The Worst May Be Over for Nokia

Nokia (NOK 3.60%) reported its second-quarter results before the market opened on July 26. It was another weak quarter, with slumping sales in the networks segment driving a steep decline in the bottom line. But there's light at the end of the tunnel, with Nokia expecting improvements in the second half followed by much stronger demand through 2020.

Nokia results: The raw numbers

Data source: Nokia. All figures non-IFRS.

What happened with Nokia this quarter?

• Adjusted for currency, Nokia's revenue declined by just 1%.
• Nokia's networks revenue dropped 6% year over year to 4.69 billion euros. Adjusted for currency, revenue was flat. Within the networks segment, ultra-broadband networks revenue slumped 5% to 2.06 billion euros, global services revenue fell 8% to 1.33 billion euros, and IP networks and applications revenue dipped 3% to 1.31 billion euros.
• Networks gross margin tumbled by 430 basis points year over year to 34.8%. Operating margin fell 670 basis points to 1.5%. Price erosion in the ultra-broadband business and currency exchange rate fluctuations ate away at the company's gross profit.
• Nokia technologies revenue dropped 2% year over year to 361 million euros. Gross margin was 98.1%, up 270 basis points, while operating margin was 80.6%, up 1,860 basis points.
• Within the technologies segment, 352 million euros of revenue was related to patent, brand, and technology licensing, while 9 million euros was related to digital health. The digital health business was sold in May.
• The revenue decline in the technologies segment was due to about 70 million euros of nonrecurring revenue in the prior-year period, which was only partially offset by additional recurring licensing revenue.
• HMD Global, Nokia's exclusive brand licensee for mobile devices, launched its first smartphone with a notched display in China during the quarter. HMD is making the Nokia brand relevant in the smartphone market once again.

The Nokia 5 smartphone. Image source: Nokia.

Nokia provided the following guidance:

• Non-IFRS operating margin between 9% and 11% in 2018 and between 12% and 16% in 2020 -- unchanged from the previous outlook.
• Non-IFRS diluted earnings per share between 0.23 euros and 0.27 euros in 2018 and between 0.37 euros and 0.42 euros in 2020 -- unchanged from the previous outlook.
• Recurring free cash flow is expected to be slightly positive in 2018 and "clearly positive" in 2020.
• The networks business is still expected to outperform its primary addressable market in 2018 and in the long run. The company sees the market declining by 1% to 3% this year, adjusted for currency, with growth in 2019 and 2020 and improved conditions in the second half of this year.
• The licensing business is expected to grow by about 10% annually through 2020, with an operating margin of 85%.

What management had to say

Nokia CEO Rajeev Suri reminded investors that a weak first half was expected: "Nokia's Q2 2018 results were consistent with our view that the first half of the year would be weak followed by an increasingly robust second half. Pleasingly, I am able to confirm that we expect to deliver 2018 results within the ranges of our annual guidance."

Suri reiterated that Nokia is in good shape in the 5G market: "Our view about the acceleration of 5G has not changed and we continue to believe that Nokia is well-positioned for the coming technology cycle given the strength of our end-to-end portfolio. Our deal win rate is very good, with significant recent successes in the key early 5G markets of the United States and China."

Looking forward

With a weak first half in the books, Nokia expects business to pick up in the next couple of quarters. Profits in the networks business tumbled in both the first and second quarters, so margins will need to improve dramatically for Nokia to hit its full-year targets.

In the longer run, the adoption of 5G technology should put an end to Nokia's revenue woes. The company expects to outperform a growing market in 2019 and 2020, and it sees networks operating margin potentially reaching the double digits.