Telefonaktiebolaget LM Ericsson (publ) (ERIC) Q3 2015 Earnings Report, Transcript and Summary

Welcome to the Ericsson’s conference call for the third quarter report. To view visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. [Operator Instructions] As a reminder, replay will be available 1 hour after today’s conference. Peter Nyquist, you may now open the call.

Thank you, operator and hello everyone and welcome to the call today. With me here today, I have our CEO, Hans Vestberg, and our CFO, Jan Frykhammar. So during the call today, we will be making forward-looking statements. These statements are based on our current expectations and certain planning assumptions, which are subject to risks and uncertainties. The actual results may differ materially due to factors mentioned in today’s press release and discussed in this conference call. We encourage you to read about these risks and uncertainties in our earnings report as well as in our annual report. With that said, I would like to hand over to you, Hans, please.

Thank you, Peter. So, let me go through a little bit the key developments in the market, what we have been discussing with our customers. And then we briefly mentioned in the second quarter that 5G is taking off and start to be discussed and we see implementation of testbeds very much focused on Korea in the second quarter now with also the U.S. We have China in the discussion, Brazil, many markets that we now are implementing testbeds, with us starting to look how far it will impact and it’s of course very different design on 5G than 4G, 3G and 2G. It’s much more than an industrial Internet. Would be some type of solutions that can be applied for different industries rather than only having a consumer view on their mobile technology and that goes very much hand with the Internet of Things discussion that is going all over as well at the same time. Another thing that is common theme by all operators of course the increasing radio traffic in the networks, how to handle it in the best way, how to deliver it in the best way, comes very well in hand with our investment in TV and media that we have done everything from conversion to caching to the right management all of that depending for the prime and content or not. This is both the mobile network and IPTV networks, I would say. We see and this is on news, but of course that some of the markets were there have been so-called the devaluation on the currency or weakening on the currency. They get a little bit harder to spend the CapEx in dollar and that is – and we want to be clear, it’s very important. We don’t want to put the blanket to the whole world and say it’s a macro problem. There are certain markets that have had these – have an impact on us. And I would say Brazil and Russia, for example, I think two large markets for us, has lesser purchasing power due to the weakening in ruble and reais. And there are some markets in Middle East as well, but we don’t extrapolate on all markets when it comes to infrastructure. Remember we talk about the infrastructure and nothing else. We also – if you then talk a little bit ourselves, we have a little bit slower 4G in China. Remember now been a very high pace for three quarters in China on the 4G, ramping up for more than a year ago. We saw a little bit slowdown this quarter. We believe with our Northeast Asian management that their underlying demand on 4G is still there. There is still even though there is a lot of subscribers on 4G, there are many, many more to go. We see also digitalization trend in China, where Internet of Things and connectivity going into industries happening as well. So, clearly, on the long-term, we think that this is an enormously important infrastructure for Mainland China. And that we haven’t seen any change, but we, Ericsson, we had a little bit slower pace in the third quarter. More, I mean, we can report as we did in the second quarter, stable business on networks in North America. So, we have sort of – we had a two, three quarters when it came down from a very, very high level. Now, it has stabilized as we saw in the second quarter. There are other businesses that are growing services, OSS/BSS, etcetera, which of course is very positive. On the result of the quarter, we had 10% operating margins, excluding restructuring on the whole Ericsson. That is a clear improvement from our year-over-year is 46% up. We had 7% operating margin last year in the third quarter going to SEK6.1 billion from SEK4.1 billion. So, it’s a clear SEK4.2 billion. So it’s a big, big increase. Services, main contributor, but all segments are contributing, but services mainly. Now, this quarter 46% of our sales was Global Services. And the Professional Services, stable on the operating margin and then the Network Rollout then that we have talked about in that question for long time was breakeven in the quarter, which is good. We can conclude that it has based on the company is going well. The target area that we will talk more about at the Capital Markets Day are continuing for the fourth consecutive quarter to be above 10% in growth. And we have strengthened senior position a couple of very important announcements in the quarter. And we will acquisition, but also AT&T’s commitment to the media room and the media platform that we have off there down the acquisition of DIRECTV, very important for us, which we have been waiting for. And also with the Jan report in the second quarter, we saw some signs of the profitability program that were the cost out. In this quarter, we saw clear impact of it even though we are in the beginning of the program we can clearly see the impacts of it that we are very much committed to the SEK9 billion out in 2017 and we are clearly on track for that. If we then look at the third quarter in summary, yes, up 3%, down 9% in constant currency. Remember also that even all the tailwind we get from currency is converted to Swedish kroners, you get the headwind also when it comes to emerging markets like Brazil and Russia when it comes to the purchasing power. And of course, there is a lot here, we will come to Networks is of course networks that has a harder time with the growth right now. And you can see that North America, Japan, Russia and Brazil have low levels compared to last year, however, India, very strong, Southeast Asia, strong, sub-Sahara, strong when it comes to growth in this quarter. Fairly normal seasonality, 2%, nothing much to talk about. The main difference here between second quarter and third quarter when it comes to top line is China and that’s the slowdown I talked about. And then I have already talked about the SEK6.1 billion in bottom line compared to SEK4.2 billion last year, the 46% improvement and a gradual improvement that management is working with constantly to really taking the things we can do. We can look into the regions. I have already talked about the majority here. So, you can see on the right hand side that India, Southeast Asia, are growing well and sub-Sahara, and then you can see on the other hand Northeast Europe, Central Asia, which is including Russia, is coming down as well as Northeast Asia, where you have Japan and China. If we do it sequentially, little bit different pattern, India came back a little bit from a little bit lower growth pace in the second quarter even though it was high, Latin America as well. And then you see Northeast Asia coming down a little bit due to the things we talked about in China slowdown compared to second quarter. And then we talked a little bit about Middle East as well. So, it’s a little bit different path than when you do sequentially compared to year-over-year. I will hand over to Jan to talk about the financials more in detail.

Okay, thank you, Hans. Let me then start to talk a little bit about the gross margin, close to 34% in the quarter, about 35% a year ago. The main reason for this drop compared to a year ago is higher share of services, it’s approximately 3 percentage points high share of services in the quarter. The rule of thumb that we have talked about for sometime now approximately is still valid, approximately every percentage points increased in services share has approximately a 0.3 percentage points impact on gross margin. I think that holds up also this quarter. Also higher restructuring charges, is one explanation. Similar explanations when it comes to the increase in gross margin compared to the second quarter. If we look at the operating income, then Hans has mentioned a lot of this already. I think underlying of course this year is the year where we have a positive impact, net FX positive impact on operating income, that’s there. Of course, this revaluation of the hedge contract talk, I mean that goes up and down every quarter and that has to do with the future and obviously the exchange rates that we closed the books with. Lower cost is the fact. Breakeven in Network Rollout is good. Its one quarter we would like to make this a trend of course. But I think if you look at the improvements over the course of many quarters, we have seen an improvement quarter-over-quarter over a couple of quarters now. We now want to make sure that we create a sustainable breakeven situation in Network Rollout. Then if you – if we then talk about operating expense, SEK14.9 billion in the quarter, if we then exclude the restructuring charges, it’s SEK14.3 billion compared to SEK15.2 billion a year ago. And let me spend a few minutes on the different elements here of the operating expense. If I make an estimate on the FX headwind then on the operating expense, it’s about SEK1 billion if I compare a year ago. Around half of it is related to translation exposures, meaning then the monthly translation of the local subsidiaries, that’s mainly done in the SG&A item. And then the rest is transaction exposure. And that’s been reimbursement of R&D expenses in our local company, its back to the operating entity in Sweden. So that’s mainly impacting R&D for comparison reason. Also I got some questions this morning around capitalized R&D expenses. And here, I want to refer to the Page 34 in the quarterly report where you see all of these different relevant items both depreciations, capitalizations and so forth. And if you look at the table there, you see that we have had since the fourth quarter of last year an increasing trend in terms of capitalization of R&D. And this has to do with the fact that we are in the phase of now developing systems for releases during 2016, ’17. For instance, there is some radio system, for instance the TV software, the MediaFirst and also somewhat impacted by – to cement this development for our global ICT centers. This is nothing unusual. It goes a bit in cycles, depending on where we are, everything is disclosed. But it has been questions in the morning around it, so therefore it’s better to take this upfront. Net-net, it is a reduction in cost base, if we make everything – if you make adjustments for all of these things. Not all of it is related to the cost reduction programs. Some of it is also related to normal adjustments that has to do with business volumes, but that we have to do all the time. We will continue to see improvements in the cost base here when we go into Q4 and next year. So that’s what I want to say on the operating expense. If we then take the operating income, wanted to show then how it looks per segment, excluding restructuring charges. And here you can see that the main improvements compared to the year ago is in the Global Services segment, it’s split equally between Professional Services, that’s mainly then volume driven, but also efficiency related. And then you have the improvements in Network Rollout. And also a big item is, of course the exit of the modem business. If we then take the next picture, which has to do with sales growth and FX, this quarter you see that the delta between reported and organic FX adjusted has come down a bit and that’s natural because of the fact that the major strengthening of U.S. dollar towards Swedish krona happened during the course of last year. And it will – if we assume that we have a similar currency mix in Q4, this will come down a little bit more. In this quarter Q3, we had approximately 45% of top line being U.S. dollars and we have been in this range between 40% and 45% basically for many, many quarters. So the U.S. dollar is the most important currency from a top line point of view. Then if we look at currency movements and a lot has been said already on that topic by Hans here, but if you look at the U.S. dollar versus Swedish krona development, you see that it’s been stabilizing on levels between let’s say, 8.10 and 8.40 during the course of the year. It varies still between different months and quarters. We disclosed these FX rates on the homepage of Investor Relations every month. Then on the right hand side of this graph, you see the U.S. dollar development versus a basket of six different currencies, just to make a point out of this comment that Hans made around the purchasing power, if I may say so on some of the emerging markets. And you can see then that there has been a strengthening of the U.S. dollar against these currencies since end of last year of around 28% in average. You have then and the networks business is in U.S. dollars because a lot of the – or all components and so forth is in U.S. dollars. So it’s a U.S. dollar-based business. Global Services then is mainly local currency. So, that’s really where there is a company today has around 105 different currencies we do business in and that’s been mainly impacting the services business. Okay. We take then the cash bridge to operating cash flow in the quarter, SEK1.6 billion plus. Remember now that we have made SEK1.1 billion in cash out related to the restructuring programs in that. You also see that the main challenge this year continues to be working capital and it has to do with the mix of a lot of coverage in Mainland China, but also some emerging markets and related project terms that we have in those businesses. When you think about the operating cash flow and the profile over the year, typically Q4 is the strongest year – quarter for us in operating cash flow. And I think we would obviously try to repeat that also this year, we have the target of more than 70% cash conversion. Given where we are year-to-date, it looks a bit challenging, but we never give up, Hans and I. So I think with that, I hand back to you, Hans.

Thank you, Jan. Let me then go into the different segments, starting with Networks. So we have spoken quite a lot about the things that are happening in Networks and up 4% in reporting currency and then down 15% in constant currency. That’s a little bit more than we had in previous quarter, mainly again in China. So, it’s nothing new, it’s more somewhat slowdown we have seen from a high level in China. There are also regions growing well here. And then sequentially down 6%, basically nothing extraordinary neither. And here of course is China an important piece of it. Operating margin 12%, excluding restructuring, we now had double-digit margin in Networks, eight of the nine latest quarters. Q1 we all remember, we were not there and we said it’s not the trend and it was on the trend now. We have hopefully proven that we have a very ambitious plan to stay below 10%. We will understand that we cannot sort of have it always clear, but we definitely work with them. Eight out of nine is proving that we have a good track record there. And of course expenses as Jan has talked about important. Two important things that its radio system is starting to be shipped in this quarter and that we launched in Barcelona. We will also get our first contract on the HDS 8000, which is a hyper scale cloud server that we are building and that’s also very encouraging. We launched also in Barcelona and resides in our business unit cloud and IP. Now, you can see there that on the operating income margin, we have gradually improved from the beginning of the year to a 10 and that of course also includes restructuring charges. So, it’s excluded. This would be more even as in the second quarter we had quite a lot of restructuring charges. We have talked about it, both me and Jan, 11% up, even grow flattish on the whole of course Network Rollout declining then that means that Professional Services is growing in total 15% now in this quarter, both with system integration and managed services. We have doubled the growth in 8 out of 10 regions in this quarter on services which you can see in the enclosures we have. And of course and ending up with a SEK1 billion improvement bottom line year-over-year from SEK1.7 billion to SEK2.7 billion, 10% operating margin which is, I think quite astonishing achievement by the team Network Rollout to breakeven and of course improved earnings in absolute number in Professional Services which has been stable between 12 and 15 the last, I am not sure, how many years. I think that we have a lot of good recurring business that we are working with here. Support Solutions then, move to that. Support Solutions also stabilizing even though the reported sales up 8 and down 8. And here it’s more TV and media that is coming down. OSS/BSS very good momentum, as Jan said, we are coming down a little bit on TV and media here and it has been one customer that has been more important than others. As you saw in the quarter, we signed the agreement then with AT&T, which is very important for this business. Our margin is coming up as well here, we see compared to the second quarter clearly coming up. And on an EBITDA level, of course, as we are required quite a lot of companies, 7% EBITDA level here, which is also an improvement from previous quarter. We also made a bid for Envivio in the quarter, which is a global leader in software-based video encoding. So, then we would be the leader on the hardware-based video encoding through the Tandberg acquisition that we had for many years now and then we are in software. We really believe that we are now building a state-of-the-art TV and media business, where we can actually supply any type of customer if it’s a mobile operator, fixed operator or if it would be a satellite or the cable company and the broadcast as well, which I think is very interesting. I sum it up with a couple of things as I said before, slowdown in the third quarter in Mainland China, not strange at all. After several quarters of high deployment, you can see a slowdown. We don’t connect this to any macroeconomic discussions in China. It’s more related to our customers that had a little bit slower rollout this quarter. North America stabilized on the mobile broadband. We see on the mobile broadband business or network business a little bit weaker business in the emerging market that has been impacted by currency devaluation. We name the countries in order to not talk that everyone is in there. Services, of course, good quarter, 8 of 10 regions growing; strong demand for Professional Services; Network Rollout, breakeven. Concluding then, fourth phase in the company transformation, global cost and efficient program on track, I hope you can see that what we announced in Q4 last year that has contributed to lower cost level, as Jan went through with you in all the details. And it’s important to remember all these details to talk about that is also currency going against us in all this. So, the net-net it’s a good first sort of steps in the program, where we should achieve SEK9 billion in fixed cost by 2017. We also talked about the target areas and the target areas are performing well. They are growing about 10%. We reported that in every quarter right now since the Capital Markets Day last year in November. We will come to the Capital Markets Day and have a little bit more in depth in each and every area, how they are doing and what the nature of the businesses are to taking the next step, but we are encouraged with the growth we are seeing and sort of the rally we have done around these areas, which are very important for the markets and for transformation. Thank you very much.

Thank you, Hans. And now, operator, we are open for questions from the audience. So, please?

Thank you. [Operator Instructions] Our first question comes from Alexander Duval from Goldman Sachs. Please go ahead.

Yes, good afternoon. Alex Duval from Goldman Sachs. A couple of quick questions. Firstly, on the U.S. networks in particular, it looks like those were double-digits down organically given the FX benefit you get. But when I look at Verizon’s wireless CapEx that was actually up and AT&T was roughly stable. Obviously, the correlation is never perfect between the two, but I wondered if you could give a bit of update on that? Second of all, on the China slowdown in the third quarter, obviously, activity levels have been high for a while. But you have expressed some confidence in longer term 4G demand. So, I wondered if you could update on what underpins that view? And thirdly, on gross margin, it looks like that number was somewhat light versus where consensus was modeling. That significant degree seems to have been caused by higher mix of services, but could you give a bit of an update on pricing in the market and competitive intensity as well? Many thanks.

Great. I was trying to capture all your questions here. Talking with the North American markets and the CapEx, I mean, you are right, I mean it’s hard to draw a correlation within the CapEx of the U.S. carriers and – first of all, it’s a lag between when they are spending and we have our revenues. And then second is of course the nature of what is inside the CapEx, because it could be areas that we are not into or it could be areas that they can even decline CapEx and we are getting more business. So, that’s very important. But also if you look at some of the carriers in the U.S., they are using CapEx not only for the U.S. anymore. They are sort of moving CapEx into Latin America, for example. And of course, we can benefit from that in Latin America, so that will be reported somewhere else even though you see that they are stable on CapEx and/or they can deploy it to TV and media, for example. So, we are working with it very closely to see how our customers are developing there and how they are spending the CapEx, but your sort of insight there about the levels, those are correct, but it’s not correlated 100% though how it’s interpreted in the business for us. When it comes to China, yes, I said, I have just very recently been in China myself with some of my executive team members, met the customers to talk to them see what’s happening. I can at least at this moment not say that we don’t see an underlying demand growth in subscriber, 4G subscribers is unparallel in this market as well as we see – as any other market in the world, we see that the discussion on the utilization of using the technology for connecting cars, for Internet of Things and all of that, that we see in other markets. So, that’s where I base it that medium to long-term, I think that the rollout on Q4 will continue. It’s a big country, many subscribers. The gross margins, Jan will come back to that. I can only say you are on it. I mean, we are on the all-time high on services, 46% of the company. That intrinsically means that you get a little bit lower gross margin, but it doesn’t mean that you get the lower bottom line. And that we just wanted to – and of course then the modeling becomes hard for the market when you are a little bit wrong on that gross margins, but ultimately, bottom line, you can see that we are producing equally much bottom line on these units right now even that were different gross margins. On the competition on pricing, nothing new to report, I mean, network side, always, when it’s new deals, always a little bit more tougher pricing environment. There is no difference on that. If you fight for new market share, always a little bit tougher, but it’s nothing as well no revenue word here, it is the same, it’s tough, it’s a competition. As always, it’s less in the competition in fewer companies for sure, especially on mobile infrastructure. Then if you go to billing system, here, we meet totally different competition. We would meet Oracles and Accentures of the world. And if you would go into pure services, it can equally be HP and the IBM. So, we clearly want to talk about competition. It’s a very broad term for Ericsson nowadays how we have selected our areas. Jan, do you want to add something?

No, I don’t want to add anything. I think the gross margin bridge there, Alex it has to do with services. You shouldn’t read anything else into mix than that.

Many thanks indeed.

Okay, are you happy with that?

Thanks.

Next question please.

Thank you. Our next question comes from the line of Pierre Ferragu from Bernstein. Please go ahead.

Hi Pierre.

Hi, good morning, how are you? So a quick question actually on your cost reduction programs. You have made significant progress in reducing your OpEx this quarter. And I had two questions. The first one is could you give us a sense of what’s behind you and what stands still in front of you in the next 6 months to 12 months in terms of cost reduction. And so we have your target of SEK9 billion for the full year of 2017. If you could just recap what are the drivers that you have improved yet and that will be on your to do list in coming months. And if so if you can give us a quick reminder of how much of that cost cutting is going to affect your OpEx and how much more is coming into ship [ph] after on your gross margin. And of course on the gross margin side, it’s difficult for us to read what you have achieved so far. So if you could tell us what you achieved so far there, that would be great. And then my second question is about your recession development costs. So the amount of costs you are capitalizing has increased over the last three quarters – two or three quarters by SEK600 million, SEK700 million, so it’s a highly significant number. And I was wondering if you could give us some visibility on what’s happening in your R&D, why is this number increasing and how we should think about it as a run rate number going forward as we track your progress on cost cutting, it’s important for us to make a very clear difference between expenses that are getting capitalized and expenses that are actually taken out of your cash expense every quarter? Thanks a lot.

Okay. Pierre, it’s Jan here. So let’s start with the overall cost reduction program then. And the ambition is to improve the cost base by SEK9 billion in 2017 and the baseline is 2014. It’s – in terms of the activities and so forth, it’s still very relevant to model with half-half between cost of sales and the operating expense, that’s still very relevant. Also remember that we started 2015 on an upward growing trend here in terms of R&D expenses in particular, but when we measure this we baseline from the operating expense and fixed cost of sales levels as they look in 2014. So – and in terms of the things we are doing, obviously we will continue to execute activities. You see that if you look at the headcount numbers, the gross number is down 5,000 people in the quarter. Not all of that is related to the cost reduction programs, some of it is also normal rightsizing that you have to do and the normal efficiencies every year. I think in terms of what you will see happening here in 2016 first half and so forth is of course that we will start to see a more material impact from the program that was announced in Sweden. We are continuing then with things that is addressed – that is addressing the service delivery, that continues as a continue to do list for next year. We will also continue to work with the IT infrastructure and IT related costs and so forth. So there is a to do list, I agree. But when it comes to people, you also know Pierre that we prefer to communicate all of these things to the relevant organizations first. But I think we have got start – we have gotten – we are already in execution and we start to see impact on the cost base and I think that’s important. When it comes to the cost of sales, I agree with you that it’s tough to see that because it’s mix and so forth. I will try to make a shot of that when we meet at the Capital Market Day to give you some progress. On the capitalization of R&D then, this is – it goes a bit. And so if you were to look at this Page 34 in the report and you will look back a few years, you would see that when we did the development around the RBS 6000, for instance we were in a capitalization phase as well. Then – when once you get into more of this twice a year software releases, those are short projects. Those, we don’t capitalize. So I think when it comes to modeling this Pierre, some of the products that I mentioned there, they will be in the market, end of this year and during 2016. So if there is no new big project, then you will start to see this trend going in the opposite direction during next year. Then of course, you will start to have some developments related to 5G and so forth. So it goes a bit in cycles. But right now you will see that the products that I refer to, they will be in the market here end of this year and next year. And then you will start to see this going in the other direction, so to say. So it’s a little bit goes in cycles. So I would hope that, that was good enough answer for – on your question.

Thank you.

Thank you, Pierre. We will go to next question.

Thank you. Our next question comes from Tim Long from BMO. Please go ahead.

Hello Tim.

Hi, thank you. Just back to the services business, thinking about the gross margins here longer-term, so it’s been overall Op margins have been pretty consistent for managed and Professional Services. So is there – are we kind of really no chance to improve gross margins that would only be pricing, is there anything that could be done to help improve the gross margins and maybe mitigate the mix shift that we see. And secondly, on the Network Rollout side good performance in the quarter, how was that – a little bit more detail on how that was done, is this just being a little bit more strict on pricing or was there good cost outs to help us get an idea of how sustainable that might be to have that run at breakeven? Thank you.

Thank you. Good questions, I mean when we talk about the gross margin, that’s as you said it will be a combination of hardware, software and services which all of them have different type of nature. But given the push we have for software, of course there is also a chance that the gross margin can go up. I mean we are in the pricing transformation right now with our customers a 3-year – over 3-year term in order to actually price our products more like a software. And the reason is very simple, we have so little hardware, and it is going down dramatically. We launched that one year ago, our software model that we did publicly as well so everybody knows. But we cannot do it immediately. It comes up new tenders or new renovation of contracts and we are negotiating each one of them and the area which is further to have their support solution that has done that for a while. Tougher has been in Networks because you also need to move and change the technology in order to be able to charge like a software. You need LTE locks and keys and optionality, packages, etcetera. And that’s it guides us on tremendously over the last 3 years to put together and now we can do it, so that will of course increase software over time. And we have an ambition to increase our software and services in totality. So that’s all we structure doing in order to get there. Then the mix will always be there, services intrinsically have a lower gross margin, but they can definitely still get out bottom line that is very competitive.

Okay. Let me add a few things. So on the Professional Services margin, how do you get more leverage, I mean the work that the team does is of course to work diligently with tools, methods and automation. And we invest significant amounts on tool development for services each and every year. So we will continue to do that in order to create both automation and one-to-many delivery models. That’s one important leverage. On the Network Rollout piece, that’s more of a business that has higher element of variable or consultants or subcontractors in delivery. But still, there is a lot of tools development to reuse solutions and so forth. This particular case has been very much focused on knowledge sharing tools and also much closer work between the radio product areas together with services around the ease of installability and so forth. We need to do those kind of things because we know that we can’t go and ask for price increases to customers. We need to care take care of the projects that we have taken on in a good way. So those are the things we can work with it.

And then on Network Rollout, it’s not pricing. I think the guys has worked a lot with the projects in Network Rollout, the ways of work in the tools methods and processes. So, I think that is a very tedious and good work that has been done across the globe. Just imagine how many Network Rollout projects we have in 180 countries. It’s enormous lot of work and it has taken some time. And we saw one quarter right now. Jan has said it several times. We are now looking for sustainable, because we think that this will not be a high margin business, but it should not be a drain to the bottom line, but we will also have quarters where we have certain projects coming in and out. But to be clear, this is hard work with our cost base and the ways of working. And Jan mentioned tools, method, processes, consistent work across the globe. We have global teams that are working with all our local organizations. So, I think growth [indiscernible] and they have been able to turn this around.

Okay, thank you.

Thank you, Tim. Next question please.

Thank you. Our next question comes from the line of Edward Snyder from Charter Equity. Please go ahead.

Thank you very much. Hi, Hans, you have talked about again on 5G rollouts starting in China specifically more of an industrial event like IoT. I was just wondering is the profile of this upgrade going to be quite a bit different than we have seen from say 2G to 3G and 3G to 4G? In those, we saw a big change in the backbone of the infrastructure, the modulation scheme etcetera. A 5G is going to be LTE like 4G was? Does this change not just the ASPs, but the margin profile of what you are looking at or even the timeframe that it takes to roll this out given that probably going to be dealing with the LTE for quite sometime now given the radio capacity issues? And then Hans also if you are looking at the profile of demand in 4G now in China starting to slowdown, I know it has something to do with the economy, but if you compare that to what happened in North America, we had several years of very strong build-out and the next followed by kind of a lower level and stability. It looks like maybe China is following the same path. Is this the template we can expect you think for most 4G rollouts as they get into India several years of growth and then a big drop-off and then more of a stable? Just trying to get an idea of what you think the profile will be once we see maturation of 4G in some of the emerging markets? Thanks.

Yes. Starting with the China comment together in 5G, so when I talked about the utilization in China, it’s based on 4G, so we are clear on that. So that was related to 4G and IoT. Still I said in the beginning that many markets are now looking into 5G and China would be one of them. But when I talk about that the 21st century’s infrastructure would be mobility broadband and cloud. That is 4G-based in China, but 5G will come later on, so just to clarify that. If we then talk about the pattern and profile we could see, yes, I think Jan has talked about that several times that we have a pattern on coverage first and then depending a little bit how much capacity was in that coverage, you get to phase a little bit slower and then you cancel capacity. That’s how we work in all technologies. However, we don’t say that this is the case in China right now. We say it’s one quarter of a slowdown and it might not be – the underlying and the coverage is still there. So, I would say, you need more coverage in China. So, the coverage phase is not over in China, that’s what I am saying. But the pattern, as you described, that’s how it work between technologies. Then your next question is how will – how do you correlate the 2G, 3G and 4G? It’s a little bit early to say. We have standardization both this working on standardizing 5G to as much extent we would like of course, we would like to see that we can reuse as much as possible of the installed base when it comes to basebands, etcetera, when you move to 5G. However, the radio units have to be changed, because it’s going to be different frequencies. But we will only know that when we have decided what frequency is going to be and how it will define, but of course, one way to see it is that this could be upgradable from where we are, but it’s too early to say. We are now discreetly running 5G tests where you can – we can show 5 gigabits per second right now in our 5G test plants here in Kista, which enormous, but it can also give a latency it is 10 to 20 times lower than 4G. So, there is many new carrier guys on the network. And that’s why I am talking about many industries will be very interested, but we – we are trying to see that this is going to be as much reuse of the previous infrastructure, because that’s important of our customers and they don’t need to reinstall or reinvest again, but it depends a little bit how the standardization is going to be done. We will push for that.

Yes, I guess a follow-up then. If that turns out to be the case, would you reuse? And that seems to be the scenario that’s playing out given you are not going to see big change in modulation. Does that radically change the ASP revenue versus margin profile of wider deployment of 5G? So, if you go to IoT in the U.S. and eventually in China whenever it shows up and you are looking at industrial applications, would you expect your financial statements would show a significant change at least in networks as this started to penetrate some of the more advanced markets?

We are very early out now speculating on the margin profile. Remember, commercially, volumes is 20:20, but of course, if it goes that way, it will be more software centric sort of next generation mobile networks rather than hardware as it will be probably. Still you are going to need more sites, because you need to densify again a lot in order. And so – and you will also have much more of sort of orchestration layer over this, because now you cannot have discrete product in the network. They need to hang together if you are going to enable this, because it’s not enough that Radio Access is 5G. You need also the radio and maybe the transmission on IP radio and something to control that. So, there is going to be more and broader definition on 5G than we have seen on Radio Access.

Great. And then finally if I could, C-RAN are you seeing – I know there are some test deployments now, too, is that something that we can expect the next year or so or was that further out like 5G?

I think that C-RAN is such a wide sort of the question. I mean, there are different ways of doing C-RAN. I mean, you can do based on halters as I call them, you can virtualize parts of it. Parts of it we are already doing today. Other things we are looking if there can be more efficiency for our customers and if the used cases are there. So, you can say yes, we are doing C-RAN today, because we can actually pull together the baselines in one place, but then it depends on how much IP you have in between the radios and the basebands. So, you can do a lot of what C-RAN. So, it’s a more definition of what is C-RAN. We will – as a world leader in mobile technology, we will be exploring all new ways of actually delivering radio waves in a more efficient way. If that is part of doing different things, we will do it. We are very early on in the research on this area and some things we can already do.

Thank you very much.

Let’s go to the next question please.

Thank you. Our next question comes from the line of Achal Sultania from Credit Suisse. Please go ahead.

Hello, Achal.

Hi, thanks for taking my question. Just a couple. I think first on the Western European market, actually we have seen some moderate growth in the last few quarters and now this is the first quarter of year-on-year decline. And I think you mentioned a couple of projects getting completed, like a few projects getting completed in the region. Like can you give some more color around it like is it just one customer, is it more than one customer, and where we are in terms of project completion and how should we think about 2016 in Europe?

I think that the way why we write that in the report is obviously that one of the important projects that we have been carrying out for one very important customer is gradually coming to an end that is peaking, that’s why the comment is there and then I think we don’t talk more about it, I think you know what it is. I think in the terms of growth story for Europe in general, I think that – I think the – on the overall level it’s a lot of work still to be done in Europe in terms of 4G both coverage and capacity. So, that’s an opportunity to grow obviously. We have had in some markets lower investment levels for sometime driven by a lot of the consolidation discussions that is ongoing, but also driven partly by slowness from a macro point of view in some countries and so forth. So, I mean, I think trading points for growth is going to be around 4G and continued 4G deployments as well as perhaps hopefully some resolutions on some of the consolidation opportunities and so forth. So, that’s really what I see. I brought it there, because I think it’s important for you to understand that in the case of Western and Central Europe, you have that aspect of those projects with one particular customer.

That’s clear, Jan. And then maybe one follow-up on China, like if we try to understand clearly, I think you have seen a big rollout 4G in the last three, four quarters. Can you talk about where we are in terms of mix because my understanding was that the mix in China should improve as we get more and more 4G subscriber uptake on these networks, so can you talk about like where we are in that process, are we like just starting to see that or are we still like some just some – a few quarters away from that?

I think from my point of view and I will let Hans talk about his view on 4G in more mid to long-term in mainland China. I think for us, it’s – we are still predominantly, it is coverage, so capacity which we all would like to see has still not materialized and become relevant part of the business mix. So it’s mainly coverage still. Hans, do you want to talk about 2016, ‘17?

No. I think that we still have a coverage going out. The last time China reported 4G subscriptions, it was 200 million. That was in mid-year. I am pretty certain that they have many more right now. But it’s still a long way until they have full coverage and the subscribers on 4G. So that’s why I am saying we still have a coverage phase to go. And then of course that will go to the normal profile. When that is – it’s not now for sure. It will take some more rollouts before we will get there. And then of course, if you then start to get into industrial Internet of 4G, then you need to densify and a lot of other things as well. So we are going to see. Then we have the shift of the leadership of the three Chinese operators at the same time in this quarter as well, China Unicom, China Mobile, China Telecom has all changed Chairman. So that’s also something need to be taken into consideration here.

Thanks a lot guys. Thanks.

Thanks Achal. We will go to the next question operator.

Thank you. Our next question comes from the line from Francois Meunier from Morgan Stanley. Please go ahead.

Hello Francois.

Yes. Thanks for taking my question. You are talking a lot about TV broadcasting and you seem pretty excited about your contract with AT&T and DirecTV. The first question is could this big R&D investment you are putting into the cash flow something which could be reused for Netflix type clients, that’s the first question. And the second question is also about your new areas of growth, IP routing and you have not made a comment yet on IP routing and I was wondering if you could give us an update on how it’s going, especially with the new system you introduced this year? Thank you.

Yes. On the first question, it’s pretty simple, it’s yes. We had already worked with over the top providers like CMOR [ph] and HBOs, etcetera that were delivering these type of services for us. So yes, we could work with that. We have different type of TV platforms. We have one broad TV platform that can actually handling, which is MediaFirst, which can basically handle all types of accesses everything from IPTV to over-the-top linear TV to satellite TV at the same time. Then very much smaller sort of over the top service for TV that we acquired from Azuki that we can deliver to sort of standalone, over the top solutions only. So yes, we are addressing both those markets at the same time. Then was the second question about, I forgot. So as I reported a little bit briefly then and I understand your question, we say that we have good growth in all target areas. IP is in the target area when it comes to the areas that we have then put focus on when it comes to our IP portfolio. We have good growth there as well. We will be a little bit more detail how it looks like when we meet in the Capital Markets Day. As for all of the different area, but we see a continued good focus. As I said also the HDS 8000, we have our first customers on that and that we will of course start deploying in the beginning of next year. So yes, it is going according to our plan that we will take out with ambition to be in certain areas of the IP routing and that is moving along. But we will be giving you more updates when we meet at the Capital Markets Day as well as on OSS/BSS, TV & Media, the industry verticals and the cloud initiatives that we have as well.

Thank you, Hans.

Thank you.

Thank you, Francois. Next question?

Thank you. Our next question comes from the line from Gareth Jenkins from UBS. Please go ahead.

Hello Gareth.

Yes. Hi guys. A couple if I could. Firstly, I just wondered whether you have seen any change in market behavior following the announcement of consolidation earlier this year whether more aggressive pricing behavior or less aggressive pricing behavior or just no real change. And then secondly is a follow-up on China, just the working capital movement again seems quite heavy through the first nine months of this year and I wondered whether you feel that will unwind next year, whether the payment terms of those may be extended in China or in particular and that you will make good on some of those investments that you have to make upfront? Thank you.

Market behavior.

Okay, looking at Jan for answering the second question, okay. The first question, yes market behavior, I assume you talk about mobile infrastructure because we always end up talking about Networks when it comes to market behavior. Then you need to remember, 4% to 6% of our turnover is in pure services, OSS/BSS, TV and media with very different competitors as well with other behaviors. But I used to assume that you are talking about the consolidated market there. Now nothing new has happened. I mean, it is competitive when we all have new sort of infrastructure deals where you are building a new footprint or that you can have for 10 years if you perform well or maybe 5 years at least. So of course we see the same pattern there. But it’s nothing incremental or any major changes. Then you always – as I always say you always remember the last couple of deals that you have done and those can impact on your view what’s happening. But we would try to take it over longer period and see how the price and the market is developing, but nothing significantly changing in the market so far.

On working capital then, Gareth, this is – we are in project terms, right, which means that you obviously I mean typically you get you reach the billing milestone before that. It’s obviously in inventory, working capital inventory and then you reach the billing milestone. And that you reach based on preliminary or final acceptance. And that’s really what is creating the challenge when you are into project terms versus bid contracts. So it’s nothing else than that. We will do our utmost to make sure that we obviously reach the billing milestones, build the revenue here. And we have said that we think that there will be some project completions in Network Rollout and so forth in Q4, right. And that’s obviously linked to the fact that you reach the billing milestones and then you can collect. So I think that’s what we are doing. So it’s nothing else than the mix of mainland China, but also some other emerging markets, obviously. So that’s – we will work hard to make sure we improve, I promise you.

Okay. Thanks guys.

We are now open for the last question of this conference call, so please.

Thank you. Our final question comes from the line of Simon Leopold from Raymond James. Please go ahead.

Hello Simon.

I wanted to see if we could drill down a little bit on North America since so that’s your largest region. And I wanted to look at it from both a shorter term and longer term. From a shorter term perspective AT&T CapEx, it looks like it’s going to be very backend loaded to the fourth quarter. And I did hear your earlier comments about the challenge of aligning specific quarters, but just want to see what you are thinking in terms of that shorter term trend. And of more significance, when we look at this year and we think about 2016, I am wondering about the relatively easy comparison given weakness in North America yet, I think the prospect of improvement in 2016 and I am thinking about drivers such as the AWS-3 auction that was held earlier this year when the carriers need to spend to utilize that spectrum. So shorter term and longer term North America comments please?

I think I have said this many times that wireless CapEx is a lagging indicator to then the revenue just to be clear on that, because they obviously, once we have invoiced and build and so forth the operators do the actual capitalization. So it’s not a leading indicator to then the revenue, it’s a lagging indicator to then revenue. Hans?

Ramped in my comment, but thank you very much, Jan it was an important comment. I mean, for us you have to understand how we work. I personally are in contact with the Chairman and the CEOs of the operators, our key account manager as well to understand sort of the structure of the CapEx. I mean that’s what we need to understand. As Jan said, it’s a lagging indicator is what we are going to say and what they are going to spend and what they are going to spend and it’s not really hanging together with our revenue stream. We need to know what’s inside there things that’s important. And yes, there is a lot of new spectrum auctions coming up in the U.S. next year. I used to say if somebody buys spectrum, they want to build on it. So, it depends on when it’s going to be auctioned and when it’s going to be available. We know that those are coming out in the first half of next year, then of course, we are going to see who is going to acquire and when it’s going to be cleaned up, but clearly, new spectrum creates more need for deployment. However, many of the customers right now worldwide have multi-standard radio. So, then it comes down to carrier aggregation, using our baseband, adding new radio features in the towers, but using them carrier aggregation in order to have the best possible performance of the network, combining them the 600 and 700 or the 1800, 1900 in order to have it. That’s from a technology point of view and network point of view, I wouldn’t say its simple, but it’s fairly easy to do. It will take some time and it’s very – but what is really important is of course that the handsets can handle the same carrier aggregation in order to get the full throughput and their uses of uplink and downlinks on different frequencies. And I think that’s what we are working with the whole ecosystem to see and that of course can drive a lot of investment. And that is also one of the main pillars how we can handle the increasing data flows that we can combine frequencies in the future. And now there is of course new technology. And the third one is definitely more spectrum.

Thank you, Hans and thank you, Simon. Are you happy with that?

Yes, thank you for the help.

Thank you. Before letting Hans conclude this, I would like to invite all of you to the CMD, the Capital Markets Day in November 10, listen to Hans and Jan today it’s going to be very interesting with a lot of talk about other areas, etcetera. So, you are welcome to Stockholm on the November 10 with a dinner before on the 9. So please, Hans?

No. My summary will be fairly simple. I mean, again, I think we are in the midst of a transformation. I hope that U.S. industry analysts and investor analysts see that what we are trying to achieve. I think we have good traction in many areas. We are working with both in the course, but also with the target areas. We see also that we have an improved core business which was also target that this management put up. And I think that we – I think I would say that this quarter is very stable sort of next step in our process. And we will be very happy to meet at the Capital Markets Day where we will go deeper down the drivers for these different target areas, where we have selected them, how we see them growing, how we are performing in the markets and how we can be the world leader in those as well. So, I think that’s the summary, Peter. Thank you very much.

Thank you. This now concludes our conference call. Thank you for attending. You may now disconnect your lines.