Broadcom Ltd (AVGO) Q4 2017 Earnings Conference Call Transcript

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Broadcom Ltd (NASDAQ: AVGO) Q4 2017 Earnings Conference CallDec. 6, 2017 5:00 p.m. ET

Contents:

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  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to Broadcom Limited's Fourth-Quarter and Fiscal Year 2017 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.

Ashish Saran -- Director, Investor Relations

Thank you, Operator, and good afternoon, everyone. Joining me today are Hock Tan, president and CEO; and Tom Krause, chief financial officer of Broadcom Limited. After market-close today, Broadcom distributed a press release and financial tables describing our financial performance for the fourth quarter and Fiscal Year 2017. If you did not receive a copy, you may obtain the information from the Investors 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 comments section of this call, Hock and Tom will be providing details of our fourth-quarter and Fiscal Year 2017 results, guidance for our first fiscal quarter of 2018 and some commentary regarding the business environment. We will take questions after the end of our prepared comments.

In addition to U.S. 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?

Hock Tan -- Chief Executive Officer and President

Thank you, Ashish. Good afternoon, everyone. Well, we closed our Fiscal 2017 on a very strong note with solid financial results for the fourth fiscal quarter. Fourth-quarter revenue of $4.85 billion grew 17% year on year and 9% sequentially.

On the earnings front, earnings per share were $4.59, growing by 32% year on year and 12% sequentially. Our business continued to become more profitable through fiscal 2017. We achieved operating margins of 47% in our most recent quarter, comfortably ahead of our long-term operating margin target of 45%, which we had announced at the end of Fiscal 2016. And EBITDA rose to 50%.

This led to substantially improved free cash flow generation in 2017, which drove the 72% increase in our dividend we announced today. As you may recall, this latest dividend increase comes on top of the doubling in dividend we had announced at the end of Fiscal Year 2016. We remain very focused on increasing capital returns to our shareholders. We also continued to successfully execute our M&A strategy, having completed the acquisition of Brocade early in the first quarter of Fiscal 2018, this current quarter, adding one more business to our broad portfolio of networking and storage franchises.

Against this backdrop, clearly, our business continues to be strong. All our 20 product franchises continue to perform extremely well. Before I turn to a discussion of segment results, please note that commentary today for the fourth quarter does not include any contribution from Brocade. As I look forward within each of the segment commentary, I will also touch on specific trends and growth drivers for our business in Fiscal 2018.

Guidance, however, for first fiscal quarter does include a partial quarter of expected contribution from the Brocade Fibre Channel SAN business. Please also note that this first quarter 2018 is a 14-week quarter for us. Starting on wired, our largest segment. In the fourth quarter, wired revenue was $2.15 billion, growing 4% year on year, declining 3% sequentially.

The wired segment represented 45% of our total revenue. As expected, wired segment revenue declined sequentially as a result of the typical seasonal decline in demand for our broadband access and set-top box products. Similar to a number of our peers, we also experienced a slowing -- a slowdown in demand for our optical products from access and metro networks. In contrast, however, demand from data centers continued to hold up quite well into the fourth quarter.

Turning to the first quarter of 2018. We expect to see the bottom of the seasonal decline in demand for our set-top box and broadband access. And if we look further into the rest of '18, we are rather excited about the ramp that we are enabling for key -- for our key cloud customers and a couple of OEMs in artificial intelligence. OK, in broadband, we are also seeing increasing contraction on 10G technology to support broadband video delivery.

Beyond even that point, we see that 10G cable technology going full duplex. Moving on to wireless. In the fourth quarter, wireless revenue was $1.8 billion, growing 33% year on year and 40% sequentially. This wireless segment represented 37% of our total revenue.

Fourth-quarter wireless revenue was driven by the ramp in shipments of next-generation platform from a large North American smartphone customer. The growth was partially offset by a decline in shipments to other customers. And the substantial year-on-year growth in revenue was driven by the large increase, as already indicated, in Broadcom's total dollar content in this new platform. As we look into first quarter 2018, unlike the last two years, we expect wireless revenue to continue to grow sequentially as the ramp in demand from our North American customers this year was pushed out compared to prior years.

Going beyond that into '18 -- into the rest of 2018, we see significant increase in FBAR content driven by the need for additional filtering at the antenna. We are also very excited by the launch of the second half of '18 of the next-generation WiFi product, the 802.11ax, which we expect to see happen at retail and progressing to handsets. Let me now turn to our enterprise storage segment. In the fourth quarter 2017, enterprise storage revenue was $645 million, growing 15% year on year and declining 12% sequentially.

The storage segment represented 13% of our total revenue. Sequential decline in storage revenue was driven by an anticipated correction in demand for hard disk drive products. In contrast, our server and storage connectivity business, the MegaRAID business, experienced an increase in demand driven by the Purley server launch cycle. Looking into the first quarter of 2018, we are seeing this Purley launch continue to gain traction and drive very strong growth in demand for our server storage connectivity products.

We also expect hard disk drive demand to have bottomed in the first quarter and start to recover. Starting with the first quarter of Fiscal 2018, the enterprise storage segment -- this enterprise storage segment will include Brocade's Fibre Channel SAN business, which is expected to generate a partial quarter revenue contribution of $250 million in Q1 Fiscal '18. Beyond this, as we look into 2018, we see the storage landscape being driven very well by our products supporting the adoption of all-flash arrays in storage appliances infrastructure with our PCI Express and NVMe technology. Finally, our last segment, industrial.

Fourth quarter industrial segment revenue was $257 million, representing 5% of total revenue. Revenue for this segment grew 59% year on year, 8% sequentially. And this strong year-on-year growth, however, included the impact from a large increase in our IP licensing revenue, which as you know tends to be quite lumpy in nature. What is significant is that sustainable industrial resales continue to grow double digits year on year.

And looking into the first quarter, while we expect IP licensing revenue to decline sequentially, industrial shipments and resales are likely to continue to trend as they did in the preceding quarter. And in fact, for the rest of 2018, we see strong adoption and ramp of our optical isolation product to continue to drive growth coming from electric vehicles. So in summary, fourth quarter -- for the fourth fiscal quarter, we delivered very strong financial results. Our first-quarter Fiscal 2018 revenue continues to be good as we see an outlook of $5.3 billion, which includes the partial quarter contribution from Brocade.

This will position us, we believe, for a very strong start to the new fiscal year. We made great progress, I believe, in executing to all key parts of our strategy through Fiscal 2017. Solid revenue growth and improved profitability, which ended up exceeding our current financial target, led to a significant increase in capital return to our shareholders. These achievements, coupled with the expected rapid integration of Brocade and a background of continuing strength in our various businesses, will allow us to now improve on our long-term target operating model, particularly as it applies to 2018.

While we will continue, having said all that, to target long-term sustainable revenue growth of just 5%, even as in the first quarter Fiscal '18 we are seeing double-digit growth, we are increasing the gross margin target to 65%. We expect to sustain R&D expenses at about 15% of net revenue and drive SG&A expenses below 3% of net revenue. This positions us to increase the target for operating profit margin to be 47.5% and sustain a 50% EBITDA margin for this company. With that, let me turn the call over to Tom for a more detailed review of our fourth quarter financials and first-quarter outlook. Tom?

Tom Krause -- Chief Financial Officer

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 in the earnings release issued today and is also available on our website at broadcom.com. Let me start first with comments on the progress we have made toward our long-term target operating model.

As Hock outlined and I'm pleased to report, for Fiscal '17, we did exceed our long-term target of greater than 60% gross margins and 45% operating margins. We delivered fourth quarter 2017 gross margins of 63.3%, a 250-basis-point increase from the same quarter last year, and operating margin of 47.3%, which was a 580-basis-point increase from the same quarter of last year. On capital returns, as you recall, starting last year, we did increase the target for aggregate dividends to 50% of free cash flow on a trailing 12-month basis. And a result of that financial policy, we did double our dividend at the end of Fiscal 2016.

Leveraging the significant improvement in profitability and operating cash flow generation in Fiscal 2017, we announced today a 72% increase in dividends. This increase takes our interim dividend to $1.75 per share or $7 per share on a full-year basis and represents an approximate return of $3 billion annually to shareholders. We closed the acquisition of Brocade about three weeks ago -- excuse me, three weeks into the fiscal quarter of 2018. We completed the divestiture of Brocade's campus WiFi and switch business to Arris for $800 million in cash in the first fiscal quarter of '18.

And we also sold Brocade's headquarter building in Santa Clara for approximately $225 million in cash, also in the first quarter. These transactions, along with the completion of several other smaller deals, marks the completion of portfolio rationalization activity for the Brocade acquisition and resulted in lowering the total consideration for Brocade to approximately $5 billion. We look forward to fully integrating Brocade over the next few quarters and expect our total operating expenses in Fiscal '18, including Brocade, to remain within our target of 17.5% of net revenue. Let me take a moment to reiterate our financial policies, which we'll remain committed to going forward.

We expect to continue to target long-term permanent gross leverage of approximately 2x EBITDA as long as the cost of that debt remains attractive. We also plan to continue to target aggregate dividends of approximately 50% of free cash flow on a trailing 12-month basis. Given our free cash flow generation, we believe that this will also allow us sufficient balance sheet flexibility to pursue acquisitions that are consistent with our proven business model. As we look forward, the credit quality of the business continues to strengthen, and we remain focused on maintaining and improving our investment-grade ratings, including on our current debt.

As Hock mentioned, we're also updating our long-term target operating model. Sustainable long-term revenue growth remains at 5% on an annual basis. Gross margin target increases to 65%, and operating margin targets increase to 47.5%. Target free cash flow as a percent of revenue increases from 35% to 40%.

And I would note that includes our long-term CapEx target remaining at 3% of net revenue. With that, let me quickly summarize our results for the fourth quarter of Fiscal 2017, focusing primarily on balance sheet and cash flow items. We delivered strong financial results for the fourth quarter starting with revenue at $4.85 billion, which grew by 8.5% sequentially and 16.9% year on year. Our day sales outstanding were 46 days, a decrease of three days from the prior quarter.

Our inventory at the end of the fourth quarter was $1.447 billion, flattish from the prior quarter. We generated $1.959 billion in operational cash flow, which includes the impact of a $345 million payment to fund our legacy pension plan in the U.S. Free cash flow in the fourth quarter was $1.726 billion or 35.6% of net revenue. I am pleased that even with the impact from the pension payment, which is approximately 7% net revenue, we were able to drive free cash flow conversion above the 35% target we'd set last year.

Capital expenditure on the fourth quarter was $233 million or 4.8% of net revenue. As we have indicated on prior calls, we expect overall CapEx to decline meaningfully starting in 2018. We expect CapEx to approach our long-term target of 3% of net revenue in the second half of Fiscal '18. Moving on to additional items in the cash flow statement.

A total of $439 million in cash was spent on the company dividend and partnership distribution payments in the fourth quarter. We received approximately $4 billion from the issuance of long-term debt to finance the Brocade acquisition. And we also received approximately $440 million from the sale and leaseback of the Irvine campus. We ended the fourth quarter with a cash balance of $11.2 billion, but I would note that cash balance is at an elevated level through the fourth quarter in anticipation of closing the acquisition of Brocade.

Now let me turn to our non-GAAP guidance for the first quarter of Fiscal Year 2018, which includes expected contributions from Brocade's Fibre Channel SAN business for a portion of the quarter. Also to note, this is a 14-week fiscal quarter. This guidance reflects our current assessment of business conditions, and we do not intend to update this guidance. This guidance is for results from continuing operations only.

Net revenue is expected to be $5.3 billion, plus or minus $75 million. Gross margin is expected to be 64%, plus or minus 1 percentage point. Operating expenses are estimated to be approximately $900 million. Tax provision is forecasted to be approximately $106 million.

Net interest expense and other is expected to be approximately $126 million. The diluted share count forecast is for 458 million shares. Share-based compensation expense will be approximately $300 million. CapEx will be approximately $210 million.

And as a reminder, our first quarter is generally a weaker quarter for operating cash flow due to the payment of our annual employee bonuses relating to the prior fiscal year. In addition, we do expect to start incurring cash restructuring expenses related to integrating Brocade. OK. Finally, before we open up the call for questions, I do want to briefly address where we stand on redomiciliation and Qualcomm.

First, on redomiciliation. On November 2, I think as everybody knows, we announced our intent to initiate a redomiciliation process to change the parent company of the Broadcom corporate group from a Singapore company to a U.S. corporation. The redomiciliation will occur whether or not there is corporate tax reform in the United States.

The redomiciliation is subject to a shareholder vote and is expected to be effected in a manner intended to be tax-free to shareholders. We are confident that our shareholders will support this move. The final form and timing of the redomiciliation and the shareholder vote will depend in part on tax reform efforts in the United States. On the Qualcomm front, on November 6, we made a proposal to acquire Qualcomm for a per-share consideration of $70 in cash and stock.

Our proposal represents a 28% premium over the closing price of Qualcomm common stock on November 2, 2017, the last unaffected trading day, and a premium of 33% to Qualcomm's unaffected 30-day volume-weighted average price. We expect that the proposed transaction will be completed within approximately 12 months following the signing of the definitive agreement. Earlier this week, on December 4, we notified Qualcomm of our intention to nominate a slate of 11 independent, highly qualified individuals for election to the Qualcomm board at the 2018 annual meeting of stockholders, which Qualcomm has announced will be held on March 6, 2018. The highly qualified slate brings significant technology sector, financial, and operational experience.

While we have taken this step, it remains our strong preference to engage in a constructive dialogue with Qualcomm. We firmly believe that this complementary transaction will position the combined company as a global communications leader, enabling us to deliver more advanced integrated solutions for our global customers and drive enhanced shareholder value. We continue to receive positive feedback from stockholders and customers. In addition, after having had initial meetings with certain relevant antitrust authorities, we remain confident that any regulatory requirement necessary to complete the combination will be met in a timely manner.

Given our common strengths and shared focus on technology innovation, we are confident we can quickly realize benefits for all stakeholders. As a reminder, the purpose of today's call was to discuss our quarterly earnings. Please keep your questions focused on today's financial results. We will not be commenting in the Q&A on Qualcomm or the redomiciliation activities.

With that, let me turn it back to the operator. Operator?

Questions and Answers:

Operator

Ladies and gentlemen, if you have a question at this time, please press * and then 1 on your touchtone telephone, and if your question has been answered and you wish to remove yourself from the queue, please press the # key. And also, to prevent any background noise we do ask that you please put your line on mute once your question has been stated. And also, we ask that you limit yourself to one question and one follow-up. Our first question comes from line of Stacy Rasgon with Bernstein Research. Your line is now open.

Stacy Rasgon -- Sanford Bernstein -- Analyst

Hi, guys. Thanks for letting me ask a question. First, I guess a tactical one. Given where it's falling in Q1, how much revenue and OpEx is actually really coming in, in that extra week? Should we think of both of those as a full week? Or is the revenue maybe less than a full week and the OpEx is a full week? What's the best way for us to think about the different puts and takes on your guidance impacted by that extra week?

Tom Krause -- Chief Financial Officer

Yes. This is Tom. Good question. I think, as you look at the seasonality in our business and you look at where we are in Q1 relative to where seasonally you typical go in Q2, you can argue, I think we believe, it's less than an additional week of contribution.

And OpEx, what I would suggest to you is it's flat because you're basically just taking an extra week from a payroll and other fringe perspectives on the OpEx side.

Stacy Rasgon -- Sanford Bernstein -- Analyst

Got it. Thank you, that's helpful. For my follow-up, I wanted to ask a little bit about the guidance and particularly the segments. You said wireless was up.

I wasn't sure if that was because of the extra week or if that was normalized for the extra week. And I guess given the metrics, wireless seems like it's strong, storage looks like it's bottomed, and other pieces are growing. It seems to me the wired infrastructure may still be down sequentially, I guess, if I normalized the extra week, given the drivers that Hock talked about. I guess, could you give us a little more color on, I guess, how much of the strength in wireless is extra week versus normalized? And, I guess, what do those drivers for the rest of the guidance imply for wireless as we go into the January -- for wired as we go into the January quarter?

Hock Tan -- Chief Executive Officer and President

OK. Best way to describe it, to expand a bit on what Tom was saying, 80% of our revenues is direct OEM revenues. And so the extra week has very little impact for Q1 in terms of top-line revenue. This TL revenue does have an impact, obviously, on the basis that resale is very time-based.

And so you might say on an overall revenue basis, if I were to hazard an estimate, that additional week provides probably an additional one-third addition of a week's revenue, is the way I look at it. But as Tom indicated, expenses, we will be showing a full week of expenses, which are largely for a company of our nature, obviously, salaries, people costs. So full week of expenses, probably one-third of a week of top line is the best estimate to put it on a consolidated basis. And based on that, to answer your question on wireless, it really doesn't make much difference.

Our wireless business is all direct largely. It makes very little difference that there's an additional one week. But it is strong, as I indicated in my remarks. It is strong because of the fact that unlike the year before and the year before that as well, the rollover of the product life cycle of a North American -- large North American smartphone manufacturer has been sort of pushed up, pushed up by over one month.

Stacy Rasgon -- Sanford Bernstein -- Analyst

So I guess, the wired outlook then, is it just the set-top box, I guess, bottoming in Q1, which is just driving that? Or are there other drivers?

Hock Tan -- Chief Executive Officer and President

Set-top box and broadband access, carrier access, has bottomed out in Q1. [Inaudibe ] data centers continue to be OK, good. And a big part of it driven by the ramp of our opportunity in AI, in cloud, and a couple of OEMs.

Stacy Rasgon -- Sanford Bernstein -- Analyst

Got it. Thank you, guys.

Operator

Thank you. And our next question comes from line of Ross Seymore with Deutsche Bank. Your line is now open.

Ross Seymore -- Deutsche Bank -- Analyst

Hey, guys. Thanks a lot for letting me ask questions. Hock, I wanted to follow up on the wired side of things. The last couple of quarters, on average, you've been kind of the low to slightly below mid-single-digit growth in that business.

You talked a little bit about what the broadband access and set-top box has done. You talked about optical in the AI side. If we think about those three buckets as we look into Fiscal '18, can you just talk about the direction that they should go? Is there going to be the optical side snapping back? Or this year, it seemed like you had a number of headwinds that might not persist into next year? So any color you can get on an annual basis would be helpful.

Hock Tan -- Chief Executive Officer and President

Sure. And you did touch on that, saying that is true. In '17, especially the second half of '17, in our wired business, we run into a lot of puts and takes but quite a bit of headwinds in that whole regard simply because, especially in the second half, you start to see declines, seasonal declines in broadband, permanent broadband then -- and especially in optical, we all have seen the slowdown in demand from metro and access networks, particularly out of China. But against that, we see data centers continue to perform very well.

And the net result of it was -- has been a relatively slow to flattish -- if you look at the whole year, flattish -- slow single-digit growth in wired in '17 with those headwinds. '18, the sense we have is we've seen a lot of those headwinds. The worst of those headwinds seems to be over. Data centers continue to be very well -- presenting itself very well, not just from switching, routing, which has always been very good throughout this period but also the additional push from deep-learning chips that we are providing for a few large customers.

And against that, given that we have seen the worst on broadband, I think our wired business in '18 will probably grow over 5%.

Ross Seymore -- Deutsche Bank -- Analyst

Great. That's helpful. Tom, switching gears over to your side for a moment. The free cash flow target increasing from 35% to 40%, the dividend increase was a bit more than I expected at 72%.

It seems like you guys actually were closer to 60% of free cash flow. So I guess, as we go forward, 1) did the policy change at all? Are you giving back more? And then 2) what's the biggest driver of that free cash flow margin increasing? Is it one-time charges going away? profitability increasing? Any color on those would be helpful.

Tom Krause -- Chief Financial Officer

Yes. So Ross, obviously, you can do the calculation on the free cash flow just based on the cash flow statement. So there were a couple of things that we took into consideration. One, I think you know we had a big campus initiative both in Southern California, around the Irvine campus, and then up here in San Jose.

And a lot of that has tailed off, and then we went off and actually monetized the Irvine campus, which we just reported. So we thought we should give back that portion as well to shareholders in the form of a dividend. So I think that's the biggest driver. The CapEx initiatives beyond that, we're really around the test program, the consignment work we did, which I think is largely done.

And then, of course, we delevered. We delevered around the pension. So we've had the Agere pension, which is the LSI pension that we inherited when we both LSI several years ago. We took steps toward derisking that pension by fully funding it in effect and then turning it more into a fixed-income-based portfolio.

So we think that was the right thing to do. But it's also a one-time event that hit free cash flow, and so we backed that out. Going forward, really, it's all about the business model and the financial model that gets put out of that business model that Hock articulated earlier. CapEx is coming down to 3% as a percentage of revenue, which is consistent with largely established business model.

And given the operating margins of the business, the balance sheet that's got 2X gross leverage less, than 4% sort of average cost of debt capital, we think 40% is a very achievable target.

Ross Seymore -- Deutsche Bank -- Analyst

Great. Thank you.

Operator

Thank you. And our next question comes from the line of Craig Hettenbach with Morgan Stanley. Your line is now open.

Craig Hettenbach -- Morgan Stanley -- Analyst

Yes. Thank you. Hock, now that you've closed Brocade, can you talk about just the synergies from a technology and product perspective and the implications to your enterprise storage business?

Hock Tan -- Chief Executive Officer and President

Well, the main reason we acquired Brocade, very simply put, is that we believe that product line is a very sustainable product franchise. It is for certain customers with mission-critical data set storage requirements. They need to use Fibre Channel SAN, storage area network. The more conventional, so to speak, basis of [inaudible] IP networking stuff are not of a performance level, quality level that will address those mission-critical requirements that financial institutions know.

As an example, agencies, governments need to make work in those storage systems. So it's fairly unique in some regard, but it's a nice addition to our enterprise storage portfolio, which tends to address more conventional storage requirements. And we see this business as a business that will continue into the foreseeable future and not just in America, worldwide, simply because this storage is -- this kind of storage system and network fiber channel is literally bulletproof mission-critical systems and practically not hackable.

Craig Hettenbach -- Morgan Stanley -- Analyst

Got it. And if I could just follow up and look to expand on your comments about AI and just the type of visibility you have in some of those product ramps as well as just the role you expect ASICs to play from your side.

Hock Tan -- Chief Executive Officer and President

Well, we believe a lot of these emerging requirements that we are seeing in very specific -- application-specific and market-specific requirements for deep learning, as we call it, artificial intelligence is what other people call it, where you need training and you need inference on large databases that continually upgrade, we tend to see it as being very customized. A lot of software that needs to be written on a hardware silicon platform that -- because of the particular nature of the application, will tend to be very customized. And we are making -- we are producing, in a nutshell, ASIC or custom silicon solutions that addresses those market niches, and it's pretty substantial. And our visibility today is extremely good in terms of the demand for these products.

Craig Hettenbach -- Morgan Stanley -- Analyst

Got it. Thank you.

Operator

Thank you. And our next question comes from the line of John Pitzer with Credit Suisse. Your line is now open.

John Pitzer -- Credit Suisse -- Analyst

Yeah. Good afternoon, guys. Thank you for letting me ask questions. Hock, in your prepared comments, you talked about excitement around continued FBAR content increases in Fiscal Year '18.

I'm kind of curious, to what extent is that just new flagship phones growing as a percent of the overall mix where content growth has already been very strong? To what extent is that an expectation that maybe flagship phones that get introduced in Calendar Year '18 will continue to have content growth? And to the extent that it's the latter -- this year, you gave us pretty explicit guidance as to how much you thought your content was going up. I'd be curious, as we look out to Calendar Year '18, how we should think about that FBAR content story.

Hock Tan -- Chief Executive Officer and President

Well, it's an interesting story. And by the way, to answer your question, it's not the same old story again about more FBAR, more bands. This is not. This is actually -- think of filtering as being stage.

This is -- most of the front-end modules we talked about in the past where we have power amplifiers and FBAR filters, we tend to put it close to the transceivers, where you filter signals that are channeled by the antenna. What we are seeing here is going in and filtering the signals close to the antenna before it channels down the front-end module. That's the thing that actually -- it's almost like you're creating an additional level of filter, level of stage of filtering, which in effect -- and hence is increasing -- increases the amount of filters unique. And these FBARs are the only things that can do very effectively those filtering.

We call it extraction of signals at the antenna. And the benefit of all that is it allows antenna to be shared as opposed to multiple antennas in the fold.

John Pitzer -- Credit Suisse -- Analyst

That's helpful. Any sense on what this new application could do to your dollar content in the phone?

Hock Tan -- Chief Executive Officer and President

Probably we should tell you as we progress through the year. Now might be a bit immature but it's definitely going to increase it.

John Pitzer -- Credit Suisse -- Analyst

Perfect. And then as my follow-on, Hock, I just wanted to get back to your AI comments in the prior question. It just seems like over the last couple of quarters, I wouldn't say you were being dismissive of the market opportunity but you clearly weren't sort of highlighting it as one of the key drivers. It sounds like you're being a little bit more front foot on the AI opportunity.

Did something change? And can you help us understand how you're thinking about your TAM in this market over time?

Hock Tan -- Chief Executive Officer and President

Well, the dollars as it affects us has suddenly grown a lot, so I guess I better have -- make a few comments on it. Dollars drives it.

John Pitzer -- Credit Suisse -- Analyst

Any sense on how we should think about the total addressable market over a three-year horizon, Hock?

Hock Tan -- Chief Executive Officer and President

You know, We see driving our dollars to a level not dissimilar but significant level, not that far off from even our switching revenue.

John Pitzer -- Credit Suisse -- Analyst

Perfect. Thank you very much.

Operator

Thank you. And our next question comes from the line of Vivek Arya with Bank of America Merrill Lynch. Your line is now open.

Vivek Arya -- Bank of America / Merrill Lynch -- Analyst

Thanks for taking my question. Just first as a near-term question on wireless. Hock, on the last call, I think you said you expected Q1 to hold up, which at that time sounded sort of flattish. Now you're saying Q1 could be better.

My question is, did something change? Was it just perhaps conservatism before? But more importantly, how do you track the sell-through of the different flavors of products that your customer is selling to make sure that you're sort of shipping in line with sell-through?

Hock Tan -- Chief Executive Officer and President

Well, as I mentioned, to answer your latter question, 80% of our revenues, over 80%, goes direct to customers. And we get very good visibility in orders backlog with our customers. So that -- to start with, that track is pretty clear. Over 80% goes directly to our various customers, and that enables us to track very well.

That also enables to track if there's overshipment in terms of -- in the sense that a customer got more products than they truly need because it adjusts itself very, very quickly, so just doing it directly as opposed to going through any distributor or middleman. And as far as the question on wireless, yes, I guess the answer is, it's nothing to do with conservatism. Since we last talked a quarter ago, visibility has obviously come full -- crystal clear. And we're just -- in the interest of being transparent, we're just passing on what we see today.

Vivek Arya -- Bank of America / Merrill Lynch -- Analyst

Got it, thanks. And then for my follow-up, Tom, you raised your long-term targets on margins. When I look at the gross margins versus what you reported in Q4, there seems to be another, I think, 170 basis points of upside to the 65% target. But on operating margins, you're already above the target.

So I'm just curious what's driving that delta.

Tom Krause -- Chief Financial Officer

Well, I'm not sure I totally understand your question. But basically, as you look at it with Brocade, you're right, we're running 64-ish on the guide. I think what you see consistently and part of the key driver of the overall financial model and the new targets is our ability to continue to drive gross margin expansion. And I think a lot of that ties back to the business model, continue to introduce more and more content-rich products that carry higher values.

And I think that's what's driving it, consistent for a very long period of time. And obviously, given the scale of the company, we'll continually invest in R&D at a very healthy clip, 15% of expanded revenue. But we're growing mid-single digits, obviously, did better last year. We're keeping SG&A lean and simple, which is consistent with our model, and that gives us leverage.

So you're right. I mean, I think we'll continue to monitor the long-term model. We've obviously updated it a number of times over the past several years. But right now, we're very comfortable with a target of 65% and 47.5% operating margins.

Vivek Arya -- Bank of America / Merrill Lynch -- Analyst

Thank you.

Operator

Thank you. And our next question comes from the line of Ambrish Srivastava with BMO. Your line is now open.

Ambrish Srivastava -- BMO Capital Markets -- Analyst

Hi. Thank you very much. Hock, I just wanted to visit the longer-term driver for wireless specifically in '18. Besides the antenna, you also talked about WiFi the back half of the year.

And I think, correct me if I'm wrong, you said first retail and then it starts to show up in handsets. So can you give us some idea on what that would do to content within the handset space? And then I had a quick follow-up as well.

Hock Tan -- Chief Executive Officer and President

Well, it does. But when you try to run it over time, it becomes very hard. And I'm very loath to give you misleading answers, but all it does is it's definitely directionally pushing in the right direction. As I've always indicated to you guys, on a long-term basis, which is what you're asking, year on year, we're seeing the dollar content increase, which I would say a large part of it is content increase, driving top-line dollar -- revenues in wireless closer to the range north of 10% -- 10%, 15% annually on an annual growth rate basis.

And that's all content increase in our view. Whether it's an improvement of WiFi connectivity through 802.11ax or -- and/or more FBAR as we enhance the RF experience on smartphones, it all comes back to the same thing. We seem to see, based in history, empirically, that last five years CAGR, compounded annual growth rate, CAGR, is around the mid-teens. And using that -- and using the trends in architecture and designs and the needs of phones, that the next five years, we'll see that same CAGR of mid-teens.

Ambrish Srivastava -- BMO Capital Markets -- Analyst

OK. That's very helpful. And then on the non-wireless side, Marvell and Cavium are proposed to be combining. Just from your vantage point, does it or does it not change the competitive landscape the way you see it?

Hock Tan -- Chief Executive Officer and President

We don't really see any material change at all as far as our business is concerned. As far as their business is concerned, of course, there could be major impact, and I'm not dismissing that at all. But as far as we are concerned and our various franchise businesses are concerned, we do not see any impact.

Operator

Thank you. And our next question comes from the line of Harlan Sur with JPMorgan. Your line is now open.

Harlan Sur -- JPMorgan Chase -- Analyst

Good afternoon and thank you for taking my question. On the OpEx guide, if I assume the OpEx run rate similar to Q4 for core Broadcom and then normalize to the 14-week quarter and then try to back out the implied Brocade OpEx, I'm actually coming out with Brocade OpEx contribution on an annualized basis of around $280 million, which is right where you wanted Brocade OpEx to be post-integration back when you first announced this acquisition. So am I doing the math correctly? And I guess, the question is how much more cost synergies will be coming out on the integration plans over the next few quarters?

Tom Krause -- Chief Financial Officer

Harlan, good question and certainly the right one. I think the benefit of being able to spend a little extra time between sign to close and, of course, the benefit of being able to announce a number of the sale processes, which were in effect restructuring activities, at the same time has helped us get to our target model with Brocade factor. Now that doesn't mean there isn't more to do. I would suggest we probably got about $20 million a quarter in operating expenses in the business right now on a run rate basis that still need to come out of the model, but we are ahead of schedule relative to where we normally would be when we close a deal.

And I'd expect over the next six months or so, we'll be trending toward sort of getting that $20 million out of the business on a quarterly basis.

Harlan Sur -- JPMorgan Chase -- Analyst

Great. And Hock, a question for you. As we speak with many of your data center customers, they're all anxiously awaiting Tomahawk III, 12.8 terabits of total switching throughput. I think the bigger opportunity here is that you're moving the market to 50 gigabits per switch port using this new PAM-4 technology, which means that you not only change the switch silicon, but you have to change the PHY and NIC products and after components as well.

So you've got a lot of potential for content enhancement here for you and the team. So I guess the question is, are you still on track to get Tomahawk III to customers end of this year, beginning of next year? And do you have a view as to how big this opportunity could be for the data center business probably starting in 2019?

Hock Tan -- Chief Executive Officer and President

Answering your first question, yes, we are very much on track to get samples out to our customers by the end of this year, calendar year. Very much on track. And as far as how big the impact will be, well, to be fair I think -- let's not get -- I hope let's -- me not get carried away. Tomahawk III, which goes to 12.8 terabit throughput, will just replace, to a large extent, the existing versions of Tomahawk II, which is faster to be fair, and Tomahawk I, which is 3.2.

Now, of course, it replaces 8 by 4x and gives us, therefore, room, opportunity for delivering more value to our customers. But at the end of the day, the number of sockets -- there's a certain level of replacement of existing sockets. With higher throughput equipment, silicon no doubt, which gives us some enhanced dollar value, but it's not a total add-on in the overall scheme of things.

Harlan Sur -- JPMorgan Chase -- Analyst

Got it. Thank you.

Operator

Thank you. And our final question comes from the line of Chris Caso with Raymond James. Your line is now open.

Chris Caso -- Raymond James -- Analyst

Yes, thank you, good evening. The first question is regarding seasonality and how we should be thinking about the April quarter. Of course, I know you don't want to provide guidance for that now. But as we build our models, I assume we would be taking out the extra half week of revenue as we model out April.

How should we also be thinking about wireless there? Because I guess there was some extra wireless revenue in the January quarter during the pushout. How should we think of that as we build out our April expectations?

Tom Krause -- Chief Financial Officer

Chris, obviously, we're not going to give guidance on the April quarter. What I'd tell you is, yes, there is a little bit of the extra week. That's right. But I think, more importantly, as we've talked about, the long-term model here is mid-single digits.

And I think that's where we plan to be going forward.

Chris Caso -- Raymond James -- Analyst

OK. Fair enough. And just as a follow-up on Brocade. You guys had set out some targets.

I think it was $850 million of EBITDA. My assumption of what you're talking about was taking the additional $20 million out that basically gets you to that target. Are you still staying behind that target as potential -- or maybe do a little bit better than that?

Tom Krause -- Chief Financial Officer

Yes. No, I'm sure we can do a little better than that, but we certainly are in and around that target today and the business actually. I think what we're happy about is the business is performing very well. It's performing on plan, and we think it's a great addition to the other 19 franchises we have in the portfolio.

Chris Caso -- Raymond James -- Analyst

Great. Thank you.

Hock Tan -- Chief Executive Officer and President

Thank you, guys.

Tom Krause -- Chief Financial Officer

Thank you.

Operator

Thank you. And that concludes Broadcom's conference call for today. You may now disconnect, everyone, and have a great day.

Duration: 58 minutes

Call Participants:

Ashish Saran -- Director, Investor Relations

Hock Tan -- Chief Executive Officer and President

Tom Krause -- Chief Financial Officer

Stacy Rasgon -- Sanford Bernstein -- Analyst

Ross Seymore -- Deutsche Bank -- Analyst

Craig Hettenbach -- Morgan Stanley -- Analyst

John Pitzer -- Credit Suisse -- Analyst

Vivek Arya -- Bank of America / Merrill Lynch -- Analyst

Ambrish Srivastava -- BMO Capital Markets -- Analyst

Harlan Sur -- JPMorgan Chase -- Analyst

Chris Caso -- Raymond James -- Analyst

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