LM Ericsson Q2 2008 Earnings Call Transcript

Aug. 4.08 | About: LM Ericsson (ERIC)

LM Ericsson (NASDAQ:ERIC)

Q2 2008 Earnings Call

July 22, 2008 8:00 am ET

Executives

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

Hans Vestberg – Chief Financial Officer and Executive Vice President

Gary Pinkham – Vice President of Investor Relations

Analysts

Jan Dworsky - Handelsbanken

Andrew Griffin - Merrill Lynch

Michael Andersson - Evli Bank

Thomas Langer - West LB

Clara van der Elst - Standard & Poor’s

Nicholas Von Stackelberg - Sal Oppenheimer

Gareth Jenkins - UBS

Peter Lindsberg - SS Global

Rod Hall - JPMorgan

Ilkka Rauvola - Danske

Alexandre Peterc - Exane/BNP Paribas

Mark Sue - RBC Capital Markets

Kulbinder Garcha - Credit Suisse

Janardan Menon - Dresdner

Mike Alexander – Charter Equity Research

Tim Boddy - Goldman Sachs

Operator

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

Mr. Gary Pinkham, Vice President, Investor Relations, will now open up the call.

Gary Pinkham

Hello, everyone, and welcome to our conference call this afternoon. With me here in Stockholm is Ericsson’s CEO, Carl-Henric Svanberg, and Hans Vestberg, the Chief Financial Officer.

As you know, we will be making some forward-looking statements during the call today and these statements are based on the current expectations and certain planning assumptions.

There are risks and uncertainties associated with these planning assumptions, and the actual result may be different due to a number of factors. Therefore we encourage you to use caution when considering such forward-looking statements.

With that out of the way, I’d like to hand over to Carl-Henric for some comments about our results and plans going forward.

Carl Henric Svanberg

Thank you, Gary. Hello, everyone. Couple of comments then; first on Q2 in summary. We see very much a stable business activity. There are some regional variations, which I will come back and talk about. Business is, for us, a lot driven by the continued stand on GSM, more than maybe most of us thought a couple years ago, but also accelerating demand on mobile broadband.

We have seen a high proportion of new network builds that continue to put pressure on our margins. Cash flow was quite strong in the quarter, $8.5 billion, and we’ll come back and talk more about that.

We have seen no reason to change our planning assumptions, and I’ll comment more on this later, but they are staying. Of course we are affected by Sony Ericsson’s breakeven result in the quarter.

A couple of comments on the Networks side of the business; the fact that GSM continues and the interest for HSPA mobile broadband accelerates with the roll out there and also LTE in early phase. This means that we will have three technologies that will exist in parallel for several years.

But it’s also important to note the winning technology track, where also the base stations and equipment that we’re rolling out now is prepared for a migration path. Even the GSM base stations today can be gradually upgraded all the way through LTE over time.

3.7 billion mobile subscriptions is already an incredible number and continues to grow; 170 million in the quarter. Also to note that within our soon 240 million Wideband CDMA subscriptions − 236 million right now − it is growing with 31 each quarter. That pace is twice as high as a year ago.

On the fixed teleconvergence side, a lot of focus on network transformation. How do I take my network as it looks today into where I want to be in the future? IP plays a very important role here for the conversions as such.

In that context, Redback is a very important part of that process for us where we use their technology increasingly now in product development in our own equipment. So, they are now being part of, for example, our radio base stations.

On the broadband side, there are now 352 mobile and fixed broadband connections, which shows a growth trend of 17 million per quarter and overall a very strong demand for broadband of various kinds.

On Services, we see continued strong demand for managed services. We have now 210 million subscribers throughout the world, on par with the largest operators; 50-50 split between the emerging markets and mature markets.

What we also see is that with more and more of the networks being rolled out, it becomes more of as, I said previously, on migrating the network that is there into the next generation, which means that it becomes more service-driven sales and that systems integration and consulting are key elements in our strength locally.

In the managed services business, we see major efficiency opportunities as we have often spoken about between ourselves and the operators with overlapping work. But also in what we’re doing now in leveraging more and more of our global resources in low-cost countries, as more and more of the surface work now can be done remotely across borders.

If we look at, then, going to the numbers, we hit sales of $48.5 billion, which in the Swedish reporting currency is 2% up, but in constant currency, organic growth corresponds to 7%.

The operating income reached SEK 4.7 billion, as I’m sure you’ve all seen. That includes SEK 0.2 billion from the enterprise divestment and operating margins of 9.7% here.

Cash flow was strong in the quarter, SEK 8.5 billion, and that was a combination of, to some extent, all the activity that goes on with terms and conditions with suppliers and customers and efficiency gains in work flows. That also reflects the fact that we have an asset of growth in the turnkey-dominated regions and higher growth in U.S.

A couple of regional comments. If we start with Western Europe, we are 3% down in the quarter, and if you look at the graph there you can see that it’s a pretty flattish development over the last couple of years.

Some of it is impacted by continued operator consolidation activities, talks or mergers that have to put investments on hold. It is throughout Europe, which I think everybody’s aware who is living in Europe, lots of folks in mobile broadband and wireless connections in laptops everything.

That is going on, but there are capacities in the rollout networks that can absorb that traffic for a while. So we don’t expect at least any upgrades for this year.

We continue to see U.K. very slow, as we’ve reported on since Q3. Spain is also slow for us now, and while the strongest growing countries in the region is right now the Nordic countries.

We will then look at Central Europe, Middle East and Africa; there is actually a slight decline there, but still lots of activities going on, both 2G and 3G rollouts. Mobile penetration is growing beyond most expectations; closing into 200 million in Africa, just as one example.

Africa in general, very strong, but we have parts of Eastern Europe and Middle East, primarily Turkey and Saudi Arabia, that were slower in this quarter, but underlying good activity level.

Same goes for Asia Pacific, which is 5% down in the quarter. This is almost all due to a tough comparison. If you look at the diagram, you can see the strong growth pattern resulting from high business activity throughout the region.

There is higher growth right now and the highest growth right now is in India, Pakistan, and Indonesia. India may soon become our largest market, and since that is so much rollouts of new equipment, including third-party and turnkey projects, that puts some pressure on our margins here.

China, it actually had a very strong quarter, but they were the reason for the very tough comparison from last year. On the numbers they come out as flattish with last year or slightly down, but the activity level was very high now preparing for the Olympic Games.

Japan was actually down in the quarter, which is more a phenomena of being between rollout projects here. We have new large expansion orders from SoftBank that will come back and drive sales primarily in the fourth quarter.

If we look at Latin America, good trends, you can see the comparisons from last year there. Generally, good demand for mobile and fixed broadband throughout the region.

Brazil and Mexico are strong-growing markets that pushed the numbers big time. Chile is also growing equally much, but from a smaller base. Generally good momentum in Services, and several managed services deals are being worked on and landed there in Latin America.

If we look at North America is the region that sticks out probably most here, especially considering that the economical development in North America isn’t that strong. We are 47% up there.

Of course you can see that it’s to some extent depending on an easy comparison in this case. Generally in the market there’s an accelerating demand for broadband services, both fixed and mobile, with rollouts of different technologies there.

In our case it’s obviously the increased coverage build-outs in HSPA and capacity expansions that goes on that drives our sales.

With that I will leave over to Hans, who can talk more about the financials.

Hans Vestberg

Thank you, Carl-Henric. Let me go through the financial figures a little bit more in detail, starting with a couple of overall comments. First of all, the figures that I will now comment on will be excluding restructuring charges, if I don’t say otherwise.

There will also be a move of a product between Professional Services and Multimedia, which is the micropayment system, IPX, which is in the figures that move. Also we have included here in the figures the capital gain of enterprise, so you know that when I comment there.

As Carl-Henric said, the 2% growth in the second quarter; 7% in constant currency, indicating that we continue to have quite a large effect of the U.S. dollar decline, even in this quarter.

If you look at the gross margin, 37%, which is a decline from last year’s 43%. Of course here we have all the explanation with the business mix and the U.S. dollar that we have been talking about previously.

If you look sequentially, it was down from the first quarter, and I would say that it remains being though that India accelerates in the quarter with good turnkey, as we said already, in the first quarter. We had a more normal quarter, software and IPR sales. As you remember in the first quarter we said that there are slightly higher software and IPR sales.

If you talk about OpEx, that was sequentially almost flat, a little bit down, and then we can see some early, even though fairly small, indication that our cost adjustments are now starting to take some form and shape. I will come back to where we are on those cost adjustments, but the OpEx basically flat sequentially.

All this leading us to our operating margin; it was SEK 4.7 billion, including the capital gain, SEK 3.2 billion from Enterprise, giving us 9.7% operating margins. Excluding Sony Ericsson, also 9.7% operating margin, of course with breakeven results of Sony Ericsson. That means that we had no contribution in the second quarter from Sony Ericsson.

If we then move on, looking at the other items on the P&L. The net income, which includes the restructuring charges, ends at SEK 1.9 billion. Consequently we’re having earnings per share of SEK 0.60 billion, which also includes the restructuring charge.

The cash flow from operating activities SEK 8.5 billion. This is mainly due to, I would say, rather good collection. We continue with a very good focus in our orientation on the cash flow. Secondly, we have a fairly stable working capital position even though we sequentially grew.

Then thirdly I would say that we also had an increase in other current liabilities. As we have talked about before, other current liabilities is everything from advance in customers, cost accruals, provisions, VAT reforms, et cetera.

All of them, I would say, are harmonizing with how the project’s going that quarter, and of course that will vary between quarters all the time. We have been continually seeing that before. All in all, still it’s a good development on the cash flow.

Networks business, a 1% decline in the business, and here of course we’ll have a U.S. dollar impact both in top and bottom line, as I said before. You can also see on the network rollouts, that they continue to grow the network rollout portion within segment Networks. They’re growing at 11%, which of course indicates that we continue to have a high proportion of new network build-outs – that puts some pressure on the margins – as well as we have India accelerating in turnkey in the quarter as well.

As Carl-Henric said, we will probably see now that India will be the largest market in Q3 already. We also had in the quarter a more normal level of software and IPR sales in Networks.

If we continue in Multimedia; growth of 16% here. I would say now that our acquisition and divestments are neutralizing each other, so that is not an impact on that either-or, even including the move of IPX.

So, a good growth of 16%; sequentially 10%. The operating margin ended at minus 1%, which of course sequentially is a good improvement. Here of course we have the SEK 0.2 billion from the enterprise divestment that we announced in the second quarter and also concluded in the second quarter.

Again, when it comes to the margin, just to be clear, that we might have variation between quarters here. We have still 25% that are investment areas with fairly small revenues, not high investment in R&D, and we have three-quarters that is normal business, growing well with normal margins.

Adding to that, we are happy for the good progress that we have in both Tandberg Television and LHS, both from a growth perspective, but also from an operating point of view they’re doing well.

Going to Professional Services; Professional Services grew 7%; 11% adjusted for currency and the move of IPX. That’s given also that we have adjusted a Hutch U.K. contract, as you’ll remember from the first quarter, which is impacting here. Still, a growth of 11%.

Managed services grew by 17%, with the same comment on Hutch U.K. of course. We had in the quarter, six new managed services deals signed. I think most important and publicly announced deals were the two in Latin America with Telefónica and Telcel, or América Móvil, which are of course the key players in Latin America, which is good there. Stable margins in the quarter; 14% operating margins.

When we talk about the cost reductions, we announced earlier this year a SEK 4 billion saving program, with effect 2009, with an estimated charge of some SEK 4 billion. Second quarter continued with the good progress.

We took SEK 1.8 billion in restructuring charges related to two areas. One is where we have done product and supply rationalization. We have either decided to merge products or close them, which means that that has rippling effect on everything around it, from sites to people, et cetera.

That has also had, on the product rationalization, some consequence on capitalized development, as substitution of the closed product impacted on that. The second area is layoff costs in Western Europe that were down in the second quarter, including the announced layoffs in Sweden in the beginning of the second quarter.

We are now totaling charges of SEK 2.6 billion so far this year, and we are feeling that we have a good progress in all areas of the project.

Carl-Henric Svanberg

Very good. Let me then just quickly comment on Sony Ericsson. Sony Ericsson’s strongest foothold is the European market, which is significantly down, according to Gartner, at 16% down.

Of course that has an impact on Sony Ericsson, but on top of that they haven’t been as successful in launching their new product over the last three or four years, when they’ve been growing tremendously. So for that reason their units shipped was slightly down, and their sales was more down, and they are at the breakeven level.

This is a tough situation for Sony Ericsson as such, but they are working very hard now on the (inaudible) to rectify this situation, and they have launched this cost-cutting program of SEK 300 million, which they will do now in the quarters to come.

All in all, a challenging year for them, but I must say we’ve had good presentations from the company, and Sony and Ericsson are strongly behind here.

When it comes to our planning assumptions, we haven’t seen any reason to change those, as I said. We continue to plan for a flattish mobile infrastructure market with better growth in both Professional Services and Multimedia.

We have said before that we believe that the industry fundamentals and consumer behavior support a more positive longer-term outlook.

So in summary, I would say that we’re seeing a challenging yet stable business environment. The business mix continues to affect us; the declining dollar has its impact on top and bottom line. We have good growth in constant currency − 7%, driven by GSM largely, and the interest for broadband and services.

We have a lot of focus now on operational excellence, as we’ve had through the last years, but more so now also on the restructuring activity, so the cost cutback activities and the execution of those in all the aspects of the company, in sales, G&A, and in research and development, and in the operations.

So with that I’ll hand back to Gary to guide us through the questions.

Gary Pinkham

Thank you, Carl-Henric. Operator, we are ready to start our question-and-answer session.

Question-and-Answer Session

Operator

We’ll now take our first question from Tim Boddy - Goldman Sachs.

Tim Boddy - Goldman Sachs

I’d like to ask a broad question about the macro environment, obviously following Vodafone’s comments today. You are not the only operator, for example, to see significant slowdown in usage in Spain.

To what extent are you seeing any trends of pressure on usage, your customers in developed markets, or could you expect to see that become a broader trend, if the economic challenges of Spain spread across Europe, as of course they’re present in the U.S.?

Then in a similar vein, in the emerging markets, have you seen any market where there’s evidence that, whether it be inflation of food or commodity prices, starting to also weigh on usage growth? That would be very helpful.

Carl-Henric Svanberg

Let me start with the first one, and I’ll let Hans take the second question here. But when it comes to macro environment, I must say that we haven’t really seen any effects on us and very little in the discussions with the operators. Vodafone obviously was out there and talked about Spain today, but generally we haven’t seen anything of that kind yet.

Of course our business is driven by many factors, and you can see the contradiction there in U.S. which is presently our strongest growth market, 47% up, when the economic situation is a bit squeezed.

But if the financial crisis would worsen or go on for a long time, I’m sure there will come eventually some effects on us as well, but so far we haven’t seen really anything.

Hans Vestberg

Some comments on emerging markets and inflation et cetera; yes, there are some markets that actually have a very high inflation at the moment. Here’s it all about the balance, the value chain between our suppliers and our customers. You’ll see that we’ve spread out that cost for the inflation.

Of course it’s a little bit different from contract to contract. But in general terms, we try to protect ourselves from those types of things, because we talk about service engineers in field, or we talk about local surcharges that are impacted by the inflation.

But of course, if we’re hitting a very high level of inflation, it’s always difficult to dispute that in a value chain between suppliers to us and the customers. But so far we have been handling that well.

Tim Boddy - Goldman Sachs

Just to clarify on that, within, for example, your Managed Services contracts, are you exposed – either in developed or emerging markets – to a rise in inflationary pressures? Or do you write into the contract some kind of inflation index?

Hans Vestberg

It’s different from type of contract to type of contract, but we are always trying to get as much protection on it as possible when it comes to inflation, especially for our local costs.

Tim Boddy - Goldman Sachs

Okay, thanks very much.

Operator

We’ll now take our next question from Ed Snyder - Charter Equity Research.

Mike Alexander – Charter Equity Research

Hi, this is Mike Alexander in for Ed Snyder. My question is what percent of your growth in North America was due to AT&T? And was the preponderance of that due to a second career in 3G?

Carl-Henric Svanberg

When you look at North America, we have several customers there, but it’s well known that AT&T is our largest customer and that we could hardly present a figure like that without them being a significant part of it. But they are one of several customers. It is also a mix of new rollouts and to some extent also increased capacity build-outs.

Mike Alexander – Charter Equity Research

And just a follow-up on that. With the high mix of network rollouts, when can we expect these systems to mature and yield higher margins? Or are the margins going to remain low and we’ll just see services revenue go up? Thank you.

Carl-Henric Svanberg

The mix shift that we saw here in the autumn with a higher proportion of new networks build, that does continue as we go along here, and as we predicted it would do for several quarters. But if anything, we have even stronger growth in new network builds.

That obviously is good for us for the longer run because it increases our footprint. The slower trend with the upgrades and expansions are primarily coming out of Europe, and we see no shift in spend there.

Mike Alexander – Charter Equity Research

Thank you.

Operator

We’ll now take our next question from Janardan Menon - Dresdner.

Janardan Menon - Dresdner

Thanks for the question. I was just wondering, on your gross margin trend, you did drop a bit because of, you said, the IPR dropping off a bit and because emerging markets like India were coming up stronger.

But you also said that India was going to be your largest market in Q3 and perhaps even beyond that. Can we take that to assume that you could see further pressure on gross margins going forward, or would there be any other factors which could enable you to keep it roughly at the current level of about 37%?

Carl-Henric Svanberg

The pressure that we get from a higher proportion of new network builds, where India is maybe the prime example because they are the fastest growing and the most competitive market because of the big potential there, and our position is strong in India, that is one element that affects the gross margins.

But there are different elements, some working up and some working down. We are working hard in general to improve our margins over time. We can all understand why our margins took a hit last year when we saw the business shift mix, but even if it’s logical, we want to improve the margin.

All our activities are directed in that way, and we’re not going to give any particular further guidance.

Janardan Menon - Dresdner

Will you have any further cost-cutting measures at the end of this year to support that improving margin? Are you putting in the plan right now which you will probably tell us later in the year or something like that?

Carl-Henric Svanberg

The cost cuts that we announced, the SEK 4 billion, to adjust for a slower growth, they are fine for the situation as it is. We don’t expect to launch anything else relative to that.

But in this industry, obviously because of the competitive pressure and the more slow and everything, everything is constantly thought through, every process, every way of working, every way of building have drawbacks. I do hope that we can find more and more efficient ways of working, but no programs of this kind, we don’t expect.

Janardan Menon - Dresdner

Okay. Thank you very much.

Operator

We’ll now take our next question from Kulbinder Garcha - Credit Suisse.

Kulbinder Garcha - Credit Suisse

Thank you. If I look at the comments you’ve made today and on the press conference, it seems that India’s going to rise in your mix; it seems that China is going to be weak in the near term; there’s uncertainties in Western Europe.

All of those suggest to me that your margins actually go down in the next six months. Rather than making that conclusion, what are the positive bias in gross operating margins? Is it just cost-cutting? That’s my first question.

My second one is, on Western Europe, I take the point that you’re not seeing any macro weakness today. Can you remind me what kind of visibility you have in Western Europe?

Carl-Henric Svanberg

If we circle to the gross margins, there are always a number of positive factors and negative factors that you can summarize all in one direction if you like. It is true that India is impacting us; it is true that China could be slightly weak in the third quarter because of the Olympic Games and so on.

But there are other markets as well, that creates this mixed bag, and as I said we’re not going to guide for a particular quarter, but generally we’re working to improve the situation, and that’s where our focus lies.

When it comes to the visibility of the European market, if there would come into some sort of a major stop, we could be more affected. But remember also that Europe is like U.S. is, but a little bit ahead of U.S. There is a fight on new attractive services and broadband rollouts and everything.

In the Nordic region, here in Sweden, it’s driven very much around the mobile broadband rollout. I think there is sold 1 million broadbands here. Every laptop has a wireless connection today.

It’s not a very smart strategy to try to starve the European operator to success. So, as long as we have a reasonable development, I don’t think we should foresee that.

Kulbinder Garcha - Credit Suisse

Thank you.

Operator

We’ll now take our next question from Mark Sue - RBC Capital Markets.

Mark Sue - RBC Capital Markets

Thank you. In Asia, and China in particular, do you have any data to suggest things will bounce back later this year? What’s your initial read on the impact of the restructuring, if you can give us your thoughts?

Just finally on gross margins, understanding that it will bounce around, is there a new range that we should consider? Is it more 37% to 43%, or is it a tighter range than that?

Carl-Henric Svanberg

I don’t think we’re going to guide on that. I think we’ve given you enough commentary on the gross margin. The restructuring was commented on China, wasn’t it?

Hans Vestberg

No, that was in general.

Carl-Henric Svanberg

I’ll leave it to Hans, because he heard the question.

Hans Vestberg

On the restructuring in U.S., if I understood the question, it’s when will it get an impact? As we’ve said before, that’s going to be in 2009. We see some slight impacts right now, but the whole idea with what we’re doing right now is that we’re going to have an impact on the results in 2009.

Mark Sue - RBC Capital Markets

Okay.

Hans Vestberg

Then the other question on Asia; if it will bounce back was the question, as I understand. As we have said before several times, China has in all industry segments and right now in the third quarter due to Olympics, will have some sort of slowdown, so they will most probably come back. We believe that we can grow in China this year.

Secondly, as we said also in the second-quarter about Japan now that we have had going up and down and temporary down I would say, and now we’re back in order so that can come up by end of the year, what we have there. But other than that, I don’t comment more on Asia.

Carl-Henric Svanberg

(inaudible)

Mark Sue - RBC Capital Markets

And the earthquake impact in China, any thoughts on what that might do for demand?

Carl-Henric Svanberg

Just one more comment on Asia, and then the earthquake. I encourage you to look at the chart on Asia. You will see that Asia is slightly down because of a tough comparison from an unusually strong quarter last year in Q2. But generally the growth trend is there. There is some impact in Bangladesh, which is slow, and Japan between quarters, but the growth trend in Asia is good.

When it comes to the earthquake, there were many vendors in many industries were obviously hit, and so in our industry. So there is some slight shortage here that we’re still coping with and haven’t had really effects. We don’t have really indications that we will start to have constraints, but it’s a tight race because there was some capacity that was put on hold there. So far so good.

Mark Sue - RBC Capital Markets

Thank you.

Operator

We’ll now take our next question from Alexandre Peterc - Exane/BNP Paribas.

Alexandre Peterc - Exane/BNP Paribas

Thanks for taking my question. I’d just like to come back to an earlier comment you made at the time of H2 2007 decline in profitability. At that time you had stated that Q1 would be the bottom of this cycle. So could you maybe come back on this statement now a little bit and explain to us where we sit in your either margin or activity cycle? Thanks.

Carl-Henric Svanberg

What we said at that time was that we expected the business mix to prevail for several quarters and therefore it would be logical that Q1 was a low point since the seasonality would affect us also in Q1. And so far it’s proven to be that way.

If you exclude Sony Ericsson we are on a good trend this year. I won’t give you any particular further guidance than that, but we have concluded that the higher network builds continues and that Europe still is slow. So I think we have to add that to the picture.

Alexandre Peterc - Exane/BNP Paribas

All right. A quick follow-up. Given the relatively strong organic growth that you are getting, with like-for-like sales up – I think it was 8% in Q1, 7% in Q2 – why are you maintaining such a prudent stance on the overall markets?

Carl-Henric Svanberg

Remember now that that stand is on the mobile infrastructure market; then we have a stronger growth in Multimedia and Services that adds to the average. Remember, it is the market and remember it’s our planning assumption.

We felt in Q3 that when we were somewhat surprised by the mix shift, that this wasn’t the time to go out and be very precise on exactly where the market was going to go. But we feel that the planning assumptions that we expect at least is not going to be too optimistic. Then we’ll see how it develops from there.

Alexandre Peterc - Exane/BNP Paribas

Okay, thank you very much.

Operator

We’ll now take our next question from Ilkka Rauvola - Danske.

Ilkka Rauvola - Danske

Thanks for taking my question. It looks that your North America sales were flat during the quarter sequentially. In the quarter did you recognize revenues from a large software upgrade from AT&T, or would that happen perhaps in the second half, assuming that AT&T will test that to see how the iPhone, for instance, works on the network.

Carl-Henric Svanberg

There was nothing in particular regarding software-hardware mix when it comes to America that there’s reason to comment on.

Ilkka Rauvola - Danske

It looks that the work-in-process inventories were up in the balance sheet. So, would that be related to anything that relates to the U.S. market?

Hans Vestberg

We don’t go into details on where the work-in-progress or the inventory; of course inventory’s up, compared sequentially to the second quarter, which of course indicates a high activity level in our business going forward as well.

Ilkka Rauvola - Danske

Okay, thanks.

Operator

We’ll now take our next question from Rod Hall - JPMorgan.

Rod Hall - JPMorgan

Thank you for taking my question. I just had a quick question on provisions. I noticed the balance is up again by almost a billion this time around, and the provisions impacts are fairly high as well.

I wonder, Hans, if you could comment on how we should expect the provisions additions to go in the next couple of quarters? Should we be expecting that you’re going to continue to add to these? And also if you could talk us through what it is that’s driving those additions; that would be helpful as well.

Hans Vestberg

When it comes to provisions in the second quarter, they should of course reflect the business mix that we have at that moment. Given the product mix, the country risk and also the country mix and the project mix that we have, that has created that level of provisions.

As you know, we have a very thorough process where we go through them all. But of course it should reflect the situation that we have at the moment in the company and what business we have.

Going forward, I don’t comment on it, but it will always reflect the right level of provision given the business mix that we have. I don’t give any guidance either to the lower or higher. This reflects the right level of provisions that we have right now.

Rod Hall - JPMorgan

Okay. Also just on the Services, I noticed your other services grew fairly well in the quarter. I wondered if you could comment on two things on that: One, what’s driving that? And two, do you expect that growth to continue, or is that a one-off for Q2?

Hans Vestberg

Related to Professional Services?

Rod Hall - JPMorgan

Yes, but non-managed services.

Hans Vestberg

Okay. If you look into Professional Services, we have two-thirds basically of the total revenue being some kind of recurrent business, which is of course important. But then we have one-third that is system integration projects, consulting projects, that is varying between quarters as well.

But I would say that we saw a growth of 11% in the quarter and we still believe in the market as such has a good growth possibility. So, yes and no on the question. It might vary between quarters, but we have two-thirds that are recurrent business.

Rod Hall - JPMorgan

Okay, thank you.

Operator

We’ll now take our next question from Peter Lindsberg - SS Global.

Peter Lindsberg - SS Global

The dichotomies and the discrepancies between different regions must have surprised you, I’m sure, given what’s happening with one of the operators in Japan in terms of the traffic load on the networks, in Australia, and your most prominent operator in North America, the one that recently said that it needs to upgrade the capacity of the base stations by factor of two. They doubled the base station capacity in the next six months plus.

That is starkly contrasting the situation in Western Europe, where at least two operators are contemplating merging their networks with 3,000 base stations each by roughly a third of what AT&T in North America currently plans to double.

SoftBank in Japan is hovering around 60,000 base stations many of which already with two or three carriers. That must be opening up enormous opportunities for you, should other operators behave like the front-runners.

Can you comment on that in general terms, how you see your business evolving if many operators in your core markets were to behave like the front runners in terms of accommodating mobile data? Thank you.

Carl-Henric Svanberg

The various operators that you comment on, they are in different parts of development. You take SoftBank as an example. They are a challenger of the incumbent, and they have to just develop superior services and better coverage and everything else, if they succeed in their venture to challenge the incumbent there.

They’re really working hard and they do it in all aspects of the business, and they’re doing an interesting job, and we continue to expand their network.

If you look at Mobilecom in Austria or Telstra, they are incumbents that are driving very, very hard with the same conviction, that it is only long-term, strong services and attractive service in the market base that can build growth and success. The three of them are working very hard, and from our point of view very much the same.

We have this situation in Europe where everybody’s more hesitant and sitting back a little bit and watching. AT&T is the biggest of them all and are doing exactly what you’re saying. I don’t think we have to do too big conclusions in one single quarter, but it is indicating a little bit where things should end up in the longer run.

Peter Lindsberg - SS Global

You must see a very stark contrast in terms of the number of base station you’re rolling out to operators that start pushing the agenda and hence say tripling or quintupling traffic compared with those that are holding back?

Carl-Henric Svanberg

That is clear, and we should remember that from a more technical point of view when you had a DSM base station that wasn’t fully loaded then that traffic was lost. The 3G technology is much smarter, so if it’s not fully loaded it expands the cell.

Some of you may know, but it means that when the load picks up, you actually shrink the cell and you end up with having to fill out the network. So you are right there; if you build with the hard determination of course you end up with tighter and more filled-up network.

Peter Lindsberg - SS Global

Thank you.

Operator

We’ll now take our next question from Gareth Jenkins - UBS.

Gareth Jenkins - UBS

Just a couple of quick ones if I can. Just coming back to the market growth outlook, I think if I aggregate constant currency terms, yourself and NSN and put aside, while way are faster growing, you grew around 5 to 6% for H1. I just wondered whether we’re going to expect a slowdown in H2, or whether you’re more confident than you were six months ago.

The second question, just on the second carrier channel upgrades in Europe, et cetera, we talk about Telekom Austria, we talk about Telstra, and yet your Australian sales are down, Telekom Austria expecting a 5% decline in domestic CapEx this year. I just wondered whether you can give a sense of when second carrier channels actually lead to upgrades in network capacity CapEx. Thank you.

Carl-Henric Svanberg

If we come to the first question about whether we see a slowdown, obviously we’re not guiding here. So we need to be cautious. But there’s nothing in particular that changes the way things are progressing at this point in time.

When it comes to Australia, there was a massive build-out where we changed in fact 5,000 base stations in almost 12 months. That’s one of the largest projects in the shortest period of time that Ericsson has made.

When you compared that going forward, it will be a decline, almost irrespective of what then happens. Following your query after that, there are upgrades to second carrier which some of them really have been quite vocal about, so they have started to do that.

Gareth Jenkins - UBS

Thank you.

Operator

We’ll now take our next question from Nicholas Von Stackelberg - Sal Oppenheimer.

Nicholas Von Stackelberg - Sal Oppenheimer

Thanks for taking my question. I’ve got a question regarding free cash flow, which was exceptionally strong at SEK 7.1 billion. However, SEK 5 billion of those relate to changes especially on the liability side of your balance sheet.

In your introduction, you touched on these. Can you give us a feel for how this will behave more on a short-term basis, looking into Q3? Should we expect some swing back on these items, and therefore a significantly lower free cash flow figure in Q3?

Hans Vestberg

We’ll not give any guidance on that, but as I said before, other current liabilities, we have been following that for several quarters back. That will swing with the type of projects and customers that we have. If we have a lot of projects being closed that we have in the fourth quarter, then it means all that of will increase our accruals.

Then we can get advance payments from our customers, certain customers will get more VAT sort of liability. That’s a little more swinging back and forth depending on the mix that we have on other current liabilities.

I will not give any indication where it will go in to the future. But this quarter, we had that type of mix, and it can go back and forth. But anyhow, we would say that we had a good progress in cash flow.

Nicholas Von Stackelberg - Sal Oppenheimer

Then just a quick housekeeping question, if I may. If I remember well, in Q2 last year, you benefited from a contract around SEK 1.6 billion that was pushed into Q2 from Q1. Can you just remind us of which region that was allocated to?

Carl-Henric Svanberg

We don’t know what that is. What is that comment?

Nicholas Von Stackelberg - Sal Oppenheimer

When you go back to your Q2 reporting last year, you talked about a contract that was pushed over from Q1 into Q2, if I recall well. The question is about a base effect in the regions.

But we can take this offline, maybe?

Hans Vestberg

Yes, we can take this offline. I cannot recall it. But we will definitely look up that, but I don’t know.

Nicholas Von Stackelberg - Sal Oppenheimer

Thanks.

Operator

We’ll now take our next question from Clara van der Elst - Standard & Poor’s.

Clara van der Elst - Standard & Poor’s

You’ve talked about price competition and have linked it to regions, to India for instance. I was wondering if you could also link it to network product types? For instance, DSM compared to 3G, and how has that developed with sales mix (inaudible)?

Carl-Henric Svanberg

You broke up at the end there, but I think we’ve got the question. There is today, I would say, no difference for us on 2G versus 3G. We have been clear that initial rollouts are more squeezed margins than maybe upgrades and expansions with more softer content.

As 3G tends to be more new rollouts and DSM more expansions, that could be a difference. But between the technologies, they’re both mature enough, so there is really not that big a difference.

The reason why the Indian market is so competitive is it’s only because there’s such a potential. Now that we have learned that China has gone to 500 million, probably going to go to 800 million subscribers, then you are going to (inaudible) the 200 million in India, everybody wants to be part of it. But that’s why that’s more competitive.

Clara van der Elst - Standard & Poor’s

Okay. Just wondering if you could disclose the number of Professional Services staff that’s based in Sweden currently, just a follow-up from the wage inflation question?

Hans Vestberg

We don’t go in exactly how it is distributed but it of course correlated a little bit to our business. But we have it fairly evenly spread on the local resources with our revenues, and then I would say our global resources, they are in many cases placed in local countries like Romania, India, China, et cetera.

Carl-Henric Svanberg

It’s probably a fair comment to say that historically if you go some years back, Services was an entirely local business, where it was reflecting our local position in that particular market. If you look further ahead, 5- 10 years, you will have much more that is cross-border, in low-cost countries, doing remotely.

Clara van der Elst - Standard & Poor’s

Okay. So you still have a quarter of this staff that’s based in Sweden; I would say the bulk. Okay, thanks.

Operator

We’ll now take our next question from Thomas Langer - West LB.

Thomas Langer - West LB

Thanks for taking my question. For the time being, I just want to diverge a little bit from mobile equipment and maybe just want to get the owners’ view on the prospects for Sony Ericsson.

So the question is, should we model a further dividend cash-in in the third quarter? Secondly do you think Sony Ericsson can maintain a simple handset JV also in the future?

You mentioned at the presentation by Sony Ericsson management, maybe there’s something you want to convey to the investor audience how should we look at the future of Sony Ericsson. Thank you.

Carl-Henric Svanberg

Our Sony Ericsson joint venture, if you look at it, over the last seven years, although they are less successful right now, but they have certainly built a very good business foundation. There’s no fundamental things that have changed in the way they work. They simply have to shape up in some areas, which they are working very forcefully with.

The strategic importance for us, the value for us is there. For us it’s important not just to be able to build the network, but also to provide an end-to-end solution, and understand how we do that effectively with a product that enables such advanced services and communication.

When it comes to their dividend, this is still for the owners to decide on, but as communicated by Sony Ericsson in the quarter, they are planning for a dividend later this year.

Thomas Langer - West LB

Okay, if I may, I just want to come back to that JV question. In essence what you say is that cost-cutting plus better products will eventually do the trick. The question I’m asking is simply the fact that also Apple again mentioned the importance of their applications tool they just launched, and I’m just wondering whether we should see more initiatives also on that front?

Carl-Henric Svanberg

Such questions I think are of course best put to Dick Komiyama and his team; they speak for their company. One should remember, though, that Apple is really targeting a very high-end niche of the company. Sony Ericsson’s problems lies where they are strong, in the middle to high end, but not necessarily in that particular segment.

Where Apple will go long term, we will have to see. Sony Ericsson’s issues (inaudible) but certainly I’m sure there are opportunities there and we should turn the question to them.

Thomas Langer - West LB

Thank you.

Operator

We’ll now take our next question from Michael Andersson - Evli Bank.

Michael Andersson - Evli Bank

I have a new question regarding Western Europe and the network or the operators’ network capacity there. You’re writing in the report that there is some excess capacity, especially in the HSPA networks.

Is there a chance of you to quantify that, as what scares me a little bit, if the macro environment in combination with excess capacity in the networks at a lower usage, that we will get a hit on CapEx in Western Europe.

The second question is the U.S. good growth you had, this morning, Carl-Henric, you mentioned also the fixed line here, or the fixed-line IP and also iPhone. Do you see similar growth within both mobile and fixed IP networks in the U.S.? Thank you.

Carl-Henric Svanberg

The vast majority of the business in U.S. is driven through mobile networks in our case. If we look out into Europe, the investment level, as all of you know, because of the excess capacity, there is that. We must remember, though, that we talk about 50, 60 operators, many operators have a unique situation.

But it is because initial capacity that has even been expanded with software upgrades to faster networks with faster speeds, which initially give some extra capacity. It doesn’t do that when you expand it to even higher speeds, as we have talked about before. But it’s already now at the lower spending, so it’s more a matter of when it can start there rather than how it gets slowed down.

Michael Andersson - Evli Bank

All right, thank you.

Operator

We’ll now take our next question from Andrew Griffin - Merrill Lynch.

Andrew Griffin - Merrill Lynch

You mentioned lower turnkey projects as one reason for the better cash flow. In the past you’ve said that turnkey would generally increase as a percentage of sales, which is why the cash conversion guidance has been less than 100%.

I wondered if you could elaborate on the turnkey slowdown? Is this more a one-quarter effect or a bit of a broader trend? If you could throw in any impact in particular on particular regions or change in business mix, that’ll be helpful too. Thank you.

Hans Vestberg

Some regions, primarily Asia and Central Europe and East Africa, are turnkey like regions, whereas Latin America and North America and Europe are not typically turnkey projects.

Of course there are variations to that, exceptions, but basically that’s a good split to think about. In a turnkey project, it means that such an operator doesn’t build up his own resources to roll out that version, and he gets dependent on us doing it.

In other markets where the opposite is, then he has full resources. It’s not something that he chooses from time to time; he has a way of working. Obviously, in a turnkey project, you’re much more third-party products, and you get paid at the end of the project. That’s why we build up much more working capital.

From a cash flow point of view, it’s when such projects grow faster than the company as such or faster than the market. That’s when we build up the working capital and drain cash flow. Once you are at the more steady state, then the cash flow returns again.

That is a little bit what you’re seeing in this particular quarter, where U.S. is growing stronger and traditional turnkey markets are growing less. But remember that you cannot do a full one-to-one comparison between where sales has been and where working capital build-up is, because working capital build-up is for the future.

But that probably gives you some guidance on the lesser turnkey growth that have given us some lesser constraints on the cash flow.

Andrew Griffin - Merrill Lynch

Your cash conversion guidance is still 70% plus. Is that correct?

Hans Vestberg

Our target is still about 70% cash conversions.

Andrew Griffin - Merrill Lynch

Okay. Thank you very much.

Gary Pinkham

Operator, we can take one last question, please.

Operator

Now we’ll take our last question from Jan Dworsky - Handelsbanken.

Jan Dworsky - Handelsbanken

Thank you for taking my question. I had a question on the number of employees, and as I understand it it’s increasing in managed services but it’s also increasing in R&D staff. In relation to the restructuring program, should we expect the head count excluding managed service contracts add-in to start declining in the second half of the year?

Carl-Henric Svanberg

That’s a little bit difficult to predict, precisely how that is going to work. Remember now that we are walking a thin line here, when we are on one hand adjusting the number of employees and the costs down because of prudent planning for a flattish mobile infrastructure market.

At the same time we are making sure that we’re not compromising on the R&D side, as you rightfully say, so we have some expansions on the R&D. But all in all it’s of course a slowdown. But the services activities are very man-intensive. It’s not just managed services contracts that builds up services, it’s as much via systems integration or just support services or consultants that are pushing the numbers the other way.

Jan Dworsky - Handelsbanken

Okay, thank you.

Operator

That will conclude today’s question-answer session. I will now turn the call back over to your host for any additional or closing remarks.

Gary Pinkham

Thank you, operator. Before we finish today, I would like to remind you of our Investor Forum scheduled for August 14 in Boston. The forum will mainly address technological developments and will not cover any financial information. Agenda and registration information is available on our website. Thank you very much. See you next quarter.

Operator

Thank you. That will conclude today’s conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.

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