QUALCOMM Incorporated — Q1 FY2017 10-Q
Business context and period. The unaudited quarter ended December 25, 2016 and comprised 13 weeks. Qualcomm earns revenue principally from semiconductor products and services (QCT) and intellectual-property licensing (QTL); QSI makes strategic investments.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Revenue | $5.999 billion | $5.775 billion | +4% |
| Gross margin | 59% | 56% | +3 percentage points |
| Operating income | $778 million | $1.685 billion | -54% |
| Net income attributable to Qualcomm | $682 million | $1.498 billion | -54% |
| Diluted EPS | $0.46 | $0.99 | -54% |
| Operating cash flow | $1.379 billion | $2.739 billion | -50% |
- Equipment and services revenue was $4.139 billion, up 1%; licensing revenue was $1.860 billion, up 10%.
- QCT revenue was $4.101 billion, essentially flat, while segment earnings before tax rose to $724 million from $590 million. MSM chip shipments fell 10% to approximately 217 million; higher-priced mix and connectivity shipments helped offset lower volumes.
- QTL revenue rose 13% to $1.811 billion and segment earnings before tax rose to $1.532 billion. Reported device sales were approximately $62.9 billion, up 4%.
- Cash, cash equivalents and marketable securities totaled $29.785 billion at quarter-end, down from $32.350 billion at September 25, 2016. Current assets were $15.779 billion versus current liabilities of $7.994 billion.
- Debt was approximately $11.684 billion, comprising $1.749 billion short-term and $9.935 billion long-term. The company had $1.7 billion of commercial paper outstanding and no borrowings under its revolving, bridge or term facilities.
- Operating cash flow was $1.379 billion; investing activities provided $681 million and financing activities used $1.104 billion. Cash and cash equivalents ended at $6.885 billion.
- Dividends paid were $784 million and share repurchases were $444 million. The announced dividend was $0.53 per share; $2.5 billion remained authorized for repurchases.
Material changes and unusual items
- Operating results included an $868 million charge for the Korea Fair Trade Commission (KFTC) decision. The charge drove much of the year-over-year decline in operating income and was not tax deductible.
- The prior-year quarter included a $380 million gain on the sale of UK wireless spectrum; the absence of that gain also reduced the comparison. Prior-year other expenses included restructuring charges, partly offset by a gain on sale of an augmented-reality business.
- Current-quarter gross margin improved, primarily from segment mix, higher QCT margin and lower acquisition-related inventory step-up and intangible amortization charges.
- Net investment income increased to $182 million from $99 million, including higher realized gains and higher impairment losses. The company recorded a $242 million other comprehensive loss, largely reflecting unrealized losses on available-for-sale securities.
- Inventories rose 23% from fiscal year-end to $1.910 billion. Management attributed the increase to higher unit holdings to support demand, a customer’s cancellation of a flagship product and higher average unit costs.
Outlook, risks and contingencies
- Management expected continued growth in demand for 3G/4G products and new device categories, including automotive and IoT. It gave no specific quarterly revenue or earnings guidance in the supplied filing text.
- The proposed NXP acquisition was valued at approximately $38 billion in cash and was expected to close by the end of calendar 2017, subject to regulatory and other conditions. Qualcomm planned to use foreign-held cash and new debt, with $13.6 billion of committed bridge and term financing; it expected to issue additional debt. Management warned the transaction would use a substantial portion of liquidity and add significant debt.
- At quarter-end, $1.95 billion was restricted as collateral for letters of credit tied to potential NXP termination compensation. Qualcomm could owe NXP a $2.0 billion termination fee in specified circumstances; NXP could owe Qualcomm River Holdings $1.25 billion in specified circumstances.
- The KFTC imposed a fine of approximately 1.03 trillion Korean won ($868 million) and ordered changes to certain licensing and chipset practices. Qualcomm recorded the charge, disputed the findings, and said it would challenge the decision and seek a stay.
- Other material legal and regulatory matters included the FTC complaint filed January 17, 2017, Apple litigation filed January 20 and reported China complaints, European Commission proceedings, and patent and securities litigation. Qualcomm said it believed the claims were without merit. Except for the KFTC charge, it had not accrued losses for these matters because it considered losses not probable and could not reasonably estimate a range; adverse outcomes could materially affect results, cash flows or business practices.
- Qualcomm said it expected its liquidity sources to meet working and other capital requirements for at least 12 months under current plans. However, $27.9 billion of cash, equivalents and marketable securities was held by foreign entities, most of it indefinitely reinvested and potentially subject to material tax effects if repatriated.
- Key operating risks include intense chipset competition, customer concentration and in-house or competitor chip adoption, longer device replacement cycles, possible royalty underreporting or delayed licensing agreements, supplier concentration, and changes to licensing practices resulting from legal or regulatory decisions.
Important facts for investors to verify
- Progress and final regulatory approvals for the NXP acquisition, its funding mix, debt issuance, integration assumptions and any termination-fee exposure.
- Status, payment timing and appeal or stay of the KFTC fine and remedial order, and developments in the FTC, Apple and European Commission matters.
- Whether QCT can stabilize shipments and margins amid customer concentration, competitive pricing and customer use of alternative or internally developed chips.
- Whether QTL improves licensee reporting and reaches new or renewed agreements, and the effect of licensing disputes on royalties and cash collection.
- Inventory levels and cash conversion, including the impact of customer product cancellations and acquisition-related portfolio sales or impairments.