Welcome to Broadcom Limited's third quarter fiscal year 2016 financial results conference call. At this time, for opening remarks and introductions, I would like to turn the call over to Ashish Saran, Director of Investor Relations. Please go ahead, sir.
Thank you, operator, and good afternoon, everyone. Joining me today are Hock Tan, President and CEO, and Tom Krause, Acting Chief Financial Officer of Broadcom Limited. After market close today, Broadcom distributed a press release and financial tables describing our financial performance for the third quarter of fiscal year 2016. If you did not receive a copy, you may obtain the information from the investor section of Broadcom's website at www.broadcom.com. This conference call is being webcast live and a recording will be available via telephone playback for one week. It will also be archived in the investors section of our website at broadcom.com. During the prepared comment section of this call, Hock and Tom will be providing details of our third quarter fiscal year 2016 results, background to our fourth quarter fiscal year 2016 outlook, and some commentary regarding the business environment.
We will take questions after the end of our prepared comments. In addition to US GAAP reporting, Broadcom reports certain financial measures on a non-GAAP basis. A reconciliation between GAAP and non-GAAP measures is included in the tables attached to today's press release. Comments made during today's call will primarily refer to our non-GAAP financial results. Please refer to our press release today and our recent filings with the SEC for information on the specific risk factors that could cause our actual results to differ materially from the forward-looking statements made on this call. At this time, I would like to turn the call over to Hock Tan. Hock?
Thank you, Ashish. Good afternoon, everyone. Well, we did deliver very strong results for our third fiscal quarter 2016, with revenue at $3.8 billion, up 7% sequentially and above the midpoint of guidance. Earnings per share of $2.89 grew by a more impressive 14% sequentially as we benefited from the leverage inherent in our business model. I'm rather pleased with our execution on integrating classic Broadcom businesses and divesting several of its non-core businesses we had identified as assets held for sale. We have also made rapid progress in driving towards our target business model within the first two quarters after closing the acquisition, but we're not yet done with the full realization of expected acquisition related cost synergies. Let me now turn to a discussion of our third quarter segment results, starting with wired.
In the third quarter, wired revenue came in at $2.07 billion and the wired segment represented 54% of total revenues. Revenue for this segment was flat sequentially as the strong demand we had seen for wired products in the prior quarter continued to sustain into the third quarter. This was slightly weaker than we had expected due to lower than expected set-top box product shipments because of supply constraints. However, the reduction in set-top box revenue was offset by growth in our ASICs, particularly in Ethernet switching and fiber optic shipments into the fiber to the home applications. We also benefited from strong demand for fiber to the home products in our broadband access business. Switching and routing ASSPs sustained as data center operators continue to upgrade their infrastructure.
Our Jericho routing product family, which is enabling a whole new set of switching and routing platforms for our core customers, had a strong ramp in this quarter. As we look into the fourth quarter for our wired segment, similar to the prior quarter, we expect wired to sustain and continue to come in flat sequentially. We continue to resolve supply constraints in this segment as we progress through the fourth quarter. Moving on to wireless. In the third quarter, wireless revenue came in at about $1 billion and this segment represented 27% of total revenues. Revenue for this segment was up 27% sequentially, somewhat stronger than expectations. Growth was primarily driven by the expected start of a ramp from a large North American smartphone customer as they transition to their next generation platform, further enhanced by a substantial increase in Broadcom's content in the new handset.
We also benefited from continued demand increases from our large Asian handset customer. Looking towards the fourth quarter fiscal 2016, we expect strong growth to continue in our wireless segment, and we are projecting revenue growth over 30% sequentially here. We expect this growth to result from the full ramp of the new phone model and our North American smartphone customer, partially offset by the annual product cycle rollover and a large Asian customer. Let me now turn to enterprise storage. In the third quarter, enterprise storage revenue came in at $527 million, and this segment represented 14% of total revenue. Segment revenue came in flat sequentially compared to the large seasonal decline in the prior quarter.
We had expected revenue in this segment to decline sequentially, but instead, we delivered better results as some stability returned to both the hard disk drive and server storage SAS connectivity businesses in the third quarter. Looking into the fourth quarter, we expect positive end market seasonality to drive enterprise storage revenue growth in the low single digits sequentially. Finally, to our last segment, industrial. As I mentioned previously, this segment also includes our IP, intellectual property licensing business. In the third quarter, industrial segment revenue came in at $202 million, up 11% sequentially, much better than expectations. Industrial segment represented 5% of our total revenue. In IP licensing, as expected, after a strong and lumpy second quarter, revenue dropped in the third quarter in IP licensing.
In contrast, industrial product resales, that's our distributors selling to our end customers, their end customers, grew by a healthy 15% sequentially with strong demand from all geographies. As a result, industrial product revenue also increased sequentially and significantly as we replenish depleted channel inventory during the third quarter. Accordingly, as we look into the fourth quarter and take into account the strong inventory replenishment in the third quarter, we plan on reducing shipments into the channel as we head towards the seasonally weaker end of the calendar year. Therefore, even as we forecast resale to continue to be firm and trend up mid-single digits, we expect an approximate 20% sequential decline in fourth quarter industrial revenue. In summary, therefore, I'd like to say visibility to near-term projected demand remains very solid, and we anticipate continued momentum into the fourth quarter.
We expect the ramp in our wireless segment to drive consolidated revenue growth of 8% sequentially. We expect our operating leverage to drive earnings per share growth of 16% sequentially, twice our projected revenue growth. With that, let me now turn the call over to Tom for a more detailed review of our third quarter financials.
Thank you, Hock, and good afternoon, everyone. My comments today will focus primarily on our non-GAAP results from continuing operations, unless otherwise specifically noted. A reconciliation of our GAAP and non-GAAP data is included with the earnings release issued today and is also available on our website at broadcom.com. We continue to focus on our core businesses or franchises, as we call them, to drive a financial model that delivers sustainable mid-single-digit annual revenue growth at greater than 60% gross margin and greater than 40% operating margin. To that end, in the third quarter, we took another very positive step towards our target model. We achieved healthy top-line growth with gross margin over 60% and operating margin at just over 39%. As our integration plans progress, we see a very clear line of sight to achieving our target model in fiscal year 2017.
We were also able to improve our capital structure in the quarter. We completed both previously announced divestitures, collecting over $600 million in cash and paid down $1.3 billion of our long-term debt. Finally, just after the quarter close, we took advantage of favorable credit markets to refinance our outstanding term loans at substantially lower rates. I will touch on the details of the refinancing later in my prepared remarks. Now let me turn to a summary of our results for the third quarter. Revenue for the third quarter came in at $3.8 billion, growing 6.7% sequentially. Foxconn was a greater than 10% direct customer in the third fiscal quarter. Our third-quarter gross margin from continuing operations was 60.4%, about 40 basis points above the midpoint of guidance, primarily due to better-than-expected operational efficiency. Turning to operating expenses. R&D expenses were $667 million, and SG&A expenses were $141 million.
This resulted in total operating expenses for the third quarter of $808 million, in line with guidance. Operating expenses were flat sequentially as the benefits from the ongoing realization of acquisition-related cost synergies were offset by higher bonus accruals due to higher profitability. Our fourth quarter guidance for operating expenses anticipates a similar outcome. We expect our IT platform integration, which is scheduled to be completed in early fiscal year 2017, to continue to drive operating expense reductions next year as we work towards the full realization of projected acquisition-related cost synergies. On a percentage basis for the third quarter, total operating expenses were 21.3% of revenue. As a percentage of sales, R&D was 17.6%, and SG&A was 3.7%. Operating income from continuing operations for the quarter was $1.5 billion approximately and represented 39.2% of net revenue. Taxes came in at $61 million, slightly above our guidance.
This was primarily due to higher than expected net income. Third quarter net income was $1.3 billion approximately, and earnings per diluted share was $2.89. Third quarter interest expense was $139 million, and other income net was $4 million. As I mentioned in the opening remarks on August 2nd, right after the quarter close, the second day of the fourth fiscal quarter, in fact, we completed a refinancing of our outstanding term loans by upsizing our term loan A and reducing our term loan B by an equivalent amount, and simultaneously repricing the remainder of the term loan B at a lower interest rate. The net effect is a reduction of our blended cost of debt based on current LIBOR from 3.5% to 2.9%. This refinancing significantly lowers our projected ongoing interest expenses starting with the fourth fiscal quarter of 2016.
Keep in mind, our indebtedness is 100% floating rate and is therefore subject to movement in short-term interest rates. Our share-based compensation expense in the third quarter was $213 million, which included the full impact from new grants issued to classic Broadcom employees after the close of the acquisition in the second quarter. In the fourth quarter of fiscal 2016, we anticipate share-based compensation expense will also be approximately $213 million. Just as a reminder, our definition of non-GAAP net income excludes share-based compensation expense. Moving on to the balance sheet. Our day sales outstanding were 52 days, an increase of four days from the prior quarter due to the timing of the seasonal ramp in our wireless revenues. Our inventory ended at $1.3 billion, down from $1.47 billion in the prior quarter.
This was primarily due to the depletion of wireless filter inventory we had built up in prior quarters to support the strong second-half production ramp, which started as expected in the third quarter. We generated $963 million in operational cash flow, which reflected the impact of approximately $96 million of cash expended on restructuring activities. We ended the quarter with a cash balance of approximately $2 billion. In the third quarter, we spent $232 million on capital expenditures. For the fourth quarter, we expect CapEx to be approximately $325 million. As I had mentioned previously, we expect CapEx to run at an elevated level over the next several quarters, driven by campus construction, primarily at our Irvine and San Jose locations, integration-related operations and IT investments, and the ongoing RF filter fab capacity expansion we've discussed in the past.
A total of $211 million in cash was spent on company dividend partnership distribution payments in the third quarter. As I think you've seen already, our board just recently declared a dividend of $0.51 per share to be paid later in this fourth fiscal quarter. Now let me turn to our non-GAAP guidance for the fourth quarter of FY 2016. This guidance reflects our current assessment of business conditions. We do not intend to update this guidance. This guidance is for results from continuing operations only. Net revenue is expected to be $4.1 billion, plus or minus $75 million. Gross margin is expected to be 60.5%, plus or minus one percentage point. Operating expenses are estimated to be approximately $808 million. Taxes are forecasted to be approximately $71 million.
Net interest expense and other is expected to be approximately $104 million, and the diluted share count forecast is for 448 million shares. That concludes my prepared remarks. Operator, if you could please open up the call for questions.
Ladies and gentlemen, if you'd like to ask a question at this time, please press the star, then the number 1 key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, you may do so by pressing the pound key. In the interest of time, we ask that you limit yourself to 1 question and 1 follow-up. Our first question comes from the line of John Pitzer with Credit Suisse. Your line is now open.
Yeah, guys. Hock. Tom, thanks for letting me ask the question. Hock, my first question, just on the wired business, you talked about supply constraints in the set-top box area. Was that all of the miss in the July quarter? When you look at the non-set-top box portion of wired for both July and October, I'm just kind of curious if you could qualify how that business is trending, especially because some companies have been talking about a re-acceleration in data center spending in the back half of the year. I would think that you guys would probably be an early leading indicator for that because you really don't want to buy CPUs if you don't have kind of your top-of-rack switches. Any kind of color around that would be helpful.
Okay. Well, with regard to data center spending, yes, we do see strength. In fact, we saw the strength as early as Q2, our fiscal Q2, not calendar, but our fiscal Q2. That strength has continued into Q3 and even as we sit here right now.
Hock, as my follow-up on the wireless business, you're guiding sequential growth higher in the October quarter than the July quarter, which is consistent with what you said on the last conference call. I'm just curious if you can help us understand what's unit driven versus content driven. Now that we're sort of a quarter into some new builds of new cell phones, can you talk a little bit about your content growth expectation on both the FBAR and the connectivity side for some of those new phones?
Well, one thing I have to preface, what we're seeing in this quarter, Q3 fiscal quarter and most of Q4 fiscal quarter is not all of it that ends in October. That represents a period where it's still a ramp. Okay, it's how one constructs the ramp, and that's tied to orders required of our key customers. It's not necessarily representative of volumes that would eventually be sold through the various channels into end customers. With that preface, all we're saying is with the build year-on-year, if we compare to back to a year ago, the build in unit terms has not significantly changed. It's largely all about content changes.
Perfect. Thanks, guys, appreciate it.
Okay.
Our next question comes from the line of Blayne Curtis with Barclays. Your line is now open.
Hey, guys, nice results. Just two questions on wireless. If you could just talk about, Hock, you obviously have one customer doing a big ramp. You mentioned one maybe [flying out]. Can you talk about the China market and what you're seeing there? Then on the connectivity side, could you just talk about the roadmap there for content increase? I know you're getting a little GPS, this go around, but just for Wi-Fi combo chips, what's the roadmap and what's the opportunity to gain more content over the next couple of generations?
Okay. Well, let's talk about Wi-Fi, which is wireless connectivity with the Bluetooth combo included in it. What we're seeing now today is, by the way, we are largely in the high-end phones where we are driving 802.11ac generation. In that regard, we are not seeing that much content increase, say, from a year ago. We expect to see that content increase as we move into next year as more functionality, higher performance, multi-bands start to come into play, which includes not just 2.5 gigahertz, but 5 gigahertz. We also expect to see beyond that 802.11ac moving into AX, which would be a big step up further in content gain. In many ways, this is all about increasing capacity throughput of bandwidth of data transfers through these Wi-Fi connections.
A parallel situation to our LTE wireless situation where increasing bands, first LTE, and then the increase in the number of bands in LTE in the connectivity leading to increasing FBAR content. Very similar. May not match each other as we move one generation to the other, but the overall trend upwards is extremely alike. All right.
Thanks, Hock. Maybe if you could just talk about on the cellular side, what you're seeing in China. Thanks.
Well, our visibility in China is not that good in the sense that we sell to OEMs. They sell into all over the world. Our focus largely are on very high-end premium phones, be they premium phones from Chinese makers or U.S. makers or Korean makers. It's not really a good representation of true end demand as others may see it in China.
Okay, thank you.
Our next question comes from the line of Vivek Arya with Bank of America. Your line is now open.
Thanks for letting me ask a question. For my first one, Hock, you mentioned supply constraint in your set-top box business, which I believe is around $500 million, $550 million a quarter or so. Can you quantify how much sales you're missing? Is it a 5% impact? Is it a 10% impact? Is there going to be a quarter in the future when you catch up with all these sales that you're missing right now?
First of all, it's very hard for us to quantify because customer comes in and place their request date. We obviously modulate it with what we can ship, so there will be push and pull. By the time it's all done, I'll be honest I don't have a good idea what it is. Even if I do, I probably wouldn't disclose it in this public forum. That aside, we are very aware that we could ship more were it not for supply constraints. We've been improving that over the course of the last several months, actually, and we expect to be largely out of it by the end of this fiscal quarter Q4.
Got it. As a follow-up, I wanted to ask about the leverage in the model. You mentioned you'll already be at your target operating margins by Q4. I'm curious how much more room is there on the gross margin side? Is it possible to get to, say, 61% or 62%? On the OpEx side, I believe, Tom Krause, you said that you would have the full realization of synergies in OpEx next year. Since you are sort of around $808 million, what does full realization of synergies mean, in terms of either an absolute number or as a percentage of sales by next year? Thank you.
Let me try to answer that question on both sides very simply. We had said, I know it's publicly disclosed early on when we closed the deal in early February 1st, that we target to exit fiscal 2016, which is this current quarter Q4, at 40% operating margin. As Tom Krause's guidance is showing, we're going to achieve that goal. Is that our targeted end-state operating margin? Obviously, you hit it right, Vivek Arya. That's not our targeted operating margin necessarily at all, because we do see the operating spending and the current level is about $800 plus, $808, to take a step down, especially, particularly after we integrate our two ERP systems. As you know, Classic Avago runs Oracle, Classic Broadcom runs SAP.
After the end of November, which is our day two, what I call day two, when we integrate two systems into one database, one ERP system, we expect to run only one system. That will be a step down, in terms of our headcount requirements, in terms of our support costs, and obviously an improvement in our operating cost structure significantly. That will come through obviously in fiscal 2017, which will then give our operating margin a further lift up. Without due consideration to further expansion of our gross margin, which as you've seen over the last two, three quarters, is likely to continue.
Thank you.
Our next question comes from Chris Danely with Citigroup. Your line is now open.
Hey, thanks, guys. Hock, just a quick clarification on the previous question. You said that the GMs, there should be a little bit of lift, they should be able to keep going up. Was that kind of what you were saying to the last question? Then I'll get started.
Yes.
Okay, great. The first one is, can you just touch on the connectivity business? Was that up sequentially? Maybe talk about the margins there and the progression and how you feel about how that business is progressing, what the margin goals are.
In terms of wireless connectivity?
Yeah.
You're talking about the Wi-Fi combo chips and all that?
Yeah, the classic Broadcom connectivity.
Oh, Broadcom connectivity. That's progressing very well. It addresses the same end markets as our FBAR business, has the same characteristics, has the same stickiness, and driving towards the same margin goals.
Was that revenue up sequentially as well?
Yes, it was.
Great. Then for my follow-up, I guess just to take a step back, Hock, how do you feel about the overall semiconductor environment today versus a quarter or two quarters ago? Better? The same? Maybe talk about where you feel better, where you're more nervous, if any.
It's not much. Well, that's broadly, to call it microscopically, it's sustaining. It's holding up. Best word is it is holding up, sustaining. Is it booming? Not really, but just sustaining. Obviously, you see seasonal effects versus secular effects, which I assume your question is addressed. Secular is holding up. Seasonally, you've seen the ramp on the smartphone business, as we always do, end of the year, and we're experiencing that ramp, but that's a seasonal effect as opposed to the secular. Secular, which is, as I said, just holding up.
Great. Thanks, guys.
Sure.
Question comes from Amit Daryanani with RBC Capital Markets. Your line is now open.
Yep. Thanks. Good afternoon, guys. I guess two questions from me as well. Hock, when you look at your operating model today, I guess I'm looking at October 15 quarter, pre the Broadcom deal, you did 62% gross, 43.8 op margins. Structurally, do you think there's anything different in Avago plus Broadcom that prevents you from getting there over the next several quarters?
No. Nothing prevents us from getting there, nor exceeding it.
Perfect. I guess, any update on Tony and the CFO position as you go forward from here? I think the expectation was four months after you get announced that there would be some update.
No, we don't have any particular updates at this point, but we'll be sure to let you guys know as soon as we have it.
Perfect. Thanks, and congrats on the quarter, guys.
Thank you.
Our next question comes from the line of Craig Hettenbach with Morgan Stanley. Your line is now open.
Yes. Thank you. I had a question on the RF dollar content story, Hock. If you can just give an update in terms of particularly what you're seeing from carrier aggregation and implications there for growth as you move forward.
Continues. When you say that, I assume wireless content, RF content, you're referring particularly to cellular RF content, which is largely our FBAR and the front-end modules associated with that FBAR. That story has not changed. The continued increase in the number of bands continue to grow, and carrier aggregation is another phenomenon in parallel that increases FBAR content in those high-end handsets, be they in China or in the U.S. You're right, and that content increase continues to steadily progress generation after generation. We have seen that last three years, and I see that the next two years.
Got it. Great. Then as my follow-up on the supply constraints, just to clarify, you mentioned set-top boxes, but on the Tomahawk or switching side, have those constraints eased at this point?
Those constraints, after much vigorous supply chain action, have eased, and have eased quite significantly. By the end of this quarter, we would certainly be out of the woods there.
Got it. Thanks for the color.
Our next question comes from Ross Seymore with Deutsche Bank. Your line is now open.
Hi, Hock. Just a question on your wireless business. In the past, your seasonality has changed substantially in the January quarter. I realize you're only guiding to the October quarter, but could you just walk us through the puts and takes of what normal seasonality is from what you see now that you include classic Broadcom with classic Avago?
You're right. The sharper seasonality of the past when it was just classic Avago would probably have reduced. Simply, if nothing else, because wireless used to be north of 40% of classic Avago's revenues. Today, wireless, which is the highly seasonal part of our business, even as it's grown bigger in absolute dollars, represents closer to 30% of our total revenues. The bigger portion of it, the 70% representing networking, enterprise storage, and industrial, as you well know, are extremely stable, almost like to say predictable, businesses. It certainly has modulated down very well volatility of our revenue seasonally. Q1, we don't give forecast, but we fully expect it to be not as volatile as perhaps it might have been two years ago.
Great, and thanks. For a follow-up one for Tom. On the OpEx side of things, I believe in addition to the margin guidance that you had given exiting this year at 40%, et cetera, you also said exiting this year, you'd have about half of the OpEx dollar savings that you expected to achieve. Is that still on target? I guess if we just made the world simple and said you had the other half left remaining from the $808 that you're guiding to, where would getting that other half bring OpEx down to on a dollar basis? Thanks.
Oh, you are really pushing it.
He's getting there. He's getting there.
You are getting there.
You want to answer, Hock, go ahead.
Yeah, I will answer that roughly. You probably get it down like some $30 million.
A quarter.
Perfect. Thank you.
A quarter, sorry.
Yeah.
A quarter.
The answer quite direct, yes, we're just about halfway there.
Great. 780 is kind of the base you're talking about?
That's first part of the year. Second half of 2017 will remain to tell it.
Perfect. Thanks, guys.
Our next question comes from Harlan Sur with J.P. Morgan. Your line is now open.
Good afternoon, thanks for taking my question. Within your data center switching and routing ASSP product families, that would be Jericho, Qumran, Tomahawk, Trident, demand continues to be pretty solid. As was mentioned, cloud data center spending in second half looks pretty strong. Hock, I'm just wondering, how far are you into the Tomahawk and Jericho 25 Gig adoption curve? Are we 15% of the way through, 30% of the way through? Just want to get a sense on how much growth potential lies ahead of the company.
The Jericho ramp , as I indicated in some remarks, but maybe not that clear, is just starting. By the way, Qumran and Jericho are similar in some ways, different specific application. The Jericho ramp has just started. Tomahawk was about 6 months earlier, 3-6 months earlier. Again, many of these products have fairly been, [Wyatt] could have more extended life cycle. I would say definitely even Tomahawk is less than 40% of the way, maybe no more than one third of the way. Jericho, which is the aggregation switch, or call it a router too if you want to, it's probably maybe 20%, if even that at all, of the way.
Great. Thanks for the insights there. Then there's a portion of the wireless business that gets sort of less visibility. These are the analog ASICs to some of your large smartphone customers. We've heard that the design pipeline there is quite good. How do you see this sub-segment adding to the content growth story in wireless this year and over the next few years?
That one I'm not at liberty to disclose to you, sorry.
All right.
Simply because of the nature of what you characterize as an ASIC.
Got it. Okay. Maybe just a follow-up question. On the supply constraints in the set-top box business, Q3, Q4, where was the mismatch in terms of supply and demand? Is there just more demand for some of the high-end set-top boxes, like some of these new 4K UHD boxes, or was the mismatch more around some of the low-end boxes? Any color would be helpful.
Well, our sense, our perception is the mismatch between demand and supply is because of very strong demand and much more than normal, and it's probably driven, we guess, by two factors. One, you hit it right on, is perhaps the ramp, the rollout of those 4K systems, the Ultra HD, as you call it, and that coupled with the late summer Olympics, where there were some operators, like Comcast, which had a very strong promotion on cable for the Olympics. That drove, I suspect, a one-time upside and couple that with the rollout of 4K systems.
Thanks, Hock.
Our next question comes from Toshiya Hari with Goldman Sachs. Your line is now open.
Hi. Thanks for taking my questions. My first one is on CapEx. You're guiding for another step up in CapEx in your fiscal fourth quarter. Can you maybe remind us how much capacity you're adding in the FBAR business this year and what your preliminary plans are going into 2017?
Yeah, no, you're right. We continue to make conversion from six to eight-inch, that's ongoing and it depends on what frame of reference you're using in terms of how much we're adding. It's approximately 50% at this point. Keep in mind, though, if we talk about CapEx more broadly, the main reason at this point for the uptick is in a campus expansion strategy, where we're moving from leasing buildings to buying and owning buildings, which drops our overall cost of inhabiting those campuses. That's a key driver. The second key driver is we're also moving to consigned testers. We're no longer leasing testers. We're actually spending money to own our own testers and consigning them to our CMs. Those are the two big drivers of the uptick in CapEx.
Great. Thank you. As my follow-up, I had one on gross margins. Hock, you talked about your comfort level when you think about gross margins going forward. When we kind of zoom into the fiscal fourth quarter, you're guiding gross margins pretty much flat sequentially despite an 8% increase in revenue. Can you discuss what the puts and takes are here?
Well, maybe I should guide you to looking back over the last three quarters, where we have been stepping up gross margin on a fairly steady and hopefully more predictable basis. Each time we guide, we guide from what we've actually seen. We try not to guide from what we have not seen, simply because gross margin is, as you put it, a lot of puts and takes. As Tom touched on earlier, highlighted in respect to CapEx, we have initiatives on hand to actually improve our gross margin, not just because of product mix, but also the sheer fact that, for instance, in wireless, moving to six to eight inch, increasing CapEx reduces our cost of sales quite dramatically in our wireless business.
Going from leasing testers, and we use a whole lot of them for our semiconductor ICs, to owning the testers on a fairly substantial basis, is also driving our cost of purchase material significantly down. All these actions are ongoing, all these actions are continuing to proactively reduce our cost of sales and expand our gross margin. You will see that. Rather than forecasting what it will be, we're basically using the current reference point and telling you where it's likely to move to the next quarter.
Very helpful. Thank you so much.
Our next question comes from Ambrish Srivastava with BMO. Your line is now open.
Hi, thank you. I had a couple of longer-term questions. The first one, Tom, just following up on the capacity expansion. You had given us a 50% expansion for FY 2016, what is the thinking beyond that? What I'm trying to get to is that, with the content game that you have laid out longer term, would you have capacity and the ability to supply other than the two big customers that you're supplying? Then I had a follow-up after that.
No, we don't have any specific update on that other than to say, any capacity expansion beyond what we've talked about will be based on line of sight demand. We've always built to capacity levels where we know we have demand in hand, and we'll continue to do that.
Makes sense. Hock, on the question longer term ASIC, you guys have built a great business there, and to us it seems competition has been weakening. A couple of weeks ago at the Intel Developer Forum, Intel was very vocal about their aim and their goal to go after the communications infrastructure. We all know what happened last time they went after it, they ended up buying the company. What is the right way? Just provide us your perspective on how easy or how hard it is to go after that business. We all know that not just having a SerDes is not the only answer. Please help us understand that a little bit better. Thank you.
Could you repeat? I didn't quite catch it. What was Intel indicating in IDF about going after the what? Communication chip business, you mean?
In the foundry business, the other area besides the client handset business where they announced a partnership with Arm. The other area that they were talking about is the infrastructure, networking. There were other customers of yours that were also there at the forum that were talking to Intel's foray into the business. Essentially going after Cisco's business.
Well, to be honest, didn't hear much about that. As you probably may know, the ASIC business, especially the high-end ASIC business, where your customer is requiring technology, is pushing the limits of technology, be they SerDes bandwidth, be they IP in embedded processing that has very low power, very high performance, and IP features like that. It's not a business one gets into on an overnight basis. Your question is correct, it's a long-term basis. Simply because first you have to have the strength of the IP portfolio, the capabilities, which we have in plentiful supply, if you don't mind my saying that. Number one, that's only a necessary condition, it's not even a sufficient.
The sufficient one is that you are able to execute on silicon implementation, you're talking about leading-edge nodes related to foundries that have proven ability to deliver on those leading-edge nodes and been able to execute your design well. The proof comes with the eating, which means you got to have the confidence of your customers that you are able to do what they want you to do, because if you don't, they are screwed, literally, simply because their roadmap depends on it. They're not about to rush into any new opportunity, even on a price, even on whatever nice stuff it is, just because on a say so that might happen. It takes a long time. It's almost a catch-22. You want to get into this business, be it leading-edge nodes as a foundry or leading-edge SerDes or intellectual property in silicon.
You have to convince your customer you can deliver, your customer is putting their future, at least in one next generation, in your hands. Which customer in their right mind would easily do that? They won't. They want you to prove it, you can't prove it unless they try it. It's a catch-22. It's hard. All I'm trying to say, it's very hard. It's a long process. We are fortunate to be in a position that we have proven ourselves, competition will come. It always does. We will deal with it as we always have.
We concur. Thanks, Hock.
Thank you.
Our next question comes from Vijay Rakesh with Mizuho. Your line is now open.
Hi, good quarter and guide here. Just on the wireless side, when you look at your FBAR, it looks like on the wireless side, you seem to be gaining share. With this FBAR, are you able to get your cost down and compete more effectively with BAW or up and down that chain?
We continue to do that. You note that every new generation, which is almost every year, we change our process. We just not only change our design. I said that before, too, in several meetings, several calls of this nature ago. Our FBAR process technology, our FBAR technology grows or evolves on two fronts, on process as well as on the design, so that a Band II FBAR three years ago doesn't look like the Band II FBAR today, and that Band II FBAR three years from now will be also very different than what it is today. It improves on power, it improves on insertion loss, it improves on performance.
We continue to invest in that, and it's part of the reason why we go from six-inch to eight-inch, not only to gain more capacity, but to be able to improve the process we put into it. Yeah, BAW technology or even SAW technology, temperature-compensated, continues to try to improve. We are very well aware of the development that continue in some of our competitors. All I have to say is that we continue to maintain, at least maintain, if not better, our technology lead over those guys.
Got it. I agree on that. As you look at your eight-inch, as you ramp that, what do you expect your mix of eight-inch FBAR to be exiting, let's say, calendar 2016 and calendar 2017? Thanks.
Calendar 2016 is very low. As Tom said, we continue to spend money, CapEx. We are barely at a 50% milestone. Our concept, at the end of the day, is to convert 100% of our six-inch into eight-inch. That will not happen until 2018. We are barely 50%, and we continue to methodically, steadily per plan, convert six to eight. Exiting this fiscal 2016, very low. 2017, significantly higher. 2018, maybe gets done.
Got it. Thanks.
Our last question comes from Stephen Chin with UBS. Your line is now open.
Great. Thanks for squeezing me in. Hock, if I could, I wanted to get a little more color on some of the demand trends within your switching ASSP business. If I recall correctly, classic Broadcom, the switching demand was roughly one-third, driven by cloud data center, enterprise, and service providers. I was wondering if you could talk a little more about how enterprise and the service provider verticals are performing in terms of demand in the recent quarter and the visibility into the current quarter.
First and foremost, while we like to say it's split up nicely, as you put it, to be that way, that tends to be very conceptual and a bit theoretical. At any point in time, sometimes we have a tough time knowing where the particular chip we ship ends up in. We ship a lot to OEMs, as you know, many of the OEMs could ship to service provider or enterprise or even to the cloud guys. That's a part of it where we're not 100% sure. To try to answer your question in substance, we're seeing a lot of strength, a lot of demand driven from service providers today, as well as from the cloud guys. Enterprise tends to be more stable as opposed to strongly trending up.
Okay. I appreciate the color on that. As my follow-up, just within enterprise storage, appreciate that in the current quarter, you guys are seeing some good seasonality there. I was wondering from a technology upgrade or roadmap perspective, can you talk about any other upcoming technologies that can continue to drive growth in enterprise storage in terms of the server storage products?
Server storage connectivity products? Yeah, there is. I know some of the trends are very interesting, but keep in mind, I can tell you all this, but enterprise storage is slow to change. For good reason, right? People are very conservative, very careful in that area. There's a cadence they go by in the CPU cadence. We're now shipping Grantley, as you know, next year we'll start shipping against Purley. Some of the interconnects expanding capacity, though, for enterprise, a lot of it is SAS. Slowly, very slowly, perhaps considering a move into PCI Express or NVMe potentially as all-flash arrays start coming into the picture. To answer your question directly, it moves very slowly. Most enterprise today are still driven on SAS.
Okay, great. Thank you very much.
Sure.
That concludes Broadcom's conference call for today. You may now disconnect.