Telefonaktiebolaget LM Ericsson (ERIC) 2014 Q3 法說會逐字稿

Welcome to the Ericsson analyst and media conference call for the third quarter report.

To view visual aids for this call, please log on to Ericsson.com/press or 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 our call today.

With me here today I have our President and CEO, Hans Vestberg; our CFO, Jan Frykhammar; and our Head of Communication, Helena Norman.

During the call 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 result 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 those words, I would like to hand over the call to you, Hans.

Thank you very much, Peter.

Let me talk with a little bit of the market development in the quarter.

This, of course, my feeling after having both being out in the field and met a lot of customers.

It just continued to accentuate what is happening in the networks.

It's more data, more video, things are happening in the networks.

There's more connectivity, new devices, industries using networks.

And all that leads to the networks becomes differentiated more and more.

Of course the discussions we have with operators is very much about capacity enhancement, small cells to meet the agency that you can actually give a very good consistent experience.

And that is where we are and we can definitely see that moving.

Other thing in the margins, of course, there's China going full steam ahead on 4G.

We clearly see that that is happening.

And on top of that, we can also see that many transformations -- we have talked about these transformations.

They are going from ICT IT transformations, TV and media versus Asia.

All of those are either in planning phases or in execution in order to be able to handle data and use revenue streams -- or service streams.

All of this is a great thing, not only the demand on software, but also on system integration.

In our case, that's a very labor-intensive business.

You had need to have project leaders, solution architects, consultants, et cetera.

And that is very important to remember.

Finally, on the market development, we saw in the quarter that some of the operators in North America slowed down during that month, basically due to focus on cash flow optimization.

It has to be added that consumer demand, the innovation in North American markets, remains very exciting.

We see new phones coming out, new industries using mobility broadband in the cloud.

And then, of course, also adding that our position remains very strong.

It's more about sometimes our customers are in situations when optimize the cash flow.

And that impacted us some in the third quarter.

But long-term and from a market point of view and our position point of view, nothing has changed.

Internally, we launched peak radio-base station, which means that we have the full range of radio-base, it's more satisfied now.

Everything from the dot up to the micro.

The peak that came out had 3G, 4G and wi-fi.

So a very useful product in the more dense areas where you need the [broad] more cells.

We talked at the beginning of the year that we had good visibility of new product coming in the second half, and they will impact our business mix.

We can now see that they are in the business mix in this quarter.

Many of those contact.

Some were announced and some were not announced, but they are now in the base, as we predicted earlier in the year.

We made three acquisitions in the quarter, all of them sort of addressing the areas where we want to grow and take an extended leadership.

All of them also cloud-based.

All of them, high degree of software.

Apcera is cloud software controlling, security, policies, governance of the cloud.

And especially between the enterprise cloud and the telecom clouds.

Fabrix is the next generation set-top box, which is a cloud-based set-top box.

Which is very, very important for our end-to-end solution in our MediaFirst, which is the extension, or the evolution, of our Mediaroom acquisition from Microsoft.

And finally MetraTech is a cloud-based billing system, BSS system.

All of them are the areas we want to grow, adding to our organic investment and our transformation.

Finally, you can say that we reached a milestone on the broadcasting services that we've now been running for a couple of years.

We are now past 500 channels under management for broadcasters, which of 150 are over the top and 350 are linear channels.

Of course, predominantly we are strong in Europe.

That's where we started the expansion with broadcast services.

And as you're going to see later on, we're growing well in this area.

[And then, to throw] something to numbers.

9% growth in the quarter.

Tailwind from the currency.

Big currency fluctuation in the quarter between US dollars and Swedish krona, which is the only meaningful exposure we have.

Jan will come back to that.

Many markets contributing, but I have to mention Middle East, China, India and Russia, all of them growing well.

Decline in North America for the reason that I talked about earlier.

Sequentially we also had a growth of 5%.

Gross margin improved year over year to 35%.

Operating income of SEK3.9 billion.

Here we're adding then that we got the tailwind on the top line.

We got the headwind in the P&L mainly because of the reevaluation of the hedge contracts.

That, at these days, are not realized.

We have some realized effects on hedge effect as well.

Jan will come back to it, that those re-evaluation on hedge contracts in the quarter that are not realized are SEK1 billion negative.

Then continue to look at the regions.

Here is, of course, great to see the strength of Ericsson.

We're not growing in North America, negative 3%, for the reasons that I mentioned before.

On the other hand, we are very strong still in North America.

Nothing has basically changed from a market point of view or Ericsson's position.

And then you can see the Middle East up 38%, India 56%, Northeast Asia 16%.

Where China is, of course the one growing other IPRs broadcast services.

And you can also see Latin America growing.

So it's a broad array of markets and countries that are contributing to our growth this quarter.

Very similar outlook if you do it sequentially.

There's a bit more accentuated, as North America comes down a little bit more sequentially.

But basically the same regions added to the growth.

Jan.

Yes.

Hello, everyone.

So let me then comment a bit on the P&L and balance sheet.

So the first point I want to make on the P&L is, of course, to look at the gross margin over the last four quarters, that has been establishing itself on a much better level than a year ago, for the reasons that we have been explaining many times.

The most important one, obviously, being the business mix.

More capacity than what we used to have a few years ago, with a lot of coverage but also, of course, the European modernization projects back then.

Also we had the increased revenues from the licensing business on patents.

Slightly lowered level of services share this year, as well as lower restructuring charges.

We are operating the Company on a higher level of gross margin for the last four quarters.

We had also a decline sequentially, meaning compared to the second quarter for the reasons that Hans mentioned.

We have started to see a bit more business mix in regards to these new projects or contracts.

Of course, China would be an example of that 4G, but also other contracts, such as the ones in Taiwan and so forth.

But I think what is important here is, of course, that we know and you know the dynamics of the business.

We also had slightly lower share of capacity sales in North America this quarter, for the reasons that Hans had already mentioned.

If we then we look at the operating expense, in the third quarter of last year, which is what we compare with here, we still did not have the modems business in-house.

We did not have the Mediaroom business in-house.

They, both of them, came in, in the fourth quarter of last year.

And what has happened then in this quarter is that we now have the impact of the organic increases in research and development, mainly related to IP and cloud.

But we are operating that business now on the run rate that we expect for the rest of the year.

Then, on the operating income -- I will come back to the hedge explanation then later on.

Operating cash flow of minus SEK1.4 billion.

Typically we have a bit of a seasonal impact on operating cash flow related to inventory in the third quarter to prepare for the bigger Q4.

Nothing dramatic in that.

But what is obviously also happening here is that we see a bit of shift towards more projects and so forth.

And that is what also has impacted the working capital.

As we always say, let's look at the operating cash flow on an annual basis.

And we continue to strive to hit the target of more than 70% cash conversion on a full-year basis.

If we didn't take the FX impact on sales, 3% organic and adjusted for acquisitions of 7% in the networks business, 13% reported, minus 2% organic FX adjusted on global services.

Within global services, then, we had a continued decline of the network cloud business.

Not in the same pace as in the second quarter, but still a decline compared to a year ago.

Professional services then fueled by managed services and consulting and system integration grew well.

Support solutions, 10% organic FX adjusted, and also reported 30%.

You can see then, on this picture, how impacted we are in a positive way thanks to the currency development.

From a top-line point of view, US dollars, Hans mentioned, is the most important currency.

And typically for the last three, four, five years we have been between 40% and 44% of top-line billing dollar related.

If you then look at the operating income, here on this picture we have adjusted for the impact of the unrealized hedges.

So you can see then, that the underlying profit has improved significantly compared to a year ago.

Of course, driven by volume but also margin improvement, and then partly offset by the investments in operating expense.

If we take the FX exposure, the majority of the impact on the bottom line for us is transaction exposure.

That is then foreign exchange exposures that refer to exports mainly from our legal entity in Sweden, either directly to customers or via a local subsidiary.

That is the majority of the impact on the income.

On the left-hand side of this picture you see then the transaction exposure disclosed in exactly the same numbers as we disclosed in our annual report.

You can see SEK22 billion of loan exposures in US dollars as an example.

And this is obviously, I think, a good way of looking at main impacts on the bottom line with currency movements over time.

Of course assuming that business volumes and so forth stay the same.

If you don't take the hedges, this is about the stock of hedge contracts for hedges of forward-looking, obviously, transaction exposures.

Typically we do have a hedge horizon on a transaction expose of about five to six months.

The majority of the exposures are in US dollars.

The rule of thumb, then, that we established to the capital market, I think about a year ago, still holds very well.

So, if we have a difference here between quarters of, let's say, EUR25 up and down against the dollar, that impacts up and down these revaluations of approximately SEK500 million.

This quarter we had SEK1 billion hit and the dollar has strengthened toward the Swedish krona of about EUR53 or EUR54, or something like that.

This rule of thumb holds very well.

This is, of course, about -- so what this really means in reality is that if we look at, as an example then, now all the contracts have been revalued at SEK7.27.

And if then, for instance, the dollar would end the year this year at SEK7, we would then have a positive revaluation impact here.

So that is how you should understand this.

If we don't take the change in US cash, operating cash flow, as I mentioned, minus SEK1.4 billion.

The impact on net cash is minus SEK3 billion.

The majority of that has to do with operating cash flow.

But also an evaluation of the post-employment benefits that we take into consideration when we calculate the net cash.

It has to do with a lowering of the interest rates predominantly around post-employment benefits in the US and in Sweden.

With that said, I hand back to Hans.

Thank you, Jan, and let us then look into the segments, starting with networks.

Networks then growing 13%.

Of course, some tailwind here as well on the currency, but still 7% one year take away the currency impact and any potential acquisitions we have there.

That is a strong quarter from networks when come to growth.

A lot of happenings in the quarter.

We talked about the small cell.

We've always had a continued good momentum for the SSR.

And I said here we are down the Apcera investment.

Same market that is going here, as I talked about in the beginning - - Middle East, China, India, et cetera.

We can add that we see a good growth on IMS, driven by the force of [LTE], the VoLTE limitations that is ongoing in the market.

Profitability-wise, this quarter above a double-digit operating margin.

Of course this is all included with the both conversations and the deprivations, so this is full P&L for networks.

And here, of course as Jan said, the majority of the unrealized hedge contracts that were revaluated is in networks.

So of course that's SEK0.8 billion negative in the networks.

So the gradual improvement we are seeking for we're here and we have growth in networks as well.

Services.

We have talked about services in two dimensions.

We had the good funnel and lots of activities in professional services the first half year.

Now we see that rolling in as the sales.

We grew 10% in professional services, of course fueled by managers is growing about 20% in the quarter.

And that was contract.

That, of course, we saw coming in already in the first half year.

Now we're executing.

The same goes for system integration.

On the other hand, we see network rollout declining.

That's also as we had expected, given that they have been a little bit behind networks.

They always are, two to three quarters after that.

So the rollout is coming a little bit later on.

So now we have a decline here.

From a profitability point of view, professional services in line with what we've seen for many, many quarters, between 12% to 15%, 16% operating margin.

But a small impact on the hedges here as well, still 12%.

And network rollout is reducing the losses.

Not at breakeven yet, but reducing the losses.

Support solutions.

We launched in the quarter the next generation TV, MediaFirst, which is the evolution on the Mediaroom acquisition that we did one year ago.

Sales increased 30% in the quarter.

We are now four consecutive quarters quite large growth numbers.

Of course partly by acquisition, but that's part of the strategy we had to solidify our leadership in this areas, like OSS, BSS, and TV and media.

Still without taking that away, we still are growing with double digits.

Bottom line, small loss.

Still in the movement from legacy products to the new portfolio.

That is creating a small loss, but clearly much better sequential than in the second quarter.

So that's how we see support solutions.

Quick on modems.

We have a special session on modems, both the press release and the investor call on that one.

Nothing new here, the decision is taken.

We discontinued the modems business.

The M7450 we maintained and delivered on the commitments we have.

The reasons for it were discussed.

We are shifting a portion of them, place into radio, some 500 new positions will be created in radio in order to deliver on some new opportunity with radio.

That will happen in this quarter.

We keep the financial implication guidance that we had last time.

This year's OpEx levels remains as forecasted - - SEK2.6 billion for the year, SEK700million in the quarter.

We expect significant reduction in cost rate in the modems, this is in the first half of 2015.

And we expect no impact in the second half of 2015.

So that's going according to plan, we're in the means of execution.

Summarizing it up, we have growth in all segments.

We have growth in several regions.

We have improved profitability in all segments, all the way from services, to networks, to support solutions.

That's the gradual improvement we're looking for.

We talked about North America because that is a very important market for us.

And of course for the whole telecom industry, North America is important, both from a leading market, but also from an investment point of view.

And that becomes also for us an important market.

However, even though they declined in sales due to the cash flow optimization, we succeeded to grow.

And I think that is a very, very important strength we have in the global spread we have in 180 countries.

We continue with our strategic agenda and the strategic direction, whereby we made three acquisitions, all cloud-related.

Going into the new areas where we want to solidify our leadership and being relevant in the next generation of the telecom industry.

We also took the position in the quarter then, as mentioned, to discontinue modems, and that we're executing right now.

So by that, I hand it back to Peter.

Okay, thank you, Hans.

Operator, we are now open for questions.

So, please.

(Operator Instructions)

Edward Snyder, Charter Equity Research.

Thank you very much.

Hans, you mentioned a slew of new products that you talked about at the beginning of the year that are now in the mix.

What should we think about in terms of gross margin profile for these?

Are they at your consolidated average?

And you consider them to be material to the revenue impact on networks now?

And if not, when will they be?

And then maybe could also walk through what you think the mix will look like in the next coming quarters.

You've got North America slowing down here and China building up.

It sounds like rollouts may pick up there.

And then, Hans, you only provided IPR revenue on an annual basis.

But is it fair to assume that it's relatively evenly distributed over the quarters?

Or is it more heavily weighted to one quarter or the shipments of some of your licensees?

Thanks a lot.

I can start with IPR and Jan will take the other.

Normally it's fairly evenly spread out.

Depends a little bit how the performance is on the markets, as matter is attached to the mobile handset industry.

But remember last year that was not evenly the spread because we had that some slowly coming in in the fourth quarter.

I think that is good to remember.

That of course, was not evenly spread.

We had quite a big money coming in in the fourth quarter, so it's not evenly spread.

Normally it's fairly evenly spread, but of course contracts coming in and out can, of course, change that.

Our plan is to have a bit gradual improvement here and have it evenly spread out.

Okay, on those contracts then, that you referred to.

They are in the mix as we speak now in the third quarter.

And if you remember then, we gave some examples, such as the wins in Taiwan.

They are in the mix.

We gave examples such as the Vodafone spring initiative, and so forth.

That's also the mix.

I think what you have to think about when it comes to the fourth quarter, is really two main things, or three main things.

One being the fact that typically in the fourth quarter, we typically have a lot of project completions.

If you look historically, the share of network rollout of the total picture of Ericsson in terms of sales, typically is higher in the fourth quarter.

So I think that's one thing to be aware of.

Secondly of course, the slow-down in capacity business somewhat at least in North America, has impacted Q3.

The command is of course there, because it's a short-term uncertainty also for Q4.

And then the final point is, of course, that as Hans said, last year we had the initial payment of Samsung in the third quarter.

And then, of course, if the dollar versus SEK stays on the level we have, we will also continue to have some tailwind from currency in the fourth quarter.

Those are the main points, I think, that you need to be aware of.

Thank you.

Mark Sue, ARC Capital Markets.

Thank you, good morning.

If I look at it at a high level, your ability to improve margins and increase cash flow is predicated on your ability to grow revenues in your most profitable regions.

The carriers in these regions seem to be focused on improving their cash flow, so their incentive is always to reduce CapEx.

As we think about next year and the future, are there considerations to align the incentives for the carriers and for Ericsson?

In other words, do something different so it's not a constant tug of war, so that both Companies, both Ericsson and the service providers, can improve their margins and both can improve their cash flows?

Let me start from another angle.

I think you're making an assumption that we would not tend to agree with.

Meaning that margin profile from us depends on the type of project, not type of market.

I think that is an assumption that we probably don't -- so then the question becomes a little bit hard to answer.

If we have a coverage project that by design has a lower margin, because it's more hardware going out, which has a lower margin and, of course, usually in a more competitive environment, one.

Then of course if you have capacity, and capacity is the same wherever you are, a high degree of software.

So I think that's a little bit how we see it.

And then of course, your question about cash flow optimization, how we can work together with operators in that.

I think that we do it all the time, to try to support them in their transformations in a good way.

But again, it's nothing strange.

I wouldn't play up what we see in North America right now, if it wasn't that North America is such a significant portion of our business.

I think that's why we're telling what happened in the second quarter.

But again, it has not changed our position in North America.

It has not changed the underlining consumer demand in North America.

But that type of thing happens, and I don't think it's much dramatic into it, to be honest.

I think that the underlying demand is therefore mobility, broadband and the cloud.

Probably the US is the most innovative technology market in the world at the moment.

Just a quick follow-up.

Is there a way to move it from less of a CapEx discussion in the future to possibly an OpEx discussion for the carriers?

I think so.

If you follow the way our last industry events, where we talked about our new software models.

Of course software models in the future will be different ways how you can buy that.

Either you do a software buy-out early on, or you can buy it at capacity, or you can buy it over time.

We have different models and think about that, out transformation is going pretty quickly into software.

Already right now the majority of all our R&D is into software.

And of course the solutions we're selling have much less hardware.

So that's why we had an industry event for a couple of weeks ago, when we launched both our new software and the way we're working with it in the pricing transformation.

So yes, they are going to be ways for carriers to decide how they want to acquire or buy software from us in the future.

That will have different impacts for them.

Thank you.

Good luck, gentlemen.

Next question, please.

Sandeep Deshpande, JPMorgan.

Thank you for letting me on.

Two quick questions, if I may.

Hans, your margin in the network business has now been for a few quarters, above the 10% level.

Where do you think the margins in networks for Ericsson should be in the midterm as such?

So where is the target for the Company?

And then you've been acquiring a whole bunch of companies, which are reported, I think, much of them in the support solutions business.

We see the revenue growth there, but the margin there has -- Modeling it or what the margin is going to be and how we should be looking at support solutions?

Maybe you can help us on that.

When it comes to the networks business, we're working closely for gradual improvements.

We are now executed on that for five consecutive quarters, we are on 11%.

And then the unrealized hedge contracts impacted heavily, as well, on networks.

Of course we are well on track improving.

We are not giving any final guidance, but I think all this is important here.

Remember also, we have a fully loaded P&L for networks.

There's no allocations outside.

The depreciation is included.

You can see on the detail level that if you take away the depreciation, we're gaining some 3% to 4% more on bottom line in the networks business.

So, let us just continue to do gradual improvement here.

I think that's what we're seeking, but quarters may go up and down.

But long-term we're constantly working on that.

On support solutions, yes, we are now coming to a breakeven level, even though we had the growth.

We are in that transition between the legacy portfolio and the new areas.

And of course ultimately, this should be a good business for us.

That's what we are driving for and taking the leadership here.

One needs to remember that when we drive the support solution business, we are driving equally much in services.

You see a growth right now of 10% in professional services.

Part of that is driven from the support solution contracts.

Always has been a SaaS transformation, TV and media transformation, as well.

One needs to look at a little bit more holistic on the whole support solution business in order to see what we're driving here.

Still, we are not satisfied with being at breakeven on support solutions.

We're, of course, striving for much better.

Thank you.

Okay, Sandeep.

Next question, please.

Stuart Jeffrey, Nomura.

Hi, thanks very much.

A quick question on OpEx and restructuring.

Restructuring in particular is running at a very low level compared to history of around 1.4% of revenue.

Could you talk but whether that's the level that you hope to sustain going forward?

Related to that, OpEx has taken that step change up.

You've held it reasonably constant sequentially.

But are you happy with your OpEx structure at the moment?

Is there more to come?

Or should we factor in some higher restructuring charges as you try to, perhaps, moderate your OpEx numbers?

Thanks.

Well, let's see, I guess that's a question for me.

I think if we start with the first question around restructuring for Q3 and Q2 and Q1 versus the full year and so forth, I think what we have is we are typically a little bit back-end loaded in terms of restructuring charges, predominantly related then to the service delivery transformations.

So I think for Q4, we work on a slightly -- obviously we think that there will be a small increase, or a slight increase in restructuring charges because of that same thing.

Then when you think about the overall operating expense level, what I meant when I said that we have the organic investments in the social development that are now on the run rate, that is okay to model with.

That is of course, then helping you to model the OpEx for the full year.

Typically we have, actually, a seasonal impacting OpEx in Q3, so typically operating expense is slightly lower in the third quarter compared to the second quarter.

Here you see a flattish scenario, so for me that is really an increase, to be honest with you.

I think that there will be seasonal uptick in operating expense this year.

But it will be easier to compare in the fourth quarter because then we had the modem business inside Ericsson and the Mediaroom business inside Ericsson, and so forth.

There will be a little bit of a seasonality impact in Q4.

If we look going forward, on efficiency and so forth, and restructuring related to continuous efficiencies, we work with [tractibly] to identify efficiencies all the time.

I think we will come back and talk a little bit more about our agenda in terms of efficiency when we meet at the Capital Market Day.

And then, as we always try to do when we have the January meeting there on the Q4, we can give some more color to what we think the restructuring level will be for the year.

That is the plan, at least.

Next question please, operator.

Francois Meunier, Morgan Stanley.

Yes, it's actually Francois Meunier from Morgan Stanley.

A question, maybe an update about your the cloud strategy, and how do you see the virtual network strategy impacting your packet core and your voice packet core business?

Which I think at the moment is still quite profitable, as this is moving to more software less hardware.

And what's going to be the impact of potentially on your profitability?

And what do you think you're investing in these two to protect the profitability?

Okay, of course.

Let me take you on a little bit longer journey.

Already in 2010 when we started to look into hardware platforms and software platforms, we had probably some 35 different hardware platforms, more than 20 different software packs.

When we tried then to bring that down after a while of acquisitions, we then targeted -- we had three hardware platforms and very few software packs.

In that work we came up with a component-based architecture that enables to virtualize our products.

So that has been an ongoing work for us from 2010.

And basically in 2015 all our products except the radio technologies will be virtualized, if you so want.

They can be disconnected between hardware and software.

So we're already prepared for that, so that's number one.

We are prepared for that technical revolution.

Secondly, your question is of course when will it happen and what will -- I think we're going to see a gradual change.

I mean, we are already selling certain core elements, billing elements as virtualized, and that is part of the industry transformation.

We see that as a good opportunity for us, as we are really in the lead there.

The other part of the cloud is, of course, that then you get the data centers, especially with our service organization, to consolidate that.

And on top of that we see, of course, one of the most important things, that will happen a little bit in the future, I have to say.

That's, of course, the connectivity between enterprise cloud and the telecom cloud, and there is, of course, Apcera acquisition, very important to connect those two together where Apcera will start together with working with the enterprise cloud, with the governance, security, with the visualization there, but will all the time going to the telecom network.

I think we're in the early stages.

I think we are well-prepared to have the discussion, and even deliver on that.

But remember, that that's a pretty big transformation for our customers to go from a verticalized network structure to a horizontalized network structure.

But we will be there with the products and our service engineers that can do it.

So let's see how fast it goes, but it's nothing that we should feel worried about.

We see it more as a great opportunity given our competitor area.

Right, thank you, Hans.

The point is that I think there is someone in on the line and it is very difficult to listen to your questions.

So probably we'll ask again at the Analyst Day.

This is an area that we'll cover.

We'll cover more in depth the target areas, as we call them: OSS, BSS, IP cloud, TV and media and industry and society.

We will cover them in more extent at the Capital Markets Day.

You usually don't have time for that on an earnings call, but that is going to be one of the important things to cover during the Capital Markets Day.

Thank you.

Thanks, Francois.

Next question, please.

Achal Sultania, Credit Suisse.

Hi, thanks for taking my questions.

Hans, if I look at the gross margin structure for the industry, we had 2011 and 2012, where we were operating at about 32%, 33% gross margins.

Now we've seen a step up to 35%, 36%.

Is it fair to say that all of that improvement is basically being driven by product mix?

Or is it also somewhat impacted by somewhat more rational pricing environment from competition?

And then I've got a follow-up on Middle East.

No, the gross margin has so many dynamics in them.

But you mentioned some of them.

Of course the mix is one.

Efficiency improvement, pricing is to others.

The third one in our case of course, how services is playing against the networks business.

Intrinsically, service has a lower gross margin.

That is growing the last couple of years for us.

Last you I think we're up to 42%, 43% but it told the turnover in media and services.

So we don't think that is bringing it down, that is not negative.

That gross margin goes down because of services is not negative.

Because as I told the different OpEx structure than our networks business.

But then, as I said, the mix has been changed from when we were investing in market share in the beginning of the cycle.

And of course also, we have worked with efficiencies, and that's why we see it gradually coming up.

But there's a lot of dynamics within it, so it's a little bit hard to generalize over a long term, because some is going against and some is going for us on the gross margin.

For us, of course, gross margin is important, but for each and every segment it's very important.

Finally it's about improving our bottom line that we are looking on, the gradual improvement of bottom line.

All right.

And then maybe a follow-up on Middle East and India.

We saw very strong growth in Middle East this quarter, and India has been strong for the last few.

Can you just give us some color on what kind of projects?

Is it like more coverage projects or capacity projects that you are doing in these regions?

The reason I'm asking is about the sustainability of the growth in these regions going forward.

Jan is here.

I think if you start with India, it's great to see investments in networks again in India.

There has been for us, at least, very much a service-centric market centered around managed services for quite many years now.

Now it's also networks driving and of course that's in the case of India at least, so far, that's the 3G build-out coverage mainly, I would say.

In the certain cities I'm sure there is some capacity as well, but mainly coverage and 3G.

If you don't take me the least, that's a bit of a mix depending on where in Middle East you are.

There are, for sure, very advanced cities that have started to deploy 4G.

But the main driver of the business in Middle East continues to be 3G, where you have coverage but also, in certain areas, some capacity on 3G.

Depends a bit on where you are, if you are in Saudi or in UAE and so forth.

So that is the story.

It is very much the basic mobile broadband business that is building the momentum in Middle East.

Despite the fact, I should say, that we also buckets of countries that have been slow for a few years, like Egypt, as an example, driven of course by some lack of hard currency.

And also quite slow business in Turkey.

So I think in Middle East, I think you could say it's fantastic to see the growth.

And it's the growth in mobile broadband here, despite that we have some slowness still in some other markets.

Great.

Thanks a lot.

Next question please, Operator.

Simon Leopold, Raymond James.

Thank you very much.

I wanted to come back to the North American market trends and really ask two parts.

One degree is the decline that you experienced sequentially in the September quarter.

To what degree was that a surprise versus your expectations?

And then in terms of the behavior that you saw that caused the slowness, what's your feeling of the duration?

Is this a very temporary measure?

How much does it affect the fourth quarter and how much does it affect 2015?

Thank you.

That's a good question.

Very hard to answer.

Can I talk?

And, Hans, talk about 2015 a bit.

But I think the nature of the capacity business is that we have very short order cycles.

There are pros and cons as, we have talked many times about coverage and capacity.

The good thing with coverage is obviously that it is typically very long projects, very much often involving site acquisition and site builds and so forth.

Which means that we have longer planning horizons and depth of visibility.

Capacity is shorter order lead times.

In many cases it is about obviously shipping the latest software release or supporting the operators with the capacity feelings from a hardware point of view.

So, there are obviously better margin profile on capacity, but also a little bit more short term uncertainty.

So I think that's the most important thing for you to know.

That capacity is great, but it could be three or four weeks of order lead time, not more than that.

I think on 2015, then, Hans.

No, I wasn't planning to answer on 2015, I would just say that for certain reasons of course, this is our customer talking as well.

And as Jan said, first of all, short lead time, and they are communicating with the financial markets.

And remember there are not that many operators in North America and some of them are very big.

So they are important and big for us and they have an impact as well so much business here.

But finally on any predictions on what they will do and how they will cash optimize, we need to let them communicate that more than we say it.

So that's why we say we can see this quarter and that's why Jan is saying what he's saying.

So any sort of future look at what they will do with their cash flow optimization, that is not for me to comment.

That we need to let our customers do at this moment.

But we are close to them; we are working with them constantly.

So even though the lead times are much shorter in capacity, we are very close with these operators.

And to what degree was the September quarter performance a surprise versus what you were thinking?

I don't think it's about the surprise or not.

I think as Jan said, capacity can be acquired very quickly and filled in very quickly.

You have to be prepared for that type of things happening, and that's happening all the time for us.

It's just that in general we can balance it out between regions, between customers, et cetera.

Then there is of course, some larger carriers in the world that can have some impact on us.

But again, let's look at the totality.

We're growing 9% in the quarter.

We have other regions that are compensating.

We're not deteriorating our position in North America.

There's no market or consumer behavior that has changed from macro economics in the US.

Thank you.

Thanks, Simon.

Next question please, Operator.

Kai Korschelt, Merrill Lynch.

Hi, it's Kai.

A couple follow-ups on gross margins, please.

One shorter-term, I think you mentioned more project completions in Q4.

I think typically you had indicated that the average seasonality is down, I think, down 100 to 200 basis points Q4 versus Q3.

Is that still the right way for us to think about the gross margin?

And then the second one is a slightly more midterm.

Obviously as you'd said many times on the call, capacity spending in the US has been very strong.

You've had a very high gross margin the first half of this year.

And it also seems like you're winning more services contracts, which I believe, Hans, you mentioned on the press call this morning.

I'm just wondering, could that mean that your gross margins were, from a directional perspective, (technical difficulties) because maybe this a bit more of a permanent shift in the mix?

Or is it really too early to tell?

Thank you.

Kai, thank you for the question.

It is Jan here.

I think first and foremost, we have established ourselves on a higher level the last four quarters compared to the previous two or three years.

I think we start there.

It's driven by several parameters, as Hans and I myself have mentioned many times.

If we then zoom in to Q4, there is typically in our business, there is more project completions that translates into more natural revenue.

I think that the best way to look at this is that for every percentage point increase in services share of the total revenue, typically we talk about 0.3 percentage points of impact on Company gross margin.

I think that's still a relevant rule of thumb, if I may say so.

So I think that's -- then of course, we work every day as a Company to try to make good deals, whether it's capacity or software and so forth.

But reality is that there will be a lot of project completions and the rule of thumb, as I have mentioned, still holds.

Operator, we have quite a message here that it seems to be someone else put on the microphone that disturbs the transfer here.

But please take the next question and try to fix that as well.

We will be looking into it already.

Pierre Ferragu, Bernstein.

Hi, thank you for taking my question.

We've heard a lot of comments and questions, of course, on your gross margin and your level of spending in OpEx.

What I would like to do is actually to wrap that up in a couple of very, very simple questions.

The first one is, in the long run is your expectation to continue to expend gross margins?

And I'm really not talking about the next few quarters, but on a multi-year horizon.

Is the way you manage the Company makes you feel confident that gross margin is going to continue to expand over time?

So that's my first question.

And then my second question is about your OpEx.

You've been signalling a lot about your spending level at the moment has fully [run to EBITDA] which is very encouraging.

But could you concern that we should consider that your OpEx now is at the peak?

All these investments that you want to make to secure of Ericsson are now reflected in your numbers and we can be certain that over time, you're not going to continue to grow your OpEx.

And as I speak, I just think about a third very quick question, very related.

What about acquisition discipline?

So you're making a lot of acquisitions.

Even your best peers don't have a very high success rate with acquisitions.

It's very often doesn't work.

So my question is, are you aware of that?

Do you agree with that?

And do you plan to manage your acquisition flow in a way where you're going to actually shut down and take down the additional cost of acquisition bringing into your cost base if the acquisition doesn't work well and doesn't [proliferate] very rapidly.

Thanks a lot.

That was many questions in one.

Let me start with the gross margin.

Of course we're striving for every different unit to continue to improve.

And of course the business mix going forward with some of the target areas we're investing in every thing from OSS, BSS, cloud, et cetera, they have a higher degree of software.

So that of course.

But they also have a higher degree of R&D.

So you need to think about that if you're really focused on the gross margin development, which is a combination of software and services, of course we're focused on improving that for each and every unit.

And that we'll continue to do.

When it comes OpEx, you have already seen this issue, and that is to discontinue modems.

I think that is an important OpEx decision that we're not -- we take a portion of that and reallocate to the radio.

But the other, as we said, in the second half next year we expect that that doesn't have an impact.

So we will continue to work on that.

And we have been in a cycle where we're investing in a special R&D.

With this year, what is not non-organic is, of course, explainable.

But what is organic growth, that is in one area.

That is in IP that we have ramped up.

As Jan said, that has come into the area in more in force in the second half as expected.

On acquisitions, if you're trying to follow us, we are acquiring companies in this area.

So TV, media, OSS, BSS and cloud, where we won't establish leadership, were not acquiring anything in the core business.

We'd rather deploy our own R&D, if it goes to mobile infrastructure and traditional services.

Of course services like system integration or cloud would be an area that would be a new area.

We are following it closely and you're right.

There are probably some successes in acquisitions and some that are not successful.

We are doing everything to use our experience, our background, when we both acquire and making our business cases.

Additionally we're looking much more into culture, how these companies can be integrated with Ericsson and working with Ericsson.

So I think we have learned a lot the last couple of years in acquisitions.

I think we're applying that as much as possible to as successful as possible with acquisitions.

Thanks for that.

That's very clear.

We are ready for the last question of the session.

So, please.

Andrew Gardiner, Barclays.

Good afternoon.

Thank you for taking the question.

A fairly quick one, really, just around cash flow, Jan.

You mentioned the impact from some of these key contracts that were signed earlier in the year that had a negative impact on your working capital in the third quarter.

You also mentioned the seasonality there, which I think we can understand in terms of the inventory build into the final period of the year.

But in terms of the specific contracts, are you suggesting that there was perhaps an abnormal level of inventory associated with it that weighed on working capital?

Or is it that perhaps payment terms are longer for some of these contracts?

I was curious about some of the moving parts there.

Thank you.

I think you spoke on many counts to inventory of course.

I think on the working capital related to those projects, it's more related to the fact that typically when you run a big project, you have different milestones related to, for instance, building milestones related to preliminary acceptance and final acceptance.

While when you are in a capacity business, typically you can have split contracts, which means that you ship hardware and software separately from services, as an example.

So the impact on working capital is more the fact that the project in itself has a different way of reaching its building milestones.

That goes, actually, for most projects we have globally.

It's not that we have worse terms, it's just the nature of projects.

We'll see.

We'll come back in January and see if we can do a great Q4 on cash flow.

We have done that for a few years here.

But I think we just want to highlighted that there is a bit of mix shift this quarter.

We'll see.

The year isn't over yet.

Understood, thank you.

Andrew.

Hans, maybe you can end this.

Let me end this by talking about the Capital Markets Day.

Of course we are now coming up for our annual event, very important event.

The 13th of November when we're going to gather here in Stockholm.

And that of course, that event will have a couple of different topics.

I think we already mentioned them.

We're going to talk more about the areas that we are (inaudible) for transformation.

They are like OSS, BSS, TV, media, IP cloud, industry and society, or industry verticals.

We will talk more about them and give a fully-loaded picture of them as possible, the growth potential, market size, compared to competition what we are doing, why we should succeed.

We will try as good as we can.

We know that is a question out there.

And of course also clarify the clear adjacency with these areas with the rest of the Company.

As Jan said, we will talk about the expenses and operating expenses, because that is part of the ingredients here, how we allocate the resources and capital allocate.

And then of course, the normal seasonality or normal business, core business we'll talk about, of course, like mobile infrastructure and service as well.

This is a little bit of the feedback we have from you, what you would like to discuss and we will bring it up.

Hopefully, it's going to be like last year.

You'll see, this is a picture from the last year, a lot of sharing people and happy people.

We will do our best, at least from our side, Jan and me.

But let's see.

Thank you.

Thank you very much.