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Ericsson (NASDAQ:ERIC)
Q3 2019 Earnings Call
Oct 17, 2019, 3:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to Ericsson's Analyst and Media Conference Call for the Third Quarter Reports. To view visual aids of this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. [Operator Instructions] As a reminder, a replay will be available one hour after today's conference.

Peter Nyquist will now open the call.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you Mark and welcome everybody to this Q3 earnings call. With me here in the room I have Borje Ekholm, President and CEO and Carl Mellander, Chief Financial Officer.

I will state the following statement first. 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 risk 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.

Before leaving the word to Borje, I would like to say that this call is focused on the Q3 earnings and later this afternoon we will have an investor update and then we'll take more Q&As on the long-term strategic issues.

By that, I would like to leave the word to you, Borje.

Borje Ekholm -- President and Chief Executive Officer

Thanks, Peter, and welcome to all of you for this call for the third quarter. And of course we appreciate that all of you have the time to join us. So in the third quarter, we continue to execute on our focus strategy that we defined and laid out in 2017. The execution during the third quarter shows that we do what we said we will do and execute toward building a stronger Ericsson longer term.

A key part of our strategy is to increase investments in R&D for technology and cost leadership and we see good momentum in our business based on a strong portfolio and a good cost position. Another key part of our focus strategy was to strengthen our footprint. And we see good progress here with several wins. We're disciplined in how we take contracts and we target opportunities where we have a clear technology advantage. However, these contracts are margin dilutive in the short-term. But the good thing is here we're also starting to see some of the early contracts we have taken to gain footprint to become margin contributive and actually helping us drive margins. So the impact during the third quarter net of operating leverage was about 80 basis points from these type of contracts. But the important is here to remember that we will try to manage or we will manage these strategic contracts within our overall profitability and we can still deliver a healthy gross margin.

We see faster rollout of 5G than we earlier anticipated, driven by the pioneers in North America, Northeast Asia. During the third quarter, we also recorded a provision of $1.2 billion or SEK11.5 billion as the estimated costs for resolving the situation with SEC/DOJ. Of course, we are ashamed of our historical performance, but we confront the issues head on and we're now investing significant resources to strengthen our future compliance program. Over the last two years, we've focused on improving our cash generation capability or capacity. During the third quarter, our free cash flow before M&A was SEK5.5 billion and we now have a net cash position of SEK37 billion.

The geopolitical uncertainty has continued during the quarter and as always, uncertainty is never good for investments. So we see really no impact in our order books yet, but if anything we see uncertainty among our customers and actually it's delaying investment decisions in certain parts of the world.

If we move into summary of the numbers for Q3 2019. We had a strong cash flow, as we said, SEK5.5 billion during the quarter before M&A. Organic growth were 3%. Underlying margin when we adjust for the provision for SEC/DOJ and one-time refund of social security costs was 11.4% and that improved both year-over-year and quarter-over-quarter. Networks had a good gross margin, absorbing the dilution from strategic contracts. And in digital services, we see improved results. When we laid out our strategy in 2017, we did not target the fastest possible turnaround of digital services, instead our priority was to build a strong unit for us longer-term and create a strong product portfolio and thereby we defined the ambition to reach low-single digit margins in 2020. And what we see now is that the underlying business continues to improve and we're getting closer to break-even. We still carry costs for the 45 previously identified critical contracts, but we're resolving them one by one. But what's very encouraging and makes us comfortable about the target for 2020 is a strong development in the underlying portfolio or underlying business. Maybe the most encouraging thing with digital services is the strong growth we see in our new growth portfolio to actually combat the declining legacy portfolio. We saw managed services to be after bit of a bump in Q2 to be back on where it should be, delivering a good and improved margin. In emerging business, we see good growth, especially in our IoT offering where we have also decided to double down to be the stronger business longer term.

Short summary of the market area sales then. We see very good growth in the regions with early 5G launches, that's really the US and Northeast Asia. In Europe, we saw growth in networks and digital services while Latin America saw declines following a strong 2018, tough comparable. In Southeast Asia, Oceania and India, we saw declining sales due to lower sales of our legacy products in digital services. In Middle East and Africa, we saw actually growth because strong investments in 4G as well as 5G in key markets, but we also had a headwind from contract exits in managed services.

So with that, over to you Carl.

Carl Mellander -- Senior Vice President, Chief Financial Officer

Thank you, Borje. I will start by mentioning two items affecting comparability in the third quarter those are important to understand the underlying business. And first is the SEC/DOJ related cost provision. The cost here is estimated at $1.2 billion, which is the same as in our earlier communication. And when we apply the exact exchange rate on this in the closing and this translated into Swedish Krona amount of SEK11.5 billion. Secondly, it's the refund of Social Security costs related to pensions in Sweden and this amounts to SEK0.9 billion. Both of these are booked on segment emerging business and other and for the only reason of keeping them easy to track for external stakeholders. When we adjust for these one-off items, we arrive at an operating income of SEK6.5 billion or an operating margin of 11.4%. And you also see here that the adjusted operating income for segment emerging business and other is negative SEK0.8 billion.

Let's have a look at the four segments, starting with networks. Networks grew by 4% currency adjusted to SEK39.3 billion, again driven by North America mainly. Gross margin was flat year-over-year and down 0.8% sequentially if we exclude an item affecting comparability in the second quarter. We'll come back to that later. So within the decline of 0.8 percentage points, we have absorbed the margin impact and inventory provisions related to the so-called strategic contracts. Both operating income and operating margin here increased year-over-year. And if we drill-down into this a bit more, the underlying margin is stable year-over-year as in the third quarter [Technical Issues] 2018 we had burdened the margin by some revaluations of customer financing and also some impairment losses of trade receivables. So as you can see here in the graph, the operating margin in this quarter exceeded the 2020 target range, 18.4%.

If we move to digital services, sales grew by 5% FX adjusted to SEK9.9 billion. And as Borje said, a good momentum in the 5G-ready and cloud native portfolio and geographically here we're talking North America, Northeast Asia. And again, we're happy to see the growth in the new product portfolio of 19% if you look at a rolling four-quarter basis. Gross margin improved both year-over-year and quarter-over-quarter from increased software share of sales and also continued cost reductions. On operating income level, we saw significantly reduced losses here, now down to minus SEK0.5 billion versus negative SEK1.4 billion a year ago and minus SEK1.3 billion last quarter and this was done in spite of absorbing the negative impact of the remainder of the 45 critical contracts that we defined way earlier of SEK0.5 billion. So now we have addressed 29 of the 45 contracts. As you know, we target to have 75% of those 45 completed by the end of this year. I also want to mention that the BSS strategy execution which we have communicated about earlier is progressing well and here we have recorded several new BSS wins in the quarter as well. So all-in-all I would say, excuse me, the turnaround here in digital services is on track for the 2020 low-single digit margin targets, but again, please bear in mind as we have said many times before that the impact of the remainder of these 45 contracts will continue to vary between quarters as they are addressed.

Managed services delivered well in the quarter and operating margin above the 2020 target range and here we -- decline topline if we adjust for FX, but this is mainly following the planned exits from contracts that we have talked about. Gross margin improved also here, following continued efficiency gains, but also thanks to a higher portion of what we can call add-on sales, meaning additional business generated under existing contracts. And looking at operating income, we also here increased both year-over-year and quarter-over-quarter following the higher gross margin. I would say it's also relevant for here in Managed Services to look at the year-to-date operating margin, which is 6.9%, up from 5.4% for the corresponding period last year and there we have to exclude the positive effect of certain provision reversal we did in the first quarter and this again, in line with the 2020 target range. Here in Managed Services, we continue to invest in R&D for automation, machine learning, artificial intelligence, obviously to continue develop this business into a competitive and value generating part of Ericsson.

In segment Emerging Business and Other, sales was SEK1.6 billion, which is an organic decline of 7% and operating income here was impacted by some non-recurring items that we talked about before. When we exclude this, it's minus SEK0.8 billion compared to SEK1 billion negative in Q3 '18. Looking at the different parts, we have the emerging business including iconectiv and here Borje already mentioned already, but it's -- I think this is worth repeating. This is good that we see our IoT business growing almost twice the space in the market and we have now 4,500 enterprises on-board into our platform via telecom operators. And yeah, then we have Red Bee Media, stable business at break-even, working hard to improve and the Media Solutions of course divested earlier, now generating a negative SEK0.3 billion operating income. When it comes to gross margin, here you see the long-term development. We could say the gross margin has established itself at the high level in line with the target for 2020 and I think I have mentioned most of the factors there, so we can move on.

Here let me say a few words about the Networks gross margin and the so-called strategic contracts in the form of this margin bridge here. Some of the contracts that we decide to take, they do come with lower initial margins, however they are all selective for value creation long-term and the product offering and cost structure we have now is more competitive and this is an enabler for us to capture these opportunities without jeopardizing the target for 2020. But we have a certain negative impact on the gross margin. You saw the 0.8 percentage points here in the third quarter and the dilutive impact can vary between quarters of course, but this is about building for the long-term. So you see the underlying margins Q2 was 42.3%. If you make an adjustment for an IPR settlement there, compare that with the Q3 number, 41.6% and you get the 0.8% delta including this margin impact and inventory provisions, but also offset by operational leverage.

OpEx quickly. Starting from the left at with R&D, slightly up and we have seen reductions now continuously in digital services as well as emerging business, that's mainly related to the divestment of MediaKind and we invest in networks as well as managed services as you are well aware. SG&A in the middle and stable underlying level. You can say we compensate for the negative currency effect by continued cost savings and then we have the impairment losses on trade receivables. Yeah, they continue to vary between quarters, it was a positive this quarter, thanks to good collection efforts in our company.

Free cash flow, SEK5.5 billion is the key number here, free cash flow before M&A. We saw some outflow from provisions here, SEK2.2 billion in this quarter. Looking at the future in Q4, we expect the majority of the SEC/DOJ related costs to be paid out, but this is of course uncertain. This is with the current information, but let's see how the discussions there play out in reality. Just to highlight also the year-to-date free cash flow, which is SEK11.8 billion compared with SEK1.2 billion same period last year. A lot of this has to do with working capital management and obviously good cash collection in the quarter and the whole year.

Planning assumptions here. Again, please look at the full report for all the planning assumptions. I don't go through the details here. There are a few additions and changes here. So I just suggest that you have a look in the report where you can find all of that.

And with that, I'll hand back to you, Borje.

Borje Ekholm -- President and Chief Executive Officer

Thanks Carl. So our focus strategy stays firm. We are excited about the opportunities to expand the market with our 5G technology as we enter the enterprise space and many more advanced consumer applications. We continue to invest in R&D for technology and cost leadership. Our investments are of course focused on 5G, but also cloud native portfolio and AI. We continue to seek to expand our footprint in a disciplined way. We're building on a strong portfolio and the good and competitive cost structure, but nevertheless the margins can be or the contracts can be dilutive to margins in the short-term, but they are surely creating value long-term and strengthening our market position. But we can take those within the targets we have previously communicated. Our focus strategy is aimed toward building a stronger Ericsson longer term, think in terms of five to 10 years out and we feel we are doing what we said we will do and delivering on that. So we are very comfortable about our targets near term for 2020 and 2022 as some sort of intermediate checkpoints on their way to a longer term stronger Ericsson.

With that back to you, Peter.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you Borje. And on the topic of investor update this afternoon, we will then focus that session more on the strategic question. You will get a run through with both Borje and Carl with details around what we're going to say about targets and the strategy at that point, so we will focus this Q&A session on the Q3 earnings.

With that operator, we will open-up for the Q&A, please.

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Daniel Djurberg of Handelsbanken. Please go ahead. Your line is open.

Borje Ekholm -- President and Chief Executive Officer

Hi Daniel.

Daniel Djurberg -- Handelsbanken Capital Markets -- Analyst

Thank you very much for taking my question and congratulations on the strong report. The question would be to Carl I think on the network side, you had inventory provisions in the quarter making up part of this 80 basis point gross margin impact in the full. How much of this 80 basis points came from this inventory provision and how much was from strategic contracts?

Carl Mellander -- Senior Vice President, Chief Financial Officer

Hi Daniel, Carl here. We don't go into that level of detail here. But we say we talk about the net impact here of the 80 basis points, but we're not going to break it up in the smaller components of that.

Daniel Djurberg -- Handelsbanken Capital Markets -- Analyst

Fair enough. I have one more question and perhaps to Borje. It might be interesting to get your view on this development of open radio access network with some operators, quite large operators starting to talk about it now and I was thinking if this openRAN so far impacted your strategic plans for network segments long-term or what you are thinking on the openRAN?

Borje Ekholm -- President and Chief Executive Officer

Yeah. We have and you'll see from our earlier announcements, we for example joined the O-RAN alliance already in the beginning of the year. So we believe the openness and the open architectures will of course be important part of the market going forward. So we see that as a natural extension and an area that we are surely going to participate in. So we are working to position ourselves as a strong competitor in the -- as an open provider or provider of an open solution, no question. Then exactly how that's going to be impact and when it will be introduced etc, that's still a bit unclear. Solutions of course can be done for 4G already today, but so far we haven't really seen that on 5G. So you know we will continue to work on our path and it's going to be an important part of our business going forward as well. But as you see, we continue to have a guidance of strong networks going forward. So we believe we have a good position also here.

Daniel Djurberg -- Handelsbanken Capital Markets -- Analyst

Perfect. Thank you very much and good luck in Q4. I'll go back in queue.

Borje Ekholm -- President and Chief Executive Officer

Thanks.

Carl Mellander -- Senior Vice President, Chief Financial Officer

Thank you. Talk to you later Daniel I guess.

Peter Nyquist -- Vice President, Head of Investor Relations

Next question, please.

Operator

Thank you. Our next question comes from the line of Alexander Peterc of Societe Generale. Please go ahead. Your line is open.

Borje Ekholm -- President and Chief Executive Officer

Good Morning, Alex.

Alexander Peterc -- Societe Generale SA -- Analyst

Yes. Good morning. Good morning to all of you. I just have a few questions. One is simple and housekeeping. When you say there's a 0.8% impact on gross margins from competitive price contract, is that quarter-on-quarter or year-on-year?

Then the second question would be on the impact of Kathrein. How should we model sales, gross profits and operating profit contribution within networks here? I think you alluded to us about SEK3 billion being the sales level that we should model for the full year, but I'd like to have a little bit more detail on that.

And then lastly on guidance. So you lift the midpoint I'd say by about 9%. Is it correct to assume that about half of that is down to FX changes since your last update about a year ago? And also is there an inorganic contribution of Kathrein that I don't think was modeled in that initial guidance syndication you gave a year ago. Thank you.

Carl Mellander -- Senior Vice President, Chief Financial Officer

Should I start then? Yeah. First of all that 0.8% is the sequential delta on the networks margin if you adjust for a one specific non-recurring item regarding an IPR settlement in Q2.

When it comes to Kathrein, what we have said earlier is that it's about EUR270 million in topline in 2018 and so that's about the level we have talked about. No, then the -- sorry, I'm reading on the wrong line. It's actually around EUR220 million exactly, apologies for that. We have a certain negative impacts on Kathrein in Q4 and also in 2022 and it has to do with changing the portfolio and modernizing the portfolio there and the whole shift that we are going to do. Of course, over-time the acquisition is going to be accretive clearly, but there is some short-term hits on that.

Borje Ekholm -- President and Chief Executive Officer

But it's important to say, put it in the context of 2020. That's why we're still comfortable with our targets and they remain firmly in place. So of course, as Carl said, we expect to see a bit of a headwind from Kathrein in 2020, but we need to modernize the portfolio and make sure to invest in our antenna technology and that's a strategic investment we're making. So that -- but we can manage that within our targets.

And I guess your third question was around the the midpoint on the 2020 topline, right?

Alexander Peterc -- Societe Generale SA -- Analyst

Yes.

Carl Mellander -- Senior Vice President, Chief Financial Officer

No, I can take that. Yeah. It's divided between the FX impact but also good market momentum and thirdly then the Kathrein acquisition. I mean to give you a rough idea, FX is probably around, say SEK9 billion of that market, another SEK9 billion in Kathrein, say two [Phonetic].

Alexander Peterc -- Societe Generale SA -- Analyst

Okay, That makes sense. Thank you very much. Perfect. Thanks.

Peter Nyquist -- Vice President, Head of Investor Relations

We're open for next question.

Operator

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

Borje Ekholm -- President and Chief Executive Officer

Good morning Sandeep.

Sandeep Deshpande -- JPMorgan Ltd. -- Analyst

Yeah. Hi, good morning. I have couple of questions. Firstly, regarding the United States. I mean, you have mentioned on your release that T-Mobile-Sprint may cause some issues. Maybe can you elaborate on what you think that will do to your normal seasonality in the fourth quarter?

And then secondly, if I look at, I mean you've talked about DSS in the past, when do you think DSS adoption in the US will start? Thank you.

Borje Ekholm -- President and Chief Executive Officer

Repeat the last question, please. You meant DDS or --

Sandeep Deshpande -- JPMorgan Ltd. -- Analyst

The Dynamic Spectrum Sharing.

Borje Ekholm -- President and Chief Executive Officer

Yeah. Okay, I'll take that. If you look in the US, what we're saying is that there are a bit uncertainty relating to a potential merger as Peter announced. And we think that is going to impact their spending levels in the second or during the fourth quarter. So of course that will be a lower seasonality affecting Q4 than normal as a consequence of this. So it's hard for us to be much more specific, but we want to say that overall, you should expect to know where seasonality are normal or lower seasonality affect the normal.

And coming back to your question about the Dynamic Spectrum Sharing, this is an important technology. We're taking steps forward. When it will be introduced, that depends on launch plans with our customers. So we're not going to comment on details, but it will of course be announced as it is deployed.

Peter Nyquist -- Vice President, Head of Investor Relations

Okay. Sandeep?

Sandeep Deshpande -- JPMorgan Ltd. -- Analyst

Okay, Thank you.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you. Next question, please.

Operator

Thank you. That's from Edward Snyder at Charter Equity Research. Please go ahead, your line is open.

Borje Ekholm -- President and Chief Executive Officer

Good morning, Ed.

Jack Egan -- Charter Equity Research -- Anlayst

Hi, this is Jack Egan [Phonetic] on for Ed Snyder. Thank you for taking my question. So operators -- good morning. So operators such as Verizon and British Telecom backing off extra monthly charges for 5G service suggest ARPUs are remaining flat. Is there a specific reason why they haven't risen yet. Is it due to an effective marketing or reduced capex. Just trying to get an idea of expectations for commercial uptake for 5G? Thanks.

Borje Ekholm -- President and Chief Executive Officer

if you look at, it's also I think to be able to charge a premium you need to also consider other aspects like how much coverage for example you have for this service, right. So when you look at other parts of the world where we see early movers actually get the price premium for 5G but it's typically linked to a broader coverage, broader user spectrum so to say. And so far in the US, it's -- the build out is happening, it's happening very quickly and it's building out quickly. Coverage is not -- it's not deep yet and I think that limits your ability to charge a premium, but you know, if we learn from the history, we have seen the first movers always be able to extract the price premium and we see the same thing in 5G or expect the same thing in 5G.

Peter Nyquist -- Vice President, Head of Investor Relations

Okay, Jack.

Jack Egan -- Charter Equity Research -- Anlayst

Okay. Yeah, thank you for that. For my follow-up for sub-6 base stations with 64 antennas, can we get a general cost point for these? Are they twice as expensive or 10 times as expensive? Really just looking for a ballpark estimate? Thank you.

Borje Ekholm -- President and Chief Executive Officer

I guess you would love that, but you're not going to get it. Sorry.

Jack Egan -- Charter Equity Research -- Anlayst

Okay, no problem. Thank you.

Peter Nyquist -- Vice President, Head of Investor Relations

Thanks Jack. We'll move on to the next question, please.

Operator

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

Peter Nyquist -- Vice President, Head of Investor Relations

Good morning, Achal.

Achal Sultania -- Credit Suisse AG -- Analyst

Hi Peter. Good morning, everyone. Just coming back to the US market and maybe Korea as well. Like obviously we've seen continued strength in both these market as 5G leaders. You obviously have been commenting for the last few quarters that we have to be careful as some of these markets may start peaking. We still haven't seen that. Q3 was another quarter of growth from a very high base. So what has been the surprise element for you when trying to predict the demand coming out of the US and Korean operators? Is it 4G catch-up spending? Is it the pace of 5G roll-outs? Is it the densification part? Just trying to understand like where -- are we missing something which is going on in the US and Korea?

Borje Ekholm -- President and Chief Executive Officer

You know, it's not easy to give a very clear answer but if you look back two years ago with the expectations of 5G introductions, we would have said more like a 2020 event. Since then it's been actually accelerated by more than 12 months. So you see a much faster rate of introduction of 5G than expected. You also continue to see a very high increase in the data consumption among the users. So what you're seeing is actually a need to invest in the network to actually give the end user the quality needed. So you see operators invest in both 4G as well as 5G and yes, you could have said should we have expected this? To some extent, we should have, but the reality is, it's happening even faster than we expected just a few months ago. So the demand here is strong and when we look at early launch markets for 5G, we see a very sharp increase of data consumption among the 5G users, which indicate that 5G yet again shows that you will use your device in a different way when you get a better service. So if we look at -- compare that for example to Europe where we typically have weaker coverage or weaker networks as more of an average compared to Northeast Asia and the US and we see much lower data consumption as well. So I think the reality here is a better network drives new type of behaviors that actually also drives investment needs and drives our business and that's why it's important I think that the operators also are able to charge a premium for 5G because it will create new type of use cases, so --

Achal Sultania -- Credit Suisse AG -- Analyst

Okay.

Borje Ekholm -- President and Chief Executive Officer

It's a multitude of factors, but it's actually back to the demand for -- it's almost a -- you're feeding the data consumption beast in a way and then the consumer continues to love consuming data.

Achal Sultania -- Credit Suisse AG -- Analyst

And maybe just a follow-up on Japan. Have we started seeing the 5G prep getting done in Japan or is it still more like a 2020 event and how is your relationship with all the three major operators? I know you've announced SoftBank and KDDI, but what's the progress with the third operator in Japan in terms of what you can supply in the new relationship? Thank you.

Borje Ekholm -- President and Chief Executive Officer

The Japan is still preparing to upgrade the network and launch 5G, so they are in that phases. So that -- it's more of a 2020 event, as you called it. We see good progress in the market. And of course our ambition is to be stronger in 5G than we've been before. So that would include working together, as we've said before with Fujitsu and approaching the market that way as well. So we feel quite positive about the situation in Japan.

Achal Sultania -- Credit Suisse AG -- Analyst

Thank you, Borje.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you Achal. We are now ready for the next question, please.

Operator

Thank you. That's from the line of David Mulholland of UBS. Please go ahead. Your line is open.

Peter Nyquist -- Vice President, Head of Investor Relations

Good morning, David.

David Mulholland -- UBS Investment Bank -- Analyst

Just on China, I think your commentary is getting increasingly over the last few quarters confidence around your ability to take market share into 2020. I just wonder if you could update us to where you are on -- has business been awarded yet that you've seen? When do you expect that to happen? And is that also in terms of impacting your P&L, something that's already going to kick-in Q4 this year or really a 2020 story.

Borje Ekholm -- President and Chief Executive Officer

Yeah. Our ambition is clear. We want to be stronger in China in 5G than we were in 4G. 4G spent or 4G market in China is really more than 60% of the global market. So it's clearly very important. We have no reason to believe 5G will be less than that. So we try to position ourselves for gaining share. We feel we're making progress. We're making investments to do that. Still we don't know -- no awards have been made. We have really no way of knowing potential market shares and we don't really know price levels either, but we expect that to be awarded in the -- at least in the near term in next few months, but we will see and we will update you based on what we achieved.

David Mulholland -- UBS Investment Bank -- Analyst

And then just one quick follow-up on Kathrein. I think that the commentary you're making around potential margin impact that as in diluted margin impact is that shouldn't just the Q4 issue because whenever you announced it, you said it would have a positive impact to your profitability targets for 2020.

Borje Ekholm -- President and Chief Executive Officer

What we have said is that it will have a near term dilutive impact. We're closing it much later than we expected. So it will clearly carry into 2020. So it's going to provide headwind in 2020, but the reality is it's still fitting into the overall guidance. So you can quantify it a bit and say that, yeah, it's going to have an impact, but not that much.

David Mulholland -- UBS Investment Bank -- Analyst

That's fair. Thanks very much.

Borje Ekholm -- President and Chief Executive Officer

Thank you.

Peter Nyquist -- Vice President, Head of Investor Relations

Thanks David. Next question please.

Operator

Thank you. Our next question comes from the line of Jorgen Wetterberg of Nordea. Please go ahead. Your line is open.

Peter Nyquist -- Vice President, Head of Investor Relations

Good morning Jorgen.

Jorgen Wetterberg -- Nordea Markets -- Analyst

Yes. Good morning. Thank you and congratulations on the report. A couple of questions if I may. One related to the operating expenses. So you had some good improvements there after adjusting for the Social Security benefit, repayment, etc, right. And you're saying that it's driven by FX and seasonality. Still, you're increasing employees by 1,000 people. So could you give us a bit of understanding, is it only FX and seasonality or do we have structural improvement trends here and how are you thinking about OpEx going forward into Q4 and 2020? That's number one.

Number two is, you had quite a big uplift on digital services sales in Northeast Asia and you pointed Japan. Could you give us a flavor since they are kind of pre-5G investment, what type of investment is that? Is it you know 4G packet core capacity increases because 5G isn't there yet or what do we see? Thank you.

Borje Ekholm -- President and Chief Executive Officer

If you start with increases on number of employees, it's really in our service delivery organization. As we win contracts, we need to step-up accordingly, so that you should see in that conjunction, right. So you see a topline growth and you will see some increase in service delivery staff. On our SG&A that you see and I think Carl said it also in a way we have currency headwind, so structural efficiency gains we're making are in a way cancelling out the headwind from currency. So you do see a continuous improvement there. So we're able actually to take costs out in SG&A and grow our topline. So there is an operating leverage and operating efficiency gain in there.

Then on the question about Japan, what we see and we have seen that in other markets before, there is a need also to upgrade the whole network including the core orchestration etc and all of that has to be done before you can launch 5G. So you see, this is a natural spending cycle going on in Japan as well.

Jorgen Wetterberg -- Nordea Markets -- Analyst

Okay, thank you.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you. Next question, please?

Operator

Thank you. The next question comes from the line of Johanna Ahlqvist of SEB . Please go ahead, your line open.

Peter Nyquist -- Vice President, Head of Investor Relations

Hi. Good morning, Johanna.

Johanna Ahlqvist -- SEB Enskilda AB -- Analyst

Good morning. Thank you. Two questions if I may. The first one relates to IPR revenues. You still guide for SEK9 billion for the full year, which if I do the math correctly implies that you will end up at SEK1.8 billion in Q4. I'm just wondering, if there any reason why the patent revenues should decrease in Q4 versus the SEK2.4 billion we see now in Q3?

And then my second question relates to the US market. If you can comment anything of how you expect 2020 to develop in the US. I know you sort of guided previously for more service heavy type of revenues and also how you see the mix on clients. I would expect the two major telcos in the US are very big part of your capex now and if you expect that to change in 2020. Thank you.

Carl Mellander -- Senior Vice President, Chief Financial Officer

Well, I can take the IPR question first of all. So hi Johanna. It's when we talk about SEK9 billion that is really the contract baseline annualized. This year I think we can expect the Q4 more or less in line with Q3. That would bring you a bit higher than the SEK9 billion then for this year because of some FX and well performing contracts here and then one-offs, so that would bring you to about SEK9.5 billion.

Johanna Ahlqvist -- SEB Enskilda AB -- Analyst

Thank you.

Peter Nyquist -- Vice President, Head of Investor Relations

And US market I guess was second question in 2020.

Borje Ekholm -- President and Chief Executive Officer

Yeah. We have seen a great growth in the US during 2019. We don't see that the US market is in that sense, structurally slowing down and that's because it is driven by the end user -- it's the end users consumption of data that drives the need for building network capacity. So we don't see the US market necessarily in that sense slow down because the end market is actually growing. In addition, we will have clarity on the merger, what's going to happen. So we think there are a couple of things speaking in favor of the market. On the other hand, when you have these high development, you have to at least be prepared to absorb some negative surprises. So we're just trying to position ourselves. On the other hand, we have other global markets that we see also that could contribute positively, Northeast Asia for example. So when we put together the targets for 2020, we kind of -- we said it's 230 to 240 [Phonetic] is a realistic number on the overall and that's where we're sticking to and then we can absorb some short-term fluctuations in certain markets compensated by others.

Johanna Ahlqvist -- SEB Enskilda AB -- Analyst

Thank you.

Peter Nyquist -- Vice President, Head of Investor Relations

Okay. Thank you, Johanna.

Johanna Ahlqvist -- SEB Enskilda AB -- Analyst

Absolutely.

Peter Nyquist -- Vice President, Head of Investor Relations

Then we will continue to the next question.

Operator

Thank you. And that comes from the line of Amit Harchandani of Citigroup. Please go ahead. Your line is open.

Peter Nyquist -- Vice President, Head of Investor Relations

Good morning Amit.

Amit Harchandani -- Citigroup -- Analyst

Good morning all. Amit Harchandani from Citi and thanks for taking my questions. Firstly if I may, I guess I don't know if you can help me on this. But as we look toward Q4, you've talked obviously about the revenue line and how we should think in terms of probably below seasonality. Is there any steer or assistance you can provide us as we think in terms of the gross margin, in terms of the impact of strategic contracts or any other puts and takes around the gross margin if you can help us. And then I have a follow-up.

Carl Mellander -- Senior Vice President, Chief Financial Officer

I can take that. So you saw then the impact of the so-called strategic contracts in Q3 and fairly limited 80 basis points. I think we can -- we don't see any dramatic impact of those going forward either, more dramatic, but it is there and for the reasons we have explained, we take some of these contracts when they are value accretive longer term to being the stronger footprint and this is of course in line with strategy, but somewhat negative impact that I would say contained and are limited. So I think that's the thing to keep track of for gross margin into Q4. And we mentioned also Kathrein in the planning assumptions with certain negative impact from that short-term. We also mentioned that. Final point perhaps then on digital services. You know that the 45 contracts that we have identified may have an impact in individual quarters and that impact can vary from quarter-to-quarter of course, but again just to repeat we are on track there on the recovery toward the low-single digit margin for next year.

Amit Harchandani -- Citigroup -- Analyst

And just to clarify in terms of the mix of networks, there's nothing that we need to be aware of in terms of the mix. I guess Q4 potentially tends to be a higher software quarter. So fair to assume product mix would be positive in networks?

Carl Mellander -- Senior Vice President, Chief Financial Officer

No. I wouldn't assume any specific positive mix changes into Q4. I will not model that.

Amit Harchandani -- Citigroup -- Analyst

Okay, thank you. And as a follow-up, yes, please, if I may ask, is there -- could you give us a sense for your own perspective of how the stand-alone versus non-stand-alone deployment is shaping up across your conversations with operators? How do you feel Ericsson is positioned? I understand there are few releases down the pipeline with 3GPP, but a sense of your perspective on stand-alone versus non-stand-alone would be helpful. Thank you.

Borje Ekholm -- President and Chief Executive Officer

It varies a bit by market, but we see the initial deployments being non-stand-alone, but we're seeing also the interest for stand-alone increasing, so we feel that we're well positioned in both and it depends a bit about the operator priority and how they are going to build out the network, but we see ourselves to be well positioned here in the early phases of stand-alone as well.

Amit Harchandani -- Citigroup -- Analyst

And is there any clarity around timelines or still too early to comment on that?

Borje Ekholm -- President and Chief Executive Officer

It's a bit early. You know when China launches, it will most likely be a stand-alone and we will see how that develops, right.

Amit Harchandani -- Citigroup -- Analyst

Thank you very much.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you, Amit. And we're open for the next question, please.

Operator

Thank you. And that's from Andrew Gardiner at Barclays. Please go ahead. Your line is open.

Peter Nyquist -- Vice President, Head of Investor Relations

Good morning, Andrew.

Andrew Gardiner -- Barclays Plc -- Analyst

Good morning guys. Thanks for taking the question. Just another one on China, please. Compared to the way you and others in the industry were talking earlier in the year, the contract awards have sort of been delayed and continued to be delayed, are you getting any visibility from the operators around why they're delaying it. I think we can speculate on it, but I'd be interested in the feedback you're hearing as to why this process seems to be dragging?

Also in the report this morning you're saying you do expect deliveries to China to start in the near term? Is that 4Q, are you getting any indication that could be that quickly or is it really a 2020 event?

And then just in terms of thinking about the margin impact from that, you know, is that -- are you taking into account China when you talk about the near term impact of strategic contracts or would that be additional to that still? Thank you.

Borje Ekholm -- President and Chief Executive Officer

It's easy to make predictions, it's just hard to be right. I think that holds to China as well. So we can speculate a bit and I think we don't really know. We know there are changes in the market. Two operators decided to share the network etc and I think those discussions while they're ongoing leads to certain delays and that's not to be surprised and we're not talking a particularly long delay, we're talking rather months, right. And so it's not a whole lot. So we see still China starting, it may well be early next year, it will be late this year. We honestly don't know, but we're trying to invest to gain market share and trying to be stronger in the market. That's our ambition. That's not changed. We don't know the price level yet. So it's a bit hard to forecast. But if you look historically, you typically had the tough margin in the beginning of the contract as you roll out and then you catch-up over the contract period. What we say is that we're committed to the target we have given for 2020, so you can see that it's incorporated in there and of course it can be dilutive, but we should be able to handle that in the targets we have. We see no reason to change those.

Andrew Gardiner -- Barclays Plc -- Analyst

Okay, thanks. And then just another one is related to the strategic contract. Now that we're sort of few quarters beyond when you guys first started talking about it. Can you give any sense to us of the breadth of these contracts here, is it a small number but that are particularly important and therefore you've been more aggressive and you're starting to see that impact or is it much broader across the 5G discussions that you're having and therefore you're seeing a little bit, you're being a bit more aggressive in price on a broad range of contracts? Can you help us sort of between those two ends of the spectrum? Thank you.

Borje Ekholm -- President and Chief Executive Officer

You know the first time we mentioned it was actually 2017 when we said our focus strategy builds upon gaining footprint. So it's, hey, we're delivering, we're doing what we said we will do. What we see is some of the early wins we had already in '18 actually are now contributing to our gross margin. So the reality is we see the model of gaining a footprint actually works in real contracts. Why do we define them as strategic? Well, it was the overall sense of built upon a technology advantage to gain a increased footprint. Those were defined as strategic, maybe that was the wrong wording, but that's what we call them. We are engineers, we're not great at marketing and the reality is we're trying to say that these are contracts that where we have a unique technology advantage to try to gain the footprint and they are associated with some early costs and that's typically costs for changing equipment, for example and service related costs typically. We're taking those over the P&L and we see some short-term headwinds from them, but we also see that we create a stronger business for Ericsson five to 10 years out. So it's nothing new in this. It's actually 2.5 years old.

Peter Nyquist -- Vice President, Head of Investor Relations

Okay, Andrew, you are happy with that?

Andrew Gardiner -- Barclays Plc -- Analyst

Thank you guys.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you. So we'll move to the next question, please.

Operator

Thank you, That's from the line of Janardan Menon of Liberum. Please go ahead. Your line is open.

Peter Nyquist -- Vice President, Head of Investor Relations

Good morning.

Janardan Menon -- Liberum Capital Limited -- Analyst

Good morning. Thanks for taking the question. I just wanted to go back to the strength that you saw on the digital services revenue. You said that it came from North America, North Asia and response to a previous question you said it's a normal course of business as operate as preparing for changes. So can we take this as an inflection point in the digital services revenue trend as in do you have a good pipeline of business of this nature coming in these cloud native products, which will sustain the growth that you are seeing in Q3 into Q4 as well as potentially into 2020 or could it be quite volatile as we go through the next few quarters?

Borje Ekholm -- President and Chief Executive Officer

And I won't have to just take a step back. When you look at our business, it has an element of volatility because contracts tend to be rather large and that's why it's very hard to predict and it's almost inappropriate to predict which quarter that we would never be accurate on. But the reality is what we're doing is we're building a cloud native portfolio with a modern architecture that we are seeing, gaining momentum with customers and we have a number of important wins up to date, but they are also continuing. So if you look a bit longer term, we should be able to grow this part of our business quite substantially, benefiting from the technology advantage we are creating right now.

Janardan Menon -- Liberum Capital Limited -- Analyst

Understood. And just going back to North America, previously you had talked about certain sort of constraints in terms of like tower crew and things like that. Are we now well beyond that? You've trained up your people and you have enough resources on the ground to deal with contracts as they come through?

Borje Ekholm -- President and Chief Executive Officer

Tower crews are still one of the main shortages in the US. But there are also other problems in the US, right. You can't ramp-up fast because of permitting process, it still takes quite some time to get permits, depends on which geography, depends on local counties etc. So there are restrictions in other areas as well, but tower crews are important and it actually slows down ramp-up.

Janardan Menon -- Liberum Capital Limited -- Analyst

Understood. Thank you very much.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you. We will take the next question, please.

Operator

Thank you. That's from Stefan Slowinski of Exane BNP Paribas. Please go ahead. Your line is open.

Stefan Slowinski -- Exane BNP Paribas -- Analyst

Great. Thanks and good morning.

Peter Nyquist -- Vice President, Head of Investor Relations

Hi Stefan.

Stefan Slowinski -- Exane BNP Paribas -- Analyst

Hi. Just two quick ones. First for Carl I guess on restructuring. You only have I think SEK500 million of restructuring in the first nine months of the year. You're guiding for 1% of sales for the full year, which would imply significant restructuring charges in Q4. Do you expect some sort of need for that in the fourth quarter? That's different from what you've seen in the first three quarters or is that just kind of a cautious guidance there on the restructuring side?

And then secondly for Borje on the geopolitical risks that you flagged today and the macro risks, are these related to the security discussions that we've been hearing about for well over a year now in the market or is this sort of new more macro economic risks that you're seeing, delaying some projects and is there any geography in particular that you would call out where you're seeing maybe an increase in those potential delays? Thank you.

Borje Ekholm -- President and Chief Executive Officer

No, I wouldn't say we're not flagging a delay in the market in that general sense, but we're rather saying that everyone seems to assume that the geopolitical uncertainty and the quality of security discussions will be beneficial and it would make life easy for us. That we don't see if any thing we see it rather being slower with certain customers, so it's not that we're trying to warn or anything or flag in any way, but it's more combating that notion that life is easy and the walk in the park because we don't know it's a very competitive market we still see -- compared to those being aggressive on price levels, etc. So that's more -- the norm -- the business as usual kind of prevails, so don't read anything more into it. But then it's fair to say that what goes on is something in a way it's a political national security mix into one thing where I don't think we can have any view or shouldn't have any view, we can only focus on one thing, which is working with a customer, make sure they get the best solutions, make sure they get the best way to operate their network, providing the best quality service to their end customers. And if we do that, we will win business. And I think that's what you see us do during Q3 and you've seen us do it for the last year and a half as well. So our focus is clearly on winning business and we win business based on our own merits.

Then on the restructuring, Carl takes that.

Carl Mellander -- Senior Vice President, Chief Financial Officer

I can take that. Hi, Stefan. So of course, we're always working on efficiencies and cost out, but we are able to limit the cost to do that, restructuring costs and and we also have growth absorbing headcount at the moment. So there's less of restructuring costs then for those reasons and you're right that we have invested or spent quite a low amount so far this year. There will be some more in Q4 and we aim now for about 1% of net sales as a total. And as you will remember, this is also our long-term ambition that we talked about a year ago at the Capital Markets Day about 1% of net sales and we're looking out for that already now in 2019.

Peter Nyquist -- Vice President, Head of Investor Relations

Okay, Stefan.

Stefan Slowinski -- Exane BNP Paribas -- Analyst

Thank you very much.

Peter Nyquist -- Vice President, Head of Investor Relations

So operator we're open for the last question as we're getting closer to the hour, so please let the analyst into the call.

Operator

Thank you. The last question comes from the line of Fredrik Lithell of Danske Bank. Please go ahead. Your line is open.

Peter Nyquist -- Vice President, Head of Investor Relations

Hi, Fredrik.

Fredrik Lithell -- Danske Bank -- Analyst

Hi, thank you for taking last question. Much has been answered, but maybe Borje if you could just clarify your early comment on how we should view the potential in Q4 and on the sequential growth expectations and what you have seen in the latest years if your sequential growth normal base sort of what we should base it on?

And the second one is you have talked about sort of mix shifts throughout the year here, North America product and service mix shift and then also geographic mix shift. If you could sort of update on those comments if they still stand or if they have are more muted right now and/or if they are pushed, so just clarifying that. Thank you.

Borje Ekholm -- President and Chief Executive Officer

What we say is that the normal seasonality is about 18% Q3 to Q4 over the last two years. We foresee a bit less seasonality this year and that's because of the uncertainty of this. I don't know what would be announced merger in North America without going into customer names. We see that to limit spend a bit and limit that seasonality. So we should see -- we expect to see less seasonality. That's basically what we've guided. I think the mix question is of course an important, but I also want to say we see given the work we've done on cost efficiency and adjusting our cost structure and we leverage here both of course product costs, hardware costs, but also AI and automation to limit -- to gain efficiencies in service delivery. We see less exposure to the mix than we have in the past, because I think overall our business is a bit tighter and a bit leaner. Having said that, the guidance we've said this pretty much still there, as you said.

Fredrik Lithell -- Danske Bank -- Analyst

Okay, thank you.

Peter Nyquist -- Vice President, Head of Investor Relations

Okay, Fredrik. Thank you. So before handing over to Borje for his closing remarks, I just want to remind you of the investor update we have at 3'O clock Central European Time. There we can spend more as I said in beginning more on strategic long-term topics.

By that, I would like to hand over the closing remark to you Borje, please.

Borje Ekholm -- President and Chief Executive Officer

So thanks everyone for listening in. We are very excited about the opportunities we see in front of us for our technology and we see the market for 5G being much bigger than we've seen for 4G. We see 5G as we create new applications both for consumers, but most importantly for enterprise, we see a much larger market potential for 5G than we've seen for 4G and we are determined to capture that growth potential first by investing in R&D for technology and cost leadership, but also to make sure we have a strong footprint in the market as we expand into 5G. And with the third quarter result, we continue to see progress on executing on our focus strategy to be a stronger company five to 10 years out.

So with that, thank you and thanks for listening in.

Peter Nyquist -- Vice President, Head of Investor Relations

Thank you.

Operator

[Operator Closing Remarks]

Duration: 63 minutes

Call participants:

Peter Nyquist -- Vice President, Head of Investor Relations

Borje Ekholm -- President and Chief Executive Officer

Carl Mellander -- Senior Vice President, Chief Financial Officer

Daniel Djurberg -- Handelsbanken Capital Markets -- Analyst

Alexander Peterc -- Societe Generale SA -- Analyst

Sandeep Deshpande -- JPMorgan Ltd. -- Analyst

Jack Egan -- Charter Equity Research -- Anlayst

Achal Sultania -- Credit Suisse AG -- Analyst

David Mulholland -- UBS Investment Bank -- Analyst

Jorgen Wetterberg -- Nordea Markets -- Analyst

Johanna Ahlqvist -- SEB Enskilda AB -- Analyst

Amit Harchandani -- Citigroup -- Analyst

Andrew Gardiner -- Barclays Plc -- Analyst

Janardan Menon -- Liberum Capital Limited -- Analyst

Stefan Slowinski -- Exane BNP Paribas -- Analyst

Fredrik Lithell -- Danske Bank -- Analyst

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