Telefonaktiebolaget LM Ericsson (publ)
Q3 2019 Earnings Call Transcript

Published: 17 Oct 2019

[Operator:]

Welcome to Ericsson's Analyst and Media Conference call for their Third Quarter reports. 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, a replay will be available one hour after today's conference.Peter Nyquist will now open the call.

[Peter Nyquist:]

Thank you, Mark. And welcome everybody to the Q3 earnings call. With me here in the room I have Börje Ekholm, President and CEO; and Carl Mellander Chief Financial Officer. I would [Indiscernible] the following statement first. During the quarter 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 all to read about these risks and uncertainties in our earnings call -- earnings report as well as in our annual report.Before leaving the word to Börje, I would just like to say that this call is focused on the Q3 earnings and later this afternoon we will have an investor update and then we’ll take more of Q&As on the long-term strategic issues. By that, I would like to leave the word to you Börje.

[Börje Ekholm:]

Thanks, Peter and welcome to all of you for this call for the third quarter. And of course we appreciate that all of you have the time to join us. So in the third quarter we continue to execute on our focused strategy that we defined and laid out in 2017. The execution during the third quarter shows that we do what we said we will do and execute towards building a stronger Ericsson on longer term.A key part of our strategy is to increase investments in R&D for technology and cost leadership, and we see good momentum in our business based on a strong portfolio and a good cost position. Another key part of our focused strategy was to strengthen our footprint, and we see good progress here with several wins. We are disciplined in how we take contracts and we target opportunities where we have a clear technology advantage. However, these contracts are margin dilutive in the short term, but the good thing is here we are also starting to see some of the early contracts we have taken to gain footprint to become margin contributive and actually helping us drive margins. So the impact during the third quarter net of operating leverage was about 80 basis points from these type of contracts. But the important thing is here to remember that we will try to manage or we will manage these strategic contracts within our overall profitability, and we can still deliver a healthy gross margin.We see faster rollout of 5G than we earlier anticipated, driven by the pioneers in North America and Northeast Asia. During the third quarter, we also recorded a provision of USD$1.2 billion or SEK11.5 billion as the estimated costs for resolving the situation with SEC/DOJ. Of course, we are ashamed of our historical performance, but we confront the issues head on and we're now investing significant resources to strengthen our future compliance program.Over the last two years, we focused on improving our cash generation capability or capacity. During the third quarter, our free cash flow before M&A was SEK5.5 billion and we now have a net cash position of SEK37 billion.The geopolitical uncertainty has continued during the quarter, and as always, uncertainty is never good for investments. So we see really no impact in our order books yet. But if any anything, we see uncertainty among our customers and actually it’s delaying investment decisions in certain parts of the world.If we move into summary of the numbers for Q3, 2019, we had a strong cash flow as we said SEK5.5 billion during the quarter before M&A. Organic growth were 3%. Underlying margin when we adjust for the provision for SEC/DOJ and the onetime refund or social security cost was 11.4% and that improved both year-over-year and quarter-over-quarter.Networks had a good gross margin absorbing the dilution from strategic contracts. And in digital services, we see improved results. When we laid out our strategy in 2017, we did not target the fastest possible turnaround of digital services. Instead, our priority was to build a strong unit for us longer term and create a strong product portfolio and thereby we defined the ambition to reach low single digit margins in 2020.And what we see now is that the business, the underlying business continues to improve, and we're getting close to break-even. We did carry costs for the 45 previously identified critical contracts. But we're resolving them one by one. But what's very encouraging, and makes us comfortable about the targets for 2020, is there is a strong development in the underlying portfolio or underlying business. Maybe, the most encouraging thing we did with digital services is the strong growth we see in our new growth portfolio to actually combat the declining legacy portfolio.We saw managed services to be after a bit of a bump in Q2 to be back on where it should be, delivering a good and improved margin. In emerging business, we see good growth especially in our IOT offering, where we have also decided to double down to be the stronger business longer term.Short summary of the market area sales then, we see very good growth in the regions with early 5G launches. That's really the U.S. and Northeast Asia. In Europe, we saw growth in networks and digital services, while Latin America saw declines following a strong 2018 tough comparison.In Southeast Asia, Oceania and India we saw declining sales due to lower sales of our legacy products and digital services. In Middle East and Africa, we saw actually growth because strong investments in 4G as well as 5G in key markets, but we also had a headwind from contract exits in managed services. So with that over to you, Carl.

[Carl Mellander:]

Thank you, Börje. I will start by mentioning two items affecting comparability in the third quarter. Those are important to understand, they are the underlying business. And first is the SEC/DOJ related cost provision. The cost here is estimated at US$1.2 billion which is the same as in our earlier communication. And when we apply the exact exchange rate on this in the closing, then this translated into SEK11.5 billion.Secondly, it's the refund of Social Security costs related to pensions in Sweden. And this amounts to SEK0.9 billion. Both of these are booked on segment emerging business and other, and for the only reason of keeping them easy to track for external stakeholders.When we adjust for these one off items, we arrive at an operating income then of SEK6.5 billion or an operating margin of 11.4. And you also see that the adjusted operating income for segment emerging business and others negative SEK0.8 billion.Let's have a look at the four segments starting with networks. Networks grew by 4% currency adjusted to SEK39.3 billion. Again driven by North America mainly, gross margin was flat year-over-year and down 0.8% sequentially if we exclude an item affecting compatibility in that second quarter, we'll come back to that later.So within that decline of 0.8 percentage points, we have absorbed the margin impact and inventory provisions related to the so called strategic contracts.Both operating income and operating margin here increased year-over-year. And if we drill down into this a bit more, the underlying margin is stable year-over-year as in the third quarter 2018. We had burdened margin by some re-evaluation for customer financing and also some impairment losses of the trade receivables.So as you can see here in the graph, the operating margin this quarter exceeded the 2020 target range, 18.4%. We’ll move to digital services, sales grew by 5% FX adjusted to SEK9.9 billion. And as Börje said a good momentum in the 5G ready and cloud native portfolio. And geographically here we're talking North America and Northeast Asia. And again, we're happy to see the growth in the new product portfolio of 19% if we look at a rolling four quarter basis.Gross margin improved both year-over-year and quarter-over-quarter from increased software share of sales, and also continued cost reductions. On operating income level, we saw significantly reduced losses here now down to minus SEK0.5 billion versus the negative SEK1.4 billion a year ago and minus SEK1.3 billion last quarter. And this was done inspite of absorbing a negative impact on the remainder of the 45 critical contracts that we defined way earlier of SEK0.5 billion.So, now we have addressed 29 of the 45 contracts. As you know, we target to have 75% of those 45% completed by the end of this year. I also want to mention that the BSS strategy execution which we have communicated about earlier is progressing well. And here we have recorded several new BSS wins in the quarter as well.So all-in-all I would say excuse me, the turnaround here in digital services is on track for the 2020 low single digit margin targets. But again, please bear in mind as we have said many times before, that the impact of the remainder of this 45 contracts will continue to vary between quarters as they are addressed.Managed services delivered well in the quarter, and operating margin above the 2020 targets, target range. And here we decline top line if we adjust for FX, but this is mainly following the planned exits from contracts that we have talked about.Gross margin improved also here, following continued efficiency gains, but also thanks to a higher portion of what we can call add on sales, meaning additional business generated under existing contracts. And looking at operating income, we also here increased both year-over-year and quarter-over-quarter following the higher gross margin. I would say it's also relevant for hiring managers is to look at the year-to-date operating margin, which is 6.9% up from 5.4% for the corresponding period last year. And though we have to exclude the positive effect of certain provision reversal we did in the first quarter.And this again in line with our 2020 target range. Here in managed services, we continue to invest in our in R&D for automation, machine learning, artificial intelligence, obviously to continue develop this business into a competitive and value generating part of Ericsson.In segment, emerging business and other, sales was SEK1.6 billion, which is an organic decline of 7% and operating income here was impacted by some non-recurring items that we talked about before. When we exclude this, it's minus SEK0.8 billion compared to SEK1 billion negative in Q3 2018.Looking at the different parts, we have the emerging business, including iconectiv and here Börje mentioned already, but it’s I think this is worth repeating. This is good that we see our business IoT growing almost twice the pace in the market, and we have now four and a half thousand enterprises onboard into our platform via telecom operators.And yes, then we have Red Bee media, stable business at break-even working hard to improve, and the media solutions of course divested earlier are now generating a negative point 0.3 operating income.When it comes to gross margin, here you see the long term development, we could say at the gross margin has established itself as at the higher level in line with the target for 2020. And I think, I have mentioned most of the factors there so we can move on. Here, let me say a few words about the network's gross margin and the so-called strategic contracts in the form of this margin bridge here. Some of the contracts that we decide to take, they do come with lower initial margins. However, but they're all selective for value creation long term, and the product offering and cost structure we have now is more competitive, and this is an enabler for us to capture these opportunities, without jeopardizing the targets for 2020.But we have a sort of negative impact on their gross margin, just over 0.8 percentage points here in the third quarter, and the dilutive impact can vary between quarters of course, but this is about building for the long term. So you see the underlying margins Q2 was 42.3% if you make an adjustment for an IPR settlement there compare that with the Q3 number 41.6% and you get the 0.8 delta, including this margin impact and inventory provisions but also offset by operational leverage.OpEx, quickly starting from the left at with R&D slightly up, and we have seen reductions now continuously in digital services as well as emerging business. That's mainly related to the divestment of MediaKind. And we invest in networks as well as Managed services as you are well aware.SG&A in the middle, and stable underlying level you can say we compensate for the negative currency effect by continued cost savings. And then, we have the impairment losses on trade receivables. They continue to vary between quarters, it was a positive this quarter, thanks to good collection efforts in our company.Free cash flow SEK5.5 is the key number here. Free cash flow before M&A. We saw some outflow from provisions here SEK2.2 billion in this quarter. Looking at the future in Q4, we expect the majority of the SEC/DOJ related costs to be paid out. But this is of course uncertain, and this is with current information. But let's see how the discussions that play out in reality.Just to highlight also the year-to-date free cash flow which is SEK11.8 billion compared with SEK1.2 same period last year. A lot of this has to do with working capital management and not least good cash collection in the quarter, and the whole year.Planning assumptions here again, please look at the full report for all the planning assumptions. I won't go through the details here. There are a few additions and changes here so I just suggest that you have a look in the report where you can find all of that.And with that, I hand back to Börje.

[Börje Ekholm:]

Thanks, Carl. So our focus strategy stays firm. We are excited about the opportunities to expand the market with our 5G technology as we enter the enterprise space and many more advanced consumer applications. We continue to invest in R&D for technology and cost leadership. Our investments are of course focused on 5G, but also cloud native portfolio and AI. We continue to seek to expand our footprint in a disciplined way. We're building on a strong portfolio and a good and competitive cost structure. But nevertheless, the margins can be -- the contracts can be dilutive to margins in the short term, but they are surely creating value long term and strengthening our market position.But we can take those within the targets companies [ph] has previously communicated. Our focus strategies is aimed towards building a stronger Ericsson longer term, think in terms of five to 10 years out. And we feel we are doing what we said, we would do and delivering on that. So we are -- we are very comfortable about our targets near-term for 2020 and 2022 as some sort of intermediate checkpoint on their way to a longer term Ericsson.With that, back to you Peter.

[Peter Nyquist:]

Thank you, Börje. And on the topic of investor update this afternoon, we will then focus that session more on the strategic question. You will get a run through with both Börje and Carl, when it turns around what we're going to study about targets in this definitely at that point. So we will focus this Q&A session on the Q3 earnings.With that operator, we will open up for the Q&A, please.

[Operator:]

Thank you. [Operator Instructions]. And as always, please limit yourself to one question at a time and please keep your questions at a broad level. Detailed information is provided in the report. And Ericsson’s Investor Relations and media relations teams will be happy to take additional questions and discuss any further details with you after the call.And our first question comes from the line of Daniel Djurberg of Handelsbanken. Please go ahead. Your line is open.

[Börje Ekholm:]

Hi, Daniel?

[Daniel Djurberg:]

Thanks very much. Thank you very much for taking my question and congratulations on a strong report. The question would be to call I think on the network side, you had inventory provisions in the quarter, making up part of this 80 basis point gross margin, or impact in full. How much of this 80 came from this inventory provision, and how much was from strategic contracts?

[Carl Mellander:]

Hi, Daniel. Carl here. Now we don't go into that level of detail here, but we say we talk about the net impact there of the 80 basis points. But we're not going to break it up into smaller components of that.

[Daniel Djurberg:]

Fair enough. Then I have one more question then perhaps to Börje. And it might be interesting to get your view on this development over Open Radio Access Network that some operate, there's quite large operators, lots to talk about now. And I was thinking if this O-RAN so far has impacted your strategy plans for network segments, long term or what you're thinking at some O-RAN.

[Börje Ekholm:]

Yes. We have – and you'll see it from our earlier announcements, we for example joined the O-RAN Alliance already in the beginning of the year. So we believe the openness and the open architecture, so we'll of course be important part of the market going forward. So we see that as a natural extension, and an area that we are surely going to participate in so. So we are working to position ourselves as a strong competitor in the -- as an open provider or provider of an open solution. No question, then exactly how that's going to impact and when it will be introduced etcetera. That's still a bit unclear. You know solutions of course can be done for 4G we're ready today, but so far we haven't really seen that on 5G.So we continue to work on our path and it's going to be an important part of our business going forward as well. But as you see we continue to have a guidance of a strong network going forward. So we believe, we have a good position also here.

[Daniel Djurberg:]

Perfect. Thank you very much, and good luck in Q4. I will go back in queue.

[Börje Ekholm:]

Thank you.

[Peter Nyquist:]

You can write to them Daniel, I guess.

[Operator:]

Thank you. Our next question comes from the line of Aleksander Peterc of Societe Generale. Please go ahead. Your line is open.

[Börje Ekholm:]

Good morning, Aleks

[Aleksander Peterc:]

Yes, good morning, good morning to all of you. I’ve just have a few questions. One is simple on housekeeping, when you say the there is a 0.8% impact on gross margins from competitive price contracts and stats quarter-on-quarter or year-on-year. Then the second question would be on the impact of Kathrein, how should we model sales gross profit and operating profit contribution within networks here. I think you alluded to about SEK2 billion being the sales level solution model for the full year. But I'd like to have a little bit more detail on that?And then lastly on guidance. So you lift the midpoint, I'd say about by about 9%. Is it correct to assume that about half of that is down to FX, changes since your last update about a year ago? And also, is there an inorganic contribution of Kathrein that I don't think was modeled in that initial guidance indication you gave a year ago? Thank you.

[Carl Mellander:]

Should I start then. Yes, first of all that 0.8 is the sequential delta on the network's margin. If you adjust for one specific non-recurring item regarding an IPR settlement in Q2. When it comes to Kathrein what we have said earlier is that it's about €270 million in top line in 2018. And so that's about the level we have talked about, no – sorry I’m reading on the long line, it's actually around €220 million. Exactly. Apologies for that.And we have a sort of negative impacts on Kathrein in Q4, and also in 2022, and it has to do with changing the portfolio and modernizing the portfolio there. And the whole shift that we are going to do. Of course, overtime this acquisition is going to be accretive clearly, but there are some short term hits on that.

[Börje Ekholm:]

But it's important to still put it in the context of 2020. That's why we're still -- we're still comfortable with our targets and they remain firmly in place. So of course, as Carl said, we expect to see a bit of a headwind from Kathrein in 2020, but we need to modernize the portfolio and make sure to invest in our internal technology, and that's a strategic investment we're making.So that, but we can manage that within our targets.

[Carl Mellander:]

And I guess your third question was around the midpoint on the 2020 top line, right?

[Aleksander Peterc:]

Yes.

[Börje Ekholm:]

Now I can take that. It's divided between the FX impact, but also good market momentum. And thirdly, than the Kathrein acquisition. I mean to give you a rough idea FX is probably around say SEK9 billion on that market. Another SEK9 billion in Kathrein say 2.

[Aleksander Peterc:]

Thank you very much. Perfect, thanks.

[Peter Nyquist:]

We are open for next question.

[Operator:]

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

[Börje Ekholm:]

Good morning, Sandeep.

[Sandeep Deshpande:]

Yes, hi good morning. I have a couple of questions. Firstly, regarding the United States. I mean you have mentioned on your release that you know the T-Mobile, Sprint may cause some issues. Maybe, can you elaborate on what you think that will do to your normal seasonality in the fourth quarter?And then secondly, if I look at I mean, you've talked about BSS in the past. When do you think the BSS adoption in the U.S. will start?

[Aleksander Peterc:]

Repeat the last question please, you meant DDS or?

[Sandeep Deshpande:]

No. The dynamic spectrum sharing.

[Börje Ekholm:]

Okay, I'll take that. If you look in the U.S. what generally what we're saying is that, there are a bit uncertainties relating to a potential merger that's been announced. And we think that this is going to impact their spending levels in the second or during the fourth quarter. So of course that will be a lower seasonality effect in Q4 than normal, as a consequence of this. So I know -- it's hard for us to be much more specific, but we want to say that overall you should expect to know where seasonality than normal and we know lower seasonality affect than normal.Then come back to your question about the dynamic spectrum sharing. This is a important technology. We're taking steps forward. When it will be introduced, do you know that? That depends on the one's [ph] plants with our customers. So we're not going to comment on details, but it will be of course be announced as it is deployed.

[Peter Nyquist:]

Okay, Sandeep.

[Sandeep Deshpande:]

Okay, thank you.

[Peter Nyquist:]

Next question, please.

[Operator:]

Thank you. That's from Edward Snyder at Charter Equity Research. Please go ahead. Your line is open.

[Börje Ekholm:]

Good morning, Ed.

[Jack Egan:]

Hi, this is Jack Egan on for Ed Snider. Thank you for taking my question. So operators, good morning. So operators such as Verizon and British Telecom, backing off extra monthly charges for 5G service suggests ARPUS are remaining flat. Is there a specific reason, why they haven't risen yet? Is it due to an effective marketing or reduced CapEx? Just trying to get an idea of expectations for commercial uptake for 5G? Thanks.

[Börje Ekholm:]

If you look at, it's also -- I think to be able to charge a premium. You need to also consider other aspects like how much coverage for example you have for the service. Right. So when you look at the other parts of the world, where we see early movers actually get the price premium for 5G, but it's typically linked to a broader coverage, a broader user spectrum so to say. And so far in the U.S. it's the build out, this is happening, it's happening very quickly, and is building out quickly. Coverage is not, it's not deep yet. And I think that limits your ability to charge a premium. But if you learn from the history, we've seen the first mover is always be able to extract the price premium and we see the same thing in 5G or expect the same thing in 5G.

[Peter Nyquist:]

Okay, Jack. You’re done through with that.

[Jack Egan:]

Okay, yes thank you for that. For my follow up for Sub-6 base stations with 64 antennas. Can we get a general cost point for these? Are they twice as expensive or 10 times as expensive really just looking for a ballpark estimate? Thank you.

[Börje Ekholm:]

I guess you would love that, but you’re not going to get that. Sorry.

[Jack Egan:]

Okay, no problem. Thank you.

[Peter Nyquist:]

Thanks, Jack. We'll move on to the next question please.

[Operator:]

Thank you. And our next question comes from the line of Achal Sultania of Credit Suisse. Please go ahead. Your line is open.

[Peter Nyquist:]

Good morning, Achal?

[Achal Sultania:]

Hi, Peter. Good morning everyone. Just coming back to the U.S. market and maybe Korea as well, like obviously we've seen continued strength in both these markets as 5G leaders. You've obviously been commenting for the last few quarters that we have to be careful as some of these markets may stock peaking. We still haven't seen that. Q3 was another quarter of growth from a very high base. So what has been the surprise element for you when trying to predict the demand coming out of the U.S. and telco Accordion operators, is it -- is it 4G catch up spending? Is it -- is it the pace of 5G rollouts? Is it the densification part, just trying to understand like where are we missing something, which is going on in the U.S. and Korea?

[Börje Ekholm:]

You know it's not easy to give a very clear answer. But if you look back two years ago, with the expectations of 5G introductions, we would have said more like a 2020 event. Since then it's been actually accelerated by more than 12 months. So you see a much faster rate of introduction of 5G than expected. You also continue to see a very high increase in the data consumption among the users. So what you're -- what you're seeing is actually a need to invest in the network to actually give there. And you said the quality needed, so you see operators invest in both 4G as well as 5G. And yes, we you know you could have said should we have expected this? To some extent we should have, but the reality is, it's happening even faster than we expected just a few months ago. So the demand here is strong and when we look at early launch markets for 5G, we see a very sharp increase of data consumption among the 5G users, which indicate that 5G yet again shows that you will use your device in a different way, when you get a better service.So if we look at -- compare that for example to Europe, where we typically have weaker coverage or weaker networks as it’s more of an average compared to Northeast Asia and the U.S. And we see much lower data consumption as well. So I think the reality here is a better network drives new type of behaviors that actually also drives investment needs and drives our business. And that's why it's important I think that the operators also are able to charge a premium for 5G, because it will create new type of use cases.So...

[Achal Sultania:]

Okay.

[Börje Ekholm:]

It's a multitude of factors, but it's actually back to the demand for -- it's almost a you’re feeding that the data consumption beast in a way, and the consumer continues to love consuming data.

[Achal Sultania:]

And maybe just a follow up on Japan. Have you started seeing the 5G prep getting done in Japan, or is it still more like a 2020 event? And how is your relationship with all the three major operators? I know you've announced SoftBank and KDDI, but what's the progress with the third operator in Japan in terms of what you can supply in the new relationship? Thank you.

[Börje Ekholm:]

You know the Japan is still preparing to upgrade the network to launch 5G -- during that phases. So that it's more of a 2020 event as you call it. We see good progress in the market and of course our ambition is to be stronger in 5G than we've been before. So that would include working together as we have said before with Fujitsu and approaching the market that way as well. So we feel quite positive about the situation in Japan.

[Achal Sultania:]

Thank you Börje.

[Peter Nyquist:]

Thank you, Achal. We are now ready for the next question please.

[Operator:]

Thank you. That’s from the line of David Mullholland of UBS. Please go ahead. Your line is open.

[Börje Ekholm:]

Good morning David.

[David Mullholland:]

Just on China, I think your commentary is getting increasingly over the last few quarters confidence around your ability to take market share into 2020. I just wonder if you get update us on where you are on, how’s business been awarded yet that you've seen? When do you expect that to happen? And, is that also in terms of impacting your P&L something that's already going to kick in Q4 this year, or really a 2020 story?

[Börje Ekholm:]

Yes. Our ambition is clear. We want to be stronger in China than we -- in 5G than we were in 4G. You know 4G spent or 4G market in China. It's really more than 60% of the global market, so it's clearly very important. We have no reason to believe 5G will be less than that. So we tried to position ourselves for gaining share. We feel, we're making progress, we're making investments to do that. Still we don't know. No rewards have been made. We have really no way of knowing potential market shares and we don't really know price levels either. But we would expect that to be awarded in the -- at least in the near-term, in the next few months. But we will see and we will update you based on what we achieved.

[David Mullholland:]

And then just one quick follow up on Kathrein, I think that the commentary you're making around potential margin impact that as in adds in dilutive margin impact. Is that just a Q4 issue? Because whenever you announced that, you said it would have a positive impact to your profitability targets for 2020?

[Börje Ekholm:]

I -- what we have said is that we will have a near-term dilutive impact. We're closing it much later than we expected. So it will clearly carry into 2020. So that this it's going to, it's going to provide a headwind in 2020. But the reality is it's still fitting into the overall guidance. So you know you can quantify it a bit and say that yeah it's going to have an impact, but not that much.

[David Mullholland:]

That's right. Thanks very much.

[Börje Ekholm:]

Thank you.

[Peter Nyquist:]

That's David. Next question please?

[Operator:]

Thank you. Our next question comes from the line of Jörgen Wetterberg of Nordea. Please go ahead. Your line is open.

[Börje Ekholm:]

Morning, Jörgen

[Jörgen Wetterberg:]

Yes, good morning. Thank you. And congratulations on the reports. A couple of questions if I may. One related to the operating expenses, so you had some good improvements there after adjusting for the Social Security benefits repayment etcetera? Right.And you're saying that it's driven by FX and seasonality, still you're increasing employees by you know a thousand people, so could you give us a bit of an understanding? Is it only affects seasonality or do we have you know our structural improvement trends here and how are you thinking about OpEx going forward into Q4 and 2020? That's number one number.Number two, is you had quite a big uplift on digital services sales in Northeast Asia and you point at Japan. Could you give us a flavor sense, they are a kind of pre-5G investment. What type of investment is that? What is it? Is it 4G packet core capacity increases because 5G isn’t there yet? Or what are we seeing? Thank you.

[Börje Ekholm:]

If you start with the increases on the number of employees, it's really in our service delivery organization. As we win contracts, we need to step up accordingly. So that you should see in that conjunction, right. So you see a top line growth and you will see some increase in service delivery staff.On our SG&A and that you see and I think Carl says it also in a way we have currency headwind. So efficient structure and efficiency gains, we're making are in a way canceling out the headwind from currency. So you do see a continuous improvement there. So we’re able actually to take costs out in SG&A and grow top line. So there is an operating leverage, and operating efficiency gain in there.Then on the question about Japan, you know what we see and we have seen that in other markets before, there is a need also to upgrade your whole network including, their core orchestration etcetera. And all of that has to be done before you can launch 5G. So you see this is a natural spending cycle going on in Japan as well.

[Jörgen Wetterberg:]

Okay. Thank you.

[Peter Nyquist:]

Thank you. Next question please.

[Operator:]

Thank you. The next question comes from the line of Johanna Ahlqvist of SEB. Please go ahead. Your line is open.

[Börje Ekholm:]

Hi, good morning, Johanna.

[Johanna Ahlqvist:]

Good morning. Thank you. Two questions if I may. The first one relates to, IPR revenues, you still guide for SEK9 billion for the full year, which if I do the math correctly implies that you will end up at SEK1.8 in Q4. I'm just wondering is there any reason why the patent revenues should decrease in Q4 versus the 2.4 we see now in Q3.And then my second question relates to the U.S. market. If you can comment anything of how you expect 2020 to develop in the U.S? I know you sort of guided previously for more service heavy type of revenues, and also how do you see the mix on the client. So I would expect the two major telcos in the U.S. are a very big part of your CapEx now and if you expect that to change in 2020? Thank you.

[Carl Mellander:]

Great. I can take the IPR question first of all. So hi, Johanna, it’s a – when we talk about SEK9 billion that is really that contract baseline annualized. This year, I think we can expect a Q4 more or less in line with Q3. That would bring you a bit higher than denying them for this year, because of some effects and were well performing contracts here and there and one off. So that would bring you to about 9.5.

[Johanna Ahlqvist:]

Thank you.

[Carl Mellander:]

And U.S. market. And I guess was second question. In 2020…

[Börje Ekholm:]

You know -- it's when you look at it, we have seen a great growth in the U.S. during 2019. We don't see that the U.S. market is in that sense structurally slowing down and that's because it is driven by the end user, it's the end users consumption of data that drives the need for building network capacity.So we don't see the U.S. market necessarily to in that sense slow down, because the end market is actually growing. In addition, we will have clarity on the merger, what's going to happen. So we think there are a couple of things speaking in favor of the market. On the other hand, it's when you have these high developments you have to at least be prepared to absorb some negative surprises. So we're just trying to position ourselves. On the other hand, we have our global markets that we see also that could contribute positively, Northeast Asia for example.So when we put together the guidance for -- the targets for 2020, we kind of -- we've had is 230 or 240. It's a realistic number on the overall and that's what we're sticking to. And then we can absorb some you know short term fluctuations in certain markets compensated by others.

[Peter Nyquist:]

Okay, thank you Johanna. Then we will continue to the next question.

[Operator:]

Thank you. And that comes from the line of Amit Harchandani Citigroup. Please go ahead. Your line is open.

[Börje Ekholm:]

Good morning, Amit.

[Amit Harchandani:]

Good morning, all. Amit Harchandani from Citi and thanks for taking my questions. Firstly, if I may, I guess I didn't if you can help me on this, but as we look towards Q4, you've talked obviously about the revenue line and how we should think in terms of probably below seasonality. Is did any steer or assistance you can provide us as we think in terms of the gross margin in terms of say the impact of strategic contracts or any other puts and takes around the gross margin if you can help us? And then I have a follow up.

[Carl Mellander:]

I can take that. So you saw then the impact of these so-called strategic contracts in Q3 and fairly limited 80 basis points. I think we can. We don't see any dramatic impact of those going forward either more dramatic, but it is there, and for the reasons we have explained, we would take some of these contracts when they are value accretive longer term to being the stronger footprint. And this is, of course, in line with strategy. But a somewhat negative impact that I would say contained and the limited. So I think that's the thing to keep track of for gross margin into Q4.And then he mentioned also Kathrein in the planning assumptions, certain negative impacts from that short term. We also mentioned that. Final point perhaps than on digital services. You know that the 45 contract that we haven't identified may have an impact in individual quarters, and that the impact can vary from quarter-to-quarter of course. But again, just to repeat, we are on track there on the recovery towards the low single digit margin for next year.

[Amit Harchandani:]

And just to clarify in terms of the mix of networks there's nothing that we need to be aware of in terms of the mix? I guess Q4 potentially tends to be a higher software quarter. So fair to assume product mix would be positive in networks?

[Börje Ekholm:]

No I wouldn't assume any specific capacity of mixed changes into Q4. I would not model that.

[Amit Harchandani:]

Okay. Thank you. And as a follow up if -- yes please. And as a follow up if I may as it -- is there, could you give us a sense for your own perspective of how the standalone versus non standalone deployment is shaping up across your conversations with operators. How do you feel Ericsson is positioned? I understand there are a few releases down the pipeline with 3GPP, but a sense of your perspective on standalone versus non standalone would be helpful? Thank you.

[Börje Ekholm:]

It's varies a bit by market, but we see the initial deployment being non standalone, but we are seeing also the interest for standalone increasing. So we feel that we're well positioned in both, and it depends a bit about the operator priority and how they were going to build out the network. But we see -- we see ourselves to be well positioned here in the early phases of standalone as well.

[Amit Harchandani:]

And is there any clarity yet on timelines are still too early to comment on that?

[Börje Ekholm:]

It’s a bit early. When China launches, it will most likely be a standalone and we will see how that develops. Right.

[Amit Harchandani:]

Thank you very much.

[Peter Nyquist:]

Thank you, Amit. And we’re open for the next question, please.

[Operator:]

Thank you. And that's from Andrew Gardiner at Barclays. Please go ahead. Your line is open.

[Börje Ekholm:]

Good morning, Andrew.

[Andrew Gardiner:]

Good morning, guys. Thanks for taking the question. Just another one on China, please. Compared to the way you and others in the industry were talking earlier in the year the contract awards have been delayed and continue to be delayed. Is – are you getting any visibility from the operators around why they're delaying it? I think you know we can speculate on it, but I'd be interested in the -- in the feedback you're hearing as to why this process seems to be dragging?Also in the report this morning, you're saying you do expect deliveries to China to start in the near term. Is that 4Q, are you getting any indication it could be that quickly, or is it really a 2020 event? And then just in terms of thinking about the margin impact from that, is that are you taking into account China when you talk about the near term impact of strategic contracts or would that be additional to that still? Thank you.

[Börje Ekholm:]

You know it's easy to make predictions. It’s just hard to be right. I think that holds to China as well. So we can speculate a bit. And I think, we don't really know. We know there are changes in the market, you know two operators decide to share the network etcetera. And I think those discussions while there are ongoing leads to certain delays and that's not to be surprised. And we're not talking a particularly long delay we're talking rather months. Right.And so it's not -- it's not the whole lot. So we see still China starting. It may well be early next year. It will be late this year. We honestly don't know. But we are trying to invest, to gain market share, and trying to be stronger in the market. That's our ambition. That's not changed. What -- we don't know the price level yet, so it's a bit hard to forecast.But if you look historically, you've typically had the tough margin in the beginning of the contract as you roll out, and then you may you catch up over the contract period. What we say is that we're committed to the targets we’ve given for 2020. So you can see that it's incorporated in there. And of course, it can be dilutive, but we should be able to handle that in the targets we have. We see no reason to change those.

[Andrew Gardiner:]

Okay. Thanks. And just another one sort of related to the strategic contract, now that we're off to a few quarters beyond when you guys first started talking about it. Can you give any sense to us of sort of the breadth of these contracts is. Is it a small number, but that are particularly important, and therefore you've been more aggressive and you're starting to see that impact or is it much broader across the 5G discussions that you're having and therefore you're seeing a little bit you're being a bit more aggressive in price on, on a broad range of contracts. Can you help us sort of between those two ends of the spectrum? Thank you.

[Börje Ekholm:]

You know the first time we mentioned it was actually 2017, when we said our focused strategy builds upon gaining footprint. So it's you know hey we're delivering, we're doing what we said, we would do. What we see is, there is some of the early wins we had already in in 2018 actually are now contributing to our gross margin. So, the reality is we see the model of gaining a footprint actually works in real contracts.Why do we define them as strategic value, was the overall sense of build upon a technology advantage to gain a increased footprint. Those we defined as strategic maybe that was the wrong wording, but that's what we're what we call them. We're not -- we're engineers, we're not creative marketing. And the reality is we're trying to tell to say that these are contracts that where we have a unique technology advantage to try to gain a footprint.And they are associated with some early costs. And that's typically costs for changing equipment, for example, and it's service related cost typically. We're taking those over the P&L. And we see some short term headwinds from them, but we also see that we create a stronger business for Ericsson five to 10 years out. So you know it's not -- it's nothing new in this. It's actually a two and a half years old.

[Peter Nyquist:]

Okay, Andrew you’re happy with that.

[Andrew Gardiner:]

Thank you guys.

[Peter Nyquist:]

Thank you. So we’ll move to the next question, please.

[Operator:]

Thank you. That's from the line of Janardan Menon of Liberum. Please go ahead. Your line is open.

[Börje Ekholm:]

Hi, good morning.

[Janardan Menon:]

Hi good morning. Hi. Good morning. Thanks for taking the question. I just wanted to go back to the strength that you saw in the digital services revenue. You said that it came from North America and North Asia. In response to a previous question you said, it's a normal course of business, as operators are preparing for changes. So can we take this as an inflection point in the digital services revenue trend, as in do you have a good pipeline of business of this nature coming in these cloud native products, which will sustain the growth that you're seeing in Q3 into Q4 as well as potentially into 2020? Or could it be quite volatile as we go through the next few quarters?

[Börje Ekholm:]

And I won't have to just take a step back. When you look at our business, it has an element of volatility, because contracts tend to be rather large and that's why it's very hard to predict and it's almost inappropriate to predict which quarter that we would never be accurate on. But, the reality is what we're doing is, we're building a cloud native portfolio with a modern architecture that we are seeing gaining momentum with customers and we have a number of important wins up to date, but they are also continuing.So if you look a bit longer term, we should be able to grow this part of our business quite substantially benefiting from the technology advantage we are creating right now.

[Janardan Menon:]

Understood. And just going back to North America, you know previously you had talked about certain sort of constraints in terms of, I think tower crew and things like that. Are we now well beyond that, you've trained up your people and you have enough resources on the ground to deal with contracts as they come through?

[Börje Ekholm:]

Tower crews are still one of the main shortages in the U.S. And you know – but there are also are there problems in the U.S. right. You can't ramp up fast because of a permitting process it still takes quite some time to get permits. Depends on which geography, depends on local counties, etcetera. So there are restrictions in other areas as well. But tower crews are important, and it actually slows down ramp up.

[Janardan Menon:]

Understood. Thank you very much.

[Börje Ekholm:]

Janardan, thank you.

[Peter Nyquist:]

Take the next question please.

[Operator:]

Thank you. That's from Stefan Slowinski of Exane/BNP Paribas. Please go ahead. Your line is open.

[Stefan Slowinski:]

Thanks, and good morning. Just two quick ones. First for Karl, I guess on restructuring. You only have I think SEK500 million of restructuring in the first nine months of the year, you're guiding for 1% of sales for the full year, which would imply significant restructuring charges in Q4. Do you expect some sort of need for that in the fourth quarter? That's different from what you've seen in the first three quarters or is that just kind of a cautious guidance there on the restructuring side?And then secondly, for Börje on the geopolitical risks that you've flagged today, and the macro risks. Are these related to the security discussions that we've been hearing about for well over a year now in the market, or is this sort of new more macroeconomic risks that you're seeing delaying some projects and is there any geography in particular that you would call out where you're seeing maybe an increase in those potential delays? Thank you.

[Börje Ekholm:]

No. I wouldn't say, we're not flagging a delay in the market in that general sense, but we're rather saying that everyone seems to assume that the geopolitical uncertainty and the quality, the security discussions will be beneficial. And it will make life easy for us. You know that we don't see. If anything, we see it rather being slower with certain customers. So it's not that we're trying to war or anything or flag in anyway, but it's more combating that notion, that life is easy on the walk in the park, because we know it's a very competitive market. We still see compared to those being aggressive on price levels etcetera.So it’s -- that's more the norm and the business as usual kind of pervades. So don't -- don't read anything more into it. And then it's fair to say that what goes on this is something, in a way, it's a political national security mix into one thing, where you know I don't think we can have any view or show don't have any view. We can only focus on one thing which is working with the customer, make sure they get the best solutions, make sure they get the best way to operate the network, providing the best quality service to their end customers.And if we do that, we'll win business. And I think that's what you see us do during Q3 and you've seen us do for the last year and a half as well. So our focus is clearly on winning business. And we win business based on our own merits.Then on the restructuring, Carl. Take that.

[Carl Mellander:]

I can take that. Hi, Stefan. So of course we're always working on efficiencies and cost out, but we are able to limit the cost to do that. The restructuring cost and we also have growth absorbing headcount at the moment. So there's less of restructuring cost and for those reasons and you're right that we have invested or spent quite a low amount so far this year, there will be some more in Q4 and we aim now for about 1% of net sales for this as a total.And as you will remember this is also a long term ambition, that we talked about a year ago in at the Capital Markets Day about 1% of net sales and we're looking out for that already now in 2019.

[Peter Nyquist:]

Okay, Stephan.

[Stefan Slowinski:]

Thank you very much.

[Peter Nyquist:]

So operator we are open for the last question as we’re getting closer to the hour. So please let’s get the last analyst into the call.

[Operator:]

Thank you. The last question comes from the line of Fredrik Lithell of Danske Bank. Please go ahead. Your line is open.

[Börje Ekholm:]

Hi, Fredrik?

[Fredrik Lithell:]

Hi. Thank you for taking the last question. Much has been answered but maybe Börje if you could just clarify your earlier comment on how we should view the potential in Q4 and on the sequential growth expectations. And then what you have seen the latest years is your sequential growth normal base sort of what we should base it on?So and the second one is, if you have talked about sort of mix shifts throughout the year here. You know North America product and service mix shift, and then also your graphic and mix shift. If you could sort of update on those comments if they still stand or if they have are more muted right now, and if they are pushed. So just clarifying that? Thank you.

[Börje Ekholm:]

What we say is that the new normal seasonality is about 18% Q3 to Q4 over the last two years. We foresee a bit less seasonality this year, and that's because of the uncertainty of this. I don't -- I don't know what would be announced merger in North America without going into customer names.So we see that to limit spend to beat and limit that seasonality so. So we should see. We expect to see less seasonality. That's basically what we've guided. I think, the next question is of course an important, but I also want to say we see you know given the work we've done on cost efficiency, and adjusting our cost structure and we leverage here both of course product costs, hardware costs, but also KI [ph] and automation, to limit, to gain efficiencies in service delivery. We see less exposure to the mix than we have in the past because we are I think overall our business is a bit tighter and a bit leaner.And having said that, the guidance we've said is pretty much still there as you said.

[Fredrik Lithell:]

Okay, thank you.

[Peter Nyquist:]

Thank you. So before handing over to Börje for his closing remarks, just want to remind you of the investor update we have at three o'clock Central European time. There, we can spend more as I said in the beginning, more on strategic long term topics. By that, I would like to hand over the closing remarks to you Börje, please.

[Börje Ekholm:]

So thanks to everyone for listening in. We are very excited about the opportunities we see in front of us for our technology. And we see the market for 5G being much bigger than we've seen for 4G. And we see 5G as we create new applications, both for consumers, but most importantly, for enterprise. We see a much larger market potential for 5G than we've seen for 4G. And we are determined to capture that growth potential first by investing in R&D for technology and cost leadership, but also to make sure we have a strong footprint in the market as we expand into 5G. And with the third quarter result, we continue to see progress on executing on our focused strategy to be a stronger company five to 10 years out. So with that, thank you and thanks for listening in. Thank you.

[Operator:]

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