Qualcomm Highlights Its Realignment Plan To Address Its Medium Term Issues & Long Term Growth Prospects: Q3’15 Earnings Review

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A significant highlight of Qualcomm’s (NASDAQ:QCOM) Q3 2015 earnings (reported on July 22nd) was the company’s detailed restructuring plan to address near-term issues and drive its long-term profitable growth. Qualcomm’s top line has grown at a CAGR of over 20% in the last five years. However, the rising competition (from HiSilicon, Intel, MediaTek, Marvell, Samsung and others), the exclusion of its application processor from Samsung’s new Galaxy S6 smartphone, as well as the regulatory investigations in China, the U.S. and Europe, have all slowed the company’s growth momentum in the last few quarters. Qualcomm paid $975 million earlier this year to settle the regulatory investigation by China’s National Development and Reforms Commission (NDRC) for alleged monopolistic practices in the region. While the settlement helped clear the uncertainty around Qualcomm’s business in China, the company is still suffering from the heightened competition in the premium-tier segment as well as the continued underreporting by certain licensees in the region.

Despite these short-term headwinds, 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. These areas include automotive communications, the Internet-of-Things (IoT), mobile computing, networking, small cells and datacenter solutions. The company believes that its strategic realignment plan will help increase stockholder value and position it for success in an ever-changing industry environment.

Our price estimate of $71 for Qualcomm is approximately 10% above the current market price. We are in the process of updating our model for the Q3 2015 earnings.

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See our complete analysis for Qualcomm stock here

Quick Snapshot of the Q3 2015 Earnings

Qualcomm’s Q3 2015 revenue ($5.8 billion) and non-GAAP earnings ($0.99) were in line with company expectations, declining 14% and 31% year on year, respectively.

At $3.85 billion, the company’s QCT (Qualcomm CDMA Technologies) revenue declined 22% year on year and 13% quarter on quarter, in line with expectations. The operating margin for the segment stood at 7.5%, at the low end of the guided range, as stronger than expected market share and unit sales in the low tier segment in China were more than offset by weaker mix in the premium tier. Sell-through for some of Qualcomm’s premium tier customers was weaker than expected, leading to an inventory build, which is expected to impact its QCT MSM demand in the current quarter as well.

In QTL (Qualcomm Technology Licensing), the total reported device sales by Qualcomm licensees were $60.4 billion, up 4% year over year, but below the low end of the company’s guidance range. This was on account of lower than expected reported device shipments, primarily driven by a higher mix of unlicensed three-mode units and the fact that it is taking Qualcomm longer than previously expected to conclude new license agreements with certain Chinese OEMs. Overall QTL revenue for the quarter ($1.9 billion) was up 7% year on year but declined 20% sequentially. (Read the earnings release here)

Six Key Initiatives Of Qualcomm’s Realignment Plan

1. Right-sizing its cost structure

Qualcomm is working with an independent third-party consultant to conduct a comprehensive review of its cost structure. It aims to lower its spending base by approximately $1.1 billion annually, and expects to be operating at this run rate by the end of fiscal 2016. Additionally, Qualcomm plans to lower its share-based compensation grants by $300 million.

For QCT, Qualcomm’s  goal is to lower costs without sacrificing its technology leadership, customer commitments, or valuable IP roadmap. It plans to lower its workforce by 15% and streamline its operations by having fewer office locations overall and shifting some of its resources to lower-cost regions. The company is targeting to lower its QCT expenses by approximately $800 million annually, which is expected to improve the segment’s operating margin to 16% or better by Q4 2016, without assuming meaningful improvement in the current industry environment. For the long term, Qualcomm continues to target a QCT operating margin of at least 20%.

Qualcomm intends to lower its QCT R&D spend, focusing its investments on the most differentiated technologies and products that can deliver the highest return on investment. It is also working on increasing SG&A efficiencies across the company, and is combining corporate functions and reorganizing to gain efficiencies from scale in the near term.

2. Reviewing financial and structural alternatives (including the possibility of business separation)

In light of recent industry developments and other elements of its strategic realignment plan, Qualcomm is conducting a fresh review of its corporate structure and financial alternatives to create stockholder value. The company is reviewing possible business separation alternatives, additional capital return opportunities, and other potential strategic and financial alternatives that may be available to the company to create stockholder value. It plans to complete the review before the end of the current calendar year. Qualcomm has been under pressure from one investor, hedge fund Jana Partners, to spin off its business from its highly profitable patent-licensing business.

3. Reaffirming the intent to return significant capital to stockholders

In March this year, Qualcomm announced its plan to repurchase $10 billion of common stock before March 2016, in addition to its existing commitment to return at least 75% of free cash flow to stockholders, going forward. In its Q3 2015 earnings call, the company reaffirmed its intention to execute the largest capital return program in the history of Qualcomm.

4. Adding new directors with complementary skill sets and reducing the average tenure of board members

While two of its directors retired from its board, Qualcomm added two new directors (with significant experience in cost rationalization) to its board and expects to appoint a third new independent director soon.

5. Further aligning executive compensation with performance and stockholder return objectives

Qualcomm has added return on invested capital as a metric for determining performance-based equity awards. The company also intends to use EPS results in determining additional cash bonuses and plans to take stock-based compensation awarded to all employees into account when calculating EPS.

6. Making disciplined investments to further its leadership positions and build upon its core technologies and capabilities

QTL remains a source of strength for Qualcomm, where its IP and technology leadership is unrivaled, with more than 275 3G licensees and more than 140 4G single-mode licensees. The company intends to invest in adjacent opportunities; namely, networking, mobile computing, IoT, and automotive, which are expected to drive meaningful growth for QCT in the coming years. The above mentioned segments have an addressable opportunity of more than $10 billion; and based a mix of third-party estimates and Qualcomm’s own forecasts, opportunity for these four areas is expected to double to more than $20 billion by 2020. [1]

Qualcomm stated that it investments outside QTL and QCT will be refocused on the highest return areas and reduced by approximately $300 million.

Q4 2015 Outlook

– Revenue in the range of $4.7 – $5.7 billion, down approximately 22% annually and 11% sequentially at the midpoint.

– QTL revenue to flat to up slightly, driven by increased 3G/4G total reported device sales.

– 45 million unit sequential decline in MSM shipments, driven by a larger than expected decline in premium tier demand.

– QCT operating margins to be approximately 2% to 4%.

– Non-GAAP EPS to be approximately $0.75 to $0.95. Fiscal 2015 full year earnings estimate is expected to be in the range of $4.50 to $4.70 per share.

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Notes:
  1. Qualcomm’s Q3’15 Earnings Transcript, Seeking Alpha, July 22, 2015 []