24 July 2010

NOK: Income Statement Analysis for the June 2010 Quarter

Nokia Corp. (NYSE: NOK) earned 0.06 per diluted share on an IFRS basis in the 2010's second quarter, which ended on 30 June. This EPS amount was 40 percent less than the €0.10 Nokia made in the same quarter of 2009.

On a non-IFRS basis, which excludes items such as restructuring charges and intangible asset amortization, second-quarter earnings fell from €0.15 to €0.11 per share.

This post examines Nokia's Income Statement for the latest quarter and compares the entries on each line to our revised "look-ahead" estimates.  Reported earnings fell short of the €0.07 per share we had forecast by €0.01 per share.

In a second article, we will report Nokia's scores as measured by the GCFR financial gauges. The follow-up post will also provide the latest figures for the various financial metrics we use to analyze Cash Management, Growth, Profitability and Value.

Before getting into the details, we will take one step back to introduce the subject of today's analysis.

A Finnish company with a rich history, Nokia Corporation has been the leading global producer of mobile phones since 1998. Nokia also sells the network infrastructure that supports these phones. The company has three business segments: Devices and Services (D&S), Nokia Siemens Networks (NSN), and NAVTEQ. Despite a substantial head start, Nokia has been losing market share to upstarts such as Apple's (NASDAQ: AAPL) iPhone in the smartphone product category. Additional background information about Nokia and the business environment in which it is currently operating can be found in the look-ahead.

Please click here to see a full-sized, normalized depiction of the actual and projected results for the just-concluded quarter, as well as the 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.

In the June quarter, Nokia's Revenue rose 0.9 percent, from €9.91 billion last year to €10.0 billion in the last three months. Revenue was 1.0 percent less than the €10.1 billion target we established after Nokia lowered expectations for its Devices and Services unit.

Revenue decreased 2.5 percent in Europe, which is (by far) Nokia's largest market. The bright spots were Latin America and “Greater China,” where second-quarter sales soared 25 percent and 16 percent, respectively. Sales in North America were down 4 percent and were only 5.1 percent of total sales. (Nokia's long-standing difficulties in the U.S. have been well chronicled.)

The Devices and Services business segment had Revenue of €6.8 billion, which was consistent with the company's warning on 16 June 2010 to expect sales "at the lower end of, or slightly below" the €6.7 billion to €7.2 billion range it had defined in April. D&S revenue increased 3.2 percent when compared to the amount in the June 2009 quarter.

Nokia shipped 111.1 million mobile devices in the quarter, 8 percent more than last year as economic conditions improved modestly. The volume increase was led by a 26-percent rise in the number of devices sold in Latin America. Continuing a trend, the average selling price of these devices slipped from €64 to €61. The price of Nokia’s higher-price smartphones has been falling due to stiff competition, and it is not selling enough of them to counteract the inexorable price erosion on the lower end of the product line.)

Nokia estimated that it achieved a 33 percent share of the global mobile device market in the latest quarter, down from a 35 percent share in the second quarter of 2009. It would be interesting to learn how much the market share would rise if North America, where Nokia sold only 2.6 million devices in the June quarter, is excluded.

Revenue from Nokia Siemens Networks was €3.04 billion, down 5 percent from €3.2 billion in last year's second quarter. The decline was a steeper 11 percent when measured on a constant-currency basis. NSN's reported revenue was below the €3.1 billion to €3.4 billion range in the company’s guidance. The revenue decrease was primarily due to sales-completion delays in India because of new requirements related to product security. Component shortages also had a negative effect on sales.

Sales at the smaller NAVTEQ increased an impressive 71 percent to €252 million. Nokia attributed the rise to "improved conditions in the automotive industry and growth in mobile device sales."

The Cost of Goods Sold in the quarter was €6.93 billion, or 69.3 percent of Revenue. This ratio translates into a Gross Margin of 30.7 percent, a substantial 190 basis points less profitable than the 32.6-percent Gross Margin in last year's second quarter.

Nokia's Gross Margin also fell 50 basis points short of the 31.2-percent target we established for the second quarter.

Nokia's spending on Research and Development added up to €1.48 billion, essentially flat relative to the same period of 2009. The R&D expense was 4.3 percent less than our €1.55 billion estimate. As a percentage of Revenue, the R&D expense inched up from 14.7 percent in June 2009 to 14.8 percent in the latest quarter.

Sales, General, and Administrative expenses of €1.29 billion were also about the same as last year, and they decreased from 13.2 percent of Revenue to 12.9 percent. The amount spent on SG&A nearly matched our €1.3 billion estimate.

Other operating items resulted in a net expense of €2 million.

Subtracting the various operating expenses from Revenue yields Operating Income of €295 million. Operating Income sank 31 percent when compared to €427 million in last year's second quarter.

Operating Income was only €5 million less than our €300 million estimate. Less R&D spending balanced lower-than-expected Revenue.

Non-operating items, mostly financial income and expenses, resulted in a net expense of €74 million. We had expected €70 million.

Nokia’s effective income tax rate has tended to fluctuate widely from quarter to quarter, and this experience was repeated in the second quarter.  The tax rate was a steep 52.9 percent, compared to 24.5 percent in last year's second quarter.  Nokia stated that its taxes were “unfavorably impacted” because “no tax benefits are recognized for certain Nokia Siemens Networks deferred tax items.

We were optimistic in expecting a 20 percent tax rate.

The exclusion of a €123 million after-tax loss attributable to non-controlling interests (Siemens?) leaves €227 million (€0.06 per share) as the bottom-line Net Income "attributable to equity holders of the parent." Net Income on this basis was 40 percent less than in the 2009's second quarter.  Our estimate for the latest quarter was €269 million (€0.07 per share).

Full disclosure: Long NOK at time of writing.

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