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Nokia Corp. (NYSE:NOK)

Q2 2007 Earnings Call

August 02, 2007 8:00 am ET

Executives

Bill Seymour - VP of IR

Olli-Pekka Kallasvuo - President & CEO

Rick Simonson - EVP & CFO

Analysts

Tim Long - Banc of America Securities

Phil Cusick - Bear Stearns

Kulbinder Garcha - Credit Suisse

Paul Sagawa - Sanford Bernstein

Tim Boddy - Goldman Sachs

Sherief Bakr - Citigroup

Mike Walkley - Piper Jaffray

Ehud Gelblum - JPMorgan

Mark Sue - RBC Capital Markets

Stuart Jeffrey - Lehman Brothers

Gareth Jenkins - Deutsche Bank

Ed Schneider - Charter Research

TRANSCRIPT SPONSOR
Wall Street Breakfast

Operator

At this time, I would like to welcome everyone to the Nokia Second Quarter 2007 Earnings Conference Call. After the speakers' remarks, there will be a question-and-answer session (Operator Instructions).

I will now turn the call over to Mr. Bill Seymour, Head of Investor Relations. Sir, you may begin.

Bill Seymour

Thank you. Ladies and gentlemen, welcome to Nokia's second quarter 2007 conference call. I'm Bill Seymour, Head of Investor Relations; Olli-Pekka Kallasvuo, President and CEO of Nokia; and Rick Simonson, CFO of Nokia are with me today.

During this briefing and call, we will be making forward-looking statements regarding the future business and financial performance of Nokia and the mobile communications industry. These statements are predictions that involve risks and uncertainties.

Actual results may therefore differ materially from the results currently expected. Factors that could cause such differences can be both external, such as general economic and industry conditions as well as internal operating factors. We have identified these in more detail on pages 12 to 24 in our 2006 20-F and our press release issued today.

Our aim is to finish this call in approximately one hour. To view the supporting slides, while listening at the call, please log on to Nokia.com/investor. A replay of this call will be available until next Wednesday. The call will also be archived on our website.

Olli-Pekka, please go ahead.

Olli-Pekka Kallasvuo

Thanks Bill. And good morning and good afternoon. The performance of our device businesses were simply excellent in the second quarter. This was our third consecutive quarter of improving device across margins combined with stability of ASPs, driven by a broad balanced product portfolio from top to bottom.

We also gained market share in the second quarter, achieving a balance that reinforces what I have said with you on many occasions. For Nokia, increasing market share and profitability are not new to our exclusive. We have broad product portfolio, our customers demand, and it is supported by our cost structure and distribution network that is second to none.

While our device business had an excellent performance across the board, in stark contrast Nokia Siemens Networks had disappointing results in the first quarter of operations. It was a challenging quarter for the new company, which fell short both in terms of revenues and margins. A little later in the call we'll discuss the reasons for this and the strong actions already underway to address the situation.

Overall Nokia continued to grow in the second quarter. Our estimated share of the global device market improved significantly to 38%. Profitability was excellent, helping drive diluted EPS up 39% year-on-year, excluding special items. Our device portfolio is shaping up well and we now have multiple hit devices in the higher mid end to complement our leading portfolio of highly profitable entry-level devices.

In particular the Nokia 6300, the Nokia N95 multimedia computer, and the Nokia E65 have been hugely successful helping drive operating margins in our device businesses to their highest levels in three years. We have more products coming this year and you will see some announcements this quarter of new devices that I think customers and consumers will find exciting.

Let's take a closer look at the overall device market and our device business. We estimate the second quarter mobile device market was 262 million units, growing 14% year-on-year and 3% sequential. In the interest of time, I won't get into the details on the overall market. The slide shows our estimates of the markets that is fixed for the second quarter.

On to the product highlights for the second quarter. The entry level Nokia 1600 and Nokia 1110 families were again the top volume products for us. The midrange Nokia 6300 was available in volume in most regions globally during the second quarter and we shipped over 5 million units of this popular device.

This made it Nokia's number three volume product and Nokia's number one revenue and profit contributor for the second quarter. Nokia N Series multimedia computers had volumes of over 9 million units. The Nokia N70, N73, and Nokia N95 were the big products for multimedia during the quarter. The N73 and N95 were in the top three for Nokia in terms of revenue and profit for Q2. We shipped approximately 1.5 million units of the Nokia N95 in the quarter, and it had a good sell through.

The Nokia N95 is one of Nokia's first devices with a true total product offering, combining the device and services on top of that. The N95 comes with onboard GPS mapping and for a fee users can get turn-by-turn navigation. Early signs from N95 users have been very encouraging. We also recently announced the availability of a GPS service for the N95, the Nokia 6110 navigator, and the future Nokia GPS devices.

It is still early days, but it is already clear that as device conversions progresses, there is growth potential in location-based services and the like on mobile devices. For players who are well positioned in the converts device market, as Nokia clearly is, we believe we could be seeing early signs of the next wave of growth in this industry.

On to the Enterprise Solutions. Our target growth for the business growth is to become profitable in the second quarter and they certainly delivered. The Nokia E65 was the hit product, selling over 1 million units during the quarter. Volumes of the E61i also grew and late in the quarter we started shipping our new communicator, the Nokia E90.

Now for the important products for the third quarter. In the entry level, the high volume devices are expected to be the Nokia 1600 and 1110 families. During the third quarter we expect to start shipments of the thin and highly functional Nokia 2630 Barracuda. We also expect to start shipments of some of our new entry-level products based on the single chip Champion platform including the Nokia 1200, 1208, and 1650. We expect that these new entry-level products will start shipping towards the end of this quarter, but will not ramp to big volumes until the fourth quarter.

I want to explain something about the timing of entry-level chipset platforms as they relate to Texas Instruments and Infineon. Champion is a single chip entry-level chipset that we are currently doing with Texas Instruments, TI. Our partnership with Infineon is for a second source of single chip entry-level chipsets. Shipments of products based on the Infineon chipset will begin in the first half of 2008.

The Infineon partnership a good example of Nokia now being more flexible in our chips of sourcing and in our prioritization of R&D. Use of Nokia will continue to be in objective in its make versus buy decision in the future, with a focus on where we can add value. You will hear more on this soon, consistent with the Infineon example and the overall strategy we have communicated.

In the midrange, we expect the Nokia 6300, Nokia 5200, and 5300, and the new Nokia 6120 phone will sell in high volumes. We expect to start shipments of the Nokia 3500, the Nokia 6500 Classic, and the 6500 Slide. The Nokia 6500 Classic is Nokia's thinnest device yet with CDMA and two megapixel camera, it does not compromise on looks or features.

In multimedia, the significant products are expected to be the Nokia N73, N70, and N95 multimedia computers. New products like the N95 have strong volume, which translates into very good initial demand. After this early adopter phase these types of products are more likely to level off or increase slightly in volumes over the short-term. For enterprise we expect the key volume product will continue to be the Nokia E-65.

Nokia's product portfolio continues to improve and we will start to ship several new products this quarter. However, since these products will start shipping towards the end of the quarter, they will likely have a limited impact on volumes.

As we talked about last quarter, the challenging part of this is ramping up all these new devices during a relatively short period of time. In fact we believe that this will be one of the biggest ramp-ups of new products in Nokia's history. To give you an example, the Nokia 1200 and 1208 entry level products will need to go from zero to tens of millions of units in a matter of weeks. Challenging, yes, but this is the kind of execution we expect from the Nokia team and it is necessary to stay well ahead of competition.

As you are all aware, Q2 was the first full quarter of operations for Nokia Siemens Networks. While Rick will talk about the financials in more detail, and there's quite a bit of detail there, I will touch on some key points.

At the outset, let me say that I'm disappointed with the final performance of Nokia Siemens Networks during its first full quarter of operations. The new company clearly underperformed the market. Both revenues and margins were weak and these adverse developments require decisive action. Accordingly, synergy savings target has been accelerated and increased. We believe that these actions will lead to a cost base that is competitive and will provide a platform for acceptable return on invested capital.

At the same time, getting the cost base into shape is only one part of the equation for Nokia Siemens Networks, as we must ensure that the company's position for success and leadership in the fast changing infrastructure market. These factors require NSN to quickly transform its business.

This transformation will need to take place on a number of fronts, including a stronger focus on services and communication solutions with greater software content and rebalancing of operations towards the high growth areas in India, China, and other emerging markets the NSN has a strong market presence and where the company can lower its costs.

NSN will also focus more on solution sales and cross selling the full product range of the new company, an area of considerable opportunity, which NSN has only just begun to exploit.

Despite NSN's core final performance, they were a number of quite promising developments for the new company. Customer support for the new company remains strong. The early customer satisfaction survey data shows that customers view Nokia Siemens Networks as greater than the sum of its predecessor companies. While this support did not necessarily translate into strong Q2 results, it gives the proper foundation to build on in the future.

NSN won deals recently with a range of customers, including a €900 million end-to-end network expansion deal with Bharti Airtel in India. Another major win in India was with IDSL Limited for a €500 million GSM network expansion.

During the quarter, Nokia Siemens did leverage its GSM radio technology know-how to win a contract for the worlds longest high-speed railway line in southern China. NSN will supply both of GSM solutions including base stations, a core network, intelligent network, and an advanced high speed railway tunnel communications solutions and services

Now I'll pass over to Rick for more on the financials. In fact, this time, we need to spend quite a bit of time here because of the developing complexity of the topic.

Rick Simonson

Thanks, Olli-Pekka, and thank you, everyone. And let's see if we can work through this in a constructive way here. Let me cover Nokia overall in our device business financials first and then I'll get to Nokia Siemens Networks in more detail.

In the second quarter, Nokia net sales were up 28% year-on-year and sequentially. Of course, the 28% is not organic growth, because the comparable quarters did not include the full Nokia Siemens Networks result.

Nokia's reported gross margin was 31.1%, but excluding the portion of the NSN restructuring charge that hit gross margin, it was 33.3%. The 33.3% Nokia gross margin also included a negative impact of €182 million for the merger-related NSN inventory value adjustment.

Gross margins for our three device businesses were strong in the second quarter. If you look at the three combined device-related businesses, as many of you do, it was the third straight quarter of increasing device gross margins. All three device-related business group’s gross margins were up well over 300 basis points sequentially. The increase in gross margin for all three business groups was the result of an improved product portfolio, as well as good product cost management.

As Olli-Pekka mentioned, the products that had the biggest impact were the Nokia 6300, the Nokia N95, and the Nokia E65. Hit products certainly are important. These three alone represented 20% of Nokia's device revenues and almost 30% of device profits in Q2, but we have to remember that they must also be supported by a wide range of solid products and with regular renewal in the product portfolio.

Of course, gross margins wouldn't be nearly as high without combining a solid product portfolio with our traditional competitive advantages of brand, lowest cost, scale, world-class logistics and technology innovation. We continue to invest in these areas in order to sustain our much better margin structure versus the competition. However, as I've said before, you should expect and will see some volatility from quarter-to-quarter on our device gross margins.

And on that note, the third quarter product portfolio looks very solid. However, I'd caution that we will essentially have the same product portfolio this quarter as we had in Q2. We expect that many of the new products shipping this quarter will have a relatively limited impact on volumes in Q3.

Thus, we're less likely to be as strong a catalyst to device gross margins in Q3 as they were in Q2. And I also would like to stress that the usual, other factors are still relevant for device gross margins. For example, we need to retain the flexibilities to react to different competitive pressures as they come. This is a very competitive market and it will remain to be so in the future.

We also need to renew our portfolio continuously with great products in order to achieve the kind of device margins we've been seeing recently. Reported Nokia operating margin was 18.7% in Q2 and excluding special items, operating margin was 11%. The 11% Nokia operating margin also included the intangible asset amortization of €115 million, and of course the negative impact of €182 million for the merger-related NSN inventory value adjustment that I mentioned earlier.

Nokia's operating margins for the device related businesses were very strong and the same as for the gross margins. If you combine the three device related businesses, the operating margin was also up for the third straight quarter. Excluding special items, mobile phones' operating margin was up almost 400 basis points sequentially, driven by the improved gross margins and some OpEx leverage.

Excluding special items, multimedia's operating margin was up almost 200 basis points sequentially, driven entirely by the improved gross margin as OpEx was up as a percentage of sales as planned. Enterprise Solutions clearly hit its target of breakeven for the second quarter with an operating margin of 18%. All the Enterprise Solution business units, devices, software, and security were profitable in the quarter. Of course the biggest driver for Enterprise Solutions positive margin development was the success of the Nokia E65.

Nokia's second quarter device ASP was €90, up sequentially from €89 in Q1. The increase in ASP was primarily driven by a greater percentage of high-end device sales, which more than offset continued robust sales from the entry-level segment. In fact, the sub-50 euro segment actually grew by a couple of points in Q2 compared to Q1, rising to approximately 50% of our total device volume.

Now on to the Nokia Siemens Networks financials. Clearly, this was a weak first quarter of operations for NSN. The reasons for the poor results can be summed up in two ways, issues related to competition, and issues related to the start of operations. We're in an extremely competitive environment today, especially in the wireless infrastructure market.

Specifically, we have recently been seeing very aggressive and we believe unsustainable pricing behavior in the industry, with some competitors looking to capitalize on the Nokia Siemens Networks integration. NSN has simply not participated in many of these deals because of the overall bad financial terms.

The first quarter of operations was a quarter of transition and stabilization as NSN merged. We suspect there was a larger than expected delay in purchasing from customers who took a wait-and-see approach to the merger during the period of uncertainty related to the delayed start of the new company.

While NSN maintained its strong customer base, there was clearly a slowdown in order uptake. This situation is already working itself through, but given the lag between the order receipt and booking of revenue in the infrastructure section, there will be likely some lingering affects.

In addition to the external effects of the NSN's start of operation, there was inevitable some internal disruption. The complexity of the initial integration required management focus and in addition the implementation of the previously announced compliance program also consumed considerable management resources. Understandably, given all these issues, the organization has been somewhat distracted and this had a temporary impact on execution.

Now on to the numbers. As we've discussed, we cannot give sequential or year-on-year comparisons for the periods before the closing of Nokia Siemens Networks. I know this is inconvenient for you so we'll try, at least where we can to add a little color where we have missing comparison periods.

Net sales for NSN were €3.4 billion in the second quarter. According to our estimates, net sales were down over 10% both year-on-year and sequentially for the combined company. Nokia Siemens Networks reported gross margin was 15.5% and excluding the restructuring costs, it was 23.6%.

The 23.6% gross margin also includes a €182 million charge for the inventory value adjustment taken during the quarter. You can do the math on what gross margins would have been without this charge.

Pricing pressure and a mix of lower margin regions and lower margin products had a negative impact on NSN's underlying gross margins. NSN's reported operating loss was €1.3 billion in the second quarter. Excluding special items, the operating loss was €361 million, for a margin of negative 10.5%.

Operating profit, excluding special items, was negatively impacted by a combination of the low net sales and the weak gross margins. The negative 10.5% NSN operating loss also included the intangible asset amortization of €115 million and the inventory adjustment that I just mentioned. Again, you can do the math on what the operating loss would have been without these items.

In summary, Nokia Siemens Network's operating margin was negatively impacted by poor performance, but also as expected by a substantial amount of non-cash accounting and restructuring costs associated with the creation of the new company. These costs for the restructuring, the inventory value adjustment, and intangible asset amortization totaled €1.2 billion in Q2.

Let me spend a few minutes to go through the accounting treatment for the NSN charges and costs from Q2, including the restructuring charges, the gain realized on the transaction, and the inventory adjustment as well as the intangibles created by the transaction.

First, the restructuring cost. As we showed in the press release, the total restructuring costs and one-time items for NSN incurred in the quarter was €905 million, which is a significant portion of the €1.5 billion in restructuring costs we originally targeted.

Of the €905 million taken in the second quarter, €646 million was in personnel-related restructuring and the balance related to other merger and integration costs. We've laid out where these charges hit the P&L.

Our guidance on restructuring charges and special items is in the press release. For your modeling purposes, you may use NSN-related restructuring charges in the second half of this year, totaling approximately €300 million plus or minus with the majority estimated to hit in the fourth quarter.

Now the gain from the creation of NSN. In the second quarter Nokia realized a non-cash accounting gain on the Nokia Siemens Networks merger transaction in the amount of €1.9 billion. The gain reflects the partial divestiture of the Nokia Networks business given that 50% of NSN is owned by Siemens.

The gain was calculated from the fair value of the Nokia Networks business minus the book value of the Nokia Networks business. For the first portion transferred or sold to Siemens. The gain was booked under other operating income and expenses in Nokia group common functions.

Next, the inventory value adjustment. In performing the acquisition accounting, adjustments to the Siemens carrier-related operations, it was determined that inventory values needed to be marked-to-market and increased by €182 million to reflect their fair values. Since these inventories were sold or disposed of during the second quarter, the inventory fair value adjustment is reflected as an expense in cost of sales in NSN's P&L for Q2.

And lastly, the newly created intangibles. We said in last quarter's earnings call that the creation of the new company would result in a sizable amount of intangible assets hitting Nokia's balance sheet. We engaged an independent evaluation firm and it was determined that the intangible assets acquired from Siemens were approximately €2.5 billion.

These intangible assets included customer relationships, developed technology, in process research and development costs and licenses to use trade names and trademarks, all of which are capitalized under IFRS. The intangible assets had lives ranging from three to six years and need to be amortized on a quarterly basis.

As we disclosed today, the Q2 amortization was €115 million. We know this is a bit messy and many analysts will take the amortization out from their clean operating EPS estimates, as it is non-cash, non-operative hit to the P&L.

So in order to make sure we're all speaking the same language, when submitting estimates to the likes of First Call, Bloomberg, Reuters, and SME, we would encourage analysts to submit their estimates excluding both special items and the intangible asset amortization.

Just as a reminder, since Siemens owns 50% of the equity, Nokia Siemens Networks' profits and losses are shared 50/50 between the parents, Nokia and Siemens. The 50% share to Siemens, whether it is positive or negative, will flow through Nokia's minority interest line item on our P&L as it did in Q2.

We have again attached a slide at the end of this presentation that walks you through how the NSN accounting works for Nokia's P&L. As many of you determined, you must take into account things like tax treatment when you calculate the NSN results that flow through the minority interest of the line item.

Now let me give you an update on the financial targets and integration progress for NSN. First, financial targets. In the first quarter conference call, we said we would maintain the target of achieving double-digit operating margins, excluding special items for NSN by the end of its first year of operations, but acknowledge that that goal would be challenging.

In light of the recent developments, we now do not expect NSN to meet that earlier target. However, we do expect that NSN's operating margin will improve in the second half of this year, excluding special items.

Second, operational synergy targets. Nokia will now accelerate and increase NSN's synergy savings goals, shifting from achieving approximately €1.5 billion in annual savings by 2010, to achieving those savings by the end of 2008. In addition, NSN is targeting a further €500 million in synergy savings. We'll keep you posted on this.

Despite the challenges of the second quarter, the integration plans remain on track. Nokia NSN, excuse me, NSN took many steps in Q2 to ensure that it is on track to achieve additional reductions in personnel in the future, including agreement with works counsels in Finland and negotiations in Germany and in other parts of the world.

In addition to direct reductions in Finland and Germany announced previously and included in the total reductions NSN will continue to look for additional opportunities in both countries to transfer personnel to its business partners. NSN has also focused on the culture of the new company, given how important this for the success of any merger.

In addition to a strong focus on ethics and integrity, NSN has engaged all employees in defining values for the new company and built a strong sense of commitment and ownership. I really feel NSN is on the right track and fully capable of building a strong, sustainable culture.

Let me now summarize the total special items for all of Nokia in the second quarter. During the quarter we had net positive €970 million in special items. All the one-time items are outlined on the slide and in the press release. Excluding these, the second quarter operating margin was 11% versus a reported 18.7.

The impact of the second quarter special items to diluted EPS was a positive 40 euro cents. So excluding these items, second quarter diluted EPS was 32 euro cents versus a reported EPS of72 euro cents. Again, just to be clear nearly the intangible asset amortization nor the inventory value adjustment is included in the special items.

So if you exclude these two items, which totaled €297 million in Q2, and you exclude, the special items EPS would have been higher than the 32 euro cents. Because of the tax deducibility, the NSN loss had a positive impact on our reported tax rate for Q2. Overall, we are still estimating a tax rate for Nokia of approximately 26% in the future.

Next let's look at some of Nokia's balance sheet and cash flow items. Inventory was up by €1.1 billion in the second quarter sequentially. This and the increase in accounts receivable were due primarily to the consolidation of NSN into Nokia's balance sheet. We've explained the components of this in the next slide.

CapEx was €221 million. Total operating cash flow in the second quarter was €1.5 billion. Cash flow from our device businesses was very strong, but was offset by NSN negative cash flow of approximately €500 million, or an NSN related cash flow of negative €500 million.

Negative cash flow is not unusual at this phase of operations at this type of new company and we expect NSN-related cash flows will improve going forward. Our cash and other liquid assets were €8.3 billion at the end of the second quarter, down from €9.1 billion in Q1. The decrease in cash balance was driven by the €1.7 billion in dividends paid in Q2 and €996 million used to buy back stock.

Since Nokia is fully consolidating Nokia Siemens Networks balance sheet as well as the P&L there's been a significant impact from NSN on Nokia's balance sheet. On this slide we compared Nokia's second quarter balance sheet to the first quarter and have added some comments on the line items that were impacted the most by the creation of NSN.

I'll not review these, but have provided the slide for your reference and modeling purposes. On currencies, the reported second quarter year on year net sales growth was 28% and at constant currency, it would have been 32%. Over the last few months, the dollar has continued to weaken and the euro dollar is now at around the 1.37 level.

Going forward, the weaker dollar will likely have some negative impact on our top line, especially considering about 40% of our net sales are dollar denominated. In terms of our outlook for Nokia and the industry, please prefer to the earnings release and the slide. After all of that, I'll hand it back to you, Olli-Pekka.

Olli-Pekka Kallasvuo

Thanks, Rick. I would like to close with some thoughts on Nokia longer term strategy. We estimate that the €3 billion wireless subscriptions mark will be surpassed very soon with equal amazing 45% global penetration. And the industry continues to grow as we are well on our way to achieving the €4 billion mark in 2010.

It is natural to think that the strong industry growth we've experienced over the last several years would eventually slow in what I would call the traditional device business. However, I believe there remains many great opportunities for growth in this industry and here Nokia's strength and incredibly wide footprint are again huge competitive advantages.

As just was announced, Nokia now has the number five brand in the world and with our over 300,000 points of sales, we clearly have the best logistics and the distribution machine in the world.

And there are more than 900 million people out there using Nokia devices. To the best of our knowledge, no other producer of consumable durables in history has managed to achieve the footprint that we have today.

So in the face of changing industry dynamics, how are we going to realize the full value of the incredible opportunity presented by a customer base of almost 1 million people? We have already begun adopting our business model for this changing industry. We have also recently announced a new organizational structure to support our strategy.

These are the first of many concrete steps we will take as we set out on new growth paths. Nokia wants and needs to grow as we believe growth goes hand in hand with providing the greatest value to our shareholders and our new consumer Internet strategies has been designed with this in mind.

Let me give you an example of how we are already seeing some results from our strategy. Nokia recently launched the Nokia Maps application, a navigation service and so far it has been well received by the marketplace. The experience that people get from the combination of the Nokia N95 and the Nokia Maps service is a good, early indicator of the development of our services platform.

We realize that we don't necessarily have all the ingredients or experience we need in this new environment, that's very clear. As a result, we will likely be more active in looking for opportunities to expand our portfolio as we move into new but related areas of business.

We assure you that we will do so carefully, applying the Nokia discipline, and the conservative approach you are used to. There never seems to be a dull moment in this industry. Once again we are living in exciting times and in coming quarters I look forward to being able to report more concretely on our new strategy. Thank you very much.

Bill Seymour

Thanks, Olli-Pekka. We'll now continue with a Q&A session. As a friendly reminder, please limit yourself to one question only. Operator, please go ahead.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Tim Long with Banc of America.

Tim Long - Banc of America Securities

Thank you. Two-parter, if I could, on the handset operating margins. I guess the message about next quarter with a similar product set, that's clear. But could you just talk a little bit, maybe, Olli-Pekka, on whether or not you think there's been a change back in the industry that's going to cause the operating margins you're seeing to be a little more sustainable? Have they taken a leg back up given some of the transition?

Second, Rick, if you could just qualify for us, quantify for us a little bit the treatment and impact of the royalty dispute with QUALCOMM maybe on the numbers in the June quarter and how we should think about that going forward? That would be very helpful. Thank you.

Olli-Pekka Kallasvuo

Okay. This is Olli-Pekka. I will start on the operating margins. So, definitely, we need to be happy with the operating margins we generated in the business in the second quarter and you're right that we made the point about the portfolio being pretty much the same, not exactly but pretty much the same in the third quarter as it was in the second quarter.

Now this overall question is there change somehow in the margin dynamics. I think the competitive situation needed faced in the second quarter was relatively easy. And of course, so competitive dynamics are the biggest driver on gross margins overall. Of course, your mix has to do with that and both product mix and area mix, but competitive dynamics, of course, come to play there very much.

To say that we would have going forward in every quarter a similar very good competitive type of situation that we did have in the second quarter, I think that would be too much to say.

It's will simply be we will see margin volatility going forward, that's been the case in this business, will continue to be the case at the end of the day. The consumers are voting every day with their purchase decisions and who is competitive and who is not and what type of margin you can get.

But having said that, I have definitely sort of have a lot of confidence in Nokia's overall product portfolio going forward. And definitely we will continue to assess the target levels we do have in the devices business in our capital markets, that we have done in the past. So that's really the time to look at sort of what type of targets we should have.

Rick Simonson

And Tim, in terms of the impact on royalties in the quarter, when you look at our WCDMA royalty provisions, it had some positive impact on the gross margin, but there are far many more important drivers for the sequential gross margin improvement in Q2.

The success of the total product portfolio and particularly driven by having very desirable hit products in every part of the range, high end, low end, midrange, a little bit of the slightly moderated price competition that Olli-Pekka just mentioned would be the second thing that I would call out. Our favorable product mix with M and ES growing faster than MP, thirdly. And fourth, the overall good cost management.

In other words, the benefit that we got in the COGS. Those four things far swamp the very small incremental benefit from the gross margin related to our total WCDMA royalty provisions. In other words, we would be writing the exact same story of this quarter without even that small incremental benefit.

Tim Long - Banc of America Securities

So we can assume that provision is lower than what was actually was being paid previous percentage rate but it's lower than what was being paid previously?

Rick Simonson

Well, again as we talked before, we necessarily have to be somewhere in between there because we feel strongly in our position that the rates under the old agreement with the one party, QUALCOMM are not correct and we wouldn't be spending the time on this debate if in fact we felt that we were accruing at the same rate. But it is, to repeat as we said before, somewhere in between those two.

Tim Long - Banc of America Securities

Thank you very much.

Olli-Pekka Kallasvuo

Thanks. Next question, please.

Operator

Your next question comes from the line of Stuart Jeffrey with Lehman Brothers.

Bill Seymour

Go ahead, Stuart. We'll catch up with Stuart later. How about next question, please?

Operator

Your next question comes from the line of Phil Cusick with Bear Stearns.

Phil Cusick - Bear Stearns

Can you guys hear me?

Bill Seymour

Yes, yes. Phil, we can hear you.

Phil Cusick - Bear Stearns

Okay. Sorry about that. I wondered if we could talk about the networks business. One, the level of competition, is this more insurgence coming in? Or is it really a big incumbent who is trying to grab market share where you guys are distracted? And second, on the incremental €500 million in synergies, where are those coming from? Thanks.

Olli-Pekka Kallasvuo

Olli-Pekka here. When you look at the competitive picture with NSN on Internet part and you look at the mobility part, which is definitely the core area of NSN, so it's very clear the competition predominantly comes from Ericsson and Huawei. Outside these two people, so there we see relatively little of other competitors. So in fact, the competitor dynamics here really relate to what Ericsson, Huawei, and Nokia Siemens Networks are doing in the marketplace.

Now when it comes to the 500 million additional synergy target that we have, we have now communicated, the planning work of course there is ongoing. We feel it is a realistic target and we of course have an idea of where it comes, but to be more exact to identify it more exactly, we are not in a position to do it as of yet. But we definitely feel that is doable. Otherwise, we would not communicate that.

Phil Cusick - Bear Stearns

If I can follow-up on the competition side. Given the financing of Huawei and the scale of Ericsson, why is this unsustainable? Or do you think it just lasts until you and Alcatel are no longer distracted or sort of have things shored up?

Olli-Pekka Kallasvuo

Well, I think there are certain elements that relate to the competitive dynamics in general and then there are matters that relate to the fact, like what was said by Rick in his opening, that relate to the fact that we are integrating two big operations as we speak.

And of course, it's very natural that the competition has a price to exploit that situation. I definitely would do the same, to some extent. So in that way, I mean that's only natural. But of course the overall competitive situation in the marketplace, even putting aside this angle to this remains very poppy.

Rick Simonson

So, I would add that we'll take care of the internal issues, that's our responsibility, and we'll get the benefits, but I would just remind economic gravity applies to everyone, sooner or later.

Phil Cusick - Bear Stearns

Sooner or later. Thanks.

Olli-Pekka Kallasvuo

Okay, next question.

Operator

Your next question comes from the line of Kulbinder Garcha with Credit Suisse.

Kulbinder Garcha - Credit Suisse

A question on Nokia Siemens. My question is that would you think Nokia Siemens have bottomed here, or do you think actually given the disruption of pricing in the industry things would get worse in the second half of the year?

And the additional question related to that, is that, have you actually started the restructuring in head count and rationalization? Has that begun and could you give an idea of how many heads left in Q2 or how that process is going.

Rick Simonson

Kulbinder, as I said before, we expect to improve in the second half. Clear and simple. And then on the reductions of force, where it's appropriate, those have in fact already been underway and it accounted for more than 600 million of the 905 million restructuring costs in Q2, so I think that gives you a magnitude.

Kulbinder Garcha - Credit Suisse

Okay, thank you.

Bill Seymour

Next question, please.

Operator

Your next question comes from the line of Paul Sagawa with Bernstein.

Paul Sagawa - Sanford Bernstein

Hi, thanks. If I'm looking at the device market, with your eventual ramp through the course of the year of the new low end platforms, with the overall increased volumes, both from market share gains and from a continued strong underlying market, and with pricing pretty stable these days, with Motorola showing no signs of becoming more aggressive anytime soon.

I know in the past you've laid out a 17 to 18% margin target range in the device businesses. Obviously, this quarter you completely blew through it. Should we really be thinking about this as a better margin type business until we see substantive change in the nature of the competition in the marketplace?

Olli-Pekka Kallasvuo

Yeah, Paul, I think I in fact touched upon this earlier in my previous answer. And I said there that we will have margin volatility, but of course we will some -- and then look at the target levels that we would need to have in this business and communicate that in the capital market space. But it's very clear, even though I've said that the competitive picture in the second quarter was relatively easy, it's very, very clear that the competitors we do have in the marketplace continue to be there very much.

I want to emphasize, as I did in the previous call as well, Motorola has not gone away. They are there, they're competing, they do have products and they want to take share. In that way, it's another situation where Motorola suddenly would have withdrawn or exited and we would not have them there.

I want to name one example and the same is applicable of course to the others in real, so competitive situation remains tough, that's very clear, like in any industry, but we then feel that we've got ingredients here that we can definitely sort of improve, but margin volatility we will continue to have here. That's been the case, it will be the case.

Paul Sagawa - Sanford Bernstein

Does Motorola still have a lot of channel inventory out there that's affecting them, or do you think that's mostly done?

Olli-Pekka Kallasvuo

They continue to be very much an active player in the marketplace.

Bill Seymour

Okay. Next question, please. Thanks, Paul.

Operator

Your next question comes from the line of Tim Boddy with Goldman Sachs.

Tim Boddy - Goldman Sachs

Thanks for taking my question. I'd like to focus on your comments on the potential need to broaden your portfolio in services. I guess, thinking more of consumer Internet services, but also to look at the situation in networks. Do the challenges networks are facing at present change your thinking about the viability of doing any kind of transactions in that area? Are you happy with the portfolio in Nokia Siemens Networks?

Olli-Pekka Kallasvuo

Yes. I've been speaking about this consumer Internet services and I continue to do that and I definitely believe that in this situation, where we are not anymore selling a piece of hardware only, but the consumers are more and more interested looking at the totality. What is the experience, what is the service they can get and buying something more than a piece of hardware. To support our handset business and generate incremental revenue streams, this mobile Internet service is a big opportunity to us.

And as I've said this mapping service, turn-by-turn navigation that we are already selling to the consumers is a small but a very good start in that area. You definitely will hear more about that going forward and it's very clear that the organizational change we are going to implement as of on 1st of January is basically meant to align our structure with our strategy. Where we are really separating, in fact, the software and services part of Nokia to a new unit in order to give it more attention, more possibility, and more flexibility to drive a new business model as well.

And of course, there's an area where we need to partner quite a lot, it's very complex, and definitely we see our traditional mobile operator customer here the most logical partnering opportunity for us. And we have quite a good response from them in this respect. And here definitely we will then identify our final targets and what we are seeing to be the most possible going forward, again in the capital markets.

I think it's really time for us to give you something more than only strategies. We need to have complete targets that we communicate. Then when it comes to networks part of the question, definitely I don't know whether it's related to services or not, but overall there is growth in the service part of the business there and we intend to be an active participant in that market as well, more active, in fact than what we are today.

The product portfolio question, we really have concentrated in our integration and on making that happen and really expansions when it comes to the product portfolio, that's something that we need to consider later. But we are not being as active there as we speak.

Bill Seymour

Okay, next question. Thank you.

Operator

Your next question comes from the line of Sherief Bakr with Citigroup.

Sherief Bakr - Citigroup

Thank you very much. A question for Rick, maybe. With your operating margin as strong as it's been for many, many quarters, does this encourage you to become slightly more aggressive with the capital structure of the company particularly in the form of buybacks and dividends? Thank you.

Rick Simonson

I think as we've talked, we've had a substantially increasing dividend and we've done material buybacks on a continuing basis to have what I think is a pretty tax effective distribution of excess cash to the shareholders.

We are kind of hitting on all cylinders and generating great operating cash flow and as I've said, we will target executing under the current authorization on the share buyback. Mentioned before, model in somewhere around 5% and we have authorization from the Board of up to using €4 billion in that annual April-to-April cycle. And we don't anticipate any change of that in the short-term.

Sherief Bakr - Citigroup

Okay. Thank you.

Bill Seymour

Next question, please.

Operator

Your next question comes from the line of Mike Walkley with Piper Jaffray.

Mike Walkley - Piper Jaffray

Great. Thank you very much. You talked about share gains again sequentially into Q3. We haven't heard the 40% target much recently, but you're closing on that level. Is that now a level we should think about longer term for Nokia?

And maybe if you could also give us some color on the regions or market segments you see the best opportunity to gain share in Q3?

Olli-Pekka Kallasvuo

First of all, we definitely did give guidance in the release saying that the estimate to increase our market share in the third quarter, so that was clearly communicated. Then the 40% question, so we never set a 40% target in the way that that would be the holy number and that's all we would need to look at.

It's been a directional thing. We continue to believe more market share will make sense in this business, but we need to do that in a way that is sustainable and I think we did that. Did have that thinking in mind when we managed to combine market share gains and good profitability in the second quarter.

And going forward, definitely market thinking here in a way that is sustainable in terms of being able to hold the share we get more or less. That continues to be the thinking of target setting. And I don't see any reason to limit our thinking to 40%.

It can be more if we can make progress in the future in the thinking and with our products in the portfolio and depends on the competition as well. In that way, I would not like to sort of overly emphasize the 40% as a number here. It's directional.

Bill Seymour

Next question, please?

Operator

Your next question comes from the line of Ehud Gelblum with JPMorgan.

Ehud Gelblum - JPMorgan

Hi. Thank you very much. Can you hear me?

Bill Seymour

Yes, we can.

Ehud Gelblum - JPMorgan

Okay, great. A couple of clarifications, if I could, and a question. First of all, Rick, on the 182 million inventory adjustment, can you give us a sense as to what the after-tax impact was of that so we can perhaps see what the EPS run rate coming off the quarter looked like?

Second clarification, you didn't mention anything that I heard at least about growth in 3G and perhaps the percent of phones that were 3G, if you can give some clarity on that and how you saw the growth in the 3G market this quarter vis-à-vis the growth in the entire market.

And then Olli-Pekka, I was a little confused in your earlier discussion about the Nokia Siemens Networks, who of the competitors was applying pressure. I had been under the impression that Alcatel Lucent was much more of a, from some of the commentary on their conference call, was some of the aggressor in the pricing and that you seemed to indicate that it was more Huawei. Just wanted to understand how those two competitors compared with respect to pricing pressures and what they were applying? Thank you.

Rick Simonson

Ehud, I'll take the first one in terms of the inventory adjustment. I'm not going to break it out into that affect on the tax. Primarily, we had the tax benefit again from the operating loss at NSN overall. And again, this inventory adjustment, is a Q2 item only and it's related to the formation, so we would not expect that to be reoccurring.

As I mentioned, the dynamics in our overall effective tax rate in the businesses remain such that the blend of that between the device and NSN, we're still targeting around this 26% range, by we did get the benefit of that operating loss in the quarter. And Olli-Pekka, 3G and then the networks questions were the second two parts of the three-part question.

Olli-Pekka Kallasvuo

Yes. When it comes to CDMA or 3G, so definitely the products like N95 and the E65 did contribute to the strong CDMA sales in the second quarter and we definitely did take market share in wideband CDMA in the quarter.

Then when it comes to the NSN question, so maybe I was simplifying too much, but still I repeat what I said. I said when you look at the core area or the biggest area of NSN business, which is mobile networks, and you can really not limit, but you can really sort of only name Ericsson, Huawei as estimator players that we see in the marketplace on a day-to-day basis competing against us. And of course there are other players in the marketplace, but the competitive dynamics here relate very much to what these three companies are doing.

Bill Seymour

Next question, please.

Operator

Your next question comes from the line of Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets

Thank you. Is it fair to say that the volatility of gross margins and ASPs is subsiding for mobile devices? I understand that we should see some movement quarter-to-quarter, but is the band getting tighter?

Rick Simonson

Yes, Mark. I think we started talking in a strong way a year ago about let us show that we can stop the declining gross margins in the device business and then show some stability. And again, what I see in the last three quarters is certainly we showed stability plus. Obviously, we've had nice increase here and we've been able to bring that really down to the operating margin line, but again, I think it really relates to what Olli-Pekka was talking about is we will take market share if we believe it's sustainably profitable market share.

So we don't have a yo-yo kind of affect here. And I view that at the same way in terms of this gross margin, let us have some stability here around these levels and let's not get carried away of extrapolating those. We would like to have less volatility than what we did one and two years ago, and I think we've proved we've brought a little bit of that to the table. So yes, maybe the range is a little bit lower than it was one, two, and three years ago. But it will still move around.

Mark Sue - RBC Capital Markets

Okay. That's helpful. Thank you, gentlemen.

Bill Seymour

Thanks, Mark. Next question?

Operator

Your next question comes from the line of Stuart Jeffrey with Lehman Brothers.

Stuart Jeffrey - Lehman Brothers

Well, thank you very much. A quick question on Nokia Siemens Networks, two parts. First, a clarification. You have mentioned an extra 500 million of synergies, should we assume that is also for 2008 or is that for the 2010 timetable?

And secondly, I guess going into the expected wireline will still be the problem area for Nokia Siemens and you've been talking very much about wireless being perhaps the biggest delta of pain. Can you just give an update on what's happening in the wireline business, is that performing in fact, much better than wireless from the profitability basis and how is the topline developing there just a broad sense rather than specific numbers? Thanks.

Olli-Pekka Kallasvuo

Okay. Very quickly, the 500 million synergies that we have, we have like I said, sort of (inaudible) we have not given a time line as for when we expect to be able to deliver that. Like I said, the planning work is ongoing there and of course, we'd then intend to communicate this in due course as we are ready.

And then the wireline of fixed line business, so, no, I would say you cannot make that sort of distinction that this would be a mobile situation where we did suffer a bit in the second quarter. I think the dynamics here that NSN had or experienced are similar or same type also when it comes to fixed line.

Bill Seymour

Okay. Next question. Thanks.

Operator

Your next question comes from the line of Gareth Jenkins with Deutsche Bank.

Gareth Jenkins - Deutsche Bank

Yes. Thanks, gentleman. A couple of quick ones, if I could. Just wondered what the cost savings, as you moved through to the (inaudible) platform are and likewise as you move through to Infineon on a like-for-like product basis?

And secondly on acquisitions, NSN, I just wondered what your holistically your viewpoint is on whether you dilute your -- whether you allowed Siemens to be diluted down or whether the cash injection will be 50/50 as well if you chose to acquire an NSN? Thank you.

Rick Simonson

Yeah, Gareth, thanks. In terms of the cost savings, when we're talking about these moves in chipsets, it's really very much a continuation of when we made our move to the so-called Scott engine. As we said, in terms of a bond cost, that move allows us through better integration, all sorts of different things to -- generally, we have a little bit of a step function move down in the bond cost there, but remember that's not the biggest driver in terms of the equation on profitability here.

So we do this because we can get a bit of a step change, but again, I wouldn't focus so much on that other than this allows us to have flexibility in terms of the products that we develop and also flexibility in terms of the supplier, so it just helps on this continuous improvement in the cost. And remember, the Infineon-based products will not hit the market until 2008.

And then in terms of -- on your next question was around acquisitions speculation around Nokia Siemens Networks and what does that do to the ownership structure. We're in a joint venture, 50/50 with Siemens. As we've talked before, that's a six-year deal and based on any kind of strategic moves, it's up for the shareholders to decide is that a good strategic move if it makes rational sense, on a prudent basis we would do it and each shareholder is responsible to fund 50% of that if that's the decision to go forward. So beyond that, I can't give you any color.

Bill Seymour

Okay, thanks. Operator, this will be the last question, please. Thank you.

Operator

Your final question comes from the line of Ed Schneider with Charter Research.

Ed Schneider - Charter Research

Thank you very much. If you look at your -- you guided last quarter to maintaining your market share and in the current period that obviously isn't what happened. You gained share. How much of that share gain was due to the very weak competitive environment, basically Motorola. If you look at the actual numbers there, you gained almost everything that Motorola dropped. And then I know your product portfolio is going to improve as the second half of the year comes upon us.

Motorola is expected at some point I would imagine to start recovering and fielding a new line of phones, so the competition is going to start getting stiffer. So you're guiding for market share gains in the second half of the year. I know you haven't quantified that yet. What can we expect, do we have to continue to see extraordinary weakness by our competitors to see these large gains, or will the product portfolio that you're about to field lead to these market share gains.

And corollary to that, the iPhone, which was the Paris Hilton hype of last quarter didn't do quite as well as people had expected it to in unit volume numbers. I know you and a lot of other competitors were looking at the price and positioning of that phone. What does it say about the pricing on kind of a sophisticated multimedia phone. Are you changing your opinion at all of what's possible in terms of the high-end models based on the initial returns out of iPhone? Thanks.

Olli-Pekka Kallasvuo

To be exactly, we did guide for market share gain in the third quarter, not in the second half. That was the language. And I would come back to what I said earlier about the competition. We have a relatively good competitive position in the second quarter, that's very clear and that did show in the market share gains and profitability. And of course, when we are guiding for market share gains in the third quarter, we definitely continue to believe that we are pretty competitive in the marketplace. That goes without saying.

But as I said earlier, I would not go to identifying one competitor and saying that they were not there. Motorola as well as the others are competing there on a daily basis, they are big players and I definitely agree with you that Motorola's and other competitor's product cycles still improve as they have product cycle volatility and in Motorola's case, it would be natural to think that because they are already down in the cycle, they would come up sooner or later. And we have to be prepared for that and I think we are.

When it comes to the iPhone, that's of course a long topic and maybe I just don't go into that in detail, but I definitely would mention and I've said this before as well, that looking at that type of high-end device that goes to the marketplace, they definitely add excitement to the industry. And in that way I would say these are pretty sort of relevant moves from the industry point of view.

However, if you think about the volumes we have been able to generate with our high-end devices, I would take N95 as an example here. We did sell 1.5 million of N95s in Q2. So we've got a huge success here, definitely sort of illustrating very well the fact that there is a market for this type of phones, this type of price points and we are definitely going to exploit that going forward as well.

Bill Seymour

Okay. Ladies and gentlemen, this concludes our conference call. I would like to remind you that during the conference call today, we have made a number of forward-looking statements that involve risks and uncertainties. Actual results may therefore differ materially from results currently expected.

Factors that cause such differences can be both external, such as general economic and industry conditions as well as internal operating factors. We have identified these in more details on pages 12 to 24 in our 2006 20-F and our press release issued today. Thank you and have a nice day.

Operator

Thank you for participating in today's conference call. You may now disconnect.

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Source: Nokia Q2 2007 Earnings Call Transcript

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