Thanks to earlier reports of a strong cell phone market, it didn't surprise many analysts that Qualcomm, (QCOM) a leading cell phone company, on Friday boosted its earnings guidance.
They were surprised, though, that Qualcomm said it might change how it accounts for royalties from its patent licenses, by far its most profitable business.
It's mulling the change because of a changing market for products and services related to a wireless technology standard called CDMA. Qualcomm developed CDMA and thus has deep insights into the market. It has a lesser hold on the new flavors of CDMA that are emerging, possibly hurting its ability to forecast royalties.
The accounting change might more accurately reflect Qualcomm's true results. It also might make it tougher for Qualcomm to give quarterly guidance.
"It increases transparency," said James Faucette, an analyst at Pacific Crest Securities, "but general guidance is going to be more difficult."
One thing is definite. The company says if it enacts the change this quarter, it would reduce profit by $298 million, or 17 cents a share. As a result, its shares fell 3.9% on Friday. The shares, though, rebounded from a more than 5% decline early in the day. And analysts say the biggest impact to the change would be felt in just the one quarter. Even with Friday's fall, steadily rising sales and profit have made Qualcomm's stock one of tech's best performers this year.
Cell phones are selling well, sparked by fast-improving features such as the ability to take photos. Qualcomm says it now expected 46 million CDMA phone shipments this quarter at an average price of $210. It had forecast 44 million at a $206 average.
This growth prompted Qualcomm to boost its profit forecast for its fiscal fourth quarter ending Sept. 26. It now expects to earn 28 cents to 30 cents a share.
It earlier forecast 26-28 cents. The consensus of analysts had been 29 cents a share.
The accounting change deals with how it recognizes licensing revenue. Since it's the main patent holder for CDMA, or code division multiple access, Qualcomm gets royalties from phone makers like Motorola (MOT) and Samsung each time they sell a CDMA phone.
Qualcomm estimates royalties, but says it might now wait until licensees actually pay.
Royalties account for about 30% of Qualcomm revenue. The rest comes from chip sales and smaller business units. The royalties contribute about 90% of Qualcomm's earnings, says analyst Albert Lin of American Technology Research.
"But who knew the quality of their earnings, since they were based on estimates?" Lin said.
He expects Qualcomm will make the accounting change.
A new, wide-band flavor of CDMA, called WCDMA, is making it harder for Qualcomm to estimate royalties. WCDMA phones can surf the Web quickly and make video phone calls.
Qualcomm does have WCDMA patents, but so do a number of other companies. It doesn't sell the majority of WCDMA chips. Pacific Crest's Faucette estimates Qualcomm's share of WCDMA chip sales at 20%.
Standard & Poor's telecom analyst Ken Leon says there are no tricks in Qualcomm's use of royalty estimates. The change would merely be one of when revenue is recognized, not the "quality" of the revenue.
Qualcomm does "not have enough history with (WCDMA) to be comfortable with estimating royalties," Leon said. "As Qualcomm moves more into the (WCDMA) license business, (estimating) revenue may be less predictable." <<
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