Ericsson (NASDAQ: ERIC) Q1 2020 Earnings Call Transcript

Ericsson (ERIC) Q1 2020 earnings call dated Apr. 22, 2020

Corporate Participants:

Peter Nyquist — Vice President, Investor Relations

Borje Ekholm — President and Chief Executive Officer

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

Analysts:

Daniel Djurberg — Handelsbanken — Analyst

Edward Snyder — Charter Equity Research — Analyst

Francois Bouvignies — UBS — Analyst

Jorgen Wetterberg — Nordea — Analyst

Peter Kurt Nielsen — ABG — Analyst

Stuart Jeffrey — Agency Partners — Analyst

Paul Silverstein — Cowen — Analyst

Johanna Ahlqvist — SEB Enskilda — Analyst

Alexander Duval — Goldman Sachs — Analyst

Patrick Chan — Credit Suisse — Analyst

Presentation:

Operator

Welcome to Ericsson’s analyst and media conference call for their first quarter reports. To view visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. [Operator Instructions] As a reminder, replay will be available one hour after today’s conference.

Peter Nyquist will now take you through the call.

Peter Nyquist — Vice President, Investor Relations

Thank you, operator, and welcome to today’s call, the Q1 result call. And as due to the unprecedented circumstances, we will obviously do this call a little bit different. We have our President and CEO, Borje Ekholm in US, and we have our CFO here — Carl Mellander here in Stockholm. So, we will conduct the meeting based on that, but I think that will work fine.

So before starting the meeting, I would just like to read the following text. 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 factors mentioned in today’s press release and discussed in this conference call. We encourage you to read about these risks and uncertainties in our earnings report as well as in our newly published annual report.

So with that said, I would like to hand over the call to you, Borje. So please, Borje.

Borje Ekholm — President and Chief Executive Officer

Thanks Peter, and again, welcome to this analyst briefing. Of course, it’s a bit different than usual, and I cannot be in Stockholm due to the restrictions. And I guess it’s – it may well be the new way of working. So working from home is the new normal. But anyhow, we’ll try to do it as much as normal as possible.

So let’s go to the first slide. Of course, we have to recognize that with COVID-19, we truly live in an unprecedented time. It’s impossible to predict how long and also at what level this pandemic will impact our lives. But one thing is for sure, it has direct and indirect impact on all of us and the way we live and the way we work. Every business decision we have taken have — we have made with the safety and health of our employees, customers and other stakeholders as a primary concern.

And what we’re doing? We’re working to support our customers to ensure that they keep the critical national infrastructures around the globe up and running during these unprecedented times. We continue to push forward on our focused strategy, and we are determined to get through these difficult times as a much stronger company, more agile and well positioned in the market.

We delivered a solid Q1, which is seen across our segments, and we’re delivering a strong gross margin and good cash flow. We’re pleased to see a strong performance in Networks, which is a result of high activity across many of our regions. Operating leverage compensated for an increased portion of strategic contracts. And in the quarter, we have seen very limited impact from COVID-19.

Unfortunately, we’ve seen a decline in sales for Digital Services. This has been a result of one, reduction in hardware, which is fully along our strategy to reduce the dependence on hardware in Digital Services. But we have also seen some timing of contracts, partly explained by COVID-19, which simply have made it difficult for us to gain access to customer networks during the lockdown and travel restrictions. At the same time, it’s good to see that the underlying business is strong. We can deliver gross margin of 40% for Digital Services, and that’s on the back of growing software sales, and that’s also after we have taken a provision for critical contracts of SEK200 million.

So we feel that we have a very strong and competitive portfolio, and we have several wins during the first quarter. And we are also very comfortable that this positions us well for the future. We continue to drive forward with investments in R&D for a cloud-native and 5G core portfolio areas. Our industry has shown resilience even during this pandemic, but I think it is reasonable to expect some impact as well. And we continue to be prepared to take action, if needed. But one thing is for sure, our commitment to coming through this as a stronger company requires us and demands us to continue to push forward on R&D as a way to create a competitive advantage.

At the end of the quarter, we have signed 86 commercial 5G contracts and delivered 29 live networks, and now we have actually 31 networks live. So it’s a bit of a daily number. So we remain positive on the long-term outlook, but we anticipate a tad softer second quarter, and this is due to the uncertainty from COVID-19, but also that we see a number of strategic contracts falling in Q2 instead of being evenly spread out over the year. And that, of course, include the important win in China.

However, I prefer to look at the longer-term perspective of our company, and I have not felt better than I do today about the competitiveness across our business and across our portfolio. We see a very different discussion with customers today. So we are on the right track here. So, that’s why we also remain committed to our targets for 2020 and 2022 due to the fact that we have a strong business.

On the next slide, we put together some summary of the COVID-19. And of course, it’s — we’re in the same situation as every company, and we’ve been required to take a number of decisions based on the facts available when we — at the time of decision. And here is a way to at least to put some of them on a slide. So you see, the most important guiding principle for us has been the safety and health of our employees and partners and customers. And we have also always kept the customer at the center, how do we ensure that they are not affected. And I would overall say, and that’s very important, we have seen very, very limited impact, if any, on the customers’ business.

We’ve made a couple of significant decisions over the quarter. So to summarize, we have encouraged and now we actually have about 85,000 of our workforce working from home and successfully using the collaboration tools we have available. We have limited all travel, except for business essential travel. Today, it’s shut down, but we did that early. We cancelled all external events, and we cancelled our participation in Mobile World Congress already in early February. We’ve had our Crisis Management Council established, and part of that work is also to assess our business continuity.

And we have teams focused on ensuring that supply, R&D, service delivery, our network operating centers are all managed to respond to different scenarios and different customer requests. And thankfully, we have multiple production sites and global sourcing, which has enabled us to key flexibility to deliver against our commitments to customers.

And overall, I must say, I’m super proud of the dedication and commitment our — my colleagues have shown in the situation here, working really hard to deliver to customers, keeping their networks running 24/7. We have field engineers out servicing the equipment, continue to do so despite the lockdown and tough environments. And it shows the real stamina of the — of our people in the company and that we have undoubtedly the best people in the industry.

If we move on to look at the different market areas, we see that Europe and Latin America fell, which is, to a large extent, due to very large deployments in the first quarter of 2019 in Latin America, but also some planned exits of Managed Services contracts as part of the contract review. What we also have seen is that Europe actually grew during this period.

Then, if we take the next, which is then Southeast Asia, Oceania and India, we saw sales declining in — due to timing of projects and deliveries and milestones. We see Northeast Asia experienced a decline in 4G deliveries to China but had a solid growth in Japan. Middle East and Africa saw good growth on the back of investments in 4G and 5G in key markets.

And North America had a good growth, driven by a strong 5G momentum. Worth to mention here is that the merger continued to affect with uncertainty during the first quarter, and we expect the merged company, now that it’s approved, to pick up the spending in the second half of 2020. We also note that the Managed Services or their view on outsourcing is different, so we expect to be negatively impacted during Q2 on Managed Services from that merger.

Finally, on the segments, in Networks, we continue to strengthen gross margin, and it’s now at 44.6%, as operating leverage more than offset an increased portion of the strategic contracts. And here, we see that our investment in R&D is paying off in 5G momentum, but also on a very solid in-field performance of our gear.

Sales in Digital Services declined primarily due to lower hardware sales and timing of contracts, part of that timing impact by COVID-19. But we also see the focus on software is starting to pay off and with growing sales of software, and that helped gross margin reach 40%, despite the charge of SEK200 million on critical contracts. But the most important thing for Digital Services is that we continue to execute on the roadmap of providing leading solutions to our customers, and we see very good traction on our portfolio with several important wins during the quarter.

Managed Services top line declined as a part of the contract review — or contract exits as part of the contract review we conducted over the last few years. But the more important thing here is, we see a continued good gross margin development, and it’s now above 20%. As we have said before, operating margins will vary a bit by quarter because of timing of contracts and costs. But the ambition we have to invest in R&D to develop new automated offerings are really starting to gain traction, and we can see that is a key driver of the improved gross margin.

Emerging Business saw continued growth in the different businesses. The IoT platform continued to grow faster than the market, and this is an investment area where we’re encouraged by the traction we have.

With that, I give the word over to you, Carl.

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

Thank you, Borje, and good morning, good afternoon to everyone. Thanks for joining the call. So let’s look at Q1 2020 numbers a bit more.

To start with then, you see the top line, SEK49.8 billion. And this is a decline of 2%, if we adjust for non-organic and FX, due mainly then to, as Borje mentioned, Digital Services, where we had reduced sales of services and legacy hardware. And the services piece, yeah, we saw fewer project completions in the quarter and some negative effect of COVID-19 as well, rather limited. Network was flat and Managed Services down 5% due to planned contract exits, as was mentioned before.

Gross margin, 40.4%. It’s the highest in a long time. And all segments improved. I think that’s a strong point in this quarter. Favorable business mix contributed, but also efficiency gains to this number.

If you look at the operating income then, SEK4.6 billion. That’s 9.3% operating margin. However, if we adjust for some of these positive one-offs we had in the first quarter of 2019, you see that the — then adjusted operating income increased by 30% from SEK3.5 billion to SEK4.6 billion.

As you know, judging us or any company by individual quarters might not be the right thing. So, we prefer to look here at the rolling to complement the picture as well. So if you look at the graph there in the bottom left, you see that our net sales on a four-quarter rolling basis is SEK228.1 billion, with an adjusted operating margin of 9.6%, both being well in line or aiming for the 2020 target. And importantly, as Borje said, with the visibility we have now, we see no reason to change the targets for 2020 or, for that matter, 2022.

Here, you see the gross margin development over a number of quarters, blue line here being the rolling four quarters value, again, and of course, obviously, showing a much smoother development than the individual quarters that you can see on the gray dotted line here. And as you see, the current rolling four-quarter number is very much in line with and aiming for the midpoint of the 2020 target. As you remember, the target was expressed as 37% to 39% gross margin.

So, in the first quarter here, we recorded 40.4%, again, excluding restructuring, up from 37.1% in Q4, driven by improvements in all segments, but as a matter of fact, also by a higher share of IPR in this quarter. IPR as such was flat, but the share of IPR of sales was higher in Q1. And gross margin improvement then come from — in Networks, it’s to a large extent, the business mix question; Digital Services, higher software share, but also better hardware margins; and Managed Services then, lower cost in the quarter and efficiency gains coming out of the investments we do in R&D, therefore, artificial intelligence, etc.

So I wanted here to take the opportunity also to highlight some of the planning assumptions that impact the gross margin. And as we discussed, the China Mobile has awarded us their 5G RAN market share. And we, by the way, also expect to have market share decisions from the other two major operators in China soon, towards the end of the month here. Deployments there will start to happen in Q2, and that we expect to have an increasingly negative impact on our results then in Q2 compared with Q1. Of course, as in all previous quarters, we expect to partly offset this by continued operational improvements. And this will, of course, never stop to offset and compensate with other improvements.

When it comes to North America, we expect then investments from the carriers there, capex investments to intensify during the second half, not so much in the second quarter, but in the second half of 2020. And of course, we believe we have a strong position in the North American market.

And finally here, we should say and we always say that we can expect to continue to see variations in gross margin. And this is particularly true, I would say, in Digital Services and Managed Services due to sales mix and project mix and the timing of cost in those segments.

Okay. If we move on to the next one, let’s look at R&D and SG&A. And of course, these items also can vary between the quarters, not least due to seasonality. So here, the comments are really about the year-over-year development, starting with R&D then.

In general, investments in R&D, as you know, is a strategic cornerstone for us, and we see clear correlation between R&D investment and gross margin improvement. And here, we’re focusing, of course, the investments on 5G, but also AI, for example, across the segments. The year-over-year development here shows an increase of the R&D by SEK0.2 billion then for the group, and part of that is actually due to FX. Also, the net capitalization impact here was SEK0.2 billion lower than a year ago. So you could say the underlying increase is slightly more than that. And where is that increase? It’s mainly Networks because in Digital Services, we reduced the focus of — focus to portfolio, but also reinvest some of those reductions into the new 5G and the cloud-native portfolio.

Moving to the bottom part here, SG&A expenses increased by SEK0.2 billion then due to FX, but also the investments in digitalization that we have talked about last quarter as well. And some of the final points, we had a revaluation of customer financing, impacting SG&A here SEK0.3 billion, and also an impairment loss on trade receivables at SEK0.2 billion. And you can compare that then with a positive SEK0.6 billion in the first quarter of last year.

So we have previously talked about the planning assumption when it comes to SG&A, and we stick to that. So we expect somewhat higher operating expenses in general here than in 2019, driven then by, as we have talked about before, compliance, security and digitalization investments, but also when it comes to R&D, then including now the acquired antenna business from Kathrein. But again, I said at our investor update as well, the ambition we have is to grow top line more than the expenses here, of course.

Free cash flow: we delivered positive free cash flow of SEK2.3 billion before M&A. And remember here, when we do the year-over-year comparison, that we had a positive onetime effect in Q1 ’19, which was a payment of a large overdue customer receivable of SEK0.7 billion.

If you look at the working capital line, there is a small buildup in this quarter, SEK0.4 billion. And I would say this is a mix of inventories and trade payables after a very long period of reduction in working capital. And of course, this is a big — we have a big focus internally here on maintaining good working capital efficiency also going forward now in this current climate.

Capitalized development, which is then part here of the capex line was reduced, so it’s about SEK250 million this quarter versus SEK450 million a year ago.

Finally, on this slide and on a rolling four-quarter basis, again, free cash flow before M&A amounts to SEK16.6 billion, and this is then if we exclude the DOJ/SEC fine, and that is amounting to 7.3% of sales on a rolling basis.

Here, you see the current financial position and you see cash position here, gross and net to the left, and our debt maturity profile to the right in this chart. And so, end of this quarter, we ended with a net cash position of SEK38.4 billion and gross cash now amounts to SEK79.5 billion. And if you look at the debt maturity profile here, you can see that our debt that we have now matures over the coming five years, and the average maturity is 2.4 years. What’s important to keep in mind is that now in Q4 this year, SEK8.7 billion of that will mature, and our intention here is to repay this with cash on hand.

And now, before handing over to Borje again, I recommend you all strongly to read the planning assumptions closely. We will not go through them in any more detail than what I’ve already said. And also on Page 1 in the report, you find the planning assumption highlights. And on Page 4 in the report, you find a complete planning assumption. So, please read those assumptions to guide the Q2 and full year outlook here.

Thank you so much. And let me now hand over to our CEO, Borje Ekholm.

Borje Ekholm — President and Chief Executive Officer

Thanks Carl. So in closing, before we head into Q&A’s, we have worked hard now to ensure that we are the leader in 5G, which is basically underpinning our performance. We see our focused strategy with increasing investments in R&D is paying off. And we have now established the gross margin on a new level, but more importantly is that our technology is winning in the market. I would say that is proven with our 86 commercial contracts and 29 live networks on 5G by the end of the quarter. And today, it’s, as I said before, 31 live networks.

The criticality of the networks has never been more apparent than we see it today. The COVID pandemic has further strengthened the need for all countries to invest in communications infrastructure, as it is the backbone of society in many ways, and that has been increasingly clear. And here, we especially call upon the European government to look for ways to encourage investments in 5G, as that is surely one way to help restart the economies once the pandemic is over. We have now so many proof points on how this will help emergency services, small and large businesses, as well as consumers. And not to mention it but, as most of us today in Europe work from home, we depend on good and solid telecommunications infrastructure.

We will continue to make our investments in the technology to strive even further ahead with our portfolio leadership. And here, we feel that we are well positioned for the future. We have completed a solid first quarter with limited impact on our operations from the pandemic. And with what we can see today, we see no reason to change our financial targets for 2020 and for 2022.

So with that, thank you. Over to you, Pete.

Peter Nyquist — Vice President, Investor Relations

Thank you, Borje. Yes. Thank you, Borje. So we have about 30 minutes for Q&A. So with that, I would like to hand over to you, operator, to open the Q&A session. So please.

Questions and Answers:

Operator

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

Peter Nyquist — Vice President, Investor Relations

Good morning, Daniel.

Daniel Djurberg — Handelsbanken — Analyst

Good morning and thank you for letting me on the call, number one. Congratulations on a strong quarter. I just would like to ask you about the very strong Network gross margin of 44.6% despite strategic contracts. And to me, this shows a very good impact perhaps on currency, but also network capacity upgrades. And my question is really, if this assumption is correct, should we expect to see this capacity upgrade boost helping also Q2 and onward? Or is it more of a onetime upgrade effect that you can do remotely to help your operators to cope with the capacity constraints we’ve seen in the quarter? Thank you.

Peter Nyquist — Vice President, Investor Relations

Will you start that, Borje?

Borje Ekholm — President and Chief Executive Officer

I can start that. As you note, of course, there is some element of upgrades. But it’s also part of the longer term strive to gradually change the business to be more and more tied towards software upgrades. So the improvement in gross margin may be somewhat bigger in an individual quarter, but you also have seen the trend go in that direction. So I think you should not see it as a one-off, but rather as part of a strategic initiative to change our gross margin profile in Networks. What we can say, though, is that we do expect the gradual improvement to continue over time. That’s our fundamental premise for the focused strategy. But you will see a tad soft top line and gross margin in Q2 due to the reasons of the COVID-19, but also disproportionate share of strategic contracts, including China in Q2.

Daniel Djurberg — Handelsbanken — Analyst

Okay. Thank you. I’ll get back in line. Good luck in Q2.

Borje Ekholm — President and Chief Executive Officer

Thanks.

Peter Nyquist — Vice President, Investor Relations

Thank you, Daniel. We’re open for the next question.

Operator

Thank you. That’s from the line of Edward Snyder at Charter Equity Research. Please go ahead. Your line is open.

Peter Nyquist — Vice President, Investor Relations

Good morning, Ed.

Edward Snyder — Charter Equity Research — Analyst

Thank you. Good morning. Carl, if I could, on gross margin again, clearly, you’re facing a more strategic investment environment, especially in North America with the T-Mobile and Sprint merger coming up here. You’re normally seasonally down in 2Q in gross margins. Should we expect that to be a bit exacerbated this year? Or is that going to be pushed to the second half of the year, as you mentioned, most of that will play out then? And then, Borje, if I could, now that you have antennas, will that be brought to bear in your revenue line soon enough to affect 5G? I know there’s a lot more invested by the carriers in the antenna side of the business, especially for the MIMO systems. Can you get your qualification and bring up a product soon enough to affect that? Or is it more of a long term investment? Thank you.

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

Hi, Ed. Carl here. I’ll start with the — yeah, thanks Borje. I’ll start with the first one. It’s a bit similar when it comes to the gross margins there. Of course, we have a favorable business mix in Q1, and gross margins will vary. Now in Q2, of course, the China volumes will come in, and that will weigh on the margin somewhat. While the merger investments, what we see now is that the investments there will take off in second half, so not so much in the second quarter. But over time, that will, of course, come into the mix as well, but not so much in the very near term. But I would say, the full year guidance remains. And if you look further down on EBIT, it’s still the 15% to 17% operating margin that we talk about for Network that we are aiming for. And with 16.8% here, we are clearly in that range and in the upper end of that range. So we keep the 15% to 17% for the full year.

Peter Nyquist — Vice President, Investor Relations

Great. Borje, on the antenna.

Borje Ekholm — President and Chief Executive Officer

Yeah. We acquired, of course, the Kathrein business for a couple of reasons. One is the capabilities and product portfolio in passive antenna. But we also see the importance of offering integrated site solutions between 4G and 5G to our customers. So what we are doing there is investing — basically, we’re increasing the investments in developing the portfolio of Kathrein to make it even more competitive in the market. And we see a good growth opportunity in antennas, and that’s what we’re investing to capture. That will be partly in more complicated antennas systems like Massive MIMO, but will also be in the more passive antennas. And that is a key investment area for us. It will take some time. You will not see that to yield a quick result. It takes — it’s going to take maybe 18, 24 months to upgrade the product portfolio of Kathrein, but we feel encouraged by the progress we’ve made since the acquisition closed late last year. Thanks Ed. We will go to the next question, please, operator.

Operator

Thank you. That question comes from the line of Francois Bouvignies of UBS. Please go ahead. Your line is open.

Peter Nyquist — Vice President, Investor Relations

Good morning, Francois.

Francois Bouvignies — UBS — Analyst

Hi. Thank you very much. Good morning. I just have a quick question on the full year outlook for 2020. So you still, according to Dell’Oro, see RAN of 4% growth for the full year 2020. And if we look at Q1, it was flat. And if we look at your guidance for Q2, it’s also not growing. So I just wanted to see like what are the main drivers that you will see in H2, if you can quantify as well? And with the COVID, do you see any potential downside risk to this compared to, let’s say, one quarter ago, given that it’s all pushed out into the second half? Thank you very much.

Peter Nyquist — Vice President, Investor Relations

Would you start that, Borje?

Borje Ekholm — President and Chief Executive Officer

Yeah. The COVID-19 impact is, of course, hard to assess. And we need to be a bit humbled in predicting what is going to impact. On the one hand, if we look globally, we see a number of countries actually accelerating investments into 5G as well as 4G capacity in response to the pandemic. One of the clear cases is clearly China. But if you look in Europe, it’s doing the opposite, slowing down adoption of 5G. So, the impact is a bit difficult and not transparent to see. What we see so far is actually, on the totality for our business, it’s no impact at all. We see continued good demand, and that we expect to continue throughout the year.

What we do say is that deployments in China, it’s a partly bookkeeping effect that you need to book the cost upfront, but we will also start to see acceleration in the second part of the year. So the — we use Dell’Oro as an estimate for the total market during the year, and there’s an outside perspective on the growth. We don’t see any reason to have a different view than Dell’Oro. So, we believe we will see growth in the RAN market of some 4% this year. But of course, it’s an acceleration in the second part, partly driven by China.

Francois Bouvignies — UBS — Analyst

Okay. And the US as well, quantifying?

Borje Ekholm — President and Chief Executive Officer

Yeah. The US will clearly also — the merger uncertainty will be removed, and we don’t think it’s right to plan for any ramp in the merged operator spending until the second part of the year.

Francois Bouvignies — UBS — Analyst

Thank you very much.

Peter Nyquist — Vice President, Investor Relations

Okay, Francois, thank you. We’ll move to the next question. Okay, Francois. Thank you. We’ll move to the next question.

Operator

Thank you. That’s from the line of Jorgen Wetterberg of Nordea. Please go ahead. Your line is open.

Peter Nyquist — Vice President, Investor Relations

Good morning, Jorgen.

Jorgen Wetterberg — Nordea — Analyst

Good morning. Thank you very much for taking my question and congratulations. So two questions, if I may. One is related to your China business, if you could give a little bit more color on whether you think it will be EBIT accretive versus the margin targets of 10% this year or maybe if it will be later during the lifetime of the contract? And then maybe more in particular, since you have more detail on that on the China Mobile 5G contract that has been announced. And also if there will be — if you think there will be further investments from China Mobile in H2?

Question number two is relating to Digital Services. What level of confidence do you have to reach the full-year guidance that you have? If I take the midpoint sales and the low-single-digit EBIT margin target, if I do the math, correct, that gives between SEK1.5 billion and SEK3.5 billion EBIT to bridge before the end of the year. So, what is your confidence there? And will we see progress already in Q2? And what are the main levers? Thank you.

Peter Nyquist — Vice President, Investor Relations

Will you start, Borje?

Borje Ekholm — President and Chief Executive Officer

We start with the China question then. It’s — if you look at the typical profile in China, it’s margin accretive over the full contract, but it’s, of course — it’s loss making in the beginning, and that’s what we’re trying to say here. So exactly how that is going to look like, we will see when we — when the other operators have concluded their RFPs. So we will come back on that. But what we have — we have already, and when we set out a target of 10% margin for 2020 in the beginning of — in late last year and the beginning of this year, we actually assumed that we would have negative contribution from China in there. So exactly how that is going to look like for the full year, we’re comfortable about the overall outlook, but we also say that we will have a disproportionate effect in Q2. But then you can conclude, you will see benefits in the rest of the year.

Digital Services. The most important thing with Digital Services is, of course, that we have said that we are going to reach low-single-digit margins this year, and we continue to execute on that plan. Here, you do have some effects of the COVID-19 that actually pushes projects over quarter ending, etc. So it is a bit more exposed and that is service delivery with physical persons traveling into countries, going to customer premises, etc., and that is difficult in today’s environment. So, that you should bear in mind. But the most important thing with Digital Services is the investments we make in the forward-looking portfolio. So what we feel very comfortable about is our competitive ability with the solutions in Digital Services. And that we see driving — that’s what’s really going to turn around the business. And there, we see great progress.

I will be honest to say, we’re not focused on an individual quarter. And DGS, it fluctuates quarter-by-quarter depending on project completions, etc. So predicting a quarter is always associated with a large degree of uncertainty. But the trend is there and makes us very comfortable to see that we’ll turn around this business and make it into a contributor for Ericsson. That confidence is not shaken out at all.

Jorgen Wetterberg — Nordea — Analyst

Thank you, Borje.

Peter Nyquist — Vice President, Investor Relations

Thanks, Borje. Okay, Jorgen, are you happy with that?

Jorgen Wetterberg — Nordea — Analyst

Yes. Thank you.

Peter Nyquist — Vice President, Investor Relations

Good. Operator, we’ll move on to the next question.

Operator

And that’s from the line of Peter Nielsen at ABG. Please go ahead. Your line is open.

Peter Nyquist — Vice President, Investor Relations

Hope you are good.

Peter Kurt Nielsen — ABG — Analyst

Thanks a lot. Thank you. Just last quarter, we spoke a lot about the investments in digitalization and the loss in Kathrein in Q4. We’ve spoken less about it this time, obviously given impressive margins. Could you just talk about the — are these investments on track or sort of in line with the size you indicated three months ago? And similarly, has Kathrein also showed the expected, I guess, it has improvement in the profitability that you anticipated? Has anything changed in these two regards versus three months ago? Thank you. Also, looking ahead for the rest of the year. Thank you.

Peter Nyquist — Vice President, Investor Relations

Carl, maybe you should start.

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

Both of these actually are on track. So we can say on the digitalization, we continue to invest in digitalizing our Company. We believe that is going to help us to come out as a stronger company also when the COVID-19 pandemic has subsided. So we feel those investments are critical for our long-term competitiveness, and we will push ahead. And of course, they’re included in the targets for 2020. And the same thing applies to Kathrein. We know that there will also be a gradual journey, so we are investing for technology leadership in antennas. So we’re increasing R&D, but we’re at the same time, working also to have the right cost structure in the business. So progress there is according to plan that we said in Q4.

Peter Kurt Nielsen — ABG — Analyst

Super. Thank you very much.

Peter Nyquist — Vice President, Investor Relations

Thank you. Operator, we’ll move to the next question.

Operator

That’s from the line of Stuart Jeffrey at Agency Partners. Please go ahead. Your line is open.

Stuart Jeffrey — Agency Partners — Analyst

Thank you. Good morning, everyone.

Peter Nyquist — Vice President, Investor Relations

Hi, Stuart.

Stuart Jeffrey — Agency Partners — Analyst

Hello. So I got a question on capacity investments. Just thinking intuitively, if there are fewer people traveling due to COVID, there are more people at home, which in turn, means there’s more people on Wi-Fi. And that should mean there’s less demand on your overall mobile network, specifically LTE 4G networks.

So I guess, I’m trying to understand why do you see or are you seeing still strong demand on capacity investments during the course of this year? And why we wouldn’t we expect that to perhaps ease off, perhaps compensated for by investments in 5G, but why wouldn’t the investments in 4G capacity not ease off, if fewer people are traveling and using the mobile networks? Thanks.

Borje Ekholm — President and Chief Executive Officer

This all vary by country. It’s a much more complex picture than you described there. And what you see is an increase in overall traffic in the networks. So despite roaming being down, which is clearly affecting the market negatively, and to some extent, some of the mobility features are also down. But you see a quite large increase in overall traffic in the network. So it’s — in some countries, you’re going to see exactly the situation you described. That’s in countries with a very strong fiber network, for example. But there are a large number of countries with a very — not at all similar, but they’d rather experience very heavy growth in traffic.

So I think the picture is not as straightforward as you show. And in large parts of the world, we see that the people hardly have a fixed line connection at home and rather rely on the mobile network for their older connectivity needs. But if you live in a country with a poor mobile network, which actually many countries have, also in Europe. Of course, you’re going to rely more on alternative means.

Peter Nyquist — Vice President, Investor Relations

You good with that Stuart?

Stuart Jeffrey — Agency Partners — Analyst

Yeah, I was just thinking that the vast bulk of revenues do come from countries with pretty established and strong fixed line networks. I don’t understand that for India?

Borje Ekholm — President and Chief Executive Officer

But in most of these countries — but we have to look at the real pattern in the traffic, right? And the traffic actually increases. So does that mean that they may not benefit from all the features that you have from mobility, but you see the overall traffic increasing in the mobile network as well.

Stuart Jeffrey — Agency Partners — Analyst

Okay. Thanks.

Peter Nyquist — Vice President, Investor Relations

Okay. Thanks, Stuart. We’ll move over to next question.

Operator

Thank you. That’s from the line of Paul Silverstein at Cowen. Please go ahead. Your line is open.

Paul Silverstein — Cowen — Analyst

Appreciate taking the question.

Peter Nyquist — Vice President, Investor Relations

Good morning, Paul.

Paul Silverstein — Cowen — Analyst

Good morning. Good evening. Clarification. You all pointed out that with respect to the Chinese contracts, long term, it’s net positive impacts on the bottom line, but adverse early on. And maybe I misheard, but I thought you also said that you’re expecting most of the adverse impact to hit in Q2 then followed by, I thought you said benefit in the second half of the year.

Do you literally — do you expect to see an actual benefit in terms of net impact in the second half of the year, or do you mean — do you expect to see improvement from the particularly severe impact in Q2, albeit still a negative impact throughout the year? I assume it’s the latter.

Peter Nyquist — Vice President, Investor Relations

Will you start there, Borje?

Borje Ekholm — President and Chief Executive Officer

Yeah. Q2 will be negatively impacted, clearly, as we have said here. So that’s no question. And you will see improvements in the second part of the year, leading up to the full year forecast. When we know the full knowledge of the business in China, we can be more specific how it’s going to impact, but we foresee the negative effect primarily in Q2 and then improving during the year.

Paul Silverstein — Cowen — Analyst

Borje, just to be clear, when you talk about improve — when you talk about improving, can it actually benefit in the second half of the year from a bottom line perspective?

Borje Ekholm — President and Chief Executive Officer

Our plan is that — I don’t want to talk about specific quarters, except that we see the pain in Q2, right? But we also see that we can reach the full-year target, right? So you have to kind of assume based on that, that at least we’re taking a contract, which hurts us short term, whether that hurts us in Q2 and Q3, or if it’s going to be only Q2, I cannot say today, because it ultimately depends on when delivery starts and how they look like. But we can clearly foresee a bit of a hurt in Q2, but reducing over the year, but it’s not the business.

The rollout business, and that’s general for all operators. It’s actually not a quarterly business. So it’s a very artificial time line when we introduce quarters. So some go — it may actually take six months to roll out the network or seven months and then it’s all of a sudden impacting three quarters. So it really depends on and it’s a bit early to know yet.

Paul Silverstein — Cowen — Analyst

Understood. I appreciate that. Thank you.

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

Maybe just to complement, Carl here, and reiterate the fact that one of the operators have decided, but the other two have not yet. So we — it’s really a bit too early or very much too early to talk about specific volumes. But I guess the assumption here is that we will have high volumes in Q2, and that’s mainly what we’re talking about. That’s why it will weigh on the margins, especially in Q2. But then the rest of the volume will come in the later part of the year. So let’s see when we have clarity from all operators in China.

Peter Nyquist — Vice President, Investor Relations

Great. Thanks, Paul, for that question. We’ll move over to the next question. So operator, please.

Operator

That’s from the line of Johanna Ahlqvist of SEB. Please go ahead. Your line is open.

Peter Nyquist — Vice President, Investor Relations

Good morning, Johanna.

Johanna Ahlqvist — SEB Enskilda — Analyst

Good morning. Thank you so much and congratulations to strong results. I’m just wondering on — we talk a lot about the margins, but I’m thinking the seasonality you guide for less than the normal seasonality on sales in the second quarter.

And I’m just wondering, given the fact that you just commented on high volumes in China in second quarter, how do you foresee — I mean, normal seasonality is 11%. How much less — what’s lower, so to say, is it 5%, or is it — because I guess then you need to assume that other countries, except China, will be much worth of. So I’m just wondering how if you can give any favor on how you see seasonality in Q4, split on geographies or divisions?

And then just a second question, if I may, in terms of visibility on operators capex spend. What is your visibility? Is it three months, six months, or yeah, how do you foresee that? Thank you.

Peter Nyquist — Vice President, Investor Relations

Will you start, Carl?

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

Yeah. I can start. So when it comes to visibility, I would say, we are, of course, extremely close to the customers now, not only to make sure that the networks are up and running and can cater for the traffic pattern changes and so on, but also on the investment plans, of course, on how to carry out rollouts and the deliveries during the rest of the year.

I would say we have a pretty good understanding and visibility on those plans. Of course, there is an overall — as we say in report, I mean, there’s an overall uncertainty on the macro level. But we have, I would say, good visibility when it comes to customer plans at least.

When you talk about the growth, I just wanted to underline what we say and what’s important in the report is that, yes, we believe Q2 will be a weaker-than-normal 11% seasonality. But it will still grow, that’s our assumption. And the planning assumption we want to transmit to you as well. So, we’re not talking about a decrease here. We’re still talking about the growth, but somewhat lower than the 11%, without commenting exactly what the specific geographies there.

Johanna Ahlqvist — SEB Enskilda — Analyst

But can you comment, where you foresee less than normal seasonality? I guess, you expect more than normal seasonality in China, for instance?

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

Yeah. I think probably in Latin America, for example, we will see less-than-normal seasonality. That’s about it, probably also maybe in Middle East and Africa as well. But let’s see. I think China is definitely going to go. And the US is rather flat this time because, as we said, the merger investments are not taking off until the second half. Borje?

Borje Ekholm — President and Chief Executive Officer

I was going to say that we — when you run a company of Ericsson, we have a number of markets that we think are going to be stronger, some are going to be weaker. And it varies by quarter. And you saw Q4 had a different revenue mix than it has now. That’s always going to be the case. And that’s going to be the case for Q2 as well.

And based on when we just form the view of the overall interactions we have with customers, we are saying that, okay, we would see an acceleration in China. That will be one aspect, but we’re going to see some deceleration in other parts so to formulate an overall guidance. And I don’t think it’s appropriate for us to start guiding by geography, by business area. Because then, you’re going to hold us accountable to something that we actually look at as a totality with some variations in each part. So that’s why we are not going to be more specific in guidance than you see.

Peter Nyquist — Vice President, Investor Relations

Clear, Johanna?

Johanna Ahlqvist — SEB Enskilda — Analyst

Thank you. Yeah. I’m happy with that. Thank you.

Peter Nyquist — Vice President, Investor Relations

Great.

Borje Ekholm — President and Chief Executive Officer

Thank you.

Peter Nyquist — Vice President, Investor Relations

Johanna. We’ll continue to the next question.

Operator

That is from the line of Alex Duval at Goldman Sachs. Please go ahead. Your line is open.

Peter Nyquist — Vice President, Investor Relations

Good morning, Alex.

Alexander Duval — Goldman Sachs — Analyst

Yeah. Good morning, everyone, and congrats on the strong results. Just a couple of quick ones. Firstly, just wanted to understand one of the Scandinavian telcos recently has been talking about potential component issues in the second half on vendors. Just wondered if you could give a bit more color on how you ensure that you safeguard the logistics components and the late situation there?

And then just quickly on Digital Services. Obviously, you talked about how we shouldn’t look at this just quarter-to-quarter. But just wonder if you could give a bit more color in terms of the pipeline and how we should think about business opportunities there? Thank you.

Borje Ekholm — President and Chief Executive Officer

If we start with the supply situation, we — this is, in a way, it’s an unprecedented situation with COVID-19 and disturbances on supply chains. And I don’t know which operator you’re talking about or which vendor they referred to. We can only comment from our situation. And of course, so far, we could manage Q1 without any problems, a lot of hard work on this — by the supply people, but we could manage that.

We foresee that we can manage the volumes in Q2 as well, thanks to the fully diversified production base we have in the Company and the supplier base that’s also diversified. We have also benefited, of course, with the very sharp interruption we got during Q2 because we have built up strategically bigger buffer stocks over the last two years. And we’ve done that in order to try to unconstrain the supply chain as much as possible to reduce — I mean, we have no chance of forecasting the pandemic to happen. So don’t misunderstand me there.

But we said it must be natural to try to unconstrain the supply chain due to the geopolitical uncertainty, the uncertainty of supply in general that we saw happening as a notion of all the geopolitical tensions rising and trade tensions rising. So that has helped us quite a lot in this pandemic to actually supply our customers what they need. We — as of today, we have — we believe we can fulfill supply also in the second half of the year because we have prepared for it, and we’ve put ourselves in that position.

Will the lockdown and the restrictions go on for very long? Of course, then we will be increasingly stressed in the supply chain. But we will do our utmost to fulfill the customer’s demand of equipment. And that’s our strong commitment. And I talk for everyone in supply we live and die by what we supply to our customers on a daily basis. And that will not — we will not waver from that commitment.

And then if you look at — yeah, Digital Services. The key here is we made basically a couple of decisions. Now it’s three years back to invest in a cloud-native portfolio. And that has served us really well. So we see very good traction on 5G core and our dual mode 4G, 5G core and the whole 5G offering. That’s why we are very comfortable on the turnaround plan of Digital Services.

Fluctuations will be there by quarter, that’s for sure. They are not going to go away, but we are very encouraged with the wins we see on the 5G side. We’re also seeing very good traction on the DSS side. So, we think the overall business we have now in Digital Services actually will have some very interesting developments over the next couple of years as the operators are building out their business into 5G, as well as expanding their offerings into enterprise. So, we are — we’re very happy with the investments we made in Digital Services a few years back and the way the team is executing.

Peter Nyquist — Vice President, Investor Relations

Thanks, Borje. Alex, are you are happy with that?

Alexander Duval — Goldman Sachs — Analyst

Very happy. Many thanks.

Peter Nyquist — Vice President, Investor Relations

Thanks. We are getting close to the hour. We will have one final question coming up now, and then we will close for Borje’s closing remarks. So please, next question, please.

Operator

Thank you. That’s from the line of Patrick Chen at Credit Suisse. Please go ahead. Your line is open.

Patrick Chan — Credit Suisse — Analyst

Hi, good morning. Thank you very much. So I have actually two questions, if I may. Just very quickly. So first question, just want to understand, do you think there’s any scope of increasing the market share further in the US post emerging situation?

And the second one is, can you please talk about the latest on any progress of getting into, even a stronger position in Japan by targeting the remaining operators?

Peter Nyquist — Vice President, Investor Relations

Okay, Borje?

Borje Ekholm — President and Chief Executive Officer

Yeah. If we start with Japan, we are — we have a partnership there with Fujitsu, as you know. And we’re working, of course to see if we can strengthen our position further in Japan. It’s a very important market for us, and we have invested quite heavily there over the past few years, including putting own research in Japan as well. And our ambition is to be a stronger player in the Japanese market, that’s for sure. Where we end up, of course, we will fight hard to do that. But that’s what we invest for. We will see where we end up, and then we can report after the fact. But we feel that we have a very competitive offering there as well.

The capital spend in the US, it’s — what’s quite clear is it’s been — the uncertainty caused by the very long approval process for this merger has impacted us during the last few quarters. That’s clear. What we see though is that the combined company, they will leverage the assets they have now in the merger and start to invest again. We see that in the second half of the year. Then, of course, we’re going to fight hard to keep our position in that. And if we — if our technology wins, we can be better. But let’s see where that ends up over time here.

Peter Nyquist — Vice President, Investor Relations

Thanks, Borje. Thanks, Patrick. You are happy with that?

Patrick Chan — Credit Suisse — Analyst

Yeah. Thank you.

Peter Nyquist — Vice President, Investor Relations

Okay. That ends the Q&A. But before ending this call, I would like to hand over again to you, Borje with some closing remarks.

Borje Ekholm — President and Chief Executive Officer

Thanks, Peter. So I’m only going to end by saying this is an unprecedented time we live in. And despite that, we can continue to execute on our strategy of technology leadership by investing in R&D to drive market leading portfolio, and we could deliver a solid first quarter with good gross margin and a solid free cash flow. So with that, we feel that we are well positioned to manage a difficult environment. But we are very comfortable about our position and the long-term attractiveness of the market. With that, thank you.

Peter Nyquist — Vice President, Investor Relations

Thank you all, and stay well.

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

Thank you.

Operator

[Operator Closing Remarks]