Qualcomm (NASDAQ:QCOM) shares are down by more than 16% year to date as of this writing after the company reported its fiscal third quarter earnings results and disappointing outlook for its fourth fiscal quarter, significantly underperforming the PHLX Semiconductor Sector Index ETF (NASDAQ: SOXX).
The chief culprit to Qualcomm's underwhelming business performance this year seems to be its mobile chip business. In order to improve its profitability in what company CEO Steve Mollenkopf describes as a "challenging environment," the company is implementing a "strategic realignment plan" designed to lower the company's operating expenses.
To get a better feel for what's going on, here are four key items that Qualcomm's management discussed on its most recent earnings conference call.
How deep are these cost cuts?
According to Mollenkopf, the company is bringing down its annual spending by $1.1 billion annually. Of that, $800 million will come out of the company's chip business, with the remaining $300 million coming out of areas beyond QCT and its wireless technology licensing business, QTL.
"The plan still allows for significant [research and development] in the company," Mollenkopf said. He also reminded investors that Qualcomm will still be spending more than $4 billion per year in product research and development, which still puts it well ahead of its nearest mobile chip competitor, MediaTek, which spent just under $1.4 billion in research and development during 2014.
Additionally, Mollenkopf also said that the company will be cutting out an additional $300 million in share based compensation in addition to the $1.1 billion mentioned earlier.
What is the nature of these cuts?
It's clear how much Qualcomm is aiming to save, but how will the company go about it? According to Mollenkopf, the full-time employee count in the company's chip business will be reduced by 15%. He also said that Qualcomm plans to "make significant reductions in [its] temporary workforce."
On top of that, the company plans to reduce the number of office locations that it has, and it expects to move some of its resources to regions where operating costs are lower.
Management stressed, however, that it plans to do these cost reductions while keeping its technology position, customer commitments, and its "valuable [intellectual property] roadmap" intact.
In short, Qualcomm seems to be aiming to "cut the fat" in its organization.
What will these cost cuts mean for Qualcomm?
As Qualcomm implements this "strategic realignment" plan, Mollenkopf says the company expects to bring its chip business operating margins up to 16% (or better) by the fourth quarter of its next fiscal year. Given that Qualcomm expects operating margins in this business to come in between 2%-4% in the fourth quarter of fiscal year 2015, this is a pretty substantial improvement.
Additionally, management indicated that this operating margin target assumes no "meaningful improvement in the current industry environment." This means that if Qualcomm is able to win-back a high-volume, high-end spot at Samsung (NASDAQOTH: SSNLF), for example, its operating margins could be better as it brings in significantly more high-margin revenue.
What about splitting the company in two?
In Qualcomm's "strategic realignment" presentation, the company said that it intends to "review alternatives to the Company's corporate and financial structure." This, according to the presentation, includes "possible business separation alternatives."
The "business separation alternative" that Qualcomm is likely exploring is the separation of its chip business from its wireless technology licensing business.
Unfortunately, while investors now know that Qualcomm is looking at this possibility with, in the words of Qualcomm Chairman Paul Jacobs, "no preconceived notions," management says that it "does not expect to publicly comment on this review prior to its completion, which is expected to occur by the end of the calendar year."
Qualcomm is certainly facing a challenging environment for its chip business, but the company seems to be doing the right thing for its shareholders by trying to realign its cost structure with reality. Of course, while cost cutting will help boost the bottom line in the near-to-medium term, over the long-term Qualcomm will still need to deliver revenue growth at good margins to drive long-term profit growth.