Qualcomm beats analysts' expectations in Q3, but struggles to ink Chinese licensing deals

Qualcomm (NASDAQ:QCOM) reported quarterly earnings that beat analysts' expectations, even as its sales and profit fell sharply from a year ago. However, Qualcomm's expectations for its current quarter fell below analysts' forecasts, as the chipset giant is facing headwinds in negotiating new patent licensing deals with Chinese smartphone makers.

In the fiscal fourth quarter, which ended Sept. 27, Qualcomm said its net income plunged 44 percent to $1.1 billion, or 67 cents per share. Meanwhile, the company's total revenue slipped 18 percent to $5.45 billion. Analysts on average predicted earnings of 62 cents per share on revenue of $5.21 billion, according to Bloomberg.

However, for the company's fiscal first quarter of 2016, Qualcomm said it is predicting earnings of 80 cents to 90 cents per share and revenue of $5.2 billion to $6 billion. Those figures would represent a decrease in earnings of 33 to 40 percent from a year ago and a drop in revenue of 15 to 27 percent from a year ago. The figures are also below estimates of analysts polled by Thomson Reuters for per-share profit of $1.08 and revenue of $5.79 billion.

Qualcomm gets most of its revenue from chip sales but more than half of its profit from licensing its technologies. The company has been under pressure from an activist investor, Jana Partners, to consider splitting up the two businesses.

Qualcomm CEO Steve Mollenkopf said yesterday on the company's earnings conference call that the firm's review of whether it should split is "on track" and is expected to be completed by the end of 2015. As part of a reorganization it announced in July, Qualcomm is cutting $1.4 billion in costs, slashing more than 4,500 jobs from its workforce, changing some of its corporate practices and reviewing whether to split up its chipset and licensing units.

In February Qualcomm agreed to pay a $975 million fine and change its licensing practices to settle a Chinese antitrust investigation. Under the terms of the settlement, Qualcomm agreed to offer licenses tied to its current 3G and 4G essential Chinese patents separately from licenses to its other patents. Qualcomm also agreed to 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.

Mollenkopf said on the conference call that the company's performance has been affected by "delays in concluding new license agreements in China and share gains by Chinese OEMs that have been under-reporting royalties" to its licensing unit.

The Qualcomm chief said that the firm has been "working hard" to implement the settlement with China's National Development and Reform Commission (NDRC) terms and improve compliance. "While we have made progress with these negotiations and concluded new agreements recently with two major Chinese OEMs, progress has been slower than we had originally anticipated," he said, referring to deals with ZTE and TCL. "The timing of concluding new agreements and progress with compliance is inherently difficult to predict, but we fully expect to successfully conclude new agreements and improve compliance over time."

Qualcomm President Derek Aberle said the company has offered the NDRC license terms for its current 3G and 4G essential Chinese patents to its licensees and to a number of unlicensed OEMs and manufacturers. Qualcomm has signed more than 60 China patent licensing agreements to date, and the deals include royalty bearing licenses for devices that include TD-LTE technology.

"The key point is we believe we are going to resolve these things," Mollenkopf said in an interview with Re/code, adding that the company has been cautious about assuming any new agreements in its short-term financial guidance.

Looking ahead, Mollenkopf said that in the premium tier, Qualcomm is seeing strong customer interest in its high-end Snapdragon 820 "among leading OEMs with more than 60 designs overall." The company has also launched its fifth-generation Snapdragon X12 LTE modem, "which offers industry leading throughput and power efficiency with support for all modes and the latest Cat 12 downlink and Cat 13 uplink capabilities. We have confidence in customer traction and expect it to be a significant product for us in the second half of the fiscal year."

Mollenkopf said the Snapdragon 820 will help the company's results in the second half of its fiscal year, meaning in the spring and summer of next year.

Qualcomm has also been hurt as Samsung Electronics and Apple (NASDAQ: AAPL) have each used their own applications processors in their latest smartphones, though Apple relies on Qualcomm for the iPhone's modem chips. Samsung's Galaxy S6 line of phones uses Samsung's own Exynos processors and not Snapdragon. However, Mollenkopf said that Qualcomm has "a very good relationship with Samsung" that is "much broader than perhaps people ask us about."

"We are a strong foundry partner and foundry customer of theirs. We obviously have an IP arrangement as well as a product arrangement. We also have partnerships with products that we put on our Reference Design, so it's a very broad relationship," he said, according to a Seeking Alpha transcript. "And the way I would characterize it is that it's getting stronger versus moving the other direction. So it's good to have the scale and the breadth of products that we have. I think it gives us probably a little bit more to bring to the table when we talk to large multinational companies."

For more:
- see this release (PDF)
- see this Seeking Alpha transcript
- see this WSJ article (sub. req.)
- see this Reuters article 
- see this Bloomberg article 
- see this Re/code article

Special Report:  Wireless in the third quarter of 2015

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