QUALCOMM Incorporated — Fiscal 2020 First-Quarter 10-Q
Reporting period: Three months ended December 29, 2019; comparable period ended December 30, 2018. The interim financial statements are unaudited. Qualcomm develops and sells wireless semiconductor products through QCT and licenses intellectual property through QTL; it also has a strategic investment segment, QSI.
Financial performance and liquidity
Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Total revenue | $5,077 | $4,842 | +5% |
| Equipment and services revenue | $3,534 | $3,754 | −6% |
| Licensing revenue | $1,543 | $1,088 | +42% |
| Gross margin | 58% | 55% | +3 percentage points |
| Operating income | $1,030 | $710 | +45% |
| Net income | $925 | $1,068 | −13% |
| Diluted EPS | $0.80 | $0.87 | −8% |
| Cash from operations | $1,118 | $356 | +$762 |
| Capital expenditures | $296 | $152 | +$144 |
- Revenue and gross margin improved mainly because higher-margin QTL licensing made up a larger share of sales. Operating expenses included $1,406 million of R&D, up from $1,269 million, principally reflecting increased development spending on 5G, RF front-end and related technologies.
- Net income fell despite higher operating income, in part because the prior-year quarter included a $509 million income tax benefit; Q1 FY2020 recorded $22 million of tax expense. The current-quarter effective tax rate was 2%, including $102 million of discrete net tax benefits. Management estimated an 11% effective tax rate for FY2020.
- Operating cash flow was $1.118 billion; less $296 million of capital expenditures, this equates to approximately $822 million of cash flow after capital expenditures. Cash and cash equivalents were $11.109 billion at quarter-end, and cash, cash equivalents and marketable securities totaled $11.458 billion, down $838 million from September 29, 2019.
- Balance-sheet debt was $2.498 billion short-term and $13.437 billion long-term. Management reported $15.5 billion of principal notes outstanding, including $2.0 billion maturing in May 2020, and $499 million of commercial paper. No revolving credit facility borrowings were outstanding; the facility provided up to $5.0 billion. Management said available liquidity and expected financing and operating cash flows should meet needs for at least 12 months.
- Current assets were $16.205 billion and current liabilities $9.194 billion. Accounts receivable increased to $2.737 billion from $2.471 billion; inventory was $1.420 billion. The filing states that 29% of total receivables included estimated royalties from two key Chinese licensees.
- Qualcomm repurchased 9.2 million shares for $762 million and paid $710 million in dividends during the quarter. It had $6.3 billion remaining under its $30 billion repurchase authorization. The announced dividend was $0.62 per share.
Material changes and business developments
- QCT revenue was $3.618 billion, down 3%; segment earnings before tax were $479 million versus $598 million. Qualcomm sold approximately 155 million MSM integrated circuits, compared with 186 million a year earlier. Management attributed the decline primarily to lower modem and related chipset shipments, including lower sales to Apple and reduced 4G premium-tier shipments ahead of the 5G ramp.
- QTL revenue rose to $1.404 billion from $1.018 billion, and segment earnings before tax increased to $1.017 billion from $590 million. The quarter included Apple royalties following the April 2019 settlement and Apple’s fall device launches. Qualcomm recorded no revenue for royalties due on Huawei product sales; the prior-year comparison included $150 million under an interim Huawei agreement.
- Qualcomm expected to begin recording chipset revenue under its multi-year Apple supply agreement in the second half of FY2020. Apple was not using Qualcomm modems in the iPhone models launched in September 2019.
- QSI reported a $3 million pretax loss, compared with $8 million of pretax earnings a year earlier, with investment impairments and gains affecting the comparison.
Outlook, risks, contingencies and unusual items
- No numerical revenue or earnings guidance is provided in the filing. Management expects 5G network deployments and device launches to continue through calendar 2020 and beyond, while consumer demand shifts toward 5G products and growth opportunities develop in automotive, computing, IoT and networking.
- Qualcomm’s Huawei license agreement expired December 31, 2019; no new agreement or arbitration had been initiated as of the filing. Two key Chinese license agreements were extended through March 31, 2020, with negotiations continuing. Delayed or reduced payments could affect future licensing revenue and cash flow.
- The FTC’s May 2019 ruling imposed licensing and business-practice remedies. Qualcomm appealed, and the Ninth Circuit stayed certain remedies pending appeal; oral argument was scheduled for February 13, 2020. The filing warns that an unfavorable outcome in this or other competition matters could materially affect the licensing model, revenue, cash flow and capital returns.
- Other significant matters include an EC fine of approximately €242 million relating to alleged predatory chipset pricing, under appeal, and a separate €997 million EC fine relating to Apple, also under appeal. The two fines, including related foreign-exchange effects and accrued interest, totaled about $1.4 billion at quarter-end and were supported by financial guarantees rather than cash payment. Qualcomm had paid the $927 million KFTC fine; the Korean court affirmed some findings and overturned some remedial orders, with appeals pending.
- Except for the EC fines, Qualcomm recorded no accrual for the described legal and regulatory contingencies because it considered losses possible but not probable; it said potential loss ranges could not be reasonably estimated. It cautioned that adverse outcomes could have a material effect.
- Management identified the coronavirus outbreak originating in China and U.S.–China trade and national-security policies as potential threats to consumer demand, manufacturing, supply chains and results. Additional risks include customer and licensee concentration, competition and in-house chip development by customers, semiconductor cyclicality, supplier constraints, intellectual-property disputes and debt obligations.
- The company recorded $72 million of impairment losses on other investments during the quarter. The prior-year quarter included $149 million of net other expense, principally restructuring charges partly offset by a favorable legal settlement. Adoption of new lease accounting added $449 million of operating lease assets and $500 million of lease liabilities at adoption; management reported no material effect on operating results or cash flows.
Important facts for investors to verify
- Progress and payment outcomes for Huawei and the two Chinese licensees, including the collection and timing of the royalties included in receivables.
- Developments in the FTC appeal, EC proceedings and other competition matters, including potential remedies, cash requirements and effects on Qualcomm’s licensing practices.
- Whether anticipated Apple chipset revenue begins in the second half of FY2020, and the pace of 5G chipset adoption and QCT shipment recovery.
- Effects of the coronavirus outbreak and trade restrictions on customer demand, suppliers, manufacturing and Qualcomm’s China-related business.
- Liquidity and debt maturities, capital returns, and the difference between the quarter’s unusually low 2% effective tax rate and management’s 11% FY2020 estimate.