LM Ericsson Telephone Company's (ERIC) CEO Hans Vestberg on Q2 2014 Results - Earnings Call Transcript

Jul.18.14 | About: LM Ericsson (ERIC)

LM Ericsson Telephone Company (NASDAQ:ERIC)

Q2 2014 Earnings Conference Call

July 18, 2014 08:00 AM ET

Executives

Peter Nyquist – Head of Investor Relations

Hans Vestberg – Chief Executive Officer

Jan Frykhammar – Chief Financial Officer

Johan Wibergh – Head of Networks

Helena Norrman – Head of Communication

Analysts

Edward Snyder – Charter Equity Research

Gareth Jenkins – UBS

Mark Sue – RBC Capital Markets

Alexander Peterc – BNP Paribas

Stuart Jeffrey – Nomura Securities

Achal Sultania – Credit Suisse

Francois Meunier – Morgan Stanley

Simon Leopold – Raymond James

Sandeep Deshpande – JP Morgan Chase & Co

Andrew Gardiner – Barclays Capital

Sumant Wahi – Redburn Partners

Operator

Welcome to the Ericsson's analyst and media conference call for the Second Quarter Report. To view the visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. (Operator Instructions) And as a reminder, a replay will be available 1 hour after today's conference. Peter Nyquist, will now open the call.

Peter Nyquist

Thank you, operator. And hello, and everyone, and welcome to this call. With me here today, I have our CEO, Hans Vestberg; our CFO, Jan Frykhammar; and our Head of Communication, Helena Norrman and Head of Networks, Johan Wibergh.

During the call today, we will be making forward-looking statements. These statements are based on our current expectations and certain planning assumptions which are subject to risks and uncertainties. The actual result may differ materially due to factors mentioned in today's press release and discussed in this conference call. We encourage you to read about these risks and uncertainties in our earnings report, as well as in our annual report.

With that said, I would like to hand over the call to you, Hans. Please.

Hans Vestberg

Thank you, Peter. Let me start with some of the key developments in the quarter from the market point of view, I think we are seeing a consistent focus from operators on the network performance as a key differentiator especially in the more advanced mobile broadband markets. It's not about capacity enhancement in urban areas, but also densification in urban areas that is very important in that sort of differentiation on the performance on the network.

Those discussions, those are the most common discussion we have with our customer today. Another thing that is of course happening, it's that the quick transition to 4G in China. We see a quick deployment on 4G and quick ramp on 2G investments, till of course subscriptions and subscribers on 4G still to come, but we can clearly see a very quick and strong push for 4G LTE in China.

Another thing that is also happening in our customer interaction, is that we discuss more and more the acronyms like SDN, NFV, cloud because we see a new generation of the virtualized networks and we see actually a lot of debates, how you're going to design the networks in the future, this is initial phases. Some operator complete with further but definitely we are into a process where operators are now thinking how to virtualized and use the software defined networks and virtualization.

I think we are shifting really good. Here we have been designing and defining our product portfolio virtualized for quite some time and our product is coming out virtualized as we speak and we can report on that transformation. Another highlight in the second quarter from market point of view was our release of Ericsson Mobility Report, very good reception of it, talking in many markets.

This is sort of becoming defacto [ph] standard the outlook of mobility and mobile broadband in the world, mobile data as well, and we think it's very important to have that base, when we think about our business going forward and we think, we are unique in the sense that we're in 180 countries and we work with all these operators and we seed investments as well.

If we look at ourselves, we saw continued rise on demand for managers because we've signed 21 new contracts across nine regions in the quarter. And this is of course very important for us. Another thing that we see, at size ahead our portion of Mainland China, 4G LTE deployment, where part of that, we see a high degree of activities as well in Taiwan. And we can also say, that we are very proud of taking portal or leading getting awarded the Multi-year BSS Contract with T-Mobile.

This is sizable, very important for the industry, for us reference. How we want to transform the billing systems in the future and of course taking up one of the main competitors here, which is important for us. And we acquired or we concluded acquisition of Red Bee in this quarter, being now to a very strong portfolio in broadcast services 2,500 employees and some roughly 330 TV channels under management in our broadcast services.

We are building a sizable and very important broadband services connecting that with our TV and media investment of course, we are really trying to see that we are keeping and developing our number position, that's a little bit of key development. We would then take the quarter in numbers; SEK 54.8 billion in sales that is slight negative growth of 1%.

Of course, quite vested in the first quarter, when were down 9%. Where couple of markets year-on-year does contributing Middle East, China, India all have very high growth numbers. On the other hand, we also had good capacity business in North America. If then we look at our sequential growth that was 13%, very good. Gross margin coming up, Jan will be come back to this and our that ends our operating income went up to SEK 4 billion year-on-year improvement from loss.

Operating class flow continued positive at income SEK 2.1 billion and we need to remember that we had SEK 10 billion in the first quarter. So we're adding in good cash flow generation at the moment.

If you then look at the regions and look year-over-year, five regions out of 11. We have other as well, so it's 11 regions. We are growing and the rest were not growing and if you take it from them, lower this one, is other. Other includes then the broadcast services that is now included and of course Red Bee came in to the play in this quarter, but also we have the IPRs that of course year-over-year has a higher portion across licenses agreement, that is at the increase as well.

There is also Middle East, India growing well. On the other side, Sub-Saharan Africa down to 29%. This is of course, clear decline. There are few large operators in Africa and one of them are investing a little bit less right doesn't change our view on Africa that mobile broadband and mobile internet will be extremely important and will for the next five years at the local new subscriptions. We are well positioned in that region.

If you then look at sequential, you see a totally different picture of course. We have now, 10 out 11 regions growing and of course North America has a very strong sequential growth and as I said, since the second quarter last year, we have lower activity on the large coverage project and that's still the case.

What we see instead, we see capacity enhancements coming in the second quarter there, but it's also Northeast Asia talked about it, China strong in the quarter given that we're now rolling out 4G Middle East, Mediterranean as well strong sequentially, by that I hand over to Mr. Jan Frykhammar.

Jan Frykhammar

Okay, thank you. Hans. Hello everyone, so second quarter highlights then, top line Hans have talked about that a lot. I will not spend time on that. I think gross margin is important, you look at the graph you can see that, we operated the company at between 30% to 32% gross margin for basically the whole of 2012 and most of 2013. Now we have established ourselves on a higher level.

What is important here of course is to understand, that this is driven by more capacity business on mobile broadband. Also what Hans mentioned the higher level of factors in licensing revenues as well as slightly lower restructuring charges. The mixed shift is reasonable in the networks segment numbers, but also the same thing as in the first quarter, if you look at the network allowed revenue then, coming down.

Operating expenses increased year-over-year to SEK 15.6 billion. The main drivers for the first half were also the second quarter, if the acquisition of Mediaroom and also the integration of the modems business, but we have an organic increased in the second quarter of R&D in the area, that Hans have mentioned already and this is very much in line with the strategy, we have.

We saw a small reduction in selling and G&A expenses and we continue to work on making sure that we do the right efficiency measures and at the same time, create a long-term sustainability for the R&D investments, that will create a new Ericsson over the years to come.

Operating cash flow, Hans mentioned it already. I think; driven very much by the strong income in this quarter. you see the working capital in absolute numbers coming up a little bit driven by mainly inventories partly offsite by payables, but I think it's important to highlight that, and of course that's an indication of higher activity, going into the second half of the year.

The sales growth and FX impact, you see the table there with the numbers per segment worthwhile to mention obviously 5% in networks, 5% in support solutions, 8% minus in services. This is network cloud impact professional services that allots [ph] well, I also want you to look more at the sequential growth especially in managed services in that segment.

The major FX or the major currencies that was impacting us continuous to be Dollar, Euro and Yen and from a profitability point of view it's mainly movements in Dollar and also to certain degree Yen that impacts the operating income. We are quite near, to as I've said on the Euro side.

I will also then come back to this rule of thumb of that we talked about at the Investor Day in November, which is really that if you see we have a movement of $25 up or down in the Swedish Krona versus Dollar, that impacts approximately this unrealized revaluations of FX contracts with about SEK 500 million and that was exactly what we had this quarter.

Now, the FX hedge contracts are then valued at the closing rates of end of this quarter. So what this time, will be end of third quarter depends on the differences between closing exchange rates of dollars now and end of September, so that's I just want to be clear on that.

And then operating income bridge; just highlighting again the main drivers. We had some one-time costs last year related to divestment of the power business, but also the investment of part of Telcordia business. The main driver for improvement, we will know that gross margin is that then we had, the increased OpEx that is partly offsetting the improvement, net-to-net the way we look at it, it's an improvement of SEK 600 million year-over-year.

Change in gross cash, lot has been said net cash negative SEK 11.1 billion in the quarter mainly driven by dividend. When it comes to operating cash flow, we repeat what we've said many years before; that we look at this numbers on a full year basis and since we have typically the biggest quarter from an income [indiscernible] point of view in our fourth quarter, you have to remember that there is some seasonality in operating cash flow.

Also we typically build up some inventory in third quarter for fourth quarter deliveries. So with that said, I want to hand back to or I want to hand it you, Johan, please.

Johan Wibergh

Thank you, Jan. So for networks, then we had a good second quarter and as Jan said, that we were favorably and supported and by having operators focused on that performance leading to capacity in investments and here we are seeing it's not only the advance LTE market that driving, but we see it's spreading into more parts of world such as Europe supported by the Vodafone Spring product for instance.

We are almost happy to see, that we had a good second quarter income to the SSR product and seems to launch, now we have 120 customers to chose, not for the SSR product, usable fixed and mobile IP and it feels really good. So that was 11 new customers during the quarter.

Then on the top line then, net sales were up 5% organic FX adjusted; and strong countries and regions during the quarter were Middle East, China, US and India and if you looked on various products. Radio [ph] had a strong second quarter and that was IP had a very good net sales growth as well as IMS and that it was driven, it's VoLTE, it's voice-over-IP it's the early advanced LTE markets that are now migrating or starting to offering voice based services based on VoLTE, which is IMS based.

And then, we there had a number one position in the market. We have started very strong in there that is not paying often on the top line side. And quarter-over-quarter 19% up and operating income SEK 3.6 billion which is a good improvements in year ago and it's based upon improved business mix and then the things below understand at the Investor Day back in 2012 regarding the [indiscernible] worked upon commercial excellence, operational effectiveness and cost adaption.

The cost adaptations were down. All the work we are doing around commercial excellence and how we are handling prices, upselling, using the installed base etc is paying off and operational effectiveness is really the application or lean methodology, all across the unit, which is really paying off and increased efficiency, lower cost and bigger output.

I'm extremely happy and encouraged with all those improvements, we've done on the operational effectiveness side. We also were supported by higher IPR revenues during this quarter. So that landed in 12% operating margin and of course supported and by higher sales, because it feels extremely good now to have had four consecutive quarters with double-digit margin and it will now continue to be our focus and see if we can keep that up and that's the ambition of the coming quarters of course, to make sure that we're on double-digit margin, and we will continue to work hard on that and with that, over to Hans.

Hans Vestberg

Thank you, Johan. And then I think global services is done, couple of highlights. I talked about the Red Bee, I talked about higher activity on managed services and also we see some 12 significant consulting and system integration contracts. We were down 8% in phase year and Johan has already talked about it.

It's very much driven about network roll out that has been declined, that was very much expected and we talked about already in the second quarter last year, driven by reduced activity in both Europe [ph] and North America which are roll out markets.

If then look at sequentially 13% growth pretty good and of course North America was important here, but also as Johan mentioned managed services sequentially was growing. We see an operating income of SEK 1.5 billion, where professional services remains on the 13% operating margin and in a row was in a loss but narrowing down the loss, now with a lower volume.

All in all, leaving to 6% operating margin. Support Solutions talked about the Multi-year contract with T-Mobile, which is very important. We are in a transition from legacy business and oversized business to new businesses, as well as going into TV and media. Then reported sales up 21%, Mediaroom important but oversized [ph] as well, that is small sequential increase only.

And their operating margin was negative, here is very much about transforming the legacy portfolio to new portfolio. We still have a good gross margin business here in Support Solutions and this should be leveraged more than this quarter. We had moreover transformation of certain projects and contracts that made this happen and all the time, we still believe very strongly in Support Solutions adding both on top line and bottom line for us.

Last segments, modems; 7450 will be out in the market in sales by end of this year. We are getting more and more global operator certification, some of them we have announced, SEK 500 million in OpEx this quarter adding to SEK 1.2 billion so far this year. We have estimate of OpEx of SEK 2.60 billion this year and that we will keep. We will see, that this is in line with what we have decided.

We have good grip on this organization and this investment as we are now having this in house [indiscernible] being joint venture. Just to read the rates, what I've said so many times before success of the modems business will be mentioned in 18 months to 24 months from the day of integration. Which was basically end of third quarter, 2013? So we really work on this and see that, it's really going to be successful.

Then summarizing up, a little which we've already said; good momentum for superior performance on the mobile broadband networks. Strong sequential growth, good profitability in networks were improved. Maintained good profitability and professional services. Solutions had the perfect quarter as I explained, we are continuing the investment in new untold areas as well as seeing that the core areas are gradually performing better and we can see that in networks.

And I think, we are very well positioned being strategic important, in this transformation in industry with the investment we are doing. So we'll roll that these statements then just reiterate, what we said in the first quarter, Jan and me with the current visibility. Key contract awarded, with gradually impact sales and business mix in the second half of 2014. And here some of these contracts were public announced and talked about, but there are of course others as well.

And we have good visibility on the coverage project that are longer, where we now the tollgates and when they're going to be roll out and as said, we have been awarded some of those and those will be impacting our business mix in the second half, by that I hand back to Peter.

Peter Nyquist

Okay, thank you Hans. So operator, we are now ready for questions, please.

Question-and-Answer Session

Operator

Ladies and gentlemen. At this time, we will begin the question-and-answer session. (Operator Instructions). As always please limit yourself to one question at a time and keep your questions at a broad level. Detailed information is provided in the report and Ericsson's Investors Relations and Media Relations team will be happy to take any additional questions and discuss further details with you after the call.

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

Edward Snyder – Charter Equity Research

Thank you very much. Jan, it's clear the IPR revenues were having a significant impact on your results especially, the gross margins. Can you give us any idea of how much of an increase you saw this quarter or what the impact to gross margins were or actually any indication at all, which you expect the run rate will be whether they go up, down or remain flat quarter-on-quarter? And then Hans, it's still mentioned in the press release that voice over LTE is a initiative which carries, is starting to roll out now. How long do you believe it will be before we see commercial operation and then similarly small cells, when do you expect to have a significant effect on carrier systems and your top line in performance? Thanks.

Jan Frykhammar

Okay and so as you know, we do disclose our IPR revenues, but we do that on an annual basis, what you should be aware of is that, compared to a year ago, the IPR revenues are higher. Which we clearly mentioned in the report, if you compare it to Q1, they are slightly down but not so much, so we have established ourselves on a higher level.

I disagree with a statement, that they're clearly the main driver for the gross margin improvements. The main drivers are related to business mix and more of mobile broadband capacity projects that we have discussed before here, but they're absolutely part of the mix and they're also part of why the investment margin research and development, Hans?

Hans Vestberg

Johan Wibergh, will answer on the voice and the small cells, when it comes in the market. Johan?

Johan Wibergh

So, hi. It's Johan here. So I mean, VoLTE, there are already a couple of operators that are live and commercial on VoLTE, it's not only in Korea, but in couple of other places and I think, we should expect to see more and more to low and start the later part of the year and I'm not going to comment on any names, but I know there are several operators that are working upon it.

If you talk about our total offering, I mean – we see more and more build out of the mobile broadband networks both on 3G and 4G. I mean, that's helping up on our business and its both a lot of volumes and macros identification but also small cells. Actually we are getting a substantial traction, already last year, but this year worked on small cells shipments to the market and I'm really, really happy about that pick up and those deliveries.

Peter Nyquist

Next question please. Hello, operator?

Operator

Gareth Jenkins from UBS is in line with the question.

Gareth Jenkins – UBS

Yes, thanks for taking the question. I just wanted to, if you could talk about sustainability of margins going forward. You've obviously taken the business in terms of structural gross margins to higher level in the last two quarters, but given that's driven by IPR revenues, by European modernization rolling off. As you look forward with more managed services coming on, do you feel that we should sustain in the kind of 35% to 40% or do you feel that we major up back down towards, kind of 30%, 35% range that we had in the last two years? Thank you.

Hans Vestberg

When we look at our business, I mean first of all we continue to work on a gradual improvement on our profit level and we had a couple of years of investments both in R&D and market share which are clearly articulated to the market. We have now articulated the market, that's why we're working on improved profit levels – that of course is, as you say if the mix changes and you get more services your gross margin might change that should not take away that we are working with a gradual improvement in the profit levels, then income of the company.

So I think that we will continue to work on that and yes, you are correct. We have a good sort of activity level of managers at the moment, when it comes to deals, but again for us we are working definitely to improve our overall profitability of the company and that we will continue to do.

Gareth Jenkins – UBS

And just as a follow up, I just wanted to figure out, ask on the network roll out business, whether you feel you can get that to breakeven?

Jan Frykhammar

[Indiscernible] of the gross margin improvements in during first half. I would say that the, the business mix is the most important improvement of course together with efficiencies and so forth that's one market, right? The second improvement is the higher revenue of licensing and the third one is more mechanical, which is, a share of services that has come down and there, you know the typical rule of thumb that we use is that for, every percentage point of increase in services shared you have a dilution at the company gross margin of approximately 0.3%.

So you know it's – those are the factors and those are the modeling factors that we think still are very relevant then of course, if some of these projects that we now see will mean that network roll out revenue started to grow significantly again, that will when as Hans said, have an impact on company gross margin, but that doesn't exclude that we continue of course to work with positives. So that's what we want to say on the gross margin.

Gareth Jenkins – UBS

Jan, could I just follow up on that?

Peter Nyquist

Operator, next question please.

Operator

Yes, we have Mark Sue from RBC Capital Markets on line with the question, please go ahead.

Mark Sue – RBC Capital Markets

Thank you, gentlemen. Ericsson is the largest wireless solutions provider and the premise has always been that the bigger, the better since you could spread fixed cost, but when we – all the questions are going to be on margin. So and if I'm looking at it from a regional point of view, where quality and superiority matter. North America and Japan for example you can actually dominate, but in other areas Africa and Mediterranean for example, it's harder to even differentiate.

So on margin, the function of size or a function of them being in the right regions and Hans, since you remade the company, the team has remade the company to look more services over the last eight years. Would you consider actually now into focus of Ericsson, do you need to be in all these countries over the longer term?

Hans Vestberg

First of all I think on the first question, when it comes to staying. I think we need to look on the CapEx investment per region or per country in the world and of course North America, it's regions that expanding the most on CapEx so of course by nature then you have more business there done, how much they're investing in Africa for example that at this stage.

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

So I think the balance of having both services and technology and then having the geographic spread for us, that it should be helping us going forward of having said the improvement and set these potential for the company to develop, so I think that's, that is something that I really believe in.

Peter Nyquist

Are you happy with that? Next question, please.

Operator

Alexander Peterc from BNP Paribas in line with the question, please go ahead.

Alexander Peterc – BNP Paribas

Hi, thanks for taking my questions. I would just like to clarify few things on peripheral businesses here or not, peripheral business, let's say smaller. So in Support Solutions, I understand there's a change in business model there from license to subscription revenue models. So when do you expect this position to be over and should we expect increase volatility in earnings during these adjustment period or is it just poor earnings outlook over the next, let's say I don't know six quarters perhaps until your makeover is complete.

And then just sort of housekeeping on modems, why do we see such volatility in OpEx there. That exponentially lower, last this quarter in modems and last quarter just, I'd like to understand why we are not having a smoother cruise there? Thank you.

Johan Wibergh

Okay, Alexander. Johan here, I take both questions. So on the, so on the first one then on Support Solutions. The business that we have today mainly in Support Solutions or the businesses around the OSS systems that to a great degree, we obviously acquired from Telcordia. So that's an installed base that we have, we also have an install base that is very much an emerging market, installed base around prepaid system and we also have an installed base of 3D solutions coming from Mediaroom and then we have the compression business installed base.

Now if you think about, what is going on in both OSS, BSS and in TV. It's very much both a development focus and a pre-sales focus to get into the next generation of software's around this different solutions and that is why, we make the statement we do around that data transition between, if I may call it legacy and next generation or future solutions, that doesn't mean that we are not taking very good care of the installed base, we are, but we also need to develop the new stuff, in order to be able to transform the old to the new.

This implementation of new more software subscribed based business models is obviously going to be a gradual one that is coming, was partly with the new business model that many of them by the way in the end will be cloud based. So I think, short term, I agree with you that the business is still very dependent on top line versus the fact that we are investing in the new.

We will continue to make sure, what have we try to capture the opportunities around the installed base we have and at the same time win new areas and I think a couple of examples of important win in new areas or the ones that Hans mentioned before, but also some of the OSS transformation project that we have communicated during the first quarter, like the one in the US with Sensorlink.

So this is the reality of the business right now. We also think that the, opportunities are there from an opportunity point of view to steal the lead that the market will grow between those 9% and 11%, if you look through years out. So that's what I want to say, on the Support Solutions side.

On the modern side, what we have is obviously that the business is still, that you rightfully say, more of a development unit and the operating expense outlook there that we have, we keep to that, it's approximately SEK 2.6 billion for the year. It might be in this quarter, we have still some integration cost for instance related to the integration of the business, but it's also so that, not whole of the costs in businesses like this or owned employees, there are also project assignment cost and so forth, right.

So but overall, I think what I want you to model with is that the SEK 2.6 billion full year and then some top line later in the year, that's what I want you to model with.

Alexander Peterc – BNP Paribas

Thank you.

Peter Nyquist

Operator, next question please.

Operator

Stuart Jeffrey – Nomura. Please go ahead.

Stuart Jeffrey – Nomura Securities

Hi, thanks very much. I had a question on, [indiscernible]. You seemed very upbeat in terms of some of the new contracts coming through and benefitting the second half, but in the press conference, you also spoke about typical holiday patents weighing on third quarter. So perhaps, you could just talk through some of the headwinds, that we should think about before we get too enthusiastic about forecasting and exceptionally strong fourth quarter revenues.

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

Hans Vestberg

I'm not sure, why you draw the conclusion of that upbeat feeling I think, will just reiterate what we said in the first quarter. We had not said anything new about the second off with current visibility of the awarded projects and contacts that we got in the beginning of the year, we know tollgates on those roll outs and that's why we said in the first quarter and we just reiterate.

So I'm not sure, why you interpreted as upbeat or something new. It's actually the same communication that we had in the first quarter. so that's was to comment on that. Jan?

Jan Frykhammar

I obviously think that one should think about the outlook for second half, a bit in the context of the fact that we were bit light in Q1 and we've recovered now in Q2, right. The comment I made on the press conference on vacation is of course, based on historical patterns. It tends to be a bit of seasonality impact on the business because a big portion part of the world, summer holidays and that means that there are slower activities in both amongst operators but also in our company and that has an impact on business.

So that's why I made a comment, I think it's nothing else that I think people deserve sometimes to have a little time off.

Stuart Jeffrey – Nomura Securities

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

Jan Frykhammar

When it comes to gross margin, the modernization project in Europe that we have together being through our journey over a couple of the years. Those projects are now materially behind, as we still have a small impact on the network roll out business. Going forward, what we need to think about is more the dynamics around coverage projects which means that we have deliverables in coverage projects that typically has lower margins, than capacity.

So we do roll out projects but we don't perhaps roll out projects with negative margin in the coverage stage in normal circumstances. So coverage projects, you know we don't think that coverage projects is something that necessarily because of course, it means that we create an installed base that we can then later on market money and returns out of.

So network roll out, losses are for the reasons that are stated in the report. They're the same as in Q1. We work hard on trying to improve network roll out throughout the course of this year, but I understand that we have still work to do here in convincing all of you, that this will actually become a breakeven business overtime.

Stuart Jeffrey – Nomura Securities

Thank you.

Peter Nyquist

Thank you. Operator, next question please.

Operator

The next question comes from Achal Sultania from Credit Suisse. Please go ahead.

Achal Sultania – Credit Suisse

Hi, guys. Thanks for taking my question. So if I start with, your western European business. Have you seen Vodafone project Spring ramped up it seems during the quarter. can you talk about where we are in terms of that project and for example like, which all countries have they started and how should we think about the ramp as we go into the second half and then I'm going to follow-up on the professional services business?

Hans Vestberg

It's a very good question you know, but I think from our point of view, we cannot comment on what Vodafone is ramping and not, I think that question probably should be asked to Vodafone and then, of course for obvious reason we know, what we are doing and where we are doing, but I seldom comment on my customers ramp up in different markets, as it might be a competitor advantage.

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

Achal Sultania – Credit Suisse

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

Jan Frykhammar

So on that point, what we said in Q1. I mean, it's obviously call Vodafone Spring, so we started the project activities with some impact then obviously as Jan said, rightfully I mean exactly how much we will ramp or where we will ramp around the project itself, that you will have to talk to Vodafone about, but we have some impact on Vodafone Spring in the quarter.

Achal Sultania – Credit Suisse

All right, thanks. And then on professional services, if I look at your operating margins there, it seems to have fallen down by about 200 basis points versus last year, if you look at first half year numbers. I'm just trying to understand, what's the reason for that? is it just because of top line issues in that part of the business or is it just something more structural there in terms of scope of contracts or size of contracts?

Jan Frykhammar

You asked about professional services or?

Achal Sultania – Credit Suisse

Yes, just about professional services, yes.

Jan Frykhammar

Professional services business consist of capital of different businesses. It's managed services, it is network design and optimization, it is customer support and consulting a system integration and of course depending on the mix of these different business lines in a particular quarter, you get a different margin profile and I think the way you should think about the professional services business is that.

We have been delivering in the past and that's obviously our ambition to continue to have a profitability, let's say between 12% and 15% operating margin and it may vary between quarters because of different business mixes. What is important of course if you get higher portion of managed service contracts early in transitions that has a challenging margin, but then obviously we transformed those contracts in order to M&A more margin.

So it has really a little bit of business mix issue. Underlying the services business continues to execute on their service delivery transformation. So margin may vary between quarters because of mix, simply.

Achal Sultania – Credit Suisse

Okay, great. Thanks.

Peter Nyquist

So, we're open to the next question please, operator?

Operator

Francois Meunier from Morgan Stanley in line with the question, please go ahead.

Francois Meunier – Morgan Stanley

Yes, thanks for taking my question. Congratulations on the number for this quarter. I've got a question about the modems and maybe I'm trying to read between the lines of your statements because you're saying that you're targeting that the SEK 50 billion market for the wide internet proceedings in the coming year.

So does that mean, if the size on that, good this year. With those modem chips [ph] and maybe next year, then you're more likely to stick to it because in longer terms the opportunity is so big.

Hans Vestberg

I think on the modem strategy, we need to come back. We've said, that we are going to make sure the success of that in 18 months or 24 months and we promise we will come back on that. ahead on that before that, we want just to conclude. We have made the call about, divestment on the joint venture. We have now full control over this. We want to guide market on much, we are investing in it so it's clear to the market, but we will come back if there are any changes or necessity or make sure success [ph] offered 18 months to 24 months.

Francois Meunier – Morgan Stanley

Okay, thank you. Now I've got a question in terms of the IPR impact on gross margins. I mean, I think we are trying, is to measure how much it was and compare all the original revenues versus what they were like in the previous year. So working that back does it make sense that Jan, that actually the IPR impact was something like 80 bps only this quarter.

Hans Vestberg

Let me start and then Jan can fill in, but it is important when we talk about, Francois. We see that is very much linked to our business. Remember, we are spending $5 billion a year in our research and development. We are fairly wide portfolio, all patents that we are investing in and development we are doing. This is sort of our contribution back on the investments, we're doing and that's why we see this as a business model that we have developed, that means vested in many other.

In the industry, that we actually also are learning and not sharing on those patents. So we see this very much our business. We outline in 2011 at the Investor Day that this is the strategy for Ericsson to see that we can capture revenues from other industries and other segments of the industry and that's what we are doing and I think, I hope that you've seen that we outline the strategy Q2, 2011 and we are executing and we are growing in this business.

Jan Frykhammar

And then Francois, on your question around if it's 80 basis points or not. It's what I said before, was that, if you think about the gross margin compared to year ago, the gross margin improvement the main impact is related to the business mix, then secondly I said the patents and thirdly I said, the lower services share. So those are the three main drivers and then you have to decide what you believe in your assessment.

Francois Meunier – Morgan Stanley

Okay, that's very helpful. Thank you so much.

Peter Nyquist

Operator, next question please.

Operator

The next question comes from Simon Leopold from Raymond James. Please go ahead, sir.

Simon Leopold – Raymond James

Thank you very much, just a quick clarification. You mentioned earlier, that you disclosed the IPR in an annual basis. If you could just remind us, last year's numbers to save me a little time looking that up and then a question, I wanted to follow-up on was, you've demonstrated an ability to defy CapEx in North America in terms of the seasonal trends, this quarter versus the weakness in the last quarter?

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

Hans Vestberg

Talk about the actual revenues, last year SEK 10.6 billion but of course have an impact of the Samsung that we made at the end of last year, so that had a impact of that, but if you look on the historic levels, we have basically going from SEK 2 billion in revenues on IPR's up to SEK 11 billion, well right now.

So we have every year, add the new cross-licenses and we are up more than 100 cross-licenses as agreement right now in industry. If you talk about the CapEx to North America, I can start and then Jan, can will fill in. One thing, that we have learnt a lot couple of years that the correlation between CapEx on a operator and our revenues, can be very different. First of all, the reduction on CapEx might be reduction on concrete and building sites equally matches on electronics.

Secondly, a ramp up can be sort of also going to sites, which were an part of as well as when they do software that might be a smaller CapEx investment than doing in hardware. So we need to be much more close as to our customer to understand what inside the CapEx probably stand for us, how that will impact us and that's a generic company not only North America. Jan?

Jan Frykhammar

No, I also think that capital commands more there. It's obviously, we are in a cycle now in many markets and also valid for Q2 in North America with more capacity and that is, that's good. Underneath there, we still have the declines of the two major projects that also mentioned in the report one should remember that, that's still there.

What we also should know is that, the lead time or form order to sales conversion cycles are much shorter for capacity business? So as Jan said before, when we have bigger and longer projects we have better visibility. The capacity projects are shorter because they are very, often they are shipping hardware to customer warehouses and switching on software and increasing capacity on current base station and so forth.

So it's shorter with the lead times on those types of projects that creates a bit more of a short and uncertainty on exactly how much capacity it will in the coming quarters, so forth. The second point is, that we think that it's probably more relevant to look, when you look at the CapEx versus vendor revenues it's probably backward to look at the some of the vendor revenues especially the ones that disclose network type of segment rather than looking at operator CapEx as such because, operators have I mean very sometimes operators or capitalizing each and every quarter and sometimes they do, the capitalization work twice per year and something like that, right?

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

Simon Leopold – Raymond James

Thank you, very much.

Peter Nyquist

We are open for the next question, please operator.

Operator

The next question comes from Sandeep Deshpande from JP Morgan. Please go ahead.

Sandeep Deshpande – JP Morgan Chase & Co

Hi, if I may ask couple of questions. Firstly, regarding European 4G. You've talked about Vodafone Spring earlier in the call as well as before have you seen any reaction from any your other customers. You're largest shareholder in Europe in terms of wireless. How you see that ramping up through the rest of this year in the second half and secondly on the modem business, Jan you talked about taking a review into 18 months to 24 months, but if you do the math on the business.

I mean you'll require volumes of 80 million to 100 million units to be able to breakeven in the basis. So are you looking at it that way, are you looking at a strategic business and this is not necessarily a business that you're intending to breakeven in?

Johan Wibergh

On the first question about seeing signs of others moving on 4G in Europe. Yes, we see signs of that, there are high activity ongoing in the region of Europe, when it comes to 4G, that's for sure. How that will material slight later on in business for us that's another topic, we can discuss about but we see many operators thinking and talking about 4G and remember some markets like areas, we even got the iPhone with 4G frequencies not that long ago.

So of course, they're also coming in handsets on 4G to the region. So let's see how that turns out for us later on, but definitely there are activities and discussions about 4G.

On the modem side, not sure what as you comment on that. I remain, with the focus I have remembered Jan, I'm just going to reiterate what I said, we took that over, we've divested a joint venture. We have control over this right now and we know, what we're doing and we will measure in 18 months and 24 months, where this step will take us and what success, we will have, very much in line with what we said, when we made sort of breakup with STMicroelectronics.

We will come back on that and comment on any new strategies or different strategies or volume and options and etc.

Sandeep Deshpande – JP Morgan Chase & Co

Thank you.

Peter Nyquist

Operator, next question please.

Operator

Andrew Gardiner from Barclays, is in line with the question. Please go ahead.

Andrew Gardiner – Barclays Capital

Thanks very much. I just had a couple around a cost side of the equation. firstly on OpEx, Jan you didn't indicated earlier in the year that, investment spending in R&D would increase materially that's happening as you've guided, but you'd also previously indicated that it would continue to build through the year, as you hide into these key areas.

So given that, is it something we can expect to see R&D continuing to grow sequentially in third and fourth quarters and then also a follow-up onto, so the call you had this morning around the restructuring side of things. Do I take your comments to mean, that around the services business picking up later in the year that we will see a sort of higher level of restructuring expense later in the year after what is been a fairly, well a lower level of restructuring in the early part of the year. Thank you.

Jan Frykhammar

Okay, thank you. Andrew. So on the R&D side, it's correct what you say that we are gradually increasing the organic elements related to the area that we've talked about today and before as well. We saw some impact in the second quarter, but a major impacts were the ones I mentioned around modems and Mediaroom's team.

Still, this is about recruiting people in different parts of the world. So it's not like, you go from CRO [ph] to something bigger overnight. So it takes a bit of time, at the same we are working hard to offset these increases with efficiencies in other areas, but I think it's, I know for a fact that R&D organic will come up a bit in the second half of the year.

Then there is, in operating expense there is also some variations between quarters and that is also something that I think you should look at a bit historically to understand that there's a little bit of variations between quarters here as well. Then on the restructuring side, it's right what you said. We think that the elements of restructuring related to services transformations will increase a bit in the second half of the year compared to the fairly low levels in the first half of the year, then if we decide to do something bigger or so we will always inform our employees first and then inform the market, if we think it's material.

So right now, what we have in the mix is the service delivery piece as the main thing. So that's what I want to say, Andrew.

Andrew Gardiner – Barclays Capital

Thank you very much.

Peter Nyquist

And we're ready for the last question. Please operator.

Operator

The last question comes from Mr. Sumant Wahi from Redburn. Please go ahead.

Sumant Wahi – Redburn Partners

Hi gentlemen, thanks for squeezing me in. congratulations on the good result. My question is around, the software defined networks market and this is the second quarter, Hans you mentioned that you are having deep discussions with customers regarding the deployment of this?

And I was wondering, if you could give us a bit more longer term strategic view on this market, how do you see it growing. I mean, I have spoken to a couple of leading customers of yours and the strategy officers there and they suggest that SDN could be part of every CapEx product they buy essentially over the next five years or after in five years time.

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

Johan Wibergh

This is Johan, let me in talk and give a few views on it. So I mean, first of all, it is true that the networks will be rebuilt in the coming years and it will clearly start in the IP space, where it's already starting up. I think in the whole transport space, it will be rebuilt. It has already started in data center as we all know, but it will start to become in the transport area and eventually it's going to be in network wide effecting.

In the radio access, as we proceed by small changes due to the nature of the network and how it's structured and built up, but the special in the transport and IP sector lot of things will happen. How quickly it will come, I think we have a tendency to hide things in our industry. He hide it up, so if we think that one thing is going to come quicker and it usually takes a bit longer time, but when it comes it's a much big change and most people realize.

So I think that will happen here, I mean this is one of the reasons, why we are investing in IP because, who would have believe that the network need to be rebuilt and the SDN concept, comes originally from data centers and I mean, we have launched something for service provider SDN, which is really a network wide usage of SDN and it will mean a complete rebuilt of the IP networks, we believe and that are really needed because if you look on the type of applications that needs to be rounding on IP networks.

We need predictability and latency, for instance something you that can't get from today's IP networks. So if you look on really using the internet, so even more services and getting into realize and real-time application. We need certain characteristic as a concave [ph] today. Wasn't today's quite too expensive to deploy certain transport based services and by introducing SDN and by introducing cloud based services, you can radically reduce lead times on getting new service operation.

I think, that's why you have some of the major operators in the world that are looking into cloud and SDN based services to make their own operator much more efficient. I think this is quite important, we shouldn't over hype it short term, but I think in some years out, it's going to be a major part of the major change and we intend to be in the middle of it. Thank you.

Sumant Wahi – Redburn Partners

Thanks and just a very quick follow up on current quarter. I know, everybody seems to be asking regarding the fantastic gross margin improvement. I'm just wondering, if you could give us some color on the North America sales. Is it fair to assume that the capacity sort of angle of the revenue was probably maybe more than 70% of North America revenue or is that way too high?

Jan Frykhammar

I think, you have to look at. I mean, we break down the business by segment and regions. And if you look at those different statistics over a couple of quarters. I guess, I think you get a pretty good feeling. The structural declines that we have or not the structural declines. The declines we have, in regards to the big coverage projects. They're still in the mix and obviously in the networks area, we had a good growth in the quarter driven by these normal broadband capacity.

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

Sumant Wahi – Redburn Partners

Okay, thanks very much.

Jan Frykhammar

Answer we want to give on that.

Sumant Wahi – Redburn Partners

Thanks.

Peter Nyquist

Okay, by that I would like to hand it over again to Hans for some closing remarks.

Hans Vestberg

No, I think, I'll just will make a quick summary of the quarter and where we are. I think that we are continuously working with the gradual improvement on our performance. We also, of course allocating resources and capital in new areas in order to strengthen Ericsson even further going forward area, that has high degree of software, higher growth rate in our core business and that's and have a good adjacency toward, what we're doing.

So here we continue with that work, but we're also very focused on performing well in our core businesses, which is the main revenues and profits, we have. So I think that we will to continue to do and I think that's the summary of this quarter and the previous quarters, we've had.

Peter Nyquist

Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!