Welcome to Ericsson's analyst and media conference call for their fourth quarter reports. To view visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors. Ladies and gentlemen, when you would like to ask a question, please press zero one on your push-button phone. If you'd like to decline from the polling process, please press zero two. As a reminder, replay will be available one hour after today's conference. Peter Nyquist will now open the call.
Thank you, operator. Hello, everyone, and welcome to today's call, the Q4 call. With me here today, I have our CEO, Börje Ekholm, and our CFO, Carl Mellander. This short statement first. During the call today, we will be making forward-looking statements. These statements are based on current expectation, certain planning assumptions, which are subject to risk and uncertainties. The actual result may differ material due to factors mentioned in today's press release and discussed in this conference. We encourage you all to read about these risks and uncertainty in our earnings report as well as in our annual report. With that said, I would like to hand over the call to our CEO, Börje Ekholm. Please, Börje.
Thanks, Peter. Welcome, and thank you for joining us for this report for the fourth quarter. Again, Q4 marks another quarter of execution on the focus strategy, building on technology leadership, cost leadership, product-led solutions, and global skill and scale. We continue here to benefit from our strength and competitiveness as we grow faster than the market with maintained strong gross margin. Our underlying business fundamentals remain strong, and we feel we have a very solid competitive position. Top line grew organically during 2019 with 4% and 1% during Q4. We are in the beginning of a technology shift, and our investment to lead in 5G is now starting to yield results. Today, we have 79 contracts and 24 live 5G Networks. We see that we now win new contracts based on our leading technology. The rollout of 5G continues in North America with good underlying growth.
The uncertainty related to the announced merger has reduced sales in one account during the Q4. The decline in North America was compensated by good demand in Northeast Asia and the Middle East. We maintained a solid gross margin at 37.1% overall and 41.1% in Networks. The sequential reduction in gross margin in Networks were fully attributable to the Kathrein business that we acquired during the quarter. When we win new footprint, the overall margin in those contracts are positive and contributes to our long-term margin targets, but the initial margin is challenged. We also see during this last quarter that the initial low margins have been fully compensated by operating leverage, showing the strength of our underlying business. As I said, the acquisition of Kathrein closed during the quarter.
This is a very important acquisition for us as it will allow us to strengthen our antenna capabilities and improve our ability to supply integrated site solutions. We're now working on integrating Kathrein into Ericsson and thereby establishing and building a leading portfolio of antenna solutions. The contribution during the fourth quarter was a negative on our operating margin. If you look for the operating margin, excluding restructuring and the fine to the U.S. authorities, it was 9.7% for the full 2019, actually putting us very close to the target for 2020 one year early. The fourth quarter was impacted by a couple of decisions we took. One is clearly the Kathrein acquisition that raised OpEx, but that we see will pay off over time through strength and competitiveness in the antenna space.
The other area where you see very discrete increases, and it's in OpEx, is for digital transformation. That's critical investment for us to digitalize the internal ways of working and the way we interact with customers, fully in line with our focus strategy. We take these investments to take the next step in automating our processes, and we will see them gradually pay off during 2020 and into the future through better cost efficiencies. That is clearly an investment program that, of course, have bumped up OpEx in the short term. It should help lower longer-term OpEx. The other area that we're investing in is, of course, security as well as our compliance program. That's impacting also the OpEx short term.
The underlying business continues to be strong in Networks, and the gross margin, as I said, was a solid 41.1% during the quarter. The operating margin was sequentially reduced to 14.5% during Q4, and that's due to the Kathrein acquisition, as well as Networks' share of the higher investment I just went through. For the full year, however, we are at 16% operating margin, which is in the range, and we're also very comfortable with the outlook. Digital Services, we continue to execute on the turnaround plan, and this past quarter they reached a positive operating income, despite actually provisions of about SEK 300 million for critical projects. You know we have now resolved three-quarters of the 45 initially identified critical projects. The next item, free cash flow before M&A, was SEK 7.6 billion for the year. That's after the payment of the fine to SEC/DOJ.
If we were to look at cash flow before the fine, the free cash flow was the highest since 2010, showing the underlying strength of the business. The board proposes a dividend of SEK 1.50 per share, and that is to confirm the confidence in our strategy and ability to execute and reach the target sets for 2020 as well as 2022. With short comments on the market during the fourth quarter. We can see that overall the market in North America was very strong, except in the accounts affected by the uncertainty of the announced merger, and therefore the sales overall shrank, FX adjusted. Europe was flat after growth in Networks was offset by contract exits. Latin America declined as large contracts were finished in 2018. Southeast Asia, Oceania, and India grew based on strong demand for 4G.
Northeast Asia grew following strong 4G, I would say 5G deliveries to prepare the network for 5G. Here we suffered also from Digital Services that fell due to lower sales of legacy products. Middle East and Africa grew, driven by growth in the Middle East. If you look for the full year, we saw that North America was very strong, of course driven by the initial demand for 5G. We saw also Northeast Asia be very good. Europe fell due to contract exits for Europe and Latin America. Here, Latin America fell due to timing of large projects. Southeast Asia, Oceania, and India fell slightly, this is explained by decline of legacy products in India within Digital Services. Middle East/Africa was flat. With that, I'm going to give the word over to Carl.
Thank you, Börje, good morning, good afternoon to everyone.
Thanks for taking the time. Let's look at the full-year performance to start with, where we reached SEK 227.2 billion in net sales, this corresponds to 4% organic growth. Gross margin at 37.5% is within the 2020 target range already. The operating margin here at 5% was of course including the SEC/DOJ settlement. If we exclude that, the operating margin was 9.7%, which is also close to the 2020 target, as Börje said. The full-year operating income number, SEK 22.1 billion, again, having added back the SEC/DOJ settlement cost, that's more than double the profit of 2018. Net income, a positive number, improved to SEK 1.8 billion, driven by the higher operating income, of course, but also lower financial net. Earnings per share diluted here came out at SEK 0.67. Free cash flow, again, SEK 7.6 billion for the full year.
Also here that if adjusted for SEC and DOJ payment, we delivered SEK 17.8 billion free cash flow before M&A, which is four times higher than that of 2018. Zooming in on the fourth quarter, net sales SEK 66.4 billion, 1% up organically year-over-year. Here, the operating margin, 9.7%, was impacted by a couple of items. We made a partial release of the SEC and DOJ provision. I will come back to that, SEK 0.7 billion. There was also a non-cash element coming from the wind-up of the legal structure of a former joint venture we had, ST-Ericsson, which is included here in the cost with a SEK -0.3 billion. Yeah, we can exclude for that, then the operating income is SEK 6 billion and operating margin thereby 9%. Also, you see net income improved here to SEK 4.5 billion from a SEK -6.5 billion last year.
Finally, free cash flow before M&A in the quarter was -1.9, of course, obviously in that amount we have absorbed the SEK 10.1 billion payments to SEC and DOJ. Let me guide you through how the SEC and DOJ settlements have affected the accounting. A bit of technicality, but could be good to know. The settlement was fully covered by the provision we took in the third quarter. We paid out the SEK 10.1 billion now during December, that obviously reduced the provision with the same amount. The interest component of the settlement came out lower than we had estimated when we made the provision. This means that we could dissolve a further SEK 0.7 billion of the provision, that again had an impact on the P&L now in the first quarter positively.
Now we still remain with SEK 0.6 billion of provision for this purpose, and that will then cover future monitoring costs in this connection. Let's look quickly at the segment performance, starting with the largest segment, Networks. We see organic growth year-over-year of 2%. Sequentially, we grew Networks by 13%, but that's a bit lower than the historical seasonality, which is typically 18%. As Börje described, this was really affected by or impacted by the uncertainty in the U.S., with one account coming in a bit lower. The underlying business fundamentals in North America remain strong. I think that deserves repeating. Encouraging to see then that while North America was somewhat weaker, several other markets stepped up and compensated here, and we saw particularly strong market growth in Japan and Saudi Arabia, for example, as they prepare to launch 5G.
Gross margin in Networks stayed above 41%, solid, but with a certain decline then quarter-over-quarter. I'll come back to that shortly. Operating margin 14.5% was down year-over-year and quarter-over-quarter. In a minute, I'll go through a bit more of the key items behind that development. For the full year, as you see in the graph, Networks delivered an operating margin of 16%, excluding restructuring, and this is right in the middle of the 2020 targets of between 15% and 17%. 5G leadership momentum continues. We have now 78 or even 79, I believe, commercial 5G agreements when checking this morning and 24 live 5G Networks. That's going well as well. Here we have earlier talked about strategic contracts. We wanted to update you all on that as well and the rationale for those contracts.
As you know now, in essence, these are selected few contracts that allow us to capture opportunities in the market to advance our position, coming often, typically with lower initial margins, but positive and value-creating, of course, overall. Several quarters in a row, we have shown the impact of these contracts now. What we do there is we net the impact of the contracts against what we call operational leverage, so other offsetting profit improvement measures. Essentially, we look at the sequential gross margin development. In Q4, as you can see here, the net effect was zero of strategic contracts and operational leverage, and the whole effect sequentially is explained by Kathrein, as Börje mentioned before. Kathrein obviously is going to gradually improve over 2020. That's worth adding as well.
Digging a bit further into Networks, I wanted to show this graph as well. Again, full year performance, very solid with a 16% operating margin. Also Q4 gross margin can be deemed solid at 41.1%. Here I wanted to show a bit more on how operating margin has developed over the year. I think this is relevant to understand the bigger picture here. As you see, the year to date operating margin has been rather stable at around 16%, with some fluctuations between quarters. Q3 was, of course, a very strong quarter for Networks with 18.4% isolated operating margin. You also can see in the graph how this was supported by a low OpEx ratio. While in Q4, OpEx came back to a bit higher levels, but fairly in line with previous quarters also.
That, of course, is visible then in the operating margin. What we should consider here, and you see the bullets to the right. One, Kathrein, about SEK 0.5 billion of impact. That's 1 percentage point or so. We have the investments that we have decided to make in digitalizing the enterprise, but also compliance and security. We also have customer financing revaluation and some impairment of accounts receivable, and that's an effect of SEK 0.3 billion in the quarter. Actually, that was a positive number in the third quarter. We're obviously investing also in R&D. If you look year over year, we've added also some SEK 900 million or so in R&D. Lastly, the lower seasonality on top line also shines through here. Again, the full year performance in Networks, strong. Digital Services.
I think the main news item here is that the result was positive in the quarter. Börje mentioned it already. It's actually SEK 42 million. Although we use SEK 1 billion here with one decimal, it looks like it's SEK 0.0 billion. It's actually SEK 42 million positive. I think that's a great testament to the turnaround efforts in Digital Services. We see good momentum in the portfolio, customers migrating to 5G. Sales were good here in OSS and cloud infrastructure, not least. There was some decline of organic sales due to core sales in Northeast Asia coming down somewhat. Gross margin stable, 38.1%. I think what we see now is the continued impact from cost reductions and efficiency gains in Digital Services. That continues. We're working on re-rationalizing the portfolio on the legacy side and reinvesting that, part of it at least, into the new 5G cloud-native portfolio. Yeah.
10 contracts remain out of the critical ones. All the other ones have been handled now according to plan. I just want to highlight here when we look forward that we, of course, are very committed to the target of low single digits operating margin for 2020. It might not be a linear journey through the quarters here. It can vary between the quarters, of course, depending on sales mix and business mix, et cetera. Managed Services. I'll speed up a little bit. Sales SEK 7 billion in the quarter, relatively flat if you adjust for FX, but with an improved gross margin year-over-year. This is fundamentally a stable business in Ericsson, but we can have some fluctuations in margin between the quarters due to the level of add-on sales, for example, that we deliver to customers and the timing of costs.
Gross margin declined a little bit because of that. Full year, you should look at the full year here, I think 6.3% operating margin, and this is even excluding a positive one-off we had in the first quarter. Even this number is fully in line with the 2020 target for profitability. Emerging Business and Other. We had some extraordinary items, and we have described them before. It's the provision release and the ST-Ericsson legal wind down. If we exclude those special items, we see that this segment has improved its performance in 2019. We see organic growth and reduced losses, both full year and in the fourth quarter. We should bear in mind also, when we look at organic growth, we have adjusted not only for FX, but also for the 51% divestment of MediaKind.
We talked about strong momentum in the third quarter and in the investor update. This continues. Sales growth in IoT, almost twice the market growth, and now we have more than 5,000 enterprises on the IoT platform. This is going well and right in line with our strategy. Finally, we have iconectiv. That's our software-based number portability solution that also continues to deliver profitable growth in both the fourth quarter and the full year. OpEx. R&D and SG&A here. In R&D, obviously, we continue to focus investments, 5G, cloud native, AI. You see how R&D has shifted here between the segments. Well, we're investing in Managed Services and Networks and reducing the other two segments.
In SG&A, in the middle, you see here the one-off item of SEK 0.2 when it comes to customer financing, then the SEK 0.4, which is around the corporate projects for the items that we have talked about earlier here. Of course, there is also a negative FX element on both R&D and SG&A, worth to keep in mind. On the right side, you can look at the graph here showing the yearly development of the R&D and SG&A. You see that SG&A is down about SEK 1 billion per year. Obviously lower absolute amount, but also lower percent of sales. R&D, meanwhile, up in absolute money terms, which is key part of our strategy, I would say, but stable or even down in %.
For 2020, we do expect some higher operating expenses than in 2019, and this is driven by these investment areas, but also the fact that we have included the new Tata business. Of course, the ambition at the same time that we have is to grow top and more than expenses. In other words, expenses as a percentage of sales should come down. Free cash flow, quickly. I think we've said most of it already, but coming in at 4 x better than 2018, if we adjust for SEC and DOJ. We have had very strong focus on working capital efficiency again this year. I must say it has yielded a good result here, good cash collection, et cetera. Working capital days now down to 75 days, which is the lowest I can remember.
We end the year with SEK 34.5 billion in net cash and more than SEK 72 billion gross cash. That's supporting one of the fundamentals here in the strategy to provide resilience for our company. To our planning assumptions here, and I really want to refer you as usual to the full report. To mention very few ones here. Dell'Oro, which we listen to when it comes to the RAN market estimates. Estimates that that market will grow by 4% in 2020. 2019, they have estimated grew 5.5%. Our Networks business grew a bit faster than that in 2019. For sales in Q1, our average sales here is, when it comes to seasonality, is -25%, but it's worth considering that Q4 was impacted by the U.S. uncertainty we talked about.
The base is lower. Meaning that the seasonality effect into Q1 should be somewhat better, a lower negative % then. IPR, we have signed a couple of new IPR contracts during the year. The new base is SEK 10 billion, if we look at the contract stock we have, compared with the SEK 9 billion we have mentioned before. We also talked about Kathrein quite a lot, and its impact here. Obviously gradually improving during the year, but still we expect that to be loss-making for the full year. OpEx, finally, typically we see a decrease here in between the quarters, Q4 to Q1. Last two years, average decrease was SEK 2.3 billion. As we have said several times, we expect somewhat higher level than compared to 2019 we see. That is it from me. Thank you so much, and I hand back to you, Börje.
Thanks, Carl. Closing, we launched our focus strategy in 2017, with the ambition to build a stronger Ericsson longer term. The first ambition was, of course, to turn around the company and return to growth. We can now see that the increased investments in R&D is paying off. We established ourselves as a leader in 5G with 79 commercial contracts and 24 live Networks across four continents. Our ambition is to grow faster than the market, we continue to see a faster growth. We're winning contracts here based on technology merits, which has allowed us to maintain a solid gross margin. During the quarter, we've been able to reach an agreement with the DOJ and SEC, with this agreement, it allows us to move forward building Ericsson with a focus for the long term.
We continue to increase our investment to ensure that we have a compliance program that is fit for purpose. We are fully committed to our zero tolerance policy and building a compliance program that's world-class. It includes work on changing our culture, updating processes, improving third-party management, vetting of senior executives, et cetera. The board proposes an increased dividend to SEK 1.50 per share, reflecting a strong confidence in our strategy and ability to deliver on our financial targets. We will keep focusing on building a stronger company longer term. We will never trade off the long-term perspective for a short-term gain. Having said that, we are comfortably tracking towards our financial targets for 2020 and 2022. Thank you.
Thank you, Börje. By that, we are now ready for the Q&A. Operator, I invite you to open that session, please.
Thank you. Ladies and gentlemen, at this time, we will begin the question-and- answer session. If you'd like to ask a question, please push zero one on your push button phone. If you would like to decline from the polling process, please press zero two. As always, please limit yourself to one question at a time, and please keep your questions at a broad level. Detailed information is provided in the report, and Ericsson's investor relations and media relations teams will be happy to take additional questions and discuss further details with you after the call. Our first question comes from the line of Edward Snyder at Charter Equity Research. Please go ahead. Your line is open.
Morning, Ed.
Good morning.
Good morning.
I had a question about the U.S. market, especially regarding the T-Mobile-Sprint merger, which I would expect should be decided within the next month or so. If they should get approval for the merger, how do you see that impacting CapEx spending? I know it's been kind of put on hold, but if it does get approved, they're going to change plans on how they're going to deploy, especially 5G and band 41, et cetera. one, how long do you think it will take to return to a more normal CapEx profile for that firm? two, what happens with the margin profile of your business in North America when we start seeing more aggressive build-outs in the, I'll call it Sub-6, for lack of a better word. But AT&T's been talking about deploying on FirstNet, then T-Mobile would go on band 41.
If that becomes a reality and we start seeing 5G equipment actually and bands deployed in the infrastructure, what does that do to the margin profile? Thanks.
As we said, the announced merger has impacted Q4, clearly. I would also say that what drives CapEx need in this industry, it's really a couple of things. One is, of course, the technology shift from 4G to 5G. We're in the beginning of that. The second one is the data growth. The underlying need to invest in capacity hasn't really changed. We don't really see short term that it's more important that the outcome is resolved. Whichever way it goes, we believe that reduced uncertainty will actually lead to spending because there is a need to do that. Of course, the investments will vary depending on the outcome. That's why it's very hard to speculate about. Let's see where that brings us. If you look at the margin profile, and we talked about this for quite some time.
We have tried to make Ericsson less exposed to. Our geographic mix and mix between markets and mix between technologies in that sense and business segments. I think when you look at the fourth quarter, you see an unusually low North American share, and we still have sequentially a strong gross margin. I think it indicates that we have a much less geographic mix or business mix exposure than we've ever had in the past. That's what we are going to continue to work on because a resilient company has less of those, I don't know, variability depending on mix.
Okay. You happy with that, Ed?
Yes. Thank you very much.
Thank you. We're open for the next question.
That comes from the line of Achal Sultania of Credit Suisse. Please go ahead, your line is open.
Good morning, Achal.
Hi. Good morning, Peter. Good morning, everyone. Just a couple of questions. First on the Kathrein. Obviously, you're losing a lot of money right now, SEK 200 million gross profit loss, SEK 500 million EBIT loss in Q4. Just trying to understand what's the path and the timing of trying to get this business back to profitable levels. Is it more about the new product launch? Is it about trying to launch those new products with the antenna systems as we go into 5G? Can we actually expect that business to be break even by the end of this year? Secondly, on the OpEx side, can you help us understand when you talk about slight increase in 2020, what is the right OpEx base we should use for 2019? Because there have been a number of moving parts, one-off items in 2019.
Just trying to get a sense of what are the puts and takes for 2020 OpEx. Thank you.
Yep. If we start with Kathrein, I'll leave Carl to comment on the OpEx. With Kathrein, it's a couple of effects we've had during the fourth quarter. When we took over the business, we didn't have the permits to operate in the factory. We have actually stopped supply in the beginning of the quarter, and the effect of that you see in gross margin. We will always ensure the safety of the people working for us. For us, we did not want to operate a facility without fire permits. That's one effect we had in Q4. You just keep that in mind. We also see that Kathrein was impacted by the uncertainty in the U.S. as well. When you should put that aside and say that was what we saw in gross margin.
When we now move into 2020, we expect to have a loss for the full year. We do that because we are investing in building a strong roadmap within antenna, and within a bigger product offering. You will see us gradually improve through the year, but the year will overall clearly be negative. We're establishing a very strong competitive position and competitive offering in antenna solutions. It's probably going to take 12, 18 months before we're there. That's the plan we're working according. We think this is going to be even more important in the 5G world when we can offer fully integrated site solutions.
On the OpEx, yes. Hi, Achal. I can take that then.
As you know, we don't guide on OpEx typically, but we have said now that if you start with the baseline for 2019, it's about SEK 64 billion or so. We are saying that we will increase that a bit. Of course, the ambition here is to grow the top line more, as I said, in order to decrease the percentage of OpEx to net sales. Some of the moving parts that you asked about, we do have Kathrein obviously, brought in, and both SG&A and R&D comes from them. We have the three areas that we talk about here, digitalization, which will yield return, longer term of course, in a more efficient enterprise, but also compliance and security. I would say, obviously we work with constant efficiency measures as well to be as efficient as possible in the SG&A side.
In R&D, it's also about improving productivity, not necessarily decreasing the amount of investment there, because I think definitely we have proven that the investments in R&D have yielded results in strongly improved the gross margin and competitiveness. We will manage it in a good way, all within the 2020 targets.
Okay. Thank you, Carl.
Achal, you are happy with that?
Yep. Thank you, Peter.
Thank you, Achal. We're open for the next question too, operator.
Thank you. The next question comes from the line of Daniel Djurberg of Handelsbanken. Please go ahead. Your line is open.
Morning, Daniel.
Thank you very much.
Good morning, and thank you for taking my question. First, congratulations to strong cash conversion here in the quarter, and then also on the improvement in Digital Services. Just a short follow-up on Kathrein.
Should we expect, given what you stated, that H1 will be slightly better, or will it get even a bit worse than getting better second half? That was the first question.
Yeah, we should. This is a gradual process. What we've seen during Q4 is this loss of production, but also investment in the product portfolio. Investments in the product portfolio will clearly continue. The ambition is to get back more to normal production. We think we're going to focus the product portfolio and invest for the future, and that's going to carry some costs throughout the year, with a bigger loss first part of the year than the second part. We should see, you can probably assume similar to Q4, give or take.
Perfect. May I also just ask you about China and the 5G procurement? You commented about initial launches of 5G impacting growth in the area. Can you say anything about what you expect for the 2020 uptake, and also if you have seen anything on the market share so far would be great.
The procurement in China has not been concluded, and we don't know when it will be. It's a bit hard to speculate. What I can say is our ambition is to strengthen our position in 5G than 4G. That ambition we have, and we're going to continue to focus on delivering on that.
Perfect.
Is that all then?
Sure.
Yeah.
Okay. Thank you. I will go back in line. Thank you.
Okay. Okay, operator, let's move to the next question.
Thank you. The next question comes from the line of Amit Harchandani of Citigroup. Please go ahead, your line is open.
Good morning, everyone. Amit Harchandani fom Citi.
Good morning.
Morning, Peter. Thanks for letting me on. My question really goes back to the resilience of the Networks' gross margin that we saw in Q4, which is, I guess, particularly noteworthy given the lower contribution from North America. For the full year, your Networks' gross margin was, I believe, around 41.8%. You've talked about, at least you've referenced Dell'Oro talking about the market growing 4%. There should be some leverage coming through for you on the top line. Is it a fair assumption to make that you will be able to manage the impact of strategic contracts, and given the growth in the RAN market, your gross margin for Networks should at least be flattish year-on-year in 2020? Put it other way, how would you advise us to think in terms of gross margin evolution for Networks over the course of 2020?
Carl, take it.
I think what we have shown now, during Q4 also, is that we are able to compensate for strategic contracts with other operational leverage. We don't expect that to dramatically change. Of course, we are fully committed to the targets that we have set up, including the bottom line of 15%-17%. We will deliver on that. There are puts and takes there with strategic contracts and China. We're also working on improving, obviously, the underlying operation in Networks. That's what I would say.
I would say what we do now is we're also working on changing the way we work in the company and improving our ways of working through digitalizing the company more than in the past.
The whole ambition with those investments is actually that it should lead to efficiency gains and lower cost levels in the future. We're taking some costs during Q4 in order to deliver those benefits 2021 and beyond. When you look at 2020, as Carl described, I think it's a good way to think about it. Longer term, we should see a lower ratio of OpEx to sales and a strong gross margin. I've said it before, gross margin is the best indication of a competitive product portfolio. That's why it's a very important metric for us to follow. Of course, we're happy to see that we can reduce some of the geographic mix, and in addition see a good gross margin despite taking some contracts with the challenged short-term margin in there. They will contribute to 2022 and beyond.
We feel very comfortable about 2022.
Okay. You good with that, Amit?
Thank you, Peter. Thank you, gentlemen.
Thank you. Thank you. Thank you, Amit. Thanks. We'll continue with next question, please.
The next question comes from the line of Johanna Ahlqvist of SEB. Please go ahead, your line is open.
Good morning, Johanna.
Good morning. Thank you for taking my question. Maybe two, if I may. The first one relates to OpEx again. You mentioned that the base is 64, and I'm just trying to understand the magnitude of the OpEx increase, because you have some one-offs in 2019, and just putting back those one-offs would imply an increase of at least SEK 1 billion. Then, adding more cost for Kathrein to that would get us to SEK 2 billion higher OpEx. I'm just wondering, are you really expecting an underlying increase in OpEx, or are these the one-off effects not be there anymore and the addition of Kathrein, or how should we think about it, just to get the magnitude? That's the first question. If I may, I have another one.
Sure.
After.
Okay. I would say, we're also doing efficiencies, of course, to deliver what I said before. There will be an increase in absolute number, and of course, there are one-offs included, fully aware of that, in the 2019, and there will always be one-offs, but that's not really what we steer on, of course. Essentially, there will be a certain increase because of the investments and because of Kathrein. Again, thanks to the efficiency measures we are taking, we are aiming to reduce the percentage of net sales. Yeah, that's what I can say.
Okay. My second question, if I may, was just on gross margin again, because given the fact that you expect a higher OpEx level for 2020, I guess you need to feel pretty confident in the fact that you can keep the gross margin on fairly the same levels as 2019 for the group. I'm just wondering how big negative impact do you expect or incorporate from China. Is it a negative initial gross margin, or is it just a low initial gross margin? I guess that will have an important driver in either way. Thank you.
Johanna, it's a great question. It's very hard to comment on China yet because we don't really know what market share we will get, what prices will be. We'll have to come back on that. Of course, we factored in costs. When we guide for 2020, we have made certain assumptions that include costs that affect gross margin negatively, but still reaching guidance. Depending on what the outcome will be, we cannot comment. A realistic case, based on increasing our market share in China, will have a negative effect on gross margin. We factored that into the guidance for 2020.
Perfect. That's clear. Thank you.
Thank you, Johanna. We'll move to the next question, please.
That comes from the line of Fredrik Stenkil of Danske Bank. Please go ahead. Your line is open.
Morning, Fredrik.
Thank you. Good morning. Thank you for taking my question. Many questions have been answered. On the cash flow generation, you have improved many of your metrics, worked well with the working capital metrics in the year of 2019. Are there still a lot to do for you there, or do you see that you have reached a level where it's difficult to squeeze any additional out of those if we take the operational side support?
I think we have made very big strides, actually, on working capital during this year. We continue with that, definitely. There is more to do. It's about lead times in project contract delivery and so on, terms and conditions, and also the cash collection machinery, I would mention, which has been very effective during 2019, and that will certainly continue as well. Yeah, the effort is 100% on to continue to deliver good capital efficiency. Of course, in a growth scenario, what we try to do is to still keep working capital at bay, if you like, even during growth. Of course, that puts another challenge into the mix if the whole business is growing.
Okay, thank you. Maybe a question for Börje then on China. Again, I know it's difficult to answer, but when you think about this situation with the initial phase, which we have seen many times before with pressure on the margins when you roll out, what sort of timeframe are you expecting that to be under? Is it going to be a year or two, or how do you see that playing out? If you would say that it starts now, would it take a year or two? How do you think about that? Thank you.
It's very hard to say, in reality, how long the rollout will be. If you think about 4G, it took a few years to build out a complete nationwide coverage. You can probably assume that this is going to have something similar, but it's very hard to speculate. What we have done is we have based a case on the historic experience. You've seen the way we said in 2017. I think it's the same thing now. We have factored something similar in, and then we'll have to see where it comes out. We'll hope, of course, we can gain market share. We will see.
Okay. Thank you.
Thank you, Fredrik. Please, next question.
The next question comes from the line of Jörgen Wetterberg of Nordea. Please go ahead. Your line is open.
Good morning, Jörgen.
Good morning. Thank you, gentlemen, for letting me on. A quick question on the Digital Services contracts. You write that you have some pressure from continued impact from the BSS strategy. We know that you had these major trouble contracts that you took provisions for last Q4 with 0% gross margin. When can we expect those to go away, and how should we think about relief on gross margins from those in 2022? Thank you.
Some of these contracts are actually very long. Even if we deliver and convert them into revenue-generating contracts, there will be a margin drag for a long time. Some of them are even 10 years. These are going to have an impact quite a long period of time. Our ambition is still that we will see Digital Services be profitable this year, low single-digit margins, and then reach double-digit margins in 2022. That is including a drag from those long-tail contracts. We've said this before, I think the execution in Digital Services has always been focused on establishing a competitive product portfolio longer term, and that's why we have said the improvements come gradually. Of course, that factors in the drag from some of the contracts which will live there for another decade.
I think over the last few quarters, you've seen us systematically deliver on that, and that's something we will continue to do. You can always hope for some of these contracts to generate additional sales, additional revenues as you have a footprint, depending on how the customer scales their business, et cetera, and then the margin profile can change. As of now, we're focused on delivering on the plan we've put in place.
Okay. Thank you.
Thank you.
Thank you, Jörgen. Let's move to the next question.
That is from the line of Stefan Slowinski of Exane BNP Paribas. Please go ahead. Your line is open.
Good morning, Stefan.
Good morning. Thanks for taking my question. I've just got two quick ones on cash. Maybe the first one for Carl. You had SEK 18 billion of free cash in 2019, about 8% of revenues. Can you help us understand more the outlook for 2020? We've got the restructuring guidance you've given, should we expect any other significant changes in CapEx or working capital movements? Do you need to increase inventories, for example, to prepare for China? Anything else that we should expect to impact cash flow in 2020?
As you know, and we talk about this at the investor update, we have provided this illustrative bridge coming from a 12% operating margin, which is a 2022 target, and down to 8%, and describing then how the various components there between will impact. I think we stick to that one. Now, we were very successful, I would say, in 2019 in delivering a good cash flow. We are on those parameters that we mentioned in that bridge, we overperformed on several, not least on working capital. I think in that bridge, we put working capital as stable in absolute or in a percentage, I should say. It's sort of neutral on working capital. I think that's a decent ambition to have going forward. When it comes to CapEx, as you asked, no major shifts.
We are investing in the U.S. production, for example, that could be small variations there, but nothing major to mention. We have a very big focus on generating cash flow, I think that we see the result of that in 2019 now. The whole organization is much more geared towards producing cash flow, that includes working capital, also discipline in capital in general and in both allocation and spending on these various items. We will continue to work on that. That whole area also, I should say, is supported by the incentive schemes that we have in the company. That's also giving a lot of result, actually, where we have working capital, we have cash collection, we have economic profit, which is a value creation metric then for most people with short or long-term incentives. That certainly helps as well.
It's a big focus area.
Okay. Maybe just a follow-up.
Second question?
Yeah, just a follow-up question maybe for Börje on that, which is with the cash flow, you've got the SEC fine behind you, most of the major restructuring has been done, and you have this net cash position. It could be as high as SEK 50 billion by the end of this year, even after paying the dividend. Is there more you can do to optimize the balance sheet? Do you need to have SEK 50 billion of net cash?
It's a better problem than the opposite that we had, I think, in 2017, when everyone told us we needed to raise equity. We will come back on this. I think it's important for us to have a strong financial position, given the industry we're in. We see that when we meet customers, when they look at our long-term plans and they look on our ability to be a long-term competitor, they look at our financial position. It is important. Maybe we can do something on that. It's something we haven't looked at right now. We've been focused on making sure we get the business in much better shape, and then we can take the next step. Let's come back and discuss that at a later point.
Understood. Thank you.
Thank you. Realizing that we have a long line of questions coming, we will take the last question. Again, for those on this line, you can always reach out to the IR team or the press team if there are journalists. We will now take the last question for the call. Please, operator.
Thank you. That question is from the line of Peter Kurt Nielsen of ABG. Please go ahead, your line is open.
Thank you very much. If I can just return to the OpEx and the decision to invest in digitalization of business processes. I don't recall having heard you speak of this before. Obviously, one of your competitors has spoken of the need for similar investments. Could you perhaps discuss briefly what has driven your decision to invest in this, the need, how long will this investment be? Is it a one-year horizon? Is the impact which Carl illustrated for Q4, I think it was SEK -400 million, roughly sort of a good guide for what we should expect in the coming quarters? Thank you.
Thank you, Peter Kurt.
Yeah. If you think about them, it's actually that we increase cost level short-term. That should result in lower cost level over time. That's the reason why we do it. It includes a couple of different things, or it's a number of different projects. We feel that we need to automate a lot about our own order processes, visibility of customer orders, the way we run projects. All of these should result in efficiency gains down the road, That's what we invest for. The reality is, when we do these investments, we talk about them in the light of serving the customer in a better way. It's all about making sure that the customer gets the service, the customer gets the delivery on time, the quality on time, right the first time, et cetera. Why haven't we started doing it before?
We said that, first, let's get our basic processes in order before we automate them. We felt during the year of 2019, we got the house in order, and we got the business in shape. We said we can, during the year of 2019, take the next step and see if we cannot get further efficiency gains and improvements through digitalizing our business. That's why we took the decisions during Q4 or during Q3, Q4. Going forward, you can probably expect a similar level as we had in Q4, and gradually see the improvements coming through towards the end of the year.
Understood. Thank you very much.
Thank you, Peter Kurt. Before handing over for the conclusion from Börje, some practical things. First of all, we have our event in Barcelona for the investor community and obviously also for customers on the 24th to 25th of February. You can find more information about it on our website, how to join that. Secondly, this time we only have one call. We don't have an afternoon call. However, this call will be recorded and posted during the morning on our web so you can listen in again on that. With that, I would actually leave over to Börje to conclude this call, please.
Thanks, Peter, and thank you everyone for joining. With the focused strategy we put in place, we now have a very strong underlying business. We took some investments during Q4 that we will see yield result in the future. We feel that we are comfortably on track to delivering on the targets we set for 2020 and 2022. That is only a first goal towards building a much stronger Ericsson longer term. With that, thanks for joining us this morning.
Thank you.
Thank you.
This now concludes our conference call. Thank you all very much for attending. You may now disconnect your lines.