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LM Ericsson Telephone Company (NASDAQ:ERIC)

Q4 2011 Earnings Call

January 25, 2012 8:00 AM ET

Executives

Åse Lindskog – VP, Head-Industry, IR

Hans Vestberg – President and CEO

Johan Wibergh – EVP and Head of Business Unit Networks

Magnus Mandersson – EVP and Head of Business Unit Global Services

Per Borgklint – SVP and Head of Business Unit Multimedia

Jan Frykhammar – EVP, CFO and Head of Group Function Finance

Analysts

Kulbinder Garcha – Credit Suisse

Edward Snyder – Charter Equity

Alexandre Peterc – Exane BNP Paribas

Sandeep Deshpande – JP Morgan

Mark Sue – RBC Capital Markets

Francois Meunier – Morgan Stanley

Simon Shepherd – Goldman Sachs

Matthew Hoffman – Cowen & Company

Richard Kramer – Arete Research

Operator

Welcome to the Ericsson Analyst and Media Conference Call for their fourth quarter reports. To view visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. (Operator Instructions)

As a reminder, a replay will be available one hour after today’s call. Åse Lindskog will now open the call.

Åse Lindskog

Thank you, operator, and hello, everyone. You are all very welcome to our call today where we will comment on our fourth quarter and full-year earnings report. So with me here today I have Hans Vestberg, President and CEO of Ericsson; Jan Frykhammar, Chief Financial Officer; Johan Wibergh, head of our business unit Networks; and Magnus Mandersson, head of business unit Global Services. And for the first time in our quarterly call, Per Borgklint, Head then of the business unit Multimedia.

So to start with, I have to make the usual reminder that we during the call today will be making forward-looking statements, and these statements are based on our current expectations and certain planning assumptions which are subject to risk and uncertainties. The actual results may differ materially due to factors mentioned in today’s press release and discussed in this conference call. We encourage to you read about these risks and uncertainties in our earnings report as well as in our annual report.

And so with this introduction, then, I would like to hand over the call to Hans Vestberg.

Hans Vestberg

Thank you, Ase. Okay, I will start to briefly go through the 2011. Some of you probably attended a press conference, but we will repeat as we know many are joining only for this call. So if you take 2011, it was definitely the year of Mobile Broadband where we had modest subscriber grow. We had over one million Mobile Broadband subscriptions, which was in line, we estimate that which was fairly in line with what we thought the orders were as well with new devices.

If we look at the Roam business in 2011, we grew 90% if comparing units and adjusted for currency. That’s probably one of the years that we had grown the most if we go back in history, ending at some SEK227 billion almost.

Networks grew 17%. I will come back to that. Had a profile of a very, very strong first half-year, and then declined towards the second half and the fourth quarter, Global Services, the opposite, slower first half and then a stronger second half and especially fourth quarter.

If we adjust for currency, we actually had all regions growing in the full year. We also had the clear strategy of gaining market share that we already end of 2010 started to communicate. We wanted to regain the market share in Europe, in the modernization work. We have done so and – but it also comes with a business mix shift that will talk about that impact or numbers. We end also 2011 with a good and a strong financial position.

If I may just go through a little bit what are the main topics with our customers, our main topics in this quarter has been, firstly, I would say, the effect of the economic uncertainty. As I said in the third quarter report as well as in the Capital Markets Day, we could not exclude that short-term operators will be more cautious on investments. What we now see, they have been cautious on investment, and it’s not strange given what is happening all around us. That means that budget cycle is a little bit longer, project decision takes a little bit longer than normal. And we normally have by yearend more investments coming from operators. We saw less of that this year.

So it is a little bit more cautious, but the impact on the fourth quarter still was not that much. It’s more a feeling about the cautiousness when it comes to the macroeconomics. That we of course have discussed a lot.

Then the three others are the ones that we have been discussing before, mobile broadband, peer pricing in order to monetize the mobile broadband is on top of agenda. And that leads to both our ability to support that with our technology but also in the OSS/BSS transformations. And finally, we discussed quite a lot about operation efficiency given the circumstances, and Magnus will come back to how the year ended on managed services, but we clearly see an interest there.

If we then take the fourth quarter, as I said before, and Johan will come back to it, networks slowed down in the fourth quarter, with the same comments as we had in the third quarter and the second quarter, on the Capital Markets Day. North America, three factors impacted North America: consolidation, high level of investment for a while that comes down, which is strange, and then the shift from CDMA to LTE. And Russia as well came down in the fourth quarter.

Services, the opposite, grew heavily on network rollouts due to the mix we have, and in general, it was growing by yearend and in the fourth quarter. Multimedia, more normal quarter at least from seasonality point of view, the quarter – quarter-on-quarter up 33%, then flat, you can say, year-over-year.

If we then take the profitability, starting with the gross margin, we continue with the business mix that we explained both in the third quarter, second quarter and in the Capital Markets Day, meaning we have more coverage projects and modernization projects, having in average a lower margin, in average, as we roll them out, we have a higher percentage of that. At the same time, the gross margin is, for obvious reasons, impacted also from services that had a strong quarter and now had an all-time high, 42% of our sales in the quarter was services.

All in all, that led to a net income decline in the fourth quarter, driven by networks that had lower volumes and a lower bottom line, but also the JVs, that I will come back to, that also had a difficult quarter. Full year, despite the JVs, we increased the net income with SEK1.3 billion.

The joint ventures then, Sony Ericsson, won’t spend too much time with, you have read the report. They had a big loss in the fourth quarter, half of it driven by restructuring charge. I think the most important for us to communicate the plan is to close it in February. There are no price adjustments, nowhere on the balance sheet adjustment given the results I’ve had. That means that the difference will be that the capital gain will be – will be higher, given that the result was low in the fourth quarter. Our investment on the balance sheet goes down so the capital gain becomes higher when we close. Now expected of February, of course, someone is responsible for getting all of the approvals, and they are indicating to the market that, that will happen during February.

If Ericsson continue on the same path, various good situation, feature phone market which is the main revenue source for Ericsson. It has gone down for several quarters and continues to go down extremely fast. Now R&D is geared to small phones where we do inroads and get them into new hands and manufacturers but not at all to offset the decline in – in the decline in the feature phones, meaning that we have two low sales to support our R&D at the moment.

We have a new CEO that is reviewing the strategy with the board. We’re going to see what we’re going to do. If there are any strategy changes or anything else but all in all the focus is to maintain the value in the company and come to a break even as soon as possible. However, I also need to say it will take some time because given the dynamics of Ericsson that will go up and down. I leave over to Johan Wibergh talking about networks.

Johan Wibergh

Thank you, Jan. So on the network side and overall, we had a strength in market sharing in 2011, and that was rated as executed on the strategy that we decided in the beginning of the year. And we will see then how much the market shares increase when we summarize 2011 but after three quarters we said that we have increased of around four percentage points. We can also then see when it comes to the important LTE and fourth generation mobile systems that we are now two years after we started delivering LTE, we still have more than 60% market share in LTE and that’s just really good for our position going forward.

I also feel very happy with the strong contribution from the new generation of portfolio technologies that we brought to the market during 2011 and I feel extremely good about the position we have right now. Also, at the end of last year, we brought to the market as planned another SSR, the – our combined IP edge and the packet core router. Looking then on the fourth quarter how that developed and as Hans already said then, we had a tough quarter in a couple of markets that impacted us.

In North America it was down 27% quarter over quarter, almost half year-over-year. And of course, that was impacted by the operator consolidation and the rapid technology shakedown from CDMA to LTE that is moving quite quickly. And also a slower pace of investments after a period of very high investments in network capacity.

We also saw an impact of lower volumes in Russia. We had a very strong 2010 overall in Russia and that was good also during the first six months of 2011 and that slowed down quite a lot during the end of the year.

The rollouts in India, all three, they peaked over the first six months and that slowed down quite a lot at the end of the year. And then finally, and we see a normalization on the GSM sales in China as well as a shift to LTE coverage in the Korean market.

Looking, then, on the profitability side, the, of course, the lower volumes overall in the baseness as well as a higher degree of network coverage project and modernization projects pushed the margin down as expected. And, of course, when we put out this new generation of technology, it has typically a life-span of seven to ten years, and we saw an increasingly higher degree of those projects during 2011 where 2011 – and 2011 that is the period of the seven to ten years. As we then go on, the coverage will change to more capacity as we demonstrated at the capital markets day.

We also decided early in 2011 and to increase our R&D investments to move ahead some things in 2011 and to utilize the opportunity with tough situation in the market and the competitive situation, so we have really accelerated in some areas which makes me feel very confident about our product portfolio position going into 2012 and 2013.

Looking then on 2012. We expect operators to continue to be cautious with spending and short terms, due to of course the economic climate. The underlying fundamentals with smartphone take up and usage and data volumes in networks, that remains, and that goes on quite well and exactly according to what we have communicated in our traffic and market data report that was disclosed back in November.

We also then expect a rapid CDMA transition to LTE to continue as we’re now coming to 2012.

With that, I hand over to Mr. Magnus Mandersson, Head of Global

Services.

Magnus Mandersson

Thank you very much, Johan, Head of Networks. Let me then start with talking a little bit about the full year. I think we had a good full year. We, as Hans said, began the year, the first half with lower growth and lower margins which was caught up in the second half with higher growth.

And we can see straight through our portfolio that we have good growth in network rollout as well as in Professional Services in the local currencies. And of course, if you look into it in sec, we have a little growth in Professional Services; however, it’s compensated with the network rollout, which is very high growth, and very much driven by the demand on Mobile Broadband.

We continued the 70 Managed Services contracts over the year. That is we came from 54 the year before where it was extended, contracts were over 32 contracts, which is a very strong. We’ve also assigned more than 30 contracts in OSS/BSS and SMP area as well as within datacenter development.

We’re also seeing a very, very good progress in consulting and SI in – over the year, and we’ve also signed a capital vertical contract universally in the industry in transport here with Masse Klein, basically the biggest shipping company in the world. And we’ll do mobile communication for them.

we also had a very strong demand on network optimization as networks is getting more and more complex as we now have three difference technologies out on the networks. We also seen that service is increasing strongly. And they are, as we said, in capital markets base that’s higher margin saves.

We have increased our workforce now so we end the year with 56,000 professionals which is very strong as well as we are now managing the networks in managed services of more than 900 million subscribers. The quarter then, we can see a very strong development still in North America on the Services side, a lot of product execution we can see there. We also had full effect of network modernizations in Europe. Northeast Asia and Japan has given us a high level of projects executions which has grown a lot of sales.

So, of course, I’m shown a good sustainable margin, I would say, on Professional Services which has been around 14% to 15% over the year, and remember here that we, this year, included restructuring. And that was more than 2% impact in the quarter.

For 2012 then, we see, of course, as everybody else that the economic environment is weakening and that should give us more opportunity on Managed Services as our customers is focusing more and more on operations and efficiencies.

You’ll also see that the ITT industry then drives a lot, it will continue to drive on the modern growth in consulting and system integration. And we’re still executing a lot on our network rollouts and, of course, there is a lot of project execution that we are focusing on, as well as the way we are delivering our services, that we do more and more on remote deliveries.

So with, that I will hand over to Per Borgklint.

Per Borgklint

Thank you, Magnus. Hi, everyone. So Multimedia. The sales in the quarter decreased 2% year over year and 33% sequentially increased. What we can see is that Multimedia brokering and TV showed in the fourth quarter a good development. For the full year, sales were kind of flattish, and it was also negatively impacted by a decrease in activities in India but also the political unrest in the Middle East.

All in all, the EBITDA margin, due to project mix that was unfavorable, stopped at 6%, compared to 16% last year. And that was mainly lower sales of revenue management, licenses, and that also reflects the full-year margin of 2% compared to three last year. We are on top of the agenda with the integration of Telcordia and also with new strategic direction, putting efficiency measures in place to improve profitability and strength in the project portfolio going forward.

And as of now, the integration of Telcordia starts off, and with this, we will get a leading position within OSS and BSS. And as you know, Telcordia generated some US$709 million in revenue, ending with the fiscal year 31st, 2011. And we expect it to be accretive to Ericsson’s earnings within 12 months.

And I think that is all in all Multimedia.

Hans Vestberg

Thank you, Per. If we then talk about the Q4 and the regional sales, we’ll not dwell on that. We had talked about the regions that are impacting us, North America of course, but maybe not talking so much China, Northeast Asia, that has again a strong quarter, Japan, Korea and China, very important. And sometimes we tend to forget Latin America as well which had very good year with its 23% growth.

But again, ending up then, talking about other, in other we have cables, we have IQR revenues, we have mobile broadband modules, power modules, et cetera had a good growth, and that was mainly, I would say, driven by our recurrent revenues in IQR sales revenues.

And we also in other, we decided in the quarter to phase out our mobile broadband modules.

Jan, I’ll leave it to you.

Jan Frykhammar

Thank you, Hans. So let me then go to the slide that explains the business mix and the impacts on the gross margin. This is the same slide basically that we ended the Capital Market Day with in November. I have now added the fourth quarter. In all periods here, the margin numbers are excluding restructuring charges.

What we can see here is that the major impact in the shift in the gross margin during second half of 2011 is the business mix, meaning more of coverage projects in relation to capacity projects, but also that we have now all the modernization projects that we have won in Europe, are now in execution, and that the impact is also then shown in this slide. And then we also added the impact of the increased services sales. Also now what is important of course is to remember that the business mix and the modernization projects will prevail a couple of more quarters.

If we then take some highlights on the P&L, operating expense, obviously in focus, more so as well as in uncertain times. We have, as Johan mentioned, we have invested a bit additional operating expense in R&D this year, and that is to strengthen the technology leadership. And the areas, is known to all of you, the areas are IP, radio, and that’s very important obviously from a technology leadership point of view.

SG&A continued to find ways of optimizing the fixed cost structures. Some of the selling expenses are obviously variable, with also a lot of activity

that we have had in the business during 2011.

If we then look at the expenses going into 2012, the ambition that we have here is to reduce the R&D expenses. We have – we ended the year, as I said, on $32.6 billion. Now we give the range between 29 to 31 for next year. And that, is of course, it is an easy explanation. I mean, we said we have some additional investments during 2011. Now in 2012, we will go more back to the normal rate should we see that we have a very strong portfolio, but we also continue on a high level with R&D because this is obviously core to us when it comes to technology leadership.

These numbers also include the impact of Telcordia. If we look at restructuring charges, this is an estimate. We believe, then, that the number for the year will be approximately four billion. We also say here that we think that the main part of activities will take place during the first half of 2012. And if you want to try to estimate the impact in cost of sales versus operating expense, let’s use 50/50.

If we then take the balance sheet, some highlights, if we look, KPI stand, the days of sales outstanding, I think if you look at since second half of 2010 into 2011, we have been able to reduce days of sales outstanding overall. Now we are operating average wise on between 90 to 100 days. The target still remains. It’s below 90 days.

The big challenge on the balance sheet from a working capital point of view this year has been inventory. We had good progress in reducing inventory in the fourth quarter. And we have also then had a lot of project completions, its advisability in the network rollout numbers. This will continue to be in focus for us going into 2012, working hard on working capital over net sales ratios.

If you take the cash flow for the fourth quarter, operating cash flow 5.5 billion, adjusted for cash out related to restructuring six billion. The big change compared to fourth quarter of 2010 is the net income impact, and it is related to core Ericsson earnings that were higher in the fourth quarter of 2010. But also if you look at the full year which is next slide, you can see that the big impact for the year is working capital.

And we have, if you are look at working capital over net sales as such, that rate has been reduced during the year but not enough to self-fund, if I may so, the growth. But this is something that we will continue, of course, to focus on. It is about product execution, efficiency, and so forth.

All in all, net cash for the year went from $51.3 billion to $39.5 billion during the fourth quarter, an improvement. We end the year with a strong net cash position. And if you go to the next slide, then, which is proposed dividend, we – the board will propose to the annual meeting an increase of dividends of 11% up to $2.50 per share. May 8, 2012, is the record day for payment.

Also important to highlight here is that when the board has made this proposed, they have been looking at 2011 earnings as well as balance sheet structure, but they have also been reviewing the

business plan and the expected economic development going forward.

With that said, Hans, I hand over to you again.

Hans Vestberg

Thank you very much, Jan. Year three (inaudible), our performance targets that we have for long-term and not trying to update too much growth in the market, this is just one indication on a three-year plan. So where we should grow more, between 4% to 10%, the first year at least we are above it. But again, its two years left.

On the investing clause margins, we are below that because, as you all remember, we exclude this restructuring in 2010 and we include it in 2011 meaning that the basis has been tougher but again its two years left to deliver on that. The cash conversion, however, that we define every year and that means on the long-term variable pay that we will not get a payout on that ninth as we missed the cash conversion for this year. And Johan had talked about the main reasons for it.

Finally, the focus going forward, I think it’s clear that we will capitalize on our market share gains and as Johan had said remind us as well – that means executing well on the projects we have see, that the customer is satisfied without them seeing on the footprint. We stay in there for a long time because that’s an investment we’ve done long term to really be strong with our customer, have a big footprint. Then of course we still believe put all the momentum in the three areas where we are strong. Mobile Broadband managers as always, OSS/BSS and here it’s about executing on our growth strategy in these three areas and of course the additional core area is adding up to our strength also in OSS/BSS.

Johan had talked also that we will be focus on an efficient course of action, not that we haven’t done it before but I think it’s important just to bring it up that we will continue to look for efficiencies both of course in the transition that service is doing with the high activity that you have service and delivery transformation, product portfolio, conservation as well and finally looking at the fixed costs as well we’ll discuss as well. So we are working hard on that and we have already started – as we said at the capital market day in November – with those types of activities and we have been planning so we are in full swing.

All in all, important long term is to leverage and keep our technology and service leadership because that’s finally is going to payoff both from a profitability point of view and customer satisfaction point of view long term and we are here to see that with really great long-term value for all of the stake holders that we have. And we have now gained market share and it’s time to execute on that in a very well good way. Thank you.

Åse Lindskog

Thank you, all of you. So, operator, we are now ready to open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Detailed information is provided in the reports and Ericsson Investor Relations and media relations team will be happy to take any additional questions and discuss further details with you after the call. Our first question comes from Kulbinder Garcha from Credit Suisse.

Kulbinder Garcha – Credit Suisse

Thanks. My question is for Hans and Jan. I guess obviously the gross margin level you’ve produced this quarter is even below anybody’s thoughts. I know you guys signaled it but clearly either that signal wasn’t understood or something else has happened. I guess my question really is, how much of this gross margin pressure is structural and maybe if we go back historically, when your gross margins went down from the low 40s to initially to high 30s, that change proved structural.

This move now down from 36%, 37% to 31%, how much of that is structural? The reason why I ask is that it seems to me at least the decline in CDMA being replaced by LTE, you’re not going to get the same gross margin structure on LTE and CDMA. The competitive dynamics are different. You’ve also then got the network modernization which could prove temporary but a permanent higher services mix. So what conviction do you have that you could even return to mid-30s gross margins? I’m not asking for next quarter’s guidance, two to three years out. So if you could comment on the structural versus the temporary nature that would be very helpful. Thanks.

Hans Vestberg

Thank you, Kulbinder. I think we have tried to explain the business dynamics as they are coming in right now. We see long-term that we should be able to create those margins that we’ll have but, again, we are not guiding for short term here at all. But definitely, if you CDMA to LTE, for example, they are in totally different cycles. CDMA is at the end of the cycle and LTE is in the beginning. That would be going the same discussion with 2G to 3G and we don’t see in general any difference on gross margins there.

It’s more about the scale of them and the scale it takes to build them up. So I think that’s very important. But again, right now, we have a very hardware centric rollout and that gives us a certain type of margin, but this management team is definitely committed to improving that with a mix. And all same given, we should be able to get back. But remember, again, now remember what I said again, the margins will, in this modernization, prevail for a couple of quarters. So that we know. But that doesn’t mean we’re not working to improve them.

Kulbinder Garcha – Credit Suisse

I just on that...

Hans Vestberg

And also if I could add here, I mean, this question you that raise, first of all, I think it’s very important to look back to the business cycle slides from the capital market day where we have coverage and capacity, that is very important to understand this. I think also that we get this question allot in a transition from 2G to 3G, and we manage to improve margins over the cycle of 3G so that they become really strong over time. Thirdly, the thing that I think you need to consider, of course, is the share of services sales going forward. When we were operating at gross margin levels that were significantly higher, we had the much lower services share of the business.

Kulbinder Garcha – Credit Suisse

Okay. Thank you.

Operator

Edward Snyder from Charter Equity Research is on line with a question.

Edward Snyder – Charter Equity

Thank you. Hans, you mention political uncertainty is a reason for the slower spending. Can you give us a little more color on that, and how much impact is the credit crunch in Europe having on the operator’s ability or willingness to spend?

And then I have one, Jan. I’m sure you’re like everyone, you followed the developments with the euro. What happens to your business and more importantly to your balance sheet if Greece does goes into default? And besides hedging, what impact will a high inflation environment have on your financials, or your spending by your customers particularly in the Network business? Thanks.

Hans Vestberg

Hi, Ed. We talked already in the first and the second quarter that we had two impacts on the sort of uncertainty in the world. Southern Europe and Northern Africa and Middle East, and they are a bit different the reasons for it that happened all year. We have not added any regions or countries that we now see a slow down due to macro economics.

What we have done is that in the conversation that I had with operators all around the world and my management team and a discussion with my region heads, we have seen that operator more cautious than last time I could not exclude that they will be cautious, now they are a little bit more cautious. It has not impacted much in the quarter. It’s more a feeling that they are thinking more on the budget, taking longer time to close it, taking longer time to decide on projects. But in general, the business activity, meaning possibilities, are equally the same, I would say.

But the feeling is that people are more cautious, and I think that’s nothing strange. We see what’s happening around us and read all the reports so, of course, all responsible business leaders thinks about this and being more cautious. So we’re going to see how that impacts investment level later on. The only visible or impact we had, which was time only, that was a normal year. We have more year-end investments on network side. We had less of this year. But again, it was not any huge thing this year. But that is why I am coming out and saying we believe that they are going to be a little bit more cautious but how that will translate into investments, that remains to be seen.

Jan Frykhammar

Okay. Let me then try to answer at least partially the question around the possibility for the situation in Greece and the impact on the euro, that’s a big question, Ed. I think to begin with, we are, as many other multi-national companies, looking at the different scenarios for how to act in certain situations and so forth. What is important to remember, of course, is that when it comes to exposures, our biggest currency is dollars.

Most contracts, infrastructure contracts are in hard currency, both euros and dollars. Our policy and principal that we apply in the company is to have as little equity as possible in any subsidiary.

Finally, if a euro breaks up and so forth, that is going to be obviously a long period of implementing a certain currency.

On your final point around high inflation, we have good experience of handling high inflation situations. We have been in Latin America I think for 100 years. We are experienced on this. What we have to do, of course, is to handle, to have as little local tied-up capital as possible and transparent payment terms and so forth. So I think we are as prepared as we can be for possible scenarios. At the same time, we have business in a lot of different countries, so we are exposed to currencies, but that is part of doing business in many countries.

Edward Snyder – Charter Equity

Great. Thanks a lot.

Operator

Alexandre Peterc from Exane BNP Paribas is on line with a question.

Alexandre Peterc – Exane BNP Paribas

Thanks for taking my question. Can we come back a little bit on the North American situation? Obviously it had a very strong sequential decline there against the usual seasonal patterns. So, would you expect in Q1, again, a slightly atypical seasonality given this bizarre Q4 base? And secondly, I understand there’s an element of CDMA going down, there’s also an element of M&A that impacts the operation spending in the quarter. Can you consider those up, you know, which one was stronger impact, and would you expect a snap-back related to the M&A that now didn’t happen and so this CapEx might come back? Thanks.

Hans Vestberg

Thank you. On North America, you’re absolutely right. The year-over-year decline was on Networks big, and that was, as previously communicated, due to three reasons. One was we had a sort of a period of higher investment in North America; but I think also very important for us was the planned mergers – planned merger that was planned, which sort of made less of investment; and thirdly, the transition from CDMA to LTE.

So then you can say the merger will not happen, so that you can take away. When those operator will start to invest, I guess that’s not for me to comment and that’s more for them to comment as there are few of them and you will know them by name. And every time I started to comment on their business, I guess then I’m in trouble. But that merger plan, which hold back the investment, that has gone away. When they will start and do something that we will see, that’s too early for me to say.

The CDMA to LTE, that’s happening. We have peaked CDMA, it’s going down. And that decline is not really offset by the LTE ramp-up, at least initially. Over time, of course, it will. But right now it’s not doing it. Then we had a very strong CDMA year in 2011, we have to remember that. On the investment level that has been high and now coming – has been come down in the second half, that is a little bit more temporary depending on cycles and that’s harder to predict.

Finally, I think as far as we can judge, the underlying sort of factors in North America, they remain. People use mobile a little bit more, they’re coming out with new devices, et cetera, and that’s important. But again, we had quite a substantial decline both sequentially and year over year, and some of those factors remains, of course, going into next year. The others we will see this year; it will be 2012. And on the acquisition, yes, there are of course a portion of that acquisition that goes to North American markets.

Alexandre Peterc – Exane BNP Paribas

Okay, great. Thanks a lot.

Operator

Sandeep Deshpande from JP Morgan is on line with a question.

Sandeep Deshpande – JP Morgan

Yeah, hi. Can I go back to that earlier question on the gross margin? Given what is happening with the network modernization project, would you say that what you’ve seen in the last few quarters is radically different from the change in margin you saw in 2007, and then this scenario will result in improved gross margin once the capacity-related shipments start whenever later this year or next year?

Jan Frykhammar

I think the answer is, first of all, I think, as we have said now at the Capital Market Day and that Johan mentioned as well, we have invested in the footprint, and the average length as we think of the networks are between seven and ten years. So, of course, once capacity cycle is coming, there will be more software, there will be need for hardware expansions and so forth. So, of course, the whole investment is built around an upside in gross margin as the traffic puts requirements on increased capacity.

Secondly, I think 2007 was slightly different because in 2007 and early 2008 we also had more of circuit switched core and laid architecture. Now it’s more radio in the mix. As Johan as well has mentioned before we are working hard to establish a good position on the smart service router and that type of business which is more software centric.

Sandeep Deshpande – JP Morgan

So you are seeing that there is no real competitive impact or price special impact in this margin at this point?

Hans Vestberg

I think every time there is new footprint available or a new technology there is more dynamics in the pricing. That’s been the case when 3G was introduced in Europe, when 3G was introduced in the U.S. and so forth. So those are the most – every time new footprint is available either by means of new technology or green fake footprint, there is more competitive situation. The modernization projects as such, nothing has changed compared to the business cases and again the business cases is about getting the projects done and then as fast as possible getting into the capacity cycle.

Sandeep Deshpande – JP Morgan

Thank you.

Operator

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

Mark Sue – RBC Capital Markets

Thank you. Hans, if network modernization is something Ericsson has done in the past with hopes of better margins someday and if that someday is today and we’re still pursuing network modernization, just wondering why would net margins get better in the future particularly as operators proactively reduce their CapEx to revenue ratio?

Hans Vestberg

Yes. I think that we decided to communicate clearly on the European modernization because of the reason that we saw a large proportion of the install base in Europe needs to be modernized. We don’t see any such launch happening. Of course it’s going to be new licenses coming out, et cetera but not on the magnitude as we saw the European modernization. That’s why we have been so clear talking about. It seems fourth quarter 2010 through other quarters, first quarter, second quarter, third quarter, fourth quarter because it has been unique. Remember also we were not number one on mobile infrastructure in Europe because during the 3G race we had to back off there. We decided this time as a leader in the industry, we always want to be number one in Europe. So that will not come back as opportunity. It’s now in the next ten years.

So I guess that’s hopefully answering your question about network modernization. It was a very specific region and a specific task we had. Then it will always be deals up and downs and some will be capacity, some will be modernization but this was a cluster of many of them at the same time and we don’t envision that we see that in the other region happening right now. It will be folded out in over years then.

Mark Sue – RBC Capital Markets

So, Hans, does that mean you continue to drive with modernization over all or do you step back and say regionally we do some of it here but less of it here.

Hans Vestberg

I think I tried to say it in my last slide. This is the year to capitalize on our market shares, execute what we’ve taken and the market share we have. There of course will be opportunity we can gain market share but we have no specific region or specific area that we are now targeting as we have in 2011. Then we would say it. Then it’s a normal year that we’re going to focus equally much on bringing the profitability up as anything else.

Mark Sue – RBC Capital Markets

Okay. Good luck, gentlemen.

Operator

Francois Meunier from Morgan Stanley is on line with a question.

Francois Meunier – Morgan Stanley

Hello?

Operator

Francois is on line with the question.

Francois Meunier – Morgan Stanley

Yes. Can you hear me?

Hans Vestberg

Yes.

Francois Meunier – Morgan Stanley

All right. So I’ve got a question actually on CDMA again. You tried to claim this morning at the press conference that you haven’t lost any market share in CDMA. I think our recent discussion with Alcatel actually show that in Q3 they haven’t seen any decline so far. So I was just wondering from what type of information you can basically affirm that you’ve not lost any market share in CDMA and how fast it’s been Q4 versus Q3. If you could be a bit quantitative on that one and then I’ve got a follow-up question.

Hans Vestberg

First of all, remember that our CDMA footprint is only North America. We have not gone expanding outside. They are very, a little bit well outside but mainly we worked on the footprint that we got from Nortel, and in order to go into LTE with it. So there might be different markets we’re talking about. We talk about our markets and the few customers we have on CDMA. They are migrating to LTE.

We can of course see that we have a decline year-over-year and sequentially on CDMA at the moment, and that is still better than expected and we required CDMA, but it was clear that it would go down sooner or later. And we have a few customers in North America that are migrating quite quickly to LTE. That means we will see a decline in 2012 on CDMA.

And we are preparing for that. And seeing that we both from a efficiency point of view, resource confidence point of view on the right, we already now as we presented at capital markets day, a range based station 6,000 can include CDMA, meaning that we are migrating from a technology point of view that into the ready base station as well. So we are doing all of that. We have already kicked off our efficiency work et cetera in the CDMA, even what we see.

Francois Meunier – Morgan Stanley

Do you confirm it’s a double digits significant number of decline in Q4 versus Q3?

Hans Vestberg

We have not disclosed that exact number, but, again, it is declining in CDMA both sequentially and quarter-to-quarter.

Francois Meunier – Morgan Stanley

Okay. Then I’ve got another question around getting network rollouts, as you disclosed them in the (inaudible) services now. It looks like margins were around minus four, minus five of quarter, and as they are around minus ten. Is there any way to cut costs in this network category?

Hans Vestberg

I think so first of all, the same message as we have been conveying throughout the year, there are three reasons for the low margins in network rollout. The first reason was that we got efficiency issues with the projects because of the supply chain issues, predominantly first half. We also had first half of 2011 rollouts in India. And then we have the modernization projects.

The two first items are gone, the impact that you see now on network rollout is related to the modernization projects in Europe. And having said all of that, we know that network rollout is a lower margin business but as the leadership team we are not happy with losses of course not so what we work on is, of course, to execute the projects, to improve the efficiency in the project and so forth, but as long as the modernization projects will be there, we will have an impact in the network rollout margins.

Francois Meunier – Morgan Stanley

Okay. Thank you very much.

Operator

Simon Shepherd from Goldman Sachs is on line with a question.

Simon Shepherd – Goldman Sachs

Yes. Thanks so much. It’s Simon Shepherd from Goldman. I actually wanted to go back to this question about the tailing off of network modernization projects. I think at the capital markets day, you were talking about 18 to 24 months but then in Q4 obviously there seems to have been a good amount of pull in, if anything and mix weighting towards those modernization projects. So in essence, my question is, are you still comfortable that will fade as a percentage of the mix relatively quickly or how should we look at the timing in terms of that mix effect into 2012?

Hans Vestberg

I think so what we said was that if we have to remember a bit what we have said during 2011. I mean, in January of last year, we thought that the modernization projects would be – have commenced already in Q1 of 2011. It was only a minor impact in Q1. The projects really started in the second quarter of 2011.

And what we also said was that all projects would have commenced in the fourth quarter and that is what we confirm. So from the starting point, you have to calculate then 18 to 24 months, and that is what we stick to. We have detailed the control, of course, of all of these projects, rest assured. So they will stay with us for a couple of more quarters.

Simon Shepherd – Goldman Sachs

Understood. Thank you. And then secondly, on the same sort of topic, how does this makeshift effect your aspirations to improve your working capital times? It looks like Q4, perhaps, again, if anything, you’re falling slightly short of your cash conversion target so maybe just as a reminder as to how that mixed dynamic may affect your working capital in the first half and the second half of 2012.

Hans Vestberg

I think that, first of all, I think we have the reasons for the – the high inventory is during 2011 was slightly different if you look at first half and second half. I mean, first half we had the inventory because of the supply chain issues. Second half, we started to get more coverage projects and modernization projects and projects in our business means more working capital or project capital.

Then in the fourth quarter we had good progress on – on reducing working capital. Everything else equal, we still see a potential to improve the inventory from the levels we have. But we should also remember that we have a mix with more coverage projects that tie up slightly more capital. But when I say that I’m not happy with the working capital or in that sense, it is of course because we think that we have potential to improve here throughout the year, during the year.

Simon Shepherd – Goldman Sachs

Got it. Thanks so much.

Operator

Matthew Hoffman from Cowen is on line with a question.

Matthew Hoffman – Cowen & Company

Yeah. Hi. Thanks, Hans. My question is why, as you think about the options for ST Ericsson, why is the ST Ericsson JV structure still strategic to Ericsson if they are going to continue to pursue the outprocessor market? And why not just move to a modem only strategy similar to the old Ericsson mobile platforms which was so successful. I’ll have a follow-up too. Thanks.

Hans Vestberg

Again, we have a new CEO in and we are reviewing our options all in the company. We have two main toss – or main objectives in that view. One, keep the value that we think we have in that joint venture because we have really a lot of value. And second is to bring the – the breakeven point and the sensitivity in the business down. Let us come back with that, not to pre-empt any annual reviews that we’re doing at the moment.

Matthew Hoffman – Cowen & Company

Perhaps that was a leading question. But is there any chance where we’ve reached the level where operator upfront subsidies of handsets like the iPhone have become an issue as operator cash flow goes into subsidies and now have less to spend on network rollouts? And if so, would that – what would reverse that? Thanks.

Hans Vestberg

Of course, you’re right. The subsidy moderates in certain markets, not all over the world. I mean, there are regions in the world where there is no subsidy at all. We’re clear on that. So it’s really a bit different how the market structure has been in there. So I think that for the markets where the subsidies have been there, that has been given for us where it has not been there. So of course, we would be happy if there’s no subsidy because that will create more opportunities for us to get the investment. I don’t see any change of the subsidy model in a big way at the moment at least but let’s wait and see because it’s a big ticket for the operators or cost for the operators doing subsidies, especially with the phones that you’re mentioning.

Matthew Hoffman – Cowen & Company

Thank you. And good luck.

Åse Lindskog

We’ll take one final question.

Operator

The last question comes from Richard Kramer from Arete Research.

Richard Kramer – Arete Research

Thanks, guys. A couple of questions. For Hans or Jan, you made a point of calling out intellectual property at Capital Markets Day, could you give us a sense of what the yearend royalty income was? And now that you’ve promoted Hasin as a direct report to January, can you give us a sense of the kind of growth you expect in royalty income for next year, given the wide range of 3G devices that is are now coming to market and some recent – obviously some license agreements you’ve made? And then I’ll have a follow-up for Magnus, please.

Hans Vestberg

Okay. We’ll not give you that much of information here. We have not disclosed finally the yearend IPRs as we’re not disclosing that. We did that at Capital Markets Day after 2010. We will come back when the first quarter is starting the report. As I said, we change disclosures once a year and that’s in the first close. We will come back if we’re going to change that or not. So we’ll come back to that.

On the royalty growth rate, I will not give you any indication, but I will – what I have told you and everybody else, we think we’re very good portfolio. We see a growing number of – of devices coming out. We see the 50 billion connected devices. We see more infrastructure base coming in. We say, as we have said before, if you want to do infrastructure or handsets or anything, you need license with us with us. We will motor with everyone that is acting right now. So over time, we believe this should be an important asset, an important asset that can grow. And secondly, we need to remember it’s a flip side on our R&D investment. We would not have these patents if we didn’t do the R&D investment so we need to continue them with them in parallel as we said before.

Richard Kramer – Arete Research

Okay. And a quick one for Magnus. It seems almost as if you have declining returns in the Global Services business. The larger the scale you get, the lower the margins, and you clearly added a lot of staff. Is there any reason to expect that you shouldn’t need some sort of restructuring for next year? You’ve seen some of your major competitors going through this and talking about efficiencies in their global knocks. Why wouldn’t Global Services, instead of looking to pursue revenue growth, start to look to rebuild the double-digit operating margins that as group that you saw two, three years ago in that business?

Magnus Mandersson

Let’s try to capture what’s on the question here. I think first of all, we are actually growing our business in local currencies. That’s one thing. Restructuring is a part of our business. We are restructuring every operation we are sitting on in the 175 countries as day by day, everything from the Managed Services contracts we are doing as well as the way we are delivering our services, from global service centers as well as the global network operation centers. And we are collapsing basically every local knock we are having into global knocks. Romania, for instance, we have one in 26 operations hooked up to that center. We have the Indian network operations center is also a double digit numbers on operation hooked up to that and with many, many hundreds of millions of subscribers. I think we are leading in that transformation in the industry.

Hans Vestberg

Maybe just adding there that we need to separate it to be network rollout as Jan has said. They were down satisfactory profitability, given the projects that we have at the moment, we will working that. If you look at Professional Services, being in the same range over this basis since we started to report, and we all need to remember that 2010 figures excluded restructuring and now we’re including restructuring. So we’re a little bit unfair to remind us when you look at Professional Services because that would be flat between the years if you look at that for Q4 when it comes to Professional Services. But again, network rollout is not good but Professional Services has been in the same range since we started even though with the expansion we are growing 12% in Professional Services in Q4.

Magnus Mandersson

And of course, we are consistently working with the improvement programs in network rollout, and basically doing everything right from the beginning and execute on the project and conclude those on a daily basis.

Richard Kramer – Arete Research

Okay. Thanks.

Hans Vestberg

So full focus on it.

Åse Lindskog

Thank you very much all of you. And before concluding this call then, I would like to take the opportunity then, to invite all of you to our Investor Day on November 6 here in Stockholm. So by this, we conclude our call and I wish you all a very good day. Thank you and, bye-bye.

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