QUALCOMM Inc. (QCOM)
F4Q06 Earnings Call
November 2, 2006 4:45 pm ET
Paul Jacobs - CEO
Steve Altman - President
Sanjay Jha - President of CDMA Technologies Group
Bill Keitel - CFO
Lou Lupin - General Counsel
Bill Davidson - IR
Paul Sagawa - Bernstein
John Bucher - BMO Capital Markets
Mike Ounjian - Credit Suisse
Steve O’Toole - Lehman Brothers
Ehud Gelblum – JP Morgan
Mike Walkley - Piper Jaffray
Inderbir Singh - Prudential Equity Group
Brian Modoff - Deutsche Bank
Hasan Imam - Thomas Weisel Partners
Daryl Armstrong - Citigroup
Tim Long - Banc of America
Matt Hoffman - Cowen & Co.
Welcome to the QUALCOMM fourth quarter conference call. (Operator Instructions) I would now like to turn the call over to Bill Davidson, Vice President of Global Marketing and Investor Relations. Bill, please go ahead, sir.
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 in Regulation G, you can find the required reconciliations to GAAP on our website. I would also direct you to our 10-K and earnings release which were filed and furnished respectively with the SEC today and are available on our website.
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 $2 billion in the fourth fiscal quarter, up 28% year over year and 2% sequentially. Fourth fiscal quarter pro forma net income was $705 million, up 30% year over year and down 3% sequentially. Pro forma diluted earnings per share were $0.42, up 31% year over year and even sequentially. Fourth fiscal quarter pro forma free cash flow, defined as net cash from operating activities less capital expenditures, was $907 million, up 8% year over year and was 45% of revenue.
Before I turn the call over to Dr. Paul Jacobs, I would like to mention that we are hosting an analyst meeting on November 13 in London. The meeting will be simulcast on our website with audio and slide presentations. Questions from our webcast participants can be submitted prior to the meeting by going to QUALCOMM's Investor Relations website at www.QUALCOMM.com and following the links to our London webcast.
Now it is my pleasure to introduce QUALCOMM's CEO, Dr. Paul Jacobs.
Thank you, Bill and good afternoon, everyone. Let me begin by thanking the employees of QUALCOMM for delivering another spectacular year. Despite the numerous challenges by a few companies to our business model this year, as an organization we have remained focused by continuing to both innovate and execute, and I am delighted to report that this effort has resulted in some excellent financial and operational results.
Let me first comment on our financial results. Our pro forma earnings per share were up 41% year over year to $1.64. We were able to significantly outperform our original FY '06 guidance of $1.43 to $1.47 because we, with our partners and licensees, enabled stronger than predicted growth in handset shipments across all forms of 3G CDMA and because average selling prices of phones stabilized due to customer adoption of higher end features and a more rapid transition of 2G subscribers to 3G.
These trends drove record pro forma fiscal year revenue, generating $7.53 billion, up 33% year over year, and pro forma net income of $2.8 billion in FY 2006, up 42% year over year.
Now let me spend a few minutes going through some of the key achievements for our business in fiscal 2006. In QCT, each quarter of fiscal 2006 represented a new record for shipments, that obviously resulted in a record for the entire year. This outstanding performance included a total of 207 million chips shipped this year as compared to 151 million in fiscal 2005 and 137 million in fiscal 2004. QCT continues to demonstrate the benefits of our fabless business model and its ability to scale to our increasing volumes.
Our growth also continued in QTL where we signed 22 new 3G CDMA licenses. Other significant licensing milestones included granting our first-ever licenses for single mode OFDM, OFDMA, a license for a manufacturer in India and one for a third-party FLO chipset manufacturer.
In QIS we now have 69 BREW operator partners in 31 countries with BREW developer payments surpassing a cumulative $700 million. The launch of uiOne on the Pantech Ice handset in September highlights our successful acquisition of Trigenix, and other European operators are in the process of deploying BREW uiOne.
In addition to also deploying uiOne, Sprint extended our relationship on QChat and announced that they will be deploying it as their solution for Push-To-Talk as they begin migrating their iDEN subscriber base to CDMA DO Revision A.
In QSI we announced Verizon as our launch partner for media flow and are looking forward to deploying this revolutionary technology early next year. In addition, the FLO Air Interface standard was ratified by TIA, dispelling the misinformation that FLO is a closed technology. We were very pleased with the unanimous FCC ruling released in response to a petition for a declaratory ruling filed by QUALCOMM in January of 2005. This ruling greatly expands the number of markets in which MediaFLO USA can operate prior to the digital TV transition date of February 17, 2009.
I would once again like to express our appreciation to Chairman Martin, the other commissioners and the FCC staff for their support for the new services that MediaFLO will enable.
As I look forward to fiscal 2007, our challenge is clear. It is critically important that we help our customers grow their market share, and we continue to enable the operators' data businesses to be successful.
Our R&D spending in fiscal 2007 is tracking to our long-term plan. Our R&D investments are targeted at both near and long-term projects, and the amount dedicated to longer-term projects is greater than it has been at any other point in our history. The industry move from commodity voice services to differentiated data services provides us with many opportunities to create new technologies and future revenue streams.
The competitive advantages in cost, size, power and performance of QCT chipsets are clearly being leveraged in CDMA2000. There are 85 EV-DO deployments in more than 50 countries worldwide, and Sprint Nextel recently announced that they were the first operator to deploy EV-DO Revision A. San Diego is the first of 21 markets where Sprint will roll out EV-DO Revision A this year with coverage expected to reach more than 40 million people by year end. Additionally other forward-looking CDMA2000 operators such as Verizon, KDDI, Leap Wireless and Telecom New Zealand and LG Telecom already have aggressive plans for their evolution to EV-DO Rev A.
For the WCDMA market, HSDPA is in its initial rollout stage. CDMA has been primarily a voice market to date since the data capability within the initial WCDMA specification was not a significant improvement over Edge or GPRS. Up until now in Europe specifically, there has been minimal distinction between 2G and 3G handsets, and consumers have continued to purchase largely based on form factor and known brands as opposed to functionality.
But similar to the way the CDMA market matured over time, we have seen the number of manufactures increase in the WCDMA market. QCT alone has more than 30 customers with 267 designs available or coming to market. QCT will work to increase its share of the WCDMA chipset by assisting their existing partners or gaining new ones.
In an example which highlights the power of the QUALCOMM business model to foster competition and support wireless operators' initiatives, Huawei and Vodafone recently announced the commercial availability of the first Vodafone-branded handset, the V710 manufactured by Huawei. In February the two companies entered into a strategic relationship in which Huawei will supply exclusive Vodafone-branded handsets in 21 countries over the next five years.
As a result of the increased competition, prices have come down dramatically for WCDMA handsets, while volumes have increased. Using Yankee Group estimates for total market shipments and our own royalty reports for WCDMA unit shipments, WCDMA handset sales represented 41% of total sales in Western Europe, up from 30% in the March quarter and 25% in the December quarter of 2005. Competition is a far more important piece in driving down price in the handset market than any other single factor.
I would also like to comment on recent speculation concerning the health of the CDMA2000 market based on a small number of emerging market operators considering GSM overlays to their CDMA2000 network. CDMA2000 continues to pace the migration from 2G to 3G and strengthens its market position. Close to 80% of the entire 3G subscriber base uses CDMA2000 devices and services. According to the CDMA Development Group, nearly 200 CDMA2000 networks are in operation worldwide as compared to 127 at this point last year.
Now turning to WCDMA, according to the Global Mobile Suppliers Association, the GSA, more than 120 operators around the world have deployed WCDMA as of October 10, 2006. The vast majority of these deployments have been as overlays to GSM networks. Gartner Dataquest forecasted 54% of all spending this year as going to CDMA2000 and WCDMA infrastructure. By 2007 the firm expects spending to jump to 61% for 3G infrastructure, as spending on 2G technologies like GSM continues to decline. Strategy Analytics also predicts that more than half of the global spending for 3G wireless infrastructure will go to CDMA2000 and WCDMA during 2006 and that 2G technology investments will continue to decline.
The continued deployment of HSDPA and ultimately HSUPA will be an important component of this infrastructure spending. HSDPA was introduced in November 2005 and is now commercial with 65 operators in 33 countries with 21 others in deployment. There are 51 commercial devices on the market from 16 suppliers that support HSDPA.
The next evolution of this wireless broadband technology, HSUPA, is expected to be available in 2007 and will offer higher data throughput speeds in the uplink and other enhancements to improve the economics and performance of the 3G network.
QCT was first to market with a HSDPA chipset solution, and we are pleased that our chipset customers have been the first device manufacturers to support HSDPA launches. QCT was also first to market with an HSUPA chipset, and we have design wins with ten manufacturers for that device. We are now working to make the broadband capabilities of HSDPA technology accessible to broader audiences. 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 the mass market.
Our leadership in HSDPA and in 1xEV-DO and DO Rev A has created the opportunity for us to build close relationships with laptop manufacturers. As a result, our HSDPA and DO chipsets are now being used in 73 commercial notebooks from nine manufacturers on 11 wireless operators' networks. As this industry evolves, you can be sure that QUALCOMM will design and deploy the highest performance air links for a broad array of applications. Beyond that, we will work with our partners to turn these into services that consumers and enterprises will demand.
In closing, I am exceedingly proud of our accomplishments this year and remain steadfast in my belief that our business model has and will continue to be a positive force in the industry. Our philosophy is simple. Manufacturers should be able to compete in an open market, not a closed market controlled by a limited number of manufacturers using their intellectual property to stifle competition. By QUALCOMM acting as an aggregator of R&D for the industry, all participants in the value chain get the benefit of equal access to technology, enabling the best products to win in the market.
I'm excited about the future for QUALCOMM. Our vision and execution in R&D programs, as well as the development of products and services by our partners, puts us in an enviable position to take advantage of the many opportunities ahead. I would now like to turn the call over to Steve Altman.
Thanks, Paul, and good afternoon, everyone. I would like to first update you on the status of some of the legal proceedings that we are involved in. Let me start first with the complaints that were filed in Europe by six companies that have been referred to as Project Stockholm. There has recently been some confusing media reports issued about the expected next step in the process, and so I would like to clear up the confusion.
The next step in the process is for the EC to decide whether or not to continue its informal investigation. Although we expect that the EC will shortly make a decision to continue its informal investigation, such a decision means only that the EC will continue to do what it has been doing. That is gathering and evaluating information in order to fully understand the complaints. Such a decision would not signal that the investigation has become formal or intensified as some media reports have mistakenly suggested.
The decision to continue the informal investigation is not the equivalent of a statement of objections which would signal a more formal phase, nor does it indicate one way or the other whether a statement of objections will ultimately be issued. We have been advised that in complex cases it can sometimes take years -- in some cases as long as five to six years -- for the commission to reach the next milestone, namely a determination whether to either reject the complaints or initiate formal proceedings and issue a statement of objections or negotiate proposals to close the case. Because we feel that our agreements and actions have been lawful, we remain optimistic that the commission will ultimately decide not to issue a statement of objection.
We have seen several positive developments in our litigation with Broadcom in the past few months. Broadcom's antitrust complaint against QUALCOMM was dismissed in federal court on September 1. Essentially the judge determined that even if she accepted as true everything that Broadcom alleged in its complaint, QUALCOMM has not violated any U.S. antitrust laws. This was a very significant and favorable ruling for us, and although it is certainly not binding upon the determination of similar issues that have been raised by the Project Stockholm group in the EC, we believe that it will be carefully reviewed and considered by the European Commission. Broadcom has appealed the ruling, and the appeals process will likely take a year-and-a-half or more to conclude.
In the Broadcom International Trade Commission matter, on October 10 a judge determined that QUALCOMM did not infringe two of the three patents asserted by Broadcom. Although the judge determined there was infringement of certain claims of the third patent, he recommended that no downstream remedies, including no injunctions be implemented against the wireless handsets of third parties that incorporate QUALCOMM chips and software. We maintain that this third patent, which does not apply to CDMA technology but rather deals with transitioning the handset to a power saving mode when out of a service area, is invalid and not infringed, and we will ask the full commission to reject the judge's recommendations on these issues. In any case, we are exploring designs to replace the features accused of infringement with superior functionality.
During the course of our litigation with Broadcom, we discovered that Broadcom had engaged in a successful multi-year effort to improperly acquire thousands of pages of our confidential business and technical information, including source code related to our WCDMA chip development. We also recently announced that the federal court in San Diego has enjoined Broadcom from any further solicitation, use or dissemination of QUALCOMM's WCDMA trade secrets, including source code. A copy of the injunction order is available for your review on our website. If we are later able to demonstrate that Broadcom is using any of our misappropriated trade secret information, Broadcom will be in violation of the injunction which could result in a finding of contempt.
In April we identified Nokia as a company whose CDMA agreement needs to be extended. In the event that after April 9, 2007 the existing agreement is not extended or a new agreement is not signed, Nokia's rights to sell handsets under most of our patents and, therefore, Nokia's obligation to pay royalties to us, will both cease under the terms of the current agreement. And our rights to sell integrated circuits under Nokia's patents will likewise cease under the terms of the current agreement.
Although we regularly meet with Nokia to discuss the terms of such an extension, given, among other things, Nokia's recent public statements and the little progress we have made to date, our negotiating team is not optimistic that we will conclude the extension by April 2007.
Changing topics, we see continued signs of strong 3G growth in virtually every market around the globe. In Japan, as of the end of September, approximately 62% of Japan's nearly 94 million cellular users now subscribe to 3G services. In anticipation of local number portability, DoCoMo, KDDI and Soft Bank all introduced a wide variety of new handsets to the Japanese market, which we expect will continue to help grow that market.
The U.S. market continues to experience rapid growth in the use of data. Verizon recently noted that their customers exchanged 232 million picture and video messages and completed 55 million downloads of games, ring tones and other content in the September quarter. Verizon’s VCast music service now has a 1.3 million song library, and the September quarter represented the first quarter when data revenue exceeded $1 billion, up 84% year over year.
Sprint noted that its data service revenue is up 74% year over year, driven by increased usage of its 1xEV-DO PowerVision Network. Interestingly, Sprint noted that the monthly average data ARPU for CDMA subscribers is $10, twice that of the average for their iDEN subscribers.
In developing markets, CDMA 450 is gaining significant traction around the world. CDMA 450 provides an extremely efficient wireless telecommunications solution by offering wide coverage and the ability to provide superior voice quality and high-speed data services and therefore has great potential for future growth. According to the CDMA Development Group, CDMA 450 networks are now deployed in 35 countries around the world, including China, Pakistan, Russia, Romania, Indonesia, Cambodia and Vietnam.
In China, we have seen the continued expansion of CDMA2000. In the first nine months of calendar 2006, China Unicom introduced more than 60 devices and sold more than 5 million units. We continue to be very excited about the prospects in China, especially when the 3G licenses are issued. However, given the highly speculative nature of when the 3G licenses will actually be issued, we have not included the potential growth from 3G licenses in our '07 forecast.
Turning to India, the CDMA market experienced strong growth with average monthly net additions of more than 1.7 million subscribers in the third quarter of 2006. India now has a cumulative base of over 38 million subscribers with Reliance and TADA surpassing 23 million and 12 million subscribers respectively. This quarter the Telecom Regulatory Authority of India has permitted CDMA operators to bid for 3G mobile phone services in 800 megahertz spectrum which they already use for their current services. We are pleased with this outcome as it enables easy expansion to existing networks and lays the foundation for the potential deployment of EV-DO in India.
In Western Europe, we continue to see increasing 3G adoption across the region as next generation devices continue to decrease in cost and improve in form factor and battery life. The deployment of HSPA and the proliferation of new devices are becoming catalysts for operators’ 3G focus. The number of 3G capable handsets has accelerated rapidly in the past 12 months with over 60 new WCDMA handsets launched in the first half of 2006.
As we look towards next year and beyond, we see a global market that will continue growing very rapidly due to a variety of factors, including a wide range of attractive and affordable devices combined with the improved network performance and the introduction of compelling new applications and services.
We take pride in knowing that our broad licensing program, our engineering expertise and our continued investments in R&D are an important contributor to the industry's growth. Although our success and the success of our partners has resulted in challenges to our business model by some of our competitors, we remain confident that we will overcome these challenges. We feel very strongly that we have well-established the fair and reasonable value of our patent portfolio through bilateral arms-length negotiations with over 130 companies, and we will make our decisions considering the long-term best interests of QUALCOMM and its shareholders. I would now like to turn the call over to Sanjay Jha.
Thank you, Steve. Good afternoon. I would like to review some key highlights for QCT. In the fourth quarter of fiscal 2006, QCT continued to set new milestones for financial performance. We set records for MSM chipset shipments, for revenue and for CSM channels. By shipping approximately 56 million MSMs, QCT established a record for the fifth straight quarter. This compares to approximately 55 million MSMs shipped in the third quarter of fiscal 2006 and 40 million in the fourth quarter of fiscal 2005. Year over year, this represents a 40% increase.
For the full 2006 fiscal year, QCT shipped approximately 2007 million MSMs compared to approximately 151 million in fiscal 2005 for a 37% annual increase.
For the fourth quarter of fiscal 2006, QCT achieved record revenues of over $1.1 billion. This amount is marginally higher than the third quarter but represents a 26% increase year over year. Our fiscal 2006 annual revenue of over $4.3 billion is a 32% increase over fiscal 2005. This represents a compound annual growth rate over the last four years of 28%. While QCT's annual operating profit of 26% in fiscal 2006 remains consistent with 2005, our operating profit increased 33% to greater than $1.1 billion for this fiscal year.
As chip shipments and revenues accelerate, we are seeing the results of our technology innovation in the form of wireless devices launching throughout the world. QCT tripled our shipment of EV-DO chipsets in fiscal 2006, a fact that can be partially attributed to strong market acceptance of mobile broadband services. Both PC cards and mobile handsets supporting the next evolution of EV-DO networks, EV-DO Revision A, will be commercially launched before the end of the year.
We remain committed to emerging markets, and this past quarter introduced that QSC 1100 single chip solution that will enable CDMA2000 handsets to break new price barriers. In addition to bringing wireless communication to new users in emerging marketplaces, the QSC 1100 is also designed to double talk time compared to CDMA2000 handsets on the market today and improve network capacity by up to 100%.
Even as we continue to build our technology leadership in CDMA2000, we are continuing to increase our technology leadership in UMTS. This past quarter QCT completed successful test calls delivering 2 Mbps on the uplink with HSUPA and performed HSUPA inter-op testing with multiple leading infrastructure vendors. HSUPA is the next evolution of wideband CDMA technology that together with HSDPA delivers wireless broadband capability on the uplink as well as the downlink. Our HSDPA and wideband CDMA chipsets continue to gain traction, and we're enabling hundreds of models with our wideband CDMA chipset.
We continue to invest into future technology and this past quarter acquired Qualphone, a San Diego-based provider of IP-based multimedia subsystems or IMS embedded client software solutions. Qualphone's IMS product and interoperability testing resources will enable QCT to accelerate our delivery of more feature-rich devices to global marketplaces as HSDPA and HSUPA, as well as DO Revision A get deployed.
Our GPS1 assisted GPS technology has reached a new milestone with 200 million GPS1-enabled handsets now shipped around the world. GPS1 powers the majority of location services that are currently available at over 50 networks around the world. These applications bring enhanced functionality to consumer, business and personal safety markets at significantly lower costs and oftentimes with better capability than stand-alone GPS devices.
In order to keep pace with growing demand for QCT products, we have announced a strategic agreement with Semiconductor Manufacturing International Corporation in China. As part of our ongoing commitment to China industry, our agreement with SMIC will help us streamline our operation, accelerate time to market and focus on our core technology strengths.
I will now turn this call over to Bill Keitel for an overview of our financial results.
Thank you, Sanjay and good afternoon, everyone. We are very pleased to report another year of record revenues, earnings per share and operating cash flow. GAAP earnings for fiscal 2006 were a record $1.44 per fully diluted share. Share-based compensation was an estimated $0.19 per share. QSI was a $0.02 loss per share, net tax benefits related to prior years were $0.02 per share, and acquired in-process R&D expense was $0.01 per share.
Excluding these items, our pro forma earnings for fiscal 2006 were a record $1.64 per fully diluted share. Pro forma revenues increased 33% yea –over year to $7.53 billion, and pro forma net income increased 42% to $2.8 billion. Our businesses continued to generate strong cash flows. Operating cash flow for fiscal 2006 was $3.25 billion, up 21% year over year and was a healthy 43% of revenue.
During the year, we returned approximately $2.2 billion in capital to our shareholders through a combination of stock repurchases and our growing dividend program. This includes cash dividends paid of $698 million, or $0.42 per share, and 34 million shares repurchased for $1.5 billion. Although our share repurchases were reduced in the fourth fiscal quarter as compared to the third fiscal quarter, we continue to believe that our stock is undervalued. From time to time, however, we make judgments that due to the tendency of potentially significant events -- for example, earnings announcements, litigations, major contracts or acquisitions -- that it would be inappropriate for us to be in the market for our stock until such events had been concluded and then subsequently disclosed.
Fortunately, we have a lot of exciting things happening at QUALCOMM. Unfortunately, from time to time that impedes our ability to execute on the stock buyback program at the pace we would otherwise choose.
QCT shipped a record 207 million MSMs in fiscal 2006. QCT's operating margin ended the fiscal year at 26% as volume ramped, driven by increased shipments of EV-DO, WCDMA and low tier MSMs.
QTL continues to be positively impacted by the growing adoption of CDMA around the world. WCDMA royalties from handsets shipped during the June quarter grew to approximately 49% of third-party royalties reported by licensees in the fourth fiscal quarter. Of $705 million in QTL revenues for the fourth quarter, $44 million represented inter-company royalties, $13 million were license fees and $648 million were royalties from third-party licensees. QTL's operating margin was 91% for fiscal 2006 and 90% for the fiscal fourth quarter.
In our last quarter conference call, we advised of a larger than normal channel inventory build for China and India. We had adjusted our guidance accordingly, and we forecasted a correction in the channel to occur by the end of the calendar year. I'm pleased to report that we see the correction has occurred largely as we anticipated. We believe channel inventory levels are now comfortably within a normal 15 to 20-week band and will increase during the current quarter to a seasonally normal upper end of the band.
R&D investment remained a strategic priority this year as we continue to invest in our WCDMA chip development, multimedia functionality and enhancements to the CDMA2000 technology roadmap. We also continue to increase our investment in longer-term business opportunities and technology innovations, including MediaFLO, OFDMA and display technologies. Pro forma R&D increased 28% year over year, and we expect this will maintain our leadership position with exciting and innovative products and services, and their associated intellectual property.
Based on royalty reports from licensees, worldwide CDMA-based handsets shipped in the June quarter were approximately 70 million units, up from 66 million units shipped in the March quarter, driven primarily by sequential growth in shipments of WCDMA handsets in Europe. The average selling price of CDMA-based handsets was approximately $223 for the June quarter and $215 for the fiscal year.
I will now highlight our forward guidance. For the calendar 2006 CDMA market, we now expect approximately 290 million to 298 million CDMA-based handsets to be shipped, including approximately 98 million WCDMA handsets. Based on the 294 million midpoint of our estimate, worldwide CDMA handset shipments for calendar 2006 are anticipated to grow approximately 40% year over year. We estimate the calendar 2007 CDMA phone market will increase approximately 25% to 32% over 2006 with shipments of approximately 368 million to 388 million units.
Last year we refrained from estimating when the Chinese authorities would issue 3G licensees. We are including such estimates in our financial guidance, and we're continuing that practice this year. Based on the 378 million midpoint of our 2007 estimate, we anticipate shipments of approximately 203 million CDMA2000 units and approximately 175 million WCDMA units as 2G to 3G migration accelerates in many regions around the world.
Based on the current business outlook, we anticipate fiscal 2007 revenues to be in the range of approximately $8.1 billion to $8.6 billion, an increase of 8% to 14% over fiscal 2006. We anticipate pro forma diluted earnings per share to be in the range of $1.76 to $1.81, an increase of 7% to 10% year over year. We estimate average selling prices for CDMA2000 and WCDMA phones combined to decrease approximately 5% in fiscal 2007 to approximately $205, and this of course compares to $215 in fiscal 2006.
We anticipate pro forma R&D and SG&A expenses combined to increase approximately 16% for fiscal 2007. This increase is driven primarily by the full-year effect in fiscal 2007 of the growth in our employee base during fiscal 2006, as well as we’re planning for further increases in our legal expenses.
QCT continues to invest meaningfully to grow our WCDMA chip share, and at this point, our guidance reflects a modest growth in share for fiscal 2007 over fiscal 2006.
We anticipate our pro forma tax rate in fiscal 2007 to be approximately 26%. unchanged versus fiscal 2006.
We estimate our GAAP diluted earnings per share will be approximately $1.45 to $1.50 for fiscal 2007. This estimate includes an estimated loss of approximately $0.11 per share attributable to QSI, as well as approximately $0.20 per share attributable to estimated share-based compensation.
Turning to the first quarter of fiscal 2007, we estimate revenues will be in the range of approximately $1.98 billion to $2.08 billion, an increase of 14% to 19% year over year. We estimate first quarter pro forma diluted earnings per share to be in the range of approximately $0.42 to $0.44, an increase of 8% to 13% year over year. This estimate assumes shipments of approximately 55 million to 58 million MSM phone chips during the December quarter and an estimate of approximately 74 million to 76 million CDMA-based handsets shipped in the September quarter at an average selling price of approximately $209.
We expect QCT operating margins to be lower sequentially and total company pro forma R&D and SG&A expenses combined to increase approximately 5% to 8%.
Our full year fiscal '07 earnings estimate assumed the renewal of Nokia's license agreement prior to April 2007. If we're unable to resolve licensing issues with Nokia and Nokia refuses to pay for its use of our patents, we estimate a possible impact to our earnings of $0.04 to $0.06 per diluted share in fiscal 2007. This estimate is based on our current expectations for June 2007 quarter handset shipments, average selling prices and market share. And, of course, those numbers will be recorded in our fiscal fourth quarter.
At this time, we expect a seasonal decline in MSM shipments in the second fiscal quarter of 2007 as channel inventories are reduced post the Christmas season. Our second fiscal quarter royalty revenues will reflect licensee shipments from the typically seasonally strong December quarter, and our operating expenses also tend to increase in the second fiscal quarter for seasonal reasons. In combination, we expect pro forma second fiscal quarter earnings to be in the range of our first quarter guidance.
The QUALCOMM Investor Relations website includes an extensive slide presentation on the many data points included in this conference call. I look forward to sharing with you additional data points regarding our fiscal 2007 guidance, including regional handset shipment estimates, at our London analyst meeting on November 13. This meeting will be webcast for those of you not able to attend.
That concludes our remarks, and I will now hand the call back over to Bill Davidson.
Before we go into our question-and-answer session, I would like to remind our participants that our goal is to address as many as possible before we run out of time. Therefore, I’d like to ask you to limit your questions to one per caller. Operator, we are ready to accept questions.
(Operator Instructions) Your first question comes from Paul Sagawa - Bernstein.
Paul Sagawa - Bernstein
Hi. So if I'm looking ahead into 2007 and the next quarter, I think a lot of folks in the market have been a little bit spooked by comments from Nokia and Texas Instruments about WCDMA demand in the near term, particularly out of European carriers. Your guidance for 2007, $175 million, upbeat and I must say I agree with it, but it is a little bit counter to some of that more cautious commentary.
Can you talk a little bit about what you're seeing with regard to demand for WCDMA handsets in Europe that leads to a more optimistic view? Also, is this some indication that you believe that your chipset customers may be taking market share in the near term in WCDMA?
Hi Paul. With regard to our WCDMA estimates for next year, we are expecting very substantial growth for the European market. We will get into the details of that in London. But I have heard some concerns by some of the parties you have mentioned more focused on the near term. I have heard that a bit in Europe, with reference to Europe.
I would say that we are expecting, based on our information and forecasts that a lot of our licensees have shared with us, we expect an increased number shipments into the European market in the September quarter relative to the June quarter, and I expect the same continuing into the December quarter.
Where I have seen some statements that sync with ours, I would note that in the Japan market as strong as things are there, I think people have stocked up on inventory in anticipation of local number portability, and we have a modest decline estimated for our shipments of product in Japan in the September quarter, although picking back up in the December quarter. So I think that did sync with a number of other comments from other people.
But overall for WCDMA in Europe, I would say that we see HSDPA being deployed at an increasing rate, and I think that data ARPU is going to be the compelling point there. As well as the ASPs I think will continue to improve and make it even more enticing for operators to be pushing WCDMA.
Thank you. We are also heartened by the price competition that is happening, and in particular this Huawei phone that I talked about earlier is coming in at a significantly lower price that allows WCDMA phones to enter a different tier in the pricing. So we hope to see that as a significant driver of volume as well.
Paul, you had a question about how I see our wideband CDMA chipset demand going forward. We have seen a fairly substantial increase in demand for wideband CDMA chipsets for the December quarter over September quarter, so I have to say September quarter was, for wideband CDMA, not as strong for us as we had initially hoped. But there is a fairly substantial uptick in demand in the December quarter. Consistent with what Bill and Paul said, we see significant strengths in the wideband CDMA marketplace and our guidance reflects that.
I should make one additional point. One of our competitors who indicated the Japan market is weak for them has a particularly large exposure to DoCoMo's high-end OMAP kind of marketplace. As you have seen with number portability, both Soft Bank and KDDI appear to be doing rather well. I could certainly see that that could be the case.
Paul Sagawa - Bernstein
Your next question comes from John Bucher - BMO Capital Markets.
John Bucher - BMO Capital Markets
Thank you. A question on your fiscal 2007 outlook. Bill, I guess this would be for you. You indicated R&D and SG&A would be up 16%, so that would explain why pro forma EPS will grow at a slower rate than the revenue outlook.
I am wondering how much you are factoring in there – and the employee base stuff I understand, you probably have a pretty good idea on that – but how much variable expense might be there, just all depending on a variety of the legal contingencies and how they play out? Could there be, perhaps a range that the R&D and SG&A would be up, the 16% perhaps being a midpoint? What is the standard deviation if things go well on the legal front? Thank you.
Sure, John. A couple of points. On that 16% year over year estimate, it isn’t a midpoint. First, I would say that the majority of that is what I call carryover from fiscal 2006. We have ramped our employee base, particularly our engineering base, significantly in fiscal 2006. Now we will see a full year effect of that in fiscal 2007. We do expect to reduce quite substantially the rate of new hiring into fiscal 2007 relative to the past three or four years. So the majority of that increase I think is the carryover from a full year effect of the hiring we put in place this year, number one.
Number two, I did also mention it is also legal fees. The numbers are quite substantial, and we're planning at this time in our estimates to increase our spending on legal for fiscal 2007. We will have to see how that proceeds, but if you put a band around that 16%, I would say it is a plus, minus 4% or so, like a 12% to 20% kind of band.
John Bucher - BMO Capital Markets
Thank you very much.
Your next question comes from Mike Ounjian - Credit Suisse.
Mike Ounjian - Credit Suisse
Great, thank you. Also looking at the '07 guidance but for the handset shipments, particularly on the CDMA side. As you mentioned, there has been a lot of focus on a few operators in the developing regions who are looking at GSM. Could you talk about some of the factors that are driving the overall number to be up and in particular what regions you really see growth coming from next year?
I will take a stab at that. So for CDMA2000 the calendar '07 versus calendar '06 guidance that we just shared with you, I think it's about a 4% year-over-year increase for CDMA2000. We will give a regional breakdown consistent with how we define our regions today and breakdown our global estimates, but I'm pretty confident when you see that, we will show you a growth in all markets. Our expectation is good growth in all markets with the exception of Latin America. Take Latin America out of our CDMA2000 estimates and I think our forecast for CDMA2000 growth is closer to about 9%. So we think there's a good market ahead for CDMA2000 in most all regions around the world.
Mike Ounjian - Credit Suisse
Your next question comes from Steve O’Toole - Lehman Brothers.
Steve O’Toole - Lehman Brothers
With respect to the framework you outlined for Nokia and the pending issues there, you said there was little progress to-date, so you would expect it to go beyond the April timeline. You mentioned that you would be looking to pursue or entertain injunctions. When you think about that as a framework, should we be thinking that is a dispute that you would anticipate going through several quarters, perhaps then, of the fiscal '08 given the way you see it now?
I am sure Bill you may be reluctant to share some of the assumptions behind $0.04 to $0.06, that is quite a precise range that you're suggesting would be the impact from Nokia in September. Perhaps you might be able to give some framework for how you think that might develop going forward, or should we going forward and just use that as a reasonably steady-state rate?
Lastly, maybe just directionally in terms of the regions, while you're going to give detail at the Analyst Day, should we think about Brazil and India -- given the issues there -- as growing next year, or how should we think about that?
It is Steve. Let me just real quickly respond to your question regarding Nokia. I think it is very difficult to forecast how long or short these negotiations will go. It is certainly very possible that it could go for several quarters or even beyond as the courts systems are used and so forth. So it is a possibility, and like we said, we have discussions with them regularly. We will continue to have those discussions, and if progress is made, we will let you know.
Steve O’Toole - Lehman Brothers
But you, in terms of expectations, look for a fairly lengthy and drawn out process?
Let's say it this way that we plan accordingly to that, but we are hopeful that it does not go as long as it could.
On the $0.04 to $0.06 estimate for Nokia, I have been through that a few different times in the last few months or more. It has been a stable forecast. It is a good forecast. At this point I would say I would be surprised if it fell outside that band.
Then on India, again, we will share the regional guidance in London, but we are looking for a healthy growth year over year for CDMA2000 in India, albeit it is a low-end market. So as I have said in the past, it is an important market for us, but in terms of bottom line contribution, it is more of a business development than anything else.
Your next question comes from Ehud Gelblum – JP Morgan.
Ehud Gelblum – JP Morgan
Thank you very much. First, a quick clarification and then a question. The clarification, did you mention ASP on the 3G phones that you had in prior quarters? If not, can you give us some sense as to what it looked like and how it has trended over the last couple of quarters? That would be great.
As you look forward to the EPS guidance ranges that you gave for the first quarter and for the fiscal year '07, they seem to be a little lighter than the optimism on the top line and the $175 million WCDMA handsets for '07 would suggest, which I think are both very strong numbers.
Two things you said relative to the OpEx and related to headcount and then the legal. Is there any anything in your assumptions for both Q1 fiscal '07 that takes into account a shift perhaps in the vendors that are selling the WCDMA phones, particularly towards one that did well this past quarter that may have a different royalty rate than the rest? Is that somehow tying into the thought process?
I will take a stab at your answers here. On the ASP, the trend here has been for the quarter we just reported, average ASP was $223, it was $213 in the prior quarter, $208 in the quarter before that. We averaged $215 for the fiscal year. We have not disclosed the WCDMA versus CDMA2000 breakout of that here this quarter. But suffice it to say, WCDMA remains at a fairly significant premium, although the range of handset prices available in WCDMA is very broad.
In terms of your point on mix of royalty payments, I would say it is more, Ehud, that you get variability in terms of the mix of handset royalties and infrastructure royalties. Of course, there are a lot of changes OEM to OEM and what they are selling quarter to quarter, and then region by region. But other than that, no, I don't think there's anything really of note that I would point out. We will get into a little more detail in London on margins and profitability, et cetera.
Your next question comes from Mike Walkley - Piper Jaffray.
Mike Walkley - Piper Jaffray
Great, thanks. Just another question on the fiscal '07 guidance. I think on your QCT division, you mentioned a 25% to 32% rate with a big ramp in R&D again this year. Would it fall below that rate maybe in '07 and go back to that range into '08?
With the price of GSM phones continuing to fall, I think Nokia said in their conference call north of 40% of their volume was below EUR50, maybe you can talk about the single chip solution and how that is progressing and how you are closing the gap on pricing between CDMA and GSM on the entry markets?
I will take that. Yes, you're right. I have guided you to 25% to 32% of the range that we drive the business to. This year we were at 26%, as we were last year. My expectation is that we will come in below 25% for overall operating profit for QCT for '07. But obviously we see this right now as the kind of investment that we need to make while there is ongoing consolidation in UMTS industry.
We see our ability to invest as a core competitive advantage, and it is a conscious decision that we are taking to continue to make that investment, not only in reducing cost of our chipsets but also investing in the next generation of HSPA, sometimes often called HSPA+, to further improve the capabilities of HSPA technology. I think that we have made a conscious decision, and yes, for the first time, we are falling outside the long-term range that we have guided you to.
Secondly, on single chip solutions, I expect that there will be launch of handsets based on our single chip solution this year in various parts of the world. Of course, you recognize that Ron Garriques (Motorola, President, Mobile Devices) in his analyst call said that he will deliver. I expect that there is a chance that one other handset manufacturer might deliver a handset based on single chip solutions this year, and there is a possibility that they may not, and they cannot do it in January/February.
But there are 18 handsets being designed based on single chip solutions, so I think that we will see healthy competition in the low end, and we really think that we will drive the price of low-end handsets to be very, very competitive with GSM.
Again, I'm cautious in saying that we will be exactly the same price, but we will get closer and closer. We have shown that combined with very cost effective, low-end handsets the capacity increases that we are offering makes this quite compelling for our carriers. I think that those were the two parts of your question.
Your next question comes from Inderbir Singh - Prudential Equity Group.
Inderbir Singh - Prudential Equity Group
Thanks very much. I wanted to just come back to the comments that you made in the press release about in the event that the Nokia agreement is not signed in time, obviously you have indicated there would be some legal options you might pursue.
In the past, Paul or Steve, I think you've also addressed the possibility of business actions you might take, business restructuring perhaps. Could you maybe bring us up-to-date on where you are on your thought process on that?
I guess all I would say is that we are keeping our options open and looking at what the best thing to do is to enhance or maintain shareholder value. I would not say that I have any specific new initiatives to announce along those lines. Just to say that it is a possible response to these negotiations.
Your next question comes from Brian Modoff - Deutsche Bank.
Brian Modoff - Deutsche Bank
On page 6 of the press release, you talk about your inability to use self-integrator circuits under Nokia's patents. Do you see any issues getting around those patents, or do you see them having potentially leverage on your chipsets from that?
Also, talking about low-cost CDMA, are you working on a single chip WCDMA type product, and could we see something like that for next year?
What are the carriers you're seeing in Europe saying to you around their promotion plans for WCDMA? Christmas clearly Vodafone with 77% of their phones WCDMA, has some plans there. We are also hearing from Orange similar plans around that. Can you kind of comment on that, please?
I will take the latter two questions. First, on single chip solution, Brian, clearly after having established the technology for CDMA, we have the ability to go deliver that in wideband CDMA, and we look forward to announcing that at the appropriate stage in the near future.
On the second part of the question about the carriers' plans, we actually see fairly aggressive plans from the carriers. If you look at the Vodafone UMTS lineup, it is actually a really compelling lineup. We think that looking from a broader wideband CDMA perspective Nokia has some good devices. Motorola has some good devices, and there are lots of devices based on our solution on Vodafone's lineup, which I think will be very compelling for consumers.
As you say, Orange is also becoming more aggressive. We see Cingular in the U.S. with their rollout of HSDPA and UMTS becoming more aggressive. And the M&P competition that is now raging in Japan, also driving more sales of both CDMA and UMTS devices in Japan. So I think that it is fair to say that we are cautiously bullish on what happens in the December quarter.
I will answer the first part of your question. We have never believed that Nokia's patents are applicable to our products. As you probably know, our current rates for Nokia are royalty-free. So there has been never any tacit acknowledgment of their applicability to our products.
Having said that, we believe that if we are unable to resolve the current impasse in the negotiations before April that there is likely to be litigation going both ways. I'm sure Nokia is going to take a different position, and that question, if not resolved through some kind of amicable arrangement, will get sorted out in the courts and various other bodies that have the responsibility for deciding patent matters.
Your next question comes from Hasan Imam - Thomas Weisel Partners.
Hasan Imam - Thomas Weisel Partners
My question has to do with actually the December quarter guidance. Last year's seasonality and WCDMA ramp had contributed to pretty strong sequential growth, and this year it appears to be more flat lining, despite your positive comments on the WCDMA handset segment and the India inventory overhang clearing up. So I am just wondering why we don't see more of an acceleration? Is that primarily the trade out between unit growth and ASP declines? Thank you.
In terms of unit growth, I think that as I said, we always expected the channel inventory excesses we were concerned about for China and India to work itself out by the end of the calendar year, and we see that happening. So we're very encouraged by that. It is consistent with our prior estimates, but we do think that is happening as we speak, and part of that in this current December quarter. So that would be part of the effect, number one.
Number two, you have quite a ramp I think that occurred in Japan in anticipation of a L&P, so I think that was also a factor that adjusted a bit what you might otherwise have seen in a quarterly profile.
In terms of ASPs, I think our forecasts in the past have been pretty accurate on ASPs. I hope they will be again. We certainly have put the same effort into them, so we are expecting a modest decline in the ASPs, but other than that I think it is pretty much business as usual.
Hasan Imam - Thomas Weisel Partners
As a follow-up to that, if we continue to see the WCDMA ramp in December quarter, does that indicate because of your revenue recognition, a stronger first half '07?
As phones ramped in the December quarter, that will positively affect our royalty revenues in the March quarter. So to the extent our forecast of units is correct for the December quarter, I have tried to size that in my March estimates, and I gave you some indications of guidance for the second fiscal quarter.
Hasan Imam - Thomas Weisel Partners
Great, thank you.
Your next question comes from Daryl Armstrong - Citigroup.
Daryl Armstrong - Citigroup
Thank you very much. I have a question for Lou. You talked about the litigation that will likely extend from QUALCOMM to Nokia and Nokia back to QUALCOMM post the April deadline. Do you think that litigation exposure also extends to your chipset customers if they accept your chips after that deadline? Do you anticipate that QUALCOMM would indemnify those customers if there is some exposure there?
The litigation could in theory extend to those customers who don't independently have rights from Nokia. Having said that, I think it is unlikely that Nokia wants to involve most of our customers in this because they are going to again get a similar reaction from the customers. That is, the customers will assert patents back against Nokia, as well as the patents that we would be asserting. So I think it is unlikely that they would want to draw in our customers.
I don't really want to comment on the terms and conditions of our supply agreements between us and our customers. So I think I will leave it at that.
Your next question comes from Tal Liani - Merrill Lynch.
Tal Liani - Merrill Lynch
I had just one clarification on the prior answer and then one question. Nokia on their conference call discussed specifically about pass-through rights and said that they are not getting pass-through rights. Probably you're not going to answer on a specific question on Nokia, but would you mind to clarify the issue of pass-through rights, how does it work? What kind of rights do you have in general that you pass through your customers?
My question is something very specific on Japan. Can you discuss on any potential inventories at NTT for WCDMA phones?
This is Steve. On the pass-through rights, it probably would take longer than we should give it here on this conference call. But let me just say at the analyst conference in London, I will go into more detail on pass-through rights, how they work and so forth. If you can bear with us until then, I think you will get a better understanding.
Tal Liani - Merrill Lynch
About inventories at NTT since TI made a comment about some inventories in Japan?
Tal, we do have some handsets at NTT DoCoMo, but I think we don't have enough visibility for the entity DoCoMo to comment in detail except to say, as Bill said, there was some buildup of inventory in anticipation of mobile number portability. So far, we see Soft Bank and KDDI being disproportionate winners out of that transition. So I think beyond those data points, I couldn’t point to anything else.
Your next question comes from Tim Long - Banc of America.
Tim Long - Banc of America
Bill, if I could just ask you a question on the September quarter QTL line. I was a little surprised to see it up only 3% sequentially. If you could just explain if there was anything funny in the quarter there? Because if you look back at the June numbers, you had a pretty good spike in ASP, up 4% or 5%, and unit shipments looked like they were up about 6%. So I am just curious as to why the royalty line with the quarter lag, it seems like the license revenues were about stable, why we didn't see a bigger sequential jump in that line? Has there been any change in overall rate or anything else in the quarter?
Tim, no change in rates for licensees. Those rates stay constant. So again, it comes back to a different mix of infrastructural royalties versus test equipment royalties versus phone royalties. And then there are small amounts of special credits that sometime folded into the QTL segment. I think we had a modest amount of those in the September quarter.
Tim Long - Banc of America
Okay. Well, Bill, should I think of it as the prior quarter was helped out on the high side or the June quarter or the September quarter was hurt on the low side? Which was a more normal number would you say?
Tim, I will go into a little more specifics for 2007. I think that is the key is 2007, and we will go into a bit more specifics in London.
Let me just clarify. When we talk about credits or so forth, what we're really talking about is time to time with special programs with carriers, we will provide incentives to carriers to sell more product or focus more on certain applications and so forth. Those types of expenses get allocated to QTL in terms of growing the overall CDMA business. So that impacts the amount.
Your final question comes from Matt Hoffman - Cowen & Co.
Matt Hoffman - Cowen & Co.
Thanks. Another question on the term changes in the negotiations with Nokia. Steve, Nokia discussed a four-part test for an injunction post April 9 and thought QUALCOMM would not be able to meet the standards for that test. Could you discuss both the test and QUALCOMM's ability to prove the company is entitled to an injunction if no agreement with Nokia is reached. Thanks.
I will take that one. We think we will have utterly no problem meeting the four-part test. You're talking about a situation of a company that had a license that has been paying royalties, acknowledges the applicability of our patents in the most sincere way by paying large amounts of money for them, and then declines to renew and deliberately infringes. I think under those circumstances we are going to have very little difficulty in getting an injunction in meeting the test. I would be happy to expand upon the legal specifics of that test at a later time. I think it would take more time than we have now. I'm planning on being in London as well. So either Steve or I would be happy to address that there.
Dr. Jacobs, do you have any closing remarks?
I would just like to say that for the first full year of our new management team, I'm extremely pleased by the results that we were able to deliver. You know, there were obviously a few companies that decided to attack us and certainly have attempted to flood the market with a lot of misinformation. I guess I had hoped that we would have built a stronger working relationship with some of those companies, and I still remain hopeful that that will happen in the future.
But I definitely want to highlight the fact that we are working extremely well with a large number of partners, and we are creating many new partnerships both inside and outside of the wireless industry. So despite these attacks, we really have remained extremely focused on innovation, execution and partnerships, and I think that you will see that we have many new products, new technologies and news services that we will bring to market in the next fiscal year. So thanks, everybody for joining us. I will look forward to seeing some of you in London.
This concludes the QUALCOMM fourth quarter conference call.