Qualcomm warns of big shortfall as Apple chokes supplier royalties

Qualcomm warned investors on Friday that it could face a multibillion-dollar shortfall in sales and profits over the coming years if it is unable to resolve its legal fight with Apple, after the iPhone maker choked the ability of its own suppliers to pay royalties to the chip designer. 

In a drastic deterioration in the legal battle with one of its largest customers, Qualcomm slashed its revenue guidance for the current quarter by about $500m. Apple’s move fulfils what one Wall Street analyst had previously described as a “doomsday scenario” for the world’s biggest wireless chip company. Qualcomm shares were down 3 per cent to $51.58 in mid-morning trading on Friday.

Apple told Qualcomm this week that it is “withholding payments” from contract manufacturers such as Foxconn, which the companies would normally owe to Qualcomm in royalties for iPhone sales — a practice Qualcomm has described as an “example of Apple wielding its enormous commercial leverage over its suppliers”. In turn, these suppliers are dependent on Qualcomm’s intellectual property for key wireless components of the iPhone.

“Apple has indicated it will continue this behaviour until its dispute with Qualcomm is resolved,” the chipmaker said in a statement, a process some analysts believe could take years. 

As a result, for the quarter ending in June, Qualcomm said its revenues would be in a range of $4.8bn-$5.6bn, compared with its previous expectation for sales of $5.3-$6.1bn, making a year-on-year decline all but inevitable. Diluted earnings per share would be markedly lower than it had previously suggested to investors, in a range of $0.52-$0.62, down from $0.67-$0.92. 

Friday’s cut to its outlook suggests Apple is responsible for more than 20 per cent of the chipmaker’s sales for the March quarter. Analysts estimate Qualcomm relies on Apple royalties for more than a quarter of its earnings.

Qualcomm’s warning comes just a week after it had told investors that it did not anticipate “a scenario where no payment is made by the contract manufacturers”. Qualcomm had, however, warned of greater uncertainty in its forecasting due to the Apple litigation. 

On Friday, Qualcomm said Apple’s contract manufacturers “may make some form of partial payment, but initial indications are that any payment would likely be insignificant”. Its new guidance assumes no payment is made for the quarter. 

“Apple’s continued interference with Qualcomm’s agreements to which Apple is not a party is wrongful and the latest step in Apple’s global attack on Qualcomm,” Don Rosenberg, Qualcomm’s general counsel, said.

Apple contends that it has been “overcharged billions of dollars” over several years by Qualcomm, accusing the chipmaker of “exclusionary tactics and excessive royalties”. 

“We are extremely disappointed in the way Qualcomm is conducting its business with us and . . . we have no choice left but to turn to the courts,” the iPhone maker said in January. 

On Friday, it responded: “We’ve been trying to reach a licensing agreement with Qualcomm for more than five years but they have refused to negotiate fair terms. Without an agreed-upon rate to determine how much is owed, we have suspended payments until the correct amount can be determined by the court. As we’ve said before, Qualcomm’s demands are unreasonable and they have been charging higher rates based on our innovation, not their own.”

We are surprised by the number of investors that believe the two companies are likely to reach a quick settlement

Apple’s litigation included a demand for $1bn that the iPhone maker claims Qualcomm owes it and withheld after Apple participated in an investigation by the Korea Fair Trade Commission. Earlier this month, Qualcomm warned that Apple had withheld that $1bn sum from its suppliers. The iPhone maker’s latest move goes much further, with far-reaching consequences for the designer and maker of Snapdragon processors and other key smartphone components. 

Analysts at Citi in January had described the prospect of Apple withholding royalties from Qualcomm as a “Doomsday scenario”, while Morgan Stanley, in a recent note, predicted the legal battle could last for two to three years. 

“We are surprised by the number of investors that believe the two companies are likely to reach a quick settlement,” Morgan Stanley analysts said. 

In a note on Friday, analysts at Stifel cut their estimates for Qualcomm’s full-year earnings, saying that Apple's royalty payments represent as much as 30 per cent of the company’s total earnings.

“We view Apple's refusal to pay Qualcomm's royalties as a bold gesture and an escalation of the tensions between the two companies,” Stifel said. “While we view the reduced contribution from Apple as being priced into the shares, we believe investors remain concerned that Qualcomm will be forced to change its broader licensing business strategy.”

Apple has never held a direct licence for Qualcomm’s IP, instead relying on agreements between contract manufacturers such as Foxconn. Mr Rosenberg said that Qualcomm’s licence agreements with Apple’s suppliers “remain valid and enforceable”. 

“While Apple has acknowledged that payment is owed for the use of Qualcomm’s valuable intellectual property, it nevertheless continues to interfere with our contracts,” he said. “Apple has now unilaterally declared the contract terms unacceptable; the same terms that have applied to iPhones and cellular-enabled iPads for a decade.” 

He added: “We will continue vigorously to defend our business model, and pursue our right to protect and receive fair value for our technological contributions to the industry.”

Apple’s action threatens to escalate further a bitter legal battle that is already raging in courts across three continents. 

Earlier this month, when it filed its legal response against Apple, Qualcomm said that the iPhone maker’s “tortious interference” in its contracts with suppliers “violated . . . California law”. “The prospect of Apple’s continued interference threatens significant additional injury to Qualcomm,” it warned in the April 10 filing, leaving open the possibility that it could seek further legal redress against Apple or its suppliers after its latest move.