Legal Costs Hit Qualcomm's Bottom Line

Investors sold the stock Friday after it lowered its quarterly earnings forecast

Qualcomm's contentious relations with communications industy players appear to have come back to haunt the company. On Dec. 22, Qualcomm (QCOM) warned of lower than expected quarterly profit attributable in part to hefty legal costs.

The San Diego chipmaker, which is fending off complaints about its competitive practices, said late Dec. 21 that its earnings per share (EPS) will be between 41 cents and 42 cents during the quarter ending Dec. 31, compared to 39 cents in the year ago quarter. Previous guidance had been for EPS between 42 cents and 44 cents.

The embattled company said it's deferring revenue that it hasn't gotten yet from its client Pantech Group of South Korea, which is restructuring debt. "Additionally, our legal expenses in the quarter have increased above our prior expectations as we continue to vigorously defend the legal attacks on our business model," Qualcomm said in a statement.

To be sure, Qualcomm also said its quarterly revenues will range between $1.98 billion and $2.08 billion, at the high end of prior guidance. Qualcomm had larger than expected shipments during the quarter of Mobile Station Modem chips, which are essentially computer chips used with cell phones and a kind of network known as "third generation" or 3G.

"While it is encouraging to see both handset shipments and MSM shipments in new guidance at or slightly above the higher end of previous guidance ranges, the sheer magnitude of the implied increase in legal expenses—on top of prior guidance for operating expenses to rise 5-8% sequentially already—reveals legal expenses as a significant cost of doing business," JPMorgan analyst Ehud Gelblum said in a research note. Gelblum downgraded Qualcomm's stock to underweight from neutral. (JPMorgan does and seeks to do business with companies covered in its research reports.)

Qualcomm's stock price sank 1.1% to $38.11 per share in early trading on the Nasdaq.

Qualcomm's CEO Paul Jacobs is standing in a hornet's nest. Cell-phone giant Nokia (NOK), a client whose license agreement with Qualcomm expires in April, 2007, claims Qualcomm is using Nokia's 1,800 patents for wireless devices to extract outsize royalties on products. Meanwhile Qualcomm's chipmaker rivals, led by Broadcom (BRCM), say they are being denied licenses to key technologies at reasonable rates (see BusinessWeek, 10/30/06, "Like Father, Like Son at Qualcomm").

Qualcomm did not immediately respond to a voicemail requesting an interview.

Some focused more on Qualcomm's growth prospects than its legal troubles. "This quarter the key revenue drivers, namely handset shipments, handset ASP and chip shipments were all better than expected and we believe the legal issues are mostly known and discounted in the stock," Merrill Lynch analyst Tal Liani said in a research note. Liani maintained a buy rating on Qualcomm.

The Mad Money TV show host and former hedge fund manager Jim Cramer said he used to own Qualcomm stock but got fed up with the company. "I felt its insistence on endless legal problems with both competitors and clients in an attempt to keep earnings higher than they might normally be would have to have a cost eventually, either in lost clients or in enormous legal fees," Cramer wrote on "We got the latter last night."

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