QUALCOMM INC quarterly report, Q2 FY2018

QUALCOMM Incorporated — Form 10-Q Summary

Reporting period: Second quarter and six months ended March 25, 2018; fiscal 2018. Amounts are U.S. dollars unless stated otherwise. The interim financial statements are unaudited.

Business context

Qualcomm earns revenue primarily from QCT, its semiconductor products business, and QTL, its intellectual-property licensing business; QSI makes strategic investments. The quarter reflected stronger equipment and services activity, including RF front-end products, while licensing results were pressured by disputes with Apple and another licensee. Qualcomm continued preparing a proposed acquisition of NXP Semiconductors.

Financial performance

Metric	Q2 FY2018	Q2 FY2017	Six months FY2018	Six months FY2017
Total revenue	$5.261 billion	$5.016 billion	$11.329 billion	$11.015 billion
Operating income	$441 million	$729 million	$471 million	$1.507 billion
Net income (loss)	$363 million	$749 million	$(5.590) billion	$1.431 billion
Diluted EPS	$0.24	$0.50	$(3.78)	$0.96
Operating cash flow	Not presented separately for quarter	Not presented separately for quarter	$2.278 billion	$2.406 billion

Q2 revenue increased 5%; equipment and services rose $247 million to $3.936 billion, while licensing revenue was essentially flat at $1.325 billion. Six-month revenue increased 3%.
Q2 gross margin was 57%, versus 56%; six-month gross margin was 57%, versus 58%. Management attributed the six-month decline primarily to lower higher-margin licensing revenue as a share of sales, partly offset by improved QCT margins.
Q2 operating income fell 40% and net income fell 52% year over year. Six-month net loss chiefly reflects a $5.95 billion income tax charge associated with U.S. tax reform; the six-month reported tax expense was $5.922 billion.
QCT Q2 revenue was $3.897 billion, up $221 million; segment earnings before tax were $608 million, up $133 million. QTL revenue was $1.260 billion, down $989 million, and segment earnings before tax were $850 million, down $1.109 billion.

Liquidity, debt and capital returns

At March 25, cash and cash equivalents were $37.946 billion and marketable securities totaled $1.660 billion, or $39.606 billion combined. Cash, cash equivalents and marketable securities were up $1.028 billion from September 24, 2017.
Short-term debt was $3.733 billion and long-term debt was $19.361 billion, approximately $23.1 billion combined. Outstanding commercial paper was $2.2 billion; Qualcomm reported no borrowings under its revolving credit or delayed-draw term facilities at quarter-end.
Six-month operating cash flow was $2.278 billion; investing activities provided $1.481 billion and financing activities used $874 million. Cash dividends paid were $1.689 billion and capital expenditures were $411 million.
Qualcomm paid dividends of $1.14 per share during the first half and announced an increase in the quarterly dividend to $0.62 per share, payable June 20, 2018. It repurchased $425 million of shares in the first half; $1.2 billion remained authorized.
Management stated existing liquidity, expected operating cash flow and financing sources were expected to meet working and other capital needs for at least 12 months, based on current plans.

Material changes and unusual items

Tax reform: The provisional tax charge included an estimated $5.3 billion repatriation tax and $562 million from remeasuring deferred taxes. Qualcomm estimated net cash payments of $3.2 billion after tax credits, payable over eight years beginning January 15, 2019. The accounting remained subject to refinement.
Regulatory fines: Qualcomm recorded a $1.18 billion charge for the European Commission fine in Q1; the quarter-end liability, including currency effects, was $1.23 billion. It appealed the decision and planned to provide financial guarantees instead of cash payment while the appeal proceeded. The outstanding Taiwan Fair Trade Commission fine was approximately $771 million, payable in installments through December 2022.
Cost plan: Announced in January, the plan targets $1 billion of annual cost reductions, excluding costs of any future acquisition, expected to be fully captured in fiscal 2019. Qualcomm recorded $310 million in restructuring and related charges in Q2 and expected total charges of $400–$525 million.
NXP transaction: The tender offer price was raised to $127.50 per share, with estimated consideration of $44 billion; the minimum tender condition was reduced to 70%. The closing remained subject to regulatory clearance, including MOFCOM approval. On April 19, 2018, the parties extended the end date to July 25, 2018. Qualcomm anticipated using cash, existing notes and committed financing. Failure to close could involve a $2.0 billion termination fee payable by Qualcomm in specified circumstances.
Apple and licensing disputes: Qualcomm recorded no Q2 or first-half royalty revenue for sales of Apple’s products by its contract manufacturers or for the other licensee in dispute. Management said the disputes reduced QTL revenue and earnings and could continue to affect revenue, cash flow and legal costs.
Broadcom’s proposed takeover was withdrawn in March after a U.S. presidential order prohibited the transaction. Qualcomm said responding to the proposal consumed management resources and increased legal and advisory costs.

Outlook, commentary and principal risks

Management expects continued demand growth in 3G/4G and emerging 5G, and opportunities in automotive, IoT and networking. It continued substantial investment in 4G/5G and related technologies; no specific consolidated revenue or earnings guidance is provided in the filing text.
Qualcomm said QTL results could remain affected by royalty disputes, incomplete reporting by some licensees, delayed licensing agreements, and potential changes in licensing practices. Its announced SEP-only licensing terms through 5G Release 15 and a lower smartphone royalty cap may support long-term stability but could pressure near-term licensing revenue.
Risks include NXP regulatory approval and financing/integration, substantial litigation and regulatory proceedings, possible changes to patent licensing arrangements, customer and licensee concentration, competition and pricing pressure, longer device replacement cycles, U.S.–China trade relations, supply constraints, and execution of the cost plan.
Other material exposures include provisional tax accounting and tax examinations. The company stated that outcomes of legal and regulatory matters, other than accrued EC and TFTC fines, could not be reasonably estimated and that unfavorable outcomes could materially affect results, financial condition or cash flows.

Investor verification checklist

Track Apple and other licensee disputes, royalty reporting and collections, and resulting QTL revenue and cash-flow trends.
Verify NXP regulatory approval, tender progress, financing needs, termination provisions and the effect on liquidity and leverage.
Monitor appeals, guarantees, payment obligations and potential additional exposure relating to the EC and Taiwan fines.
Check for revisions to the provisional tax-reform charge, estimated $3.2 billion cash Toll Charge, and effective tax-rate outlook.
Assess progress toward the $1 billion cost-reduction target, restructuring cash costs and the timing of realized savings.
Compare future QCT performance, margins and customer mix with QTL performance, while monitoring competitive pressure and licensing-model changes.