QUALCOMM Incorporated — Fiscal 2016 Third-Quarter 10-Q
Reporting period: Three and nine months ended June 26, 2016; comparisons are with the periods ended June 28, 2015. Qualcomm designs and supplies wireless chips and software through QCT, licenses intellectual property through QTL, and makes strategic investments through QSI. Figures below are in U.S. dollars.
Financial performance
| Metric | Q3 FY2016 | Q3 FY2015 | Nine months FY2016 | Nine months FY2015 |
|---|---|---|---|---|
| Revenue | $6.044B | $5.832B | $17.370B | $19.825B |
| Operating income | $1.592B | $1.235B | $4.691B | $4.636B |
| Net income attributable to Qualcomm | $1.444B | $1.184B | $4.106B | $4.209B |
| Diluted EPS | $0.97 | $0.73 | $2.74 | $2.53 |
| Operating margin | 26.3% | 21.2% | 27.0% | 23.4% |
- Quarterly revenue rose 4%, net income attributable to Qualcomm rose 22%, and diluted EPS rose 33%. Nine-month revenue declined 12%, while net income fell 2%; diluted EPS increased 8%, helped by a lower weighted-average diluted share count.
- Equipment and services revenue was $3.875B in Q3 and $11.311B for the nine months; licensing revenue was $2.169B and $6.059B, respectively. Quarterly equipment and services gross margin was approximately 35%, versus 36% a year earlier; the nine-month margin was 36%, versus 40%.
- Q3 segment results: QCT revenue was $3.853B and earnings before tax (EBT) $365M; QTL revenue was $2.038B and EBT $1.749B. Nine-month QCT revenue and EBT were $11.285B and $1.125B, compared with $13.529B and $2.185B; QTL revenue and EBT were $5.780B and $4.945B, compared with $6.162B and $5.395B.
- For the first nine months, operating cash flow was $5.316B, capital expenditures $389M, and operating cash flow less capital expenditures approximately $4.927B. Operating cash flow increased 39% year over year.
- At June 26, cash, cash equivalents and marketable securities totaled $31.032B. Total debt was $11.773B, comprising $1.749B short-term and $10.024B long-term; the resulting excess of cash and securities over debt was approximately $19.259B. The $4B revolving facility was undrawn. Current assets were $20.979B and current liabilities $6.843B.
Changes, capital allocation and unusual items
- Q3 QCT revenue was flat year over year despite MSM chip shipments falling 11% to about 201 million. For the first nine months, QCT revenue declined $2.244B, reflecting lower unit shipments, lower average selling prices and a less favorable product mix. Management cited premium-tier share shifts, competition in China and customer sourcing choices; QCT nine-month EBT margin fell to 10% from 16%.
- Q3 QTL revenue increased 6%. It included $235M of royalties related to prior periods recognized after settlement of the LGE arbitration; QTL had deferred those royalties during the dispute. Nine-month QTL revenue declined 6%, and the company said unreported or unlicensed sales continued to affect results.
- Other items affected comparisons: nine-month FY2016 included a $380M gain on the sale of U.K. wireless spectrum, $158M of restructuring and related charges, and a $48M gain on sale of an augmented-reality business. Q3 also included a $101M discrete tax benefit. The year-ago nine-month period included a $975M China NDRC charge and impairment charges, among other items.
- Qualcomm repurchased and retired 70.2 million shares for $3.7B during the first nine months and paid $2.2B of dividends. It stated an intention to return at least 75% of free cash flow to stockholders through buybacks and dividends. The quarterly dividend announced after period-end was $0.53 per share.
- Cash and marketable securities included $28.6B held by foreign entities, most of it indefinitely reinvested and potentially subject to material taxes if repatriated. Management said U.S. liquidity, expected operating cash flow and financing would meet needs for at least 12 months.
Outlook, risks and contingencies
- The filing provides no specific consolidated revenue or EPS forecast. Management expected continued demand growth for 3G/4G products, while citing challenges from China licensing and reporting, intense chipset competition, customer concentration, premium-tier share shifts and pricing pressure.
- The Strategic Realignment Plan targets approximately $1.1B in annual cost reductions from FY2015 levels, adjusted for variable compensation, and approximately $300M in lower annual share-based compensation grants. Management expected the initiatives to be substantially implemented by FY2016 year-end; it expected another $25M–$100M of restructuring and related charges in FY2016 and FY2017.
- The planned TDK radio-frequency joint venture was expected to close by early calendar 2017, subject to approvals and other conditions. Qualcomm’s initial purchase price was $1.2B; it also has an option to acquire TDK’s interest for $1.15B 30 months after closing, with up to $200M in additional sales-based payments to TDK.
- Material legal and regulatory matters include competition investigations in Korea, Europe, the United States, Taiwan and Japan, as well as patent and licensing disputes. Qualcomm said outcomes and potential losses could not be reasonably estimated, and it had not accrued contingent losses because it considered them possible, but not probable. It warned adverse outcomes could materially affect business, results, financial condition or cash flows.
- Other significant risks include dependence on third-party chip manufacturing and testing, customer and licensee concentration, intellectual-property challenges, execution of cost reductions and acquisitions, and potential effects of debt, foreign exchange and tax changes. Management reported disclosure controls were effective and no material change in internal control during the quarter.
Important facts for investors to verify
- Whether Qualcomm secures complete and timely royalty reporting and payments from licensees, particularly in China, and how regulatory proceedings affect its licensing model.
- Whether QCT can stabilize shipments, customer share and margins amid competition, lower pricing and customer use of alternative or internally developed chips.
- How much of reported earnings and cash generation depends on prior-period royalty recoveries, asset-sale gains, tax benefits and restructuring costs.
- Whether the company delivers the planned cost savings, maintains its capital-return commitment, and funds the TDK transaction without weakening liquidity.
- The scale and timing of potential legal or regulatory liabilities, which the filing says are not currently estimable, and the accessibility of substantial foreign-held cash.