Yes, there are certainly customers who, as part of their year end, try to manage their inventory levels down. And we've watched that and learned our lesson, and we're just trying to make sure that we've accounted for that appropriately.

Operator

[Operator Instructions] Our next question comes from Ross Seymore of Deutsche Bank.

Ross Seymore - Deutsche Bank AG, Research Division

Just a question on the Infrastructure side. You mentioned that both the service providers staying weak and I think the data center and enterprise getting weak were the causes in your fourth quarter guidance. Can you give us any color about the geographic sources of that? Is it customer specific? Any sort of details on that? And then maybe looking forward off of that, which side of that do you expect to bounce back first? And kind of when would you expect that to occur?

Scott A. McGregor

I would say it's pretty geographically distributed. I don't see it in one particular place. Certainly, the U.S. is soft. Europe has been soft for a while and that's ongoing. We've seen some definite softening in Asia and China. On the recovery, how does that bounce back? My guess, you guys are probably better at forecasting that than us. But we are hearing discussion of, as the new Chinese government comes into place, that you'll see more infrastructure spend there. There is some talk of tenders about to go there. So I guess I'd be optimistic that change of government there might, as they bring in new folks, is that, that'd be a positive and that they'd spend more money on the infrastructure side there. So I would say I'm more confident of that coming back in the first half of next year, but we'll have to see how the overall economy plays for the rest of it.

Operator

Our next question comes from Craig Berger of FBR Capital.

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

Can you just give us an update on now NetLogic acquisition is progressing for you? Is that doing reasonably well versus your initial expectations? And also, what do you see for the base station market right now?

Scott A. McGregor

We no longer break out NetLogic as a separate group. But I'll make some overall comments on it. The integration went extremely well. In fact, I'd say it's probably the best integration of a public company I've ever seen. The employees are on board. We've had almost no attrition. They're performing extremely well. The primary reason we acquired NetLogic was for the processors, network processors, and we're doing very well there. You've seen we've announced a number of new products there, the 28-nanometer XLP 200 family, and we've got considerable design win traction there. Our revenue in processors has gone up every single quarter since we acquired the company. We're taking share. Looking at the design win traction there, we're taking share from a lot of the incumbents in that space. So I'm feeling pretty good about it.

Operator

Our next question comes from Ambrish Srivastava from BMO Capital Markets.

Emily Scudder

This is Emily calling in for Ambrish. Can you comment on what your sense is of inventory level at customers, where they are versus historical levels? And are there any markets where you have seen meaningful adjustments in the fourth quarter?

Scott A. McGregor

Inventory is always higher at some customers, lower in others. I would say on balance, it's normal-ish. As Eric mentioned, we do have some customers who have a Q4 inventory flush that they go through as a seasonal thing. We have some customers who probably have a little more inventory than they want. We also have customers that are expediting us. So I would say on balance, it feels about normal.

Operator

Our next question comes from Stacy Rasgon of Sanford Bernstein.

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

First, I had a question on OpEx. So obviously, it was higher this quarter because of incentives. But it sounds like that incentive increase is also carrying through into Q1 and into Q4 because you've got an increase there as well. What's driving that incremental Q4? Why is the incentive, I guess, carrying through? And how can we get a handle -- I guess why wouldn't the incentive actually be included in the guidance that we've set at the high end? How can we get a handle on whether or not that sort of thing is going to hit in Q4 and even going forward? And I think secondly, just can you give us some color on the Emulex settlement from last quarter? Was that booked into your results this time? And what does the accounting on that going to look like?

Eric K. Brandt

Okay. So Stacy, it's Eric. Two things. First of all, on the incentive true-up, the way -- and it's published, our proxies. And the way our incentive compensation works, as you know, is on relative performance. In the first quarter, we were outperforming our peers roughly on a weighted average by about 300 basis points. In Q2, that number was up close to 500 basis points. And in Q3, that number is close to 800 basis points. And the nature of the way you book these things is if we really thought we were going to outperform in Q3 by that much, we would have booked it earlier in the year. And so because the acceleration from Q2 to Q3 was as significant as it was, it triggered that true-up of the incentive compensation such that through Q3 on a year-to-date basis, we're actually outperforming our peers by roughly 600 basis points. And that is pretty significant when you're talking about an industry that's growing somewhere around 0 or actually below 0 for many of our peers. So that does catch up in Q3. That does not roll into Q4. You're correct in the sense that it should not roll into Q4 because you're catching up Qs 1 and 2 into Q3. What's driving Q4 is actually a pretty significant step-up in design and development, which you can read into that as mask [ph] costs and engineering costs associated with masks [ph] as we move more and more product into dedicated 40-nanometer products for production and even 28-nanometer products on dedicated masks [ph]. In fact, in Q3, over 85% of the masks [ph] that we did were 40-nanometer and below, and 10% of the masks [ph] we did were 28-nanometer and below. So that's really what's driving the OpEx delta into Q4. I wish I could give you a better picture, but I can only get a sense of how we're going to do in the next quarter based on how our peers report and guide into next quarter, and it's a very incomplete picture when we close our books certainly. And then your second point on Emulex, we booked about $1.5 million to past damages and about $2 million on an ongoing basis to the royalty line.

Operator

Our next question comes from Daniel Berenbaum of MKM Partners.

Daniel A. Berenbaum - MKM Partners LLC, Research Division

Eric, maybe if I can just follow up a little bit on a couple of the OpEx questions that have been asked. I mean, it looks now like you're set again this year to have OpEx outgrow revenue. Obviously, in 2010, you had a big revenue outgrowth compared to OpEx growth. But 2011 and this year, we're growing OpEx faster than revenue. When should I think about that changing maybe on a year-over-year basis to the extent that you're comfortable kind of talking about how we should think about our models going forward? Should we think about there being a time relatively soon giving the 40-nanometer costs you're incurring now about revenue consistently outgrowing OpEx again?

Eric K. Brandt

Yes, Daniel, it's an interesting question. Certainly, if you look at the growth, it's principally in the R&D line. And year-over-year, let's just use the number that you've got in the non-GAAP financials, it's about $90 million. If you take that $90 million, probably somewhere around $20 million of it is just wrap-around effect from the decisions we made in the prior year. So now you're down to about $70 million. And if you take that $70 million, it's probably split equally or close to equally between the step-up associated with the acquisition of NetLogic into the P&L and an increase in our investments in LTE. Philosophically, in terms of how we're managing, we're trying to manage the company between 20% to 22% product operating income on a non-GAAP basis. This quarter, we were 21%. So we're trying to manage within that. Having said that, I think the biggest challenge for the industry is the relatively low growth in 2011 and 2012. And I've said before that I think that the inherent inflation in R&D without increasing headcount resources or tape-outs is probably in the vicinity of 3% to 5%. And so for us, we're growing slightly faster. We do have a pick-up because of some changes principally driven acquisition and an investment in LTE. But beyond that, we aren't making significant changes to the infrastructure of our R&D spend. And I suspect that, that won't change meaningfully into next year as well. And we'll try to manage that so that, hopefully, if we see a reasonable growth here, we'll actually see that leverage come back to the P&L and grow revenue faster than operating expenses.

Operator

Our next question comes from Srini Pajjuri of CLSA Securities.

Srini Pajjuri - Credit Agricole Securities (USA) Inc., Research Division

Scott, you said that your progress in baseband in China could be better. Given that you've been in that market for a while and it does seem like that market is growing pretty nicely, I'm wondering why you think the progress has been less than at least you were hoping for? And what are you going to do to fix those as we head into 2013?

Scott A. McGregor

I think we originally designed products that were targeted not for China. And so the reason it wasn't better is that our products were targeted for the top 5 handset makers, most of which are not in China. As we broaden our product category and do a broader range of basebands, I think it'll naturally appeal more in China. So I believe that's something that naturally gets fixed as we broaden our family.

Operator

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

Vivek Arya - BofA Merrill Lynch, Research Division

I actually have a 2-part question, both, Scott, related to the Mobile business. First, on the connectivity side. TI said recently said that they plan to exit that market, and I'm wondering if you're starting to pick up any incremental share. And then on the baseband side, just to follow up on the prior question that Srini asked, do you see line of sight to sustained profitability in baseband given the competitive landscape with Qualcomm and MediaTek and others? And where I'm going with that is that right now, your strategy seems to be doing quite well on the midrange and low-end side. But in terms of profitability, is that a sustainable strategy? So that just comments on those 2 parts of Mobile will be very helpful.

Scott A. McGregor

I think basebands, to get the business to be profitable, we need to see a larger scale. And I think that's going to come from broadening our product family to include LTE and broadening out in 3G as well. So as we become more competitive in those products, we will see scale. And I think that's how we grow into the R&D that you have there. Apologize, can you ask again your question on connectivity?

Operator

Our next question comes from Anil Doradla of William Blair.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

On the modem side, you -- we saw a strong September quarter with DOCSIS 3.0, but you talk about some softness in the December quarter. Is that inventory buildup? Or is that related to product transition from 4-channel to HM [ph]?

Scott A. McGregor

I think it's a little bit of both. A lot of our customers in that space, they work through the MSOs who do promotions. And as those promotions ebb and flow, we sometimes see surges and other things. So I attribute it a bit to that in that space. There's possibly a little bit of a product transition, but I think it's mostly just the programs that go back and forth. A question on the previous caller also on TI and connectivity. Yes, we do take share from TI as they exit that business. A number of the larger customers that they had have transitioned to Broadcom in the connectivity space, and that's been part of how we've taken share.

Anil K. Doradla - William Blair & Company L.L.C., Research Division

But did that DOCSIS 3.0 inventory or softness in Q4, did that surprise you or that played pretty much in line with expectations?

Scott A. McGregor

I think we've got a pretty good read on that market. We have the luxury of fairly high share and participation with pretty much all of the major carriers out there. So I think we've got pretty good visibility on the market. But if the customer wants the product in one quarter, you give it to them. And if they don't want the quarter -- in the next quarter, that's the natural ebb and flow of that business.

Operator

Our next question comes from Alex Gauna of JMP Securities.

Alex Gauna - JMP Securities LLC, Research Division

I was wondering if you could give us some color on your gross margin outlook with enterprise so weak. It's actually performing very nicely. And I was wondering, with some of these tape-outs you're doing in Q4, do you have further accretion in cards -- in the cards potentially entering 2013?

Eric K. Brandt

Yes, Alex, it's a really good question. There are 2 parts to this. One is, as you know, we continue to see an increased mix of our consumer businesses, which create a bit of a headwind to the gross margin. And we've been working quite hard on the product mix and optimizing our chips to improve the margin on individual products to try to offset that. So that's sort of the natural put and take. I think secondarily, one of the things that's also going on is, we are cognizant of what we're trying to operate to in our operating model, and we are trying at this point not to let the gross margin get too far out ahead because we'd rather take the market share in the market. In periods of time where market growth is slow, you should be trying to hoover up as much market share as possible. And clearly, in 2011 and 2012, it's been a pretty slow year, and we have been quite aggressive in trying to make sure that we are pushing our technology and leveraging our cost position and price position to pick up market share, which is why we think we're outperforming by close to 800 basis points to our peers, say, in Q3.

Operator

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

Doug Freedman - RBC Capital Markets, LLC, Research Division

Scott, a couple of quarters ago, you did talk about trying to come out with some higher-end apps processors and target the higher end of the market. Since that time, we've seen some new products out of your competitors. How do you feel about the design targets that you have for those products? And do you still think you can achieve sort of the top end of the range with what you're trying to achieve?

Scott A. McGregor

The answer is I feel very good about our processor development. We've got good teams on that. I think you've seen our progress on that faster than market. Now admittedly, we came from behind. But I feel good about the fast single-core and the faster dual-core products that are coming out, and I believe that trajectory will continue. It's interesting; we have processors across Broadcom in almost every one of our businesses: in our Broadband group, in our Networking group and in our Mobile group. And more and more, we've got the opportunity to get the processor experts together. It's kind of interesting because in the NetLogic acquisition, we have processors that are at the extreme end of anything that any of our competitors do, whereas in the mobile space, you're far more focused on power consumption and other things, and finding the right balance is important. And I think we've got the expertise in the company to do performance and power management, and that's the real key. One of the things you have to be careful of is it's very easy to do a processor of any speed you want. The question is what will be the power consumption when you do that? So it would be no problem at all for us to announce a processor that's faster than any of our competitors', but then the question is, what's the balance in terms of battery life and other things? And that's why looking at processor performance, you really need to look at performance per watt, okay, as the metric. And a lot of people aren't trained to look for that. So I do believe on the important characteristics for our customers: Number of cores, power performance. I don't see any reason we can't be best in class over the course of the next year.

Operator

Our next question comes from Kevin Cassidy of Stifel, Nicolaus.

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

You gave the distribution of new masks [ph]. It's like -- you said 10% were less than or 28 nanometers or below. Can you say what your distribution is of production in -- by process node?

Eric K. Brandt

Well, I can tell you that about 60% of our revenue is in 55, and about 15% of our revenue is in 40. And the rest of it pretty much balances the process nodes that are higher than that, some of that for chips that are high power. That would be a higher process nodes, but that's the majority of it. The typical peak, because I was just looking at it, is that we tend to peak out in a process node at around 70, which was last quarter, for 65. So I expect that you will see 65 drifting down and 40 moving up. 40 was last quarter, not Q3. Q2, sub 10. And it was about 15 in Q3. So you can see it's moving pretty aggressively up in the mix of the business.

Operator

Our next question comes from Steven Chin of UBS.

Steven Chin - UBS Investment Bank, Research Division

My primary question is regarding 20 nanometers. I was wondering, just given that a lot of the emphasis this year has been your peers moving to 20 nanometers for sort of premium Mobile and Wireless tech products and given that a lot of the competition at the low end of the market are competitors that are focused on the Chinese market, is 20 nanometers a node that you might move to more aggressively, before your Mobile and Wireless products, given that the major foundries are spending a lot of money in there right now and supply and maybe the cost curves could come down more aggressively compared to 40 nanometers at this time in the life cycle?

Scott A. McGregor

Well, I think 28 nanometer is going to be the node that we see as the next one that's going to drive a fair amount of business, and we'll ship 28-nanometer products next year. 20 nanometer is a little further away. And I think one of the things that's going to be new for people is as we go to 20 and then 16 or 14 depending upon your marketing, the price per transistor, cost per transistor, is no longer going down. So I don't think 20 nanometer is going to give you any cost breaks. It may allow you to design a faster chip, but the cost per transistor will start going up us you start going into these nodes. And I think that's going to cause a real change in the industry in that you're going to stay with some of the older nodes longer, and for products that are more focus on cost, you'll especially stay with those older nodes and try and get the best cost per transistor out of those rather than pushing the envelope on geometry. It used to be in the industry for decades that if you were to push the geometry, you would find better cost solutions, and that's no longer the case going forward. So we'll start to see sort of a bottoming out of that and eventually an increase as you go into smaller geometries and the cost per transistor.

Operator

Our next question comes from you Steve Smigie of Raymond James.

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

Scott, you've mentioned a lot on you trying to be [indiscernible] ready, but most of it seems to have been around the product side. I was wondering if you could comment. Is there a component where you need more sort of local R&D support to generate adoption? Or is it more, just as you mentioned so far, just on the product side?

Scott A. McGregor

To your question, I think it's both. In China, they really do a good job supporting our Chinese customers. We need both the right technologies and the capability to support them locally in language, on-site. And so Broadcom, when we look at where we've done a lot of our hiring recently, we've ramped up our Chinese team. We have created a team that's capable of doing reference designs. That's a very common way of doing business in China where they want you to do pretty much a turnkey handset. And we now have a team in place capable of doing that, and they are producing turnkey designs. And I think that's going to be just as important, to your point, as having the right technologies there supporting local customers with a local support team with reference designs.

Operator

Next question comes from Shawn Webster of Macquarie.

Shawn R. Webster - Macquarie Research

Two questions. One is I was wondering if we could revisit your views. Eric, you had mentioned that seasonally, mobility would be down 5%. I was wondering if you could share your views on seasonality for Broadband and Networking. And maybe in the Networking category, share some thoughts on whether we could see that stabilizer start to improve. Or what would need to happen for that to happen? And then as a quick follow-up, I was wondering when the step-up charges on the inventory side were going to completely go away.

Eric K. Brandt

Well, Shawn, in terms of seasonality, remember that the standard deviation on seasonality is huge. But typical seasonality for Broadband going into Q1 is normally also down, sort of mid to high single digits. That's their normal seasonal pattern, at least over the last 5 years or so. If ING, as I mentioned, is in Q4 usually down a little bit, it's usually about flattish in Q1. Now I think that's really driven much more by the rate of adoption in some of the data center customers and the rate at which the providers start to dole out CapEx. And I think some of Verizon's commentaries probably have been fairly sobering to the service provider space. And then as I mentioned in Mobile and Wireless, it's down about 5% typically in Q1. So again, standard deviations on these things are 8 to 10 points. So the standard deviation is much larger than the actual result, but that does give you a picture of what we normally see. In terms of inventory step-up, Q4 should be the end of any material number. We stepped down about $36 million in Q3. There's about $6 million, $7 million left. We'll probably wipe out most of that in Q4. And I think from a GAAP perspective, other than the amortization, which stays at the level it's been at relatively consistently, it will be pretty much where it is for -- from a GAAP to non-GAAP adjustment unless there's another acquisition we do.

Operator

Our next question comes from Ruben Roy of Mizuho Securities.

Ruben Roy - Mizuho Securities USA Inc., Research Division

I just had a quick follow-up on the infrastructure commentary from earlier. And I understand that the guidance is down for Q1 and we'll see what happens seasonally for -- I'm sorry, for Q4, and we'll see what happens seasonally for Q1. But in terms of Scott’s commentary around multicore -- the multicore segment specifically being up every quarter throughout the year, is that expected to continue into Q4? And also, with the XLP II coming out, number one, I'm wondering if you're actually recording some revenues today from XLP I. And then also, as you look out into 2013, if you think there will be a pause in multicore revenues ahead of XLP II ramping.

Eric K. Brandt

Yes, so it looks like it could be flat to up slightly. I think it really does depend on the uptake on some of the places where these products go on the service provider on data center side. But I think the momentum is there. And whether it's the existing and legacy products, which are ramping now, some of the newer products Scott mentioned ramping into next year and the year after, we feel pretty good that we are, at least from a design perspective and from a revenue perspective, picking up meaningfully share in the space.

Scott A. McGregor

And to be helpful, I think year-over-year, I'd expect that to be next year one of our highest percentage growing groups.

Operator

That was our final question. Did you have any closing remarks?

Scott A. McGregor

I do. Thank you all for joining us today. In summary, Broadcom achieved multiple record revenue records in this quarter. We introduced best-in-class products across our entire portfolio, and we have continued to deliver stronger top line performance versus our peer group. We see that going forward. We look forward to seeing many of you at our Analyst Day event in San Jose on December 6 and invite any of you who need additional details on this event to please contact Chris or Nick [ph]. With that, thanks again for joining us. Have a good day.

Operator

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

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