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QUALCOMM, Inc. (NASDAQ:QCOM)

F3Q06 Earnings Conference Call

July 19, 2006 4:45 pm ET

Executives

Bill Davidson - VP IR

Dr. Paul Jacobs - CEO

Steve Altman - President

Dr. Sanjay Jha - President of CDMA Technologies Group

Bill Keitel - CFO

Analysts

Brian Modoff - Deutsche Bank

John Bucher - Harris Nesbitt Gerard

Paul Sagawa - Sanford C. Bernstein

Avi Silver - Bear Stearns

Tim Luke - Lehman Brothers

Natalie for Brant Thompson - Goldman Sachs

Jeff Walkenhorst - Banc of America Securities

Christin Armacost - Lazard Freres & Co

Matthew Hoffman - SG Cowen

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the QUALCOMM third quarter conference call. (Operator Instructions) I would now like to turn the call over to Bill Davidson, Vice President of Investor Relations. Sir, please go ahead.

Bill Davidson

Thank you and good afternoon. Today's call will include prepared remarks by Dr. Paul Jacobs, Steve Altman, Dr. Sanjay Jha, and Bill Keitel. An Internet presentation and audio broadcast accompanies this call, and you can access it by visiting www.QUALCOMM.com.

During this conference call, if we use any non-GAAP financial measures as defined by the SEC and Regulation G, you can find the required reconciliations to GAAP on our web site. I would also direct you to our 10-Q and earnings release, which were filed and furnished respectively with the SEC today and are available on our Web site. As a reminder, the QUALCOMM Investor Relations Web site includes a thorough presentation on the many data points included in this conference call.

We may make forward-looking statements relating to our expectations and other future events that may differ materially from QUALCOMM's actual results. Please review our SEC filings for a detailed presentation of each of our businesses and associated risks and other important factors that may cause our actual results to differ from these forward-looking statements.

Pro forma revenues were $1.95 billion in the third fiscal quarter, up 44% year-over-year and 6% sequentially. Third quarter fiscal pro forma net income was $726 million, up 56% year-over-year and 3% sequentially. Pro forma diluted earnings per share were $0.42, up 50% year-over-year and 2% sequentially. Third fiscal quarter pro forma free cash flow, defined as net cash from operating activities less capital expenditures, was $795 million, up 116% year-over-year, and was 41% of revenue.

Now, it's my pleasure to introduce QUALCOMM's CEO, Dr. Paul Jacobs.

Paul Jacobs

Thank you, Bill, and good afternoon, everyone. In spite of the turmoil in the market, QUALCOMM has continued to focus and the execution of our business continues to be extremely strong. We had a fourth consecutive quarter of record revenues and chip shipments. Our revenue is up 44% year-over-year and our pro forma free cash flow is 41% of revenue and increased 116% year-over-year. I'm proud of these results and I thank our employees for their efforts and our customers for their support.

The 2G to 3G migration is well underway worldwide. Our business is being driven by the growing adoption of 3G CDMA-based technologies in multiple regions around the world. As a result, we are once again raising our handset guidance for 2006 and increasing our revenue and earnings estimates for this fiscal year.

We're focused on continuing to foster new and vigorous competition, bringing innovative products and lower prices to the rapidly growing 3G CDMA market. QUALCOMM and our licensees have been demonstrating to many audiences worldwide the consumer benefits of rapidly decreasing handset costs and the increasing variety of innovative devices resulting from our pro-competitive business model.

During the quarter, we saw 3G subscribers grow to more than 324 million worldwide, including more than 33 million 1x EV-DO subscribers and more than 66 million WCDMA subscribers. We are quite happy with the continuing record of growth of 3G technologies worldwide.

From March 2005 to March 2006, WCDMA handset shipments grew in Western Europe and comprised 30% of the handset shipments in the March quarter. In the same year, GSM handset shipments have declined by 14%.

Our success in the competitive dynamics of the 3G CDMA market has caused a small number of companies to challenge our licensing business model. The challenges we are facing are not new to us and we remained steadfast in our strong belief that because of the pro-competitive business model we have established, we will overcome these challenges. The royalties we charge are a small part of the overall cost of handsets, represent a reasonable return to us for the value of the intellectual property that we license, the risks that we assumed in developing, marketing, and commercializing CDMA technologies, the investments we made and continue to make, the market and competition that we helped create and enable, and our ongoing innovation that provides new capabilities, services and revenue opportunities for all of those in the wireless value chain.

QUALCOMM participates in and contributes significantly to many major standards processes. The majority of our technologies are standards-based. In this light, I'm pleased to note that the MediaFLO air interface has recently become a TIA standard through the work of the FLO Forum, a group of 46 partner companies.

The best measure of the value of our contribution to standardized technologies is the 130 license agreements that were freely negotiated with manufacturers around the world, including the largest and most sophisticated companies in the wireless arena, beginning in 1990 and continuing today with five new licensees during the last fiscal quarter.

However, as one indicator of the significance of our contributions to open standards, publicly available sources can be used for one objective measure of the value of essential patents in the WCDMA standard by examining how often patents essential to the WCDMA standard were cited as prior art in the patents of other inventors.

While we do not believe that counting schemes of any kind are a reliable measure of the value and quality of patents, the frequency with which one’s patents are cited by others is obviously more of an indicator of the importance of a patent portfolio than simply counting essential patents in a standard.

Looking at citations is a measure of significance somewhat analogous to the way Google ranks Web pages by examining the number of links to that page. When you factor out citations by a company of its own patents, QUALCOMM has 47% of the citation-weighted portfolio of essential patents for WCDMA, followed by Ericsson at 21%. Significantly, Nokia has only 3%, NEC 2%, Panasonic 1%, and TI and Broadcom have less than 1%.

Of course, to reiterate, the best measure by far of the value of QUALCOMM's patent portfolio is the 130 arms-length license agreements that we've negotiated over 15 years with nearly every major supplier in the industry. Those agreements have established, confirmed and reconfirmed our patents portfolio's market value.

We continue to believe that the operation of free market forces provides the only true indicator of patent value, but looking at citations provides another interesting indicator of innovative importance.

There have been significant advances in the CDMA2000 roadmap. QCT shipped five times the number of EV-DO Rev A bay station chips than last quarter, setting a new record. It's clear that operators are aggressively migrating to EV-DO Rev A. The 170 different EV-DO device models have made it possible for operators to increase their data ARPUs.

For example, in May, Verizon reported nearly an 80% year-over-year increase. In April, KDDI reported a 37% year-over-year increase, and Sprint reported a 55% year-over-year increase. In May, Vivo reported a 38% year-over-year increase. The move from commoditized voice to differentiated data services is generating revenue for the operators and therefore, they're willing to further invest in higher-speed networks.

In addition to the ability to drive wireless data, we have demonstrated significant increases in voice capacity with Voice-over-IP, or VoIP, running on DO Rev A. Over the coming years, the technology roadmap enabled by VoIP will continue to provide CDMA2000 operators with the most cost-effective roadmap to increase capabilities.

The deployment of DO Rev A Voice-over-IP devices will allow carriers to transition from circuit-switched networks to an all-packet, all-IP future. As subscribers transition from 1x to DO Rev A, operators will be able to bond together multiple channels using DO Rev B techniques to enable extremely high data rates. Combined with interference cancellation techniques implemented in our next generation CSMs, this roadmap provides the CDMA2000 operators with the most efficient and cost-effective solutions for wireless broadband in their existing spectrum.

In the past quarter, there's been significant discussion surrounding some of the emerging market operators, in particular Vivo and Alliance and how they may move from 3G CDMA to 2G GSM. QUALCOMM royalties have been cited as a reason for this potential shift. In fact, the lowest CDMA2000 phones are below $40 in these emerging markets, and with net phone royalties under 5%, the royalty is a small amount in absolute dollars. We continue to invest significant effort and resources to drive the cost of the lowest MCDMA2000 phones down.

Utilizing the advantages of CDMA, we have long believed that data services would be important not just to the high-end users but also the low-end subscribers. We are encouraged by recent reports from China and India that the lowest-end subscribers are making significant use of data services, thereby increasing operator revenues.

In India, Tata is one of the top 10 operators worldwide for revenue downloads on BREW. Tata doubled the number of applications downloaded from its network between the months of May and June this year with two-thirds of the activity coming from users of the Kyocera Prisma low-cost phone.

In order to free up capacity for increasing use of data services, we will nearly double the voice capacity of CDMA2000 systems using the new 4GV Vocoder, integrated receive diversity in both handset and base station interference cancellation. We see the use of CDMA2000 as the best way to bridge the digital divide in emerging markets.

We made a conscious decision several quarters ago to accept very low margins to enable emerging markets with very low-end subscriber devices. We are encouraged by the increasing importance of data services for existing CDMA2000 and by the impending rollouts of WCDMA as a path to improved economics for GSM operators.

To further address that market opportunity, we sampled three low-end WCDMA chip sets during the quarter with the MSN 6245 focused at the lowest end of the market. WCDMA continues to grow with WCDMA royalties accounting for 47% of overall royalties, up from 36% in the prior-year quarter.

Turning to MediaFLO, MediaFLO USA continues to move towards the launch of commercial service. Its broadcast operations center and network operations center are now up and running at MediaFLO USA's headquarters in San Diego. Currently, MediaFLO USA's facilities are being used for service trials and preparing for Verizon Wireless' launch of MediaFLO.

MediaFLO USA continues its discussions with many wireless operators on how to leverage a dedicated media delivery network that aggregates compelling content for their subscriber base and that will complement their existing 3G network.

Outside of the United States, we continue to see tremendous interest in FLO technology. In May, QUALCOMM and British Sky Broadcasting signed a nonbinding letter of intent to conduct the first technical trials of MediaFLO technology in the UK. Beginning this summer, the trial will feature ten channels of BSkyB content and a small number of non-commercial devices provided by QUALCOMM. The BSkyB technical trial is the first of what we expect to be a number of FLO technology trials in Europe and in other parts of the world. In addition to our trial agreement with BSkyB, QUALCOMM and KDDI have formed a joint venture to explore the deployment of MediaFLO services in Japan.

We took advantage of the recent decline in our stock price to repurchase 32 million shares of our common stock for $1.4 billion. Combined with our recently increased cash dividend, we provided a total return of capital to our shareholders of $1.6 billion since the end of the fiscal second quarter.

Our balance sheet strength and unique business model continues to provide significant financial flexibility, allowing us to pursue strategic growth objectives, pay dividends, and repurchase shares in our continuous effort to enhance stockholder value.

I'd now like to turn the call over to Steve Altman.

Steve Altman

Thanks, Paul and good afternoon. As we look at 3G deployments around the globe, we see continued signs of strong growth in virtually every market. Europe is witnessing an increase in the adoption of 3G, enabled by new handset form factors, improved battery life, and rapidly decreasing prices. Feature-rich 3G phones are becoming the must-have consumer gadgets, even in regions that do not have 3G networks.

WCDMA handsets sales in Western Europe during the March quarter of '06 represented approximately 30% of the total handset sales in Western Europe, compared to approximately 25% of the total handset sales in the previous quarter.

This enthusiasm for 3G is encouraging operators to expedite HSDPA deployment with commercial service now available in a growing number of countries. The initial targets for HSDPA-enabled mobile broadband services had been enterprise customers via data cards, and now the first HSDPA-enabled handsets are also beginning to reach the market.

The India market had another strong quarter with average monthly net additions of 1.3 million in the second quarter of 2006, reaching a cumulative base of 33.6 million subscribers. Leading CDMA2000 operators Reliance and Tata have crossed 20 million and 10 million subscribers, respectively.

BSNL, India's largest telecom company, sees significant opportunities in rural India, and has reiterated commitment for CDMA2000 technologies for its rural expansion. In a recent bid opened by state-owned service provider MTNL, more than one-third of the 2 million expansion planned is ear-marked for 3G mobile services, based on WCDMA.

In North America, the 3G momentum continues with broad-based DO growth and expanding HSDPA coverage. Cingular now offers their Broadband Connect 3G service in 18 markets, including New York City. Verizon recently announced that Lucent and Nortel will provide DO Revision A technology into Verizon's nationwide network, enabling them to introduce a range of new services, including enhanced Push-to-Talk, messaging, and Voice-over-IP.

Also of note, the FCC approved the first dual-mode CDMA2000 1x IDEN phone that Sprint previously reported it would launch later this year. The introduction of this dual-mode device will more readily allow Sprint Nextel to migrate its existing IDEN customers so they can experience the voice and data improvements that CDMA2000 provides before Sprint Nextel's DO REV A nationwide build out is complete.

The Korean handset market is in line with expectations and well on track to reach 40 million subscribers by the end of the year. Of note, SKT broadened its base by announcing an investment in China Unicom, creating an opportunity for those companies to share their expertise in growing the CDMA2000 market in China.

Despite, as Paul mentioned, the uncertainty of Vivo's rumored potential build out of a parallel GSM network, the Brazilian market has performed close to our expectations to-date.

In Japan, the number of 3G subscribers continues to surpass the number of 2G subscribers. As of the end of June, approximately 57% of Japan's 93 million-plus cellular users now subscribe to 3G services, and we expect a vast majority of the remaining 2G subscribers to upgrade to 3G by 2008.

Attractive handset models and the pending launch of mobile number portability have led to strong increases in new handset sales and replacement rates. 15 new handsets were launched in Japan in the month to June. KDDI unveiled seven new CDMA2000 handset models, six of which were EV-DO. DoCoMo introduced six new WCDMA handsets this quarter in the 3G FOMA 7 series. DoCoMo now has more than 51 million total subscribers, including an unmatched 26 million WCDMA subscribers.

Let me turn now to Nokia's recent announcement that it will discontinue its CDMA2000 development and scale down its CDMA2000 business. As part of that announcement, Nokia also reported that it will continue to participate in some key CDMA2000 markets that it recognizes are too large to ignore, such as North America, through an ODM model. We were not surprised by this announcement. Unlike GSM where Nokia's business model has been successful and allowed it to capture and hold the dominant position, the CDMA2000 handset market is dynamic and highly competitive.

Nokia has experienced difficulties competing against the large number of CDMA2000 suppliers, enabled by QUALCOMM's business model, and was never able to maintain a significant share in CDMA2000. For this reason, it is also not surprising that Nokia's announcements attempted to downplay the significance of the worldwide CDMA2000 market.

We do not believe that Nokia's announced plans will negatively impact the growth and continued adoption of CDMA2000 products. In fact, with their announced departure from CDMA2000, we have already seen evidence of even stronger interest from competing handset manufacturers that view Nokia's departure as an excellent opportunity to not only grow their share in CDMA2000 but also grow their share in the overall wireless handset market.

As to our license agreement, we remain in discussions with Nokia regarding an extension of their CDMA agreement. Although we're hopeful of being able to include such an extension before April, we continue to maintain our position that we have fairly valued our intellectual property portfolio and will take the necessary measures required to protect our business interests if we're not able to successfully conclude our extension by April.

Our litigation with Broadcom is continuing. The case in the ITC concluded its remedies phase on July 12. There is no liability or remedies recommendation by the judge at this point. We expect the judge to issue a recommendation towards the end of August and not later than August 21.

Verizon, Sprint, Motorola, Kyocera, Samsung and LG all intervened in the ITC action against Broadcom during the remedies phase to explain to the ITC why the remedies sought by Broadcom are inappropriate and insupportable.

The growth of the 3G market and our leading position in it is why we are seeing this litigation and attacks from some of our competitors. Over the past year, we have seen increased media activity, threats, complaints and litigation against our business model. Some of the complaining companies criticize our business model because they incorrectly hope that this will cause us to lower the subscriber royalties that they agreed to pay us. Others challenge our business model because the competition that we have enabled through our technology innovation, our licensing program, and our advanced chipset and software processes threatens the success that these complaining parties have had in 2G GSM technologies. In all of these cases, we are very confident that our business practices are not only lawful, but promote healthy competition within the industry.

I will now turn the call over to Sanjay Jha.

Sanjay Jha

Thanks, Steve. Good afternoon. I'd like to go over some key highlights for QCT business. QCT continues to set performance records. We shipped more than 55 million MSMs, compared to 49 million in the previous quarter, which is a 12% quarter-over-quarter increase. In comparison to the third quarter of last year in which QCT shipped 36 million MSMs, this represents a 53% year-over-year growth.

Our revenue of $1.1 billion was also record-setting, up 11% from last quarter and 48% year-over-year.

This quarter, we delivered record operating profit of $303 million, a 20% increase over the previous quarter. QCT's operating margin was 27% in the third quarter of fiscal 2006, compared to 24% in the third quarter of fiscal 2005. We can attribute this growth not only to greater MSM shipment but also to a trend towards higher-end solutions with more CDMA2000 1x EV-DO and wideband CDMA MSMs shipped this quarter than in the past.

We also shipped a record number of CDMA2000 cell site-to-modem voice equivalent channel elements in the quarter. Historically, we have seen that CSM shipments are a strong, leading indicator of future demand and data usage and quantity of handsets.

The CDMA market continues to grow at a strong rate and there are numerous indications that it will continue to do so. According to market research, 21 of the 34 sub-$50 designs in India are CDMA devices. Additionally, these handsets are available from ten suppliers, compared to five for GSM devices.

Part of the driving force behind the growth of CDMA in the emerging market is that growing demand for functionality that only CDMA handsets can offer at the low tier, such as downloadable polyphonic ring tones. We have 11 customers designing handsets based on our QSC single-chip solutions with commercial products expected beginning at the end of this year.

Overall, our growth in UMTS is strong with 34 device manufacturer customers and 267 wideband CDMA devices available or in design with our chipsets. Our UMTS MSM shipment increased by 24% from last quarter.

To help expand the market, we demonstrated UMTS in 900 MHz, which will help network operators deploy the 3G technology in existing spectrum with up to 70% reduction in CapEx. Furthermore, ten device manufacturers are now using our HSUPA chipsets and have started HSUPA interoperability testing with multiple leading infrastructure providers.

QCT is building on technology leadership we established with the industry's first HSDPA solution by making the broadband capabilities of HSDPA technology acceptable to a much larger segment of wireless users. We sampled our MSM 6260 chipset ahead of schedule, which leverages the cost efficiencies of 65-nanometer process technology to accelerate the availability of HSDPA handsets to mass market.

QCT is helping drive the rapid growth of this technology around the world, as evidenced by the 34 live networks and 43 networks in process of deployment in just six months after the first was launched, according to Informa.

Along with driving HSDPA into mass market, QTC is also making wideband CDMA devices more accessible with MSM 6245 and MSM 6255-A chipsets. Together with MSM 6260 chipsets, they are part of a family of PIN software and RF-compatible UMTS chipsets that deliver shortened design cycles and reduce development costs for device manufacturers. All three chipsets leverage 65-nanometer process technology and the highly integrated RTR 6275, RFCMOS, GSM, GPRS, UMTS transceiver to enable cost-efficient handsets.

Embedded modules for 3G connectivity in laptop computers remain a priority for QCT. There are now nearly 50 laptops in design or commercially available that feature embedded connectivity to either EV-DO or HSDPA networks with a QUALCOMM chipset. This has been an extremely rapid growth area and we anticipate that it will continue to accelerate.

We continue to make strong investments into IP-based multimedia subsystem or IMS technology, and are developing an air interface agnostic IMS device client solution that will be able to provide a consistent client environment to drive faster deployment of innovative IP-based applications. This translates to greater flexibility for operators in configuring and controlling services such as Voice-over-IP, video sharing, and Push-to-Talk with other applications planned for the future.

We are seeing strong traction for our 7000 series converged platform chipset, which features the industry's leading integration to offer numerous consumer electronics features and mobile devices. There are currently 25 devices in design with our first commercial unit expected to be available by the end of this year.

QCT also announced a collaboration with Microsoft to deliver integrated support for Windows Mobile on our 7000 series converged platform chipset. Our work with Microsoft will result in a wider range of slim, attractive and power efficient Smartphones, which we anticipate will be available by the end of this year and next year.

I will now turn this call over to Bill Keitel for an overview of our financial results.

Bill Keitel

Thank you, Sanjay, and good afternoon, everyone. We are very pleased to report another quarter of record revenues, chip shipments, and earnings per share. GAAP earnings for the June quarter were $0.37 per diluted share and our pro forma earnings were $0.42 per diluted share, excluding $0.05 in estimated stock option expense. Revenues increased 44% year-over-year to $1.95 billion. Pro forma diluted earnings per share increased by 50% year-over-year.

During the quarter, we returned $1.4 billion in capital to shareholders, including $202 million of cash dividends, or $0.12 per share, and $1.2 billion to repurchase our common stock. Shortly after the quarter end, we repurchased an additional $238 million of our stock. In the past two months, we have repurchased a total of $1.4 billion of our stock and looking forward, it will be accretive to earnings per share.

Our business continues to generate strong cash flow. Operating cash flow was $816 million for the third fiscal quarter, up 56% year-over-year. Pro forma free cash flow was $795 million, up 116% year-over-year. Our pro forma estimated tax rate for fiscal 2006 is 26% as compared to our prior estimate of 27%.

As Sanjay mentioned, QCT again had record MSM shipments during the quarter. QCT's third quarter revenues increased 48% year-over-year. MSMs shipped increased 53% year-over-year. QCT's operating margin increased to 27%. QCT earnings before tax increased 63% year-over-year.

QTL earned record revenues of $683 million this quarter, up 52% year-over-year, as licensees reported approximately 66 million new handset units shipped with an average selling price of approximately $213 per handset. These shipments occurred in the March quarter and were awarded to us by our licensees in the June quarter.

Of the $683 million in total QTL revenues, $43 million represented inter-segment royalties, $13 million were license fees, and $627 million were royalties from third-party licensees. WCDMA royalties were approximately 47% of third-party royalties reported this quarter, and QTL's operating margin was 90%.

Based on our recent checks, we believe higher-than-normal channel inventory build has occurred for China and India, consistent with our prior expectations. For the rest of the world, we believe channel inventory levels are comfortably within the normal 15 to 20-week band.

Before addressing our guidance, I will offer a little more perspective to Paul's comments on emerging markets and a couple of operators potentially moving to GSM. Although emerging markets are important to QUALCOMM, I want to be clear that financial contribution of significance from very low-end is a few years away. Although we dedicate significant support to emerging market operators and continue to invest in low-end solutions, today this business is appropriately characterized as business development in the context of bottom line profit.

Turning to our guidance, we are increasing our estimate for the calendar year 2006 CDMA-based handset market. We now estimate shipments of approximately 285 million to 295 million units in calendar 2006, an increase of 36% to 40% over calendar 2005 shipments.

Based on the 290 million midpoint of this estimate for calendar 2006, we now anticipate shipments of approximately 190 million CDMA2000 units and approximately 100 million WCDMA units. This increase to our calendar year estimates is driven primarily by strength of CDMA2000 in North America and India and WCDMA in Europe. A detailed regional breakdown of our increased market estimates is available on our Investor Relations web site.

We are also increasing our guidance for fiscal 2006 revenue and earnings per share. We now expect fiscal 2006 revenues to be in the range of approximately $7.4 billion to $7.5 billion, an increase of 30% to 32% over fiscal 2005. We anticipate pro forma diluted earnings per share to be in the range of $1.61 to $1.63, an increase of 39% to 41% year-over-year.

We now estimate the fiscal 2006 average selling price for CDMA2000 and WCDMA phones combined to decrease approximately 1% year-over-year to approximately $213. We continue to see a wide array of wholesale prices occurring with CDMA2000 devices and increasingly so with WCDMA devices.

We expect a combination of pro forma R&D and SG&A expense for fiscal 2006 to increase approximately 28% to 29% year-over-year, driven by growth in R&D as we continue to invest in the evolution of CDMA2000 and WCDMA, multimedia functionality, single-chip low-cost solutions, and longer-term technology enhancements, including OFDMA.

We estimate GAAP diluted earnings per share will be approximately $1.40 to $1.42 for fiscal 2006. This estimate includes a non-cash expense of approximately $0.20 per share for estimated share-based compensation, a loss of approximately $0.03 per share attributable to QSI, a gain of $0.03 attributable to tax benefits related to prior years, and a $0.01 loss attributable to in-process R&D from completed acquisitions.

Turning to our guidance for the fourth fiscal quarter of 2006, we estimate revenues to be in the range of approximately $1.88 billion to $1.98 billion, a 21% to 27% increase year-over-year. We estimate fourth quarter pro forma diluted earnings per share to be approximately $0.39 to $0.41, a 22% to 28% increase year-over-year. This estimate includes shipments of approximately 53 million to 56 million MSM phone chips during the September quarter.

We continue to see very strong demand across multiple product segments, including CDMA2000 EV-DO, WCDMA, and HSDPA. We estimate approximately 67 million to 70 million CDMA-based handsets shipped in the June quarter at an average selling price of approximately $215.

Our unit forecast reflects sequential growth in multiple regions, including WCDMA in Europe and CDMA2000 in North America when compared to the March quarter, while the overall market reflects a 40% to 46% growth over the year-ago quarter June.

We anticipate fourth fiscal quarter pro forma R&D and SG&A expenses combined to increase sequentially by approximately 3% to 6%, driven by our continued investment in new products and services to address the growing market.

In closing, it has been another great quarter of record financial results and strong cash flow driven by the growing adoption of 3G CDMA technology around the world and continued strong execution in our business units. We are well-positioned for the significant opportunities in front of us, as we continue to invest and innovate.

As well, we're pleased to be actively returning capital to our shareholders while maintaining financial flexibility to take advantage of new opportunities and to continue to grow our business at a high rate in the years ahead.

That concludes my comments. I will now turn the call back to Bill Davidson.

Bill Davidson

Thank you, Bill. Before we go into our Q&A session, I'd like to remind our participants that our goal is to address as many questions as possible before we run out of time on the call. Therefore, I'd like to ask that our participants limit their questions to one per caller.

Operator, we're ready to receive questions.

Question-and-Answer Session

Operator

Our first question comes from Brian Modoff - Deutsche Bank.

Brian Modoff - Deutsche Bank

Good afternoon. Thanks for taking the question. You've raised your WCDMA forecast from 96 million to 100 million this quarter. Can you kind of give some granularity as to why you did that? And specifically, can you address the demand trends you're seeing in Western Europe? Thank you.

Bill Keitel

Our WCDMA estimates, we increased slightly our estimates for Europe from 51 million to 53 million units, and we increased our estimates for rest of world -- that being everything but Japan and Europe -- from 5 million units to 7 million units.

Brian Modoff - Deutsche Bank

Can you give some granularity behind what caused that? What kind of trends are you seeing in Europe? You know, what's driving this? Because we get mixed signals on Europe, so I'm curious what's driving this demand trend over there particularly.

Bill Keitel

What I see driving it, Brian, is now broadly across many operators is increasing attraction for buckets of minutes, packages and I think an increasing interest in HSDPA and the enhanced data capabilities, both quality to the consumer and cost for the operator, with the rollouts that are occurring now.

Brian Modoff - Deutsche Bank

All right, thank you.

Bill Keitel

Brian, I just want to add also that, in rest of world, we're seeing a lot of WCDMA handsets being sold onto GSM-only networks, so that was not an insignificant part of our estimate increase for rest of world.

Brian Modoff - Deutsche Bank

Thank you.

Operator

Our next question comes from John Bucher - Harris Nesbitt.

John Bucher - Harris Nesbitt

Thank you. There's been a lot of attention devoted to whether certain CDMA2000 carriers may go to GSM. Yet it would seem that with the substantial installed base of GSM carriers that could migrate to WCDMA, that you've got a huge opportunity there.

With Sanjay mentioning the 900 MHz WCDMA chip sets being sampled, do you think that's the key tipping factor that might get some GSM carriers to move to WCDMA? Or are there political and regulatory factors that might open up this opportunity for you?

Paul Jacobs

We are definitely seeing a shift in the regulatory and political landscape towards enabling technology neutrality and the operators are clearly pressing on having that opportunity to lower their CapEx by moving to a WCDMA 900. That's certainly a tremendous opportunity for us.

But we also see the opportunity, we talked about the fact that, in India, we're starting to see operators being interested in moving, so even in emerging markets, we see that as well. It seems to be happening worldwide.

The fact that people are buying WCDMA handsets and running them on 3G networks is also not escaping the notice of the operators as well, so they see an opportunity to launch new services there as well. Sanjay, I don't know whether you want to add anything.

Sanjay Jha

Yes, John, I spent a little time in Europe in the last few weeks and actually the attraction of the UMTS 900 was one of the key things that struck me as a positive trend, certainly for QUALCOMM. Of course that means lower CapEx and better coverage, both indoors and in rural space for UMTS operators. I'm actually very, very positive and very excited about this opportunity, not the least because we have leadership in providing integrated RF solution for this band, so I see this as a very important development.

Operator

Our next question comes from Paul Sagawa - Sanford Bernstein.

Paul Sagawa - Sanford Bernstein

Thank you very much. So as we sail towards that April 9 date, obviously there's been a lots of noise in the marketplace, and it's those that would try to seek a better deal with you who put as much pressure as possible. I'm interested about those post-April 9, as we move into a timeframe when both companies, if they continue to ship, would be in likely violation of patent infringement.

What actions are available to you? Obviously, you can file suit. There would be damages associated with that. We know that, in the United States, there are treble damages for willful infringement. If you could talk a little bit about what damages you think might be available in pursuing this here and in Europe? Also, the potential of getting injunctions in those markets.

Then finally, are the carriers and distributors of phones that infringe upon your patents also at risk, or are they party to the infringement? Would they be potentially a pressure you could bring to bear on this circumstance, should it come to it?

Steve Altman

Part of that question you answered as well. Let me go through it. You're right. In the U.S., there would be treble damages as an opportunity. I think that once we get past April 9, if there's no agreement, they will be infringing our patents, so we will take all appropriate measures, which would be I think pretty obvious to you in terms of what steps we would have to take.

In addition to damages, we would look and seek injunctions in a variety of markets where there are shipping certainly WCDMA at that time.

In terms of carriers that would be subject to risk, while it would be true that a carrier who buys an unlicensed product that's infringing our patents from a company like Nokia after April 9 would also be infringing on those patents by using those products.

We are very good partners with our carriers and we believe very strongly that the remedies that we would seek would be very applicable to the manufacturers, so I don't think that you will see us asserting these patents, I don't think we need to assert these patents against our carrier partners.

Paul Sagawa - Sanford Bernstein

Do you think the carriers would respect your patents with regard to an infringing product?

Steve Altman

I think that as the carriers decide what products that they're going to want to purchase and rely on in their product portfolio, I think it's widely recognized that licenses from QUALCOMM are necessary. So to the extent that they were to buy from somebody and include those products in their portfolio, they would do so knowing that they could be very abruptly removed from their portfolios. I think they would take that into consideration as they make their purchases.

Paul Sagawa - Sanford Bernstein

Thank you.

Operator

Our next question comes from Avi Silver - Bear Stearns.

Avi Silver - Bear Stearns

I had two questions. Is there anyone out there that is manufacturing the WCDMA or CDMA phone that doesn't currently have a license agreement with QUALCOMM?

My second question is a follow-up on Sanjay's comment earlier. It seems like two major catalysts for 3G in Europe are 900 MHz and HSDPA. Can you talk about some of the timing regarding 900 MHz, whatever process that needs to go through to get approved and the potential timing for that, as well as commercialization of HSDPA? We see LG's phone now with Cingular in the U.S. When does that launch in Europe on a wider scale?

Steve Altman

Well, certainly we can say that there's nobody that is manufacturing and selling WCDMA of any significant volume that does not have a license. If you look back at QUALCOMM's historical practices, if there are companies that were proceeding with CDMA but we were in licensed negotiations and making what we perceived as reasonable progress, we don't rush into litigation if we think there's a good opportunity to resolve the issue. So there's nobody of any significant volume, and we are in discussions with new companies that would become WCDMA licensees.

Sanjay Jha

In terms of UMTS 900, let me just say that there has been a significant amount of regulatory discussion and most all of the European countries with the possible exception of one; the one company which is objecting, their motivation is not to stop UMTS 900 but to get some other concession in some other band. Most of the countries are supporting UMTS 900.

There are one or two issues with respect to those carriers who have 3G spectrum but don't have access to 900 spectrum, and H3G comes to mind as one such carrier. Finding appropriate arrangements for sharing the benefits of 900 MHz spectrum, as that happens, I think that UMTS 900 will happen.

In terms of timing, we will have commercial products available in the second half this year. There are at least two carriers who are going to mandate that every UMTS phone that they buy, starting June next year, that every phone they buy has 900 MHz support. So I think that 900 MHz is going to happen faster than perhaps some people anticipate, and the case for 900 is so overwhelmingly compelling that anyone who is capable of moving and freeing spectrum to support a 900 MHz band, that they will definitely migrate to UMTS.

In terms of HSDPA, I think you have seen the CU500 from LGE being launched at Cingular. I expect you would see between one and ten phones being launched -- broad range I know, but I need to cover myself here -- being launched based on HSDPA. Every single data card starting from about July or August will be HSDPA.

As I mentioned, a large number of laptops are coming onto market with embedded HSDPA modules. So I think those are the three things that I think will drive HSDPA. The number of networks being launched is accelerating not least because most of the networks are software upgradeable to HSDPA. So both 900 and HSDPA are big positive trends for QUALCOMM.

Paul Jacobs

To amplify Sanjay's comment, I was in Europe recently and the guys got me a very attractive laptop with embedded HSDPA and I was able to use it almost everywhere I went in HSDPA mode, so the networks are getting up and being launched. Now, I was in major metropolitan areas of course, but the experience was tremendous.

Avi Silver - Bear Stearns

Great, thank you.

Operator

Our next question comes from Tim Luke - Lehman Brothers.

Tim Luke - Lehman Brothers

Thank you. Just a clarification for Bill. Could you just give us a framework of what the inventory build is in India and China? You said it was 15 to 20 weeks elsewhere. How many weeks is it there or can you give us some framework for how we should think about that?

Then for Paul, you were obviously just in India and talking to Reliance. Can you give us some sort of framework of what the issues are there? Do you think it's fairly likely that they will proceed with some GSM there or not, and how should we view that? Maybe if you could give us a similar framework for your expectations with respect to Brazil.

Bill, you eluded to the fact that it's not insignificant in terms of the contribution. Maybe frame that, that might be helpful. Thank you.

Bill Keitel

On the inventory, as we said, outside of China and India, looking at the world as a whole, the channel is comfortably within a 15 to 20-week band. Last quarter, we mentioned that we are cautious; we've been cautious on India and China, in the context of thinking that OEMs were perhaps targeting to gain a little too much share from each other, or perhaps a little too optimistic on what the operator sell-through would be.

Tim Luke - Lehman Brothers

But the guidance implies that it will be done by the end of this quarter, in terms of cleaning out that inventory?

Bill Keitel

I think it's going to improve this quarter. I still see a steady flow of our product, but I think that channel would probably improve this coming quarter, and then right itself probably the quarter after that.

In the context of total world inventory, the excess that we see for China in inventory is not inventory that we think is very likely transportable to other regions of the world, so to the extent it was bought for India or China, we think it will probably stay directed at those markets.

Tim Luke - Lehman Brothers

Thank you.

Paul Jacobs

This is Paul. On Reliance, I would say the issue started out, at least publicly, around royalty rates. I think we had pretty much a meeting of the minds that the issue is predominantly handset costs and that's what we need to focus on. We have done, I think, a very good job over the last year. I think the result was that through competition we got the handset prices at the very low end down by 25% in the last year.

So we're going to continue to drive that. They are always focused on the cost differential between their lowest-cost phone and the lowest-cost phone available to the GSM operators, although on an average basis, the gap is extremely small in the sub-$50 range. Across the entire market, CDMA actually has lower average selling prices, although that has something to do with the strategy of focusing more in on the low end of the market. So we are discussing with them things like how to get a broader range of handsets, some higher-end handsets into that market as well.

Clearly, the way the spectrum is being allocated in India and the relative lack of spectrum availability is playing into some of their concerns. They are a GSM operator in certain circles, so I would say it's still up in the air, what their decision-making process is going to be, and we are still in pretty deep discussions with them, not just us but also other partners.

So, I think that's going to continue on and there's a lot of negotiating back and forth that's currently happening.

Tim Luke - Lehman Brothers

Will it be this calendar year? You would expect the decision to be made by the end of this calendar year with respect to their direction?

Paul Jacobs

They say things like that to us, so I would expect so, but we've been in discussion with them for a fairly long period of time, so we'll see how it goes. Like I said, the negotiations continue; the discussions continue.

I should point out that while I was there, I also met with Tata and BSNL, both of whom seem to be very aggressive on their CDMA2000 plans, and met with some of the WCDMA operators. So India is turning out to be a very increasingly interesting and complicated market, and we will spend a fair time focusing on that.

You know, with respect to Brazil, we've all heard the issues. There has clearly been some disagreement in the ownership of Vivo about the direction we've heard of, very aggressive offers being made by the GSM vendor community. So we continue to talk with them as well.

Clearly having the low-end phone and having the range of phones -- I mean, it's a similar dynamic for these markets, although I would say that we've seen expansion of DO and the use of data services is probably higher in terms of DO and so forth in Brazil, so we'll see that discussion continue on.

Tim Luke - Lehman Brothers

But you would expect them to do GSM in the regions where they don't have Spectrum or Vivo?

Paul Jacobs

NanoTel has opened up consultations and it looks like there will be 1900 MHz spectrum available for them to cover. But it is an interesting point that in both of these situations we're talking about, there is spectrum availability and regulatory issues that are causing these operators to have some problems in terms of just having adequate capacity or adequate coverage, so we are actively working those issues, we have been trying to work those issues over an extended period of time. I think there are some breakthroughs in Brazil that are possible.

Tim Luke - Lehman Brothers

Thank you.

Steve Altman

In the context, Tim, of characterizing the very low end as more business development, I will just say that we think we are seeing $40 wholesale handset prices now occurring, and we think with our single-chip solution towards the end of this year, that's going to go down substantially further. To enable a sub-$40 wholesale handset price, obviously the chipset price is very low and the royalty we get off that is very low.

As Paul said several quarters ago, we consciously made a decision to even accept lower margins on our sales of these very low-end devices to just further help these emerging markets.

As I said, from a financial perspective, it's more of a business development area. The operators are very important to us and we dedicate a lot of time and resource to them. But the opportunity, the financial opportunity, is really some years ahead.

Tim Luke - Lehman Brothers

This is a framework for investor expectations, though, that you would acknowledge that you may see announcements about GSM or WCDMA deployments in that region in Brazil in the next several months, or you think that's an unlikely prospect? How should we think about that?

Paul Jacobs

I mean, the possibility exists, so we would certainly welcome the announcements of WCDMA.

Tim Luke - Lehman Brothers

Great. Thanks, Paul. Thanks, Bill.

Operator

Our next question comes from Brantley Thompson - Goldman Sachs.

Natalie for Brant Thompson - Goldman Sachs

This is Natalie in for Brant Thompson. Sanjay, you had talked a little bit about expectations over the next few quarters for the QCT margins seems to be coming in stronger, at least than we had expected. So any commentary around what we should look for going forward?

Sanjay Jha

Natalie, no update to the guidance that I've provided for long-term operating profit for our business, which is 25% to 32% is where we look for, so clearly, we are very happy about the quarter which is coming in slightly stronger driven by two things: a slightly richer mix and higher volume.

Going forward, we are hopeful that we will maintain our performance.

Bill Keitel

I would just add to that, too, Sanjay, at the outset of the year said that he thought the year would end plus or minus about a 25% operating margin, and it looks like that's about where we're going to come in.

He also said that, quarter-to-quarter, it's going to go up and down, and that truly has been the case, too. So we're going to have fluctuations quarter-to-quarter as the mix changes, but nonetheless, I think that business is operating extremely well.

Operator

Our next question comes from Tim Long - Banc of America.

Jeff Walkenhorst - Banc of America

Yes, it's Jeff Walkenhorst for Tim Long. Thanks for taking the question. I'm wondering if you can talk a little bit more on Nokia's decision to ramp down on CDMA?

The first question would be more towards Sanjay. When do you think that the chipset business might see some share gains in some of the other vendors that may be clamoring for some of that share?

I guess the flip side is, do you think that Nokia will be so aggressive that it might make it hard for CDMA to maintain relative market share to GSM? Thanks.

Sanjay Jha

Two things there: first of all, that I think, in the last earnings call I talked about how Nokia actually already had some phones based on our solutions, ODM phones based on our solution in the marketplace, both in the very low-end as well as DO devices. So as Nokia ramps down their effort, they are still shipping a considerable amount of products based on our solutions. That's one.

Secondly, we already see that all the other manufacturers are very aggressive about going after and winning market share from Nokia worldwide, as well as in particular regions. India and U.S are particularly important, and as Paul mentioned, so as Latin America. So I expect that does lead to some positive gains for us.

In terms of Nokia making it hard, Nokia has actually been very public about not playing even in GSM, in the absolute low end of the marketplace. In fact, I see them being quite aggressive right now in wideband CDMA, so I actually see Nokia's move as a net positive overall for QUALCOMM, certainly a net positive in CDMA2000 to the chipset business.

Jeff Walkenhorst - Banc of America

Okay, thanks. As far as the pricing differential in India and low-end markets, maybe it is around $4 or $5 at the absolute low end. What do you think that might be a year from now?

Sanjay Jha

It's very difficult to tell because it's a very dynamic marketplace. If you look at where that market has been, it has come down very dramatically. What both of us are chasing is really a pretty rapid curve down. I expect that our objective certainly is to get closer and closer to GSM price, and with a single-chip solution, I think we have the opportunity to get much closer.

Paul Jacobs

The other thing that we are absolutely trying to do in that low-end market, though, is to make use of the data capabilities of CDMA and the functionality that Sanjay's team is integrating into the chipsets, and that's why we are so happy to see these reports that the very low-end subscribers are actually generating a fair amount of data ARPU, more ARPU on data than through the tier just above them. That's a strategic insight that we've only recently gotten, and we are always focused on data for the low end, but now it's very clear that there's an opportunity for us there.

Jeff Walkenhorst - Banc of America

Great, thanks. Good luck, guys.

Operator

Our next question comes from Christin Armacost - Lazard.

Christin Armacost - Lazard Freres & Co.

Thank you. I wanted to ask you a question about the guidance and in particular, Bill, your comments about QCT margins. With so many metrics that you give us, there's very little for us to play around with in the September quarter estimate. Especially in QCT, QCT margins and the ASP for the MSM chipset.

So what I'm trying to understand is, relative to your guidance and the metrics, are you anticipating a pretty significant decline in QCT margins to get to the EPS numbers or a significant decline in MSM ASPs?

Bill Keitel

I will offer my thoughts here and Sanjay can add to it if he sees anything. We are expecting a very modest decline in the ASP of our average chipset sales, consistent with our prior expectations and consistent with our trends. But in addition to that, we are continuing to increase our R&D spending and a good portion of that increase we expect to be in QCT. So yes, we are expecting a decrease in QCT operating margins in the September quarter.

Christin Armacost - Lazard Freres & Co.

Great, thank you.

Operator

Our next question comes from Matthew Hoffman - Cowen & Co.

Matthew Hoffman - Cowen & Co.

Bill, I hope we can continue with that line of thought real quick. To get to the new EPS guidance, you talked about the R&D and the QCT margins. But what about gross margins? They ticked down a little bit for this quarter. Should we assume that they are also going to tick down again next quarter?

Then Sanjay, it seems like pretty good news on the CSM Rev A chips. Geographically, where should we assume those chips are headed? Are they going to base stations in Japan and the U.S. or any in emerging markets?

Sanjay Jha

Matt, let me take the second part of your question first. In terms of DO Revision A chips, actually the carriers who are driving are it -- Sprint, Verizon, KDDI -- are the three carriers who are driving the migration to DO Revision A very fast. I think that those three carriers are the key drivers of that growth, therefore Japan and U.S. being the drivers of that growth.

Operator

Ladies and gentlemen, we have reached the allotted time allowed for questions and answers. Dr. Jacobs, do you have anything further to add before adjourning the conference call?

Paul Jacobs

Yes, I'd like to thank everybody for joining us. I think, despite all the noise that is out there, the real events of this quarter demonstrate our values of innovation, execution and partnership, and I think that that has resulted in the absolutely outstanding financial performance that we turned in.

The data capabilities and 3G are really leading to a better mix for us and all the core businesses. We remain focused on those opportunities that are ahead of us as 3G CDMA continues to be the key mainstream technology for enabling compelling new devices and services.

If we just used the growing subscriber base worldwide, we can see that consumers are buying 3G. So we look forward to continuing to help drive that market.

Thanks very much, everybody. Bye.

Operator

Ladies and gentlemen, this concludes the QUALCOMM third quarter conference call. Thank you for your participation. You may now disconnect.

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Source: QUALCOMM, Inc. F3Q06 (Qtr Ending June 25, 2006) Earnings Conference Call Transcript (QCOM)
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