Ericsson's (ERIC) CEO Jan Frykhammaron Q3 2016 Results - Earnings Call Transcript

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LM Ericsson Telephone Company (NASDAQ:ERIC)

Q3 2016 Earnings Conference Call

October 21, 2016 08:00 AM ET

Executives

Peter Nyquist - Vice President and Head of Investor Relations

Jan Frykhammar - President and Chief Executive Officer

Magnus Manderson - Executive Vice President

Carl Mellander - Chief Financial Officer

Analysts

Kai Korschelt - Bank of America Merrill Lynch

Achal Sultania - Credit Suisse

Sandeep Deshpande - JP Morgan

Gareth Jenkins - UBS

Pierre Ferragu - Bernstein

Jess Lubert - Wells Fargo

Simon Leopold - Raymond James

Francois Meunier - Morgan Stanley

Operator

Welcome to the Ericsson’s Analyst and Media Conference Call for the Third Quarter Report. To view visual aide 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 on one hour after today’s conference.

Peter Nyquist will now open the call.

Peter Nyquist

Thank you operator and hello everyone and welcome to our call today. With me here today I have Jan Frykhammar, President and CEO; Magnus Manderson, Executive Vice President and Carl Mellander, Chief Financial Officer.

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

With that said, I would like to handover to you Jan. please.

Jan Frykhammar

Thank you, Peter and good afternoon to all of you on the call or good morning even perhaps. So let me then try to summarize the third quarter 2016. Of course, it ended up becoming a very challenging quarter.

We saw the negative investor trends that we highlighted already in the first and second quarter accelerates during the quarter, which in turn then created a situation where we had to pre-announce our earnings, because the impact of these trends then meant that we had a performance that was lower than our own expectation.

It really came mainly from the mobile broadband business within networks, but also then impacting the network rollout business in services and if you then see in this picture, here you will seeing that the network’s sales declined 20% year-over-year and that compares then to 11% in the second quarter year-over-year. So that was really where they acceleration impacted.

So then, we also had a gross margin that was low in the quarter. It was impacted then by the lower capacity sales both in the countries that are impacted then by macro economy, but also a lower capacity sales in parts of Europe more than what we anticipated.

And then, to mitigate this of course, I think as a company - leadership team, It is obviously very important to then say that we started the program to reduce costs, become more efficient already in end of 2014. We have seen in the quarter good progress on these cost reductions, but there is more to be done and we have done. We remain on the objective that we discussed in the second quarter, which is down SEK53 billion sake of operating expense by second half of 2017.

We also indicate that we think that the current challenging market situation then being to mobile broadband and in turn then being to these margin count as you can say with weak macro, that will prevail in Q4. But also that the current business mix that we have with coverage and capacity would remain short-term. And we have a seasonal growth typically between Q3 and Q4, we think that will be somewhat weaker this year and I think Carl can come back to that.

So the numbers then you have that in the table I don’t think I need to repeat all the numbers, because I think, I’m sure that most of you have read them already. I think if you go to the regional sales split and year-over-year Q3, you see of course a lot of [indiscernible] here, in terms of the relative numbers. You see a big decline year-over-year in Middle East, you see a big decline in Latin America, you see a big decline in India, you see a big decline in Europe and Sub-Saharan Africa. And some of this we knew and some of it was then this negative surprise for us.

If we then look at the net sales and if we try to categorize it in these buckets here, you see that regions or countries within those regions that has had a big impact year-over-year. So the Middle East, Latin America, Sub-Saharan Africa and also Russia in that bucket. Then you have the European Union countries, part of this we knew, because that was at the backend of the big project with very important customer that was finished here in the end of last year, but some of it was also more short-term uncertainty than on the capacity side.

And then, we have India, where we have a continued good and strong services business and we also had good CAPEX business last year. This year the spectrum auctions as all of you know but now has been delayed. We are now in a situation where they are about very close to be finalized and we’ll see if we will have time to actually make the projects in time for this year or if it will be an activity for Q1, Q2.

And then on the North American side, the decline year-over-year is mainly related then to rescope of a major managed service contract and what we see impact here is the valuable part of that contract and more fixed part of the contract would impact in the fourth quarter. So, quarter-over-quarter per region then on the next picture, it shows that we have - well here we see clearly the European sequential decline both in the Mediterranean region as well as in Western and Central Europe, but you also see Middle East on a declining pace there and Africa.

And I think it’s important to remember typically the fourth quarter is very big in terms of seasonality than in some of these regions such as Middle East and Latin America and Africa. So this is also a good time understand that the statement we are making is of course linked to the same reasons as Q2 and Q3.

If we look at the segments, networks sales of 23.3 in the quarter compared to close to 29, one year ago a big decline in operating income. It is both linked to volume drop, but also more challenging margin situation in this year for the reasons that I have mentioned. This was partly offset by good work on operating expense reductions in the network segment.

We also had a good quarter for our cloud and IP business where we saw good development in sales both for our cloud platforms, the blade server platform but also continued good interest on the hi-tech scale data center equipment and also IP. But the main thing is of course the lower mobile broadband demand there.

On global services, it’s also there, a reduction in top-line and if you look at it, the lower professional services sales is of course linked to the managed service event that I have mentioned already, but also network rollout sales and in turn that’s linked to the challenging regions on mobile broadband.

The operating margin then on professional services, it stayed stable compared to second quarter, still not with the ranges that we operated professional services on, one or two years ago. So we still are working hard to get back to those profit levels and then that network rollout we unfortunately then had some under absorption in that business at the back-end of volumes. So of course we will take actions there to adjust the size of the organization here in the fourth quarter.

Support solutions, SEK2.9 billion in revenue and a loss of 400 million. It is the media business has remained stable, we had softer sales linked to OSS, BSS that was down and this is some of the big transformation projects that we are conducting at the moment in regards to OSS, BSS where we had last year in Q3 important milestones than on one of those big projects that enabled software sales. So we have a little bit of those impacts here. So the revenue might go up and down, underlying we are working on the transformation of business models to more recurring revenues.

And then I actually want Magnus to comment based on the customer agenda, please.

Magnus Manderson

Thanks Jan. On the customer agenda we have seeing an increased focus on 5G and in order to, but also on higher speeds and less latencies on the 4G. We are seeing them of course that the associations of GSMA and GMM is driving this change and increase of course is digital transformation in connection with the new opportunities that 5G would give us.

Also it is a great change in the core networks and well just three agenda items is driving our R&D at the moment and there as you have seen in many of our press releases we are well positioned for the next generation. So we’re quite happy about the development that’s happening and of course the way it plays for us.

With that said, I hand over to Carl Mellander, Chief Financial Officer.

Carl Mellander

Thank you so much Magnus and good morning or good afternoon to all. So let’s look into the financial then starting with the operating income. We saw the operating income decline to 0.3 billion in the quarter. The main reasons are the lower sales volume that Jan described earlier, of course the sales decline of 14% and especially then in network where the decline FX is 20%. But we also saw in parallel decline in the gross margin for reasons that we will talk a bit more about on the next slide as well.

Restructuring was somewhat larger than Q3 2015 and this is of course linked to the cost and efficiency program which is shown here as the green bar and this is a positive FX then of 900 million Swedish kroner in OpEx saving, which is the cost program has delivered. So that’s the good thing around the operating income aside from the negative effect that we described.

If we go to gross margin, on the next slide here I think this is best shown in this way as a sequential comparison from Q2 to Q3 and then we see that especially the lower mobile broadband capacity sales brought the growth gross margin down and this is mainly related to region impacted by weak macro economy as Jan mentioned also.

We also had a higher sales services sale in the quarter 49% this is a very high number and this is impacting gross margin as well due to the nature of the business there. I should also say when it comes to capacity sale that this also was a pattern that we saw in Europe more than expected.

If we move on then to the cost savings program, we are doing this program in order to secure competitiveness in the market, but also resilience for the company of course and we are on-track, we have earlier announced the target level of SEK53 billion in OpEx at the run rate in the second half of 2017 and we are heading towards that target. As I mentioned in 900 million savings year-over-year in OpEx and if you look at the graph on the right hand side there, you can also see where we are on the rolling four quarter basis with 56.7 billion now compared to one billion higher last quarter but also slightly less than 5 billion, 4.7 to be exact billion lower than 2015 in volume.

We have during the quarter announced several headcount reduction activities here including an announcement in Sweden, three weeks ago but also in certain other countries mentioned here in the U.S. and [indiscernible] and the UK to mention some major ones these. When it comes to cost of sales, as mentioned and this is about the correct dimensioning in-line with lower demand. So we are taking continues action and now further actions are now being implemented to adjust to the volume.

And when it comes to the debt restricting charges then, our previous indication at SEK4 billion to SEK5 billion for the full year still remains and we take the opportunity to state there also that we expect this high pays for the restricting to continue also in 2017.

If we move to the cash situation and the cash flow during the quarter, this is as I mentioned earlier also this is really a top priority for the company and for the whole leadership team. Of course, cash generation and gross cash decreased 5.2 billion in the quarter to a level of 43.6 and our net cash position is currently at 16.3 billion.

When we look at the different components here, you will see that the operating cash flow was negative 2.3 billion, of course starting with a relatively low net income, reconcile to cash but then also due to certain build up of working capital in the quarter.

Two main components there, trade payables decreased advances from customers also decreased and then I would like to explain the trade payable piece. We have been reducing the production in the quarter to meet or to adopt to the weaker demand. This we did proactively and that had a positive effect on inventory, which is good. At the same time, as we are sourcing less material into production this also meant that the accounts payable or trade payables decreased with a negative effect on cash flow. So this is a timing aspect here in the balance sheet you can say.

Then when it comes to investing not much to report, the global ICT centre investment is coming down as we are completing those. On the financing side, it’s about repayment of certain short-term borrowings and, nothing special there. FX on cash was positive 1.3 billion in the quarter. So we are now treating cash as an absolute top priority and we have been taking additional actions both operational and structural to improve cash flow on the very short-term, but also for the near-term.

Thank you. I hand back to Jan.

Jan Frykhammar

Okay. So if we look at the planning assumptions for short-term and mid-term. The start with the short-term and this is statements that we have made in the report. So this is just a summary to simplify for you on the call. So we believe that the current industry trends that we are faced that they will still prevail in the short-term and that we will see somewhat weaker than normal seasonal growth between Q3 and Q4 and it is for the reasons that I have explained.

It was important to remember that we had a very strong licensing revenue in the fourth quarter of last year. And then coming down to the renewed managed service contract in North America that will have the full impact so to say in the fourth quarter. And we got some questions here around if this is a structural change in the managed service business and so forth, it is not, it’s quite natural that from time-to-time customers are looking at their strategies. So from time-to-time we get this scope changes in the contract.

So I think underlying demand for managed services still remains very a good focusing very much on customer experience as well as efficiencies and as every technology site will actually become somewhat more complex both from the core network environment as well as on the radio environment that’s also drive to way for customers to handle competence and competence shifts.

But of course this particularly managed service contracts as all of you know it was I think probably the biggest contracts in the Ericsson’s history when it was announced. So of course, it hasn’t impact on the numbers and that’s also while we wanted to highlight that to you.

Then the current business mix, which means that we are in a phase still even though from a lower level, but we still have a coverage projects in many parts of the world and the balance between coverage and capacity meaning that we have still even though lower, but still hardware [indiscernible] business. And also with a big services here, we think that will prevail in the short-term and the way we see this is its a few quarters, some two, three quarters.

Mid-term we continue to work on making sure that we have a resilient company, but also that we make cost reductions for competitiveness that’s not only related to operating expense its equally much the very important project that we talk about this year in the network segment, which is called Ericsson Radio System. That’s the new radio platform and that will of course enable both competitiveness as well as cost reduction and it’s also very much designed for serviceability, so it’s very much a work that is ongoing between the radio business and the services business there. So that’s an important one. And then as Paul said, we continue to have high pace of restructuring charges in both Q4 but also for next year.

Peter Nyquist

Thank you Jan and operator we are now opened for the Q&A session. So please.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen at this time, we will begin the question and answer session. [Operator Instructions] Our first question comes from the line of Kai Korschelt of Bank of America Merrill Lynch. Please go ahead. Your line is open.

Kai Korschelt

Hello gentlemen, good afternoon and yes I just had a couple. So the first one was on the gross margin. So I think if I interpret your sort of outlook correct then we’re going to stay in sort of high 20s level for the next two quarters. And so I’m just wondering with gross margin not snapping back, because I seem to remember in the first half you talked about additional cost savings both in network rollout in the service business. You also mentioned the radio system is much more cost down products.

I’m really puzzled why the gross margin wouldn’t improve from the current level. And then the second question is on the U.S., from what I understand and from what I see in the release, you seem to have lowered the expectation, I think you were previously saying flat and I think now you are saying down year-on-year. So I’m just wondering what do you think is the reason for that change in view? Thank you.

Jan Frykhammar

Okay Kai, I can take those questions. I mean the I think on the cost reductions linked to both services as well as adjusting production capacity and so forth, that is very much ongoing and it will remain on high pace both in the fourth quarter and into next year. Of course, it is somewhat of a challenge to just fasten up when you have had the challenging volume quarter. So that’s one aspect of it.

On the Ericsson Radio System, we state in the report a big portion of total volumes that are Ericsson Radio System and for so far and its close to 10% and we also give you as a service based in for next year, which is more than 50%. And I remember now that this is going to increase gradually by quarter. So it’s a very important and we will continue to give you that KPI, because we agree with you that it’s an important platform change for us. The old platform will be 6000 or platform five has been with us now for four years. So it’s important that to get this new platform out as soon as we can.

And then on the network rollout, I mean it is so that we need to continue to adjust the size of operations and we will also that in the fourth quarter here to reflect the volumes. Having said that underlying these things yes we are reducing the cost base also with efficiency measures. So they are big, the [indiscernible] gross margin is linked to capacity, which comes with higher margin.

So we think it’s fair to plan for the business mix that remains the same way and that is what we think and that’s also why we write that in the report. On the U.S. side there is some - the impact is linked mainly to the managed service contract, but it’s also one customers that at a time being reducing CapEx throughout the year. The rest of the customers or in capacity sales, yes, but it’s stable.

Peter Nyquist

Okay, you are happy with that Kai?

Kai Korschelt

Yes. Thank you.

Peter Nyquist

Thank you Kai. Next question please, operator.

Operator

Our next question comes from the line of Achal Sultania of Credit Suisse. Please go ahead. Your line is open.

Peter Nyquist

Hi, Achal.

Achal Sultania

Hi, Peter. Thanks for letting me on up. First question on the OpEx side. So it seems like, if I do my math, if I’m being it correctly, it seems like you probably will have somewhere about 55 billion of OpEx ex-restructuring for this year. And your guidance is 53 for next year. So it seems like a small step down from where we are already. So I’m just trying to understand like most of the cost cutting that you are doing right now is it going to be more seen on the cost of goods line or is it still heavily tilted towards OpEx?

Jan Frykhammar

So, I mean it’s important to have Achal to look at detail side, because we have been supported in the OpEx line also with the net of capitalized development expenses and amortizations and also amortization of intangibles. So as we grow into - we started to see a little negative on those items in Q3, but that we now start to normalize this, because products have been put in general availability and that’s when we start to amortize. So you have to look at the dark blue part of that bar there, because that’s really the underlying expense level.

Achal Sultania

That’s clear. And then maybe very quickly one follow-up on the services side. So now I think we've seen like this would be the third year in a row, when global services is actually down on a constant currency basis. So I’m just trying to understand like you obviously mentioned it’s not a structural issue, but like when you go into negotiating or renewing some of the older contracts like what is the main discussion about. Is it like - are you not able to offer more services around the work you would already offering on top of what you are already offering or is it more about that pricing is coming under slightly more pressure. I’m just trying to understand like this is now third year where services have been grown?

Jan Frykhammar

I think Achal you have to segregate network rollout from the recurring services as well as professional services such as system integration. And if you look at professional services it’s not been declined into the same period and I mean a lot of the opposite we are establishing ourselves in a good way as a transformation partners to our customers in the digital transformation that’s one example.

Really the challenge has been around the network rollout business, we know that that business is lagging the rest of the networks business or mobile broadband business obviously to six months and I think the big decline really on network rollout happened when coverage projects was completed on 4G North America about year and a half ago and then as we started to enter Mainland China with 4G, we don’t have the same scope there. So that those are the big impacts that I talked about.

Achal Sultania

Okay that’s clear. Thanks a lot.

Peter Nyquist

Thank you Achal. We are open for next question please operator.

Operator

Thank you. Our next question comes from the line of Sandeep Deshpande of JP Morgan. Please go ahead, your line is open.

Unidentified Company Representative

Hi Sandeep.

Sandeep Deshpande

Yes hi. My first question is regarding the business mix again, I mean my question on the business mix is you all need to remember in the modernization projects in Europe in 2010, 2011 when the last time you had seen your margin at weak level. You had talked about that in a five-year view these margins will be much better because of the software in the mix. So what has gone wrong with that model, because yes I could understand the macro impact on the top-line, but what I don’t understand is that this is the point when you should be seeing the positive impact from the software sales and on the margin where as the margin itself is getting very badly impacted. And my second question is to Carl on the cash flow. Are you now saying that you will not reach your full-year target on the cash conversion or is it that you are going to try as much as possible to achieve that through optimizations in the fourth quarter? Thank you.

Magnus Manderson

Okay. So I’ll start with the business mix question and I agree with you that when we were at the peak of the or in the middle of the monetization projects, we obviously had challenging margin as well. Though we did not have as high services share as we have today. I mean that is to be at 49%, we have not been that high before. We have been typically between 40 to 43%, so of course that has an impact on the overall group gross margin.

Nevertheless, the more important question I think you raised is that the capacity model, does it work or on not and that is I think it’s important to state that if we look at some countries, it’s really worked out well with densification and software and hardware related capacity. I mean North America is one example of that, it also worked well in Europe during last year clearly, but where customers invested a lot in upfront capacity was for instance in Japan and Korea and they are the same kind of model around coverage and capacity has not worked as well as in North America and parts of Europe.

That I think is fair and I think that’s also is something that we as a team of course need to look at. Another element that we discussed about a few years ago is this small sales deployment and whether we treat the small sales whether its indoor solutions or small sales as part of the bigger macro sales and then their added software and so forth around those. And I think that market have not taken off in a way we expected. So it has become still much more macro-centric deployments in that point of view. Carl.

Carl Mellander

Yes, hi Sandeep, Carl here. So on your question regarding the 70% cash conversion targets, which is part of the executive long-term incentive plan as well. Of course the target remains, it looks challenging I have to say that we are looking at the actual so far. This is also there is and why we have put in place even more forceful action on the cash flow. So we are working just to mention a few examples on very hard on the collection piece, of course this is about removing any obstacle with the customer to get collection when due or even advance payment.

We are working on dimensioning the inventory in the whole supply chain to fix them on and fix it in the excess capacity there. And then of course it’s about in the projects dimension and to make sure that we go for reaching billing milestones and acceptance criteria in the project so that we can deal and then collect within the quarter, as early as possible in a quarter. So we are taking a lot of measures, the target looks challenging, but we have by no means given up on it.

Sandeep Deshpande

Okay. Thank you.

Peter Nyquist

Okay Sandeep. Next question please, operator.

Operator

Thank you. Our next question comes from the line of Gareth Jenkins of UBS. Please go ahead. Your line is now open.

Peter Nyquist

Hi, Gareth.

Gareth Jenkins

Hi. Just two quick ones structured. First I just wanted around additional restructuring assets into next year and additional cost saving measures. Obviously there has been quite a market shift down and top-line performance since the last the round of nine billion and the 53 billion have been put in place. So I just wondered if you can talk to that and maybe talk to the balance sheet you say that you have got a strong balance sheet.

But we are seeing two rating agency down grades and I think I'm right in saying that 2002 you had a rights issue and you had over 40 billion cash on the balance sheet. So maybe you could just explain to us what is different now and it leveled you start to worry about that the cash level and the balance sheet? Thank you.

Carl Mellander

Okay. I can start with the OpEx point there, I think it’s important to understand this, put this in a bit of context. And first is that we get a leadership team, we took action proactively in end of 2014. We accelerated actions here in the first half of 2016. Hadn’t we done that of course, we would have had a very tough situation at the moment. We agree that it’s a poor and weak result in the third quarter. But this it shows that it’s important to be proactive on these items for sure.

We have also wanted to highlight some of the countries, where we have made announcements in the quarter and as you can see on some of those countries not all, I mean it is obviously important to follow the local labor laws and call the termination processes and so forth and it takes a bit of time. For us it’s very important to make sure that we are resilient, but that we are also competitive and we need to make sure that the side, the wider side strategy that is linked to not only access, but the core network evolution, the OSS, BSS and so forth that is a success for us.

So we will make sure that we balanced long-term and short-term, on the more volume related items of course we will adjust the capacity of the company on those elements and in concrete terms it means looking at own as well as partner related resources for project delivery and that goes for production as well, and that we will do and then there we will adjust, that’s also up here not in the report.

On the cash balance, I think it’s important to understand where the company was in 2011, 2012 where we had the handset business that was volatile. We did not have the recurring revenue coming from services, although we of course understand that the gross margins are lower in that business, but still its more recurring revenues. So it’s not relevant to look at the balance sheet in the same way as we did in 2010, 2011. So I think that’s important.

And then when we look at the balance sheet of course we look, we also know that the fourth quarter is typically the strongest quarter from an operating cash flow point of view and as we clearly said and I remember we accepted the same situation last year and then we delivered a very, very strong fourth quarter of operating cash flow. We know that part of that obviously was linked to an IPR agreement but still we are working very hard in the fourth quarter.

So let’s first do what we should do and that is to finalize the 2016 target and then we look forward on the business mix and the type of businesses. But the company is very, very different compared to the situation 13 to 14 years ago.

Peter Nyquist

Okay, Gareth.

Gareth Jenkins

Thank you.

Peter Nyquist

Thanks Gareth. Next question please operator.

Operator

Thank you. Our next question comes from the line of Pierre Ferragu of Bernstein. Please go ahead, your line is open.

Peter Nyquist

Hi Pierre.

Pierre Ferragu

Hi. Thank you for taking my question. Jan I would like to come back to some to the point ointments you have made not selling as much software upgrade and capacity you would have like especially this quarter. So I understand your point, but when you look at the magnitude of the gross margin decline, you attribute to that it looks like an enormous volume of that kind of revenue disappeared sequentially.

And what I like to understand and I didn’t really get that you answer that is why are you clients not buying these products? Is that because you have not been structuring your contracts in the right way and that it remains weak to discretionary for them to commit to these software releases or is that because of software release is not bringing enough value to our clients. So they are very happy to speak to the other one, is that because traffic is not growing on the networks.

So it would be good to have some sense of what went wrong compared to the plan that you described to us a few years ago. And it’s good to hear you talking about taking cost out and launching like a new product platform, but what are you going to address that issue. How do you get this software revenues back in into model, because you definitely need them to make Ericsson successful.

Jan Frykhammar

It’s a very big question Pierre that you asked. So let me try to explain it both on a more long-term perspective and the short-term perspective. So if we take a more long-term perspective, the fairly short answer to your question is of course that we are in the middle of very important transformation industry wise, which means that the IT industry and the telecom industry are gradually going to come together as one industry.

And as a result of that there was increment in the Ericsson software model that will mean that we go more towards the recurring software and when we had the Investor Day in November last year, we also said that the ambition is to be on more than 30% of the software revenue being recurring. I think that’s one important aspect to this. So today we still are at lease for most part of the networks in this twice a year software release model and a software buyouts and CapEx and so forth. And of course in that model, you also become a bit sensitive to the purchasing power of customers.

The other element of course if you compare with 2010 back then we will peak in the core revenue linked to 3G build out, so we have probably SEK20 billion of core revenue that has this year started to grow a little bit at the backend of our product called blade server platform. So the platform that is actually showing good progress in the quarter, but we are not going to come back to those levels. So therefore, we need to be successful in digital transformation and network transformation on that.

And then on the more short-term question and well it’s not software that is the main issue on the short-term, it’s actually hardware capacity, which is as you know software like and part of that is linked to operators being cautious on where capacity spend in the countries, where they are impacted by micro economy. And then also with short term impact in Europe. So the more long-term question, I think I have answered the short-term, I have talked about many times and then there is nothing else then the explanations that we have made around the gross margin.

Pierre Ferragu

Thank you.

Peter Nyquist

Okay thanks. Next question please, operator.

Operator

Thank you. Our next question comes from the line of Jess Lubert of Wells Fargo Securities. Please go ahead. Your line is open.

Peter Nyquist

Hello, Jess.

Jess Lubert

Hi, guys. Two questions, first I was hoping maybe you could provide some additional details around what you consider to be below seasonal trend for Q4 and to what extent the 18% sequential improvement we saw in 2014. The reasonable proxy we should be thinking about lower number and then secondly I was hoping you could touch base on the competition you are seeing in the networks business into what degree that’s playing a role and some of the weakness we’ve been seeing here over the last several quarters? Thanks.

Jan Frykhammar

You take the seasonal question.

Carl Mellander

I can take the seasonal question, its Carl here. So the typical seasonality effect between Q3 and Q4 is an increase of around 20%, on top-line this is based on a five-year average. What we see now given market conditions is that we don’t see that start happening in the quarter. I believe we can indicate mid single-digit drop from that level. And in addition we have also managed services contract in the U.S. as we referred to earlier, which will now come into effect, the lowering of that volume will come into full effect in Q4.

Jan Frykhammar

And then I think in but you will know that I mean we are now in the monthly, we had changed more in FX a few years ago, right and all of you know that we have a lot of sales in the last month of each quarter and also lot of both software as well as hardware capacity related sales. So of course, the FX levels at the end of November is important because that’s the FX rates we use them for December revenue and invoicing. So I think that’s important.

On the competitive question, yes the short-term challenges that we have and had this quarter are not linked to competitive dynamics. I mean Ericsson is operating in many countries on the mobile broadband side that’s really where we have together the services the global presence and we do business in more than 180 countries and of course we are successful in many emerging markets. And of course when there are challenges in those markets where we’re also impacted being in those countries.

The competitive question I mean when it comes to competitive dynamics and mobile broadband. I mean it’s still linked very much to new footprint or big technology shift or anything like that. I mean at price, changing pricing and so forth, I mean it takes three or four quarters before its impacting the P&L. So what we have in the P&L now are days that we took related to coverage in Southeast Asia for instance in four quarters ago. So that’s the lead times in some of these projects.

Peter Nyquist

Hey Jess, are you happy with that?

Jess Lubert

Yes, thank you.

Peter Nyquist

Great. Thanks. Next question please operator.

Operator

Thank you. Our next question comes from the line of Simon Leopold of Raymond James. Please go ahead, your line is now open.

Peter Nyquist

Hi Simon.

Simon Leopold

Thank you for taking my question, hello. So I know you don’t love providing longer-term guidance and I do appreciate what you have offered us on the call the day. But when I look at consensus estimates for 2017 sales, I see a very broad range, ranging from low of about 200 billion to about 250 billion.

So any color you could offer to help narrow that range and get folks focused on what you see as a trend for sales in 2017 and related to that given a less than seasonal growth in the fourth quarter, I assume we could think about less than seasonal pattern in the first quarter of 2017 and if you are able to do that. And just as a follow-up if we can get an update on the Cisco partnership I would appreciate that as well. Thank you.

Carl Mellander

I think on the 2017 sales number there a couple of things from that. One is we think that the current market situation we have is quite challenging trends that is in the market that we now discussed many times. That situation will prevail short-term and that is two or three quarters. So that’s a correct observation. We are not betting on a big change in the market in the coming two to three quarters. Then if we look at towards the end of next year and I also think it’s important even though not as big portion of the total. It is important to look at the sales in what we call the targeted areas.

Sales in those areas shows resilience and it was growing 3% I know that we have high ambitions in those areas, but is still at least that where we have the issues now is on the mobile broadband side, particularly in the margin market. I think when it comes to next year in mobile broadband, I think it’s too early to start to anticipate any impact of 5G or 5G related sales. I think where we can see some growth opportunity is for instance in India. It could also be some growth opportunity at the backend of lot of discussions around public safety either the operators or a standalone networks. So that’s another possible area I think so.

So I think those two aspects and then when we meet at the Investor Day, I hope you will be there in a few weeks time. We will also discuss a bit more in detail how we view the market now in the more mid-term versus more long-term, because I think that’s also important to spend time on that on the Investor Day. So we will do that.

And the second question was around Cisco partnership, the Cisco partnership is now, we announced this about 10, 11 months ago and we wanted it to be really a business partnership guided by business opportunities and in this fairly limited time we have been able to gather to create more than 60 opportunities and we see IP revenue related professional services growing.

So I think that we have created momentum and it was very much linked to the fact that we wanted to see business growth. So I think so far we are happy with the progress, we always want more, we are business people. But I think thanks to push on really having a stretched objective has created on both sides, it has created good business momentum.

Peter Nyquist

Okay Simon.

Simon Leopold

Thank you.

Peter Nyquist

Okay. Now we are opened for the last question please, operator.

Operator

Our last question comes from the line of Francois Meunier of Morgan Stanley. Please go ahead. Your line is open.

Peter Nyquist

Hello Francois, you are going to ask the last question.

Francois Meunier

Yes, thanks for that. I don’t know how much granularity you can give on this, but it looks like we think there is product transition at Ericsson [Indiscernible] Ericsson Radio Systems, there is a change in gross margin. So what can you tell us about this new platform, how those compare the [Indiscernible] in terms of pricing and margin structure and is there anything you can do in the next 18 months two years to basically redesign the cost, of course margin is higher or is it something which is too late?

Jan Frykhammar

So Francois, thank you for last question. I think first and foremost, I can assure you that design to cost and design to serviceability has been two critical design criteria when we have developed the Ericsson Radio System, but also the related services packages and the product itself is very limited in volume so far, we mentioning that in the report. If we are successful with the ambition, meaning that the product will be on a year-to-date basis next year more than 50% than we have achieved the product substitution of all radio base stations last 15 years. So I think that’s a very ambitious target.

We are sure that it’s the sign for cost, competitiveness, as well as serviceability. So it’s very important of course we have learnt a lot from the [Indiscernible] both platform four and five. So that’s important and I think that when it comes to the customer benefits that’s absolutely part of the equation as well, everything from energy efficiency. So there are very, very important aspects here.

Another very important aspect is that this time we actually start with emerging market, which was not the case with [indiscernible] because back then it was very much the 4G paradigm in Japan and U.S., it’s important this time as well, but really at this time to cost for a million market. So we have learnt, it’s quite a lot of different things that are exchanged at this time.

Peter Nyquist

You are okay with that Francois?

Francois Meunier

Yes, we probably get more information [indiscernible]. Thank you.

Peter Nyquist

That was a good comment as well. So before closing this event, I would like to welcome you all to the next event that we will have, which will take place in New York, November 10, which is the Ericsson Investor Update. With those remarks, I would like to close this call. Okay, thank you all.

Operator

That concludes our call. Thank you for attending. Participants, you may disconnect your lines.

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