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Get Ready for Nokia Earnings

Nokia's second-quarter financial results are due out Thursday. Expect strong results based on Nokia's dominant consumer appeal and consistent record of trouncing its primary competitors, Motorola and Ericsson. By focusing on six simple metrics drawn from all three financial statements, you'll be able to discern the full scope of Nokia's business performance.

By Matt Richey (TMF Verve)
July 24, 2000

Often, spotting the Rule Maker in an industry is laughingly simple. Take, for example, the major wireless communications players -- Motorola (NYSE: MOT), Ericsson (Nasdaq: ERICY), and Nokia (NYSE: NOK). By applying common sense and simple mathematics, it's easy enough to see that only one of these companies is truly making the rules. Just look around and you can see that Nokia phones are the most popular, best designed handsets on the market. Beyond that, Nokia's financials are a clear cut above the rest. But nothing's to be taken for granted in the business world. That's why we'll be paying close attention when Nokia reports its second-quarter financial results this Thursday.

Analysts are looking for earnings per share (EPS) of $0.19, but may I suggest that this is only a marginally relevant number for assessing Nokia's business performance, or really that of any company. EPS captures only one small dimension of the income statement, and the income statement is only one-third of the story at that. What about the balance sheet, which measures the assets upon which the business is built? How about the cash flow statement, which tells us how much cash profits the company really earned? The income statement is only the starting point for gauging Nokia's success this quarter.

So, when Nokia reports this Thursday, I encourage you to ignore all the typical hoopla over the EPS number and spend 20 minutes to calculate six simple metrics: sales growth, gross margins, net margins, ratio of cash to debt, Foolish Flow Ratio, and Cash King Margin. Don't know how to crunch 'em? No problem, they're all explained right here in our Rule Maker Criteria page. If you have questions, drop a note on our Rule Maker Beginners folder. The time you spend learning those six calculations will be one of the best investments of your financial life.

To show you how revealing those six metrics are, let's turn back the clock three months and examine a breakdown of the first-quarter results for Motorola, Ericsson, and Nokia. Take a look at the table below and see what conclusions jump out at you.

Q1 2000         Motorola  Ericsson   Nokia
Total Revenue    $8,768M  $6,568M  $6,315M      
Revenue Growth     13.3%    42.1%    68.9%
Gross Margin       40.7%    41.3%    38.6%
Net Margin          5.1%     7.2%    13.6%
Cash-to-Debt        0.53     0.52     4.37
Flow Ratio          1.53     1.54     1.05
Cash King Margin  -18.1%    -9.9%     4.5%

Some observations:

• In a few years from now, Nokia's revenues will far exceed that of its competitors. All three companies have a similar level of current revenues, but not for long. Nokia is the Ferrari alongside an Oldsmobile (Ericsson) and a tricycle (Motorola). Nokia's blistering revenue growth (68.9%) is its most impressive financial attribute. For many consumers, it's Nokia or nothing. That's Rule Making.
  
  
• Nokia has extensive competitive advantages, and it shows up in its superior net profit margins (13.6%), which are almost double the runner-up. Nokia's advantage seems to come from a combination of cutting-edge handset design, renowned quality, high-margin phone accessories, manufacturing efficiency, management savvy, and maybe even inept competition.
  
  
• Nokia is playing offense, while Motorola and Ericsson are stuck on defense. It's all in the cash-to-debt ratio. Nokia has cash reserves four times greater than debt, giving Nokia the flexibility to be opportunistic. In contrast, the competition is wallowing in debt.
  
  
• Nokia is in a position of power relative to its customers and suppliers. You can see it in the Foolish Flow Ratio. Nokia's Flowie (1.05) is one-third lower than that of either competitor. A low Flow Ratio means that Nokia is quickly collecting cash payment on sales, keeping inventories to a minimum, and using its authority to force suppliers to finance part of its business.
  
  
• Nokia is advancing its position of power through cash generation. Only Nokia is earning positive free cash flow on its sales, albeit at a relatively low rate. The Cash King Margin of 4.5% means that Nokia collects 4.5 cents of pure cash profit on each dollar of sales. I'd like to see Nokia improve its cash profitability, but even as is, it's a heckuva lot better than either of its competitors.
  

In sum, as of one quarter ago, Nokia was making chopped liver of Ericsson and Motorola. This quarter's scorecard isn't likely to be much different. Wireless communications is certainly a fast-moving space with new technologies constantly emerging, but the businesses themselves are more predictable. Nokia has positioned itself as the clear front-runner. Trailing behind is Ericsson and off in the distance is Motorola. Here's how the second quarter is shaping out so far:

Q2 2000          Motorola  Ericsson  Nokia
Total Revenue    $9,255M   $7,229M     ?
Revenue Growth     15.3%     28.0%     ?
Gross Margin       40.5%     39.6%     ?
Net Margin          2.2%     15.6%     ?
Cash-to-Debt        0.46      0.66     ?
Flow Ratio          1.64      1.52     ?
Cash King Margin     N/A      3.7%     ?

Motorola's numbers have continued to sour with a worsened net margin, cash-to-debt ratio, and Flow Ratio. Ericsson's results are a mixed bag of lower revenue growth, higher net margins, and slight improvements in the ratio of cash to debt and Flow Ratio. What will Nokia's quarter bring? I expect more of the same -- dominance on all fronts, through strong sales growth in excess of 50%, steady or slightly climbing gross and net margins, more cash, less debt, a steady or declining Flow Ratio, and a mid- to high-single-digit Cash King Margin.

So, on Thursday, instead of getting caught up in the noise of what management is saying and what analysts are saying and what pundits are saying, just take a few quiet minutes to punch the numbers into your calculator, compare the results with the competition, and draw your own conclusions. Make that a habit for all your companies, and you'll be a better investor.

Got questions or comments? Fools on the Nokia discussion board are in the know. They've put together a fantastic Nokia FAQ, which is a cornucopia of information about the company.

Related Links:

Rule Maker 1/31/00: The Mobile Information Society

Rule Maker 1/26/00: Why Nokia Rules the Roost

-- Matt Richey, TMFVerve on the Discussion Boards