Nokia Oyj (NOKIA) Earnings Call Transcript

Good morning. This is Sandeep Deshpande. I cover the global technology space from JPMorgan in London. And thank you for joining us at our Global TMC Conference. And I'd like to welcome Bhaskar Gorti, the Head of Nokia Software and Chief Digital Officer. Thanks, Bhaskar, for joining us this morning at our conference.

Thank you, Sandeep. Good afternoon to all of you, and really glad to talk to you. Looking forward to it.

So maybe, Bhaskar, I will start off with some general Nokia questions, and then I will go to your expertise, which is, of course, your software business, which you run yourself. So maybe we are living in very strange times. I mean, none of us have been through these sort of times before. Maybe you can talk through what you're hearing from customers regarding demand in your space at this point overall for the company?

Sure. Definitely, as you said, these are very strange times, and telecom is actually impacted a little differently. Unlike some other industries, the demand for telecom services has skyrocketed. And at the same time, what we are seeing from customers, I would say, they fall in 4 buckets, I would say. First, if you think about it, now more and more people are working from various locations, so security is becoming a very key aspect of it as how do you secure the network to prevent -- because your sites are now pretty much equal to the number of employees you may have. So I think security is becoming a very key aspect of it. Second, scaling the network, which is becoming very, very important. How do you scale and optimize the network to the demand is the second thing that we hear from our customers consistently. Then we also hear about, okay, how do I stimulate new business that are now, for example, in Europe, as an example, we see that the consumption of sports videos have gone down. So how do we stimulate new ways to generate monetizable business? So that's the third area we hear. And then finally, we're all hopeful that at some point, this will pass, where a new normal will come. So how do we prepare for the new way of consuming these services? So this is what we hear from our customers in terms of security, scale, how to stimulate business and then how to prepare for the new normal.

Understood, Bhaskar. I mean, what do you see -- is there any clear long-term impact on the industry from this as such really? I mean, does it change the way telecom's -- the telecom's equipment, telecom software work over the next 5 years, for instance?

I think the long term, which already is going on, it will accelerate more, is what we feel, is the importance of software and automation is going to really become very important. Remote services will become very important. Because instead of designing networks for peak, I think the ability to throttle capacity or to move capacity and services will become very important. We are continuously seeing a need for security to be now a prime area from our customers. So -- and fixed wireless access. I think we are definitely seeing the blend of broadband rollout and fixed networks rollout as a key enabler for -- so I would say these trends are just building upon what was going on, and I think this will accelerate. For example, the only area we are seeing a lot of traction in software automation is zero-touch operations, right? That's just going to be very important. How can we operate with minimum people in, I would say, operation centers? So I think zero-touch operation centers is going to be -- is something we are seeing a lot more from our customers. The other area that we are also seeing from our customers is how do you anticipate demand for different services? So I think that is another area. I think these are trends that were already there, but they've got dramatically accelerated with this situation.

Understood. I mean, one of the things -- themes that Nokia has been about is diversifying its business. I mean, beyond just being a wireless equipment company, much more diversification of the business. Maybe you could talk about the progress in what you're doing as such in terms of diversifying the business?

Sure, sure. I think, as you said, from the start, we are a multi-network company in the sense, mobile, fixed, routing and optics. And I think we are also -- have been focused on 2 key areas of diversification. One that we started almost 5-plus years ago is the diversification towards software. And in the last 1.5 years or more, we formalized our diversification towards enterprise network connectivity. And I think we're making very good progress. I would say, if I talk about the software business, very pleased with the strong, consistent performance now. We've had some -- we've made some structural decisions, which, now looking back, were the right things. Whether it was a structural decision in building a common software foundation, which is completely cloud-native, it took us 2.5, 3 years to actually build that foundation. So that has definitely gained momentum for us. We also have built now a dedicated sales force that is built ground up for software. That has definitely shown the traction in the market. And I think we're doing similar things now on the network. So I think you would say -- if you look at the 2 diversification areas, one's been going on for 4 to 5 years; and the other one, it has started now, a year to 2 years, and we're building upon the structural things that we did, and the results are showing. For example, if you look at the most recent Q1, while Nokia Software was about 12% of our overall revenue, we were about 60% of our underlying operating profit and about 44% year-on-year improvement in the profitability of the software business. So I think we have made good progress, but we're focused on doing more.

Understood. Just one comment to the audience. I mean, we are also taking questions from the audience. I mean, there's a Q&A tab at the bottom of your screen, you could put in questions, and I'll put those to Bhaskar. Remember that Bhaskar will be able to answer questions directly related to software, but much more generally in terms of Nokia itself as such really. Maybe I'll ask a more general question on Nokia, Bhaskar. I mean, overall, I mean, Nokia's margin in Q1 has improved. The Q1 results were a function of improvement in the margin in networks, but much more so in software. We have seen this in the past, unfortunately, that particularly Networks -- sorry, in software. In software, you had a secular trajectory as such really. I mean, every year, you had improvements in margin.

Yes.

But in Networks, it has been improving, and then you -- doesn't improve anymore, and you had a relapse as such really. So I mean, what is changing overall to make this much more secular?

Sure. I think if you think about our margin improvements, they have happened over time. But I think this time, I would draw the attention on some of the structural things that have been done, which would sustain in the long run. So I think if you look at our network side, our improvements on the mobile product cost improvements. Now those are structural things that affect cost advantage of silicon and share will be there for us down the road. Our improvement in services in terms of digitization and remote automation of delivering services and upgrading networks is, again, another structural things. So I think on the Network side, we definitely have put some structural things to improve the profit. On the operations side, as you said, I wear another hat as a Chief Digital Officer of the company, and even in how we run the company in the IT side, we have really improved and optimized our spend in key areas that will help us accelerate the overall margin profile. And of course, in software, as I said to you, we have now a good momentum in terms of continuous profit margin improvement, which actually is a key focus for us. Margin improvement is a very key focus for us across the board.

Understood. I mean now talking specifically about software, I mean, you can see that in Q1, your margin was up very strongly year-on-year, above 10% margin in Q1, which is typically a weak quarter. I mean, historically, when you go back and look at software margin, it is historic. So is there a one-off element in contracts there in Q1, which has helped the margin? Or is there -- I mean, underlying structural trends which you've talked about and we will talk about -- more about has been helping you improve the margin in software?

So first of all, there was no one-off event or contract or anything that happened in Q1. So I just want to be very clear, there was no one-off here. And I think so our margin improvements have been consistent because that is -- as we have built and now have most of our portfolio, 80-plus percent of our portfolio is now cloud-native on a common platform. So that gives us R&D velocity and R&D optimization of bringing products very -- we are now able to bring products every quarter on a cloud-native platform, which definitely gives us more velocity and higher productivity on R&D, right? So now that's been going on for 4 to 5 years. Over -- since 2017, '18, we also started our dedicated sales team coverage across the board. And there is a very key focus in our sales organization to get orders and sales, but also margin. It's an equally weighted factor. So we are not chasing any -- all kinds of these, we're very, very diligent in looking at pursuing profitable opportunities for us. So I think these are some of the things that we have done structurally that I think will continue. And the other thing that we benchmark ourselves, of course, compared to the telecom software peers, we are doing better. But we are benchmarking ourselves to enterprise software companies, right? That's the kind of margin profile we're trying to drive towards. That's the kind of R&D productivity we're trying to drive. That's the kind of sales productivity we want to drive. So that's something we're doing on the software side to -- so therefore, you are beginning to see things in Q1. You are right, Q1 is typically -- or sometimes, it's a low quarter. Because you have to look at in the -- in our software space, from the time we get a new order to the time it becomes revenue, it can be 2 to 3 quarters, okay, because of delivery acceptance, which especially in these times, is a little challenging. So you will see some fluctuations in the top line, but therefore, we always look at a 3- to 4-quarter trend in terms of how we are improving, but the margin will be consistent.

Understood. One last company-wide question, I would ask you, and then I'll move on to more specifics. So I mean, over the last 6 months, one of the problems investors had is you're cutting -- Nokia cutting the dividend. I mean, does Nokia still believe that you'd be in a position to have a quarterly dividend by the fourth quarter of this year with a net cash position over EUR 2 billion? Clearly, I don't expect you to make an announcement here because that's not what the purpose is. But you're talking about the trajectory towards what you're trying to achieve.

Yes. We are still guiding to a positive free cash flow in 2020, right? So we are still with that guidance. And based on the seasonality, we do expect in 2020 Q4 that we would have the potential to get our net cash to be EUR 2 billion threshold. So I think that's where we are at this point.

Understood. Okay. So maybe I'll just go much more deep into the soft -- sorry, I mean, there is a question here. I mean, anybody wanting to ask questions, please do put through your questions, and I'm happy to put them to Bhaskar. And there's a question here from the audience. What new or improved functionality does the software provide that is resonating with clients and reading -- and leading to the recent strength?

Yes. So I think it's a very good question. I would say the recent strength is built upon over the last few years, I would say. I think the key traction we are beginning to see is, I think, the industry we've been talking about how to move into a virtualized environment for quite some time. And that actually has now -- is going on. It's now pretty much a norm right now. I think in the last year to 2 years, we are seeing a massive uptake of cloud-native platform, CNS. And actually, that is where we are seeing a very good uptick in the market from a cloud-native, whether it's cloud-native core or it's cloud-native applications, we are definitely seeing that as a driver. The second point that we're also seeing a driver is companies are looking at how can these network functions, cloud-native functions, not only work inside their own premise, but also on industry platforms. So we have made a public commitment almost 2-plus years ago that our software, cloud-native platforms, will be available on public cloud, which is you have seen some announcements we have made where they've been available on all the 3 major public clouds in the U.S.: Amazon AWS, Azure and Google. We've been working with Red Hat and VMware for quite some time. I would say these are the ones that are picking up momentum. Of course, there's always new functionality, feature function, but that can be caught up by others. But structurally, we see the cloud-native platform picking up momentum in the last 12 months.