Telefonaktiebolaget LM Ericsson (ERIC) 2014 Q2 法說會逐字稿

Welcome to Ericsson analyst and media conference call for the 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.

Hello, everyone.

Welcome to this call.

With me here today I have our CEO, Hans Vestberg, our CFO, Jan Frykhammar and our Head of Communications, Helena Norman and our Head of Networks, Johan Wibergh.

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 the call to you, Hans, please.

Thank you, Peter.

Let me just start with some of the key developments in the quarter.

From the market point of view, I think we are seeing a consistent focus from operators on network performance as a key differentiator, especially in the more advanced mobile broadband markets.

It's a lot about capacity enhancement in the urban areas but also densification in the urban areas that is very important in that differentiation on the performance of the network.

Those discussions -- those are the most common discussion we have with our customers today.

Another thing that is of course happening is that the quick transition to 4G.

In China, we see a quick deployment on 4G and a quick ramp-down on 2G investments.

Still, of course subscriptions and subscribers on 4G still to come, but we can clearly see a very quick and strong push for 4G/LTE in China.

Another thing that is also happening in our customer interaction is that we discuss more and more the acronyms like SDN, NFV, cloud, because we see a new generation of virtualized networks.

We see actually a lot of debates how you're going to design the networks in the future.

This is in initial phases.

Some operators come a little bit further, but definitely we're into a process where operators are now thinking how to virtualize and use the software-defined networks and virtualization.

I think we are sitting really good here.

We have been designing and defining our product portfolio virtualized for quite some time.

Our product is coming out virtualized as we speak.

We can report on that transformation.

Another highlight in the second quarter from market point of view was our release of the Ericsson Mobility Report.

Very good reception of it, talking in many markets.

This is sort of becoming the de facto standard of the outlook of mobility mobile growth but in the world, mobile data as well.

We think it's very important to have that base when we think about our business going forward.

We think we're unique in the sense that we're in 180 countries.

We work with all these operators and we see the investments as well.

If you look at ourselves, we saw continued rise on the momentum for managers as we saw in 21 new contracts across 9 regions in the quarter.

This is of course very important for us.

Another thing as we see, as I said, our portion of the Mainland China 4G/LTE deployment report of that, we see a high degree of activities as well in Taiwan.

We can also say that we are very proud of taking part or leading -- getting awarded the multi-year BSS contact with T-Mobile.

This is sizable, very important for the industry, for us a reference how we want to transform the billing systems in the future, of course taking out one of the main competitors here which is important for us.

We acquired or we concluded acquisition of Red Bee in this quarter, adding now to a very strong portfolio in broadcast services, 2,500 employees and some roughly, 330 TV channels under management in our broadcast services.

We are building a sizable and very important broadcast service connecting that with our TV and media investment of course.

We are really trying to see that we are keeping and developing our Number One position.

Now a little bit on key development, it will impact the quarter in numbers, SEK54.8 billion in sales.

That is slight negative growth of 1%, of course, quite better than the first quarter when we were down 9%.

We have a couple of markets year-on-year that are contributing, Middle East, China, India, all have very high growth numbers.

On the other hand, we also had good capacity development -- capacity business in North America.

If then, look at our sequential growth that was 13%, very good.

Gross margin coming up, Jan will come back to it.

Our [that hints], our operating income went up to SEK4 billion, clearly an improvement from last year.

Operating cash flow continued positive adding some SEK2.1 billion.

We need to remember that we had more than SEK10 billion in the first quarter.

So we are adding in good cash flow generation at the moment.

If you now look at the regions and look year-over-year, for 5 regions out of 11 -- we have all of the rest while, so it's 11 regions, we're growing and the rest we're not growing.

If you take it from the largest one is other.

Other includes then the broadcast services that is now included.

Of course, Red Bee came into the play in this quarter.

But also we had the IPRs that of course year-over-year has a higher portion across licenses agreements.

That is adding to this as well.

There is also the Middle East in growing well.

On the other side, sub-Sahara in Africa down 29%.

This is of course a clear decline.

There are a few large operators in Africa.

One of them are investing a little bit less right now.

Doesn't change our view on Africa that mobile broadband and mobile Internet will be extremely important and will for the next five years add a lot of new subscriptions.

We are well-positioned in that region.

If you then look at sequential.

You see a total different picture of course, where now, 11 -- 10 out of 11 regions growing.

Of course North America had a very strong sequential growth.

As we said, since the second quarter last year, we have lower activity on the large coverage projects.

That's still the case.

What we see is that we see capacity enhancement coming in, in the second quarter here.

But it's also Northeast Asia, talked about it.

China, strong in the quarter given that we're now rolling out 4G, Middle East, Mediterranean as well, strong sequentially.

By that, I hand over to Mr Jan Frykhammar.

Okay.

Thank you, Hans.

Hello, everyone.

So, second quarter highlights then top line, Hans has talked about that a lot.

I will not spend time on that.

I think gross margin is important.

You look at the graph, you can see that we operated the Company between 30% to 32% gross margin for basically the whole of 2012 and most of 2013.

Now we have established ourselves on a higher level.

What is important here of course is to understand that this is driven by more capacity business on the mobile broadband.

Also as Hans mentioned, the higher level of patents and licensing revenues as well as slightly lower restructuring charges.

The mix is visible -- the mix shift is visible in the networks segment numbers but also the same thing as in the first quarter if you look at the network rollout revenue then coming down.

Operating expenses increased year-over-year to SEK15.6 billion.

The main drivers for the first half were also the second quarter is the acquisition of Mediaroom and also the integration of the modems business.

But we have an organic increase then in the second quarter of R&D in the areas that Hans has mentioned already.

This is very much in line with the strategy we have.

We saw a small reduction in Selling and G&A expenses.

We continue to work on making sure that we do the right efficiency measures.

At the same time, create a long-term sustainability for the R&D investments that will create a new Ericsson over the years to come.

Operating cash flow, Hans mentioned it already.

I think driven very much by the strong income in this quarter.

You see the working capital in absolute numbers coming up a little bit driven by mainly inventories partly offset by payables.

But I think it's important to highlight that.

Of course, that's an indication of higher activity going into the second half of the year.

The sales growth and FX impact, you see the table there with the numbers per segment.

Worthwhile to mention, obviously 5% in networks, 5% in support solutions, 8% minus in services, this is the network allowed impact to professional services develops well.

I also want you to look more at the sequential growth, especially in managed services in that segment.

The major FX or the major currencies that is impacting us continues to be dollar, euro and yen.

From a profitability point of view, it's mainly movements in dollar and also to a certain degree yen that the impacts the operating income.

We are quite neutral, as I've said before on the euro side.

I would also then come back to this rule of thumb that we talked about at the investor today in November, which is really that if we have a movement of SEK25 up or down in the Swedish krona as dollars that impacts approximately this unrealized revaluations of FX contracts with about SEK500 million.

That was exactly what we had this quarter.

Now the FX hedge contracts are been valued at the closing rates of end of this quarter.

So what this then will be, end of Q3 depends on the differences between closing our cash rates at dollars, now and end of September.

So I just wanted to be clear on that.

Then operating income bridge, just highlighting again the main drivers.

We had some one-time costs last year related to divestment of the power business but also the divestment of the part of [Cordia] business.

The main driver for improvement, we will know that gross margin is that.

Then we had the increased OpEx that is partly offsetting the improvement net-net.

The way we look at it's an improvement of SEK600 million year-over-year.

Change in gross cash, a lot has been said.

Net cash negative SEK11.1 billion in the quarter mainly driven by dividend.

When it comes to operating cash flow, we repeat what we have said many years before that we look at these numbers on a full-year basis.

Since we have typically the biggest quarter from an income and so forth point of view in our fourth quarter, you have to remember that there is some seasonality in operating cash flow.

Also we typically built-up some inventory in Q3 for Q4 deliveries.

So with that said, I want to hand back to -- or I want to hand to Johan.

Thank you, Jan.

For networks then we had a good second quarter.

As Hans said that we were favorably and supported them by having operators focus on network performance, leading to capacity and investments.

Here we are seeing it's not only the advanced LTE markets that are driving it, but we see it spreading into more parts of the world such as Europe supported by the Vodafone Spring Project, for instance.

We are almost happy to see that we have a good second quarter incomes to the SSR product.

Since the launch now, we have 120 customers that is using us.

So this is our product, you're supposed to fix the mobile IP This is really good.

That was 11 new customers during the quarter.

On the top line then, net sales were up 5% organic FX adjusted.

Strong countries and regions during the quarter were the Middle East, China, US and India.

If you look on various products rate have a strong second quarter but also IPR had a very good net sales growth as well as IMS.

There it was driven, it's VoLTE says voice over LT.

It's the earlier advanced LT markets that now are migrating or starting to offering voice-based services based on VoLTE which is IMS-based.

We, there have a Number One position in the market.

We have started very strongly there.

That is not paying off on the top line side.

Quarter-over-quarter, 19% up.

Operating income SEK3.6 billion which is good improvement since a year ago.

It's based upon an improved business mix.

Then the things we launched then at the investor day back in 2012 regarding the three areas we worked upon, commercial excellence, operational effect and lastly cost adaptations.

The cost adaptations were down.

All the work we doing around commercial excellence and how were handling prices, upselling, using the installed bases is paying off.

Operational effectiveness is really the application or lean methodology all across the units which is really paying off in an increased efficiency, lower cost and a bigger output.

I'm extremely happy and encouraged with all those improvements we've done on the operational effectiveness side.

We also were supported by higher IPR revenues during this quarter.

So that landed in 12% operating margin, of course, supported then by higher sales.

But it feels extremely good now to have had four consecutive quarters with double-digit margin.

It will now continue to be our focus.

See if we can keep that up.

That's the ambition for the coming quarters of course to make sure we earn double-digit margin.

We will continue to work hard on that.

With that, over to Hans.

Thank you, Johan.

Then it would take global services down.

A couple of highlights.

I talked about the Red Bee.

I talked about the high activity of managed services.

Also we see significant -- some 12 significant consulting and systems integration contracts.

We were down 8% in sales here and Jan has already talked about it.

It's very much driven about network rollout.

That has been on decline.

That was very much expected.

We talked about it already in the second quarter last year driven by reduced activity in both Japan and North America which are big rollout markets.

If then look at this sequentially, 13% growth, pretty good.

Of course North America was important here but also as Jan mentioned, managed services sequentially was growing.

We see an operating income of SEK1.5 billion, where professional services remains on a 13% operating margin.

Then they're always in loss, but narrowing down the loss now with a lower volume.

All-in-all, leaving a 6% operating margin.

Support solution talked about the multi-year contract with T-Mobile which is very important.

We are in a transition from legacy business on OS/BSS to new business as well as going into TV media.

The reported sales up 21%.

Mediaroom important but OSS as well.

But a small sequential increase only.

Their operating margin was negative.

Here it's very much about transforming the legacy portfolio to a new portfolio.

We feel we have a good gross margin business here, in support solution and this should be a leveraged model.

This quarter, we have more of a transformation of certain projects and [contract making is] up.

Over time we still believe very strongly in support solutions adding both on top line and both line for us.

Lower segment modems, 7450, will be out in the market in sales by end of this year.

We are getting more and more global operators certification.

Some of them we have announced.

SEK500 million in OpEx this quarter, adding to SEK1.2 billion so far this year.

We have estimated OpEx of SEK2.6 billion this year, that will keep -- we will see that this is in line with what we have decided.

We have good grip on this organization and this investment as we are now having this in-house rather than being a joint venture.

Just to reiterate what I've said so many times before, success of the modem business will be imagined in 24 months from the daily integration, which was basically the end of Q3, 2013.

So we will work on this and see if that's really going to be successful.

Then summarizing up a little, which as I have already said, good momentum for superior performance on the mobile broadband networks.

Strong sequential growth.

Good profitability in the networks are improved.

Maintain good profitability in professional services.

Be the solutions -- have the profit before I explained.

We are continuing our investment in new and targeting areas as well as seeing that the core areas are gradually performing better.

We can see that in networks.

I think we are very well-positioned to be a strategic partner in this transformation in the industry with the investments we're doing.

So overall that is the statement.

[Then your street rate] will be set, in the first quarter Jan and me, with the current visibility, key contracts awarded, will gradually impact sales and business mix in the second half of 2014.

Here, some of these contracts were public announced and talked about but they're of course others as well.

We have good visibility on the coverage projects that are longer, where we know the tollgates and when they are going to be rolled out.

I said, we have been awarded some of those.

Those will be impacting our business mix in the second half.

By that, I hand back to Peter.

Okay.

Thank you, Hans.

So, operator, we are now ready for questions, please.

(Operator Instructions)

Detailed information is private in the report and investor relations and media relations teams will be happy to take any additional questions and discuss further details with you after the call.

The first question is from Edward Snyder from Charter Equity Research.

Thank you very much.

Jan, it's clear the IPR revenues are having a significant impact on your results, especially the gross margins.

Can you give us any idea of how much of an increase you saw this quarter or what the impact of gross margins were or actually any indication at all of what you expect the run rate will be whether they go up, down, or remain flat quarter on quarter.

And then, Hans, you mentioned in the press release voice over LTE as initiative with carriers starting to roll out right now.

How long do you believe it will be before we see commercial operation?

And then similarly with small cells, when do you expect you will have a significant impact on carrier assistance and your top-line performance?

Thanks.

Okay.

Ed, so as you know we do disclose our IPR revenues, but we do that on an annual basis.

What you should be aware of is that compared to year ago, the IPR revenues are higher which we clearly mentioned in the report.

If you compare to Q1, they are slightly down but not so much.

So, we have established ourselves on a higher level.

I disagree with the statement that they are clearly the main driver for the gross margin improvements.

The main drivers are related to the business mix and more of mobile broadband capacity projects that we have discussed before here, but they are absolutely part of the mix and they are also part of why we invest so much in research and development.

Hans.

Johan will answer on the VoLTE and the small cells when it comes to the market.

Hi, Ed.

It's Johan here.

So, VoLTE, there are already a couple of operators that are live and commercial VoLTE.

It's not only Korea but in a couple of other places, and I think we should expect to see more and more to launch at the latter part of the year.

And I don't want to comment on any names, but I know there are several parties that are working upon it.

If you talk about our total offering, we see more and more build out of the mobile broadband networks both on 3G and 4G because that's helping up in our business.

It's both a lot of volumes of macros densifications but also small cells, actually.

We are getting a substantial traction already last year but this year also on small cells shipments to the market, so I'm really, really happy about that pickup and those deliveries.

Gareth Jenkins from UBS is on line with a question.

Yes, thanks for taking the question.

I just wondered if you could talk about sustainability of margins going forward.

You've obviously taken the business in terms of structural gross margins to a higher level in the last two quarters, but given that is driven by IPR revenues, by European modernization rolling off, as you look forward with more managed services coming on, do you feel that we should sustain in the kind of 35% to 40% range or do you fear that we made drop back down towards the kind of 30%, 35% range that we had in the last two years?

Thank you.

When we look at our business, first of all we continue to work on a gradual improvement on our profit level, and we had a couple of years on investment both in R&D and market share which I clearly articulated to the market.

We are now articulated to the market are working on improved profit levels.

That of course, as you say, if the mix changes and you get more services your gross margin might change.

That should not take away that we are working with a gradual improvement on profit levels than at the income of the Company.

So, I think that we will continue to work on that and, yes, you are correct.

We have good sort of activity level on managers at the moment when it comes to this.

But, again for us we're working definitely to improve overall profitability of the Company and that we continue to do.

All right.

And just as a followup on that.

I just wondered if I could ask on the network rollout business whether you feel you could get that to breakeven?

Importance of the gross margin improvements during first half I would say that the business mix is the most important improvement of course together with efficiencies and so forth.

That's one bucket, right.

The second improvement is the higher revenue of licensing, and the third one is more mechanical which is the share of services that has come down and there the typical rule of thumb that we use is that for every percentage point of increase in services share, you have a dilution impact of Company gross margin of approximately 0.3%.

So, it's -- those are the factors and those are the modeling factors that we think still are very relevant.

And of course if some of these projects that we now see will mean that network rollout revenue start to grow significantly again, that will then, as Hans said, have an impact on company gross margin, but that doesn't exclude that we continue of course to work with positives.

So, that's what we want to say on the gross margin.

Jan, can I just follow-up on that?

Operator, next question please.

Mark Sue from RBC Capital Markets on line with a question.

Thank you.

Gentlemen, Ericsson is the largest wireless solutions provider and the premise has always been the bigger the better since you could spread fixed cost, but all the questions are going to be on margins.

And if I look at it from a regional point view where quality and security matter, North America and Japan for example, you can actually dominate, but in other areas Africa, Mediterranean, for example, it's harder to differentiate.

So, are margins a function of size or a function of being in the right regions and, Hans, since you re-made the Company, the team has re-made the Company with more services over the last eight years, would you consider actually narrowing the focus of Ericsson?

Do you need to be in all these countries over the longer term?

First of all, I think on the first question when it comes to scale, I think we need to look on the CapEx investment per region or per country in the world.

Of course, North America is the region that is spending the most on CapEx.

Of course by nature then you have more business there than how much they are investing in Africa, for example, at this stage.

That's one comment.

The other comment, yes, I think that in our portfolio we think that one of the strengths that we have and unique balance is that we're in 180 countries and we can balance out regions and you can only remember two years back which region were growing for us then and which is growing right now.

So, I think the balance of having both services and technology and then having the geographic spread for us, that should be helping us going forward over having a steady improvement and steady potential for the Company to develop.

So, I think that's is something that I really believe in.

Are you happy with that?

Next question please

Alexandre Peterc from BNP Paribas.

Thanks for taking my question.

I would just like to clarify a few things on the peripheral businesses here, or not peripheral but less is smaller.

So, in support solutions I understand there is a change in business model there from license to subscription revenue models.

So, went do you expect this tradition to be over and should we expect increased volatility in earnings during this adjustment period or is it just poor earnings outlook over the next let's say, I don't know, six quarters perhaps until your makeover is complete?

And then housekeeping on modems.

Why do we see such a volatility in OpEx there?

There was essentially lower loss this order than last quarter.

I'd like to understand why we're not having a smoother cruise there.

Thank you.

Okay, Alexandre.

It's Johan here.

I'll take both questions.

So, on the first one then on the support solutions, the business that we have today mainly in support solutions are the businesses around the OSS systems that to a great degree we obviously acquired from Telcordia, so that's an install base that we have.

We also have an install base that is very much an emerging market install base around prepaid systems, and we also have an install base of TV solutions coming from media room, and then we have the compression business install base.

Now, if you think about what is going on in both OSS, BSS, and in TV, it is very much both a development focus and a pre-phase focus to get into the next generation of softwares around these different solutions and that is why we make the statement we do around -- that there is a transition between if I may correlate legacy and next generation or future solutions.

That doesn't mean that we are not taking very good care of the install base.

We are, but we also need to develop the new stuff in order to be able to transform from the old to the new.

This implementation of new and more software subscriber-based business models is obviously going to be a gradual one that is coming or supported with the new business models that many of them by the way in the end will be cloud-based.

So, I think short-term I agree with you that the business is still very dependent on top line versus the fact that we are investing in the new.

We will continue to make sure that we try to capture the opportunities around the install base we have at the same time we're in the new areas.

I think a couple of examples of important win in the new areas are the ones that Hans mentioned before, but also some of the OSS transformation projects that we have communicated during the first quarter like the one in the US with CenturyLink.

So, this is the reality of the business right now.

We also think that the opportunities are there from an opportunity point of view to still believe that the market will grow between those 9% and 11% if you look three years out.

So, that's what I want to say on the support solutions side.

On the modem side, what we have is obviously that the business is as you rightfully say is more of a development unit, and the operating expense outlook there that we have, we keep to that is approximately 2.6 billion CX for the year.

It might be in this quarter we had still some integration of course for instance related to integration of the business, but it's also so that not all of the costs in businesses like this are only employees, there are also project assignments costs and so forth, right.

But overall I think what I want you to model with is the 2.6% full year and then some top line later in the year.

That's what I want you to model with.

Thank you.

Stuart Jeffrey from Nomura

I had a question on your revenue outlook.

You seem very upbeat in terms of some of the new contracts coming through and benefiting the second half.

Then the press conference you also spoke about typical holiday patterns weighing on Q3.

So, perhaps you could just talk through some of the headwinds that we should think about before we get too enthusiastic about forecasting an exceptionally strong Q4 revenue.

And then linked to that, some of these new revenue streams coming through and diluting gross margins, are those contracts or does the gross margin impact sort of stop at the end of this year or does it spill over into 2015?

Thanks.

I'm not sure why you could draw the conclusion of that upbeat feeling.

I think we reiterate what we said in the first quarter we not saying anything new about the second half.

With current visibility of the awarded projects, contracts that we got in the beginning of the year, we know toll gates on those rollouts and that's why we said in the first quarter and we reiterate so I'm not sure why you interpret that as an upbeat or something new.

It's exactly the same communication that we had in the first quarter.

So, that's the comment on that.

Jan?

I also think that one should think about the outlook for second half in the context of the fact that we were a bit light in Q1 and we recovered now in Q2, right?

The comment I made on the press conference on vacation is of course based on historical patterns.

It tends to be a bit of seasonality impact on the business because a big portion of the part of the world has summer holidays and that means there are slower activities both amongst operators but also in our Company and that has an impact on business.

So, that's why I made a comment.

I think it's nothing else than I think people deserve sometimes to have a bit of time off.

On the gross margin dynamic, do the new contracts continue into next year in terms of gross margin dilution or should we think of that being largely complete by year end?

When it comes to gross margin, the modernization project in Europe that we have together then through journey over a couple of years, those projects are now materially behind us.

We still have a small impact on the network rollout business.

Going forward, what we need to think about is smaller the dynamics around coverage projects which means that we have deliverable in coverage projects that typically has lower margins than capacities.

So, we do roll out projects but we don't perhaps roll out projects negative margin in the coverage phase in normal circumstances.

So, coverage projects -- we don't think that coverage projects is something bad necessarily because of course it means that we create an install base that we can then later on make money and returns out of.

Network rollout losses are for the reasons that are stated in the report.

They are the same as in Q1.

We work hard on trying to improve network rollout throughout the course of this year.

But I understand that we have still work to do here in convincing all of you that this will actually become a breakeven business over time.

Thank you.

Operator, next question please.

Achal Sultania from Credit Suisse.

Hi, guys.

Thanks for taking my question.

So, if I start with your Western European business we've seen Vodafone Project Spring ramp-up it seems during the quarter.

Can you talk about where we are in terms of that project and, for example, like which countries have started and how should we think about the ramp as we go into the second half?

And then I've got a followup one on the professional services business.

It's a very good question, but I think from our point of view we cannot comment on what Vodafone is ramping or not.

I think that question should probably be asked of Vodafone.

Of course for obvious reasons we know what we're doing and where we're doing it, but I seldom comment on my customer's ramp up in different markets as it might be a competitive advantage for them.

So, I'm sorry I cannot comment on that.

Was Vodafone impact significant in your numbers in this particular quarter in Q2 or was it still something very, very small?

On that point then, what we said in Q1, it's obviously called Vodafone Spring.

So, we started the project activities with some impact.

Then obviously, as Hans said rightfully, exactly how much we will ramp and where we will ramparound the project itself, that you will have to talk to Vodafone about, but we have some impact on Vodafone Spring in the quarter.

Right.

Thanks.

And then on professional services, if I look at your operating margins there, it seems to have fallen down by about 200 basis points versus last year if you look at first half year numbers.

I'm just trying to understand what's the reason for that?

Is it just because of top line issues in that part of the business or is it something more structural there in terms of scope of contracts or size of contracts?

You ask about the professional services?

Yes.

Just about professional services.

Yes.

Professional services business consists of a couple of different businesses.

It's managed services, it is network design and optimization, it is customer support and consulting and system integration.

And of course depending on the mix of these different business lines in a particular quarter, you get the different margin profile.

And I think the way you should think about the professional services business is that we have been delivering in the past and that's obviously our ambition to continue to have a profitability let's say between 12% and 15% operating margin.

And it may vary between quarters because of different business mixes.

What is important of course if you get a higher portion of managed service contracts early in transition, that has a challenging margin, but then obviously we transform those contracts in order to generate more margin.

So, it has really a little bit of a business mix issue.

Underlying the services business continues to execute on their service delivery transformations.

So, margin may vary a bit between quarters because of mix simply.

Okay.

Great.

Thanks.

We are open for the next question please, Operator.

Francois Meunier from Morgan Stanley.

Yes.

Thanks for taking my question.

Congratulations on the numbers this quarter.

I've got a question about the modems.

Maybe I'm try to read between the lines of your statement because you're saying that you're targeting the 50 billion market for the Internet of Things in the coming years.

So, does that mean that if the sales are not that good this year we've lost more than chips and maybe next year then you are more likely to stick to it because the longer-term opportunity is so big?

I think on the modem strategy we need to come back.

We have said that we are going to measure the success of that in 18 to 24 months and we promise we will come back on that.

I handled that, but before that we want just to conclude, we have [9-day] carve out, divestment from the joint venture, we have now full control over this.

We want to guide the market how much we are investing in it.

So, it's clear to the market, but we will come back if there are any changes or (inaudible) and measure the success over 18 to 24 months.

Okay.

Thank you.

Now I've got a question in terms of the API impact on gross margins.

I think we are trying to give you as to measure how much it was in compared to the other original revenues versus what they were like in the previous years.

So, working that back, does it make sense that Jan should the API impact was something like 80 bps only this quarter?

Let me start and then Jan can fill in.

I think it is important when we talk about the IPR we see this very much linked to our business.

Remember, we are spending $5 billion a year in our research and development.

We have a fairly wide portfolio of patents that we are investing in and development we're doing.

This is sort of our contribution back on the investments we're doing and that's why we see this as a business model that we have developed.

I think vested in many other in the industry there were actually also our earning on that sharing on those patents, so we see this very much our business.

We outlined in 2011 at the investor day that this is the strategy for Ericsson to see that we can capture revenues from other industries and other segments of the industry and that's what we're doing.

And I hope that you have seen that we outlined a strategy Q2 2011 and we're growing in this business.

And then, Francois, on your question is around 80 basis points or not, what I said before is that if you think about the gross margin compared to a year ago the gross margin improvement, the main impact is related to the business mix.

Then, secondly, I said the patents and, thirdly, I said the services, the lower services share.

So, those of the three main drivers.

And then you have to decide what you believe in your assessment.

Okay.

That's very helpful.

Thank you so much.

Operator, next question please.

Simon Leopold from Raymond James.

Thank you very much.

Just a quick clarification.

You mentioned earlier that you disclosed the IPR on an annual basis.

If you could just remind us last year's numbers to save me a little time looking that up.

And then a question I wanted to follow up on was you've demonstrated an ability to defy CapEx in North America in terms of the seasonal trends this quarter versus the weakness in the last quarter.

And I'd like to maybe step back and help understand how you think about the balance of North America for this year given that it appears at least the CapEx models indicate unseasonable trends, how you're thinking about North America for you the balance of this year?

Talk about the IPR revenues.

Last year SEK10.6 billion, but of course had an impact of the Samsung that we made at the end of last year, so that had an impact on that, but if you look on the historical levels, we're basically going from SEK2 billion in revenues on IPRs up to the level we are right now.

So, we have every year added new gross licenses and we are up more than 100 cross license agreement right now in the industry.

If you talk about the CapEx in North America, I can start and then Johan will fill in.

One thing that we have learned the last couple of years is the correlation with the CapEx as an operator in our revenues can be very different.

First of all, the reduction on CapEx might be a reduction on concrete and building sites equally much as electronics.

Secondly, a ramp up could be sort of also going to sites which we're not part of, as well as when they do software that might be a smaller CapEx investment than doing in hardware.

So, we need to be much more closer to our customers to understand what's inside the CapEx to understand for us how that will impact us and that's a general company, it's not only North America.

Jan.

I also think that a couple of comments more there.

It's obviously -- we are in a cycle now in many markets and also valid for Q2 in North America with more capacity and that's good.

Underneath there, we still have the declines of the two major projects that we also mentioned in the report, one should remember that, that is still there.

What we also should know is that the lead time from order to sales conversion cycles are much shorter for capacity business.

So, as Hans said before, when we have bigger and longer projects, we have better visibility.

The capacity projects are shorter because they are very often they are shipping hardware to customer warehouses and switching on software and increasing capacity on current base stations and so forth.

So, it is shorter order lead times on those types of projects.

That creates a bit more of a short-term uncertainty on exactly how much capacity it will be in the coming quarter and so forth.

The second point is that we think that it's probably more relevant to look when you look at the CapEx versus vendor revenues, it's probably better to look at the sum of the vendor revenues, especially the ones that disclose network-type of segments rather than looking at operator CapEx as such because operators have -- sometimes operators are capitalizing each and every quarter and sometimes they kept the [station] work twice per year and something like that, right.

So, it's probably better to look at the vendors and the sum of the vendor revenues if you want to find some correlations.

Thank you very much.

We're open for the next question, please, Operator.

Sandeep Deshpande from JPMorgan.

Hi.

If I may ask a couple of questions.

Firstly, regarding European 4G, you've talked about Vodafone Spring earlier in the call as well as before.

Have you seen any reaction from any of your other customers in Europe?

You got your largest shareholder in Europe in terms of wireless, how you see that ramping up through the rest of the year in the second half?

And, secondly, on the modem business, Hans, you talked about taking a review into 18 to 24 months, but if you do the math on the business I mean you will require volumes of 80 to 100 million units to be able to break even in the business.

So, are you looking at it that way or are you looking at it as a strategic business and this is not necessarily a business you are intending to break even in?

On the first question about seeing signs of others moving on 4G in Europe, yes, we see signs of that.

There are high activity ongoing in the regions of Europe when it comes to 4G, that's for sure.

How that will materialize later on in business for us, that's another topic we can discuss, but we see many operators thinking and talking about 4G.

Remember, some markets like here in Sweden got the iPhone with 4G frequencies not that long ago, so of course they're are also coming in handsets on 4G into the region.

So, let's see how that turns out for us later on, but definitely there are activities and discussions about 4G.

On the modem side, not sure whether I should comment on that.

I remain with the focus I have remember and I am just going to reiterate what I said.

We took that over, we divested it on venture.

We have control over this right now and we know what we're doing and we will measure in 18 to 24 months where this will take us and what success we will have.

Very much in line with what we said when we made sort of break up with ST Microelectronics.

So, we will come back on that and comment and any new strategies or different strategies or volume assumptions, et cetera.

Thank you.

Operator, next question please.

Andrew Gardiner from Barclays.

Thanks very much.

I just have a couple around the cost side of the equation.

Firstly on OpEx.

Johan, you indicated earlier in the year that investment spending in R&D would increase materially.

That's happening as you've guided, but you'd also previously indicated that it would continue to build through the year as you hired into these key areas, so given that, is it something we can expect to see R&D continuing to grow sequentially in third and fourth quarters?

And then also a follow-up on to the call you had this morning around the restructuring side of things.

Do I take your comments to mean that around the services business picking up later in the year that we will see a sort of higher level of restructuring expense later in the year after what has been a fairly lower level of restructuring in the early parts of the year?

Thank you.

Thank you, Andrew.

So, on the R&D side it's correct what you say that we are gradually increasing the organic elements related to the areas that we have talked about today and before as well.

We saw some impact in the second quarter, but the major impacts were the ones I mentioned around modems and media room still.

This is about recruiting people in different parts of the world.

So, it's not like you go from zero to something bigger overnight.

So, it takes a bit of time.

At the same time, we are working hard to offset space increases with efficiencies in other areas, but I think it's -- I know for a fact that R&D organically will come up a bit in the second half of the year.

Then there is an operating expense, there's also some variations between quarters and that is also something that I think you should look at a bit historically to understand that there is a little bit of variations between quarters here as well.

Then, on the restructuring side it's right what you said.

We think that the elements of restructuring related to service transformations will increase a bit in the second half of the year compared to the fairly low levels in the first half of the year.

Then, if we decide to do something bigger or so we will always inform our employees first and then inform the market if we think it's material.

So, right now what we have in the mix is the service delivery piece as the main thing.

So, that's what I want to say, Andrew.

Thank you very much.

For the last question, please, Operator.

Sumant Wahi from Redburn.

Hi, gentlemen.

Thanks for squeezing me in.

Congratulations on a good result.

My question is around the software defined networks market and this is the second quarter, Hans, you mentioned that you have been in deep discussions with customers regarding the deployment of this.

And I was wondering if you could give us a bit more longer term strategic view on this market?

How do you see it growing?

I have spoken to a couple of leading customers of yours and strategy officers there and they suggest that SDN could be part of every CapEx product they buy essentially over the next five years or in five years' time.

So, I just want to understand what you see as an opportunity and more importantly what are the risks to your current business where you could see some rationalization because of this impact of virtualization?

This is Johan.

Let me start and give a few views on it.

First of all, it is true that the networks will be rebuilt in the coming years and it will clearly start in the IP space where it is already starting up.

I think in the whole transport space it will be rebuilt.

It has already restarted in the data centers as you all know, but it will start to become in the transport area and eventually it is going to be network-wide affecting.

In the [rajacks] we foresee quite small changes due to the nature of the network and how it structured and built up, but especially in the transport sector a lot of things will happen.

A quick (inaudible) I think we have a tendency to hide things in our industry.

We hype it up so everyone thinks it's going to come quicker.

It usually takes a bit longer time but when it comes, it's a much bigger change than most people realize.

So, I think that's what happened here.

This is one of the reasons why we are investing in IP because we do believe that the networks need to be rebuilt.

And (inaudible) comes originally from data centers.

We have service provider SDN which is really a network-wide usage of SDN and it will mean a complete rebuild to the IP networks we believe.

That is really needed because if you look at the type of applications that needs to be rounding on IP networks, we need predictability and latency, for instance, something that you can't get from today's IP networks.

So, if you look on really using the Internet and even more services and getting into real life and real-time applications, we need certain characteristics that we cannot get today.

Also, today is quite expensive to deploy certain transport-based services and by introducing SDN and by introducing cloud-based services you can radically reduce lead times on getting new service operation.

I think that's why you have some of the major operators in the world that are looking into cloud and SDN-based services to make their own operation much more efficient.

I think this is quite important.

We shouldn't over hype it short term, but I think in some years out it's going to be a major part of the major change and we intend to be in the middle of it.

Thank you.

Thanks.

And just a real quick followup on current quarter.

I know everybody seems to be asking regarding the fantastic gross margin improvement.

I'm just wondering if you could give us some color on the North America sales.

Is it fair to assume that the capacity sort of angle of the revenue was probably maybe more than 70% of North America revenue or is that way too high?

I think you have to look at -- we break down the business by segment and region and if you look at those different statistics over a couple of quarters, I think you get a pretty good feeling.

The structure declines that we have -- or not the structure declines, the declines we have in regards to the big coverage projects, they are still in the mix and obviously in the networks area we had a good growth in the quarter driven by the mobile broadband capacity.

So, take a look at the segment by region and over a couple of quarters you get the feeling for the dynamics.

Thanks very much.

Okay.

By that, I would like to hand over again to Hans for closing remarks.

I think I will make a quick summary of the quarter and where we are.

I think that we are continuously working with a gradual improvement on our performance.

We also are, of course, allocating, resourcing capital into new areas in order to strengthen Ericsson on even further going forward, areas that has higher degree of software, higher growth rate than our core business and have a good adjacency to what we're doing.

So, here we are continuing with that work, but we are also very focused on performing well in our core businesses which is the main revenue stream and profit stream we have.

So, I think that we will continue to do and that's the summary of this quarter and the previous quarters as well.