(did I post this several weeks back?) BTAB:
Recommendation Change
NASDAQ: QCOM
· F2Q (Mar.) 1999 sales and EPS (excluding charges) were $932.0 million and
$0.82, respectively, versus our expectations of $927.2 million and $0.60
(consensus was $0.59).
· As expected, Qualcomm is benefiting from strong CDMA subscriber growth
in the U.S., Korea, Japan and Brazil.
· Key growth drivers in the quarter were CDMA handsets, ASICS and
royalties.
· Pro forma presentation indicates the powerful earnings leverage afforded by
the unprofitable infrastructure segment divestiture (to Ericsson).
· We have increased our EPS estimates meaningfully, and have raised our 12-
month price target to $200 (>35x our CY 2000 EPS estimate of $5.67).
· We have upgraded our investment rating on the shares to "strong buy."
Details
Qualcomm reported 2Q 1999 revenue and EPS (excluding charges) of $932.4 million
and $0.82, respectively, versus our expectations of $927.2 million and $0.60. The
consensus EPS estimate was $0.59. Results included one-time charges of $166
million, mainly related to the sale to Ericsson of the Company's terrestrial wireless
infrastructure division. With the effect of these charges included, the Company
recorded a net loss of $43 million or $0.59 per share.
Strong results are consistent with our expectations that Qualcomm would be the
beneficiary of strong CDMA subscriber growth in the U.S., Korea, Japan and Brazil.
The Company is benefiting from (1) significant increases in royalties due to
subscriber growth, (2) its dominant position in the CDMA chipset market, and (3)
strong handset sales, assisted by the fact that formidable new CDMA handset vendors
such as Motorola and Nokia still are ramping volumes and have not yet entered the
market fully. Importantly, the sale of the Company's infrastructure division to
Ericsson has added significant earnings leverage, as illustrated below.
With the albatross sold to Ericsson, assured growth in pure-margin royalties and the
continued strong performance of the Company's Communications Division product
lines, we have raised our estimates significantly and have upgraded our investment
rating on the shares to "strong buy" with a 12-month price target of $200 (based on
>35x our CY 2000 EPS estimate of $5.67).
PRO FORMA NET INCOME DEMONSTRATED POSITIVE EFFECT OF INFRASTRUCTURE
DIVISION SALE
These impressive results significantly exceeded Street expectations. Even more
surprising, however, were the pro forma financial results provided by the Company
that showed the effect of removing costs associated with the infrastructure division,
which had been losing money and had exerted a drag on the Company's profitability.
The division has been sold to Ericsson as part of the two companies' broad cross-licensing
agreement for CDMA. With the infrastructure division excluded, the
Company's pro forma sales for the quarter would have been $908 million, or 2.6%
lower than reported sales, while pro forma EPS would have been $1.20, nearly 50%
higher than reported operating EPS. The disparity between reported and pro forma
earnings is a significant demonstration of the earnings leverage afforded by the
unprofitable infrastructure segment divestiture.
The transaction is expected to close in late May. Therefore, about two-thirds of the
F3Q (June) 1999 will include the negative effect of the infrastructure business. The
Company also will provide pro forma results for F3Q 1999.
COMMENTS BY PRODUCT AREA
Key growth drivers in the quarter were CDMA handsets, ASICS and royalties.
Further comments on each of these product/revenue categories follows.
ASICS
The ASIC division had an extremely strong quarter, shipping 9 million MSM phone
chips, up sequentially from 5 million last quarter. The quarterly book-to-bill ratio for
the ASICs business was 1.7x, indicating that next quarter sales should continue to
ramp strongly.
Qualcomm has a very strong presence in the CDMA chipset market. The Company
has shipped over 40 million chipsets cumulatively, and currently has approximately
90% market share in the CDMA phone chipset segment and 70% market share of the
market for infrastructure chipsets (the handset segment is the larger and more
important market, accounting for about 90% of division sales). Please see our March
31, 1999 research note for an extensive discussion of Qualcomm's competitive
advantages in the CDMA ASIC market.
However, we believe Qualcomm is not likely to maintain its current commanding
market share. Two leading handset vendors, Nokia and Motorola, primarily use their
own chipsets (a portion of Motorola's CDMA products are OEM'd from a Korean
manufacturer that does use the Qualcomm chipset). As these companies' CDMA
handsets gain market share, Qualcomm's ASIC market share should decline from its
current unsustainably high level. Our current numbers assume that Qualcomm's
handset ASIC market share will decline from 83% for the FY (Sept.) 1999 to 59% in
FY 2000.
Although Samsung recently announced it would develop an internal CDMA chipset,
management stressed that they expected zero impact on sales this FY, and a minimal
impact in future years. Management suggested that Samsung was developing an
internal second source, but should continue to use Qualcomm as primary vendor.
Our checks into Korea indicate that Samsung will use its own chipset late this year in
a low-end handset targeted at the domestic Korean market. As long as Qualcomm
continues to produce leading-edge CDMA ASICs, we believe that major handset
vendors such as Samsung will be compelled to use Qualcomm as a key supplier.
Bottom line, in our view, Qualcomm can still generate strong chipset sales growth
with some market share loss due to handset ASIC unit growth of approximately 49%
annually over the next five years. Further, higher unit volumes and cost-advantaged
redesigns should allow Qualcomm to stay ahead of the declining price curve. We are
forecasting that the ASICs gross margin will increase from 43.5% this year to 45.0%
in FY 2000.
HANDSETS
Qualcomm shipped 1.7 million CDMA phones in the quarter, up sequentially from
results in the seasonally strong December quarter. Yields were strong. Qualcomm
has a strong presence in CDMA handsets, having shipped over 10 million units
cumulatively. We estimate the Company's 1998 CDMA handset market share was
26%.
Last month, during a visit to the QPE manufacturing facility, we noted 9 handset
production lines, and 10 final assembly and test lines. The facility is running 24/7
and current capacity is 650,000 phones per month (this volume was achieved in
February). The Company is currently in preproduction on the "Thin Phone" and
expects to begin producing in commercial volumes next month. The "pdQ Smart
Phone" is also in preproduction and is scheduled to enter commercial production next
month, although volumes will be significantly lower. The "Q" phone production was
clearly at low levels. Qualcomm continues to ramp the production of IS-95 CDMA
handsets and anticipates reaching 1 million in monthly capacity by year-end.
The Company also mentioned some components shortages. The Company would not
identify exactly which components are in short supply, but characterized it as a
general industry issue that may be impacting other handset vendors, including other
digital air interfaces. We note that this problem occurred in F2Q, but did not impact
the Company's ability to meet our expectations.
In the future, the challenge for the Company, in our view, will be to prove it can
compete with the top-three handset vendors (Nokia, Motorola and, eventually,
Ericsson) for market share in an increasingly competitive CDMA handset market.
All of these companies have significant brand name recognition, economies of scale,
and distribution versus Qualcomm. We are assuming that Qualcomm's CDMA
handset market share falls to 21.4% for FY 1999 and 16.2% in FY 2000. We are
assuming that Qualcomm's gross margin on phones improves to 22% for FY 1999
and 25% in FY 2000.
LICENSE/ROYALTIES
License and royalty fees (L&R) increased significantly, to $77 million for the
quarter. This is an impressive number in that it is nearly all royalties and not one-time
licensing fees. The year-ago L&R fees of $70 million included a significant
amount of one-time license fees, and an upward adjustment of $18 million due to a
change in accrual policies. The higher percentage of royalties is significant because
they are a recurring revenue stream. Higher royalty payments are contributing to
significantly higher blended margins. We are forecasting $281 million in L&R for
FY 1999 and $375 million for FY 2000.
OMNITRACS
OmniTRACS continued to be a good business. In F2Q 11,000 OmniTRACS units
were sold, bringing the cumulative total to 280,000.
GLOBALSTAR
The Globalstar LEO satellite communications network has launched over 20
satellites. Qualcomm has shipped 38 gateways, and will not ship any additional
gateways unit commercial launch. Total contract services revenues were $81 million
in the quarter.
BALANCE SHEET AND CASH FLOWS
Balance sheet metrics were generally strong, in our view. Cash decreased to $204.6
million in F2Q 1999 from $237 million in F1Q (Dec.). Cash from operations was
strongly positive. The Company paid the balance of its bank facility down to zero.
Accounts receivable increased at a rate slightly below revenue growth, DSOs were
down sequentially from 82 days to 79 days, and inventory turns improved from 7x to
8.9x. The positive cash flow in F2Q may obviate the need for additional financing
this year.
RAISED ESTIMATES AND UPGRADED RATING
The savings obtained through the sale of the infrastructure division are more
significant than we had assumed previously, and that adjustment adds substantially to
our earnings forecasts. In addition, stronger royalty revenues (which essentially drop
to the bottom line) are driving an improved margin outlook. As a result, we have
increased our earnings estimates meaningfully.
PREVIOUS ESTS. REVISED ESTS.
3Q 1999 Sales (mils) $927.2 $812.7
3Q 1999 EPS $0.60 $1.19*
1999 Sales (mils) $3,787.1 $3,805.3
1999 EPS $2.77 $3.92
2000 Sales (mils) $4,002.5 $3,642.0
2000 EPS $4.35 $5.40
*The company plans to take an additional charge of about $100 million related to the
infrastructure division sale in F3Q 1999. With this charge included, we are
forecasting EPS of $0.42.
We have upgraded our investment rating on the shares from "buy" to "strong buy"
and have raised our 12-month price target to $200 (>35x our CY 2000 EPS estimate
of $5.67).
~~~~~~~~~~~~~~~~~~~~~ |
