Hello, and welcome to the Nokia Third Quarter 2019 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Mr. Matt Schimmel, Head of Investor Relations.
Sir, you may begin.
Ladies and gentlemen, welcome to Nokia's Q3 2019 conference call. I'm Matt Chimau, Head of Nokia Investor Relations Rajeev Suri, President and CEO of Nokia and Christian Pilola, CFO of Nokia are here in Espoo with me today. During this call, we will 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. Have identified such risks in more detail on Pages 60 through 75 of our 2018 annual report on Form 20 F, our financial report for Q3 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, Rajiv, over to you.
Thanks, Matt, and thanks to all of you for joining today. Nokia's Q3 was solid. We had guided to a quarter that would be soft and believe that the end result was better than that. Free cash flow was positive. Sales were up, including in 4 of our 6 regions.
Operating margin was solid. Our strategic focus areas of Nokia Enterprise and Nokia Software performed well. IP routing sales grew at 4th consecutive quarter. Our cost discipline was good, and we continue to win new 5 gs deals and launch new 5 gs networks. As you will have seen in our release today, we also expect a strong Q4 with robust operating margins and a €1,200,000,000 improvement in net cash, allowing us to end the year with a €1,500,000,000 net cash balance.
Despite this progress, some of the risks that we flagged previously are materializing, and we believe these will create some challenges going forward. Several of these risks are related to the market and others are specific to Nokia. I will talk about these risks in greater detail. You will have seen, however, that they caused us to revise our guidance for this year and the next as well as define a longer term operating margin target. In addition, our Board of Directors resolved not to distribute the 3rd and 4th quarterly installments of the dividend for the financial year 2018.
The Board will continue to review dividends on a quarterly basis and expects to resume payments when our net cash position has improved to €2,000,000,000 We believe this approach gives us the necessary operational flexibility to increase investments in 5 gs, continue investments in growth in our strategic focus areas of enterprise and software and strengthen our cash position. With that as an introduction, in the rest of my remarks today, I would like to address quarterly highlights, some of the risks that we are seeing, adjustments that we are making to our corporate strategy and the drivers that position us well to create future value. First, the quarter. Net sales landed at €5,700,000,000 up 1% year on year in constant currency. Non IFRS operating margin was 8.4%, down 50 basis points and earnings per share were €0.05 down 0 point 0 $1 from the same quarter last year.
While Christian will talk more about cash, let me provide an update on 2 important areas. First, free cash flow was positive in the quarter at about €300,000,000 While not where we wanted to be, this was a good reversal from the negative trend in the first half of the year. 2nd, while our net cash decreased in Q3, the change was less than the €320,000,000 in dividend payments we made in the quarter. We also had meaningful cash outflows from restructuring as well as from cash taxes and capital expenditure. We have actions underway in pretty much every part of the company to improve our cash performance.
We have strengthened our centralized pricing war room and margin management controls, tightened our deal decision making process to include a greater focus on cash and return on capital employed, reinforced mandatory contractual terms and realigned planned management incentives for 2020. We're also reviewing existing contracts to ensure that they continue to make commercial sense, and we will look to renegotiate or exit where they do not. This could result in some country exits if we find that the overall mix of projects in any particular country does not meet our standards. We're already seeing early signs of progress. And as I noted, we expect to see the impact already in Q4 with more to come in the following quarters.
Turning to our business groups. The underlying story of Q3 was challenges in mobile access and fixed access, but strength in our other units. Consider the following. Nokia Software saw year on year sales growth of 5% in constant currency and a more than doubling of absolute operating profit. Yes, there were some benefit from strong in quarter completions and acceptances, but you could also see the sustainable power of the underlying product and go to market improvements that we have made.
Nokia Enterprise maintained its trajectory to grow in double digits for full year 2019. Sales were up well over 20% in the quarter, and we continue to add new customers at a rapid pace. In fact, we added more than 30 new customers in Q3 alone, bringing the year to date total to 84. Across the spectrum of vertical enterprise segments that we are targeting, energy, transportation, webscale companies and the public sector, the need for mission critical networking is clear. Whether it is providing private wireless networks, helping mining companies automate, improving safety and efficiency in transportation systems or enabling smart cities, our work is putting us at the heart of the industrial automation that will be so important in years to come.
As I've said before, quarterly results in enterprise will be a bit lumpy as we push to drive fast growth, and that remains true. But the opportunity for us remains large, and it is high on my list of priorities. IP routing maintained its excellent momentum with year on year sales up 13% in constant currency and clear product leadership. Our SP4 based products are performing very well, and we continue to increase our footprint and displaced competitors. Optical Networks saw a sales decline after several quarters of strong performance, but I'm not concerned by this as it was largely driven by a tough compare to last year and project timing.
Orders were up sharply in the quarter and most importantly, products based on our industry leading PSE3 chipset are now in the hands of select customers for testing with a full ramp up to follow in the coming quarters. Nokia Technologies grew by 2% in constant currency while maintaining strong profitability. You may have seen our press release after the close of the quarter announcing that we have declared more than 2,000 patent families as essential for the 5 gs standard. While our focus remains on patent quality, we are delivering that quality in increasingly large numbers. So my point here is that much of Nokia is performing very well.
Our access businesses, on the other hand, are facing some challenges. Fixed Access, which saw a 10% decline in constant currency sales in Q3, is, as I've noted before, in the midst of a significant market transition as copper declines and fiber grows. We have traditionally had very strong market share in copper access, but a significantly lower, although still strong position in fiber. By default, that means we are losing operating leverage as the market changes. Offsetting cost reductions and expansion in areas such as fixed wireless access is underway, but a full turnaround will still take more time.
Then mobile access, where many things are working very well. We continue to deliver the world's best performing 4 gs networks, have unified our single RAN product on a common platform after years of fast getting back on track. Sanjay Goyal, who took over leadership of Global Services a bit more than a year ago, has moved swiftly to fix poorly performing projects, improve operational efficiency through digitalization and automation, protect the profitability of care services, reduce overall costs and introduce new offerings with robust longer term profit potential. The results are starting to show and we expect to benefit further as low margin deployment services decline over the course of next year. 5 gs is where we still have work to do, even if we continue to win and have successfully launched 15 live networks.
Those networks include some of the world's largest with customers like Sprint, Verizon, AT and T and T Mobile in the U. S, Vodafone Italy, Zane in Saudi Arabia and SK Telecom, Korea Telecom and LG U Plus in Korea. With one customer in Washington, D. C, we saw download speeds reaching a blazing 2.3 gigabits per second, absolutely amazing when you experience it. As you will recall, I talked openly in Q1 about some of the issues we are facing in mobile.
And I noted that higher radio product costs also had an impact on gross margins. Given the importance of this topic, let me go into some more detail. It is not unusual at this early stage in a new technology cycle to have high product costs. Those costs typically go down significantly as scale increases and cost optimization work proceeds. This is certainly true for 5 gs, where we have a comprehensive ongoing program to address every possible part of product dealer materials, PCBs, power supplies, RF and other analog components, materials and mechanical components and of course semiconductors, which are a large cost driver.
Over the course of 2020, we expect our cost reduction efforts deliver results, particularly related to semiconductors. Our 5 gs product mix should improve considerably with a constantly increasing share of hardware based on our cost competitive reef shark system on chip products. To ensure that we execute on this fast and effectively, we are increasing investment in system on chip capabilities and moving aggressively to strengthen and diversify our supplier base. Thus, while we have a near term challenge, no denial about that, I am confident that we are taking the right steps to resolve the issue. Given the complexity and lead times associated with semiconductor technology, however, it will take some time to improve the situation.
Our current expectation is that our 5 gs product costs will improve progressively over 2020, and we will start 2021 in a much stronger position. And of course, even as ReefShark lowers costs, it also provides significantly improved performance as well. As I think many of you are aware, we appointed a new leader of mobile networks, Tommy Uitto, about 9 months ago. Tommy and his team have developed a comprehensive plan to ensure Nokia is competitive in 5 gs and they are relentlessly executing against that plan. Tommy is a strong leader and he has my full support.
One other comment that I would make related to mobile is that we are seeing some selective pricing pressure as competitors seek to gain footprint in 5 gs. As some of these deals also involve upgrades to 4 gs, we're not seeing the margin uplift in 4 gs that one would normally expect at this stage of the cycle. We believe this situation will be short lived and not extend beyond a small number of large early deals. Then to look at things from a regional perspective, where our story in Q3 was one of weakness in China and Middle East and Africa, growth in North America but less than expected and relative strength elsewhere. China, where sales were down 23% in constant currency, was not a surprise.
We have consistently flagged concerns about our ability to deliver adequate returns in that country, particularly in mobile access, and that view remains unchanged. While we have admiration for China's fast move to 5 gs and overall technological progress, we still take a prudent approach to the market. If there are deals that make commercial sense on their own terms, we will take them. If there are not, we will not, simple as that. I expect that this may lead to some tough decisions in the upcoming procurement rounds in China, but that remains to be seen.
Then North America. Overall, we remained strong in North America and grew 2% in the region in Q3 in constant currency. Unfortunately, however, our progress fell short of what we expected given 5 gs project acceptances and completions and uncertainty related to the announced operator merger where we have a particularly large footprint. We cannot predict how long the situation will continue and hope that the relevant authorities will move quickly to find a resolution. Next, let me talk about strategy.
While I'm not with you. First, we are updating how we think about both enterprise and software given the progress that we have made. On the enterprise side, we originally talked about expanding network sales into select vertical markets. With the progress that I discussed earlier, we believe we have successfully shown that enterprise can be a meaningful business for Nokia. Now we are setting our sights on growth and on consistently and significantly outgrowing the market.
In terms of software, our initial focus was on building a strong stand alone software business. We have made massive improvements, re architecting many of our products, moving to become truly cloud native and creating a strong experienced software sales force. For 2 years in a row now, Analysis Mason has ranked Nokia as the top telecom software provider. So I think it is safe to say we have delivered on our original intent. Going forward, it is about strengthening, about taking the foundations that we have built and making them stronger.
As examples, we see opportunities to move even more products onto our common software foundation and further develop a recurring revenue business model. The second thing we have done is to explicitly define those businesses for which we will prioritize profit and cash and those for which we will prioritize growth. In particular, our mobile and fixed access businesses will focus on profit and cash. This approach will largely be reflected in how we address the market in terms of deals that we are willing to accept and how we structure our offers. It does not mean that we will stop investing in the business or pursuing growth in 5 gs.
We absolutely will do both, but there will be no pursuit of share just to gain share. In fact, we will work relentlessly to drive advantage to strong technology, time to market and significantly lower product costs in 5 gs, while leveraging our differentiation in superior 4 gs network performance and the most comprehensive small cell portfolio. IP routing, optical networks, Nokia Software and Nokia Enterprise will all be aimed at growth, not growth by sacrificing margins, but growth based on other competitive advantages. We believe that IP routing can expand based on product leadership. Nokia Enterprise can outperform a growing market given the demand for our mission critical networking capabilities and Nokia Software can leverage the strong product and sales foundation we have built to target robust growth opportunities.
Optical Networks is in a position of technological strength that will get even better with its coming PSE-three products. Additional scale in Optical can drive meaningful profitability improvements and that is what we are aiming for. Nokia Technologies will target significant cash generation in its core patent licensing activities as well as growth through diversification into IoT and consumer electronics. These changes will be reflected in how we set targets and how we set management incentives. It is important to recognize that they are designed to reflect priorities so that when the inevitable choices need to be made, we have clear guardrails in place.
We expect this change to slow our growth slightly, and as a result, you would have seen in our earnings release that we now expect to grow in line with the market, not outperforming as previously mentioned. This change in growth expectations is just one of several amendments we made to our guidance today. Given the risks that I talked about earlier, we are lowering our expectation for full year 2019 2020. For operating margin in 2019, that means we now expect 8 point 5 percent plus or minus 1 percentage point. For 2020, our operating margin guidance is now 9.5 percent plus or minus 1.5 percentage point.
At the same time, we have been clear about the fact that we expect 2021 to be better than 2020 as we make progress towards our longer term target to deliver an operating margin of 12% to 14%. One other comment on our guidance related to costs. As you will have seen, we also reduced our target to deliver €700,000,000 in cost reductions in full year 2020 to €500,000,000 As I noted before, we believe there is a need to increase investments in 5 gs system on chip capabilities. We also intend to invest further in the digitalization of internal process. We expect this will improve productivity and generate further cost reduction opportunities beyond 2020.
As we make these important additional investments, rest assured that we are not taking our eye off the golf ball. 31% of net sales in Q3 of 2018 to €1,560,000,000 or 27% of net sales in this past quarter. When and where we see further opportunities to reduce costs, we will do so even if it requires additional restructuring. That is just the nature of our industry today. With all of this context, let me take a step back and talk about 5 drivers that give me confidence in our ability to meet our longer term goals.
1st, our unique end to end portfolio will allow us to drive a strong share of wallet and benefit from the virtuous 5 gs cycle of investment that I have talked about before, a cycle that covers multiple domains of CapEx spending, spanning mobile and fixed access, transport, services and software. 2nd, Nokia has a demonstrated ability to create value and drive cash flow through product leadership. For proof, look no further than our FB4 based routing products. As I noted earlier, we have our challenges in the early stages 5 gs, but expect progressive improvement over the course of 2020 and to be in a much stronger position in 2021. We have a clear record of providing the world's best 4 gs networks and see no reason why we cannot in time do the same in 5 gs.
In fact, as a barometer of that, we have converted all of our 4 gs customers who already have selected a 5 gs vendor to Nokia. A 100% conversion rate of 48 customers and plenty more still to go. 3rd, we expect to continue our successful diversification into enterprise and software. Both are meaningfully accretive opportunities for our margins as well as our cash position. Our progress has been good and the market opportunity remains very large.
4th, our cash generated patent licensing business with mobile phone makers is large and sustainable for many years to come. We also see no reason to limit this business to mobile devices and see meaningful opportunities for diversification of our licensing activities into IoT Verticals and Consumer Electronics. And finally, we continue to see opportunities for significant cost reductions enabled by digitalization and automation of processes, product cost innovation, ongoing R and D efficiencies and related site consolidation, procurement savings, improved product serviceability and more. So as I said earlier, I'm not satisfied with our performance, but we see good reasons to have confidence in the future. We have given guidance for 2020 and expect our turnaround to firmly have taken hold by the end of that year.
2021 should better than 2020 as we proceed on our path to deliver on our long term targets. With that, over to Christian.
Thank you, Rajiv. Today, I will take you through the financial performance of Nokia Technologies and Group Common and Other as well as group level results. I will be quicker than normal in this section in order to focus my prepared remarks on 4 key topics: our cash performance, our cost savings programs, our outlook and what makes Nokia a compelling long term investment. 1st, starting with Nokia Technologies. The 2% year on year growth in Q3 primarily reflected higher onetime licensing net sales, which totaled €10,000,000 in Q3 '19 compared to 0 in the year ago quarter.
Our annualized licensing run rate continued to be €1,400,000,000 From a profitability perspective, operating margin in Q3 was 82.1% compared to 82.6% in the year ago quarter. This was driven by a decline in gross margin, which was largely offset by lower operating expenses. The gross margin decline was mainly related to a onetime sale of patent assets. The operating expense improvements were primarily driven by lower patent licensing costs, lower patent sorry, lower patent litigation costs, lower patent licensing costs and lower incentive accruals in the quarter. All in all, the performance of Nokia Technologies continues to be solid and as expected.
Moving to group common and other. Net sales were flat year on year, both on reported as well as constant currency basis, with Alcatel Submarine Networks net sales being up and radio frequency systems net sales being down. The operating loss for group common and other worsened year on year, primarily due to lower gross margins in both RFS and ASN and the digitalization investments that focus on driving automation and productivity that was then partly offset by lower incentive accruals. As I said in the past, for modeling purposes, we continue to expect group common and other operating expenses to be approximately €20,000,000 a quarter higher than in 2018 due to investments we are making in digitalization. Now we see this also continuing in 2020.
Moving to Nokia level results. Group level non IFRS operating margin was 8.4% in Q3 'nineteen compared to 8.9% in the year ago quarter. This largely reflected lower gross profits, partly offset by continued progress related to our cost savings program. Looking at non IFRS financial income and expenses in Q3, we experienced higher expenses year on year, largely reflecting a deterioration in our FX results due to adverse currency movements. Given that our year to date financial income and expenses and FX results are $50,000,000 higher than a year ago, they increased our full year 2019 assumption to now be €400,000,000 up from €350,000,000 previously.
Our non IFRS tax rate came in at 27% in Q3 2019 and we continue to expect full year non IFRS tax rate to be approximately 28% for 2019. At the Nokia level, our non IFRS diluted EPS was $0.05 in Q3 compared to $0.06 in the year ago quarter, primarily due to lower gross profit in networks and the negative fluctuation in financial income and expenses. This was partly offset by higher gross profit in Nokia Software as well as solid progress related to our cost savings program. Now let's turn to our cash flow performance in Q3. On a sequential basis, Nokia's net cash decreased by approximately €160,000,000 to a quarter end balance of €340,000,000 Within this decrease, we generated positive net cash from operating activities, which was partly offset cash outflows from investing and financing activities, including the payment of the quarterly dividend.
Our free cash flow was positive €299,000,000 in Q3, largely reflecting stronger operating cash flow. Excluding restructuring cash outflows, net working capital generated a decrease in net cash of €50,000,000 Within working capital, liabilities decreased €440,000,000 primarily related to a decrease in deferred revenues and advanced payments, a decrease in liabilities related to employee benefits and a decrease in accounts payable. Receivables decreased €390,000,000 primarily due to improved collections, which were achieved through higher sale of receivables. On the last quarter call, we said that we were unable to collect approximately €350,000,000 of receivables, which negatively impacted cash flows in the quarter. In Q3 2019, we collected approximately half of the $350,000,000 The other half, which entirely relates to the collection of a large receivable from a state owned operator, we anticipate to recover in the coming quarters.
Inventories were approximately flat sequentially, and we expect our inventory levels to improve in Q4 as large scale 5 gs deployments and acceptances accelerate meaningfully. In Q3, we showed some positive signs of improvement in our free cash flow efforts, which notably with notable progress lowering central inventories. We expect ongoing progress to result in a stronger cash position in Q4 and for net cash to increase sequentially by approximately €1,200,000,000 Next, a quick update on our cost savings program. On a year to date basis, excluding the impact of lower incentive accruals, we have already achieved approximately €180,000,000 of recurring cost savings. Even though FX is a significant headwind when it comes to our cost savings targets, we have executed well, and we are seeing good evidence of improved operational discipline, and we are well on our way to achieve our targets for 2019.
Given the need for higher 5 gs and IT investments that we have spoken about, we now see that our cost savings program will yield $500,000,000 of net benefits compared to the previous target of 700,000,000 dollars We have also updated the expected time line for restructuring related cash outflows, and you can find these changes laid out in the cost savings section on Page 13 in our Q3 release. Then turning to our guidance, where I would like to spend a bit more time complete. I want to be clear and complete. 1st, starting in 2019. As Rajeev mentioned in his prepared remarks, we have updated our outlook to reflect a number of risks that we have previously flagged, which have materialized in Q3.
These are driving margin pressure in our Networks business. In response from a product perspective, we have made the decision to increase 5 gs investments focused on accelerating our product roadmaps and our product cost reductions. Specifically, these investment areas include our system on chip based 5 gs hardware, including diversifying and strengthening the related supplier base. This will help us drive lower 5 gs hardware product cost over the medium to long term. We also see the need for additional digitalization investments in IT tools and operational processes, which I mentioned earlier.
Additionally, from a regional perspective, we are also experiencing temporary CapEx constraints in North America related to the customer merger activities and profitability challenges in Greater China. Given these developments, we now expect the following for full year 'nineteen. Our non IFRS diluted EPS to be €0.21 plusminus0.03 Our non IFRS operating margin to be 8.5 plusminusone percentage points and our recurring cash flow is now expected to be somewhat negative. Implied in that, we still expect a strong Q4. We are now guiding using a range around the midpoint.
For Q4, our guidance mathematically implies a diluted non IFRS EPS of €0.135 a non IFRS operating margin of 16.5 percent and net cash increasing sequentially to approximately 1 point €1,000,000,000 at the end of the year. We have also lowered our 2020 outlook and now expect non IFRS diluted EPS to be $0.25 plusminus0.05 and our non IFRS operating margin to be 9.5 percent plusminus1.5 percentage points, and the recurring free cash flow is now expected to be positive. Then over the longer term, which we define as 3 to 5 years, we believe that we can deliver Nokia level non IFRS operating margin in the 12 to 14% range. Finally, as CFO of Nokia, I expect to be asked many times over the coming months by many of you, why should I continue to be or become a Nokia shareholder? While I acknowledge that our performance has not lived up to our potential, I believe that we have the right assets and are making the right are taking the right actions to fix our short term issues and to unlock significant value as the 5 gs cycle expands to address not only consumer use cases, but also the industrial productivity use cases.
Nokia has unique long term value drivers. These include the unique entry portfolio we have, the product leadership position, diversification into enterprise and software, our sustainable patent licensing business and last but not least, our structural cost reductions. We believe and I believe that these will enable us to expand margins and generate significant cash flow over the longer term. With that, I will hand over to Matt for Q and A.
Thank you,
Christian. Nicole, please go ahead.
Thank Our first question comes from Andrew Gardiner of Barclays. Please go ahead.
Good afternoon, guys. Thanks for taking the question. If I could ask a bit about the increased sort of 5 gs investment that you've been talking about. You spent a lot of time on the call just now talking about the semiconductor side of things, the SoC strategy in particular. Can you just give us a bit more detail of around what's happening with ReefShark in terms of the internal development versus external development.
You mentioned Rajeev sort of diversifying the supplier base. Are you having to now sort of invest or spend your own money in order to get outside suppliers in and sort of restart that sort of the chipset strategy around 5 gs? And so we're going to see both your own internally developed ASICs with an outside SoC provider. And just sort of how long it's going to take fix that and then get to the lower product cost that you've highlighted?
Thank you, Andrew. So number 1, this is not a new strategy. We started working on the system on chip strategy already in 2018, right? And so when Tommy joined, we started accelerating that. So we're already on a path here.
Specifically, last year, we started to diversify our suppliers. Those decisions have been made sort of over the last several months. So what's happening right now is when we moved to 5 gs, we chose FPGA based products. They give flexibility. They give you time to market advantage, but then they're expensive.
And so what we're doing is we're moving to SoC based products, which will progressively start shipping during 2020. So it's not like it will all come at one go at the end of 2020 or or something. It's going to progressively start shipping, and hence, we think it will progressively mitigate.
Now why are
we spending even more? Because we want to be continuing to be aggressive there and accelerate what we have already started. And yes, we do our own sort of SoC design, but now we're working with multiple suppliers.
Thank you, Andrew. Nicole, next question please.
Our next question comes from Sandeep Deshpande of JPMorgan. Please go ahead.
Yes. Hi. Thanks for letting me on for a question. My question is, I mean, when we look at your 3rd quarter results in terms of your performance on the margin front, on your cash generation front and in terms of what you're guiding to cash generation into the Q4, What I'm trying to understand is why are you signaling this dividend deferment or cut to the market when you are indicating that by the end of this year, your cash position will be at the higher €1,500,000,000 I mean, a cut in dividend would have been fair given the more difficult environment, but why this complete lack of dividend? Is this a signal that you expect this business to remain very difficult through 2021 or 2022 because the kind of dividend cut you've instituted seems to suggest a much more difficult environment?
Thanks, Sandeep. So I think I'd call it pause
is the right word. So what did the Board decided to be resolved to not distribute the 3rd and 4th quarterly installments of the dividend for the financial year 2018, right? So number 1. Now why is that the case? 1, we want to guarantee our ability to increase 5 gs investments.
2, we want to continue investing in the growth areas that are accretive to Nokia, whether you look at margins or you look at cash position, so those are enterprise and software, and C to strengthen Nokia's overall cash position. So what we've said is that the Board expects to resume dividend distribution after the net cash position of Nokia improves to approximately €2,000,000,000 So that's when we'll be able to resume. Now the mechanics of that are that the Board will seek a dividend authorization from next Annual General Meeting and will continue to review distributions on a quarterly basis from there. So I think the key word for me is pause.
That's good. Thank you, Sandeep. Nicole, next question please.
Our next question comes from Richard Kramer of Arete Research. Please go ahead.
Thanks very much. Rajeev, I just want to get your take on what's been missing in the execution and leadership in mobile access because that seems to be your principal area where you're having difficulty. You've had 3 leaders in 4 years. I know you've had very difficult integration. You've staked out some time ago that your desire to lead in 5 gs.
I mean, what is it specifically over the last few years that has been so difficult in the execution in that area? And how confident can you be now that that's going to change into 2020 beyond given how difficult the environment is for many of your large operator customers? Thanks.
Thanks, Richard. Fair question. So I changed leadership in mobile access. First, we broke into 2, and I sort of brought in Sanjay Goyal for leading the services side. And you're already seeing results and proof points of that business turning, right?
So it will be less and less on the watch list, if I can call it like that, by next year, I expect a substantial turnaround there, okay? So we're seeing automation of services. We're seeing digital workflow systems. We're seeing new growth potential services like cognitive, AI driven services, enterprise services, IoT services, which have higher margins. We're seeing better management of prices and hence protection of margins in Care and Technical Support Services.
We're reducing Deploy rollout, which is traditionally lower margin. We're seeing more remote delivery and global delivery. So I think that will start to be out of the woods in the next few months, although it will be very critically on my watch list. That's number 1. So Sanjay has brought in that sort of change.
And then Tommy. Tommy has taken the list of 10 major steps that he's taking to drive performance improvements, and we're already seeing proof points of that, not least evidenced by the fact that we have got these 48 deals, and we are launching 15 commercial networks as well. So if you go back a couple of years, what really happened was that, of course, Nokia was dealing with the migration of the portfolio that nobody else in the industry had to deal with with regard to this alkydolucin phase out. And you recall, we had some delays in 2017 as well with our migration projects. But we got out of that in a way that we are now the best performing 4 gs networks vendor.
Whether you look at route metrics with an external study, it's not a Nokia study, or if you look at Ookla, these folks have said in 125 metro markets in the U. S, both in 2018 and the first half of twenty nineteen, pointing to the ASK product that we've helped our customers get number one position for network performance. That gives me confidence that we're going to be able to do the same in 5 gs. Now the reason we chose SBGA was that when we were dealing with the footprint migration of formaldehyde, we wanted to ensure that we get the time to market catch up as soon as possible. Now that is not the most efficient from a cost point of view.
That is why we diversified our supplier base as well as and admittedly, one supplier let us down as well. And so we diversified our supplier base and started ramping up the SoC thing. It is not starting now. It's already been in progress. It's the shipments that will start to begin in our portfolio that will make the difference.
So I expect that we'll be in a much better position at the end of 2020, beginning of 'twenty one, but it will progressively mitigate over the course of the year. And so I'm watching this very closely with Tommy, with Sanjay and the teams, and I have confidence. The last thing I will say, Richard, is that 5 gs NR is based on NSA non standalone. So what really matters is your 4 gs installed base. And that is our strongest competitive advantage because we have the best performing 4 gs networks and there is no 5 gs network that performs well without an underlying strong 4 gs layer.
This is why our customers will stick with us through this situation.
Thank you, Richard. Nicole, next question please.
Our next question comes from Alexander Vaterik of Societe Generale. Please go ahead.
Yes, hi. Thanks for taking my question. Just like to understand given the sizable cut to your 2020 margin outlook, would you be able to give us more color on where that is more of scale or top line issue, a gross margin issue, maybe related to pricing pressures or an OpEx issue? And it's a combo of those, but which is the most important here? Thanks.
Thanks. We've said, Alex, that next year that we could expect to grow in line with the market as opposed to outgrow the market, and it's also driven by our prioritizing cash and profit over growth. But what has changed? Four things. Like we said, high cost associated with the early generation 5 gs products, the 3rd generation products profitability challenges in China, which we think will continue given the nature of aggressive price making expected there in 5 gs.
Some pricing pressure in early 5 gs deals, and I'll say it's selective. And of course, uncertainty related to the announced operator merger in North America, where we have a particularly large footprint. So we saw that impact in Q3. We're likely going to see it in Q4, and we can't predict when that will close. So it could also likely be for the first half of next year.
So I think in that order, it's gross margin because of this product cost issue, which we'll progressively mitigate over 2020.
And then of course, on top of that, we do have the negative impact that comes from the additional investments that we are now making in 5 gs as well as in IT and digitalization, which is also kind
of impacting then operating margins. Kind of be clear that's OpEx and it's not comps.
Okay. Thank you, Alex. Nicole, next question please.
Our next question comes from David Mulholland of UBS. Please go ahead.
Hi. Thanks guys. There's been discussions and questions around the competitiveness of your portfolio or whether we call it price competitiveness or performance for quite a while. I think it was about 2 years ago now that we saw Ericsson saying they were facing issues in reinvesting. And it seems to be now largely executing on that from a gross margin perspective.
Was it taken so long to come to this realization of the need to reinvest as you look into next year?
Yes. Thanks, David. So this isn't so 5 gs only started meaningfully rolling out this year. This for us is not a 4 gs product cost issue, let's say. It's a 5 gs product cost issue.
And so that's started from beginning of this year. So it's like I said earlier, I mean, the system on chip strategy has been put into motion already a while ago, diversified our supplier base. We are increasing the investments purely because we want to increase even more SoC penetration in our products and continue that. And of course, we know how to do system on chip. Yes, we started with FPGA with 5 gs because it gave us that time to market catch up advantage, but we do that in much of our portfolio with SP4 and PSE 3.
So we're just replicating that in mobile now.
Our next question comes from a call from Michael Sultania of Credit Suisse. Please go ahead.
Hi, good afternoon. I'm just trying to understand like how you're positioning with your product on the 4 gs side of the market. I think when we look at your revenues in a number of regions, for example, China, U. S, Korea, I think we've seen that there's a big divergence between your performance and your key competition's performance year to date. U.
S. And Korea, I can understand predominantly because there was a first mover advantage with 5 gs. China, still 5 gs hasn't actually started in full flow, yet there is a big divergence. And still we haven't seen any gross margin impact on your competition. So just trying to understand, are you losing share on 4 gs because of these issues that you are facing on 5 gs?
And how does that position you going into next year and your ability to actually grow in line with the market next year?
Thank you.
Thanks, Achal. I'll just try to step back and sort of look at that question. So I think the issue we've seen in Q3, what we're pointing to also in Q4 is the impact of this one operator situation with regard to the merger activity where we have a sort of large particularly large footprint. So that impacts us more than the other players. And so that reduces or negatively impacts the business mix.
So that's what I would say to that answer. Then when it comes to China, I know 5 gs has not started, But the reality is that even in the underlying business, there are sort of profitability challenges, hence our priority on profit and cash in that market.
Thank you, Achal. Nicole, next question please.
Our next question comes from Robert Sanders of Deutsche Bank. Please go ahead.
Yes. Just a question on your 5 gs SoC strategy. I was just interested in understanding what your view is on ASIC versus ASSP. I mean, you had this issue with ReefShot with Intel's 10 nanometer process. It seems like you're over engineered for what the customers want.
But given you've got these challenges now, wouldn't it make sense just to switch to an vendor like Marvell to just get your time to market right rather than pursuing this ASIC strategy at all costs, given that they are typically more expensive and take longer to get to market? Thanks.
Thanks, Robert. So nothing much to add apart from what I've already said. So it's not a case of over engineering the product. That's not what we see. It is the case of shipping more SoC relative to FPG and it's as simple as that.
So when we get more SoC being shipped in our products, which will progressively happen in 2020, start to see the gross margin benefit.
Okay, Rob. And thank you. And then Nicole, we'll take our next question.
Our next question comes from Stefan Slowinski of Exane BNP Paribas. Please go ahead.
Yes. Hi. Thanks for taking my question. Just had a question regarding, I think comments you made about country exits, potentially exiting countries as you focus on profitability and margins and cash flow. And you've specifically called out China multiple times as being challenged from a profitability standpoint.
So, I mean, are you suggesting that potentially China could be a country that is a candidate for exiting altogether, at least part of your business? And how would that impact your ability to have enough share globally to continue to invest in order to maintain the product? Thank you.
Thanks, Stefan. No, we are I think we'll be a significant player in China for a long time to come. Look, I mean, let's just talk about China for a minute. The China volume of base stations in the world are approximately 60%, right? The revenue share of that volume is approximately half that.
The profit share of that volume in the medium term is negligible. So that to me explains the China question. So in China, we are going to change our business mix more private networks with state owned enterprises, it will take some time, more core networks, higher margin, more routing and transport and backhaul, higher margin with service providers, obviously, 4 gs radio and we'll see what happens with 5 gs radio. And then more routing and transport and optical of that scale players. We're not starting this now.
We already have that underway. So the business mix might change. The cash flow will get better. And the contribution margin sort of as the quality improves, yes, the revenue might come down. And if that's the case in some other markets, we'll do the same.
But again, there might be some projects we have to do it, but there are no wholesale country exits per se.
Thank you, Stephane. Nicole, next question, please.
Our next question comes from Pierre Ferragu of New Street Research. Please go ahead.
Hi, this is Raul standing in for Pierre, who's in a noisy environment and on mute. Thanks for taking our question. You mentioned your hardware issues in your radio portfolio and how you plan to address them. And we were wondering what about software issues. You mentioned earlier this year some difficulties which led to revenue recognition and delayed revenue recognition in radio software.
And there's been reports that you're meeting challenges on that front as well. Could you talk about the situation there and how you plan to address potential
issues? Thank you for the question. So first of all, it's not in mobile radio. All of it is just in 5 gs. I mean, only in 5 gs is what I mean, not in 4 gs, not in single RAN, not in 3 gs.
So it's in 5 gs. It is primarily product cost issue, as we've just discussed. But tied to that SoC shipment or ReefShark family of chipset shipping in our ASK base station are also some features that would be brought forward. So but we have the feature for launch. Even if some features might be delayed because of SoC, the reality is that there are work around solutions all the time that we work with our customers on.
We've launched 15 networks. We're winning 48 customers. We are converting 100% of our 4 gs customer base to 5 gs. It is the 5 gs product cost issue that's the primary thing.
Thank you, Olaf. Nicole, we'll take our next question.
Our next question comes from Sebastian Tablitz of Kepler Cheuvreux. Please go ahead.
Hello. Thanks for taking my questions. I know it's a little bit early, but could you please help us understand what kind of growth do you see for your key markets for 2020? Should we expect a better market environment in 2020 versus 2019? And where do you see, I would say, basically growth or top line pressures in the coming quarters?
Thank you.
Thanks. We see growth continue in 2020. Within that, there'll be a mixed dimension, depends on where the growth comes from. In general, we can expect transport to be strong. We can expect software, our success to continue that.
We can expect enterprise growth to continue. Of course, 5 gs will drive growth as well. But overall, we'd say growth for the market will continue, and we'd likely be in line with the market.
Thank you, Sebastian. Nicole, next question, please.
Our next question comes from Simon Wieffel of Raymond James. Please go ahead.
Thank you for taking the question. You've given us, I think, a lot of the breadcrumbs around the cash flow and the general trending, but I want to make sure I'm interpreting your expectations as to when you think you can resume paying a dividend. Roughly speaking, it sounds like you expect to be at the targeted levels of net cash by the end of 2020, perhaps early 2021. I just want to make sure I'm interpreting your commentary accurately or if there are other variables I need to consider.
So let's just if I kind of repeat the facts that Rajiv talked about. We've taken a pause on the dividend. The Board has said that it will resume payments as we get to $2,000,000,000 or so of net cash. We've also said that we will seek an authorization from the next AGM to be able to track the situation on a quarterly basis. That's all we have.
Yes, we've also said that from a cash expectation point of view, we expect to end the year
at $1,500,000,000
and that we expect to generate positive cash flow in 2020. Clearly, our objective is to try to get to a dividend payment situation as quickly as possible.
Thank you, Simon. Nicole, I think we have time for one more question today.
Our next question comes from Stuart Jeffrey of Agency Partners. Please go ahead.
Hello. Thank you very much. I just got a question again on the China angle, linking into economies of scale questions. I appreciate that you don't want to chase unprofitable business, but China 5 gs could be a huge proportion of 5 gs spend late next year and in 2021. And if you don't play a role in that for margin issues, then doesn't that impact your ability to drive manufacturing economies of scale, R and D coverage, all those things that have historically led people to other companies to struggle for scale and then struggle to be competitive in the long term.
So I just I'd like to better understand, can you really pull out of some of these big contract opportunities without damaging your long term competitiveness globally, not just in China?
Thanks, Stuart. So first of all, I'm not giving any particular guidance on where we'll end up in share in 5 gs in China. But I will say that I'll just repeat. So it's yes, China 5 gs, just like China 4 gs, will be about 60% of the global volume of base stations and half of that will be the revenue market share of that. But in the next, let's say, medium term and for me medium term, let's say, it's about 3 years, the profit share of that will be negligible.
Then the question on volumes, do you need the strong China volumes, even if unprofitable, to help your overall situation? We've done the math on that. It is not decisive. No, we don't have to have them just because we are always going to be in a scale position the way we see it. And for me, scale position is the market share that we are aspiring to globally.
So I think we'll be able to cover it. Remember also that we have recently increased our market share in Japan quite a bit with a couple of customers, etcetera. So on the whole, we will always be in a strong scale position and additional volume to China do not necessarily give us component purchasing economies of scale or manufacturing economies of scale.
Thank you, Stuart, and thank you, everyone, for your questions today. I'd now like to turn the call back to Rajeev.
Thank you, Matt and Christian, and thanks to all of you for your questions. If you take a step back and look at what we have said over the course of the call, I hope 2 things are clear. 1st, while our performance today is not where we want it to be, we have the right actions underway to drive meaningful improvement over the course of 2020 and a full turnaround in 2021. 2nd, we see a clear set of drivers for creating future value. Some of these are near term, some are mid term and some have a longer horizon, but all are important, all will get our focus and all can create value.
With that, Matt, back over to you.
Ladies and gentlemen, this concludes our conference call. I would like to remind you that during the conference call today, we have made a number of forward looking statements that involve risks and uncertainties. Actual results may therefore differ materially from the results currently expected. Factors that could cause such differences can be both external, such as general economic and industry conditions as well as internal operating factors. We have identified these in more detail on Pages 60 through 75 of our 2018 annual report on Form 20 F, our financial report for Q3 issued today, as well as our other filings with the U.
S. Securities and Exchange Commission. Thank you.