QUALCOMM Incorporated — Q3 FY2017 Form 10-Q
Reporting period: Quarter ended June 25, 2017; year-to-date figures cover the nine months ended June 25, 2017. Unaudited interim results; comparisons are with the corresponding periods ended June 26, 2016, unless noted.
Business context and reporting period
Qualcomm develops and sells wireless integrated circuits and licenses intellectual property. Its principal segments are QCT (semiconductors), QTL (technology licensing) and QSI (strategic investments). The quarter’s results reflected growth in QCT equipment and services, offset by lower licensing revenue amid royalty disputes and nonpayment by certain licensees.
Financial results and liquidity
| Metric | Q3 FY2017 | Q3 FY2016 | Nine months FY2017 | Nine months FY2016 |
|---|---|---|---|---|
| Total revenue | $5.371B | $6.044B | $16.387B | $17.370B |
| Operating income | $773M | $1.592B | $2.281B | $4.691B |
| Net income attributable to Qualcomm | $866M | $1.444B | $2.297B | $4.106B |
| Diluted EPS | $0.58 | $0.97 | $1.54 | $2.74 |
| Gross margin | 54% | 58% | 56% | 58% |
| Operating cash flow | Not separately presented for quarter | Not separately presented for quarter | $2.276B | $5.316B |
- Revenue mix: Q3 equipment and services revenue was $4.121B, up $246M; licensing revenue was $1.250B, down $919M. Nine-month equipment and services revenue was $11.949B, up $638M; licensing revenue was $4.438B, down $1.621B.
- Segment results, Q3: QCT revenue was $4.052B and earnings before tax (EBT) $575M, versus $3.853B and $365M. QTL revenue was $1.172B and EBT $854M, versus $2.038B and $1.749B.
- Cash flow: Nine-month investing cash outflow was $342M and financing cash inflow was $7.001B. Capital expenditures were $428M. Operating cash flow fell 57% year over year; management cited the BlackBerry payment, KFTC fine, working-capital changes and royalty collection issues.
- Cash and liquidity: Cash, cash equivalents and marketable securities totaled $37.752B at June 25, 2017, compared with $32.350B at September 25, 2016. Cash and cash equivalents alone were $14.909B. The company reported $2.495B short-term debt and $19.403B long-term debt. A $2.0B deposit was restricted as collateral for NXP-related letters of credit; $27.8B of cash and marketable securities was held by foreign entities, most of it indefinitely reinvested.
- Other balance-sheet items: Accounts receivable rose 59% to $3.532B, inventories rose 29% to $2.002B, and total assets increased to $64.379B from $52.359B. Consolidated days sales outstanding rose to 60 from 33 days.
Material changes versus prior comparable periods
- Q3 revenue declined 11% and net income attributable to Qualcomm declined 40%. Nine-month revenue declined 6% and attributable net income declined 44%.
- QTL revenue and profitability were pressured by Apple contract manufacturers’ short payment of reported royalties and by another licensee’s failure to report or pay royalties. The company said the affected products represented about $700M of QTL revenue in the year-ago quarter. Q3 MSM chip shipments fell 7% to about 187M units.
- QCT revenue increased, supported by radio-frequency front-end (RFFE) products, including RF360 Holdings, and connectivity shipments; lower MSM shipments and reduced share at a large customer partly offset growth.
- Gross margin fell as lower high-margin licensing revenue made up a smaller share of total revenue. Research and development expense rose to $1.391B for the quarter, and SG&A rose to $710M.
- Nine-month other expenses included a $927M charge for the Korean Fair Trade Commission (KFTC) fine and $35M of restructuring charges. The prior-year nine-month period included a $380M spectrum-sale gain and net restructuring-related charges.
Outlook, commentary, risks and unusual items
- NXP transaction: Qualcomm expected to acquire NXP for $110 per share in cash, or estimated consideration of $38B, with closing anticipated by the end of calendar 2017, subject to regulatory and other conditions. Funding plans included the May 2017 $11B debt issuance, a committed $4B term loan expected to be drawn at closing, and foreign-held cash. The company warned the deal would use a substantial portion of liquidity and carry regulatory, financing, integration and execution risks. A $2B termination fee may be payable by Qualcomm in specified circumstances; $2B was cash-collateralized for related letters of credit.
- Debt issuance: In May, Qualcomm issued $11B of unsecured floating- and fixed-rate notes, with maturities from 2019 to 2047. Debt carrying value increased materially year over year. $4B of the May issuance is subject to special mandatory redemption at 101% plus accrued interest if specified NXP deal conditions occur.
- Legal and regulatory exposure: The company paid the approximately $927M KFTC fine and was appealing the decision and seeking a stay of its remedial order. Apple and Qualcomm pursued multiple U.S. and foreign lawsuits and regulatory complaints relating to royalties, patent licensing and competition; Qualcomm also sued Apple and Apple’s contract manufacturers. The company said it had not accrued losses for these matters because losses were not considered probable and a range could not be reasonably estimated. It warned an unfavorable outcome could materially affect results, financial condition or cash flows.
- BlackBerry arbitration: Qualcomm paid $940M in May 2017 to resolve the award, interest and attorneys’ fees, and recorded a $940M reduction to licensing revenue for the nine-month period.
- Business outlook and risks: Management expected continued demand growth for 3G/4G products and investment in LTE, 5G, RFFE, IoT, automotive and other markets, but provided no specific company revenue or earnings guidance in the supplied filing text. It expected royalty disputes to continue weighing on revenue, cash flow and financial condition until resolved. Other cited risks included Apple modem dual-sourcing, customer concentration, competition, licensing challenges and dependence on third-party semiconductor suppliers.
- Capital returns: Nine-month dividends were $2.411B cash paid, or $1.63 per share announced. A $0.57 per-share dividend was announced for payment in September 2017. Qualcomm expected share repurchases in coming years primarily to offset employee-plan dilution while funding the NXP transaction.
- Controls: Management concluded disclosure controls were effective at quarter-end and reported no material changes in internal control over financial reporting.
Important facts for investors to verify
- Progress, regulatory approvals, financing, tender conditions and potential termination costs for the proposed NXP acquisition.
- Collection of Apple contract manufacturers’ royalty receivables, resolution of the other licensee dispute, and resulting effects on QTL revenue and operating cash flow.
- Developments in KFTC, FTC, European Commission, Apple, consumer-class-action and other licensing-related proceedings, including any injunctions, fines, damages or required changes to business practices.
- Debt-service and liquidity implications after the NXP financing, including use of foreign-held cash, collateral restrictions and the mandatory-redemption terms on $4B of notes.
- Whether QCT growth in RFFE and connectivity can offset lower MSM shipments, customer share losses and competitive pricing, and whether RF360 meets operational and return expectations.
- The company’s reported cash and securities balances, receivables and inventory levels, given restricted collateral, foreign cash concentration and the substantial year-over-year decline in operating cash flow.