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| QCOM > SEC Filings for QCOM > Form 10-K on 3-Nov-2004 | All Recent SEC Filings |
3-Nov-2004
Annual Report
In addition to historical information, the following discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results may differ substantially from those referred to herein due to a number of factors, including but not limited to risks described in the section entitled Risk Factors and elsewhere in this Annual Report.
Recent Highlights
Revenues for fiscal 2004 were $4.9 billion, with net income of $1.7 billion. The following recent developments during fiscal 2004 were key for our business:
• Strong CDMA market growth throughout the world drove demand for our products and the products of our licensees. Enhanced multimedia functionality, increased growth of 1xEV-DO, local number portability initiatives and improving competitive positioning of CDMA operators drove worldwide growth in CDMA phone sales. Introduction of new CDMA networks in developing regions, as well as continued growth of networks in China and India, also contributed to growth in CDMA sales. Worldwide, 1xEV-DO grew to over nine million subscribers in September 2004. During fiscal 2004, we shipped approximately 137 million Mobile Station Modem (MSM) integrated circuits for mobile CDMA phones and data modules, nearly all of which were third generation (3G), including CDMA2000 1X, 1xEV-DO and WCDMA.
• By calendar year end 2004, operators are expected to have launched 70 WCDMA networks as reported by GSMA (GSM Association). WCDMA subscriber growth in Japan and Europe, and new network launches in Europe and Asia drove growth in WCDMA phone sales during fiscal 2004. Thirteen subscriber licensees and eleven infrastructure licensees reported sales of WCDMA products in the fourth quarter of fiscal 2004. WCDMA royalties grew from 12% of royalties reported in the first fiscal quarter of 2004 for licensee sales during the fourth fiscal quarter of 2003 to 26% of royalties reported in the fourth fiscal quarter of fiscal 2004 for licensee sales during the third fiscal quarter of fiscal 2004. Currently, average WCDMA phone prices are significantly higher than worldwide average CDMA2000 phone prices. During fiscal 2004, several leading manufacturers announced the selection of our WCDMA MSM integrated circuits for their WCDMA phone products, including Siemens, Samsung, LG Electronics, Sanyo and Option.
• As a result of record demand for CDMA products, our integrated circuits business continued to experience supply constraints which resulted in our inability to meet certain customer demands. To enable better supply of integrated circuit products, we have increased and extended firm orders to our foundry suppliers and are working with them to increase capacity. We are also evaluating potential new suppliers to augment our future needs.
• In the fourth quarter of fiscal 2004, we determined that, due to the global growth of WCDMA networks and the increasing variability of our licensees' market shares due to greater global competition, we would begin to recognize royalty revenues solely based on royalties reported by licensees during the quarter, rather than continuing to estimate royalty revenues earned from certain licensees in advance of receiving their royalty reports. Accordingly, we did not estimate royalty revenues earned in the fourth quarter of fiscal 2004, and royalties recorded as revenue for fiscal 2004 do not reflect an entire year's worth of royalties (some royalties reported in the first quarter of fiscal 2004 were recorded based on estimates as revenue in the fourth quarter of fiscal 2003).
Our Business and Operating Segments
We design, manufacture and market digital wireless telecommunications products and services based on our CDMA technology and other technologies. We derive revenue principally from sales of integrated circuit products, from license fees and royalties for use of our intellectual property, from services and related hardware sales and from software development and related services. Operating expenses primarily consist of cost of equipment and services, research and development, selling, general and administrative, amortization of acquisition-related intangible assets, asset impairment charges and other expenses.
We conduct business through four operating segments. These segments are:
QUALCOMM CDMA Technologies, or QCT; QUALCOMM Technology Licensing, or QTL;
QUALCOMM Wireless & Internet, or QWI; and QUALCOMM Strategic Initiatives, or
QSI.
QCT is a leading developer and supplier of integrated circuits and system software for wireless voice and data communications, multimedia functions and global positioning. QCT's integrated circuit products and software are used in wireless phones and infrastructure equipment. The wireless phone integrated circuits include the Mobile Station Modem (MSM), Radio Frequency (RF) and Power Management (PM) devices. The wireless phone integrated circuits and software perform voice and data communication, multimedia and global positioning functions, radio conversion between radio and baseband signals and power management. The infrastructure equipment integrated circuits provide the core baseband CDMA modem functionality in the operator's equipment. QCT software products are the operating systems that control the phone and the functionality imbedded in our integrated circuit products. QCT revenues comprised 63% of total consolidated revenues in both fiscal 2004 and 2003 and 54% of total consolidated revenues in fiscal 2002.
QTL grants licenses to use portions of our intellectual property portfolio, which includes certain patent rights essential to and/or useful in the manufacture and sale of CDMA (including, without limitation, cdmaOne, CDMA2000 1X/1xEV-DO/1xEV-DV, TD-SCDMA and WCDMA) products. QTL receives license fees as well as ongoing royalties based on worldwide sales by licensees of products incorporating our intellectual property. QTL revenues comprised 27%, 26% and 29% of total consolidated revenues in fiscal 2004, 2003 and 2002, respectively.
QWI, which includes QUALCOMM Wireless Business Solutions (QWBS), QUALCOMM Internet Services (QIS) and QUALCOMM Government Technologies (QGOV), generates revenue primarily through mobile communication products and services, software and software development aimed at support and delivery of wireless applications. QWBS provides satellite and terrestrial-based two-way data messaging and position reporting services to transportation companies, private fleets, construction equipment fleets and other enterprise companies. QIS provides the BREW product and services for the development and over-the-air deployment of data services on wireless devices. QIS also provides QChat and QPoint products and services. QChat enables virtually instantaneous push-to-chat functionality on CDMA-based wireless devices while QPoint enables operators to offer E-911 and location-based applications and services. The QGOV division provides development, hardware and analytical expertise to United States government agencies involving wireless communications technologies. The QGOV division included the former Digital Cinema business prior to June 2004. In June 2004, we were notified that a competing digital cinema compression technology was selected by the motion picture studio consortium tasked with technology selection for digital cinema applications. As such, we are no longer pursuing the Digital Cinema business. Revenues from the Digital Cinema business were $1 million, $9 million and $14 million in fiscal 2004, 2003 and 2002, respectively. QWI revenues comprised 12%, 13% and 16% of total consolidated revenues in fiscal 2004, 2003 and 2002, respectively.
QSI makes strategic investments to promote the worldwide adoption of CDMA products and services for wireless voice and Internet data communications. Our strategy is to invest in CDMA operators, licensed device manufacturers and start-up companies that we believe open new markets for CDMA technology, support the design and introduction of new CDMA-based products or possess unique capabilities or technology to promote Internet data communications. Effective as of the beginning of fiscal 2005, we expect to present the operating results of our wireless multimedia U.S. operator in the QSI segment.
Looking Forward
In fiscal year 2005, we expect continued growth in the overall CDMA2000 and WCDMA market, with particularly strong growth in WCDMA and emerging CDMA2000 markets. We expect continued growth in 1xEV-DO in South Korea, Japan and Latin America, as well as North America, with expected launches of nationwide service by both Verizon Wireless and Sprint PCS. The global expansion of broadband data services is expected to continue to drive demand for both 1xEV-DO phones and data cards for laptop services. Operator competition in Japan, North America and other regions is also accelerating data strategies and services as one operator responds to the plans of another. As reported by mobilemonday.net, a community of and for mobile professionals, operators are expected to have launched 70 WCDMA networks by the end of calendar 2004, which is expected to drive meaningful growth in WCDMA phone sales during fiscal year 2005. Cingular Wireless in North America is looking to launch WCDMA/HSDPA later in 2005. We anticipate 3G wireless licenses will be granted in China in calendar 2005. When the licenses are granted, we expect operators in China will be authorized to upgrade and deploy third
generation CDMA-based networks. We also expect additional CDMA450 network launches in fiscal 2005 to contribute to growth. We believe our QCT business will increasingly benefit from strong growth in the WCDMA market as we leverage our high quality products and customer relationships to further a strong and growing list of WCDMA phone manufacturer customers.
Growing demand for phones and devices with greater multimedia functionality will continue to drive demand for increasing functionality in our MSM chips. We will continue to invest heavily to position our QCT business for success in the WCDMA market, as well as to continue to maintain our strong position in the CDMA2000 market. In particular, we intend to continue to invest significant resources in developing integrated circuit products to support high-speed wireless Internet access and multimode, multiband, multinetwork operation including CDMA2000 1X and 1xEV-DO, WCDMA, FLO, OFDM and multimedia applications which encompass development of graphical display, camera and video capabilities, as well as higher computational capability and lower power on - chip computers and signal processors. We continue to work on different initiatives for low-cost phones in addition to reducing costs through further integration of multimedia capabilities of mid- to high-end phones. We will also continue our significant development efforts with respect to our BREW applications development platform and our new MediaFLO content distribution system and FLO technology for delivery of low cost multimedia content to multiple subscribers.
We are working closely with many operators and manufacturers to support rapid and reliable WCDMA deployment and availability of WCDMA phones (with increasing multimedia features and capabilities). We expect that in 2005 average WCDMA phone prices will decrease significantly, although we expect them to still be higher than average CDMA2000 phone prices.
BREW is expected to play an increasingly important role in generating consumer demand for wireless phones. BREW offers operators new capabilities for their products and an open platform for delivery of data services that can grow operator's data revenues. We expect more operators to launch BREW services and greater volumes of BREW software downloads to drive increasing revenues for our BREW business.
Although we have taken action to mitigate shortages of integrated circuits that we supply, the effects of such shortages have caused some customer frustration and could negatively affect our future business. We expect that the costs of certain integrated circuit products could increase as a result of our efforts to increase the availability of products in short supply. While we work closely with customers to expedite their processes for evaluating products from our new foundry suppliers, in some instances, transition to new product supply may cause a temporary decline in shipments of specific products to individual customers. As a result of our efforts to increase capacity at our current suppliers combined with the potential to bring on additional suppliers, we expect our shortages of integrated circuits to be alleviated in the future.
We are dependent upon the adoption and commercial deployment of 3G wireless communications equipment, products and services based on our CDMA technology to increase our revenues and market share. We continue to face significant competition from non-CDMA technologies, as well as competition from companies offering other CDMA based products. You should also refer to the Risk Factors included in this Annual Report for further discussion of these and other risks related to our business.
Revenue Concentrations
Revenues from customers in South Korea, the United States and Japan comprised 43%, 21% and 18%, respectively, of total consolidated revenues in fiscal 2004 as compared to 45%, 23% and 15%, respectively, in fiscal 2003, and 39%, 31% and 18%, respectively, in fiscal 2002. We distinguish revenue from external customers by geographic areas based on customer location. The increase in revenues from customers in Japan, as a percentage of the total, is primarily attributed to higher royalties from licensees in Japan resulting from the growth of CDMA2000 and WCDMA in Japan as well as their success in exporting products worldwide. The decrease in revenues from customers in the United States, as a percentage of the total, is primarily attributed to overall increases in revenues in geographic regions other than the United States.
Critical Accounting Policies and Estimates
Our discussion and analysis of our results of operations and liquidity and capital resources are based on our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent
assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition, valuation of intangible assets and investments, income taxes, and litigation. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results that differ from our estimates could have a significant adverse effect on our operating results and financial position. We believe that the following significant accounting policies and assumptions may involve a higher degree of judgment and complexity than others.
Revenue Recognition. We derive revenue principally from sales of integrated circuit products, from royalties for our intellectual property, from messaging and other services and related hardware sales, from software development and related services, and from license fees for intellectual property. The timing of revenue recognition and the amount of revenue actually recognized in each case depends upon a variety of factors, including the specific terms of each arrangement and the nature of our deliverables and obligations. Determination of the appropriate amount of revenue recognized involves judgments and estimates that we believe are reasonable, but it is possible that actual results may differ from our estimates.
We license rights to use portions of our intellectual property portfolio, which includes certain patent rights essential to and/or useful in the manufacture and sale of CDMA (including, without limitation, cdmaOne, CDMA2000 1X/1x EV-DO/1xEV-DV, TD-SCDMA and WCDMA) products. We recognized royalty revenue as earned when reasonable estimates of such amounts could be made for certain licensees through the third quarter of fiscal 2004. Starting in the fourth quarter of fiscal 2004, we recognize revenues solely when royalties are reported to us by our licensees as we no longer have the ability to reliably estimate these amounts. The change in the timing of recognizing royalty revenue was made prospectively and had the initial one-time effect of reducing royalty revenues recorded in the fourth quarter of fiscal 2004 due to the fact that no estimated royalty revenues were recorded in that quarter. As a result of this change, we believe that the estimates and assumptions used in applying our revenue recognition policies with respect to the timing and amount of recording our royalty revenues will have a less material impact on our consolidated financial statements.
Valuation of Intangible Assets and Investments. Our business acquisitions typically result in goodwill and other intangible assets, and the recorded values of those assets may become impaired in the future. As of September 30, 2004, our goodwill and intangible assets, net of accumulated amortization, were $356 million and $128 million, respectively. The determination of the value of such intangible assets requires management to make estimates and assumptions that affect our consolidated financial statements. We assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of our acquired businesses, market conditions and other factors. Although there are inherent uncertainties in this assessment process, the estimates and assumptions we use are consistent with our internal planning. If these estimates or their related assumptions change in the future, we may be required to record an impairment charge on all or a portion of our goodwill and intangible assets. Furthermore, we cannot predict the occurrence of future impairment-triggering events nor the impact such events might have on our reported asset values. Future events could cause us to conclude that impairment indicators exist and that goodwill or other intangible assets associated with our acquired businesses is impaired. Any resulting impairment loss could have an adverse impact on our results of operations.
We hold minority strategic investments in publicly-traded companies whose share prices may be highly volatile. These investments totaled $150 million at September 30, 2004. We record impairment charges when we believe an investment has experienced a decline that is other than temporary. The determination that a decline is other than temporary is subjective and influenced by many factors. Future adverse changes in market conditions or poor operating results of investees could result in losses or an inability to recover the carrying value of the investments, thereby possibly requiring impairment charges in the future. When assessing a publicly-traded investment for an other-than-temporary decline in value, we consider such factors as, among other things, how significant the decline in value is as a percentage of the original cost, how long the market value of the investment has been less than its original cost, the performance of the investee's stock price in relation to the stock price of its competitors within the industry and the market in general and analyst recommendations. We also review the financial statements of the investee to determine if the investee is experiencing financial difficulties. In the event our judgments change as to
other-than-temporary declines in value, we may record an impairment loss which could have an adverse impact on our results of operations.
We hold minority strategic investments in private companies whose values are difficult to determine. These investments totaled $163 million at September 30, 2004. We record impairment charges when we believe an investment has experienced a decline that is other than temporary. The determination that a decline is other than temporary is subjective and influenced by many factors. Future adverse changes in market conditions or poor operating results of investees could result in losses or an inability to recover the carrying value of the investments, thereby possibly requiring impairment charges in the future. When assessing investments in private companies for an other-than-temporary decline in value, we consider such factors as, among other things, the share price from the investee's latest financing round, the performance of the investee in relation to its own operating targets and its business plan, the investee's revenue and cost trends, the liquidity and cash position, including its cash burn rate and market acceptance of the investee's products and services. From time to time, we may consider third party evaluations, valuation reports or advice from investment banks. We also consider new products/services that the investee may have forthcoming, any significant news that has been released specific to the investee or the investee's competitors and/or industry and the outlook of the overall industry in which the investee operates. In the event our judgments change as to other-than temporary declines in value, we may record an impairment loss which could have an adverse impact on our results of operations.
Income Taxes. Our income tax provision is based on calculations and assumptions that will be subject to examination by the Internal Revenue Service and other tax authorities. We regularly assess the potential outcomes of these examinations and any future examinations for the current or prior years in determining the adequacy of our provision for income taxes. Should the actual results differ from our estimates, we would have to adjust the income tax provision in the period in which the facts that give rise to the revision become known. Such adjustment could have a material impact on our results of operations.
The Company regularly reviews its deferred tax assets for recoverability and establishes a valuation allowance based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and the implementation of tax-planning strategies. As of September 30, 2004, gross deferred tax assets were $1.1 billion. If the Company is unable to generate sufficient future taxable income in certain tax jurisdictions, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, the Company could be required to increase its valuation allowance against its deferred tax assets which could result in an increase in its effective tax rate and an adverse impact on operating results.
As of September 30, 2004, the Company has recorded gross deferred tax assets of $418 million related to capital loss carry forwards. We can only use capital losses to offset capital gains. Based upon our assessments of projected future capital gains and losses and related tax planning strategies, we expect that our future capital gains will not be sufficient to utilize all the capital losses that we have incurred through fiscal 2004. Therefore, we have provided a valuation allowance in the amount of $139 million for the portion of capital losses we do not expect to utilize. Adjustments to our valuation allowance based on changes to our forecast of capital losses and capital gains are reflected in the period the change is made.
We consider the operating earnings of non-United States subsidiaries to be indefinitely invested outside the United States. No provision has been made for United States federal and state, or foreign taxes that may result from future remittances of undistributed earnings of foreign subsidiaries, the cumulative amount of which is approximately $1.5 billion as of September 30, 2004. Should we repatriate foreign earnings, we would have to adjust the income tax provision in the period in which the decision to repatriate earnings of foreign subsidiaries is made. We are currently studying the impact of the one-time favorable foreign dividend provisions recently enacted as part of the American Jobs Creation Act of 2004, and may decide to repatriate future earnings of some of our foreign subsidiaries.
Litigation. We are currently involved in certain legal proceedings. Although there can be no assurance that unfavorable outcomes in any of these matters would not have a material adverse effect on the Company's operating results, liquidity or financial position, the Company believes the claims are without merit and intends to vigorously defend the actions. We estimate the range of liability related to pending litigation where the amount and range of loss can be estimated. We record our best estimate of a loss when the loss is considered probable. Where a liability is probable and there is a range of estimated loss with no best estimate in the range, we record the minimum estimated
liability related to the claim. As additional information becomes available, we assess the potential liability related to our pending litigation and revise our estimates. The Company has not recorded any accrual for contingent liability associated with the Company's legal proceedings based on the Company's belief that a liability, while possible, is not probable. Further, any possible range of loss cannot be estimated at this time. Revisions in our estimates of the potential liability could materially impact our results of operations.
Licensing
We grant licenses to use portions of our intellectual property portfolio, which includes certain patent rights essential to and/or useful in the manufacture, use and sale of CDMA (including, without limitation, cdmaOne, CDMA2000 1X/1xEV-DO/1xEV-DV, TD-SCDMA and WCDMA) products. Licensees typically pay a nonrefundable license fee in one or more installments and ongoing royalties based on their sales of products incorporating or using our licensed intellectual property. License fees are recognized over the estimated period of future benefit to the average licensee, typically five to seven years. We earn royalties on such licensed CDMA products sold worldwide by our licensees at the time that the licensees' sales occur. Our licensees, however, do not report and pay royalties owed for sales in any given quarter until after the conclusion of that quarter, and, in some instances, although royalties are reported quarterly, payment is on a semi-annual basis. During periods preceding the fourth quarter of fiscal 2004, we estimated and recorded the royalty revenues earned for sales by certain licensees (the Estimated Licensees) in the quarter in which such sales occurred, but only when reasonable estimates of such amounts could be made. Not all royalties earned were estimated. Royalties for licensees for which we had minimal reporting history and certain licensees that did not incorporate our integrated circuit products into their own products were recorded one quarter in arrears, i.e. in the quarter in which the royalties were reported to us by those licensees. Estimates of royalty revenues for the Estimated Licensees were based on analyses of our sales of integrated circuits to Estimated . . .
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