QUALCOMM Incorporated — Q1 FY2019 Form 10-Q
Reporting period: Three months ended December 30, 2018. The quarter comprised 13 weeks. Unless otherwise noted, amounts are in U.S. dollars.
Business context
Qualcomm develops and sells wireless integrated circuits and licenses its intellectual property. Its principal businesses are QCT (semiconductors) and QTL (technology licensing); QSI makes strategic investments. The quarter reflected weaker chipset sales, ongoing licensing disputes, and adoption of a new revenue recognition standard.
Key financial results
| Metric | Q1 FY2019 | Year-ago quarter |
|---|---|---|
| Total revenue | $4.842 billion | $6.035 billion |
| Operating income (loss) | $710 million | $(4) million |
| Net income (loss) | $1.068 billion | $(5.983) billion |
| Diluted EPS | $0.87 | $(4.05) |
| Operating cash flow | $356 million | $1.762 billion |
| Capital expenditures | $152 million | $226 million |
- Revenue declined 20% year over year. Equipment and services revenue was $3.754 billion, down $950 million; licensing revenue was $1.088 billion, down $243 million.
- Gross margin was 55%, versus 56%. Operating margin was approximately 14.7%; reported net income includes substantial tax benefits.
- QCT revenue was $3.739 billion, down $912 million; segment earnings before tax were $598 million, or 16% of revenue, versus $955 million and 21%. QCT sold approximately 186 million MSM integrated circuits, compared with 237 million.
- QTL revenue was $1.018 billion, down $248 million; segment earnings before tax were $590 million, or 58% of revenue, versus $854 million and 67%.
- Cash, cash equivalents and marketable securities totaled $10.350 billion at quarter-end. Total debt was approximately $16.386 billion: $998 million short-term and $15.388 billion long-term. Current assets were $16.294 billion and current liabilities $10.556 billion.
- Operating cash flow fell 80% year over year. Financing cash outflow was $1.887 billion, including $1.019 billion of repurchases and $750 million of dividends. Cash and cash equivalents declined to $10.066 billion from $11.777 billion at fiscal year-end.
Material changes and unusual items
- QCT revenue was affected by lower modem sales to Apple, which used competitors’ modems in its 2018 iPhone release. Lower unit shipments and average selling prices also weighed on QCT results.
- QTL revenue was affected by the Apple and contract-manufacturer dispute. Qualcomm recorded no royalties for Apple products in the quarter. QTL included $150 million of Huawei royalties under an interim agreement; this was a minimum payment and not the full amount Qualcomm says is due.
- ASC 606 adoption accelerated estimated sales-based royalty recognition by one quarter and increased opening retained earnings by $840 million. Prior-year results were not restated. The standard reduced reported Q1 FY2019 net income by $33 million compared with the filing’s ASC 605 presentation.
- A separate immaterial prior-period royalty recognition error was corrected in the filing; Qualcomm said it was not material to prior annual or interim periods, but its cumulative correction would have significantly affected current-quarter results if recorded entirely in the quarter.
- The reported $509 million income tax benefit included a $570 million discrete benefit from tax elections. Management estimated a 7% annual effective tax benefit rate for FY2019; the quarterly effective rate was not representative of that estimate.
- Other expense included $180 million of restructuring and restructuring-related charges, partly offset by a $31 million favorable legal settlement. The prior-year quarter included a $1.2 billion European Commission fine charge.
Outlook, risks and contingencies
- Management expected $1 billion of annual cost reductions from its Cost Plan to be fully captured in FY2019, excluding litigation costs above baseline. It reported $867 million of cumulative net restructuring and related charges and expected up to $50 million of additional charges.
- Qualcomm expected initial commercial 5G network deployments and device launches to begin in calendar 2019, and described continued investment in 4G/5G, automotive, IoT, networking and other adjacent markets.
- Management said available liquidity, expected operating cash flow and financing activities should meet working and other capital needs for at least the next 12 months, based on current plans. No specific quarterly revenue or EPS guidance is provided in the supplied filing text.
- Major uncertainties include Apple-related litigation and unpaid royalties, the FTC case (trial held in January 2019), regulatory proceedings and licensing challenges that could require changes to royalty practices. Qualcomm said it had not accrued losses for most such matters because losses were not considered probable and could not be reasonably estimated.
- The $1.2 billion EC fine liability was under appeal and accruing interest. The company also faced substantial purchase commitments, including $3.748 billion for the remainder of FY2019, and had a $1.15 billion RF360 joint-venture purchase option in August 2019.
- Other disclosed risks include dependence on a concentrated customer and licensee base, competition and pricing pressure, U.S.-China trade tensions, supply-chain constraints, and execution risk in cost reductions and new markets.
Important facts for investors to verify
- How much of QTL royalty revenue and receivables is collectible, particularly amounts involving Apple’s contract manufacturers and Huawei.
- The progress and potential outcomes of the FTC, Apple, EC and other regulatory or licensing proceedings, including possible business-practice remedies or financial exposure.
- Whether QCT can offset lower Apple modem sales through other customers and products, and whether segment margins stabilize.
- The quality and timing of estimated royalties recognized under ASC 606, including later adjustments when licensees report actual sales.
- The sustainability of reported earnings after excluding the discrete tax benefit and considering restructuring charges and ongoing litigation costs.
- Cash generation relative to debt, dividends, repurchases, the RF360 option, tax payments and purchase commitments.