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Qualcomm Guidance Critical

The interesting question will be the source of the EPS 'upside.'

Editor's Note: This column by Bob Faulkner is a special bonus for and RealMoney readers. It appeared on Street Insight on Jan. 24. To sign up for Street Insight, where you can read Faulkner's commentary in real time, please click here.


(QCOM) - Get Qualcomm Inc Report

is scheduled to report its fiscal first-quarter 2006 results after the close Wednesday and will have a conference call at 5:30 p.m. EST. Current First Call median estimates are for revenue of $1.75 billion (+26% year over year; +12% quarter over quarter) and pro forma EPS of 38 cents.

In the prior quarter, the company reported revenue of $1.56 billion (+40% year over year; +15% quarter over quarter) and pro forma EPS of 33 cents. QCOM's chip business (QCT) posted revenue of $912 million, up 7% year over year and up 19% sequentially. Chip units were up 3% quarter over quarter but average selling prices gained 7% on new WCDMA and EV-DO parts. QTL (royalties) enjoyed another very solid quarter, with revenue of $497 million, up 23% year over year and up 11% quarter over quarter. QCOM collected royalties on 48 million units shipped (in June) with an average selling price of $213.

Pro forma gross margin increased by 30 basis points sequentially to 71.7% and operating margin increased a very strong 250 basis points to 44.6%. Much of this gain was from QCT, which saw operating margin increase by 490 basis points sequentially to 29.2%. This was due to the aforementioned mix shift and management holding spending below guidance. The balance sheet showed solid strength following a dip in the fiscal third quarter.

Cash increased more than $800 million to $8.7 billion. Cash from operations recovered to a very strong $945 million and there were no repurchases of common stock in the quarter. Accounts receivable decreased by $90 million, reducing days sales outstanding by 11 to 31 days. Inventories decreased $10 million sequentially, dropping days of inventory to 36 days vs. 43 last quarter.

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While management provided guidance on its last conference call, it updated that guidance with a press release on Dec. 8. Revenue is expected to be at the high end of its original range, $1.67 billion-$1.77 billion (up 7%-14% quarter over quarter). Pro forma EPS are expected to be 38 cents-39 cents vs. the prior quarter's 36 cents-38 cents. Chip shipments should be approximately 47 million vs. the prior range of 46 million-48 million.

To view Robert Martorana's video preview of Qualcomm, click here


Eyeing the Upside

As I have mentioned in other previews, if you are in any way associated with the handset business, you better have a good December quarter, so QCOM's guidance increase was nothing unusual. However, the interesting question will be the source of the EPS "upside." In each of the last three quarters, it has been due completely or in-part to "other income."

On the day prior to the company's update, one of its two put option contracts expired. With the closing price on Dec. 7 slightly above that at the end of the September quarter, chances are pretty good that the company locked in a gain equivalent to at least 2 cents a share.

I think you should also look for QCOM to bring discretionary spending in below guidance. Throughout each quarter in fiscal 2005, OPEX spending was consistently well below prior guidance. Once or twice, sure, but four consecutive quarters is little more than sandbagging.

Critical to the stock will be management's guidance for the March quarter. Current consensus is for revenue of $1.73 billion, down 1% sequentially from fiscal first-quarter consensus, and pro forma EPS of 36 cents.

Bob Faulkner has been in the investment business for 18 years with an exclusive focus on technology stocks. He started as a sell-side analyst with Wood Gundy and Alex. Brown & Sons. In 1990, he moved to the asset management side with portfolio management/analytical positions at 1838 Investment Advisors and Merrill Lynch. Bob has an M.B.A. from Seton Hall and a B.S. from Waynesburg College.