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Apple seeks to offset Chinese iPhone ban in Qualcomm row

Talks underway with exempt supplier Pegatron to boost production

Chinese customers take a look at iPhones at an Apple Store in Beijing in 2016. (Photo by Akira Kodaka)

TAIPEI -- Apple is in talks to shift production of older iPhones to a key Taiwanese supplier in a bid to avoid the loss of billions in revenue in China as a result of a long-running global patent row with Qualcomm of the U.S.

A court in the southern Chinese city of Fuzhou ruled on Monday that Apple had infringed two of Qualcomm's software patents. It ordered the smartphone maker to stop importing and selling certain models such as the iPhone 6 series and the iPhone X introduced last year.

However, smartphones produced by Pegatron, which is one of Apple's three major iPhone assemblers along with Foxconn and Wistron, are exempt from the ban, according to documents seen by the Nikkei Asian Review.

Sources close to the matter said the exemption was due to the fact that Pegatron, on behalf of Apple, paid a fee to license the contested software, unlike Foxconn and Wistron.

One of the sources with direct knowledge of the situation said Apple had held initial discussions with Pegatron about whether the Taiwan-based company could take on more iPhone production to make up for the impact of the ban. No decision has yet been taken, however.

Apple has also said it could implement software updates "to address any possible concern about our compliance with the order," according to report by Reuters. However it was unclear whether this would be accepted by the Chinese court.

The ruling is the latest in a long-running dispute that involves dozens of lawsuits around the world. Apple is also suing Qualcomm for unfair licensing practices and has appealed the Chinese judgment.

Qualcomm on Thursday stepped up its assault by seeking a court order to extend the ban to Apple's latest ranges, launched less than two months ago. It is believed that Pegatron will still be exempt due to its licensing arrangements. The preliminary ruling states that Qualcomm had argued "the judgment and ruling of this case are not applicable to the cellular products manufactured by Pegatron Corporation with the commission of Apple Inc."

The ruling comes at a difficult time for Apple, which is already suffering disappointing sales of its new iPhone models globally. The company has struggled to make much headway in China against the rise of homegrown rival Huawei, which earlier this year overtook the U.S. company to become the world's second biggest smartphone maker. Meanwhile, global smartphone sales are forecast to fall in 2018.

China contributed 20% of Apple's total $166.69 billion in iPhone sales for fiscal 2018. For all of 2018 so far, about 6% of total iPhone revenue came from the sale of older phones such as the iPhone 6s and iPhone X in China, two sources with knowledge of Apple's Chinese sales said.

Taking into account a consumer shift to newer models, it is estimated that the order barring production of older iPhone models by Foxconn and Wistron could hit Apple's sales by some $5 billion next year in 2019, or 3% of total iPhone revenue.

This could be halved to about $2.5 billion in 2019 if Pegatron is exempted, two sources said. And if Apple later decides to ask Pegatron to step up production, the impact would be even less, the sources added.

Apple and Qualcomm have been locked in a bitter legal dispute since early 2017 over licensing fees. The row was sparked when the world's most profitable smartphone company asked its iPhone assemblers Foxconn, Pegatron and Wistron to stop paying royalties owed to Qualcomm on its behalf. Apple accused Qualcomm of unfair patent licensing practices, while Qualcomm hit back with claims that the smartphone maker had infringed its patents.

Qualcomm signed separate contracts with the three iPhone assemblers, agreeing to different royalty fee terms. Under previous practice, the iPhone assemblers paid the chipmaker on behalf of Apple, which later paid the three suppliers.

"Each iPhone assembler's negotiation with Qualcomm is slightly different," a source with direct knowledge of the matter told the Nikkei Asian Review. "Pegatron's patent coverage to Qualcomm is more than Foxconn and Wistron. That's why it is exempted in this case."

Qualcomm confirmed to the Nikkei Asian Review on Thursday night that iPhones manufactured by Pegatron were excluded from the injunction. "Pegatron has a license to both patents" that the Chinese court had ruled Apple had infringed, Qualcomm said. iPad manufacturer Compal Electronics also has a license to one of the two patents, Qualcomm said. Compal does not manufacture iPhones.

The ongoing trade war between the world's two biggest economies could add further uncertainty to Apple's outlook and its deep-rooted supply chain in China. Other industry sources claim the timing of the Chinese ruling is part of Beijing's effort to show Washington that it can still make U.S. companies suffer, even if the punishment this time is not severe.

Pegatron Chairman Tung Tzu-hsien said on Thursday that he had not yet seen the court injunction and could not confirm whether his company is exempted from the ruling.

"However, if we really are excluded from the order, it might be because of our respect for intellectual property rights, and we cover more patents," Tung told reporters in a public appearance in Taipei.

Apple did not respond to a request for comments.

Don Rosenberg, general counsel and executive vice president of Qualcomm, said in a statement through a public relations agency to the Nikkei Asian Review early on Thursday that: "If Apple is violating the orders, Qualcomm will seek enforcement of the orders through Enforcement Tribunals that are part of the Chinese court system."

Jeff Pu, a Hong-Kong based analyst at GF Securities, said the Qualcomm court victory seemed to be part of the trade and technology showdown between the U.S. and China.

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