Qualcomm Earnings Preview: Cost Cutting Measures In Focus As Struggle Expected To Continue

Qualcomm (NASDAQ:QCOM), the  leading developer of CDMA technology, will report its Q4 fiscal 2015 earnings on November 4^th.  (Fiscal years end with September.)  The past fiscal year has been a tough one for the company. Last February, the company achieved a settlement with the government of China governing the royalties it charges to licensees in that large market. Due to performance and other issues with a new Snapdragon processor, Qualcomm lost a socket on the new Samsung Galaxy 6, as the Korean Smartphone behemoth opted to use one of its own. Facing diminished growth on the wider scale adoption of 4G LTE, the company announced a broad reorganization with the last quarter release, offered with sober guidance for this quarter’s release. And since then, economic weakness in China has induced a decline in Smartphone demand, with a resultant inventory build in the supply chain.  Indeed, consensus revenues and EPS estimates for the final quarter of the fiscal year at the midpoints look grim and encompass declines of 22% and 32%, respectively.

However, 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 in areas such as automotive communications, the Internet-of-Things, mobile computing, networking, small cells and data center solutions.

Our price estimate of $65 for Qualcomm is approximately 10% above the current market price. We will update our model after the Q4 2015 earnings release.

See our complete analysis for Qualcomm stock here

QCT Revenues To Fall In Q4 2015, But Key Developments Can Spur Future Demand

Even though the total reported device shipments are expected to increase by 5%-10% globally, Qualcomm expects to report Q4 fiscal 2015 revenue in the range of $4.7 billion – $5.7 billion, which reflects a decrease of 15%-30% year-over-year. The company’s chipset business, which constitutes 62% of the revenue, will be affected due to weak smartphone sales in China. Qualcomm’s revenue from China constituted approximately 50% its international revenue in 2014. According to a Gartner report in August 2015, the worldwide smartphone sales recorded slowest growth rate since 2013.

In addition to the smartphone slowdown, a number of other factors have slowed the growth momentum for Qualcomm’s chipset sales. These include: 1) the rising competition from HiSilicon, Intel, MediaTek, Marvell, Samsung and others; 2) the exclusion of its application processor from Samsung’s new Galaxy S6 smartphone; and, 3) the increasing trend of phone manufacturers towards choosing to design their own chipsets to lower costs. We currently forecast Qualcomm’s chipset market share to decline from 86% in 2014 to around 67% by the end of the Trefis forecast period.

While we acknowledge that the company’s top line from the chipset business has been under pressure over the last few quarters, recent developments can help re-accelerate Qualcomm’s mobile chips demand in fiscal 2016. Earlier this year, Qualcomm unveiled new processors that may well reignite its near term growth.  These include the Snapdragon 430 and Snapdragon 617 for mid-range mobile devices and Snapdragon 820 processor for the premium segment. Also, there are reports that Samsung is looking at the possibility of integrating the Snapdragon 820 in its upcoming premium mobile, Galaxy S7 in fiscal 2016, which can spur the demand for company’s chipset next year.

Licensing Revenues Affected By Decreasing Royalty Rates And Underreporting Of Sales 

Qualcomm paid litigation charges of $975 million earlier this year, to settle regulatory investigation by China’s National Development and Reforms Commission for alleged monopolistic practices in the region. As a part of the settlement with NDRC, Qualcomm has agreed to ease its royalty rate regimen for Chinese vendors. Lowering its royalty rates in China could affect the company’s licensing deals elsewhere, forcing the company to reduce its royalty rates globally. The company planned to decrease the under-reporting by negotiating with the licensees on the new China terms in Q4 fiscal 2015, but the longer term prospects for its licensing business still remain a concern.

We currently forecast that Qualcomm’s royalty rates for mobile devices will decline from 2.8% in 2014 to 2.6% by the end of the Trefis forecast period.

Focus To Improve Shareholder Return Amid Sluggish BottomLine

In Q3 2015, Qualcomm announced its intention to create more value for its shareholders through a series of targeted cost reductions (by $1.1 billion) in its strategic realignment plan. The company plans to reduce stock-based compensation by approximately $300 million and lower its workforce by 15% and have fewer offices going forward. Qualcomm’s goal is to decrease costs and improve its focus only on high growth and profitable segments, apart from its current QCT and QTL investments. Earlier this year, the company announced plans to buy back shares worth $10 billion and return 75% of excess cash flow to stock holders, which is in line with its goal to create more value for its shareholders. Furthermore, Qualcomm linked EPS results to cash bonuses awarded to employees to improve execution and enhance financial performance.

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