Qualcomm's Numbers and Apple Commentary Within a Healthy Margin of Error

 | Apr 19, 2017 | 9:34 PM EDT
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In some ways, Qualcomm (QCOM)  is looking like the anti-Netflix right now. Whereas the latter traded lower on Tuesday after missing subscriber expectations and offering better-than-expected guidance against a backdrop of high expectations and multiples, the former is higher after beating estimates and issuing slightly soft guidance after going into earnings with low multiples and plenty of baggage.

One thing the companies do have in common: Their earnings commentary featured clarifying details and business stats that make each company's outlook appear a little better. But Qualcomm's outlook did come with some question marks attached, the biggest of which involve its high-profile legal battle with Apple (AAPL) .

Qualcomm reported adjusted fiscal second-quarter revenue of $6 billion (up 8% annually) and adjusted EPS of $1.34 (up 29%), topping consensus analyst estimates of $5.86 billion and $1.19. It also reported 179 million MSM processor/modem chip sales (down 5%) and $82.6 billion in royalty-bearing, 3G/4G device shipments (based on December quarter device sales, up 18%), topping guidance midpoints of 175 million and $78 billion.

But the company guided for June quarter revenue of $5.3 billion to $6.1 billion (down 12% to up 1% annually) and adjusted EPS of $0.90 to $1.15 (down 22% to up 1%), below consensus estimates of $5.9 billion and $1.09 at the midpoints. MSM shipment and reported device sales guidance ranges are respectively at 180 million to 200 million and $59 billion to $67 billion, mostly below consensus estimates of 197 million and $66.5 billion.

Shares nonetheless rose 2.4% in after-hours trading to $53.87. The fact that they went into earnings trading for just 11 times a consensus fiscal 2018 (ends in September 2018) EPS estimate of $4.75 -- an estimate that doesn't account for Qualcomm's pending and highly accretive acquisition of NXP Semiconductor (NXPI)  -- doesn't hurt.

It probably also doesn't hurt that Qualcomm's remarks about Apple's royalty payments indicates a doomsday scenario -- Apple stops paying Qualcomm altogether while their battle drags out -- hasn't transpired. Though Qualcomm said the contract manufacturers responsible for paying iPhone royalties to Qualcomm paid less than they owed (on account of being paid less by Apple) for December quarter iPhone sales, it added the payments were only equal to the $1 billion in rebates that Qualcomm has withheld from Apple.

In the lawsuit it launched against Qualcomm in January, Apple claimed the company withheld rebate payments because Apple cooperated with a South Korean regulatory probe of Qualcomm. But an FTC complaint made around the same time claimed Qualcomm provided "billions of dollars in conditional rebates" to Apple in exchange for the exclusive use of its modems -- something that Apple stopped doing with the iPhone 7, which relies on both Intel (INTC) and Qualcomm modems.

Either way, Qualcomm states the Apple agreement for which it's withholding payments concluded at the end of 2016. That means going forward, Apple can't use Qualcomm's withheld payments as an excuse to cut its royalty payments. Of course, this doesn't guarantee that Apple still won't underpay, and for this reason the midpoints of Qualcomm's revenue and EPS guidance assume some underpayment. The high end of its guidance assumed full payment.

Qualcomm also mentioned that its fiscal Q2 results and Q3 guidance would be higher if not for a dispute with another licensee that had a $150 million impact on royalty revenue.

Like Apple, the licensee is paying some, but not all of the royalties Qualcomm thinks it owes. And the company also noted that chip sales are affected by supply constraints for its flagship Snapdragon 835 processor, which is used in some Galaxy S8 models as well as other high-end Android phones.

On the other hand, earnings were boosted by a lower-than-expected 15% tax rate. And it recorded $75 million in revenue from a month of activity at its just-launched RF360 Holdings JV, which makes RF filter components.

Meanwhile, Qualcomm notes a late-2016 Chinese smartphone inventory buildup -- also observed by Taiwan Semiconductor (TSM) -- boosted its March quarter royalty revenue, and will depress its June quarter revenue. Importantly, the company is keeping its full-year 3G/4G device shipment guidance unchanged at 1.75 billion to 1.85 billion, even as it now estimates 1.7 billion devices were shipped last year (the high end of prior guidance).

Taking in all the positive and negative near-term events, Qualcomm is arguably performing a little better than feared. Moreover, there were a handful of encouraging disclosures about business conditions:

  1. The estimated average selling price (ASP) for the 3G/4G devices that Qualcomm collected royalties on fell by just $1 annually, to a range of $204 to $210. For now, Qualcomm still expects to see a low-single digit ASP decline this fiscal year.
  2. Automotive, networking and IoT chip sales were said to be strong last quarter. Along with higher MSM ASPs, they allowed total chip division (QCT) revenue to rise 10% annually in spite of a 5% MSM shipment decline. In the auto market, Qualcomm says it now has Snapdragon infotainment system design wins with 12 of the top 25 auto brands. Qualcomm previously disclosed its non-phone chip revenue rose 40% in fiscal 2016 to $2.4 billion (16% of division revenue). NXP, it should be noted, is the world's largest automotive chipmaker and got the lion's share of the $9.5 billion it recorded last year from products other than phones.
  3. Qualcomm reported its mid-range Snapdragon 600 and 400 processor lines respectively have 200-plus and 190-plus devices in design, thanks partly to strong adoption among Chinese OEMs. Reports have indicated Qualcomm is gaining mobile processor share in China, aided by the value of its 4G modem edge over Asian rivals.

But for all the positive datapoints, Qualcomm will likely have no choice but to issue an earnings warning if Apple decides to play hardball and instructs its contract manufacturers to stop making royalty payments altogether. And it's still possible -- as some analysts have speculated -- that Apple will choose to fully rely on Intel's new XMM 7560 modem for this year's iPhone launches. We might not know for sure until Qualcomm provides its September quarter outlook in its next earnings report.

All the same, shares went into earnings down 21% from where it traded before the FTC and Apple filed suit. That gave Qualcomm a healthy margin of error that its latest earnings report seems to fall well within.

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