Source: Seeking Alpha
Qualcomm Inc. (NASDAQ:QCOM)
F3Q 2014 Earnings Conference Call
July 23, 2014 5:45 PM ET
Warren Kneeshaw – Investor Relations
Steve Mollenkopf – CEO
Derek Aberle – President
George Davis – EVP and CFO
Mike Walkley – Canaccord Genuity
Tim Long – BMO Capital Markets
Brian Modoff – Deutsche Bank
Kulbinder Garcha – Credit Suisse
Simona Jankowski – Goldman Sachs
Ehud Gelblum – Citigroup
James Faucette – Morgan Stanley
Stacy Rasgon – Sanford Bernstein
Romit Shah – Nomura
Timothy Arcuri – Cowen and Company
Tal Liani – Bank of America Merrill Lynch
Mark Sue – RBC Capital Markets
Rod Hall – JP Morgan
Anil Doradla – William Blair
Welcome to the Qualcomm Third Quarter Fiscal 2014 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions)
As a reminder, this conference is being recorded July 23, 2014. The playback number for today’s call is 855-859-2056. International callers, please dial 404-537-3406. The playback reservation number is 63935250.
I would now like to turn the call over to Warren Kneeshaw, Vice President of Investor Relations. Mr. Kneeshaw, please go ahead.
Warren Kneeshaw – Investor Relations
Thank you, Brent, and good afternoon everyone. Today’s call will include prepared remarks by Steve Mollenkopf, Derek Aberle, and George Davis. Steve is joining us from Beijing, where he is attending the U.S.-China CEO dialog, co-convened by the U.S. Chamber of Commerce and the China Center for Economic Exchanges. Murthy Renduchintala and Don Rosenberg will join the question-and-answer session.
An Internet presentation and audio broadcast is accompanying this call and you can access them by visiting our web site at www.qualcomm.com.
During this conference call, if we use non-GAAP financial measures as defined in Regulation G, you can find the related reconciliations to GAAP on our website. I’d also like to direct you to our 10-Q and earnings release, which were filed and furnished respectively with the SEC today and are available on our web site.
During this conference call, we will make forward-looking statements regarding future events or company results. Actual events or results could differ materially from those projected in the forward-looking statements. Please refer to our SEC filings, including our most recent Form 10-Q, which contains important factors that could cause actual results to differ materially from the forward-looking statements.
And now, I would like to introduce Qualcomm’s Chief Executive Officer, Steve Mollenkopf.
Steve Mollenkopf – CEO
Thank you, Warren, and good afternoon everyone. We are pleased to report another very strong quarter, with record revenues and earnings per share, driven by broad-based demand for our 3G and multimode 3G/4G chipsets. In QCT, we shipped a record 225 million MSM chipsets, well ahead of expectations, driven primarily by strength in emerging regions.
We continue to benefit from our tiered roadmap and diversified customer base, as revenues in MSM chip shipments were up 17% and 31% year-over-year respectively. Total 3G/4G device demand in the March quarter, was stronger than our expectations. However, QTL total reported device sales and revenues were down from our prior guidance expectations, as a result of a dispute with the licensee. Under reporting by certain licensees, in China, and sales of certain unlicensed devices in China. Derek will discuss this more fully, including the actions we are taking to address this situation. We will also give a brief update on the ongoing NDRC investigation.
We began the year with several key objectives; first, we set out to compete effectively across all tiers in the LTE rollout in China, while driving the modem and AP roadmap to maintain our competitive lead. Second, we have developed plans to focus our investments on adjacent opportunities, that adopt our core technologies, as well as technologies that address the 1000X data challenge, and drive IOE adoption.
Third, we set challenging OpEx targets to achieve greater operating leverage from our scale, and finally, we committed to materially increase our return of capital. As I will explain further, I am very pleased with our results to date on all of these elements.
I will begin with the operational front, where we are executing against our initiatives to drive productivity. We remain committed to exiting our fiscal year at an overall operating expense run rate lower than our exit from last year. Our team is executing to this, while making critical investments in our roadmap and supply chain initiatives. We also continue to make progress on our efforts to focus our new business initiatives across the company.
As part of that effort, we are accelerating our transition from the current generation Mirasol display technology to the licensing of the next generation, with a focus on wearable devices. However, we will continue to make and sell the current generation Mirasol displays, to support certain existing customer requirements.
As a result of this new plan, we expect a significantly lower spend in our QMT division in fiscal 2015, providing an expected annualized savings of more than $125 million. The actions related to these changes resulted in an impairment to the QMT business this quarter, which George will cover in more detail.
Adding to our portfolio of important technologies, we recently completed a few noteworthy acquisitions. First, we acquired Velocity, a leader in the development of 60-GHZ chipsets based on the IEEE, 802.11ad standard, also known as WiGig. We have been working closely with this team for many years, and see this technology as important to the new high bandwidth used cases we expect.
The Black Sand acquisition supplements our RF team, and expands our RF 360 roadmap. And finally, we acquired leading digital still camera technology from CSR, which further enhances our differentiation in the important area of image processing.
On the product front, the first device based on our Snapdragon 805 and fourth generation multimode 3G/4G modem was launched. The Samsung Galaxy S5 broadband LTE-A. The Snapdragon 805 processor is the first mobile processor to offer system level Ultra HD support, 4K video capture and playback and when coupled with our industry-leading Gobi modems, enables users to stream and watch 4K content over LTE.
The fourth generation Qualcomm Gobi 9×35, is the first 3G LTE modem to commercially ship in smartphones, that’s the port’s global carrier aggregation deployment, up to 40-MHZ with both LTE TDD and FDD Category 6.
QCT has seen very strong design traction across its peers, with the emerging China customers. It is worth nothing that our success to-date in China is based on chipsets that were launched last year, and we are on track this quarter to commercialize our new low cost architecture with our Snapdragon 410. We believe the launch of the Snapdragon 410 and our follow-on LTE chipsets, raised the competitive benchmark and improve product costs.
With our Wi-Fi and RF360 solutions, we continue to pursue growing our share of content in devices. Both product lines continue to ramp, with our overall Wi-Fi unit volumes on track to grow more than 40% this fiscal year, as our attach rate in mobile continues to grow significantly. We now have over 100 devices launched or in design incorporating RF360, including the first launch of the device to feature the Envelope tracker, antenna tuner and power amplifier.
Looking forward, the continued roll-out and growth of multimode 3G LTE has a significant opportunity for the company. According to the GSA, 300 operators have deployed LTE and more than 200 more have committed to deploy LTE. In addition, over 55 operators have or are planning to deploy LTE Advanced services, including carrier aggregation.
We are now positioned to help enable this opportunity with our LTE Leadership position, including chipsets across multiple product tiers, and we expect to launch the Snapdragon 810, the world’s first premium tier integrated SoC with Category 6 for smartphones, later this calendar year. To-date, over 2,000 multimode 3G LTE devices have now either been launched or are in design, based on our chipset solutions. The LTE feature set continues to evolve, with features such as LTE Broadcast and LTE Direct. LTE Broadcast has been commercialized in Korea, and has been demonstrated in the U.S., Europe and Australia. We have also announced an LTE Direct trial in Germany, in collaboration with Deutsche Telekom.
Although still early in the adoption cycle, opportunities in the automotive, healthcare and wearable segments are taking shape. Our automobile pipeline continues to add OEMs and design wins. Our leadership in LTE is an advantage in this segment, as it moves from 3G to multimode LTE and this quarter, we saw General Motors launch OnStar LTE. In addition, new Android Wear devices were recently announced and Snapdragon 400 is enabling devices offered by Samsung and LG.
Adjacent opportunities allow us to build off our core investments into new growth segments. We expect to see an increasing impact of this over time.
In closing, we are making substantial progress on the key objectives we set for the company. We delivered a record quarter, and see significant opportunities ahead. Our portfolio of multimode 3G LTE chipsets has strong design traction, which positions us well, and we are working hard to address the near term challenges in our licensing business.
That concludes my remarks, and I will now turn the call over to Qualcomm’s President, Derek Aberle.
Derek Aberle – President
Thank you, Steve, and good afternoon everyone. We continue to see healthy end user device demand, spurred by among other things, the transition to 3G LTE in China. In fact, we now believe 3G/4G device demand, excluding TD-SCDMA GSM devices for calendar 2014, will be at the high end of the 1.22 billion to 1.3 billion device range that we provided last quarter, reflecting strength in both developed and emerging regions.
Turning to China, China Mobile has launched LTE service in over 300 cities, with over 300 LTE device models, and has seen increased data usage in ARPU from its LTE subscribers. In addition, LTE FDD trial licenses have been granted to both China Unicom and China Telecom. Both operators are launching hybrid LTE TDD and FDD trial networks in 16 cities. We expect those trials to expand to additional cities throughout the year. We are working closely with the operators to help them optimize their networks, and our chipset solutions, which support both the TDD and FDD modes of LTE, provide the mode, band and hand-off combinations they require for their 3G and LTE networks.
As Steve mentioned, we continue to have strong LTE chipset design momentum with manufacturers in China, and we are seeing significant demand for our multimode 3G LTE chipsets.
Here in the U.S., we have also seen positive trends as a result of competition amongst the carriers. In addition, promotions tied into the World Cup have shown success in Latin America, and we have seen positive 2G to 3G migration trends in Southeast Asia as well.
Despite this healthy 3G/4G device demand environment, we have reduced our financial outlook for QTL for this fiscal year, to reflect some challenges in China, that could prevent us from collecting royalties in the near term on the full 3G/4G device demand.
First, we have a dispute with the licensee that has resulted in a portion of that licensee shipment activity being excluded from our fiscal third quarter results and fiscal fourth quarter outlook. Like other disputes we have had in the past, we expect to resolve this situation and are in active discussions with this licensee. However, the timing of a potential resolution is uncertain.
Second, as we have previously said, the timing of the LTE launches in China, as well as device composition at China Mobile, has been a bit difficult to forecast. Although, we have signed more than 70 single mode LTE license with Chinese OEMs, we still need to sign agreements with a number of other Chinese OEMs, in order to be able to collect royalties on all three mode devices in China.
Given the time it will take to complete the remaining single mode LTE licenses in China, we expect to experience a delay in the timing of our collection of royalties on these devices.
Third, we recently have seen an increase in sales of lower tier 3G connected tablets by a number of Chinese OEMs, and we expect sales of these devices to continue to grow. This is a positive sign for 3G/4G attach rates and tablets, but the tablet OEMs are largely not the same companies that have been supplying the handsets in China, and therefore in most cases, are not currently licensed. We are in the process of negotiating licenses with this new base of potential licensees, but those discussions will take some time to complete.
Fourth, we believe that some of our Chinese licensees are under reporting, and may continue to under report a portion of their 3G/4G device sales. As we have explained in the past, we have robust and active compliance programs in priority for the business going forward. We are taking steps to confirm the underreporting and to work with the licensees to resolve the issues.
In summary, primarily, as a result of these four items, a revised QTL fiscal year outlook reflects a reduction of approximately 8% in total reported device sales for the second half of fiscal 2014. The timing of the resolution of these items is uncertain, and we will update you on our progress next quarter.
For the calendar year 2014, 3G/4G device forecast, we now expect that total unit demand will be at the high end of our prior unit estimate, for approximately 1.3 billion devices. However, we currently expect that QTL will not participate near term in the full device demand, based on the four items we just explained.
We now expect that between 1.04 billion and 1.13 billion 3G/4G devices will be reported to us for sales during calendar 2014. We estimate the impact from these four items on total reported device sales on a percentage basis to be between 6% and 9% for calendar year 2014. The percentage reduction in units is greater than in total reported device sales, because the units are expected to be lower priced devices.
Although we have these near term challenges, we continue to expect to collect royalties on all LTE devices globally, including three mode devices sold in China, and have executed more than 110 single mode LTE licenses, in addition to our more than 260 3G licenses, which cover multimode 3G/4G devices.
We have had disputes in the past, and have a good track record of successfully resolving those disputes. It is also not uncommon for a licensor to experience some delays in collecting royalties, while they negotiate license agreements covering new entrants or new products.
Finally, we are closely monitoring and in discussions with companies that we believe are underreporting or operating without a license, consistent with our longstanding compliance activities around the world.
Let me now move on to discuss the status of the investigation in China. As previously disclosed, the China National Development and Reform Commission or the NDRC, is conducting an anti-monopoly investigation of certain aspects of the company’s business, primarily the company’s licensing business and certain interactions between the company’s licensing business and our chipset business. We have met with and are continuing to fully cooperate with the NDRC, as it conducts its investigation, but the timing and outcome of any resolution remains uncertain, as does the impact on our future business in China.
That concludes my comments, and I will now turn the call over to our Chief Financial Officer, George Davis.
George Davis – EVP and CFO
Thank you, Derek and good afternoon everyone. We are pleased to be reporting strong operating and financial results this quarter, primarily driven by record QCT performance.
Fiscal third quarter revenues were a record $6.8 billion, up 9% year-over-year, and 7% sequentially. Non-GAAP operating income of $2.43 billion was up 19% year-over-year, and non-GAAP earnings per share of $1.44 was up 40% year-over-year and up 10% quarter-over-quarter. Overall, non-GAAP earnings per share were $0.24 above the midpoint of our guidance range.
Our results included a $164 million charge or $0.08 per share related to the transition of our Mirasol business, as well as a $208 million gain or $0.12 per share for reversal of expenses, related to the favorable ruling in the ParkerVision litigation.
Excluding these two items, non-GAAP earnings per share would have been $1.40, $0.20 above the midpoint of our prior guidance range. In QTL, total reported device sales by our licensees were $58.1 billion, and we estimate that 250 million to 254 million 3G/4G based devices were reported by our licensees for the March quarter at an average selling price of $228 to $234, up approximately $7 sequentially at the midpoint.
QTL’s ASP in the fiscal third quarter reflected strength in mid to high tier devices, as well as the absence of lower ASP devices associated with the licensing challenges, summarized by Derek.
In QCT, revenues, earnings before tax and MSM shipments were all quarterly records, as demands strongly exceeded our prior expectations. QCT shipped 225 million MSMs, 12 million units above the high end of our prior guidance range, primarily driven by shipments to Chinese manufacturers for 3G and 3G LTE devices. Implied revenue per MSM was approximately $22, slightly lower sequentially on the mix of demand.
QCT operating margin was 23%, also above our prior expectations, reflecting the stronger than expected MSM demand, as well as some favorable impact as a result of the ParkerVision ruling.
Non-GAAP combined R&D and SG&A expenses grew 7% sequentially, in line with our prior expectations. Investment income was strong this quarter, adding $0.06 in EPS relative to our prior guidance. Strength in the financial markets, and changes in asset allocation to lower long term risk in certain of our investment portfolios drove this contribution. Looking ahead, we forecast fiscal fourth quarter investment income to be in the range of $200 million to $250 million, which is down sequentially on lower realized gains.
Cash flow from operations was strong at 39% of revenues, and we ended the quarter with cash and marketable securities of $32.7 billion. During the quarter, we returned almost $2.1 billion to stockholders, including approximately $700 million in dividends and $1.35 billion in stock repurchases. At the end of the quarter, we had approximately $6.5 billion remaining on our buyback authorization.
Our non-GAAP tax rate was 13% and lower than expected on business mix and the effects of the ParkerVision reversal.
Now, turning to our guidance; we are updating our financial forecast for fiscal 2014 to reflect our fiscal third quarter results, and increased outlook for QCT, partially offset by our lower estimates for QTL. We estimate fiscal 2014 revenues to be in the range of approximately $26.3 billion to $27.2 billion, up approximately 8% year-over-year and unchanged at the midpoint from our prior guidance.
We expect fiscal 2014 non-GAAP earnings per share to be in the range of $5.21 to $5.36, up approximately 17% year-over-year at the midpoint, and up $0.14 per share from our previous guidance midpoint on the strength of our fiscal third quarter.
We are increasing our estimate for the reported fiscal 2014 QTL average selling price to approximately $222 to $228, which is $2 above our prior $223 estimate at the midpoint, again reflecting the absence of the mixed impact of underreported and disputed devices.
We expect combined non-GAAP R&D and SG&A expense to grow approximately 5% to 6% year-over-year, and as Steve indicated, we are still on track to exit the fiscal year below the run rate at the end of the last fiscal year.
Turning to the fourth fiscal quarter, we estimate our revenues to be in the range of approximately $6.5 billion to $7.4 billion, up approximately 7% year-over-year at the midpoint. We estimate non-GAAP earnings per share in our fourth fiscal quarter to be approximately $1.20 to $1.35 per share, up approximately 21% year-over-year at the midpoint. We anticipate fourth fiscal quarter non-GAAP combined R&D and SG&A expenses will be between 2% lower and flat sequentially.
In QTL, we forecast total reported device sales of $53 billion to $59 billion, down approximately 4% sequentially at the midpoint, reflecting the uncertain timing of potential resolution of the licensing matters.
In QCT, we anticipate MSM shipments of approximately 230 million to 245 million units during the September quarter, reflecting continued strong demand across all tiers, with particular strength in low and mid-tier chipsets for Chinese OEMs.
We expect QCT operating margin to exit the fiscal year above 20% as previously forecasted, as a result of solid execution on spending and supply chain initiatives.
We continue to expect 3G/4G channel inventory to remain within the normal 11 to 16 week range through this calendar year, with China related inventory increasing on LTE channel fill.
That concludes my comments, and I will now turn the call back to Warren.
Warren Kneeshaw – Investor Relations
Thank you, George. Operator, we are ready for questions.