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Earnings Call Transcript 2018-Q2

[Operator]

Hello, and welcome to Ericsson's Analyst and Media Conference Call for the Second Quarter Report. To view the visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. [Operator Instructions] As a reminder, the replay will be available 1 hour after today's conference.Peter Nyquist will now open the call. Please begin, sir.

[Peter Nyquist, Vice President of Investor Relations]

Thank you, operator, for that great introduction. With me today here at this call, I have our CEO and President, Börje Ekholm; and our CFO, Carl Mellander.During the call, we will make forward-looking statements. These statements are based on our current expectation and certain planning assumption, which are subject to risks and uncertainties. The actual result may differ materially due to factors mentioned in today's press release and discussed in this conference call. We encourage you all to read about these risks and uncertainties in our earnings report as well as in our annual report.So with that said, I would like to hand over the word to you, Börje. So please, Börje.

[Börje E. Ekholm, CEO, President & Director]

Thank you, Peter. Good morning, and welcome to our presentation of the second quarter. As you all know, last year, we defined the new focused strategy in order to turn our company's performance around. It really relied on, I would call, 3 pillars: the first one, to increase investments in R&D to secure technology leadership, to provide leading solutions to our customers, but also leveraging technology to improve our cost competitiveness of our product; to investing in R&D basically to improve our gross margin, and we can see that our ERS platform is very competitive as it is 5G-ready and only requiring a software upgrade to carry 5G traffic; we also needed to obtain a competitive cost position in G&A, but maybe more importantly, in service delivery by simplifying and taking costs out, so again helping us to drive gross margins. And with this improved competitiveness, we would selectively strengthen our market position. So our ambition with the strategy was to establish a satisfactory profitability assuming flat revenues. And basically, we needed to improve our business performance, what we would label a flat or falling market, by controlling what we actually can control, the cost. This will allow us to have a very competitive cost structure. So when we would see growth and we would see market opportunities, we could actually selectively take advantage of them with the strong product portfolio and competitive cost offering. Of course, there's been tons of hard work by everyone in the company. But we're now seeing that all that hard work is paying off with good progress in turning around our performance, and you can see that in the second quarter. I would also say the second quarter shows a very strong business momentum, and we now see Networks returning to growth. So a lot of work remains, but the traction is very good.The targets we established for 2020 at the Capital Markets Day last year was to reach an operating margin of 10%, and we are tracking well towards achieving that target with the strategy execution. We have invested in technology leadership. We have increased our R&D investments. We've hired more than 2,500 engineers. We have also achieved the cost-out objective from last year of the SEK 10 billion run rate by the end of second quarter. It's clear that the work on the cost side kind of never ends, but we will not have any other programs. Instead, it's just going to be part of business as usual.We also are investing in capturing selective market opportunities with our competitiveness, both from a product portfolio point of view as well as cost position. Of course, these type of opportunities have short-term cost, but we're very disciplined and focusing on making sure that it doesn't impact our operating profit.What we see in the market is really strong demand for data traffic. Demand for data basically doubles every 18 to 24 months. And we are seeing now operators investing again in their product offering in order to manage this traffic increase and provide the user with the experience they want. And clearly, we believe technology here is a critical way to solve this, call it, conundrum the operators are facing. And it's in that light we should see the 5G heating up even further. The standard has accelerated more than a year, and operators are increasingly preparing to invest in the network.The first business case for 5G, we believe, will be enhanced, mobile broadband, but we also see interest for fixed wireless access growing as well. And the other trend is that operators are increasingly wanting to install 5G-ready hardware. By doing that, they won't have to rip out any hardware when they launch 5G. And as you all know, our ERS platform is already software upgraded built to carry 5G traffic. So based on the progress and the visibility we see, we feel comfortable that we're on track to achieving our long-term objective of 12% operating margin.Our top line has started to flatten out with a decline of only 1%. The reason for the decline is really the strategic priorities to exit some parts of our business. And we are now seeing Networks returning to growth on the back of a competitive cost structure and competitive portfolio.Gross margin has continued to improve as a result of, primarily, the cost out and the increased ERS penetration. Operating income, still not at a level we want, but it has clearly improved compared to last year as well as the first quarter. Our -- we remain focused on the free cash flow, and that is something that has also improved compared to last year. We are slightly negative, which is primarily a result of the acquisition we made in Emerging Business as well as less sales of receivables in the quarter.Overall, turn to next slide, overall, we have achieved savings in excess of our target of SEK 10 billion per -- or run rate by the end of second quarter. The full effect of the actions will not be fully visible in the P&L until the second half of this year. We have achieved structural savings or run rate savings in G&A of SEK 2.7 billion at the end of the second quarter, and that's now visible in the P&L. In service delivery, we have reduced cost in excess of SEK 8 billion run rate. We see this in improving gross margin in all segments, for a total uplift of about 300 basis points in gross margin during the second quarter. So while we have achieved the SEK 10 billion target, we continue to work on our efficiency, and we estimate restructuring cost still of SEK 5 billion to SEK 7 billion for the full year even though we just used SEK 3.1 billion in the first half.On the cost side, our service delivery was not cost competitive. But following changes in ways of working and overall in simplification and delayering, we have now a much more competitive cost position. Unfortunately, this has led to a reduction in workforce by a net of 20,500, and that's after we increased our R&D of 2,500, so the gross reduction is 23,000. This has, of course, put a lot of stress on the organization, and it's a lot of hard work that have gone in here. But I would also say that the hard part is not necessarily to take the cost out, it's actually to do it while protecting the top line. And I must say here, we can see that the company has proven our ability to execute on that.And of course, we focus on the total workforce. That is really what drives the cost structure. We see a further reduction in the total workforce in the second quarter, and that's despite that we see some increases following new contracts we have taken during the quarter. So I would say, overall, we are at a much more competitive cost structure than we were a year ago.If we look at the market areas, we see good growth in North America as customers are gearing up to prepare for 5G. We see falling LTE investments in China that has impacted Northeast Asia market area. In Europe, we see good growth. It's offset by some declines in certain markets as well as exited contracts. Middle East and Africa had a slight decline due to some countries with monetary restrictions, as well as Southeast Asia where it's more related to timing of contracts.We continue to execute on our focused strategy, putting us comfortably on track towards the targets for 2020. In Networks, we see penetration of ERS continue to increase and is now 84%. We have also taken out significant cost in service delivery. And we have increased our investments in R&D to strengthen our cost position in 4G, but also prepare for 5G.Losses are reduced in Digital Services, but we clearly have more to do. We have seen cost efficiency gains in service delivery, but we're also changing our ways of working in R&D, resulting in some improvements in R&D spend. In parallel, we're increasing our investments in 5G-ready and cloud-native product. Managed Services achieved the second quarter of positive operating income. This is on the back of cost-out, but also contract reviews. There are some one-time positive effects in the second quarter, but we see a much more competitive offering. Our investments in automation and machine learning are increasing, and we are getting some selective customer wins in that market area -- or business area.In our other business, operating income is still negatively affected by the Media business of about SEK 400 million. We continue to invest in selected new opportunities in areas like IoT where we see good growth, but revenues are not yet covering the cost, but we see a very strong customer traction and a good interest in the -- or growth here.With that, I'm giving the word over to Carl.

[Carl Mellander]

Thank you, Börje, and good morning, good afternoon, everyone. And let's look at the financial performance then per segment to start with, and we can start here with Networks. And as we heard also from Börje, Networks is back to growth, reaching now SEK 32.4 billion of sales in the quarter based on the competitive ERS portfolio. And a year ago, we started to increase investments here in technology leadership, an area where we see the fruit of that here in the radio portfolio, not only in gross margin, but also in growth in Networks. So the growth was accompanied here by a significantly improved margin as well, and the gross margin at 40.2% is a good result in the quarter. We see, of course, as Börje mentioned, the strong momentum in North America driving this with the service providers gearing up for 5G. Then summary, on Networks, good market traction competitiveness and growth returning for the first time here since Q4 2015, with a strong margin improvement as well.Digital Services has improved the margin substantially, still reporting a loss of SEK 1.5 billion, but the direction is the right one. It's improving since earlier, which is encouraging to see. I'd like to mention here that the proportion of large transformation contracts actually increased in the quarter versus Q1, as anticipated and as we said in connection with the Q1 report also, and this weighs on the margin. But this was, on the other hand, offset then by further cost reductions, but also stronger software margins.And the top line decrease you see here in Digital Services is really due to a continued decline in the legacy portfolio. And the new portfolio also declined this quarter, but that is actually largely explained by a specific delay in Telecom Core in Northeast Asia against the tough comparison in Q2 2017. So again, we are encouraged by the improvement here, of course, in the margin. And so far, still a lot of work to do to reach a sustainable profit level and moving towards the 2020 target of low single-digit profits.Managed Services, also here, we follow the strategic path that we set up -- set out earlier, namely working through the nonstrategic contracts, the 42 identified contracts, and 33 of them are now done, reducing cost, which is going well, and also staying disciplined when it comes to new contracts. And we see the impact of this strategy execution in the margins here in the second quarter. And noteworthy also that we delivered positive operating income for the second consecutive quarter in Managed Services.We have a very strong gross margin here at 14% this quarter, but I should also mention and point out that, that was helped by certain one-offs here at around SEK 0.1 billion. We were also announcing last week the divestment of the field services in Sweden. And of course, glad to see that this business now will have a new good owner that can develop this business further, and this is also another sign of our strategy execution in this area.Looking at Emerging Business and Other, and I'd maybe just start to comment around the various parts here. We have one part, iconectiv, where the North America number portability contract has now started, and that is contributing then both to top and bottom line. In Emerging Business, we invest in future growth areas, such as Internet of Things. One example there, we recently announced the contract with China Mobile for the device connectivity platform. And here, of course, it's about making disciplined investment decisions based on achievements made in the various parts of the portfolio there and follow that with a great amount of discipline while building new growth areas.And then within Media, we have, as you know, 2 assets: one, Media Solutions, which is now rebranded MediaKind. Full-speed ahead now in the quarter towards closing of the transaction with one equity partner in Q3. And meanwhile, gross margins have improved, continue to improve, both in MediaKind and also in Red Bee Media, which is the other media set which we have, as you know, decided to keep in Ericsson. And I would say, that announcement to remain with Red Bee Media has created more comfort now with customers to entrust us their business. And we have some promising signs here, among other things, with our managed OTT platform. So all in all, as Börje said, SEK 0.4 billion of the operating income, loss here of SEK 1.2 billion is related to the Media portfolio.Moving to gross margin. As you can see here, we do have improvements in gross margin in all the segments, and it's mainly driven by structural improvements. And the market mix has an impact as well, but again, the main driver here is of structural nature in terms of cost out. That's about half of the improvement we see, 300 basis points or so, and then another 200 basis points comes from the ERS ramp-up with an improved cost situation there. And then we have another 100 basis points coming from other items, including Managed Services improvements then from the contract reviews that we are conducting. Sequentially, the improvement comes mainly from Managed Services as the Networks and Digital Services were stable sequentially in gross margin.Next -- actually, let's jump to the next one, please, which is the R&D and SG&A bridges here. R&D follows the same pattern as earlier. We have certain negative impacts from capitalized R&D. But more importantly, we are investing, as we all know then, in the Networks and reducing some in Digital Services. But that -- and net-net, we are increasing our investment in R&D. And when it comes to SG&A, we record cost reductions now in the quarter of SEK 0.7 billion. That comes from the SEK 10 billion program then, and that means a run rate, as Börje mentioned, of SEK 2.7 billion on an annualized basis. In this quarter, though, this was offset by a couple of things. One is reevaluation of customer financing, around SEK 200 million, and some other items which also includes additional provisions for our variable compensation scheme.And what is not shown on this picture but worth noting also is the third line now in OpEx, which comes through IFRS 9, and that is related to impairment of trade receivables. And this line was a negative SEK 0.4 billion in the second quarter versus SEK 0.2 billion in Q2 2017.Now I can go to the operating income slide here. And with all the improvements I talked about now, we delivered a 4% operating margin. Perhaps the more relevant question here is what will it take us to move towards the 10% operating margin target for 2020 and then to 12% beyond 2020? And of course, many improvements to be done across the business, but to mention a few of them, of course, continued razor-sharp and relentless cost focus for competitiveness; the continuation of the turnaround of Digital Services; and then a continued, of course, investment in technology leadership because that's really where we create competitiveness and advance our position in the market.Cash flow was improved year-over-year, fueled by mainly by working capital improvements. This is really about shortening lead times and being more efficient in our delivery to customers. Year-to-date then, the free cash flow was minus SEK 0.3 billion, and we can compare that with minus SEK 4.6 billion at the same period last year, so in other words, strongly improved. And then on the financial position, it remains strong. We have a solid cash position at SEK 33 billion net cash and SEK 67 billion -- close to SEK 67 billion gross cash at the end of the period. We signed a 5-year related loan with the European Investment Bank in the quarter. I can mention that again, we announced that earlier. This is a 5-year maturity, and we have not drawn down on that loan yet. So once that is done, partly to refinance future maturities, that will further extend the maturity profile here. And all of this, of course, contributes to the financial strength and resilience of the company.We present here a number of other financial items, and I will actually not walk through this slide now in the interest of time, but we wanted to include this for your later reference. And as you can see here, it contains info which is relevant for the quarter regarding impairment losses, financial net, taxes, pensions and restate that we have done between the segments in the quarter as well.Finally, the planning assumptions here, I'd like to refer you to the actual report where this is detailed. There are no major changes here since last quarter. There's only one piece of news here, actually, and that's the admin cost related to the Media Solutions' carve-out in that transaction, and it's estimated at SEK 0.3 billion to impact us in the third quarter.So with that, thank you. And back to you, Börje.

[Börje E. Ekholm, CEO, President & Director]

Thanks, Carl. So in closing, we set out a focused strategy last year. The objective, as said before, was to turn the company around on a flat revenue base, i.e., not hoping for revenue growth to help us out. So we will do that turnaround by investing in R&D to have a competitive portfolio and significantly taking cost out in service delivery and G&A. And we are now starting to see this strategy generating results, with a good improvement in gross margin that indicates a competitive product offering and competitive cost position.So we are now adding a second quarter with improved performance. We're not there yet, but we will continue to execute on the strategy, investing in technology leadership, but at the same time, keeping a tight cost control. And we also know that when we have a competitive offering and we have a competitive cost profile, we can actually capitalize on market opportunities. And we see strong momentum in our business discussions with our customers, and we have already seen Networks returning to growth.We see also that operators are increasingly needing to invest in new technology to cope with the growing traffic, providing us with opportunities. And we also see here the 5G discussion increasingly gaining momentum around the world, led by developments in North America as well as in Asia. So we will use our strong product portfolio as well as competitive cost position to selectively grab new opportunities while maintaining a financial discipline.So with that, thank you for listening in.

[Peter Nyquist, Vice President of Investor Relations]

Okay, thank you, Börje. So operator, we are now prepared and ready for the Q&A session.

[Operator]

[Operator Instructions] Detailed information is provided in the report, and Ericsson's Investor Relations and Media Relations teams will be happy to take additional questions and discuss further details with you after this call. So we go to the first question, which is from the line of Pierre Ferragu at New Street Research.

[Peter Nyquist, Vice President of Investor Relations]

Pierre, are you there?

[Operator]

You might want to unmute your line, please.

[Peter Nyquist, Vice President of Investor Relations]

Right, yes.

[Pierre C. Ferragu, Global Team Head of Technology Infrastructure]

Okay, apologies, I was muted, indeed. I was wondering about...[Technical Difficulty]

[Peter Nyquist, Vice President of Investor Relations]

I think this is Pierre.

[Operator]

Yes, I think he may have pushed the wrong button. So we'll go on to the next one, which is Sandeep Deshpande at JPMorgan.

[Sandeep Sudhir Deshpande, Research Analyst]

My 2 questions are, firstly, on the restructuring cost. I mean, you've spent SEK 3.1 billion in the first half, and you've said that the cost-cutting program is over. So can we understand where now the rest of the money is going to be spent on because there's quite a lot of -- SEK 5 billion to SEK 7 billion is the guidance, so there's almost half of which, which is not spent for the rest of the year. So I mean, to be spending that much when the ongoing restructuring program is over seems quite excessive. So can we understand where this money is going to be spent? Secondly, in terms of your earnings itself, the earnings improvement that you have seen, I mean, in North America, would you be able -- sorry, not earnings, I mean sales improvement. I mean, in North America, could you quantify how much of an impact you're seeing from 5G?

[Börje E. Ekholm, CEO, President & Director]

Okay. If we take on the restructuring cost, what I think we're trying to say is that we have reached the SEK 10 billion. We still see opportunities to improve our cost position, and that's why we're going to pursue those opportunities and will be associated with some restructuring costs. And that's why we maintain the guidance on restructuring cost for the year. So this includes -- of course, it will include workforce-related cost, but it's also other type of restructurings, like in real estate contracts, et cetera. So there are a number of areas where we can further realize savings, and we think it's financially attractive to do so. On the sales, so far, we should really say that, of our sales, of course, our ERS is actually 5G-ready, so it's in a way already a software upgrade away from carrying 5G traffic. And that is, as you have seen, 84% of sales. So in that sense, yes, 5G is important. But from an aspect of commercial 5G revenues, it's very limited.

[Sandeep Sudhir Deshpande, Research Analyst]

Sorry, let me understand. With regards to 5G, you're talking about it's mostly ERS, which is 5G upgradable. But have you actually begun selling those 5G upgrades to the ERS? Because you will probably charge for that software [ come ] hardware card that goes in. And has that started that rollout of those 5G line cards as well as the software started, or is it still to happen? And I mean, are we talking only of wireless here? Or are we talking about fixed mobile -- fixed access as well which is where you are exposed?

[Börje E. Ekholm, CEO, President & Director]

The reality is we have commitments on our product portfolio that we will not discuss in detail. This includes that. So what you know in North America is the discussion has been the first use cases, and now this is a general comment, has been around fixed wireless access. But where exactly launches will be, we will not disclose.

[Operator]

We've gone to Andrew Gardiner at Barclays.

[Andrew Michael Gardiner, Director]

I had one on the sort of on the market, in particular, the impact of sanctions or potentially lack thereof on ZTE. It was just starting at the time that we had the first quarter results. And clearly, it was too early for you guys to comment at that point. But now we can see that you've won a particular deal back in Italy. I was just interested in the conversations you've been having with customers and how you think these sanctions or the threat of sanctions may play out as we look to future contracts.

[Börje E. Ekholm, CEO, President & Director]

It's very hard to speculate about that. What we have done and our focus is really on the things we can control, which is our offering. That's why we continue to invest in R&D for technology leadership and show innovative solutions to our customers' problems. That's what we do. That's what we're going to compete with. Then we can say that, of course, the uncertainty that some of the operators have faced following the sanctions clearly raises the topic, how will they deal with that uncertainty. How that's going to pan out is way too early to discuss. But yes, we did win a deal in Italy. But I think we do that based on a competitive product portfolio, not on anything else. So we're going to continue to focus on that.

[Andrew Michael Gardiner, Director]

Okay. And if I could, just a follow-up on some of the comments you were making on 5G. So the increased activity, particularly in the U.S., would you say that, that -- the increase in activity is in line with what you had been anticipating as we move towards the active field trials and commercial adoption? Or is it perhaps increasing more quickly than you anticipated? And of course, thinking forward for your guidance, you haven't changed your market CAGR. And I realize it is early, but I'm just wondering whether you think the increased activity is either upside in terms of the overall market or is it your portfolio that is resonating better with customers?

[Börje E. Ekholm, CEO, President & Director]

What we -- I mean, I think it's fair to say that 5G has been dramatically accelerated over the past 18 to 24 months. And we have really seen the -- even the standards have been accelerated by 12 months, which is a pretty phenomenal achievement. So you have -- you are seeing a very strong momentum for 5G. And your question is well taken in that sense, yes, it is stronger than also we anticipated just 6 to 9 months ago. So the discussions we are having with customers is much more active now than we anticipated. If we look at -- it's very hard to judge the overall market. We focus on our business, but of course, we're seeing more traction with our customer discussions than the overall, call it, the external market report seems to indicate. And so we're very excited about the prospects of our portfolio and our cost position. So we look very positively to the future.

[Operator]

That is over to Johanna Ahlqvist, SEB.

[Johanna Ahlqvist, Analyst]

And I'm just wondering on -- sort of 2 questions, if I may. First, on cost savings in general. You mentioned that -- how much really -- my question is how much of the SEK 10 billion cost savings are visible in numbers now in Q2 and how much is sort of expected in the second half in addition? And my second question is related to OpEx in particular. How -- I mean, previously, you mentioned about [ SEK 60 billion ] on OpEx for the full year, some sort of range, and I guess you will end up a bit higher than that. So if you just can comment on that, it would be helpful.

[Carl Mellander]

Johanna, Carl here. Regarding how much of the cost savings are visible in the quarter, on SG&A, it's SEK 0.7 billion, translated then into a run rate of SEK 2.7 billion to be precise then. And cost of sales is around SEK 2 billion, a bit more. And so you can say from the start of the program, SEK 9 billion out of the SEK 10 billion is visible in the P&L. When it comes to OpEx guidance, we rather not do that. The entire strategy here is built on investing in R&D to generate a better return, better gross margin. And the OpEx may vary over quarters with seasonality and so on as well. So we refrain from putting a number out there on OpEx.

[Operator]

We are now over to the line of Fredrik Lithell at Danske Bank.

[Fredrik Lithell, Senior Analyst]

On Digital Services, in Q1, you had a very strong gross margin. You talked a lot about that you had a very favorable project mix in that quarter and that it would probably not repeat. It looks like it did repeat. So could you sort of talk a little bit about how the mix is in revenue recognition? How much of loss-making projects you still have that will be recognized and if we should assume sort of that this is sort of the run rate and that it will improve given that, for example, the big Veon contract is coming to an end towards the second half of this year?

[Börje E. Ekholm, CEO, President & Director]

I can start, Fredrik. When it comes to the mix in the quarter, as we said back then in Q1, the proportion of these transformation contracts was actually higher now in Q2, so that is -- that had an impact negatively on the margin. But it was compensated by better software margins and cost-out. So yes, it had a bigger proportion in the overall numbers. When it comes to the future, I mean, what we are so focused on is really the 2020 delivery of profitability in Digital Services to get to at least low single-digit margins. And individual quarters, I want to say, it can vary, of course, so it might not or will not be a straight line. But yes, so that's in essence where we're going. We're focused on the 2020 number.

[Operator]

That is over to the line of Jörgen Wetterberg at Nordea Markets.

[Jörgen Wetterberg, Senior Analyst of Telecom and IT]

So I have a quick question on Digital Services. You cite that you see strong demand for 5G-ready and cloud products. Could you shed a little bit of light around whether you see strong margin accretion for that and also which flagship products that you've talked about before during the Capital Markets Day that you see the strongest demand for?

[Börje E. Ekholm, CEO, President & Director]

In short, we see that the operators are -- they're increasingly preparing the network with virtualization. So we see that. And they basically depend on having programmable networks. So we see basically very good demand in the Packet Core. We see good demand in OSS. We see actually quite good demand in IMS as well. This is -- with our strategy, this is going to be converted more into software sales. We've been service-heavy before. And as you know, we are trying to pre-integrate solutions more to provide to our customers. So this should translate into better gross margins, and that's a little bit what you're seeing here in the second quarter. But of course, more work needs to be done to fully turn the performance around.

[Operator]

That is over to the line of Aleksander Peterc at Societe Generale.

[Aleksander Peterc, Equity Analyst]

I will just have 2 points that I'd like to clarify. First one is you seem to agree that there has been some acceleration in 5G plans of operators, particularly in the U.S. And I'd just like to know if there are any financial implications to this, such as higher trial costs, and maybe that's somewhat embedded in your higher R&D expenses here. And also, will we see any high revenue in H2 as those rollouts start to have an impact in the U.S.? That was on 5G. And the second question is a more general level around margins. Your flagship cost-cutting program is now completed, but the ERS is now at 84%, so that's basically ticked, done. Your margin is at 4%. So I'd like to know what will drive it to 10%, which is your objective 2020? Is it going to be the additional restructuring? If that's the case, could you tell us what you are planning to do with that restructuring in terms of OpEx cuts and gross margin improvement? Or is it further benefits of contract exits and renegotiations of contracts in Digital Services and Managed Services? Or is it just economies of scale as you start to grow again? Any clarity on that will be much appreciated.

[Börje E. Ekholm, CEO, President & Director]

If we take the first one then on 5G, we are already carrying quite substantial costs for trials as well as R&D. These could well increase as we go forward, but it's -- we're going to be disciplined and manage them with a tight focus on bottom line. So that doesn't change. We haven't disclosed how much we have as additional cost, and we don't intend to do it. It's embedded in the numbers already. We don't guide for the second half of the year, so we'll not do that now either. You have the planning assumptions, and I think you have to judge from that. The reality is we see very good customer engagement, and we see the importance for many customers of launching 5G. So we intend to capture a good part of that, but that is something that will come out during the second half of the year and into '19. And then if you look at the profit improvement for the goal, I would -- when we -- I think the key here, and I will let Carl go into more of the details. But when we set out our objective of a 10% operating margin in 2020, we said that we would achieve that with a flat revenue base. And that's -- so we didn't want to put the plans on hold for growth because that wouldn't allow us to put enough focus on the cost structure. So really, what you should see on the improvements, it's actually that ERS will continue to -- even if it's high now, it's still a lot more to go. We will see growing penetration of that. We will see additional cost-out as well as transformation of the business model in Digital Services to turn that around. And we will see improvements in Emerging Business and Others as [indiscernible] we way invest for growth and we get the growth, or we're also going to see us leave the Media segment. But maybe Carl can go into more on details on that.

[Carl Mellander]

I think you captured the highlights very well, Börje. I mean, those are the key items to drive it from where we are now up to the 10% and then later 12%. So nothing to add, I think you captured it.

[Börje E. Ekholm, CEO, President & Director]

Yes. So we should really see growth should just help us. We won't -- we work on what we can control, costs.

[Operator]

Well, that is over to Handelsbanken and Daniel Djurberg.

[Daniel Djurberg, Research Analyst]

My question is back actually to Digital Services, the solid gross margin despite the transformation project [ due to software is down ]. You added 8 contracts, totaling 16, that you have been addressing. Can you just comment on the terms a little bit? Are you satisfied with the negotiation? And will this impact already in the second half of the additional 8? Or can you just help us out a little bit on how your negotiation [ is progressing ]?

[Börje E. Ekholm, CEO, President & Director]

Basically, so those contracts are concluded, majority are concluded, so there will be a certain impact. As you know, there are different categories here. One part is what we call the strategic or critical projects and the large transformation contracts, and that is really about honoring the commitments we have, but run the projects in a good disciplined way. The other category is really exiting from what we used to call industry and society type of contracts, and this is what we see now. So this will have an impact, and we see certain impact from that already, and we expect to close half of this during the year.

[Daniel Djurberg, Research Analyst]

Perfect. And out of the 16, how many is related to the 34 strategic ones?

[Börje E. Ekholm, CEO, President & Director]

That number, we haven't broken that down actually, Daniel.

[Operator]

And that is over to the line of Achal Sultania at Crédit Suisse.

[Achal Sultania, Director]

Just a question on 5G again. You talked about North America. Obviously, things are moving at a much faster pace there. Can you talk about other regions, maybe Japan, Korea, what you're seeing in terms of 5G adoption there? How much behind they are versus the U.S., is it 6 months, 12 months? And can we expect any kind of benefit from those regions as we go into second half of this year, or is it more 2019? And then also maybe a question on -- what are you seeing from your operators in China about 5G, given that this implication, this ZTE ban? Is it going to slightly derail their ambitions for 5G, postpone it until we get more clarity on this issue between U.S. and China? Any color on that would be helpful.

[Börje E. Ekholm, CEO, President & Director]

We get a lot of focus on 5G in North America, so I think that almost becomes [ sort of one-eyed ]. We see very good engagement in many other markets. So we see Northeast Asia, a lot of discussions about leadership in 5G, and we will see early deployment there. We see in Australia, we see in the Middle East, we even see some in Europe. So the interest, maybe a little bit spearheaded, but we should not neglect the rest of the world. So we see it's a very different tone in the 5G discussions now than it was 6 months ago, including here in Europe. So how that is going to pan out and exactly how that's going to look like, I think it remains to be seen. But I do not think we should think this is only a U.S. or North American opportunity. It's much more global. Then on your, yes, China ZTE. I think China and the Chinese operators have an ambition to roll out 5G. There are time plans for that. How that's going to be impacted by the current issues is, I think, uncertain. And we will have to see how that happens.

[Operator]

It's over to the line of Johannes Schaller at Deutsche Bank.

[Johannes Schaller, Research Analyst]

Just maybe coming back to the mix. I mean, you had a bit of a distorted mix in Q4 in Networks on the negative side and a bit in Q1 in Digital Services on the positive side. Would you say that in both divisions that the product mix in Q2 is fairly normal? Or is there anything we should be aware of that is maybe distorting it this time? And then maybe as a second question, just as you have more of these discussions with North American operators around 5G, how do you see the market structure, and particularly market share, from your perspective shaping up? Do you think you can actually expand your market share somewhat with the strong product portfolio you have in North America?

[Carl Mellander]

Shall I take the first one, Börje? Then when it comes to the mix within the segment, Johannes, there is nothing standing out, nothing unusual in the mix, I would say. But again, especially in Digital Services, it can vary between quarters. You have to keep that in mind when it comes to the large projects. But there is nothing out of the ordinary in Q2.

[Johannes Schaller, Research Analyst]

So the large projects' contribution is fairly normal, you would say, this quarter?

[Carl Mellander]

Yes.

[Börje E. Ekholm, CEO, President & Director]

Yes, market share in North America, the -- I think we always like to talk about our own products and our own business. Then we're going to be very competitive, and hopefully, that translates into market share. And those are typically published afterwards, so we will see. But we've had a very good development in North America, as you can see, on top line.

[Operator]

That is to the line of [ Wanke Limushiper ] at [ Kopali Business Daily ].

[Unknown Analyst]

How do you see your position to 5G rollouts over your rivals, Nokia and Huawei?

[Börje E. Ekholm, CEO, President & Director]

I missed the first part of your question. Can you repeat that?

[Unknown Analyst]

Okay. So how do you see your position to 5G rollouts over your rivals, Nokia and Huawei?

[Börje E. Ekholm, CEO, President & Director]

As I said, we focus on really our own product portfolio and the competitiveness of our own portfolio. That's the thing we can impact, and we're having very good customer engagements and very good discussions and business momentum in the interaction with customers. That then I think the other companies, they have to pursue their strategies, and we don't comment on that.

[Operator]

And that is UBS and the line of David Mulholland.

[David Terence Mulholland, Director and Equity Research Analyst]

Just 2 quick questions. Firstly, as you start to look towards more of a ramp towards 5G, I just wonder if you could comment on how you see in terms of supply chain readiness. To be able to cope with potential increased volumes again? And then secondly, obviously, there's been increased R&D spending in Networks this -- the last 12 months. Can you just comment a little bit on whether there's been any change in your mindset on what you need from a product perspective? And maybe to put a little wider context to it on how you feel about relationships with the likes of Cisco and whether there's any progress on what we should expect from that going forward.

[Börje E. Ekholm, CEO, President & Director]

Yes, what we see -- I mean, we see -- put it this way, our existing hardware is already 5G-ready. So in reality, we're shipping the hardware that's going to be the same as we enter into 5G. There will be a little bit different frequency bands, different radios, et cetera. But the reality is the supply chain, it has very little impact [ per se ] from 5G. We are, as you can understand with the sales development in Networks, actually seeing a ramp in production and being ready to supply. So this is always a challenge when you get that rapid ramp. But I would say, we're coping with that well. On Cisco, we continue to work with them. The reality is we've said that the objectives set out, we probably will not achieve or we will not achieve. But we're working as resellers, and we're, of course, exploring other opportunities to collaborate.

[Peter Nyquist, Vice President of Investor Relations]

David, are you fine with that?

[David Terence Mulholland, Director and Equity Research Analyst]

Yes. I was just kind of wondering whether there's been any -- whether you're comfortable with the kind of product positioning you have in the context of moving towards the -- this year has obviously been about the new radio standards for 5G, and next year is the full kind of new transport network as well. So I just wondered how you feel about your product readiness as we head towards that second evolution of 5G as such.

[Börje E. Ekholm, CEO, President & Director]

No, we feel very comfortable about our competitive portfolio. We have invested in the radio, and we have invested in the 5G core. So of course, both of these are giving us an end-to-end offering. That's really critical for us. We're moving forward with a high pace. That's why it drives a certain amount of R&D investment, but we see this to be a very attractive revenue opportunity that we are going to capture.

[Peter Nyquist, Vice President of Investor Relations]

Operator, we are now ready for the last question of this session. And for you who haven't been able to ask a question, there is a call at 2:00 as well.

[Operator]

The final question in today's call is from the line of Janardan Menon at Liberum Capital.

[Janardan Nedyam Menon, Technology Analyst]

I've got 2 questions. One is again on Digital Services. Can you give us a split for how you stand right now on the legacy products, which is and perhaps on the services side versus the new software products? And how are you seeing the traction on the software products coming through right now? You talked about a delay in Telecom Core sales in North Asia. Is that just a customer issue? Are your products already ready? And are you seeing a sort of broadening demand for those products, which could tilt that mix more towards software in coming quarters? And my second question is, there has been quite a bit of talk about you taking market share in a few contracts even in the second half of last year, and you yourselves have talked about it previously. Is any of the strength that we've seen in your sales levels in Q1 and Q2 a reflection of that? In your opinion, are you outgrowing the market right now, do you think? Or is what you're seeing pretty much in line with market trends?

[Carl Mellander]

Okay, Carl here. I can take the first one. When it comes to the split of the portfolio in Digital Services, I would say around 40% of sales relate to the legacy portfolio. And yes, if you go back a little bit to 2016, it was around 50%, you could say. Then what we talked about here was a specific delay. It's not a delay on the product side. It's more a contract timing issue with a particular customer, and we expect that to come in going forward. It happened in Q2 last year, and we expect it to come in the second half of the year, this year then. So that's about that. And maybe, Börje, you -- on the market side.

[Börje E. Ekholm, CEO, President & Director]

On the market, yes, the -- as we said, we did take a couple of wins late last year. We have taken a number more that may not always have been disclosed. So we feel quite good in the customer momentum, and that's what you've seen in actually Networks coming back to slight growth. It's low, it's 2%, but it's still growing. What the market shares are ultimately going to be, I think we have to wait for the market data. But I would also say that the -- in the engagements we have, we have very good traction.

[Peter Nyquist, Vice President of Investor Relations]

Okay. Thank you, Janardan. Are you happy with that? I guess so. Before we end, I guess, Börje, a closing remark from your side?

[Börje E. Ekholm, CEO, President & Director]

So in short, last year, we set out on a new focused strategy, and the objective was to turn the company around. We are very -- it's satisfactory to see that the strategy is generating the result. We see that the increased investment in R&D gives us a very competitive product portfolio, and that is in combination with taking costs out in service delivery, and general -- and G&A has allowed us to be also cost competitive. So we see good momentum with customers, a very strong momentum with customers, both on the 4G portfolio as well as on the 5G discussions. So we feel that with the strategy in place and with the execution we've shown to date, we're in good position and feel very comfortable about the objective for 2020 of achieving a 10% operating margin as well as a 12% operating margin long term.So with that, thank you.

[Peter Nyquist, Vice President of Investor Relations]

Thank you.

[Operator]

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