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Qualcomm Earnings Report Will Shed More Light on Royalty Damage

Qualcomm (NASDAQ: QCOM) is in a tough situation going into the release of its fiscal fourth-quarter earnings report, set for after the market closes on Nov. 1. The chipmaker's business has been hurt by its royalty dispute with Apple (NASDAQ: AAPL), which has dented the lucrative licensing business that supplies the lion's share of its earnings before taxes (EBT).

The problem for Qualcomm is that the Apple feud has taken a turn for the worse. Cupertino has been allowed to pursue lawsuits in 11 foreign jurisdictions against Qualcomm's licensing structure, and the latter has retaliated by trying to get a ban on iPhone sales in China. This protracted battle could hinder Qualcomm's chances of getting back on track.

Image source: Qualcomm.

Revenue and earnings will take a hit

Qualcomm anticipates a 6% year-over-year drop in fourth-quarter revenue to $5.8 billion. However, the bottom-line impact will be greater as the chipmaker forecasts earnings of $0.80 per share at the midpoint of its guidance. This is significantly lower than the prior-year period's earnings of $1.28 per share.

Such a steep drop in Qualcomm's earnings can be attributed to the headwinds faced by its licensing business. The EBT from the company's licensing business stands at a whopping 73% of the revenue generated by the QTL segment. In the Qualcomm CDMA Technologies (QCT) business, EBT is only 14% of revenue.

Now, as Apple suppliers have stopped paying royalties to Qualcomm, the licensing revenue had nosedived 42% year over year in the third quarter, triggering a 51% decline in the EBT. Given that Qualcomm gets 59% of its total earnings before taxes from Qualcomm Technology Licensing (QTL), its earnings are bound to take a big hit in the fourth quarter as the fallout from the royalty payment dispute continues.

Don't expect a turnaround

Apple and Qualcomm have continued trading punches in their ongoing battle, so a resolution can't be expected anytime soon. Furthermore, the company's licensing business can get into more trouble if others follow suit. Once Apple stopped royalty payments to Qualcomm and directed its suppliers to do the same, the chipmaker was faced with the risk of other smartphone original equipment manufacturers (OEMs) following a similar path. In fact, Qualcomm has already admitted that another big smartphone maker has also stopped paying royalties.

"Our financial guidance for the fourth quarter of fiscal 2017 excludes QTL revenues related to the sale of Apple products by Apple's contract manufacturers as well as the other licensee in dispute as we expect the recent actions taken by these licensees will continue until the respective disputes are resolved," Qualcomm said in a July press release.

There's a good chance that this "other licensee" could be Huawei, which would severely dent Qualcomm's outlook in light of the latter's rapidly increasing smartphone sales. As it turns out, Huawei has already shipped over 100 million smartphones in the first three quarters of the year, and it is now going after the high-end market with new devices.

And Huawei could set a precedent for other big Chinese OEMs such as Oppo and Vivo, creating a catastrophic scenario for Qualcomm's licensing business.

On the other hand, Apple has designs of altogether eliminating Qualcomm's technology from its phones. Cupertino is reportedly investing in its own baseband modem chips after hiring Qualcomm's vice president of engineering earlier this year, so the future of the licensing business seems to be in jeopardy in any case.

Investors will be anxious to hear what Qualcomm has to say in this next earnings report.

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Harsh Chauhan has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Qualcomm and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.