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LM Ericsson Telephone Co. (NASDAQ:ERIC)

Q1 2007 Earnings Call

April 26, 2007 8:00 am ET

Executives

Carl-Henric Svanberg - President and CEO

Karl-Henrik Sundström - CFO

Gary Pinkham - VP, Investor Relations

Analysts

Paul Sagawa - Sanford Bernstein

Has Malik - Citigroup

Mats Nystrom - SEB

Kulbinder Garcha - Credit Suisse

Alexandre Peterc - Exane/BNP Paribas

Stuart Jeffrey - Lehman Brothers

Tim Boddy - Goldman Sachs

Per Lindberg - DKIB

Matthew Hoffman - Cowen & Company

Edward Snyder - Charter Equity Research

Ed Bell - Cazenove

Presentation

Operator

Welcome to the Ericsson's Analyst and Media Conference Call for the First Quarter Report. To view visual aid for this call, please log on to www.ericsson.com/press, or www.ericsson.com/investors. (Operator Instructions).

As a reminder, replay will be available one hour after today's conference. Mr. Gary Pinkham, Vice President of Investor Relations, will now open the call.

Gary Pinkham

Thank you, operator. Hello everyone, and welcome to our conference call for the first quarter results for 2007. With me here in Stockholm is Ericsson CEO, Carl-Henric Svanberg; and Karl-Henrik Sundström, our Chief Financial Officer.

Before we get started, I would like to remind you that we will be making forward-looking statements during the call today. These statements are based on our current expectations and certain timing assumptions. As you know, the actual results may be different due to a number of risks and uncertainties associated with these timing assumptions. So therefore, we urge you to consider any of these forward-looking statements with caution.

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

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Carl-Henric Svanberg

Thank you, Gary. Ladies and gentlemen we have had a good start to the year. Take the next slide please. I will see if we can get some slides rolling here. Just want to make sure that we have the first slide up here. I want to make sure that we can flip through the charts in a good way here. What do you say Gary, should we get started on this?

Let me get started and see how we get the computer to work. But the important thing, I guess is the presentation as such.

We are now approaching 2.9 billion subscribers in the world. But what is more exciting is the data traffic, that we actually saw tripling over the last 12 months, data traffic in the world's networks. We actually even saw doubling in the high-speed networks over the last six months. This is exciting, that means that this is strong indication that multimedia is happening now. Fixed broadband connections are up to 280 million.

We and Sony Ericsson had solid performance in the quarter. We had 8% growth, which also should be seen in-lieu of the weakening dollar with 11%. So, either way, we calculate, and as a company or networks or the mobile systems, we would be in double-digit with cost and currencies. As I will show you on the slides, as we go forward. We have a tough comparison in the US with the Cingular roll-off and I think you are aware of that. I think we've got the pictures up and running now.

Then if we look at it, we have a new organization in place. Networks, Professional Services and Multimedia, I think you are all aware of that. So, I won't go too much into it, I can just tell you that it is a good organization. It creates much more clarity for customers, clarity internally, so on and so that was a good move.

And if we go another page, we will now follow this in our new reporting, but networks also includes the roll-off and I will not comment on the details here, I will come back to the details on later slides. But you can see how sales is basically split in between 30 billion networks, 10 billion on professional services and 3.5 billion in multimedia. You can also see the margins, how they are distributed and you can see growth. And let me come back to the bits and pieces.

When it comes to mobile systems, just want to make one clarification there, because this is how we have guided the market previously and assert on giving you data. Mobile systems, is the mobile part of networks. It is in Multimedia, the mobile Multimedia systems, prepaid and other such products, and it's from professional service part of the system integration for building those multimedia systems. All that builds up mobile systems. And there we have Q1 sales growth of some 6%. Again, with the strengthened dollar would have been double-digit. We will continue to report mobile systems at least through 2007 for comparability.

If we look into the next slide to the Q1 financial highlights. We have group sales of 42.2 billion. I think you know that by now, again, growth over 8%. I have said enough probably about the US dollar. We had also the peak of the Cingular roll-off in Q1 last year. So that adds also to that comparison.

Gross margin was actually up sequentially 0.8%, which was good, because gross margins are normally higher in the fourth quarter when we have bigger utilization of the resources. Operating margins was up significantly. Of course to a good degree because of Sony Ericsson, but also of continuous operational excellence work.

If we continue on the highlights, operating income was 8.2 billion, which is up 23% year-over-year, EPS up 28% year-over-year, and operating cash flow was 4.6 billion. That includes the dividends from Sony Ericsson, and that was done in a prepaid arrangement this year. That whole part was because we always paid the Sony Ericsson dividend in the first quarter, but Sony this time, asked us to do it in the second quarter, which is another fiscal year for them. And we accepted that as long as we get the payment in normal ways, that’s why it was called prepaid.

I will come back and mention a couple of comments on the cash flow on the next slides. But we’ve had increased working capital of 4.7 due to large projects. Net cash of 29.1 billion after the acquisition of Redback/Entrisphere, and also some shares that we have been buying in the acquisition process of Tandberg.

Let me make a couple of comments then on the next slide on cash flow, because I think it's important that we all understand how our business is driven.

There are two types of contracts. The upper contract, which is where we run separate contracts for shipments and installation. We ship our products, could be into warehouse with a customer, or could be on to the site. And then we return back when the customer tells us to go and install our stuff and commission it.

This is typical for Europe, for Americas, both actually in North and South America. Then we have the turnkey projects. Those are typically in CEMA region and the Asia-Pacific, where we take the whole responsibility, may even acquire the sites, put up the towers, put up air-conditioning, put up everything and obviously buildup working capital as we go along.

We obviously do get progress payments of various kinds, but not offsetting the buildup for working capital. So, this is typical for a turnkey project.

So if we then go to the next slide and look at how have the developments been done over the last years' at Ericsson. Well turnkey projects are growing in importance all over the world but primarily in APAC and the CEMA region. 60% of our total growth from 2003 to 2006 was turnkey driven, 70% last year. If we then do [another cut] and again look at the total growth, CEMA and APAC where turnkey projects are prevailing, we have 65% of the total growth from CEMA, 2003 to 2006 and 75% in 2006 alone.

If we then look at the next slide and just conclude a couple of things about these turnkey projects. Remember that if we roll-out a project, be it in Nigeria, be it in Vietnam, Pakistan, or Bangladesh or India, our capability is to run such large projects.

They are as important as our technology leadership in driving market share and driving growth. And we have gained market share more in these markets than almost anywhere else.

Of course this builds up working capital that we understand. But we are well compensated, for these are projects with healthy margins, they keep up our margins not only for the projects, but for the way we tie up the capital and capital costs we have. Remember also that collections here have never been an issue. Obviously, when we get in balance here and we have as much turnkey one year as we have in the last year, the year before, we will get in balance a better balance, good cash flow and income. But as long as we grow, the stronger we grow the more we will have to wait a bit for the moment. Still we should remember, what says on the tagline at the bottom. Through the whole 90's from 1990 to 1999, we generated 3.7 billion in cash flow, over the last four years we have generated 70 billion. So from our point of view, our capability in handling large project is an asset that we are happy with.

If we then say a couple of things on the three segments. Let's start up with Networks here, we had 5% growth, in fact as you probably figured out, we were in this particular quarter and as for the rollout was down 4%. And that is included here, so Networks ex (inaudible) growth was actually higher. But here is where we are hit by the Cingular comparison with last year. If we exclude the Cingular effect, growth outside US amounted to 14% for Networks year-over-year, which is a pretty impressive number. Operating margins are stable 17%. GSM continues actually quite inspiring with good growth in many markets. And I will come back to the various markets, and also mobile broadband starting to happen in a bigger way.

Last year was really a big breakthrough for mobile broadband and that is also what we are seeing –with data traffic doubled over the last six months in the HSPA networks.

We are also in the process of integrating the acquired companies obviously. And that is an exciting project in itself, where the Redback Company, Tandberg, Entrisphere is a smaller one, but Redback is a great add-on and lots of lots of excitement in that company, I must say.

We then go to next one, and look at Professional Services. Here you can see the margins of services being stable around 15%. Growth is here 15% as well. But in services this is all local business. So here we can do an easy calculation of growth on local currencies that was 20%.

Managed services grew 11% and for the same reason in local currencies 15%. In managed services, obviously growth depends a little bit on how larger contracts comes in here. As you know, we had this larger contract with Vodafone, which was a very innovative contract, I would say, where they for the first time signed a contract from global for their [opticals]. Normally they sign individual contracts in the various opticals. But this is really leveraging synergies for handling spare parts for all their different vendors in one setup for the whole of the Europe

We are now supporting 1 billion subs in networks and we have 120 million subs in the networks that we actually run.

We then go to multimedia, strongest growth 19%, operating margins here of 8%, up from 3% a year ago. A lot of growth right now from EMP and from what we call revenue management, that's where you have prepaid and such systems as well. Good margin improvement. Because we have here EMP and we have revenue management, we have enterprise, we have IPTV solutions, and now the multimedia solutions. Depending on how growth will happen in this smaller unit, it could affect the profitability and margins for the unit as a whole, because that will vary a bit as we go on and we have to learn how that looks.

Tandberg was obviously a great addition, we acquired the company yesterday, that's all in place and it adds both an excited crew of skills and competencies, but then it also adds products. And you can see on the animation, that's the picture from the press conference when we acquired it, when we announced the acquisition, we are actually the only player in the industry that can provide a solution from in-house in IPTV.

We then have a couple of quick comments on the regions. Europe was up 9%. As we have said several times, that we are starting to see bottlenecks in networks and we said last time in Q4 that we saw a potential upside in Europe. We are seeing how investments in mobile networks is growing, this time especially in Southern Europe.

We are also seeing how the accelerating data traffic is creating transmission bottlenecks, and we have a continued strong focus on managed services. So, much the same story as before, but slightly better I would say.

If we look at Central and Eastern Europe, Middle East and Africa 9% up underlying business from (inaudible) before, where we have a seasonally much stronger growth, but we had a bit slower quarter. A lot of activity, especially in Sub-Sahara, lots and lots of roll-out there.

Middle East was a bit slower in the quarter, but good business momentum with new licenses in both Saudi and Egypt. We are seeing Russia that is preparing for 3G as a [couple of comments].

We then go to APAC, we come to the strongest growing region in the quarter, 36%. I think you are all familiar with the various projects that are going on, but we had Japan, where we had major rollouts. Lots of activities there. Bangladesh, Indonesia, two quickly growing countries. India has taken over the position as the leader, in terms of subscriber growth, the fastest growing country in the world.

Now added, I think it was 6.8 million subscribers in the last month. Slightly ahead of China, but of course on a lower level. They are now at 160 million subscribers and they are heading for some 500. The BSNL court case has been ended and the award of contract is now going on with high intensity. We shouldn't forget though that BSNL is just one out of four or five large equally large operators, where Maxis and Hutch and Bharti are into similar expansions.

Finally, we have China where the decision was taken by authorities to start a major trial of TDS-CDMA, the Chinese standard in eight cities. And we expect 3G licenses not to be awarded before that trial is over. It's probably going to take the remainder of the year or more so. And that has started off investments in 2G again where there's a pent-up demand. So, China should be a pretty interesting year.

Then if we go to Latin America where we are 9% down. Remember now that Latin America in 2005 was 100% up and we saw a bit of a catching breath there last year and we are starting to see more momentum again. There are a lot of bottlenecks in those networks there. We are also seeing how Telefónica and América Móvil are now preparing for 3G and even growing discussions also there for managed services.

Finally, if we go into North America. This is where we faced a tough comparison, Q1 2006 with peak roll-out for Cingular which we indicated all that in Q4, that I wanted you to be aware of. So the 41 down here gives a little bit of an odd comparison and you will see all that in Q2, when the rollout was ended last year, that the comparisons starts to be much more normal.

Quite an interesting market. Lots of triple play focus and rollout of fiber-to-the-home and new spectrums and so one awarded that to generate business and we have strengthen our position quite considerably through Tandberg and Entrisphere and Redback. That has been clearly noted by all the American customers and that will help us going forward in generating new business.

If we then look at Sony Ericsson, I think this is all familiar to you, 63% up in number of phones. Their 'Wow' products as they called them, drive very much of their success.

Also in the entry segment, the whole idea is to take the successful Cyber-shot phone, Walkman phone, and with [entrée] variance, make sure we enter further down into deeper segments with price premium being the premium brand in every sub-segment. We are not at all approaching the lowest part of the segment, but gradually seeking whether it's a profitable business to be captured.

And this was done with stable margins. You saw the ASP come down a bit in the quarter, because the mix shift to somewhat more entry phones and also the fact that there was lesser new introductions in the quarter.

If we look at their numbers, Q1 sales was up 47%, profit were up 139% and strong growth, primarily driven by Europe, Latin America, and Asia Pacific, actually an exciting 110 million music-enabled phones have been sold to date. An interesting comparison with any provider of MP3 players.

If we look then finally at the market outlook, we haven’t changed really anything, we see a mid-single digit growth for the markets in this year, in mobile systems. And we believe we have that order also in Q1. For Professional Services we continue to expect good growth from the markets and in both areas, we expect to continue to grow market share.

That was my input and then I will ask Karl to comment more on the financials before we have the questions.

Karl-Henrik Sundström

Okay. Thank you and good morning and good afternoon to all ladies and gentlemen. If I go to my first slide, financial summary, I would like to point out that we had a 8% increase if you exclude the [divested defense] business that we sold up in the third quarter last year.

The other area I would like to point out that have increasing operating margin, both including and excluding Sony Ericsson, and we have been able to increase our EBITDA margin compared to the same period last year. Basically we generated an increase in profit of 1.6 billion in this quarter compared to the first quarter of last year, of which 0.9 is coming from Sony Ericsson and 0.7 from our increased sales which is driven by the 8% compared to increase of OpEx of only 3%.

Please go to the next slide. I think you all have noticed that the tax rate is 29% in the quarter compared to the 31% last year and we still believe that it will be around 30% for the full year. And I also would like to point out that we are now having an equity ratio of almost 57%, which is a very strong balance sheet.

And if we then go to the cash flow analysis, I think it's a little bit important here that you understand and I can explain, that last year we had dividend of 1.2 billion coming from Sony Ericsson, which is then booked under the adjustment to income to cash. As you can see, this year, we received a prepayment that is part of explanation in the report of 3.5 billion. This means that we build up working capital of 4.7 billion in the cash flow in the first quarter of this year, compared to 5.4 billion last year.

We are slightly better than last year when it comes to working capital management. However, we still need to work in this area. But it's also reflection of the stronger growth in a lot of the big project that Carl-Henric mentioned.

We made acquisitions of 15.7 billion and if you deduct that from the net cash of 40.9 billion at the end of last year and you add back the cash flow in the first quarter, you end up with a new net cash position of 29 billion.

And then if we go to the last of my slide, which is operating efficiency trends. DSO days has increased by 7 days compared to last year in the first quarter and that is mainly driven by the huge growth, especially in APAC where you traditionally have longer payments.

When it comes to inventory turnover, we have the same inventory turnover as last year at 4.2 and we are now starting the big journey to get to the 5.5, which is the target for this year. When it comes to payable days, we have now for this year changed the target, with the previous 45 days. We have now changed the target to be over 60 days. We managed to get 67 days in the first quarter. And this is an area where we need to work harder, because when it has to be reflected in the terms and condition when we do turnkey, we need to bring our partners along.

And with that I handover to Gary Pinkham.

Gary Pinkham

Thanks Karl. Operator, we are ready to start our Q&A session now.

Question-and-Answer Session

Operator

Ladies and Gentlemen at this time we will begin the question-and-answer session. (Operator Instructions). We will take our first question now from Paul Sagawa from Bernstein. Please go ahead.

Paul Sagawa - Sanford Bernstein

Hi. Clearly, over the last number of quarters you've had an increasing amount of these turnkey solutions and that's having an impact on the working capital. And that's also have picked up [ponderous] of new build, turnkey type solutions also has some impact on margins. Is that fair to assume that the turnkey -- these new built turnkey solutions do affect gross margins and the overall operating margins of business.

And as we look further into 2007, into 2008, do you anticipate that transition either stabilizing or even shifting back in a cyclical form to larger performance, with a higher margin less working capital intensive sort of upgrade and expansion kind of business. Can you just talk about the shape of that business? I think people are really concerned about the impact of margin.

Carl-Henric Svanberg

First of all turnkey projects, those have more shape than install in all the new networks. Turnkey projects tends to depend on margins better, because we have unique capabilities there. Operators are less tough on bargaining on the contracts, if we load off them, the whole [methods]. So, turnkey projects are working in our favor.

However, we should remember that turnkey projects or be it shape in install the other alternative, they are both new network rollouts. And the investors, they are more price competitive, they price-up then an expansion project later on. So, in that terms, you are right. So, I think you need to keep track on both of those aspects.

Of course, when we are coming to a time like, when we have more additions in expansions, rather than new networks. Then you are right, then that balance shifts a bit and this depends a bit on where the market is going. But I think we tend to be surprised of how much new business that comes, simply because phones and equipment and services becomes more and more affordable. So, we are now looking at 4.5 billion of people that are looking to have a phone and it could even go beyond that as time goes. Then of course it drives new business and that is great add-ons that we don't want to miss.

But obviously over the longer period, it will become bigger portion of expansion, with the effect that you are saying.

Paul Sagawa - Sanford Bernstein

Thank you.

Operator

Thank you. We will take a question now from Has Malik from Citigroup. Please go ahead.

Has Malik - Citigroup

Thanks. I have two questions. The first is, given the cash flow performance and the ongoing growth [boost] in emerging markets, at least probably over the next year. Do you think are the prospects of substantial increase in the return of what might be put in excess capital in your balance sheet? Do you think the prospects of a substantial increase have been reduced?

And the second is more of a kind of market question. How close do you think we are to a phase of European 3G capacity upgrades and what sort of impact do you think that would have on your margin structure? Thank you.

Carl-Henric Svanberg

Well, I think that I would answer the second question first and then I just want a clarification on your first question. But I think that it is easier to say that there is capacity in the 3G networks. But in reality, with the tripling of traffic and quadrupling pace in the mobile broadband networks, because you can't really do all the great things you want to do. Also in now mobile music downloads or what have you.

Of course quadrupling for a couple of years that starts to be pretty massive. I think that could also be and we see examples of that operators overestimate what capacity they have, because the real traffic cases don't come as even or as well as you would like them to be, as you reach ceilings. And you don’t want to have a network where your subscribers don’t get the quality they expect.

So, we have indicated it for a while, where we have both indicated about license transmission coming first, and then secondly talking about Europe with a potential upside. And we saw now increased spending in southern Europe now for the second quarter as a first example. So, I think we are gradually moving into that space. Your first question, I didn’t exactly get your point.

Has Malik - Citigroup

Well I suppose another way of asking that is you’ve always talked about net cash on the balance sheet as a strategic asset and the near-term memories of what happened three or four years ago, have always persuaded you that its important to retain a strong net cash position?

Given what we have seen in other parts of the equity market and even within [tech], the willingness of some companies to raise debt and some companies having debt forced upon them. Do you think that’s altered your own perception of the amount of net cash or the amount of net debt you will be willing to take on? Thank you.

Carl-Henric Svanberg

Well and we said when we had $50 billion on the cash, that was not a bad position to have, considering all the various aspect that you said and the preparedness for whatever reasons. And since then we have used cash flow for strategic acquisitions. So I don’t really think we have changed our position since then, and because we have used cash flow for acquisition, this point has not been a major topic on the agenda in board discussions. This is more of an ordinary issue and so on. So I think there is a good reason to have some preparedness, but obviously over time, we should generate good cash here, that may need to be discussed. But we are not there now.

Has Malik - Citigroup

Okay. Thanks very much.

Operator

Thank you. We've got a question now from Mats Nystrom from SEB. Please go ahead.

Mats Nystrom - SEB

Yeah, hello its two questions if I may. Firstly, you talk about tripling of the data traffic and noble networks and so on. But the question is, is Ericsson already benefiting from this in terms of revenues and shipments? Or is this more something to account from your perspective so to speak, or [open] opportunities going forward, or are you really seeing this in your numbers, today.

And secondly, I think you presented a very good slide in explanation of the difference in contracts in the emerging markets versus the [western world]. But having said that, there should have been large turnkey projects also in end of '05, early '06. I’m sure that they have kicked in so to speak in the current numbers in your cash flow, in terms of reversal of working capital or am I doing the thinking wrongly here? Thank you.

Carl-Henric Svanberg

The first, I would say that on the data traffic side, in the bigger scheme of things we are seeing some smaller numbers because we have bottlenecks in transmission in networks and so on. But generally, not guessing the numbers. But certainly it's quite interesting when you talk to the large deals. I mean they will all say that it is happening now and you can read it in TeleSonera's recent reports. You can read about it in Cingular's report, you can read it about in the reports from Japan and from Pakistan and so on.

But everybody would confirm it, that it's happening. You are obviously at some point, you are right that it should be seen in 2005 and I guess it was. But it was really starting to happen then. The reason now that a phenomena here all says that, when in 2003 and 2004 that we have the recovery from the downturn. Operators that were in difficulty there, they started to buy their separate pieces in the projects themselves because they thought they could bargain harder. And that is also the adverse trend where they have come back and said it's much better you do it all, we are not gaining anything by trying to do the bits and pieces. So the bigger effects have been there in 2006, however there was also some initial effect in 2005 obviously.

Mats Nystrom - SEB

Okay. Thank you.

Carl-Henric Svanberg

We saw that clearly in Q3 2005.

Operator

Thank you. We have got a question now from Kulbinder Garcha from Credit Suisse. Please go ahead.

Kulbinder Garcha - Credit Suisse

I have got two questions. The first one is on, are you impressively telling us that given the turnkey contracts are going to grow. This year your net income to free cash flow conversion won't improve. Or is it your target to improve and recognize that last year was a particularly average year in that regard.

That's my first question. And if free cash flow is going to improve this year, when might that be, is it near term, is it the second half. That's my first question.

The second one is you mentioned in your press conference, I mean in your press release on India how faced the BSNL contract and then several other contracts. Just in terms of magnitude; the BSNL contract I think is $5 billion, the Reliance one is maybe as much as $7.5 billion, $102 billion contract with Hutch-Essar. Now in that context, maybe $15 billion to maybe $17 billion worth of contracts in India, that will probably be awarded in the next six months. Is that something that you see in active discussion there? Are we getting the right kind of magnitude in terms of the speculation in the Indian press or is it much smaller than that?

Carl-Henric Svanberg

Well, I think the BSNL contract is quite well captured and that will last for now for several years. And we'll get our share, we obviously hope, it's not awarded yet. The others are in similar magnitudes going forward over the same period of time. Some of them for half a year or a year at a time, some others by a major bigger contract like BSNL, but it is higher activities.

Let me say and I think that is important that the reason why we bring up the turnkey projects and so on in this particular press conference, is not that we are going to warn for any new situation or anything. This will go on in business as usual, and of course if we grow more, we will have more of those effects. And if we grow less, we would generate more cash flow. That goes for most businesses.

Why we bring it up, is because we have found that the there is a lack of understanding on quite a few hands on what it means. What is it actually that's (inaudible) the working capital and what are the effects? And that presentation we could have done equally well, one or two or three or four quarters ago. We just want to give some extra information and understanding to it.

Kulbinder Garcha - Credit Suisse

I guess just one follow-up. Do you think your free cash flow conversion this year will improve as to last year? I am not asking for a particular quarter. Do you think year-to-year it will improve?

Carl-Henric Svanberg

Well, I think that it depends actually on the growth. So, it's a moving target a little bit. And if the market is slower, I guess, that should be the conclusion. If the market is accelerating it may not be the conclusion. But, let's also remember that we do have turnkey projects as such, in a stable situation where it adds much every year doesn't have this effect. It is more of the fact that we have a disproportional high growth in turnkey. So, it depends on which markets and so on that the growth is going to come from.

Kulbinder Garcha - Credit Suisse

Okay. Thank you.

Operator

Thank you. We've got a question now from Alexandre Peterc from Exane/BNP Paribas. Please go ahead.

Alexandre Peterc - Exane/BNP Paribas

Yeah. Hi. I have two questions. Firstly, can you maybe tell us a little bit. There was lot of talk about network sharing what impact that would have on vendors. And clearly, Europe still looks quite good. So, is it too early to see any knock-on effects from that or was it much to about nothing.

And then secondly, if you could just come back a little bit on the selling & other expenses in Q1. Could you explain why that progressed more in [networking] costs? Thanks.

Carl-Henric Svanberg

Let me start with the first one and I will let Karl answer about the second one here. But network sharing is a matter which (inaudible) complexities. First of all, it has a smaller impact on us in terms of selling equipment, because any two networks that you want to share don't tend to have overcapacity in terms of voice, for example, that wouldn't to be smart to build a huge overcapacity. Which means that, the major savings is that you can reduce down to one site, into one of everything that is site-related. Whereas the radio equipment for example, that will be needed as it was held by both parties. So, that wouldn’t be a big change.

Of course, that could be in [XM, Sirius] and so on, but you could get away with that sort of equipment. But these effects are marginal. So, I wouldn’t say it matters so much from equipment sales point of view. But it does matter a lot for, in terms of sharing sites and all the costs related to that.

It is however, also a bit difficult with network sharing, because when you go in, especially multimedia and all that. What is it that triggers what kind of expansions and who are going to pay for what expansions and which business case is the one you want to drive, who wants to do more of a mobile broadband early rollouts, and be first, and others want to be second and go slower. There is lot of interest in network sharing, but there is also more hesitation among us, those that actually share. Several of them are trying to get out of the arrangements.

That doesn't mean that there aren't going to be successful cases, but they need some serious consideration I would say. And lots of interest, but not very much concrete deals as we see, except the one we see in UK. Is that fine with you or --?

Alexandre Peterc - Exane/BNP Paribas

Yeah. Thanks.

Carl-Henric Svanberg

Then I will let Karl comment.

Karl-Henrik Sundström

The selling expenses are up higher than the 8% growth in sales. And the reason for that is that you might have between quarter fluctuations. And this is a reflection I think of the high activity that we are having in the local markets, with driving costs, and a lot of pre-sales activities. And this will go back to normal patterns overtime. It's a little bit unusual quarter.

Alexandre Peterc - Exane/BNP Paribas

Okay. Thank you. Can I just have a quick follow-up on TDS-CDMA? You were mentioning China Mobile, having extensive steps there. Can you tell us what is your position in that technology and to what extent you would be involved in that? Thanks.

Karl-Henrik Sundström

What we do in -- yeah?

Alexandre Peterc - Exane/BNP Paribas

TDS-CDMA.

Karl-Henrik Sundström

Yeah, TDS-CDMA. I mean, it's quite clear and I think everybody understands and we've said it a few times that TDS-CDMA will play its role in China. They want to build up their Chinese standard, I guess they did (inaudible) and so on and competence. It is hard to see that would play a bigger role as GSM has a much more natural migration over to wideband CDMA. So, once they go for building out 3G I think, we will see wideband as we have expected it all the way. That's what was expected to happen sooner than it does.

On TDS-CDMA, we got awarded a smaller piece of it, the only foreigner that actually got that. This is a trial system and it [fits this] and after that trial, we will see more of what happens to it. And as time has gone by, we have actually done more in that field. So, we start to be fairly equipped should the time come, and there should be interest. Because it's a standard with much lesser economies of scale, operator will have to pay more money for the equipments simply because there is those effects. And if the prices are good, we can participate. It's really going to be a bit of a deciding factor for us in China.

Alexandre Peterc - Exane/BNP Paribas

Okay. Thank you very much.

Operator

Thank you. We've got a question now from Stuart Jeffrey from Lehman Brothers. Please go ahead.

Stuart Jeffrey - Lehman Brothers

Thank you very much. I have got a question on margins. If we strip out Sony Ericsson and go back to last year, we started the year with 15% margins. And part of the explanation for that was the integration of Marconi and also some of the lower margin services contracts, and as those stated out, so the margins improved for 2006.

The question now is as we look at the start of 2007, margins in Q1 are only about 40 basis points higher than they were in Q1 last year. So, is there anything unusual suppressing margins in Q1 of this year. And are there any specific drivers such as we had last year that will give us that margin up as we go through the year, or will be revenue driven because of the margin upside on a sequential basis?

Carl-Henric Svanberg

Well, I mean, first of all, we have got the effects other than the Marconi restructuring as we expected we have said, so that has had its possible effect on the margins. Let me first say so we don't lead too much into particular numbers because there will always be reasons for margins going one way or the other little bit up or down between quarters. But still also be quite substantial if you will remember, market networks outside US growing by 14%, that is clearly above market growth, that’s all I understand. A lot of that is market share driven. And when we grow market share, we'll always enroll. Note that we go out and bargain with the prices as such, but when an operator is interested in looking at a change of situation and so on, as we’ll always enroll some up front of costs and re-changing some equipment and so on and that. And that has it's effect.

It's obviously little bit the same way that we had on that services side, but our growth remains very high. So even if you expected to take some of the old contracts to start off new ones as well. So I think that is probably the bulk of the explanation.

Stuart Jeffrey - Lehman Brothers

So just to explain it, is there a sense that there is perhaps a higher level of SOP that's going on in Q1 this year than same stage last year?

Karl-Henrik Sundström

Yeah I mean 14% networks growth outside US is clearly higher market share driven than we've seen before.

Stuart Jeffrey - Lehman Brothers

Okay. Thank you.

Operator

Thank you. We've got a question now from Tim Boddy from Goldman Sachs. Please go ahead sir.

Tim Boddy - Goldman Sachs

Yes thanks very much. Just to talks on those share gains. Obviously your competitors finish their pursuit of consolidation or begin to make traction, we settle to see some contract wins, particularly after Lucent's, and Nokia-Siemens maybe a bit further behind. But how durable do you think your market share gains are? Can you see them stretching out into 2008 or are we already seeing the first time there is more competitiveness in the market as your competitors who have merged, start to use some of those synergies to improve their market position. Thank you.

Carl-Henric Svanberg

Well, first of all we should to remember that we have picked your market share, I think over the years since 2004. So in that sense, 2006 was not unique. 2007 maybe, but you can't draw the conclusion so much one-to-one and say that we had more market share gains in Q1 and that was because of the mergers. There are many reasons behind why you can win market share, but your explanation is isn’t a significant one.

I think it is hard to speculate, we still think that even beyond the mergers, we think we will have somewhat healthier margins with stronger more long-term players that have invested tremendously for building a long-term successful business. I think it was more unhealthy couple of years ago when you have many small ones that forced to [cry] desperately for a single contract. So I think that we look forward to more healthy and well balanced market. What we are keen on doing here is build as much things as we ever can and I think we are doing it well. So we can continue to be strong leaders here.

Tim Boddy - Goldman Sachs

So you are not seeing any indication that some of these players are coming back to market more aggressively. Now they have got some synergies to help them with their pricing?

Carl-Henric Svanberg

I think they have fully paid for those synergies, so they will be in the synergies, with the kind of business they made, with the deals that they made. But I'm not sure what you particularly are thinking about. Do you have any particular examples you are willing to share with us?

Tim Boddy - Goldman Sachs

No. Its interesting. You might take out the recent winning at SSR, or in Softbank in Japan. It just seems there is a little more aggression. But I could be wrong.

Carl-Henric Svanberg

As far as it won't hurt for them, that I think is very logical. Softbank, you may be referring to their indoor solution. Is that the case?

Tim Boddy - Goldman Sachs

Yes.

Carl-Henric Svanberg

No. But I mean, we remember that if we have a market share of 35 to 40 %, we would still lose the bulk of business in the world, if you look at that way.

Tim Boddy - Goldman Sachs

Yeah. And that's very good. Thank you.

Operator

Thank you. We've got a question now from Per Lindberg from DKIB. Please go ahead.

Per Lindberg - DKIB

Yes. Thank you very much. And I would like to hear your perspective on the market environment, because from your report today as well as Nokia-Siemens, Alcatel-Lucent, one can easily discern not only that you are gaining market share at their expense. But also quite enlightingly that the margin difference between you and the rest is expanding. And also for the network division, clearly.

Could you comment on that and how you see the situation progressing. Have you discerned any change in the pricing environment that could lead to your competitors catching up in terms of margins later on? It would be investors who take interest to behave in such a manner.

Carl-Henric Svanberg

I think what we have said a couple of times is that we saw more desperation back in 2005 in the deal makings then, before the merger took place. And of course, that penetrates too in terms of sales in to 2006, at least, at the beginning of the year. That is not really there as much. I don't think that we cannot necessarily see their deterioration of margins, I think its something one has to ask them about. It's not easy to see why it happens from our side. But I think also in this whole situation that coming back to what this is all about, being a partner, a vendor for 10-year, 15-year perspective with operators. I think our position in that sense has improved over the last periods where we are fairly safe there.

Per Lindberg - DKIB

Okay. Thank you very much.

Operator

Thank you. We have got a question now from Matthew Hoffman from Cowen & Co. Please go ahead.

Matthew Hoffman - Cowen & Company

Hi, Carl-Henric it looks like North America was a negative delta in the quarter. But Cingular recently indicated it added 2.5 million UMTS subs. And based on what we are seeing in the channel 3G, is a much larger part of the handsets than it was. So, with Cingular winding down its strategic review on the network deployment side of the vendors there. Do you expect to see some sort of spending increase kicking in 2Q and if so, do you see any shake up with regard to the market share fixture in that account? Thanks.

Carl-Henric Svanberg

Well, I think it's difficult to have opinions in the short timeframe. But it was clearly encouraging to read what they wrote in their report and obviously that is what that role (inaudible) saying to us in our own business meetings with them. But it was interesting that they wrote about it. There is a lot of excitement there and obviously that should eventually lead to such effects. But the first rollout will always create some capacity that will hold up for a while, but it is encouraging to see the trends and it is showing in also among the other competitors in US. The mobile broadband business is clearly picking up and there is quite a lot of exciting things happening.

Matthew Hoffman - Cowen & Company

Okay. I know you don’t give the book-to-bill but can you comment on the 1.3 book-to-bill that Alcatel-Lucent had and just indicating in their earning release. Are they expressing any sort of trend along those lines?

Carl-Henric Svanberg

Again we shouldn't comment too much on competitors here. But I think it is well known that Lucent has always and everybody does it their way. They have often packaged up a lot of their business that they have, especially with their American customers in bigger framework deals. I mean, we are doing the same thing at times with our larger customers that you put a big frame contract, then it's up to every vendor how much you want to publish of that. So I think it's hard to comment. I don't think that is necessarily reflecting an activity there.

Matthew Hoffman - Cowen & Company

Okay. Great. Thanks.

Operator

Thank you. We've got a question now from Edward Snyder from Charter Equity Research. Please go ahead.

Edward Snyder - Charter Equity Research

Yeah, a couple, if I could go back and touch on the Sony Ericsson issue. Back to the point, do you take out Sony Ericsson's contribution year-over-year. Your [ad] line will be up 40 basis points. But more troubling, as you pointed out, they are moving more into the low-end handsets, which is clearly pushing down their ASP and will probably affect margins. Is that factored into your growth prospects for EPS in the coming year?

And then to your other point where you were talking about a tripling of data traffic in a lot of broadband networks, if you look at Vodafone's results, even though they have grown in it's regard. You are still only talking about less then 6% of their ARPU is coming from non-messaging data, several years after deployment of 3G. So even though the units or the packets that you are seeing traveling through these networks may be increasing, isn't it a little bit misleading, isn't the value of the growth much lower than that. You are certainly not seeing traction from the European carriers?

Carl-Henric Svanberg

First when it comes to ASP, I think when it comes to the Sony Ericsson and so on their ASP is moving a bit up and down depending how they introduce new phones. They always introduce new phones at a certain price level and then that comes down over the lifetime of that phone and matched by growth stuff. So they have stable margins during that period. If then they have more introductions of new phones, or less that moves the ASP of it.

The other reason for the ASP to move, and then when that moves, it doesn’t really impact margins. The other reason for the ASP to move down is because more success in the entry segment.

But as you see the margins are stable, and Sony Ericsson does not have an ambition to go in and make a major attack all over the entry segment. But actually you gradually move down into the upper part of the entry segments and move down and see whether or not a profitable business to make because there is always a price premium to be captured in every sub-segment for more exciting phones. And so far that has worked well.

The question whether we have included that in our ASP guidance, we haven’t guided anything on the ASPs. So, that I have really no comment to. But I must say that we are quite confident in what Sony Ericsson is doing. They have been aiming to leverage their skills in doing attractive phones, so far and we are quite optimistic of what they can do.

When it comes to Vodafone and their data, I think its actually an interesting comment you have made because first of all we should remember that the 3G has been around for a quite a while. But three out of four kilobits per second, is not a basis for an exciting multimedia service. So what really needs to look at it from the time they upgrade it to HSPA and that is when you see the traffic increases kick in.

The aspect you bring in is, how do they translate traffic increases into revenue? That's another discussion and of course there are operators out there, carriers that offer a flat rate and then somebody starts to pound you too further through the networks. Then you got a lot of traffic increase that requires networks expansion, it doesn’t mean revenue for the operators. Here I think we are on the nerdy learning table so how should the carriers actually set up their business models and charge for this and different services, that's another scene. But it's the traffic growth that drives the expansions on networks.

Edward Snyder - Charter Equity Research

But would you agree that it's got to be necessary for the carriers to actually drive substantial value to this in order to pay the CapEx to expand the networks? They are not going to throw additional funds at the network because it's not giving any return on, correct?

Carl-Henric Svanberg

That's the same on fixed-to-mobile that's the same thing. But I actually do believe that we have entered into a phase, the many carriers have come up there and we have been used to offer in and at a flat rate and it's the same thing on the fixed side. That is easy to do, when the date of services are not very demanding.

But then when you start to run like Voice-over IP it's a terribly demanding application that has to come through at real-time and so on. And just talked to have IPTV and so on. So, business models will be developed and go hand in hand with technology development.

Edward Snyder - Charter Equity Research

Thank you.

Gary Pinkham

Operator, one last question please.

Operator

Okay. We've got a question from Ed Bell from Cazenove. Please go ahead.

Ed Bell - Cazenove

Yeah hi. Thanks for taking that question. Just in terms of your comments earlier, you made a point that market shares gains were having some margin impact. Can you give an indication of what kind of margin impact you would consider acceptable to grow market share, to make the most of the current situation with your competitors. Are we talking about 100 basis points, 200 basis points?

And then the second question on the provision line. We have seen that line falling sharply for about 18 months. When can we expect to see Ericsson report stable provisions quarter-on-quarter and a stable growth margin. Is that going to happen at some point this year or will we have to wait till 2008? Thanks very much.

Carl-Henric Svanberg

Well, if we start with the market share again this is not something that we look at case-by-case and customers-by-customers. You could have a customer that you know is going to hefty investments for the next five years. Then it's of course quite interesting and you can surge quite far to go in and create a five-year old platform. You have other operators that would love you to come in and take over as a prime supplier, whether its lots of cost, but a little upside. And then you will not be interested at all.

So I think you have to look at the business case customer-by-customer, situation-by-situation. But there are some pretty exciting opportunities in many situations where you get in and you create the platform for many years of good relationship.

Ed Bell - Cazenove

So you are very happy with a one year margin impact to make the most of the current situation?

Carl-Henric Svanberg

Well, I don’t think it's easy to make a guideline of that kind. But I don’t think neither we or you would make a different analysis in that situation. I think you are sitting down and say this is going to drive profitable business for us and of course it is something we should do. If it's not for you, we don't go into it.

So, and I think we have learned that you cannot drive market share gain or swaps by throwing money at the customer, that doesn't work. It has to start with a customer that he feels that I am not sure I have a reliable partner here or that I have a partner that will be a good partner for the future. And therefore I am interested. Because either ways, even if you compensate him in many ways, he will still have disruptions in his networks and so on.

So, he has to be quite motivated to do a little bit change and then you need to sit down and see what are we willing to do and change our course and so on. And then of course the beauty comes in over time then.

Ed Bell - Cazenove

And provision question?

Carl-Henric Svanberg

Yeah, when it comes to provisions, there are different kinds of provisions. We need to understand that and we did a major restructuring as you know in 2003 that still have provisions that are being consumed by coming course. And it's a same thing when we did the Marconi and the career change program, then we took the reserve that everybody knows and then we are consuming that as we go along.

Then when it comes to the normal provisions besides that external provisions. They are just following the normal developments of business. But, this is an expertise field for Karl, so you should may be add something.

Karl-Henrik Sundström

No, I think in the annual report, on note C-18, we have given some sort of indication how the utilization of the provisions will end up during the year and we see no reason to change that right now. And you have to understand like Carl-Henric said they are extraordinary. But it's also related a lot to the big project. It's not a fixed percentage over sales or out of sales, it's moving depending on certain ways, how you see the situation at every end of every quarter, every month. So, you can never have it as stable. Because for example, warranties might go up or warranties might go down depending on how well our products are performing in the customer network.

Ed Bell - Cazenove

Okay. When do you expect it to start going up?

Karl-Henrik Sundström

I cannot tell you that because that's depending on how we see the business situation.

Ed Bell - Cazenove

Okay. Thanks very much.

Operator

That concludes the question-and-answer session today. At this time, I would like to transfer the conference back over to you for any additional or closing remarks. Thank you.

Gary Pinkham

Thank you, operator. And before we finish today, I would like to remind you that our next management briefing will be at our capital market's day, here in Stockholm on May 9th. Agenda and registration information is available on our website and I encourage you to sign up if you want to participate.

With that I would like to say if you have any more questions about the interim report. Don't hesitate to give us a call, and we will see you on May 9th. Thank you. Goodbye.

Operator

That will conclude today's conference ladies and gentlemen. Thank you for your participation and have a good day. You may now disconnect.

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Source: LM Ericsson Q1 2007 Earnings Call Transcript
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