Qualcomm (QCOM -1.75%) owns a whole body of patents that are essential to the operation of devices that utilize the 3G and 4G LTE wireless standards. Qualcomm licenses those patents to companies that want to build and sell devices that connect to 3G and 4G LTE networks, and it's generally paid a percentage of the selling price of each device.
But a little while back, Apple (AAPL -0.57%) stopped paying Qualcomm royalties for each iPhone sold.
Image source: Apple.
The more a company sells a 3G or 4G LTE-capable device for, the more Qualcomm gets paid for each device. And as my fellow Foolish colleague Evan Niu explained back in May, Apple doesn't think it's right for Qualcomm to get paid more for higher-priced smartphones, even though those higher-priced smartphones have the same wireless capabilities as their cheaper brethren.
"The reason that we're pursuing this is that Qualcomm's trying to charge Apple a percentage of the total iPhone value," Apple CEO Tim Cook said on the company's earnings call back in May. "And they do some really great work around standards-essential patents, but it's one small part of what an iPhone is."
Cook went on to explain that Qualcomm's wireless patents have "nothing to do with the display or the Touch ID or a gazillion other innovations that Apple has done."
Since Apple appears to be withholding royalty payments to Qualcomm until this legal spat is resolved, Qualcomm's wireless technology licensing business -- known formally as Qualcomm Technology Licensing (QTL) -- cratered in the company's most recent quarter.
What's the damage?
Qualcomm reported QTL revenue of $1.172 billion last quarter, representing a 42% drop year over year and a 48% drop quarter over quarter. Operating profit in the business segment followed revenue into the abyss, plunging from $1.749 billion in the prior-year period to just $854 million last quarter.
Because of this so-called "loss of leverage" in QTL, Qualcomm reported that pre-tax earnings as a percentage of revenue in QTL in its most recent quarter declined to 73% from 86% in the prior year and 87% in the previous quarter.
Since QTL has historically made up the bulk of Qualcomm's overall corporate profits, Qualcomm's operating income for the quarter dropped 51% year over year even though revenue was down just 11%.
What does this mean for stockholders?
There's no getting around the fact that this legal battle is ugly, and until a resolution is reached, Qualcomm's financial results are set to remain in the proverbial doldrums.
Now, if all this is resolved in Qualcomm's favor -- that is, Qualcomm is ultimately entitled to a reasonable percentage of iPhone selling prices -- then I'd expect the pressure that's currently on Qualcomm's stock to lift.
However, if Qualcomm finds itself entitled to royalties on, say, just the cost of the wireless subsystems within smartphones, then this could have a dramatic, highly negative impact on Qualcomm's business.
