QUALCOMM Incorporated (QCOM) Earnings Call Transcript & Summary

All right. I think we're going to go ahead and get started. So if everybody could grab a seat. Last session of the day, but not the least by any chance, by any means. So my name is Rod Hall. I'm the infrastructure, technology and mobile systems analyst at Goldman Sachs, and I've got the pleasure of having Steve Mollenkopf, the Chief Executive Officer of Qualcomm Incorporated with me. So Steve, welcome, thanks for coming.

Thank you. Thanks for having me.

Really appreciate it. Steve is running over from a Samsung event earlier today. So having a busy day as usual as the CEO. I don't know if you want to open up with any comments about the announcements today. Want to kick it off that way, or you want me to jump right into questions, up to you.

Well, just real quickly. I mean I think we just came over from the Samsung event. As expected, they did a number of phones. All of them, I think, good examples of technology that we work with them on. And I'm really happy to see them really going with a lot of innovation, particularly in the area of -- so you got a lot of 5G going on, which is obvious, but then just tremendous amount of work going on in the camera. Things that we've been investing in, and it's great to see that hit the market. And as you know, there's some great devices there. And it's the first of, I think, many.

A couple of millimeter-wave devices, good content for Qualcomm, I assume? So that's good.

Yes.

So on that front, we believe that 5G should be good for Qualcomm. However, your chip business ASP increased by quite a bit more than the EBT per chip in this last set of earnings that you just reported. And a lot of people came away from that thinking, "Well, maybe these 5G chips are being sold at lower margins." So I wonder if you could just elaborate on that, kind of -- is that telling us anything or is it really too early to tell? What should we be taking away from that for 5G economics?

Well, I think the real data point is, we've been talking about the content growth in kind of similarly situated phones between 4G and 5G. And this is, I think, the first time where you start to see the real example of that hitting the business actually, which is a very good thing. And it's actually happening at the beginning part of ramp. If you look, for example, look at the December quarter versus the March quarter guide, I think the only thing you can conclude is the first inflection point that we were looking for happened and probably happened a little bit sticking into the December quarter, which we really didn't anticipate, we're very happy to see. Now I will tell you that there's been nothing going on with gross margin percent sequentially or even different than what we think. But these -- the -- so you really -- you're kind of seeing that you're seeing a little bit less units maybe. From quarter-to-quarter, you've got to carry that through and do the calculation, obviously. But there's more content, more complexity in the 5G devices themselves. They cost us more to sell, and they cost more to buy. Net-net all -- net all that together, we -- you do see a growth in revenue and content per device. You do see even a flow-through to an improvement in operating income in the chip business, and that will continue particularly as we get to the second inflection point, which really happens in the last part of the year as well. So we're seeing everything that we expected to see. There's really nothing here that looks unusual other than probably a little bit more in the December quarter than we thought.

Okay. And as you look over the next 2 or 3 years and you think about the margins and what 5G does to margins, would it be -- do you believe it's a tailwind to margins over that period? You just think you'll kind of hold QCT margins where they -- roughly where they are, plus or minus a little bit?

It's a tailwind. I mean, right now, we have the investment in 5G, got some investment in some early businesses that we've seen the right things, but you don't have the business running at the full revenue scale, which you will see really exiting the year. Our intention is to get the leverage. We do have some operating expense growth that we see but very small relative to what we see. So the real model is, get the benefit of 5G, get all the customers in there that we think are going to get in there, make sure that we hold the operating expenses in the right place and get the earnings growth. And then we fully expect to see that. We haven't seen anything this year other than confirmation of the model that we see. And we're probably a little bit north of what we expected to see in December.

Okay. All right, fair enough. So you indicated you expect QCT revenues in the June quarter to be flattish on the March quarter. And knowing that 5G is ramping pretty rapidly in China, we thought you'd see some sequential increase there. So could you just walk us through kind of the puts and takes around that indication that you've given, the demand related, timing related? Just give us some idea of what's happening there.

Yes. We didn't speak a lot about the Q3, the June quarter other than to try to make sure people had the shape of the year and then kind of the right place generally. And I would say we had probably 2 things that were there. One is kind of how we saw directionally, the June quarter, we gave some very light commentary there. And I think reminded people also at the end of the year, end of the fiscal year, you're going to get another inflection point as other flagship devices launch, all good stuff. I'll remind you, the March quarter has the benefit of a very good mix. So you get flagship devices like you saw launched this morning with Samsung. And you start to see less of an impact of those individual devices, particularly in the developed world, which happen -- tend to be in this quarter. You have a seasonally lower quarter in terms of units, but higher in terms of mix. And then as that transitions into China, you might see a little bit more units, but maybe less expensive units. Although I will tell you, as the units are growing in 5G in China, they're still using very good chipsets, from our perspective, our financial perspective, even as they're driving handset prices down to even close to RMB 2,000. So it tends to still be a very good chipset that they're buying. But you'll tend to see that mix change a little bit throughout the year. But playing out pretty much the way that we think kind of an inflection point that you're seeing now, then a second inflection point as you exit the year.

Any inventory dynamics in there? Or is it...

I don't think so. I mean the 5G is...

Are you exiting -- do you exit March with maybe some inventory and then that burns off in June? Or is that not really as big a factor in the June indication you've given?

Yes, I wouldn't attribute much to inventory.

Okay.

We're not trying to guide in any way on that. I would remind you, what you're really seeing with 5G is, "Get me as much 5G as you can and get it out the door as quickly as possible." That tends to be the dynamic versus anything else right now.

We just wondered if the rapid ramp in demand that is expected in China and maybe that you'd need to lay inventory in just to anticipate that demand as it ramps through the year because it is expected to be so rapid.

Yes, I think that it is just, get it in, get it out the door...

Make as much as you can as...

And get the end -- get customers successful, that tends to be the real mantra right now.

All right. Can you talk a little bit the Huawei dispute is ongoing. I guess there's an assumption by a lot of investors that that's related to trade -- well, everybody guess that it's related to trade. But then there's also a lot of history of Qualcomm resolving these sorts of disputes and a lot of times the resolution of those are pretty similar in terms of timing. I wonder if you could comment on is this something that you would expect to resolve on a normal time frame. Or do you think it -- how much trade is there in the mix on this?

Yes. Okay, first comment, I think that thinking is actually pretty reasonable, but let me just put a little caveat on it. I think every one of these is different. They all have their unique scenarios. The only thing that's constant is that it's the same people on our side resolving it, it seems like. That the -- what you have is, I think, an environment which is incrementally better for getting to these resolutions post the trade -- the Phase 1 trade deal. And the reason I say that, I think it's very difficult for a high-profile situation like this to be resolved in the middle of trade talks. And if you look at the trade deal, it does have elements that we think are helpful to resolve the deal. Now it doesn't have a line item that says, Huawei-Qualcomm dispute will be resolved, but you do see a lot of things that could be applied. And you also see the resolution or the resumption of kind of traditional kind of conflict resolution mechanisms, the 2 sides talk on a regular basis. Now -- so net-net, what that means is, I think the environment is much better post that deal for us to get something done. I think there is an incentive for both sides to do it because there is a backstop for the agreement where we could -- we currently can initiate -- they can initiate going into arbitration, that arbitration is argued in the U.K., with U.K. law. But traditionally, that's not the mechanism to get these things done. It's a backstop. It's a forcing function. It's something that I think wouldn't be my preference. We could do it, of course, but I think this will be resolved, hopefully, through negotiation. I am very careful not to set an expectation other than the environment is incrementally better, the 2 sides talk and the issues are not -- this is a fairly simple issue, quite frankly. And particularly post the resolution with Apple, there are a number of other agreements with strong IP holders, LG, Samsung, that were either amended or extended post the resolution of that issue. And I think it's significant that we chose not to create another interim or extend the existing agreement with an interim payment. And that the way to look and think of that is the focus is on getting to a final resolution, not kicking the can down the road.

Okay. So we were talking a little bit about coronavirus before we came out here. And to use a quote from the -- a big quote from the film industry, nobody knows anything about anything. But any update or updated thoughts on kind of where things are going there or effects on Qualcomm, other than what you said in the earnings.

Yes, not much. I mean we -- at the time of guidance, just as a reminder, we extended the low end of our guidance by $0.05. There's a certain amount of precision that, that probably implies that I think it's difficult. You can do very precise calculations on input that you're not sure is correct. I think everybody is struggling with that, what the data is. So really not much to add in there. I would tell you, our -- so I'll answer a little bit about market demand or what we see, which is very opaque and kind of supply chain. So our supply chain tend to be -- we don't have a big exposure to China or even to those regions. We do have a little bit of a factory there that does some of the components that we sell not related to MSMs. We have had people at work. We're not at full capacity, but people there at work. You are starting to see, as I understand, other people coming back to work, but it's too early to tell kind of where it sits. So we're like everybody else. It was great that there was, I guess, less new cases over the last several days. But again, I'm not sure everybody knows that the data is incredibly -- who knows how true the data is all the time. Everybody's watching the same thing.

Okay. All right. So we think of wireless technology upgrade cycles, we're used to thinking about a 10-year upgrade cycle usually for the networks themselves and the phones following that or coming through that whole cycle. Given that 5G seems to be rolled out in a more synchronized way than 4G did, we saw a lot of staggered rollouts with 4G. 5G seems to be coming to many more markets kind of all at the same time. Do you think it will be a 10-year cycle? Do you think it will be attenuated?

Okay. One different thing. So 4G -- I would agree, you kind of had a 10 year cycle, 3G, 4G, 5G. 5G, 2 aspects of it that I would lead you to, and the conclusion is it's happening faster up-front. It is likely to be longer in total duration and probably have multiple waves that kind of sit in the following way. The first wave for 5G is really, I call it the more G wave, essentially is were going to give you more capacity and more data rate for cellular. And everybody asked me all the time, what's the killer app? It's actually, the killer app is capacity. And the fact that my cost per bit as an operator is going down dramatically. And if I have that and my competitor doesn't have it, I'm in a great position or what really drives action is, if I feel like I'm going to be in the other -- say, other situation. So you're going to see more capacity, better cost base structure for better cost per bit for the operator, which drives then the ability to go forward. That's why they're bidding up millimeter-wave spectrum because they know that that's such an important asset to do that. That's what you're seeing right now, that's the Release 16 stuff that's happening right now. Then you're going to see that -- follow that, you're going to see a big deployment, really, on kind of a 2-, 3-year cycle where you get big features that come out of the standards body not -- no longer focused on the cellular industry. They're focused on automating factories, automating huge amounts of, "What do I need to do to extend the enterprise cloud, for example, so that the end points are using 5G?" And there's a huge set of features that are coming out that will extend, I would say, the traditional -- that never existed in 4G, and that's going to extend it out longer. Now those industries are yet to be structured to take advantage of this 5G situation. There's a lot of demand -- a lot of people have 5G strategies. But what we've been trying to figure out is how do we get people access to that technology so that second wave is going to happen out -- the second, third wave can to happen outside of the traditional cellular industry. In total, I think that will create a longer period of time that 5G will be around and there'll be multiple launches. They'll just go through different industries, different verticals. We'll take the car being one of the first ones to take it, for example.

Yes, obviously, automated driving. Maybe give another example of what you see coming in that second, third wave. We see it a lot...

Yes, factories and retail. The factories. Like a car company, car company comes -- we have tremendous relationships with car companies now. And primarily because they're all trying to ask us -- they're asking 2 things. They're asking for the car user experience is so heavily influenced by cellular, they look to us to try to help them understand what the road map should be. That's kind of -- that's why our infotainment business has turned out to be fairly good. The other thing they want to understand is, okay, what's the ramification to 5G, not of the fleet, but in the manufacturing. And what they want to be able to do is they want to reconfigure their factory more quickly. And one of the biggest issues that they have is how do I securely connect -- securely and with a high level of availability -- reliability, how can we connect my -- the factory wirelessly so I can reconfigure it, let's say, 3 times a year because I have to react to the product lines much more quickly. And we're getting a lot of discussion on that. And that's one of the reasons that you hear so much about the private networks is because they view it as, okay, now I have the ability to build my entire network, automate my factory and then who's my partner? And so there's a lot of people trying to enter in at that time using us as a partner. Even to the degree where you're starting to see auto companies buying spectrum to make sure that they can control that network because then it makes sense, that's where their IP is, they want to make sure that, that network is not operated in a way that they can't control it. So we're seeing a lot of that. Retail, just the -- if you just think about the retail experience being everything is connected, you have cameras everywhere that are securely connecting the things and handling the retail experience. Even factory or flow of logistics, people -- helping people pick just packages coming out and accurately putting them on the right truck. Tremendous improvements in efficiency multiplied by a large number is a big deal for a company. So they're asking us to help them resolve that. And then you get you get into health care, the education, all the things that people tend to talk about.

Do you -- you mentioned the bit delivery costs and the advantage for carriers that way. We've seen a much more synchronized rollout with the carriers as well. What do you think that is? What do you think is driving that? Is it just the delivery costs? Do you think there are other elements of 5G that incentivize people to roll out? And why are they not waiting -- used to be, there'd be a learning curve. Some -- 1 or 2 would roll out, take a pain, and then the others would follow because of the learning curve would have occurred.

I'll do North America and China. Maybe I'll start with China. China is moving as quickly as I've ever seen them move on a new technology. Just to put it in perspective, 100,000 base stations by the end of last year, 1 million goal by the end of this calendar year. These are sub-6 base stations. You should think of that as 1,000 times the footprint of a millimeter-wave base station in New York just because of the spectrum. So a tremendous desire to go forward. That's something, I think the government has really put a target and said, make sure you do. Why do they do that? They want to do that because they know that the digital economy is going to depend a lot on having a deployed 5G network that is secure and available for people to do experimentation on top of that 5G network. So for example, it's not just getting the network out there, it is who experiments first with automated factories or whatever your vertical use of 5G. Whoever gets the scale on that will be able to export that worldwide. It's kind of the equivalent of why is it that you have search engines that are based in the United States being used in Europe. It's because we got to the large number of scale, and then that became the path of least resistance for the rest of the world. That's happening on a vertical-by-vertical basis for all of the major applications of 5G. Chinese want to make sure that they're doing that, which is, I think, a smart policy from their perspective. U.S. trying to do the same thing. Now the U.S., what you're seeing, I think it's layered on top of it an ability or a desire on the part of certain U.S. operators to see whether they can, particularly with millimeter-wave, compete with wireline operators in places where it's advantageous to do that. And when you get millimeter-wave spectrum, you have so much spectrum, and the cost of delivering that per bit gets down to the point where you could run the experiment, "Hey, maybe I can go after a wireline operator." And of course, there's a lot of debate. There's a lot of rhetoric back and forth. But the reality is that experiment is going to be run here over the next year. And we'll find out whether that's true or not. Now the environment that's sitting there from Qualcomm's perspective is actually quite healthy for us. It's a lot of people trying to figure out how to compete using technology that we're good at, and there are a lot of new people that are trying to figure out how to take advantage of it. I mean all the streaming video that's going around, that there's going to be so much of that being delivered over 5G, even into the enterprise, eventually. So I think you're kind of seeing maybe 2 different business models happening in the United States. Now in the United States, there's another angle, which is, I'd say, the Sprint-T-Mobile merger is actually quite -- is very -- I was very happy to see the news flow over the last 24 hours. I think that will be very beneficial to the intensity with which 5G will be deployed. I mean you have 3 very, very well -- what do I say, financially strong operators who can compete with each other, not just in the cities, but out in the entire community. So that's very healthy, we think, for the environment.

What do you think that means for other -- what others might be able to do as well, like other competitors, satellites and so on?

Yes. Well, I mean, I think there might be a fourth person who has maybe a dog in the hunt or whatever the right term is, and that's great, I think. I mean when you have these big transitions like this, you get business model experimentation. And that usually ends up becoming something interesting. And so the U.S. to me looks much better than it did from a structure of the market from an operator perspective for the growth of 5G today than it did 6 months ago.

What do you think about -- on fixed wireless access, I don't think it's a binary, it will exist somewhere. But where do you think we see that emerging and how far does it go towards -- does it ever work in densely populated cities? Or you think it's more of a suburban, rural kind of a technology?

So millimeter-wave, which really is -- works very, very well in dense deployments, extremely well, actually. So I think there's an opportunity for the wireline -- the wireless operators to really kind of make a move there. Whether that -- how that will be successful or not, it's too early to tell. I will tell you, we do sell CPE equipment. We sell -- which is actually quite a good business for us, actually. We'd love to see that happen, but it's too early to tell. We have purposely added into the company the ability to not only combine millimeter-wave and sub-6 5G, but also enterprise quality WiFi. And the reason is we believe that over time, those 2 things will exist as a pair and travel together. And so one of the reasons we have, for years, been investing in all this peer-to-peer and self-organizing network technology in the WiFi space is because when people try to deploy this business model, they want to make it so that there's no truck roll. Same thing in the enterprises. So we've been working on that because we want that industry -- we want the pie to grow there. It also is a good business for us.

Do you -- when you think about fixed wireless access, and you talk about dense deployments and how well it works, you think 5, 10 years down the road, are we going to be in a world where, like -- most houses now, people aren't running ethernet, they're just using wireless as their access technology. Do you think that's a place that we potentially are going in the world?

Yes. Yes.

And you think that we end up with fixed access connections that last few hundred feet just all of it's wireless? Or how do you see the world in 5 or 10 years?

Yes, I think it really moves to wireless dramatically. Then the question is how much of it is going to be WiFi versus 5G coming in from the street. And what we've tried to do is position the company that we really don't care either way. Although I think, by and large, just due to the security features and some of the controllability is a word I just made up, but the ability to really manage the cellular network is much further advanced on a kind of institutional basis. It's built into the standard, and it works a particular way at a particular robustness that that's going to be an advantage for that world. But for us, we're going to be in a good spot either way. But I think people streaming more and more video on their cellular service, that's really what millimeter-wave was designed for, I mean tremendous capacity. I will remind you, we had it on our -- and I referred to it obliquely earlier. We had -- I mentioned on our earnings call that the millimeter-wave auction that they're currently doing. Remember, there's a huge amount of spectrum already been allocated. They're allocating an additional 3,400 megahertz or 3.4 gigahertz of spectrum, which put that in perspective, that's more than the total spectrum that people have been using on earth for a long period of time for any commercial purpose. And the cost per pop is still very strong. I mean they really believe in that business model. So we're going to see. But I would say from a technical perspective, it works very well. And we were very surprised and pleasantly surprised as to how well propagation worked in dense deployments in millimeter-wave.

I'm going to come back to part of that comment with regards to carrier economics. So you were saying that the -- which we would agree with that wireless networks are inherently more automated, more modern than some of the fixed networks because they're all cobbled together over 100 years, really. Do you think that the carrier economics or OpEx economics improve a lot if they choose to go down the road of all wireless access? Would you say that?

Well, I mean, wireline operators have a very good business themselves and the cost goes down per bit in their case also. But I think you're at the point where the wireless folks could now meaningfully compete actually in some of these areas, which I think will be interesting. What I was referring to in terms of robustness is if you want to manage something, so you want to manage a factory, you want to manage a hospital, you want to manage even an enterprise, that's already built into the standard in a way that you can -- it's very difficult to layer in on top of WiFi, even given all the great work that's happening in WiFi, and we're one of the companies doing it. It's just going to be very, very strong with the second and third big feature sets of 5G coming out for that to occur, which is why you have, for the first time, car companies and manufacturing plants, saying, "Okay, now I have an opportunity to truly connect my robot wirelessly." They have better latency. They have better security. They have better -- a number of features that we put into the standard so that they could do that application. That's going to really impact what you end up using in your home and in your enterprise because that whole ecosystem will now roll out here over the next decade.

You had said another thing earlier I thought was interesting, which is, as this rolls out, you've got this experimental platform onto which you can develop new business models, maybe new things to help people deploy industrial, what, 5G and so on. If you were to think about industries beyond this microcosm we look at and disruption, where would you -- a lot of investors here are looking at all different industries, where would you be looking? Where would you be thinking disruptions most likely as a result of 5G?

You know the thing that I -- I don't know the answer to this. If I did, I probably wouldn't be sitting here. The -- okay, today, if you look, we added, quite frankly, a fairly small amount of technology to create smartphones and tremendous changes in the business model of the Internet, a lot of things. So for example, we put a connected computer in your pocket, we gave it a camera, we gave a position location and we gave it the ability to run an OS at reasonable power, a lot of technology to produce that, but that's really all you saw from a business perspective. Big changes and you got -- now you got companies that are trillion-dollar valuation based off of taking advantage of that. Well, what you're going to see with 5G is you're going to see a situation where now you get everything connected securely, including kind of the fabric of the economy. And the relationship between things, money, people in real-time will be known securely. Somebody is going to make, there will probably several trillion-dollar companies that are created because someone figured out how to create that, how to take advantage of that. For Qualcomm, that's not our business model, but I guarantee we will see that happen through somebody that we enable to create that. I mean, today, just look at the enterprise -- enterprise cloud. Everybody is trying to figure out, "How do I extend that into the 5G world?" Massive valuations companies based off of that. But nobody has really taken advantage of yet the fact that all this data is going to be sitting there and if we can figure out how to use it -- and there's all these different companies that come and talk to us. And I think that's going to be very interesting. And what -- the reason I bring that up is, that's the reason that you see so much energy between the western world and the eastern world, the United States and China, is because they know that that's going to be the key thing to understand, not just society, but the economy of the world will be who figures out how to do that well.

So you think it really is almost like an arms race, whoever rolls it out first, whoever has that experimental platform first or maybe a net scale?

Yes, I think that's very, very important. And -- but security is very important. Trust is important. It's all these elements that have to happen. So for example, one of the things that we do is because our business model is really based on not so much who wins, but just we need the technology to be deployed at scale quickly. And so I spent a lot of time in Washington trying to make sure that people understand that this is coming and that there are certain industries that you have to have the appropriate amount of regulation or else they won't develop. For example, you will not have self-driving cars unless there's some sort of appropriate level of regulation. And I know that people argue that, that's not the case. But I don't think -- I think the wild west days of we're going to do business model evolution or experimentation for technologies or industries that will be impacted by 5G, probably it's not going to happen that way anymore. So they -- so lawmakers, policymakers have to be educated about the ramifications in order to take advantage of it. So there's going to be some heads up that these things are coming, but I think there's a lot of economic opportunity being created or will be created in that transition.

The fixed wireless access, I want to come back to it just quickly. We know this experiment going on here, all of us track it pretty closely that look at this industry, but I wonder if you -- is everyone just waiting to see what happens there, carrier-wise, if you look globally? Or are people actually doing their own experiments and starting to think about taking things forward themselves up in the horizon?

I think technically, the experiments are done. I mean they definitely see it. It's just the business model experimentation is added. And U.S. is going quickly. I think you're going to see it in Japan and Korea. A little bit later kind of next year in parts of Europe. But it's really -- I think it's a great opportunity for the United States to show that this thing works in certain areas. And of course, we would love to see it even happen faster.