04 August 2007

NOK: Financial Analysis through June 2007

We have analyzed Nokia's (NOK) financial results for the quarter that ended on 30 June 2007.

Nokia's finances changed radically during this quarter. Total Assets increased 38 percent, from €22.8 billion to €31.4 billion. So-called "other income" shot up from €335 million in the second quarter of 2006 to €1.988 billion in the second quarter of 2007. Despite all this income, the company paid next to nothing in income taxes during the quarter.

The explanation is that Nokia Siemens Networks, a 50/50 partnership with the German powerhouse, began operating on 1 April 2007. The results of the partnership, which would be considered a large-cap company if independent, are fully consolidated in Nokia's financial statements.

Nokia's latest results are, therefore, not directly comparable to the company's earlier results. And, this calls into question whether the GCFR methodology can be fairly applied to Nokia in its current form. Readers are strongly cautioned to consider the comparability question. In addition, readers should be aware of some facts about Nokia's financial reporting that distinguish it from companies based in the U.S. First, the financial statements are prepared in accordance with International Accounting Standards (IAS), rather than U.S. Generally Accepted Accounting Principles (GAAP). Second, the Euro is the currency used in Nokia's financial statements. Third, Nokia isn't required to file 10-Q and 10-K reports with the SEC.

Nokia, headquartered in Espoo, Finland, is a global seller of cellular phones and the equipment for mobile phone networks. Nokia once held a commanding, and quite rewarding, position in the mobile phone market. Today, consumers have many more choices, and the phones sport stylish designs can outshine their technical capabilities in the battle for popularity. Nokia's fortunes suffered at the onset of this sea change, and market share was lost to Motorola's (MOT) Razr. Nokia subsequently adjusted, and now their share of the mobile phone market is increasing.

Challenges remain, however, including Apple's (AAPL) iPhone and an increasingly contentious patent battle with Qualcomm (QCOM ). Nokia might, according to Fortune magazine, respond to the first threat by establishing their own online music service.

When we analyzed Nokia after the March quarter, the Overall score was a mediocre 36 points. Of the four individual gauges that fed into this composite result, Growth was the strongest at an impressive 19 points. Value, however, was weakest at a single, solitary point. [Note that recent algorithm tweaks led to minor changes in the previously reported scores.]

Now, with the available data from the June 2007 quarter, and subject to the limitations identified above, our gauges display the following scores:

Before we examine the factors that affected each gauge, let's compare the latest quarterly Income Statement to our previously announced expectations. This will help show how the new partnership changed the company's finances, since our prediction did not take the new corporate structure into account.


June 2007
June 2007
June 2006

Op expenses



(1129) (1019)

Other 1828
Operating Income

Other income


Interest, etc.
Pretax income

Income tax

Net Income


€ 0.72/sh€ 0.30/sh
€ 0.28/sh

Revenue was 11.5 percent above our estimate. We expected Revenue to be 15 percent greater than in the year-earlier quarter, and the actual increase was 28.3 percent. A major part of this increase can be attributed to new revenue from the businesses that Siemens contributed to the partnership. Of the joint venture's €3.438 billion of revenue, let's say that half, €1.719 billion, was from Nokia businesses (and, thus, part of the historical baseline) and half was from Siemens businesses (a new revenue stream to Nokia). If we subtract €1.719 billion from the reported €12.587 billion, we get a pro forma revenue figure of €10.868 billion. This is 10.75 percent about the revenue in the year-earlier quarter, and much closer to our expectation.

Maybe it is a result of the new partnership, or maybe it reflects changing business conditions, but Nokia's current operating costs as a percentage of revenue are much higher than Nokia's historic costs. We thought the Cost of Goods Sold (CGS) would be 66 percent of Revenue, and the actual value was 69 percent. Research and Development (R&D) expenses were 13.6 percent of Revenue, quite a bit more than our 10 percent estimate. Sales, General, and Administrative (SG&A) expenses were 13.3 percent of Revenue, compared to our forecast of 10 percent.

These additional costs, although major, were dwarfed in the opposite direction by the huge amount of partnership-induced "other income" Nokia recorded. It resulted in Operating Income 50 percent above the forecast value. The irony is that the Nokia Siemens partnership had a substantial loss in the second quarter. Some of the Nokia Siemens loss was due to restructuring charges, but €361 million can be attributed to business operations.

Non-operating income was €458 million greater than expected. The Income Tax Rate was a minuscule 1.5 percent, instead of the predicted 25 percent. The tax rate was low because much of the "other" income was the result of a non-taxable gain due to the partnership's formation. (Alchemy?) As a result, Net Income blew away our prediction by 132 percent.

Cash Management. This gauge decreased from 10 points in March to 3 points now.

The measures that helped the gauge were:
The measures that hurt the gauge were:

Growth. This gauge decreased from 19 points in March to 14 points now, yet it was clearly helped by the new partnership.

The measures that helped the gauge were:
  • Net Income growth = 43 percent (yr/yr), up from 20.8 percent in a year
  • CFO growth = 39.6 percent (yr/yr), up from 8.4 percent in a year
  • Revenue growth = 16.3 percent (yr/yr), good but down from 18.9 percent in a year
Net income benefited significantly from a change in the income tax rate from 26 to 14 percent

The measures that hurt the gauge were:
  • Revenue/Assets = 141 percent, down from 185 percent in a year; sales efficiency worsened

Profitability. This gauge decreased from 15 points in March to 13 points.

The measures that helped the gauge were:
  • ROIC = 41 percent (!), up from 39 percent in a year
  • FCF/Equity = 42 percent (!), up from 32 percent in a year
  • Accrual Ratio = 2.2 percent, down from 3.1 percent in a year (good cash flow)

The measures that hurt the gauge were:
The increase in operating expenses was primarily the result of a decrease in Gross Margin.

Value. Nokia ADR's shot up from $22.92 to $28.11 over the course of the quarter. The Value gauge, based on the latter price, increased to a still-weak to 3 points, compared to 1 point three months ago.

None of the measures helped the gauge appreciably:

The average P/E for the Communications Equipment industry is currently a much more expensive 32. The average Price/Revenue for the industry is currently 5.

Now at 29 out of 100 possible points, the Overall gauge dropped despite the substantial increase in revenue and earnings in the recent quarter. This is because the stock surged in advance of the second quarter results, costs went up faster than revenues, and the earnings increase was driven by financial restructuring rather than core operations. The stock market reacted positively to the nice top-line and bottom-line numbers. We suggest that more attention be given to the numbers in between. It will probably take a year or so to distinguish operating changes from non-operating changes. In the mean time, caveat emptor.

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