Apple Stops Paying iPhone Royalties, Escalating Feud With Qualcomm

Apple has stopped paying its iPhone manufacturers for royalties owed to Qualcomm for the first quarter, Qualcomm said on Friday. Apple sued Qualcomm in January, saying that the royalties were excessive, and will now be withholding payments until the legal battle is resolved.

The escalation forced Qualcomm to slash its financial forecast for its current quarter to account for the loss of about $500 million of lucrative royalty revenue. Qualcomm developed and owns the rights to many cellular and mobile phone communications technologies and its royalty division brings in 80% of its pre-tax profit. On the iPhone, Qualcomm’s licensing agreements are with Apple’s manufacturers directly, who in turn charge Apple.

Qualcomm’s revenue in the second quarter will total $4.8 billion to $5.6 billion, $500 million less than the company forecast almost two weeks ago, when it reported results for the first quarter and said it wasn’t sure if Apple would continue paying royalties, which also cover iPads with mobile chips. Adjusted earnings per share will be 75 cents to 85 cents, down from the earlier forecast of 90 cents to $1.15 (Qualcomm starts its fiscal year at the end of September, so the revised forecast covers the company’s third fiscal quarter of 2017).

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Investors didn’t like the news, pushing the company’s share price down 2% in midday trading. Shares of Qualcomm have now lost 20% so far this year, as the dispute with Apple and various regulators around the world have threatened the company’s core business model. Qualcomm currently charges royalties for a portion of the value of every phone sold, whether it contains communications microprocessor chips made by the company or by its rivals. But Apple and regulators claim Qualcomm is abusing a dominant market position to extract excessive payments.

Apple said it had been trying unsuccessfully to negotiate a direct licensing agreement with Qualcomm for more than five years. “They have refused to negotiate fair terms,” the company said in a statement. “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.”

Analysts fretted that the dispute could drag on for years. “The shares could be range-bound/dead money for a considerable amount of time,” Bernstein Research analyst Stacy Rasgon wrote in a report on Friday. “A court date would likely be several years away if it goes that far. And one really has to wonder about management credibility (expectations here appear to have been managed extremely poorly).”

Apple (AAPL) had previously withheld about $1 billion of prior royalty payments dating to 2016 sales, but Qualcomm (QCOM) offset the losses by withholding equal amounts that it owed Apple under a separate cooperation agreement between the companies. That agreement expired at the end of 2016 and Qualcomm said on April 19 that it didn’t know if Apple would withhold further royalties. Now it knows.

“Apple has now unilaterally declared the contract terms unacceptable; the same terms that have applied to iPhones and cellular-enabled iPads for a decade,” Qualcomm general counsel Don Rosenberg said in a statement. “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. 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.”

The dispute between the two titans of the mobile business broke out after Apple started using modem chips from Intel (INTC) in about half of new iPhones last year, instead of buying all its chips from Qualcomm. According to Apple’s lawsuit, Apple may pay the same royalty rates—or more—for iPhones that don’t use Qualcomm chips.

Qualcomm counter-sued on April 10, accusing Apple of harming its business and breaching deals between the two companies. Qualcomm says it licensing agreements are fair and legal, pointing to a 2015 agreement with Chinese regulators and its hundreds of active license agreements with other manufacturers.

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