Nokia Oyj (NOK) Q4 2005 Earnings Report, Transcript and Summary

At this time I would like to everyone to Nokia's fourth-quarter and full-year 2005 earnings conference call with our host Mr. Bill Seymour, Vice President of Investor Relations. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instruction). I would now like to turn the call over to our host Mr. Bill Seymour. Mr. Seymour, you may begin.

Ladies and gentlemen, welcome to Nokia's fourth-quarter 2005 conference call. I am Bill Seymour, VP of Investor Relations. Jorma Ollila, Chairman and CEO of Nokia, and Rick Simonson, CFO of Nokia, are with me today. During the 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 22 in our 2004 Form 20-F and also in our press release issued today. Our aim is to finish the call in approximately one hour. To view the supporting slides while listening to the call please log onto www.Nokia.com/investor. For your convenience a replay of the call will be available beginning two hours after the call ends today until Tuesday, 7 AM Helsinki time. The call will be archived on our website. With this it is my pleasure to pass the call over to Jorma. Jorma, please.

Thanks, Bill. Welcome to the show. Ladies and gentlemen, I'm extremely pleased with the performance of the Nokia team in Q4 and 2005. In 2005 Nokia achieved record-breaking device volumes and had healthy device market share gains. Our 2005 net sales grew 16%, the highest growth we have had since 2000, and our EPS grew by 20%. We grew faster than the market in Q4 in device volumes year-on-year as well as sequentially. Nokia Network's sequential sales growth far outpaced the market in Q4 as well. There are a number of accomplishments to highlight in the fourth quarter. Nokia device volumes of 84 million were up 26% sequentially and 27% year-on-year leading to a market share of 34%. Based on our estimates Nokia is the only vendor of the top five to gain share sequentially in Q4, all the other players, including the number two vendor, lost market share. We're the clear number one device company globally. We are number one in all of Europe, all of APAC, Middle East, Africa, Southeast Asia Pacific, China, Russia as well as India. And we are number one in GSM, in EDGE, in wideband CDMA and in smart phones. During the fourth quarter we have made great progress in our entry-level business. The US market overall, CDMA, clamshells and wideband CDMA. And we continue to make good progress in steadily improving our mobile device portfolio. During the fourth quarter we introduced 20 new handsets. Nokia Networks had a strong quarter with sales up 25% sequentially and operating margins of almost 14%. During the quarter we bought back 121 million shares for a total of 315 million shares repurchased in 2005. Now I would like to make some brief comments about the overall device market. According to our estimates the fourth-quarter mobile device market…

Thank you, Jorma. Ladies and gentlemen, let me touch on the financials in some detail and first looking at the P&L. In the fourth quarter net sales were up 23% sequentially and 9% year-over-year, and on a constant currency basis sales growth was 13% year-on-year. Gross margins were up sequentially 40 basis points to 34.1% driven primarily by improvement in Network's gross operating margin. Reported group operating margins were down 50-basis point sequentially to 13.2%; but, if you exclude the special items related to both quarter three and quarter four, the operating margins were up 90 basis points sequentially to 13.5%. This improvement was driven primarily by improved networks margins and overall lower OpEx as a percentage of sales. So while the reported OpEx was up 90 basis points sequentially as a percentage of sales to 20.9%, again, excluding the special items from both quarter three and quarter four, OpEx was down 50 basis points to 20.6% of sales in quarter four. Sales and marketing was up sequentially as a percent of sales in quarter four and was a primary reason why we didn't deliver a bit more operating leverage in the fourth quarter. Strong marketing programs in multimedia and mobile phones contributed to most of this increase. Multimedia marketing programs in the fourth quarter include the continuing expenditure for the overall long-term establishment of the Nokia N series and for specific key products shipping in the quarter such as the N70. For mobile phones the 6101 and the imaging driving 6111 and 8800 were some of the big programs. The 6101, 8800 and 6111 are both positive brand drivers, but let me emphasize that they also are positive strong profit drivers. So we think the marketing spend being put against these products is well spent. As we discussed in…

Thanks very much, Rick. I'd like to cover the first-quarter and 2006 market and Nokia outlook very briefly. For the first quarter of 2006 Nokia does expect the overall mobile device market volumes to reflect normal industry seasonality following a strong fourth-quarter selling period. We expect our own share of the device market in the first quarter to be flat to slightly up sequentially, up year-on-year. We also expect the Nokia device average selling price in the first quarter to be flat or slightly down sequentially driven by a regional mix shift. Sales in our network business are expected to experience a seasonal decline in the first quarter, but be up year-on-year. For the full year 2006 we expect the mobile device market volumes to grow by more than 10% from our preliminary estimate of 795 million units this past year in 2005. We also expect that the device industry will experience value growth in 2006, but expect some decline in industry ASPs, primarily reflecting an increasing insight from the emerging markets. Nokia expects that the majority of the growth and over 50% of industry units in 2006 will come from emerging markets. Nokia expects that the replacement market will account for over 60% of industry device volumes in 2006. Nokia expects moderate growth in the mobile infrastructure market in euro terms in 2006. And our goal is to increase our market share both in mobile devices as well as in the infrastructure market. We are indeed entering this year with a strong product portfolio; great products are key but we are also taking actions to turn this critical product momentum more to our advantage. We have the most extensive distribution network in the world and we have one of the world's leading global brands. We will continue to leverage and extend these advantages. For example, in 2005 we conducted what I believe to be one of the broadest and most sophisticated segmentation projects in the consumer goods industry. The survey consisted of more than 60,000 hours of interviews done in 16 countries. In 2006 we will systematically apply what we learned from this study in retail. Last November we opened our first flagship store in Moscow and we are already seeing some very good traction there. We will be rolling out flagship stores in many more prime urban spots in the world, different parts of the world in 2006. Finally, thanks again to the exceptional Nokia team for delivering such excellent 2005 results. And we really are eagerly working on a great 2006 to happen. So I'll now turn to Bill for some final comments.

Thank you, Jorma. Will now continue with the Q&A session. In order for us to be able to answer the questions properly please limit yourselves to one question only. Operator, please go ahead.

(Operator Instruction) Your first question comes from the line of Has Malik with Citigroup.

I'd like to ask two questions on multimedia division. Can you comment on the N series volume expectations in terms of what kind of approximate share of your total shipments in 2006 you hope to come from N series branded products? And second, when you talked about multimedia related marketing spending being higher than what you would perceive as normal levels, how much longer do you expect that to continue? Thank you.

Thanks for the question. It's clearly, if you look at the N series products, I think the comment would be that the second half performance overall for how we were able to ramp up and get the real volumes going with some real complex products was exceptionally good. So the ramp up capability that was demonstrated by the business group and the organization working on that was exceptional. So that really accounted for the better performance for multimedia than what we expected when we looked at the plans for the year 12 months ago, and really is ahead of plan overall. I don't have a figure, but it's a, the majority of the products already towards the end of the year were N series and will continue to be. The N70 being the top revenue generator among the N products, so I might even say that it's the great majority of the multimedia products being from the N series, so it's really moving towards the N series branded products within the division. Your second question related to the marketing and I think a couple of observations there. First of all, we have done a lot of work in terms of understanding the productivity of our marketing and sales on one hand and then the R&D expenditure on the other hand. What sort of gross margin are we getting short- or medium-term from those investments is a very major management parameter to follow and have systems in place to, not only to monitor but to get real planning understanding on what needs to be done. And I think, so we have a systems in place, like Rick mentioned in his presentational comments. So when we look at the marketing, and as you know, let's leave R&D, that question I'm sure will…

Okay, thank you.

Your next question comes from the line of Tim Long with Banc of America Securities.

Can we just touch on the North American market a little bit? You talked about some real, real good share movement there getting back to 20%. Just give us your sense on how you view the sustainability of those share gains, particularly in light of some of the technology changes that are going on here moving from CDMA to EVDO and the move to WCDMA. So if you could just talk about how you feel about sustainability given the product cycle over the next few quarters as well as the technology changes. Thanks.

Thanks. If you look at first of all how after three not so good quarters particularly we were able to come back very well starting towards the end of the third quarter and now having what I would a very respectable quarter in terms of the share development in the final quarter. It's really coming from good products, both the improved GSM as well as the improved CDMA products. When I look at the momentum that I see as we speak in the US it's going to continue or extend into Q1. So this is not a one-off and we obviously see that we are well-placed to continue that momentum based on the discussions we have with the operators in GSM and in wideband CDMA when we go forward. But also we, as you know, we will be bringing a DO product and the CDMA recovery and getting back on track and into volume deliveries there to the key customers. That is very much happening. So being above 20, that's the first step. Now we will be stabilizing at a level which is above 20 and then going to the next step and really establishing ourselves hopefully as a strong contender for the number one position. That's not for me to talk about because I'm here for the first and second quarter. I think it will take a little bit more; so you'll have to talk to my colleagues and I'm sure they will enlighten you in the next conference call. Are you okay with that, Rick?

We will be here and Tim will see me.

Thank you.

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

I've got a quick question on your emerging markets business. You mentioned in the text that you lost some market share in Latin America, Middle East and Africa. You said that you were hoping for that to bounce back in Q1. I was hoping that perhaps you could go into a bit more detail as to what it was that caused that market share to erode? Was it product issues? Was it pricing issues? What it distribution issues? Was it increased competition for example?

First of all, Middle East and Africa. Our share is very high and in that sort of a situation, when you have typically volatility in terms of some deals which have been priced at levels which don't long-term, which aren't destructive long-term for anybody. And then we decided to say no, we will not be party to this sort of an extravaganza just doing business for one-off. You know, then that very easily shows in a bit of a lower level. So it's this strong presence that we have which every now and then gets, because of the non maturity of the distribution on a broad basis in Middle East and Africa gets sort of disturbed, disturbed with spot deals. I think that's perhaps the best way to describe that dynamic. We are miles ahead in terms of building our distribution broadly in that region and we expect to be real strong and come back. So nothing special, difficult volatility and also some sell-in/sell-out issues there so our sell in doesn't necessarily tell the story about how the product moved from the shops. And that one can say knowing exactly that our trade inventory situation, channel inventory situation is very solid all the way in that region. On Latin America, that's traditionally an extremely fluctuating market in terms of deals moving back and forth and a lot of changes between different players. We have historically been either number one or two. There's one guy who's sort of very close to us and we tend to swap places quarter-to-quarter. So there is nothing special. Our somewhat lower than typical share was to have more than anything else coming from us not participating in some out sell CDMA action which was there in the market. That you can always take if you want, but if you decide in a good quarter with volumes moving otherwise, as was the case with us, why go in there? So nothing special. I don't think there's a big story, that's kind of what I'm saying.

Just in the text you gave the impression that you lost share during the whole of the year, in 2005?

It was a little lower on both scores than in 2004, that's correct.

Your next question comes from the line of Wojtek Uzdelewicz with Bear Stearns.

Thank you, good afternoon. Jorma, I just want to get your sense on, I think some of the concerns that people or the call might make that, okay, well, Nokia, obviously you guys do great when there's a component tightness. So in the fourth quarter you definitely gained market share. You outperformed any of your competitors, there's no question about it. But then people say, okay, well, in Q1 there's a competitor who has several new product lines they could not execute in Q4, but they're going to deliver, come out with a more competitive offering. When you look, you've probably got a couple months already of the sense how the competition is doing with some of the new products. You have new products, I understand Japan and Korea are flat so you don't participate. So maybe on seasonal levels you're a little weaker because you don't play in those markets. But in your respective market what's your sense, how are you doing competitively against some of those new products? And related to that, because the big part of your story I think in the second half of the year is if you guys get right enterprise business that would be huge upside for the story; that's such a big market. Now it's a little bit underperforming. Are you accelerating some product developments there? Could you just touch on the milestones we should be looking? Because that's somewhat under performing but that's also such a huge area of upside for you down the road?

Two questions. First of all, we don't see any new pressure, new market dynamics coming from any one competitor in Q1. Our channel inventory situation is very good. I don't know the situation with other people exactly, but I think it's okay overall in the marketplace. So there shouldn't be any overhang. This is a healthy transition from Q4 to Q1. And that is coming through when you look at how the order book and how shipments are moving in the first five or six weeks which we have good visibility. So we feel good about our position with our products and nobody has come in with something which would make us feel that there is a new situation. There is not. Then on the dynamics towards the second half vis-a-vis the potential presented by the fact that we have been so heavily on the investment mode and continue to be. And the enterprise solutions, with that being such an early phase of the market with a lot of complexity in getting the solutions as well as the handsets which support those solutions to really get going. And I think obviously we have a lot of potential to turn this around into a much, much improved result in the second half. Yes, we are working very much toward second half being significantly better. You're already starting with some volumes of E series which we have launched during the second quarter, but you're putting on a finger in the second half is exactly correct.

Okay, thank you. But bottom line from the European markets or American markets at least, some of the thin phone factors from competitors, when you compare them for competitive reasons, you don't think that's going to impact your market are, at least based on what you see so far?

No, no, we don't see any new dynamics on that. No.

Thank you.

Your next question comes from the line of Jeffrey Schlesinger with UBS.

Just two questions if I could. From an earlier question you talked about the market share gains in the first quarter and momentum in North America. Will that likely continue to put pressure on gross margin sequentially in the first quarter? And then second, Jorma, music continues to get a lot of attention in the mobile world, do you think the ecosystem is there? It appears to be very fragmented, a lot of people doing a lot of different things. Do you think that will be all in place to drive this market as we come to the second half and into '07? Thank you.

I missed the last bit of your question, the last sentence literally. Can you just repeat that, please?

On the music side, do you think the ecosystem, which appears to be very fragmented now, portals, Apple's doing what it's doing, do you think that will be sufficient to actually drive this market towards the end of '06? Or how do you see that developing and Nokia's relationship?

Okay, so first of all, on the momentum and its impact on the gross margin in the, the US momentum and its impact on the margin. If you look at the gross margins in the US, the gross margins are slightly lower than the corporate average in the US because of the lower ASPs. US average ASP is lower. And so, but it's interesting because if you have a new good product like we have had a couple, as mentioned, in the final quarter, our ASP in the US went up from Q3 to Q4. So it's not so straightforward in what happens. And I wouldn't sort of draw a conclusion that there we go; the US is going to have a big impact. No, it certainly will not have a big negative impact. At worst it's muted and at best there can be good contribution coming from volumes and then the right kind of mix of midrange and the higher end phones. Because we are also making sure that the, we could benefit from the retail traction that we have for our high-end product even if we need to build a distribution, which is a retail distribution rather than through the operator. So I think we are moving nicely not with an explosive speed because it's difficult to do that ever in the US So don't count on having a big negative impact. No, there will not be one with us moving. But it's not a big positive impact either because of the intrinsic nature of the ASP level of the market. On music, yes, I think it was said that 2005 was going to be the year of music. It's all relative, it's in a fragmented way towards the year-end and everybody became aware. I think 2006 will actually be the year when it will be very broadly accepted and broadly a phenomenon in devices. We will be looking into music increasing in importance throughout the year accelerating towards the second half. So it will probably not be a big story, dramatic story in the first quarter or so, but then working towards the second half. There is a very positive expectation there and the volumes will be significant.

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

I was wondering if you could maybe just touch a little bit on the pricing pressure, especially with Motorola trying to go more into the emerging market. Can you maybe talk about any pricing pressure you might be seeing in those markets? And then, also you touched on given your large share and brand in some of those markets, any price premium you might have on some of those low-end products? That would be helpful. Thanks.

That's obviously an issue where it's about product and cost competitiveness, that's number one; number two, it's about brand; and number three, it's about distribution. And all have an importance. The relative importance of those three in the emerging markets varies from whether you are in an urban environment in Shanghai or whether you are in a countryside in India. So the relative importance can be very significantly different, but your overall business model has to be in shape in order for you to be successful. And I think that the fact that we have invested in a patient way into that has really paid off. And if there is somebody trying to catch us you can bet that we will be running with some really good sneakers at a faster pace and making sure that there's a gap. And it really, really comes about the overall business model, overall value chain being in good control. We did gain share in 2005 in the emerging markets overall. So if you look at Africa, Latin America, Asia-Pacific, India, China, Russia, if you take overall we have looked at how did we do. We gained share and it came in the first half because of the 1100 being in very, very good shape as a product and the second half increasingly 1110 and 1600 starting to perform and giving a real sort of spread of products. Not just one product priced desperately, but rather getting a breadth of products and that will be the story also in 2006. There will be new products. It's not that we're sort of phasing out some products which you saw in Europe or in the US two or three years ago that we would now then start shipping them. No, they are custom-made to emerging markets and cost optimized and feature optimized. So pricing pressure, no, we have not seen here. Had we seen significant pricing pressure you would not have seen the 17% margin in mobile phones in the fourth quarter. No, it's been well controlled in terms of good balance between taking deals and getting the volumes as well as making sure that we get a good return for our shareholders. And I think our folks; they are very, very good at doing exactly that in the field. So it's a great organization in that sense and if you look at the gross margin of our entry product line, it has improved since the second quarter of last year. So we have improved our gross margin in the emerging market product line since the second quarter of last year. So that's kind of as a summary the story about the price pressures and this and that competitor heading towards what used to be easy for us. No, this is not easy. This is challenging, but we are getting higher gross margin as a total impact of those factors which I mentioned.

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

A question for Rick. If we look at the trend in your device gross margins, they've continued to I think reach new lows. And I'm just wondering as we head into now 2006 and level to about Q4, is that probably a low? Because I'm just thinking, you've talked a lot about the transition to your new low-cost platform. At some point I'm assuming that helps gross margins a bit in that part of the business. And I think you almost already said that there's some recovery already happening there. And also you've got the rise towards 3G where you've said before your profitability has materially accretive. So I'm wondering, is this the bottom and should we see a recovery or are there some other factors maybe in the early part of the year that may impact gross margins?

Thanks for that. Why don't we talk a little bit of the positive and the negative factors of what will drive gross margin? I think Jorma outlined in the opening remarks and then with the question of Mike's really on this low-end, we are seeing the refresh there, positive impact there on the gross margins. It's something that we talk about a lot, last quarter and the quarter before that as we rotate from the 1100 to the 1110, 6030 so-called Scott chipset family. And I'd amplify there that we're talking about what kind of price premiums can you get there. Well, obviously initially when you come out with the replacement products for the 1100 you get some initial price premium while they're both selling in the market. But importantly what's happening is what we talked about, that many people are choosing the 1600 as their first entry phone. That's color. And again, to me, to my mind, way of thinking, that is kind of a price premium or a price step up, it's a rotation up that gives us opportunity. And so we are executing that, as we said. We're seeing the benefit there, but we don't stop there. Like we talked about just a number of weeks ago in December in New York, what's the next step? Well, it's the low-cost single chip entry and, again, we expect to have the combined benefits there of some, again, some bill of material cost advantage compared to the current platforms and then you get this effect of having new product in and you can work up the ladder. So that's a positive impact. Clearly WCDMA, the 3G device is our strong position there and the potential for the industry where we think volumes are going to more than double plays…

Okay, thanks very much.

Ladies and gentlemen, this concludes our conference call. I would like to remind you that during the conference call today we made a number of forward-looking statements that involve risks and uncertainties. Actual results may therefore differ materially from the results currently expected. Factors that cause such differences have been identified in more detail on pages 12 to 22 of our 2004 Form 20-F and also in our press release issued today. Thank you and have a nice day.

Thank you for participating in today's Nokia fourth-quarter and full-year 2005 earnings conference call. You may disconnect at this time.