OVERVIEW
Our Business and Operating Segments We conduct business primarily through four reportable 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, data cards 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 58%, 64% and 63% of total consolidated revenues in fiscal 2005, 2004 and 2003, respectively. 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 products, including, without limitation, products implementing cdmaOne, CDMA2000, WCDMA and/or the CDMA TDD standards and their derivatives. QTL receives license fees as well as ongoing royalties based on worldwide sales by licensees of products incorporating our intellectual property. QTL revenues comprised 32%, 27% and 26% of total consolidated revenues in fiscal 2005, 2004 and 2003, 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, position reporting and wireless application services to transportation companies, private fleets, construction equipment fleets and other enterprise companies. QIS provides BREW (Binary Runtime Environment for Wireless) products and services, including the uiOne customizable user-interface product and the deliveryOne content distribution system, 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. QWI revenues comprised 11%, 12% and 13% of total consolidated revenues in fiscal 2005, 2004 and 2003, respectively. QSI makes strategic investments to promote the worldwide adoption of CDMA products and services. 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. Effective as of the beginning of fiscal 2005, we present the operating results of our wireless multimedia operator, MediaFLO USA, Inc. (MediaFLO USA), in the QSI segment. Our MediaFLO USA subsidiary expects to offer a nationwide mediacast network based on our FLO (Forward Link Only) technology and MediaFLO Media Distribution System (MDS), initially targeting 100 top domestic markets, with the eventual capability for broader nationwide coverage. This network is expected to be utilized as a shared resource for wireless operators and their customers within the United States starting in latter 2006. FLO is a multicast technology specifically designed for markets where dedicated spectrum is available and where regulations permit high-power transmission, thereby reducing the number of towers and related infrastructure required to provide market coverage. MediaFLO USA plans to use nationwide 700 MHz spectrum for which we hold licenses and will be procuring and distributing content which we will make available wholesale to our wireless operator customers. Distribution, marketing, billing and customer relationships are expected to remain services provided by our wireless operator customers. We are evaluating a number of corporate structuring options, including distributing our ownership interest in MediaFLO USA to our stockholders in a spin-off transaction. Nonreportable segments include the Qualcomm Wireless Systems division, which sells products that operate on the Globalstar low-Earth-orbit satellite communications system and provides related services, the Qualcomm MEMS Technologies division, comprised of the Iridigm business, a display technology company that we acquired in the first quarter of fiscal 2005, and other product initiatives. Looking Forward
We are dependent upon the 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. Recent reports suggest that inflation could have adverse effects on the global economy and the capital markets. You should also refer to the Risk Factors in the Company’s Annual Report on Form 10-K for further discussion of these and other risks related to our business. Revenue Concentrations Critical Accounting Policies and Estimates Revenue Recognition. We derive revenue principally from sales of integrated circuit products, from royalties and license fees for our intellectual property, from messaging and other services and related hardware sales and from software development and licensing and related services. 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 products, including, without limitation, products implementing cdmaOne, CDMA2000, WCDMA and/or the CDMA TDD standards and their derivatives. Licensees typically pay a 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 the 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 recorded based on estimates. In the fourth quarter of fiscal 2004, we determined that, due to escalating and changing business trends, we no longer had the ability to reliably estimate royalty revenues from the Estimated Licensees. These escalating and changing trends included the commercial launches and global expansion of WCDMA networks, changes in market share among licensees due to increased global competition, and increased variability in the integrated circuit and finished product inventories of licensees. Starting in the fourth quarter of fiscal 2004, we began recognizing royalty revenues solely based on royalties reported by licensees during the quarter. 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. Valuation of Intangible Assets and Investments. Our business acquisitions typically result in the recording of goodwill and other intangible assets, and the recorded values of those assets may become impaired in the future. As of September 25, 2005, our goodwill and intangible assets, net of accumulated amortization, were $571 million and $237 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 investments in publicly-traded companies whose share prices may be highly volatile. These investments, which are recorded at fair value with increases or decreases generally recorded through stockholders’ equity as other comprehensive income or loss, totaled $1.16 billion at September 25, 2005. 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. During fiscal 2005, 2004 and 2003, we recorded $12 million, $12 million and $100 million, respectively, in other-than-temporary losses on our minority investments in publicly-traded companies. We hold minority strategic investments in private companies whose values are difficult to determine. These investments totaled $122 million at September 25, 2005. 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. During fiscal 2005 and 2003, we recorded $1 million and $28 million, respectively, in other-than-temporary losses on our investments in private companies. Such losses were not significant in fiscal 2004. Income Taxes. Our income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. While we believe we have appropriate support for the positions taken on our tax returns, 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. As part of our assessment of potential adjustments to our tax returns, we increase our current tax liability to the extent an adjustment would result in a cash tax payment or decrease our deferred tax assets to the extent an adjustment would not result in a cash tax payment. We continually assess the likelihood and amount of potential adjustments and adjust the income tax provision, the current tax liability and deferred taxes in the period in which the facts that give rise to a revision become known. Although we believe that the estimates and assumptions supporting our assessments are reasonable, adjustments could be materially different from those which are reflected in historical income tax provisions and recorded assets and liabilities. We regularly review our deferred tax assets for recoverability and establish 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 25, 2005, gross deferred tax assets were $937 million. If we are 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, we could be required to increase our valuation allowance against our deferred tax assets which could result in an increase in our effective tax rate and an adverse impact on operating results. As of September 25, 2005, we had gross deferred tax assets of $301 million related to capital loss carryforwards. 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 2005. Therefore, we have provided a valuation allowance in the amount of $62 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 certain 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 $1.2 billion as of September 25, 2005. 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. On October 22, 2004, the American Jobs Creation Act of 2004 (the Jobs Creation Act) was signed into law. The Jobs Creation Act created a temporary incentive for corporations in the United States to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. In the fourth quarter of fiscal 2005, we repatriated approximately $0.5 billion of foreign earnings qualifying under the Jobs Creation Act and recorded a related expense of approximately $35 million for federal and state income tax liabilities. The distribution does not change our intention to indefinitely reinvest earnings of certain foreign subsidiaries outside the United States. 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 our operating results, liquidity or financial position, we believe the claims are without merit and intend 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. We have not recorded any accrual for contingent liability associated with our legal proceedings based on our 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. Acquisitions In August 2005, we completed the acquisition of ELATA, Ltd. (ELATA), a developer of mobile content delivery and device management software systems, for a total of approximately $57 million in cash. Our acquisition of ELATA will enable us to offer a unified mobile content delivery system to operators who desire an enhanced framework for managing, delivering and marketing rich wireless content. The ELATA single service delivery framework, which leverages open standards interfaces to ensure interoperability and retain backward compatibility, is platform-agnostic and will allow operators to consolidate the delivery of all of their content services without having to change their device portfolio. This acquisition will also expand our presence in Europe by enabling us to offer European operators a content delivery system that can be easily integrated with their existing core network and business systems. The ELATA single service delivery framework has become part of our family of BREW product offerings and is being marketed under the brand name deliveryOne. In August 2005, we announced our intention to acquire Flarion Technologies, Inc. (Flarion), a developer of OFDMA technology. Upon completion of the acquisition, which is anticipated in the first half of fiscal 2006, pending regulatory approval and other customary closing conditions, we estimate that we will pay approximately $545 million in consideration, consisting of approximately $272 million in shares of Qualcomm stock, $235 million in cash, and the exchange of Flarion’s existing vested options and warrants with a fair value of approximately $38 million. Upon achievement of certain agreed upon milestones on or prior to the eighth anniversary of the close of this transaction, we may issue additional aggregate consideration of $205 million, consisting of approximately $173 million payable in cash to Flarion stockholders and $32 million in shares of Qualcomm stock, which will be issued to Flarion option holders and warrant holders upon or following the exercise of such options and warrants. Our acquisition of Flarion is intended to broaden our ability to effectively support operators who may prefer an OFDMA or a hybrid OFDM/CDMA/WCDMA network alternative for differentiating their services. The addition of Flarion’s intellectual property and engineering resources will also supplement the resources that we have already dedicated over the years towards the development of OFDM/OFDMA technologies. Strategic Investments in our QSI Segment Our QSI segment maintains strategic investments in marketable equity securities classified as available-for-sale. We strategically invest in companies in the high-technology industry and typically do not attempt to reduce or eliminate our exposure to market risks in these investments. The fair values of these strategic investments are subject to substantial quarterly and annual fluctuations and to significant market price volatility. Our strategic investments in specific companies and industry segments may vary over time, and changes in concentrations may affect price volatility. Downward fluctuations and market trends could adversely affect our operating results. In addition, the realizable value of these securities and derivative instruments is subject to market and other conditions. QSI also makes strategic investments in privately held companies, including early-stage companies and venture funds. These investments are comprised of equity investments, recorded at cost or under the equity method, and warrants that are recorded at fair value or at cost. The recorded values of these investments may be written down due to changes in the companies’ conditions or prospects. These strategic investments are inherently risky as the market for the technologies or products the investees are developing may never materialize. As a result, we could lose all or a portion of our investments in these companies, which could negatively affect our financial position and operating results. Most of these strategic investments will not become liquid until more than one year from the date of investment, if at all. To the extent such investments become liquid and meet strategic and price objectives, we may sell the investments and recognize the realized gain (loss) in investment income (expense). We regularly monitor and evaluate the realizable value of our investments in both marketable and private securities. If events and circumstances indicate that a decline in the value of these assets has occurred and is other-than-temporary, we will record a charge to investment income (expense). In some cases, we make strategic investments that require us to consolidate or record our equity in the losses of early-stage companies. The consolidation of these losses can adversely affect our financial results until we exit from or reduce our exposure to the investments. Key developments in our strategic investments during fiscal 2005 included our ongoing investment in our MediaFLO USA subsidiary, a slow down in the rate of strategic investment, including our investment in Inquam, and realized gains on certain strategic investments. Investment in Inquam Limited. Since October 2000, we and another investor (the Other Investor) have provided equity and debt funding to Inquam Limited (Inquam). Inquam owns, develops and manages wireless CDMA-based communications systems, either directly or indirectly, primarily in Romania and Portugal. We recorded $33 million, $59 million and $99 million in equity in losses of Inquam during fiscal 2005, 2004 and 2003, respectively. At September 25, 2005, our equity and debt investments in Inquam totaled $26 million, net of equity in losses, and we had no remaining funding commitment under our bridge loan agreement. During fiscal 2005, Inquam secured new long-term financing (the new facilities). We and the Other Investor each guaranteed 50% of a portion of the amounts owed under certain of the new facilities, up to a combined maximum of $54 million. Amounts outstanding under the new facilities subject to the guarantee totaled $49 million as of September 25, 2005. The guarantee expires and the new facilities mature on December 25, 2011. In October 2005, we and the Other Investor agreed to restructure Inquam. Upon close of the restructuring, which is expected to occur in the first half of fiscal 2006, the Portugal companies will be spun-off through the exchange of portions of our and the Other Investor’s debt investments for direct equity interests in the Portugal companies. Inquam, which will continue to own the Romania companies, will repurchase certain minority equity interests. Immediately after the restructuring, we will hold an approximate 49.7% equity interest in Inquam and a 23% equity interest in the Portugal companies, which is expected to be reduced over time as the Other Investor makes the further investments in the Portugal companies contemplated by the restructuring agreements. In addition, we and the Other Investor will have a put-call option arrangement. Under this arrangement, the Other Investor will have the right to buy our equity and debt investments in Inquam, subject to certain conditions, by exercising its call option, which will expire no later than May 14, 2008. The minimum purchase price will be approximately $66 million. In the event that the Other Investor’s call option expires, or in certain other circumstances prior to that date, we will have the right to sell our equity and debt investments in Inquam to the Other Investor at a minimum sales price of $66 million. Such right will expire after six months. We do not anticipate providing any further funding to Inquam or to the Portugal companies. Fiscal 2005 Compared to Fiscal 2004 Revenues from sales of equipment and services for fiscal 2005 were $3.74 billion, compared to $3.51 billion for fiscal 2004. Revenues from sales of integrated circuits increased $165 million, resulting primarily from an increase of $396 million related to higher unit shipments of MSM and accompanying RF integrated circuits, partially offset by a decrease of $241 million related to the effects of reductions in average sales prices and changes in product mix. Revenues from the sale of satellite and terrestrial-based two-way data messaging systems and related messaging services increased $25 million and revenues from the sale of satellite portable phones that operate on the Globalstar low-Earth-orbit satellite communications system increased $19 million. Revenues from licensing and royalty fees for fiscal 2005 were $1.93 billion, compared to $1.37 billion for fiscal 2004. During fiscal 2005, the QTL segment recorded royalty revenues solely based on royalties reported by licensees during the year, as compared to the method used during the first three quarters of fiscal 2004 of recording royalty revenues from certain licensees based on estimates of royalty revenues earned by those licensees during the quarter. The increase in royalty revenue year to year resulted primarily from a $350 million increase in royalties reported to us by our external licensees and the effect of changing the timing of recognizing royalty revenues in the fourth quarter of fiscal 2004. Royalty revenues recorded in fiscal 2004 excluded $151 million of royalties that were reported by external licensees in the first quarter of fiscal 2004, but estimated and recorded as revenue in the fourth quarter of fiscal 2003. Royalties reported to us by external licensees in fiscal 2005 were $1.64 billion, as compared to $1.29 billion in fiscal 2004. The increase in royalties reported to us by external licensees was primarily due to an increase in sales of CDMA products by licensees, resulting from higher worldwide demand for CDMA products at higher average selling prices due primarily to the growth in sales of high-end WCDMA products and shifts in the geographic distribution of sales of CDMA products. Cost of Equipment and Services. Cost of equipment and services revenues for fiscal 2005 was $1.65 billion, compared to $1.48 billion for fiscal 2004. Cost of equipment and services revenues as a percentage of equipment and services revenues was 44% for fiscal 2005, compared to 42% for fiscal 2004. The margin percentage decline in fiscal 2005 compared to fiscal 2004 was primarily due to a 1.3% decrease in QCT margin percentage. Increases in product support costs and the reserves for excess and obsolete inventory contributed 1.1% and 0.5%, respectively, to the total decrease in QCT margin percentage. Cost of equipment and services revenues as a percentage of equipment and services revenues may fluctuate in future quarters depending on the mix of products sold and services provided, competitive pricing, new product introduction costs and other factors. Research and Development Expenses. For fiscal 2005, research and development expenses were $1.01 billion or 18% of revenues, compared to $720 million or 15% of revenues for fiscal 2004. The dollar and percentage increases in research and development expenses primarily resulted from a $275 million increase in costs related to integrated circuit products and other initiatives to support lower cost phones, multimedia applications, high-speed wireless Internet access and multimode, multiband, multinetwork products and technologies, including CDMA2000 1X/1xEV-DO, WCDMA, HSDPA, GSM/GPRS/EDGE and OFDMA, and the development of our FLO technology, MediaFLO MDS and iMoD display products using MEMS technology. We expect that research and development costs will increase in fiscal 2006 as we continue our active support of CDMA-based technologies, products and network operations and other product initiatives. Selling, General and Administrative Expenses. For fiscal 2005, selling, general and administrative expenses were $631 million or 11% of revenues, compared to $547 million or 11% of revenues for fiscal 2004. The dollar increase was primarily due to a $38 million increase in professional fees, primarily patent administration and outside consultants, a $33 million increase in employee-related expenses, and a $13 million decrease in other income. Net Investment Income. Net investment income was $423 million for fiscal 2005, compared to $184 million for fiscal 2004. The change was primarily comprised as follows (in millions):
The increase in interest and dividend income on cash and marketable securities held by corporate and other segments was a result of higher average cash and marketable securities balances and higher interest rates earned on interest-bearing securities. Net realized gains on corporate investments increased primarily as a result of an increase in the positive performance of marketable equity securities as a percentage of total corporate investments in fiscal 2005, as compared to fiscal 2004. The increase in net realized gains on strategic investments in QSI resulted primarily from a $48 million gain on our minority investment in a wireless publisher and a $41 million gain on the sale of our investment in NextWave Telecom Inc. Gains and losses on derivative instruments in both fiscal 2005 and 2004 related primarily to changes in the fair values of put options sold in connection with our stock repurchase program. Equity in losses of investees decreased primarily due to a decrease in losses incurred by Inquam, of which our share was $33 million for fiscal 2005 as compared to $59 million for fiscal 2004. Income Tax Expense. Income tax expense from continuing operations was $666 million for fiscal 2005, compared to $588 million for fiscal 2004. The annual effective tax rate for continuing operations was approximately 24% for fiscal 2005, compared to 25% for fiscal 2004. The annual effective tax rate from continuing operations for fiscal 2005 was lower than the annual effective tax rate from continuing operations for fiscal 2004 primarily due to an increase in foreign earnings taxed at less than the United States federal tax rate. The annual effective tax rate for fiscal 2005 was 11% lower than the United States federal statutory rate primarily due to benefits of approximately 10% related to foreign earnings taxed at less than the United States federal rate, 3% related to an increase in tax benefits resulting from our increased ability to use our capital loss carryforwards and 2% related to research and development tax credits, partially offset by state taxes of approximately 4%. As of September 25, 2005, we had a valuation allowance of approximately $62 million on previously incurred capital losses due to uncertainty as to our ability to generate sufficient capital gains to utilize all capital losses. We will continue to assess the realizability of capital losses. The amount of the valuation allowance on capital losses may be adjusted in the future as our ability to utilize capital losses changes. A change in the valuation allowance may impact the provision for income taxes in the period the change occurs. Fiscal 2004 Compared to Fiscal 2003 Revenues from sales of equipment and services for fiscal 2004 were $3.51 billion, compared to $2.86 billion for fiscal 2003. Revenues from sales of integrated circuits increased $652 million, resulting primarily from an increase of $994 million related to higher unit shipments of MSM and accompanying RF integrated circuits, partially offset by a decrease of $331 million related to the effects of reductions in average sales prices and changes in product mix. Revenues from licensing and royalty fees for fiscal 2004 were $1.37 billion, compared to $985 million for fiscal 2003. The increase resulted primarily from higher QTL segment royalties, resulting primarily from an increase in phone and infrastructure equipment sales by our licensees at higher average selling prices, partially offset by the effect of the change in timing of recognizing royalties to an “as reported” method during the fourth quarter of fiscal 2004. Royalty revenues recorded in fiscal 2004 excluded $151 million of royalties that were reported by licensees in the first quarter of fiscal 2004, but estimated and recorded as revenue in the fourth quarter of fiscal 2003. Royalties reported to us by licensees in fiscal 2004 were $1.29 billion as compared to $837 million in fiscal 2003. Cost of Equipment and Services. Cost of equipment and services revenues for fiscal 2004 was $1.48 billion, compared to $1.27 billion for fiscal 2003. Cost of equipment and services revenues as a percentage of equipment and services revenues was 42% for fiscal 2004, compared to 44% for fiscal 2003. The margin percentage improvement in fiscal 2004 compared to fiscal 2003 was primarily due to the increase in QCT revenues as a percentage of total equipment and services revenues, resulting in increased QCT margin relative to the total. Research and Development Expenses. For fiscal 2004, research and development expenses were $720 million or 15% of revenues, compared to $523 million or 14% of revenues for fiscal 2003. The dollar and percentage increases in research and development expenses primarily resulted from a $187 million increase in costs related to integrated circuit products and other initiatives to support multimedia applications, high-speed wireless Internet access and multimode, multiband, multinetwork products and technologies, including CDMA2000 1X/1xEV-DO, WCDMA, HSDPA and GSM/GPRS/EDGE, and the development of our FLO technology and MediaFLO MDS. Selling, General and Administrative Expenses. For fiscal 2004, selling, general and administrative expenses were $547 million or 11% of revenues, compared to $483 million or 13% of revenues for fiscal 2003. The dollar increase was primarily due to a $61 million increase in employee-related expenses, a $21 million increase in professional fees, primarily patent administration and outside consultants, and a $12 million increase related to a charitable grant to an educational institution for the primary purpose of furthering the study of engineering and math, partially offset by the effect of a $34 million impairment loss recorded in fiscal 2003 on our wireless licenses in Australia due to developments that affected potential strategic alternatives for using the spectrum. The impairment loss recognized was the difference between the assets’ carrying values and their estimated fair values. Net Investment Income (Expense). Net investment income was $184 million for fiscal 2004, compared to net investment expense of $8 million for fiscal 2003. The change was primarily comprised as follows (in millions):
The increase in interest and dividend income on cash and marketable securities held by corporate and other segments was a result of higher average cash and marketable securities balances, partially offset by the impact of lower interest rates earned on interest-bearing securities, and $6 million in interest income recorded as a result of a refund from the United States Internal Revenue Service. The decrease in QSI interest income was primarily the result of the prepayment on the Pegaso debt facility in the first quarter of fiscal 2004. The other-than-temporary losses on investments during fiscal 2003 primarily related to an $81 million impairment of our investment in a wireless operator in South Korea and a $16 million impairment of our investment in a provider of semiconductor packaging, test and distribution services. Equity in losses of investees decreased primarily due to a decrease in losses incurred by Inquam, of which our share was $59 million for fiscal 2004 as compared to $99 million for fiscal 2003. Income Tax Expense. Income tax expense from continuing operations was $588 million for fiscal 2004, compared to $536 million for fiscal 2003. The annual effective tax rate for continuing operations was approximately 25% for fiscal 2004, compared to 34% for fiscal 2003. The annual effective tax rate for continuing operations for fiscal 2004 was lower than the 2003 effective tax rate for continuing operations primarily due to an increase in foreign earnings taxed at less than the United States federal tax rate, an increase in tax benefits recorded arising from our increased ability to use capital loss carryforwards and the reduction of QTL earnings, which are taxed at a rate that is lower than our effective tax rate, as a percentage of total earnings due to the change in the timing of recognizing QTL royalties. Foreign earnings taxed at less than the United States federal rate were higher in fiscal 2004 primarily due to the adjustment of an intercompany royalty agreement and an increase in foreign earnings. The annual effective tax rate for continuing operations for fiscal 2004 was 10% lower than the United States federal statutory rate due primarily to a benefit of approximately 14% related to foreign earnings taxed at less than the United States federal rate, research and development tax credits and our increased ability to use capital loss carryforwards, partially offset by state taxes of 4%. Our Segment Results for Fiscal 2005 Compared to Fiscal 2004 QCT Segment. QCT revenues for fiscal 2005 were $3.29 billion, compared to $3.11 billion for fiscal 2004. Equipment and services revenues, primarily from MSM and accompanying RF integrated circuits, were $3.20 billion for fiscal 2005, compared to $3.04 billion for fiscal 2004. The increase in integrated circuits revenue was comprised of $396 million related to higher unit shipments, partially offset by a decrease of $241 million related to the effects of reductions in average sales prices and changes in product mix. Approximately 151 million MSM integrated circuits were sold during fiscal 2005, compared to approximately 137 million for fiscal 2004. QCT’s earnings before taxes for fiscal 2005 were $852 million, compared to $1.05 billion for fiscal 2004. QCT’s operating income as a percentage of its revenues (operating margin percentage) was 26% in fiscal 2005, compared to 34% in fiscal 2004. The decline in operating margin percentage in fiscal 2005 as compared to fiscal 2004 was primarily the result of a 45% increase in research and development expenses for fiscal 2005 as compared to fiscal 2004, mainly related to increased investment in new integrated circuit products and technology research and development initiatives to support lower cost phones, multimedia applications, high-speed wireless Internet access and multiband, multimode, multinetwork products and technologies, including CDMA2000 1X/1xEV-DO, WCDMA, HSDPA and GSM/GPRS/EDGE. QTL Segment. QTL revenues for fiscal 2005 were $1.84 billion, compared to $1.33 billion for fiscal 2004. QTL’s earnings before taxes for fiscal 2005 were $1.66 billion, compared to $1.20 billion for fiscal 2004. QTL’s operating margin percentage was 90% during both fiscal 2005 and 2004. The increase in both revenues and earnings before taxes primarily resulted from a $350 million increase in royalties reported to us by our external licensees and the effect of changing the timing of recognizing royalty revenues in the fourth quarter of fiscal 2004. Royalty revenues recorded in fiscal 2004 excluded $151 million of royalties that were reported by external licensees in the first quarter of fiscal 2004, but estimated and recorded as revenue in the fourth quarter of fiscal 2003. Royalties reported to us by external licensees in fiscal 2005 were $1.64 billion, as compared to $1.29 billion in fiscal 2004. The increase in royalties reported to us by external licensees was primarily due to an increase in sales of CDMA products by licensees, resulting from higher worldwide demand for CDMA products at higher average selling prices due primarily to the growth of higher priced WCDMA sales and shifts in the geographic distribution of sales of CDMA products. Revenues from license fees were $69 million in fiscal 2005, as compared to $59 million in fiscal 2004. During fiscal 2005, we recognized $4 million in revenue related to equity received as license fees, compared to $5 million in fiscal 2004. Other revenues were comprised of intersegment royalties. During the 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 recorded based on estimates. In the fourth quarter of fiscal 2004, we determined that, due to escalating and changing business trends, we no longer had the ability to reliably estimate royalty revenues from the Estimated Licensees. These escalating and changing trends included the commercial launches and global expansion of WCDMA networks, changes in market share among licensees due to increased global competition, and increased variability in the integrated circuit and finished product inventories of licensees. Starting in the fourth quarter of fiscal 2004, we began recognizing royalty revenues solely based on royalties reported by licensees during the quarter. 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. Accordingly, we did not estimate royalty revenues earned in fiscal 2005. QWI Segment. QWI revenues for fiscal 2005 were $644 million, compared to $571 million for fiscal 2004. Revenues increased primarily due to a $37 million increase in QIS revenue and a $27 million increase in QWBS revenue. The increase in QIS revenue was primarily attributable to a $41 million increase in fees related to our expanded BREW customer base and products. The increase in QWBS revenue was primarily attributable to a $16 million increase in equipment revenue, net of a $24 million decrease in amortization of deferred revenues related to historical equipment sales, and a $10 million increase in related messaging services revenue. QWBS shipped approximately 46,800 satellite-based systems and 62,500 terrestrial-based systems during fiscal 2005, compared to approximately 43,400 satellite-based systems and 10,000 terrestrial-based systems in fiscal 2004. QWI’s earnings before taxes for fiscal 2005 were $57 million, compared to $19 million for fiscal 2004. QWI’s operating margin percentage was 9% in fiscal 2005, compared to 3% in fiscal 2004. The increases in QWI earnings before taxes and operating percentage were primarily due to a $39 million increase in QIS gross margin largely resulting from the increase in fees related to our expanded BREW customer base and products. During fiscal 2005, QWBS completed the process of moving high volume, standard product manufacturing to Mexico to reduce manufacturing costs. The low-volume, prototype and new product manufacturing activities remains in San Diego. We continue to evaluate other low-cost manufacturing opportunities. QSI Segment. QSI’s earnings before taxes from continuing operations for fiscal 2005 were $10 million, compared to losses before taxes from continuing operations of $31 million for fiscal 2004. During fiscal 2005, QSI recorded $101 million in realized gains on marketable securities and other investments, compared to $56 million in fiscal 2004. Equity in losses of investees decreased by $43 million primarily due to a decrease in losses incurred by Inquam during fiscal 2005 as compared to fiscal 2004, of which our share was $33 million for fiscal 2005 as compared to $59 million for fiscal 2004. These improvements in QSI’s earnings before taxes from continuing operations were partially offset by a $42 million increase in MediaFLO USA operating expenses. Our Segment Results for Fiscal 2004 Compared to Fiscal 2003 QCT Segment. QCT revenues for fiscal 2004 were $3.11 billion, compared to $2.43 billion for fiscal 2003. Equipment and services revenues, primarily from MSM and accompanying RF integrated circuits, were $3.04 billion for fiscal 2004, compared to $2.39 billion for fiscal 2003. The increase in integrated circuits revenue was comprised of $994 million related to higher unit shipments, partially offset by a decrease of $331 million related to the effects of reductions in average sales prices and changes in product mix. Approximately 137 million MSM integrated circuits were sold during fiscal 2004, compared to approximately 99 million for fiscal 2003. QCT’s earnings before taxes for fiscal 2004 were $1.05 billion, compared to $805 million for fiscal 2003. QCT’s operating income as a percentage of its revenues (operating margin percentage) was 34% in fiscal 2004, compared to 33% in fiscal 2003. The operating margin percentage in fiscal 2004 as compared to fiscal 2003 increased slightly primarily as a result of the increase in gross margin percentage, partially offset by a 40% increase in research and development and selling, general and administrative expenses. Research and development and selling, general and administrative expenses were $153 million higher and $55 million higher, respectively, for fiscal 2004 as compared to fiscal 2003 primarily associated with increased investment in new integrated circuit products and technology research, development and marketing initiatives to support multimedia applications, high-speed wireless Internet access and multiband, multimode, multinetwork products and technologies, including CDMA2000 1X/1xEV-DO, WCDMA, HSDPA and GSM/GPRS/EDGE. QTL Segment. QTL revenues for fiscal 2004 were $1.33 billion, compared to $1.00 billion for fiscal 2003. Royalty revenues from external licensees were $1.14 billion in fiscal 2004, compared to $838 million in fiscal 2003. QTL’s earnings before taxes for fiscal 2004 were $1.20 billion, compared to $897 million for fiscal 2003. QTL’s operating margin percentage was 90% in fiscal 2004, compared to 89% in fiscal 2003. The increase in both revenues and earnings before taxes primarily resulted from a $455 million increase in royalties reported to us by our external licensees, partially offset by the change in our ability to estimate royalties. Royalty revenues recorded in fiscal 2004 excluded $151 million of royalties that were reported by external licensees in the first quarter of fiscal 2004, but estimated and recorded as revenue in the fourth quarter of fiscal 2003. Royalties reported to us by external licensees in fiscal 2004 were $1.29 billion, as compared to $837 million in fiscal 2003. The increase in royalties reported to us by external licensees was primarily due to an increase in sales of CDMA products by licensees, resulting from higher demand for CDMA products across all major regions of CDMA deployment at higher average selling prices. Revenues from license fees were $59 million in both fiscal 2004 and 2003. During each of fiscal 2004 and 2003, we recognized $5 million in revenue related to equity received as license fees. Other revenues were comprised of intersegment royalties. During the 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 recorded based on estimates. In the fourth quarter of fiscal 2004, we determined that, due to escalating and changing business trends, we no longer had the ability to reliably estimate royalty revenues from the Estimated Licensees. These escalating and changing trends included the commercial launches and global expansion of WCDMA networks, changes in market share among licensees due to increased global competition, and increased variability in the integrated circuit and finished product inventories of licensees. Starting in the fourth quarter of fiscal 2004, we began recognizing royalty revenues solely based on royalties reported by licensees during the quarter. 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. QWI Segment. QWI revenues for fiscal 2004 were $571 million, compared to $484 million for fiscal 2003. Revenues increased primarily due to a $58 million increase in QWBS revenue and a $37 million increase in QIS revenue. The increase in QWBS revenue was primarily attributable to a $14 million increase in messaging revenue as a result of a larger installed base and a $44 million increase in equipment revenue, net of an $19 million decrease in amortization of deferred revenues related to historical equipment sales. QWBS shipped approximately 43,400 satellite-based systems and 10,000 terrestrial-based systems during fiscal 2004, compared to approximately 32,200 satellite-based systems and 5,300 terrestrial-based systems in fiscal 2003. The increase in QIS revenue is primarily attributable to a $53 million increase in fees related to our expanded BREW customer base and products, partially offset by a $19 million decrease in QChat revenue resulting from the wind down of development efforts under the licensing agreement with Nextel. QWI’s earnings before taxes for fiscal 2004 were $19 million, compared to $15 million for fiscal 2003. QWI’s operating margin percentage was 3% in both fiscal 2004 and 2003. The increase in QWI’s earnings before taxes was primarily due to a $31 million increase in QIS gross margin largely resulting from the increase in fees related to our expanded BREW customer base and products, offset by a $29 million increase in QWI research and development and selling, general and administrative expenses. QWI’s operating margin percentage remained flat in fiscal 2004 as compared to fiscal 2003 primarily due to a decline in QWBS gross margin percentage, offset by an improvement in QIS gross margin percentage. The decline in QWBS gross margin percentage in fiscal 2004 as compared to fiscal 2003 was primarily attributable to a decline in the gross margin percentage on equipment sales, which are lower than the margins on messaging services, combined with an increase in equipment sales as a percentage of total QWBS revenue. The improvement in QIS gross margin percentage was primarily attributable to the increase in fees related to our expanded BREW customer base and products. QSI Segment. QSI’s losses before taxes from continuing operations for fiscal 2004 were $31 million, compared to $168 million for fiscal 2003. Equity in losses of investees decreased by $42 million primarily due to a decrease in losses incurred by Inquam during fiscal 2004 as compared to fiscal 2003, of which our share was $59 million for fiscal 2004 as compared to $99 million for fiscal 2003. During fiscal 2004, we recorded $12 million in other-than-temporary losses on marketable securities and other investments as compared to $127 million for fiscal 2003. During fiscal 2003, we also recorded a $34 million impairment loss on our wireless licenses in Australia due to developments that affected strategic alternatives for using the spectrum. These improvements in QSI’s losses before taxes were partially offset by a $31 million decrease in interest income resulting from the prepayment of the Pegaso debt facility in the first quarter of fiscal 2004 and $28 million in MediaFLO USA operating expenses. Liquidity and Capital Resources On March 8, 2005, we authorized the repurchase of up to $2 billion of our common stock under a stock repurchase program with no expiration date. Through November 2, 2005, we repurchased and retired approximately 27,083,000 shares of our common stock for $953 million. In connection with this stock repurchase program, we have two put options outstanding, with expiration dates of December 7, 2005 and March 21, 2006, that may require us to repurchase 11,500,000 shares for $411 million (net of the option premiums received). At November 2, 2005, $636 million remained authorized for repurchases under our stock repurchase program. We announced dividends totaling $524 million, $307 million and $135 million, or $0.320, $0.190 and $0.085 per share, during fiscal 2005, 2004 and 2003, respectively. On October 10, 2005, we announced a cash dividend of $0.09 per share on our common stock, payable on January 4, 2006 to stockholders of record as of December 7, 2005. We intend to continue to pay quarterly dividends subject to capital availability and periodic determinations that cash dividends are in the best interest of our stockholders. Accounts receivable decreased by 6% during fiscal 2005. Days sales outstanding, on a consolidated basis, were 30 days at September 25, 2005, compared to 43 days at September 26, 2004. The change in days sales outstanding is consistent with the increase in revenue and the decrease in accounts receivable resulting from cash collections. We started construction of two facilities in San Diego, California in fiscal 2003, totaling approximately one million additional square feet, to meet the requirements projected in our business plan. The remaining cost of these new facilities is expected to be approximately $149 million through fiscal 2007. In fiscal 2005, we announced our plans to expand our backup Network Management Center in Las Vegas, Nevada, which uses satellite and terrestrial-based technologies to track freight transportation and shipping nationwide. We expect the remaining cost of this expansion will be approximately $35 million through fiscal 2008. In fiscal 2005, our MediaFLO USA subsidiary, a wireless multimedia operator, began the development of a nationwide mediacast network based on our FLO technology and MediaFLO MDS. As part of this development, MediaFLO USA has executed a number of lease agreements at broadcast tower sites and has begun the installation of equipment and leasehold improvements at some of these sites. The remaining costs for our existing tower sites under lease, including equipment and leasehold improvements as well as the costs of installation, are expected to be approximately $18 million through fiscal 2006. On August 11, 2005, we announced our intention to acquire Flarion, a developer of OFDMA technology. Upon completion of the acquisition, which is anticipated in the first half of fiscal 2006, pending regulatory approval and other customary closing conditions, we estimate that we will pay approximately $545 million in consideration, including approximately $235 million in cash. Upon achievement of certain agreed upon milestones on or prior to the eighth anniversary of the close of this transaction, we may issue additional aggregate consideration of $205 million, including approximately $173 million payable in cash, to Flarion stockholders. We intend to continue our strategic investment activities to promote the worldwide adoption of CDMA products and the growth of CDMA-based wireless data and wireless Internet products. As part of these investment activities, we may provide financing or other support to facilitate the marketing and sale of CDMA equipment by authorized suppliers. In the event additional needs for cash arise, we may raise additional funds from a combination of sources including potential debt and equity issuance. We believe our current cash and cash equivalents, marketable securities and cash generated from operations will satisfy our expected working and other capital requirements for the foreseeable future based on current business plans, including acquisitions, investments in other companies and other assets to support the growth of our business, financing and other commitments, the payment of dividends and possible additional stock repurchases. Contractual Obligations/Off-Balance Sheet Arrangements At September 25, 2005, our outstanding contractual obligations included (in millions):
Additional information regarding our financial commitments at September 25, 2005 is provided in the Notes to our Consolidated Financial Statements. See “Notes to Consolidated Financial Statements, Note 4—Investments in Other Entities and Note 9—Commitments and Contingencies.” Future Accounting Requirements |
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