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Edited Transcript of ERIC B.ST earnings conference call or presentation 17-Jul-19 7:00am GMT

Q2 2019 Telefonaktiebolaget LM Ericsson Earnings Call (Morning)

Stockholm Jul 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Telefonaktiebolaget LM Ericsson earnings conference call or presentation Wednesday, July 17, 2019 at 7:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Carl Mellander

Telefonaktiebolaget LM Ericsson (publ) - Senior VP, CFO and Head of Group Function Finance & Common Functions

* E. Börje Ekholm

Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director

* Peter Nyquist

Telefonaktiebolaget LM Ericsson (publ) - VP & Head of IR

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Conference Call Participants

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* Achal Sultania

Crédit Suisse AG, Research Division - Director

* Aleksander Peterc

Societe Generale Cross Asset Research - Equity Analyst

* Andrew Michael Gardiner

Barclays Bank PLC, Research Division - Director

* Daniel Djurberg

Handelsbanken Capital Markets AB, Research Division - Research Analyst

* David Terence Mulholland

UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware

* Johanna Ahlqvist

SEB, Research Division - Analyst

* Johannes Schaller

Deutsche Bank AG, Research Division - Research Analyst

* Jörgen Wetterberg

Nordea Markets, Research Division - Senior Analyst of Telecom and IT

* Pierre C. Ferragu

New Street Research LLP - Global Team Head of Technology Infrastructure

* Sandeep Sudhir Deshpande

JP Morgan Chase & Co, Research Division - Research Analyst

* Stefan Julien Henri Slowinski

Exane BNP Paribas, Research Division - Research Analyst

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Presentation

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Operator [1]

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Hello, and welcome to the Ericsson's analyst and media conference call for the second quarter report. To view visual aids for this call, please log on to the www.ericsson.com/press or www.ericsson.com/investors. (Operator Instructions) As a reminder, a replay will be available 1 hour after today's call.

Peter Nyquist will now open the call. Please begin.

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Peter Nyquist, Telefonaktiebolaget LM Ericsson (publ) - VP & Head of IR [2]

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Thank you, operator. And hello, everyone, and welcome to the second quarter call, the first one of today. With me today, I have our CEO, Börje Ekholm; and our CFO, Carl Mellander.

I will start with this short note. 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 hand over the word to Börje Ekholm, our President and CEO. Please, Börje.

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [3]

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Thanks, Peter. And again, welcome to our call here for the second quarter. Two years ago, we laid out and defined a focused strategy and we now add another quarter to our execution on that plan, putting us on the way to reaching our targets in all segments for 2020 and 2022.

So 5G is rapidly gaining momentum around the world. And 5G is now launched in 4 continents, and we see actually good pickup in the -- on the consumers. We also see that 5G actually give our customers an opportunity to deliver premium services and premium prices in certain markets.

Our strategy is to invest in technology leadership, and we are starting to see that bearing fruit in increased competitiveness in our solutions offerings as well as in improved gross margin. And today, we have a competitive portfolio across RAN as well as core.

Our priority is to work with lead customers in lead markets, and that have allowed us to launch commercial services in both mid-band as well as in millimeter wave. And we are today providing our solutions to about 2/3 of all commercially launched networks. And of course, here for us, it was important to be first, but now we're moving into a world where it's really about delivering in the field and providing the best in-field performance.

What we see today is that in most customer engagement, there is a 5G component, and that's very different compared with just a few quarters ago. The first use cases for 5G is clearly enhanced mobile broadband. But we see also that the big potential for 5G will be enterprise-driven use cases where the enterprises can leverage the capabilities of 5G: high speed, low latency, long battery life, a lot of connected devices per service unit as well as, of course, the security inherent in 5G.

Our sales grew by 7% FX adjusted, driven by Networks in North America and Northeast Asia, and that's the markets where 5G was launched the first. Our cash flow was SEK 2.2 billion for the free cash flow after absorbing actually large conversion of provisions to cash. So the last few years, Q2 has typically been a negative free cash flow. So it’s a milestone for us to generate a positive cash flow.

Our strategy, as I said, builds on our ambition to be technology leaders. And of course, we continue to invest in our 5G portfolio both in radio as well as in our cloud-native core portfolio in Digital Services. What we also see is that we are increasing our investments in R&D in Managed Services to fundamentally change the model and improve the margin profile.

Move to the next slide. Organic sales increased by 7% and reported sales growth was 10%. Operating margin increased year-over-year, but was flat sequentially when adjusted for the onetime items we had during Q1.

Networks saw a growth of 11% driven by 5G traction and, of course, strategic contracts. We saw an increasing portion of strategic contracts in the second quarter, and that has a negative margin effect, and we kind of combined that with the IPR settlement that we announced recently. But we still have a large demand, and this -- we still saw a good performance.

Digital Services is executing on the plan to reach single-digit margins by 2020, and losses are falling sequentially. But as we have said before, improvements will not be linear. We see good traction in our turnaround plan with costs coming out as planned. Gross margin fell year-over-year due to very sharp reduction in our legacy portfolio as well as a less attractive mix.

But what's more important here is our offering of cloud-native 5G core are gaining momentum. What we see here is that we will need to invest in R&D here to ensure that our new portfolio is competitive but, at the same time, we also see new ways of working in R&D in Digital Services that will improve the efficiency. What's also encouraging is we see traction in our new BSS strategy with several new customers as well as portfolio wins.

In Managed Services, sales was flat when we adjust for the planned contract exits. Gross margin declined, which is really due to more timing of costs between quarters. What we are also doing is, of course, increasing the investments in R&D in automation, machine learning and AI, to strengthen our Operations Engine. Short term, this is impacting margins negatively. But over time, it will definitely improve the margin profile.

Emerging Business is our area to invest in new innovative solutions. Results improved here as this was really the first quarter excluding MediaKind, but we also saw a good development in our profitable iconectiv business. And as I said before, free cash flow was SEK 2.2 billion after absorbing SEK 3.7 billion in cash outlays for provisions and restructurings.

We have seen good overall growth driven by the regions with early adoptions of 5G, that's North America and Northeast Asia. And we see North America to continue at the current level. And in China, we have also seen the 5G frequencies being issued. I think it's worth to note here that China is significantly more clever than Europe in issuing frequencies, that instead they use -- instead of using (inaudible) to maximize price for frequencies, they actually award them free of charge. Of course, this will lead to a much faster build-out in China than in Europe.

We saw Europe and Latin America had a slight decline in sales, and this is fully explained by the planned contract exits in primarily Managed Services. So if we exclude the planned exits, we saw actually slight growth.

Southeast Asia and Oceania saw a reduction in sales, and that's explained by the legacy portfolio in Digital Services. But we also saw growth in Managed Services and have a good 5G demand in Australia.

In Middle East and Africa, it was actually negatively affected by planned contract exits as well as timing of project milestones. But overall, we see a good momentum in our underlying business.

With that, I give the word over to Dr. Mellander.

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Carl Mellander, Telefonaktiebolaget LM Ericsson (publ) - Senior VP, CFO and Head of Group Function Finance & Common Functions [4]

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Thank you, Börje. I will talk about segments, margins, costs, cash flow and planning assumptions, and let's start with Networks. Networks delivered according to plan and continues to grow, as you see, in Q2 here at 11% FX adjusted. This is driven by 4G and increasingly 5G investments. And North America and Northeast Asia, as Börje mentioned, including China and Korea, notably, stood for the main growth this quarter.

We also grew our business on the strategic contracts. And as you will remember, just to repeat, the strategic contracts will be margin accretive in the long term but weigh on the margin short term. And of course, we take these contracts to capture opportunities to build the 5G footprint. As anticipated, North America Networks business remains stable on a high level, as we had communicated. And the sequential growth in North America on Networks was 3% in U.S. dollars.

Gross margin in Networks improved year-over-year driven by a couple of factors: higher IPR revenue and the positive mix as well. But this was also partly offset by mainly 2 factors that I'd like to mention: and first off is the license settlement cost that we press released about earlier in June; and secondly, as expected, we also saw an impact from the growth under this strategic contract in the quarter.

Looking at the sequential development, as you see in the table here, we see a 1.2 percentage point gross margin decline. And on top of those strategic contracts and the settlement, it was also due to lower IPR revenue Q2 versus Q1. But note here again that IPR is up year-over-year but down sequentially quarter-over-quarter.

Operating income and margin increased year-over-year, SEK 5.7 billion or 15%, which puts Networks now in the lower end of the target range that we have given for 2020. And this improved profitability level follows really from higher sales and gross margin, partly offset then by increased R&D and some trial costs in connection with 5G introduction as well.

Turning to Digital Services next. Our FX-adjusted sales here declined by 3% due to continued and rapid decline in the legacy business. However, there is continued customer momentum with the new portfolio of 5G in cloud-native products. I think it's also encouraging to see now the reshaped BSS strategy, but that is gaining traction on the market with several new customers, as Börje already mentioned.

Gross margin 37.1% down year-over-year and quarter-over-quarter, and here we saw an impact from the business mix. And again, this mix will vary over quarters in Digital Services. Operating income follows the path with continued reduced losses now at SEK 1.3 billion in Q2. We continue to take out costs here in service delivery from offshoring and automation. And we have also reduced OpEx by some SEK 900 million so far this year in spite of the FX headwind that we see.

Now out of the 45 identified contracts, we have addressed 27, adding 2 more in the second quarter. And with this, we are on track towards the ambition we have stated to have 75% completed at the end of this year. We still have a negative impact from amortization of previously capitalized R&D. As you see here -- but in 2020, the absolute majority of this will be behind us, and that gives a benefit of SEK 0.8 billion annually compared to 2019.

So we're tracking towards the 2020 target here of low single-digit profit. But again, please bear in mind that we don't expect improvement to be linear. Quarters' results and margins will vary depending on seasonality, on business and on project mix.

Let's turn to Managed Services where our FX-adjusted sales declined 6%, but again this is as expected following the decided contract exits. Excluding those, there was a flat development. Gross margin declined in the quarter, explained by negative impact from timing of costs mainly. And if we look back to Q1 '19, costs were lower than normal and now a bit higher than normal. So therefore, it's probably more representative to look at the first half combined where the gross margin then was 14.9%. This is a more representative figure. And the same goes for operating income where we reached 5.8% if we look at the first half, which is then in range with the target range that we have set.

But I should also mention the R&D investments in automation and AI, which we do to enhance the customer offering, of course, and then this has a negative near-term impact on the margin but will longer term improve, of course, the margin profile for this business.

Moving to the fourth segment, Emerging Business and Other. Here, this is where we invest in initiatives that we aim to scale and help create future business for Ericsson. And this portfolio is in an early investment phase, except for iconectiv there, which is already a profitable business. We grew here 24% if we adjust for FX. And the operating income also improved to minus SEK 0.7 billion from minus SEK 1.2 billion, supported by increased profits in iconectiv and -- but also the divestment of MediaKind.

As usual, we show here on this slide the 3 main parts of the segment, same in the report, and you see starting with Emerging Business, including iconectiv, where the growth again comes from iconectiv and profits increased also based on improving profits from the iconectiv business. Media Solutions, you know that we divested 51% of MediaKind, 1st of February, and the losses have reduced significantly there. So now we carry 49% of the MediaKind quarterly results in our result.

Red Bee Media, finally, stable sales year-over-year, improvement of the operating income, and this is according to plan. And just remember, last quarter in Q1, we had an impact -- a positive impact by capital gains from the divestiture of MediaKind at SEK 0.8 billion. So that distorts a little bit the sequential picture.

Okay. But that concludes the look at the segments here, and let's move to a quick look at the gross margin trend over time. And again, we summarize here the factors that I've mentioned that impacted the gross margin coming from a high Q1: the announced license settlement agreement, strategic contracts in Networks, timing of costs in Managed Services and lower IPR revenues. But with 37% here, we're tracking towards the 2020 target of 37% to 39% gross margin.

Next slide on OpEx showing, first of all, that we have increased the R&D investment from SEK 9.3 billion to SEK 9.5 billion, notably for 5G and AI. At the same time, we divested MediaKind, and we're continuing with efficiencies, of course, in BGS. And we also have an FX effect of SEK 0.2 billion in the mix here as well with an adverse effect.

Number two, SG&A up to SEK 6.9 billion from SEK 6.6 billion, impacted partly by 5G field trials as well as FX. And then thirdly that the trade receivables impairment was positive in the quarter, SEK 0.2 billion. However, actually, this is more of a move between the lines because we -- some receivables for a certain customer were moved into customer financing and the risk provision follow there, so that's now recorded in SG&A instead of on this line.

We move on to cash flow. Free cash flow, this is a strong point in the report that Börje emphasized. And our key metric here is really free cash flow excluding M&A, SEK 2.2 billion up from negative SEK 0.2 billion mainly driven by improved earnings. And if we look at the year-to-date number here, free cash flow before M&A was up from SEK 0.6 billion last year to SEK 6.3 billion, so in other words, improved by SEK 5.7 billion, which is quite strong.

And also want to mention and underline again that the cash outlay for provisions restructuring was SEK 3.7 billion in Q2 and even SEK 6.9 billion in the first half of the year. Cash position remains strong. Solid gross and net cash at SEK 69 billion and SEK 33.8 billion, respectively. And no news on the debt maturity profile. It remained completely intact in the quarter.

Finally, planning assumptions. And here, as usual, I want to refer to the full report for complete planning assumptions. But to mention a few, when you think about net sales going forward, it can be worthwhile considering our expectation of a lower-than-normal sales seasonality between quarters throughout 2019. As we said before, we expect North American sales level to remain rather flat. And we maintain the IPR baseline for '19 at SEK 9 billion.

On gross margins, we expect a higher impact from the strategic contracts in Networks in the second half. And as we also stated before, large 5G deployments in parts of Asia are expected to start end of '19 with a short-term negative GM impact. The share of services in North America will gradually increase. And bear in mind also that the improvements in Digital Services will not be linear between the quarters.

OpEx, we typically don't guide on the expense side, but OpEx typically decrease somewhat from Q2 to Q3 due to seasonality. We will have continued costs for field trials though, so that's important to bear in mind. Networks R&D will be gradually flattening out over the coming periods. And then finally then, we have decreased the range for restructuring charges for the full year 2019 from earlier SEK 3 billion to SEK 5 billion, now to SEK 2 billion to SEK 4 billion.

And that's it for me. Thank you for that. And I hand back to you, Börje.

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [5]

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Thanks, Carl. So closing remarks, we have good underlying momentum in our business. Demand is good as customers are increasingly focused on getting ready to roll out and build out 5G. We see also that our solutions in radio and core is showing its competitiveness in the market.

Our strategy of working with lead customers in lead markets have made us provide solutions for about 2/3 of the commercially launched 5G networks. This strategy relies on technology leadership, and we continue to invest in R&D to ensure we can provide the leading solutions. We are also increasing our investments in our cloud-native portfolio, AI and machine learning and automation.

Our intention is to continue to capture market opportunities to execute on our strategy of disciplined growth. We will see somewhat more impact of strategic contracts in the second half of the year, but they will also strengthen our position longer term and create a platform in 5G. We remain fully confident that the targets we put out for 2020 as well as '22 that we will reach them with the strategy we're executing on.

So thank you. With that, over to you, Peter.

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Peter Nyquist, Telefonaktiebolaget LM Ericsson (publ) - VP & Head of IR [6]

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Thank you, Börje. So operator, we -- or the team here in Stockholm now is ready to handle the Q&A. So please go ahead.

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Questions and Answers

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Operator [1]

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(Operator Instructions) So we now go to the questions in the queue, and the first question is from Societe Generale and Aleksander Peterc.

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Aleksander Peterc, Societe Generale Cross Asset Research - Equity Analyst [2]

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I'd just like to understand when you talk about sequential growth being a little bit faster going into the remainder of the year given that North America is leveling off, now you had last year third quarter, which is particularly strong, like in quarter-on-quarter were around by about 8%. So does this imply that we are going to decelerate quite strongly in terms of the year-on-year growth from the just reported strong growth of 7% to something that's more like level or slightly down year-on-year like-for-like constant currency, please?

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Carl Mellander, Telefonaktiebolaget LM Ericsson (publ) - Senior VP, CFO and Head of Group Function Finance & Common Functions [3]

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No, I think that's drawing too much conclusion from what we say. We just talked about this, the normal seasonality here, about 3% up on Q2 to Q3. In North America, I mean being very strong already a couple of quarters now, we'll continue at the same level. And that's about it what I can say now. At 7% growth, of course, compared with the Dell'Oro forecast for the whole year of 3%, it's indicating that we have good momentum with customers and a competitive portfolio. And let's see where the second half will end.

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Aleksander Peterc, Societe Generale Cross Asset Research - Equity Analyst [4]

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Okay. And just briefly, can I also ask about Europe? Do you see actually Europe developing a bit more slowly than initially thought in terms of 5G deployments? Has there been any change in this respect?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [5]

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There hasn't been a change. Europe, we have forecasted Europe to be slower because of the situation with spectrum in Europe as well as Europe actually lags behind, as a continent, North America and China on 4G as well. So it's been in the plans the whole time of a little bit slower European development. So that's no change, really.

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Operator [6]

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Which is over the line of Sandeep Deshpande of JPMorgan.

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Sandeep Sudhir Deshpande, JP Morgan Chase & Co, Research Division - Research Analyst [7]

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My question is on the Digital Services business itself. What do you think you have to do from here to turn it around? I mean you have taken the charges in the BSS business and you take -- and also charges as well as provisions. So I mean I'm trying to understand what is further needed here to bring the margin towards breakeven.

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [8]

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In Digital Services, what -- we continue to execute on the strategy that we defined sometime back. Of course, it's been fine-tuned, but it's all about industrializing our solutions to bring them to the market in order to become more efficient in service delivery as well as increase the software portion. And that is something that we have said will reach single-digit margins in 2020, and we feel that we are on track to deliver that with the execution we do and the improvements we do. We have also said that it's not going to be a linear path to that because it's a lot of efforts that have to go through. So we're executing on that strategy.

In addition, we are addressing the critical contracts we have, and we identified 45 contracts. But half of them -- or a little bit more than half are addressed, and we said we should be at 75% by year-end. We're on track for that. Whilst we have gone through this, we will see the improvements in the financial result. If you also look for the second quarter, we continue to see cost coming out and efficiency improving in this segment. And that, of course, is something that will continue to gain traction towards the end of the year. So we feel that the guidance we have given we will deliver on, and that's our commitment.

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Operator [9]

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We are over to the line of Daniel Djurberg at Handelsbanken.

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Daniel Djurberg, Handelsbanken Capital Markets AB, Research Division - Research Analyst [10]

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And congrats to a stable report on Networks. I would like to ask you about the impact of strategic contracts. You saw it in Q2, and you expect it to increase some further in the second half. Can you give any visibility or granularity to how much is impacted and how much more it will impact second half from a gross margin perspective? Just to help how to think on the impact seen so far versus what to see coming up.

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Carl Mellander, Telefonaktiebolaget LM Ericsson (publ) - Senior VP, CFO and Head of Group Function Finance & Common Functions [11]

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We're not able to quantify exactly here. But what we can say is that the share will increase somewhat the second half compared with the second quarter, not just one. If you look at the gross margin decline here in Networks, it's about 1.8% quarter-over-quarter between Q1 and Q2. And then we have a couple of factors that we mentioned: the license settlement, strategic contracts then that you asked about and also IPR. So there, you can get the ballpark feeling maybe for how much these impact the margin, and it will be a bit more than in the second half. Important being, of course, with these contracts, we take them to generate long-term value. And it is advancing our footprint. We do it on a selective disciplined basis with certain short-term hit on the margin then, but all of that within the framework or the borders of our targets for 2020.

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Daniel Djurberg, Handelsbanken Capital Markets AB, Research Division - Research Analyst [12]

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Okay. Any changes to your former plans in terms of geographical mix coming faster? Or in terms of change of geographical mix, you mentioned Northeast Asia, et cetera. Was that also in your plans in Q1?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [13]

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We see no real changes globally to that extent. The demand continues to develop in line with what we have said before and what we have planned for.

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Operator [14]

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It's over the line of Achal Sultania of Crédit Suisse.

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Achal Sultania, Crédit Suisse AG, Research Division - Director [15]

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Just one clarification on the gross margin again. So you mentioned that the gross margin obviously went down slightly from Q1 to Q2. But if we adjust for the 2 factors, the IPR in Q1 and then patent settlement in Q2, it seems that gross margins would have been almost flattish quarter-on-quarter. Is my math wrong on that? And then if that's the case, like are you trying to say that even though strategic contracts had some like headwinds in the quarter, the mix continues to improve and it kind of offsetting the headwinds from strategic contracts?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [16]

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We're trying to say, we're trying to manage within that framework. The reality is when you look at the quarter, we have the IPR settlement being a clear negative. You know that and you have seen that. As a matter of fact, we also see improvement in the underlying business. And part of that improvement, we reinvest in strategic contracts.

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Achal Sultania, Crédit Suisse AG, Research Division - Director [17]

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Okay. And one clarification on BGS as a follow-up. Can you help us understand on the cost-cutting plan, like what are the targets for BGS? How much of the cost cutting has been done this year? What's the plan to do over 2019 and 2020 combined and also the benefits from capitalized R&D going forward? Those 2 numbers, please.

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Carl Mellander, Telefonaktiebolaget LM Ericsson (publ) - Senior VP, CFO and Head of Group Function Finance & Common Functions [18]

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So on the cost side, we -- and as I've mentioned, we've taken out almost SEK 1 billion, SEK 900 million year-over-year in OpEx there, and that's in spite of the FX headwind that we see. And we also continue on service delivery with cost efficiencies, and that is based on offshoring but also additional automation in the service delivery. So that will continue. When it comes to the capitalization impact here, you see some of the numbers. And going into 2020 compared with [2029], it's a difference of SEK 0.8 billion annually. So that's a benefit in 2020 of SEK 800 million compared with '19.

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Operator [19]

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It's over the line of Johanna Ahlqvist at SEB.

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Johanna Ahlqvist, SEB, Research Division - Analyst [20]

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So one question relates to China. You mentioned a bit about strategic contracts, and I'm wondering whether the majority of those relates to China 5G contracts. And if you have any visibility in the potential 5G rollout in China and your market share expectations, do you expect them to be in the levels we've seen in the 4G? And any timing would be helpful as well.

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [21]

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No, these do not relate to China. Chinese contracts on 5G has not really been awarded yet. So there are no effects. There are field trials ongoing now that, of course, will be important in determining the future market share. And we are investing in the field trials but also in technology and solution development that will -- with an ambition to at least have the 4G market share.

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Operator [22]

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Which is the line of Jörgen Wetterberg at Nordea Bank.

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Jörgen Wetterberg, Nordea Markets, Research Division - Senior Analyst of Telecom and IT [23]

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So I have a question on the gross margin from strategic deals, timing-related. So you expect that to continue to have some pressure during H2. If you could give some color on which regions do you think would drive that. And when can we expect an inflection point from the initial pressure to relative positive contribution on the gross margin from these strategic deals?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [24]

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We are not going to disclose which regions in detail for the simple reason that we compete with the competitors on a daily basis and we may not want to talk about that. So that's why we're not going to give more on that. But what you will see is that these type of contracts, they're most likely going to weigh on margins the next few quarters and then they will start to contribute.

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Jörgen Wetterberg, Nordea Markets, Research Division - Senior Analyst of Telecom and IT [25]

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Okay. And maybe a follow-up question is, there's been some talk by some of your competitors that they're swapping you more than the other way around. Do you have any comments to those statements? What's the overall momentum that you feel account by account in the market right now?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [26]

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We would never start commenting on competitors. So if you can forward me the information that they have of the swapped contracts, I look forward to that.

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Operator [27]

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Which is Pierre Ferragu at New Street Research.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [28]

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I want to try and understand more how things are doing in the U.S. So when I see your level of revenues, they're fairly impressively high. And I was wondering what are the activities behind that. So what are your clients in the U.S. investing in at the moment? Is that increasing capacity on the 4G network? Is that more like specifically 5G-related? And of course, my key question is, how does that mix change in 2020? Are we in the middle of the capacity upgrade cycle at the moment that eventually will be replaced by the ramp of 5G next year? So how do your clients plan their network activities in that region?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [29]

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See, we clearly see an increase in the -- it's really an increase in the capacity need in the network, and that's really what's going on. So you can say that we see investments in 4G as well just to fulfill the demand from the end consumer. But of course, there are also investments to make sure you are ready to ramp 5G at a faster pace. So we're seeing both of these trends happening in the U.S. now.

You also see the growth of data is continuing at a very high pace, and that's ultimately what drives demand as Networks start to get more or get into higher-capacity utilization. And that's really what we see happening there. That's most likely something you can see happening in other parts of the world over time as well, although it hasn't happened yet. But we see a fairly -- in that sense, we're in an industry where the end consumer has a lot of demand.

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Pierre C. Ferragu, New Street Research LLP - Global Team Head of Technology Infrastructure [30]

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Okay. And in 2020, do you think the mix of activity is going to be similar or is that going to change?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [31]

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We think it's going to remain fairly similar as there is a need to build out capacity in the wireless access.

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Operator [32]

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Which is over the line of Stefan Slowinski of Exane BNP Paribas.

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Stefan Julien Henri Slowinski, Exane BNP Paribas, Research Division - Research Analyst [33]

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Just a follow-up on the previous question on China, you sort of -- you talked about the potential for China to begin ramping towards the end of the year. Feels like that's being brought forward a bit. I mean do you see that potentially benefiting your Q4? If those tenders do come through, could we see kind of for the group better-than-typical sequential growth in the fourth quarter? And how do you see China overall impacting 2020? Do you see 2020 as a growth year for your Networks business?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [34]

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We are -- it's a little bit too early to know exactly the timing in China. We don't know. But what we see is that it's likely to start by the end of the year. We will also, of course, know how terms look on the contract by the end of the year. And it's a little bit too early to give any definite guidance on that, and we'll come back probably in our capital markets update towards, what dates, October, November.

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Stefan Julien Henri Slowinski, Exane BNP Paribas, Research Division - Research Analyst [35]

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Okay. Just because it looks like consensus for 2020 is already at the high end of your revenue guidance range, and just kind of wondering if you're still comfortable with that or if we should be expecting an update on that guidance range.

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [36]

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As we have said today as well, we're very confident about our target for 2020 and 2022. So we execute in line with those plans.

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Stefan Julien Henri Slowinski, Exane BNP Paribas, Research Division - Research Analyst [37]

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And when do you expect to give an update on the guidance?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [38]

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I believe it's the -- if we do anything, it will be at the Capital Markets Day.

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Peter Nyquist, Telefonaktiebolaget LM Ericsson (publ) - VP & Head of IR [39]

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Which is planned for, as you probably know, we will have it in Q3 quarterly investor update.

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Operator [40]

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Which is over the line of Andrew Gardiner at Barclays.

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Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [41]

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Just another one on the strategic contract front. I'm just wondering whether you -- would you consider that you're seeing more opportunities than you anticipated for such contracts? Or are you still being sort of targeted around the ones that you'd aimed at? And can you sort of weave a comment into that sort of regarding the trade war? Carl, I think I see a quote from you on one of the Newswires saying that hasn't really been an impact on your order books yet. But I'm just wondering if you can give an update as to how conversations with operators are progressing and what you're seeing. It feels like indecision rather than any sort of proactive decision, but I'd be interested in hearing the latest from your side.

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [42]

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Well, we see no real impact yet, as Carl said. When you -- if we look at the strategic contracts just a bit, we get a lot of focus on that and I understand that. But the reality is also we have said that we are going to invest for technology leadership. We're going to develop a competitive solution, competitive product in the market. We're in an industry that is globally large, but we also know that we need to strengthen our footprint to be a global leader in the market, and that's what we are aiming for. When we take those contracts, they are associated with upfront costs. When we look at the total contract, it's very accretive. But of course, they're going to hurt upfront earnings.

So what we're trying to say is that we run the company on the overall guidance and the overall financial performance. We're going to be disciplined, and we try to keep an overall gross margin level and operating income level. But of course, the improvement that we see in the underlying business, part of that improvement, we reinvest in those contracts.

So if you look at the Networks segment, for example, where these are more important and more pronounced, yes, there is a slight margin dilution for the second quarter compared to the first quarter. Most of that dilution, you actually see IPR settlement. But then they are also weighing down -- the underlying is improving, but it's countered by a loss with selective gains of footprint. So we try to manage that overall situation. And the numbers would have been very different without the IPR settlement, and those are just quarter-by-quarter. We can't really -- we don't know when they're going to come, right? But we run the underlying business for continuous improvement and use that partly to invest in strategic contracts. Otherwise, you would have seen a much better improvement.

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Andrew Michael Gardiner, Barclays Bank PLC, Research Division - Director [43]

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Understood. Perhaps, I'd ask it just another way. I mean given how you framed that relative to the 2020 and 2022 margin targets, the strategic contracts that you're taking this year that, to your point, are pressuring margins in the near term, are we going to see most of the impact this year and, therefore, it will lessen in 2020 and beyond? Or is it -- do you think it's going to be that sort of short term of an impact in terms of 2019 and we won't really see too much of it in 2020? Or how long will it continue?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [44]

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I think what we have tried to say is that we run -- we're going to -- we're very committed to our 2020 targets. And depending on what opportunities we see, we may use the part of the improvement to make sure that we further strengthen our competitive position, call it 2022 and beyond. And that's really what we are aiming for. And for us, it's not about what the third quarter is and the fourth quarter is. It's about building a company that's significantly more profitable 2025. If we can -- we need to invest for that. That's what we are targeting. And we're not going to sacrifice that just to fulfill a quarterly demand, right? But as you can see, we still manage the company on the overall financial position, but we're investing for the long term out of the resources we create.

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Operator [45]

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We're now over the line of David Mulholland at UBS.

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David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [46]

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Just a follow-on on some of the longer-term issues in the business. But in terms of contract wins, I wonder if you could talk a little bit about how you've been doing in terms of contracts there for full 5G? Is there anything yet for standalone? Or are you still just working on kind of new radio specifications? And where are you in terms of your product readiness for standalone deployments?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [47]

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Yes. Actually, we had the first call on standalone quite recently here. So we are ready for that. I feel very comfortable about that. But so far, the rollout we see is non-standalone.

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David Terence Mulholland, UBS Investment Bank, Research Division - Director and Equity Research Analyst - Technology Hardware [48]

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When do you think that starts to transition?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [49]

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They probably -- we haven't really seen any of that yet. The benefits of -- if you don't have standalone, you need a fairly big network to really enjoy the benefits. So you're more likely to see that in areas that are aggressively rolling out. And so far, that would probably be China, right? But we don't know yet exactly how that's going to look like, and it also relates a bit. But the demand so far has really been more non-standalone.

But I think that also brings another item which is important to remember. It's very hard for us to differentiate between 4G and 5G because our hardware is really capable of doing both. So if you have one frequency band running dynamic spectrum sharing, allocating dynamically between 4G and 5G, is that 5G equipment or 4G equipment? We classify that as equipment. It's very hard. So market shares and what you talk about 4G, 5G, it's very hard for us to differentiate because of the capabilities we have built into our hardware.

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Operator [50]

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Which is over the line of Johannes Schaller at Deutsche Bank.

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Johannes Schaller, Deutsche Bank AG, Research Division - Research Analyst [51]

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Just, Börje, you mentioned industrial services, the legacy revenues that came down and that were a drag on profitability. Could you just help us understand how big the remainder of these legacy revenues now still are and how we should think about those going forward? And then just as a follow-up, on your headcount, that's been reasonably flattish for the last few quarters now. Just thinking if the kind of 95,000 where you are right now, if that's the right level of headcount you're thinking about going forward.

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [52]

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And the good news is the legacy portfolio can soon not shrink much more. So it's starting to be less, but that includes like circuit-switched, et cetera. So those are disappearing rather fast now, and it's probably going to weigh a bit more for the remainder of the year. But after that, we see it's going to be very limited.

If you look at the headcount, yes, we have kept a fairly stable headcount despite growing sales. And we -- it's our ambition to continue at this level, and we should be able to accommodate a little bit more growth within the numbers, continue to gain operating efficiency. And we get that really to -- one part is, of course, being attentive to cost, but it's also the investments we do in automation that's starting to help us.

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Johannes Schaller, Deutsche Bank AG, Research Division - Research Analyst [53]

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Understood. So when you say weigh a bit more for the remainder of the year on legacy, are you implying the effect is maybe getting a little worse on the P&L? Or am I misunderstanding you here?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [54]

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It's not going to get -- I mean, of course, you may see a continuing headwind there. But we're, on the other hand, also seeing good momentum in the growth portfolio. So we're in that transition, and you shouldn't really read much more than -- without that hurting from legacy sales, we would have a better sales development, but it shouldn't really hurt much more than that.

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Operator [55]

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Which is also the last question in the queue, which is over the line of [Rafael Baranari] of [Lesaco].

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Unidentified Analyst, [56]

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I just wanted to be sure about the number of the 5G contracts that you have now. Do you still have 23 and then 15 of them are live? Is that correct? And also could you give -- could you say a few words on France? The regulator just laid out this week the auction process. How many 5G contracts do you hope to have in France? How do you see this looking forward?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [57]

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If you -- I actually think the whole debate about contracts is a very -- it's just -- we don't even announce some of the contracts we have, et cetera, so I think it's starting to be a less relevant number. That's why I think it's much more important to focus on how many do you have live, how many live networks and how do they work in the live networks. And that's what we really target. So for us, we thought it was starting to get a bit funny about the contracts. So we -- I don't really know if it's 23 or if it's a different number right now, to be honest, that we did state publicly. That's what it is. Of course, in France, we're investing for the market there as well, and we have a strong presence. And we are going to continue to serve our French customers as well as we can.

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Unidentified Analyst, [58]

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But for the number of live contracts, so you have 15, 1-5?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [59]

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Yes.

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Operator [60]

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Okay. As that was the final question in today's call, can I please pass it back to you for any closing comments at this stage.

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Peter Nyquist, Telefonaktiebolaget LM Ericsson (publ) - VP & Head of IR [61]

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Well, thank you very much, and we'll hand over for some closing remarks from our CEO, Börje Ekholm, please. Börje?

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E. Börje Ekholm, Telefonaktiebolaget LM Ericsson (publ) - President, CEO & Director [62]

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Okay. So just to wrap up, our strategy is to invest in technology leadership, and we see that to start to come through in an increased competitiveness of our portfolio and growing top line, but also lower cost and improved gross margin. Second quarter, we saw solid growth driven by Networks. Profitability was negatively impacted by strategic contracts and IPR settlement but largely offset by other improvements. We also improved sequentially the profitability or we reduced the loss in Digital Services. And we continue to execute on the plan that we'll achieve low single-digit margins in 2020, and we are confident to get there.

In Managed Services, we continue to invest in AI, machine learning and automation to create an improved margin profile longer term, of course, at some costs today. In Emerging Business, it's our area to basically explore innovations building on our core technology leadership. And here, we have seen good growth during the quarter driven by our profitable iconectiv business. We are a leader in 5G, and we are very confident in reaching our targets for all segments in 2020 as well as 2022.

So with that, thank you, everyone, for listening to the Q2 report.

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Peter Nyquist, Telefonaktiebolaget LM Ericsson (publ) - VP & Head of IR [63]

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Thank you. And we will return then at 2:00 Central European Time, I think it is, and then we will have a shorter presentation and focus on Q&A. So thank you very much, and we'll see some of you at 2:00. Bye-bye.

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Operator [64]

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This now concludes today's session. So thank you all very much for attending, and you can now disconnect.