Nokia's Future Is Still Full Of Uncertainty

| About: Nokia Corporation (NOK)

On Thursday, Nokia announced its quarterly earnings for the last quarter. It looks like Nokia's (NYSE:NOK) business saw declines in almost every unit during the fourth quarter of 2013, and there will be uncertainty in the near future as we move forward. On a positive side, getting rid of the handset devices segment might actually prove to be the right move for the company.

The company earned 10 cents per share while the analysts were looking for a little bit over 6 cents per share. The company generated $4.52 billion on revenues, whereas, the analysts were looking for $5.73 billion. Basically, the company beat on net earnings but missed big time on revenues.

NSN (Nokia Solutions and Networks) posted stronger margins on declining revenues because the company divested from some business contracts where it did not expect to have healthy margins. As a result, the business segment's operating margin rose from 8.4% to 11.2% during the quarter even though the revenues fell 22% year-to-year. On quarter-to-quarter basis, the business segment saw its revenues rise by 20%. Quarter-to-quarter, NSN's operating profit was up 46%; however, year-to-year, the business segment's operating profit fell by 4%. On non-IFRS basis (which excludes one-time charges or extraordinary items), NSN saw its operating profit fell by 39% from the fourth quarter of last year and this number rose by 60% compared to the last quarter. For the full-year, NSN saw its sales decline by 18% but the segment saw its operating profit rise by 39%. Basically, the NSN sold fewer contracts in 2013 but it made more profits each contract during the year. On non-IFRS basis, NSN's operating margin rose from 5.7% to 9.7% between 2012 and 2013. Currently, NSN has the highest operating margins in the industry. In comparison, Ericsson (OTC:ERIAF) had an operating margin of 7.96% and Alcatel (ALU) had an operating margin of negative 0.57% in the last quarter.

Nokia's mapping business, HERE, saw its revenues fall by 9% in the quarter, while the operating profit went down by 38% compared to the previous quarter. On year-to-year basis, HERE's revenues rose by 20% while the operating profits rose by 25%. HERE's non-IFRS operating margin of 9.8% was down from the last quarter's 14.4%, but up from the last year's 9.5%. When we compare the full-year of 2013 with 2012, HERE's revenues fell by 17% and its operating income fell by 69%. In the full-year of 2013, HERE's operating margin was 5.2% compared to 2012's much stronger 13.9%. Nokia's mapping business is still struggling to be comfortably profitable and the business segment's operating margins seem to be very volatile as they change up and down sharply from quarter to quarter. It may be a while before HERE's margins stabilize and we have an idea about what they will look like in the future.

Nokia's Advanced Technologies segment basically consists of the company's patent portfolio. This is the business unit with the highest margins, since it does not have a lot of costs beyond legal costs. Most of the patented technologies were developed under other businesses, so the R&D expenses were typically charged to those segments, which gives this segment strong margins. Advanced Technologies business saw its sales dive by 20% year-to-year and 14% quarter-to-quarter while the operating profits fell by 35% year-to-year and 22% quarter-to-quarter. Still, this segment enjoyed non-IFRS operating margin of 67.8%, which is very strong. For the full-year, Nokia generated $688 million from its patents in revenues, which is pretty flat compared to 2012's $694 million. In terms of operating profits, both years resulted in $428 million of operating profits.

For the purposes of reporting, Nokia labeled its phone business as "discontinued operations" for the last quarter since this business segment will be transferred to Microsoft (NASDAQ:MSFT) moving forward. Nokia's phone business saw its revenues fall by 5% quarter-to-quarter and 29% year-to-year. Considering that the fourth quarter is always the strongest quarter of the year for the consumer electronics, it is very rare for a consumer-electronics focused company to post revenue declines from third quarter to fourth quarter. It is possible that many consumers were holding off on buying a Nokia smart phone while the company's smart phone business is being sold to Microsoft, but we will have a better view on that in the next few quarters. Nokia's phone business had a negative operating margin of -7.3%, down from last year's -1.3% and last quarter's. -4.7%. For the full-year, Nokia's phone business saw its revenue fall by 29% and its operating margin improved from -6.7% to -4.8%. It will be interesting to see if Microsoft can accomplish profitability for this business segment.

Nokia did not explain how many phones it sold during the quarter; however, it mentioned that both average sale price and volume of its phones came down. This is particularly concerning because until the fourth quarter, Lumia phones were on a hot roll and they were growing at a double-digit rate every quarter. If Lumia's growth suddenly came to a screeching halt, Microsoft will have to work hard on reversing the trend.

For comparison purposes, Nokia's continued operations (basically the current Nokia minus the phone business that got acquired by Microsoft), posted a revenue growth of 18% from last quarter but it saw a revenue decline of 17% from last year on constant currency.

When we look at Nokia's balance sheet, the company's total cash and liquid assets actually fell by $212 million to $11.66 billion. While NSN generated net cash flow, the company's phone business generated enough negative cash flow to offset all of NSN's gains. I am sure when Nokia's management saw that, they were glad that they sold the phone business to Microsoft.

For the full-year of 2014, Nokia expects NSN's operating margin to range between 5% to 10%; however, the company thinks it is very possible for NSN's operating margin to come towards the high-end of this estimate (i.e., closer to 10% than 5%). For the first quarter, the company gave a very wide operating margin estimate, ranging from 1% to 9%, noting seasonality and competitive industry dynamics. The company said that it will continue to invest into HERE in the early part of 2014, which will definitely hurt the margins of HERE; we may see it go back to negative margins in the next quarter or two. Nokia expects its patent revenues to rise by 20% during the year after Microsoft's license payments start getting realized by the company.

Moving forward, Nokia still has a lot of work to do in order to stabilize its earnings and make sure it stays on the right path. Both NSN and HERE are very volatile in terms of both revenues and margins and they are very difficult to predict. Nokia's net cash position will allow it to have a cushion while the company accomplishes stability in its income. I also wouldn't expect much in terms of dividends until the company has a better picture about what the future looks like. In the full-year of 2013, Nokia generated only 2 cents per share in net earnings and $94 million in net cash flow from operations; and the company generated 27 cents per share in net earnings and $1.50 billion in net cash flow from operations if we exclude the company's phone business. This is an increase of 62% compared to 2012's 17 cents per share. The growth in net earnings looks promising but only time will tell if Nokia can keep this up.

Disclosure: I am long MSFT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Tagged: , Communication Equipment, Earnings, Finland
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