Qualcomm's Earnings Call Dominated By Apple Lawsuit

By Evan Niu, CFA Markets Fool.com

CEO Steve Mollenkopf. Image source: Qualcomm.

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Mobile chip giant Qualcomm (NASDAQ: QCOM) reported fiscal first-quarter results last night. While the results as well as guidance mostly topped analyst expectations, Apple's (NASDAQ: AAPL) recent lawsuit against the company expectedly dominated the subsequent earnings call ("Apple" was mentioned 74 times). For good reason, too, since Apple is widely considered Qualcomm's largest customer, combined with the fact that the lawsuit threatens Qualcomm's licensing model.

Beyond a few brief statements, this is the first time that Qualcomm has commented publicly and in granular detail regarding the suit. Here's what management had to say.

Prepared remarks

CEO Steve Mollenkopf first noted that the two companies have historically had a strong relationship, and Qualcomm intends to "remain a good supplier" despite the legal complaint. The company would naturally have preferred to settle its dispute with Apple in private negotiations instead of litigation, but it remains confident that it can defend itself in court. Mollenkopf summed it up: "Apple's complaint contains a lot of assertions, but in the end, this is a commercial dispute over the price of intellectual property. They want to pay less for the fair value that Qualcomm has established in the marketplace for our technology, even though Apple has generated billions in profits from using that technology."

President Derek Aberle continued:

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Touching briefly on Apple's complaints filed in San Diego and China, it claims that Qualcomm should be required to license its cellular standard essential patents, or SEPs, to modem suppliers. That even when licensing those patents at the device level, Qualcomm should only be able to charge royalties on the price of the cellular modem chip inside the device.

These positions, however, are inconsistent with long-standing industry practice, the [intellectual property rights] policies of the relevant standard-setting bodies, the realities of licensing large portfolios of patents, and basic notions of efficiency, fairness in economics.

Aberle points out that device-level licensing is utilized throughout the industry by many major patent holders beyond Qualcomm. (Apple is seeking chip-level licensing.) Qualcomm says its patents also contribute to many other features in modern smartphones beyond cellular connectivity, further justifying device-level royalties. Shifting to chip-level royalties would then introduce different layers of licensing for all the various chips that Qualcomm enables or sells itself, so it licenses the entire portfolio for the sake of efficiency.

Apple says that there is no limit to the royalty rates, which is why it seeks per-unit royalty relief in the form of "rebate" payments. Aberle says this is untrue:

In addition, it is well known that Qualcomm has per-unit running royalty caps as part of its licensing program. This effectively results in licensees not paying running royalties as a percentage of the device price above a certain net selling price of any given device. Apple's claim that royalties are uncapped is simply incorrect.

Aberle also reiterated that Qualcomm believes Apple is instigating these regulatory attacks as well as providing inaccurate information:

Apple claims that Qualcomm retaliated because Apple cooperated with government investigations. To be clear, we did no such thing. We simply objected to Apple making false and misleading statements and withholding information to motivate attacks against Qualcomm. We welcome the opportunity to have Apple's claims heard in court, where we will be entitled to full discovery of Apple's practices and a robust examination of the merits. We will prove that Apple's irresponsible claims of extortion are false.

There should be no immediate impact to sales from the lawsuit, either. Apple still needs modems, and Qualcomm will still supply them. CFO George Davis said, "We are not forecasting any impact to revenues related to the dispute with Apple, as we are continuing to meet their supply needs in good faith and expect Apple will continue to meet its obligations."

Questions and answers

As usual, the analyst Q&A often provides more color. Qualcomm affirmed that Apple does not have a direct license, but rather an indirect license through its contract manufacturers. Qualcomm isn't worried about collecting, said Aberle:

Apple does not have a direct license with Qualcomm today. And so the royalties on Apple products that get paid to Qualcomm are reported and paid by their contract manufacturers. So although we do have a dispute now with Apple and they are challenging some of the offers and some of our licensing terms, the contracts that we have in place with their suppliers remain valid and enforceable. And we would expect that our licensees will continue to comply with the terms of their agreements. And we would also hope and expect that Apple would not interfere with the terms of those agreements. But of course, we can't fully control those actions.

When asked about the exclusivity and monopoly power allegations, general counsel Don Rosenberg (who incidentally used to work for Apple a decade ago), downplayed the idea that Qualcomm wields monopoly power:

With regard to your question about so-called exclusivity deal, first of all, we -- I think you called this monopoly power or had monopoly power. We don't believe we have monopoly power in the chip market or any other market. And nor do we have an exclusivity arrangement. We have never prevented Apple or anybody else from buying from competitive chipmakers. And in the Apple case, it's pretty clear since, as you know, they have been buying from Intel fairly recently. So it's a mischaracterization to call it an exclusive dealing arrangement.

This is a little murky, since Apple had been exclusively buying basebands from Qualcomm for five years, and only started buying from Intel after the alleged exclusivity ended.

Overall, Qualcomm thinks Apple is simply trying to finagle lower payments -- lower being beneath fair value as established by its hundreds of other licensing deals with many companies over the years. That risks somewhat oversimplifying Apple's complaint, because Apple is also accusing Qualcomm of various forms of anticompetitive behavior. Whether or not those allegations stand up in court remains to be seen.

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Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple and Qualcomm. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends INTC. The Motley Fool has a disclosure policy.