Qualcomm’s Q2 2015 Earnings Preview: Increasing Competition To Lower Guidance in 2015

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Leading mobile chipmaker Qualcomm (NASDAQ: QCOM) will report its Q2 2015 earnings on April 22nd. (Fiscal years end with September.) The company reported a strong Q1 2015, achieving record revenues and non-GAAP operating income in the quarter, with QCT (Qualcomm CDMA Technologies)  accounting for approximately half of the upside. Qualcomm’s QTL (Qualcomm Technology Licensing) business, which has been facing challenges in China since the last few quarters, came in ahead of expectations and the company resolved a previously disclosed dispute with a large Chinese licensee.

After a year long battle, Qualcomm last month agreed to pay China’s National Development and Reforms Commission (NDRC) $975 million in fines for alleged monopolistic practices in the region. China is a major source of growth for Qualcomm’s 3G/4G LTE chipsets. The country’s expanding high-speed 4G network is driving demand for smartphones with leading-edge technology. Settling the anti-trust probe with NDRC removes a significant source of uncertainty from Qualcomm’s business and positions its licensing group to really participate in the full growth of the wireless market in China, in the company’s view.

Qualcomm is also being  pressed by one of its key investors, Jana Partners, which has assets of about $11 billion.  Jana, which owns 4.4 million Qualcomm shares (for a 1.75% stake in the company), urges management to spin off its chip business from its patent-licensing business to restore investor confidence in the company. Jana Partners also wants Qualcomm to cut costs, accelerate its share buyback program, improve disclosures and refresh its board. [1]

For Q2 2015, Qualcomm’s revenue guidance is between $6.5 billion to $7.1 billion, up 7% year on year at the midpoint. The company expects its QCT and QTL revenue to be up 6% and 3% year on year, respectively, at the midpoint of the guided range. Despite incresing competition, Qualcomm is confident that its long-term outlook remains strong, both in smartphones and adjacent areas where its mobile technologies and capabilities can bring next generation solutions, areas such as automotive communications, the Internet of Things, mobile computing, networking, small cells and data center solutions.

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Our price estimate of $72 for Qualcomm is marginally higher than the current market price. We will update our model after the Q2 2015 earnings release.

See our complete analysis for Qualcomm stock here

Reduced Outlook For The QCT Business In The Second Half Of Fiscal 2015

Qualcomm’s QCT business achieved a number of records in Q1 2015, including shipments of 270 million MSM chipsets, revenues of $5.2 billion and earnings before tax of $1.1 billion. Revenue in MSM chip shipments were up 14% year on year as Qualcomm saw broad strength across multiple OEMs, driven by demand in emerging regions and strong device replacement in the U.S.

Though Qualcomm’s outlook for the first half of fiscal 2015 is ahead of its initial expectation, the company has reduced its forecast for the second half of the year due to the following factors:

1. Due to technical issues, Qualcomm’s Snapdragon 810 processor will not be in the upcoming design cycle of Samsung’s  S6 device, impacting the company’s outlook for both volume and content in that device.

2. The company claims to be seeing a shift in share among OEMs at the premium tier, which has lowered the near term addressable opportunity for Qualcomm’s Snapdragon processors and has skewed the product mix towards more modem chipsets in this tier.

3. Although Qualcomm had a very strong competitive position exiting fiscal 2014, it has admitted to seeing heightened competition in China at the mid and high tiers. The company continues to gain share with OEMs based in China, but not at the pace previously expected. This is in part due to some product challenges with one of its chips in meeting some of the more demanding design points of mid and high tier segment. This has provided an opening to competitors who are being very aggressive in order to establish a position in the marketplace, resulting in more pricing pressure than previously expected.

Qualcomm claims to have already addressed many of the initial product challenges in order to support early customer device launches in these tiers and continues to further enhance the performance of this chip. It expects to see a broad range of devices successfully launch and drive volume with this chip in the future. The design momentum for the Snapdragon 810 processor remains robust, with more than 60 products in the pipeline, including the recently announced LG G Flex2 and the Xiaomi Mi Pro Note.

Clouds of Uncertainty Cleared As Licensing Dispute With A Major OEM Resolved

In Q1 2015, Qualcomm resolved its patent-licensing business with China’s National Development and Reform Commission by agreeing to pay $975 million fine. Aside from the fine, Qualcomm laid out some specific changes to its business it will make as a result of the resolution. Interestingly, the company revealed its patent-licensing rates—a figure the company generally doesn’t make public. The company said: [2]

1. It will offer licenses to its current 3G and 4G essential Chinese patents separately from licenses to its other patents.

2. It will charge a 5 percent royalty rate for most 3G devices in China and 3.5 percent for most 4G devices. The company’s existing licensees will be able to move to the new rates now. [3]

3. And “Qualcomm will not condition the sale of baseband chips on the chip customer signing a license agreement with terms that the NDRC found to be unreasonable or on the chip customer not challenging unreasonable terms in its license agreement,” the company said. However, Qualcomm noted this doesn’t require it to sell chips to any entity that is not a Qualcomm licensee, and does not apply to a chip customer that refuses to report its sales of licensed devices as required by its patent license agreement.

For companies opting for the new agreement, which applies to phones sold for use in China, Qualcomm will calculate royalties based on 65% of the phone’s selling price, instead of on the whole price. Lowering its royalty rates in China could affect the company’s licensing deals elsewhere, forcing the company to reduce its royalty rates globally.

Qualcomm now has greater confidence that it will be able to collect royalties over time on substantially all LTE device shipments, including 3-mode devices in China and other currently unlicensed products. OEMs supplying a meaningful portion of 3-mode devices and lower Tier 3G connected tablets remained unlicensed. The company is undergoing discussions with many of these OEMs and claims to be making positive progress, though it will take some time to conclude all of the negotiations.

As a result of the resolution, Qualcomm now expects revenues in its fiscal year ending September 27th, 2015, of between $26.3 billion and $28 billion, up slightly from its previous range of $26 billion to $28 billion.

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Leading mobile chipmaker Qualcomm (NASDAQ:QCOM
Notes:
  1. Will Spinning-Off Its Chip Business Be A Good Move For Qualcomm?, April 15th, 2015 []
  2. Qualcomm agrees to $975M fine to end China dispute, February 9th, 2015 []
  3. Qualcomm in $975m deal to settle Chinese probe []