Quarterly report pursuant to Section 13 or 15(d)

Basis of Presentation and Significant Accounting Policies Update (Notes)

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Basis of Presentation and Significant Accounting Policies Update (Notes)
3 Months Ended
Dec. 30, 2018
Basis of Presentation [Abstract]  
Basis of Presentation and Significant Accounting Policies Update
Basis of Presentation and Significant Accounting Policies Update
Financial Statement Preparation. These condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and the instructions to Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the interim financial information includes all normal recurring adjustments necessary for a fair statement of the results for the interim periods. These condensed consolidated financial statements are unaudited and should be read in conjunction with our Annual Report on Form 10-K for the fiscal year ended September 30, 2018. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year. We operate and report using a 52-53 week fiscal year ending on the last Sunday in September. Each of the three-month periods ended December 30, 2018 and December 24, 2017 included 13 weeks.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in our condensed consolidated financial statements and the accompanying notes. Actual results could differ from those estimates. Certain prior year amounts have been reclassified to conform to the current year presentation.
Revision of Prior Period Financial Statements. In connection with the preparation of our condensed consolidated financial statements for the three months ended December 30, 2018, we identified an immaterial error related to the recognition of certain royalty revenues of our QTL (Qualcomm Technology Licensing) segment in the quarterly and annual periods in fiscal 2018 and third and fourth quarters and annual period in fiscal 2017. In accordance with SAB No. 99, “Materiality,” and SAB No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements,” we evaluated the error and determined that the related impact was not material to our financial statements for any prior annual or interim period, but that correcting the cumulative impact of the error would be significant to our results of operations for the three months ended December 30, 2018. Accordingly, we have revised our consolidated balance sheets at September 30, 2018 and September 24, 2017 and condensed (if applicable) consolidated statements of operations, comprehensive income (loss) and cash flows for the years ended September 30, 2018 and September 24, 2017, and the three months periods ended September 30, 2018, June 24, 2018, March 25, 2018, December 24, 2017, September 24, 2017 and June 25, 2017, including the related notes presented herein, as applicable. A summary of revisions to our previously reported financial statements is presented in Note 11. We will also correct previously reported financial information for such immaterial error in our future filings, as applicable.
Earnings (Loss) Per Common Share. Basic earnings (loss) per common share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding during the reporting period. Diluted earnings per share is computed by dividing net income by the combination of dilutive common share equivalents, comprised of shares issuable under our share-based compensation plans and shares subject to accelerated share repurchase agreements, if any, and the weighted-average number of common shares outstanding during the reporting period. Due to the net loss for the three months ended December 24, 2017, all of the common share equivalents issuable under share-based compensation plans had an anti-dilutive effect and were therefore excluded from the computation of diluted loss per share. The following table provides information about the diluted earnings (loss) per share calculation (in millions):
 
Three Months Ended
 
December 30,
2018
 
December 24,
2017
Dilutive common share equivalents included in diluted shares
10.3

 

Shares of common stock equivalents not included because the effect would be anti-dilutive or certain performance conditions were not satisfied at the end of the period
11.7

 
46.0


Share-Based Compensation. Total share-based compensation expense, related to all of our share-based awards, was comprised as follows (in millions):
 
Three Months Ended
 
December 30,
2018
 
December 24,
2017
Cost of revenues
$
8

 
$
10

Research and development
157

 
156

Selling, general and administrative
65

 
82

Share-based compensation expense before income taxes
230

 
248

Related income tax benefit
(48
)
 
(49
)
 
$
182

 
$
199


At December 30, 2018, total unrecognized compensation expense related to nonvested restricted stock units granted prior to that date was $1.5 billion, which is expected to be recognized over a weighted-average period of 2.3 years. At December 30, 2018, we had outstanding 29.4 million restricted stock units that contain only a service requirement and 3.9 million stock options.
Recently Adopted Accounting Pronouncements.
Revenue Recognition: In May 2014, the Financial Accounting Standards Board (FASB) issued new accounting guidance related to revenue recognition (ASC 606), which outlines a comprehensive revenue recognition model and supersedes most current revenue recognition accounting guidance. The new accounting guidance defines a five-step approach that requires a company to recognize revenue as control of goods or services transfers to a customer at an amount that reflects the expected consideration to be received in exchange for those goods or services. We adopted ASC 606 in the first quarter of fiscal 2019 using the modified retrospective transition method only to those contracts that were not completed as of October 1, 2018. We recognized the cumulative effect of initially applying the new revenue accounting guidance as an adjustment to opening retained earnings. Prior period results have not been restated and continue to be reported in accordance with the accounting guidance in effect for those periods (ASC 605). We have implemented new accounting policies, systems, processes and internal controls necessary to support the requirements of ASC 606.
Adoption of this new accounting guidance most significantly impacts the timing of sales-based royalty revenues, which are the vast majority of our QTL segment’s revenues. Previously, we recognized sales-based royalties as revenues in the period in which such royalties were reported by licensees, which was after the conclusion of the quarter in which the licensees’ sales occurred and when all other revenue recognition criteria had been met. Under the new accounting guidance, we estimate and recognize sales-based royalties in the period in which the associated sales occur, subject to certain constraints on our ability to estimate such amounts, resulting in an acceleration of revenue recognition compared to the historical method. Since we do not invoice for sales-based royalties recognized in any given quarter until after the conclusion of that quarter (which is generally the following quarter when such royalties are reported by licensees), revenues recognized from sales-based royalties results in unbilled receivables (included in accounts receivable, net on the condensed consolidated balance sheet). The adoption of ASC 606 did not otherwise have a material impact.
The new accounting guidance also impacts the timing of recognizing certain customer incentives, which are recorded as a reduction to revenues in the period that the related revenues are earned. We previously accounted for certain customer incentive arrangements, including volume-related and other pricing rebates or cost reimbursements for marketing and other activities involving certain of our products and technologies, in part based on the maximum potential liability. Under the new accounting guidance, we estimate the amount of all customer incentives.
The following table summarizes the cumulative effects of adopting the new revenue accounting guidance (substantially all of which related to the impact to QTL’s sales-based royalties) on our condensed consolidated balance sheet at October 1, 2018 (in millions):
 
Balance as of September 30,
2018
 
Adjustment
 
Opening Balance as of October 1,
2018
Assets
 
 
 
 
 
Accounts receivable, net
$
2,904

 
$
957

 
$
3,861

Other current assets
699

 
1

 
700

Deferred tax assets
936

 
(98
)
 
838

Other assets
1,970

 
1

 
1,971

 
 
 


 


Liabilities
 
 
 
 
 
Unearned revenues, current
$
500

 
$
6

 
$
506

Other current liabilities
6,978

 
125

 
7,103

Unearned revenues
1,620

 
(110
)
 
1,510

 
 
 
 
 
 
Stockholders’ equity
 
 
 
 
 
Retained earnings
$
542

 
$
840

 
$
1,382

The following tables summarize the impacts of adopting the new revenue accounting guidance on our condensed consolidated balance sheet and statement of operations (in millions):
 
As of December 30, 2018
Balance Sheet
As Reported
ASC 606
 
Adjustment
 
ASC 605
Assets
 
 
 
 
 
Accounts receivable, net
$
3,426

 
$
(845
)
 
$
2,581

Other current assets
855

 
23

 
878

Deferred tax assets
3,923

 
56

 
3,979

Other assets
2,056

 
1

 
2,057

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Unearned revenues, current
$
484

 
4

 
$
488

Other current liabilities
6,831

 
(271
)
 
6,560

Unearned revenues
1,420

 
309

 
1,729

 
 
 
 
 
 
Stockholders’ equity
 
 
 
 
 
Retained earnings
$
3,415

 
$
(807
)
 
$
2,608

 
Three Months Ended December 30, 2018
Statement of Operations
As Reported
ASC 606
 
Adjustment
 
ASC 605
Revenues
 
 
 
 
 
Equipment and services
$
3,754

 
$
(15
)
 
$
3,739

Licensing
1,088

 
51

 
1,139

Investment and other income, net
5

 
2

 
7

Income tax benefit
509

 
(5
)
 
504

Net income
1,068

 
33

 
1,101


Adoption of the new accounting guidance had no impact to net cash provided (used) by operating, financing or investing activities on our condensed consolidated statement of cash flows in the first quarter of fiscal 2019.
Financial Assets: In January 2016, the FASB issued new accounting guidance on classifying and measuring financial instruments, which requires that all equity investments, other than equity-method investments, in unconsolidated entities generally be measured at fair value through earnings in the statement of operations. Additionally, it changes the disclosure requirements for financial instruments. We adopted the new accounting guidance in the first quarter of fiscal 2019 using the modified retrospective transition method for investments in marketable securities, which have readily determinable fair values, with the cumulative effect of applying the new accounting guidance recognized as an adjustment to opening retained earnings. Upon adoption, we reclassified $50 million of unrealized gains, net of the associated tax effects, related to our investments in marketable securities from accumulated other comprehensive income to opening retained earnings. We have applied the prospective transition method for investments in non-marketable securities, which are investments in privately held companies that do not have readily determinable fair values and will recognize any unrealized gains that have accumulated in the period in which there is an observable transaction, if any.
Hedge Instruments: In August 2017, the FASB issued new accounting guidance that expands and refines hedge accounting for both financial and non-financial risks, aligns the recognition and presentation of the effects of hedging instruments and hedged items in the financial statements, and includes targeted improvements related to the assessment of hedge effectiveness. The new accounting guidance also modifies disclosure requirements for hedging activities. We adopted the new accounting guidance in the first quarter of 2019 using the modified retrospective transition method and recorded a negligible adjustment to opening retained earnings. The new accounting guidance did not have a material impact on our condensed consolidated financial statements.
Statement of Cash Flows: In August 2016, the FASB issued new accounting guidance related to the classification of certain cash receipts and cash payments in the statement of cash flows. We adopted the new accounting guidance in the first quarter of fiscal 2019 using the retrospective transition method for each period presented, which did not have a material impact on our condensed consolidated statements of cash flows.
In November 2016, the FASB issued new accounting guidance that requires companies to include changes in restricted cash and cash equivalents in the statement of cash flows. As a result, the statement of cash flows no longer reflects transfers between cash and cash equivalents and restricted cash and cash equivalents. We adopted the new accounting guidance in the first quarter of fiscal 2019 using the retrospective transition method, which will result in certain amounts in fiscal 2018 being adjusted to conform to the new accounting guidance. During fiscal 2018, we had restricted cash and cash equivalents related to funds deposited as collateral for outstanding letters of credit in connection with a then proposed acquisition. Restricted cash and cash equivalents related to the outstanding letters of credit totaled $2.0 billion at the end of the fourth quarter of fiscal 2017 and first quarter of fiscal 2018. There was no impact of this change on the activity presented within the statement of cash flows for the three months ended December 24, 2017.
Income Taxes. In October 2016, the FASB issued new accounting guidance that changes the accounting for the income tax effects of intra-entity transfers of assets other than inventory. Under the new accounting guidance, the selling (transferring) entity is required to recognize a current tax expense or benefit upon transfer of the asset. Similarly, the purchasing (receiving) entity is required to recognize a deferred tax asset or deferred tax liability, as well as the related deferred tax benefit or expense, upon receipt of the asset. We adopted the new accounting guidance in the first quarter of fiscal 2019 using the modified retrospective transition method, with the cumulative effect of applying the new accounting guidance recognized as an adjustment to opening retained earnings of $2.6 billion, primarily as the result of establishing a deferred tax asset on the basis difference of certain intellectual property distributed from one of our foreign subsidiaries to a subsidiary in the United States in fiscal 2018 (Note 3). The ongoing impact of this accounting guidance will be dependent on the facts and circumstances of any transactions within its scope.
Recent Accounting Pronouncements Not Yet Adopted.
Leases: In February 2016, the FASB issued new accounting guidance related to leases that outlines a comprehensive lease accounting model and supersedes the current lease accounting guidance. The new accounting guidance requires lessees to recognize lease liabilities and corresponding right-of-use assets for all leases with lease terms of greater than 12 months. It also changes the definition of a lease and expands the disclosure requirements of lease arrangements. We will adopt the new accounting guidance in the first quarter of fiscal 2020 and expect to use the modified retrospective approach and to elect certain practical expedients, with the cumulative effect of applying the new accounting guidance recognized as an adjustment to opening retained earnings in the year of adoption. We are in the process of determining the effects the adoption will have on our consolidated financial statements.
Financial Assets. In June 2016, the FASB issued new accounting guidance that changes the accounting for recognizing impairments of financial assets. Under the new accounting guidance, credit losses for certain types of financial instruments will be estimated based on expected losses. The new accounting guidance also modifies the impairment models for available-for-sale debt securities and for purchased financial assets with credit deterioration since their origination. The new accounting guidance will be effective for us starting in the first quarter of fiscal 2021 and generally requires the modified retrospective transition method, with the cumulative effect of applying the new accounting guidance recognized as an adjustment to opening retained earnings in the year of adoption, except for certain financial assets where the prospective transition method is required, such as available-for-sale debt securities for which an other-than-temporary impairment has been recorded. Early adoption is permitted starting in the first quarter of fiscal 2020. We are in the process of determining the effects the adoption will have on our consolidated financial statements and whether to adopt the new accounting guidance early.
Accounting Policy Update.
Revenue Recognition. As a result of the adoption of ASC 606, we revised our revenue recognition policy beginning in fiscal 2019 as follows.
We derive revenues principally from sales of integrated circuit products and licensing of our intellectual property. We also generate revenues by performing software hosting, software development and other services and from other product sales. The timing of revenue recognition and the amount of revenue actually recognized in each case depends upon a variety of factors, including the specific terms of each arrangement and the nature of our performance obligations.
Revenues from sales of our products are recognized upon transfer of control to the customer, which is generally at the time of shipment. Revenues from providing services are typically recognized over time as the performance obligation is satisfied. Revenues from providing services were less than 5% of total revenues for all periods presented.
We grant licenses or otherwise provide rights to use portions of our intellectual property portfolio, which, among other rights, includes certain patent rights essential to and/or useful in the manufacture and sale of certain wireless products. Licensees pay royalties based on their sales of products incorporating or using our licensed intellectual property and may also pay a fixed license fee in one or more installments. Sales-based royalties are generally based upon a percentage of the wholesale (i.e., licensee’s) selling price of complete licensed products, net of certain permissible deductions (including transportation, insurance, packing costs and other items). We broadly provide per unit royalty caps that apply to certain categories of complete wireless devices, namely smartphones, tablets and laptops, which in general, effectively provide for a maximum royalty amount per device. We estimate and recognize sales-based royalties on such licensed products in the period in which the associated sales occur, subject to certain constraints on our ability to estimate such royalties. Our estimates of sales-based royalties are based largely on an assessment of the volume of devices supplied into the market that incorporate or use our licensed intellectual property. We estimate sales-based royalties taking into consideration the mix of such sales on a licensee-by-licensee basis, as well as the licensees’ average wholesale prices of such products, and considers all information (historical, current and forecasted) that is reasonably available to us. Our licensees, however, do not report and pay royalties owed for sales in any given quarter until after the conclusion of that quarter, which is generally the following quarter. As a result of recognizing revenues in the period in which the licensees’ sales occur using estimates, adjustments to revenues will be required in subsequent periods to reflect changes in estimates as new information becomes available, primarily resulting from actual amounts reported by our licensees.
License agreements that require payment of license fees contain a single performance obligation that represent ongoing access to a portfolio of intellectual property over the license term since such agreements provide the licensee the right to access a portfolio of intellectual property that exists at inception of the license agreement and to updates and new intellectual property that is added to the licensed portfolio during the term of the agreement that are highly interdependent or interrelated. Since we expect to expend efforts to develop and transfer updates to our licensed portfolio on an even basis, license fees are recognized as revenues on a straight-line basis over the estimated period of benefit of the license to the licensee.
We account for a contract when it is legally enforceable, the parties are committed to perform their respective obligations, the rights of the parties regarding the goods and/or services to be transferred are identified, payment terms are identified, the contract has commercial substance and collectability of substantially all of the consideration is probable.
From time to time, companies initiate various strategies to attempt to renegotiate, reduce and/or eliminate their need to pay royalties to us for the use of our intellectual property. Certain licensees have disputed, underreported, underpaid, not reported and/or not paid royalties owed to us under their license agreements with us or reported to us in a manner that is not in compliance with their contractual obligations, and such licensees may continue to do so in the future. In such cases, we estimate and recognize licensing revenues only when we have a contract, as defined in ASC 606, and to the extent it is probable that a significant reversal of cumulative revenues recognized will not occur. We analyze the risk of a significant revenue reversal considering both the likelihood and magnitude of the reversal and, if necessary, constrain the amount of estimated revenues recognized in order to mitigate this risk, which may result in recognizing revenues less than amounts contractually owed to us.
We measure revenues based on the amount of consideration we expect to receive in exchange for products or services. We record reductions to revenues for customer incentive arrangements, including volume-related and other pricing rebates and cost reimbursements for marketing and other activities involving certain of our products and technologies, in the period that the related revenues are earned. The charges for such arrangements are recorded as a reduction to accounts receivable, net or as other current liabilities based on whether we have the contractual right of offset. Certain of these charges are considered variable consideration and are included in the transaction price based on estimating the most likely amount expected to be provided to the customer/licensee.
Revenues recognized from sales of our products and sales-based royalties are generally included in accounts receivable, net (including certain unbilled receivables) based on our unconditional right to payment for satisfied or partially satisfied performance obligations.
We disaggregate our revenues by segment (Note 7) and type of product and services (as presented in our statement of operations), as we believe this best depicts how the nature, amount, timing and uncertainty of our revenues and cash flows are affected by economic factors. Substantially all of QCT’s revenues consist of equipment revenues, which are recognized at a point in time, and substantially all of QTL’s revenues represent licensing revenues that are recognized over time.
Revenues recognized from performance obligations satisfied (or partially satisfied) in previous periods were $72 million in the first quarter of fiscal 2019 and primarily relate to QTL royalty revenues recognized related to devices sold in prior periods and certain customer incentives.
Unearned revenues (which are considered contract liabilities) consist primarily of license fees for intellectual property with continuing performance obligations. In the first quarter of fiscal 2019, we recognized revenues of $133 million that were included within the unearned revenues balance at October 1, 2018.
Remaining performance obligations, substantially all of which are included in unearned revenues, represent the aggregate amount of the transaction price of certain customer contracts yet to be recognized as revenues as of the end of the reporting period and exclude revenues related to (a) contracts that have an original expected duration of one year or less and (b) sales-based royalties (i.e., future royalty revenues) pursuant to our license agreements. Our remaining performance obligations are primarily comprised of certain customer contracts for which QTL received license fees upfront. At December 30, 2018, we had $2.0 billion of remaining performance obligations, of which $411 million, $450 million, $415 million, $409 million and $193 million was expected to be recognized as revenues for the remainder of fiscal 2019 and each of the subsequent four years from fiscal 2020 through 2023, respectively, and $77 million thereafter.
Marketable Securities and Non-Marketable Securities. Prior to the adoption of the new accounting guidance in the first quarter of fiscal 2019, investments in marketable equity securities were generally classified as available-for-sale equity investments, with net unrealized gains or losses recorded as a component of accumulated other comprehensive income, net of income taxes. Beginning in fiscal 2019, all gains and losses on investments in marketable equity securities, realized and unrealized, are recognized in investment and other income, net.
Prior to the adoption of the new accounting guidance in the first quarter of fiscal 2019, investments in non-marketable equity securities were recorded at cost less impairment, if any, with any losses resulting from an impairment recognized in investment and other income, net. Beginning in fiscal 2019, investments in non-marketable equity securities are recorded at cost, less impairments, adjusted for observable price changes in orderly transactions for identical or similar securities. All gains and losses on investments in non-marketable equity securities, realized and unrealized, are recognized in investment and other income, net.