Nokia’s (NOK) CEO Rajeev Suri on Q2 2014 Results – Earnings Call Transcript

Our complete results report with tables available on our website includes a detailed explanation of the content of the non-IFRS information and a reconciliation between the non-IFRS and the reported information.

With that, Rajeev, over to you.

Rajeev Suri – President and Chief Executive Officer

Thank you, Matt, and thanks to all of you for joining. It is a pleasure to speak to you today after my first quarter as CEO and after what was a very positive quarter for the company. Before I go into the details of our performance, however, I thought I would provide an update on the five priorities I set for my first 100 days and which I outlined on the call last quarter.

The first of those priorities was engaging and understanding. Since being appointed, I have met with senior customers, including the CEOs of Deutsche Telekom, Vodafone, China Mobile and SoftBank. I have talked to more than 15,000 employees in town hall meetings on three continents. I have spent time with government leaders, including the Premier of China and the Prime Minister of Finland. And I have engaged with many of our largest investors in San Francisco, Helsinki, London, representing about 30% of our shareholder base. These meetings have helped give me a perspective on how we are viewed today, our strength and weaknesses and the hopes and concerns people have for our future.

The second priority was to move rapidly from the high-level strategy and vision that we announced last quarter to bold and detailed execution plans. We will share more about the work that we are doing in this area at the Capital Markets Day that we are planning for November. But I am confident that we are heading in the right direction. Of course, we are not waiting to act. To take just one example, we have recently announced five acquisitions, Medio and Desti for HERE and Mesaplexx, SAC Wireless and a 3D geolocation solution from NICE Systems for Networks. These are the kind of deals we like, modest in size, relatively easy to integrate and providing access to new technology that we scale up or execution capabilities that bring us closer to key customers.

My third priority was to develop and implement a number of key systems across our business. I am pleased that we have already begun to implement a new operational governance model, including a company-wide performance management process. These steps will be codified into what we are calling the Nokia Business System, which is designed to ensure that we have best practices based upon common processes, spanning the whole company in a number of areas that include talent development, M&A integration, cost management and lean methodologies.

The fourth priority was culture. Today, we are taking the important step of sharing our new company values with almost 2,000 of our senior leaders, who will then help cascade those values to all employees. By September, we expect to be well on track with our overall cultural transformation, where we will focus on a common culture across the entire organization, with some differences between the businesses that reflect their unique circumstances.

Finally, I said we could not and would not lose sight of our operational performance. And I think the results of the second quarter show that we have kept our focus and discipline even during a time of significant change.

So let me now turn to those results. At the group level, we delivered net sales from continuing operations of €2.9 billion, a 44% non-IFRS gross margin and a non-IFRS operating profit of €347 million or 11.8%. Of course, the group level results reflect the performance of our three distinct businesses, and I will cover each of those today. I will spend most of my time on Networks, as I know some of you have questions about its strong margins and what they imply for the future.

Networks, which comprises our mobile broadband and global services business units, had what was in my view an excellent quarter. We showed very clearly that we could improve our topline performance, while still delivering strong profitability. This is, as I think you know, no small achievement in our sector. And we believe that we continue to outperform the competition on a number of metrics. While Timo will cover cash performance, let me provide some perspective on other key areas.

Second quarter net sales for Networks at €2.6 billion were down year-on-year. But when you adjust for currency fluctuations as well as divestments and country and contract that’s consistent with our strategic focus, the business would have actually grown by 1%. Pleasingly, net sales in our mobile broadband business unit were up 6% year-on-year. This performance was driven by strong sales not just in LTE, but also by double-digit growth in core sales, which typically are more profitable than radio. In recent quarters, we have seen our core solutions, including those in fixed mobile convergence, gain increased traction in the market.

We still have work to do to get global services back to growth after our many contract exits during the last two years. That said, I am confident we are making progress. Take the example of managed services. We can now say that Nokia Networks is very much back in the managed services business. We have won 10 new managed services deals this year. And while that is less than at least one of our competitors, we remain disciplined about limiting our efforts to those contracts where we can generate significant value for our customers and an adequate return for ourselves. We like managed services and can operate very effectively in this business without excellent global delivery centers, but are happy to leave to others those deals that do not make sense to us.

On a regional level, two out of our six regions, Asia-Pacific and Greater China, were back to year-on-year growth, and all regions grew sequentially. The large LTE rollouts in China are proceeding well for us. And we believe we have won the largest share of those rollouts of any foreign vendor. Europe, which has been a difficult region for us, declined year-on-year. That said, we believe that momentum is coming back. The value of new deals won this year was well above that for the same time last year. Our customer satisfaction scores have improved. And our technology is strong, as shown by our recent delivery of telco cloud-based Voice over LTE services to three major customers in the region.

North America was largely between major rollouts, although Sprint deployment activities are likely to accelerate in coming quarters. As we transformed our business in the Middle East and Africa, we saw a decline in net sales on a year-on-year basis, but in recent quarters, our deal momentum in the region has strengthened significantly. Latin America remains our most challenging region, partly a result of regulatory changes in Mexico, but also partly due to our earlier overreliance on services in the region and high impact of exits from those projects during our transformation. We are working hard to turn the situation around, but no one should expect an immediate rebound there.

We believe that demand for our Networks products and services was slightly higher than we were able to deliver, as we continue to face some component shortages in the second quarter. While I recognize that some of our customers are not yet satisfied, we are making progress and the trend improved from the first quarter to the second. If you look at the progress in Networks over the last three quarters, we have shown a consistently better topline trend, have slowed the rate of decline and now expect to return to growth.

Non-IFRS gross margin was a very strong 38%. Operating expenses remained well under control, with a 10% year-on-year decline. And non-IFRS operating profit margin was an excellent 11%. In addition, we had positive operating profits on a reported basis for the eighth consecutive quarter. This performance bodes well for the future. And as you will have seen from our press release today, we expect the full year 2014 non-IFRS operating margin for Networks to be at or slightly above the high end of the targeted long-term non-IFRS operating margin range of 5% to 10%.

While this shows optimism, we continue to take a balanced view for the second half of 2014, given that some of the expected sales increase will come from the strategic, but margin-dilutive deals that we have mentioned previously. Overall, it is my view that these results showing a good balance between growth and profitability are being driven by our unique operating model and strong emphasis on execution excellence and continuous improvement. Part of this includes an ongoing focus on our cost position, which we believe gives us flexibility in the market.

Now even if the major restructuring in Networks was completed at the end of 2013, we continue to be relentless in driving waste from the system, so that every euro we spend is invested as efficiently as possible. We have specific programs underway in a number of areas, including deploying lean and Kaizen methodologies across the company and increasing automation. We believe that our cost effectiveness is one of our most powerful competitive advantages in Networks, and we will not lose sight of that in the future.

Let me now turn to HERE, which is also making progress, consistent with the goals for the business that we have discussed in the past. Net sales of €232 were roughly flat year-on-year, partly reflecting lower revenue from the former devices and services business. Non-IFRS operating margin was at the breakeven level, reflecting our continued investment in future growth opportunities.

In the second quarter, we saw some positive signs. HERE’s leadership in the Connected Car space continued with automotive-related sales up year-on-year. In the market for embedded navigation systems, HERE grew unit sales of new vehicle licenses by 22%. Quite simply, more new cars are driving out of the showroom with HERE Maps onboard.

Enterprise sales remained small, but we see potential in this area and added some new deals in the quarter, including with companies such as Accenture and Teliasonera. The HERE location platform is also being used to power the recently announced Amazon Fire Phone, which we think is an exciting development.

As I said on the last call, our focus when it comes to HERE is on making the right near-term investments to capture longer-term growth opportunities. As I have immersed myself in the HERE business over the last 100 days, my view on the importance of these investments has not changed. I do believe, however, that HERE could benefit from some further operational efficiency improvements that could expand overall R&D capacity and enabled investment in new areas. As we take steps in this direction, we will do so prudently to ensure we maintain our focus on growth.

Then on to Technologies, where the biggest news is the announcement we made earlier today that Ramzi Haidamus will join Nokia as the President of Nokia Technologies. Ramzi is the right person for this business in various roles at Dolby, his previous employer, he built very strong intellectual property and technology licensing activities, while also playing a key role in incubating and growing new businesses. He will join us in early September and I’m looking forward to his contribution to taking the performance of our Technologies business to the next level. Paul Melin, who runs our IP licensing activities, remains in place and he will report to Ramzi.

While we have a strong intellectual property business today, we continue to believe it can be better now that we are no longer in the devices business. This belief is strengthened when we see at least one major competitor generate more IP revenues even with our view is that our industry-leading portfolio is the result of both broader and deeper investments in mobile and adjacent technologies.

I know there’re a number of questions about what we will do in technologies in the future beyond the licensing business. Some of you may have seen us experimenting with a publicly-available beta of what we call the Z Launcher, which provides a constantly learning predictive interface for Android phones. While we continue to look at many options, we do so in a methodical way and will not be rushed into providing a definitive answer in any direction. Ramzi will continue the assessment process as well ensuring we maintain our venture capital-like funding model. That way, we can minimize risks, while also keeping the spirit of innovation alive.

Before turning to Timo, I will just close by saying that my first 100 days have strengthened my confidence in our future. We have shown that we can balance topline and profitability well in Networks. There are opportunities for both growth and efficiency improvements in HERE. We can license our intellectual property to new customers and expand agreements with existing ones over time and more.

With that, Timo, over to you.

Timo Ihamuotila – Executive Vice President and Chief Financial Officer

Thank you, Rajeev. I would like to start by spending the next few minutes taking you through our cash performance during Q2 as there were quite a number of significant drivers that impacted our cash flow and quarter-ending cash balance.

On the Microsoft transaction, last quarter I provided an initial estimate of the purchase price adjustments relative to the original €5.44 billion total consideration as well as estimates for other transaction-related items. In total, we estimate that the net proceeds from the transaction would add approximately €5 billion to Nokia’s net cash. When we confirmed this estimate in today’s release, due to the timing of certain payments, the net proceeds received in Q2 added approximately €4.8 billion to Nokia’s net cash, with the remaining balance expected to be received during the second half of 2014.

On a sequential basis, Nokia’s gross cash increased by approximately €2.2 billion with a quarter-ending balance of €9 billion. Net cash and other liquid assets increased by approximately €4.4 billion sequentially, with a quarter-ending balance of €6.5 billion.

Compared to Q1, the primary driver of the increase in our net cash balance was the €4.8 billion benefit from the Microsoft transaction, partially offset by approximately €400 million of cash outflows, of which approximately €300 million related to continuing operations and €100 million related to discontinued operations.

Looking at approximately €300 million cash outflow from continuing operations, this was primarily driven by two factors. Approximately €400 million of cash outflows related to net financial income and expenses, which included cash outflows related to the early redemption of Nokia Networks borrowings as well as net cash tax outflows and capital expenditure, and approximately €100 million of cash generated from operations primarily related to Nokia Networks, where strong underlying profitability was partially offset by cash outflows related to net working capital.

The cash outflows related to net working capital were primarily due to incentive payments related to its strong performance in 2013, an increase in inventories and approximately €90 million of restructuring-related cash outflows, partially offset by an increase in deferred revenues and payables. The discontinued operations cash outflows of approximately €100 million were related to the period between the end of Q1 2014 and the closing of the Microsoft transaction on April 25th.

In addition to the factors affecting Nokia’s overall net cash in Q2, gross cash was impacted on a sequential basis by the repayment of the Microsoft convertible bond as well as the redemption of materially all of Nokia Networks debt during Q2.

Then a few words on OpEx. Continuing operations non-IFRS OpEx of €940 million in Q2 declined by 7% year-on-year and was up 2% sequentially. Nokia Networks benefited from continuous improvements in its cost structure with a strong focus on quality and efficiency. And this kind of stands out even in technology market. Quality and efficiency are as important differentiators of innovation. And we think we have the right formula.

Non-organic non-IFRS research and development expenses declined by 9% year-on-year. Spending in growth areas such as LTE, small cells and liquid core increased by 9% compared to the year-ago quarter. To be clear, we are investing and will continue to invest in R&D in the focus areas.

With regards to HERE, as we have said over the last couple of quarters, we are investing to capture long-term transformational growth opportunities. We believe that the automotive market has strong underlying growth trends that we can capitalize on as penetration of navigation systems continues to increase and cars become connected to the cloud. We believe that these trends coupled with our industry-leading asset, deep customer relationships and next-generation investments position us well for growth, which is a priority for us. In addition, the revenue headwind related to our former devices and services business will continue to lessen for HERE compared to recent quarters.

Turning to the OpEx trends in Nokia Technologies, where we are investing in both patent creation as well as supporting our licensing efforts. On a quarterly basis, OpEx is predominantly impacted by the timing of R&D projects as well as certain costs related to our licensing activities. These then fluctuate as we invest in new projects and negotiate new license agreements. Completing our OpEx picture, we also have costs related to Group Common Functions. On a non-IFRS basis, these totaled €33 million of SG&A in Q2. Note that in Group Common Functions, the SG&A is generally stable, but the other income and expense can fluctuate.

And now a few words on capital deployment. During Q2, we received shareholder approval to pay both the ordinary and special dividends, totaling €0.37 per share or approximately €1.4 billion. As a reminder, these payments were made in early July, so please take this into account in your Q3 models. In addition, the Board also received approval to commence repurchasing shares after Q2 results. It is our intention to commence the two-year €1.25 billion share buyback program during the current quarter.

Finally on the capital optimization program, as part of our plans to reduce debt by approximately €2 billion, we redeemed approximately €950 million of debt instruments during Q2 related to Nokia Networks. As previously stated, the debt reduction related to our capital optimization program is expected to result in annualized run rate interest savings on at least €100 million, and we are on track to achieve this.

Looking ahead, as we stated in the outlook section of today’s press release, we currently expect our quarterly net financial expense to be approximately €40 million per quarter, subject to changes in foreign exchange rates, which are difficult to predict, and the amount of debt we have on the balance sheet. After taking the actions during Q2, Nokia no longer has material financial covenants in any of its financing instruments or activities.

Now a few words on the acquisitions we announced during Q2. As part of our efforts to effectively deploy capital, we look at acquisitions primarily in two ways: first, as a way to add certain specific technologies or expertise to gain speed versus our own internal development; second, as a way to bring in products which we can leverage more broadly in the rest of our businesses and sales channels. We continue to have a very fragmented and rational approach as it relates to value creation through strategic transactions, a process we have applied to the benefit of our shareholders in recent time.

Earlier, Rajeev mentioned the acquisitions we announced in Q2. We believe all of these announcements are consistent with our M&A approach and our commitment to effectively deploy capital.

In closing, I’m pleased with the progress we have made in Q2, having closed the transaction with Microsoft at the end of April. We delivered a strong quarter, particularly in Networks, and are highly focused on capitalizing on the value creation opportunities we see ahead of us across all of our three businesses.

And with that, I’ll hand over to Matt for Q&A.

Matt Shimao – Head of Investor Relations

Thank you, Timo. For the Q&A session, we’ll extend the time a bit. Thank you for bearing with the technical difficulties. But please limit yourself to one question only. Carmen, please go ahead.

Question-and-Answer Session

 

Read the Full Transcript here

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