Note this event is being recorded. I would now like to turn the conference over to Mr. Matt Schimmau, Head of Investor Relations. Sir, you may begin.
Ladies and gentlemen, welcome to Nokia's Q3 2018 conference call. I'm Matt Chibau, Head of Nokia Investor Relations. Rajeev Suri, President and CEO of Nokia and Christian Pulola, 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 Q3 and January through September 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.
Thanks, Matt, and thanks to
all of you for joining the call. I would like to start today with an overview of our Q3 results and then discuss the strategic changes we announced this morning. In general, our Q3 results validate the view that we shared earlier this year that a weak first half in networks would be followed by improving conditions in the second half. You could see that in many areas of our results, a strengthening top line, excellent momentum in our order book, gross margins up from the 1st two quarters and more. All of this is good and when you add the progress we are making in executing our strategy, it has increased my confidence that Nokia is well positioned to benefit from the 5 gs cycle that is now upon us.
Similar to what we said on our last call, however, we see some risks as we head to the end of this year with project timing and product deliveries. The orders are certainly there, but we are facing a heavy workload in the Q4 given the scale of the rollouts underway. We also continue to see a sales impact from shortages of some standard components, particularly in IP routing similar to what I flagged last quarter. Those shortages had a meaningful impact in Q3 and while the situation is improving could also have an impact in the 4th quarter. Again, the orders are certainly there and we expect to capture any missed sales in the coming quarters.
Despite these risks, we still expect that a strong 4th quarter along with our ongoing solid strategy execution will allow us to deliver a full year Networks operating margin within our guidance range. Now let me give a bit more detail on our Q3 performance, starting with top line, where we saw widespread strength. Nokia level sales in constant currency were up 4% year on year when you exclude non recurring licensing sales, which benefited Q3 2017. Sales in constant currency increased in all 5 of our Networks business groups and in 4 of our 6 regions. As a whole, our Networks business posted a very healthy 3% year on year increase in constant currency sales, the best quarterly performance that we have seen in a number of years.
Nokia Technologies declined year on year as we booked substantial catch up licensing revenue in Q3 2017. Excluding that, however, Nokia Technologies recurring licensing net sales were up by 19%. In addition to the overall good top line performance in the quarter, we also saw excellent order intake reflecting growing market demand for our products and services. Very large mobile networks 5 gs deals made up a large portion of this, but we also saw strong activity in other parts of our business and particularly in Nokia Software. As a result, our backlog of orders has increased significantly, up approximately 30% since the start of the year.
Pleasingly, multi business group deals now make up 43% of our pipeline, up sharply from 1 year ago and a testament to the power of our broad end to end portfolio. On the profitability side, we landed at a non IFRS operating margin of 8.9% at the Nokia level and 5% for Networks in line with our expectations for an improvement compared to the first half of the year. We are making progress, but still have more work to do to get our networks margins where we would like them to be. As part of that effort, you will have seen that we announced further cost actions today, and I will come back to this topic shortly. Some of the margin challenges continue to come from product mix.
In the Q3, we saw a higher than expected level of network implementation projects, an area where margins are currently quite soft. Strong sales in optical networks within our IP optical networks business group also put a drag on near term margins. We expect, however, that the mix will return to more normal levels over the course of 2019. Regional mix on the other hand has improved given our strengthening sales in North America, which grew by 12% in constant currency compared to the same quarter last year. I would also note that our business in India, which sits in our Asia Pacific market, posted its 8th consecutive quarter of year on year sales growth in Q3.
In fact, its highest ever quarterly sales, buoyed again by solid traction across several parts of our Networks portfolio. In Greater China, on the other hand, we saw sales decline sharply, a reflection of market conditions and our desire to remain prudent given profitability challenges in this market. With that, let me briefly highlight some of the progress we made in the quarter on the execution of our strategy. Starting with our 1st pillar, leading in high performance end to end networks with communication service providers, you will have seen that we announced some large deals in the quarter, including the $3,500,000,000 multiyear 5 gs network deal with T Mobile and AT and T naming Nokia as one of its 5 gs suppliers. We also achieved some important firsts.
The first to demonstrate a 5 gs connection over massive MIMO with Sprint and the first transmission of a 3 gsPP5 gs signal to a moving vehicle with Verizon. Just after the quarter ended, Rakuten Mobile Network Inc. In Japan announced that in collaboration with Nokia, it had conducted its first over the air 5 gs trials in Japan and it did so using the Nokia Airscale base station. Similarly, I would also note that Nokia performed extremely well in recent 5 gs testing by the Ministry of Industry and Information Technology in China. It was interesting to see that one of our competitors did not attend the 4.9 gigahertz test as their portfolio did not have the capability to support the test conditions.
In Global Services, the stricter governance and greater focus on operational discipline that we put into place earlier this year are starting to show results. The team has plenty of hard work still ahead, including potentially renegotiating or exiting some projects, but early signs are positive. On the fixed network side, it was pleasing to see a return to slight growth in the quarter while continuing to deliver healthy margins. Disciplined execution and a strong product portfolio are hallmarks of this team. We won some good deals in the quarter, including providing our G FAST solution to KRDI in Japan to enable gigabit ultra broadband speeds.
In the second pillar of our strategy, expanding in select vertical markets, we continued sales growth on a year on year basis, excluding the former alcatalucine third party integration business we are exiting. Order development was excellent in the quarter and we continue to expand our footprint. We added 27 new customers in the 3rd quarter after signing on 70 new ones in the first half. In our 3rd pillar, developing a strong software business at scale, Nokia Software saw another quarter of growth with sales up about 4% year on year in constant currency and orders growth was considerably higher. Our ambition for this business in terms of growth and profitability is high and I am confident that the business is heading in the right direction.
You may have heard about our developing relationship with Salesforce and the fact that our intelligent care assistant software solution was introduced into the Salesforce AppExchange during the quarter. And further highlighting our momentum, we had some new wins that included British Telecom, Telenor 1 Europe and Telefonica UK. In the 4th pillar focused on licensing, we continue to march down the strategic path that I have shared before. On the mobile devices side, we focused in the quarter on extending a major licensing agreement with Samsung and concluded that just in recent days, as well as negotiating further patent licensing deals with more Chinese companies. One of the goals of our continued shortly before the quarter ended by joining the Avanci licensing platform.
Avanci is very focused on automotive and this relationship should help us better target that sector in a very efficient way. That is it for the quarter. Let me now turn to the other announcements that we made today. As you will have seen, we are taking new actions designed to accelerate the execution of our strategy, improve customer focus and maintain our cost leadership. To accelerate our strategy, we are taking 2 steps.
1st, we are consolidating all of our enterprise specific activities into an enterprise business group. In early 2016, when we first started talking about diversifying into a new set of customers, there were several important things that we said. First, that we believe the enterprise market presented opportunities for Nokia that were higher growth and had the potential for higher profitability than our existing base of business. 2nd, that we would not go deep into the enterprise market and that we would target a limited number of companies in specific vertical segments giving us about 4,000 target organizations in all. And third, that our focus would be on providing telco grade networking capabilities, largely leveraging our existing products and services.
Essentially, we saw a new market that was developing and that was coming to us rather than us going to them. We have stuck to this approach and I like what I've seen. It is a sizable business as we have said previously approximately 5% of our revenue. It is growing nicely with a year to date growth rate of about 18% in constant currency. Order intake has been increasing consistently at double digit rates and margins are better than the average in our more traditional customer set.
In short, we have made very solid progress here. To further tap this opportunity, the new enterprise business group will go live on the 1st January. It will be led by Katherine Bubak, our current Chief Strategy Officer. The group will be responsible for all sales activities for enterprise customers as well as R and D for a limited set of enterprise only products. The second action we are taking is to focus our mobile networks business on mobile radio products.
Customers everywhere are asking for accelerated deliveries of mobile radio products and a wide range of new features. I am confident we can meet these needs, but it requires focus. This change will enhance that single-minded intensity and allow the organization to continue to strengthen roadmaps and ensure we have industry leading products. Mark Ruan will continue to run mobile networks. Additionally, to improve customer focus, we plan to consolidate our cloud core activities and accountability in Nokia Software.
All core products that have previously been in our mobile networks and global services business groups will now move to Nokia Software. With this step, which is a significant change, we can simplify the process of providing end to end fully integrated and fully tested cloud core solutions to our customers, flexibility and leveraging their strong software development and sales capabilities. Bhaskar Gauti will continue to lead the Nokia Software Group. Finally, to maintain our cost leadership, we are targeting significant further cost reductions. Earlier this year, when we first shared our 2020 guidance, I noted that we saw the opportunity to further reduce costs even after the end of this year, when we expect to successfully deliver on our €1,200,000,000 cost savings plan related to our Alcataloosant acquisition.
We have now quantified those future actions and are targeting €700,000,000 in annual cost savings by the end of 2020. We will target digitalization, automation and further process and tool simplification to generate savings. Our goal is to ensure that we are lean in every part of our business and that we maximize productivity and efficiency everywhere that we can. We do not do these things likely given the expected impact on Nokia employees, but they are the right things to do and will result in a company that is faster, simpler, more agile, a company better positioned to meet the needs of its customers and to create long term shareholder value. So in summary, we have made progress in the Q3 and there is plenty more to come.
With that, Christian, over to you.
Thank you, Rajiv. I will start today by spending a few minutes on the financial performance of Nokia Technologies and Group Common and Other. Then I will touch briefly on the U. S.-China tariffs and their impact on our overall business. After that, a few words on taxes and financial income and expenses, followed by our cash performance in Q3.
And finally, I will walk you through some of the key topics related to our guidance. Nokia Technologies reported another solid quarter of performance in Q3, delivering net sales of €351,000,000 While overall net sales declined 27% year on year, this was due to approximately €180,000,000 of non recurring net sales in the year ago quarter related to the catch up payments from the LG arbitration settlement. Excluding these, our recurring licensing revenues would have grown by 19% year on year, primarily reflecting the various licensing deals we signed throughout 2017. As Rajiv mentioned, subsequent to the end of the quarter, we extended our patent licensing agreement with Samsung, which was set to expire by the end of 2018. We expect to start recognizing revenues related to this extension in Q1 2019.
Consistent with our existing practice, we are not providing financial details related to the Samsung deal, and we will instead continue to disclose total licensing net sales in our quarterly announcements. It is important to note that we have today reiterated our guidance for recurring net sales within Nokia Technologies to grow at a 3 year CAGR of 10% through 2020. Operating margin in Nokia Technologies came in at 83% in the 3rd quarter compared to 81% in the year ago quarter, driven by improved gross margin and lower total operating expenses. These improvements reflected the exit of our digital media business in October 2017 and the digital health business in May 2018. In Q3, our annualized operating expenses were approximately €230,000,000 We believe that our Q3 operating expenses are at a healthy level and that investing at approximately these levels positions us well to achieve our guidance to deliver 85% operating margin in 2020.
Continuing next to Group Common and Other in Q3. Overall net sales decreased by approximately 6% year on year on a reported basis and by approximately 4% in constant currency. This was primarily driven by Alcatel Submarine Networks where the completion of a large project made a challenging comparison. This was partly offset by the growth in RFS, which was driven by a large customer rollout. As you may have noted, a French company called Equinox issued a statement last week saying that they were in discussions with Nokia related to the potential acquisition of ASN.
That is correct, although we have nothing more to add to this beyond a reminder that in situations like this, there is no guarantee that the parties will reach a deal. Group Common Moving on to financial income and sorry. Sorry, group common and other operating loss improved slightly year on year in Q3, primarily reflecting the gains in Nokia's venture fund investments, partly offset by the absence of the unwinding of a reinsurance contract with benefit which benefited the Q3 2017. Then turning briefly to the U. S.
China tariffs, our team has been working diligently to assess the impacts of these tariffs that these tariffs will have on our overall business. While we may not be able to completely mitigate our exposure, we believe that we can reduce this to a manageable level. We are currently working on short term actions to move some of our manufacturing from China to other countries in the Asia Pacific regions and increase our production in other locations in the Americas, which are already the main source of supply for our U. S. Deliveries.
Following these steps, we would expect that our overall annual exposure would be some tens of 1,000,000 at the gross profit level beginning in 2019 and going forward. Therefore, we expect that the tariffs will have an impact on us, but at this point that impact is relatively limited. Moving on to taxes, financial income and expense and EPS. Our non IFRS tax rate in Q3 was 30% in line with our full year 2018 guidance, which we reiterated today. Looking at non IFRS financial income and expense, the year on year improvement was primarily due to the absence of an impairment charge that impacted the year ago period as well as lower losses from foreign exchange fluctuations.
These were partly offset by the absence of gains from venture fund investments, which are now presented in other income and expenses as a result of the adoption of new IFRS 9 standards in the Q1 of 2018. To summarize at the Nokia level, our non IFRS diluted EPS was €0.06 in Q3 compared to €0.09 in the year ago period. If we exclude the nonrecurring catch up licensing net sales, which benefited the year ago period, our non IFRS diluted EPS would have only declined by €0.01 year on year. Excluding the non recurring items, our EPS performance was primarily driven by lower gross profit across all three reportable segments of our Networks business, partly offset by improved recurring gross profit performance in our Technologies business as well as lower operating expenses in both Networks and Technologies. Next, moving to our cash performance in Q3.
On a sequential basis, Nokia's cash decreased by approximately €270,000,000 to a quarter end balance of approximately €1,900,000,000 Net cash used in operating activities was approximately €80,000,000 Within this, Nokia's adjusted profit before changes in net working capital was approximately €350,000,000 in the 3rd quarter. Offsetting this, we had approximately €110,000,000 of restructuring and associated cash outflows. Excluding restructuring, we experienced a decrease in net cash related to net working capital of approximately €230,000,000 Looking at the individual components of working capital, inventories increased by approximately €270,000,000 as we continue to prepare for 5 gs deliveries. Receivables increased by approximately €80,000,000 These increases were partly offset by the increase in liabilities of Cash taxes amounted to €90,000,000 in the quarter. In addition to these items, CapEx totaled €140,000,000 in the quarter and as I flagged in the previous quarter, we made a payment of approximately €130,000,000 of withholding tax is related to the dividend payment made earlier this year.
Finally, turning to our guidance. At the Nokia level, we have reiterated our full year 2018 guidance for our non IFRS operating margin to be in the 9% to 11% range and non IFRS diluted EPS to be in the €0.23 to €0.27 range. Regarding our cost savings program, we remain on track to complete the €1,200,000,000 of savings by the end of the year. Today, we have updated some of our expectations. Specifically and pleasingly, we now expect restructuring and associated charges to total €175,000,000 and the related cash outflows to total €2,100,000,000 both of which are €150,000,000 below the previous expectations.
In addition, we now expect the charges and cash outflows related to the network equipment swaps to total €1,300,000,000 which is €100,000,000 below our previous expectations. Finally, related to the €700,000,000 restructuring program we announced today, we expect charges and cash outflows to total approximately €900,000,000 Free cash flow is an important metric for us and we continue to expect to generate slightly positive recurring free cash flow in 2018. As we expect strong seasonality in Q4, we also expect to end 2018 with a strong financial position. That said, we have a lot of work ahead of us in Q4. In addition to planning for higher 5 gs sales, we also see risks related to short term delays in project timing and project deliveries that could impact our full year 2018 projections, including our cash flow expectations.
Looking specifically at Networks, we reiterated our view that our primary addressable market will decline approximately 1% to 3% in 2018 on a constant currency basis. From a net sales perspective, we also continue to expect to outperform our primary addressable market. This continues to be driven by strong demand for 5 gs and our strategy to expand into select vertical markets. Looking at our guidance for Networks operating margin, while we do see some risk, we continue to expect a strong 4th quarter and thus we today reiterated our guidance for Networks operating margin to be in the 6% to 9% range in 2018. We are continuously pushing our teams to deliver on our commitments.
We have also reiterated our guidance for our licensing business within Nokia Technologies. We continue to expect our recurring net sales to grow at a 10% CAGR over the 3 year period ending 2020 and we continue to expect to reach operating margins of 85% for the full year 2020. Given the progress we have been making in this business, we remain confident to hit these targets. Finally, and we have most importantly, we have today reiterated our 2020 guidance and we are confident that we will hit these targets with the actions that we have quantified today. With that, I hand over to Matt for Q and A.
Thank you,
We will now begin the question and answer session. Our first question comes from David Mulholland of UBS. Please go ahead.
Hi. Thanks for taking the question. Just on the I guess the key point and question from here is just getting comfort on your ability to deliver on the Q4 margins in Networks. So I wonder if you could just help us understand a little bit what gives you the confidence you can still see such a strong margin, particularly in Q4, given the run rate that gross margins have been at in the last couple of quarters, obviously, some improvement in Q3. But can you possibly help lay out what really are the steps that will take us to the, I guess, 14%, 15% level that we need to get to the bottom end of your range in Networks margins for the full year?
I think as we have said earlier, we do expect to see improved market conditions throughout the second half of the year, particularly going into the Q4. That's one driver will provide for operating leverage. And at the same time, we also said that some of the headwinds that we had for gross margins during the first half would also ease as we go into the second half of the year, which was also visible already in the Q3 numbers and it to continue going into Q4.
Thank you, David. Nicola, next question please.
Our next question comes from Mike Walkley of Canaccord Genuity. Please go ahead.
Great. Thank you. Questions on the Technologies division. Just congratulations on extending Samsung. Can you just talk about how Nokia is positioned within 5 gs licensing and how you see 5 gs in terms of the overall 10% CAGR?
Is it accretive to your long term licensing business model? Thank you.
Thank you, Mike. Just stepping back, so we had to do this Samsung deal. I'm just going to go back to our roadmap for Nokia Technologies. The next is China. We are negotiating with a number of players in China.
We have now joined the Avanxi licensing program to target more efficiently the automotive sector and after that will come IoT, consumer broadcast, etcetera. So we're still tracking well on this roadmap and that gives us the confidence to get to this 10% CAGR in licensing. As for 5 gs, it of course is an incremental radio technology. We published some rates out there, but early to tell whether that will be neutral or positive.
Thank you, Mike. Nicole, we'll take our next question please.
Our next question comes from Richard Kramer of Arete Research. Please go ahead.
Thanks very much. Rajeev, given all the headwinds that Christian mentioned in the mix for 2018, I wonder if you could talk through how you're looking at margins in 2019 and longer? It seems like we've been waiting for the new routing products to ramp. You talked about software, you talked about enterprise entry into cable, shipping early commercial 5 gs equipment and moving that out of R and D. You mentioned in the statement a number of times about the balance between pricing and cost pressure.
But as you look into next year and beyond, do you feel confident you can build a sort of higher structurally higher margin business given all these elements that we've been waiting to come through the P and L?
Thank you, Richard. So number 1, what gives us confidence is our end to end portfolio, this 43% multi business group pipeline, which is sharply up. Number 2, our 5 gs win rate is very strong, So we're doing very well and we are the only privileged ones to play with all of the roughly 13, 14 operators that are in these lead markets of China, Japan, South Korea and U. S. In 4 gs already.
So now we're trying to convert them to 5 gs. So and the third is the strong order backlog. I said it's 30% up since the start of the year, shows us that clearly there's demand for our products and services and the early wins in the 5 gs cycle is good. We can see some of that in the optical business as well with the tailwind we're getting there because of 5 gs. We haven't started shipping in a big way SP4.
Let's remember that SP4 is trying to ramp in some areas, but that's more going to be Q4 onwards, but largely 2019. So I'll stand back and say what gives us the structural advantage over time, moving into more software, naturally Nokia software, which we've now seen growing well. Enterprise, it is more attractive from a growth perspective, also from a margin perspective. 5 gs, there are puts and takes and sometimes in the beginnings of an early cycle, there can be aggression in some parts where people want to get some land grab. On the other hand, our end to end portfolio allows us to benefit from more share of wallet.
And of course, there are some products coming through like ReefShark and PSE3 and optical and SP4 that will give us a beneficial cost advantage in the medium to long term.
Thank you for your question, Richard. Nicole, we'll take the next one, please.
Our next question comes from Sandeep Deshpande of JPMorgan. Please go ahead.
Yes. Hi, Rajeev. One question again on the 4th quarter and the margin progression in the Q4. I mean, in the Q3, were your swaps that you were doing in the first half of the year completely over? And then secondly, with regard to the 5 gs orders that you have that are going to ramp up into revenue into the Q4, do you have anything to do with the acceptance on those orders?
And is there any risk on the acceptance or you already begun to ship those 5 gs orders and have already seen some acceptances?
I think maybe I can
take the swap question. So I think we still have some swaps to do. As I said in my prepared remarks, we now expect that the cost of executing on those swaps will be somewhat lower than what we originally anticipated. But there is really no kind of correlation between that and revenues. Of course, getting out of the swap phase will enable us to fully focus our delivery capacity on the 5 gs projects in North America, and that will help.
But I think one should not kind of see that as being a source of revenue upside going forward.
Yes. And Sandeep, I would add that, of course, not having the distraction of the swap, which is basically an integration activity, is going to be helpful apart from the fact that some of those services resources can be used for these acceptances and 5 gs projects that we need them for. On the point of acceptance, that's what we mean when we say that there is some risk that some of that could slip. So there is some risk of that. Having said that, the orders are in place.
So I'm encouraged by the fact that it's all about deliveries and getting the project out there and of course customers are helping us to do so. So some risk, still feel confident that we can hit our guidance though.
Our next question comes from Sebastian Tabowitz of Kepler Cheuvreux. Please go ahead.
Yes. Hello. It seems that you have quite large backlog in hand right now. What kind of seasonality we can expect for Q4?
So again, I think from a revenue point of view, we can expect kind of stronger than normal seasonality going into Q4 now because at the same time, we do see a ramp up of the 5 gs deliveries, particularly in North America. So I would say you will have the normal seasonality. And then on top of that, you will have gradual ramp up of 5 gs, particularly in North America.
Thank you, Sebastian. Nicole, next question please.
Our next question comes from Stefan Slowinski of Exane BNP Paribas. Please go
ahead. Yes. Hi. Thank you
for taking my question. Just one for Christian. Just wondering what's happened over the course of this year to trigger the new restructuring plan you've announced today. You gave your 2020 guidance back in February and now you've reiterated that guidance, but you've said you're going to need €900,000,000 more of restructuring in order to achieve that. I'm just wondering what's happened over the course of this year to change the view on what you need to get to those targets in 2020?
Thank you.
I think when we set out the longer term guidance after Q4 results, we did call out the levers that would need to be pulled to be able to get to an improved margin. And as part of those levers, we talked about R and D productivity improvements as well as support function cost reductions. What we are doing today is really quantifying those levers and also following through on the remarks that we made in Q2 around having to take stronger cost action as a result of some of the margin headwinds that we saw. So to me, this is a natural progression and quantification of items that we have already laid out earlier.
Thank you, Stefan. Nicole, next question, please.
Our next question comes from Alexander Peteric of Societe Generale. Please go ahead.
Yes, hi. Thanks for taking my question. I'd just like to understand very briefly regarding your new restructuring plan, what part of it is pertaining to remodeling your business structure and what part of it is pure cost cuts? And are you exiting any business areas? Are you still eliminating any of the excess and duplicate cost base due to the Alu takeover?
Just like to understand that. And then a brief detail just on IP routing that seems to be actually worse year on year in Q3 versus Q2. You're now at 9% down and I think Q2 was 4% down. So is that still just component shortage or is the market a little bit weaker in IP routing than we thought previously? Thanks.
Maybe I'll start on the cost restructuring because I think it's very important to understand that in the additional announcement we made today, we talk about 2 different things like Rajeev said in his prepared remarks. We are making structural changes that will enable us to execute quicker on our strategy and to enhance our customer focus. And those relate to the creation of the enterprise business groups, making mobile networks more focused on mobile radio and moving core into Nokia Software as core more and more is really about software. So those are enablers to run a better business going forward. Then on the other hand, we are also taking cost actions.
The cost actions are in areas where we want to make sure that we have support function costs that are world class. We have now gone through, one could say, one phase of cost optimization after the Alcatel Lucent integration, and we are now moving into the next phase. We can, through leveraging digitalization and improved processes take out more cost from our support functions. At the same time, 5 gs is enabling us to move from some of the legacy platforms that we have as coming from the different acquisitions we have made into a single product platform that is used globally. And as a result, we can reduce R and D in legacy and at the same time still increase R and D investments into 5 gs and new technologies and so on.
So you should really kind of look at this as being 2 different things with which we will become a leaner company that can move faster and that will have longer term a competitive cost structure.
Then the second question, routing The second
question was the year on year growth in IP routing was a little worse in Q3 than Q2.
So Alex about that, in the last three quarters we have been taking market share in IP routing when the market is soft. So the market is soft, but we've been taking share, we've been taking share both in telco and non telco. Yes, we did suffer from these component shortages. We suffered last Q2 as well as in Q3 And we think some of this will ease in the coming couple of quarters with the mitigation activities that we're doing.
Okay. Alex, thank you for your question. Nicole, we'll take the next question please.
Our next question comes from Dan Bartus of Bank of America Merrill Lynch. Please go
ahead. Hi, this is Taliani. I think I'm on and I dialed on Dan's numbers. Yes, you're on. Thank you.
Two questions. Number 1 is why have we seen a decline in routing despite the fact you have a new portfolio? And number 2, same question, the opposite, what's the source for the 25% increase in optical? And what's the outlook? How sustainable is this growth?
Thanks.
Thanks. So first of all, as we move forward to 2019, we expect that the balance will shift a little bit. So routing will get stronger and optical will start to get more balanced towards less than this 25% that we're seeing at this point in time. The reason we're seeing that optical strength is the portfolio is very strong. We really have with all of the innovation we've done, we're getting a lot of traction.
We're getting momentum in web scale, the cloud players, enterprise, but also in telco. In telco, it's related to 5 gs because before you start the 5 gs radio, you've got to put in backhaul, fronthaul, etcetera. On the IP routing question, again, I will repeat what I said earlier. It's a soft market overall. We are taking share.
I believe we will end the year with still taking share, we're taking share both in telco and non telco. FP4 is not yet a meaningful driver. It will start to become that way. Some of the low end FP4 is shipping, but we're getting lots of momentum on FP4, but we'll see more of it in Q4 and Q1 onwards next year.
Thank you, Tal. Nicole, next question please.
Our next question comes from Robert Sanders of Deutsche Bank. Please go ahead.
Yes. Hi, good afternoon. Just coming back to the 5 gs point, if I can. I was just hoping you could quantify the growth you expect to see in the U. S.
Next year in your radio business. Some of the EMS guys are talking about 10% growth next year. I was just wondering given you're saying you're taking market share, whether you could put a bit more of a quantification around the level of growth you expect to see just in your U. S. Radio business?
Thank you.
I think, Rob, when it comes to 2019 and more specifics, you'll have to have the patience for 90 days and our Q4 numbers. We have talked about the fact that we do see improved market conditions in general on the back of the 5 gs cycle kicking in. We have talked about 2019, 2020 being growth years, but I have to leave it there for today.
So maybe we'll give you the first question for next quarter. Nicole, next question please.
Our next question comes from Alexander Duvall of Goldman Sachs. Please go ahead.
Yes, many thanks for the question. Just had a quick one on 5 gs, particularly in North America. It looked like wireless was again strong in the quarter and you're talking about strength into the next quarter. Wondered if you could just clarify at this point what technology exactly is rolling out related to 5 gs? Are we talking about standalone 5 gs, either the quarter just gone or in Q4?
Or are we talking about densifying the network with non standalone, which will be upgradable later? Many thanks.
Thanks, Alexander. So at the moment, most customers are doing rollouts of non standalone. And then they are some of them are looking at standalone as well, particularly when you want to tap into the industrial opportunity, but right now most of the deals are non standalone in the U. S. And beyond.
Thank you, Alex, for your question. Nicole, we'll take the next question, please.
Our next question comes from a call Sultania of Credit Suisse. Please go ahead.
Hi, good afternoon. Just a question on the gross margins in the Ultra Broadband business. We've had a number of quarters where you've successfully done high-40s gross margins and now obviously gross margins have been coming down. You obviously, you explained that it's partly driven by network implementation projects, but such a huge magnitude of decline in margins just because of the U. S.
Network implementation, like is there something else which is also like causing a headwind which probably goes away at some point next year?
Again, I don't think we have much to add to there what we have said before. We have had some regional as well as product mix challenges, some of which we think will reverse as we go forward. And then we also had in the second quarter, as we discussed, some pricing related headwinds, which will take some time to work through.
Thank you, Achal. Nicole, next question please.
Our next question comes from Simon Leopold of Raymond James. Please go ahead.
Great. Thank you very much. I wanted to just get a quick clarification on the savings program. You talked about $500,000,000 of operational savings, but timing is always sort of a swing factor. If we're thinking about 2018 non IFRS operating expenses in the neighborhood of 6 point $8,000,000,000 Can you help us understand how to think about the full year 2020?
I assume it's we don't just subtract 500,000,000 from that. So I'm just trying to get an idea of what you're targeting for 2020. And then broader question is if you could update us on the diversification efforts towards, webscale enterprise and cable, where do you sit today? And how do you see that mix trending into that 2020 timeframe? Thank you.
Yes. And again, maybe Matt and team can help clarify. But to me, this is relatively simple that we will take out SEK 800,000,000 of operating expenses compared to our SEK 50,000,000 number as part of the SEK 1.2 $1,000,000,000 program. And then from that number, we will take out another $500,000,000 as part of the new program for the 2020 time frame.
And on the diversification, Simon, we've in the enterprise business, we've grown at constant currency 18% year to date, excluding a 3rd party integration activity that we're exiting from former Alcatlucent. So that's going really well. And that's why we've set up a separate enterprise business group. The order intake has been double digit for many quarters. So I'm very confident that that structurally more attractive business, high growth, high margin is working well for us.
On Cable, it actually sits within the service provider operations, so not so much in the enterprise. And there, it's early days with the GainSpeed acquisition, but we can see that we are getting some wins, but it will still take much of 2019 for that to start to translate. And through being in the access business of Gainsby, we think we can pull in IP and optics as well. So over time, that will be a synergy revenue synergy activity.
Thank you, Simon for your two questions. As a reminder, please limit yourself to one question only and Nicole will take the next question please.
Our next question comes from Paul Silverstein of Cowen. Please go ahead.
Thank you for taking my question. Any impact from tight labor market conditions? Obviously Eric has been cited that on their call. I don't think I heard you referencing in this call.
Sorry, Paul, we couldn't hear you.
Yes. My apologies. Can you hear me now?
Yes. Go ahead.
Any impact from tight labor market conditions? I don't think I heard you all cite that on the call.
Did you say any impact from tight labor market conditions?
Correct. Further comments from Ericsson, particularly North America, both at their customers and within the company itself. Are you not seeing that at all?
I don't think we are seeing any material impacts there. I have to say that I don't know what they are referring to. Of course, as we said, we do have some capacity to redeploy, particularly on the delivery side when we ramp down the activities to deploy the swaps and can use that capacity to ramp up for 5 gs deliveries.
Yes. Paul, I'd just add that a couple of years ago, we acquired a company called SAC Wireless that does this build activity in anticipation that, that market will get heated over time in the run up to 5 gs. So we are somewhat better positioned and more resilient because of
that. Great. Thank you, Paul. And Nicole, we'll take the next question please.
Our next question comes from Tim Long of BMO Capital Markets. Please go
ahead. Thank you. Just want to touch on the software business. You had some growth in the quarter, but year to date it's kind of flattish again. We're seeing that rise as a percentage at other companies.
What needs to happen and what product do you think can get that line moving a little faster than overall sales and obviously helping margins as it does that? Thank you.
Thanks, Tim. So yes, we had a bit of a speed bump in Q1, we grew in Q2 and then now in Q3 as well. So the strategy is working. Again, as a reminder, we're ensuring that there are enough salespeople, the right kind of quality sales force for selling to CMOs and CIOs because this isn't just about selling to CTOs of our customer base. All that activity is behind us.
We're driving all our products, including the ones that we will now move from mobile to Nokia Software, the CloudCore activity to a common software foundation. And that common software foundation gives you cost benefit, gives you COGS benefit, but also it gives you agility in terms of moving fast in terms of R and D productivity. We just have to do more of the same. So the order backlog is robust. The order intake continues to be strong.
We just have to keep going.
Great. Thank you, Tim. And Nicole, we'll take our next question.
Our next question comes from Pierre Ferragu of New Street Research. Please go ahead.
Hey, thanks for taking my question. So Rajiv, you announced quite a lot of very significant moves for Nokia. So formalizing more like your enterprise initiative, like a push in terms of software creating independent segments for these 2. And you announced also like some significant cost cutting. So just trying to think how you came to that strategic direction.
I get the feeling that it sounds like you're not expecting like a significant 5 gs cycle and that you need to go down other routes to keep developing Nokia. So am I right thinking about it this way? Is 5 gs not going to have a significant long term impact on your revenue in your core business?
Thanks, Pierre. When we talked at the CMD in November 2016, we said our strategy in a nutshell is going to be benefit from end to end, right the 5 gs cycle when that comes. We are the only ones in the world to have an end to end portfolio at scale in every single market of the world as opposed to others. And go for software, build a standalone software business at scale and third, go for enterprise and web scale. Now having seen the progress in software, having seen the progress in enterprise, I feel it's appropriate for us to set up a separate business group or extend software even further to provide them more scale and productivity.
So it's just a follow through of the success of our strategy in diversification. I think it's nothing to do with the fact that do I see less optimism for 5 gs because I actually think the 5 gs cycle could be longer than 4 gs. This is the first time ever in a wireless technology we have such a broad spectrum all the way from a few 100 megahertz of spectrum to 28, 39, 56 gigahertz. So a good 5 gs operator will do a low band rollout, a mid band rollout and a high band rollout. And we have not seen this in 4 gs.
So if I had to venture to guess, will this cycle peak in 7 years or 8, I'd say potentially 10 is the right number. So this could be a longer cycle. Plus, this isn't just about consumer. This is also about industrial. So and some new revenue opportunities like fixed wireless access.
In terms of cost savings, Phase 1 is always about let's get the duplication out of the way. Let's make sure that the synergies are captured through the 2 companies. Phase 2 is optimize the company, get ahead of the curve, become super lean everywhere you can and then benefit it for years to come. And I'm trying to create a competitive platform at the right
time. Thank you, Pierre. Nicole, we'll take our next question please.
Our next question comes from Amit Harshindani of Citigroup. Please go ahead.
Good afternoon and good morning all. Amit Harshindani from Citi. A question and a clarification, if I may. The question is with respect to the cost erosion and pricing erosion dynamic. Could you reconfirm if the pricing erosion dynamic is function of customer pressure, competitor pressure or is it simply a reflection of your product not being fully up to date with the features?
And secondly, as a quick clarification, can you confirm that you no longer see the need to take any further charges to hit your 2020 margin targets? Thank you.
So thanks Amit on the first question. So broadly, we have not seen an increase or a decrease in competitive intensity. So we would say that that is neutral on a broad basis. We did talk about in Q2 about a specific situation where your customers wanted to accelerate a 5 gs and they wanted to use some of the 4 gs investment part, so to speak, to accelerate. And then we had some pricing issues where our pricing was robust.
And so that's it. The second question, Christian.
I think in a way, we have today, as I said earlier, quantified the earlier defined cost levers that are needed to meet the 2020 guidance. And we have also quantified how much we believe it will cost to implement these restructuring plans that take us to a €700,000,000 net reduction.
Thank you, Amit, for your question. We're running out of time, so we have time for one more question. Sorry, we didn't quite get through the queue today. Almost made it, but not quite. Nicole, we'll take our final question for today, please.
The next question comes from Stuart Jaffray of Agency Partners. Please go ahead.
Hi, thank you. I had a question on free cash flow. I think you've reiterated your slightly positive for the year target. But I think at the end of Q3, you're about €1,500,000,000 down. So even with a very strong Q4, it looks like working capital perhaps has to generate €1,000,000,000 And yet you've spoken about very strong demand from the U.
S. For 5 gs, which I would imagine you can't invoice for that until very late in the quarter. Normally, that would result in a buildup in receivables. So perhaps you can just talk through some of the levers that help you get to that sort of €1,500,000,000 of inflow for Q4? Thanks.
Yes. Thanks, Stuart. And again, I guess, you are highlighting one of the key risks that I talked about in my prepared remarks. We do have, when it comes to free cash flow, a stretch here that the team is working on. We need to get the deliveries done.
We need to get the invoicing in place, and we need to be converting those invoices to cash to be able to produce the needed cash flow in the quarter. And that's what we have set out to do.
So thank you, Stuart, and thank you, everyone, for your questions today. I'd now like to turn the call back to Rajeev.
Well, thank you. In closing, let me just make 3 comments. First, I will say again that our 3rd quarter results validate our earlier view that conditions would improve in the second half of the year and that Nokia's performance would improve as well. The 5 gs cycle is underway and we remain well positioned even if there is still plenty of heavy lifting ahead. 2nd, our strategy is continuing to work very well and we are taking additional steps further align our structure to our strategy.
While communication service providers remain at the heart of our business, we would be remiss if we did not seek to benefit from structurally attractive adjacent markets and that is exactly what we are doing. 3rd, we are not sitting still at Nokia. We have learned the hard way in previous years that cost discipline, productivity and efficiency are absolutely critical success factors in our industry. With the alkydolucine cost savings soon to be behind us, we are turning to the next level of activity to optimizing, streamlining, simplifying, all with the goal of ensuring we are the leanest, fastest, most agile player in our industry. With that, thanks for your time and attention, and I will now hand it back over to Matt.
Ladies and gentlemen, this concludes our conference call. I would like to remind you that during the conference call today, we have made a number of forward looking statements that involve risks and uncertainties. Actual results may therefore differ materially from the results currently expected. Factors that could cause such differences can be both external, such as general economic and industry conditions, as well as internal operating factors. We have identified these in more detail on Pages 71 through 89 of our 2017 Annual Report on Form 20 F, our financial report for Q3 and January through September 2018 issued today, as well as our other filings with the U.
S. Securities and Exchange Commission. Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.