Qualcomm reported earnings yesterday, and while nothing was really wrong their numbers, nothing was good either.

The numbers. Qualcomm reported revenue just shy of the $8.5 billion expectation, but EPS of $1.87 was well ahead of consensus of $1.81. For the September quarter they guided to revenue of $8.5 billion and EPS of $1.90, both just shy of consensus of $8.7 billion and $1.91 respectively. An OK quarter with a soft guide. But the numbers do not tell the whole story.

Earnings calls are one of the great wild cards of the investing world. For an hour executive teams have the whole Street focussed entirely on them, parsing not only their words but all that goes unspoken – what lies between the lines, their tone, the second and third order implications of everything they say. Most of the time, these calls end up being fairly dry, but that was not the situation with Qualcomm’s call. As management spoke, especially when we got to the Q&A portion of the call, each answer they gave seemed to layer on some new reason to be gloomy. You could see this in the stock market. After the earnings first, Qualcomm’s stock was down 2%, by the end of the call it was down 7%. After-hours trading is not a great indicator of true market value, but it does make for a real-time opinion poll.

The chief problem Qualcomm faced this quarter is the expected second half recovery in smartphone demand does not seem to be materializing. We wrote about this last quarter, where every consumer company predicted (hoped?) for some elusive spark of end demand. Inventory levels, especially in the channel, have come down, but no one seems to be in a hurry to restock.

Another big problem Qualcomm had this quarter, and longer-term, is that much of the company’s guidance depends on the new iPhone launch. On the one hand, this is good news. Apple will launch a new device probably in September, and people will buy a lot of them. On the other hand, every time Qualcomm mentioned “a large modem-only customer” our minds immediately went to the fact that Apple is unlikely to be a customer much longer. And we would guess that everyone else listening in experienced that same emotional jump. That giant apple-shaped hole in Qualcomm’s future earnings looms large. To make matters worse, the company did not have much other news to interest investors. Despite listing a few dozen achievements during the quarter few really garnered much attention. Moreover, some of those announcements could be viewed in an unfavorable light. For instance, the company highlighted the launch of cost optimized Snapdragon products to “broaden adoption of 5G”. This is Qualcomm’s standard playbook, segmenting their product lines as a new standard matures, but this means average prices for their products are going to decline, and it means they are going to start encountering competition with Mediatek for lower priced devices. We are sure that Qualcomm can manage this well, but it gives little cheer to anyone hoping Qualcomm’s numbers are set to improve any time soon.

All of this was clear by the time management finished their prepared remarks, and the Q&A just seemed to go downhill from there. The company noted that they are expecting a lot of seasonal factors in their numbers this year, and while this is true for smartphones (see above re: Apple) it does not seem to be true for IoT, which they expect to be down next quarter. And while the company was tepidly forecasting conditions to gradually improve, they also announced that they were implementing a new cost cutting plan. One step forward, one step back.

For us the most important moment in the call came when Stacey Rasgon asked our top, burning question. In regards to all the company’s talk about its AI capabilities, he asked “How will Qualcomm make money from AI?”. This is a critical question in these days of AI fever, and to be diplomatic, the company is still working on its answer. To paraphrase, management said that AI will spark a new upgrade cycle for phones and give the company room to charge for AI features in their chips (i.e. to raise prices). We think it is unclear at this stage how much of this will actually play out, and capturing much value from AI will be a challenge for Qualcomm, despite the fact that they have a fairly robust offering here.

Ultimately, Qualcomm’s story remains unchanged. They have made some smart strategic bets in areas like RF, automotive and IoT, but these all have long design cycles and it will be several years before they (especially automotive) become material to earnings. At the same time, the loss of Apple looms. So their numbers are a race between the sunset of the Apple business and the ramp of those businesses. This quarter despite all its pitfalls does not change that outlook.