Please note this event is being recorded. I would now like to turn the conference over to Mr. Matt Shimao, Head of Investor Relations. Sir, you may begin.
Ladies and gentlemen, welcome to Nokia's third quarter 2018 conference call. I'm Matt Shimao, Head of Nokia Investor Relations. Rajeev Suri, President and Chief Executive Officer of Nokia, and Kristian Pullola, Chief Financial Officer 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 third quarter 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 first 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 5G 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. We are facing a heavy workload in the fourth quarter 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 fourth quarter. Again, the orders are certainly there. We expect to capture any missed sales in the coming quarters. Despite these risks, we still expect that a strong fourth quarter, along with our ongoing solid strategy execution, will allow us to deliver a full-year Networks operating margin within our guidance range.
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 five of our Networks business groups and in four of our six 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 5G deals made up a large portion of this. We also saw strong activity in other parts of our business, and particularly in Nokia Software. 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 one year ago. 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. 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. I will come back to this topic shortly. Some of the margin challenges continue to come from product mix. In the third quarter, 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 eighth consecutive quarter of year-on-year sales growth in Q3.
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. Let me briefly highlight some of the progress we made in the quarter on the execution of our strategy. Starting with our first 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 $3.5 billion multi-year 5G network deal with T-Mobile and AT&T naming Nokia as one of its 5G suppliers. We also achieved some important firsts, the first to demonstrate a 5G connection over Massive MIMO with Sprint, and the first transmission of a 3GPP 5G 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 5G trials in Japan, and it did so using the Nokia AirScale base station. I would also note that Nokia performed extremely well in recent 5G 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 GHz 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, 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 KDDI in Japan to enable gigabit ultra-broadband speeds. In the second pillar of our strategy, expanding in select vertical markets, we saw continued sales growth on a year-on-year basis, excluding the former Alcatel-Lucent third party integration business we are exiting. Order development was excellent in the quarter, we continue to expand our footprint. We added 27 new customers in the third quarter after signing on 70 new ones in the first half.
In our third 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 orders growth was considerably higher. Our ambition for this business in terms of growth and profitability is high, I am confident that the business is heading in the right direction. You may have heard about our developing relationship with Salesforce, the fact that our Intelligent Care Assistant software solution was introduced into the Salesforce AppExchange during the quarter. Further highlighting our momentum, we had some new wins that included British Telecom, Telenor One Europe, and Telefónica UK. In the fourth 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 licensing business has been to expand into new sectors, which we 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 two steps.
First, 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. Second, 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. 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 of January. It will be led by Kathrin Buvac, our current Chief Strategy Officer. The group will be responsible for all sales activities for enterprise customers, as well as R&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. 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. Marc Rouanne 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, lower our execution risk, and improve overall commercial management.
It will also add scale and potential synergies to Nokia Software, giving them more flexibility and leveraging their strong software development and sales capabilities. Bhaskar Gorti 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 EUR 1.2 billion cost savings plan related to our Alcatel-Lucent acquisition. We have now quantified those future actions and are targeting EUR 700 million 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, that we maximize productivity and efficiency everywhere that we can. We do not do these things lightly given the expected impact on Nokia employees, 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. In summary, we have made progress in the third quarter, and there is plenty more to come. With that, Kristian, over to you.
Thank you, Rajeev. I will start today by spending a few minutes on the financial performance of Nokia Technologies and Group Common and Other. 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. 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 EUR 351 million. While overall net sales declined 27% year-on-year, this was due to approximately EUR 180 million of non-recurring net sales in the year-ago quarter related to the catch-up payments from the LG arbitration settlement. Excluding this, 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, 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 three-year CAGR of 10% through 2020. Operating margin in Nokia Technologies came in at 83% in the third 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 EUR 230 million. 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 Ekinops 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. 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 which benefited the third quarter 2017. Turning briefly to the U.S.-China tariffs.
Our team has been working diligently to assess the impacts 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 millions at the gross profit level beginning in 2019 and going forward. 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 first quarter of 2018. To summarize at the Nokia level, our non-IFRS diluted EPS was EUR 0.06 in Q3 compared to EUR 0.09 in the year ago period. If we exclude the non-recurring catch-up licensing net sales which benefited the year ago period, our non-IFRS diluted EPS would have only declined by EUR 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 EUR 270 million to a quarter end balance of approximately EUR 1.9 billion. Net cash used in operating activities was approximately EUR 80 million. Within this, Nokia's adjusted profit before changes in net working capital was approximately EUR 350 million in the third quarter. Offsetting this, we had approximately EUR 110 million of restructuring and associated cash outflows. Excluding restructuring, we experienced a decrease in net cash related to net working capital of approximately EUR 230 million.
Looking at the individual components of working capital, inventories increased by approximately EUR 270 million as we continue to prepare for 5G deliveries. Receivables increased by approximately EUR 80 million. These increases were partly offset by the increase in liabilities of approximately EUR 130 million, primarily due to increases in accounts payable, partly offset by decreases in contract liabilities. Cash taxes amounted to EUR 90 million in the quarter. In addition to these items, CapEx totaled EUR 140 million in the quarter. As I flagged in the previous quarter, we made a payment of approximately EUR 130 million of withholding taxes 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%-11% range, and non-IFRS diluted EPS to be in the EUR 0.23-0.27 range. Regarding our cost savings program, we remain on track to complete the EUR 1.2 billion 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 EUR 1.75 billion, and the related cash outflows to total EUR 2.1 billion, both of which are EUR 150 million below the previous expectations. In addition, we now expect the charges and cash outflows related to the network equipment swaps to total EUR 1.3 billion, which is EUR 100 million below our previous expectations.
Finally, related to the EUR 700 million restructuring program we announced today, we expect charges and cash outflows to total approximately EUR 900 million. 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 5G 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%-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 5G 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 fourth quarter, thus we today reiterated our guidance for networks operating margin to be in the 6%-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 three-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 perhaps 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&A.
Thank you, Kristian. For the Q&A session, please limit yourself to one question only. Nicole, please go ahead.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Again, please limit yourself to one question only. 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. I wonder if you can 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 the gross margins have been at in the last couple of quarters. Obviously, some improvement in Q3, 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 fourth quarter. That's one driver that will provide for operating leverage. 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 expected to continue going into Q4.
Thank you, David. Nicole, next question, please.
Our next question comes from Michael Walkley of Canaccord Genuity. Please go ahead.
Great. Thank you. A question on the Nokia Technologies division. Just congratulations on extending Samsung. Can you just talk about how Nokia's positioned within 5G licensing and how you see 5G 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, 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 Avanci licensing program to target more efficiently the automotive sector. After that will come IoT, consumer broadcast, et cetera. We're still tracking well on this roadmap, and that gives us the confidence to get to this 10% CAGR in licensing. As for 5G, it of course, is an incremental radio technology. We published some rates out there, but early to tell whether that'll be neutral or positive.
Great.
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 Kristian 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 5G equipment, and moving that out of R&D. You mentioned in the statement a number of times about the balance between pricing and cost pressure. As you look into next year and beyond, do you feel confident you can build a sort of structurally higher margin business given all these elements that we've been waiting to come through the P&L?
Thank you, Richard. 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 5G win rate is very strong, we're doing very well. 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 4G already. Now we're trying to convert them to 5G. The third is the strong order backlog. I said it's 30% up since the start of the year. It shows us that clearly there's demand for our products and services, and the early wins in the 5G cycle is good. We can see some of that in the optical business as well, with the tailwind we're getting there because of 5G. We haven't started shipping in a big way FP4.
Let's remember that, FP4 is trying to ramp in some areas, that's more going to be Q4 onwards, largely 2019. 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. 5G, there are puts and takes. 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. Of course, there are some products coming through like ReefShark and PSE-3 and optical and FP4 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.
Hi, Rajeev. One question again on the fourth quarter and the margin progression in the fourth quarter. In the third quarter, were your swaps that you were doing in the first half of the year completely over? Secondly, with regard to the 5G orders that you have that are going to ramp up into revenue into the fourth quarter, do you have anything to do with the acceptance on those orders? Is there any risk on the acceptance or have you already begun to ship those 5G orders and have already seen some acceptances?
I think maybe I can take the swap question. I think we still have some swaps to do. As I said in my prepared remarks, we now expect that the cost of executing those swaps will be somewhat lower than what we originally anticipated. 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 5G projects in North America, and that will help, but I think one should not see that as being a source of revenue upside going forward.
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 5G projects that we need them for. On the point on acceptance, that's what we mean when we say that there is some risk that some of that could slip. There is some risk of that. Having said that, the orders are in place, 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. Some risk, still feel confident that we can hit our guidance though.
Thank you, Sandeep. Next question please, Nicole.
Our next question comes from Sébastien Sztabowicz of Kepler Cheuvreux. Please go ahead.
Yeah, hello. It seems that you have a quite large backlog right now. What kind of seasonality we can expect for Q4?
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 5G deliveries, particularly in North America. I would say you will have the normal seasonality, and then on top of that, you will have gradual ramp-up of 5G, particularly in North America.
Thank you, Sébastien. 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 Kristian. 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. Now you've reiterated that guidance, but you've said you're going to need EUR 900 million 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. As part of those levers, we talked about R&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. 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 Aleksander Peterc 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? Are you exiting any business areas? Are you still eliminating any of the excess and duplicate cost base due to the ALU takeover? I'd just like to understand that. 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. Is that still just component shortage, or is the market a little bit weaker in IP routing than we thought previously? Thanks.
Yeah, maybe I'll start on the cost restructuring. I think it's very important to understand that in the additional announcement we make today, we talk about two 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. 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. Those are enablers to run a better business going forward. 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, 5G is enabling us to move from some of the legacy platforms that we have, coming from the different acquisitions we have made, into a single product platform that is used globally. As a result, we can reduce R&D in legacy, and at the same time, still increase R&D investments into 5G and new technologies and so on. You should really look at this as being two different things with which we will become a leaner company that can move faster and that will have longer-term, a competitive cost structure.
The second question was routing.
The second question was the year-on-year growth in IP routing was a little worse in Q3 than Q2.
Yes.
Alex, about that. In the last three quarters, we have been taking market share in IP routing when the market is soft. 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 Parkes of Bank of America Merrill Lynch. Please go ahead.
Hi, this is Tal Liani. I think I'm on. I dialed on Dan's numbers.
Yes, you're on.
Thank you. Two questions. Number one is, why have we seen a decline in routing despite the fact you have a new portfolio? Number two, same question, the opposite. What's the source for the 25% increase in optical? What's the outlook? How sustainable is this growth? Thanks.
Thanks. First of all, as we move forward to 2019, we expect that the balance will shift a little bit, routing will get stronger and optical will start to get more balanced towards less than this 25% that we are seeing at this point in time. The reason we are seeing that optical strength is the portfolio is very strong. With all of the innovation we have done, we are getting a lot of traction. We are getting momentum in web scale, the cloud players, enterprise, but also in telco. In telco it is related to 5G, because before you start the 5G radio, you have got to put in back haul, front haul, et cetera. On the IP routing question, again, I will repeat what I said earlier. It is a soft market overall. We are taking share. I believe we will end the year with still taking share.
We are 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. We are getting lots of momentum on FP4, but we will 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.
Yeah. Hi, good afternoon. Just coming back to the 5G point, if I can. I was just hoping you could actually 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 5G cycle kicking in. We have talked about 2019, 2020 being growth years, but I have to leave it there for today.
Here, Rob. Maybe we'll give you the first question for next quarter. Nicole, next question, please.
Our next question comes from Alexander Duval of Goldman Sachs. Please go ahead.
Yes, many thanks for the question. Just had a quick one on 5G, particularly in North America. Looked like wireless was again strong in the quarter, and you are talking about strength into the next quarter. Wondered if you could just clarify at this point what technology exactly is rolling out related to 5G. Are we talking about standalone 5G, either the quarter just gone or in fourth quarter, or are we talking about densifying the network with non-standalone, which will be upgradable later? Many thanks.
Thanks, Alexander. At the moment, most customers are doing rollouts of non-standalone. Some of them are looking at standalone as well, particularly when you want to tap into the industrial opportunity, where right now most of the deals are non-standalone in the U.S. and beyond.
Thank you, Alex, for your question. Nicole, we will take the next question, please.
Our next question comes from Achal 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 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. Is there something else which is also causing a headwind, which probably goes away at some point next year?
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. 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 EUR 500 million of operational savings, but timing's always sort of a swing factor. If we're thinking about 2018 non-IFRS OpEx in the neighborhood of EUR 6.8 billion, can you help us understand how to think about the full year 2020? I assume we don't just subtract EUR 500 million from that. I'm just trying to get an idea of what you're targeting for 2020. Broader question is, if you could update us on the diversification efforts towards web scale Enterprise and cable, where do you sit today and how do you see that mix trending into that 2020 timeframe? Thank you.
Yeah. Again, maybe Matt and team can help clarify, but to me this is relatively simple that we will take out EUR 800 million of OpEx compared to our 2015 number as part of the EUR 1.2 billion program. From that number, we will take out another EUR 500 million as part of the new program for the 2020 timeframe.
On the diversification, Simon, in the Enterprise business we've grown at constant currency 18% year-to-date, excluding a third party integration activity that we're exiting from former Alcatel-Lucent. 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. 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, not so much in the enterprise. There, it's early days with the Gainspeed acquisition, but we can see that we are getting some wins. It will still take much of 2019 for that to start to translate. Through being in the access business of Gainspeed, we think we can pull in IP and optics as well.
Over time, that'll be a revenue synergy activity.
Thank you, Simon, for your two questions. As a reminder, please limit yourself to one question only. Nicole, we'll 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, Ericsson cited that on their call. I don't think I heard you reference it on this call.
Sorry, Paul, we couldn't hear you.
Yeah. My apologies. Can you hear me now?
Yeah. 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. Per the comments from Ericsson, particular 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. 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 5G deliveries.
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 5G. We are somewhat better positioned and more resilient because of that.
Great. Thank you, Paul. 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 wanted 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. Yeah, we had a bit of a speed bump in Q1. We grew in Q2. Now in Q3 as well. 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 cloud core 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&D productivity. We just have to do more of the same. The order backlog is robust. The order intake continues to be strong.
We just have to keep going.
Great. Thank you, Tim. 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. Rajeev, you announced quite a lot of very significant moves for Nokia. Formalizing more like your enterprise initiative, like a push in terms of software, creating independent segments for these two, you announced also some significant cost-cutting. Just trying to think how you came to that strategic direction. I get the feeling that it sounds like you're not expecting a significant 5G cycle and that you need to go down other routes to keep developing Nokia. Am I right thinking about it this way? Is 5G 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, ride the 5G 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. Go for software, build a standalone software business at scale. 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. 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 5G, because I actually think the 5G cycle could be longer than 4G. This is the first time ever in a wireless technology we have such a broad spectrum all the way from a few hundred megahertz of spectrum to 28, 39, 56 gigahertz. A good 5G operator will do a low-band rollout, a mid-band rollout, and a high-band rollout. We have not seen this in 4G. If I had to venture to guess, will this cycle peak in seven years or eight? I'd say potentially 10 is the right number. This could be a longer cycle. Plus, this isn't just about consumer, this is also about industrial. Some new revenue opportunities like fixed wireless access.
In terms of cost savings, phase one is always about let's get the duplication out of the way. Let's make sure that the synergies are captured through the two companies. Phase two is optimize the company, get ahead of the curve, become super lean everywhere you can, and then benefit it for years to come. 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 Harchandani of Citigroup. Please go ahead.
Good afternoon and good morning, all. Amit Harchandani 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 a function of customer pressure, competitor pressure, or is it simply a reflection of your product not being fully up to date with the features? 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.
Thanks, Amit, on the first question. Broadly, we have not seen an increase or a decrease in competitive intensity. 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 to 5G, and they wanted to use some of the 4G investment pot, so to speak, to accelerate. Then we had some pricing issues where our pricing was robust. That's it. Second question, Kristian.
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. We have also quantified how much we believe it will cost to implement these restructuring plans that take us to a EUR 700 million net reduction.
Thank you, Amit, for your question. We're running out of time, we have time for one more question. Sorry we didn't quite get through the queue today. Almost made it, not quite. Nicole, we'll take our final question for today, please.
The next question comes from Stuart Jeffrey of Agency Partners. Please go ahead.
Hi, thank you. I had a question on free cash flow. I think at the end of Q3, you're about EUR 1.5 billion down. Even with a very strong Q4, it looks like working capital perhaps has to generate EUR 1 billion. Yet you've spoken about very strong demand from the U.S. for 5G, which I would imagine you can't invoice for that until very late in the quarter, and normally that would result in a build-up in receivables. Perhaps you could just talk through some of the levers that help you get to that sort of EUR 1.5 billion of inflow for Q4. Thanks.
Yeah. Thanks, Stuart. 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. That's what we have set out to do.
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 three comments. First, I will say again that our third 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 5G cycle is underway, and we remain well-positioned, even if there is still plenty of heavy lifting ahead. Second, our strategy is continuing to work very well, and we are taking additional steps to 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. Third, 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 Alcatel-Lucent 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 risk 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.