27 January 2011

NOK: Income Statement Analysis for the December 2010 Quarter

Nokia Corp. (NYSE: NOK and HEL:NOK1V) earned 0.20 per diluted share on an IFRS basis in the December-ending fourth quarter of 2010, down 21 percent from €0.26 per share in the same three months of 2009. 

On a non-IFRS basis, which excludes special items, fourth-quarter earnings fell from €0.25 to €0.22 per share.

This post examines Nokia's Income Statement for the most recent quarter and compares the entries on each line to our "look-ahead" estimates.  Reported earnings were €0.08 less than our €0.28 EPS estimate.

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.  The company also sells the network infrastructure that supports these phones. 

Nokia's sales, earnings, and share price have fallen precipitously in recent years.  In 2007, Apple's (NASDAQ: AAPL) iPhone was launched and quickly became a runaway success, one that Nokia has been unable to stem.  The financial crisis that also began in 2007 eventually led to a worldwide decline in the number of mobile phones sold, which compounded Nokia's difficulties. 

Smartphones based on the Android architecture and Blackberry products sold by Research in Motion (NASDAQ: RIMM) 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.

Fans hope Mr. Elop, a Canadian citizen, will be able to resolve Nokia's long-standing difficulties in the U.S.  Yet, the company's disappointments in this lucrative market continue.  In January 2011, Nokia canceled the launch of a smartphone intended exclusively for the U.S. market.

The overall profit attributable to Nokia shareholders rose to €1.85 billion in 2010, from €891 million in 2009.  Net Sales increased from €41.0 billion in 2009 to €42.4 billion in 2010.

The price of Nokia ADRs has fallen about 75 percent from a $41 peak in late 2007.  The company's market value is now roughly $40 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 €29.1 billion in 2010, about 69 percent of Nokia's total, and it had an operating profit of €3.3 billion.  The other two business segments had operating losses in 2010.

Revenue from Nokia Siemens Networks in 2009 was €12.7 billion, 30 percent of total Revenue.  NSN lost €686 million.  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 €1.0 billion, and it lost €225 million.

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 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 December quarter, Nokia's Revenue rose 5.5 percent, from €12.0 billion last year to €12.65 billion in the last three months. Revenue was 3 percent more than our €12.3 billion target for the quarter.

Excluding the impact of fluctuating foreign exchange rates, Nokia's revenue in the fourth quarter was essentially unchanged.

Revenue increased 31 percent in "Greater China" and 14 percent in Latin America.  Revenue was unchanged in Europe, which is Nokia's largest market.  Sales in North America remained weak, only 4.4 percent of total revenue for the quarter. 

The Devices and Services business had Revenue of €8.5 billion, which was consistent with the company's guidance to expect sales between €8.2 billion to €8.7 billion.  D&S revenue increased 4 percent when compared to sales of €8.2 billion in the December 2009 quarter.

On a constant-currency basis, D&S revenue declined 3 percent.

Nokia shipped 124 million mobile devices in the quarter, 3 percent less than last year.  The only geographic area where Nokia sold more devices than in the fourth quarter of 2009 was Greater China.  Nokia sold only 2.6 million devices in North America during the December 2010 quarter.

Nokia's market share fell because the total number of mobile devices sold across the industry grew at a robust 12 percent.  The company's preliminary estimate is that its market share declined from 35 percent in the fourth quarter of 2009 to 31 percent in the same quarter of 2010.

The average selling price of these devices rose from €64 to €69 because higher-priced smartphones comprised a greater percentage of the sales mix. 

Revenue from Nokia Siemens Networks was €4.0 billion, up 9 percent from €3.6 billion in 2009's fourth quarter.  NSN's reported revenue exceeded the €3.4 billion to €3.8 billion range in the company’s guidance.  Net sales were  "driven by growth in both the product and services businesses in most regions" and "benefited from an improvement in overall component availability."

Sales at the smaller NAVTEQ increased an impressive 37 percent to €309 million.  Nokia attributed the rise to "improved sales of map licenses to mobile device customers as well as higher navigation uptake rates in the automotive industry."

The Cost of Goods Sold in the quarter was €8.92 billion, or 70.5 percent of Revenue. This ratio translates into a Gross Margin of 29.5 percent, a substantial 450 basis points less profitable than the 34.0-percent Gross Margin in 2009's fourth quarter.

Nokia's Gross Margin was also 230 basis points below the 32.0-percent target we established for the fourth quarter.

Nokia's spending on Research and Development amounted to €1.54 billion, about the same as in the fourth quarter of 2009.  The R&D expense was 4 percent more than our €1.48 billion estimate.  As a percentage of Revenue, the R&D expense was reduced from 13.1 percent in December 2009 to 12.2 percent in the latest quarter.

The Sales, General, and Administrative expense of €1.3 billion was also about the same as last year.  This expense decreased from 11.2 percent of Revenue to 10.5 percent.  The amount spent on SG&A was 6 percent more than our €1.25 billion estimate.

Other operating items (€207 million in income, €183 million in expense) resulted in income of €24 million, a better result than we expected.

Operating Income, calculated by subtracting the various operating expenses discussed above from revenue, was €884 million.  This amount is 22.5 percent less than last year's equivalent value of €1.14 billion. The latest Operating Income amount was a disappointing 25 percent less than our €1.18 million target.  Better-than-expected Revenue was not nearly enough to offset the much lower-than-expected Gross Margin.

Non-operating items, mostly financial income and expenses, resulted in a net expense of €51 million.  We had expected €80 million.

Nokia’s effective income tax rate has tended to fluctuate widely from quarter to quarter, and this experience was repeated with the fourth quarter's unusually low 10.9 tax rate.  Nokia reported that the fourth quarter tax rate benefited from "reassessment of recoverability deferred tax assets in Nokia Siemens Networks."

We had expected a 25 percent tax rate.

The exclusion of €3 million after-tax loss attributable to non-controlling interests (Siemens?) left €745 million (€0.20 per share) as the bottom-line Net Income "attributable to equity holders of the parent."

Our earnings estimate for the latest quarter was a too-optimistic €1.05 bllion (€0.28 per share).  The Gross Margin was a disappointment, and our projection was also thrown off by the tiny exclusion for non-controlling interests.  It should be noted that Nokia's bottom line benefited from unusual tax matters.

Full disclosure: Long NOK at time of writing.

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