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Edited Transcript of NOKIA.HE earnings conference call or presentation 30-Apr-20 12:00pm GMT

Q1 2020 Nokia Oyj Earnings Call

Espoo May 16, 2020 (Thomson StreetEvents) -- Edited Transcript of Nokia Oyj earnings conference call or presentation Thursday, April 30, 2020 at 12:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kristian Pullola

Nokia Corporation - CFO

* Matt Shimao

Nokia Corporation - Head of IR

* Rajeev Suri

Nokia Corporation - President & CEO

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Conference Call Participants

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* Achal Sultania

Crédit Suisse AG, Research Division - Director

* Aleksander Peterc

Societe Generale Cross Asset Research - Equity Analyst

* David Terence Mulholland

UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware

* Dominik P. Olszewski

Morgan Stanley, Research Division - Research Analyst

* Pierre C. Ferragu

New Street Research LLP - Global Team Head of Technology Infrastructure

* Richard Alan Kramer

Arete Research Services LLP - Senior Analyst

* Robert Duncan Cobban Sanders

Deutsche Bank AG, Research Division - Director

* Sami Sarkamies

Nordea Markets, Research Division - Senior Analyst of TMT

* Sandeep Sudhir Deshpande

JP Morgan Chase & Co, Research Division - Research Analyst

* Simon Matthew Leopold

Raymond James & Associates, Inc., Research Division - Research Analyst

* Stefan Julien Henri Slowinski

Exane BNP Paribas, Research Division - Research Analyst

* Tal Liani

BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector

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Presentation

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Operator [1]

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Hello and welcome to the Nokia First Quarter 2020 Earnings Conference Call. (Operator Instructions)

Please also note today's event is being recorded.

At this time, I'd like to turn the conference call over to Mr. Matt Shimao, Head of Investor Relations. Sir, you may begin.

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Matt Shimao, Nokia Corporation - Head of IR [2]

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Thank you. Ladies and gentlemen, welcome to Nokia's first quarter 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 with me via conference call today.

During this call, we'll be making forward-looking statements regarding the future business and financial performance of Nokia and this 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 in the section titled, operating and financial review and prospects, risk factors of our 2019 annual report on Form 20-F, our financial report for Q1, published today on Form 6-K, where we have added a COVID-19 risk factor 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.

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Rajeev Suri, Nokia Corporation - President & CEO [3]

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Thanks, Matt, and thanks to all of you for joining. I hope that you're all keeping well and safe in these unprecedented times. As we all know, events related to the COVID-19 pandemic are moving quickly and the global economic outlook remains uncertain.

I want to start by briefly making 4 high level points about Nokia's first quarter. First, we made steady progress in our Mobile Access business, as our transformation and product cost reduction efforts started to take hold. Second, our Q1 showed broad year-on-year profitability improvements, thanks to strong performance across our portfolio, including Enterprise and Software, supported by continued discipline on costs. Third, we remain highly focused on generating cash and took a number of actions in Q1 to improve our total cash position in what is a seasonally slower quarter. And fourth, we are adjusting the midpoints within our previously disclosed outlook ranges for full-year 2020 to reflect the increased risks and uncertainty presented by the ongoing COVID-19 situation.

We expect the majority of this COVID-19 impact will be in Q2 and believe that our industry is fairly resilient to the crisis, although not immune. With that as an introduction, I will focus the rest of my remarks on 2 main areas: one, our Q1 highlights and the progress we are making in Mobile Access and other parts of our business; and two, the unusual situation with regard to COVID 19.

Now to the quarter. When I spoke to you when we announced our Q4 results, I said I expected to see progressive performance improvement over the course of 2020, and Q1 was largely consistent with this expectation. Non-IFRS Nokia level operating margin was up significantly from Q1 2019, rising 3.6 percentage points, while non-IFRS operating profit landed at EUR 116 million. An important driver behind that was the improvement in the Networks Business Group's gross margin, which increased year-on-year by 3.5 percentage points, largely driven by gross margin expansion in Mobile Access. In addition, the Nokia level operating margin was also improved by the profitability strength in Nokia Software and a decrease in Nokia level operating costs, including both SG&A and R&D costs. The decrease, particularly in networks R&D expenses was primarily due to progress related to Nokia's cost savings program, which was partially offset by additional critical 5G investments to accelerate our product road maps and cost competitiveness in Mobile Access.

Nokia Enterprise again delivered double-digit year-on-year constant currency sales growth and Nokia Software demonstrated again, how to drive top line growth with a clear focus on operational discipline and excellent profitability.

Importantly, we enhanced our total cash position in the quarter to EUR 6.3 billion, up sequentially by EUR 300 million, and Kristian will address in more detail, both our cash position and Nokia Technologies later on.

Now to the progress in Mobile Access, which is the combination of our product-focused Mobile Networks business group and our Global Services organization. In our Q4 2019 results, I spoke about how we continue to have a sharp focus on executing in our Mobile Access business and that we expected to make good progress in our turnaround this year.

I'm pleased to say that our first quarter performance continues to support this expectation, notwithstanding the adjustment of the midpoints of Nokia's full-year guidance today due to the risk and uncertainty presented by the current COVID-19 situation. Mobile Access saw improvements driven by product cost reductions, regional mix, strengthened operational performance in services and supported by continued competitive scale. Despite the majority of our R&D employees working from home, our road maps are on track. And in fact, some key software releases are proceeding ahead of schedule. As I said in Q4, our focus in mobile access is on 4 key areas: first, improving profitability through consistent product cost reductions; second, maintaining scale to be competitive; third, enhancing commercial management and deal discipline; and fourth, further strengthening operational performance and services.

Let me touch on each of these in more detail. First, as of today, we are tracking in line against our original plan with 5G powered by ReefShark products, accounting for 17% of our 5G shipments in Q1. We still expect to end the year at more than 35% despite the prospect of further COVID-19 related economic impacts. As a reminder, we typically see approximately a 6-month delay between shipments and impact on financial performance. We saw some important product launches in Q1, including our Dynamic Spectrum Sharing or DSS solution. Our unique solution goes beyond 4G to 5G to include dynamic sharing between 2G, 3G and 4G, offering a smooth path to 5G deployments. Initial deliveries of Nokia's DSS solution for which there has already been significant interest from operators are starting now, with volume shipments expected by July.

The second KPI relates to maintaining scale and specifically, scale related to mobile radio products. In Q4, I stated that we expect Nokia to stabilize its 4G plus 5G market share at approximately 27% by the end of 2020, excluding China. Q1 results support this statement, and we believe we remain on track. We continue to have the scale necessary to remain competitive.

The third KPI is our 5G win rate. For Q1 2020, our 5G win rate, excluding China, continued to be over 100%, reflecting a strong performance across a number of regions, and is in the mid-90% range, including China, in line with our expectations.

While the overall results did not change, we saw a reduced footprint at a customer in Asia Pacific, offset by gains with the customer in North America. Again, this was in line with our expectations. As of today, with our recent win with ReefShark, we have 70 5G deal wins and 21 live networks deployed. New customers in Q1 included Chunghwa Telecom in Taiwan, Orange Slovakia and Bell Canada. And pleasingly, we are quite optimistic that we will win a share of 5G core with China Unicom, although, we have not yet received official notification. Staying with China, we have consistently said, we would take a prudent approach to pursuing market share, given the profitability and cash challenges there. Given that, we have prioritized our 5G radio activities on features that are required globally and for markets with better economics and have avoided specific local requirements. We will remain a meaningful player in China. We have a large 4G installed base, ongoing attached independent services and continued opportunities in the broader 5G buildout with China's major operators in areas such as fixed, IP routing and optical. We also see potential with the large enterprise customers we are focusing on and have made particularly good progress, providing data center interconnect to the country's leading web scale companies. A return to 5G radio at some point in the future is also not out of the question. But keep in mind that our approach has to remain prudent.

Finally, let me now say a few words on services, which produced substantially expanded year-on-year profits in Q1. This was driven by structural improvements in deployment services, as we successfully drove digitalization and automation efforts. Services exited several more low-performing projects in Q1 and we continue to make progress in turning around other low-margin managed services deals. We expect a high level of network deployment services, as new 5G builds continue, although we do see some COVID-19 risk hampering some technology deployments due to challenges with getting on-site access.

So to conclude on Mobile Access. We are making the expected progress in our 4 key areas.

Now to our other business groups. As I alluded to earlier, our strategic focus areas of Nokia Enterprise and Nokia Software maintained strong momentum. Nokia Enterprise delivered year-on-year constant currency revenue growth of 19%. Enterprise added 30 new logos in the quarter, including Infrastructure Networks Inc., PGE Systemy of Poland and SGP of Paris. Despite the current economic environment, we believe that we have a resilient customer base in enterprise for mission-critical networks due to the verticals that we focus on.

In Nokia Software, I think it is also fair to say that the decision we took a few years ago to rewrite our applications on to Nokia's cloud-native Common Software Foundation to serve 5G and increasingly, digital customer needs is paying off when you look at both how Nokia Software is performing relative to our competitors in the telco software space and in today's environment that is making cloud-based digitalization an even more critical business necessary.

Nokia Software's year-on-year constant currency net sales grew 12% and profitability was up sharply across the board, with an operating margin increasing almost 13 percentage points year-on-year. I would caution that software's strong performance in Q2 2019 and the COVID-19 risks related to our business generally, give us a tough year-on-year comparison in the second quarter. Still, software's business execution has been solid and its trajectory is on a path where we want it to be.

Now to IP and optical networks, or ION, which also continued its strong underlying execution and increased its product leadership credentials in the quarter.

ION's year-on-year constant currency sales declined due to Q1 2019 being a particularly strong quarter, which benefited from pent-up demand from -- for some of our newly introduced FB4 products. The Q1 sales decline also stemmed from some supply chain headwinds related to COVID-19 that prevented us from delivering to certain customers. Still, the business fundamentals showed continued strength with both IP Routing and Optical Networks holding a strong order book. IP Routing also continued to demonstrate its technology leadership position, with Nokia being named in the quarter as a top company, globally, in IP edge routing. We do see some potential to recover some of what we came up short on in Q1, as we currently see good routing demand in Q2 on the back of traffic growth. In Optical Networks, year-on-year constant currency sales dropped 2%, though that was due entirely to supply constraints stemming from COVID-19 and not related to demand. We expect these constraints to improve in Q2. Our Fixed Access business saw a strongly improved order intake year-on-year, led by North America and Europe. The higher gross margin in Fixed Access was primarily due to a more favorable product mix, with less digital home net sales in China as well as a higher gross margin in digital home, driven in part by improved product cost. Now to the regions, and I aim to be brief here. Given that I've already addressed China, let me start with North America, our biggest market by sales.

Despite merger-related uncertainty during most of Q1, top line in North America remained flat in constant currency, reflecting customer demands for strengthening network infrastructure due to people working from home. We see this from certain operators who have recently announced increases in capital expenditure and across different businesses from IP routing to Nokia Software.

Middle East and Africa had a strong quarter with top line growth of 8% year-on-year in constant currency, with particular strength in Saudi Arabia, where we have large 5G network rollouts ongoing with Mobily, STC and Zen. Then India, which we report within our Asia Pacific region, constant currency sales fell, stemming in part from the uncertainty following a Supreme Court ruling that was recently upheld, requiring telco operators to pay back-taxes, and we see pressure continuing in Q2. While uncertainty in this market remains high, you may have seen in the media that we announced this week, together with Bharti Airtel, a multiyear deal in India, the second largest telecoms market by subscribers. This deal will boost Bharti Airtel's network capacity, lay the foundations of 5G in India and includes Nokia's Single Radio Access Network, AirScale Radio Access and baseband services. In addition, Nokia Global Services will play a crucial role in the installation planning and deployment of the project.

Excluding India, the Asia Pacific region saw strong growth with telco operators. Year-on-year sales in Europe declined 4% in constant currency with Q1 last year being a tough compare.

Now to what we see ahead in the COVID-19 impact due to which we deemed it prudent to adjust the midpoints within our previously disclosed outlook ranges. Let me start by saying that this crisis has made vividly clear the importance of connectivity to keep society functioning. It is literally a matter of life and death. We feel, we have a sense of duty to our customers and the communities they serve to keep vital communication networks running and accommodate the explosion in the demand all over the world.

I would like to thank all our people as well as customers and suppliers who are working so hard to keep everyone connected across the world. Naturally, Nokia's first focus in this is our employees. We are working around the clock to keep them safe, and we're doing everything we can to support them through this crisis. We have put in place strict protocols for Nokia facilities and have provided clear advice to our employees about how they can mitigate the risks of COVID-19 in situations where they have to go about critical work. I'm very proud of the role Nokia is playing in supporting our customers and their communities. The products and services that we provide have never been more critical in enabling the world to continue to function in an orderly way. We are providing the capacity and continuity for vital medical, social and financial systems that are experiencing extraordinary stress. Our global manufacturing footprint is designed to optimize our global supply chain and mitigate against risks such as local disruptive events, transportation capacity problems and political risks. Our supply network consists of 25 factories around the globe and 6 hubs for customer fulfillment. As a result, we are not dependent on one location or entity. Telecom infrastructure is an essential service in most jurisdictions. Most networks see 30% to 45% traffic volume growth over a year. But through our operator customer base, we saw similar and sometimes even larger overall increases in lockdown impacted regions in just a matter of weeks, sometimes even days, immediately after the beginning of lockdown.

The most impactful effect on the network was made by bandwidth intensive applications, such as streaming and subscription video-on-demand, for example, Netflix and Disney+ and video conferencing applications, such as Zoom, Microsoft Teams and WebEx, with some telecommunications and video conferencing applications growing by 700% or 800% in a matter of days, as analyzed by our Nokia Deepfield team. The trends were similar across China, Asia Pacific, Europe and the Americas. As of last week, we are seeing a plateauing of the growth in some regions, which is likely due to a combination of peak video consumption reaching practical maximum levels and the lowering of video streaming quality by service providers. We are working with our customers to provide real-time and granular information about their networks and enabling them to meet the increases in demand and expand capacity where needed. We're all aware that lockdowns have shuttered factories in many parts of the world, including Asia, and this caused pockets of supply chain issues in Q1 that limited our ability to completely meet the needs of a small number of customers.

In Q1, the impact was approximately EUR 200 million in net sales, and this was partly the result of supply issues associated with disruptions in China and other parts of Asia. We expect those net sales to be pushed to future periods rather than being lost.

Let me explain in more detail some of what we are seeing. Getting customer acceptances for new product deployments is being delayed in some cases due to physical factors, such as on-site access being currently blocked due to the lockdowns, and we do see this continuing further into Q2. Additionally, we are seeing sharp foreign exchange rate fluctuations in places like Latin America, driven by COVID-19. This is causing operator customers to reduce CapEx, to conserve cash in order to offset rising production costs. I've mentioned that offsetting some of those negative impacts is the fact that our primary addressable market with telecom operators as well as our chosen enterprise verticals is expected to be more resilient than the broader economy, given high network capacity demands and longer-term demand for superior networking capabilities and cloud computing capabilities. Going forward, we believe the risks and uncertainties related to COVID-19 may continue to have an impact. And that is why we adjusted the non-IFRS midpoints within our full-year 2020 guidance ranges for EPS and operating margin to EUR 0.23 and 9%, respectively. We believe that the majority of this COVID-19 impact to be in Q2. While not immune, we also believe that our industry is fairly resilient to the crisis, and I have just provided some examples of why we hold this belief. Before handing over to Kristian, I want to change gears and briefly discuss another important matter. I wanted to say a few words about our corporate sustainability performance. I've mentioned that connectivity has never been as important as now when people find themselves physically isolated from others during the lockdown. In what has quickly become the new normal, Nokia's role as a critical connectivity enabler has never been so important. This is a responsibility that we take seriously. Remote working, remote schooling, remote services and smart deliveries are just some examples that have been enabled by connectivity and digitalization solutions. As we move into the future, sustainability will play a large part in shaping our industry. And we believe that technology will further improve people's lives, and we will, therefore, be focusing on those areas we expect to have the biggest impact on sustainable development and our profitability. Those areas are climate, integrity and culture. We continue to develop and maintain solid processes and principles on other sustainability areas, ensuring compliance with all necessary standards and requirements. With that, over to you, Kristian.

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Kristian Pullola, Nokia Corporation - CFO [4]

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Thank you, Rajeev. Today, I would like to start by walking you through our current liquidity position and our cash performance in Q1. I will then continue with a brief summary of our financial results for both Nokia Technologies and Group Common and Other, then take you through a Group level results for the first quarter. And finally, I will quickly provide an update on our cost savings program and close with some remarks on our guidance.

Okay. Let's start with our liquidity position and cash performance. We closed Q1 with a solid total cash position of EUR 6.3 billion, a sequential increase of approximately EUR 310 million. The primary driver for the increase was related to a drawdown of a EUR 500 million loan from the European Investment Bank in February, which will mature in 2025. The facility was signed in August 2018 and had a drawdown period of 80 months. In addition to our solid cash position, we also have a EUR 1.5 billion revolving credit facility available to us that remains undrawn. Looking at our debt, we have approximately EUR 5 billion outstanding, all of which is financial covenant free, with an average maturity of 6 years and a smooth repayment schedule. We do not have long-term debt repayments due in 2020 and the next maturity, which totals EUR 500 million, is due in March 2021.

Additionally, we continue to explore prudent opportunities to further strengthen our liquidity position in a proactive manner. I'm confident that the conservative management of our balance sheet has positioned us well from a liquidity standpoint to run the business and to continue to fund the R&D investments needed to position us as a leader in 5G and beyond. While our total cash increased in the quarter, Nokia's net cash decreased by approximately EUR 410 million to a quarter-end balance of approximately EUR 1.3 billion. This approximately EUR 700 million difference between the change in total and net cash was primarily driven by the EUR 500 million EIB loan, which I just mentioned, and approximately EUR 140 million related to the fair valuation of certain issued bonds, as a result of unusual interest rate fluctuations.

Free cash flow was approximately breakeven in Q1. This largely reflected solid adjusted net profit and a onetime benefit as a result of settling certain interest rate derivatives, both of which were offset by Capex, restructuring, outflows, cash taxes and net working capital. In Q1, net working capital, excluding restructuring cash outflows, resulted in an approximately EUR 50 million decrease in net cash in the quarter. Within net working capital, we saw offsetting drivers. Receivables declined approximately EUR 420 million, primarily due to a seasonal decrease. Inventories declined approximately EUR 100 million, mainly due to temporary supply challenges, as a result of COVID as well as improved inventory management. These benefits were offset by an approximately EUR 570 million decrease in liabilities, primarily related to a seasonal decrease in accounts payable and lower material purchases due to COVID-19 and the inventory optimization.

Overall, I'm pleased with the progress we are making with our free cash flow program. And while our Q1 performance benefited from the settling of certain interest rate derivatives, I feel our internal focus on these topics is really starting to bear fruit. Having said that, it is not yet time to declare victory, and we will continue to put focus here and improve further. Looking forward to Q2, it is important to highlight that our cash will be negatively impacted by bonuses paid under our annual employee incentive plans. Now turning to our financial results, starting with Nokia Technologies. Q1 net sales declined 7% in constant currency, largely reflecting lower onetime sales in the quarter and lower brand licensing net sales. These were partly offset by higher net sales related to new licensing agreements. Excluding onetime sales, Nokia Technologies' topline would have increased slightly year-on-year. As of Q1, our annualized licensing run rate continued to be approximately EUR 1.4 billion.

From a profitability perspective, Q1 operating margin in Nokia Technologies improved 200 basis points year-on-year to 83.6%. This was primarily due to improved gross margin, as a result of the absence of onetime costs, which negatively affected the year ago quarter. This quarter, I would like to expand my commentary on Nokia Technologies as there are several highlights worth spending some time on. First, regarding our overall patent portfolio and the excellent joint work being done by Nokia Technologies and Nokia Bell Labs. We have been ranked #1 in several independent third-party studies for our 2G, 3G, 4G and 5G patents that have been declared essential for cellular standards. Second, an independent patent analytics company, IPlytics, ranked Nokia #2 in January 2020 for ownership of 5G standard essential patents declared as essential for 5G and granted at least in one country. As of now, Nokia has declared more than 3,000 patent families as essential for 5G. And we achieved this less than 6 months after declaring our previous milestone of 2,000 patent declarations.

Next, looking at Group Common and Other, where net sales declined 8% year-on-year on a constant currency basis. We estimate that COVID-19 had an approximately EUR 50 million negative impact on Q1 net sales, primarily related to ASN. On a year-on-year basis, the net sales decline was driven primarily by Radio Frequency Systems or RFS, due to lower net sales in North America. This was partly offset by growth in Alcatel Submarine Networks or ASN, driven by new projects. ASN's order intake continued to reflect a strong demand environment and ASN ended the quarter with a record order book. During Q1, COVID-19 had an impact on its business as 2 production facilities were closed towards the end of the quarter. While this had some impact on ASN's Q1 results, it is expected to have a more significant impact on Q2.

Having said that, we believe that the underlying business momentum for ASN will continue, as capacity requirements for subsea transport continue to grow. The operating loss for Group Common and Other worsened year-on-year, primarily reflecting net negative fluctuations in venture fund investments and to a lesser extent, lower gross profit. The negative outcome from venture fund investments reflect the fact that some of the companies that we have invested in, operate in industries and markets hit by COVID-19. Further net negative fluctuations in Q2 and beyond cannot be ruled out, if the impacted companies are unable to secure additional funding to work through the COVID-19 crisis. Then looking at Nokia Group level results. Q1 non-IFRS net sales were down 4% on a constant currency basis. When excluding Greater China, which is how we measure our performance against our primary addressable market, net sales would have been approximately flat.

As Rajeev mentioned, COVID-19 had an approximately EUR 200 million negative impact on Q1 sales, which we expect to be a shift to future periods. Within that EUR 200 million, Networks represented approximately EUR 150 million and Group Common accounted for the other approximately EUR 50 million, as I just noted. This was primarily due to supply chain constraints, and we, by no means, think these net sales are lost, given the resilience of our customer base. The timing of when we can realize the net sales will depend on a number of factors, including the easing of supply chain challenges, our ability to deliver and our ability to get customer acceptances. The Group level non-IFRS gross profit and gross margin improved significantly year-on-year to 36.4%. This improvement reflects 2 items that I wanted to touch upon. First, higher gross margin in Networks and more specifically, Mobile Access, as the transformation continued to take hold, as evidenced by the good progress against our KPIs. The second driver was Nokia Software, which delivered strong net sales growth and operating margin expansion, as a result of great sales execution, the comprehensiveness of our portfolio and delivery efficiency. This improvement in Group non-IFRS gross margin, in addition to continued progress on our cost reduction program, led to a 2.4% non-IFRS operating margin compared to a negative 1.2% in the year-ago quarter.

Looking at financial income and expenses. The year-on-year improvement was driven primarily by improved FX results and lower interest expenses. These were partly offset by losses incurred on certain financial assets caused by market volatility. Our Q1 non-IFRS tax rate was 27% and remains generally in line with our full-year expectation of approximately 26%. Our non-IFRS diluted EPS was EUR 0.01 for Q1 2020 compared to negative EUR 0.02 in the year ago quarter.

Next, a brief update on our cost savings program. We believe we are on track to realize the EUR 500 million target, of which EUR 300 million of cost savings is expected in 2020. It is worth noting that since the announcement of the plan in October 2018, net foreign exchange fluctuations has resulted in an increase of estimated full-year 2020 fixed cost of approximately EUR 130 million. This has created an additional headwind to achieve our planned savings. However, we remain confident that we will hit our targets. Our expectations for restructuring charges and cash outflows have not changed in the quarter.

Then finally, I would like to provide a bit more detail on our outlook for the full-year 2020, where we have today adjusted the midpoints for non-IFRS operating margin and non-IFRS diluted EPS. First, we now expect our primary addressable market, excluding China, to decline in 2020, as a result of COVID-19 headwinds, and we expect to perform approximately in line with this market. While we continue to expect seasonality in 2020 to be similar to 2019, we now expect Q2 to bear the majority of the COVID-19 impact.

Beyond Q2, we expect -- we continue to expect that the majority of operating profit and free cash flow to be generated in the fourth quarter similar to 2019. As I said last quarter, we intend to provide updates each quarter to our progress against our outlook ranges, and that we would adjust the midpoints accordingly, if necessary. Given the risks and uncertainties presented by COVID, we have adjusted for 2020, both our non-IFRS operating margin and diluted EPS expectations, within the previously provided ranges. We now expect non-IFRS operating to -- operating margin to be 9% plus/minus 1 percentage points and non-IFRS diluted EPS to be EUR 0.23 plus/minus EUR 0.05.

We also acknowledge that there are potential risks and uncertainties related to COVID that we have not factored into our outlook. More specifically, it is difficult to assess the scope and duration of the crisis as well as the pace and shape of an economic recovery -- of how an economic recovery could look like. These implications on customer demand are hard to predict with certainty. Additionally, we see opportunities and risks in North America, following the completion of a merger. While we recognize that there are increased macroeconomic uncertainty, we have confidence, not only in our resilient customer base, which includes communication service providers as well as large enterprise customers, but also in our strong liquidity position.

With that, I hand over to Matt for Q&A.

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Matt Shimao, Nokia Corporation - Head of IR [5]

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Thank you, Kristian. One quick thing, which is the operating margin guidance. We now expect our non-IFRS operating margin to be 9%, plus or minus 1.5 percentage points.

(Operator Instructions) Jamie, please go ahead.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And our first question today comes from David Mulholland from UBS.

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David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [2]

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I just wanted to come back on the point you've made around the supply chain. Obviously, you had some constraints impacting Q1, and you flagged there's still some risk going on into Q2. But where are we with the supply chain? I think from what Ericsson was saying the other day, it seems like from their side, they've managed it quite well that they're still able to mostly supply customers. So how much of an issue should we still expect going forward from that in terms of supply chain issues?

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Rajeev Suri, Nokia Corporation - President & CEO [3]

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Thanks, David. We saw those issues limited to a very few number of customers. Supply chain issues were from, like I said, China and sort of parts of Asia, especially when it comes to Tier 2, Tier 3 component vendors. Going into Q2, we see some supply risk. But we also see risk related to really the physical site access part in countries that are locked down. So that engineers can't go and access those sites to do the installation and commissioning. Even if we are an essential service as a sector, logistically, it is more challenged on the ground due to lockdown. So those are the 2 risks we see. Perhaps the installation one is greater than the supply.

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Operator [4]

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Our next question comes from Sandeep Deshpande from JPMorgan.

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Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [5]

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In terms of the disruptions you're seeing in the supply chain. Do you have a understanding of how much you're going to see in the second quarter? Because you say that in your release -- in your press release this morning that it is going to be worse. Or you say that the worst impact will be seen in the second quarter. So does that mean that you're going to see more than EUR 200 million of impact in the second quarter? And then if these supply chain disruptions, which are causing these issues in the first and the second quarter, will we see those made up in the second half, as the lockdowns end?

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Kristian Pullola, Nokia Corporation - CFO [6]

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So maybe I'll start here. So we do see overall for the year, that there will be a net impact from COVID. We have reflected that both in our guidance for the overall market, where we shifted the guidance from being flat to now being down. And we also adjusted for that by bringing down our -- the midpoint for both our operating margin as well as for EPS slightly. We do think that the majority of this impact compared to what we expected earlier, will come through in the second quarter. And then some of that, but still with the net impact that I talked about, will be offset in the second half.

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Operator [7]

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Our next question comes from Robert Sanders from Deutsche Bank.

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Robert Duncan Cobban Sanders, Deutsche Bank AG, Research Division - Director [8]

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My question is just about Dynamic Spectrum Sharing, given you've now launched that offering. I was just wondering, can you try and contrast the approach you're making to DSS versus that of companies like Ericsson? And what is the feedback you're getting on -- from key customers on the relative strengths and weaknesses of your approach?

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Rajeev Suri, Nokia Corporation - President & CEO [9]

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Thanks, Rob. So first of all, DSS is an important feature. We will be on time in line with commercial devices. So around July, will be volume deliveries. That's the 4G, 5G DSS that many customers need, such as in North America and elsewhere. We also have this all the way from 2G, 3G, 4G DSS, including 5G, but also 2G, 3G, 4G DDS. And that is required in many emerging markets, right? It's required in Latin America. It's required in Middle East and Africa. It'll be required in a lot of parts of Asia Pacific. To do the same thing you see in 4G 5G, so to get the spectral efficiency in 2G or 4G DSS. And here, we feel we are unique, and we are getting a lot of interest from customers. So the 4G, 5G in developed countries, advanced markets, but 2G to 4G will be released in a lot of other places in the run up to 5G.

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Operator [10]

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Our next question comes from Achal Sultania from Crédit Suisse.

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Achal Sultania, Crédit Suisse AG, Research Division - Director [11]

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Rajeev, I think, you mentioned a strong data traffic growth starting because of COVID and operators feeling the need to upgrade networks. It seems like you've had some benefit of that on gross margins along with the product cost decline. Now you also mentioned that data traffic is kind of plateauing in a lot of markets. So how should we think about the business mix going into Q2 and Q3? Do we actually see the benefit of what we saw in Q1 continue into the next couple of quarters? Or is it mainly going to be your focus on product cost decline, which gives you the benefit on gross margins?

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Rajeev Suri, Nokia Corporation - President & CEO [12]

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Thanks, Achal. So it's evidenced by the data traffic growth and let's call it, preparedness for the future. Even if it's plateauing, people have learnt a lesson and they want to prepare for the future. So we're seeing that in our order intake in Fixed Access, Fixed Networks. I talked about a significant increase in order intake there. We're seeing a good order book in IP and Optical, both in Q1 and going into this quarter. And then, overall traffic is also going up in mobile, even if the centers are changing, rather than business centers, it's more to the home. Yes, mobility is reducing and handheld is reducing, but the traffic is going up. So there's also that potential opportunity in capacity demand in 4G. And then, of course, there are some markets where Fixed Access isn't strong enough. And then you've got to see that connected through wireless. On the longer term, though, I see clear opportunities and fixed moving, copper to fiber and more robust IP and transport. There's no point of all this traffic explosion, if your IP and Optical network is not up to scratch. So it's sort of -- this is where our end-to-end portfolio really helps from a long-term perspective.

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Operator [13]

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Our next question comes from Tal Liani from Bank of America.

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Tal Liani, BofA Merrill Lynch, Research Division - MD and Head of Technology Supersector [14]

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I have 2 questions. The first one is, would you consider changing the company structure, meaning selling assets? Given the continued decline in routing or what we're seeing with optical, what's the value of keeping the company still as a combined company of multiple assets? And the second question, if you can relate to China. We are seeing Ericsson reporting better numbers in China. And I want to understand the sustainability of the trends in China for you? How do you think it's going to play out over time?

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Rajeev Suri, Nokia Corporation - President & CEO [15]

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Thank you. Actually, routing and optical, routing is just a compare issue compared to last year. But otherwise, the fundamentals are very, very strong in routing in particular, we've got some supply headwinds as well that affected us in Q1, but very, very, very strong leadership there in terms of technology, strong order book, as I said, same in optical, and both these benefit -- both these businesses will benefit from increased traffic. So there is a compare issue, but I don't see a change in fundamentals for this business. This is -- routing, in particular, as an anchor business and helps us a lot, in terms of robust future. And of course, it's the way to penetrate enterprise as well as web scale companies where we have been successful. So when it comes to the broader question, will we sell assets and so on? No, our end-to-end strategy is intact at this point in time. And there's no change to that. Our Chairman also confirmed that on the 2nd of March, when we were together in the press conference. Obviously, it's possible, the new CEO needs to come in and review strategy, and that's very normal. I think, then your second question was around China.

And from this year's point of view, we have baked in the impact from what we're seeing in our guidance. And also, not just 2020, but also the long term. And with the recent decisions in China, it will have some top line impact, but much more limited impact on operating profit. And then I just want to quickly put the situation in China in perspective. We have consistently said that we take a prudent approach to share in China, given the profitability and cash challenges in the country. Ultimately, strategy is about hard choices. We are making choices. And second, we also said that we will prioritize our 5G radio activities on globally required features, as opposed to those that would have been required for specific local requirements, which we've avoided. Then you can also see that non-Chinese players have received considerably less share in recent rounds. And that's notable, and that has continued to happen with every generation of technology.

And finally, I would say that we continue to expect to remain a meaningful player in China. We've had some victories, recently. We understand yesterday, according to China Unicom, that we won the core deal as well as the virtualized IMS. And then in Greater China, overall, in Taiwan, we're doing very well. We're winning big in Taiwan in terms of 5G, just won a recent sole supplier deal with radio and core in -- with Taiwan Star in Chunghwa, earlier. And then with web scales, we're winning a lot with all 3 web scales in terms of Data Center Interconnect, again back with the Optical question. So our strategy will be around continuing to supply to operators. And it will focus on fixed, IP routing, optical, also move to large enterprise customers, such as railways and state grid in China and other large enterprise customers. And then continue the progress with web scale companies. So a business mix change and a customer mix change. And I think, a return to 5G radio is also possible at some point in the future.

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Operator [16]

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Our next question comes from Aleksander Peterc from Societe Generale.

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Aleksander Peterc, Societe Generale Cross Asset Research - Equity Analyst [17]

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Can we come back a little bit on 5G powered by ReefShark? I'd just like to know, in your increase from 10% to 17% of 5G PBR products. If you could give us an insight on which part of the family of ReefShark chipsets have been contributing to this increase over the quarter? And which element for part of the ReefShark family you're working on that will come through in the remainder of the year to increase this share?

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Rajeev Suri, Nokia Corporation - President & CEO [18]

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Thanks, Aleks. So with 10% at the end of Q4, we have started shipping the -- some of the radio SoCs, especially in Massive MIMO. And now we've expanded that to the range of 5G. The baseband SoC will come later in the year, putting us in a significantly stronger position in 2021. And it doesn't have to be linear necessarily. It can be nonlinear from 1Q to the other, but we are confident we can get to that 35% -- greater than 35% by the end of the year. So yes, good progress there.

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Operator [19]

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Our next question comes from Dominik Olszewski from Morgan Stanley.

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Dominik P. Olszewski, Morgan Stanley, Research Division - Research Analyst [20]

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Yes. Just one on my end, which is on the Software business. Could you dig a little bit deeper on detail in terms of what's been performing so well to drive the margins so high in this quarter at the least?

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Rajeev Suri, Nokia Corporation - President & CEO [21]

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Well, particularly good execution in the quarter, operational efficiency. But I think, if you step back and see what's happening in software because we are consistently putting in a good performance in this area of diversification. It is when we decided to rewrite our software on a cloud-native portfolio to rewrite on a common software foundation and make it cloud native, that just allowed us the ability to become more agile in that R&D piece, get better time to market, but also expand gross margins. And so that's the lever. The other one they've been driving, is services. Just -- we have a solid portfolio. We're ahead of the curve compared to others, cloud-native Common Software Foundation and just good execution in the quarter.

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Operator [22]

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Next Question is from Richard Kramer from Arete Research.

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Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [23]

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I'd like to ask you both about the topic of capital allocation. Rajeev, it feels like you crossed the Rubicon in China, where you chose not to allocate capital there to radio. And that kind of begs the question for yourself and Kristian, whether shareholders should be concerned with the EUR 640 million level 3 liabilities for the put option around NSB? And on the flip side, given that Nokia now has 2 sort of overlapping growth businesses between Enterprise and Software, what ways can you -- can we look forward to that you could allocate more capital to those areas since they're seeing rising margins and rising sales in the current climate?

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Kristian Pullola, Nokia Corporation - CFO [24]

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Yes, Richard, I think, as Rajeev described, we continue to see China as a key market, our business mix in China will change. We'll continue to work on the market, together with the existing partner that we have in the country.

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Rajeev Suri, Nokia Corporation - President & CEO [25]

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And then on -- Richard, your question on Nokia Software and Enterprise, thanks for that. So it's not overlapping. These are 2 different diversification areas. But we are doing that. We are absolutely doing that. That's why you see the performance. In Q4 last year, enterprise grew 33%. Overall, strong double-digit growth last year, 18% for full year, 19% in Q1, Nokia Software now 13%. It might vary between quarters for Nokia Software, given the nature of that business. But hey, we are putting all of the attention there. We're absolutely focused on diversification. The money is available to them, and we will allocate capital to them. I'm a big believer in Software and Enterprise.

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Operator [26]

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Our next question comes from Stefan Slowinski from Exane BNP Paribas.

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Stefan Julien Henri Slowinski, Exane BNP Paribas, Research Division - Research Analyst [27]

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Yes, just for Kristian. After the Q4, you gave a pretty specific OpEx outlook talking about the OpEx in 2020 being EUR 50 million greater than 2019. I didn't see if you had reiterated that today or with the currency moves you mentioned, if you can give us an update on what that number is? And then, I guess, on the top line, you've talked about the addressable market being lower this year. Can you help quantify that, so we can think about how much lower we should be modeling on the top line?

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Kristian Pullola, Nokia Corporation - CFO [28]

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Yes, I think, on the OpEx question, nothing has really changed. We feel confident that we will be able to hit the EUR 500 million overall reductions, which will bring EUR 300 million of savings this year. Some of those savings will be offset then by hopefully, higher incentive accrual this year and thus, the same OpEx year-on-year logic holds as after Q4. When it comes to market and top line change, the way to think about that is that while we haven't quantified how much we believe that the market will decline this year, you should really kind of look at the changes that we made to the midpoint of our operating margin and EPS to be a good proxy of how much the top line would be down because there, that's actually the main driver why we are adjusting our outlook for margin and EPS.

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Operator [29]

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Our next question comes from Sami Sarkamies from Nordea Markets.

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Sami Sarkamies, Nordea Markets, Research Division - Senior Analyst of TMT [30]

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I have a question on your IPR licensing business, where royalties were flattish in Q1. Even though the smart home market was severely impacted by COVID-19. Last night, Qualcomm guided for about 30% lower license revenues in the June quarter, but you are not flagging any headwinds. Can you please explain why your business model seems more stable, given the situation?

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Kristian Pullola, Nokia Corporation - CFO [31]

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Yes. I think, the big reason for that is that a big portion of our agreements are actually fixed price and fixed cost, over time. And as a result of that, we haven't seen a lot of growth when the market was growing. Now we don't see any decline when the market is declining.

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Operator [32]

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Our next question comes from Simon Leopold from Raymond James.

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Simon Matthew Leopold, Raymond James & Associates, Inc., Research Division - Research Analyst [33]

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I wanted to see if maybe you could drill down on the Fixed Access business. It was weaker than I would have imagined in this quarter. And I think we've all expected it would be a declining business in 2020 all along, but it does look a little bit worse. And I just want to see if we can think about some of the cross currents like usage for 5G backhaul as well as maybe some of the deficiencies that have been evident in consumer broadband in Europe. How you think about those opportunities and how we should think about the full year for Fixed Access?

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Rajeev Suri, Nokia Corporation - President & CEO [34]

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Yes. Thanks, Simon. The business has benefited recently from strong order intake growth. But overall, this industry is going through a transition from copper to fiber, and that's just taking time because some of the operators don't yet see the full business case for fiber. So I think, the growth drivers here are going to be that transition potentially accelerating, especially with what everybody's learned through the pandemic, evidenced a little bit in our order intake at this point. But then fixed wireless access for those operators that do not have fixed, that is a good revenue opportunity. And there, we are seeing some momentum. So for us, the growth drivers are going to come down to fixed wireless access and the acceleration of fiber.

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Operator [35]

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The last question comes from Pierre Ferragu from New Street Research.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [36]

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Rajeev, I'd like to get an update from you on how Nokia stands in the open RAN and vRAN debate. I see you guys have been active with Rakuten in Japan. I saw an announcement with Bharti, where you will be one of the main 5G suppliers and along with Altiostar, supplying like an open vRAN solution as well. And at the same time, in the debate in the U.S. with the administration, you seem to be pushing back on the legislation that is trying to impose open RAN to operators. So it looks like you're fairly positively-minded on the topic. But at the same time, you -- you're not comfortable with open vRAN going too fast, maybe?

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Rajeev Suri, Nokia Corporation - President & CEO [37]

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Thanks, Pierre. We have always been of the view that the industry eventually will be open, and we need to play, rather than hide. And so we played the Rakuten one much to our success. We were able to launch with them on time, but also we were able to upsell a broad part of our end-to-end portfolio. And I'm a believer that vRAN/ORAN will happen. I think it will start with vRAN, gives us an edge over some of the smaller players because ultimately, vRAN/ORAN also need that silicon capability. And feature parity with the old, not just with the new. So we will have vRAN compliance and availability on time, when the largest operators need it and their business case is justified. And on the ORAN, I think, it is going to take still a number of years before it becomes meaningful for anybody. But I'm positive on that, but it will take time.

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Matt Shimao, Nokia Corporation - Head of IR [38]

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Thank you, Pierre, and thank you all for your questions today. I'd now like to turn the call back over to Rajeev.

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Rajeev Suri, Nokia Corporation - President & CEO [39]

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Thank you all for your questions, and I'll close with a couple of comments. First, despite the COVID-19 impacts I discussed, I remain confident that inside Nokia, we are taking the right steps to deliver progressive improvement in the 4 key areas of Mobile Access. While I'm pleased with our solid improvement in Q1, I want all of you to know, we appreciate that you are rightly measuring Mobile Access' progress over a multi-quarter perspective. This is how it should be, and that is what our employees are working to. Second, the technology strength we have will enable Nokia to better serve our customers in the current environment, whether it is our FP4 based routing or PSE-3 optical networking products, our Common Software Foundation and cloud computing capabilities or the private wireless networks we are building in our Enterprise business.

The strength of our position in these businesses continues to serve Nokia well. Thank you all, and please stay safe and well. With that, I will hand the call back over Matt.

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Matt Shimao, Nokia Corporation - Head of IR [40]

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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 in the section titled Operating and Financial Review and Prospects, risk factors, of our 2019 annual report on Form 20-F; our financial report for Q1 published today on Form 6 K, where we have added a COVID-19 risk Factor; as well as our other filings with the U.S. Securities and Exchange Commission. Thank you.

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Operator [41]

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Ladies and gentlemen, that does conclude today's conference call. You may now disconnect your lines.