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BROADCOM CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) Cautionary Statement The information contained in this Quarterly Report on Form 10-Q is intended to update the information contained in our Annual Report on Form 10-K for the year ended December 31, 2013, referred to as our 2013 Annual Report, and presumes that readers have access to, and will have read, the "Management's Discussion and Analysis of Financial Condition and Results of Operations" and other information contained in such Form 10-K. The information in this Form 10-Q is also not a complete description of our business or the risks associated with an investment in our common stock. You should read the following discussion and analysis in conjunction with our Unaudited Condensed Consolidated Financial Statements and the related Notes thereto contained in Part I, Item 1 of this Report and the various other disclosures made by us in this Report and in our other reports filed with the Securities and Exchange Commission, or SEC, including our 2013 Annual Report and subsequent reports on Forms 10-Q and 8-K, which discuss our business in greater detail. The section entitled "Risk Factors" contained in Part II, Item 1A of this Report, and similar discussions in our other SEC filings, describe some of the important risk factors that may affect our business, financial condition, results of operations and/or liquidity. You should carefully consider those risks, in addition to the other information in this Report and in our other filings with the SEC, before deciding to purchase, hold or sell our common stock. All statements included or incorporated by reference in this Quarterly Report on Form 10-Q, other than statements or characterizations of historical fact, are forward-looking statements within the meaning of the federal securities laws, including the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements include, but are not limited to, statements concerning projected total net revenue, costs and expenses and product and total gross margin; our accounting estimates, assumptions and judgments; the amount and timing of reduced research & development and selling, general & administrative expenses resulting from the exit of our cellular baseband business, the amount of additional restructuring charges related to the exit of our cellular baseband business, our ability to drive growth through our planned reinvestments in our Broadband & Connectivity, and Infrastructure & Networking businesses; the demand for our products; our dependence on a few key customers and/or design wins for a substantial portion of our revenue; our commitment to research and development efforts; the accuracy of our estimates and forecasts; estimates related to the amount and/or timing of the expensing of unearned stock-based compensation expense and stock-based compensation as a percentage of revenue; manufacturing, assembly and test capacity; the effect that economic conditions, seasonality and volume fluctuations in the demand for our customers' consumer-oriented products will have on our quarterly operating results; our ability to adjust operations in response to changes in demand for existing products and services or the demand for new products requested by our customers; the competitive nature of and anticipated growth in our markets; our ability to consummate acquisitions and integrate their operations successfully; our ability to migrate to smaller process geometries; our success in pending intellectual property litigation matters; our potential needs for additional capital; inventory and accounts receivable levels; our ability to permanently reinvest our foreign earnings; the effect of potential changes in U.S. or foreign tax laws and regulations or the interpretation thereof; the level of accrued rebates; and our intention to continue to pay dividends. These forward-looking statements are based on our current expectations, estimates and projections about our industry and business, management's beliefs, and certain assumptions made by us, all of which are subject to change. Forward-looking statements can often be identified by words such as "anticipates," "expects," "intends," "plans," "predicts," "believes," "seeks," "estimates," "may," "will," "should," "would," "could," "potential," "continue," "ongoing," similar expressions, and variations or negatives of these words. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors, some of which are listed under the section entitled "Risk Factors" in Part II, Item 1A of this Report. These forward-looking statements speak only as of the date of this Report. We undertake no obligation to revise or update publicly any forward-looking statement to reflect future events or circumstances. Additional Information Investors and others should note that we announce material financial information using our company website (www.broadcom.com), our investor relations website (investors.broadcom.com), SEC filings, press releases, public conference calls and webcasts. Information about Broadcom and our business may also be announced by posts on the following social media channels: • B-Connected Blog (blog.broadcom.com) • Broadcom's Twitter feed (www.twitter.com/Broadcom) • Broadcom's Facebook page (www.facebook.com/Broadcom) 22-------------------------------------------------------------------------------- Table of Contents The information that we post on these social media channels could be deemed to be material information. As a result, we encourage investors, the media, and others interested in Broadcom to review the information that we post on these social media channels. These channels may be updated from time to time on our website. The information on or accessible through our websites and social media channels is not incorporated by reference in this Quarterly Report on Form 10-Q. Overview Broadcom Corporation (including our subsidiaries, referred to collectively in this Report as "Broadcom," "we," "our" and "us") is a global leader and innovator in semiconductor solutions for wired and wireless communications. Broadcom products seamlessly deliver voice, video, data and multimedia connectivity in the home, office and mobile environments. We provide the industry's broadest portfolio of state-of-the-art system-on-a-chip solutions, or SoCs. Our solutions are used globally by leading manufacturers and are embedded in an array of communications products . Because we leverage our technologies across different markets, certain of our integrated circuits may be incorporated into products used in multiple platforms. We utilize independent foundries and third-party subcontractors to manufacture, assemble and test all of our semiconductor products. Our diverse product portfolio includes: • highly-integrated and complete platform solutions for set-top boxes and broadband access; • platforms primarily for mobile devices that include low-power, high-performance and highly integrated wireless connectivity solutions, cellular SoCs and other technologies; and • highly-integrated platforms for infrastructure deployments that include Ethernet switches and PHYs, automotive Ethernet, communication processors and wireless infrastructuresolutions, and Ethernet controllers. Operating Results for the Three and Nine Months Ended September 30, 2014 In the three months ended September 30, 2014 our net income was $98 million, as compared to a net loss of $1 million in the three months ended June 30, 2014. This increase was the result of an increase in net revenue of $219 million and a gross profit margin improvement of 150 basis points, combined with a net reduction of $67 million in research and development and selling, general and administrative expenses, primarily associated with the restructuring plan that we initiated in July 2014. The increase in profitability was partially offset by net increases to restructuring costs of $91 million and impairment of long-lived assets of $35 million. In the three months ended September 30, 2014 our net income was $98 million, as compared to net income of $316 million in the three months ended September 30, 2013. This decrease was primarily the result of impairment of purchased intangible assets of $200 million and restructuring costs of $114 million recorded in the three months ended September 30, 2014, partially offset by an increase in net revenue of $114 million. In the nine months ended September 30, 2014 our net income was $262 million, as compared to net income of $256 million in the nine months ended September 30, 2013. The increase in profitability was primarily the result of a net decrease in charges for the impairment of long-lived assets of $121 million and increase in other gains of $85 million, offset in part by decrease in settlement gains of $95 million and a net increase in restructuring charges of $130 million. Reportable Segments All prior-period amounts below have been adjusted retrospectively to reflect our reportable segment changes. For additional information about our changes in reportable segments and the "All Other" category (including revenue and expense items reported under the "All Other" category), see further discussion in Note 11 of Notes to Unaudited Condensed Consolidated Financial Statements as well as the"Net Revenue by Reportable Segments" discussion below. 23-------------------------------------------------------------------------------- Table of Contents The following table presents details of our reportable segments, and the "Cellular Baseband" and "All Other" categories: Reportable Segments Broadband and Infrastructure and Total Reportable Connectivity Networking Segments Cellular Baseband All Other Consolidated (In millions) Three Months Ended September 30, 2014 Net revenue $ 1,512 $ 651 $ 2,163 $ 97 $ - $ 2,260 Operating income (loss) 398 213 611 (35 ) (465 ) 111 Three Months Ended June 30, 2014 Net revenue $ 1,302 $ 655 $ 1,957 $ 84 $ - $ 2,041 Operating income (loss) 297 244 $ 541 (128 ) (399 ) 14 Three Months Ended September 30, 2013 Net revenue $ 1,403 $ 587 $ 1,990 $ 156 $ - $ 2,146 Operating income (loss) 336 194 530 (62 ) (132 ) 336 Reportable Segments Broadband and Infrastructure and Total Reportable Connectivity Networking Segments Cellular Baseband All Other Consolidated (In millions) Nine Months Ended September 30, 2014 Net revenue $ 4,060 $ 1,900 $ 5,960 $ 325 $ - $ 6,285 Operating income (loss) 940 647 1,587 (281 ) (1,011 ) 295 Nine Months Ended September 30, 2013 Net revenue $ 4,107 $ 1,563 $ 5,670 $ 485 $ 86 $ 6,241 Operating income (loss) 966 416 1,382 (179 ) (917 ) 286 We have provided combined financial information for our Broadband and Connectivity and Infrastructure and Networking reportable segments above (shown as "Total Reportable Segments") to assist in understanding the trends of our ongoing business. The "Cellular Baseband" category shown in the tables above represents the operations of the cellular baseband business that is currently winding down. In addition, as Cellular Baseband has not completely ceased operations and will continue to generate revenue, albeit declining, and expenses for the foreseeable future, it does not currently meet the requirements for "discontinued operations" under applicable accounting standards. We have included net revenue and operating income (loss) in the above tables as if it did meet the requirements of a reportable segment because we believe this information is useful to readers of our financial statements. See Note 11 of Notes to Unaudited Condensed Consolidated Financial Statements for further information. The increase in operating income for our Broadband and Connectivity reportable segment in the three months ended September 30, 2014, as compared to the three months ended June 30, 2014 and September 30, 2013, resulted primarily from a 16.1% and 7.8% increase in net revenue, respectively, offset in part by additional research and development expenses. The decrease in operating income for our Infrastructure and Networking reportable segment in the three months ended September 30, 2014, as compared to the three months ended June 30, 2014, resulted primarily from inventory charges related to certain Ethernet switches and PHY products. The increase in operating income for the nine months ended September 30, 2014, as compared to nine months ended September 30, 2013, for our Infrastructure and Networking reportable segment was driven primarily by relatively flat operating expenses, while increasing revenue by 21.6%. As discussed below under "Exit of Cellular Baseband Business," we decided to wind down our cellular baseband business as the commercial and economic opportunity is not sufficient to justify the continued investment. 24-------------------------------------------------------------------------------- Table of Contents As discussed in further detail elsewhere in this Report, other highlights during the nine months ended September 30, 2014 include the following: • Our cash and cash equivalents and marketable securities were $5.42 billion at September 30, 2014, compared with $4.37 billion at December 31, 2013. • We generated cash flow from operations of $1.29 billion during the nine months ended September 30, 2014, as compared to $1.39 billion in the nine months ended September 30, 2013. • In January 2014 our Board of Directors adopted an amendment to our existing dividend policy pursuant to which we increased our quarterly cash dividend by 9% to $0.12 per share ($0.48 per share on an annual basis) payable to holders of our common stock. • We repurchased 6.0 million and 12.2 million shares of our Class A common stock at a weighted average prices of $37.86 and $34.26 in the three and nine months ended September 30, 2014, respectively. • In March 2014 we sold certain Ethernet controller-related assets and provided non-exclusive licenses to intellectual property, including a non-exclusive patent license, to QLogic Corporation for a total of $209 million, referred to as the QLogic Transaction. In connection with the transaction, we recorded a gain on the sale of assets of $48 million (net of a goodwill adjustment of $37 million) and deferred revenue of $120 million. • In March 2014 we recorded impairment charges primarily for completed technology of $25 million related primarily to our acquisition of SC Square Ltd., or SC Square, and our purchase of LTE-related assets from affiliates of Renesas Electronics Corporation, or the Renesas Transaction. • In June 2014 and September 2014, we recorded purchased intangible impairment charges of $35 million and$200 million,respectively, related to our acquisition of NetLogic. • In July 2014 we issued senior unsecured notes in an aggregate principal amount of $600 million, which consist of $350 million aggregate principal amount of notes that mature in July 2024 and bear interest at fixed rate of 3.500% per annum, and $250 million aggregate principal amount of notes that mature in July 2034 and bear interest at fixed rate of 4.500% per annum. • In August 2014 we utilized a portion of our net proceeds from the issuance of senior unsecured notes discussed above to redeem $400 million principal aggregate amount of our 2.375% senior notes that were due November 2015. As a result of the transaction we recorded interest expense of $11 million in the three months ended September 30, 2014, primarily from premium paid upon redemption of the notes. • As discussed below under "Exit of Cellular BasebandBusiness," we recorded $136 million of restructuring costs, $130 million of non-cash charges for the impairment of certain long-lived assets and $27 million for inventory charges in the nine months ended September 30, 2014. Exit of Cellular Baseband Business On June 2, 2014 we announced that we were exploring strategic alternatives, including a potential sale and/or wind-down, for our cellular baseband business, previously included in our former Mobile and Wireless reportable segment. See Note 11 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of recent changes to our reportable segments. We reached this decision based on our conclusion that the commercial and economic opportunity in this business was not sufficiently compelling to justify the continued investment, especially when compared to other opportunities within our product portfolio. On June 26, 2014 the Audit Committee of our Board of Directors approved a global restructuring plan that focuses on cost reductions and operating efficiencies and better aligns our resources to areas of strategic focus. As of June 30, 2014 we had not made a determination as to whether we would exit the cellular baseband business through a sale or wind-down. Therefore, the restructuring plan relating to cellular baseband employees (who were primarily engaged in research and development) was subject to significant change and uncertainty since the plan was dependent upon the outcome of our effort to sell the business. In July 2014 we decided to pursue a wind-down of the cellular baseband business. As a result, we have begun to (i) reduce our worldwide headcount by approximately 2,300 employees, (ii) close or consolidate up to 18 locations and (iii) terminate certain contracts. Communications to impacted employees began in July 2014. The restructuring charges related to the cellular baseband business were considered a non-recognizable subsequent event for financial reporting purposes for the three months ended June 30, 2014. In the nine months ended September 30, 2014, we recorded $136 million in restructuring charges. These charges are comprised of (i) $18 million recognized in the three months ended June 30, 2014 for ongoing termination benefits for 25-------------------------------------------------------------------------------- Table of Contents employees related to selling, general and administrative and other corporate functions, (ii) $108 million recognized in the three months ended September 30, 2014 for termination benefits primarily for employees related to research and development and marketing functions in the cellular baseband business, and (iii) $5 million in each of the three months ended June 30, 2014 and September 30, 2014, respectively, primarily for certain non-cancelable contract costs. We expect to record additional restructuring charges of approximately $60 million over the next twelve months for costs associated with certain non-cancelable contract and facilities costs. Restructuring costs are primarily comprised of cash-based termination benefits and contract costs to be incurred without economic benefit. Due to various complexities in our international locations, some employee terminations may not be complete for some time. We anticipate most of the expenses associated with this plan will be recognized within the next twelve months. As part of these actions, we also recorded $130 million of non-cash charges for the impairment of certain long-lived assets and $34 million of inventory charges in the three months ending June 30, 2014. See Note 9 of Notes to Unaudited Condensed Consolidated Financial Statements for further information. The wind-down of the cellular baseband business and associated cost saving initiatives is currently expected to result in up to approximately $650 million reduction in annualized research and development and selling, general and administrative expenses, of which up to approximately $50 million relates to estimated reductions in stock-based compensation. Stock-based compensation savings was reduced by approximately $50 million from our original estimate due to the eventual geographical mix of employees that were terminated, their years of service and their resulting equity holdings. We currently expect to organically reinvest approximately $50 million of these savings on an annualized basis into projects in our Broadband and Connectivity and Infrastructure and Networking reportable segments. This incremental spending is currently expected to strengthen and accelerate our plans in the area of small cells, embedded processing and low-power connectivity. Critical Accounting Policies and Estimates The preparation of financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenue and expenses in the reporting period. We regularly evaluate our estimates and assumptions related to revenue recognition, rebates, allowances for doubtful accounts, sales returns and allowances, warranty reserves, inventory reserves, stock-based compensation expense, long-lived asset valuations, strategic investments, deferred income tax asset valuation allowances, uncertain tax positions, tax contingencies, self-insurance, restructuring costs, litigation and other loss contingencies. We base our estimates and assumptions on current facts, historical experience and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the recording of revenue, costs and expenses that are not readily apparent from other sources. The actual results experienced by us may differ materially and adversely from our estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected. For a description of our critical accounting policies and estimates, please refer to the "Critical Accounting Policies and Estimates" section in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of our 2013 Annual Report. There have been no material changes in any of our critical accounting policies and estimates during the nine months ended September 30, 2014. 26-------------------------------------------------------------------------------- Table of Contents Results of Operations The following table sets forth certain Unaudited Condensed Consolidated Statements of Income data expressed as a percentage of net revenue for the periods indicated: Three Months Ended Nine Months Ended September 30, 2014 June 30, 2014 September 30, 2013 September 30, 2014 September 30, 2013 Net revenue: Product revenue 100.0 % 100.0 % 100.0 % 100.0 % 98.6 % Income from Qualcomm Agreement - - - - 1.4 Total net revenue 100.0 100.0 100.0 100.0 100.0 Costs and expenses: Cost of product revenue 47.7 49.2 48.6 49.1 49.1 Research and development 25.3 31.1 28.3 29.4 29.4 Selling, general and administrative 7.8 8.9 8.4 8.6 8.6 Amortization of purchased intangible assets 0.4 0.4 0.7 0.4 0.7 Impairments of long-lived assets 8.8 8.1 - 6.2 8.2 Restructuring costs, net 5.0 1.1 0.6 2.3 0.2 Settlement costs (gains) 0.1 0.8 (3.5 ) 0.3 (1.2 ) Other charges (gains), net - (0.3 ) 1.2 (1.0 ) 0.4 Total operating costs and expenses 95.1 99.3 84.3 95.3 95.4 Income from operations 4.9 0.7 15.7 4.7 4.6 Interest expense, net (0.8 ) (0.2 ) (0.3 ) (0.4 ) (0.4 ) Other income (expense), net 0.5 (0.5 ) (0.3 ) - - Income before income taxes 4.6 - 15.1 4.3 4.2 Provision for income taxes 0.3 - 0.4 0.1 0.1 Net income (loss) 4.3 % - % 14.7 % 4.2 % 4.1 % The following table presents supplementary financial data as a percentage of net revenue: Three Months Ended Nine Months Ended September 30, 2014 June 30, 2014 September 30, 2013 September 30, 2014 September 30, 2013 Net Revenue Broadband and Connectivity 66.9 % 63.8 % 65.3 % 64.6 % 65.8 % Infrastructure and Networking 28.8 32.1 27.4 30.2 25.0 Total reportable segments 95.7 95.9 92.7 94.8 90.8 Cellular Baseband 4.3 4.1 7.3 5.2 7.8 All Other - - - - 1.4 Gross Margin Data Product gross margin 52.3 % 50.8 % 51.4 % 50.9 % 50.3 % Total gross margin 52.3 50.8 51.4 50.9 50.9Stock-Based Compensation Expense (included in each functional line item) Cost of product revenue 0.3 % 0.2 % 0.3 % 0.3 % 0.3 % Research and development 3.2 3.9 4.0 3.8 4.5 Selling, general and administrative 1.2 1.4 1.5 1.4 1.6 27-------------------------------------------------------------------------------- Table of Contents Net Revenue The following tables present net revenue from each of our new reportable segments and the Cellular Baseband category: Three Months Ended Quarter over Quarter Year over Year September 30, September 30, 2014 June 30, 2014 2013 $ Change % Change $ Change % Change (In millions, except percentages) Broadband and Connectivity $ 1,512 $ 1,302 $ 1,403 $ 210 16.1 % $ 109 7.8 % Infrastructure and Networking 651 655 587 (4 ) (0.6 ) 64 10.9 Total reportable segments 2,163 1,957 1,990 206 10.5 173 8.7 Cellular Baseband 97 84 156 13 15.5 (59 ) (37.8 ) Total net revenue $ 2,260 $ 2,041 $ 2,146 $ 219 10.7 $ 114 5.3 Nine Months Ended Year over Year September 30, September 30, 2014 2013 $ Change % Change (In millions, except percentages) Broadband and Connectivity $ 4,060 $ 4,107 $ (47 ) (1.1 )% Infrastructure and Networking 1,900 1,563 337 21.6 Total reportable segments 5,960 5,670 290 5.1 Cellular Baseband 325 485 (160 ) (33.0 ) All Other - 86 (86 ) (100.0 ) Total net revenue $ 6,285 $ 6,241 $ 44 0.7 Broadband and Connectivity. The increase in net revenue in the three months ended September 30, 2014, as compared to the three months ended June 30, 2014, resulted primarily from increases in sales of our wireless connectivity products of $126 million, our broadband modems solutions of $33 million, our set-top box (STB) solutions of $21 million and other broadband and connectivity technologies of $30 million. The increase in net revenue in the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, resulted primarily from increases in sales of our STB solutions of $62 million and our broadband modem solutions of $50 million. The decrease in net revenue in the nine months ended September 30, 2014, as compared to nine months ended September 30, 2013, resulted primarily from a decrease in our wireless connectivity products of $204 million and other broadband and connectivity technologies of $36 million, offset in part by increases in sales of our broadband modem solutions of $101 million and our STB solutions of $92 million. Growth in sales of broadband modem solutions is generally driven by subscriber growth, global deployments and upgrades of broadband infrastructure, the adoption of new features and technologies (including DOCSIS 3.0 and VDSL) and market share gains. STB growth is generally driven by global subscriber growth, the adoption of new communication features (including HEVC, transcoding and MoCA 2.0), market share gains and the roll-out of more highly integrated platforms by global service providers. Sequential growth in revenue related to wireless connectivity is consistent with seasonal strength in the third quarter. The decline in revenue year-on-year is driven principally by the impact of slowing growth rate in the smartphone market, particularly in higher-end devices, and reduced sales into low-cost smartphones. Low-cost smartphones have trended toward integrated platforms from single suppliers, which in many cases tend not to include Broadcom solutions. Infrastructure and Networking. The increase in net revenue for the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, resulted primarily from increases in sales of Ethernet switches and PHYs of $48 million and processors of $11 million. The increase in net revenue in the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013, resulted from increases in sales of our Ethernet switches and PHYs of $255 million, processors of $61 million and our Ethernet controller products of $20 million. Growth in Ethernet switches and PHYs is generally driven by continued build outs of packet-based networks to support the delivery of video and mobile data over the Internet, an increase in hosted services and cloud computing, the ongoing growth in unified communications in the enterprise, and market share gains. Growth in sales of our processor solutions is driven by growth in sales of SoCs that incorporate processor and switch functionality and serve a wide range of end markets, including point-of-sale devices and enterprise and retail routers. 28-------------------------------------------------------------------------------- Table of Contents Cellular Baseband. The increase in net revenue for the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, was driven principally by stronger than expected sales in legacy design wins. Due to our announced exit of the cellular baseband business, we expect associated revenue to significantly ramp down in the near term and trend to zero over the next twelve to eighteen months. Rebates. We recorded customer rebates of $251 million, or 11.1% of net revenue, $176 million, or 8.6% of net revenue, and $264 million, or 12.3% of net revenue, in the three months ended September 30, 2014, June 30, 2014, and September 30, 2013, respectively. We recorded customer rebates of $615 million, or 9.8% of net revenue, and $617 million, or 9.9% of net revenue, in the nine months ended September 30, 2014 and 2013, respectively. We reverse the accrual of unclaimed rebate amounts as specific rebate programs contractually end or when we believe unclaimed rebates are no longer subject to payment and will not be paid. We reversed accrued rebates of $8 million, $13 million and $2 million in the three months ended September 30, 2014, June 30, 2014 and September 30, 2013, respectively. We reversed accrued rebates of $28 million and $15 million in the nine months ended September 30, 2014 and 2013, respectively. We anticipate that accrued rebates will vary in future periods based upon the level of overall sales to customers that participate in our rebate programs. Concentration of Net Revenue Sales to our significant customers, including sales to their manufacturing subcontractors, as a percentage of net revenue were as follows: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Two largest customers 29.9 % 34.9 % 28.2 % 34.6 % Five largest customers as a group 45.4 49.1 44.6 48.3 We expect that our largest customers will continue to account for a substantial portion of our total net revenue for the foreseeable future. However, we cannot predict whether our decision to exit the cellular baseband business will negatively impact those relationships. Our largest customers and their respective contributions to our total net revenue have varied and will likely continue to vary from period to period. From time to time, our key customers place large orders causing our quarterly net revenue to fluctuate significantly. We expect that these fluctuations will continue and that they may be exaggerated by the seasonal variations in consumer products and changes in the overall economic environment. For these and other reasons, our total net revenue and results of operations for the three months ended September 30, 2014 and prior periods may not necessarily be indicative of future net revenue and results of operations. Total Net Revenue, Cost of Product Revenue, Product Gross Margin, and Total Gross Margin The following tables present total net revenue, cost of product revenue, product gross margin and total gross margin: Three Months Ended Quarter over Quarter Year over Year September 30, September 30, 2014 June 30, 2014 2013 $ Change % Change $ Change % Change (In millions, except percentages) Product revenue $ 2,260 $ 2,041 $ 2,146 $ 219 10.7 % $ 114 5.3 % Cost of product revenue $ 1,077 $ 1,005 $ 1,044 $ 72 7.2 $ 33 3.2 Product gross margin 52.3 % 50.8 % 51.4 % 29-------------------------------------------------------------------------------- Table of Contents Nine Months Ended Year over Year September 30, September 30, 2014 2013 $ Change % Change (In millions, except percentages) Product revenue $ 6,285 $ 6,155 $ 130 2.1 % Income from Qualcomm Agreement - 86 (86 ) (100.0 ) Total net revenue $ 6,285 $ 6,241 $ 44 0.7 Cost of product revenue $ 3,086 $ 3,062 $ 24 0.8 Product gross margin 50.9 % 50.3 % Total gross margin 50.9 % 50.9 % Cost of Product Revenue and Product Gross Margin. Cost of product revenue comprises the cost of our semiconductor devices, which consists of the cost of purchasing finished silicon wafers manufactured by independent foundries, costs associated with our purchase of assembly, test and quality assurance services and packaging materials for semiconductor products, as well as royalties and license fees paid to vendors and to non-practicing entities, or NPEs. Also included in cost of product revenue is the amortization of purchased technology and inventory valuation step-up, and manufacturing overhead, including costs of personnel and equipment associated with manufacturing support, product warranty costs, provisions for excess and obsolete inventories, and stock-based compensation expense for personnel engaged in manufacturing support. Product gross margin is product revenue less cost of product revenue divided by product revenue and does not include income from the Qualcomm Agreement. Total gross margin is total net revenue less cost of product revenue divided by total net revenue. The improvement to product gross margin in the three months ended September 30, 2014, as compared to the three months ended June 30, 2014, was the result of a decrease in excess and obsolete inventory expense of $33 million. The excess and obsolete inventory expenses recorded in the three months ended June 30, 2014, were primarily related to reductions in our forecast following our decision to exit the cellular baseband business. The increase in product gross margins for the three and nine months ended September 30, 2014, as compared to the three and nine months ended September 30, 2013, resulted primarily due to increases of 10.9% and 21.6% in net revenue, respectively, in our Infrastructure and Networking reportable segment (which products typically produce higher product gross margins), as well as a decline in revenue related to our cellular baseband business (which products produce lower product gross margins). Our product and total gross margin may also be impacted by, among other items, additional stock-based compensation expense, as discussed below, and the amortization of purchased intangible assets related to future acquisitions. Research and Development Expense Research and development expense consists primarily of salaries and related costs of employees engaged in research, design and development activities, including stock-based compensation expense. Development and design costs consist primarily of costs related to engineering design tools, mask and prototyping costs, testing and subcontracting costs. In addition, we incur costs related to facilities and equipment expense, among other items. The following tables present details of research and development expense: Three Months Ended Quarter over Quarter Year over Year September 30, September 30, 2014 June 30, 2014 2013 $ Change % Change $ Change % Change (In millions, except percentages) Salaries and benefits $ 332 $ 376 $ 355 $ (44 ) (11.7 )% $ (23 ) (6.5 )% Stock-based compensation 73 80 86 (7 ) (8.8 ) (13 ) (15.1 ) Development and design costs 92 86 88 6 7.0 4 4.5 Other 76 92 80 (16 ) (17.4 ) (4 ) (5.0 ) Research and development $ 573 $ 634 $ 609 $ (61 ) (9.6 )% $ (36 ) (5.9 )% 30-------------------------------------------------------------------------------- Table of Contents Nine Months Ended Year over Year September 30, September 30, 2014 2013 $ Change % Change (In millions, except percentages) Salaries and benefits $ 1,080 $ 1,052 $ 28 2.7 % Stock-based compensation 237 280 (43 ) (15.4 ) Development and design costs 266 276 (10 ) (3.6 ) Other 260 235 25 10.6 Research and development $ 1,843 $ 1,843 $ - - % The decreases in salaries and benefits for the three months ended September 30, 2014, as compared to the three months ended June 30, 2014 and September 30, 2013, were primarily attributable to our restructuring plan related to our cellular baseband business. Prior to our decision to exit the cellular baseband business, our headcount increased from 9,300 personnel to 9,750 personnel, or 4.8% over the previous twelve months. Taking into account the subsequent restructuring plan related to the cellular baseband business, we had a net decrease in headcount of approximately 1,100 personnel, bringing research and development headcount to approximately 8,200 at September 30, 2014. This represents an 11.8% decrease from September 30, 2013. Salaries and benefits for the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013 increased as a result of the 4.8% increase in headcount mentioned above and not yet realizing the full benefit of the restructuring plan put into place in July 2014. See below for a discussion of stock-based compensation. Development and design costs vary from period to period depending on the timing of development and tape-out of various products. The decreases in the Other line item from the three months ended June 30, 2014 to September 30, 2014 is primarily attributable to a decrease in depreciation expenses related to the exit of the cellular baseband business. The increase in the Other line item from the nine months ended September 30, 2013 to September 30, 2014 is a result of increased depreciation due to the Renesas Transaction. See Note 9 of Notes to Unaudited Condensed Consolidated Financial Statements for further information. We remain committed to significant research and development efforts to extend our technology leadership in the wired and wireless communications markets in which we operate. Factors that may impact research and development costs include the diversification of the markets we serve, new product opportunities, the number of design wins that go into production, changes in our compensation policies, and any expansion into new markets and technologies, including acquisitions. For the three months ended September 30, 2014, approximately 50% and 30% of our products were manufactured in 40 nanometers and 65 nanometers, respectively. We are designing most new products in 40 nanometers and 28 nanometers, and are beginning to develop products leveraging FinFET technologies. We currently hold more than 10,000 U.S. and more than 3,600 foreign patents and have more than 6,850 additional U.S. and foreign pending patent applications. We maintain an active program of filing for and acquiring additional U.S. and foreign patents in wired and wireless communications and other fields. Selling, General and Administrative Expense Selling, general and administrative expense consists primarily of personnel-related expenses, including stock-based compensation expense, legal and other professional fees, facilities expenses and communications expenses. The following tables present details of selling, general and administrative expense: Three Months Ended Quarter over Quarter Year over Year September 30, September 30, 2014 June 30, 2014 2013 $ Change % Change $ Change % Change (In millions, except percentages) Salaries and benefits $ 91 $ 95 $ 86 $ (4 ) (4.2 )% $ 5 5.8 % Stock-based compensation 28 28 33 - - (5 ) (15.2 ) Legal and accounting fees 16 19 27 (3 ) (15.8 ) (11 ) (40.7 ) Other 41 40 35 1 2.5 6 17.1 Selling, general and administrative $ 176 $ 182 $ 181 $ (6 ) (3.3 )% $ (5 ) (2.8 )% 31-------------------------------------------------------------------------------- Table of Contents Nine Months Ended Year over Year September 30, September 30, 2014 2013 $ Change % Change (In millions, except percentages) Salaries and benefits $ 277 $ 259 $ 18 6.9 % Stock-based compensation 86 102 (16 ) (15.7 ) Legal and accounting fees 56 74 (18 ) (24.3 ) Other 124 99 25 25.3 Selling, general and administrative $ 543 $ 534 $ 9 1.7 % Salaries and benefits for the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013, increased as a result of a 2.5% increase in headcount from the prior year and not yet realizing the full benefit of the restructuring plan put into place in July 2014. Taking into account the subsequent restructuring plan related to the cellular baseband business, we had a net decrease in headcount of approximately 50 personnel, bringing selling, general and administrative headcount to approximately 1,950 at September 30, 2014. This represents a 2.5% decrease from September 30, 2013. The decrease in legal and accounting fees was primarily driven by the conclusion of several outstanding legal matters over the past year. See below for a discussion of stock-based compensation. The increases in the Other line item were primarily attributable to an increase in facilities expenses. See Note 9 of Notes to Unaudited Condensed Consolidated Financial Statements for further information. Stock-Based Compensation Expense The following tables present details of total stock-based compensation expense that is included in each functional line item in our unaudited condensed consolidated statements of income: Three Months Ended Quarter over Quarter Year over Year September 30, September 30, 2014 June 30, 2014 2013 $ Change % Change $ Change % Change (In millions, except percentages) Cost of product revenue $ 6 $ 5 $ 6 $ 1 20.0 % $ - - % Research and development 73 80 86 (7 ) (8.8 ) (13 ) (15.1 ) Selling, general and administrative 28 28 33 - - (5 ) (15.2 ) $ 107 $ 113 $ 125 $ (6 ) (5.3 )% $ (18 ) (14.4 )% Nine Months Ended Year over Year September 30, September 30, 2014 2013 $ Change % Change (In millions, except percentages) Cost of product revenue $ 17 $ 19 $ (2 ) (10.5 )% Research and development 237 280 (43 ) (15.4 ) Selling, general and administrative 86 102 (16 ) (15.7 ) $ 340 $ 401 $ (61 ) (15.2 )% The decrease in stock-based compensation in the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013, was primarily attributable to certain assumed equity awards becoming fully vested during 2013 and the cancellation of equity awards held by employees who were terminated due to the decision to exit our cellular baseband business. In the nine months ended September 30, 2014, we granted equity awards with a fair value of $400 million, primarily related to our regular annual equity compensation review program, which will be expensed over the next four years. 32-------------------------------------------------------------------------------- Table of Contents The following table presents details of unearned stock-based compensation currently estimated to be expensed in the remainder of 2014 and through 2018 related to unvested share-based payment awards: 2014 2015 2016 2017 2018 Total (In millions) Unearned stock-based compensation $ 98 $ 298 $ 191 $ 98 $ 16 $ 701 If there are any modifications or cancellations of the underlying unvested awards, including the cancellation of awards held by employees impacted by our current restructuring plan, we may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional equity awards or assume unvested equity awards in connection with acquisitions. See Note 7 of Notes to Unaudited Condensed Consolidated Financial Statements for a discussion of activity related to share-based awards. Amortization of Purchased Intangible Assets The following tables present details of the amortization of purchased intangible assets included in the cost of product revenue and other operating expense categories: Three Months Ended Quarter over Quarter Year over Year September September 30, 30, 2014 June 30, 2014 2013 $ Change % Change $ Change % Change (In millions, except percentages) Cost of product revenue $ 46 $ 47 $ 42 $ (1 ) (2.1 )% $ 4 9.5 % Other operating expenses 8 9 14 (1 ) (11.1 ) (6 ) (42.9 ) $ 54 $ 56 $ 56 $ (2 ) (3.6 )% $ (2 ) (3.6 )% Nine Months Ended Year over Year September 30, September 30, 2014 2013 $ Change % Change (In millions, except percentages) Cost of product revenue $ 143 $ 129 $ 14 10.9 % Other operating expenses 26 43 (17 ) (39.5 ) $ 169 $ 172 $ (3 ) (1.7 )% The amortization of purchased intangible assets reflects the pattern in which the economic benefits of the intangible assets were consumed or otherwise used. The following table presents details of the amortization of existing purchased intangible assets (including IPR&D), currently estimated to be expensed in the remainder of 2014 and thereafter: Purchased Intangible Asset Amortization by Year 2014 2015 2016 2017 2018 Thereafter Total (In millions) Cost of product revenue $ 42 $ 145 $ 117 $ 99 $ 84 $ 206 $ 693 Other operating expenses 3 4 4 2 2 3 18 $ 45 $ 149 $ 121 $ 101 $ 86 $ 209 $ 711 Impairment of Long-Lived Assets See discussion of our impairment of long-lived assets in Notes 9 and 10 of the Notes to Unaudited Condensed Consolidated Financial Statements as it relates to our decision to exit the cellular baseband business and wind down those operations, as well as our acquisition of NetLogic. 33-------------------------------------------------------------------------------- Table of Contents Restructuring Costs See discussion of our restructuring costs in our "Exit of Cellular Baseband Business" above and in Note 9 of the Notes to Unaudited Condensed Consolidated Financial Statements. Settlement Costs See Note 8 of Notes to Unaudited Condensed Consolidated Financial Statements. Other Charges (Gains), Net See discussion of our Other Charges (Gains), Net in Note 2 of the Notes to Unaudited Condensed Consolidated Financial Statements as it relates to the sale of certain Ethernet controller-related assets to QLogic in the three months ended March 31, 2014. Provision for Income Taxes The following table presents details of the provision for income taxes and our effective tax rates: Three Months Ended Nine Months Ended September 30, September September 30, 2014 June 30, 2014 September 30, 2013 2014 30, 2013 (In millions, except percentages) Provision for income taxes $ 5 $ 2 $ 9 10 8 Effective tax rates 4.9 % 200.0 % 2.8 % 3.7 % 3.0 % The differences between our effective tax rates and the 35% federal statutory rate resulted primarily from foreign earnings taxed at substantially lower rates than the federal statutory rate and domestic tax losses recorded without tax benefits. See discussion of Income Taxes in Note 4 of the Notes to Unaudited Condensed Consolidated Financial Statements for further information in determining our annualized effective tax rates. Liquidity and Capital Resources Working Capital and Cash and Marketable Securities. The following table presents working capital, cash and cash equivalents, and marketable securities: September 30, December 31, 2014 2013 $ Change (In millions) Working capital $ 3,313 $ 2,419 $ 894 Cash and cash equivalents $ 2,254 $ 1,657 597 Short-term marketable securities 1,068 775 293 Long-term marketable securities 2,098 1,939 159 Total cash and cash equivalents and marketable securities $ 5,420 $ 4,371 $ 1,049 See discussion of market risk that follows in Item 3. Quantitative and Qualitative Disclosures about Market Risk. 34-------------------------------------------------------------------------------- Table of Contents Cash Provided and Used in the Nine Months Ended September 30, 2014 and 2013 Nine Months Ended September 30, 2014 2013 (In millions) Net cash provided by operating activities $ 1,292 $ 1,394 Net cash used in investing activities (584 ) (890 ) Net cash used in financing activities (111 ) (597 ) Increase (decrease) in cash and cash equivalents 597 (93 ) Cash and cash equivalents at beginning of period 1,657 1,617 Cash and cash equivalents at end of period $ 2,254 $ 1,524 Operating Activities In the nine months ended September 30, 2014 our operating activities provided $1.29 billion in cash. This was primarily the result of net income of $262 million, net non-cash operating expenses of $996 million, and changes in operating assets and liabilities of $34 million. In the nine months ended September 30, 2013 our operating activities provided $1.39 billion in cash. This was primarily the result of net income of $256 million and net non-cash operating expenses of $1.20 billion, offset in part by changes in operating assets and liabilities of $66 million. Our days sales outstanding increased from 35 days at December 31, 2013 to 38 days at September 30, 2014. We typically bill customers on an open account basis subject to our standard net thirty day payment terms. If, in the longer term, our revenue increases, it is likely that our accounts receivable balance will also increase. Additionally, accounts receivable could increase due to fluctuations in concentrations of revenue with customers under rebate programs, which may result in higher levels of accounts receivables and accrued rebates on our balance sheet. Our accounts receivable could also increase if customers delay their payments or if we grant extended payment terms to customers, both of which are more likely to occur during challenging economic times when our customers may have difficulty gaining access to sufficient credit on a timely basis. Our inventory days on hand increased from 47 days at December 31, 2013 to 53 days at September 30, 2014 primarily to meet anticipated revenue levels in the three months ending September 30, 2014. In the future, our inventory levels will continue to be determined by the level of purchase orders we receive and the stage at which our products are in their respective product life cycles, our ability, and the ability of our customers, to manage inventory under hubbing arrangements, and competitive situations in the marketplace. Such considerations are balanced against the risk of obsolescence or potentially excess inventory levels. Investing Activities Investing activities used $584 million in cash in the nine months ended September 30, 2014, which was primarily the result of $214 million of property and equipment purchases to support our research and development efforts and to upgrade our enterprise resource planning system, and $451 million in net purchases of marketable securities, offset in part by $90 million primarily from the net proceeds from the sale of certain assets in the QLogic Transaction. Investing activities used $890 million in cash in the nine months ended September 30, 2013, which was primarily the result of $172 million of property and equipment purchases to support our research and development efforts and to upgrade our enterprise resource planning system, and $718 million in net purchases of marketable securities. Financing Activities Our financing activities used $111 million in cash in the nine months ended September 30, 2014, which was primarily the result of $418 million in repurchases of our Class A common stock, repayment of long-term debt of $400 million, dividend payments of $211 million, and $93 million in minimum tax withholding paid on behalf of employees for shares issued pursuant to restricted stock units, or RSUs, offset in part by $592 million in net proceeds from the issuance of long-term debt and $419 million in proceeds received from issuances of common stock upon the exercise of stock options. Our financing activities used $597 million in cash in the nine months ended September 30, 2013, which was primarily the result of $595 million in repurchases of our Class A common stock, dividend payments of $190 million, and $104 million in minimum tax withholding 35-------------------------------------------------------------------------------- Table of Contents paid on behalf of employees for shares issued pursuant to RSUs, offset in part by $292 million in proceeds received from issuances of common stock upon the exercise of stock options. The timing and number of stock option exercises and employee stock purchases and the amount of cash proceeds we receive from these equity awards are not within our control. As it is now our general practice to issue RSUs instead of stock options we will likely not generate as much cash from the exercise of stock options as we have in the past. Unlike the exercise of stock options, the issuance of shares upon vesting of RSUs does not result in any cash proceeds to Broadcom and in fact requires the use of cash, as we currently allow employees to have a portion of the shares issued upon vesting of RSUs withheld to satisfy minimum statutory withholding taxes. This withholding procedure requires that we pay cash to the appropriate tax authorities on each participating employee's behalf. Short and Long-Term Financing Arrangements At September 30, 2014, we had the following resources available to obtain short-term or long-term financings if we need additional liquidity: Registration Statements We have a Form S-4 acquisition shelf registration statement on file with the SEC. The registration statement on Form S-4 enables us to issue up to 30 million shares of our Class A common stock in one or more acquisition transactions. These transactions may include the acquisition of assets, businesses or securities by any form of business combination. To date no securities have been issued pursuant to the S-4 registration statement, which does not have an expiration date mandated by SEC rules. Senior Notes The following table summarizes details of our senior unsecured notes, or Notes: September 30, December 31, 2014 2013 (In millions) 2.375% fixed-rate notes, due November 2015 $ - $ 400 2.700% fixed-rate notes, due November 2018 500 500 2.500% fixed-rate notes, due August 2022 500 500 3.500% fixed-rate notes, due August 2024 350 - 4.500% fixed-rate notes, due August 2034 250 - $ 1,600 $ 1,400 Unaccreted discount (7 ) (6 ) $ 1,593 $ 1,394 The outstanding Notes described above contain a number of customary representations, warranties and restrictive covenants, including, but not limited to, restrictions on our ability to grant liens on assets; enter into sale and lease-back transactions; or merge, consolidate or sell assets. Failure to comply with these covenants, or any other event of default, could result in acceleration of the principal amount and accrued and unpaid interest on the Notes. Credit Facility In November 2010 we entered into a credit facility with certain institutional lenders that provides for unsecured revolving facility loans, swing line loans and letters of credit in an aggregate amount of up to $500 million. This credit facility, which was most recently amended in July 2014, has a maturity date of July 31, 2019, at which time all outstanding revolving facility loans (if any) and accrued and unpaid interest must be repaid. We have not drawn on the credit facility since its inception. The credit facility contains customary representations, warranties and covenants. The financial covenant in the credit facility requires us to maintain a consolidated leverage ratio of no more than 3.25:1.00. We were in compliance with all credit facility covenants as of September 30, 2014. 36-------------------------------------------------------------------------------- Table of Contents Other Notes and Borrowings We had no other significant notes or borrowings as of September 30, 2014. Commitments and Other Contractual Obligations There have been no material changes in the nine months ended September 30, 2014 to the amounts presented in the table under the "Commitments and Other Contractual Obligations" section in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation" of our 2013 Annual Report. Prospective Capital Needs We believe that our existing cash, cash equivalents and marketable securities, together with cash generated from operations and from the issuance of common stock through our employee stock option and purchase plans, will be sufficient to cover our working capital needs, capital expenditures, investment requirements, commitments, repurchases of our Class A common stock and quarterly dividends for at least the next 12 months. This includes our potential acquisition of property for the construction of a new corporate campus. However, it is possible that we may choose to raise additional funds or draw on our existing credit facility to finance our activities beyond the next 12 months or to consummate acquisitions of other businesses, assets, products or technologies. If needed, we may be able to raise such funds by selling equity or debt securities to the public or to selected investors or by borrowing money from financial institutions. We could also reduce certain expenditures, such as repurchases of our Class A common stock and payments of our quarterly dividends. We earn a significant amount of our operating income outside the U.S., which is deemed to be permanently reinvested in foreign jurisdictions. For at least the next 12 months, we have sufficient cash in the U.S. and expect domestic cash flow to sustain our operating activities and cash commitments for investing and financing activities, such as acquisitions, quarterly dividends, share buy-backs and repayment of debt. In addition, we expect existing foreign cash, cash equivalents, short-term investments, and cash flows from operations to continue to be sufficient to fund our foreign operating activities and cash commitments for investing activities, such as material capital expenditures, for at least the next 12 months. As of September 30, 2014 we have approximately $2.70 billion of cash, cash equivalents, and marketable securities held by our foreign subsidiaries. Should we require more capital in the U.S. than is generated by our operations domestically, for example to fund significant discretionary activities, such as business acquisitions and share repurchases, we could elect to repatriate future earnings from foreign jurisdictions or raise capital in the U.S. through debt or equity issuances. A substantial portion of repatriated amounts would be offset by our net operating loss and tax credit carryforwards. Nevertheless, these alternatives could result in higher effective tax rates, increased interest expense, or dilution of our earnings. In addition, even though we may not need additional funds, we may still elect to sell additional equity or debt securities or utilize or increase our existing credit facilities for other reasons. However, we may not be able to obtain additional funds on a timely basis at acceptable terms, if at all. If we raise additional funds by issuing additional equity or convertible debt securities, the ownership percentages of existing shareholders would be reduced. In addition, the equity or debt securities that we issue may have rights, preferences or privileges senior to those of our Class A common stock. Off-Balance Sheet Arrangements At September 30, 2014 we had no material off-balance sheet arrangements, other than our facility operating leases. 37-------------------------------------------------------------------------------- Table of Contents |