Qualcomm Posts Moderate Revenue Gains In Q1’17 As Threats From Lawsuits Loom Large Over Licensing Business

Leading chipset maker, Qualcomm (NYSE:QCOM) posted its fiscal Q1’17 results on January 25th. (Fiscal years end with September.) The company’s revenues increased in low-single digits in the quarter on a year over year basis and declined sequentially. The sequential decline was primarily because the company had gained from one time catch up payments in the prior quarter. In terms of business segments, Qualcomm’s licensing business (QTL) revenues increased by 13% in Q1’17, while its revenues from chipset business (QCT) stayed almost at similar levels as in Q1’16. Furthermore, the company’s GAAP operating margins declined in Q1, as it recorded a fine of $868 million imposed by the Korean Fair Trade Commission (KFTC).

For Q2’17, Qualcomm expects its revenues and non-GAAP earnings per share to increase by 6% and 15%, respectively, at the midpoint. Furthermore, the company expects modem shipments and total reported device sales figures in Q2 to increase by 5.5% and 11.5%, respectively, at the mid-point. The growth in device sales and modem shipments should drive Qualcomm’s growth in both its licensing and chipset businesses in the quarter.

In the table below, we can note the key metrics as reported by the company in Q1’17:

Source: Sec filings

We are in the process of updating our model for Qualcomm

See our complete analysis for Qualcomm

Threats From Lawsuits Looming Large Over Qualcomm’s Business

At the center of Qualcomm’s Q2’17 earnings call was the discussion related to recent lawsuits against the company. The company took the time to explain and dispute these charges. It should be noted that Apple recently filed a $1 billion lawsuit against the company, alleging that Qualcomm overcharged it for chips and refused to pay rebates worth $1 billion because the smartphone maker was engaged in discussions with Korea Fair Trade Commission (KFTC) in another legal proceeding against Qualcomm. Apple also alleged that Qualcomm attempted to persuade it to provide false information to the KFTC in order to get the rebates. Prior to the lawsuit by Apple, U.S. Fair Trade Commission (FTC) initiated a lawsuit against Qualcomm, alleging that certain monopolistic business practices of the company were in violation of Fair Trade Commission Act of 1914, in which basic US patent law was first set down. Furthermore, the company was slapped a fine of $846 million by the KFTC last month for alleged abuse of its market dominance.

Though Qualcomm strongly disputes these charges, there can be significant negative implications for the company if its appeal gets rejected. As a result of these lawsuits, Qualcomm’s royalty rate is likely to be pressured or even reversed. For instance, the terms Qualcomm is said to have imposed on Apple include a 5% royalty rate imposed on the full cost of the iPhone. This will likely be seen to be unreasonable. More typically, a rate of only 3% would be levied on the chipset selling price. Given that licensing business constitutes more than 80% of Qualcomm’s operating income, these lawsuits can weigh heavy on Qualcomm’s overall profitability. (For more details read our article: Qualcomm’s Licensing Business Could Be Undermined By The Rising Number of Lawsuits Against The Company)

Nevertheless, Qualcomm’s Diversification Strategy Can Drive Its Business Going Forward

Having talked about the threat of lawsuits for Qualcomm, we must not underestimate the company’s growth prospects. The company is entering new markets to drive its future growth. The company estimates its addressable market to be around $138 billion by 2020. Some of the key developments of Qualcomm that excite us about its future growth prospects are as follows:

• Qualcomm’s DRIVE Data Platform – At the CES this year, Qualcomm introduced its Drive Data Platform, which the company claims is designed to intelligently collect and analyze information from vehicle’s sensors. Given the potential to impact the huge number of people, this market can be a significant growth opportunity for Qualcomm. (For more details read our article: Qualcomm Dives Into The Connected Car Market With Its Drive Data Platform)
• Qualcomm’s collaboration with Microsoft – At the hardware developer conference in Shenzhen, China, Microsoft announced that it is collaborating with Qualcomm to enable Windows 10 on mobile computing platforms that will be based on Qualcomm’s Snapdragon chipset. This is a significant development for Qualcomm, because for the first time its Snapdragon processors will be used to power Windows devices. (For more details read our article: Opportunity For Qualcomm Could Be A Setback For Intel)
• Qualcomm’s first 10nm chip for server processor market – The company recently announced the commercial sampling and the live demonstration of the world’s first 10nm server processors. Given that currently, Intel commands more than 90% of this market, data center companies are looking for alternative suppliers to increase their bargaining power. (For more details read our article: Qualcomm Advantageously Positioned To Compete In The Server Chip Market)

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