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.
| Q3 2019 and January-September 2019 reported and non-IFRS results. Refer to note 1, “Basis of Preparation”, note 2, “Non-IFRS to reported reconciliation” and note 13, “Performance measures”, in the “Financial statement information” section for details. | ||||||||
| EUR million (except for EPS in EUR) | Q3’19 | Q3’18 | YoY change | Constant currency YoY change | Q1-Q3’19 | Q1-Q3’18 | YoY change | Constant currency YoY change |
| Net sales | 5 686 | 5 458 | 4% | 1% | 16 412 | 15 695 | 5% | 2% |
| Operating profit/(loss) | 264 | (54) | (318) | (611) | ||||
| Operating margin % | 4.6% | (1.0)% | 560bps | (1.9)% | (3.9)% | 200bps | ||
| EPS, diluted | 0.01 | (0.02) | (0.10) | (0.13) | ||||
| Operating profit/(loss) (non-IFRS) | 478 | 487 | (2)% | 869 | 1 060 | (18)% | ||
| Operating margin % (non-IFRS) | 8.4% | 8.9% | (50)bps | 5.3% | 6.7% | (140)bps | ||
| EPS, diluted (non-IFRS) | 0.05 | 0.06 | (17)% | 0.07 | 0.10 | (30)% | ||
| Net cash and current financial investments1 | 344 | 1 879 | (82)% | 344 | 1 879 | (82)% | ||
| 1Net 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
| 1. Unique end-to-end portfolio | Nokia’s unique end-to-end portfolio will drive stronger share of wallet with service provider and enterprise customers. Portfolio allows Nokia to benefit from virtuous 5G investment cycle in multiple capital expenditure domains (mobile access, fixed access, IP routing, optical networks and software). |
| 2. Value through product leadership | Nokia has a demonstrated ability to create value and drive cash flow through product leadership. Examples include FP4-based routing and PSE-3 based optical products, best-performing 4G networks, automated services, leading small cell and fixed wireless access portfolio. |
| 3. Successful diversification strategy | Nokia’s successful diversification into high growth enterprise business and medium growth software business is well underway. Both are meaningfully accretive opportunities for our margins, as well as our cash position. |
| 4. Sustainable patent licensing | Nokia’s strong and constantly growing patent portfolio provides long-term, highly profitable and cash generative opportunities, including extension into new segments, including multiple IoT verticals and consumer electronics. |
| 5. Structural cost reductions | Nokia has identified additional opportunities for meaningful cost reductions spanning both cost of sales and operating expenses, which will also help to drive improved cash performance. Opportunities include: reductions enabled by digitalization and automation of processes, product cost innovation (such as System on Chip in mobile, common software foundation in Nokia Software), ongoing R&D efficiencies and related site consolidation and improved product serviceability. |
DIVIDEND
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.
OUTLOOK
| Full Year 2019 | Metric | |
| Non-IFRS diluted earnings per share | EUR 0.21 plus or minus 3 cents (updated from EUR 0.25 – 0.29), which mathematically implies a Q4 2019 non-IFRS diluted EPS midpoint of approximately EUR 0.135 | |
| Non-IFRS operating margin | 8.5% plus or minus 1 percentage point (updated from 9 – 12%), which mathematically implies a Q4 2019 non-IFRS operating margin midpoint of approximately 16.5% | |
| Recurring free cash flow1 | Somewhat negative (updated from slightly positive), which mathematically implies a sequential increase in net cash to approximately EUR 1.5 billion at the end of 2019 | |
| Full Year 2020 | ||
| Non-IFRS diluted earnings per share | EUR 0.25 plus or minus 5 cents (updated from EUR 0.37 – 0.42) | |
| Non-IFRS operating margin | 9.5% plus or minus 1.5 percentage points (updated from 12 – 16%) | |
| Recurring free cash flow1 | Positive (updated from clearly positive) | |
| Long term (3 to 5 years) | ||
| Non-IFRS operating margin | 12 – 14% (new) | |
| Annual distribution to shareholders | An earnings-based growing dividend of approximately 40% to 70% of non-IFRS diluted EPS, taking into account Nokia’s cash position and expected cash flow generation. The annual distribution would be paid as quarterly dividends. | |
1Free 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 (This is an update to our earlier commentary, providing additional details); 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
| EUR million (except for EPS in EUR) | Q3’19 | Q3’18 | YoY change | Constant currency YoY change | Q1-Q3’19 | Q1-Q3’18 | YoY change | Constant currency YoY change |
| Net sales | 5 686 | 5 458 | 4% | 1% | 16 412 | 15 695 | 5% | 2% |
| Networks | 4 434 | 4 265 | 4% | 1% | 12 770 | 12 129 | 5% | 2% |
| Nokia Software | 677 | 623 | 9% | 5% | 1 898 | 1 775 | 7% | 3% |
| Nokia Technologies | 358 | 351 | 2% | 2% | 1 112 | 1 077 | 3% | 2% |
| Group Common and Other | 236 | 236 | 0% | 0% | 720 | 768 | (6)% | (6)% |
| Non-IFRS exclusions | (2) | (4) | (50)% | (29) | (13) | 123% | ||
| Gross profit | 1 969 | 2 019 | (2)% | 5 614 | 5 684 | (1)% | ||
| Operating profit/(loss) | 264 | (54) | (318) | (611) | (48)% | |||
| Networks | 128 | 178 | (28)% | (7) | 258 | (103)% | ||
| Nokia Software | 156 | 75 | 108% | 286 | 117 |