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Hello, and welcome to Ericsson's Analyst and Media Conference Call for their First Quarter Results. 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 1 hour after today's conference. Peter Nyquist will now open up the call.
Thank you, operator, and good morning to everyone, and welcome to our call today. With me today, I have our CEO and President, Börje Ekholm; and our CFO, Carl Mellander.So I'll start with the usual 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 all to read about these risks and uncertainties in our earnings report as well as handout and report.With that said, I would like to hand over to you, Börje, so please.
Thank you, Peter.Well, as an introduction to the first quarter report, I'd just like to reflect a little bit of what we've done.A year ago, we announced a new focused strategy, and that included a clear plan on how to turn the company around. The turnaround is based on what we need to do to be a successful company long term, call it 5 years out. Any action we do and take should really support the long-term strategy of building a stronger company. Last year, we focused on stabilizing the company, simplifying our business and taking costs out. We basically reduced the workforce by 17,000 last year, and we reported that we had lowered the run rate by SEK 6 billion at the end of Q4 of 2017. And these improvements are now starting to gain traction and be visible in our P&L.Also, in line with our strategy, we have invested in technology leadership. We're investing in 5G cloud-native solutions, automation and analytics but also in new opportunities such as IoT. Of course, we're also investing in making our 4G offering cost efficient for our customers. So basically, we're investing in R&D, increasing R&D that we will use to lower COGS or actually expand gross margins.While we clearly have more to do, we have taken good steps forward to realizing our 2020 targets, as we laid out to the Capital -- on the Capital Markets Day in November. But that also creates a foundation for stronger developments beyond 2020, realizing our long-term margin of 12%-plus.So let's step to the first slide. Overall, we see a stabilizing market, with strong focus on 5G in radio and core. We also see a clear convergence of IoT and 5G. I would say momentum, in general, in the market is very good in North America as the customers basically need to manage the growing demand of data but also positioning themselves for 5G. We also see that during the quarter, the Chinese market has slowed down as LTE investments have fallen substantially. We continue to execute on our focused strategy. Efficiency gains are now coming through the P&L, visible in gross margin and SG&A. In Managed Services, we have addressed 31 of 42 nonstrategic contracts. We see growth in new products in Digital Services; still not enough to offset the decline in legacy products, but it's encouraging to see the growth. We have addressed 8 of 45 contracts in Digital Services. ERS penetration is now up to 83% (sic) [ 84% ], contributing or helping the gross margin in Networks. In addition, we've hired 500 more engineers to ensure leadership in 5G.We have a very strong demand from customers, and that really shows that we have a very competitive product portfolio. We especially have good traction on our 4G portfolio that allows our operator customers to have an easy path to upgrade to 5G. And we also see a good traction of our new virtualized products in DGS.Take the next slide. If you look in the P&L, we see that the sales fell by 2% in constant currencies. This is really due to a couple of reasons. One is the contract reviews, of course, that impact top line, but it's also a lower RAN market following lower investments in primarily China.If we look at gross margin, it's up. It's driven by our cost-out activities we did last year in service delivery but also in ERS penetration. Last year, we -- the last 3 quarters of last year where we have data, we see that we expanded our market share, and we did that. And at the same time, we could expand gross margin.Before restructuring, our operating income was positive for the quarter. And this is really, again, the expanded gross margin and service delivery cost-out, but it's also a visible reduction in our SG&A. At the same time, as we lowered SG&A, we have continued to increase our investments in R&D. Again, I want to remind you of the strategy that we invest in R&D in order to get gross margin up, and we're starting to see that happening.We also -- in Q1, it's historically a weak cash flow quarter. We were still able to have a positive free cash flow during the quarter despite that. And this -- we have also seen quite a lot of the provisions we took for restructuring last year now being converted into cash, so that has also affected cash flow.If we move to the next slide. Last year, we let -- set out a target to reach SEK 10 billion cost reduction by mid-2018. And over the last months, we've, of course, had a focus on taking costs out and making our cost structure more competitive. At the end of last year, we were at the run rate of SEK 6 billion, and that is now starting to be visible in the P&L. And at the end of the first quarter, our run rate savings were at SEK 8.5 billion, so we feel that we are on the path to reach our goal of SEK 10 billion by mid-2018. It's also clear that it takes about 1 to 2 quarters before the full P&L effect is visible in -- or the full effect from the programs are visible in the P&L. We see in Q1 a structurally lower SG&A of about SEK 600 million, so run rate SG&A is down by SEK 2.5 billion. We have run rate savings of SEK 6 billion in service delivery, and this is seen in the gross margin expansion basically in all service areas. And as I said, we are comfortable to reach the SEK 10 billion target by the end of the second quarter.Move to the next slide. The efficiency gains are largely tied to the total workforce; that's internal and external. We focus on -- again, this is all about taking -- reducing the costs, so it's all about the total workforce, i.e. internal and external. And that's what we are focused on. So that's a more important indicator than employees, actually. So what we now can see is that we've -- we have reduced the total workforce quite substantially over the last year, with an acceleration as of midyear, when we -- where we had launched our activity program during the second half of 2017. But we have also continued to reduce the workforce this year with an additional 3,000-plus, and that's, of course, after we have increased the number of engineers in R&D.We move to the next. When we look at the market area sales, we can now see that, on an organic basis, we have growth in 3 market areas: in North America, as the operators are getting ready for 5G; we see in Middle East and Africa, we see that LTE rollout and the network modernization are expanding the market; and it's encouraging also to see that Europe and Latin America are growing, basically, due to strong network sales in Latin America, primarily. We also see that the LTE investments in China and, I would say, an unclear spectrum situation in Japan as well and -- as China has also pulled down the investment levels in Northeast Asia. The reduction in Southeast Asia, Oceania and India is really due to a tough comparable last year when we had -- several large projects were completed.With that, I will now give the word over to Carl, our CFO.
Thank you, Börje, and good morning, everybody. I would like, before going into the segment results and some commentary there, make a general comment on comparability. Last Q1 then 2017, we had a number of extraordinary items, provisions, write-downs, and we reported on them clearly in that report. We have also, since then, had a series of restatements. Now as we come out of that and into 2018, we -- after restatements, after having changed accounting standards and also concluded on those significant extraordinary items, we are going back to a simplified reporting. We are not going to continue with an adjusted level excluding extraordinary. So we will be talking about the reported results and reported excluding restructuring mainly. So this is what you see when you see the Q1 '17 result here is the reported result excluding restructuring.Okay. If we look into Networks then. We -- as Börje said, we, of course, see the investments in R&D paying off here when it comes to the gross margin improvement there. So hardware margins as well as service margins are up in the quarter. Certain sales declined there. The mix, Börje already alluded to, between China is coming down; but also strong performance, a good momentum in North America but also Latin America and Middle East. We had very strong ERS, Ericsson Radio System, deliveries in the quarter, now up to 84% from 71%. And in Networks, we continued to going forward and continue to invest in R&D for a leading portfolio and to continue to fully transition to ERS for competitiveness and, of course, also to take out costs. And with an operating margin of 13.5%, we can compare that with the long-term target of between 15% and 17% and say that this is a steppingstone in that direction.If we move to Digital Services. We see a decline of sales adjusted for FX of 3%. But here, as we have reported on earlier as well, legacy products and related services continued to decline. This quarter, we saw a growth in FX-adjusted numbers in the new product sales. The strong gross margin improvement here comes mainly out of cost out, and it's evident in the services margins then. And to some extent, a little bit lower sales in some of the large transformation contracts also contributed in the quarter.Operating margin, a loss of SEK 2 billion in the quarter. Of course, going forward, strong continued activity in cost reductions are necessary and are happened -- or are happening and further planned during 2018. Also, important to remember that we continued to invest in the 5G portfolio but also cloud-native product suite here. So another 6 contracts have been managed now out of the 45 we talked about. As you know, 34 critical contracts are being addressed or managed, and 11 nonstrategic contracts are either exited or completed. So now a total of 8 have been accomplished so far.Managed Services. The strategy in Managed Services is to turn around the business by a couple of items there. Contract reviews, addressing those low-performing 15% of the contract stock but also to improve efficiency in service delivery, i.e. take out costs also there, driven by investing in automation and tools, machine intelligence and so on, for better customer experience improved the cost situation. So as you see and as expected then, sales come down somewhat based on the contracts we exit. That is to be expected. Meanwhile, we see a good growth in the IT part of Managed Services, which is typically good for the margin development as well. On the gross margin side, we see significant improvement this quarter, again, based on the efficiency/cost-out measures that we are taking but also the contract reviews. So speaking about the contract reviews then, another 8 have been completed now, taking the total to 31. And now, as you see, the annualized profit improvement coming out of those 31 contracts that are managed is now SEK 0.7 billion annualized going forward.So operating income in Managed Services, a positive number for the first time in a long -- a very long time, really a proof of the strategy execution happening in Managed Services as well. Emerging Business and Other. Here we have the media business, as you know, Red Bee Media as well as Media Solutions. We have improved margins in those as well rather dramatically since last year. But combined, they still report a loss in the quarter of around SEK 0.5 billion. We have good momentum in the Emerging Business side: IoT and UDN both growing; iconectiv as well. And all of those are also contributing to the improvement here you see margin-wise. We intend to and are targeting to close the deal with one equity partners for Media Solutions here during the third quarter. And as you know, when -- as you know, we will retain 49% in that new entity, and we will report that going forward from the fourth quarter then according to the equity method, meaning that we will report 49% of the earning of that entity.Okay, we move forward and to summarize then this in a gross margin bridge. First of all, you see the x/o items that we reported on in the first quarter there. And then just note again that all 4 segments contribute to the margin improvement here on gross margin level.We can move on to operating margin then. And here, I just like to make another comment also that the result improvement that we see now in the first quarter is a function of how the business is performing, including the cost-out effects, rather than as an effect of, for example, provision releases or anything. And if you see in the balance sheet that provisions have decreased, that's a function of actually turning restructuring into cash-out and utilizing some of the project resource then from last year. But here, you can see then the gross margin improvement that we talked about right now and how the R&D investment and the SG&A saving are generating the 2% operating income here that we report in the quarter. And that speaking then of OpEx, we move to the next one. Looking at the R&D, which has increased according to plan, one piece, of course, SEK 1.1 billion relates to capitalization. And the other element here, SEK 0.9 billion, is following the investments that we do in technology.On the SG&A side, cost reductions are, as we said, starting to bite properly in the P&L now. And SEK 600 million, around, is the cost reduction that we deliver on now in the first quarter in terms G&A.We move to cash flow. We had a strong cash collection in the quarter. There was certain inventory build during the quarter. That is a typical seasonal pattern. And combined then, the working capital here was clearly improved year-over-year, so a positive cash flow from operations, SEK 1.6 billion compared with the SEK 1.5 billion negative number last year. And if we go all the way down to free cash flow, we report a positive free cash flow number of SEK 0.3 billion versus the negative SEK 3.2 billion and same period last year. So this means that net cash has improved further; as well as gross cash as well up SEK 1.6 billion during the quarter. I should mention that the dividend is paid in April, so that's not part of the numbers here. That's a SEK 3.3 billion payout in April. To the right, you see the debt maturity profile as another support of the financial resilience of the company. Here, average maturity is 4.1 years. And as you can see, there are no maturities in either 2018 or 2019.Planning assumptions, finally. When it comes to the market, we stick to what we have said before when it comes to 2018, a 2% decline in the RAN market. We also talked about a CAGR here for the period 2018 to '22 of growth, 2%. Important to keep track of the currency movements here when it comes to our U.S. dollar dependency, and we repeat, yes, the rule of thumb that we use. When it comes to Q2, the normal seasonality means sales growth of 9%, so that's something to bear in mind. And we are also repeating here again the SEK 10 billion possible reduction -- or up to SEK 10 billion possible reduction following us exiting certain contracts in Managed Services and the network rollout. Cost savings will continue, as we have talked about. Remember also that OpEx can vary between the quarters due to seasonality. We maintain the SEK 5 billion to SEK 7 billion restructuring charge estimate for the full year, and it will be a little bit higher, we expect, in Q2 than Q1. And finally, Media Solutions, I've already commented on.Final point on the capitalization impact. As you can see, the deltas are going to be less material quarter-over-quarter or year-over-year going forward here as we trade out those balances.With that, thank you so much, and back to Mr. Ekholm.
Thank you, Mr. Mellander. So in closing, a year ago, we defined the new focused strategy, including investments in R&D. And of course, that should result in higher gross margin as well as efficiency gains in service delivery and G&A. And during the first quarter, we have since then executed on the plan. And during the first quarter, the results are starting to be visible. We, of course, see the good execution, and that's resulting in cost-out in the P&L., but we are, of course, not yet satisfied. We see the cost efficiencies in the P&L, but we have, so far, reached a run rate of SEK 8.5 billion, and we're aiming and we're confident to reach the SEK 10 billion by the second quarter. But we clearly are not satisfied with the financial results, and we have more to do, but we're tracking along the plan to reach the goals in 2020 with a good degree of certainty.During the quarter, we've seen good performance in Networks, expanded gross margins, driven by increased ERS penetration and cost-out. We have also continued to increase the investments in R&D, with a long-term benefit of positioning us well for 5G but also to have a very competitive 4G portfolio.We have reduced our losses in DGS. It's thanks to accelerated cost-out in service delivery. But also, we have reduced R&D by reducing complexity and increasing efficiency. Our future investments are focused on our new 5G-ready and cloud-native portfolio. We have also been able to turn Managed Services into a profitable area. That's really thanks to cost-out but, of course, also the contract review that we have done. Normally, Q1 is a tough cash flow quarter, so we're -- it's -- we are happy to see a positive cash flow during the quarter; still limited but positive, and that's, of course, important to create our future flexibility. So with that, we see encouraging improvement, but we clearly have more work in front of us.Thank you.
Thank you, Börje. And now operators, we are ready for the Q&A session, so please, you can open up.
[Operator Instructions] Detailed information is provided in the report, and Ericsson's Investor Relations and Media Relations team will be happy to take additional questions and discuss further details with you after the call. Our first question comes from the line of David Mulholland from UBS.
Just the first one, I guess, there's been a lot of news for this past week around one of your competitors that's facing sanctions against their ability to procure raw components from the U.S. I know it's probably still quite early in terms of any strategy, in terms of reaction to that, but would be really helpful to get your kind of high-level thoughts on whether you see that as an opportunity and what strategy you might take around it and what you feel it might do to pricing in the market. And then I have, [ if you don't mind, ] one follow-up afterwards.
Let me be perfectly candid to say I think it's a little bit too early to comment on that. We're -- I think our focus has to be on having a competitive product portfolio in the market and win with customers. That's really what we should continue to focus on and really do. That's what we can impact. Then we have to see what the consequences are of this. But I think it is worth to note that having a compliance process is -- or trade compliance is really important for us, but I think it is -- it's hard to comment yet. Let's see that and save that a bit.
You haven't seen any initial reactions from customers around that in the last 4 -- 3 or 4 days?
No. I think it's too early. I think many customers are asking questions. That's not so strange, right? But I think let's refrain from summarizing that yet.
No problem. And if you don't mind, one quick follow-up in terms of the comment you're giving out to 2022 for the RAN market to grow 2%; then the comments you've given at the Capital Markets Day, you had 2019 growing 1% and 2020 flat. To get to 2% CAGR over that period, is there any changes in how you see the phasing of growth for the RAN market beyond 2018?
No. We're using external market estimates here. And I think it's better that we stick to the external consensus. So that's what we have elected to do. We think they're reasonable, let's put it that way.
Our next question comes from the line of Sandeep Deshpande from JPMorgan.
My question is regarding Digital Services, Börje. I mean, the gross margin in Digital Services has substantially improved. Can you actually go through some of the things that have happened there to change this gross margin so substantially and can be sustained at these levels from here through this year?
Yes, Carl here. I can take this. So the main item here boosting gross margins this quarter is the cost-out. It's very clear. A secondary reason is that's somewhat lower when it comes to milestones than in low-margin transformation contracts, but it's really the cost-out that is starting to get really visible and gets traction in the P&L. And this is what we will continue. And of course, we have talked about stability in portfolio and contracts since last year as well, and now we have achieved that to a higher degree and been able then to take out a lot of cost in the Digital Services area, mainly in service delivery but also G&A, I should say.
And Börje, I mean, just quickly on the revenue line. Looking at -- you talked a lot about 5G at Mobile World Congress. I mean, everybody -- I mean, in the audio equipment side is talking about 5G. The talk about 5G is slightly less on your customer side. But I mean, are you going to see significant revenues on 5G in the second half of this year? And is 2019 going to be the big year with a ramp-up of 5G at your customers?
I -- let's just step back to remind everyone about the -- what we said at the Capital Markets Day. So when we guided for 2020, we actually said we wouldn't expect any revenues for 5G. So I think that's worthwhile to keep in the back of your mind. So when we put the guidance out of 10% operating income ex-restructuring, it's really based on the assumption of no 5G revenues. Is that what we think? No, we think there are going to be 5G revenues ahead of that. And we already today see -- in certain parts of the world, we see commercial orders on 5G happening. So we are going to see commercial revenues already this year and, clearly, also next year.
Our next question comes from the line of Stefan Slowinski from Exane BNP Paribas.
A question on the Networks side, if I may. You are still talking about the market being down 2% this year, but you're also now talking about winning market share. And I'm just trying to understand how -- can you help us quantify how much share you think you're winning that should presumably lead you to outperform the market? And how sustainable do you think those share gains are? Has this been something sort of a window of opportunity over the past 6 to 9 months you've taken advantage of? Or is this share gain process something you expect to extend into the rest of the year and beyond?
What we see is that we're winning market share on the basis of a very strong product portfolio. And what we see is we're winning the market shares because our portfolio allows the customers an easy path to be 5G-ready. So customers put a premium on that. And you can also look at the last part of last year, where you saw our market share on kind of quarter-by-quarter increasing during the year, and we could do that and still maintain and growing actually gross margin. So this is the strategy, so continue to invest in new technology that will allow us to introduce products earlier. But at the same time, actually, the investments in technology leadership allows us to also move the costs down of our products. Both of these things should allow us to keep and expand the gross margin. Then you can say on the market share front and where we have gained, of course, it is -- our ambition is to continue, of course, to see a strengthening market position, but that is ultimately depending on situation by situation. So I think we're very happy with what we have achieved in the market and with our customers, and of course, we're going to build on that.
Okay, that's quite clear. And just one quick follow-up, if I can, on the Digital Services aside. Do you still expect by the end of this year to have addressed 50% of those difficult contracts that you are targeting to address by the end of this year?
Yes, that's our plan.
Our next question comes from the line of Fredrik Lithell from Danske Bank.
Just a follow-up on Digital Services there. You have a quite decent sales drop in Q1 if you look sequentially. Is that due to that legacy sales is dropping off in a quicker way? And is that also part to the gross margin shifting to better products, so to speak, and less of hardware? Is that part of the equation, or is it only personnel out in this equation?
We have a seasonality in sales, you should remember as well. So when you look sequentially, that's clearly one thing. We see it is a -- it's less mix question and more a cost-out question on the gross margin.
Our next question comes from the line of Achal Sultania from Crédit Suisse.
Just one question on gross margin side of things. So I'm just trying to -- just help us understand, like your gross margins went up from 30% to 36% in this quarter, and we -- you show a chart where it's about 2 percentage points benefit from a capitalized development capitalization impact, right? So just trying to understand that the rest, 4 percentage point improvement, how much of that is driven by mix, how much of that is driven by cost cutting, and how much of that is driven by this ERS. Any color around that would be really helpful.
So Carl here. Yes, so of that improvement of the gross margin, you -- we can attribute about 1/2 to the cost-out program delivering. And then, let's say, another maybe 1/3 is the Ericsson Radio System improvement there in hardware. And the rest is really a mix between some of the contract exits in Managed Services and other mix effects. That's how to see the 500, 600 basis points improvement year-over-year.
So that is with the capital -- after the capitalization impact or before the -- just to clarify.
No, capitalization is not the factor here in that comparison. Quarter-over-quarter, yes, exactly.
Our next question comes from the line of Daniel Djurberg from Handelsbanken.
Congratulations for growing gross margin. A question on Digital Services again, if you could perhaps give us some more flavor on the added 6 contracts that you have done, that you have scrutinized then. And how the margin impact will be if you're satisfied and if we'll see an immediate impact from Q2 and onwards because you also can see some of the annualized profit, the improvement that we'll see from at least 8 of 45 now.
So -- sorry, so the question around how much impact we will see from the...
Yes, from the -- you have announced 8 of 45 contracts being negotiated on Digital Services, and you added 6 in the quarter.
Yes.
And you didn't give any annualized profit improvement from this, but can you give some color on what to expect from the renegotiations, we will come out closing there.
Okay, okay. No, the effect of those 8 to the additional 6 there is limited, actually, I have to say.
Okay, okay. And also, a question. You had a really strong gross margin in Networks, 38.9% versus 31.7% last year. And of course, you said it was about half cost-out in the ERS, et cetera. And I was just thinking, given that you have taken market share, we saw market share gain also in '17 from Deutsche Telekom, Vodafone UK and so on. Should we expect this gross margin level, adjusted for seasonality, of course, to be sustainable given the new customer wins you are taking?
When it comes to the wins we have taken, we repeat that we are winning on the base of technology, and there is no impact expected on gross margin from winning those contract.
Our next question comes from the line of Douglas Smith from Agency Partners.
I wanted a little bit more into this segment of Northeast Asia, which, on a global level, obviously, encompasses some very large economies. But from Ericsson, it shrunk from, let's say, 12% of sales to 8%. Is that relative shrinkage due to your de-emphasizing those markets because of competitive or industry issues? Or is there something else going on there?
No, we're not deemphasizing those markets. This is -- we are talking about, of course, Japan, Korea, China. They still have a very high strategic priority. But as I said, we see reduced LTE investments in China. We also see spectrum uncertainty in a couple of countries, China and Japan predominately, that has delayed investments in our equipment. So it's not a deemphasis -- that we have deemphasized in any way. We continue to push ahead in those markets. And as you know, we already in our Q4 or Q3 report discussed that we are increasing our market share in China.
Yes. And could you even like share with us what the drop in China was specifically without Japan and Korea? Is that a number you could share, just China alone in terms of year-on-year fall?
Yes, we don't share those numbers.
Our next question comes from the line of Johanna Ahlqvist from SEB.
Congratulations to a fantastic gross margin. Just a question related to Digital Services, if you can say something there -- how much of Digital Services legacy today? And also, on how much is related to sort of the bad BSS contracts, if you faced stuff like that, and how much was it? I think you said that it's slightly less a mix effect of those contracts in this quarter. I'm just wondering sort of the delta between, for instance, Q1 and Q4, or how much of these were of sales?
Well, on the -- it's about -- or if we start with your first comment, it's about 2/3 legacy product. If we then look at the impact within Digital Services, and it's true, we've had a little bit lower mix of large transformation projects which have had structurally lower margins during the first quarter, but -- and that, of course, could impact the gross margin in the second quarter, more normalized mix. At the same time, we work quite hard on, continue to take costs out in service delivery, and we see effects there, and we should expect continued effects there. We see also that we take out costs in OpEx in Digital Services, and we will continue to do that as well. So we don't want to go into all the details in Digital Services for simply competitive reasons, but we see the improvements that we have planned for and targeted coming through.
Are you happy with that?
Yes, definitely.
Our next question comes from the line of Josep Bori from Berenberg Bank.
I thought -- I would like to ask a couple of questions on your initial 5G deployments just to get a sense of how your customers are going about it, and I appreciate what you said in terms of revenue expectations here. So the first one I had is, what is typically the rollout architecture approach they're taking? Are they going for a non-standalone architecture, or some of them are also upgrading to core? And the second question is, in those customers, in an account where you're having an initial 5G deployment, are you seeing an increase in sales within that account, or they typically will offset that with maybe their spending -- reducing spending on their 4G LTE investments?
It's a little bit early to see exactly how that is going to play out. And what we see is, actually, that if we look at this, it depends a little bit about geography and customer as well. So what we're starting to see is, in a way, if -- North America has focused more on fixed wireless access, for example. We see that. We see that will basically be, call it, one use case that operators can derive extra revenues from. We see quite good traction there. We see very good momentum. But we also see other parts of the world where we have more deployment for enhanced mobile broadband. But I would say it's most in a non-standalone, so far, but we are also seeing investments in, call it, preparing the core for 5G as well. So you're seeing a little bit all of the above. It's not any material revenues yet, so it doesn't impact any investment plans. So your comment, if it's going to offset, I think we'll have to wait a little bit to see how that's going to play out. The customers we have commercial contracts on, on 5G, it does not impact. But remember, they're still small, right? So they -- it does not impact our 4G investments.
Our next question comes from the line of Aleksander Peterc from Societe Generale.
I would just like you to give me a little bit of color in terms of sentiment on geographies. How have things evolved versus last time we had a market update? Do you see, particularly in North America, a slightly better outlook there? And is China perhaps a little bit worse off than you thought going into the year? Any thoughts also on renewed M&A talks in North America? Will that have an impact, in your view, on the market outlook there? And then just briefly, again, on Digital Services, would you highlight anything in terms of the mix that was particularly favorable in the quarter? And should we now understand the gross margin, basically, where they should be for this business for the year, and the rest of the improvement should come from OpEx reductions so that, that would then drive the EBIT margin in Digital Services, which is still in the red quite deeply? Is that where we should see the improvement going forward?
If we look at -- it's -- as I said when we walked through, I think what's worth to remember is the data traffic that our customers see in their network, still on a global basis, basically doubles every 18 to 24 months. That's something we have seen for the last few years, and we see that continuing. That, of course, drives, ultimately, demand for equipment. And what we see is a renewed focus on network quality and the user experience -- the end-user experience. And here, I would say, it is a global phenomena that operators are, in a way, starting to say that we need to upgrade our capacity in order to fulfill that demand. So that we are seeing. Then of course, you see a positive momentum in North America. That it really comes out of, call it, preparing the networks for 5G. So we are seeing, in that sense, renewed interest in our product portfolio coming from a relatively low level, I would say, on wireless side. We also see Middle East, for example, a very large interest in modernizing the LTE networks and rolling out a wider coverage of LTE. China, I think we knew the market would somehow taper off as they complete the buildout of the 4G network, and that's what we have seen. Then maybe it's very hard to comment this is more or less than expected while we knew it would taper off. That's what should be expected. And remember, the -- if you look at the number of nodes, probably -- or more than half of the global market is in China. So of course, at some point in time, you basically reach the coverage and the capacity you need, so that's not a big surprise. Then the operators are also there preparing for 5G. So I think when we look at the global demand, this is in line with the market expectation, I think, and in line with the RAN market expectation. So in that sense, as we combine, there's some ups and downs but, overall, in line with expectation.
The other one on DGS gross margin then, Aleksander, no, I would say, I mean, gross margin can vary over quarters, of course, with mix. But what we see is that actions are showing a visible result in the P&L now from the cost-out in the first quarter. And we don't commit to a certain level for the second half here, but we -- of course, we continue with the cost-out. That's not concluded or done yet. And we continue with the 45 contracts, to manage them, as we have talked about as well. And of course, we have our eyes on the 2020 targets when we are -- have committed to reaching low single-digit operating margin, so this is really what we're going for. But each or individual quarters may, of course, vary.
Our next question comes from the line of Jörgen Wetterberg from Nordea.
Congratulations on some fantastic progress on improving the margins. I have 2 questions. One is, as you are concluding the cost program here in Q2 of 2018, should we expect another cost program going forward to structurally lower your cost base? That's question #1. Question #2 is related to the Northeast Asia market, where a lot of operators have standalone architectures planned for 5G. Do you feel that you're well positioned to defend or improve your market shares there based on the trials that you've engaged in?
If we start with the cost program, the cost is something we will continuously have to work on. This is something that I think we have to have a mindset in the company that we are going to continuously improve our cost position. That's going to be critical for our success, but we will also run it that way, i.e. we will have continuous efforts on improving our cost position. So the program that we've put in place, the SEK 10 billion by mid '18, we are -- now we're focused on reaching that objective. Going forward, I would see less of programs, much more a continuous effort instead. And I think it's much more important for the company and for also the market that we continuously improve instead and show that we can deliver on the SEK 10 billion program and then that we, from there on, continuously improve our cost position. On the 5G, we feel we're very well positioned from a technology point of view. We have, I believe, a very good position in the market. Where the ultimate market share will end up will, of course, depend on all the ongoing trials and how it's going to look after that, but we are quite confident where we are.
Our next question comes from the line of Johannes Schaller from Deutsche Bank.
Two quick ones. Just -- sorry, following up again on Digital Services gross margins just to see if I got this correctly. So you're basically saying maybe the mix in Q1 was a little bit better than what we should normally expect. So from a pure mix perspective, this should be more normalized in Q2. And then some cost savings are basically potentially offsetting that, but the mix itself is probably getting a bit worse from here. Is that the right way to think about it? And then as a second question, I think you have given in your presentation the normal seasonality for the second quarter, around 9% on revenues. Should we take from there that this is basically Q2 is a quarter where you expect fairly normal seasonality? Or could you comment anything on that?
If we start with the -- I can take the question on gross margin in DGS. The -- if you look at -- from a percentage point margin, yes, the mix is slightly favorable during Q1 and should be normalized during Q2. From a gross profit in kroner perspective, I am very confident that we will see additional cost-out during Q2, if that helps you a bit.
That does help, yes.
Okay. Your second question, Johannes, do you want to take that?
Yes. So exactly the seasonal average there, 9% up. And of course, there are, ups and downs aside, possibilities there, but you could also consider the fact that we are reviewing some contracts and exiting. On the other hand, of course, we need to consider the dollar development, FX rate in general. So I think, yes, the historical seasonal uptick is not a bad idea to start with.
Our last question comes from the line of Andrew Gardiner from Barclays.
Another one on sort of gross margin and mix, I'm afraid, but sort of more specifically on Networks. Yes, normally, we've seen -- or I suppose the drivers you've cited for the improvement in first quarter seemed fairly, let's say, structural, right, cost-outs, the shift towards ERS. Normally, in the first quarter, we also see a nice move towards software and away from hardware that helps. Yes, has that also been the case this quarter? And if so, would you anticipate sort of that normal seasonality in gross margin impact also going into 2Q, where we would normally see a little bit of a decline within the Networks gross margin as a result of that sort of software mix getting less in the second quarter?
We have no special boost from software sales during Q1, so the mix is more normal.
Okay. And so therefore, in the 2Q, the mix again could stay fairly steady then, you think?
We have no reason to believe anything else.
Okay. And Börje, maybe some closing remark before we close this call?
Thank you, Peter. Thanks for all the questions. And yes, again, I would just reiterate that, last year, we put a new strategy in place, a focused strategy aiming at turning around the performance, with a objective to reach 10% operating margin at least by 2020 and then, a few years after that, reach our objective of 12%. We feel that we're tracking well on delivering on that objective that we presented at the Capital Markets Day. And we feel that the efforts we took last year, both on investing in technology leadership as well as our efficiency measures, are starting to pay off and starting to be visible during Q1. So we're -- we feel comfortable about the guidance we have provided, and we will continue to execute along those ways. And thank you, everyone, for dialing in.
Thank you.
Thank you.