Nokia Oyj (NOK) Q1 2019 Earnings Report, Transcript and Summary

Hello and welcome to the Nokia First Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Mr. Matt Shimao, Head of Investor Relations. Please sir you may begin.

Ladies and gentlemen welcome to Nokia's first quarter 2019 conference call. I'm 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 it's 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 60 through 75 of our 2018 annual report on Form 20-F, our financial report for Q1 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 financial 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.

Thanks Matt and thanks to all of you for joining today. Q1 was a weak quarter for Nokia as we expected. When we spoke last time, we pointed to a soft first talk and a particularly weak first quarter followed by a robust second half. We continue to stand by that view. In terms of the quarter, we understand the underlying drivers of our performance and believe that they will largely mitigate over the course of the year. As a result we are holding our fully 2019 guidance. I recognize that given the fourth quarter outcome, many of you may be skeptical that we can deliver on those commitments. All that if we do, it will be at the cost of our 2020 performance. I do not think see things that way and would like to focus my remarks today on how we expect things to develop and the risks that we see. As I do that I want to make three key points. First, many of our businesses are performing very well and have momentum moving forward. Second, we have a clear understanding of what did not go well in Q1 and have confidence that things will improve as the year progresses. Third, while we do see certain risks increasing, there are opportunities as well. Let me dive into more detail on each, starting with the easy part. Many of our businesses are performing well and are positioned well for the future. Consider the following; IP routing is in superb condition with clear product leadership and is benefiting from the virtual circle of investment that I've talked about before as customers prepare their network for 5G. IP Routing grew by 12% in constant currency in the first quarter far outpacing the market. That is the second consecutive quarter of growth for the business and we have good momentum moving ahead. Optical Networks continue to grow as well, up 7% in constant currency. While the profitability remains diluted, it is improving and tracking to our plan. Products based on our Photonic Service Engine 3 chipset PSE-3 are already in trial with two service providers in Europe and are looking very good. With this we will once again leapfrog the competition and be able to deliver massive capacity and efficiency improvement. Then, our licensing business, which continues to track well again its strategic roadmap. When you include a new licensee that we expect to sign a final agreement within the coming weeks, we will reach an annual recurring revenue run rate of approximately €1.4 billion. We're also making progress in automotive licensing including the addition of Audi and Porsche to earlier licensees BMW, Mini, Rolls Royce. As part of our investment into our end-to-end portfolio we are delivering the innovation and standard essential patents to maintain this business well into the future. To do that, we need to continue to innovate and that is exactly what we are doing. I know some of you have expressed concern that the number of patents coming from Nokia is lower than some others in our sector. But I want to be very clear about this, we are not interested in playing the volume game. We are focused on quality on the patents that really matter and have the highest potential for future monetization. By the end of Q1 2019, for example, we have declared more than 1,500 patent families essential for 5G with more to follow. We are investing to make that happen and delivering patent filings ahead of our internal plan. This is largely through the ongoing work of Nokia Bell Labs and it's unique and powerful capacity for innovation. They have been at the heart of cellular standards development for many years and we intend to keep them there for the future. We see licensing as a core engine for value creation not just for a few years, not just for the next 10 years, but for decades to come. Our new Nokia Enterprise businesses is also performing well with net sales to the enterprise customer segment up by 5% in constant currency when you adjust for the third-party integration business that we're exiting. Orders grew more than 20% and we added another 33 new customers in the quarter. We expect some variability in the quarterly financial performance of Enterprise going forward as is normal for an emerging business that has some large projects. Q2 is likely to be soft given some technology transitions and project timing, but my expectation remains that on an annualized basis, we will be able to grow net sales in the double-digits. Interest in 5G private wireless networks is particularly robust in utilities transportation and the public sector. We also see significant opportunities in industrial automation solutions in the manufacturing and logistics segment. Finally, Nokia Software which like Nokia Enterprise is a key element of our strategy. While a very strong Q4 2018 resulted in net sales that declined 4% in constant currency in the first quarter and a small operating loss, momentum is building as the year progresses, orders are strong, and overall execution is good. Within Nokia Software, we now have two areas; applications and core that are at different stages of development with different performance. On the application side, we expect solid growth and profitability. As I've discussed in previous calls, we have built a strong foundation for this business, including refreshing 70% of the sales organization and re-architecting our software on a common modern platform. As just one example of our progress we added our 100th CloudBand customer in Q1 and we have integrated that product with 45 network functions from third-parties to increase its capabilities. In terms of core, a transformation is underway in both sales and product development. We are moving our core software to a common modern platform which will make it completely cloud native by the end of 2020. Additionally, we are strengthening our sales capability and improving commercial discipline in a similar way to what we did with the applications. The lessons learned from the transformation of our application business give us confidence that we can transform the core business in an accelerated manner and that it can still deliver a better than average profitability for the company. So, in short many parts of our business are tracking well and many delivered a good Q1 performance. So, then to address my second point, why the poor quarter and why do we expect both topline and profitability to improve significantly as the year progresses? The answer is largely related to 5G. Our revenue recognition policies and contractual terms require reasonable commercial availability and customer acceptance of our own system software before we can recognize revenue related to a new generation of mobile technology. Neither of this was fully in place by the end of Q1, but that situation is changing fast. We expect to see some improvement in Q2 and much more in the second half. To put this in perspective this situation means that we missed approximately EUR 200 million in 5G revenue recognition in North America alone in Q1 and we should see that come back in full before the end of the year. Korea, although a much smaller market than North America, had similar challenges. The recent 5G launches in the country used the September 2018 3GPP baseline that leading chipset makers do not consider commercial given later changes in the standardization body that are not backward compatible. In addition, unlike last year we had no new 4G software releases in the first quarter, as we needed to ensure compatibility with our 5G product. This impacted our overall software content and thus our gross margin. But we do expect 4G releases to come in each of the three remaining quarters of the year. I would also like to openly address the question of Nokia Mobile radio roadmaps, as there is some noise about where we stand today. We do have some short-term issues, weeks and at most a few months in some select cases. But these need to be understood in the context of a technology cycle that will last well over the next decade and that is still in the process of maturing. In Q1, higher radio product costs also had an impact on gross margin and that is not unusual early in a new generation of technology. We are very focused on this issue and have a clear plan for improvement. As a proof point that the ecosystem is still maturing, we've found software defects and instability in the consumer device chipsets in the process of testing our 5G base station software. It seems reasonable to believe that, if we were significantly behind our competition as some have suggested, such defects instability issues would have already been found and then fixed by the chipset makers. I do not find these gaps particularly surprising given the speed at which things have been and are continuing to move, but it also suggests that full ecosystem stability and predictability are yet to come. I would also note that while Nokia is not always first with time to market for individual features, our products has a consistent record of outperforming our competition in the field. For proof of this look no further than our AirScale 4G base station. I've been told by some of the biggest players in North America that this product is performing far better than what they see from others. Let me take this opportunity to address some of the other product related topics that are relevant as 5G moves forward. The first is software upgradability of existing mobile base stations to 5G. I have talked about this before and software-only upgrades are meaningless, unless your hardware has the right capacity. After all, you could in theory upgrade an old laptop to the very latest version of Windows, but the end result would be lousy performance. Doing something similar when it comes to base stations, does not make any sense to us and we do not think it makes sense for our customers either. Second, dynamic spectrum sharing, or DSS. Most operators do not see this as a necessary solution in the short to medium-term given spectrum that will be utilized in most 5G launches. It also requires unique device functionality that is not yet available and will likely come only at the end of this year. DSS becomes more relevant when operators want to share the old 2G, 3G or 4G spectrum with 5G, especially in lower bands. We are well-suited to enabling this given that in the past two years, we have shipped in the range of 3.8 million 5G-upgradeable RF units. At the same time, for those customers with a near-term need for DSS, we will have the right features at the right time. Third, you're probably also hearing about common baseband boards with 2G, 3G, 4G and 5G. Nokia was the first supplier to introduce such commonality when we introduced our Flexi release too many years ago. Through that we learned that what sounds good in theory can be quite imperfect in practice. Common baseband boards, mean, compromises due to the unique processing requirements of different radio technologies and typically cannot compete with next-generation product that are optimized for the following cycle of mobile technology. Basically it means, a board that has compromises from the start and is obsolete by the time it is supposed to be most useful. That is why we believe our approach, which also offers more flexibility in multiple radio bands than what we see from others is better for our customers, better for protecting their investment and better for end-user experience. On these topics in others, it appears that our thoughtful approach focused on ensuring the best long-term value for our customers is making a difference. In past calls, I have mentioned our customer satisfaction measure called Customer Perceived Value or CPVi. It is based on a large number of rolling annual interviews with multiple respondents across 100 different accounts and is designed to give a forward-looking view on the propensity of customers to buy from Nokia. Our most recent results show that we are closing the gap with the market leader and significantly distancing ourselves from the declining number three in the market. We see particular strength coming from favorable perceptions of our end-to-end portfolio, account interaction and customer intimacy and innovation in big data and analytics. This record of performance and strong customer support is one of the key reasons that we continue to win in the market. We now have 36 5G commercial contracts including 18 with named customers. More than half of those 36 deals include portfolio elements that others do not have. Coming back to our Q1 financial performance, we also saw some execution issues in our services business. Typically, in this business vendors like Nokia have a handful of challenging services projects, nothing unusual there. And we have a couple such a projects that we have reference before that are getting intense focus. And recovery is underway even if not as fast as I would like. In Q1, however, we faced a significant hit to services profitability related to cost overruns and under performance in two large projects driven by near-term 5G delays. These projects will continue to provide a drag in Q2, but are expected to recover as the year progresses. Separate from 5G-related topics, Fixed Networks had a challenging quarter with both lower net sales and a geographical makes leading to weak profitability. We continue to run the business very tightly with a firm control on OpEx spending, but if performance does not start to recover, we will look to drive further focus and efficiency. Despite this, there are also good reasons for optimism, particularly with higher than expected demand for our fixed wireless access solution, including from customers Optus and South African operator Rain. It is absolutely unique in the market today, as it includes the new 5G gateway that launched at Mobile World Congress. Designed with the highest gain antenna in the market and massive increases in coverage and capacity compared to traditional designs, this is a compact solution that makes it literally plug and play for an operator to use their mobile network to bring 5G speeds to every corner of the home. Finally, on to my third point about risks and opportunities. I've talked about the opportunities we see based on the strength of our products and services. Nokia's unique end-to-end differentiation and 5G-related investments by our customers that benefit our entire portfolio. So what about risks? We see some evolving that are worthy of further comment. The first is execution risk for the remainder of the year, and particularly in the second half given the high volume we expect. We demonstrated in 2018 that we can deliver a fully-loaded second half and expect we can do so again. That said, I think it is reasonable to acknowledge that our slow start to the year has slightly increased risk in this area. Let me take this opportunity to note that, while we believe 2019 will bear considerable similarity to 2018 in terms of quarterly sales performance, the underlying drivers are different. 2018 ended strong as operators invested in their network in advance of 5G radio roll out. 2019 should end with the 5G ecosystem largely mature and with 5G demand continuing to grow in 2020. The second risk we see is the potential increase in competitive intensity in a limited number of accounts, as some competitors seek to be more commercially aggressive in the early stages of 5G. We have no desire to engage in such behavior, but are prepared to act as needed to maintain our footprint. Third, we see an increasing number of customers reassessing their vendor selection in light of security concerns. While it is governments who are driving this issue and who will determine the right policies for their countries, we will support our customers in cases where they have an interest in changing suppliers. In the near term, this could put some pressure on margins, but we will except -- accept that in cases with the right long-term profitability profile. On this topic, I want to be clear that a change of vendor does not necessarily mean a full-scale swap. There are other ways to manage the transition that are more cost-effective and less complex, including opening certain interfaces or deploying a light 4G overlay layer. And for more on this, I would encourage you to look at a blog on our website from Harri Holma, a Nokia Bell Labs fellow at one of the industry's top experts on radio technology. To pull all this together, yes, we do see risks. No doubt about it. But more importantly, we continue to see a path to delivering on the full year 2019 guidance that we gave in January and continuing to strengthen our performance in 2020. With that, let me briefly comment on a few other topics before I hand the call over to Kristian. First, two regions, North America and China. In North America, we reported constant currency growth of only 1%, a less than ideal outcome that was largely driven by the lack of 5G revenue that I mentioned earlier. Just to help with any comparisons you might make, if you look at just Mobile Networks and Services without Managed Services, our growth in North America was approximately 15% in the first quarter. If you assume that, we have been able to recognize the approximately €200 million in 5G revenue that I mentioned earlier, we would have grown approximately 40% in the market. This is not to execute our shortfall, but to put it in perspective. I would also note that, we do not believe there have been any material changes in market share with North American customers, but timing of our sales maybe different to what others see. China remains a challenge and our sales declined by 12% in Q1 in constant currency, largely reflecting operator CapEx control in advance of 5G. As 5G accelerates in the market, we expect that there will be early activities that are called trials, but in fact are fairly large initial rollout that require significant free-of-charge products and services. While participating in some of these will almost certainly be necessary our focus will be on the commercial phases that we expect to come in 2020. Overall, and as I noted last quarter, we will remain prudent in China and seek to balance share in the country versus overall profitability. Second costs. We continue to deliver on our cost-cutting targets and are on track to meet the €700 million target we announced with our third quarter earnings last year. As we see the various risks and opportunities play out in coming quarters, we will also continue to assess our portfolio to ensure we are focusing only in the areas where we see true market opportunity. Our view that cost leadership and clear prioritization of investments are critical success factors in our sector remains absolutely unchanged. If market conditions or our own performance suggests that we need to adjust costs, we will not hesitate to do so. Let me move now to cash. Our performance with respect to cash was weak in the quarter. However, we remain confident in our guidance to be slightly positive in free cash flow for the full year. I want to reassure you that, we are extremely focused on this subject and have initiated a number of measures to address this performance. Kristian will provide more details in a moment. Finally, Alcatel Submarine Networks or ASN, you may have seen a recent announcement that our talks to sell the asset to a French company called Ekinops have come to an end. That is true, as our view of the businesses change in step with the change in the overall optical market. While we see good reasons to keep the business as a core part of Nokia, we also understand that the French government would prefer at least partial French ownership of ASN. We will continue to work with them to see if we can find a solution that meets their needs and is in the best interest of Nokia shareholders. With that, let me turn the call over to Kristian. Kristian?

Thank you, Rajeev. Today, I will take you through a number of topics including the financial performance of Nokia Technologies and Group Common and Other as well as group level results. I would like to then focus on our cash flow in Q1 some key items for Q2 and some of the actions we are taking to improve our cash performance and balance sheet. And finally, I'll briefly touch upon our guidance. By now, I'm sure you are all familiar with our new reporting structure. As part of this, we are now providing additional disclosure with amounts related to licensing. And Nokia Bell Labs allocated 80% to Networks and 15% to Nokia Services. This ratio is in accordance with their value contribution and we are providing this information to improve comparability with our peers. On this basis, our Networks' operating margin in Q1 2019 would have been negative 1% instead of the negative 6.4% reported. And Nokia Software operating margins would have been positive 5% instead of the negative 1.3% reported. You can find this disclosure on page 6 of our Q1 earnings release. Moving to Nokia Technologies. Net sales in Q1 totaled €370 million, an increase of 1% year-on-year, primarily related to higher onetime catch-up net sales related to a new license agreement and the sale of certain patents. Net sales at constant currency were flat year-on-year. In Q1 2019, we had €40 million one-time net sales compared to €10 million in Q1 2018. On a recurring basis, net sales declined 4% year-on-year. From a profitability perspective, operating margin was up solidly on a year-on-year basis with Q1 at 82% compared to 75% in the year-ago quarter. This improvement was primarily due to the absence of costs related to Digital Health, which we divested last year. As Rajeev mentioned, we are in the final stages of signing an agreement with a new licensee. While the name of the company and the terms of the agreement are confidential for your models, our licensing run rate as of today would be approximately €1.4 billion annually, if you include this new licensee. Moving to Group Common and Other in Q1. Net sales decreased 12% year-on-year in constant currency, primarily driven by ASN. ASN is a project-oriented business. This has led to a challenging net sales performance over the past year as a number of large projects came to completion. Looking forward, we see this trend inflecting in the second half of 2019, when ASN commercials work on new projects. Group Common and Other operating loss worsened year-on-year, primarily driven by lower gross profits and higher costs related to long-term investments, to drive digitalization for the future, which negatively impacted both R&D and SG&A. These were partly offset by higher gains in Nokia's venture fund investments. Please note for your models that our OpEx run rate in Group Common and Other has now increased by approximately €20 million per quarter related to the long-term investments I just mentioned. Moving to Nokia level results. Looking at non-IFRS taxes in Q1, the group level operating loss drove a tax benefit in the quarter compared to tax expense last year. For full year 2019, we continue to expect non-IFRS tax rate to be approximately 28% at a lower rate compared to last year driven by our new tax model, which we put in place at the beginning of 2019. Looking at non-IFRS financial income and expenses in Q1, our year-on-year results reflect, an improvement in foreign exchange hedging results partly offset by higher interest expenses related to the sale of receivables and the inclusion of leasing interest expenses as a result of the adoption IFRS 16. At the Nokia level, our non-IFRS diluted EPS was negative €0.02 in Q1 down from €0.02 in the year ago quarter. Overall this performance was primarily driven by lower gross profit in our Networks business. Next turning to our cash flow performance in Q1 and our balance sheet. On a sequential basis, Nokia's net cash decreased by approximately €1.1 billion to a quarter end balance of approximately €2 billion. During the first quarter, Nokia's free cash flow was negative €930 million. In addition to the seasonally weak profitability in the quarter, our cash outflows were negatively impacted by a number of items. Firstly, we saw continued outflows related to restructuring and network equipment swaps. We also witnessed seasonally weaker cash collections following significantly higher sale of receivables in the fourth quarter of 2018 and certain unexpected and unusual overdues at the end of the first quarter. Lastly, we saw seasonally higher inventory levels as well as higher than normal inventory levels, due to our decision to ensure sufficient flexibility to deliver higher levels of equipment sales particularly related to 5G and the deferral of revenue recognition, mainly in North America. Specifically, regarding Q2 cash flow, our cash will be negatively impacted by bonuses paid under, our annual employee incentive plans. We also expect inventories to remain at elevated levels in Q2, having said that, we expect inventories to significantly improve in the second half. Additionally, regarding our dividend as mentioned last quarter Nokia's Board of Directors has proposed to the AGM a maximum – an aggregate maximum dividend of €0.20 per share to be paid in quarterly installments. The first quarterly installment is expected to be paid in June. Our cash performance continues to be an area of strong focus for us and we are diligently working to improve this. We continue to believe that the free cash flow will be slightly positive in 2019 and we acknowledge that this will require significant improvement in our execution. I am confident that we will show improvement in the coming quarters following the actions we have put in place. For example, we have established a free cash flow program to ensure company-wide focus on free cash flow and the release of networking capital, including project asset optimization, reviews of contract terms and conditions, as well as supply chain and inventory optimization. I will be tracking this on a bi-weekly basis to ensure that we meet our expectations. And we have now tied a significant part of senior leaders' incentives to free cash flow improvements in 2019 and beyond. Turning briefly to our balance sheet. As I mentioned earlier, we ended the quarter with €2 billion of net cash. During Q1, we successfully issued €750 million of unsecured notes, which will mature in 2026 and carry a 2% fixed coupon. These proceeds have been used to repay a portion of our debt in Q1 and for general corporate purposes. We are pleased with the interest rate we were able to get, which helps us lower our overall interest expense. Finally, turning to guidance. As Rajeev mentioned, we have reiterated our full year 2019 guidance even we now see signs of increased overall risk. Our view is based on a strong recovery expected in the second half of the year, driven by 5G deployments in addition to early benefits from initiatives in our cost savings program. While our expected weak first half put significant pressure on our second half execution, I believe our teams can rise to this challenge. With, that I hand over to Matt for Q&A

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

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Sandeep Deshpande of JPMorgan. Please go ahead.

Thanks for letting me on. Rajeev, I have a quick question. I mean, do you have -- we are in the early stage of the 5G transition. I mean, if you go back to the 4G transition and you were in charge at time as well, the initial part there was a lot of price – there was considerable price war in the market, but then eventually in the 4G market you did come up on top. Do you see this as a similar situation, which is causing margin -- impacted the margin? Or is this early part of 5G different from how it was in 4G? And then when you look at your overall gross margin, how would you classify, how much of that is coming from any price situation and how much from your company specific things such as a software upgrade et cetera? Thanks.

Yeah. Thanks, Sandeep. So I would say that it’s not widespread any competitive intensity. I think what we’re -- we're not seeing that as much right now. What we're seeing are potential signs of that coming through. So to be clear that we haven't seen it yet, there’s potential side of that coming through. I would again say that it's in just certain accounts and maybe even certain countries like -- and so I think our response needs to be a nuanced regional strategy. So we're not taking an approach that's similar everywhere. For example, in China we need to be far more prudent because there we expect more aggression, we expect free-of-charge deployments et cetera, so there we'll be super prudent and focus on the commercial phase. But again then there is the second aspect of security related concerns, to which there may be some replacements of competitors and so on. Long-term that's an opportunity. And again here we don't think it requires full-scale swaps, because Nokia's come up with a few solutions that we can avoid that, i.e. just put a thin layer of LTE just swap that think layer of LTE and then use that to connect to 5G on non-standalone architecture. So I guess in the early days of 4G, it was more aggressive because there were also big modernization contracts started by one particular competitor. I don't see it the same way. I will come back and address gross margin, I'm sure the question will come up in terms of what is going to change for Nokia going forward.

Thank you, Sandeep. Nicole, we’ll take our next question please.

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

Good afternoon, gentlemen. Thanks for taking the question. Rajeev you sort of foreshadowed my question. I mean, the unchanged 2019 outlook, margin outlook does imply steep ramp of gross margin as we move from first quarter through second quarter and into the back half for the year. I can understand what you're saying about the increase -- a return to some of the software releases and improving mix should help, but at the same time you're highlighting some of these competitive pressures. So after that weak first quarter and still holding the desire to meet your full year targets, how do you balance those competing factors? Do you need to seed market share in order to improve margins? Or are the mechanical things that should come through that are giving you that confidence in the ramp over the course of the year?

Okay. Thanks, Andrew. So let me take some time on this one. This is an important question. So first off it is fair for you to expect us to drive the sequential improvement in gross margin every quarter for the remainder of 2019, and let me explain the drivers. First, of course, is 5G growth that will drive improved scale, which will provide us with improved leverage, right? And there are two distinct parts to this. Number one, we expect 5G deployments to accelerate meaningfully in the second half and we have visibility to where those countries are where those contracts will be. Two, also as we highlighted, we delivered approximately €200 million of 5G hardware in Q1 that we were unable to recognize revenue on. And we expect that to be captured in full by the end of the year. So that's the first point, 5G growth. The second is product mix. And that will improve, one, because within Mobile Access, we expect a higher mix of software sales, following a Q1 during, which we did not have any software releases, not 4G, not 5G. 4G because of the compatibility with 5G and 5G because of what I've mentioned, revenue recognition. And two, if you move beyond Mobile Access for a minute, there are also several drivers of improvement. Number one, improved scale in Fixed Networks, which was down a lot in Q1; FP4 product cycle in IP Routing, structural cost benefit we have there; third, PSE-3 cycle in Optical that's coming later in the year. And then on the third big point in Services, which is within Mobile Access as I mentioned the particular challenges we are seeing are limited to a couple of services contracts where we had cost overruns and I'm confident that we can drive significant improvement in our execution in the remainder of the year. Plus we also expect cost reductions in Services, which is part of cost of sales and hence will improve gross margin. And more broadly speaking, we're focused on improving our overall product costs. Obviously we're in a new technology transition and as we progress through the 5G technology cycle, I can assure you that we've already taken the necessary actions such as more sharp chipsets, system on chip products et cetera to start in 2019 and later in 2020.

Thank you, Andrew. Nicole, we’ll take our next question please.

Thank you. Our next question comes from Richard Kramer of Arete Research. Please go ahead.

Thanks very much. Rajeev there's been a lot of attention paid on some high profile new deals like Rakuten, which are obviously using some new models. And you've seen some moves from some of your rivals from capturing a price premium in the market to now trying to be a price leader. So there seems to be a lot of evidence behind the notion of price aggression that you mentioned. I guess my question given all the execution challenges you face and not to add to them is whether you're confident that your second restructuring is going to be sufficient to bring Nokia to the cost structure it needs longer term, maybe even beyond the 2020 guidance? Or are we simply on a wheel, a hamster wheel as it is of needing constant cost reductions to sustain those margins, which I guess with the execution challenges right now are very hard to get to in the near-term? Thanks.

Thanks, Richard. So yes we expect this to be the restructuring round of not requiring more round after this. From the Rakuten, I mean, of course, we're a primary vendor there, we have key position there. So the network architecture that we see in Rakuten, I don't see that replicating across the world, because one it's still a close ecosystem; and second it's greenfield operator, so they can do it because they don't have to carry any legacy features 4G, 3G, et cetera. So it's an isolated set up. We're following that closely because we're involved. It's better to be involved than not. It's a decent contact for us. Longer term there'll be other meaningful initiatives, which is Open RAN. ORAN will start to happen, et cetera. And I think that's a good thing for the industry, because then we can stop doing swaps with each other, because you can open interfaces and change and mix supplies more readily. On the final point on price pressure. Again, we haven't seen a lot of evidence of this. I'm just pointing to particular possibilities of risks here. And I know that China will be aggressive in particular, so we will take a more nuanced regional strategy always with the right long-term profitability profile.

Great. Thank you, Richard. Nicole, next question please?

Our next question comes from Mike Walkley of Canaccord Genuity. Please go ahead.

Great. Thanks. Q1 consistent with the slower start to 2019, you still have a strong conviction on a stronger second half. Can you just update us on what regions you have the strongest visibility to support your stronger second half outlook? And if there's any consolidation risk to that outlook? Thank you.

Thanks, Mike. So in terms of the business product areas like I mentioned, more scale in Fixed Network, we have visibility to that happening; the SB4 product cycle, which is receiving a lot of warm reception by a number of customers; the PSE-3 in Optical, which is coming later this year. Then visibility from a regional standpoint, North America, I mean, that obviously – we have visibility to early launches if that happened, more will accelerate. Korea, I mean, the launches have happened and the acceleration has somewhat already underway. Japan will come next. Spectrum has been awarded and now 5G rollouts will start in earnest, as vendor decisions will get made -- to be made. And then there is China, which will happen sort of in Q3 timeframe in terms of the central procurement round one tendering decisions in Australia. That's underway from a 5G standpoint including fixed wireless access. Middle Eastern countries, we've already signed those contracts, as part of our 36 commercial 5G contracts. And then you have Nordic countries, and perhaps a couple of countries in Europe, like, the U.K., Italy, more notably. And then there'll be -- the rest of that will start to happen more in 2020. But this is the 2019 activity list if you like, from the 36 5G commercial contracts that we have which are growing by the day.

Thanks for your question, Mike. And, Nicole, we'll go to our next question, please?

Our next question comes from David Mulholland of UBS. Please go ahead.

Hi. Thanks. Just one question on the Technologies division. Obviously, you've pointed to the recurring revenue base of now about €1.4 billion. I just wonder if you can comment on whether you think there're still opportunities to grow from here, given you've taken way kind of the divisional guide for 2020, but in the past you've been targeting, I think, close to €1.7 billion. And if I can squeeze one quick clarification, on the €200 million hardware sales that you're talking about, can you clarify whether you've taken the cost or not from a COGS perspective or whether it's missing from both revenue and COGS?

Thank you. Maybe I can start just on the on the latter one. So we are talking about 5G deliveries in general in North America, including hardware and software. And the costs have not been taken. The cost will be booked when revenues are recognized.

Correct. And, David, on the tech, I think, yes, we see opportunities to grow from here on. As we said before, there is still more in China, the automotive licensing, which is very much underway. There are more IoT verticals as consumer broadcast. So, yes, we see the opportunity grow. I think perhaps what's even more important is that we see this business lasting for a very long time. It is a recurring revenue business. And given the patents that we're innovating with including the new 5G patents that we've gone with, I mean we see this as an opportunity for decades. And I want to make this clear, this isn't a few years or even 10 years, its way beyond.

Thank you, David. And, Nicole, we'll take our next question.

Our next question comes from Achal Sultania of Credit Suisse. Please go ahead.

Hi. Good afternoon everyone. Just another clarification on the Technologies business. I think last year you were mentioning already €350 million run rate every quarter. And now we've seen OPPO deal signed last quarter, we have another new licensee coming in this quarter and still the run rate is 1.4. So I'm just surprised like, is something else dragging the revenue run rate down, like, any contract which is expired? Or there's been any renegotiation which has led to lower value?

Yes. I think, your thinking is correct. We have some new licensees that have added to the run rate and then we have some renewals that have reduced it. I think the key thing is that, as of now we are at the €1.4 billion level. And what -- as Rajeev said, we're going to keep it there and improve it and its there for the long term.

Thank you, Achal. Nicole, next question, please.

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

Yeah. Hi. Thanks for taking my question. I guess my question was on the China business. Clearly, it's going to be the biggest 5G market in the world and yet you seem to be revisiting whether you want to be in this market in a major way. Is your strategy to sort of bring the share down to the single digits and participate selectively? Or is it just that in the short term, you're going to be avoiding getting involved in trials, where you're going to have to get equipment away and then you're look at look to come back and maintain your sort of mid-teens to high-teens share in the long term? Thank you.

Thanks, Robert. Look, I think there's going to be a free-of-charge large pre-commercial trial phase where one is expected to preoccupy some territory. It's going to be costly. And then they will be a -- the actual commercial round later in the year, Q3. With all of the operators, it's also likely to require some up front losses to be crystallized, given that it's going to be aggressive without any commitments. And then you have to bank on those revenue coming downstream. So both from a short-term point of view, as well as from a long-term point of view, we need to be careful and somewhat selective in how much we want to play in that game. Yes, it will be the largest market by volume, but it's certainly not by value. And we can play a nuanced regional strategy as we have played before. If you recall the Nokia Siemens Networks they used to quite a good effect. Having said that, we see opportunity on private wireless with enterprises there, straight on companies. We're lucky to have a joint venture that helps us there. We see opportunities on the IP and Optics side. We see opportunities on Fixed Network still. So we can still differentiate our play, where we see more healthy long-term margin profile.

Thank you, Rob. Nicole, next question, please.

Our next question comes from Sebastien Sztabowicz of Kepler Cheuvreux. Please go ahead.

Yeah. Hello. Thanks for taking my question. Do you see any opportunity in business within the $20 billion Rural Digital Opportunity Fund that's been launched by the U.S. government? And if yes, when do you expect that this opportunity could materialize in terms of revenue contribution?

Thanks, Sebastien. But I'm not sure I got the question. Was this on a public 5G network or...

It is on the $20 billion – yes.

Go ahead.

Yes, exactly the rural deployment of broadband in the U.S.

Yes, certainly, we see opportunity there as well. I mean all things North America. All things 4G and 5G, we see opportunity. Beyond that, we also see industrial private wireless with utilities and transportation as opportunity. So, yes, we do.

And I guess it's fair to say that this is not only a U.S. phenomena. I think we see these government-backed rural opportunities also in other places around the world. There will be linkages between 5G licensees and the operators need to put, kind of, more capacity in work in rural areas. And some of that will be able to be done with fixed wireless access solutions and other parts of the portfolio that we have.

And we've seen this in the Universal Service Fund and marketing and retail, as Kristin said. We've seen it in Saudi Arabia. We've seen it in India and other parts. And absolutely.

Thank you, Sebastien. Nicole, next question, please.

Our next question comes from Tal Liani of Bank of America. Please go ahead.

Hi, guys. I would like to focus on the gross margin. It's a major declining in gross margin and I'm wondering if you can break it down. I try to add back the $200 million to revenues. And even if I add it at 90% margin, just to see what's the impact on gross margin is, still the gross margin is only 34.5% versus 39.5% that we expected. So I'm wondering, what drives such a sharp decline in gross margin? And if you can break it down to the pieces or quantify? And then how long does it take you to go back to the 39%? I understand it's going to improve second half, but how long does it take you to go back to the 39%? Thanks.

Yeah. Thanks. So I think Rajeev already talked about the right side of the improvement where will it come from. Let me kind of talk about what happened and maybe also remind you, we said going into the year that we expected a soft first half and a robust second half and a particularly weak Q1. From a broad perspective, as we have highlighted in the past, it is typical that in the early parts of the technology cycle, product costs are relatively high and then you improve them as you work through -- as the technology matters. In addition to that, we did experience several challenges in Q1. First, as you correctly pointed out, we where unable to recognize approximately €200 million of 5G deliveries in North America. Secondly, we had a negative product mix. On the one hand, we did see lower mix of software sales due to the absence of software release also for 4G in the quarter. In mobile access, we were also negatively impacted by having a higher proportion of network deployments services in the business mix. And then thirdly, in Services within Mobile Access, we were impacted by some cost overruns and some underperformance in two large programs -- projects driven by near-term 5G delays. But as Rajeev said, we are confident that we can drive focus and significant improvement in our execution in Services going forward. So I think that's it. Then in a way, how quickly things will come back, there you need to look at what we've said: first half soft; second half robust. So I think much more of this margin improvement is second half.

Thank you, Tom for the call. Next question please.

Our next question comes from Aleksander Peterc of Societe Generale. Please go ahead.

Yes. Thanks for taking my question. I'd just like you to come back a little bit from the €200 million of revenue that you weren't able to recognize this quarter. Can you reassure us on the fact that there is virtually no risk that this will not be recognized in 2019? And also, if this was supposed to be first quarter revenue, how come it may take you until the end of the year to get it recognized? Are there also any risks attached to that like additional cost overruns? Can this occur again in the future quarters, as you know? Just put a bit of color on that. Thank you.

I think maybe I can start and Rajeev please chip in. I think what we are saying is that things are improving quickly. There will be some improvement already in the second quarter, but the full benefit of the €200 million will come through in the second half. I don't think we are saying by the end of the year, we are saying during the second half. We do feel confident that we will be able recognize this revenue. And when it comes to additional costs that's not the topic here. It's more -- it takes some time to mature the software to the stage that it needs general availability as well as the customer commitments that we made and then we'll hit the recognition milestone.

I'll just add to that Alex is that we see cost reduction in Services and cost of sales happening in the remainder of the year, particularly in the second half. And then as I said, more operational scale in Fixed Networks is going to help and as people [054:24] [indiscernible] cycle and PSE-3 optical product cycle as well. Like we said, Enterprise was only up about some 5% and it'll be up -- overall we expect it to be profitable in the remainder of the year.

Nichol, next question please.

Our next question comes from Simon Leopold of Raymond James. Please go ahead.

Thanks for taking the question. I wanted to see if we could maybe double click on the competitive environment. I appreciate you don't like to name names, but I think a lot of subtle suggestions here. I want to make sure I understand and maybe some things to clarify. Specifically, Erickson's not seeing these kind of margin pressures which suggests maybe this is reflective of the geographic mix. And it also sounds like you're implying renewed pricing pressure in the Chinese market. I'm wondering if we should interpret this as China's revenge on Huawei backlash. And lastly, and this competitive question is we hear a lot of concern about Samsung's growing position. Maybe if you could help the folks put this in context? Thank you.

Yes. There were quite a few questions there Simon. So I think first, if I remember right, one of our competitors has also pointed to some competitive intensity. And again, this is a risk that we see. We're not seeing it right now. This is a risk that we see, because a few competitors are seeking to be a little bit more aggressive. And number two, there are the security concerns which require some swaps. And to mitigate full-scale swaps, we have come up with a technology approach to do it with a light LTE layer and then connect that to a non-standalone architecture for 5G. China and this thing about the -- is that a reaction? No. We saw it similarly in 4G. I think the only difference is volume-wise China is going to be much bigger in five years in industrial policy. And of course we'll play. We expect to play, but we need to be very sensible about how we play. There's no point playing just for top line and volume. That is not the business we're in. And so we'll have to balance that with what is the right margin profile. Other than that, there's nothing specific on competitive intensity. It's a risk that we see potentially.

Thank you, Simon. And this we'll close our Q&A session for today. Thank you for your questions today. I will now like to turn the call back to Rajeev.

Thank you, Matt, and Kristian and thanks all for your questions. I'd like to close with a few key thoughts. Q1 was weak as we had expected, but we have continued reason for optimism as the year progresses. We understand the developments that impacted the first quarter and they are expected to ease over the remainder of 2019. 5G is in its early stages, the ecosystem has not yet mature and Nokia is facing some near-term challenges of our own. But overall, we see things improving quickly and surely. We have a portfolio that is unique for the 5G era. As I noted in my remarks, more than half of our 5G wins include elements of our portfolio that at least one of our competitors simply does not have. We're also seeing real evidence of what I call the virtual circle of investment and that is growth in IP and Optical as operators modernized their transport capability in advance of 5G. Our strategy is also paying off as see good progress in licensing, in software and in our expansion in the Enterprise segment. Still plenty of work to do in all areas, but momentum is with us. Yes, there are risks that I shared earlier, but overall, we remain confident in our ability to deliver in 2019 and have an even better 2020. With that, thank you very much for your time and attention. And I'll now hand it back over to Matt.

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 page 60 through 75 of our 2018 annual report on Form 20-F, our financial report for Q1 issued today as well as our other filings with the U.S. Securities and Exchange Commission. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.