Q2 2015 Earnings Call Transcript

Published: 30 Jul 2015

[Operator:]

Good day, my name is Stephanie and I will be your conference operator today. At this time I'd like to welcome everyone to the Nokia Second Quarter 2015 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. I would like now like to turn the call over to Matt Shimao, head of investor relations. Mr. Shimao you may begin.

[Matt Shimao:]

Ladies and gentlemen, welcome to Nokia second quarter 2015 conference call. I'm Matt Shimao Head of Nokia Investor Relations; Rajeev Suri, President and CEO of Nokia; and Timo Ihamuotila, EVP and Group 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 74 through 89 of our 2014 Annual Report on Form 20-F, our interim report for Q2, 2015 issued today, as well as our 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 reports 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. Nokia delivered strong results in the second quarter, underpinned by excellent performance across all three of our businesses. This outcome positions us well to meet our full year objectives for the company. At the group level, we delivered net sales of €3.2 billion up 9% year-on-year, although down 1% on a constant currency basis. Non-IFRS operating profit of €521 million or 16.2% of sales was up 51% year-on-year, and we delivered a non IFRS gross margin of 46.7%. Non-IFRS diluted earnings per share was at €0.09, partly reflecting a gain of approximately €110 million related to investments made through our venture fund. Timo will cover this in a few minutes, but even if you exclude that gain, I think it is apparent that these are very good results. I am particularly pleased by Nokia Networks, which rebounded dramatically from its tough start to the year. HERE and Nokia Technologies also maintained their excellent momentum with both delivering year-on-year sales and profit growth. I will turn to the details of results in a moment focusing mainly on Networks. Like last quarter, Timo will cover the quarterly numbers for HERE and Technologies. Before that that however, I wanted to give you an update of the Alcatel-Lucent deal as well as a brief update on our plans for HERE. First Alcatel-Lucent. We are making clear progress with the regulatory approval processes and last week took a major step forward with the approval from the European Union. This breakthrough follows the approval of the U.S. authorities. In addition to these approvals, we have obtained antitrust clearances in Brazil, Canada and Russia, with a total of 11 countries now agreeing to the transaction. We continue to have good constructive engagement with regulators in China and are cooperating with all other authorities to close the reviews as quickly as possible. Additionally, efforts are moving well on the integration planning front. Work streams are fully resourced and project plan development for those work streams have been kicked off, with key milestones identified and day one readiness checklists in place. Considerable effort has been invested in identifying the target operating model for the company, given that Nokia and Alcatel-Lucent have different approaches today. Good progress is being made, and we will continue to focus on organizational design and the designation of future leaders within that design planning. In general, we plan to take an evolutionary approach as we want to limit disruption to our business and not provide any room for competitors to attack. Then HERE

[Timo Ihamuotila:]

Thank you, Rajeev. I would like to spend the next few minutes taking you through the performance of Nokia Technologies and HERE in the quarter, as well as our venture fund investments before turning to my customary discussion on our cash performance. Finally, I will say a few words on our outlook. Starting with Nokia Technologies net sales of €193 million in the second quarter increased by 31% year-on-year, or 24% on a constant currency basis. This was primarily due to two factors. First, approximately 50% of the year-on-year growth in Nokia Technologies net sales in Q2 was related to higher intellectual property licensing income from existing and new licensees; and, second, approximately 50% of the growth was related to nonrecurring net sales. Taking all the moving parts into consideration, Nokia Technologies underlying quarter net sales run rate was approximately €25 million lower than the €193 million of net sales reported in the quarter. When compared to the year ago quarter, this still represents solid underlying top line growth. However, as we have said earlier, this can be an inherently lumpy business, particularly when viewed through a quarterly lens. On an annualized basis, the quarter exiting run rate of the Nokia Technologies net sales is approximately €670 million. As I commented last quarter, we are continuing to make very good progress in our licensing activities. For example, adding LG Electrics (sic) [Electronics] (19

[Matt Shimao:]

Thank you, Timo. Just a quick one, financing cash outflows were €330 million in Q2, just wanted to make sure that came across. For the Q&A session, please limit yourself to one question only. Operator, please go ahead.

[Operator:]

Certainly. Your first question comes from the line of Gareth Jenkins with UBS. Your line is open.

[Gareth Jenkins:]

Just a quick one on Networks if I could. So you had very strong margins in the quarter. Just wanted – it sounds from your commentary like there were some abnormally high software sales in Q2 after sort of abnormally low in Q1. So, for the rest of the year, you're basically saying down in Q3 then up again in Q4. Is that – that's the way we should be modeling it. But what about top line? Can you give us any help on how the top line progresses through the course of this year? Are you expecting a recovery in certain markets to drive good top line growth in the second half on a constant currency basis? Thank you.

[Rajeev Suri:]

Thanks, Gareth. So, let me start with the seasonality point. So we are seeing a more normal seasonality this year. And last year was not so much the case for us because in Q1 last year we had elevated levels of software sales coming from Japan. And in Q3 last year we had a big North American project starting to roll out a lot of equipment. So, if you take out that abnormality, Q1 is usually the weakest quarter of the year, Q2 a bit stronger, Q3 again seasonally weak and Q4 usually the strongest quarter of the year. And that's the seasonality we look at from a market standpoint. Now when you look at software sales, I think it's important to reflect on what was the level of software sales that we had in the first half of this year and then compare that with the first half of last year, because that becomes a bit more prudent, the way to look at software. And then it's in line. So we see overall that it's in line. So, there's no change in software per se. It is in line when you look at a longer period. And then of course we have confirmed our guidance which Timo just outlined on profitability, which of course takes into account our software outlook for the rest of the year.

[Timo Ihamuotila:]

And regarding specific top line OpEx, we are not giving any top line guidance as you know besides the fact that we have just (31

[Matt Shimao:]

Thank you, Gareth. Let me try one more time on financing cash outflows in Q2, €530 million. So, operator next question, please.

[Operator:]

Certainly. Your next question comes from Kai Korschelt with Merrill Lynch. Your line is open.

[Kai F. Korschelt:]

Yes, thank you gents. Quick question on Alcatel, on the previous call they said that they had seen already some custom hesitation I guess in wireless and IP platforms, with customers where you do overlap. Just wondering have you seen something similar? Do you expect something similar in the second half? Thank you.

[Rajeev Suri:]

Thanks Kai. No, actually we have not seen a similar impact or a hesitation from customers because of platforms in the future. So it's business as usual from that perspective.

[Matt Shimao:]

Thank you, Kai. Stephanie, we'll take our next question please.

[Operator:]

Your next question comes from the line of Sandeep Deshpande with JPMorgan. Your line is open.

[Sandeep S. Deshpande:]

Hi. Thanks for letting me on. Rajeev, you had very strong gross margin in Networks in the second quarter, possibly the strongest Nokia has had. I mean, you talked about some of the puts and takes of this associated with the mix. How should we look at this gross margin trending into the second half of the year?

[Rajeev Suri:]

I guess it really does come back to how we look at the year and this is more seasonally trending in a typical – more of a typical year. So, the way I'd at it is that Q3 will be – can be expected to be a bit weaker and Q4 can be expected to be stronger. Just as we saw weak Q1 and a stronger Q2.

[Timo Ihamuotila:]

So, again in line with us confirming the full year guidance and expecting let's say normal seasonal factors to impact the second half of the year.

[Matt Shimao:]

Thank you Sandeep. Stephanie, next question please.

[Operator:]

Your next question comes from the line of Richard Kramer with Arete Research.

[Richard Kramer:]

Thanks very much. Couple of questions if I may. One simple one and one more complicated one. For Rajeev, if you look at the underlying growth in Technologies and remove the sort of one off patent sale that happened. And also clearly this is going to be the last quarter where you're including a year-on-year Microsoft revenue improvement, the underlying growth rate seems to be tracking the growth rate roughly in the smartphones. When should we expect some of these wider technology and brand licensing efforts to be material to sales? And then a simple one for Timo, if we look at working capital sort of very crudely looked at on the balance sheet, it's up about €1 billion from where it was second quarter last year. Is this something to do with customer financing, with the business model, it's something that had been drawn down quite substantially in previous years, now it seems to be rising again quite sharply. Can you comment on that, thanks?

[Rajeev Suri:]

Okay. Thanks, Richard. Let me just start with the IP, the Technologies question. So I think when you step back and look at it, I think the team's doing a great job in building this robust pipeline of licenses, right. So we also are investing in that. So you saw a somewhat of an increase in an OpEx on account – majority of it is on account of IP and licensing activities. So in accordance with that, we found LG joined the program. So that's good progress. And I think I'm trying to sort of get the team to focus on multiple negotiations at the same time. And that really needs to be our operating model. Have a pipeline and you have arbitration, negotiations or litigations all have to happen at the same time. Then in terms of implementation patents, they're somewhat tied with (34

[Timo Ihamuotila:]

And when it comes to the working capital characteristics. So, I think what you're referring to on the group level is mostly dependent by the fact that the Technologies business earnings or profitability and cash flows can have quite a big mismatch and that runs through our working capital. So as we said in the case of (35

[Matt Shimao:]

Thank you, Richard. Stephanie, next question please.

[Operator:]

Your next question comes from the line of Alexander Peterc with Exane BNP Paribas, your line is open.

[Alexander Peterc:]

Yes, thanks. Thanks for taking my question. I'd just like to dwell a little bit on the OpEx hike in Technologies, if you could maybe share your thoughts on how this business is going to develop in the longer term? Are we going to see economies of scale coming through? Because it's now a business with very high fixed cost and also obviously high gross margin. So, I'd just like to understand will we be able to drive growth there without hiking OpEx in step with revenue. And just very quickly in terms of the calendar of you offer, do you agree with the statement that (36

[Timo Ihamuotila:]

Thanks Alex. Why don't I start with Technologies OpEx. And I think, first of all, when we look at the Technologies OpEx developments, we were up about €30 million year-over-year and then up some €8 million quarter-on-quarter. So the €30 million from a year ago is not really comparable as we have said earlier because that's when sort of Nokia Technologies was still part of the Group. I mean, that was just when the Microsoft transaction was closing and thereafter it has been made a separate business, which has required investments in IT and software. So – and like we should more compare the run rate change quarter-on-quarter and of that clear majority is actually coming from Technologies licensing business related OpEx investment. Actually, if you look at our release today and look at the Technologies head count, Technologies head count went down from end of Q1 to end of Q2, and I'm simply saying this because it demonstrates that we really are very disciplined in how we look at our investments into these new activities. And, so, no, it is not directly correlated to the top line, because basically in this business the top line can be inherently lumpy and if we would get a top line uptick from one of these lumpy things, we would not invest one penny more than we think is reasonable to do (38

[Rajeev Suri:]

Thanks Alex for the question on timeline. So the progress is good. We've got 11 countries as I said EU and U.S. being two of them. China is the next one we're absolutely focused on working with the regulators there. Good progress and discussions. I believe our stand very much still first half of 2016. And we continue to focus with all the remaining countries that we continue to look at.

[Matt Shimao:]

Thank you Alex. Stephanie next question please.

[Operator:]

Your next question comes from the line of Kulbinder Garcha with Credit Suisse. Your line is open. Kulbinder S. Garcha - Credit Suisse Securities (USA) LLC (Broker) Thanks. Just two very quick questions. Rajeev on the NSN sales performance year-to-date has that met your expectations. And the reason why I'm asking is that constant currency didn't grow again this quarter. And I would have thought, given the market share gains you have or the contracts you've done actually over the last 12 months to 18 months, I would have thought sales performance would have been better even in markets that were worse than you would have thought six to nine months ago. And then Timo can you just clarify is the Samsung IP arbitration on track? Have timelines shifted? Do you still expect it to settle (39

[Rajeev Suri:]

Okay. Kulbinder, let me start with the market question. So, first I want to step back and say how is the market looking. We said it's a flat market at constant currency. We also say that the significant part of growth overall in the global market is coming from China because of the massive LTE rollouts with the three customers there. So one can conclude that the global market outside of China could even be declining this year. So that's kind of the background of, and of course the European suppliers in China have a lower than average share, right, compared to the fellow Chinese. But when I look at our performance, 4% down constant currency and also what we did in Q1 relative to the other peers that have reported, I think we are in good shape. So market by market if we were to look at our market share, we're holding steady. It's all good. But just because China is a bigger part of the growth of the market naturally it has mechanically an implication that the European peers will have lesser share.

[Timo Ihamuotila:]

And then the Samsung arbitration, so basically we have said in our regulatory filings that we expect the Samsung arbitration to conclude during 2015 and furthermore we have also said that due to the nature of the arbitration, the public arbitration proceedings, there cannot be an assurance as to the timing of the final decision.

[Matt Shimao:]

Okay. Thank you, Kulbinder. Stephanie, next question.

[Operator:]

Your next question comes from the line of Mark Sue with RBC Capital Markets. Your line is open.

[Mark Sue:]

Thank you. If I net out the software mix benefits, are the remaining things Nokia can do to improve the operational part of margins, R&D transformation, for example, does it get harder for Mike Oran (41

[Rajeev Suri:]

Yeah, good, thanks, Mark. So the first question is really on cost structure. No, I absolutely think that we have more room to continue to find efficiency. There is more room in R&D transformation. I gave a few pointers in my prepared remarks. We got good efficiency last year and there's more to go for. The same is in other parts of the business, in this regional services productivity improvement program, which goes country by country, looks at our services delivery and focuses on improving cost there. Same goes for looking at upsell by way of software and many such initiatives. So, I think we have something like eight such initiatives ongoing, and we'll continue to find those. Another example is Global Delivery Center and how much more can we increase of our share of delivery which is remotely managed at a lower cost base. And a lot of this future efficiency drive will come from automating the way we do business. Sort of more analytics, more automation and so forth (42

[Timo Ihamuotila:]

And Rajeev, just to add a numerical anecdote to the first part of the business, so I think it's good to note that even if our OpEx is up year-on-year, where FX is a significant driver quarter-on-quarter Networks, OpEx, when now the euro-dollar rate has been actually pretty flat for the third part of the year or after the Q1 closed, we are actually sequentially down in OpEx from €803 million to €789 million. So we are really working on this hard and this is also in line what we said about the OpEx expectations after Q1.

[Matt Shimao:]

Thank you Mark. Stephanie next question, please.

[Operator:]

Next question comes from the line of Francois Meunier with Morgan Stanley. Your line is open.

[Francois A. Meunier:]

Hey, thanks for taking my question. I think Rajeev in your opening remarks, you said something about having different approach today between Nokia and Alcatel ahead of the merger. So, maybe you could explain what are those different approach you're relating to. And the second question is about the pricing in the industry. I think everyone got scared in Q1 about your comments about pricing getting really tough. And now it sounds from your comment that the margin is getting a bit better or not worse from what we heard from you in Q1. What has changed exactly? Is it because you're less aggressive on pricing or someone else is less aggressive on pricing? Thank you.

[Rajeev Suri:]

Yes, thanks you Francois. So on the operational model question, there are some differences in terms of the way we manage our regions which have execution within regions are not just sales entities there's execution driven regions. In the case of Alcatel-Lucent it's slightly different. It's more BU-centric execution. So there are those kinds of differences not huge but ones that we have to understand how each company works and what is the best (45

[Timo Ihamuotila:]

There's also a difference in services execution rate.

[Rajeev Suri:]

Yes. And we have service as a separate segment and services in their case as part of kind of the overall BUs, the BUs that they have. So we're working through that. And then on the price rationality, I think the competitive intensity is still there. That's not necessarily changed from Q1 to Q2. What has changed is how we are managing to equip ourselves for even more competitiveness in the future. And I'll tell you that this is not based on some sort of hunch. This is based on – I'm involved in a lot of the difficult deals that the company – I'm personally approving those deals. I'm in the detail on those deals so I know what I'm talking about when it comes to intensity. But equally, we need to be able to manage well and we're doing that. It's good to know what's not good enough in the market and act on it. And so that's the way we'd like to lead the company, and no denial is permissible.

[Matt Shimao:]

Thank you Francois. Stephanie, next question.

[Operator:]

Your next question comes from the line of Tim Long with BMO Capital Markets. Your line is open.

[Tim Long:]

Thank you. Rajeev I just wanted to get back to the competitive environment and pricing. It sounds like it remains challenging out there and you guys are managing through it. Just curious how severe is the pricing environment. And then secondly how do you think about the growth to margin tradeoff. You are benefiting from some good currency tail winds now. So it doesn't really show up in the reported results. But when that an anniversaries and how should we think about going – having to participate in some deals with the industry reality compared to margins? Thank you.

[Rajeev Suri:]

Yeah, thanks, Tim. This is an important question. So the balance between profit and growth is always one that we have to maintain. So the way we run the company and manage our regions is very much driven by performance relative to planning currency. So we look at constant currency and how we sort of planned our numbers rather than letting regions get away with the ForEx driven increase. So, that way we're quite pragmatic in how we sort of run the regions. Your question on the trade off. You can't of course completely ignore market reality. If some deals are tough, we'll be disciplined. We walk away from. So, we continue to retain our pricing discipline. We have a pricing committee here. We analyze price erosion looking backwards. We forecast what it'll be going forward based on the decisions we make in our different limits authority approval bodies of deals. So we're very much clued into the whole thing. And so I think the balance is at a regional level you only take those deals that are strategic for me that have long-term, good strong profitability profile. And that doesn't go away. So we're not still going to take any deals that – we'll they're just aggressive and they'll be aggressive forever, so let's participate. So while that's something we can (48

[Timo Ihamuotila:]

And maybe a quick comment on the currency as you referred to the currency as well. So the currency has a bigger positive impact on the top line, but then bigger negative impact on the OpEx line and in that sense they kind of balance out. So it's actually a bit of a driver in the profitability line.

[Matt Shimao:]

Thank you, Tim. Stephanie we'll take our next question, please.

[Operator:]

Your next question comes from the line of Ittai Kidron with Oppenheimer.

[Ittai Kidron:]

Thanks. I wanted to talk about the venture again Timo. I think you mentioned there's another billion dollars of available to sale assets there. Can you give us a sense of timing, how do you think that – what's the timing of this flowing into the P&L? And also what's the built -in gain in that billion dollar available for sale asset?

[Timo Ihamuotila:]

Yeah, thanks for the question. So, first of all, it's important to note that we have been investing for this for a long period of time. So this is not like a new activity and BlueRun Ventures was originally something which started already in the late 1990s early 2000 and then we moved from BlueRun Ventures to Nokia Growth Partners where basically Nokia is actually the sole limited partner, i.e. sole limited partner investor into the fund. So this is a long history. I'm simply saying it because this is an activity where you have to be again very disciplined and think very long term. So these are not big annual flows running necessarily into that investment pool. Now, I can't comment on kind of like the mark to market situation of the 1 billion and, of course, as is typical in this kind of business it's very difficult to estimate when they would flow through P&L because its exit situation is different, be it outright sale, possible IPO and so forth. So I don't think I can give that much more there.

[Ittai Kidron:]

Thank you.

[Matt Shimao:]

Thanks, Ittai. Stephanie, next question please.

[Operator:]

Your next question comes from the line of Simon Leopold with Raymond James. Your line is open.

[Simon M. Leopold:]

Great, thank you. Appreciate it. Looking at the HERE business. It's interesting in that you've shown great leverage sales growth without tremendous operating expense growth. I want to get a better understanding of the operating expense trends here, whether we should think about the operating expense levels as relatively stable at current levels. Or you've talked about being in investment mode. Should we expect declines or are there activities that should drive growth as revenue continues to grow, thank you.

[Timo Ihamuotila:]

Okay. Thanks a lot, Timo here. So, if we look at the HERE business what we have said earlier as well is that we think that that business can benefit from further operating leverage with top line growth. That's what we have said. Simultaneously, of course, there is quite a bit going on, on this market when people talk about move from like the current model of map to these HD maps which are needed then for driverless cars into the future and so forth. So I'm not saying that there couldn't be an increase in the OpEx related to that and of course we are simultaneously, like in any transition, then trying to drive down the current technology OpEx into more of an efficiency mode and then investing into the new. But yes we expect that that business could continue to benefit from further operating leverage.

[Matt Shimao:]

Thank you Simon. Stephanie, we'll take our next question.

[Operator:]

Your next question comes from the line of Frederick Little (52

[Unknown Speaker:]

Yes, thank you for taking my question. Rajeev could you please elaborate a little bit on what you expect from the North American market in the second half. It has been a topic in several of these conference calls and it's interesting to hear your view on if operators in the North America market have resumed activity levels or will resume activity levels to more normal levels starting from now and onwards. Thank you.

[Rajeev Suri:]

Thanks, Frederick (53

[Matt Shimao:]

Thank you Frederick. Stephanie, I think we have time for one more question for today's call.

[Operator:]

Certainly. Your last question comes from the line of Vincent Maulay with Oddo. Your line is open.

[Vincent Maulay:]

Thank you. A specific question on the LG agreement and patents. Is it fair to say it will boost gross margin as soon as Q3 and it could reach roughly €100 million annual incremental sales.

[Rajeev Suri:]

I'm sorry, Vincent, could you please repeat the question. It was regarding LG, but I wasn't quite able to follow (54

[Vincent Maulay:]

Yeah, it was on LG, just want to know is it fair to say it will boost gross margin as soon as Q3 and if you it could reach roughly €100 million annual incremental sales.

[Timo Ihamuotila:]

I'm sorry, but we have not given any exact view on any of the licensing agreements what we have and in that sense I would just like to remind that the net sales in Nokia Technologies includes revenue from all of Technologies licensing negotiations, litigations and arbitrations to the extent that we believe is currently required, but they are not a forecast of the likely future outcome of ongoing licensing projects.

[Matt Shimao:]

Thank you, Vincent. And with that I'd like to turn the call back over to Rajeev for some closing remarks.

[Rajeev Suri:]

Thanks, Matt. Thank, Timo. And thanks again to all of you for joining. I'd like to close with a couple of thoughts. First, the developments that we are seeing in the market further validate the strategic logic of the Alcatel-Lucent transaction. Scope to target new, more attractive markets and scale to give us the ability to deliver adequate profitability in tough market conditions. Absolutely the right step forward for Nokia and we believe for Alcatel-Lucent as well. Second, the performance of Nokia Networks showed that Q1 was not the start of a new normal. Well I do not excuse our performance in that quarter; I believe that Q2 shows the power of our operating model, lean cost structure, strong execution capabilities and resilient focused culture. As I suggested in my remarks, we do not see totally smooth sailing ahead, but we are well positioned today and are working to ensure we are well prepared for tomorrow. Overall, a very good quarter, no doubt about it. With that, thank you very much for your time and attention and 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 risks and uncertainties. Actual results may therefore differ materially from the results currently expected. Factors that could cause such differences can be both external, such as general economic and industry conditions, as well as internal operating factors. We have identified these in more detail on pages 74 through 89 of our 2014 Annual Report on Form 20 F, our Interim Report for Q2 2015 issued today, as well as our other filings with the U.S. Securities and Exchange Commission. Thank you.

[Operator:]

This concludes today's conference call. You may now disconnect.