QCOM

Business Context and Reporting Period

Company: QUALCOMM Incorporated
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 28, 1999 (Second Quarter of Fiscal 1999)
Business Overview: QUALCOMM is a leading provider of digital wireless communications products, technologies, and services. Revenue is generated primarily through CDMA license fees and royalties, sales of CDMA subscriber and infrastructure products (including ASICs), OmniTRACS terminals and services, and contract development services (notably for the Globalstar satellite system).

Key Financial Metrics

Revenue Breakdown (Six Months Ended March 28, 1999):

• Communications Systems: $1,591.4 million (85% of total)
• Contract Services: $161.3 million (9% of total)
• License, Royalty, and Development Fees: $121.0 million (6% of total)

Liquidity and Debt:

• Cash Flow: Net cash provided by operating activities was $23.3 million for the six months ended March 28, 1999, compared to a use of $60.8 million in the prior year period.
• Debt: Bank lines of credit outstanding were $64.0 million. Long-term debt was $2.4 million.
• Credit Facilities: The company has two unsecured revolving credit facilities totaling $600 million ($400 million expiring March 2001 and $200 million expiring March 2000).

Material Changes vs. Prior Period

Revenue Growth: Total revenues increased 22% ($171 million) in the quarter and 21% ($328 million) for the six-month period compared to the prior year. This growth was driven primarily by a 24% increase in Communications Systems revenue due to higher volumes of CDMA subscriber and ASIC product sales.

Profitability Decline: Despite revenue growth, the company reported a net loss of $42.6 million for the quarter, compared to a net income of $26.0 million in the prior year quarter. This reversal was caused by significant non-recurring charges:

• Asset Disposition Charges: A $60.4 million charge related to the sale of terrestrial CDMA wireless infrastructure assets to Ericsson.
• Restructuring: A $14.6 million charge for employee termination benefits and facility exit costs.
• Asset Write-offs: A $20.8 million charge to reduce the carrying value of remaining infrastructure assets and a $15.1 million non-operating charge to write off assets related to Telesystems of Ukraine (TOU).
• Financial Guarantees: A $37.4 million reserve for financial guarantees on projects no longer being pursued.

Operating Expenses: Total operating expenses increased significantly due to the aforementioned charges. Excluding these items, operating margins improved in Communications Systems (costs as a percentage of revenue dropped from 78% to 73%) due to cost improvements in ASIC products.

Guidance, Outlook, and Risks

Ericsson Transaction: On March 24, 1999, QUALCOMM entered into an Asset Purchase Agreement to sell its terrestrial CDMA wireless infrastructure business to Ericsson. The transaction includes a settlement of litigation and cross-licensing of CDMA patents. The company estimates additional charges of approximately $100 million in the third quarter of fiscal 1999, primarily related to employee compensation benefits for transferred staff.

Outlook:

• Globalstar: The company continues to support the Globalstar satellite system, which requires approximately $600 million in additional capital before commercial service can begin. Risks include launch failures and funding delays.
• International Markets: Significant exposure to currency fluctuations in developing markets (Brazil, Russia, Chile, Mexico). The company recorded a $29 million translation loss in equity due to the devaluation of the Brazilian real.
• Financing Commitments: The company has committed to extend up to $400 million in financing for future Ericsson sales and maintains a $265 million credit facility for Leap Wireless.

Risks and Contingencies:

• Litigation: Pending litigation with Motorola regarding patent infringement; arbitration with ETRI regarding a Joint Development Agreement; and a class action lawsuit by employees regarding stock options in connection with the Ericsson sale.
• Year 2000 (Y2K): The company is actively managing Y2K readiness with an estimated budget of $28 million. While critical systems are targeted for readiness by October 1999, there is uncertainty regarding third-party suppliers and customers.
• Performance Guarantees: The company faces risks related to performance guarantees on infrastructure contracts, where failure to meet delivery or performance criteria could result in significant costs.

Investor Verification Checklist

• Ericsson Deal Closing: Verify the status of regulatory approvals and the expected closing date for the infrastructure asset sale to Ericsson.
• Q3 Charges: Confirm the magnitude and timing of the estimated $100 million in additional charges related to the Ericsson transaction in the upcoming quarter.
• Globalstar Funding: Monitor Globalstar's ability to raise the required $600 million in capital to commence commercial operations.
• Currency Exposure: Assess the impact of continued volatility in emerging market currencies (specifically Brazil and Russia) on receivables and inventory valuation.
• Stock Split: Note the declared two-for-one stock split effective May 10, 1999, and ensure financial metrics are adjusted accordingly for comparison.
• Y2K Progress: Review updates on the Y2K remediation schedule, particularly regarding critical suppliers and customers.