Thursday, May 2, 2019

Qualcomm effectively granted Apple a late-payment discount worth billions of dollars: earnings forecast mentions one-time payment

After Apple, its contract manufacturers and Qualcomm settled their antitrust and contradict dispute at the beginning of a trial in San Diego (Southern District of California) two weeks ago, both parties declined to disclose any financial terms. Apparently Apple obtained a direct patent license from Qualcomm, and will use 5G modem chips from Qualcomm in some future iPhone models, and it became known that Apple would make a one-time payment to Qualcomm under the new agreement. On a conference call, Qualcomm CEO Steve Mollenkopf only said this (see a transcript published by CNBC) when asked about the financials of the deal: "Well, a deal like this, there’s a lot of value back and forth, and it's just best to keep it confidential."

The public version of the parties' motion to terminate a pending ITC investigation wasn't exceedingly informative either (this post continues below the document):

Apple-Qualcomm Motion to Te... by on Scribd

Despite the parties' efforts to keep the terms of the deal confidential, the impact on Qualcomm's financials is more than big enough that the patent licensing and chipset company had to say something in its earnings report for its second fiscal quarter of 2019, which also contains guidance on the third quarter and beyond:

"On April 16, 2019, we entered into settlement agreements with Apple and its contract manufacturers to dismiss all outstanding litigation between the parties. We also entered into a six-year global patent license agreement with Apple, effective as of April 1, 2019, which includes an option for Apple to extend for an additional two years, and a multi-year chipset supply agreement with Apple. While we continue to assess the accounting impacts of the agreements, our financial guidance for the third quarter of fiscal 2019 includes estimated revenues of $4.5 billion to $4.7 billion resulting from the settlement (which will be excluded from our Non-GAAP results), consisting of a payment from Apple and the release of our obligations to pay or refund Apple and the contract manufacturers certain customer-related liabilities. In addition, our financial guidance for the third quarter of fiscal 2019 includes estimated QTL revenues for royalties due from Apple and its contract manufacturers for sales made in the June 2019 quarter. Our financial guidance for the third quarter of fiscal 2019 also includes $150 million of QTL revenues from Huawei, which represents a minimum, non-refundable amount for royalties due by Huawei while negotiations continue. This payment does not reflect the full amount of royalties due under the underlying license agreement."

So we know now that the one-time payment is in the range from $4.5 billion to $4.7 billion. Let's compare this to the economically most important ones of the parties' positions in the just-settled San Diego case:

Instead of interest (or: interest on interest) on top of the $7 billion or more in previously-unpaid patent royalties, Qualcomm apparently had to discount its claim by several billion dollars in order to reach an agreement with Apple. The $4.5 billion to $4.7 billion amount of Apple's one-time payment is clearly a lot less than the royalties Qualcomm would have received if Apple, through its contract manufacturers, had made payments in accordance with the earlier agreement. In fact, just the "clawback" of de facto rebates would have amounted to roughly $2 billion, and if you add the "late payment charge" of $1.3 billion, then those secondary charges are almost at a level with the total amount of Apple's one-time payment.

What we don't know, of course, is whether Apple in exchange made some concessions with respect to ongoing royalties. And, of course, the hypothetical worst-case outcome of the San Diego litigation could even have resulted in a payment going north (from Qualcomm in San Diego to Apple in Cupertino).

The passage I quoted further above also mentions Huawei and the fact that there is only a short-term, provisional agreement in place between Huawei and Qualcomm. While Qualcomm is now optimistic that it's in a better position (after settling with Apple last month, and let's not forget they also signed a new agreement with Samsung last year) to work things out with Huawei, time will tell what's going to happen on that front. Huawei, with its HiSilicon chipset division, is in a very strong position vis-à-vis Qualcomm. And its U.S. revenues are practically zero now, so it's hard to see where Qualcomm could get any legal leverage over Huawei.

Here's a passage from Qualcomm's fine-print warnings concerning its forecasts:

"attacks on our licensing business model, including current and future legal proceedings and governmental investigations and proceedings, including potential adverse outcomes relating to the Federal Trade Commission lawsuit against us, and actions of quasi-governmental bodies and standards and industry organizations; potential changes in our patent licensing practices, whether due to governmental investigations, private legal proceedings challenging those practices, or otherwise; the difficulties in enforcing and protecting our intellectual property rights"

The FTC antitrust case in San Jose (Northern District of California) is still pending, and there hasn't been any motion to stay the case. Judge Lucy H. Koh may issue a ruling anytime now. She had already said at the end of the January trial that "this opinion [was] gonna take some time," and given the complexity, magnitude and profile of the case, that's understandable.

It's very hard (way harder than "bench reading") to infer much from the amount of time it takes a court to make a decision, but the passage of time does suggest to me that Judge Koh hasn't identified any quick "get out of jail free" card in Qualcomm's favor. As I noted in my commentary on the trial, Qualcomm basically dug itself in behind a last line of defense, claiming that the FTC hadn't proven actual anticompetitive harm (i.e., consumer harm resulting from its business-to-business practices), and that there were "procompetitive justifications." I think the allegedly "procompetitive" part is easy for the court to dismiss, but in order to get there, and to address actual anticompetitive harm (whatever the outcome may be on the different claims), the ruling has to address everything else.

In my opinion, the FTC is doing the right thing by giving Judge Koh the time she needs to rule on the case. They can still settle with Qualcomm after that decision, which will provide important guidance on a number of questions.

The Apple-Qualcomm dispute, too, involved some interesting legal questions. Fortunately, the Munich Higher Regional Court still seized its chance before the settlement to overturn (by ordering a stay, but based on the prediction that Apple's appeal would have been highly likely to succeed) a Germany-wide patent injunction that had come down without actually establishing an infringement. And now I hope there will be a chance for Judge Koh to adjudicate some key antitrust questions before the FTC settles with Qualcomm--and it appears we are still going to see that opinion.

Share with other professionals via LinkedIn: