Nokia Oyj (NOKIA) Earnings Call Transcript
May 27, 2021
Earnings Call Speaker Segments
Good afternoon, good morning, everybody. This is Sandeep Deshpande. I cover communications equipment here at JPMorgan. And I'd love to welcome Pekka Lundmark, the CEO of Nokia to our TMT conference today. Welcome, Pekka, to our conference. And it's wonderful to see you first time as CEO at our conference. So thank you very much for joining us.
I will start off with a few questions, and the audience can send through some questions to me. The conference website has a facility for you to go in and send me questions via the conference website, and I can see them here, and so I can put them to Pekka through this chat. Thanks, Pekka, again. So maybe I will quickly start with your most recent results. You had a positive set of results given where you are overall as a company. In particular, very, very strong in Network Infrastructure, routing, fixed and ALS grew very strongly. And with respect to profitability, of course, routing and fixed are the most important parts of the market -- of that segment for you, I would think. Why was routing so strong? And can it really be sustained going forward? Because the point is if it can, that it was a share gain and not just a sequencing of orders, then that would be incredibly positive for Nokia.
Thank you, Sandeep, and very nice to be part of your conference today. Thank you for the invitation. We have every reason to be proud of the Network Infrastructure results in the first quarter. And of course, the routing business is, profitability-wise, the strongest of those businesses. That is also the segment where we have the strongest technology position and as I have said many times, you haven't seen everything yet. There is more to come. We are taking market share. Of course, 22% constant currency growth in the quarter means that we are taking market share, albeit a bit weak comparables a year ago. But the direction of travel in that business is good. And it's really supported by a lot of the fundamentals. When 5G networks are being built, front haul, backhaul is needed. When more and more fiber to the home is needed, the same thing, the core network, the regional network, access networks, they need to be strengthened. That's all creating opportunities for the routing business.
And then what about the fixed strength? I mean, clearly, I mean, fixed was very strong as well, which this was a business which for a few years had not been that good as such really.
Yes. This is getting -- actually, it's becoming a pretty exciting business as well. And of course, 49% growth compared to last year, also means that we are taking market share. The same comment there, that a bit -- not so challenging comparables because of COVID hit in the first quarter of 2020. But there are 2 main drivers. One is fiber to the home, fiber access in general, I mean not only homes, but also offices and then fixed wireless access, which is growing very fast and now especially 5G-based fixed wireless access. And I do believe that the prospects of this -- the fundamentals of this business will actually continue to be pretty good for several years.
Understood. And then overall, in terms of gross margin, I mean, the gross margin in this division was very strong indeed. And if it can be sustained, do you need growth for this gross margin to be sustained or in terms of the overall business, that you can sustain the gross margin even if the growth doesn't remain that high? Because clearly, Q1 growth was like off the charts as such.
Yes. It was a very good quarter in terms of gross margin. Now in this business, in particular, we need to understand the mix question. And when we talk about very high growth, for example, in businesses like fixed wireless access, where you get strong top line growth, but when you talk about CPEs, customer premises equipment, they may structurally have structurally actually lower gross margin. So you need to zoom into the individual businesses. But within each of these segments that we have there, actually, we are seeing a positive development in gross margin across the board in all 4 businesses.
And then finally, I mean, this division, I mean, the Q1 margin was better than what you've guided for this division for the full year as such really. And the division has no known issues. I mean when we are talking about restructuring Nokia, this was not a division which necessarily required a lot of restructuring. So why are you so cautious on the full year margin in this business?
Now we, of course, have to remember that the official guidance that we are committed to updating at all times is the group level 7% to 10% comparable operating margin guidance. So the 7% to 10% that we gave for Network Infrastructure, that then, the same thing applies to the other what we call outlook assumptions is something that we may not immediately update if things go up or down. It is the group, 7% to 10%.
Understood.
And as we have discussed, we have said that we have now good possibilities to get to the -- close to the upper end of that range.
Thanks, Pekka. Maybe now I will move to the more difficult division. I mean, clearly, I mean most of the questions I'm sure from the audience are also going to be in terms of your Radio/Mobile Networks division as such really. I mean, per Dell'Oro, the market share in this business was 19% last year, 19.1%, almost 400 bps down since 2017 and only 18% in Q1 of this year. And with the U.S. share loss to come, the question is, will Nokia have the scale to be a top-tier mobile network supplier?
We will have the scale. I do not have any doubt in my mind about that. And of course, I mean, the numbers are exactly as you said, and the biggest reason for that market share decline in the last couple of years, of course, has been China. But that's why we have guided, as you may remember that this year, we would have 25% to 27% market share outside China. And this is something that we are maintaining. It's slightly lower than last year. And there you see the North American effect, but it's not dramatically lower. So what we have seen now in the cast -- past couple of years in terms of share loss is clearly slowing down. And then, of course, after this, as we explained at the Capital Market Day, then of course, after this, our goal is to then again start growing market share.
Just to the audience, if you have any questions on wireless, et cetera, please do send them through, and I could ask them as part of these questions. Another point is clearly, we've seen some of your announcements in terms of design or rather, customer wins in Europe and you have gained traction in customers in Europe. I mean you did not have some of these customers where you have announced contracts. I mean, will this help stabilize your share maybe in 2022 onwards? And -- but you have also said at the same time that the European share gains will not offset completely any U.S. share loss. So maybe you can help us walk through that.
Yes. At least in the short term, they will -- as we have said, they will not completely offset it. And then, of course, what is always important to note is that when you get into new deals and as I have said, we have 1 close to half of the value of this market -- recent market share swaps in other parts of the world. Typically, in year 1 and sometimes year 2, you have lower profitability. So that means that despite of these wins that we have had in other parts of the world, what we are, unfortunately, losing in North America will mean that the overall profitability of the Mobile Networks business is declining this year, as you can see from the numbers that we have published. Q1 was pretty good actually in Mobile Networks. And there's a lot of reasons to be optimistic about that business. And I'm sure that there will also be questions about the product side and so on. So the overall direction of travel, as I always call it, of this business, is actually pretty positive when we see it through these market share changes in North America and other parts of the world.
And then based on what you see today, based on these shares, you know more than we do, of course, outside Nokia, do you think that the share will stabilize at some point in 2022? Or is it 2023 that the share will stabilize and then start growing as you said?
It's early to say or promise in detail, but I'm referring to what we said in the Capital Market Day, that in '23, we target to grow faster than the market. So latest in '23, we would expect that we would again have started to take market share.
So now 2 markets, I just want to highlight, just recently in the last 2 or 3 weeks, India has decided not to use Chinese firms for 5G. And then also there is potential in Asia Pacific and LatAm we've -- we know as we've seen the deal flow in Europe and how you're gaining traction in this deal flow in Europe. How do you think this will play out in India, Asia Pacific, excluding China, and then LatAm as well?
They are, of course, all very important markets and India is really significant. And of course, we are not a political player. So we are not commenting or participating in those debates, but we have, of course, noted their decision, and that is positive news to us. We have a strong position in 4G in India. We are now reporting India as 1 reporting -- original reporting segment. In Q1, we had EUR 248 million sales, 27% constant currency growth. And we have strong radio business with both Bharti and Vodafone Idea VIO in India. And then with Reliance, we are in the other parts of the network in the core network. So I mean I think we have every possibility in the world to be successful also in 5G in India. And of course, it will be a very big market but it will take some time before it starts. It's still all 4G driven at the moment.
Understood. Just moving on to the U.S. and your challenges in the U.S. market. I mean this U.S. customer, just to understand, was it already low in the first quarter of this year? Or was they still buying a lot because the risk is that they will suddenly collapse, and that will cause a big impact on your Mobile Networks business. That's my first question on the U.S. And the second question is, clearly, now you've got a dynamic new management team at Nokia, you can potentially reengage with that customer. I mean you still have all the footprint at that customer. So the question is whether anything can be achieved in getting back some of that footprint or that is lost for the 5G generation?
Of course, we do not accept that anything would be lost forever. There's a lot of radio -- Nokia radio in that network. And absolutely, our goal is one way or another to be part of their 5G radio development in the future. But I cannot and it would not be prudent for me to speculate in public on their detailed plans. What, of course, is very important, and I've said this many times, is that despite of the fact that they announced that deal with Samsung, we have a strong strategic relationship with them very much also in the other parts of the network. They are one of the largest customers in the world for both Network Infrastructure and for Cloud and Network Services business. So they continue to be extremely important, and we definitely are not going to give up on 5G radio either.
Understood. And so just 1 part of the questions that you didn't answer was that were they strong in Q1, and that is still to reduce significantly or already you're seeing an impact in Q1 in radio from that customer?
There was already some impact during the second -- some impact during the second half of last year. There was a bit more in Q1, and there is more to come towards the end of the year. And since you've been asking about the guidance that despite strong Q1, how come, including in Mobile Networks, the full year guidance is perhaps a bit on the low side. So this is one of the reasons, which I just want to be absolutely…
Understood. You answered my next question, Pekka, in the sense that my next question was going to be that overall, your guidance is negative 1% to 2%. And typically, Q1 is your worst quarter in the year, and you did very well in the Mobile Network, not very well in the sense that you could do much better than that. But considering how things are, it was quite okay, as such really.
Yes. For Q1, it was actually quite okay. Of course, the absolute numbers are still far too low. I mean we are targeting 5% to 8% in '23. And then as Tommi said in the Capital Market Day, then after that, we want to go double digit. Of course, the North American situation is one part of this, why the seasonality this year will not be as pronounced as earlier. But there are also other reasons. When you, for example, look at R&D, our Q1 group R&D and of course, Mobile Networks is the biggest part of that, was actually flat year-over-year, and we have said that it will increase. So there will be increases during the year. Then also, in general, the product mix in Q1 was pretty good. And then the third one, which is a little bit difficult to quantify, even though we have been doing a great job so far, but as I've said, the semiconductor visibility is not what it typically has been. So it's a combination of these factors that leads to this overall conclusion that we will not see this year same type of seasonality as we have typically seen.
Understood. Just letting the audience know. Please do send through questions on the conference website. And I'm happy to put them to Pekka here. Moving on to my next questions here. ReefShark, I mean, the gross margin, as you said, in Q1 was better than what one would have expected given what typically Q1 is and, I mean, given where Nokia is today in the market share position, et cetera. So it was a positive gross margin considering the circumstances. So is this driven by ReefShark? I mean -- so because you do give us the percentage of ReefShark, which is shipping, et cetera. But there are 2 issues here. One is not just a shipping percentage of ReefShark but is also, from what we understand in the past, there's some recognition issue that it takes time to recognize after you ship to the customer, et cetera. So maybe you can help us understand that. And how much of that, that you are recognizing today is associated with what you are shipping today. So that would give us some indication of how much more margin improvements could occur based on what your shipments are today as such.
The margin is, of course, always driven by many factors where -- and of course, ReefShark is one, and it is an important one, but then there are also customer mix issues. There are other product mix issues and regional issues as well. And all those things together then create the gross margin. The ReefShark program is pretty much on schedule. We are on our way towards the 70% by the end of this year and 100% by the end of next year. Gradually, it will actually start becoming more important to look at the products that we launched, that are based on the ReefShark platform. There is the 6-month delay between the shipment and typical revenue recognition because the products need to get installed and they need to -- they need to get accepted by the customer one, and after that, typically then the revenue is recognized. And that is in average a 6-month cycle. But driven by ReefShark, our product competitiveness is clearly improving. And I'm repeating the statement that we have said earlier that by the end of this year, we will have largely caught up in product competitiveness, at least when we compare to our European competitor, which we, of course, know best. And 2 very important launches to come. We have now started to deliver to the first customers already, even though the official launch will come in a little bit later, but very soon, our first combined 4G, 5G baseband product, which really ticks a significant box, something that customers have been asking for a long time. Customer feedback is excellent. And now the volume ramp-up is actually going on now in Q2. And then the second one, of course, is our new Massive MIMO platform, where we also believe that we will have significant advantages, and this platform will start delivering towards the end of the year. And that ticks another very important box. There will, of course, be more details available then when the official launches will be made. But we believe that we will have a pretty competitive product from a technical specification point of view, including available bandwidth, including flexibility and configurations, including in weight and including in power consumption, which are all important factors for operators. So overall, the product program in Mobile Networks is making great progress. It's just such a shame that we have this market share loss in North America because without that, you would actually have seen pretty steady development throughout in the Mobile Networks business. Tommi and his teams have really done a great job there already for about 2 years.
Understood. There is a question from the audience. I'm not sure I understand it fully, but I'm going to put it to you. You are still looking to hit high end of margin range. So how does that stack up with the share losses and the R&D increases?
Well, it is a result of all that we have factored in everything that we know. Of course, Q1 was very good. It was 10.9% when the full year forecast is 7.10%, but exactly those reasons that you mentioned: higher R&D towards the end of the year; and then lower volumes with some customers in high-margin markets. The combined result of all this is that we cannot expect to continue quite on this level through the year.
Understood. Moving on from there, any other questions from the audience, please go ahead. I mean, otherwise I will run out of my questions. And I'm hoping that there will be some audience participation here as such really. Just going on to ask a few more questions, Pekka. I'd like a question on Cloud and Network Services. I mean, firstly, I mean, can you just help investors understand this business? I mean, I will ask about the margin, but one question investors always ask me is that what has been broken out here in Cloud and Network Services? And maybe you can help us understand why it is loss-making and you expect that last year and why it has become -- you've guided it to be profitable this year?
Well, there were some one-offs, especially in last year's comparables, which make it a little bit hard to follow. And we, of course, want to be as transparent as possible. There is, first of all, a big product portfolio revamp and restructuring ongoing because there's a lot of products. There are obviously -- there are -- most of the products from the earlier Nokia software portfolio with the exception of the network management part, which is now in Mobile Networks. But then from the previous service business, there is the managed services business there as well, which is, of course, lower-margin business than the software business. And in the software business, the network management was actually highly, highly profitable. There are some really good and profitable parts in CNS, but then there are also some less profitable products or services. And this is what we are now going through to find the right product focus to get into the real new growth areas for the future. And of course, one that goes without saying is extremely important, is the 5G core network. CNS is our answer to the 5G core business. And of course, basically, everything that will be in the core network will be gradually not only virtualized, but then also offered on various cloud platforms. And just as 1 example, we have a 5G core network deal with DISH in North America. And as you may have seen, they announced that actually their entire network will run on the AWS platform. So that means that our 5G core software will run on the AWS platform. And this is what we are doing in this business. We are implementing partnerships with all major cloud vendors. This is, by the way, true to Mobile Networks, radio network part as well. But since we're now talking about core networks, this is one clear focus. The core network, 5G core network and road map towards cloudification. Then the other part of this is then the different value-added services that you also deliver through software, which is automation -- automated deployment security. And then, of course, as part of the normal core network is all the subscriber management and billing systems, but these are kind of added value systems based on the basic platform. Very important service network slicing that operators will be using when they service their corporate customers. And then, of course, private wireless, the full network solution responsibility for the fast-growing private wireless segment in our business is with CNS. So CNS is developing a fast-growing portfolio of customers in private wireless. And all this will be extremely important then in the coming years when enterprises and industries of this world will start putting serious operational workloads on networks in addition to just the, in a way, the normal IT workloads. So this is kind of the strategic positioning of CNS. And on top of everything, what I said, the general development for all these services towards as-a-Service, Network-as-a-Service, Security-as-a-Service, Licensing-as-a-Service, business models where you actually do not sell licensees, but you expect customers to consume your services and pay as you go.
Understood. Thank you very much for that explanation. There is 1 question here on -- which is coming up here on the Trump administration. Under the Trump administration, there was a lot of talk around M&A and to create a American network player. Was there any truth in that discussion and was Nokia involved? This is a question coming from the audience.
Well, we are, of course, discussing with all relevant administrations in the world, and we are participating in many initiatives with the North American administration as we are also doing in other parts of the world. We understand that network security, for example, is extremely important for them. And we are closely connected to some network security initiatives. And this was true under the Trump administration, and I expect it to continue to be true under the Biden administration as well.
Another question here is that Ericsson has recently bought a business in the enterprise space. Does that validate Nokia's push in the enterprise space at all?
Well, we, of course, welcome competition, and Ericsson is definitely a competitor that we have an enormous respect for. We do believe that we have a head start here, with our customer base and with our product offering, but it would be naïve to expect that there would be not increasing competition in this space. This whole enterprise networking in the era of 5G and everything that will happen in new applications that require very low latency, high processing power, high quality, high security will develop a completely new segment into the network, which is usually referred to as the edge or the Edge cloud. And that edge will be a battleground because operators will have an interest there, webscalers will have an interest there, the traditional vendors like us, of course, and the one that you mentioned will want to play in that segment. And there will be a lot of start-ups also. But there is going to be massive amounts of value to be created in Edge cloud whoever captures a position. There are also some parts of the radio network will be run on various types of edge platforms for enterprise users. So that will be extremely important.
There are lots of questions coming in, Pekka, now. So I'm just going to go through the questions from the audience. With Huawei being under political pressure and Nokia facing product issues, Ericsson seems to have benefited and won meaningful market share over the last few years. How relevant, if at all, is it for telecom operators that Nokia has a competitive offering? And what, if anything, they're doing to support Nokia?
What we are hearing from operators is that it is extremely important for them that Nokia is competitive and that Nokia is there. Then when it comes to the market share question, our estimate is that we have won about half of the value of the market share swaps driven by these things that you mentioned since 2019. So we have certainly taken our share of this development.
There's another question from the audience. I think you've answered some of this before, but maybe I'll just put it to you anyway. What resulted in your technology lagging behind your European peer and what technologies were they specifically? How do you expect your market share to change? And where does your biggest 5G opportunity come from?
I mean, of course, the -- as we have admitted, we were a little bit behind in the first wave of 5G. I do not want to go back to those reasons anymore. They are behind us. And as I said, when we get to the end of this year, we believe that we will have fully caught up our key competitor. And that will also then be reflected on our market shares as I commented earlier. '23, our goal is that we would again grow faster than the market.
Another question here is on Open RAN. Nokia's position on Open RAN and whether that is a risk to future growth at Nokia.
There are clearly risks and opportunities. I believe that the opportunities are actually bigger. We have decided to endorse Open RAN and we are developing it. We will have demonstration capabilities very soon. We have already done, in a way, nonstandard types of implementations of ORAN with some of our customers. So the development itself is not rocket science. The question will really be that what is driving this? And the main driver in ORAN, which is a very different thing from vRAN. But if you talk about ORAN, the main driver seems to be operators desire to create a more competitive market and lower entry barriers. I'm not 100% certain if that will happen because they -- you still need to manage the complexity of future compatibility across the interface. There will need to be some kind of a system integration initiative somewhere that will ensure the interoperability of the products coming from different vendors. And the product development costs will still be there, both on the baseband side and on the radio side of the product. But this is not for us to decide. I mean this will be for operators to drive. And as I said, we are endorsing it. We believe that if ORAN is to come, it will come with or without us. So it's much better to be on that train rather than just waiting on the station and thinking about whether to jump on it or not. It is likely, though, if we are realistic that it's -- from market dynamics point of view, that it will not be a needle mover in the next year or 2. But perhaps after that, who knows.
I mean that is what we've heard. I mean many European telcos, for instance, have a talking up ORAN a lot, but they haven't really implemented it in the initial implementation of 5G as we can see. Would you back that as such really?
Well, that's, of course, a fact that you are stating. I mean there are no real large-scale implementations. I mean, there is developments in Japan and in North America through DISH. And then there is a lot of discussions. I mean, most of the large operators in Europe, as you know, have created an alliance where they endorse Open RAN. But of course, there has not been any large-scale implementations yet.
Understood. There's a question here from the audience. Can you discuss potential to gain back some share in China and expectations for any revenue in China this year?
We are participating the new tender rounds in China, but we have not given any estimates as to what kind of market shares we would have. Now what is different this year compared to last year is that our product is now much more competitive than it was a year ago. But that whole market share question, when it comes to China, it's a complicated question. Many factors are playing in. Our message is that we are ready to serve our Chinese customers. We have long-standing relationships there with all key operators, and we are ready if they want our services.
Understood. I have 1 -- I mean there are multiple questions from the audience. There's suddenly a lot of interest, Pekka. But just 1 question of mine, which was not answered in. The Q1 FCF was probably one of the best quarterly ones I've seen in my career of covering Nokia as such really for a long time. And I mean, in the weakest quarter of the year, can you talk to whether there were one-off elements there? Receivables factoring has been one big issue which investors have had with Nokia. So maybe you can talk to some of these factors and whether this FCF -- clearly, there was -- this was a big quarter, but then you'll -- it looks very -- from the -- or the portents are very positive for your FCF for the year and beyond.
Of course, EUR 1.2 billion free cash flow was a great quarter and equally clear is that you cannot just extrapolate that to the rest of the year. I mean, we did not achieve this through factoring. That's my first point. So in a way, it was real. But when you look at the reported numbers, you would see that accounts receivable decreased by EUR 1 billion from EUR 5.5 billion to EUR 4.5 billion. And of course, that cannot continue. So there was a lot of cash collection in the quarter. We had a lot of deliveries in Q4 and then a lot of cash collection in Q1. Then another thing that I do want to highlight is that typically in Q1, our inventories would have gone up. And this did not happen in Q1, but we are now looking at various ways of building additional semiconductor buffers because of the challenging situation in that market, which we do expect to continue well into 2022. It's not something that will go away anytime soon. And we need to increase further our preparedness, even though we have done a fairly good job so far. And that will mean that we do expect to tie in a few hundred million more into inventories towards the end of the year.
There's another question here. Telecom operator speakers at this conference have said that the peak of the CapEx cycle is already behind them. So wonder whether Nokia has already missed this 5G peak CapEx cycle, if you can only narrow the technology gap by the end of 2021.
I mean our estimate is that when you look at 5G CapEx cycle, if that's what they are talking about, that would already have peaked. When we look at market estimates and what we are seeing, we expect that, that peak will not be there before maybe in a couple of years' time, and then that peak will last actually longer than the 4G peak lasted. And you just need to look at, for example, the CapEx plans of the North American operators after the C-band auctions. You would probably come to the conclusion that we have not seen the peak yet. Of course, the Chinese market has a little bit of behavior of its own. But then in terms of 5G CapEx cycle, massive market like India, it hasn't even started yet. And then a big opportunity, which is difficult to assess exactly, will then, of course, be the new enterprise industry 4.0 driven needs, where some of the CapEx may be on the enterprise side, some of that may be on the operator side, and we will see new types of alliances investing, including some of the webscalers as well. So we made a study recently where we came to a conclusion that 70% of world's large enterprises would invest in 5G in the next 5 years. And recently, there has been a lot of new estimates on the private -- 5G private wireless side, suggesting that, that market is actually being -- going to be growing extremely fast in the coming years. So let's see, I mean, how it will go, but I would not believe that we would already have seen the peak.
One question which is possibly positive for you is that has Nokia actually gained share in T-Mobile in the U.S. because Samsung has not been named by them as a supplier after the merger with Sprint?
I do not want to comment individual customers. We have said that we have lost market share as a whole in North America, but we are only commenting the whole market in a bulk number, but not individual customers.
Understood. My last -- I mean this is the last question from the audience. I'm sure there are others, which I can't take. We've got last 1 minute. You've now been CEO of Nokia for 268 days. What is your assessment of Nokia? Has your assessment of Nokia changed meaningfully over this period? And if so, in what way?
The biggest difference that I have seen during this -- thank you for that number. That was news to me also. 269 days is really the -- first of all, internally, our strengthening product position, especially Mobile Networks and the fast progress that we have made on that road map. That's 1 thing. Then the other thing which is -- which has been a positive surprise is really kind of the strength in the underlying demand, which is now also seen in Network Infrastructure. The next-generation access both to homes and to enterprises, but very much the homes driven by COVID. And then the 5G access and then as the next wave, the big enterprise investments that are coming. So I was positive about the potential of this business when I said yes, when I was asked if I would be interested, but I'm even more positive about the potential now. That's 1 aspect. Then when we talk about internally, of course, we have been doing a lot of restructuring and new operational model and everything. And I'm pretty pleased with how that is coming through. I believe that the new model where we now have clarity inside the management team, and very clear accountability and P&L ownership that, that is going to act as a good foundation for improvement in the coming years.
Thank you so much, Pekka, for your time. It's a pleasure speaking to you at our conference.
Thank you, Sandeep. Pleasure to be here today.
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