Posted by Nokia
Solid Q3 and expected strong Q4; Lowering full year 2019 and full year 2020 outlook due to margin pressure and additional investment needs
- Strong performance in Nokia Software, Nokia Enterprise and IP routing
- 5G momentum continues; 48 deals and 15 live networks launched
- Dividend payments paused to increase investments in 5G and strategic focus areas and to strengthen cash position
- Long term target operating margin of 12-14% supported by our end-to-end portfolio, diversification and patent licensing
Rajeev Suri, President and CEO, on Q3 2019 Results
Nokia delivered a solid third quarter, with positive free cash flow; widespread sales growth; solid operating margin; strong performances in Nokia Enterprise, Nokia Software and IP Routing; and good progress towards meeting our 2019 cost reduction goals. We are proud to have launched 15 live 5G networks with customers, including Sprint, Verizon, AT&T and T-Mobile in the US; Vodafone Italy and Zain in Saudi Arabia; as well as SKT, KT and LGU+ in Korea.
Many of our businesses are performing well and we expect Q4 to be strong, with a robust operating margin and an increase in net cash of approximately EUR 1.2 billion. At the same time, some of the risks that we flagged previously related to the initial phase of 5G are now materializing. In particular, our Q3 gross margin was impacted by product mix; a high cost level associated with our first generation 5G products; profitability challenges in China; pricing pressure in early 5G deals; and uncertainty related to the announced operator merger in North America.
We expect that we will be able to progressively mitigate these issues over the course of next year. To do so, we will increase investment in 5G in order to accelerate product roadmaps and product cost reductions, and in the digitalization of internal processes to improve overall productivity. We will also continue to invest in our enterprise and software businesses, which are developing rapidly and performing well. Given these investments and the risks we see materializing, we are adjusting our targets for full-year 2019 and 2020; and we expect our recovery to drive improvement in our 2021 financial performance relative to 2020.
I am confident that our strategy remains the right one. We continue to focus on leadership in high-performance end-to-end networks with Communication Service Providers; strong growth in enterprise; strengthening our software business; and diversification of licensing into IoT and consumer electronics.
As I look to the future, it is clear to me that Nokia has some unique advantages. We have a powerful, end-to-end portfolio that allows us to benefit from 5G investments across all network domains. We have a demonstrated ability to drive value and cash flow through product leadership. We have successful diversification into enterprise and software well underway. We have a large patent licensing business that is sustainable and cash generative over time, with opportunities to enter new growth segments. We have meaningful opportunities to drive further cost reductions through digitalization and automation.
These advantages give me confidence in our ability to create value for our shareholders and achieve our longer-term operating margin target.
Net cash and current financial investments does not include lease liabilities
- Net sales in Q3 2019 were EUR 5.7 billion, compared to EUR 5.5 billion in Q3 2018. On a constant currency basis, net sales increased 1%. Our solid overall topline performance was driven by improved industry demand and the competitiveness of our end-to-end portfolio, with growth across four out of six regions and all customer types.
- Non-IFRS diluted EPS in Q3 2019 was EUR 0.05, compared to EUR 0.06 in Q3 2018, primarily driven by lower gross profit in Networks and a net negative fluctuation in financial income and expenses. This was partially offset by higher gross profit in Nokia Software and continued progress related to Nokia’s cost savings program, which resulted in lower operating expenses across Networks, Nokia Software and Nokia Technologies.
- Reported diluted EPS in Q3 2019 was EUR 0.01, compared to negative EUR 0.02 in Q3 2018, primarily driven by continued progress related to Nokia’s cost savings program and a gain on defined benefit plan amendments, partially offset by higher income taxes.
- In Q3 2019, net cash and current financial investments decreased sequentially by approximately EUR 160 million. Within this, we generated positive net cash from operating activities, which partially offset cash outflows from investing and financing activities, including the payment of the quarterly dividend.
- Full year 2019 and full year 2020 outlook lowered primarily due to margin pressure, additional 5G investments and additional digitalization investments.
Nokia’s longer term value drivers
Beginning with the distribution for the financial year 2018, Nokia started paying dividends in quarterly instalments. Under the authorization by the Annual General Meeting held on May 21, 2019, the Board of Directors may resolve an aggregate maximum annual distribution of EUR 0.20 per share to be paid quarterly during the authorization period, unless the Board decides otherwise for a justified reason. On the same day, the Board resolved to distribute EUR 0.05 per share as the first instalment of the dividend. On July 25, 2019, the Board resolved to distribute EUR 0.05 per share as the second instalment of the dividend.
On October 24, 2019, the Board resolved to not distribute the third and fourth quarterly instalments of the dividend for the financial year 2018, in order to: a) guarantee Nokia’s ability to increase 5G investments, b) continue investing in growth in strategic focus areas of enterprise and software and c) strengthen Nokia’s cash position. This is in accordance with Nokia’s dividend policy, which states that dividend decisions are made taking into account Nokia’s cash position and expected cash flow generation. Over the long term, Nokia continues to target to deliver an earnings-based dividend. The Board will seek a dividend authorization from the next Annual General Meeting, and will continue to review dividend distributions on a quarterly basis. The Board expects to resume dividend distributions after Nokia’s net cash position improves to approximately EUR 2 billion.
Free cash flow = net cash from operating activities – capital expenditures + proceeds from sale of property, plant and equipment and intangible assets – purchase of non-current financial investments + proceeds from sale of non-current financial investments.
Key drivers of Nokia’s outlook
Net sales and operating margin for Networks and Nokia Software are expected to be influenced by factors including:
- Our expectation that we will perform approximately in-line with our primary addressable market in full year 2019 and full year 2020, as we further prioritize profitability and cash, while continuing to drive growth in our Nokia Software and Nokia Enterprise businesses. (This is an update to earlier commentary to outperform our primary addressable market in full year 2019 and over the longer-term.) On a constant currency basis, we expect our primary addressable market to grow slightly in full year 2019, and for growth to continue in full year 2020;
- Competitive intensity has increased in some accounts as some competitors seek to take share in the early stage of 5G, which is particularly impacting Mobile Access. (This is an update to earlier commentary that competitive intensity could increase);
- Additional 5G investments focused on accelerating our product roadmaps and cost competitiveness. Investment areas include System on Chip based 5G hardware, including diversifying and strengthening the related supplier base (new commentary);
- Additional digitalization investments focused on driving automation and productivity, including further simplification of IT tools and operational processes (new commentary);
- Temporary capital expenditure constraints in North America related to customer merger activity, as well as other potential mergers or acquisitions by our customers (This is an update to earlier commentary for potential mergers or acquisitions by our customers);
- The timing of completions and acceptances of certain projects, particularly related to 5G. Based on the evolving readiness of the 5G ecosystem and the staggered nature of 5G rollouts in lead countries, we expect full year 2019 will have seasonality characterized by a particularly weak first quarter, a strong second quarter, a solid third quarter and an expected strong fourth quarter (This is an update to earlier commentary for an expected soft third quarter and an expected particularly strong fourth quarter);
- Some customers are reassessing their vendors in light of security concerns, creating near-term pressure to invest in order to secure long-term benefits;
- Our expectation that we will improve our R&D productivity and reduce support function costs through the successful execution of our cost savings program;
- Our product and regional mix, including the impact of the high cost level associated with our first generation 5G products; and
- Macroeconomic, industry and competitive dynamics.
Net sales and operating margin for Nokia Technologies is expected to be influenced by factors including:
- The timing and value of new and existing patent licensing agreements with smartphone vendors, automotive companies and consumer electronics companies;
- Results in brand and technology licensing;
- Costs to protect and enforce our intellectual property rights; and
- The regulatory landscape.
Additionally, our outlook is based on the following assumptions:
- Nokia’s recurring free cash flow is expected to improve over the longer-term due to lower cash outflows related to restructuring and network equipment swaps and improved operational results over time;
- Non-IFRS financial income and expenses to be an expense of approximately EUR 400 million in full year 2019 and approximately EUR 350 million over the longer-term (This is an update to earlier commentary for non-IFRS financial income and expenses to be an expense of approximately EUR 350 million in full year 2019);
- Non-IFRS income taxes at a rate of approximately 28% in full year 2019 and approximately 25% over the longer-term, subject to the absolute level of profits, regional profit mix and changes to our operating model;
- Cash outflows related to income taxes of approximately EUR 500 million in full year 2019 and approximately EUR 450 million over the longer term until our US or Finnish deferred tax assets are fully utilized. (This is an update to earlier commentary for cash outflows related to income taxes of approximately EUR 450 million in full year 2019); and
- Capital expenditures of approximately EUR 700 million in full year 2019 and approximately EUR 600 million over the longer-term.
Nokia Financial Results
Net sales by region
Net sales by customer type
Our Nokia Enterprise business is performing well. Net sales to enterprise customers, excluding the third party integration business that we are exiting, grew 29% on a reported basis and 26% on a constant currency basis in Q3 2019, and grew 14% on a reported basis and 12% on a constant currency basis in the first nine months of 2019.
Nokia, Q3 2019 compared to Q3 2018, non-IFRS
Nokia non-IFRS net sales grew 4% as our customers continued to invest in their networks in preparation for the rise in broadband traffic driven by 5G. On a constant currency basis, Nokia non-IFRS net sales grew 1%.
Our solid overall topline performance in Q3 2019 reflected improved industry demand and the competitiveness of our end-to-end portfolio, with growth across four out of six regions and all customer types. In Q3 2019, we continued to make progress with our strategy to diversify and grow, with strong performance in Nokia Software and with enterprise customers.
The strong growth in Nokia Software net sales was primarily due to the timing of completions and acceptances of certain projects. To a lesser extent, net sales also benefitted from Nokia Software’s improved product and go-to-market capabilities, with growth in both core networks and applications.
The strong growth in net sales to enterprise customers was primarily driven by increased demand for mission-critical networking solutions in industries including utilities and the public sector, with continued momentum in private wireless solutions. Net sales also benefitted from the timing of completions and acceptances of certain projects.
The overall decrease in Nokia non-IFRS gross profit was primarily due to lower gross margin in Networks. We experienced relatively high 5G product costs in Networks, as well as elevated levels of deployment services, consistent with being in the initial phase of 5G. This was partially offset by net sales growth in both Networks and Nokia Software, as well as higher gross margin in Nokia Software. In Q3 2019, Nokia non-IFRS gross profit benefitted from lower incentive accruals.
The decrease in Nokia non-IFRS operating profit was driven by the lower non-IFRS gross profit, partially offset by continued progress related to Nokia’s cost savings program. In Q3 2019, Nokia non-IFRS operating profit benefitted from lower incentive accruals.
Nokia, January-September 2019 compared to January-September 2018, reported
Nokia net sales grew 5% in the first nine months of 2019 as our customers continued to invest in their networks in preparation for the rise in broadband traffic driven by 5G. On a constant currency basis, Nokia net sales grew 2% in the first nine months of 2019. Excluding approximately EUR 80 million of one-time licensing net sales in the first nine months of 2019 and EUR 20 million in the first nine months of 2018, Nokia net sales grew 4%.
Our solid overall topline performance in the first nine months 2019 reflected improved industry demand and the competitiveness of our end-to-end portfolio, with growth across four out of six regions and all customer types. In the first nine months of 2019, we continued to make progress with our strategy to diversify and grow, with strong performance in Nokia Software and with enterprise customers.
The overall decrease in Nokia gross profit in the first nine months of 2019 was primarily due to lower gross margin in Networks. We experienced relatively high 5G product costs in Networks, as well as elevated levels of deployment services, consistent with being in the initial phase of 5G. This was partially offset by lower costs related to network equipment swaps, net sales growth in both Networks and Nokia Software, as well as higher gross margin in Nokia Software. In the first nine months of 2019, Nokia gross profit benefitted from lower incentive accruals.
The decrease in Nokia operating loss in the first nine months of 2019 was driven by continued progress related to Nokia’s cost savings program, a gain on defined benefit plan amendments and lower restructuring and associated charges, partially offset by the lower gross profit. In the first nine months of 2019, Nokia operating loss benefitted from lower incentive accruals.
Cash and cash flow in Q3 2019
In Q3 2019, Nokia’s free cash flow was positive EUR 299 million, driven by:
- Adjusted net profit of EUR 769 million;
- Cash outflows related to net working capital primarily due to a decrease in liabilities, partially offset by a decrease in receivables;
- Continued cash outflows related to restructuring; and
- Capital expenditures and income taxes.
Nokia has established a free cash flow program to ensure company-wide focus on free cash flow and release of working capital, including project asset optimization, review of contract terms & conditions, as well as supply chain and inventory optimization. Senior leaders of Nokia have a significant part of their incentives tied to free cash flow improvement targets in 2019 and beyond.
During the third quarter 2019, Nokia’s total cash and current financial investments (“total cash”) increased by EUR 36 million and Nokia’s net cash and current financial investments (“net cash”) decreased by EUR 158 million.
Foreign exchange rates had an approximately EUR 30 million negative impact on net cash.
In the third quarter 2019, net cash from operating activities was EUR 464 million:
- Nokia’s adjusted profit before changes in net working capital was EUR 769 million in the third quarter 2019.
- In the third quarter 2019, Nokia generated a decrease in net cash related to net working capital of approximately EUR 150 million. Excluding approximately EUR 100 million of restructuring and associated cash outflows, Nokia generated an approximately EUR 50 million decrease in net cash related to net working capital. This decrease was due to a decrease in liabilities, partially offset by a decrease in receivables. Inventories were approximately flat in the quarter.
- The decrease in receivables was approximately EUR 390 million, and was primarily due to improved collections achieved through higher sale of receivables. In the normal course of business, to manage our credit risk and working capital cycle, Nokia sells trade receivables to various financial institutions without recourse.
- The decrease in liabilities was approximately EUR 440 million, and was primarily due to a decrease in deferred revenues and advance payments, a decrease in liabilities related to employee benefits and a decrease in accounts payable.
- In addition, cash taxes amounted to an outflow of approximately EUR 110 million.
- The implementation of IFRS 16 positively impacted our net cash used in operating activities and negatively impacted our net cash from financing activities, both by approximately EUR 60 million.
In the third quarter 2019, net cash used in investing activities primarily related to capital expenditures of approximately EUR 190 million.
In the third quarter 2019, net cash used in financing activities primarily related to paying the second quarterly instalment of the dividend and the withholding taxes related to the first instalment, totaling approximately EUR 320 million and lease payments of approximately EUR 60 million following the implementation of IFRS 16.
Cost savings program
We expect our most recent cost savings program to result in a net EUR 500 million reduction of non-IFRS operating expenses and production overheads (“fixed costs”) in full year 2020 compared to full year 2018, of which EUR 350 million is expected to come from operating expenses and EUR 150 million is expected to come from cost of sales. This reflects a EUR 150 million reduction in our expected operating expense savings and a EUR 50 million reduction in our expected cost of sales savings. The change from a net EUR 700 million reduction to a net EUR 500 million reduction is primarily due to our expectation to make additional 5G investments and additional digitalization investments.
Note that, since the announcement of our most recent cost savings program on October 25, 2018, net foreign exchange fluctuations have resulted in an increase in estimated full year 2020 fixed costs of approximately EUR 180 million, creating an additional headwind to achieve the earlier net reduction.
The following table summarizes the financial information related to our cost savings program as of the end of the third quarter 2019.
At the beginning of Q1 2019, the balance of restructuring and associated liabilities related to prior cost savings programs was approximately EUR 630 million. This amount is included in the total expected restructuring and associated cash outflows of EUR 1 550 million, rounded to the nearest EUR 50 million, in addition to the approximately EUR 900 million of expected cash outflows related to our most recent cost savings program.
The table below includes future expectations related to our most recent cost savings program, as well as the remaining cash outflows related to our previous programs and network equipment swaps. Please note that we exclude the impact of lower incentive accruals from our definition of “Recurring annual cost savings”.
In the first nine months of 2019, excluding the impact of the incentive accruals, we achieved approximately EUR 180 million of structural fixed costs savings, compared to the first nine months of 2018. Despite net foreign exchange fluctuations resulting in an increase in estimated full year 2019 fixed costs of approximately EUR 130 million, we are well on our way to meet the cost reduction targets for 2019.
The expected timeline for the related cash outflows has been adjusted, with expected cash outflows in full year 2019 moving from EUR 700 million to EUR 550 million, expected cash outflows in full year 2020 moving from EUR 350 million to EUR 450 million and expected cash outflows beyond 2020 moving from EUR 500 million to EUR 550 million. The related restructuring charges are expected to total EUR 900 million.
Nokia showed robust momentum in Q3 2019 across its key markets and around the globe, particularly in 5G, where Nokia’s technology is now present in all regions in the world.
In the first pillar of our strategy, leading in high-performance, end-to-end networks with communication service providers:
Nokia signed multiple 5G commercial agreements during the period and the total number of 5G commercial agreements is now 48. Over half include more than radio from our end-to-end 5G portfolio. Fifteen of those networks are now live, including Sprint and Verizon in the US.
Nokia continued to strengthen its 5G foothold in Japan, where it was selected by KDDI as a primary partner to upgrade its network for 5G. Nokia also entered into a strategic agreement with Iliad for the deployment of its 5G network in France and Italy. In New Zealand, Nokia secured a deal with Vodafone New Zealand to deploy a 5G network in the country. The network, which will be launched in Auckland, Wellington, Christchurch and Queenstown in late 2019, will include Nokia’s AirScale radio access network, cloud-native core as well as design services, providing further proof of the strength of Nokia’s end-to-end portfolio. Nokia also deployed its 5G portfolio in Vietnam, where Viettel and Nokia broadcasted the country’s first end-to-end 5G trial network in Ho Chi Minh City.
Nokia further showcased its end-to-end 5G leadership with a new Future X Lab in Finland. The Lab will enable customers to experience Nokia’s full end-to-end portfolio of 5G equipment, software and services, allowing communications service providers, enterprises and infrastructure providers to learn and understand the techno-economic power of a 5G end-to-end network to better serve their customers and unleash new value.
Several 5G deals and trials, including Smart in the Philippines, Vodafone New Zealand and Viettel, involved IP Routing and Optical Networks products.
Further showcasing its market-leading technology within IP and Optical, Nokia completed the world’s first single-carrier terabit-per-second field trial, setting an optical transmission capacity record over Etisalat’s fibre network in the United Arab Emirates.
In Fixed Access, Nokia secured several Fiber To The Home (FTTH) deals with top-tier customers. After the end of the quarter, Nokia also announced it was teaming up with Telia Company to bring its 5G Fixed Wireless Access solution to customers across Finland.
In Q3 2019, Nokia was also recognized as a ”Leader” in Managed Services by industry analyst firm GlobalData.
In the second pillar of our strategy, expanding network sales to select vertical markets needing high-performing, secure networks:
Nokia continued to strengthen its position with enterprises. Nokia worked with Telefónica Peru to enable automated, digital mining operations for Minera Las Bambas, one of the world’s largest copper mines. The five-year contract will see Nokia build, deploy and support a private LTE network 4 600 meters above sea level.
Nokia, NTT DOCOMO, INC. and OMRON Corporation agreed to conduct joint field trials using 5G at their plants and other production sites. As part of the trial, the partners will leverage 5G connectivity to prove the feasibility of a layout-free production line with Autonomous Mobile Robots (AMRs) as well as real-time coaching using AI/IoT.
Nokia was selected by RigNet to upgrade its microwave communications network which supports the mission-critical communication needs of its multiple oil and gas customers located in the Gulf of Mexico, covering more than 55,000 square miles. The network upgrade will see RigNet customers offered 4G LTE services with support for 5G services in the future.
In the third pillar of our strategy, developing a strong software business at scale:
Three UK and Nokia launched the world’s first 5G-ready fully integrated cloud core network. The new 5G-ready core network, which sits in a virtual environment, offers increased security, flexibility and cost savings, allowing Three to scale more quickly and efficiently and is a critical building block for Three to deliver the UK’s fastest 5G network.
Nokia also secured deals with major operators in North America as well as MTN of South Africa, Orange of France and Telefonica Brazil.
Just after the quarter ended, Analysys Mason ranked Nokia as the top telecom software provider by market share. According to Analysys Mason’s findings, Nokia is significantly improving its 5G-ready mobile network management offering by evolving it to be cloud-native and including value features that communication service providers find valuable, while also expanding the capabilities and commercial customers for its leading platforms.
In the fourth pillar of our strategy, now focused primarily on licensing:
Shortly after the quarter ended, Nokia announced it has declared more than 2 000 patent families to the European Telecommunications Standards Institute (ETSI) as essential for the 5G standard, reflecting its continuing leadership in cellular technology R&D and standardization.―CT Bureau