07 September 2009

NOK: Look Ahead to September 2009 Quarterly Results

The GCFR Overall gauge of Nokia (NYSE: NOK) fell from 45 to 29 of the 100 possible points after the second quarter of 2009, which ended on 30 June.  Our income statement and financial gauge analyses explained in some detail how the score was attained.

Nokia sold 15 percent fewer mobile devices in the second quarter than in the same period last year, and the average price per unit sold declined by 16 percent. The company's share of the mobile device market fell to 38 percent from 40 percent.

Revenue fell by 25 percent, and the Gross Margin dropped from 33.6 percent of Revenue to 32.6 percent.  Greater-than-expected operating expenses, including a €135 million charge for amortization of acquired intangible assets, contributed to a 71-percent decline in Operating Income.  The bottom line Net Income "attributable to equity holders of the parent" was 65.5 percent less than in June 2008 quarter.

The Overall gauge reflects this weakness.  The best score any of our four category-specific gauges could manage was 10 of the 25 possible points.  Growth and Cash Management are both scraping the bottom in the zero-to-five range.  The Value gauge was particularly hard hit by the 25 percent rebound in the price of Nokia ADRs during the second quarter.

We have now modeled Nokia's Income Statement for the quarter that will end on 30 September 2009.  The intent of this exercise was to produce a baseline for identifying deviations, positive or negative, in the actual data that the company will announce on 15 October.  GCFR estimates are derived from trends in the historical financial results and guidance provided by company management.

First, we present some background information.

Headquartered in Espoo, Finland, Nokia has been the leading global producer of mobile phones since 1998.  The company also sells the network infrastructure that supports these phones.  Nokia shipped 468 million mobile devices in 2008, which was, according to company estimates, about 39 percent of these units sold worldwide.  The market for these devices is highly competitive, and product development cycles are short.

Nokia's hand-held product line runs the gamut from modest phones with tight profit margins to small, but powerful, computers that exchange voice, data, images, and music.  Traditional rivals include Samsung (SEO: 005930), Motorola (NYSE: MOT), LG Electronics (SEO: 066570) and Sony Ericsson. 

The high-end of the product line is now anchored by the N97 high-end smartphone, which became available in June 2009.  This and similar products compete with Apple's (NASDAQ: AAPL) iPhone and Research in Motion's (NASDAQ: RIMM) Blackberry

The new Ovi service for selling handset software is Nokia's counterpoint to Apple's iPhone store.

Microsoft (NASDAQ: MSFT) and Nokia agreed in August to make Microsoft Office applications available on Nokia cell phones, probably next year.  This partnership has been characterized as a challenge to Blackberry's dominance of mobile devices for business customers.

Although a global powerhouse, Nokia's share of the North American market is more limited according to Fortune Magazine.   All Things Digital noted during an interview with Nokia's CEO that the company's inability to find a U.S. carrier to promote the N97 is illustrative of Nokia's difficulties.

Gartner reported:

Worldwide mobile phone sales totalled 286.1 million units in the second quarter of 2009, a 6.1 per cent decrease from the second quarter of 2008 .... Smartphone sales surpassed 40 million units, a 27 per cent increase from the same period last year, representing the fastest-growing segment of the mobile-devices market ...
The researcher was quite candid about Nokia

Nokia maintained its leadership position, but its portfolio remained heavily skewed toward low-end devices. Its flagship high-end N97 smartphone met little enthusiasm at its launch in the second quarter of 2009 and has sold just 500,000 units in the channel since it started to ship in June, compared to Apple's iPhone 3G S, which sold 1 million units in its first weekend. "The right high-end product and an increased focus on services and content are vital for Nokia if it wants to both revamp its brand and please investors with a more promising outlook in ASPs and margins," said Ms Milanesi.

To better compete in the network infrastructure market, Nokia and Siemens (NYSE: SI) formed a 50/50 partnership in April 2007.  The new company was named, with little imagination, NokiaSiemens Networks.  NSN had sales of €15.3 billion in 2008 (about 30 percent of Nokia's total annual revenue), and NSN's results are fully consolidated into Nokia's financial statements.  This presents a comparability challenge because Nokia's financial statements before April 2007 don't include the businesses the German powerhouse contributed to the partnership.

We're now ready to look ahead.
Nokia, when it reported results for the second quarter of 2009, also described its outlook for the industry and for the company.  The outlook does not include specific Revenue or Earnings guidance, but the information nevertheless helps us understand management's expectations for the operating environment and how well the company's different businesses will perform in it.
  • Nokia expects industry mobile device volumes in the third quarter 2009 to be at approximately the same level or up slightly sequentially.
  • Nokia expects its mobile device market share in the third quarter 2009 to be approximately at the same level sequentially.
  • Nokia continues to expect 2009 industry mobile device volumes to decline approximately 10% from 2008 levels.
  • Nokia now expects its market share in mobile devices to be approximately flat in 2009, compared with 2008. This is an update to Nokia's earlier target to increase its market share in mobile devices in 2009.
  • Nokia now expects its non-IFRS operating margin in Devices & Services in the second half 2009 to be at approximately the same level as in the first half 2009. This is an update to Nokia's earlier target for the non-IFRS operating margin in Devices & Services to be in the teens for the second half 2009.
  • Nokia and Nokia Siemens Networks continue to expect the mobile infrastructure and fixed infrastructure and related services market to decline approximately 10% in Euro terms in 2009, from 2008 levels.
  • Nokia and Nokia Siemens Networks now expect Nokia Siemens Networks market share to decline moderately in 2009, compared to 2008, with a strong performance in its Services business unit expected to be offset by declines in certain product businesses. This is an update to Nokia and Nokia Siemens Networks earlier target for Nokia Siemens Networks market share to remain constant in 2009, compared to 2008.

Roughly speaking, about 2/3 of Nokia's Revenue is from its Devices and Services segment and the remaining third is from NokiaSiemens Networks. (NAVTEQ contributed about 1.5 percent of Revenue in the second quarter.)

To estimate Revenue from Devices and Services, we consider the number of mobile devices sold and the average selling price.  The first two items in the outlook indicate that Nokia expects to sell about the same number of mobile devices in the third quarter as the second quarter.  The company didn't provide any guidance with respect to the average selling price (ASP), which was €62 in the second quarter.  The ASP fell from €74 in the second quarter of 2008 and €65 in the first quarter of 2009.

We're guessing that the ASP won't fall further in the third quarter.  In essence, we're assuming the additional high-price smart phones in the product mix will balance price cuts on less expensive units.

Therefore, Devices and Services Revenue should be close to the second quarter's €6.6 billion.

The outlook states that Revenue at NokiaSiemens Networks will be lower, both in absolute terms and as a share of the market.  We assume NSN's Revenue in the third quarter will be 3 percent less than the second quarter's €3.2 billion, which corresponds to an 11.5 percent annualized decline.

Therefore, after making a small adjustment for NAVTEQ, we come up with an overall Revenue target for the third quarter of €9.8 billion.

In the second quarter, Nokia's Gross Margin was 32.6 percent.  If we assume the same margin in the third quarter, the Cost of Goods Sold in the quarter will be about (1 - 0.326) * €9.8 billion = €6.6 billion.  The Gross Margin in the third quarter of 2008 was 35.6 percent.

With fewer special charges anticipated, Research and Development and Sales, General and Administrative expenses should be less in the third quarter than in the second.  We will assume €1.3 billion for R&D and €1.2 billion for SG&A.

It's hard to predict what other operating items (e.g., restructuring charges, workforce reduction expenses, asset impairment) Nokia might report in the third quarter.  Our €100 million estimate is intended to be conservative.

With these figures, our estimate for Operating Income is €595 million.  This value is 60 percent less than the value in the same period of last year.

For Non-operating items (e.g., interest), our target of a €60 million net expense is based on the results of the first two quarters of the year.

After a couple of quarters in which significant tax benefits were recorded, Nokia's effective tax rate was 24.5 percent in the second quarter.  We will round this up to 25 percent for the third quarter.   If we also assume  €80 million for Minority Interests, our prediction for Net Income is €481 million (€0.13/share).  This estimate is down 55 percent from the year-earlier quarter.

Please click here to see a full-sized, normalized depiction of the projected results next to Nokia's quarterly Income Statements for the last couple of years.  Please note that our organization of revenues, expenses, gains, and losses, which we use for all analyses, can and often does differ in material respects from company-used formats.  The standardization facilitates cross-company comparisons.

Full disclosure: Long NOK at time of writing.

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