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Nokia Oyj (NOK) Q1 2023 Earnings Call Transcript

Nokia Oyj (NOK)

Q1 2023 Earnings Conference Call

Company Participants

David Mulholland - Head, IR

Pekka Lundmark - President & CEO

Marco Wiren - CFO

Conference Call Participants

Andrew Gardiner - Citigroup

Alexander Duval - Goldman Sachs Group

Daniel Djurberg - Handelsbanken

Sandeep Deshpande - JPMorgan Chase & Co.

Joseph Zhou - Redburn

Sébastien Sztabowicz - Kepler Cheuvreux

Aleksander Peterc - Societe Generale

Stefan Slowinski - BNP Paribas Exane

Simon Leopold - Raymond James & Associates

Francois Bouvignies - UBS

Sami Sarkamies - Danske Bank

Richard Kramer - Arete Research Services

Presentation

David Mulholland

Hi, everyone, and welcome to the Nokia Q1 2023 Results Call. I'm David Mulholland, Head of Investor Relations. And today with me is Pekka Lundmark, our President and CEO; along with Marco Wiren, our CFO.

Before we get started, a quick disclaimer. During this call, we will be making forward-looking statements regarding our future business and financial performance, and these statements are predictions of 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 as well as internal operating factors. We have identified such risks in the Risk Factors section of our annual report on Form 20-F, which is available on our Investor Relations website.

Within today's presentation, references to growth rates will mostly be on a constant currency basis, and margins will be based on our comparable reporting. Please note that our Q1 report and the presentation that accompanies this call are published on our website. The report includes both reported and comparable financial results and reconciliation between the two.

In terms of the agenda for today, Pekka will give a quick overview on our financial and strategic progress in the quarter and then Marco will go into a bit more detail for the key factors impacting our financial performance along with our outlook to 2023.

With that, let me hand over to Pekka.

Pekka Lundmark

Thank you, David, and good morning, everybody. Q1 has been a busy and exciting quarter for us. We started this year with the unveiling of renewed corporate strategy. And as you remember, refresh brand at Mobile World Congress in Barcelona. We shared the 6 pillars of our updated strategy in Q4, which you see on the slides. I won't go into detail about them again. But in general, in Q1, we have executed well on gaining market share in the CSP space, which is the first pillar. You can see that very clearly when you look at our growth rates. And we have also seen enterprise, pillar #2, continue to rise as a share of the group sales and was another quarter at close to 10% of the group, growing 62%.

Regarding pillar 3 and actively managing our portfolio, there were some actions taken in Q1. We have signed agreements to divest part of our RFS business, and we have sold our VitalQIP business. Also, we recently agreed to sell our stake in the joint venture, TD Tech, subject to closing conditions. These actions won't significantly impact our financials, but are important proof points of how we are managing the portfolio.

Underneath the 6 pillars are 4 enablers. Talent, which is about developing future fit talent. Long-term research is important. We believe that sustained technology leadership is a key driver of our success. Digitalization, we are increasing the digitalization of our own operations to increase our own performance and productivity. And finally, brand. The new branding reflects who we are today, a B2B technology innovation leader, unleashing the exponential potential of networks.

So with that, let's now turn to the financials. We delivered a solid start to 2023, with Q1 net sales growing 9% in constant currency. We saw double-digit growth in both Network Infrastructure and Mobile Networks, reflecting the ramp-up of 5G deployments in India as we expected. We also saw growth in CNS, and I will come back to the decline in technologies later.

Our comparable operating margin was 8.2%, a decline of 270 basis points year-on-year, which was primarily due to expected greater seasonality in Mobile Networks' profitability, a weaker contribution from Nokia Technologies in the quarter and the negative impact from venture fund investments.

As we look forward, we are starting to see some signs of the economic environment impacting customer spending. However, given the ongoing need to invest in 5G and fiber, we believe this uncertainty is primarily a question of timing. We will maintain our cost discipline to ensure we can successfully navigate this uncertainty, and we remain on track to deliver another year of growth in 2023 with our outlook unchanged.

If we now turn to address each of the business groups in more detail. And first, looking at the performance of Network Infrastructure. We delivered 13% growth year-on-year in constant currency. Optical Networks grew 45% with good engagement for our PSC 5 solutions and with some benefits from catch-up sales from the supply chain challenges we saw in 2022. IP Networks grew 13%, driven by North America and also a strong performance in enterprise. Our new FB 5-based routing products are now shipping, and we accept a gradual transition to the new platform in the coming years.

We saw a small decline of 5% in Fixed Networks against a tough year-on-year comparison. Weakness in fixed wireless access offset continued robust demand for fiber. Submarine Networks grew 11% as web scale-driven project deployments continued to drive growth. Gross margin expanded 330 basis points as a result of product mix benefits and lower costs in areas such as logistics, which have declined versus last year.

Operating margin of 15.3% was up 540 basis points versus last year, reflecting our gross margin expansion, which was only partially offset by higher OpEx. Going forward, growth rates are expected to slow in the coming quarters as Q1 benefited from some catch-up, as supply chains normalize and with comparisons becoming more challenging, but we remain confident in our competitive positioning.

I'd also like to highlight the product launch we made in Optical Networks in Q1. Just before Mobile World Congress, we unveiled PSE-6s, Nokia's sixth-generation super current optical engine for high-performance optical networks. With this product, PSE-6s, Nokia brings to market new optical transport capabilities, including the ability to deploy solutions with 1.2 terabits per second of wavelength, and because we are able to connect two chips together on a single line card, we can support up to 2.4 terabits per second, which is an unmatched capacity on the market. We have also set a new benchmark in performance, enabling reach of over 2,000 kilometers at 800 gigabits per second. Sustainable network evolution with 60% less power consumption per bit compared to previous generations.

We had great take-up of our PSE-5 solutions already and we see good potential to continue that momentum with PSE-6s. Our interactions with customers have been extremely positive so far.

Then turning to the next business group, Mobile Networks. Also, there, it was great to see a 13% growth in the first quarter. It was driven, as we expected, by the ramp-up of 5G deployments in India. But we also saw good traction in Europe. Together, these more than offset the expected softening in North America sales in the quarter. North America had seen a front-end loaded investment profile in 2022. So this quarter marked a normalization of customer spending and also reflected some inventory depletion.

With respect to gross margin, the regional shift had an impact as expected, but disciplined cost control partially offset this at the operating margin level. As we look forward, we expect to see broadly similar trends in the second quarter with continued pressure on gross margin from regional mix before we see this start to progressively improve in the second half of the year.

As I mentioned earlier, it's clear that there is some economic uncertainty impacting customer spending plans. In that regard, it is worth noting that if we look globally, excluding China, only about 20% of sites, mobile base station sites, I mean, are currently active for mid-band 5G, which should help illustrate how much investment still needs to be made. And even if we look at some markets like North America, which had invested earlier, mid-band site penetration is still only around 50%.

At Mobile World Congress, we also unveiled Habrok, our latest generation of industry-leading AirScale radios, which deliver future-ready performance. Habrok has high output power for increased coverage while its lower power consumption improves energy efficiency by 30%, lowering total cost of ownership. This new generation of radios enables form factor improvements over earlier generations while the Habrok 64 weighing only 24 kilograms, making them fast, easy to install. And of course, they are all powered by our cutting-edge ReefShark chipset, some of which are based on 5-nanometer technology. These optimized products refined radio performance with ultrafast 5G speeds and capacity where it's needed.

And then moving to Cloud and Network Services business. CNS grew by 3% in the quarter with growth in both core networks and enterprise. Gross margin declined as we saw a shift from software sales to lower-margin hardware sales in the quarter. So that was primarily a mix question. Operating margin was minus 2.6%, resulting from lower gross margin with some increases in SG&A and R&D expenses as we continued to invest to strengthen leadership, especially in campus wireless.

Our rebalancing work in CNS continues and in the quarter, we divested VitalQIP, a relatively small IP address management product, which was within CNS. For the full year, we continue to assume a 5% to 5% -- an 8% to 5% operating margin, keeping in mind this remains a business with significant seasonality in Q4.

Nokia Technologies' net sales declined by 22% in the quarter. On a year-over-year basis, there were 3 factors driving this decline: the fact we no longer benefit from the license that had an auction exercised in Q4; lower net sales from a smartphone vendor whose market share meaningfully declined; and finally, lower brand licensing. Excluding these 3 factors, our licensing income was essentially stable, also accounting for the renewed agreement with Samsung.

We know there have been many questions around our technologies business in the past year as we navigate the smartphone license renewal cycle and with this slide, we wanted to give you some more detail on the moving parts. We start from the EUR 1.4 billion to EUR 1.5 billion run rate we talked about back in Q2 '21 before some agreements started expiring. You can see the moving pieces from then to the EUR 1 billion run rate you now see in Q1.

The two biggest factors are the deals that are currently in litigation or renewal, and the 10-year license, which was signed in 2014, but then saw an auction exercised in Q4 2022, which meant all outstanding revenue was recognized for that license. Consequently, this agreement no longer benefits our income statement. There have also been some agreements with smartphone vendors that are no longer active or whose market share has meaningfully declined, which needs to be reflected as we go through the renewal cycle. You can also see the benefits we have seen from our progress in growth areas like automotive and consumer electronics. And finally, there is the impact of brand licensing, which was weak in Q1.

This brings you to the current EUR 1 billion run rate. We remain confident we will return to the EUR 1.4 billion to EUR 1.5 billion run rate. The biggest step to getting there is smartphone license renewals. As you know, we are in active litigation on some of those. We remain confident in our position and that we will see a good resolution to these deals. We also continue to see opportunities in the future to continue to expand in our focused growth areas.

Looking now at another one of our focus areas, the enterprise customer segment. In Q1, we saw continued momentum in our enterprise sales with growth of 62% and it was almost 10% of group sales for the second quarter in a row. Growth was particularly strong in web scale, where sales more than doubled in the quarter. Private wireless continued to grow strongly double digit and now has more than 595 customers. Customer engagement also remains positive as we added 73 new enterprise customers in the quarter.

And with that, let me hand over to Marco, who will take us through the financials in a bit more detail.

Marco Wiren

Thank you, Pekka, and hello from my side as well. So looking at our net sales performance by region, our 9% constant currency growth was fueled by India as expected, with 5G deployments continuing to ramp up for Mobile Networks in Q1, but also Network Infrastructure showed strong growth in the region. In Europe, you see that we had a 13% growth, excluding Nokia Technologies, with strong double-digit growth across the other 3 BGs. Elsewhere, we saw growth in both Middle East and Africa and Latin America. These were somewhat offset by North America, which declined 12% overall, driven by Mobile Networks and partly offset by increases in Network Infrastructure and Cloud and Network Services. Greater China and Asia Pacific also declined somewhat while Submarine Networks grew by 11%. So in summary, quarter 1 largely played out as we expected, with 5G deployments in India heavily influencing our Q1 top line.

Then turning into the operating margin performance in the quarter, and you saw the decline 270 basis points and ended up at 8.2% operating margin. This decline largely reflects the impact of regional and product mix, especially in Mobile Networks and Cloud and Network Services. We did see some benefit from that 9% group net sales growth, which provided some operating leverage. You can also see that the lower overall level of net sales in technologies had a negative impact on operating margin. And finally, our venture fund had a year-on-year negative impact of EUR 70 million, which is recorded in other operating income and expense. And the low value in this quarter of EUR 30 million was evenly split between FX fluctuations and revaluations....

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