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Chinese slowdown looms large in results of warring Qualcomm and Apple

Qualcomm and Apple may be engaged in a bitter legal battle, but they have pressures in common, notably the rising influence of China on their financial performance, and the uncertainty arising from the current trade tensions between that country and their US home.

Qualcomm’s results, in recent years, have been haunted by arguments over licensing fees, with Chinese firms as well as Apple. When the chip provider was under investigation by Chinese antitrust authorities, most of the country’s chip and handset makers withheld royalties, and although Qualcomm reached a settlement with the authorities four years ago, fees have been slow to flow again, from some partners at least. This situation has been worsened by Apple, and its manufacturing partners such as Foxconn, suspending payments while the two US firms remain locked in litigation over allegations related to patent infringement and business practices.

There was a small measure of relief on this front for Qualcomm, which said it had signed a short term licensing deal with Huawei during its first fiscal quarter of 2019 (ended December 2018). This has solved a running dispute with a major handset customer, at least temporarily. Huawei agreed to pay quarterly installments of $150m until the end of June to cover a portion of the royalties that are owing. Negotiations for a long term settlement continue however.

This reminds us that, although Apple remains obdurate, Qualcomm has been settling disputes with other major customers, including many Chinese firms, and Samsung. It agreed a new patent deal with the Korean handset leader a year ago, and that saw Samsung withdrawing from a Korea Fair Trade Commission probe into Qualcomm’s licensing practices.

Qualcomm CEO Steve Mollenkopf told the analyst call to discuss the Q1 earnings: “We continue to believe that over the course of 2019, we will reach a resolution on the key outstanding issues in our disputes with Apple through settlement or litigation, and we are prepared for both outcomes.” He added that his firm remains engaged in settlement talks with the US Federal Trade Commission. Last week, both Qualcomm and Apple presented closing arguments, and the former said it made a strong case regarding allegations about its business practices, but it would be willing to accept a deal to “remove this risk from the table”.

In the first fiscal quarter, Qualcomm reported lacklustre results, hit by weakness in the smartphone market, particularly in China. It announced a 22% fall in chip shipments, year-on-year, to 186m units, and a 20% drop in revenue to $4.8bn. However, it returned to profit, with net income of $1.1bn compared to a loss of $6bn in fiscal Q1 2018.

At Apple, results were also downbeat, with China a major factor. Apple had warned its shareholders of a poor quarter before the Christmas period, when it said sales for the critical holiday quarter would be about $84bn, rather than the figure of $89bn to $93bn that had been predicted.

In fact, fourth quarter sales were down 5% year-on-year to $84.3bn, mainly because of challenges in China and disappointing iPhone sales. Net income was also down 5%, to $19.7bn. Sales in the Greater China region were down by $4.8bn compared to the first quarter of 2018, with declines across iPhone, Mac and iPad, CEO Tim Cook said. “Most of the shortfall relative to our original guidance, and over 100% of our worldwide year-over-year revenue decline, was driven by our performance in Greater China,” he admitted.

Fourth quarter iPhone revenues were down 15% year-on-year to $52.3bn, though Apple no longer discloses unit shipment figures. Estimates by analyst Timothy O’Shea of Jefferies are that they fell 18% year-on-year to about 63.4m smartphones, which would indicate inventory problems ahead. “Apple now sits on millions of extra iPhones that will need to be sold at deep discounts to clear the channel,” wrote O’Shea in a client note. “We estimate this alone could drive 100 basis points [or 1 percentage point] of gross margin contraction.”

The high price of the iPhone has always limited its addressable market in some countries or user bases, and that becomes a problem if Apple does not achieve the obvious counterweight to that – higher margins, and continuing growth in affluent and aspirational segments. Cook hinted that Apple had overpriced the iPhone in some key markets, though he also blamed foreign exchange movements, saying: “What we have done in January and in some locations and some products is essentially absorbed part or all of the foreign currency move as compared to last year and therefore got close or perhaps right on the local price from a year ago. So, yes, I do think that price is a factor.”

The figures clearly show how Apple has allowed itself to become hopelessly over-reliant on its star product. Many analysts have expressed shock that the company has not made greater provisions, at an earlier stage, for the clearly predictable trend to slower growth in the smartphone space, plus to address challenges in China. Cook has previously said that Apple’s poor performance in China was a natural consequence of the country’s slowing economic growth, and its failure to “foresee the magnitude of the economic deceleration… in Greater China”. However, he also acknowledged that the situation had been exacerbated by “rising trade tensions with the US”.

Outside the iPhone, other revenues were up 19% in the quarter, but they are dwarfed by the sales from the main device. Apple said it had set sales records for the Mac family and its wearables, and service revenues were up 19% to $10.9bn.

The company has been focused on services as its main growth engine for a couple of years now, investing in content, media streaming, cloud offerings, smart home apps and other areas. However, this business remains only 13% of its revenue, and it brings its own challenges – not least, the pressure to move away from the famous walled garden approach, in which software and services only work on Apple devices and exist primarily to drive sales of those gadgets. If future growth is to rely on the services per se, they will need to run on as many devices as possible, but that means Apple will lose control of its fabled user experience, with lower levels of vertical integration.

The gamble may be worth taking though. Services deliver a constant stream of highly renewable revenue, especially subscription models, and are more profitable than hardware – gross margin in services was 63% in the quarter, compared with 34% in hardware. Apple is on track to double annual service revenues between 2016 and 2020, said CFO Luca Maestri, which would deliver $48.6bn in sales.

Mac sales increased by 9% year-on-year, Apple said, while wearables sales were up nearly 50%. Revenue from the iPad line was also up, by 17%, its best growth rate in almost six years.

Apple said it expects sales for the first quarter of 2019  to between $55bn and $59bn, slightly above consensus analysts’ expectations.

Intel under pressure from Chinese slowdown:

Intel was also feeling the cold winds of China’s economic slowdown in its fourth quarter earnings and first quarter forecast, both of which fell below Wall Street’s expectations.

Although Intel set a full year sales record, for the third year in a row, with 2018 revenues of $70.8bn, this was overshadowed by disappointment in the Q418 performance of its central data center unit. The group delivered 9% sales growth in the quarter, but this was lower than analysts had expected, and Intel warned that weak Chinese demand would continue to affect this most important business.

Bob Swann, Intel’s interim CEO, also pointed to sharply lower modem demand and a weakening pricing environment for NAND memory as factors in the sales shortfall, relative to Wall Street forecasts.

“Since October, trade and macro concerns — especially in China — have intensified,” Swann told analysts. “Cloud service providers shifted from building capacity to absorbing capacity and the demand pricing environment has further deteriorated. Those incremental headwinds are impacting our revenue expectations and slightly reducing our operating margin percentage forecast.”

Intel reported fourth quarter sales of $18.7bn, up 9% year-on-year, and net income of $5.2bn, reversing a loss of $700m in year-ago quarter (largely down to tax law changes).

Wall Street had hoped for Q4 sales of $19.1bn.

Q4 sales were up year-on-year across each of Intel’s business units except for IoT, where sales of $816m were down 7% (though this was entirely because of the divestment of Wind River in Q218. Organic sales were up 4%).

Despite the weak pricing environment for NAND, the memory group reached a record $1.1bn in the fourth quarter, up 25% year-on-year. Sales at the Client Computing Group were up 9% to $9.8bn, and the Data Center Group posted sales of $6.1bn, up 9%.

For the full-year 2018, Intel reported sales of $70.8bn, up 13% from 2017. The company’s profit for the year was $21.1bn, up 28% from 2017.

Intel said that it expects sales to fall to about $16bn in the first quarter, far short of consensus analysts’ expectations of about $17.4bn. This result would represent a slight decline from sales of $16.1bn in the first quarter of 2018.

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