The second quarter of 1999 produced another exceptional rate of return for our clients. We significantly exceeded the performance of all major market indices, again proving that short-term comparison to indices is a poor metric for judging investment managers who buy businesses with a long-term orientation.

Qualcomm, the toll bridge to third generation cellular, once again led the gains. We held tight to our positions, while others who tried to trade the stock were left behind. The result of rare loyalty is the capture of 6 to 1 appreciation this year alone. Although we feel Qualcomm is pretty fully valued now, the continuing addition of the stock to telecom mutual funds that failed to buy it when it was cheap pushes the stock higher.

Both you and your manager have achieved rare accomplishments in the ownership of Qualcomm. Over the past several years, there has been a barrage of negative publicity in authoritative publications such as the Wall Street Journal disparaging Qualcomm and CDMA. The increase in value of our Qualcomm investment manifests the triumph of sound research and strong conviction over popular opinion.

In the past week I attended a conference called Broadband Year ’99. Through all day tutorials and visiting with about 50 companies, I learned a great deal about Internet access technologies. There was one truly crucial lesson: There are virtually no companies that legally own the intellectual property rights of their businesses. True, Broadcom leads in chips for cable modems and ADSL networks, Ciena leads in Wave Division Multiplexing technology, Cisco dominates the Ethernet, Ascend dominates remote access concentrators, Newbridge has the largest market share in ATM switches @Home is the most popular cable access Internet portal, etc. But none of these companies really owns their technological niche. They may have majority "mindshare," and that is indeed important, but they do not own the intellectual property rights that keep competition from nipping at their heels. And, with Internet users projected to rise from 200 million to 1 billion over the next five years, most of these companies should continue to grow rapidly.

The only company I know of that has proven, through the gauntlet of litigation, that it owns its enabling technology, is Qualcomm. Indeed, there are still two skirmishes on the distant borders, but they do not affect the CDMA technology. There also is no attempt that I am aware of by a competitor to "rip-off" or "knock-off" CDMA, (not that it won’t happen!) This depth of the ownership of a telecosm technology is such a rarity. We are truly fortunate to own Qualcomm.

I had the pleasure of visiting with Qualcomm CFO Tony Thornley before our mid-June vacation.

1. Qualcomm is one to two years ahead of other companies on the CDMA learning curve.
2. Qualcomm is the brand name associated with CDMA worldwide.
3. Qualcomm has CDMA process know-how and experience leadership.

This proprietary leadership position manifests itself in revenues from royalties, sales of the chipsets and software used in about 90% of all CDMA handsets and base stations, and the production of 40% of the world’s supply of CDMA phones. Manufacture of CDMA network infrastructure (base stations) was recently sold to Ericsson, a company large enough to capitalize on this opportunity.

These businesses actually vary in their attractiveness in terms of economic value added. (Economic value added is the margin between return on invested capital and the cost of that capital. Any investment that earns a higher return than the cost of capital invested in it makes its owner wealthier.) It happens that the royalty and chipsets businesses are wonderful businesses. Royalties obviously have awesome profit margins. Chipsets (more formally referred to as ASIC’s) are tricky to design and manufacture, so Qualcomm's high performance ASIC’s bring a big price. Qualcomm is working towards a "phone on a chip," putting more phone components on their chipset, which will likely increase the chipset’s portion of the price of the phone.

Qualcomm also is working on a chipset that will allow one phone to communicate over any of the three dominant regional wireless standards used in the U.S. Europe, and Japan. This chipset will pave the way to ubiquitous 3G communication. It will allow phone manufacturers to produce the "world phones" that all wireless phone users have been dreaming of. If Qualcomm is first in this accomplishment, they are likely to sell quite of few of these!

Qualcomm estimates it is one to two years ahead of competing CDMA chipset manufacturers, who, by the way, pay royalties to Qualcomm on every chipset they make. For that reason, Qualcomm has a 90% market share in CDMA chipsets, although we expect that to decline to about 60% over the next five years as Motorola and Nokia get their homegrown chipsets up to speed.

We have made projections of profits and economic value added earned by Qualcomm in the royalty and chipset businesses. These projections are very rough, because Qualcomm does not disclose royalty rates and chipset prices. Nevertheless, we estimate that earnings per share would be significantly higher if these were Qualcomm’s only two businesses. And, the economic value added from these two businesses is, to put it simply, stunning.

Qualcomm’s stock price will be influenced in the future by the following factors:

• We anticipate the continued swell of CDMA and 3G momentum. In particular, we anticipate that Japan’s leading cellular provider, DoCoMo, and America’s leading cellular provider, AT&T will announce their plans to convert to CDMA and build out 3G. CDMA continues to build market share worldwide. Finally, 3G buildouts will start in 2001, and plans are already being announced to proceed with this huge job.
• We estimate there is room for more positive earnings surprises, especially in view of the analysis of the royalty and chipset businesses described above.
• Qualcomm has been discovered by the stock market. The stock is now pretty "hot" and we anticipate it is likely to magnify the upswings and downswings of the market, and of technology stocks in particular.
• Qualcomm is a technology company, and the world of technology is subject to rapid change. This is a persistent and difficult to quantify danger. In that vein, a characteristic of the phone industry is that it accepts change at a relatively glacial pace. Once this was an enemy of Qualcomm, now it is an ally.

Upcoming visits include Monsanto, @Home, and Verisign.

Steven L. Re´, CFA

July 16, 1999

The above is for information purposes only and is not to be construed as a recommendation to purchase or sell securities. It should not be assumed that investments in any of the above mentioned securities will be profitable, and past performance is not a guarantee of future results. Earnings projections often miss, and markets don’t always go up. The employees and families of Quality Growth Management, Inc. may own the above mentioned securities in their own accounts, and may trade them at any time without notice.