Nokia Oyj

OMXH:NOKIA

Earnings Call Transcript 2018-Q1

[Operator]

Hello, and welcome to the Nokia First Quarter 2018 Earnings Results Conference Call. [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. Sir, you may begin.

[Matt Shimao, Head of Investor Relations]

Ladies and gentlemen, welcome to Nokia's First Quarter 2018 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 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 71 through 89 of our 2017 Annual Report on Form 20-F, our financial report for Q1 2018 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.

[Rajeev Suri, President & CEO]

Thanks, Matt, and thanks to all of you for joining today. Nokia's first quarter was mixed, but underlying those results were some upbeat developments that give us considerable confidence in our ability to meet our guidance of full year 2018. In fact, we see an improvement in market conditions from what we shared last quarter. Believe that Nokia is well positioned to outperform in that strengthened market and expect that the mix of issues that impacted our gross margin in the first quarter is largely temporary in nature and expected to improve in the second half of 2018.At a group level, our net sales were approximately flat year-on-year, while Networks was down by 2.7%, both on a constant-currency basis. Nokia Technologies had a stellar quarter driven by recurring licensing revenue with sales up 49% year-on-year, also in constant currency. Non-IFRS group operating profit was 4.8% in the quarter, down 150 basis points from 1 year ago. Underlying this was weak profitability in Networks offset partially by considerable strength in Nokia Technologies. Pleasingly, Networks order intake and backlog were excellent in the quarter, particularly in North America. In fact, both were among the best that I can recall. We also saw further progress in our diversification efforts as momentum continued with large enterprise and Webscale customers. To put our Q1 performance in more perspective, I would like to focus the rest of my remarks on 3 key topics: first, market developments particularly related to 5G; second, our Networks gross margin performance; and third, progress on executing our strategy. Let me start with market development, and you will have seen that we shared an improved view of market conditions in our earnings report. We also said we expect our Networks business to outperform the market. The primary driver for the market improvement is that 5G momentum is building fast, and Nokia is remarkably well positioned as that happens. We now expect meaningful commercial rollouts in the United States to start in the second half of this year followed by large-scale commercial deployments in this and other geographies in 2019. There are 3 things driving this trend. The first is the ever-growing consumer demand for capacity. I have talked to a number of our customers who are straining to meet traffic growth and need the significant capacity increase and lower cost per bit that comes with 5G. The second driver we see for 5G momentum is competition. There is no doubt that operators are looking at their competitors and worrying about potentially facing someone else's powerful 5G marketing and network performance. They do not want to be exposed and know they will need to move to address this competitive threat. I would also note that there is competition between countries on 5G, with many pushing to be first, the United States and China to be sure, Japan and South Korea, but also within the Nordics and the Middle East. The third 5G momentum driver is industrial use cases. While the opportunity here will take longer to develop, we certainly believe the potential is there for enterprises to achieve a step change in productivity with the use of next-generation networks. That interest is real. As just one example, I had dinner the other night with a half dozen CEOs of industrial companies, all of whom saw the promise of improving efficiency through the use of dedicated 5G network slices that provide end-to-end security and ultra-low latency. From a geographical perspective, things really start with North America. Even if we had a soft first quarter in that part of the world, we see excellent momentum building for the second half of this year, both for the market and for Nokia. This is not based on expectation alone. It is also based on deals that we are winning in orders that we have already received. As I mentioned earlier, we expect commercial 5G rollouts in North America later this year, along with an overall focus on delivering improved mobile broadband network performance in the region. There was, of course, a risk that operator consolidation could put a slight dampener on our optimistic view, but we would not expect that to fully derail the trends we are seeing. Then China. Our current view is that commercial deployments of 5G will start around the middle of 2019, although we know that if China decides to accelerate, things can change very fast. Current trade tensions add some uncertainty to our business in China, but at this point, we expect that prudence will prevail. And given the overall market dynamics in China, we do not expect European companies such as Nokia to see an impact within the country. The Nordics, Japan, South Korea, parts of the Middle East, all can be expected to move fast with 5G as well.In short, and recognizing that there are some skeptics, we see 5G coming fast and coming big. As this happens, we expect an atypical seasonal trend with softness in the first half of this year, offset by a very dynamic second half. And as I said earlier, we are confident that we can outperform a strengthening market and meet our full year guidance. Just to give you a quick snapshot of Networks regional performance in the first quarter. We saw 3 of our reported regions, Asia Pacific, China and North America, decline in terms of net sales on a constant-currency basis, while the other 3: Europe, Middle East and Africa, and Latin America all grew. Quite pleasingly, both Latin America and Middle East and Africa were up in double-digit percentages, again, in constant currency. Latin America delivered an excellent performance across all Networks business groups and particularly, in Mobile Networks. Middle East and Africa was favorably impacted by increased demand for broadband services benefiting Mobile Networks and Fixed Networks. And we also saw good results for Nokia Software in the region. Then, the second topic I want to cover: Networks gross margins. As you will have seen, Networks non-IFRS gross margin dropped year-on-year by 370 basis points. And I would like to put that in some context for you. While I'm certainly not pleased with the decline, we saw a bit of a perfect storm when it came to product and services as well as regional mix. On the regional side, we saw soft sales in North America, which was the primary driver of the margin decline. North American sales as a percentage of revenue were among the lowest in many quarters. As a reminder, we had a strong Q1 2017 in North America with unusually high spending from 2 customers in particular, giving is a top year-on-year compare. Latin America and the Middle East and Africa on the other hand, had strong top line quarters. And while that is a good thing, those markets tend have lower margins than North America.On the product and services side, we saw good IP routing sales performance offset by even stronger, but lower-margin optical sales. A poor financial quarter for Nokia Software that included delays of certain projects and a lower-than-typical conversion of orders to sales, and a significant portion of Global Services sales coming from network implementation. Despite what we saw in Q1, the primary underlying reasons for Networks gross margin performance, the regional and product mix issues I just cited are largely temporary in nature, and as I said at the start, expected to improve in the second half of 2018. North America should ramp significantly for us starting in the second half, as our customers turn from planning for 5G to getting execution underway. As more of our FP4-based routers come to market, we should see a better balance between IP routing and optical. In Mobile Networks, our underlying cost base should improve significantly as we increase shipments of the latest AirScale products. Software orders were up by strong double digits in Q1 indicating forthcoming improvement. In services, we have a high level of network implementation that will continue as pre-5G rollouts proceed, And of course, as sales increase particularly in the second half, operating leverage will support better performance.I would also note that when we look at margins of specific product lines, we have not seen unusual margin compression. Products that were typically strong in earlier quarters remain robust in Q1, though that was softer, remained that way. And we certainly saw considerably more of those softer products and services as a percentage of total sales in Q1. In short, we do not have any reason to believe that Q1 was a new normal for our gross margins and remain confident that things will start to rebound in the coming quarters.Now the third point I want to cover, execution of our strategy where we are making considerable progress. I will start with leading and high-performance end-to-end networks for communication service providers. Not only are we positioned very well in key parts of our portfolio, but the strength of our end-to-end capabilities is resonating with customers. I have talked about the power of end-to-end before, and we are now seeing it really take hold. In fact, when you look at our sales pipeline, 35% of it is now comprised of multi-business group deals. On the individual product side, our innovation engine is delivering well. Among other things in the quarter, we announced 2 new chipsets: ReefShark for Mobile Networks; and our Photonic Service Engine 3 or PSE-3 for Optical Networks. Both are leaps ahead of the competition and both will give us differentiation for some time to come, as creating your own silicon takes time, effort and above all, expertise. In addition, and as I said earlier, we are in a very strong position for 5G. Our AirScale platform is performing very well in the field. Recent software releases are at the highest quality levels ever and the roadmap issues which we saw last year are largely behind us, even if there is plenty of heavy R&D lifting still to come in the sprint to 5G.By the end of Q1, we had around 55 engagements with customers in 17 countries on the design, trial and testing of 5G solutions. These include major players such as AT&T, T-Mobile, Sprint, Verizon, NTT DOCOMO, Korea Telecom, SKT, China Mobile, HTC and others. I would also note that in Q1 we won the biggest deal in Nokia's recent history and that deal is very much about 5G.Let me share just a few other highlights from the quarter that were relevant to this part of our strategy. Our worldwide IoT network grid, or WING, a new offering now, has 3 customers and massive interest from others. As a reminder, WING gives operators a ready-to-go solution for monetizing IoT connections to a recurring pricing model. AirScale migrations in North America are now ahead of customer commitments. New deals were won in the quarter that expanded our footprint with customers such as Telenor Pakistan and Orange in Middle East and Africa, with whom Nokia will build a single radio access network in 7 African countries. Continued progress was made on Fixed Networks entry into the cable market with our Gainspeed-based portfolio. And this progress included, just after the quarter ended, an important agreement with a big cable player.Onto the next pillar of our strategy, expanding in select vertical markets needing high-performing secure networks. And this is now on a clear trajectory to reach the scale necessary to become a meaningful part of our business. Excluding the third-party business that I've mentioned before and that we are in the process of exiting, our year-on-year sales to enterprise and Webscale companies were up almost 20% in the quarter and orders grew even faster. Our performance in this area is one of the reasons that I believe Nokia can outperform our primary addressable market in 2018. The second reason being the deals we are winning and the orders we are receiving in North America, which we expect will benefit our results in the second half of the year. Our product competitiveness for the areas that we are targeting is very good and showing in our results. Take for example, our IP/Optical Networks business group, which delivered excellent year-on-year sales growth of 7% in constant currency. Within that, our optical business was up sharply in the quarter compared to last year. And while a large portion of these sales were to the communication service providers, our fastest growth is with Webscale companies. In IP routing, sales were roughly flat year-on-year across all customers, while both sales and orders from enterprise and Webscale customers were up nicely in the period. I would also note that we are seeing excellent interest in our FP4-based products and now have trials underway or planned with more than 60 customers. Results of those trials look very good. Separately, we landed some meaningful new wins in the quarter, including our largest ever GSM railway contract, a good example of our ability to bring an end-to-end solution together including GSM-R and mission-critical IP MPLS and optical transport as well as managed services to enhance railway security and reliability. In the third pillar of our strategy, building a strong software business at scale, we hit a performance speed bump in Q1. But our year-on-year order growth in Nokia Software was the best of any of our Networks business groups, almost in the mid-double digits. As I've said on past calls, we have done a massive amount of foundational work over the past 2 years, rearchitecting our products on to a common software foundation, strengthening our go-to-market capabilities and more. We're also bringing modern, differentiated applications to market. And in Q1, we launched our artificial intelligence powered cognitive analytics for customer insight designed to help operators efficiently deliver a superior real-time customer experience. And also in the quarter, U.S. Cellular selected Nokia's customer experience management portfolio, which includes that new analytics product. This progress combined with our robust orders and backlog and when recognizing that Q1 was impacted by the timing of certain projects and overall softness in North America, gives me confidence that we are tracking in the right direction, even if it is also time for increased vigilance and greater focus on sales execution.In the fourth pillar, building new business and licensing opportunities in the consumer ecosystem, there are 2 developments I would like to share. The first is the strength of our licensing business, where Q1 recurring revenue was up 65% year-on-year. Based on that result, we are now at an annual recurring revenue run rate of approximately EUR 1.4 billion, and we see additional opportunities this year with Chinese mobile phone companies and in the automotive sector. We also see the potential, although not yet proven, opportunity to build meaningful businesses and brand licensing in new categories beyond our successful phone collaboration with HMD Global and technology licensing leveraging some of our unique assets. The performance we are seeing gives me confidence that we are on track to meet our goal of driving a CAGR of approximately 10% for recurring net sales for the 3-year period up to 2020. The second development is the strategic review of our digital health business that we announced in the quarter. That review is ongoing, and we continue to take costs out of Nokia Technologies as we ramp down direct-to-consumer incubation projects. Our goal is to ensure that tech is a highly focused driver of licensing activities -- patent, technology and brand for the company, and we are moving fast in the direction. With that, I'd like to turn the call over to Kristian for more on of our financials. Kristian?

[Kristian Pullola, Chief Financial Officer]

Thank you, Rajeev. I will start today by spending a few minutes on the financial performance of Nokia Technologies, then a few words on taxes and financial income and expense. Next, I will take you through our cash performance in Q1 and key cash items for Q2; and finally, I'll walk you through our guidance. Starting with Nokia Technologies. We delivered strong performance in the business in Q1 with net sales up 49% year-on-year at constant currency and operating profit up 136%. With growth reflecting very strong execution by our licensing team over the past quarters, and we believe we are well positioned to extend our track record and deliver on our long-term guidance. On a sequential basis, our recurring net sales increased primarily based on earlier signed agreements kicking in. You can calculate that we are now at an annual recurring net sales level of approximately EUR 1.4 billion. The operating margin for technologies reached 75% in the first quarter, driven primarily by higher net sales as well as a decrease in operating expenses. In addition to continued efforts to optimize costs related to our patent portfolio, R&D expenses benefited from the reduced investments in digital media. SG&A expenses also declined mainly due to the absence of the litigation costs related to Apple, which impacted the year-ago quarter. As Rajeev said, we have announced that we put our digital health business under strategic review, which is ongoing. In Nokia Technologies, we are continuing to operate with a very disciplined approach, keeping a close eye on ensuring appropriate investment levels. Moving on to taxes and financial income and expense. As you may remember, we have been involved in a long-standing tax dispute in India related to our legacy devices and services business. The Indian and Finnish governments reached a resolution in Q1, which Nokia accepted, resulting in a onetime tax expense of approximately EUR 200 million. This resolution also resulted in a cash outflow of approximately EUR 100 million in Q1 as we had already paid EUR 100 million earlier. We are pleased to put this tax dispute behind us. The resolution allowed us to release earlier booked provisions and ultimately, resulted in a positive net P&L impact of approximately EUR 160 million. Note that this positive impact was reported in discontinued operations and not in our results from continuing operations. Also note that in Q2 ,we expect to release of approximately EUR 100 million of frozen cash assets in India. This can be seen as offsetting the negative Q1 cash impact. Our non-IFRS tax rate for the first quarter was 30% in line with our full year 2018 guidance, which we have reiterated today.Turning to non-IFRS financial income and expense. Our Q1 results reflected our adoption of IFRS 9 and IFRS 15 and now include, in financial income and expense, new items such as costs related to the sale of receivables and financing elements from customer and other contracts, which were not in FIE in 2017. In addition to these expenses, FIE reflected expenses associated with the financial liability related to Nokia Shanghai Bell higher losses from foreign exchange fluctuations partly offset by lower overall interest expenses. For more details on the impact of the adoption of IFRS 9 and 15, you can refer to Note 14 in our first quarter release.Next moving to our cash performance in Q1 and select key cash items for the Q2. On a sequential basis, Nokia's net cash decreased by approximately EUR 340 million with a quarter-end balance of approximately EUR 4.2 billion. The sequential decrease was mostly attributable to net cash used in investing activities, primarily due to capital expenditures. CapEx came in particularly high in the quarter totaling EUR 260 million of which approximately EUR 100 million was nonrecurring in nature. I would like to point out that we have reiterated our CapEx guidance for the full year to be EUR 700 million. So for the remainder of 2018, we expect our quarterly CapEx to go back to more normalized level similar to that what we saw in 2017.Net cash used in operating activities was approximately EUR 110 million. With this -- within this, Nokia had approximately EUR 130 million of restructuring and associated cash outflows. Excluding restructuring, we experienced an increase in net cash related to net working capital of approximately EUR 100 million. This was primarily due to a decrease in receivables, which was driven by a payment we received related to a licensing agreement signed in the fourth quarter 2017 in addition to typical seasonal decline. This was offset by an increase in inventories and a decrease in short-term liabilities, both of which were also primarily driven by typical seasonality. Cash taxes amounted to approximately EUR 190 million in the quarter, more than half of which was related to the Indian tax dispute that I discussed earlier. We had already taken this payment into consideration when providing our 2018 cash tax outlook. So therefore, no change in the guidance. Looking ahead into Q2, there are 2 key items related to cash that I would like to remind you about. First, our Board of Directors has proposed a dividend of EUR 0.19 per share for 2017. The payment of which will have a negative impact on our cash balance of approximately EUR 1 billion when paid out to shareholders after our AGM to be held next month. In addition, as is typical in Q2, bonuses paid under our annual employee incentive plans will have a negative impact on cash. Finally, turning to our guidance. I will touch upon a few of the key updates we have made today. At a Nokia level, we have reiterated our 2018 and 2020 guidance for both non-IFRS operating margin and EPS. Moving on to our cost savings program. We remain on target to deliver the EUR 1.2 billion of recurring annual cost savings in the full year 2018, with EUR 800 million expected to come from operating expenses. Given our active efforts to drive 5G adoption in 2018, we now expect these savings to be partly offset by approximately EUR 100 million to EUR 200 million of the incremental temporary expenses in 2018 related to 5G customer trials. This is an update compared to the EUR 100 million that we previously guided for. To be clear these incremental expenses are specific to 2018. Then moving on specifically to Networks. Given the acceleration that we have seen in 5G, particularly in North America, we have updated our views on our primary addressable market in 2018. We now expect a decline of approximately 1% to 3% on a constant-currency basis, an improvement compared to our previous guidance for a decline of approximately 2% to 4%. We have also updated our net sales guidance for 2018 and now expect to outperform our primary addressable market. This view is primarily based on two things. First, customer demand for 5G. We see 5G accelerating further with commercial network deployments beginning near the end of 2018 and increasing through 2020. Second, in addition to 5G acceleration, our progress in our strategy to diversify and expand in targeted adjacencies also supports our confidence that we can outperform our primary addressable market this year. We have also reiterated our operating margin for Networks to be in the 6% to 9% range for the full year 2018. It is important to know that we are guiding for top line weakness to persist in the first half of 2018, as we expect the Q1 demand and mixed dynamics to continue into Q2. Let me also remind you that there will be a negative impact due to FX on our reported net sales in the second quarter 2018 and full year 2018, assuming the Q1 foreign exchange rates and currency mix. For Networks overall, the math would yield an approximately 8% year-on-year headwind in Q2 net sales and an approximately 6% headwind on full year 2018 only due to FX. So please take this into consideration as you update your models. Over the long term, we continue to expect to outperform our primary addressable market. We are very well positioned to benefit from our end-to-end strategy as the 5G investment cycles ramps. The progress we are making with diversifying towards attractive adjacent markets and building a strong stand-alone software business, also positions us well to outperform our competitors over the long term. Finally, on the licensing business within Nokia Technologies. We reiterated our guidance for recurring net sales to grow at a 10% CAGR over the 3-year period ending 2020 and continue to expect to reach operating margins of 85% for the full year 2020. Based on Q1, we are already off to a great start to the year in this business. With that, over to Matt for Q&A.

[Matt Shimao, Head of Investor Relations]

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

[Operator]

[Operator Instructions] Our first question comes from Aleksander Peterc of Societe Generale.

[Aleksander Peterc, Equity Analyst]

I just -- I'm just wondering on 5G. Do you see primarily the U.S. market accelerating here or pushing for faster rollouts? Or are there other regions going the same way if that tends primarily to 2019? And also will these first rollouts be for stand-alone 5G networks or nonstandalone?

[Rajeev Suri, President & CEO]

Thanks, Alex. So let me give you some color here and expand on this properly. So we see U.S. doing commercial rollouts beginning in the second half of this year, but we're talking large meaningful commercial rollouts. And in the U.S., the operators will make use of whatever spectrum assets they have. Millimeter wave in case of Verizon and AT&T, some other low-band spectrum AT&T might have. T-Mobile 600, Sprint 2.5 gig, so the spectrum they have. And then after that, we see, of course, that expanding in 2019. And then, in 2019 -- early 2019, we see South Korea that will do a nationwide 5G build. Japan that will get its spectrum in the mid-band around first quarter of '19, and then will start to build basically in time for Summer Olympics in 2020. Then you'll get China starting in around mid-2019 with tendering activity happening in the first quarter '19. So rollouts begins in second half of 2019, mid-2019, that will continue in 2020. Then you have Middle East around the same time in 2019 as well, so many advanced countries in the Middle East, Saudi Arabia, Qatar and so on. Nordic countries, Finland, Sweden, Denmark. And then, you'll get a second wave of 5G happening when the mid-band is allocated in the U.S. as well and that will happen around sort of late 2019 and so on. So that's how we see the lay of the land. Then after that will be India because the capacity needs there are becoming quite extreme, say, in 2020 and Europe around that same time frame and then 2021 onwards, the rest of the world. Sorry, I didn't answer your nonstandalone, so let me finish that. So most of the deals we're looking at right now, most of the activity is nonstandalone. And -- but there is discussion on standalone. Stand-alone 5G will come later, particularly for network slicing for industrial use cases.

[Operator]

Our next question comes from Sandeep Deshpande of JPMorgan.

[Sandeep Sudhir Deshpande, Research Analyst]

Rajeev, you talked about the -- how you see the orders into the second half of the year in 5G. But you've had low visibility on orders in the rest of your business, 3G, 4G, over the last couple of years. So how do we get some sense of -- a view of your view into these orders? And how they're going to progress for the year? Because if you do get strong 5G orders, but in the others, at this point, there is still some risk.

[Rajeev Suri, President & CEO]

Yes. Thanks, Sandeep. I think in a typical year, a more normal year, it's -- you get your ups and downs. You look at your order intake, backlog and book-to-bill and that gives you some limited form of visibility. What's different in this year is right at the start of the year, we have large commercial, build-oriented 5G contracts that are in the bag at this point in time. So we're actually moving from converting those orders to starting to execute, get the supplies in motion, prepare for services. So that is really different that we have these large contracts already in the U.S., which we know will clearly be there in second half, and then we'll start to expand in 2019.

[Operator]

Our next question comes from Richard Kramer of Arete Research.

[Richard Alan Kramer, Senior Analyst]

Just following on from that. We've now seen 3 quarters in a row where North America orders are down -- or sales, sorry, are down 20% to 30%, in some cases against declines in the previous year, and you're mentioning these large orders. I guess, the bigger question is are you looking for the recovery to be a sort of mean reversion where you get back to previous levels? Or do you think when you look at your order book within both carriers and Webscale players and others that there are large incremental bits of business for you to go after either in areas that you weren't present before or where you will take material share. And I guess, for the same notion in China, do you think there is an opportunity for given Nokia Shanghai Bell that you can take materially higher share or get incremental business that you simply weren't seeing before? Or is this just a return to the spending levels we were seeing a couple years ago?

[Rajeev Suri, President & CEO]

Thanks, Richard. So just at the highest level, I think I will say that the end-to-end portfolio is resonating with customers, particularly in the world of 5G because 5G is such a reinvention of the network and end-to-end matters much more now than before. Second, I will say that we are well positioned even this year to gain share in mobile, and IP and optical. And in the case of mobile, I see it coming from essentially 5G. And of course, with 5G, there is always a bit of acceleration that happens in carrier aggregation LTE-advanced 4G. And then in the case of IP routing and optical, it's because of doing well in the service provider space, but also because of our success in enterprise and Webscale. So I'll leave it there at the highest level. Of course, China we'll see when the opportunity comes.

[Operator]

Our next question comes from Andrew Gardiner of Barclays.

[Andrew Michael Gardiner, Director]

So another one on the 5G side of things, specifically on the raising OpEx related to the trials going from EUR 100 million to EUR 200 million. I'm just -- can you give us any more detail in terms of what has changed relative to sort of the January, February time when you first gave that number? Is it in a particular region relative to sort of how you describe things in the first question? Or can you give us an idea of how many trials you are working on and how that's increased since earlier this year, just sort of driving the incremental expense?

[Rajeev Suri, President & CEO]

Yes, thanks, Andrew. I think the first thing to say is that we are kind of creating the market here. So we see ourselves as really driving the adoption of 5G. For me, it's a good thing that there is more trial activity because it will be a temporary expense in cost of sales and OpEx that'll drive the long-term super cycle that we are so eagerly waiting for. So we are now doing about 55 trials in about 17 countries, as I said earlier. And -- so that's really what's driving the incrementally high expenses. So I think, we will fuel the adoption as needed, but of course, we'll optimize our trial expenses to the extent possible.

[Operator]

Our next question comes from David Mulholland of UBS.

[David Terence Mulholland, Director and Equity Research Analyst]

Just on -- coming back on the gross margin point, you did quite a good job of answering what's happened in Q1. But if we look back over, say, the last 5 or 6 quarters, it's been on a bit of a downward trajectory even before this quarter. Can you just help us understand what's been going on over the last 18 months? And just to clarify on the commentary you are giving on an improving -- how should we think about Q2 specifically? You've been pretty clear on [ H2 ] improving, but does that already start moving in the right direction in Q2 as well?

[Kristian Pullola, Chief Financial Officer]

I think, David, on your question, first of all, I'm not sure if I fully agree with your analysis. We have seen kind of mix shifts that have also earlier driven gross margin for us. Now as Rajeev said in his prepared remarks, we had a bit of a perfect storm when it comes to both regional as well as business mix impacting the gross margin. As I said, I think some of the revenue and mix dynamics that we saw in Q1 we also expect to continue going into the second quarter. But then, with the 5G acceleration and that happening in North America, we do see things kind of improving going into the second half. I think it's clear also that this continues to be a competitive industry in which deal discipline as well as continuous cost execution is important. We do need to continue to design for serviceability. We need to continue to take product cost out in the business to be able to maintain the good margin performance we've had also in the future.

[Operator]

Our next question comes from Alexander Duval of Goldman Sachs.

[Alexander Duval, Equity Analyst]

Just wanted to ask a question on the competitive landscape. There have been some news reports about ZTE being subject potentially to a ban receiving certain components and now also about the possibility of Huawei being subject to restrictions driven by the U.S.? I wonder to what degree that could open up any opportunities to Nokia either from a share gain or profitability perspective as we look forward?

[Rajeev Suri, President & CEO]

Thanks, Alex. We want to focus on our strengths. So we believe we are the only player that has an end-to-end portfolio that operates in a scale, weighing all markets around the world. And as I've said earlier, I really, really think that with 5G, end-to-end matters much more because it really is an end-to-end solution. You can't go to 5G just with radio if we don't do midhauls and backhaul and fronthaul. You need to able to access the fixed wireless access and there are multiple ways to do it. You could do with a fix proposition like we have called fast mile or with 5G or with 60 GPON solutions and so on. So I think end-to-end will matter much more. It's too early to say what will happen with the sanctions and the impact from our competitors. Having said that, we are a company focused very much on trust and security, that's our branding, and we do see longer-term potential opportunities, especially where we compete with them in areas such as optical and fixed and mobile.

[Operator]

Our next question comes from Achal Sultania of Crédit Suisse.

[Achal Sultania, Director]

Just, Rajeev, one clarification on the outlook comment. So I guess, you are talking about losing like 1% to 3% decline in your primary TAM. And basically, if I compare that to your European competition, they are also talking about similar levels. And then, both companies are saying that they are basically going to outgrow the end market. So I'm just trying to tie this up that are you basically trying to imply that like the European companies are going to take share versus the Chinese? And is it -- or is it a function of a fact that maybe as you go through the year, the demand and -- being much stronger, and we end up seeing a situation where market shares are flat, but the end demand, actually, ended up being much, much better?

[Rajeev Suri, President & CEO]

Thanks, Achal. So what we see at the moment based on our contracts that we have for 5G and particularly this North American contract base that we're talking about that'll kick in the second half. I would say that we are well positioned to take share in 4G, to take share in 5G, in IP routing as well as in optical. And in the case of optical, it's driven by 5G and Webscale. In the case of IP routing, it's driven by -- to some extent by 5G, but also by Webscale and enterprise. And of course, 4G and 5G, it's driven by radio itself. And we have notably if you look at the Dell'Oro reports and of course, our internal analysis, suggest that we actually took share in all of these portfolios in the recent quarters as well. So then of course, it depends upon who is taking from whom. But I think we have been taking share, and I think we are well positioned to continue to take share. We will outperform.

[Kristian Pullola, Chief Financial Officer]

And I think it's good to note that when we and our European competitor talks about the market, we talk about the different market because our product portfolios address different markets. Their market is more the random market. When we talk about our primary addressable market, it is the full market of fixed routing, optical and mobile and the related services. So take that also into account when you do -- make comparisons between our comments.

[Operator]

Our next question comes from Mike Walkley of Canaccord Genuity.

[Thomas Michael Walkley, MD & Senior Equity Analyst]

Just a question about internally developed silicon, such as ReefShark. Can you share with us kind of customer feedback? How margins might be impacted when the new product ship? Is ReefShark still in track for the second half of the year and is somewhat -- could it be possible some customers waiting for the new architecture creating a much stronger second half versus first half of the year?

[Rajeev Suri, President & CEO]

Thanks, Mike. Customer feedback is fantastic, both on this as well as the new chipset in optical, PSE-3, because this makes massive MIMO more relevant because massive MIMO then can be rolled out in the scale sort of way because it reduces the power consumption quite meaningfully by almost half, but also the size of the massive MIMO antenna is such that you can actually carry it on the top of the tower as opposed to using cranes and so on. So of course, everything changes with that sort of massive MIMO antenna because then you can really scale it. So great feedback. It will improve the cost structure over the long term. That's the point of having a competitive cost-based product. It will not stop AirScale deployments because AirScale deployments are continuing to grow. And when this comes, which it will still be on track for the second half, so this will only help scale it even further with massive MIMO in 4G as well as 5G.

[Operator]

Our next question comes from Simon Leopold of Raymond James.

[Simon Matthew Leopold, Research Analyst]

I appreciate the remarks about the strategic shift to diversify away from telco into markets like the enterprise, Webscale and cable TV. I'm hoping we could get some aspect of quantification of what percentage of your overall sales have come from these verticals historically; where we are today to help us assess the progress in this diversification effort?

[Rajeev Suri, President & CEO]

Thanks, Simon. So I'll just give you a couple data points. We said that we grew around 20% this quarter in that business. We grew about 21% in Q4 last year. Overall, last year, we had double-digit growth sort of in the range of about 13% for the full year last year. So of course, momentum is continuing to build. And we did say in Q4 that this is around 5% of our overall Networks revenue.

[Matt Shimao, Head of Investor Relations]

Right. Small, but growing fast.

[Operator]

Our next question comes from Sébastien Sztabowicz of Kepler Cheuvreux.

[Sébastien Sztabowicz, Head of Tech]

One question on AT&T because it targets to replace 60,000 third-party routers with their own white box routers notably running on their own operating system. Do you know what kind of routers are we talking about there? And is this something that could impact negatively your IP routing business going forward?

[Rajeev Suri, President & CEO]

Thank you, Sébastien. I think I don't know the exact detail of that, but they're probably smaller routers, so they don't typically compete with the kind of stuff that we put to market. So I don't see an impact there.

[Matt Shimao, Head of Investor Relations]

Okay, Sébastien. We'll maybe follow-up with you in more detail later on that one.

[Operator]

Our next question comes from Tim Long of BMO Capital Market.

[Timothy Patrick Long, Senior Equity Analyst]

Just following on, on the routers. Rajeev, you mentioned a lot of trials for the new routing platform. Could you just talk a little bit about the timing there? And I know you think it's going to help move the Webscale and enterprise business. If you could you just talk a little bit about routing and also actually about optical in there more or so? What do you think margin impact for those businesses will be? Will there be a little cost to get in and then also, those customers are known to be difficult on a profitability front?

[Rajeev Suri, President & CEO]

Thanks, Tim. So we're doing about 60 trials, as I said, with FP4. The first part of the routers in FP4 or FP4-based routers have already started shipping in December, the 7750-SR1 routers. So all on track there. Very good customer feedback. Fortunately, this FP4 has also provided a tailwind to our FP3 product set because we have a competitive portfolio, and hence, we have seen more momentum in the current business as well. If you observe over the last quarters, including this latest one, we are taking share relative to our peers and -- overall because I think the last 2 quarters we were just about flat. This time, we were flat on an underlying basis. It's not going well with the portfolio, great feedback on that. In optical, great momentum with Webscale. As I said, we've seen now 2 quarters of extremely good growth in Webscale. I would say, overall, if you look at enterprise and Webscale, they are structurally more attractive on the whole, i.e., higher-margin potential in the long-term as well as higher growth.

[Operator]

Our next question comes from Douglas Smith of Agency Partners.

[Douglas P.E. Smith, Research Analyst]

You've kept your guidance for 2018 exactly the same in terms of earnings. But within that, considering the report today, has the shift of earnings tilted more towards Nokia Technologies and away from Nokia Networks? Or when all this is said and done at the end of the year, will the balance of Networks and Technologies be the same as the assumptions at the start of the year?

[Kristian Pullola, Chief Financial Officer]

So I don't think that shift between the businesses is anything to comment here. I think what has happened as you saw from the change in our guidance is that, we do see that on the Network side, the top line performance will be slightly better than what we guided for previously, but then to offset that impact, we also see that to drive the adoption -- early adoption of 5G, there will be more investment going into trials, and so on, which then kind of means that there was nothing to update on the profitability and EPS level for the year.

[Operator]

Our next question comes from Daniel Djurberg of Handelsbanken.

[Daniel Djurberg, Research Analyst]

Most questions are answered. But I will ask you about the Nokia Software down 3% in Q1 at constant currency, including Comptel. Could you give us the organic growth number at constant currency? And also perhaps comment a bit on the ongoing transformation in this segment? Also if you do have ambition for the enterprise, Webscale in this rebuild? And also, if you are, again, interested in looking at the BSS side after exiting the business in 2013?

[Kristian Pullola, Chief Financial Officer]

I think maybe first on the organic. So we didn't break it out, but it could have been somewhat more of a decline than the 3%.

[Rajeev Suri, President & CEO]

Yes. Thanks, Daniel. On the question of the portfolio, so we are -- the strategy is working. Yes, there was a speed bump in terms of the financial results in Q1. Having said that, the order intake was quite strong. We're moving with a good backlog. We have been putting a lot of our assets on common software foundation because that will give us agility. It will also give us a better cost base, and we can come to -- quickly with new products and new features and customers like that. Great feedback from customers. It's basically an agile, DevOps way of operating. We have built a good sales capability that can target chief marketing officers and CIOs and that's starting to work. So overall, I think the strategy is tracking well, although, of course, I'm not pleased about Q1 in itself. In terms of BSS, in many of these BSS transformation cases, OSS transformation cases, a lot of our portfolio is in use and then we partner with other players on a select basis and that seems to work well in dealmaking.

[Matt Shimao, Head of Investor Relations]

Thank you, Daniel. Nicole, I think we have one more question in the queue. So we'll take that.

[Operator]

Our next question comes from Josep Bori of Berenberg Bank.

[Josep Bori, Analyst]

Ask you if you could provide a bit of an update on what level of demand you are seeing for your routers based on the FP4 chip? Specifically, could you provide some sort of maybe anecdotal evidence of success with your petabyte class router. I think it's the Nokia 7950. Is this being looked at by webscalers? Or is this still pretty much a big telco type of sale?

[Rajeev Suri, President & CEO]

Thanks, Josep. Yes, it is being looked at by Webscale players. And of course, a lot of the large operators such as even British Telecom that was there with us on stage when we launched the product, very interested in that product. So I think both on the telco service provider side, but also on the Webscale side there is clear intent. This is the sweet spot product for exactly the Webscale.

[Matt Shimao, Head of Investor Relations]

So thank you, everyone, for your question today. I'd like to now turn the call back to Rajeev.

[Rajeev Suri, President & CEO]

Thanks, Matt, and thanks, Kristian, and thanks to all for the good questions. I'd like to close on a note of optimism, tempered with the reality of some hard work to come and need to run fast and execute superbly. The reason for optimism is clear, improved market conditions this year as well Nokia's ability to outperform in those improved conditions. We are at the start of a 5G-driven cycle, and there is plenty of opportunity ahead of us. For 2018, we need to run at full tilt to the end of the year. Customer demands will be high and meeting that demand will require tight alignment between our product groups, manufacturing, delivery and services. Of course, these are the kinds of challenges we like, challenges coming from an upswing in the market and strong demand for our excellent products and services. In fact those challenges are really opportunities, and we intend to seize as many of those opportunities as we possibly can. Thanks, again, to all of you for joining, and have a great day. With that, Matt, back over to you.

[Matt Shimao, Head of Investor Relations]

Ladies and gentlemen, this concludes our conference call. I'd 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 71 through 89 of our 2017 annual report on Form 20-F, our financial report for Q1 2018 issued today as well as our other filings with the U.S. Securities and Exchange Commission. Thank you.

[Operator]

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