Bloomberg News

Qualcomm Profit Forecast Falls Short Amid China Challenge

July 23, 2014

Qualcomm Inc. (QCOM:US), the biggest maker of mobile-phone chips, forecast fiscal fourth-quarter profit that may fall short of analysts’ estimates, citing challenges to its technology-licensing business in China.

Net income in the quarter ending in September will be $1.03 to $1.18 a share, the San Diego-based company said today in a statement. On average (QCOM:US), analysts projected earnings of $1.23, according to data compiled by Bloomberg.

Chief Executive Officer Steve Mollenkopf has been trying to extend his company’s dominance in high-speed Internet-capable phone chips to China, as the country upgrades its networks to the standard known as long-term evolution. Some device makers in the world’s most populous country are failing to pay for use of the company’s patents, Qualcomm said, threatening profit growth even as it sells more chips there.

“It’s a bit of a surprise,” said Mark McKechnie, an analyst at Evercore Partners LLC in San Francisco, who rates the stock the equivalent of a buy. “Two-thirds of their profits come from royalties -- it’s high-margin, good business, and the chips can’t really make up for it.”

Qualcomm shares (QCOM:US) fell as much as 5.2 percent in extended trading following the report. Earlier, the stock was little changed at $81.60 at the close in New York, leaving it up 9.9 percent this year. That compares with a 19 percent surge in the Philadelphia Semiconductor Index.

Customer Dispute

“We are experiencing some near-term challenges in the licensing business, particularly related to China,” Qualcomm President Derek Aberle said in a phone interview. “This is something that we will take care of. The timing is pretty uncertain.”

Qualcomm is in a dispute with a large customer over license revenue, and other customers are under-reporting the amount of phones sold that they should have paid license fees on, Aberle said. Some other small companies in China haven’t yet agreed to pay, he said. He didn’t name any of the customers.

While Qualcomm gets the bulk of its profit from technology licensing, the majority of its sales (QCOM:US) come from semiconductors. Revenue in the current quarter will be $6.5 billion to $7.4 billion, the company said, helped by higher sales of its advanced chips. Analysts on average had estimated sales of $7.13 billion.

Third Quarter

Third-quarter net income (QCOM:US) rose 42 percent to $2.24 billion, or $1.31 a share. Sales in the period that ended June 29 rose 9 percent to $6.81 billion, only the second time quarterly revenue has increased less than 10 percent since 2010. Analysts on average had predicted earnings of $1.06 a share on sales of $6.52 billion.

The company said it shipped a record 225 million chips in the quarter, up 31 percent from a year earlier. It’s predicting that number will rise as high as 245 million this quarter, which would represent a gain of 29 percent.

Qualcomm’s results rely heavily on its two largest customers (QCOM:US), Samsung Electronics Co. and Apple Inc. Orders for parts for Apple’s new iPhones, projected to be coming later this year, may help Qualcomm’s chip revenue. Yesterday, Apple said iPhone sales in its most recent quarter rose 13 percent from a year earlier, including a 48 percent jump in China.

At the same time, Samsung’s Galaxy line of smartphones may be losing market share. Qualcomm doesn’t discuss individual customers.

Phone Royalties

The company benefits from the sale of handsets even when they don’t use its chips. Qualcomm’s ownership of code-division multiple-access, or CDMA, technology lets it charge royalties on most phones connected to modern data networks. The exception to that has been China Mobile, which has used a technology the Chinese government said wasn’t subject to Qualcomm’s licensing (QCOM:US).

As China Mobile shifts to LTE, Qualcomm has said it expected that to change, and that phones connecting to the higher-speed data standard will mean higher licensing fees. Qualcomm is also trying to use its lead in processors that have built-in LTE connections to increase sales of chips.

Rivals such as MediaTek Inc. and Intel Corp. (INTC:US) have been slow to cut into Qualcomm’s lead in LTE, where its market share stands at more than 90 percent. Others, such as Broadcom Inc., have given up on trying to break Qualcomm’s hold on mobile-phone modem chips.

China Investigation

The company has been working to overcome obstacles in China for several quarters. In November, it disclosed that the country’s National Development and Reform Commission had begun an investigation related to an anti-monopoly law. That caused some non-licensed device makers to hold off on negotiating with the company on fees, Qualcomm said today.

The Chinese government agency is looking at Qualcomm’s licensing business and its interaction with the company’s chip unit. Qualcomm has had talks with the NDRC and the timing and resolution of the investigation is still uncertain, Aberle said on a conference (QCOM:US) call.

“Whatever the resolution will be, it will likely include some form of payment” to the government, Aberle said.

Qualcomm predicts industrywide shipments of 1.3 billion 3G and 4G mobile devices in 2014. Of that total, the company estimates that customers will report 1.04 billion to 1.13 billion units as the basis for license revenue calculations, meaning Qualcomm won’t get paid for the technology on as many as 260 million phones this year unless it can solve the disputes and sign up new licensees, Aberle said.

“Qualcomm told investors that they had the China customers under contract, that it’s all worked out,” said Suji De Silva, an analyst at Topeka Capital Markets. He has a hold rating on the stock. “Now we’re getting a sense that it’s still a challenge. Qualcomm is trying to monetize its technology and China is a more challenging market.”

To contact the reporter on this story: Ian King in San Francisco at ianking@bloomberg.net

To contact the editors responsible for this story: Pui-Wing Tam at ptam13@bloomberg.net Jillian Ward, Virginia Van Natta


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