Q1 2017 Earnings Call Transcript

Published: 27 Apr 2017

[Operator:]

Hello and welcome to the Nokia Q1 2017 Earnings Results Conference Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Mr. Matt Shimao, Head of Investor Relations. Sir, you may begin.

[Matt Shimao:]

Ladies and gentlemen, welcome to Nokia's first quarter 2017 conference call. I am Matt Shimao, Head of Nokia Investor Relations. Rajeev Suri, President and CEO of Nokia, and Kristian Pullola, CFO of Nokia, are here in Espoo with me today. During this call, we'll be making forward-looking statements regarding the future business and financial performance of Nokia and its industry. These statements are predictions that involve risks and uncertainties. Actual results may, therefore, differ materially from the results we currently expect. 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 such risks in more detail on pages 67 through 85 of our 2016 annual report on Form 20-F, our interim report for Q1 2017 issued today, as well as our other filings with the U.S. Securities and Exchange Commission. Please note that our results release, the complete interim report with tables, and the presentation on our website include non-IFRS results information in addition to the reported results information. Our complete results report with tables, available on our website, includes a detailed explanation of the content of the non-IFRS information and a reconciliation between the non-IFRS and the reported information. With that, Rajeev over to you.

[Rajeev Suri:]

Thank you, Matt and thanks to all of you for joining our Q1 results call. Nokia's first quarter results showed our improving business momentum, and that we are effectively moving beyond the integration efforts of 2016 to making 2017 a year of execution and performance. In the quarter, we slowed the rate of our top-line decline, delivered a strong growth margin and improved group-level profitability. We also saw encouraging signs of stabilization in Mobile Networks, significant, even if early, signs of improvement in Applications & Analytics, and year-on-year expansion in both sales and profits in Nokia Technologies. We were able to deliver these solid results, even though, Q1 tends to be our seasonally-weakest quarter, and even though we had challenges in our IP/Optical Networks and Fixed Networks business groups. This truly shows the power of our end-to-end portfolio. So in short, I'm pleased, even if not fully satisfied, both with where we landed in Q1 and with our operational momentum as we head into the rest of the year. As you will recall, in recent quarters you've heard me talk about three key priorities for Nokia in 2017

[Kristian Pullola:]

Thank you, Rajeev. I will start today by spending a few minutes on our reporting structure, and then continue with the financial performance of Nokia Technologies and Group Common and Other, before commenting on our cash performance in Q1 and highlighting key cash items for Q2. Finally, I will take you through FIE and taxes, as well as progress around our cost savings target and the guidance for the full-year 2017. But first, let me say a few words on our acquisition of Comptel, which we announced on February 9. The cash offer that we made valuing Comptel at approximately €350 million was well received and accepted by the clear majority of their shareholders. This allows us to now proceed with the squeeze out of the remaining count of shares. As we gained control of the company in late Q1, we already consolidated Comptel's balance sheet into our Q1 financials. And the first full quarter of financials will be reported as part of Applications & Analytics in Q2. Moving on to a brief discussion on the re-casted 2016 quarterly financials; we have reviewed the allocation of certain expenses by function and segment and moved to a more activity-based allocations, resulting in changes how expenses are presented. In addition, as discussed last quarter as part of the Alcatel-Lucent integration, we have harmonized our FX hedging practices and simplified the related financial reporting. Overall, the recasts are small and have no impact on our business narratives. You can find the details on pages 46 through 48 in our press release issued today. Looking further towards Q2 earnings, there will be additional changes as we align our reporting structure with our new organizational structure, effective April 1. Starting from Q2, Ultra Broadband Networks will compose of the Mobile Networks, Global Services and Fixed Networks business groups, and we will provide additional financial data on Global Services. The new Global Services business group is comprised of the Global Services organization of the Mobile Networks business group, as well as company-wide managed services. To be clear, Global Services does not include the services activities of IP/Optical Networks, Fixed Networks, or Applications & Analytics, which continued to be managed and reported as part of those business groups. As a result, for our Networks business, we will continue to report net sales for total services. To provide you a bit of context, in Q1, Global Services within the Mobile Networks represented approximately 70% of total services net sales. The three other Networks business groups accounted for the remaining 30%. Continuing then with Nokia Technologies, which grew net sales by 25% year-on-year, primarily due to higher patent and brand licensing revenue, along with the acquisition of Withings in Q2 2016. Approximately one-third of the year in year increase was due to non-recurring net sales related to a new license agreement. Regarding our litigation with Apple, our agreement with them expired at the end of last year, and hence, our results do not currently include any licensing revenue from Apple. While the legal proceedings continue to move forward, we encourage the sell side to remove Apple from their numbers until we have reached a clear outcome. This includes removing Apple from 2018 models. Looking at Technologies' profitability on a year-on-year basis, the gross margin was affected by a change in business mix following the acquisition of Withings. Together with higher OpEx, this resulted in lower operating margin as we continued to ramp up our digital health and digital media businesses, and had higher litigation costs related to Apple. Having said this, as we have highlighted also earlier, we remain focused on the spend in Nokia Technologies to ensure investments at appropriate levels. As discussed last quarter, the litigation costs related to Apple could be approximately €100 million per year. We have ramped spending on licensing-related litigation, and the Apple-related costs are already at a run rate of approximately €50 million in Q1. In our quarterly earnings release, you can now find net sales disclosed separately for tax licensing and product businesses. To further help modeling tax profitability, as a rule of thumb, one can assume close to a 100% gross margin for our licensing income and approximately 40% gross margin currently for tax product businesses. Turning next to performance of Group Common and Other in Q1; the overall revenue that we report in this area increased by approximately 8% year-on-year. The growth was primarily driven by radio frequency systems, which continued its encouraging performance from Q4. Alcatel Submarine Networks on the other hand saw its net sales decline year-on-year, primarily due to the timing of projects. As we have said in the past, the strategic reviews of both businesses are ongoing and we will naturally update you on those once we have reached a conclusion. Moving then to our cash performance in the quarter; on a sequential basis, Nokia's net cash and other liquid assets decreased by approximately €890 million sequentially, with a quarter end balance of approximately €4.4 billion. The sequential decrease was mostly attributable to negative cash flow from operations. In Q1, Nokia had approximately €150 million of restructuring and associated cash outflows. Excluding this, the net working capital resulted in a decrease in net cash of approximately €390 million. This was primarily due to an increase in inventories and a decrease in short-term liabilities, partly offset by a decrease in receivables. While all of these changes are directionally consistent with seasonality, we believe we have opportunities to improve our receivables and inventory turnover metrics as we proceed through 2017. Looking into Q2, as a reminder, bonuses paid under employee incentive programs will have a negative impact on Nokia's cash flow in Q2. In addition, Nokia's board has proposed a dividend of €0.17 per share, which would impact our cash balance by approximately €1 billion, when paid out to shareholders after our AGM later this quarter. Furthermore, the settlement of the Comptel acquisition is expected to have an approximately €340 million negative impact on our cash balance in Q2. We still expect free cash flow to be slightly positive for the full-year 2017. In Q1, we continued the rationalization of our debt by issuing €1.25 billion of new bonds and repurchasing through tender offers approximately €730 million of the shortest dated euro notes and U.S. dollar notes that had been issued by Lucent Technologies back in the 1990s. The purpose of these transactions was to optimize our maturity profile, lower future average interest expenses, and eliminate subsidiary-level external debt. Given the current favorable corporate bond market, we feel the timing of the new bond issue was good. This was also reflected in the strong demand for the new bonds, enabling us to achieve highly-attractive coupons. While the bond tender offers resulted in a non-recurring cash outflows of approximately €65 million in Q1, these transactions enabled us to lower Nokia's future running interest expenses by approximately €25 million per annum, primarily due to the bond tenders and new bond issued in Q1, and lower-than-estimated costs on defined pension and other post-employment benefit plans, as well as expected performance of certain venture fund investments, we now expect Nokia's non-IFRS financial income and expenses to be approximately €250 million for the full-year 2017, down €50 million from our earlier estimate. The share repurchases under our capital structure optimization program are well on track. In Q1, we continued to execute our buyback program, bringing the total buybacks so far to approximately €450 million out of the planned €1 billion. Our intention is to continue the share repurchases after Q1 earnings and complete the program by the end of 2017. Continuing with an update on taxes; Nokia's geographic profit mix in the first quarter resulted in an unusually low non-IFRS tax rate of 19%. For the full year, we continue to expect our non-IFRS tax rate to be around the midpoint of the 30% to 35% guidance range. As discussed last quarter, to create the foundation for our long-term tax structure, we started concrete actions in Q4 to integrate the former Alcatel-Lucent and Nokia operating models. We were able to launch and complete these actions in Q1, consistent with our expectations, triggering non-recurring reported tax expenses of approximately €250 million. For the full year, we continue to expect Nokia's cash taxes to be approximately €600 million, again, in line with what we indicated last quarter. Turning finally to our €1.2 billion cost savings target and recap of key guidance items. We have today reiterated our guidance for €1.2 billion of annual cost savings in full-year 2018. We continue to track well with our plan, and I'm confident that we will achieve the planned €250 million of cost savings for this year. Regarding the overall planned network equipment swaps, we also reiterated our guidance for the swap outs and expect this to total €900 million, of which €450 million would be record recorded this year. The majority of these swap outs are still ahead of us, and we are now focused on execution here. Finally, we today reiterated guidance for our Networks business for full-year 2017; top line in line with our primary market and 8% to 10% operating margin. Again, if the market and our execution are both strong, we could land at the higher end of this range. Finally, I would like to remind you that we will be hosting our upcoming annual general meeting in Helsinki on May 23, and as Rajeev already mentioned, Basil and his team are also planning to host an IP routing event for industry analysts in mid-June in San Francisco, the main parts of which will be webcasted. With that, over to Matt for Q & A.

[Matt Shimao:]

Thank you, Kristian. For the Q&A session, please limit yourself to one question only. Carrie, please go ahead.

[Operator:]

We will now begin the question and answer session. The first question comes from Achal Sultania of Credit Suisse. Please go ahead.

[Achal Sultania:]

Hi, good afternoon. My question is on IPR. Obviously, you have now removed the guidance of €800 million of IPR revenues excluding Apple. I'm just trying to understand what has changed in the last few months in the process that you have to – that has become slightly more uncertain in terms of whether the size of the renegotiation or the timing of these renegotiations that you have to move away from the guidance, especially given the fact that you're not talking about like deepening some of these agreements in China. So that probably should be – we should be reading it as a positive. So I'm surprised why that guidance is still not valid.

[Kristian Pullola:]

Maybe I'll clarify here. So the – it wasn't really guidance for the future. It was a point in time statement that we made each and every quarter when it comes to what is the run rate of our IPR business. What we decided to do now for this quarter was actually to give a more granular breakout of the technologies business revenue per licensing and product business. And in a similar way as before, then clearly call out how much of that licensing revenue would be non-recurring in nature so that you get the same information as before about the IPR business. So there is no kind of pullback on any guidance here as you indicated in your question; just more granular actual reporting.

[Matt Shimao:]

Thank you, Achal, for your question. And by the way, you can find that disclosure on page 26 of the press release. Carrie, we'll take our next question please.

[Operator:]

The next question comes from Sandeep Deshpande of JPMorgan. Please go ahead

[Sandeep Sudhir Deshpande:]

Thank you for letting me on. My question, Rajeev, is regarding the businesses that you're trying to get into, the close verticals to your core business. How much do you think are you targeting revenue to be there this year? Or is this really a 2018 revenue opportunity for you in terms of reporting it to the market? Thank you.

[Rajeev Suri:]

Thanks, Sandeep. Yeah, we think that likely orders in Q4 if things go by the plan, and 2018 meaningful revenues, particularly from the new product launch that we will do in IP routing. We're already getting traction in Optical that paves the way for this to happen.

[Matt Shimao:]

Thank you, Sandeep. Carrie, next question please.

[Operator:]

The next question comes from Andrew Gardiner of Barclays. Please go ahead.

[Andrew M. Gardiner:]

Hi, good afternoon. Thank you. I'm just interested in a bit more insight into the gross margin performance in the quarter. Rajeev, I mean, you highlighted just how strong it was, particularly for what is normally a seasonally-weak quarter. Can you give us any insight as to how you're seeing mix evolve through 2Q and 3Q? Can this level of gross margin be sustained for the next couple of quarters given how you see your product mix evolving, particularly given what you've described for sort of IP Networks trends coming through the next couple of quarters? Thank you.

[Rajeev Suri:]

Thank you, Andrew. So for Q1, we benefited from a good regional mix, and also a good product mix within that. We continue to benefit from the end-to-end portfolio that's becoming more strategic for customers and also providing us opportunities for cross sell. And then finally of course, the disciplined operating model we have, which allows us to continue to have improvements in COGS, in fixed production overheads, and we've also seen the reduction in COGS help us to continually strengthen our margins. So those are the things. And overall for 2017, obviously that we have reaffirmed the guidance.

[Matt Shimao:]

Thank you, Andrew. Carrie, next question please.

[Operator:]

The next question comes from Robert Sanders of Deutsche Bank. Please go ahead.

[Robert Sanders:]

Yeah, hi. Good afternoon. Maybe you could just talk a bit about the routing business, given that it was one of the areas of disappointment. How quickly do you think that business can start to reaccelerate? Is there any product cycle that's coming or something that could drive that business back upwards? That would be great, thanks.

[Rajeev Suri:]

Thanks, Robert. So, what's happening is that the higher spend is taking place in co-routing and in the cloud players in that space. And that's where we're not present to the same degree. And so, the new product refresh that's coming, it's looking very good. We think it will allow us to increase our competitiveness and actually leapfrog and that'll come at some point mid of this year. And once that's launched and we start discussions with our customers, we think this will give us meaningful strength in Q4 in terms of order intake, and then turning into revenues for 2018. So the rebound is more medium term and – 2018 onwards.

[Matt Shimao:]

Thank you, Rob. Carrie, next question please.

[Operator:]

The next question comes from Richard Kramer of Arete Research. Please go ahead.

[Richard Kramer:]

Thanks very much. Rajeev, you talked about healthy orders and you also talked about a high conversion of the pipeline, even with the – obviously the weaker performance in routing. Given the target of having stable or even growing revenues, have you now reached a sort of greater than one times book to bill? And with respect to these orders and the conversion of the pipeline, do you think you're taking meaningful market share, or is it sort of too early to say given that the industry's still sort of recovering in terms of willingness to spend money?

[Rajeev Suri:]

Thanks, Richard. So, yes, we look at order intake, order backlog, all those metrics. Q4 was promising. Q1's been good. We need to watch Q2 now to give us enough granularity and visibility that the remainder of the year will track well according to our plans. But I will say that it's partially the end-to-end portfolio, it's the competitiveness of the product line-up that's giving us this high conversion rate. So I'm very pleased in particular with Mobile Networks' conversion rate that we've seen increase. In terms of your market share question, the end-to-end portfolio is really helping with operators, as we always said it would, but now it's starting to get real traction. But I think the right way to look at market share is we're very pleased with the encouraging start to the year, but you've got to look at it at least on a three quarter basis to start to declare victory that we're actually getting market share gains. Great start to the year, but not yet willing to call whether we're getting market share gains.

[Matt Shimao:]

Thank you, Richard. Carrie, we'll take our next question, and as a reminder, please limit yourself to just one question. Thank you.

[Operator:]

The next question comes from Gareth Jenkins of UBS. Please go ahead.

[Gareth Jenkins:]

Thanks. Just a quick question on swap outs. I wondered whether you could firm up some of the timing for the expenses of swap outs, and maybe whether you're able to parse some of those back by selling new product into those operators where you'd normally swap out.

[Kristian Pullola:]

So thanks, Gareth. I really don't have anything else to add to what we have in the release on the timing, €450 million expected for the year, and then the remainder in 2018. When it comes to, does this give us an opportunity to upsell, clearly, that's what we need to aim for. We are putting in kind of newer gear where then there are upsell opportunities, and clearly as part of the execution of the swaps, the teams are also focused on identifying additional opportunities for upsell.

[Rajeev Suri:]

Correct and I'd just add, Gareth, that China is more advanced in terms of swap outs and North America activity levels are starting to pick up.

[Matt Shimao:]

Thank you, Gareth. Carrie, next question please.

[Operator:]

The next question comes from Alex Duval of Goldman Sachs. Please go ahead.

[Alexander Duval:]

Yes, many thanks indeed for your time. I just wanted to get a bit more granularity on the wireless revenues. Clearly very solid versus expectations, and I wondered if you could give a little bit more in terms of what drove that. I'm trying to understand was it more to do with share shift? Was is about sort of the stabilization in the market? Or potentially and maybe in combination with this last factor, was there some catch up from the previously-delayed Alcatel base station sale because obviously there was some delays as you were aligning customer roadmaps. Many thanks.

[Rajeev Suri:]

Thanks, Alex. So, I don't think a big change in the market. In fact, maybe the market's slightly worse because China Unicom announced a big CapEx reduction. But sort of roughly the same as we had talked about in the Capital Markets Day. And no catch up discussion in particular. We benefited from the regional mix. You saw North America, some of the customers that were not spending are now spending. That's a positive. Small sales intensification is starting to happen. And as we always said, the bright spot for this year will be North America, although there are puts and takes. I mean, it'll be watching the space. India is the other. And it appears parts of Asia Pacific are seeing a rebound, particularly Japan and Korea, which are coming up from the bottom that used to be in that market.

[Matt Shimao:]

Okay, thank you, Alex. Carrie, next question please.

[Operator:]

The next question comes from Stuart Jeffrey of Natixis. Please go ahead.

[Stuart Jeffrey:]

Thank you. Hello, everyone. I had a question on cross-selling opportunities. As you talk about these coming through, I would've expected them to show up more in the routing and optic side, given that your footprint in mobile is so much bigger, and yet that doesn't seem to have happened. So could you just explain why we're not seeing that impacting routing, and where the cross selling is actually starting to come through? Thanks.

[Rajeev Suri:]

Thanks, Stuart. So, I think it's a two-way street, because we're actually also seeing it in mobile, given that there are customers that were IP optics customers and we're now selling them mobile equipment. For instance, in U.S. there are a number of smaller carriers like this. We saw some strength in optical, for instance, in Reliance in India. We call that out, and that was somewhere we went and won a deal in optical where Nokia's channel was strong. We saw the same in Fixed in India. We're now seeing traction in Japan for Fixed. Somewhat for IP as well. But I think when we start to look at cross sell, we measure our solution practices that are end-to-end. We have a number of those. We measure our multi-business group associated deal pipeline, and again, that is increasing, and that pipeline, if it increases, of course that will convert to orders to some place. We're seeing strength in cloud, which is again a cross-sell because it involves many of our business groups. So all put together, this product refresh issue in IP, once that's done, we'll see essentially more cross sell in IP routing as well.

[Matt Shimao:]

Thank you, Stuart. Carrie, next question please.

[Operator:]

The next question comes from Sébastien Sztabowicz of Kepler Cheuvreux. Please go ahead

[Sébastien Sztabowicz:]

Yes, Sébastien Sztabowicz. One question on your Red Compartida project in Mexico, could you please comment a little bit on the bidding tender and the pricing condition of this very big deal? Will it be a profitable project above the last time of the deal? And also, do you see any specific exhibition risk on this large scale project? Thank you.

[Rajeev Suri:]

Thank you, Sébastien. So, this is a project that we really wanted to get. It's a big flagship deal. It's our largest ever in Latin America, and it's a unique business model on the right kind of spectrum, with 700 MHz spectrum, so potentially large rollout. We want a good slice of that. It's actually a good end-to-end deal, because we've got about 40% of the radio, but a very large part of the core and other transport and OSS and so on, so it's really a multi-business group end-to-end deal for us. It makes sense long term otherwise we wouldn't have done it, so to your profitability question. And we should hopefully see help from this at the latter part of the year in turning Latin America a little bit more favorably, because that market has macro issues and operator issues and so on. And potentially even more help in 2018.

[Kristian Pullola:]

But I guess it's fair to say that it's a large project, it has all of the opportunities and risks that come with a large project, but we are in the business of doing large projects. So in that sense, it's business as usual.

[Rajeev Suri:]

Right.

[Matt Shimao:]

Thank you, Sébastien. So Carrie, we'll take our next question.

[Operator:]

The next question comes from Tim Long of BMO Capital Markets. Please go ahead.

[Timothy Patrick Long:]

Thank you. Just wanted to ask about the European region; it looks like it's been under a little pressure the last few quarters here. Just, is this mostly macro? And maybe a little bit of color on which of your segments might be holding up better or worse in the European market. Thank you.

[Rajeev Suri:]

Thanks, Tim. Yes, it is macro. It's Eastern Europe continues to be slow, Russia. It's also a little bit concern about the election timing and how that will unfold. It's much more about evolution of 4G on the mobile side, a little bit slow on the IP side and Fixed. There is potential for a lot of fiber deals to start coming through in the longer term with fiber to the x type of projects. So, it's sort of macro and sort of the investment climate in Europe given that there are so many operators and consolidation's yet to happen. So all of these things put together, Europe will continue to be weak overall as a market this year.

[Matt Shimao:]

And it looks like we've done a good job with our queue, and there's one question left. So Carrie, we'll take the final one for today.

[Operator:]

All right. Our last question comes from Aleksander Peterc of Société Générale CIB. Please go ahead. Aleksander Peterc - Société Générale SA (UK) Yes, hi. And thanks for squeezing me in. I'd just like to understand, because you mentioned on a previous quarterly call that you had several potential markets that could do better versus your guidance, and you mentioned the U.S. having momentum potentially, Japan, Korea rebounding, Mexico wholesale deal, and Indian LTE. So I'd see a lot of these actually materializing, so could you explain what holds you back from a little more positive outlook? Thanks.

[Rajeev Suri:]

Thanks, Alex. So, but then on flip side, there are also weaker markets like Middle East and Africa. You've got the Eastern Europe comment that I made, but Europe all in all. China is probably even incrementally a little bit worse because China Unicom announced a big CapEx reduction, as you might have seen. Even though there's possible partial offsets in China Mobile potentially available. Yes, India tracking well, North America well, but there's also some sort of merger and acquisition headwind on the operative side that we need to watch. Japan and Korea are starting to rebound, but not yet in full rebound I would suggest. Southeast Asia, a potential rebound but not fully there. So as always, I don't think the market has changed, there are puts and takes. Broadly the market is the same in terms of primary market, low-single digit decline, as we talked about in Capital Markets Day.

[Matt Shimao:]

So thank you for your questions today, and now back to you, Rajeev, for closing remarks.

[Rajeev Suri:]

Thanks, Matt and Kristian. And thanks again to all of you for joining. I'd like to close with just a few thoughts. We are pleased with the Q1 performance we delivered, and with the progress we are making to put our strategy into action, whether it is deepening and widening our footprint with communication service providers, launching new innovations, adding customers in new vertical markets, enhancing our software offering, stabilizing our top line, or progressing with our cost savings. But of course we're not complacent. We know we have some challenges in select business groups, and we're very focused on addressing those issues. And with the actions we have underway, I am confident that we can get those businesses back on track. With the integration of Alcatel-Lucent behind us, we are committed to building on that platform and to making 2017 a year of execution and performance. With that, thank you very much for your time and attention. Matt, back to you.

[Matt Shimao:]

Ladies and gentlemen, this concludes our conference call. I would like to remind you that during the conference call today, we have made a number of forward-looking statements that involve risk 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 67 through 85 of our 2016 annual report on Form 20-F, our interim report for Q1 2017 issued today, as well as our other filings with the U.S. Securities and Exchange Commission. Thank you.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your line. Have a great day.