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LM Ericsson (ERIC)

Q3 2006 Earnings Call

October 19, 2006 10:00 am ET

Executives

Carl-Henric Svanberg - President, Chief Executive Officer, Director

Karl-Henrik Sundström - Chief Financial Officer

Gary Pinkham - Vice President, Investor Relations

Analysts

Paul Sagawa - Sanford C. Bernstein

Edward Snyder - Charter Equity Research

Kulbinder Garcha - Credit Suisse First Boston

Peter Dionisio - Morgan Stanley Dean Witter

Stuart Jeffrey - Lehman Brothers

Mark Sue - RBC Capital Markets

Per Lindberg - Dresdner Kleinwort Wasserstein

Sandeep Malhotra - Merrill Lynch

Presentation

Operator

Welcome to the Ericsson's analyst and media conference call for the third quarter report for 2006. 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. Mr. Gary Pinkham, Vice president of Investor Relations, will now open the call.

Gary Pinkham

Thank you, Operator. Hello everyone, and welcome to our conference call this afternoon. This is Gary Pinkham, Head of Investor Relations. And with me here in Stockholm is our Chief Executive Officer, Carl-Henric Svanberg, and Karl-Henrik Sundström, our Chief Financial Officer.

Before we get started with the presentations I’d like to remind you that there will be forward-looking statements made during the call today. These statements are based on our current expectations and certain timing assumptions. As you know the actual results may be different due to a number of risks and uncertainties associated with these assumptions. And we encourage you to read our annual report and our earnings reports to get a better idea of what these risks may entail.

With that out of the way I would like to hand over to Carl Henric, for comments about our performance and plans going forward. Go ahead.

Carl-Henric Svanberg - Chief Executive Officer

Thanks, Gary, and hello everyone. Let me go through our presentations fairly quickly because I think it’s mostly known to you. We had the quarter in short, it’s a positive business momentum out there, and we are growing. We are taking in market share and we are securing a lot of these. Just give you some examples that of the already known, these are rolled out the essential we are doing in Brazil. Bangladesh is another one where we also will do manage services, but in India our major expansion where we manage capacity. In Chile where we are building out our core networks, Qualcomm in Poland where we are doing manage services. We have T-Com in Germany and Toc in Thailand where we do development access. And MiTV in Malaysia, these are some of the examples. Obviously, we were also extremely happy to see Sony Ericsson's performance in Q3, which contributed more than it has been before to our profitability and also a good thing to do in the five-year anniversary.

We have also a quickly growing focus on mobile broadband and not only in the mutual markets but almost more so in the high gross markets where fixed telephone is available and this may be the only way to get to broadband connectivity and access to Internet. And in terms of the mobile broadband at the next slide is this, we will know how and that enables mobile multimedia from music, mobile TV, mobile office, and notebook we want to do. And it is great to see how we lead the HSPA rolled out, 30 commercial launch networks and so far we have announced another eight contracts in the quarter. And in fact, we actually have contracts in North continent. We talked a little bit about the record fast rollout for Telstra in Australia, while we in only ten months managed to cover 98% of the population with a network that is capable of 3.6 megabits per second.

We had a wonderful quote there from one of the early users who said that sent us an email saying where do I begin. This work is simply fantastic, to give you a geek’s perspective, I’ve tried everything I can do I can to see its limits. He explain how he had downloaded the emails and listen to music and done banking business or what have you and he says there are simply no limits, it's like having a PC plugged in to my pocket. So that was a great joy and I got a lot of attention of course, but there are several of these blogs going on.

If we look at the next slide is the mobile data traffic, this is the slide from last time, no change. We seemed to wanted to give you some example so if you turn the page again we can conclude now from the research that is done by outside analyst that 3G subscribers, the date I use which is some 50 times higher than those in using 2G. We have seen that double data usage -- data was doubling over the last two years for user for 3G subscribers and also a 20 times higher data usage for those that’s -- subscribed to flat fees which may not be surprising. But to give you also, a couple of examples -- from around the world, 27% of the 3G subscribers in UK are downloading on average four songs per month. Hundred operators around the world have launched mobile TV.

If we look at the World Cup football event it jump from $300 million of revenues from data loans in those four weeks and as a similar example, the American Idol -- weeks handled 41.5 million interactive SMS’s when people were voting for their different favorites. And in meeting I had a couple weeks ago with the CEO commented on the fact that they distributed three billion SMS’s on the new Chinese New Year day. So that was just a few examples to give you been to what happening. We – on this thing about our leadership in services, we have the largest force in the industry 73,000 employees around the world plus more than 10,000 partners -- what maybe even more important for you is that we have doubled our sales now in the last four years and two-thirds of the sales in services -- in professional services is recurring.

We presently now have 80 million subscribes in managed network. We commented on our growth in Q3 which was 31% up over last year and year to date 39% up. This is of course a stronger growth than we would see going forward because we are still comparing with months or quarters last year when both the two service contract in Italy and UK was not in comparable numbers. But anyway strong growth there and we landed in the quarter some 21 managed services contract of which 14 was hosting and seven was in network operations. We talked about Q3 financial highlights where we reached 40.8 in the quarter of sales. This is -- this compares to a 12% year-over-year growth. As we said in the Q2 report we would see more seasonality, more pronounced seasonality in Q3 the noble year because we still have effects from Cingular 2G inventories. That we would see a correspondingly stronger Q4, which means that we will have a good second half of the year. And that is the national change back.

We are generally growing because market share, lots of projects where we we’ve been winning more than our share. And Marconi has been added and services are pulling strongly. We also, then on the next slide I wanted to look a little bit at growth on 2003 to 2006. And there we can see both seasonality effects, then you can see that the seasonality is slightly more pronounced. Here, this year, and earlier years. But you can also see that if we look at compounded average growth rates of sales which is 15% in 2006. Our OpEx compounded growth rate is 4%. So top line is growing 15%, OpEx going forward. A good part of that is from successful type of control and operation and excellence work, but also one part of it is because services is growing more than the rest, it’s going forward and that’s does not pull the same OpEx group.

If we look at gross margin, we were at 41.8 which is basic theory of where we were from Q2. We have 4 billion less of sales in this quarter then Q2. And that has impact also gross margin so from our point of view, more or less fabulous. If we look at the comparable numbers from last year’s it is Marconi added sales and the strong services growth that explains a good part of that difference. Operating margin ended up 21.5 which is more less than 9 in the last yea, but up 2.8% sequentially. We are getting as we said from Q2 -- services of the big jump and gross margins in operating margin. It came from the strong contribution from Sony Ericsson.

If we continue on the financial and we look at the margin developments, operating margin developments over the years, you can see that with now -- with a contribution from Sony Ericsson back from the level where we work for quite a while and still we have effect that I will come back to in a few minutes here from Marconi that begin in Q4. At the same time I think it’s fair to say that Sony Ericsson may not have this kind of quarters every time. But we are investing cost, margin level more so than even before I would say and I will come back talk about Marconi. If we talk about other Q3 highlights, the operating income reach 8.8.

We have more of a coincident the fact that we closed the deal with EMW which the sale of the -- the business we created a gain 3.0 and we also concluded the Marconi restructuring and the change program, so we have a restructuring charge for $2.9 billion. Of the 2.9, 0.7 is from the career change program of that 0.7, a $100 million has been paid out so far, the remaining part will be paid out, but we believe we should not anticipate so much on savings there because this is as you know it’s a way of giving a bit rooms to hire younger graduates from universities so that will be covered in that price.

The capital restructuring charge, Marconi has come back in a few minutes. Cash flow was at least 6.6, which includes the cash flow effect of some $3 billion from the EMW sale. Besides that we have some $3.6 billion of cash flow from (inaudible) which is a good start, it starts in a good direction here. Still we are in the operating capital because we have more larger projects than before. We have owned some more growth right now in high growth market in Asia and Africa where we have traditional longer payment service than we have in, for example, North and South America where we have sinking sales in this quarter.

We have an ambition here to close the gap to zero for the full year which means that we need to generate some $11 billion, $12 billion in Q4 exactly where we are going to end up I don’t think we can say so precisely, but that’s at least some (inaudible) from the management. We have also good growth on earnings per share from £0.34 to £0.39. If we then look at the different regions, we have to start with units here while we grow by 19% (inaudible) and growing transmission business, that is also from growing services business whereas network is more or less flattish at this point in time. There is lot focus on operators, first of all ownership and outsourcing and the battle now with -- the competitive battle with the falling high rates and falling roaming charges, but there is also an increase focus on HSPA and new services. And if we look at the Western Europe into next year we would expect more of the same, but old sort of fact that we’re starting to see increase needs for capacities upgrades.

If we look at the CEEMEA region, 34% up, so it is much the same as before, lot of activities throughout the region, lots of network rollouts, and also an increased focus on HSPA. As I said before, mobile development is all from the -- all the way to Internet access. So its at least as much focus here on HSPA as anywhere else and we are involve in rolling out some of the networks here. We expect much of the same here next year, maybe not that full year strong numbers here, but still it will be these regions. Next one, which is Asia, Asia is 38% up in the quarter. That is a sort of strong number with lots of activities in the regions and it’s a more diverse region than maybe the CEEMEAs because here we have Japan, we have Australia, we have India, China, we have Bangladesh and a lot of different markets here. Strong growth but still strong potential, we have some particular markets which we mentioned here but there is activities in basically every market and there are different ones to pick up in the different quarters.

We have as I mentioned the Telstra HSPA launch that has been I would say there is a lot of focus and I would say we look forward to another good year in 2007, maybe not at this high goals numbers, but just to lead the goals and Asian region. If we look at Latin America, this is where we have a bit of a consolidation after reckless strong rolled out in the last couple of years. This is particular was a slower quarter for us I guess you can all figure out that we will have stronger quarters now going forward with a rollout but generally daily capacity and coverage needs in the regions. So we will see -- we should see growing business in the next year and also an accelerating focus on rise on CDMA and HSPA.

If we then see these rolls to regional around through with North America, this is a quarter where we have -- where we last year had strong sales in US, we’re preparing for the rollout and for the 2G build out. And now we have this famous inventory adjustment where Cingular after the merged with AWS and the Cingular business and the trade off networks with T-mobile that happened a year ago, didn’t have full control of all the 2G equipment they had in their inventory. We actually -- it’s a quite unusual situation that an operator has an inventory between us and the site, they are turning down their inventory which means we have a little 2G sales in Q2 and Q3 we are now through that through a large extent.

We have also now seen the conclusion of the Spectrum auctions, which of course, that means that investments in Spectrum will be followed by my investments in new networks and new services. There is the Marconi site here. Let’s talk about that one. We are now along with a successful streamlining all the operations. That means that before the restructuring charge in the quarter, we prospect even and now we have also laid off the 1,600 people, some of it is till in process but basically out of the operation, which means that the charge that has now taken up 2.2 will create a corresponding full savings effect in yearly run rates from Q4. We have still the supply chain savings to materialize in 2007 and that work is on plan.

We have generally strong growth in transmission and growth demand in transmission. In fact, we have a stronger demand that we are actually delivering it we will offer in the process of doubling the production capacity to these demands. Some of which will kick in Q4 and will have full effect in Q1 next year more capacity, and as just one example we have seen this morning and we announced this morning Telstra is going to buy an optical networks from our store. And all the value of $230 million and nothing that suggest the good example of what -- of the integration of Marconi here. I doubt that they would have landed that order on their own, it’s a combination of the companies that agree to. So 2.2 in charge taken now in Q3 the staff reduction in 1.4 of this and that would be full savings of 5.24 and ISIP and facilities these are primitives and ISIT subcontract -- contract that has now been terminated and under the charge to the CNM, they were prepaid as the closing so there is no cash flow effect on the 0.8.

So then lets have a couple of comments on Sony Ericsson, I think it's all familiar to you so let me just say that we are steadily growing market share every year. We have seen successful launches especially from the Cybershot brand than the Walkman brand, and that is not only paying of single sales in the middle of the high segment that it is also becoming popular, also in the entry level don’t forget the entry version, for example, a Walkman phone and also we are pulling, we are seeing how we can pull both demand and price premium in the marketplace.

It’s also bit of a coincidence of course that we ended up with best in class margins. Also for Sony Ericsson, I don’t think we can conclude that this is going to be the case going forward because this was a quarter where everything came out and every product will successfully lower so, but anyway it was a moment of joy then. If we look at the trend lines, we have a 37% compounded average growth rate in terms of units shift over five years and a 30% failed growth rate. So we have actually very closed to the units shift so we’ve been able to keep our ASP number up with the focus on richer phones. When it comes to the outlook we obviously have no change in 2006. And when it comes to 2007, we see very much of the same as we had seen for 2006 that is similar growth, similar moderate growth and for the professional service markets, we expect to see continues good growth and in both areas we are in position to capture market opportunities and continue to reap up the market share. So thanks a lot now leave it to Karl-Henrik.

Karl-Henrik Sundström - Chief Financial Officer

Good afternoon and good morning. I would like to start with my first slide and that’s the short description of Q3 of 2006. And we manage to keep the margin stable despite an 8% sequential decrease and we also reduce the operating expenses between the quarters of almost a billion. Together with the unusual strong result from Sony Ericsson we manage to increase the operating margin from 18.7% to 21.5%. I also would like to highlight that we have now reduce the tax rate in this quarter to 29% and we’re all expecting as we mentioned the last quarter aiming as to 28% to 30% tax rate for the full year. I also would like to spend some time on this table here describing what actually happened with the Marconi restructuring, the career change programs and defense business. As you can see it was a charge to cost of sales of $1.7 billion, it was a charge two opex of $1.2 billion and of which basically 0.6 for selling in G&A and 0.6 for R&D.

This is the explanation of the changes on the cost side then in operating -- other operating income we had a $3 billion capital gain from the sale of the same business. All in all, that means that we ended up -- we did a 21.5% operating margin in the quarter. I do also want to highlight that excluding the amortization of intangible assets. It would had a 22.5% operating margin the quarter. Next slide please. We came in with a cash flow excluding acquisition of that directory of $3.8 billion. The cash flow was -- it was 6.6 for the quarter and we have then 3.1 in capital gain from the sale the cash flow we set. We had an underlying cash flow of 6.5 then you have to remember that in the quarter we also approach a net life for 4.3 bringing up the cash flow and growing acquisition and 6.8.

I think also I need to explain the adjustments and income of cash, why that is negative in the quarter and that’s explained basically by two things. In that is adjustments for the capital gain with the same business as well as the increased result from Sony Ericsson, it doesn’t bring in cash, in the way we do that equity accounting. We ended up with net cash about $34 billion and we came in with a very strong equity ratio overall 54%.

Carl-Henric Svanberg

As Carl-Henric mentioned we are growing to a larger extent this year in mortgage with payment terms or a little bit longer than traditional in North America and in Latin America. We increase the days by three days to 105, which means we will have a target to reach in 90 days for the full year. Inventory, even though it remains the same, 4.4 yet today it went down in the quarter to 4.2. The reason here is that we are building out a lot of project, big projects, in a lot of market and we are now pushing very, very hard to make contribution of this. We’ve see an increase in inventory turn over for the full year, but I am not really, there will be improvement. Account stable days went up a little bit and you can see that also in the balance sheet it went up by $1.9 billion and that is the reflection that we are taking our partners with us to finance our growth, thank you very much.

Gary Pinkham

With that operator we are ready for questions and answers.

Question-and-Answer Session

Operator

Thank you. Ladies and gentleman, at this time we will begin the question and answer session. [Operator Instructions].

Our first question from Paul Sanford with Bernstein, please go ahead.

Paul Sagawa - Sanford C. Bernstein

Working capital now you said, you know, general target nothing can probably given, you know, where you are and all the new network been -- realistic are those targets realistic for 2007? And would that imply any change in the mix of these large new built contracts versus the steadier business that requires more working capital in your mix with a achievement of those targets in 2007 be more result of, you know, just hardwork on the balance sheet? If you can just talk a little bit about that, I mean when will you achieve those targets if not 2007?

Karl-Henrik Sundström

We will be somewhere around that target and that’s depending on the hard work we’re going to have. I do agree with you that having a 5.5 in inventory turnover when we had been wining during the last 18 months or so in a big project, if these are the challenge. On the other hand, I do believe that we need to access them for every year. When we started this year we didn’t plan to have so many huge projects as we have this year and if we change the target we will do that at the end of the year during Q4 report. And I agree with you on the inventory side it is a challenge. However, we have all then we’ll probably change the target also to expand little bit when it comes to table base.

Paul Sagawa - Sanford C. Bernstein

All right, would you anticipate that the mix of new contract even what you have been winning stays at this level for the foreseeable future or is it moderate factor or normal mix of stake?

Karl-Henrik Sundström

You know, we’re talking about basically 16, 18 months in advance now so if you please let me back to that at the end of Q4 I will feel more comfortable. Thank you.

operator

Our next question (inaudible).

Unidentified Analyst

Also maybe I should just take on that, that we have -- we will always see a little bit of springs because it depends as you understand whether we see growth in Africa or Latin America or America or so on so that’s a lot of change. But the big change that we have seen from smaller to larger project that happen. We have now a mix of bigger project and smaller project. So there is no fundamental change is going to happen going forward.

operator

Our next question today is from Edward Snyder with Charter Equity Research.

Edward Snyder - Charter Equity Research

Thank you. Is customer financing becoming increasingly important as you have seen more competition, especially and that’s 3G systems, and also outside of Latin America, are seeing any indication of CDMA operators considering a move to GSM, and this finally go to housekeeping, are the savings from Marconi restructuring $2.2 billion will those be evenly distributed by quarter starting in the fourth period this year?

Carl-Henric Svanberg

Well, I’ll let Carl answer the last one here but the just the first one, customer financing is for those of you have provide because when the ninth is when where was local green peace roll outs from those start ups then -- was an access to get started the easiest when you see new start ups in the increasing start ups its bounded by all ready cash generating companies in that particular region whether their ___ or how where it is. So we don’t have that all that push for it get over times when financing is still needed and also can be asked for as a competitive tool, but its unlikely that we will able to come up with much better finance terms than they could do themselves. So it’s not a major trend but it’s a, we have seen more interest in it. from the CDMA side is that the essential sort of wideband CDMA, I think it’s quietly as that’s the market have understood that the future is much more on the wideband CDMA side and that they are all CDMA operators that are reviewing their perceptions, I guess its known that following the sales have sort of open the discussion, this maybe on subscribing network, following that I guess you have and screens when you -- several of them have taken their perceptions. Then you have China, I don’t think that will change. But I am sure that there will be mid size operators that will still and also pay some I wouldn’t be able to say. Do you have any questions?

Karl-Henrik Sundström

On the Marconi it was like 110 in the presentation he said that once we have now taken out $2.2 billion of cost out of the business in the charge. That will basically sort to get through in the Q4. Is that what your question?

Edward Snyder - Charter Equity Research

Yeah, I was just, you are looking at $2.2 billion -- more okay, thank you very much.

Operator

Our next question say is from Kulbinder Garcha with Credit Suisse.

Kulbinder Garcha - Credit Suisse First Boston

Yes, thank you, I guess the first question I have is just that you mentioned you have seen a very strong for transmission products and how should we think about how that impacts Marconi sales because I guess you would be very confident of you know, very strong sales because the Marconi going to the next year given -- then linked to that question there is a very strong demand you are seeing for wider wireline products, change of attitude is that how quickly you want to get in to market. I think -- do you think you can do all still or is the demand so strong that you may have to consider maybe even large acquisition than you have been previously considering. And then the next question that I have is just on business mix and this year I think you made it clear that business mix for the overall business especially including services with is going to be worst than previous years. Do you see that still going to 2007 or the business mix be about the same, do you think?

Karl-Henrik Sundström

While on the transition side, we are seeing a bigger amount, remember when we talk about doubling capacity in transition its not everything we acquired from Marconi was two sources that was on the transition side. And if you have a growth of a say 15% or so you double that every four years. So these are capacity needs and there is a long backlog and there are opportunity for us to expand and grow. This is the important business to us because it is -- gives us news business relationships since the transmission networks that are needed for traffic whether they come from -- or normally handled by the fixed operators, so it gives us in roads and that is very important and especially important with the Marconi has it outside US. That position in US is not that significant -- I missed your second half --

Kulbinder Garcha - Credit Suisse First Boston

Just the follow up to that just the demand you are seeing in the area on the wireline side on transmission does not, under -- you don’t have a US position, just how strongly that progress into that, change obvious to whether you can do this organically from here on in or whether you should consider a large deal is going forward.

Karl-Henrik Sundström

I think that we believe generally that when we can do things organically normally a faster way to success, because integration and so one of the companies are always take its time and we just successfully completed of course that’s the way of jumping ahead of it. We have a strategy based on own development and so on as I think it’s a -- it would be interesting to see what we can do on the rollover that goes on if we are a bit fortunate that is a way for us to get in more seriously with the operators in US. There are companies as we have said that have products, the market positions that could be interesting for us to explore fund acquisitions. We are not dependant on this, but it could be exciting to leverage such opportunities.

Carl-Henric Svanberg

I think getting into on broad band access as well as fee and specially T-com, I think is a clear sign that we have a very-very attractive portfolio when it comes to access.

Kulbinder Garcha - Credit Suisse First Boston

And then just a follow up on business mix.

Karl-Henrik Sundström

Business mix in which sense?

Kulbinder Garcha - Credit Suisse First Boston

Well, you know, in the sense of this year you had a highest leverages content and you had higher new network gross, and that seems to some degree depressurize your core wireless business in terms of margins but 2005 and 2004. Do you see that business mix at this level going forward, could it deteriorate, how do you think about that?

Karl-Henrik Sundström

I would say that, even if this is a kind of dynamic industry and things are moving fast, but the overall funds includes I think mobile networks will continue to be a very strong driver for our business and lots of roll outs that goes on, then the high speed networks and so long. I still believe when it comes to converting networks and the fixed operators in that sense, there are more strategic important deals for -- sense, but major sales in that area, we are still a couple of years ahead. So decide to transmission side, which is a growth area in itself.

Kulbinder Garcha - Credit Suisse First Boston

Thank you.

Operator

Our next question today is from Jeffrey (inaudible) with UBS, please go ahead sir.

Unidentified Analyst

Yes, thank you, just two questions if I could, just to go back to that working capital intensity. Would you say that we’ve seen a steady increase obviously to the course of this year, have we had a peak in that? Given your comments and where you are thinking to take the inventory returns going forward in DSOs, would you say that, you know a full stop that we have had a peak event -- particularly and you had a backlog to -- today. And second question, if you stripped on Marconi’s Western Europe and system business would that have been flat to down this year versus 21% reported growth and do you think you can show growth in Western Europe next year. Given your comments there is not a lot of growth in the market. Is this the market where you are thinking to take share?

Karl-Henrik Sundström

Well, if we -- you are breaking up this as -- little bit hard to this year, but if we talk generally about the working capital situation we have gone from fitting in capacity and that starts to running larger projects and follow that -- and more role scenarios where the longer payment terms and also to even larger than normal sized contracts. With that shape had happened and that means that we should be -- stable now in the working capital situation in the prerequisites from the market side. Then we can do better or worse and that depending on how we run our business and the kind of swings between quarters between markets as well, but generally -- question there, so from that point of view we should have the cash flow going forward on a good ratio. If we look at Marconi as it was added into the sales in Europe but it is clear that months for this Marconi driven gross in Europe and the other part of service is it is so but services is a major driver in Europe as so many operators both have are looking for savings but also that they are preparing for much broader scope of services and becoming much more of a multimedia component not just as service provider and therefore running networks may not be as keys, it is also correct that efforts except the transmission was more flattish, then we have, if we are going for the next year it is hard to say but I -- our own -- that we will start to see more capacity and upgrades in next year because -- rather squeezed in the networks.

Unidentified Analyst

Thank You

Operator

We now have a question from (Unidentified Analyst) with Goldman Sachs.

Unidentified Analyst

Yes, thanks very much. I just want to clarify something on the Marconi restructuring and I think that as at the end of the Q3 you now say the increment so $2.2 billion on your large saving, but per quarter or how far these savings already been realized as the businesses move to break even through Q3, so the amount we should think about for Q4 and beyond is going to be less than $2.2 billion amount. May I have a brief follow up question about the Q4 gross. If you would have say a normal second half pattern that would imply around 40% as sequential ramp and sales into the Q4, properly or is there anything we are missing thank you.

Karl-Henrik Sundström

The first question is your first alternative, you will see from the Q4 a $2.2 annual savings that may begin, that was not their in Q3. On the second question if you are getting down to these and percentages that I don’t think we should answer on that versus normal seasonality we expect normal seasonality for and obviously as Q3 was below normal seasonality, we would see that which --

Unidentified Analyst

Now, thanks very much, I understood, could you just help us to the key swing factors for the Q4 is there any areas of opportunity that we should focus on.

Karl-Henrik Sundström

I mean it’s more or less I wouldn’t say that I mean, we have a backlog of the company, the company is like probably more and more six miles than three miles which means that whatever we should do in the Q3 is already in -- so its more up to execution in that sense in a quarter that is of course not all through because there is always -- of the orders coming in and so long that can create some extra gross or -- but there is no particular triggering effect the on going contracts that are there in the conclusion based and -- so on they are already in the --

Unidentified Analyst

Thank you, very much

Operator

We now have a question from Peter Dionisio with Morgan Stanley.

Peter Dionisio - Morgan Stanley Dean Witter

Thank you, just two questions please, on 3G could you just give us a sense on how successful you have narrowed the gross margin differential within your 2G and 3G products. Specially as your 3G volume continuously increased and -- is there still a big differential between the gross margin of those two product platforms. And the second question is that in professional services in the past you have talked about to improve the economy subscale you were expecting from your large contracts, such as the ones with Hutchison Italy, and the UK. Could you just give us a sense us as to where you want it now in terms of this economy subscale, thanks.

Karl-Henrik Sundström

I can answer the 3G and I would like to say the following. Obviously the margins are on the same between 2G and 3G radio access, remember that we have the same core right now. However, quarter by quarter the GAAP is getting narrower and narrower between the two technologies and in overtime we don’t see any reason why it should be a differentiation between 2G and 3G margins.

Carl-Henric Svanberg

And I guess we are getting the actual as there. On services the -- that is difference Marconi, where you have more of a step by where you take out people and we have accepted earnings so when it comes to services as more and everyday work with operational excellence and processes and methods since -- I think we found quite forward actually and as we have stated many times that the service package as a whole on the growth and services is not particularly pulling down Ericsson's operating margin. Although it has to lower gross margin as you know, but we have come quite forward on the UK and Italian deal.

Peter Dionisio - Morgan Stanley Dean Witter

Great, thank you.

Operator

Our next question today is from John, BMO capital market.

Unidentified Analyst

Thank you very much on the operating income by segment, if you could just explain the trend from second quarter to third quarter, I understand some of the category of unallocated is kind of conclude some of the capital gains and losses, but systems trended down significantly there can you just clarify of that, thank you.

Carl-Henric Svanberg

The trends between Q2 and Q3 or -- no but on the segment the operating margin is at 17 both in Q2 and in Q3. It’s the same operating margin despite about 8% left in -- remember right.

Unidentified Analyst

Yes the systems operating income declines from $7.2 billion SEK to $3.6 billion. I just wondering if you could explain that in and the --

Carl-Henric Svanberg

Now I understand your question, that is because in that we have included a $2.9 billion a charge for the restructuring of Marconi, they amount to --2.2 and the career change also 2.2 and that was 0.7 and that was my slide was going to explain. So the restructuring charges are own contributed to the systems. And then if you look upon the capital gain or actually kept by the corporate level and there is no product of other operations, did that explained?

Carl-Henric Svanberg

Yes, that explains, thank you.

Unidentified Analyst

That means that is basically an unchanged operating margin between Q2 and Q3 as 17% adjusted for the -- if you take away the extraordinary charges of 2.9.

Unidentified Analyst

Thank you very much

Operator

We now have the questions from Stuart Jeffrey with Lehman Brothers.

Stuart Jeffrey - Lehman Brothers

Hi thank you, I have a question on Marconi you are taking $2.2 billion charge note, how about on your life savings from a break Q3? So that would imply something like a $2.2 billion profit, operating profit on revenues of annualizing -- giving you, you know, royalty margins in the mid teams. Can you talk a little about how you see that developing? Is there risk there because you like to -- with some of your key competitors that you have to step up on -- on a selective basis -- for market -- in general under that operating margin get squeeze slightly over the next 12 to 18 months as to try to gain more market share? Thanks.

Karl-Henrik Sundström

I would rather have expected the other question actually from the other point of view because we still have them to leverage the opportunity for savings and the supply chain which will begin in 2007. So we had -- as we said in the beginning, we have ambitions to bring the operating margin to Ericsson levels for the whole integration work and I think that was perceived as rather bold a year ago. We are almost there now with the savings had done an overheads only. So I don’t know why, we have -- really had any such indications that we need to step up in a particular investments or so. In fact I would rather see -- I would rather expect that number to continue come out whether nine or even -- required to company. So, I remember that is -- said that again -- so we are getting into details here longer time that is always hard to know but -- that’s a really successful integration.

Stuart Jeffrey - Lehman Brothers

Okay, thank you.

Operator

We will take our next question from Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets

Thank you, do you feel that the Nokia, Siemens and Alcatel losing combination is creating opportunity towards share gain for Ericsson. Can we potentially see some swapping by Ericsson as you attempt to increase your footprint during this consolidation period?

Karl-Henrik Sundström

Let me just say because it always sensitive we rather talk about ourselves than our competitive and probably say only things that they are already aware off, but it is obvious in two things. One is that they as we said, if you remember when we talk to Marconi integration we said, one thing for sure for 2006, don’t expect much growth because we need to do the integration right here. And I don’t think there is any otherwise to get around in integration work whether it’s -- we’re doing it or anybody else. So only that would me invest that there is energy lost in the marketplace and the opportunity for us. The other part of it is that which is also obvious and we would have in our calculations that we create something large is that they are all operators out there that are saving on dual-sources -- vendors where they happened to now be in the same camp -- single source. And that is something that with lots of plan by that operate at least, so I think that will all start opportunities that would arise and we have some such discussions going. So, I guess there are all opportunities out there.

Mark Sue - RBC Capital Markets

Okay, that’s very helpful. Thank you good luck.

Operator

We now take a question from Per Lindberg with Dresdner please go ahead sir.

Per Lindberg - Dresdner Kleinwort Wasserstein

Yes, thank you so much. First congratulations now we have understood that you have now become the world’s most profitable telecom equipment maker, not only mobile systems but also mobile phones given Nokia’s figures earlier today. Coming back I have to say you off industry market gross and their market share aspirations, have they increased in lights or Nokia's combinations with Siemens, Alcatel/Lucent/Nortel and mergers and CDMA, and also the clear fact that Motorola is shifting almost all the foreign deed to WiMAXI, and that’s a number of independent players now collapsing from 8 to say between 3 and 4.

Karl-Henrik Sundström

Well I think it is in a bit of maybe I don’t know, in a bit of funny way. We could end up with basically only winners into marketplace because the losers are those that disappear and leave room, better room for growth. I think it’s fair to say that we are the winner in the consolidation. I think it is also fair to say that even new guys like the Chinese are also winners because -- is looking for alternative. But I also think that the merger -- the merging companies also turned out to be winners from their perspective because they are creating stronger, better companies that -- it can do better in the long run. Of course, then they are the Nortel and Lucent and Siemens that get absorbed and then the other as well and that’s how they are losing out. But I think you know, that is probably a part of assumption. I think it is also good that we get to longer companies that can help, developing the industry and are not just struggling with R&D capabilities. When it comes to WiMAX, it’s I mean that’s an interesting technology and it will play its role obviously. So far -- to some extent gathering maybe more interest from those that have lost out to beat in the big race. And therefore need to find disruptive ways of creating positions and so on. Last effect that you see also an increasing activity from the IT industry so it is IT versus telecom view when it comes to what technologies to use and so on. But generally I would say the old dynamic is not working against us, it’s rather working for us, I would say.

Per Lindberg - Dresdner Kleinwort Wasserstein

Okay, thank you. And this in terms of long-term pricing I would assume them, given that we could see a slightly concentrated supplier structure especially in your track -- GSM and WCDMA.

Karl-Henrik Sundström

Yeah it’s a little bit hard to know exactly how things are going to be -- going to play out. But in -- and you all know the price trends we have been living with for the last 20 years, we did see an acceleration of price a couple of years ago before the merges took place when several companies where seating on sub-critical message and just need to grow and trying to buy market share was one way. It didn’t turn out very successful for any of them, I would say. And the merges solved the problems. But this also means that you don’t go out to spend all that money and then go out and fight for additional market share price rise, that certainly makes sense. So I think there is bit of sobering up and coming back to a more traditional terms. And I also think that the Chinese have been aggressive all the time but they aren’t getting more business now and then plus and minus -- also add up for them.

Per Lindberg - Dresdner Kleinwort Wasserstein

Thank you very much.

Operator

We now have a question from (inaudible) with SCB

Unidentified Analyst

Yes, hello, question to Carl-Henric, you are referring to - growth for 2007 mobile systems and the report what we heard from you today you is so far express great -- does that mean that you expect further market shakings in mobile system 2007? Secondly, on network rollout I recall was saying about this number in absolute terms, things will -- the whole decrease over Q1 and Q2, does that mean that we should look for like similar numbers not for terms of percentage -- in Q4 like in Q3 or do you foresee any major difference there, thank you?

Carl-Henric Svanberg

When we sort up with the outlook, we have said today as you know that we expect a similar growth ask we’ve seen in 2006, and that’s in the – we have taken market share now for the last couple of years and there is just nothing, I think, in the market that says that we wouldn’t continue to do so, I mean we are in good shape and we are focused on the market and we are focused on the future and several of other things to focus on that’s what I mean parallel. So I think we have good reasons to expect that we can continue to gain both network side and on the services side.

Karl-Henrik Sundström

When it comes to -- 0134 network grew a lot I would like to say that it’s probably going to be similar to what you have seen in this quarter. However, there were also a little bit more of short orders in to Q4, and that’s little hard to predict, actually how is it going to end up, but -- so that’s my answer right now.

Unidentified Analyst

Thank you.

Carl-Henric Svanberg

Thanks very much

Operator

We now have a questions from Sandeep Malhotra with Merrill Lynch, please go ahead.

Sandeep Malhotra - Merrill Lynch

Thank you. You know, you talked about ‘07 guidance for the mobile systems industry for moderate growth as being your earlier estimate. Could you take us through what could be some risk scenarios that moderate doesn’t materialize and growth is actually slower than what you currently expect, and also a follow up to that, could you talk a little bit about -- there has been a talk in the market about potential breakup of -- and being sold to competitors. What impact would that have on your managed services contracts, how are they structured in the event there were some kind of change of control? Thank you.

Karl-Henrik Sundström

Well, let me start up by saying that’s on the -- to the last one. First of all, I must say I haven’t come across such rumors and I am not sure how that would -- what would drive that, but the breakup from Hutch but that’s anyway if the managed services contracts with -- they are offering conceivable savings to Hutch. And if anybody which I think is very -- if anybody would come in and buy those companies, it will be the last thing that would do was to go in and try to change that. They will change -- uncontrolled grosses and lot’s of compensations and such things involved there. So that’s not an easy thing but I don’t think that will be a contractual -- I just don’t see that extra mile, that would be the last thing they would do.. If we then look at the market outlook where we see a moderate growth, large project that’s -- I mean who knew that the who would be this years, who knows where a number of companies -- operate this will be next year and exactly how they will all love that. So if you talk about the couple of percent, ask for a couple of percent down, of course, that would happen because if the project is accelerated or the project is delayed. But I also think that you have seen now over the last three, four years with us being in basically every single corner of the world we are at least, probably the least dependent on particular event. So all the -- but all the actors in the field, we have no customers that is particularly large, we have no country that is particularly large. So I would say that it’s probably a rather safe bet that it’s a deal in that --

Sandeep Malhotra - Merrill Lynch

Just a quick follow up, if I may. How much of that moderate growth that Ericsson might deliver next year would be dependent on Asia-Pacific and do you expect -- you know, what do you expect the competitive environment to be, and some of these Chinese deals coming up in light of some of the consolidation and the industry that we have search engine?

Karl-Henrik Sundström

If we start off again with the last question, I would say any of rollout that is a initial rollout of something that is considered or anticipated to be eventually large will have more competition and that is why you see such a competition in India because potentially for huge and big -- in a few years it sounds like -- So, of course, it’s going to be healthy competition in China, but I don’t think some of the -- anything different from other large deals that all being made. Asia-Pacific right now seems to become more important to us, but not necessarily because of what we may want to think about it in Asia, that is China and India -- these are all growing best, but the -- growth in Japan, which is significant and that’s the -- its more like in America or Australia or somewhere else.

Sandeep Malhotra - Merrill Lynch

Final follow up on it. So would it be fair to say that pricing environment in Asia-Pac for the larger deal, will it get worst before things get better as a result of consolidation.

Karl-Henrik Sundström

(Inaudible).

Sandeep Malhotra - Merrill Lynch

All right, thank you very much.

Operator

We will now take our question from Richard (inaudible).

Unidentified Analyst

Thanks very much, just a couple of clarifications for telecom first. You gave as the last quarter what the sale for Marconi were, could you tell us this quarter and also tell us the currency impact on sales and then perhaps for one of the two of you to, you made several commends about Sony Ericsson, which is becoming a larger portion of your earnings having an unusually strong quarter and perhaps not being able to maintain its current performance. Can you tell us what some of the swing factors there might be and what sort of expectation you have for Sony Ericsson in terms of the profitability? And also is there any plan in future to improve the disclosure for Sony Ericsson, which I think by all measures is well behind all of its major handset peers, thank you very much.

Karl-Henrik Sundström

When it comes to Marconi as I we had said already in Q2 and which we are emphasizing in this report it is getting hotter and hotter to be separated because we saw that both the big deals with T-com and the CLC in Thailand is a combination of our -- godown sales offering and their godown offering ending up in our new offering, so it becomes erratic and very wrong. The same thing is that one of the main thought in the deal was actually to replace their point -- that was started really from the beginning with -- we can’t disclose because the number is impossible to find. What we do however is having in good rife even on the cost structure and now if they can --.

Unidentified Analyst

Okay and currently impact?

Karl-Henrik Sundström

Of the Macaroni?

Unidentified Analyst

No, overall on the group in the quarter.

Karl-Henrik Sundström

The currently impact -- currency of the US dollar move 3% and this -- in the Q3 we have left 50% in US mainly because of the downturn inside, it’s probably around, in round figure its around a percentage.

Unidentified Analyst

Okay.

Karl-Henrik Sundström

Sony Ericsson it is a little bit difficult to predict -- more difficult, I would say for us to predict than maybe the network because it’s so dependence with their perception on exactly how successful they are with various drawbacks. This monthly quarter-- their product is very well in the marketplace and that they -- not always be the case, but this -- there is strong growth on the strong journey. So we shouldn’t -- 15, going forward, but it’s also clear that all the large ones are gaining market share from the smaller and also that Sony Ericsson now for a while have maybe the fastest and if you do look, which I think is official we have no particular information there, but if you -- as we do only basically DSM, CDMA phones, if you compare that to, for example Samsung and their position and look at where they are on the DSM dual-band than you’ll find that they are actually catching up very close now and the position there for a number of two years is closer in reach than the overall number three positions.

Unidentified Analyst

Are there any intentions to improve disclosure with Sony Ericsson perhaps to give a sort of breakdown in detail that all of our other major competitors do?

Karl-Henrik Sundström

I think it’s a fact -- when the company is getting so big and also starts to become so important to our profitability and not to talk about Sony, its also a venture so this is a discussion that has to go between here and Sony Ericsson and also to Tokyo, but I’m sure we will -- that is the question that should be the best.

Unidentified Analyst

Okay, thank you.

Gary Pinkham - Vice President, Investor Relations

Operator that was our last question. But before we conclude for today, I would like to remind you that out next management briefing is in Tokyo on November 15. Agenda and registration commission is available on our website and if you like to participate, I encourage you to register as soon as possible. With that I would like thank you for participating in today’s call and see you next quarter.

Operator

Ladies and gentlemen, that would conclude today’s conference call thank you for your participation you may now disconnect.

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Source: LM Ericsson Q3 2006 Earnings Call Transcript
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