QUALCOMM Incorporated — Q3 FY2015 Form 10-Q
Reporting period: Fiscal third quarter ended June 28, 2015 (13 weeks); nine-month period ended the same date. Comparative periods ended June 29, 2014. Amounts are in U.S. dollars unless stated otherwise.
Business context
Qualcomm earns revenue primarily from QCT, its chipset and software business, and QTL, its intellectual-property licensing business; QSI makes strategic investments. In Q3, Qualcomm shipped approximately 225 million MSM integrated circuits, unchanged year over year. Reported licensee device sales were approximately $60.4 billion, up 4% year over year.
Key financial results
| Metric | Q3 FY2015 | Q3 FY2014 | Nine months FY2015 | Nine months FY2014 |
|---|---|---|---|---|
| Total revenue | $5.832 billion | $6.806 billion | $19.825 billion | $19.795 billion |
| Operating income | $1.235 billion | $2.075 billion | $4.636 billion | $5.558 billion |
| Net income attributable to Qualcomm | $1.184 billion | $2.238 billion | $4.209 billion | $6.073 billion |
| Diluted EPS | $0.73 | $1.31 | $2.53 | $3.53 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $3.822 billion | $7.268 billion |
Q3 revenue fell 14% year over year as equipment and services revenue declined $1.082 billion (22%), partly offset by a $108 million increase in licensing revenue. Nine-month revenue was essentially flat. Q3 operating margin was approximately 21% versus 30% a year earlier; cost of equipment and services revenue rose to 64% of that revenue from 56%. Nine-month operating margin was approximately 23% versus 28%.
Q3 income included $162 million of other expense, primarily impairment charges. Nine-month other expense of $1.241 billion included the $975 million China NDRC fine and impairment charges of $255 million for goodwill and $11 million for intangible assets. Nine-month 2014 net income also included $430 million from discontinued operations, net of tax, related to the prior Omnitracs sale.
Cash, liquidity and capital allocation
- At June 28, 2015, cash and cash equivalents were $9.987 billion and marketable securities totaled $25.238 billion. Management reported combined cash, cash equivalents and marketable securities of $35.2 billion.
- Operating cash flow for the first nine months fell to $3.822 billion from $7.268 billion, primarily reflecting lower net income and a $950 million prepayment to secure supplier capacity. Capital expenditures were $815 million; operating cash flow less capital expenditures was approximately $3.007 billion.
- Qualcomm issued $10.0 billion of unsecured notes in May and had $9.913 billion of long-term debt and $1.0 billion of commercial paper outstanding at quarter-end. The $4.0 billion revolving facility was undrawn. Cash, cash equivalents and marketable securities exceeded reported debt, though $27.2 billion of those assets were held by foreign entities and most foreign-held balances were indefinitely reinvested.
- Nine-month share repurchases were $9.016 billion, including the $5.0 billion accelerated share repurchase agreements; dividends charged to retained earnings were $2.183 billion. The company stated an intention to return at least 75% of free cash flow to stockholders and to repurchase $10 billion of stock from March 2015 through March 2016.
Changes, outlook and management commentary
- QCT pressure: Q3 QCT revenue declined about $1.10 billion and segment earnings before tax fell to $289 million from $1.116 billion. Management cited reduced premium-tier share, lower sales of integrated Snapdragon processors, a shift toward lower-margin modem chipsets, share loss at a large customer and intense competition in China. It expected these factors to continue affecting QCT through the remainder of FY2015 and into the next fiscal year.
- QTL growth, with collection and reporting concerns: Q3 QTL revenue increased $128 million to $1.931 billion. Management cited higher reported sales of CDMA-based products and audit recoveries, partly offset by lower revenue per reported unit. It said underreporting by some licensees and sales of unlicensed products in China continued to weigh on results.
- China licensing terms: Following the NDRC resolution, Qualcomm paid a $975 million fine and agreed to modify certain China business practices. For specified branded devices sold for use in China from January 1, 2015, the plan provides royalty rates of 5% for 3G devices and 3.5% for certain 4G devices, applied to 65% of net selling price.
- Strategic realignment, announced after quarter-end: The July 22, 2015 plan targets approximately $1.1 billion in annual cost reductions from FY2015 levels, plus approximately $300 million lower annual share-based compensation grants. Qualcomm expected implementation by the end of FY2016 and $350–$450 million of restructuring and related charges, including $100–$200 million in Q4 FY2015. These are targets, not guaranteed outcomes.
- Acquisition: The proposed CSR acquisition, valued at approximately $2.4 billion, remained subject to conditions, including Chinese regulatory approval; closing was expected by the end of summer 2015. Securities and cash had been set aside to fund it.
- Liquidity outlook: Management believed available liquidity, expected operating cash flow and financing would meet working and other capital needs for at least 12 months. It anticipated continued substantial investment in research and development.
Risks, contingencies and unusual items
Qualcomm disclosed material uncertainties from multiple antitrust, regulatory and legal matters, including European Commission proceedings concerning alleged chipset pricing and exclusivity practices; an EU investigation of alleged predatory pricing; FTC and Korean investigations; SEC and DOJ investigations relating to FCPA compliance; and patent disputes including ParkerVision and Nvidia. The company said it had not accrued losses for these matters because losses were not considered probable and a range could not be reasonably estimated; an unfavorable outcome could materially affect results, financial condition or cash flows.
Other notable risks include intense chipset competition and pricing pressure, customer and licensee concentration, possible licensee royalty underreporting, reliance on third-party manufacturing suppliers, foreign-exchange exposure, and the new debt burden and associated interest-rate exposure. Management estimated that a 100-basis-point interest-rate increase would raise annualized interest expense by $30 million for floating-rate notes and related swaps. The filing reports no material off-balance-sheet arrangements.
Most important facts for investors to verify
- Whether QCT margins and premium-tier share stabilize, and whether competitive pressure in China and at major customers worsens.
- Whether licensees report and pay royalties under existing and revised China terms, and how this affects QTL revenue and cash collection.
- Progress and potential outcomes of the disclosed antitrust, FCPA and patent proceedings, including whether any loss accrual becomes necessary.
- Actual timing, cash cost and realized savings from the realignment plan, alongside its potential effects on R&D, product execution and employee retention.
- Completion and final cost of the CSR acquisition, as well as the effect of debt service, repurchases and dividends on liquidity and capital flexibility.