QUALCOMM Incorporated — Q2 FY2016 Form 10-Q
Reporting period: 13-week quarter ended March 27, 2016; comparative quarter ended March 29, 2015. Six-month figures compare the 26 weeks ended on those dates. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted.
Business context and results
Qualcomm earns revenue principally from QCT, its semiconductor business, and QTL, its technology licensing business. In Q2, reported device sales were approximately $70.1 billion, down about 8% year over year. Qualcomm shipped approximately 189 million MSM integrated circuits, down 19%.
Key financial metrics
| Metric | Q2 FY2016 | Q2 FY2015 | Six months FY2016 | Six months FY2015 |
|---|---|---|---|---|
| Revenue | $5,551 | $6,894 | $11,326 | $13,993 |
| Operating income | $1,415 | $1,336 | $3,099 | $3,400 |
| Net income attributable to Qualcomm | $1,164 | $1,053 | $2,662 | $3,025 |
| Diluted EPS | $0.78 | $0.63 | $1.77 | $1.80 |
| Cash from operations | Not presented by quarter | Not presented by quarter | $3,476 | $1,706 |
Q2 revenue fell 19% year over year, while Qualcomm-attributable net income rose 11%; the prior-year quarter included a $975 million charge related to the China NDRC resolution. For the six-month period, revenue declined 19% and attributable net income declined 12%.
- Revenue mix: Q2 equipment and services revenue was $3,349, down $1,054; licensing revenue was $2,202, down $289.
- Margins: Cost of equipment and services revenue was 64% of that revenue in Q2, versus 60% a year earlier, indicating a lower equipment/services gross margin. Consolidated operating margin was approximately 25.5%, versus 19.4%; the comparison reflects the prior-year NDRC charge and is not a like-for-like indication of underlying improvement.
- Segment performance: QCT revenue was $3,337 and pretax earnings were $170, versus $4,434 and $750 in Q2 FY2015. QTL revenue was $2,135 and pretax earnings were $1,857, versus $2,414 and $2,162.
- Cash flow: Six-month operating cash flow was $3,476; capital expenditures were $253, implying free cash flow of approximately $3,223. The comparable prior-year amounts were $1,706, $449 and approximately $1,257, respectively. The cash-flow increase was primarily attributed to working-capital changes, including the prior-year $950 million supplier-capacity prepayment.
- Liquidity and debt: Cash, cash equivalents and marketable securities totaled $29,984 at March 27, 2016, compared with $30,947 at fiscal year-end. Short-term debt was $1,949 and long-term debt was $9,993. The company had no borrowings under its $4.0 billion revolving facility. Most liquidity—$27.1 billion—was held by foreign entities and generally treated as indefinitely reinvested.
- Capital returns: Qualcomm repurchased $3.6 billion of stock and paid $1.4 billion of dividends during the first six months. It announced a 10% dividend increase, to $0.53 per share, effective for subsequent dividends.
Material changes and management commentary
- QCT was pressured by lower MSM shipments, reduced average selling prices and a lower-priced product mix, premium-tier customer share shifts, weaker thin-modem demand, reduced share at a large customer and competition in China.
- QTL revenue was affected by lower reported sales of CDMA-based products, suspected royalty underreporting, lower revenue per reported unit and royalty revenue deferred during an LGE arbitration.
- In April 2016, Qualcomm settled the LGE dispute. Beginning in Q3 FY2016, it expected to stop deferring LGE royalties and recognize more than $200 million of previously deferred revenue.
- The Strategic Realignment Plan targets approximately $1.1 billion of annual cost reductions from fiscal 2015 cost levels, adjusted for variable compensation, and approximately $300 million lower annual share-based compensation grants. The company expected substantial implementation by fiscal year-end 2016. It had recorded $271 million of net restructuring and related charges through Q2 and expected another $25 million to $125 million in fiscal 2016 and 2017.
- The company expected its FY2016 annual effective tax rate to be approximately 18%. It did not provide a clear consolidated revenue or earnings forecast in the supplied filing text.
- Qualcomm’s planned TDK RF front-end joint venture was expected to close by early calendar 2017, subject to approvals. Qualcomm’s initial purchase price was approximately $1.2 billion; it also had an option to buy TDK’s interest for $1.15 billion 30 months after closing.
Risks, contingencies and unusual items
- Qualcomm cited ongoing competition and premium-tier customer concentration, dependence on licensee reporting and royalty payments, and challenges in China, including underreported royalties and delayed license agreements.
- Regulatory matters included investigations or proceedings involving competition authorities in Korea, Europe, the United States, Taiwan and Japan. The company said outcomes were difficult to predict, had recorded no accrual because losses were not considered probable, and could not reasonably estimate a possible loss range. An unfavorable outcome could materially affect results, financial condition or cash flows.
- The SEC FCPA matter concluded with a $7.5 million penalty and a two-year self-monitoring and self-reporting period; the DOJ had terminated its investigation without charges. Qualcomm neither admitted nor denied the SEC order’s findings.
- Qualcomm disclosed patent disputes, including a ParkerVision ITC investigation scheduled for hearing in August 2016, and an Nvidia appeal of an unfavorable ITC determination. The Supreme Court denied ParkerVision’s petition in a separate case, ending further appeals in that matter.
- Six-month results included a $380 million gain on sale of UK wireless spectrum, partly offset by restructuring charges; the sale generated $232 million in cash and deferred payments due in 2020–2023. Q2 FY2015 included the $975 million NDRC charge.
- Other risks include reliance on third-party manufacturing suppliers, possible product and technology transitions, foreign-currency exposure, and the execution and costs of restructuring and strategic investments.
Important facts for investors to verify
- Whether QCT shipment declines, margin pressure and customer share shifts persist, particularly in China and the premium tier.
- Whether licensee sales and royalty reporting improve, and the timing and collection of the more than $200 million of deferred LGE royalties.
- Progress toward the announced cost and compensation reductions, including realized savings versus restructuring costs.
- Current status, potential remedies and financial exposure of the disclosed regulatory and legal matters; the filing states that loss ranges are not estimable for key proceedings.
- Availability and practical usability of overseas liquidity, alongside debt maturities, repurchases, dividends and funding needs for the TDK transaction.