Hello, and welcome to the Nokia First Quarter 2019 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Mr. Matt Schimmel, Head of Investor Relations.
Sir, you may begin.
Ladies and gentlemen, welcome to Nokia's Q1 2019 conference call. I'm Matt Chimau, Head of Nokia Investor Relations. Rajeev Suri, President and CEO of Nokia and Christian Palola, CFO of Nokia are here in 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 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 recorded 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 half 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 full year 2019 guidance. I recognize that given the Q1 outcome, many of you may be skeptical that we can deliver on those commitments or that if we do, it will be at the cost of our 2020 performance. I do not 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 3 key points. 1st, many of our businesses are performing very well and have momentum moving forward.
2nd, we have a clear understanding of what did not go well in Q1 and have confidence that things will improve as the year progresses. 3rd, 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 virtuous circle of investment that I've talked about before as customers prepare their networks for 5 gs. IP routing grew by 12% in constant currency in the Q1, far outpacing the market. That is the 2nd consecutive quarter of growth for the business and we have good momentum moving ahead. Optical Networks continued to grow as well, up 7% in constant currency. While profitability remains dilutive, it is improving and tracking to our plan.
Products based on our Photonic Service Engine 3 chipset PSE3 are already in trial with 2 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 improvements. Then our licensing business, which continues to track well against its strategic roadmap. When you include a new licensee We're also making progress in automotive licensing, We're also making progress in automotive licensing, including the addition of Audi and Porsche to earlier licensees BMW, MINI and 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 had declared more than 1500 patent families essential for 5 gs with more to follow. We are investing to make this happen and delivering patent filings ahead of our internal plan. This is largely through the ongoing work of Nokia Bell Labs and its 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 business is also performing well with net sales to the Enterprise customer segment up by 5 percent in constant currency when you adjust for the 3rd 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 5 gs 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 segments. 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 Q1 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 2 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 1 100th CloudBand customer in Q1 and we have integrated that product with 40 5 network functions from 3rd 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 applications.
The lessons learned from the transformation of our applications business give us confidence that we can transform the core business in an accelerated manner and that it can still deliver 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 top line and profitability to improve significantly as the year progresses? The answer is largely related to 5 gs. 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 €200,000,000 in 5 gs 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 5 gs launches in the country used the September 2018 3 gsPP 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 4 gs software releases in the Q1 as we needed to ensure compatibility with our 5 gs product. This impacted our overall software content and 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 have found software defects and instability in the consumer device chipsets in the process of testing our 5 gs base station software. It seems reasonable to believe that if we were significantly behind our competition as some have suggested, such defects and stability 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 have a consistent record of outperforming our competition in the field. For proof of this, look no further than our Airscale 4 gs 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 5 gs moves forward. The first is software upgradability of existing mobile base stations to 5 gs. 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. 2nd, dynamic spectrum sharing or DSS. Most operators do not see this as a necessary solution in the short to medium term given likely come only at the end of this year. DSS becomes most relevant when operators want to share their old 2 gs, 3 gs or 4 gs spectrum with 5 gs, especially in lower bands. We are well suited to enabling this given that in the past 2 years, we have shipped in the range of 3.8 1,000,000 5 gs upgradable 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. 3rd, you're probably also hearing about common baseband boards for 2 gs, 3 gs, 4 gs and 5 gs. Nokia was the 1st 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 products 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 and others, it appears that our full approach focused on ensuring the best long term value for our customers is making a difference. In past calls, I've 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 3 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 5 gs 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 of such projects that we have referenced 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 underperformance in 2 large projects driven by near term 5 gs delays. These projects will continue to provide a drag in Q2, but are expected to recover as the year progresses. Separate from 5 gs related topics, fixed networks had a challenging quarter with both lower net sales and a geographical mix leading to weak profitability.
We continue to run this 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 like Optus and South African operator, RAIN. It is absolutely unique in the market today as it includes the new 5 gs 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 5 gs speeds to every corner of the home. Finally, on to my 3rd 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 5 gs 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 networks in advance of 5 gs radio rollouts. 2019 should end with the 5 gs ecosystem largely mature and with 5 gs demand continuing to grow in 2020. The second risk we see is a 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 5 gs.
We have no desire to engage in such behavior, but are prepared to act as needed to maintain our footprint. 3rd, 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 expect 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 4 gs overlay layer. And for more on this, I would encourage you to look at a blog on our website from Hari Holma, a Nokia Bell Labs seller and 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 Christian.
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 5 gs 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 Q1. If you assume that we have been able to recognize the approximately €200,000,000 in 5 gs revenue that I mentioned earlier, we would have grown approximately 40% in the market. This is not to excuse 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 may be 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 5 gs. As 5 gs 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 this 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.
2nd, costs. We continue to deliver on our cost cutting targets and are on track to meet the €700,000,000 target we announced with our Q3 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 suggest that we need to adjust course, 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 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 this performance. Christian 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 EconOps have come to an end. That is true as our view of the business has changed 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 Christian. Christian?
Thank you, Rajim. 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, 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. To Nokia Technologies. Net sales in Q1 totaled EUR 370,000,000 an increase of 1% year on year, primarily related Net sales at constant currency were flat year on year. In Q1 2019, we had EUR 40,000,000 onetime net sales compared to €10,000,000 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 €1,400,000,000 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 years. As 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 twenty nineteen when ASN Commercial's 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 and D and SG and 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 €20,000,000 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 of IFRS 16. At a 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 €1,100,000,000 to a quarter end balance of approximately €2,000,000,000 During the Q1, Nokia's free cash flow was negative €930,000,000 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 Q4 of 2018 and certain unexpected and unusual overdues at the end of the Q1. 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 5 gs 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 1st 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 net working 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 biweekly 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 €2,000,000,000 of net cash. During Q1, we successfully issued EUR 750,000,000 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 expenses. Finally, turning to guidance.
As Rajeev mentioned, we have reiterated our full year 19 guidance even if 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 5 gs deployments in addition to early benefits from initiatives in our cost savings program. While our expected weak first half pushed 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 and A.
Thank you, Christian. Nicole, please go ahead.
Thank Our first question comes from Sandeep Deshpande Deshpande of JPMorgan. Please go ahead.
Thanks for letting me on. Rajeev, I have a quick question. I mean, do you have I mean, we are in the early stage of the 5 gs transition. I mean, if you go back to the 4 gs transition and you were in charge that time as well, I mean, the initial part, there was a lot of price war there was a considerable price war in the market. But then eventually, in the 4 gs market, you did come up on top.
Do you see this as a similar sort of situation, which is causing margin impact to the margin? Or is this early part of 5 gs different from how it was in 4 gs? And then when you look at your overall gross margin, is it how would you classify how much of that is coming from any price situation and how much from company specific things such as the software upgrade, etcetera? Thanks.
Yes. Thanks, Sandeep. So I would say that it's not widespread any competitive intensity. I think what we're not seeing that as much right now. What we're seeing are potential signs of that coming through.
So let's be clear that we haven't seen it yet. There's potential signs of that coming through. I would again say that it is it's 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 going to take 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, etcetera.
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 through 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 has come up with a few solutions that we can avoid that, I. E, just put a thin layer of LTE, just swap that thin layer of LTE and then use that to connect to 5 gs on nonstandard architecture.
So I guess in the early days of 4 gs, it was more aggressive because there was also big modernization contract 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 now. I mean, the unchanged 2019 outlook, margin outlook does imply a steep ramp of gross margin as we move from 1st quarter through Q2 and into the back half of the year. I can understand what you're saying about sort of 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 Q1 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 there 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 sequential improvement in gross margin every quarter for the remainder of 2019.
And let me explain the drivers. 1st, of course, is 5 gs growth that will drive improved scale, which will provide us with improved leverage, right? And there are 2 distinct parts to this. Number 1, we expect 5 gs deployments to accelerate meaningfully in the second half, and we have visibility to where those countries are, where those contracts will be. 2, also as we highlighted, we delivered approximately €200,000,000 of 5 gs 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, 5 gs 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 4 gs, not 5 gs, 4 gs because of the compatibility with 5 gs and 5 gs because of what I've mentioned, revenue recognition. And 2, if you move beyond mobile access for a minute, there are also several drivers of improvement. Number 1, improved scale in fixed networks, which was down a lot in Q1. FP4 product cycle in IP routing, structural cost benefit we have there.
3rd, BSE 3 cycle in optical that's coming later in the year. And then on the 3rd 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 add some 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 health, hence, will improve gross margin. And more broadly speaking, we're focused on improving our overall product costs.
Obviously, we're on a new technology transition. And as we progress through the 5 gs technology cycle, I can assure you that we've already taken the necessary actions such as more reef shock chipsets, system on chip products, etcetera, 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 using some new models. And you've seen some moves from some of your rivals from capturing a sort of 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 sort of the restructuring round, not requiring more rounds after this. On the Rakuten, I mean, of course, we're a primary vendor there. We're in a position there. So the network architecture that we see in Rakuten, I don't see that replicating other parts of the world because, one, it's still a close ecosystem and second, it's a greenfield operator.
So they can do it because they don't have to carry any legacy features, 4 gs, 3 gs, etcetera. So it's an isolated setup. We're following that closely because we're involved. It's better to be involved than not. It's a decent contract for us.
Longer term, there'll be other meaningful initiatives, which is Open RAN. Open RAN will start to happen, etcetera. And I think that's a good thing for the industry because then we can stop doing swaps of each other because you can open interfaces and change and mix suppliers 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 risk 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, 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 and fixed networks, we have visibility to that happening, the SP4 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 have happened, more will accelerate Korea. I mean, the launches have happened and acceleration is somewhat already underway. Japan will come next.
Spectrum has been awarded and now 5 gs rollouts will start in earnest as vendor decisions will get to be made. And then there is China, which will happen sort of in Q3 timeframe in terms of the central procurement round 1 decisions Australia that's underway from a 5 gs standpoint, including fixed wireless access. Middle Eastern countries, we've already signed those contracts as part of our 36 commercial 5 gs contracts. And then you have Nordic countries and perhaps a couple of countries in Europe like the UK, Italy, more notably. And then there'll be the rest of them will start to happen more in 20 20.
But this is the 2019 activity list, if you like, from the 33 5 gs 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 €1,400,000,000 I just wonder if you can comment on whether you think there's still opportunities to grow from here, given you've taken away kind of the divisional guide for 20 20. But in the past, you've been targeting, I think, close to €1,700,000,000 And if I can squeeze one quick clarification on the $200,000,000 hardware sales that you're talking about, can you clarify whether you've taken the cost on that from a COGS perspective or whether it's missing from both revenue and COGS?
Maybe I can start just on the latter one. So we are talking about 5 gs deliveries in general 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 thing, yes, we see opportunities to grow from here on. As we said before, there is still more in China. There's the automotive licensing, which is very much underway. There are more IoT verticals, there's consumer broadcast.
So yes, we see the opportunity to 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 5 gs 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, it's way beyond.
Thank you, David. And Nicole, we'll take our next question.
Our next question comes from Akal 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 a €350,000,000 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 has expired or there's been any renegotiation which has led to lower value?
Yes, I
think your thinking is correct. We have some new 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 SEK 1,500,000,000 level. And as Rajeev said, we're going to keep it there and improve it, and it's 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.
Yes. Hi. Thanks for taking my question. I guess my question was on the China business. Clearly, it's going to be the biggest 5 gs 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 give equipment away and then you're looking to 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 that 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 there will be the actual commercial round later in the year Q3 with all of the operators that's also likely to require some upfront losses to be crystallized given that it's going to be aggressive without any commitments and then you have to bank on those revenues 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 certainly not by value.
And we can play a nuanced regional strategy as we have played before, if you recall in Nokia Siemens Networks days to quite some good effect. Having said that, we see opportunity on private wireless with enterprises there, state owned companies. We are 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 Sebastian Tablitz of Kepler Cheuvreux. Please go ahead.
Yes, hello. Thanks for taking my question. Do you see any opportunity in business within the $20,000,000,000 rural digital Opportunity Fund that has 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. I'm not sure I got the question. Was this on a public 5 gs network or?
It's on the 20,000,000,000 Yes.
Go ahead.
Yes, exactly. The overall deployment of broadband in the U. S.
Yes, certainly, we see opportunity there as well. I mean, all things North America, all things 4 gs and 5 gs, 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 this government backed rural opportunities also in other places around the world. There will be linkages between 5 gs licenses 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 funds are not unique, as Christian says. 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 decline in gross margin and I'm wondering if you can break it down. I tried to add back the $200,000,000 to revenues and even if I edit at 90% margin, just to see what's the impact on gross margin, it's 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
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 a technology cycle, product costs are relatively high and then you improve them as you work through the as the technology matters. In addition to that, we did experience several challenges in Q1. First, as you correctly pointed out, we were unable to recognize approximately €200,000,000 of 5 gs 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 releases also for 4 gs in the quarter. In Mobile Access, we were also negatively impacted by having a higher proportion of network deployment services in the business mix. And then thirdly, in services within mobile access, we were impacted by some cost overruns and some underperformance in 2 large program projects, driven by near term 5 gs 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,
Tal. Nicole, next question please.
Our next question comes from Alexander Peteric of Societe Generale. Please go ahead.
Yes. Hi, and thanks for taking my question. I'd just like you to come back a little bit on the €200,000,000 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 1st 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? Just put a little bit of color on that. Thank you.
I think maybe I can start and Roger, please chip in. I think what we are saying is that things are improving quickly. There will be some improvement already in the Q2, but the full benefit of the $200,000,000 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 to recognize this revenue. And when it comes to additional costs, that's not a topic here. It's more it takes some time to mature the software to the stage that it meets general availability as well as the customer commitments that we've made and then we'll hit the recognition milestone.
I'd just add to that, Alex, is that we see cost reduction in services, in cost of sales happening in the remainder of the year, particularly in second half. And then as I said, more operational scale and fixed networks is going to help in SP4 product cycle and PSE3 optical product cycle as well as, like we said, enterprise was only up about some 5%, and it will be up overall, we expect it to be faster growing in the remainder of the year.
Thank you, Alex. Nicole, 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, Ericsson'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. Wondering if we should interpret this as China's revenge on the Huawei backlash. And lastly, in 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 2, 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 non standalone architecture for 5 gs. China and this thing about is that a reaction? No.
We saw it similarly in 4 gs. I think the only difference is volume wise, China is going to be much bigger in 5 gs. It's an 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 to say on competitive intensity. It's a risk that we see potentially.
Thank you, Simon. And with this, we'll close our Q and A session for today. Thank you for your questions today. I would now like to turn the call back to Rajeev.
Thank you, Matt and Christian, and thanks all for your questions. I'd like to close with a few key thoughts. I mean, 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 Q1 and they are expected to ease over the remainder of 2019. 5 gs is in its early stages, the ecosystem is 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 5 gs era. As I noted in my remarks, more than half of our 5 gs 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 have called the virtuous circle of investment and that is growth in IP and optical as operators modernize their transport capability in advance of 5 gs. Our strategy is also paying off as we 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 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. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.