Telefonaktiebolaget LM Ericsson (publ) (ERIC) Q2 2018 Earnings Report, Transcript and Summary

Welcome to Ericsson's Analyst and Media Conference Call for their second 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 one hour after today's conference. Peter Nyquist will now open the call.

Thank you, operator and hello everyone and welcome to this second call for today. With me today, I have our CEO, Börje Ekholm and our CFO, Carl Mellander. So during this call today, we will be making forward-looking statements. These statements are based on current expectation 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 all 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 Börje. So please, Börje. Börje Ekholm: Thank you, Peter. So welcome to our presentation of the second quarter and thanks everyone for joining. Last year, we defined the new focused strategy in order to turn our company around. We relied on three strategic pillars. The first one is to increase investments in R&D to secure technology leadership and to provide leading solutions to our customers, but also to leverage technology to improve the competitiveness of our product, so basically investing in R&D to improve gross margin. The second, was to obtain a competitive cost position in G&A, but more importantly, in service delivery by simplifying and taking cost out and that would also drive gross margin, but also structural costs. And the third is to improve our competitiveness and based on the improved competitiveness we could selectively strengthen our market position. Our ambition was to establish a satisfactory profitability level assuming flat revenues. So basically we wanted to improve our business in a fall -- in a flat to falling market by controlling what we can basically our costs. This would allow us to have a competitive cost structure that once we see growth returning in the industry, we would be in a very good position. It's been tons of hard work in the company, but it is rewarding to see that hard work now paying off and we see good progress in turning around the performance and it's visible in the second quarter following a good first quarter as well. While we also see a increasing momentum in the business and now we see Networks returning to growth for the first time in some time. So I would say a lot of work remains, but we feel traction is very good. So at the Capital Markets Day last year, we put a target for 2020 of reaching an operating margin of 10%. We see that we're tracking well towards this objective with the execution we've done on our strategy the first half year this year. We continue to invest in technology leadership. We have increased, or we have hired more than 2,500 engineers over the last year and that we do to improve our cost position in the -- what I would call a 4G portfolio, but also lead the way into 5G. We have achieved the cost out objective we set last year of SEK10 billion run rate. Of course, our work on the -- we may have reached this objective and we have finalized that program we've had in place, but the work on the costs side never ends. We will not have any more programs, but we will work with continuous improvements in the business. And we continue to invest in capturing selective market opportunities where we have a competitive advantage. We know that pursuing this type of opportunities can and will have some short-term costs, but they are long-term attractive. So we will capture those, but having a very strong discipline and a strong focus on the operating profit level, although it may impact lines above operating profit. We see traffic demand in the Networks continued to grow very strongly on a global basis, basically doubling every 18 months to 24 months. And we see now operators investing again in order to provide the user experience to their end user and at the same time manage costs. We see this can only be done really through the use of technology. We also see the 5G discussion is heating up. The standard has accelerated more than a year and operators are increasingly preparing to invest in the network and preparing for 5G. We see the first business case for 5G being enhanced mobile broadband, but the interest for fixed wireless access is heating up globally as well. We see that operators are increasingly wanting to install 5G-ready hardware. And of course, they do that for the simple reason of not having to rip anything out as you upgrade to 5G. And here we are -- our ERS portfolio is really only a software upgrade away from carrying 5G traffic. So based on the progress and the visibility we have, we feel comfortable that we're on track to achieving our long-term objective of 10% -- or 12% operating margin beyond 2020. Our top line has also started to flatten out with the decline of only about 1%. The reason for the decline is really the strategic priorities to exit some parts of our business and contracts. In addition, we're now seeing Networks actually returning to growth in the quarter on the back of a more competitive cost structure. Gross margin has continued to improve as a result of costs out and increased ERS penetration. Operating income still not where we want it to be at 2020, but it's a clear improvement compared to last year as well as the first quarter. Our focus on free cash flow continues and it has also improved compared to last year. We are now only slightly negative and that's primarily a result of the acquisition in Emerging Business, but also less sale of trade receivables in the quarter. Overall, we have achieved savings in excess of our target of SEK10 billion. The full effect of all the actions will not be fully visible in the P&L until the second half of this year. We have achieved structural run rate savings in G&A of SEK2.7 billion by the end of Q2 fully visible in the P&L. In Service Delivery, we have reduced costs in excess of SEK8 billion on a run rate basis. We see this in an improving gross margin in all segments and -- for basically a total uplift of 300 basis points in gross margin during the second quarter. So while we have achieved the SEK10 billion target, we see new opportunities to continue to improve our efficiency. And we estimate the restructuring costs therefore to remain as SEK5 billion to SEK7 billion for the full year even though we only used SEK3 billion during the first half of the year to complete the SEK10 billion target. Our Service Delivery was clearly not cost competitive before, but following the changes in ways of working as well as simplification and delayering we have now a much more competitive cost position. With the changes we have done it's not only lowering the -- our cost position or improving our cost position, it's making us much more flexible and more agile as well which allows us to respond quickly to customer needs. So unfortunately we have had to reduce our workforce by a gross of 23,000 and net 20,500 after hiring 2,500 engineers in R&D. This has clearly put a lot of stress on the organization. The hard part is may not be to take out this amount of costs. It's really to do it while protecting the top line. And I would say here we see that we've made good progress during the last year in the second -- first and second quarter. Of course, the focus on the total workforce and that's the only way to track the full costs so it's again that's why we're tracking total workforce. We see a reduction in total workforce in the second quarter of this year as well and that is net after having increased our headcount following some new contracts we have taken both in Managed Services as well as other parts of the business. So in short as a result of this reduction in costs, we clearly have a much more competitive cost position than we had a year ago. We see good growth in North America and that's really on the back of our customers getting ready for 5G and actually preparing the network. In China LTE investments have continued to fall which has impacted the Northeast Asia market area. Overall in Europe, we see good growth but it's offset by some declines in certain markets as well as exited contracts which is why you see a slight decline in sales in market area Europe and Latin America. In Middle East and Africa, we had a slight decline due to some countries with monetary restrictions. In Southeast Asia, the decline was more related to timing of contracts. So we continued to execute on our focus strategy putting us comfortably on track towards the targets for 2020. In Networks, we see penetration of ERS continue to increase and it's now 84%. We've also taken out significant costs in service delivery. Now we have increased our investments in R&D to strengthen our cost position, but also to prepare for 5G. Losses are reduced sequentially in Digital Services, but we have clearly more to do. We have seen cost efficiency gains in service delivery. And we are also changing the ways of working in R&D resulting in some improvement on R&D spend. In parallel with these cost activities we are also increasing our investments in 5G-ready and cloud-native products. Managed Services achieved the second quarter of positive operating income. This is clearly on the back of costs out, but also contract reviews. There are some one-time positive effects in the second quarter, but here we see a much more competitive offering in the market as well. And we continue to increase our investments in automation and machine learning and we see some very important selective customer wins happening right now. In our other business, operating income is still negative and is negatively affected by the Media business to the tune of about SEK 0.4 billion. We continue to invest in selective new technologies in this area like IoT where we see very good growth, but it's also quite clear from the performance that the revenues are not yet covering costs, but we would also say that we see good progress on our offering. So with that, I'm going to give the word over to you Carl.

Thank you, Börje. Excellent and good morning, good afternoon, everybody. So let's look a bit more in detail at the numbers per segment to start with. And here we look at Networks, and as Börje said back to growth 2% in the quarter. Last time we had growth in this segment was in Q4 2015. And so that growth has also come with the improved margins, and as you can see gross margin over 40% here or 400 basis points improvement year-over-year. And this is really related to a structurally lower cost base I suppose around the service delivery piece as well as the hardware Ericsson Radio System. So, a good momentum here in North America but also other places, as Börje was talking about. In summary, good market traction and growth in the portfolio with a strong margin improvement in Networks. Digital Services has improved margins substantially still reporting a loss of SEK 1.5billion, but the direction is good and it's encouraging to see that we have been able to reduce the losses in this quarter. I want to mention that the proportion of large transformation contracts actually did increase in the quarter as we anticipated when we reported on the Q1 results and this weighs on the margin, but there are effects in the other direction as well offsetting this. That has to do with further cost reductions mainly but also stronger software margins in this business. The top line decrease you see here of 12% is coming from the continued decline in the legacy portfolio. And the new portfolio also declined in the quarter, but however, that's largely explained by a single contract delay in Northeast Asia where we have a tough comparison with Q2 2017. So encouraging improvements still SEK 1.5 billion of losses and our job is of course to take this number up towards the 2020 target of low single digit profit. Managed Services executing on the strategy as Börje had mentioned earlier, taking costs out, working through the 42 non-strategic contracts 33 done to-date, and but also staying disciplined when it comes to taking new business, new contracts which is extremely important here as well. And this is working well now with as you can see a strong margin development in the quarter. I should mention that, there are certain one-offs here in the margin about SEK 100 million in one-off effects positive. We are divesting the field service activity in Sweden and we are happy about a new owner taking over this business that can develop it further so this is also another sign of strategy execution. Emerging Business and others, a collection of different parts, of course iconectiv in the North America market doing well with a number of portability contract, which is started now. When it comes to the future growth areas, we invest selectively in areas which we believe could be the future possible growth areas and scalable including IoT for example. And to mention one example, we have signed a contract with China Mobile which we announced earlier around the device connectivity platform. And here is of course about being very disciplined when it comes to investment in this area. As you know, we committed to a target of breakeven by 2020 in this total portfolio. The Media side then, yeah, where we're accelerating and full speed ahead on closing the Media Time transaction. Gross margins there have improved. Börje mentioned that the loss in this quarter from Media is around SEK 400 million. But we see a steady improvement in margins. And in the Red Bee Media piece we see positive signs now as we are clear on keeping this business in Ericsson, that customers actually take more comfort in that and entrust us with their business. So we have promising signs there also in – for example the managed OTT platform. Moving on to the gross margin. This is to say that, we see improvements in gross margin across all the segments. All segments are contributing here, which is strong. And also all what you call both hardware, software and services in our business are all contributing to an improved gross margin and there is also a market mix factor here. We should say that, so it's a positive market mix this quarter. This can vary over time of course. And final comment here is that, the sequential improvement you see is really derive from Managed Services further improving and Networks and Digital Services were stable sequentially. If we move to the cost bridges. R&D continues as planned then. It follows the same pattern with the increased investments in networks, while we are reducing some in Digital Services. When it comes to SG&A then the savings out of the cost program in the quarter was SEK0.7 billion. And we had a couple of items offsetting this, namely valuation of customer financing point two, and then certain other items here amounting in total to half a billion, and this includes also provisions -- provision increases for valuable compensation compared with 2017 where of course Q2 was a very weak quarter, whereas such prohibitions were dissolved. What's not shown on this picture is the third line in OpEx that you have noted now which follows the IFRS 9. It has to do with impairment of trade receivables, and we have 0.4 billion in Q2 versus 0.2 in Q2 2017. Operating income then, you can see what the big contributors here are and a relevant question to ask here is, of course how are we going from this 4% to the 10% target in 2020? And just to mention some of the building blocks there, starting with digital services. If we just for a minute assumed that we would take that up to break even. This would be a contribution then on bottom line for Ericsson, about three percentage points. This means continued cost out and service delivery in SG&A, but also efficiency and R&D rates are working, and then also factor of mix where software becomes larger in terms of proportion. So that's the digital service side. Break even would contribute three percentage points here. And Networks, we're continuing with Ericsson Radio system penetration. We are at 84 before and of course, we're going for 100%, but it doesn't stop there because this portfolio will continue to develop of course and deliver the investor margin over time as well. More delivery service and better scale and remember that Q2 is seasonably low in topline in Networks as well and there we have call it, say, two percentage points to be gained in our planning. And then finally, we have the emerging business and media contributing a bit more than two percentage points as well from Media improving toward break even, but also the emerging business where we will control the portfolio to deliver a break even. That has to do with, of course, the amount of investment we put into new areas. So all in all, with those improvements and the detailed plans behind, we would have a path toward the 10% operating margin by 2020. Cash flow was clearly improved from previous year, and we have had a number of quarters now in a row where we surpass the year-over-year comparison, and the main contributor here is working capital where we see further improvements now in the quarter. The free cash flow then, and you can see the isolated number here but also important to see that year-to-date numbers is 0.3 billion negative and that can be compared with the same period last year, minus 4.6 billion, so a clear improvement of more than 4 billion between the years. The financial position remains strong. Here, we feel very confident, solid cash position. We have also in the quarter signed a 5G related loan with the European Investment Bank to further strengthen the debt side and the debt maturity profile. It's a five-year maturity and that is a loan that we haven't drawn down yet. Therefore it's not visible in the graph. Next slide is around a couple of other financial items that we talk about in the report. And in the interest of time I will not walk this through now. But we included here for you future reference, but it has to do with a bit of explanation around impairment losses, the finance net taxes pensions and restates between units that we have done in the quarter. It's all in the report as well. A final word from me around the planning assumptions then, and here again I'd like to refer you to the report where this is all detailed. And there are no major changes in Q1 here, except for one thing we mentioned the cost for separation of the Media Solutions or now renamed Media Time business and that's 0.3 billion to impact in the Q3. So, with that thank you for this part. And back to you Börje. Börje Ekholm: Thank you, Carl. So before we head over to Q&A, let's summarize where we are. So we set out on a journey of our focus strategy last year with the objective to turn the company around on the flat revenue base, i.e. not hoping for revenue growth to help us out. We will do this turnaround by investing in R&D to have a competitive portfolio and by taking out significant costs in service delivery and G&A. There's a lot of hard work by my colleagues in the company, but it is of course satisfactory to see that we're executing on this strategy. We see good improvements in our gross margin indicating a competitive offering and competitive cost situation. We're now adding a second quarter with improved performance to the first quarter including reaching the costs out objective. We will continue to execute on the strategy, investing for technology leadership and at the same time keeping a tight cost control. And we know that when we have a more competitive business, we will see new opportunities materialize. We're seeing very strong business momentum in our business and we already now see Networks returning to growth in the second quarter. In addition we see the market increasingly gaining momentum. Operators are needing to invest in capacity to manage the sharply growing data traffic. And we see that this gives many new opportunity, especially with our 5G ready 4G portfolio. So we will use our cost competitive position and competitive product portfolio to selectively grab new opportunities. However, we will always remain disciplined in order to assure overall financial performance. With that thank you.

Thank you, Börje. So, operator, we are now ready to start the question-and-answer session. So please.

Ladies and gentlemen, at this time we will begin the question-and-answer session. [Operator Instructions] As always please limit yourself to one question at a time and please keep your question at a broad level. Detailed information is provided in the report and Ericsson's Investor Relations and Media Relations team will be happy to take additional questions and discuss further details with you after the call. And our first question comes from the line of Edward Snyder of Charter Equity Research. Please go ahead. Your line is now open. Börje Ekholm: Hi, Ed.

Thank you very much. Börje if I could, I'd like to dig into the Ericsson Radio System, which seems to have a large positive impact on your operating income. How much more can we expect from this? And what has changed that's giving it such an outsized impact now? Does 5G lend itself to ERS sales? Is there a redesign that's improved the cost structure of that product? Or are you bundling with systems sales to a greater extent than you had done in the past? I'm just trying to get an idea of how large of a factor is over the next -- over the near term. Börje Ekholm: Thanks for the question. No we're -- our ERS platform has a couple of key fixtures. The first one being that it is a very cost competitive platform. It's designed for cost competitiveness. So that means that when we designed it, we actually look to market demands and put the right features in place to be cost competitive. That's one thing. We continue to invest in the ERS platform to bring costs down to launch new upgrades, new solutions that lowers the cost to manufacture the hardware. And lastly, which I think is equally important for the customer decision is that it's actually ready to carry 5G traffic with a software upgrade to the hardware. So of course, if you're in a different frequency band it will differ. But for one frequency band, you may not even need to go out to a site. You can actually do it completely remote upgrade with software and carry in our traffic. And we see that responding very well with customers as they don't want to run the risk of having to make multiple site visits and tiering out what the infrastructure they have installed. So I would say it is -- we may not yet see 5G revenues on the commercial level, but we see this as the key driver for our business momentum around ERS.

So why wasn't this a larger factor in 4G? Does it play better in 5G? Or was it part of your costs or high efficiency programs awarded [ph]? Börje Ekholm: No, it's actually very important in the improvements. So we're talking about the 600 basis point improvement compared to Q2 last year. Half of that roughly comes from ERS.

Great. And then Carl, if you could, what do you the estimate the average impact of the contract renegotiations in Managed Services are on the gross and operating margin over the last year? So and will the end of that effort when you finally get to the end of renegotiation be the biggest factor in getting you to the 4% to 6% operating margin target? Or is there something else you should be focusing on for that goal? Thanks.

As a matter of fact, if you look at Managed Services, the biggest contributor to the improvement is actually the changed ways of working within Managed Services. So the way we actually serve the customer, try to automate more removing basically labor content that's a more important factor or getting efficiencies out is the more important factor in the improvement. Then of course, the contract renegotiation has added to that and the run rate of that improvement per se is about SEK800 million I believe we say that in the report. But the key reason is actually ways of working, which I think is important to remember.

Great. Thank you.

We'll continue to the next question please.

Thank you. The next question comes from the line of Alex Duval of Goldman Sachs. Please proceed ahead. Your line is now open. Börje Ekholm: Hello, Alex.

Hi, everyone. Hi, there and congrats on a strong quarter. Just wanted to ask on a couple of points. Firstly, on the OpEx, which was a little bit higher than expected in the quarter, it seems some of that was due to one-time items, but the majority was due to this R&D acceleration as you move towards 5G. The logical consequence of that seems to be that you'll have elevated R&D this year on a full year basis albeit with those nice gross margins. But is it fair to assume R&D spend, could go down next year as you already have ramped up a lot of the investment? And secondly when we think about 5G, you cited enhanced mobile broadband as being ahead of fixed access as a 5G use case. Can you talk about what's really driving that? It seems you've referenced cost effectiveness of delivering data. So maybe you could put a bit more detail around that and can you explain what is really underpinning your confidence in enhanced mobile broadband on 5G? Are you anticipating 5G handsets being released at scale over the next year or so? Many thanks. Börje Ekholm: If we look at -- the way we think about the business is of course at the investments in R&D for us is in a way needs to look at the payback over a longer period of time. So we basically see here that we need to have this R&D level for a period here when we introduced 5G developed all the feature for 5G get ready for the products that ultimately will be launched in the different markets. And here of course, we are participating in low band, mid band as well as millimeter wave products. So we have in that sense a global -- call it global opportunity for our product. Of course, it drives a little bit near term cost, but when that is going to fade away I think is too early to tell. But we remain very focused on the operating income and reaching the operating income target for 2020 of 10% operating margin. So we really think that if we are to have a higher level of R&D for a period we need to sustain that with the higher gross margin or gross profit. So it's -- we don't think -- we don't take that lightly in the sense of saying let's see what it happens but we try to run it in a very disciplined way.

What drives enhanced mobile? Börje Ekholm: Yes. What drives enhanced mobile broadband? When you look at the -- if you look at the traffic growth it's basically increasing, if you would label it in a different way eight times until 2023. So if the operators are to not have costs spiral out of control or having to degrade performance in the network they will need to lower the cost per gigabyte. How is that done? Well it's done first by adding carriers to a 4G. You get into mimo and eventually you get into 5G. So what we have looked at is to look at the costs for -- cost per gigabit transmitted. And if you look at that we see 5G can actually lower the cost or can have higher -- 10 times higher efficiency compared to a pure 4G site. So we see this as a way to manage the cost and the quality to the user to the end user. So that's why we think 5G is initially a capacity enhancer in metropolitan areas where the network is running short on capacity. Then, over time, it will evolve into broader coverage and leveraging the capabilities you get in 5G i.e. higher speed, lower latency, longer battery life, more devices per site etcetera. So the initial use case, we believe is actually just to manage the cost in the operator. After that, we will see the other revenue opportunities. So, one of the first will be we believe fixed wireless access and we -- that's clearly a interest in North America. But we see that increasing the gaining momentum in the rest of the world and it's really a trade-off building out fixed line fiber versus on air broadband. And here, I would say, it has for many operators, it makes sense to build out fixed wireless access as an access technology for broadband. And we think that actually will be a important area for revenue growth for our customers. So, start with enhanced mobile broadband as a cost case, see revenue growth as fixed wireless access. And after that, we believe we are going to see call it the massive scale and critical scale IoT. That's really will be used where connectivity is really critical first, so smart manufacturing for example connecting a factory with no latency and a very reliable and secure communication is going to be critical. We will see it in smart cities, we'll see it agriculture et cetera. But we think that's going to be phased into the market.

Great. Many thanks.

You had a question about the scale of handset as well? Börje Ekholm: Yeah. The handsets, we believe will start to come online. You will see other user devices without going into the details right now during the year. And then as we go into next year you will see other normal devices coming on.

I guess just very briefly to understand this point about massive scale IoT. Can you just clarify, why 5G would have the advantage versus other connectivity like Wi-Fi? Börje Ekholm: This is a little bit – it becomes a technical discussion. Where the – we think Wi-Fi is one access technology that makes sense in certain applications. But when you need to ensure that you have a reliable connectivity, 100% reliability in the connectivity you have to consider other factors, right? So, for example, when we look at our own factory, where we have experimented with a large scale deployment of IoT, we see that in the factory of the future you're probably going to have one device per call it square meter roughly. And when you have that amount of connectivity you will run the risk of interference in a Wi-Fi network or unlicensed spectrum. So to reduce that risk we see there is a big use case or big application for license spectrum based on 5G and that will basically ensure a more secure connectivity. And when we talk to manufacturing partners we have, we see that one of their biggest challenge in the automating the factories for the future is actually the reliability of the connectivity and they are not trusting Wi-Fi for that.

Great. Thanks.

Thanks. We continue to the next question please.

Thank you. Our next question comes from the line of Tim Long of BMO Capital Markets. Please go ahead. Your line is open. Börje Ekholm: Hi, Tim.

Hi. How are you doing? Thank you. Just wanted to ask about the European market. It's been pretty stable for you guys, but obviously North America is doing a little better here. Talk a little bit about what you're hearing. It seems for most that they're a little bit more measured in general on their approach to 5G. So when you look out the next year or two, is there a risk that that starts to look more like China is looking now, or are there other dynamics that can keep that market afloat until we get to that 5G ramp phase like you're seeing in North America? Thank you. Börje Ekholm: Thank you. No. It's – I think the European market – to put it maybe a little bit bluntly the uncertainty in the macro situation in Europe and then I'm talking about spectrum regulation, et cetera it doesn't create the best investment environment. So the discussion in Europe is very much centered of how do we deleverage the investments we have today in the best possible way, focusing less on 5G purse here as more on let's make sure we have the right capacity amount we need right now. At the same time that's where we feel that we have an advantage with our product portfolio as it is 5G ready. So the customers that buys our hardware can actually decide at some point in time in the future to switch on 5G with a software upgrade. So they are in a way hedging their bets a bit. But I think the discussion in Europe should focus more on how do we resolve the spectrum situation, how do we let the operators know more, how much spectrum will cost, and how do we change regulation to actually create a investment friendly environment in Europe than we're seeing today.

Okay. Thank you.

Thank you. We continue to the next question please.

Thank you. Our next question comes from the line of Sandeep Deshpande of JP Morgan. Go ahead. Your line is now open. We seem to have lost Sandeep. We are going to Pierre Ferragu of News Street Research. Please go ahead. Pierre, your line is open.

Thank you. Hi, can you hear me well? Hello? Can you hear me well? Börje Ekholm: We can hear you. Can you hear us?

Yes. Okay, yes, thank you. So, yes, I just wanted to go come back on your – on the Digital division where you improved the gross margin by like 15 points. And very surprisingly you've actually reiterated this performance for second quarter in a row. And so I had like three quick questions on that gross margin. First one is how much of the provisions you've taken a bit more than a year ago, are you still supporting margins in that division? So I assume you still have like projects for which you took provision a bit more than a year ago that are still running if you have any sense of the -- of how much of that is left in the number that would be very helpful? Then my second question is about the comments you made about -- on your delivery platform like being able to take down the cost of derivative and I was very curious to hear more about what you have been doing in digital services to achieve that? You know, you can say you brought the headcount down, you can take the cost of headcount down, you can improve productivity and any color you can give on that would be great? And then my last question would be, if I think about the sustainability of this margin and margin improvement, I'm starting to wonder about your pipeline or pipeline in services because you have a lot of contracts that went wrong where you lost a lot of money and this is being addressed and it’s fantastic to see the results, and then my next thought is, do you have a pipeline of additional contracts that are going to come in to replace these revenues, or do you plan to shrink the size of the service business in digital? That's my third question. Börje Ekholm: So if we start with the latter, the strategy is to be more software-led, which means that we're pre-packing solutions more, which would ultimately down the road reduce the service need. At the same time, we continue to see, even as we do that, quite a high service content in the product delivery. So I don't think it's really still to assume that we will see dramatically shrinking service content. It will happen but it will happen very gradually. So if we look at the more recent wins we have, for example in -- impact in core, they're very similar in structure as it has been before, slightly higher software content, but it's really, you know, in broad terms, it's very similar. Then on your first question, we of course have some large transformation projects where we took provisions last year that are -- we're working through and thus deliveries of these ends. They will move into a profit generating phase. We're not there yet, but we are working through some of them and we don't go into the details, but it has only had a fairly small or fairly limited impact.

Maybe I can add just the mechanics of those provisions. So when a loss provision is made it basically means that the margin of that contract will be zero going forward, so they lost this element eliminated once and for all.

Okay. And maybe one last quick word on the service delivery platform and how you mentioned Börje in your prepared remarks that you're very happy with the way you have taken down the cost of delivering services, so I wasn’t knowing in digital services, what you have done so far to get there? Börje Ekholm: Yeah, what we have done is -- now, we want to be a little bit simple in the terms. We have created pre-integration centers that we have several of them where we can more do the pre-integration and reuse pre-integration. That has allowed us to be much more efficient in the total service delivery costs. So that's changing our cost position structurally and make us much more competitive and actually that is the key driver behind the reduced loss.

Great to hear.

Thank you very much. Börje Ekholm: Thank you very much

Thank you. We’ll continue to next question. Operator, please.

Thank you. Our next question comes from the line of Sandeep Deshpande of JPMorgan. Please go ahead. Your line is open.

Yeah. Hi. My question is a more longer term one. With regards to mobile broadband and capacity increases, Börje, you've talked about that this will be a continuing driver in the future once new bands are added et cetera. What I'm trying to understand is with – in 4G we did not see this as a big driver for Ericsson. I mean this was a promise driver in 2010, 2011 but it never came through for Ericsson in terms of providing the upside. Why is it at this point? I mean, is this based on customer feedback and because in respect of having different use cases that you think this is going to happen for 5G when it did not happen into a significant extent in 4G? And my second question is actually a clarification on the previous one. Carl you mentioned that in terms of the provision where you’ve – in those contracts where you've taken provisions, are you saying that those – that the losses on those contracts now you report in your number, in the numbers we see as zero and that is important and that is part of the provision that once those contracts are restructured then you will start showing the earnings associated with those contracts? Is that how it is accounted for? Börje Ekholm: If we start with the first one. The reality is there is growth in 4G, call it, profit margin that actually is a result of the growing traffic. But it's hidden with other technologies reducing at the same time. Right? That's why you don't see the benefit. So I would just correct you on that. The second thing is, we see 5G and what I tried to say is actually, the first business case is to solve the cost position on just mobile data. The next level is when you start to get other type of business cases, whether it is fixed wireless access or, call it, massive IoT for the moment or critical IoT, that will generate new features needed, new capabilities needed in the network. And that is something that will generate extra revenues for the operator and then have the potential to generate extra revenues for us. So I think that's our whole business case here. So this is also why we invest in the, call it, Emerging Business in IoT basically to help our customers to find new revenue sources based on connected vehicles, connected everything basically. So I take a little bit the notion that there isn't any growth in the conductivity market. On a global basis there is growth in the connectivity market. We may not have captured it well enough in the past, but I think we're quite well positioned to do in the future.

Okay. Thank you.

Yeah. Sorry. Go ahead. Should I take your other question about loss provision then?

Yeah.

Yes. You're correct. When there is a loss estimated for the remainder of a contract we then make a loss provision in the P&L and it's really based on the full lifetime of that contract then. And then, of course, I mean, it's our job to try to improve over that but basically deliver on the commitment under the contract. It will stay on zero margin as long as it follows that estimation, if that improves for example of course the profit will start to generate. So that –

So sorry, Carl. So that means Carl that you are over – is that – does that mean that in terms of your actual losses because you are reporting those losses that you're generating with those contracts today were taken in those provisions last year. And so essentially, what you're reporting today is zero in those contracts and that is incrementally to you, that helps your margin as such?

Yes exactly. So for those contracts where we made the provision, that's correct, exactly.

Okay. Thank you. Börje Ekholm: Thank you.

Thank you. Our next question comes from the line of Stefan Slowinski of Exane BNP Paribas. Please go ahead. Your line is now open. Börje Ekholm: Hi, Stefan.

Yes. Hi. Thanks for taking my question. On Digital Services you're still targeting low single digit operating margin in 2020. And I'm just trying to understand maybe what the trajectory looks like from getting from here to there. You are still doing kind of minus 17% operating margins there so far this year. And you've talked about maybe addressing half of those 45 contracts by the end of this year. But should we expect kind of a steady transition towards the low single digit operating margin in 2020? Or is this a business that could even breakeven potentially as early as 2019 with a smaller uplift into 2020? Börje Ekholm: Let's put it this way. We put the guidance in place on 2020. We will not provide you any updates to that unless we feel there is a big change up or down. We are very comfortable with the guidance we've given. Of course, the improvement will not be linear until 2020. So, how that exactly is going to look like we are not going to guide in detail now.

Okay. But do you still expect, is it half of those contracts to be terminated or addressed by the end of this year? Would those be some of the larger than lossmaking ones or how should we think about how those will be addressed this year versus next year potentially? Börje Ekholm: We have a number of loss making contracts primarily in the old industry and society they were actually trying to work our way out of. So, hopefully, we will have done those, but we say half of the critical contract being addressed. We don't go into the detail there. But that's kind of the plan we are working. I would rather get those behind me in this year, if possible.

Okay. And just a follow-up question on the Networks business. It grew 2% in constant currency in Q2. I believe in constant currency it's the first growth you've seen in the Networks business since Q3 2014, if I'm not mistaken. And I'm just wondering, is that business now out of the woods? Should we expect that we've entered into a new growth phase for that business where we should see kind of year-over-year growth for the next x number of years as we go into this 5G spending cycle? Börje Ekholm: We are very happy that we have been able on the back of a strong product portfolio as well as good cost position started to see that we can take new business opportunities within Networks and that's what you see have happened that's why we get a growth of 2% in the quarter. Clearly our ambition is to stay ahead on technology never fall behind. And, therefore, we should be able to keep on developing the business like we do today and that's clearly our ambition. Then I'm not going to give you any other guidance than what we've said on 2020. So the more specific I'm not going to be, but we are very comfortable with the business momentum we see in Networks and that's really just in a way underpinned by a good growth in Q2.

Okay, Stefan you're good with that?

Thank you very much. Yes. Thank you.

We are now open for the last question for this session. So, please operator.

Thank you very much. In that case, our last question comes from the line of Tal Liani of Bank of America Merrill Lynch. Please go ahead. Your line is now open. Börje Ekholm: Hi, Tal.

Hi. I have two questions. First one is could you discuss the impact of currency? Maybe you said it and I didn't hear it the impact of currency and foreign exchange on your both revenues and expenses and margins? And second it's a broader question about the deployment of 5G. When you talk to carriers where is their mindset right now? Is it mostly consumer broadband, so just enhancement to 4G better speeds, or do you see them taking active actions to develop also the enterprise market and finding the right applications for 5G? Börje Ekholm: If we start with the latter question, the history of mobile broadband has primarily been a consumer market. You are absolutely right on that. We see carriers though increasingly focus on the enterprise market and enterprise applications of 5G. So if you take for example in China it's clearly the development, it's clearly driven by the enterprise market and the way they think about the enterprise market. But we are seeing that across the world in varying degrees, but we see that operators are increasingly getting ready to address the enterprise market. We believe that is a big revenue opportunity for the carriers and that's also when it becomes -- start to become really relevant with network slicing for example that can provide new ways to differentiate service and create new types of business. More needs to be done here. Networks not ready all the way for that, but we will see that happening over the next few years.

Yeah. On currency Tal, actually year-over-year the impact was close to zero. If you look at the sequential impact, the impact on expenses was negative around 300 million, but positive on the totality on operating income with around 0.4 billion. That's the sequential impact dimensional.

So when you say negative, you mean it's actually positive for margins right? Its negative meaning is reduced expenses?

No, no. So negative…

Okay.

Expenses increased due to the FX impact, but bottom line, 400 million positive all in all.

Got it. Thank you.

I think it's fair to update the rule of thumb, 10% on the U.S. dollar; it's about 5% and 100 basis points of margin.

Great, thank you for that question. So we will end this call with a closing remark from Börje. Börje Ekholm: Thanks Peter. So in closing, we defined our focused strategy last year with the ambition to turn the company around on a flat revenue base, so not hoping for revenue growth, and then we will do this by investing in R&D to have a competitive portfolio and grow gross margin, thanks to that, as well as to take significant cost out to service delivery in G&A. I would say that the second quarter shows that the strategy is working and that we're executing along those including having reached the cost-out target that we set. Now we see good business momentum happening with our very, call it, competitive product portfolio, but also a competitive cost structure. So we see the market in that sense in increasing the positive terms and that's the reason why we also saw networks coming back to growth in the quarter. So we're going to continue to be disciplined on the cost side. We will selectively pursue new market opportunities to expand our business, but we will do that with a very strong focus on the bottom line to ensure overall financial performance and financial health of Ericsson. So with that, thank you.

Thank you, all.

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