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Telefonaktiebolaget LM Ericsson (NASDAQ: ERIC)
Q2 2019 Earnings Call
July 17, 2019, 8:00 a.m. ET

Thank you. Hello, and welcome to Ericsson’s Analyst and Media Call for their second quarter report. To view visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. Ladies and gentlemen, when you’d like to ask a question, please press 0 and then 1 on your pushbutton phone. If you’d like to decline from the polling process, then just press 0 and then 2. And as a reminder, replay will be available one hour after today’s call. Peter Nyquist will now open the call. Please begin, sir.

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Thank you, operator. And everybody welcome to the second call for the day for the Q2 report. With me here in the room, I have our President and CEO, Börje Ekholm, and our CFO, Carl Mellander. Before reading the statement, I just want to say that we have shortened this and have — on the few slides that we present, and spend more of the time on the Q&A. But before that, I will read this statement.

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 result may differ materially due to factor 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 call, as well as in our annual report. With that said, I would like to hand over the word to you, Börje. So, please, Börje.

Thank you, Mr. Nyquist, and welcome to this second quarter presentation that shows another quarter of stable development and, on our turnaround plan, putting us well under way of reaching the targets in all segments by — that we have set for 2020 and 2022.

5G is gaining momentum around the world, and it’s now launched in four continents. And we’re starting to see some very good pickup and good interest from consumers as well. And we see some operators realizing a price premium for their premium services that 5G can give. Our strategy, our focused strategy, builds upon achieving technology leadership and we’re starting to see that the increased investments we have made in technology leadership coming to fruition in increased competitiveness as well as improved gross margin. Today, we have a very competitive portfolio across radio and core. As you know, our priority is to work with lead customers in lead markets, and this has allowed us now to launch commercial services in mid band as well as in millimeter waves. And today, we are providing solutions to two-thirds of all commercially launched networks, and we’re moving out from the face of being first, and being fast on paper, into becoming leading in peak performance. And here, we see we are making good progress.

We see today — also, in all ongoing engagements with customers, we see 5G featuring very prominently. And this has changed just from a few quarters ago. It is also clear that the first use case for 5G will be enhanced mobile broadband, or is enhanced mobile broadband. But the real potential over time will be enterprise driven use cases, where we build the leverage, the capabilities, 5G can give in terms of high-speed, low latency, low batter consumption, many connections per service units, etc. That will create all of those new use cases. We see sales growing organically by 7%, driven by networks in North America and Northeast Asia. And that’s, of course, the market that first launched 5G.

Cash flow was SEK 2.2 billion in the second quarter, and that’s after absorbing a large conversion of provisions to cash. The last few years, actually, Q2 has been negative free cash flow, so it is a bit of a milestone to also have a positive cash flow in Q2. Our strategy builds upon being technology leader so we continue to invest in our five-year portfolio, both in radio, but also in the cloud native core portfolio of digital services. But in addition, we are increasing our investments in R&D and managed services in order to fundamentally change the — or improve the margin profile of the business.

So, if we quickly look at the numbers, we see — or the reported sales was up 10%, and organic was up 7%. Operating margin increased year-over-year, but was flat sequentially when you adjust for the one-time revenue during Q1. Networks had good growth of 11%, driven by 5G traction and strategic contract. Of course, a portion of the — and we should remember, the strategic contracts we take because they — but they have a bit of a margin hit upfront. But strengthen our competitive position and are totally value creative during the contract life, but hurt us initially. We have a number of those that are visible in the gross margin to a limited effect in second quarter. But we also have a large settlement on process that is also impacting gross margin in the second quarter.

Digital services is executing on the plan to reach single-digit margins for 2020. Losses are falling sequentially. And, as we have said before, we should not expect the improvements to be linear. But we see good traction in the turnaround and costs are coming out as planned. Gross margin fell year-over-year due to product leaks as well as legacy portfolio. And with product leaks, it’s lower software sales in the second quarter than last year.

We are, though, seeing a number of positive signs. For example, our cloud native offerings are gaining momentum. And we see that our new BSS strategies also are gaining traction with customers, where we see several new customers as well as renewed engagement with existing customers. So, overall, we see that digital services is progressing well toward low single-digit margins next year. Managed services had flat sales if you adjust for the plan content exits. Gross margin declined due to timing between quarters and costs, basically. And here, we are taking some short-term cost as we increase R&D investments in order to drive our operations, and that builds upon automation and AI.

Emerging business is our area where we invest for new innovative solutions. And results here improved, driven by our profitable AI connected business. And, as I said, free cash flow is SEK 2.2 billion after having had SEK 3.7 billion in cash outplaced for provisions and restructuring.

The next. We have gotten quite a lot of questions about the gross margin development, and as you can see from this graph that we have a sequential decline in gross margin, which is — when you look quarter-over-quarter, the decrease is really due to a couple of reasons. One is, of course, that we had larger than usual IPR revenues during the first quarter, which helped gross margin and gave a boost on gross margin while we, in the second quarter, have a large IPR settlement. Of course, putting pressure on gross margin in Q2 — and then, we have some other effect on a little bit lower software portion in digital services and some timing on cost and managed services.

But if we leave that bit outside and jump to the next slide, which is focusing on the movement in networks. So, if we look at the Q1 gross margin, it was 43.2%. What we have here is an unseasonably large IPR revenues in Q1, which of course then — can relate a bit to some old — catch-up payments on old contracts. And that — if you remove that, you get to an adjusted Q1 margin — given that we haven’t given the detailed numbers here, we can look at the size of the bars and estimate them. But there are not — they are not populated with numbers. But — and that is actually due to the — I’ll go back to that later.

But the adjusted Q1 margin then comes back a little bit lower. If you look at Q2, it is reported 41.4%. We have a license settlement, basically a patent dispute, that we sent them, which hurt the short-term margins. So, if you look there — if you would put them in numbers, just to give you a size comparison, the license settlement — it’s about 1%. And the — so, it would be about 42.4%. And the IPR revenue down Q1 to Q2 is about 0.6%. So, if you are to look at the underlying change in gross margin, it’s about 0.2%. And that 0.2% is actually impacted those strategic contracts and operating leverage.

So, what we’re trying to say here is we used part of the operating leverage to invest in the strategic contracts. And the strategic contract will be somewhat more during the second half than during Q2. But we don’t see a diminished operating leverage. So, the whole notion here is we will manage the overall P&L statement, but we are going to have some of these one-time effects on IPR revenues that will vary by quarter. And of course, it’s very hard for us to predict when we have a license settlement, to be honest — on either revenue side or outflow slide. But that’s why you see the underlying gross margin quarter-over-quarter, shows a very little and very small delta, about 0.2%. Okay?

Peter NyquistVice President & Head of Investor Relations

Okay. Good. We’ll stop there for a while and then we can come back to closing remark from Börje later on.

But now, I’d like to hand over to the operator again, and for questions and answers. So, please, operator.

Questions and Answers:

Operator

Thank you. So, ladies and gentlemen, if you wish to ask a question and you haven’t already, just press 0 and then 1 on your phone keypad now in order to enter the queue. And then, after I announce you, just ask that question. And if you find that question has been answered before it’s your turn to speak, just press 0 and then 2 to cancel. And, as always, please limit yourself to one question at a time, and please keep your questions at a broad level. 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 any further details with you after the call. And so, for the first one, we go to the line of Ed Snyder at Charter Equity Research. Please go ahead.

Peter NyquistVice President & Head of Investor Relations

Hi, Ed.

Edward SnyderCharter Equity Research, Inc. — Analyst

[Crosstalk] Thank you very much. Good morning — or afternoon, as it is. The question on your strength in North America — I know we’ve talked about this at length before and you’ve mentioned 5G and different variants of it. But if we could maybe get a high level view, is the vast majority of that due to 5G buildout? Are you seeing capacity expansions in 4G, and to the extent it is 5G, is it mostly millimeter wave or the low bands?

Börje EkholmPresident & Chief Executive Officer

To get into that would also start to disclose different strategies for different of our customers. So, we’re not going to do that. But what I will say is that we see a lot of capacity expansion in North America, and that is clearly a — the most important part. But of course, we see as well 5G deployment, and that’s why there is a significant growth.

Edward SnyderCharter Equity Research, Inc. — Analyst

Great. Thank you. And then, as you stated both this call and last call, that 5G will probably be more about enterprise and private networks than just raw consumer demand. So, 4G we saw big capacity expansions in consumer demand. And then, 5G — I know you mentioned initially mobile broadband, but that it would be followed by, like I said, enterprise and private clients. And Nokia’s essentially said about the same thing. Isn’t that a fundamental change in the addressable market from a mass market horizontal product to more of a vertical? And as a result, shouldn’t we see some sort of variation on the profile of your revenue — say, higher gross margin but lower growth given vertical standing — go slower but you’ve got better pricing power?

Börje EkholmPresident & Chief Executive Officer

We’re still so early in this development. But what is clear is that connectivity in the enterprise sector is increasingly important. And while there’s connectivity that is reliable and secure is very hard to get unless you’re a licensed spectrum. So, we see an increasing interest from enterprises and we see that with our partnerships. And we just recently, for example, had a big win in Germany with an automotive company. So, we are seeing these changed the fundamentals of the business.

So, the way we think about it is that we have a consumer business, just as you said, that’s the bread and butter. But on top of that, we are starting to see an enterprise segment emerging. But it’s still too early to talk about it as a big market. It’s just in its infancy.

Edward SnyderCharter Equity Research, Inc. — Analyst

[Crosstalk] Would you anticipate any — yes. Thank you. And I guess, the last question really related to that is, given the emergence of the enterprise as more of a private client network, do you see any change in revenue profile at all? I understand it’s small and it hasn’t gotten large at this point, but shouldn’t we naturally expect some difference in the profile of the revenue, either the revenue growth of the margins or how it evolves?

Börje EkholmPresident & Chief Executive Officer

I think we — it’s a big speculative, yes. But what you are likely to see is a larger share hardware/software with a better gross margin that service revenues. Less of the rollout revenues — call it that. So, [crosstalk] —

Edward SnyderCharter Equity Research, Inc. — Analyst

[Crosstalk] Great. Thank you very —

Börje EkholmPresident & Chief Executive Officer

— ultimately going to end up it’s too early to tell.

Edward SnyderCharter Equity Research, Inc. — Analyst

Thank you.

Peter NyquistVice President & Head of Investor Relations

So, operator, we are ready for the next question.

Operator

Thank you. And that’s the line of Alexander Duval at Goldman Sachs. Please go ahead. Your line is now open.

Peter NyquistVice President & Head of Investor Relations

Hi.

Alexander DuvalGoldman Sachs Group, Inc. — Analyst

Yes, hi, Börje. Hi. Thank you for the question. Firstly, I just want to ask on your free cash flow, which seemed especially strong in the quarter, and particularly when you factor in provisions you’ve been taking. So, wondered if you could talk us through the moving parts there of that improvement and how sustainable that is. Obviously, you talked about profitability, but any of the other drivers of that would be interesting.

Second of all, there were some news reports in the last month or two about Ericsson’s market share at one of the Chinese telcos going up significantly. I realize you can’t talk about specific customers, but wondered if you could just talk about the broader situation in markets like China and how you feel about your competitive positioning and opportunities?

Carl MellanderSenior Vice President & Chief Financial Officer & Head of Group Function, Finance, and Common Functions

Should I take cash flow first? So, if we break a bit that’s — and you’re right to say that the majority of the improvement there comes from the improved profit as such. But, if we look at working capital, and — given the high business activity we have, we see some buildup in the quarter of inventory. And that’s followed to some extent by payables as well, because it goes together often with inventory buildup as well, because it’s sourced obviously from third parties, to a large extent.

But what a good part here in working capital also was accounts receivable, which came down following good collections in the quarter. So, I think that pretty much summarizes the most important points there. And that generated an — as Börje said before, it’s positive cash flow of SEK 2.2 billion, which we haven’t really seen in a second quarter for a long time. And also, looking at year-to-date, we are SEK 5.7 billion better than 2018.

Peter NyquistVice President & Head of Investor Relations

Okay. Then, market share?

Börje EkholmPresident & Chief Executive Officer

Market share — it is — so far, in China, we’re very early in the 5G cycle. So, it’s a little bit too early to have a firm view. What we are clearly aiming for is that we would be — have a stronger market share in 5G than in 4G, and we have invested for that and conducted trials for that. But we will have to see and make sure that we’re competitive to see that we end up there. We will know a lot more in the next few months, and then we can talk more about it. But that’s where we are right now.

Alexander DuvalGoldman Sachs Group, Inc. — Analyst

That’s great, and maybe just [crosstalk]

Börje EkholmPresident & Chief Executive Officer

[Crosstalk] — also say we are — we have — it’s always a bit hard to know exactly what the microdata will show once it comes. So, we will see that. But we believe that we have a very competitive offering and that we are gaining market share in several geographies.

Alexander DuvalGoldman Sachs Group, Inc. — Analyst

Many thanks.

Peter NyquistVice President & Head of Investor Relations

Okay, .

Alexander DuvalGoldman Sachs Group, Inc. — Analyst

That’s great. Many thanks.

Operator

Okay, we’re now over to the line of Sandeep Deshpande at JP Morgan. Please go ahead. Your line is open.

Peter NyquistVice President & Head of Investor Relations

[Crosstalk]

Sandeep DeshpandeJP Morgan Chase & Co. — Analyst

[Crosstalk] Yeah, thanks for letting me on. I have a question on 5G. How do you think rolling out the 5G is going to be different from the 4G rollout? Because initially, as you’ve said, it was being used as a capacity addition in terms of technology in a few areas. But is this going to become a mainstream coverage technology and — at some point? And does this rollout continue for a multiple quarter, or multiple year, period, particularly in some of these early markets like the United States, Korea, Japan, etc.? Or is this going to be a point technology?

Börje EkholmPresident & Chief Executive Officer

We actually ultimately think all frequency bands will be 5G enabled, which means all operators want to leverage their full spectrum portfolio, and the full — and the full coverage. And that’s what ultimately going to provide the long-term value of 5G. So, even when you talk about the factor connectivity, it’s very interesting that, when we talk to industrial companies, yes they’re interested in the indoor coverage and providing that in an undisturbed — and with a very high degree of reliability. But they’re equally interested in having it connected to the outside world. So, yes, I do think there are going to be initial deployments that are call it point treatment of where you’ve been if it’s 5G characteristics. But ultimately, it’s going to be connected to a broader macro network as well.

So, the way we think about this is that it will be — in a way similar type of buildout over time as you see with 4G. But that’s going to clearly take time and it’s going to be focused initially on where you have big capacity needs and big industrial applications. Did I answer your questions?

Sandeep DeshpandeJP Morgan Chase & Co. — Analyst

[Crosstalk] Yes. Just a follow-up to that would be — does that mean basically what you’re saying, that you see — given that this is — you’re seeing such a strong upcycle in billable revenue growth in networks this year, that this could be a multiyear process?

Börje EkholmPresident & Chief Executive Officer

Without getting into guidance — but yes, we do believe that the technology cycle is both going to go faster than historical cycles and probably last a bit longer. And the reason for that is the base business is going to be consumer business. But we also see a big growth potential in the enterprise area. So, networks are going to be built out first for consumer, but ultimately for the enterprise. That’s why we’re rather optimistic of the long-term outlook of the need for 5G technology.

Sandeep DeshpandeJP Morgan Chase & Co. — Analyst

Thank you.

Peter NyquistVice President & Head of Investor Relations

And we’re open for next question, please. Operator, we’re ready for the next question.

Operator

[Crosstalk] Yes, the next question is of the line of Simon Leopold at Raymond James. Please go ahead. Your line is now open.

Peter NyquistVice President & Head of Investor Relations

Hello, Simon.

Simon LeopoldRaymond James & Associates, Inc. — Analyst

Great. Thank you for taking the question. I wanted to drill down on the Northeast Asia region. Specifically, I want to understand what your assumptions are in terms of the timing for the China 5G. And the question is rooted in the potential that maybe, given the trade tensions between the US and China, that maybe some of the project activity slides out in time. So, I want to understand what you’re thinking about that. And then, also, within the Northeast Asia region, I want to get a better understanding of the materiality of your business outside of China specifically — South Korea, Japan, which I’m assuming are included in that region. Thank you.

Börje EkholmPresident & Chief Executive Officer

We’ll start by China. I can comment on that. We have said that we believe large-scale deployments will be 2020, but we will see some emerging deployments in the second half. That is still the best judgment we have. And I think it is fair to say, with the trade tensions and political uncertainty, etc., will bring, it’s very hard to speculate on. So, if that impact — we really don’t know, right now. But we plan for seeing bigger deployments in 2020. We’re also seeing, of course, the — we’re participating in the five-year rollout in Korea, and that’s been going on for some time. So, we have networks there as well in mid band.

So, that is clearly one of the key reasons why the region actually grows. We have not yet seen major deployments in Japan, but on the other hand, operators there have just been given spectrum and are in the process of gearing up. So, Tokyo Olympics, I’m sure, will help once that comes. So, I think we’re going to see a good development there as they also build out 5G to capture the opportunity. So, overall, we’re quite excited about the prospects in Northeast Asia, as we see that that is a leading technology region as well as investment region.

Simon LeopoldRaymond James & Associates, Inc. — Analyst

And how big have Korea and Japan been, in general, within the business overall? Are they combined low single-digit percent, or is that too low an estimate?

Börje EkholmPresident & Chief Executive Officer

They are sizable markets. We don’t provide you with a breakdown of the countries, so — except that we have said that I believe Korea is a top five market right now. So, you can see that — it’s about 4% or so —

Carl MellanderSenior Vice President & Chief Financial Officer & Head of Group Function, Finance, and Common Functions

Of topline —

Börje EkholmPresident & Chief Executive Officer

Of topline. [Crosstalk]

Simon LeopoldRaymond James & Associates, Inc. — Analyst

Great. Thank you for taking the question.

Börje EkholmPresident & Chief Executive Officer

[Crosstalk] — size then of Japan once it’s in the fuller swing.

Simon LeopoldRaymond James & Associates, Inc. — Analyst

Yep. Thank you.

Peter NyquistVice President & Head of Investor Relations

Thanks.

Operator

We are now over to the line of Achal Sultania at Credit Suisse. Please go ahead, sir. Your line is now open.

Achal SultaniaCredit Suisse Group — Analyst

Hi. Thanks for taking my question. So, on media solutions, I see that you still have an operating loss of a couple of hundred million krona in the quarter. I thought that this was all to be consolidated from the business after the divestment. So, can you help us understand that — why that number is a loss still and should we expect that to continue in the second half? And then, secondly, on the gross margin, again — so, Börje, obviously, thank you for explaining the moving parts in the gross margin. So, the way I think about it going forward is, you had about 20 basis points of hit in your gross margins in networks business due to the strategic contracts, some of which you said was partially offset by operating leverage.

I guess, as we move into the second half of the year, you probably expect more of these contracts to ramp up. So, the headwind probably accelerates. But then, equally, are there any other positive moving parts for gross margins that we should also think about going into the second half?

Carl MellanderSenior Vice President & Chief Financial Officer & Head of Group Function, Finance, and Common Functions

[Crosstalk] Hi, you’re right. This is coming in now. The MediaKind investment is 49% of earnings. It comes on the line share of earnings in the joint ventures and associated companies. And you’re right, that was a loss on the company and we get 49% of that. We’re not guiding specifically on how that will develop. Obviously, the intention of the two shareholders is to improve on this business and turn it around as well.

Achal SultaniaCredit Suisse Group — Analyst

So, just to clarify, Carl. So, the SEK 200 million loss is — 49% of the total loss is equal to SEK 200 million loss that you report.

Carl MellanderSenior Vice President & Chief Financial Officer & Head of Group Function, Finance, and Common Functions

Majority of that, yeah.

Achal SultaniaCredit Suisse Group — Analyst

Okay.

EkholmPresident & Chief Executive Officer

Unfortunately, costs are higher than revenues in that business. And — so far. But the intention is that clearly it will improve. On the gross margin, yes, the net effect of operating leverage and strategic contracts are about 20 basis points for the second quarter. We expect the operating leverage to continue and be significant in the business, but we also say that we’re using part of the operating leverage to actually reinvest in some of these strategic contracts, or important contracts. And that — so, you can see somewhat more than the 20 basis points, but not dramatically more.

Achal SultaniaCredit Suisse Group — Analyst

Okay. Thank you. Thank you, Börje.

Börje EkholmPresident & Chief Executive Officer

Yep. Thanks [crosstalk].

Peter NyquistVice President & Head of Investor Relations

So, the next question, please?

Operator

Is over to the line of Richard Kramer at Arete Research. Please go ahead. Your line is open.

Peter NyquistVice President & Head of Investor Relations

Hi, Richard.

Richard KramerArete Research, LLC — Analyst

[Crosstalk] Thank you very much. My two questions are — first of all, if we look at the portion of sales in North America, especially in networks, it remains very high. And you talk a little bit about the difference in gross margins that have long been understood to be much higher in the North American market than in other markets. And could that be, as the North America market starts to immortalize from the big 5G rollouts that we see now — could that be part of your thinking around second half gross margins or potentially gross margins next year?

And second, if we step back from these quarters’ moves in gross margins and networks, and we remove the IPR income from both network sales and margins over the last years and a half, your core networks business margin seems to be around 10% or 11%, roughly. And given that nearly all of those network sales come from telcos, is that the peak or reasonable margin you can expect in negotiations with what are very large customers and, obviously, now very well accustomed to a long-term procurement and how much margin they leave on the table for their vendors. Or do you see material outside beyond your near-term targets to try to get more margin out of those telco customers? Thanks.

Börje EkholmPresident & Chief Executive Officer

If we start with the first one, what we see is — what you’re trying to say is that you see a larger service portion in the second half. And of course, that is helping — hurting gross margins in the second half in North America. But I would caution you to say that it’s — we have multiple geographies with similar margin profiles as North America. So, the dependence in our current structure is less than it might have been understood to have been historically. I know I made that point to you a bit earlier also, but that is unfortunately the fact, and the knowledge from before may not be as relevant. So, that’s the one thing.

The other is, if you look at the guidance for the second half, yes we say that North America is running at the very high rate and we don’t see the same growth rate continuing. But we do — we also see an increase in service portion in the second part that is going to bear on gross margins a bit. But overall, we’re not trying to say that gross margin second half is in any way dramatically deviating from the guidance we’ve given. So, we’re not trying to give a profit warning in any way on that. If you look longer term, I do think that the interesting part here is so far the business being exclusively focused on the consumer business. We see that that is changing into becoming an enterprise business, and that’s why it’s a little bit speculative to think about how the margin profile is going to look longer term. Did it help you?

Richard KramerArete Research Services LLP — Analyst

Yeah. Thank you.

Peter NyquistVice President & Head of Investor Relations

And we will continue to take next question, please.

Operator

Okay, the next question is of the line of Stefan Slowinski of Exane BNP Paribas. Please go ahead.

Peter NyquistVice President & Head of Investor Relations

Hello, Stefan. [Crosstalk]

Stefan SlowinskiExane BNP Paribas — Analyst

Yeah, hi. Sorry to belabor on the margin, but on the gross margin you’ve quantified here with that new slide the 20 basis points of sequential impact — the net of the operating leverage and the strategic projects’ headwind. Understanding the second half, maybe there’s a slight more of a headwind on the strategic project side. I guess the question is, does that continue into 2020 on the strategic project front, or should we expect that to run its course? Obviously, there will be other puts and takes on the margin in 2020 in terms of geographic contribution and business mix. But from a strategic project standpoint, that 20 basis point headwind that you just talked about, will that continue into next year or is that something that will go away? Thank you.

Börje EkholmPresident & Chief Executive Officer

I mean, they will — our view of — the reason why we take those is to position ourselves for 5G. So, we are, of course, taking those contracts in the knowledge of — that’s not the — the impact of those are not going to be with us on the negative front for more than a few quarters. So, we are surely going to deliver on some of the strategic contracts in 2020. But think of it as the operating leverage remains, but the negative part dissipates. So, if you’re — would make that, there is an underlying improvement that today is not visible because we reinvested in strategic contracts. That underlying improvement will start to become visible. And that will happen into 2020.

Stefan SlowinskiExane BNP Paribas — Analyst

Got it. Thank you.

Peter NyquistVice President & Head of Investor Relations

You got it? Thank you. Then, we’re actually open for the last question of this session. So, please, operator?

Operator

Yes, of course the last question for today’s call is over to the line of Damian Leoni at Bank of America. Thank you very much. Your line is open.

Tal LianiBank of America Merrill Lynch — Analyst

Thank you. This is Tal from Bank of America. I have two questions. The one first is, we spoke about market share versus WAWI, but you didn’t speak about market share movement versus Nokia. How do you see them in the market? And second, can you elaborate on the advantages versus Nokia technology, etc.? Second question is about North America. What happens if there are delays in allocating spectrum on the 3.5 gig in North America? Do you expect 5G to slow down waiting for Spectrum? Or is there enough juice, if I can call it, in low band and minimum wage to continue and grow for a few years? Thanks.

Börje EkholmPresident & Chief Executive Officer

Yeah, we don’t comment on competitors and that’s — we’re here with Ericsson. That’s my focus. If they want to comment, they can do it, but I’m not going to do it. On the — if you look in the US, yes, there is a lack of mid band spectrum. That’s quite clear. There are many trusts ongoing on how to relieve spectrum. That would help for national load perspective. But from our demand perspective, we think we’re — the current kind of spectrum will drive the current type of buildout. So, we don’t see that to impact dramatically, actually, for us — in the near-term, I should say. Longer term, we need the mid band in order to capitalize on new opportunities for 5G and new use cases for 5G.

Tal LianiBank of America Merrill Lynch — Analyst

Got it. So, if I can go back maybe to my first question and ask it more in general, not versus a specific competitor? What drives your share gains? Do you have — do you think have a sustainable technical advantage that can take to your sustainable share gains over the next few years or did you just have a head start versus competitors and this is why we’re seeing strong performance? And do you expect it to even out in the next few quarters?

Börje EkholmPresident & Chief Executive Officer

We took the steps to invest in making our — technology leadership to make our portfolio competitive. And that’s in order to invest — to stay ahead so as to drive new innovation, new spectrum utilization technologies, and create that as a sustainable advantage versus competition. The — it’s like in most technology areas, there will — they will be where we are at some point in time. But then, we have also moved ahead. So, it’s increasingly difficult to catch up, for example, on dynamic spectrum sharing that we can do on our base band from 2015 and onwards. So, of course, for our customers, like COMMON Switzerland, they can actually achieve 90% population coverage by year-end, but leveraging our infrastructure. And that’s, of course, not doable unless you have a technology leadership mindset and continuously investing in technology. And that’s’ what we are intending to do.

The other part here is actually to get the continuous cost cadence. So, by introducing new platforms and new technologies, we can bring the cost down on our equipment. And that’s makes — it’s a double whammy, where we get the product benefit as well as cost benefit helping us. And then, that’s what you see in the gross margin expansion during 2018. It’s really those two factors coming through.

Tal LianiBank of America Merrill Lynch — Analyst

Got it. Thank you.

Operator

That was the final [crosstalk] —  

Peter NyquistVice President & Head of Investor Relations

[Crosstalk] So, by that — before we close this, Börje, you want to have the last remark?

Börje EkholmPresident & Chief Executive Officer

No, I want to just thank you for listening in. We are continuing to invest for technology leadership that will help us drive, of course, market position and competitiveness, but also our cost position. We saw a second quarter with solid growth, driven by networks in predominantly Northeast Asia and North America. We saw profitability negatively impacted by IPR contract and IPR swings versus Q1. We continue to execute on the plan in digital services to gradually and sequentially profit, or lower the loss, turning that into a profitable business next year.

Managed services has a bit of a lower margin in second quarter due to timing or costs. But we see that our investments in automation and machine learning is starting to pay off in operations ending. That’s longer term going to drive a very different margin profile. Emerging business saw a good growth, driven by our profitable AI connective business. So, we are overall confident in reaching the targets we set out for 2020 as well as 2022. So, again, thank you for listening to the Q2 report.

Peter NyquistVice President & Head of Investor Relations

Thank you. Goodbye.

Duration: 44 minutes

Call participants:

Peter NyquistVice President & Head of Investor Relations

Börje EkholmPresident & Chief Executive Officer

Carl MellanderSenior Vice President & Chief Financial Officer & Head of Group Function, Finance, and Common Functions

Sandeep DeshpandeJP Morgan Chase & Co. — Analyst

Simon LeopoldRaymond James & Associates, Inc. — Analyst

Stefan SlowinskiExane BNP Paribas — Analyst

Edward SnyderCharter Equity Research, Inc. — Analyst

Tal LianiBank of America Merrill Lynch — Analyst

Achal SultaniaCredit Suisse Group — Analyst

Richard KramerArete Research Services LLP — Analyst

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