QUALCOMM Incorporated — Form 10-Q Summary
Reporting period: Fiscal second quarter and first six months ended March 31, 2019. Comparisons are with the corresponding 2018 periods. Amounts are in U.S. dollars; financial statements are unaudited.
Business context
Qualcomm operates principally through QCT, its semiconductor business; QTL, its technology licensing business; and QSI, its strategic investment business. The company develops wireless technologies and products, including 4G and 5G, and licenses its intellectual property.
Financial performance and position
| Metric | Q2 FY2019 | Q2 FY2018 | Six months FY2019 | Six months FY2018 |
|---|---|---|---|---|
| Revenue | $4.982 billion | $5.220 billion | $9.824 billion | $11.255 billion |
| Operating income | $940 million | $400 million | $1.650 billion | $397 million |
| Net income (loss) | $663 million | $330 million | $1.731 billion | $(5.653) billion |
| Diluted EPS | $0.55 | $0.22 | $1.42 | $(3.82) |
| Gross margin | 56% | 57% | 56% | 56% |
| Operating cash flow | Not provided for the quarter | $1.150 billion | $2.278 billion |
Q2 revenue declined 5% year over year; equipment and services revenue fell $183 million and licensing revenue fell $55 million. Reported Q2 operating margin was approximately 19%, versus 8% a year earlier. The six-month net income comparison is strongly affected by the prior-year $1.2 billion European Commission fine and a large tax charge associated with U.S. tax reform; it is not a like-for-like indication of underlying operating performance.
For the six months, capital expenditures were $322 million; operating cash flow less capital expenditures was approximately $828 million. Cash, cash equivalents and marketable securities totaled $10.366 billion at March 31, down from $12.123 billion at September 30, 2018. Short-term debt was $998 million and long-term debt was $15.405 billion. The $5 billion revolving credit facility was undrawn. Management said available liquidity, expected operating cash flow and financing activities should meet requirements for at least the next 12 months.
At March 31, current assets were $16.324 billion and current liabilities were $10.517 billion. Six-month financing cash outflow was $2.531 billion, including $1.502 billion of dividends and $1.019 billion of share repurchases. The company had $7.8 billion remaining under its $30 billion repurchase authorization.
Material changes and comparability
- QCT revenue decreased $175 million in Q2 and $1.087 billion in the first six months. Management cited lower modem shipments, particularly reduced Apple share, and lower average selling prices, partly offset by favorable product mix. QCT earnings before tax were $542 million in Q2, down from $608 million.
- QTL revenue decreased $97 million in Q2 and $344 million in the first six months. Q2 QTL earnings before tax were $674 million, down from $809 million. The company reported $150 million of Q2 Huawei royalties under an interim agreement; these were minimum, non-refundable payments, not the full amount it says is due.
- Qualcomm adopted ASC 606 in fiscal 2019. It now estimates and records sales-based royalties in the period of licensee sales, accelerating recognition by one quarter and increasing unbilled receivables. Prior-year periods were not restated. The filing’s ASC 606 reconciliation shows Q2 2019 revenue would have been $63 million lower and net income $54 million lower under the previous guidance.
- The company revised certain 2018 comparative royalty figures for an immaterial prior-period error. It said the correction was not material to prior periods individually, but correcting the cumulative effect in the then-current quarter would have been significant.
Outlook, management commentary and risks
- On April 16, 2019, after quarter-end, Qualcomm settled all outstanding litigation with Apple and its contract manufacturers. The agreements include a six-year global patent license, effective April 1, 2019, with an option to extend two years, and a multi-year chipset supply agreement. Qualcomm expected to record $4.5 billion to $4.7 billion of revenue in fiscal Q3 from the settlement, including an Apple payment and release of certain customer-related liabilities. It also expected to begin recognizing royalties on Apple-related sales from April 1.
- Management said the Apple settlement should improve liquidity, while employee cash incentive costs would rise and litigation costs fall in the remainder of fiscal 2019. Engineering costs are expected to increase over time to support the chipset agreement. Qualcomm did not provide full-year revenue or earnings guidance in the supplied filing text.
- The company said its Cost Plan had achieved substantially all of its targeted $1 billion annual cost reductions based on the run rate exiting Q2, excluding litigation costs above baseline. It had incurred $892 million in cumulative plan charges; remaining charges were expected to be negligible.
- Management expects initial 5G network deployments and device launches to continue in 2019 and beyond, and plans continued investment in 5G, automotive, IoT, networking and other adjacent markets. It also cited competitive pressure, longer smartphone replacement cycles, customer concentration, reduced Apple modem sales, U.S.-China trade tensions and uncertainty around Huawei licensing negotiations.
- Significant legal and regulatory exposures include the FTC case, competition matters in multiple jurisdictions, consumer class actions, and the appeal of the $997 million EC fine. The EC fine liability was about $1.14 billion at March 31, including interest and currency effects. Except for that fine, Qualcomm had not accrued for the cited contingent losses because it considered loss not probable; possible loss ranges were not reasonably estimable. The filing warns that adverse outcomes could materially affect results, cash flows or licensing practices.
- Other notable obligations include $4.072 billion of purchase commitments and $387 million of operating lease payments. Qualcomm also estimated $1.8 billion of remaining Toll Charge payments over seven years and expected an option relating to its RF360 joint venture minority interest, valued at $1.15 billion, to be exercised during a 60-day period beginning August 4, 2019.
Important facts for investors to verify
- How the Apple settlement’s expected $4.5 billion to $4.7 billion Q3 revenue and subsequent royalties affect recurring revenue, cash flow and customer-related liabilities.
- Whether Huawei negotiations produce full royalty payments, and how estimated royalty recognition under ASC 606 compares with reported collections.
- Developments in the FTC, EC, KFTC and other proceedings, including potential effects on Qualcomm’s licensing model and the recorded EC fine liability.
- Whether declining QCT shipments and margins, capital returns, debt service and other commitments remain supportable from operating cash flow.