QUALCOMM Incorporated — Q2 FY2014 Form 10-Q
Reporting period: Quarter ended March 30, 2014; six-month results cover the 26 weeks ended that date. Comparative periods ended March 31, 2013. Amounts are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Business context
Qualcomm earns revenue principally from sales of integrated circuits and licensing its intellectual property. Its principal reportable segments are QCT (chipsets and software), QTL (technology licensing) and QSI (strategic investments). In Q2, Qualcomm reported shipping approximately 188 million MSM integrated circuits, up about 9% year over year; licensees’ reported device sales were approximately $66.5 billion, also up about 9%.
Financial performance
| Metric | Q2 FY2014 | Q2 FY2013 | Six months FY2014 | Six months FY2013 |
|---|---|---|---|---|
| Revenue | $6.367 billion | $6.124 billion | $12.989 billion | $12.143 billion |
| Operating income | $1.990 billion | $1.877 billion | $3.483 billion | $3.966 billion |
| Net income attributable to Qualcomm | $1.959 billion | $1.866 billion | $3.835 billion | $3.772 billion |
| Diluted EPS | $1.14 | $1.06 | $2.23 | $2.15 |
| Operating cash flow | Not separately provided for quarter | Not separately provided for quarter | $4.595 billion | $4.191 billion |
| Capital expenditures | Not separately provided for quarter | Not separately provided for quarter | $797 million | $494 million |
Revenue and segment mix: Q2 equipment and services revenue was $4.229 billion, up $239 million; licensing revenue was $2.138 billion, essentially flat. QCT revenue was $4.243 billion and QTL revenue was $2.071 billion. For the six months, equipment and services revenue rose $692 million and licensing revenue rose $154 million.
Margins and expenses: Equipment and services cost was 59% of that revenue in Q2, unchanged year over year; for the six months it was 58% versus 56%, reflecting lower QCT margin. QCT’s Q2 EBT margin was 17%, flat year over year; its six-month margin declined to 19% from 22%. QTL’s EBT margin was 89% in Q2 and 88% for the six months. R&D rose to $1.356 billion in Q2 and $2.683 billion for six months; SG&A declined to $539 million and $1.162 billion, respectively.
Cash, liquidity and obligations: Cash and cash equivalents were $6.337 billion at March 30; marketable securities totaled $25.716 billion, bringing cash, cash equivalents and marketable securities to approximately $32.1 billion. Operating cash flow less capital expenditures was approximately $3.798 billion for the six months. Current assets were $21.008 billion versus current liabilities of $5.901 billion. Total liabilities were $9.622 billion. The filing does not provide a clear separate total for conventional borrowings or debt. Management said available liquidity and expected operating cash flows should meet working and other capital needs for at least 12 months. Approximately $23.5 billion of cash, cash equivalents and marketable securities was indefinitely reinvested offshore and could incur material tax effects if repatriated.
Material changes and unusual items
- Q2 revenue increased 4% year over year and operating income rose to $1.990 billion from $1.877 billion. Six-month revenue increased 7%, while operating income declined, primarily reflecting $472 million of “other” expenses.
- Six-month “other” expenses included a $444 million impairment of QMT manufacturing-facility assets, a $16 million QRS goodwill impairment and a $12 million charge related to the ParkerVision verdict.
- Qualcomm sold Omnitracs’ North and Latin America operations in November 2013 for $788 million net cash proceeds and recorded a $665 million pretax gain ($430 million after tax) in discontinued operations. Six-month net income includes this gain; the operations’ revenue and results were described as immaterial.
- Net investment income was $282 million in Q2 and $546 million for six months, supported by higher realized gains on marketable securities; impairment losses on investments also increased.
- Six-month repurchases were $2.004 billion, and dividends paid were $1.179 billion. The quarterly dividend was increased 20%, from $0.35 to $0.42 per share, effective for dividends payable after March 26, 2014.
Outlook, management commentary and risks
The filing gives no formal revenue or EPS guidance. Management expected continued expansion of 3G/4G networks, strong demand for advanced devices, and further 4G LTE deployment in China, while noting price competition and varying growth across regions. Qualcomm expected to continue substantial R&D investment. It expected at least $2 billion of additional share repurchases during the remainder of FY2014 and stated an intention to return 75% of free cash flow to stockholders over the foreseeable future. Management estimated a 16% FY2014 effective tax rate, expected to fall to 15% after an anticipated approximately $65 million tax benefit in Q3.
Key business risks include competition and falling device or chipset prices, dependence on a limited number of customers and licensees, reliance on third-party manufacturing suppliers, and challenges to Qualcomm’s licensing model and intellectual-property rights. Management also cited risks from technology transitions, product and cybersecurity issues, foreign currency movements, tax matters and regulatory actions. It stated that liquidity was adequate for at least 12 months based on current plans.
Legal and regulatory matters: Qualcomm received an SEC Wells Notice in March regarding a possible FCPA enforcement recommendation; the company made a Wells submission in April and said it could not predict the outcome of SEC or DOJ investigations. China’s NDRC was investigating potential Chinese Anti-Monopoly Law issues involving licensing and chipset interactions; potential remedies could include fines of 1% to 10% of prior-year revenue. ParkerVision post-verdict motions were pending, with a hearing scheduled for May 1, 2014. The company reported other competition and licensing matters in Korea, Japan and the European Commission. It said potential losses in these matters were not considered probable or reasonably estimable, apart from amounts accrued for ParkerVision. Tessera litigation was dismissed with prejudice on April 1, 2014, after the parties reached an agreement.
Important facts for investors to verify
- How much of reported six-month earnings and cash generation reflects the Omnitracs disposal gain, investment gains and impairment charges, and what are the underlying operating trends?
- What are the outcome, timing and potential financial effects of the SEC/DOJ FCPA investigations and China NDRC investigation? The filing says these outcomes are not predictable and potential losses generally cannot be estimated.
- Can QCT sustain margins amid lower average selling prices, product-mix changes and strong competition, particularly in lower-tier devices and emerging markets?
- How will offshore liquidity, potential repatriation taxes and management’s stated shareholder-return targets affect future funding needs, including the possibility of borrowing in coming years?
- Does the subsequent Q3 tax benefit materialize as expected, and how do changing tax credits and foreign-income rates affect the effective tax rate?