QCOM

Business Context and Reporting Period

Company: QUALCOMM Incorporated
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: July 1, 2007 (Third Quarter of Fiscal 2007)
Business Overview: QUALCOMM designs, manufactures, and markets digital wireless telecommunications products and services based on CDMA technology. The company operates through four primary segments: QUALCOMM CDMA Technologies (QCT), QUALCOMM Technology Licensing (QTL), QUALCOMM Wireless & Internet (QWI), and QUALCOMM Strategic Initiatives (QSI).

Key Financial Metrics

Revenue Breakdown (Three Months Ended July 1, 2007):
- Equipment and Services: $1,484 million
- Licensing and Royalty Fees: $841 million

Margins (Three Months Ended July 1, 2007):
- Operating Margin: 33.6% ($782 million operating income / $2,325 million revenue)
- Net Profit Margin: 34.3%

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 19% to $2.33 billion for the quarter and 19% to $6.57 billion for the nine-month period compared to the prior year. This was driven by a 20% increase in equipment and services revenue and an 18% increase in licensing and royalty fees.
• Profitability: Net income rose 24% to $798 million for the quarter and 17% to $2.17 billion for the nine-month period. Operating income increased 11% to $782 million for the quarter.
• Expense Increases: Selling, general, and administrative (SG&A) expenses increased significantly, primarily due to a $44 million increase in litigation and legal costs for the quarter. Research and development (R&D) expenses rose 15% to $454 million, driven by investments in multimedia, lower-cost phones, and new technologies (OFDMA, MediaFLO).
• Liquidity: Cash and cash equivalents increased to $3.72 billion from $1.61 billion at the end of the prior fiscal year. Total marketable securities were $8.55 billion.
• Segment Performance: QCT revenues grew 21% and QTL revenues grew 20%. QWI revenues grew 10%. QSI reported a loss before taxes of $91 million, largely due to the launch of MediaFLO services.

Guidance, Outlook, Risks, and Unusual Items

Management Commentary & Outlook:
- Management expects continued growth in demand for 3G products (CDMA2000 and WCDMA) and the deployment of CDMA2000 networks.
- The company anticipates increased competition in the low-end phone market and expects WCDMA phone prices to segment into high and low ends.
- Significant resources are being invested in the development of OFDM/OFDMA technologies, MediaFLO, and IMOD display technology.

Material Risks & Contingencies:
- Broadcom Litigation: A jury found willful infringement of three patents by QUALCOMM, awarding Broadcom approximately $20 million in past damages. An ITC exclusion order was issued against certain products. QUALCOMM is pursuing appeals and seeking Presidential disapproval of the ITC order. Post-trial hearings on injunctions and damages are pending.
- Nokia Dispute: Ongoing arbitration and litigation regarding royalty obligations and patent rights. QUALCOMM does not expect to record royalty revenue from Nokia starting in the fourth quarter of fiscal 2007 until the dispute is resolved.
- Regulatory Investigations: Complaints have been filed with the European Commission, Korean Fair Trade Commission, and Japanese Fair Trade Commission alleging violations of competition laws regarding licensing practices.
- Tax Examination: The IRS is examining tax returns for fiscal 2003 and 2004. QUALCOMM anticipates a favorable settlement that could materially impact results of operations.

Unusual Items:
- MediaFLO Launch: The launch of MediaFLO services in March 2007 contributed to a decline in gross margin percentage for the quarter due to initial costs and marketing expenses.
- Stock Repurchases: The company announced a new $3.0 billion stock repurchase program. During the nine months ended July 1, 2007, it repurchased 6.08 million shares for $264 million.

Key Facts for Investor Verification

• Broadcom Litigation Outcome: Verify the status of the ITC exclusion order, the outcome of the Presidential review request, and the potential scope of any injunctions or royalty payments resulting from the Broadcom patent verdict.
• Nokia Royalty Revenue: Monitor the resolution of the arbitration with Nokia, as QUALCOMM has suspended recording royalty revenue from Nokia starting in Q4 2007, which could impact future QTL segment results.
• Regulatory Actions: Track the progress of antitrust investigations in the EU, South Korea, and Japan, as adverse rulings could force changes to the licensing business model.
• MediaFLO Viability: Assess the adoption rates and financial performance of the MediaFLO subsidiary, which is currently operating at a loss and dependent on carrier partners for promotion.
• Tax Settlement: Confirm the final resolution of the IRS examination for fiscal 2003-2004 to understand the potential one-time tax benefit.