12 December 2010

NOK: Look Ahead to December 2010 Quarterly Results

This post describes our model of Nokia's (NYSE: NOK and HEL:NOK1V) Income Statement for the fourth quarter, which will end on 31 December 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 sales, earnings, and share price have fallen precipitously in recent years.  Global economic weakness has certainly had a negative effect.  However, the most visible and far-reaching problem has been Nokia's inability to stem the success of Apple's (NASDAQ: AAPL) iPhone, which was introduced in 2007.  Blackberry products sold by Research in Motion (NASDAQ: RIMM) and, more recently, smartphones based on the Android architecture promoted by Google (NASDAQ: GOOG) have also become popular at Nokia's expense. 

Nokia devices have long used the Symbian operating system, but the company is now working with Intel (NASDAQ: INTC) to combine the Maemo and Moblin mobile operating systems into MeeGoMaemo is a Linux derivative.

In the latest and most dramatic attempt to regain its competitive position, Nokia replaced its Chief Executive Officer with Mr. Steven Elop, formerly of Microsoft (NASDAQ: MSFT).  One wonders if Mr. Elop will decide Nokia should build devices using Windows Phone software.

Nokia fans hope Mr. Elop, a Canadian citizen, will be able to resolve its long-standing difficulties in North America.  Only 3 percent of the mobile devices Nokia sold in 2009 and only 5 percent of Nokia's net sales in 2009 were in North America.

The overall 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 from €50.7 billion in 2008 to €41.0 billion in 2009.

The price of Nokia ADRs has fallen about 75 percent from a $40 peak in late 2007.  The company's market value is now $36 billion on a fully diluted basis.

Nokia 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 had operating losses in 2009.

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.

Nokia earned 0.14 per diluted share on an IFRS basis in the September-ending third quarter of 2010, up from a loss of €0.15 per share in 2009.  The loss in the year-earlier quarter was primarily the result of Nokia writing off €900 million of intangible assets.  On a non-IFRS basis, which excludes special items, third-quarter earnings fell from €0.17 to €0.14 per share.

Readers wanting to take another look at Nokia's September 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 September 2010 quarter.  Please recall that Nokia's financial statements conform to International Financial Reporting Standards.  Amounts are expressed in Euros (€).

When Nokia announced its third-quarter results on 21 October 2010, it delineated its expectations for the fourth quarter of 2010 and the full year.  The following subset of the guidance statements are pertinent to the present exercise.

Devices and Services
  • Nokia expects Devices & Services net sales to be between EUR 8.2 billion and EUR 8.7 billion in the fourth quarter 2010.
  • Nokia expects its non-IFRS operating margin in Devices & Services to be between 10% and 12% in the fourth quarter 2010.
  • Nokia continues to expect non-IFRS operating expenses in Devices & Services of approximately EUR 5.7 billion in 2010.

Nokia Siemens Networks 
  • Nokia and Nokia Siemens Networks expect Nokia Siemens Networks’ net sales to be between EUR 3.4 billion and EUR 3.8 billion in the fourth quarter 2010.
  • Nokia and Nokia Siemens Networks expect the non-IFRS operating margin in Nokia Siemens Networks to be between 2% and 5% in the fourth quarter 2010.
Adding the company's Revenue guidance for the Devices and Services business (€8.2 billion to €8.7 billion) and for Nokia Siemens Networks (€3.4 billion to €3.8 billion), and assuming NAVTEQ's Revenue will be between €200 million and €300 million, results in a Revenue guidance range for the entire company of €11.8 billion to €12.8 billion.

We have selected €12.3 billion, which is the midpoint of the guidance range, as our estimate for Nokia's total Revenue in the fourth quarter.  This figure is 2.6 percent higher than Revenue in the December 2009 quarter.

A non-IFRS operating margin between 10 percent and 12 percent is forecast for the Devices and Services business, according to the guidance excerpted above.  This range's midpoint, 11 percent, combined with the D&S Revenue midpoint of €8.45 billion, yields (1 - 0.11) * €8.45 billion = €7.52 billion as an estimate for D&S non-IFRS operating expenses.

Similarly, NSN's non-IFRS operating margin is forecast between 2 percent and 5 percent.  This range's midpoint, 3.5 percent, combined with the NSN Revenue midpoint of €3.6 billion, yields (1 - 0.035) * €3.6 billion = €3.47 billion as an estimate for NSN non-IFRS operating expenses.

If we assume that NAVTEQ has a 20 percent operating margin, this unit's operating expenses would be (1 - 0.2) * €250 million =  €200 million.

These figures for D&S, NSN, and NAVTEQ non-IFRS operating expenses (€7.52b + €3.47b + €0.2b) adds up to €11.2 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 €300 million assuming the guidance is realistic.

Our next step is to partition the €11.2 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 three quarters of 2010:  CGS was 74.1 percent of non-IFRS operating expenses,  R&D was 14.0 percent, and SG&A was 11.9 percent. 

These percentages gives us initial, non-IFRS fourth-quarter estimates of €8.30 billion, €1.33 billion, and €1.12 billion for CGS, R&D, and SG&A, respectively. 

The reported expenses will be somewhat higher than the non-IFRS figures.  We have estimated, based on data from the three quarters of 2010, that we need to add €70 million to non-IFRS Cost of Goods Sold, €150 million to non-IFRS R&D, and €130 million to non-IFRS SG&A to approximate the IFRS expenses.  These additions gives us totals of €8.37 billion, €1.48 billion, and €1.25 billion for CGS, R&D, and SG&A, respectively.

The CGS estimate translates into a Gross Margin of (1 - 8.37/12.3) = 32.0 percent.

We are assuming a €25 million charge for special other operating items, such as restructuring, workforce reduction expenses, and asset impairment.

With these figures, our estimate for Operating Income is €1.175 billion.  In the fourth quarter of 2009, Nokia had Operating Income of €1.14 billion.

For Non-operating items (e.g., interest), our estimate is a €80 million net expense.

Our 25 percent estimate for Nokia's effective tax rate could be far off since it has been very erratic recently.   If we also assume €225 million for Noncontrolling Interests, our prediction for Net Income becomes €1.05 billion (€0.28/share).  This compares to earnings of €948 million (€0.26/share) in the December 2009 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.

No comments:

Post a Comment