03 June 2010

NOK: Look Ahead to June 2010 Quarterly Results

This post describes our model of Nokia's (NYSE: NOK and HEL:NOK1V) Income Statement for the quarter that will end on 30 June 2010.

The purpose of the model is to establish a baseline for identifying surprises, positive or negative, in the quarterly results the company will report.  Estimates for each line of the Income Statement are derived from management's guidance, the company's historical financial results, and other publicly available data.

We begin by reviewing background information about Nokia and the business environment in which it is currently operating.

A Finnish company with a rich history, Nokia Corporation has been the leading global producer of mobile phones since 1998.  The company also sells the network infrastructure that supports these phones. 

Nokia's financial statements conform to International Financial Reporting Standards.  Amounts are expressed in Euros (€).

The profit attributable to Nokia shareholders fell to €891 million in 2009, from €4.0 billion in 2008 and €7.2 billion in 2007.  Net Sales dropped 19 percent, from €50.7 billion in 2008 to €41.0 billion in 2009.

Nokia blamed its diminished performance in 2009 on "deteriorated global economic conditions, including weaker consumer and corporate spending, constrained credit availability and currency market volatility."  The company did observe an improved environment in the second part of the year.

The price of Nokia ADRs has fallen about 75 percent after peaking at $40 in late 2007.  The company's market capitalization is now roughly $38 billion.

The company has three business segments:  Devices and Services (D&S), Nokia Siemens Networks (NSN), and  NAVTEQ.  The latter is tiny in comparison to the first two.

D&S brought in Revenue of €27.8 billion in 2009, about 68 percent of Nokia's total, and it had an operating profit of €3.3 billion.  The other two business segments both had operating losses in 2009.

The market for mobile devices is highly competitive, and product development cycles are short.  Nokia shipped 432 million mobile devices in 2009, down 8 percent from the year earlier.  The company estimated its share of the worldwide mobile device market at 38 percent.  The market share figure is remarkable given that only 3 percent of the mobile devices Nokia sold in 2009 were in the large North American market, and only 5 percent of Nokia's net sales in 2009 were in North America.  (Nokia's difficulties in the U.S. have been well chronicled.)  

Mobile device competitors include Samsung (SEO: 005930), Motorola (NYSE: MOT), LG Electronics (SEO: 066570), Sony Ericsson, HTCApple (NASDAQ: AAPL), Research in Motion (NASDAQ: RIMM), Palm (NASDAQ: PALM), and now Google (NASDAQ: GOOG).

Despite its head start, Nokia has not been able to able to stem the success of Apple's (NASDAQ: AAPL) iPhone in the smartphone product category.

As phones morph into computers, software becomes increasingly important and a potential differentiator.  Nokia devices have long used the Symbian operating system, but the company also uses Maemo, a Linux derivative, in some newer products.  Other newer mobile operating systems include Android (used by Google in the Nexus One) and Windows Phone.  Nokia is now working with Intel (NASDAQ: INTC) to combine the Maemo and Moblin mobile operating systems into MeeGo.

Revenue from Nokia Siemens Networks in 2009 was €12.6 billion, 30 percent of total Revenue.  NSN lost €1.6 billion, which included a €900 million charge for goodwill impairment.  Nokia and Siemens (NYSE: SI) formed NSN as a 50/50 partnership in April 2007 to better compete in the network infrastructure market.

NAVTEQ's Revenue last year was €579 million, and it lost €344 million.

In the first quarter of 2010, which ended on 31 March, Nokia earned €0.09 per diluted share on an IFRS basis.  Earnings by this measure tripled the €0.03 Nokia made in the same quarter of 2009.  Reported earnings fell short of the €0.13 per share we had forecast by €0.04 per share.  Readers wanting to take another look at Nokia's March 2010 quarter are referred to our Income Statement and Financial Gauge analyses.

We're now ready to look ahead to Nokia's results for the June 2010 quarter.

When Nokia announced its first quarter results on 22 April 2010, it delineated its expectations for the second quarter and the remainder of 2010.  The following subset of the guidance statements are pertinent to our present purpose.
  • Nokia expects Devices & Services net sales to be between EUR 6.7 billion and EUR 7.2 billion in the second quarter 2010.
  • Nokia expects its non-IFRS operating margin in Devices & Services to be between 9% to 12% in the second quarter 2010.
  • Nokia and Nokia Siemens Networks expect Nokia Siemens Networks’ net sales to be between EUR 3.1 billion and EUR 3.4 billion in the second quarter 2010.
  • Nokia and Nokia Siemens Networks expect the non-IFRS operating margin in Nokia Siemens Networks to be between 0% to 3% in the second quarter 2010.

If we take the D&S Revenue range (€6.7 billion to €7.2 billion), add the NSN Revenue range (€3.1 billion to €3.4 billion), and add another €200 million for NAVTEQ, we get a guidance-driven Revenue range for the entire company of €10 billion to €10.8 billion.

We have chosen the €10.4 billion midpoint as our estimate for Nokia's total Revenue in the second quarter.

To derive estimates of the company's operating expenses in the second quarter, we rely on Nokia's operating margin guidance for the D&S and NSN businesses.  One complication is that the guidance applies to "non-IFRS" operating margins.  Our objective is to estimate the elements of the IFRS-compliant Income Statement, so we will have to add provisions for expenses excluded from the non-IFRS presentation.

A non-IFRS operating margin between 9 percent and 12 percent is forecast for the Devices and Services business.  This range's midpoint, 10.5 percent, combined with the D&S Revenue midpoint of €6.95 billion, yields (1 - 0.105) * €6.95 billion = €6.22 billion as an estimate for D&S non-IFRS operating expenses.

Similarly, a non-IFRS operating margin between 0 percent and 3 percent is forecast for NSN.  The midpoint, 1.5 percent, combined with the NSN Revenue midpoint of €3.25 billion, yields (1 - 0.015) * €3.25 billion = €3.20 billion as an estimate for NSN non-IFRS operating expenses.

If we generously assume that NAVTEQ has a 20 percent operating margin, its operating expenses would be (1 - 0.2)  * 200 million =  €160 million.

These figures for D&S, NSN, and NAVTEQ non-IFRS operating expenses adds up to €9.58 billion.  If we redo the calculations using the high and low extremes for the Revenue and Operating Margin guidance, we find that the range of uncertainty is roughly plus or minus €200 million.

Our next step is to partition the €9.58 billion non-IFRS operating expense estimate into three components:  Cost of Goods SoldResearch and Development, and Sales, General and Administrative.  (Nokia divides the latter category into Selling & Marketing and Administrative & General.)  We have assumed that these expense components will have the same relative proportions they had in the first quarter of 2010:  CGS was 73.2 percent of non-IFRS operating expenses,  R&D was 14.7 percent, and SG&A was 12.1 percent. 

These percentages gives us an initial second-quarter estimates of €7.0 billion, €1.4 billion, and €1.2 billion for CGS, R&D, and SG&A, respectively.  The CGS estimate translates into a Gross Margin of (1 - 7/10.4) = 32.7 percent.

The reported expenses will be higher than the non-IFRS figures.  We have assumed, based on 2009's results, that we need to add €50 million to non-IFRS Cost of Goods Sold, €150 million to non-IFRS R&D, and €100 million to non-IFRS SG&A to produce estimates for the IFRS expenses.  These additions gives us totals of €7.05 billion, €1.55 billion, and €1.3 billion for CGS, R&D, and SG&A, respectively.

There might also be special other operating items (e.g., restructuring charges, workforce reduction expenses, asset impairment), but we will assume not.

With these figures, our estimate for Operating Income is €500 million.  This value is 17 percent more than the value in the same period of last year.

For Non-operating items (e.g., interest), our estimate is a €70 million net expense.

Nokia's effective tax rate has been erratic from quarter to quarter.  Our 20 percent estimate is a wag.  If we also assume €85 million for Noncontrolling Interests, our prediction for Net Income is €429 million (€0.12/share).  This estimate is up 13 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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