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SpokANNUAL REPORT 2004 Contents CEO letter ____________________________________3 Operational Review_____________________________4 Five Year Summary _____________________________8 Share Information _____________________________10 Letter from the Chairman ______________________15 Board of Directors’ Report (audited) _____________16 Financial Statements (audited)__________________27 Notes to the Financial Statements (audited) _______35 Auditors’ Report ______________________________84 Information on the Company____________________85 Corporate Governance ________________________97 Forward-looking Statements___________________106 Risk Factors ________________________________107 Shareholder Information ______________________112 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 1 1 C E O L E T T E R Letter from the President and Chief Executive Officer Dear Fellow Shareholder, A year ago we declared: “We’ve turned the corner.” This year, I can truly say that Ericsson has moved forward. The telecommunications industry’s confidence has returned and our market is expanding again. Our customers are buying more equipment to increase network capacity and introduce new services. This market rebound, combined with changes at Ericsson and the hard work of everyone in the company, fueled our solid performance. Sales rose by percent and our margins returned to healthy levels. Our challenge now is to secure an enduring competitive advantage in a profoundly changed market. The balance in the market has shifted from being technology driven to consumer driven. Ericsson’s strategy for success has five crucial elements: • Refining our long-term vision • Reinforcing the importance of meeting customers’ needs • Improving our ways of working • Focusing on consumer-driven technology leadership • Launching new products and services for operators Members of the management team will talk about these elements in more detail later in this review. Before they do, I would like to discuss two important themes – Operational Excellence, and the profound changes unfolding in our market. Operational Excellence goes far beyond efficiency and productivity. It also entails how we think about our customers and ourselves. In my view, highly satisfied customers, empowered employees and best-in-class margins are key indicators of Operational Excellence. Over the last year, we have made good progress against these criteria, but we know that sustaining this progress is a challenge. We have evaluated what our customers and our employees think about the changes we are making. The results are encouraging. We are now ranked as leaders not only in products and services, but also in image, loyalty and – importantly – in recommendation. This means that we are more likely to be recommended by customers than any of our competitors are. Measured as a percentage of sales,we have reduced our selling expenses by percent over the last two years – a dramatic improvement. Having said that, I believe we must become even better at listening and responding faster to our customers’ needs. Similarly, our employees were more closely involved in our strategic planningin than ever before and they made a great contribution. One result is that employees now have a much clearer sense of the mission ahead, which has made their work more productive and more rewarding. Recent employee satisfaction surveys support this assessment. profit margins are a key indicator for shareholders. Our ambition is to produce best-in-class profit margins and this year we generated the best operating margins ever. Operational Excellence means we are becoming a sharper, more responsive company. This is vital for success in today’s telecoms market, where the consumer is king. Technology remains important, but success is achieved by meeting consumers’ needs, not by developing technologies in search of a market. Consumers expect better, more affordable and easier to use services which enable them to communicate anywhere, anytime – in any way they choose. This is what drives investment by our customers and our job is to ensure that they can competitively offer such services. I believe that Ericsson has a winning proposition here with our longstanding end-to-end strategy. In other words, we are a one-stop shop offering the full range of telecoms products and services. The combination of mobile broadband networks and mobile devices using Internet technology is compelling: consumers get access to a wide range of services that are more sophisticated, less expensive and simpler to use. With increasingly complex mobile devices and applications interacting within the networks, our customers realize the importance of havingall the elements developed in close collaboration, thoroughly tested and based on open standards. We intend therefore to be the prime driver in an all- communicating world where mobility and ease of use are the main attractions for consumers. We have come far in completing the first phase of this vision. There are . billion mobile subscriptions in the world and almost million of them are connected via Ericsson technology. Now it’s time to expand this by bringing mobile broadband to existing users while making mobile voice communications available and affordable for the rest of the world’s population. By focusing on both new services and expanded coverage, we will create fresh growth areas for operators and ourselves. With restructuring and downsizing behind us, spirits are up throughout the company. Our business is growing again, with end-to-end solutions as a central differentiator. We have leading technology bolstered by one of the industry’s largest research and development programs. We have our global brand name and pole position with the world’s leading operators. And we have a clear strategy for profitable expansion as well as development of Operational Excellence. All in all, it’s a strong foundation on which to build. I invite you to read on as other senior managers discuss our progress and strategy for continued success. With best regards, Financial results also point to significant progress in achieving Operational Excellence. In addition to net income, Carl-Henric Svanberg President and Chief Executive Officer E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 3 O P E R A T I O N A L O V E R V I E W Operational Overview From Torbjörn Nilsson, Head of Group Function Strategy and Product Management: REFINING OUR LONG-TERM VISION Our vision is to help create a world where people can communicate with each other regardless of where they are or which telecommunications technology they use. I think it’s fair to say that we have completed the first phase of that vision. For the over percent of the world’s population who carry a mobile phone, communication has become a personal thing. You address a person, not a place. For those people, the second phase is to get broadband into their pocket. The second phase is also about making telecommunications simple and more affordable, delivering on the promise to make telecoms available to everyone. Broadband access is definitely becoming mobile, and with that we see new areas of growth for operators. High capacity G mobile systems enable people to access the Internet and other information at speeds similar to that of wireline connections in homes and offices, but with the added advantage that you can do it on the move. We now enjoy easier handling of e-mail and other office applications using our mobile devices, and – even more important – we see the introduction of true mobile multimedia. With the development of mobile broadband services, mobile TV may soon become a very important service for mobile operators. Voice, data and video over fixed and mobile connections will ultimately be handled by the same kind of technology. The maturity of IP has created a surge in demand for unified solutions. There are clear benefits for both consumers and operators: convenience and a cost efficient combination of voice, text, pictures and video services give users a richer experience, and create new revenue streams for the operators. IMS is the standard that will help both wireline and mobile operators move to all-IP networks. Ericsson is a major contributor to this standard and has a leading position in the market for IMS-based solutions. The convergence to IMS and all-IP puts us in a strong position. We provide broadband to homes and offices through our Ethernet Broadband Access portfolio. We provide broadband to mobile devices through G and High Speed Downlink Packet Access (HSDPA). Whether you are at home, in your office or traveling, we are there, managing the complexity so that communications can be simple and seamless. It may sound strange that the drive for simplicity for the user makes everything more complex for the operators and for ourselves. But just look at mobile phones. They are becoming digital Swiss Army knives that might include a regular phone, e-mail, radio, mp-player, PDA, GPS-positioning, game console, camera, television or credit card. It’s a great challenge to make all these functions work together as a whole. Only a few companies can do this. Our handset platform licensing business is one of our ways of ensuring that we can make services work, all the way from one person to another, regardless of what device they are using and which network they are with. New services, new devices, new ways of communicating with each other: service and network convergence is creating a dynamic telecoms market. When it comes to broadband and mobile communications, this is just the beginning. From Bert Nordberg, Head of Group Function Sales and Marketing: REINFORCING THE IMPORTANCE OF MEETING CUSTOMERS’ NEEDS My job was created in and my mission was to strengthen our market position while reducing sales and marketing costs. We have reduced our selling expenses by percent over the last two years. And despite spending less money on selling, in we increased sales by percent, and maintained or increased our share in all of our key markets. We achieved these figures because we invested time and money in a painstaking overhaul of our entire sales process. We implemented a new incentive system anda new sales training program, creating a better structured, more motivated and more effective sales force. All of our sales teams can now provide customers with immediate knowledge of the entire Ericsson portfolio of products and solutions. Our new Web-based automatic ordering system further increases the speed and efficiency of the sales process. How are customers responding to all this? They tell me they’re seeing a whole new Ericsson. We don’t just try to sell what we have off the shelves, they say; we listen carefully and work to meet their requirements for solutions. The ten largest operators represent almost percent of world-wide operator revenue, and every one of the top ten is an Ericsson customer. With further consolidation taking place amongst operators, it is a strategic priority to ensure that we meet the needs of these customers. 4 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 In we identified several significant new business opportunities. For example, many markets with good potential for growth are held back because they have dispersed or low-income populations, which increases the costs involved in the initial launch of services. We introduced our Expander solution to address this. Expander came about because we listened to the words of a high-ranking telecoms official in a developing country. He said to me: “You probably don’t realize how important telecoms are to rural areas. A village that is connected exists; an unconnected village doesn’t exist. This is a common opinion among the governments in the developing world. Connected versus not connected is becoming as serious as educated versus uneducated, or rich versus poor.” With the number of mobile phone users in the world approaching two billion, we asked ourselves: ‘‘How can Ericsson provide services to the rest of the world’s population?’’ We started by looking at scaled-down solutions. But we soon realized that people in these areas need the same services as everyone else. So we analyzed the real costs involved in building a mobile network. Typically, base stations represent less than percent of an operator’s total cost for a cell site. Land, construction, maintenance and so on make up the other percent. We searched for ways to reduce the percent, and came up with a combination of existing Ericsson base station and antenna technology that gives far better coverage using fewer sites. This is Expander. Expander provides operators with a more cost effective way to introduce voice and data services in areas where you have few subscribers. Once established, the network can be developed to meet changing patterns of demand, just like any other network. By lowering the initial investment required to launch services we are increasing the potential for sales of our equipment and services in the future. This is Operational Excellence in practice. It’s about thinking ahead and taking into account our customers’ whole business – not just the bits that we provide. O P E R A T I O N A L O V E R V I E W From Marita Hellberg, Head of Group Function Human Resources and Organization: IMPROVING OUR WAYS OF WORKING When I accepted the challenge of heading up Human Resources for Ericsson in September , the company was nearing the completion of the most extensive restructuring in its year history. Naturally, it was with a sense of great relief that, in , we could leave the ordeal of the severe cutbacks behind us. After such dramatic changes, we had to assess what needed to be done going forward and how to do it in such a way as to ensure we stay on the right course. Ericsson’s fundamental business strategy has remained solid for years. But while the essence of the strategy may stay the same, how we implement it and turn our ideas into actions must evolve in response to market developments. In we involved our employees in discussions about strategy, and their views helped to shape our strategic priorities. These priorities were defined at our Global Management Conference in , and within weeks of the conference the current thinking of management had been communicated throughout the entire company. This is the first time that Ericsson has involved so many employees in the strategy process. We know that to be competitive we must inspire and enable our people to contribute as much as they can. That means they must feel they’re part of something special. Culture will defeat strategy every time so, in parallel with the strategy work, we also reinforced our core values and ways of working through a major program of employee workshops. Our values and working methods are now a real priority for managers. By discussing matters openly we are shaping a strong culture that will help us to achieve our business goals. We also carried out an extensive analysis of competence in , and an employee satisfaction survey. Nine out of ten employees contributed to the survey. The results – and my own experiences of talking to people here – underline the motivation and loyalty of our people in the midst of so much change. Spirits are up as everybody feels that the company is on the move again. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 5 O P E R A T I O N A L O V E R V I E W From Håkan Eriksson, Head of Research and Development: Technology leadership is vital for us. By contributing effective solutions based on emerging standards we can influence the standardization process and file for patents at an early stage. We have one of the industry’s largest portfolios of granted patents – , with another , pending. Controlling patents and leading the standardization process gives us a head start in product development, and this is one reason why we command the largest market share in G and G infrastructure equipment. We also develop and license the technology platforms used inside handsets. These platforms integrate the complete inner workings of the handset, such as software and chipset design. In a world of increased complexity, with more advanced technologies and service applications, our focus on making everything from base stations to handsets work together is key to our customers. This strategy has worked. Today, our mobile platforms business holds a percent market share of WCDMA handsets and there is excellent potential for growth. The success of our Sony Ericsson joint venture also demonstrates how our approach has created value. But there is an even more important reason why our end- to-end strategy is right. While communications technologies and standards are increasingly complex, customers require complete working solutions. Our expertise ensures that our products and services work seamlessly with other suppliers’ hardware and software. This means that a network can function properly – and interact with other networks – despite the vast array of equipment and standards employed. In other words, operators and handset manufacturers know that buying from Ericsson minimizes potential interoperability issues, reducing cost, time-to-market and risk. This ability to work across a wide range of technologies is an invaluable asset for Ericsson. FOCUSING ON CUSTOMER-DRIVEN TECHNOLOGY LEADERSHIP My challenge has been to strengthen our technology leadership while getting more from our R&D organization, despite the radical scale-backs of recent years. Although we have streamlined our approach, with fewer centers and employees, our commitment to R&D has never wavered. Almost a third of our employees are involved in this area, and we remain a leading contributor to the most important technologies in mobile communications, such as GSM, GPRS, EDGE, WCDMA and CDMA standards. But these days, it’s not just about creating technology, it’s about how to apply it to meet our customers’ needs better than any of our competitors. Music-to-the mobile, M-USE, is a good example of a customer- driven solution. Clearly, strengthening our R&D is no easy task, so I’m very happy to report that our commitment to Operational Excellence has enabled us to make real improvements this year. We are now much more precise about the management of development projects. We are offering customers significantly more advanced products and platforms, while providing the assurance that they will be delivered on time, and reach their performance specifications faster than before. This is not about transporting a box from the factory to the customer; it’s about developing, installing, testing and enhancing a technically complex solution made up of evolving technologies. And getting that solution to deliver revenue- generating services for our customer – on time and on budget. To really understand the scale of our challenge you must consider the complexity of the business we are in. Ericsson thrives on technology leadership, and we are in the middle of a major transition, from G to G. A challenge in itself, this profound change in technology coincided with the recent market crisis, and the resulting turbulence really has made it tough for operators and suppliers. These have been difficult times, but we have focused on learning from our experiences and making ourselves stronger. In , for example, we consolidated our position as world leaders in radio technology by setting an industry speed record in High Speed Downlink Packet Access (HSDPA). This technology enables a subscriber to download files to a G mobile device at speeds comparable to an office wireline connection. HSDPA is a major breakthrough that will change the way we think about G. Videos, music and web pages can be downloaded in seconds, and even high quality mobile TV is possible. 6 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 O P E R A T I O N A L O V E R V I E W Hans Vestberg: Global Services has over , Ericsson employees out there working alongside customers, and in many respects these people are the day-to-day eyes, ears and voices of Ericsson. How we meet customers’ needs is vital to our success, whether it’s integrating a new radio base station, solving an intricate network-planning problem or managing an entire network. Operators all over the world are increasingly considering different forms of outsourcing. Our managed services offering enables operators to reduce cost, focus on customer care and new business, while trusting us to manage their network. Through our current managed services contracts, excluding hosting, we now manage networks that together serve more than million subscribers worldwide. This makes us the market leader in managed services. A market leader cannot stay still, however, and in we were the first to introduce managed capacity and hosting services to the market. These are an evolution of our managed services offering, and were developed at our customers’ request. Managed capacity means that we operate a network according to the ‘pay-as-you grow’ principle. We provide capacity when and where it is needed. Operators then pay accordingly, reducing the need for large up-front investments. In we signed a landmark managed capacity deal with Bharti, one of India’s leading operators. With hosting, we own and operate servers and platforms on which, for instance, multimedia and messaging services are stored. This flexible, on-demand model suits operators that want to quickly introduce mobile services, such as picture messaging, music and games downloads, video, or try out new services. We announced hosting contracts in . We track our performance carefully, and I am very pleased with the way we have improved this year. On average we improved the response time percent for some , customer service requests, ranging from general consultations to more complex issues. These requests come from our customers – operators that together serve over million subscribers. From Björn Olsson, Head of Business Unit Systems and Hans Vestberg, Head of Business Unit Global Services: LAUNCHING NEW PRODUCTS AND SERVICES FOR OPERATORS Björn Olsson: Ericsson’s business success is to a large extent built on our ability to provide complete systems solutions to our customers. They expect new services to be fast to introduce and their networks more efficient to operate while evolving towards all-IP. Our new service delivery solutions greatly reduce the time required for launching consumer services down to just one week. Improving speed-to-market supports revenue growth and improves operators’ competitiveness. The base for these solutions is our market-leading position in multimedia messaging, charging, subscriber databases and systems integration. Softswitching is an important development. This technology can radically improve the efficiency in operating mobile and fixed networks, and introduces IP into the telecom network. Using our softswitching solutions, operators can halve the number of core network sites and reduce the need for transmission capacity. We have implemented our softswitch solutions in more than mobile and fixed networks. Consumers want convenience, so the introduction of IP into telecommunications networks is good news for them. The standardized system for IP multimedia services, IMS, will ensure high levels of quality and reliability in IP-based services. Two examples are IP Telephony and Combinational Services, which enable consumers to share images, videos, etc, while having a conversation. Ericsson has signed IMS contracts for fixed and mobile systems, making us one of the market leaders in IMS. This year we also pursued opportunities in the fast-growing market for home broadband connections. The Triple Play trend, where operators offer telephony, TV and Internet services from the same wall-socket using digital subscriber line (DSL) technology, has added momentum. Our Ethernet DSL offering makes Triple Play possible, and we are one of the top suppliers of this solution. The majority of our customers operate both mobile and fixed networks. We believe there will be very few operators providing mobile or fixed services only, so we have maintained our commitment to both areas. We are being rewarded for this approach, as customers seek suppliers able to integrate their fixed and mobile networks into one network based on IP. This puts us right where we want to be – providing solutions at the heart of the convergence towards all-IP networks. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 7 F I V E - Y E A R S U M M A R Y Five-year Summary SEK million Net sales Operating income – operating margin Financial net Net income Year-end position Total assets Net assets Working capital Capital employed Tangible assets Stockholders’ equity Minority interests Interest-bearing provisions and liabilities Other information Earnings per share, diluted, SEK 3) 4) – in accordance with US GAAP, diluted 3) 4) Cash dividends per share, SEK Stockholders’ equity (SEK per share) Earnings per share, basic, SEK 3) Number of shares (in millions) – outstanding, at end of period – average, basic 3) – average, diluted 3) Additions to tangible assets Depreciation on tangible assets R&D and other technical expenses 2) – as percentage of net sales 2) Ratios Return on equity Return on capital employed Equity ratio Debt-equity ratio Current ratio Capital turnover Inventory turnover Accounts receivable turnover Return on sales Payment readiness – as percentage of net sales Net cash Statistical data, year-end Orders booked, net Number of employees – Worldwide – Of which in Sweden 2004 2003 2002 5) 2001 5)6) 2000 5)6) 131,972 28,938 21,9% –540 19,024 183,040 78,356 70,494 111,999 5,845 77,299 1,057 33,643 1.20 0.91 0.25 1) 4.88 1.20 15,832 15,829 15,859 2,452 2,434 20,420 15.5% 27.6% 29.4% 42.8% 0.4 3.0 1.2 5.7 4.1 24.6% 81,447 61.7% 42,911 117,738 –11,239 –9.5% –864 –10,844 182,372 62,780 58,873 108,989 6,505 60,481 2,299 46,209 –0.69 –0.68 0 3.82 –0.69 15,826 15,823 15,841 3,493 3,753 28,553 24.3% –16.2% –5.9% 34.4% 0.7 1.6 1.0 6.1 3.4 –6.2% 75,309 64.0% 26,998 145,773 –21,299 –14.6% –1,536 –19,013 209,113 76,076 73,026 137,539 9,964 73,607 2,469 61,463 –1.51 –1.58 0 4.65 –1.51 15,820 12,573 12,684 2,738 5,514 33,455 23.0% –26.7% –11.3% 36.4% 0.8 1.7 1.0 5.1 3.0 –11.7% 66,306 45.5% 4,751 231,839 –27,380 –11.8% –1,744 –21,264 257,521 72,240 104,998 162,119 16,641 68,587 3,653 89,879 –1.94 –2.27 0 8.67 –1.94 7,909 10,950 11,072 8,726 6,486 46,640 20.1% –26.5% –14.3% 28.1% 1.2 1.7 1.5 4.8 3.4 –9.7% 60,239 26.0% –20,955 273,569 30,828 11.3% –1,189 21,018 263,282 94,587 97,261 154,014 23,104 91,686 2,901 59,427 1.91 2.12 0.36 11.59 1.93 7,909 10,896 11,100 12,643 10,040 41,921 15.3% 26.1% 24.8% 35.9% 0.6 1.6 2.0 5.0 3.8 12.6% 23,567 8.6% –23,657 132,959 113,000 128,351 221,477 292,344 50,534 21,296 51,583 24,408 64,621 30,241 85,198 37,328 105,129 42,431 1) For 2004, as proposed by the Board of Directors. 2) 2000 adjusted to exclude research and development costs regarding customer orders included in cost of sales. 3) 2000–2001 adjusted for stock dividend element of stock issue. 4) Potential ordinary shares are not considered when their conversion to ordinary shares would increase earnings per share. 5) 2002 restated for changed accounting principles. 2001 and 2000 have not been restated as the information is not readily available. 6) Restated for changed accounting principles in Sweden 2002 regarding consolidation of companies according to RR 1. 8 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 F I V E - Y E A R S U M M A R Y US GAAP SEK million, unless otherwise stated Net sales Net income after cumulative effect of accounting change Earnings per share, basic, after cumulative effect of accounting change (SEK per share)3) 4) Earnings per share, diluted, after cumulative effect of accounting change, diluted (SEK per share)3) 5) Total assets Stockholders’ equity Capital stock Number of shares (in millions): – average, basic3) – average, diluted3) 2004 2) 2003 2) 2002 2) 2001 1) 2) 20001) 131,972 14,386 117,738 –10,597 145,773 –19,918 231,839 –24,403 273,569 23,393 0.91 –0.67 –1.58 –2.23 2.15 0.91 192,863 84,369 16,132 15,829 15,855 –0.68 195,611 69,963 16,132 15,823 15,831 –1.58 226,480 83,203 15,974 12,573 12,684 –2.27 282,207 77,801 8,066 10,950 11,057 2.12 291,013 109,217 7,910 10,896 11,017 1) Upon adaption of SFAS142 on January 1, 2002, Ericsson ceased 3) 2000–2001 adjusted for stock dividend element of stock issue. amortization of all goodwill for US GAAP reporting purposes. Amortization expense on goodwill on a US GAAP basis for the years ended December 31, 2001 and 2000 was SEK 1,123 million and SEK 761 million, respectively. 2) Effective October 1, 2001, Sony Ericsson Mobile Communications assumed substantially all of the operations of the Phones segment. As of this date, 50 percent of the results of the Sony Ericsson joint venture are reported under “Share in earnings of joint ventures and associated companies” pursuant to equity accounting principles. Retained Phones operations are reported under “Other operations”. 4) Earnings per share, basic, are calculated by dividing net income, after cumulative effect of accounting change, by average number of shares outstanding, basic. 5) Diluted earnings (loss) per share are calculated by dividing net income (loss), after cumulative effect of accounting change, by the sum of the average number of shares outstanding plus all additional shares that would have been outstanding if all convertible debentures were converted and stock options were exercised. Potential ordinary shares are not considered when their conversion to ordinary shares would increase earnings per share. Working capital: Current assets less current non-interest- bearing provisions and liabilities. Capital employed: Capital employed is defined as total assets less non-interest-bearing provisions and liabilities. Earnings per share: See Notes to the Financial Statements – Note , “Accounting Policies”, for information of principles for calculation of earnings per share. For earnings per share in accordance with US GAAP, see Notes to the Financial Statements – Note , “Reconciliation to Accounting Policies Generally Accepted in the United States”. Equity ratio: Defined as the total of stockholders’ equity and minority interest in equity of consolidated subsidiaries, expressed as a percentage of total assets. Debt-equity ratio: Defined as total interest-bearing provisions and liabilities divided by the total of stockholders’ equity and minority interest in equity of consolidated subsidiaries. Current ratio: Current assets divided by the sum of current provisions and liabilities. Capital turnover: Net sales divided by average capital employed. Cash dividends per share: Defined as dividends paid divided by average number of shares, basic. Inventory turnover: Cost of sales divided by average inventory. Stockholders’ equity (SEK per share): Defined as Stockholders’ equity divided by the number of shares outstanding. Return on equity: Defined as Net income expressed as a percentage of average adjusted Stockholders’ equity (based on the amounts at January and December ). Return on capital employed: Defined as the total of Operating income plus Financial income as a percentage of average capital employed (based on the amounts at January and December ). Accounts receivable turnover: Net sales divided by average accounts receivable. Return on sales: Operating income plus Financial income expressed as a percentage of net sales. Payment readiness: Defined as cash and short-term investments less short-term borrowings plus long-term unused credit commitments. Payment readiness is also shown as a percentage of net sales. Net cash: Defined as cash and bank plus short-term cash investments less interest-bearing provisions and liabilities. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 9 S H A R E I N F O R M A T I O N Share Information Stock exchange trading Ericsson’s Class A and Class B shares are traded on Stockholmsbörsen (Stockholm Stock Exchange), and the Class B shares are also traded on the London Stock Exchange. In the United States, the Class B shares are traded on NASDAQ in the form of American Depositary Shares (ADS) evidenced by American Depositary Receipts (ADR) under the symbol ERICY. Each ADS represents Class B shares. Approximately () billion shares were traded in , of which about (.) percent were traded on Stockholms- börsen, about (.) percent on NASDAQ, and about (.) percent on the London Stock Exchange. At an Extraordinary General Meeting on August , , it was decided to increase the voting power of the Class B shares from / of a vote to / of a vote. The voting power of the Class A shares remain unchanged at vote. (For more information, see the Board of Directors’ Report.) Ericsson rejoined the DJ Euro Stoxx list on September , , and on December , , we also rejoined the NASDAQ 100 index. Share price trend During , Ericsson’s total market value increased by about percent to approximately SEK billion (SEK billion in ). The OMX index on Stockholmsbörsen increased by percent, the NASDAQ telecom index increased by approximately percent and the NASDAQ composite index increased by approximately percent in . The Ericsson share increased by approximately percent on NASDAQ. Share capital As of December , , Ericsson’s share capital was SEK ,,, (,,,) represented by ,,, shares. The par value of each share is SEK .. As of December , , the shares were divided into ,,, (,,) Class A shares, each carrying one vote, and ,,, (,,,) Class B shares, each carrying one-tenth of a vote. As of December , , Ericsson held ,, of its Class B shares. No Class C shares, each carrying one-thousandth of a vote, are outstanding. Share trend, Stockholm Stock Exchange, 2003–2004 Share turnover (million shares) B shares SEK OMX index 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 25 20 15 10 5 2003 2004 Source: Svensk Börsinformation 10 E R I C S S O N – A N N U A L R E P O R T 2 0 0 3 NASDAQ London Stockholm Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Share data Earnings per share, diluted (SEK)2) P/E ratio, Class B shares Dividend (SEK)1) 1) For 2004 as proposed by the Board of Directors 2) 2000–2001 adjusted for stock dividend element of stock issue Share prices on Stockholmsbörsen (SEK) Class A at last day of trading Class A high for year (April 21, 2004) Class A low for year (Jan. 2, 2004) Class B at last day of trading Class B high for year (April 20, 2004) Class B low for year (Jan. 2, 2004) S H A R E I N F O R M A T I O N 2002 –1.51 – 0 2002 8.60 42.89 3.80 6.10 44.78 2.96 2001 –1.94 – 0 2001 42.25 91.00 23.98 41.35 88.11 23.18 2000 1.91 40 0.36 2000 88.17 169.72 75.83 78.00 166.83 72.94 2004 1.20 17 0.25 2004 21.70 26.10 14.00 21.20 24.50 12.70 2003 –0.69 – 0 2003 13.90 16.80 5.55 12.90 14.60 4.11 Offer and listing details Host market NASDAQ ADS Prices The tables below state the high and low sales prices quoted for our ADSs on NASDAQ for the last five years. The NASDAQ quotations represent prices between dealers, not including retail mark-ups, markdowns or commissions, and do not necessarily represent actual transactions. Principal trading market Stockholmsbörsen (Stockholm Stock Exchange) Share prices. The tables below state the high and low sales prices for our Class A and Class B shares as reported by Stockholmsbörsen for the last five years. The equity securities listed on the A-list of Stockholmsbörsen’s Official Price List of Shares currently comprise the shares of companies. Trading on the exchange generally continues until : p.m. each business day. In addition to official trading on the exchange, there is also trading off the exchange during official trading hours and also after : p.m. Trading on the exchange tends to involve a higher percentage of retail clients, while trading off the exchange often involves larger Swedish institutions, banks arbitrating between the Swedish market and foreign markets, and foreign buyers and sellers purchasing shares from or selling shares to Swedish institutions. The exchange publishes a daily Official Price List of Shares which includes the volume of recorded transactions in each listed stock, together with the prices of the highest and lowest recorded trades of the day. The Official Price List of Shares reflects price and volume information for trades completed by the members. Annual high and low market prices The annual high and low market prices on these markets were as follows: NASDAQ USD per ADS1) Period 2000 2001 2002 2003 2004 High 190.04 97.50 43.33 18.85 34.57 Low 74.92 22.03 3.40 5.20 17.93 High 169.72 91.00 42.89 16.80 26.10 Low 75.83 23.98 3.80 5.55 14.00 SEK per Class B share Low High 166.83 88.11 44.78 14.60 24.50 72.94 23.18 2.96 4.11 12.70 SEK per Class A share STOCKHOLMSBÖRSEN Share market prices prior to August 8, 2002, have been adjusted for the stock dividend element of the stock issue. 1) One ADS = 10 Class B shares. (Prior to October 23, 2002, one ADS = one Class B share. Share prices have been adjusted accordingly.) E R I C S S O N – A N N U A L R E P O R T 2 0 0 3 11 S H A R E I N F O R M A T I O N Quarterly high and low market prices The table below states for each quarter of and high and low sales prices. Period 2003 First Quarter Second Quarter Third Quarter Fourth Quarter 2004 First Quarter Second Quarter Third Quarter Fourth Quarter 1) One ADS = 10 Class B shares NASDAQ USD per ADS1) SEK per Class A share STOCKHOLMSBÖRSEN High Low High Low SEK per Class B share Low High 10.24 11.95 17.50 18.85 31.41 32.32 31.37 34.57 5.20 6.29 10.29 14.47 17.93 24.72 23.18 27.76 11.10 10.60 16.80 16.20 25.10 26.10 24.50 24.10 5.55 6.90 9.70 12.80 14.00 20.50 19.50 20.70 9.10 9.30 14.60 14.50 23.50 24.50 23.20 23.80 4.11 5.25 8.35 11.00 12.70 19.10 17.40 19.80 Monthly high and low market prices The table below states high and low sales prices for the last six months (August to January ). Month August 2004 September 2004 October 2004 November 2004 December 2004 January 2005 1) One ADS = 10 Class B shares Changes in capital stock 2000–2004 2000 Bonus issue 2000 Split 2000 Conversions 2001 Conversions 2001 New issue (Class C shares) 2002 Conversions 2002 New issue (Class B shares) 2003 New issue (Class C shares) 2003 December 31 2004 December 31 NASDAQ USD per ADS1) High 27.62 31.37 32.82 33.87 34.57 32.49 Low 23.18 26.05 27.76 29.21 31.03 28.01 STOCKHOLMSBÖRSEN SEK per Class A share High 22.60 23.40 24.10 23.50 23.50 22.40 Low 19.50 20.40 20.70 21.10 21.50 20.00 SEK per Class B share Low High 20.70 23.20 23.80 23.20 23.10 22.00 17.40 19.30 19.80 20.40 20.80 19.60 4:1 1:1 Number of shares Capital stock – 5,883,316,821 69,880,270 168,395 155,000,000 560 7,908,754,111 158,000,000 16,132,258,678 16,132,258,678 2,941,658,410 – 75,830,899 168,395 155,000,000 560 7,908,754,111 158,000,000 16,132,258,678 16,132.258.678 12 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 Shareholders As of December , , we had , shareholders registered at VPC (the Swedish Securities Register Center). According to information provided by Citibank, there were ,, ADSs outstanding as of December , and , registered holders of such ADS. A significant number of the ADSs are held of record by banks, brokers and/or nominees for the account of their customers. As of December , , this level is represented by , accounts. According to information known to us, approximately () percent of our Class A and Class B shares at year-end were owned by Swedish and international institutions. Ten largest countries, capital: Sweden United States United Kingdom Luxembourg Switzerland Germany Norway France Belgium Denmark Other countries Source: SIS Ägarservice AB S H A R E I N F O R M A T I O N As of December 31, 2004 53.7% 26.9% 4.7% 4.1% 1.7% 1.2% 1.0% 0.9% 0.9% 0.8% 4.1% 2003 56.1% 23.8% 4.5% 4.0% 2.3% 1.9% 0.9% 1.2% 1.5% 0.8% 3.0% The following table sets forth, as of December , , share information with respect to our largest shareholders registered at VPC, the Swedish Securities Register Center, known by us, ranked by percentage of voting rights: Largest shareholders by voting rights, December 31, 2004 Identity of person or group1) Investor AB AB Industrivärden Svenska Handelsbankens Pensionsstiftelse Livförsäkrings AB Skandia Pensionskassan SHB Försäkringsförening Robur Fonder AMF Pension Gamla Livförsäkringsaktiebolaget SEB-Trygg SHB/SPP fonder Nordea Fonder Tredje AP-fonden Första AP-fonden Fjärde AP-Fonden SEB fonder Alecta Svenska Handelsbankens Personalstiftelse Oktogonen, Stiftelsen EB Stiftelsen, Skandinaviska Enskilda Banken Svenska Handelsbanken Astoria i Linköping Foreign owners 2) of which Fidelity Funds Others Total Number of Class A shares Percentage of total Class A shares Number of Percentage of total Class B shares Class B shares Voting rights, Percentage of capital percent 513,320,192 372,000,000 83,903,000 58,960,986 63,360,000 6,690,973 4,763,682 27,923,095 3,142,274 3,419,614 12,245,095 7,472,938 2,872,755 3,530,210 2,484,915 20,000,000 12,903,000 5,179,200 2,931,500 1,440,000 23,774,261 – 39.22 28.42 6.41 4.51 4.84 0.51 0.36 2.13 0.24 0.26 0.94 0.57 0.22 0.27 0.19 1.53 0.99 0.39 0.22 0.11 297,073,324 – – 74,093,181 – 393,056,151 318,236,318 58,236,405 257,261,739 244,273,043 144,271,862 173,281,311 194,019,545 185,824,740 185,442,985 – – 7,679,200 3,658,592 2,566,612 1.82 – 7,434,524,245 819,164,919 76,462,228 5.85 4,849,979,507 1,308,779,918 100% 14,823,478,760 2.00 – – 0.50 – 2.65 2.15 0.39 1.74 1.64 0.97 1.17 1.32 1.25 1.25 – – 0.05 0.02 0.00 50.15 5.52 32.75 100% 19.46 13.33 3.01 2.38 2.27 1.62 1.33 1.22 1.05 1.01 0.97 0.90 0.81 0.80 0.75 0.72 0.46 0.21 0.12 0.06 27.48 2.93 20.04 100% 5.02 2.31 0.52 0.82 0.39 2.50 2.00 0.53 1.61 1.54 0.97 1.12 1.22 1.17 1.16 0.12 0.08 0.08 0.04 0.02 46.23 5.08 30.55 100% 1) Sources: SIS Ägarservice AB and VPC AB, December 31, 2004 2) Including Nats Cumco as Nominee: 1,576,621,014 Class B shares. E R I C S S O N A N N U A L R E P O R T 2 0 0 4 13 S H A R E I N F O R M A T I O N The following table indicates changes in holdings of the Class A and Class B shares, respectively, held by major shareholders and percent of voting rights, as of December , , and . Person or group Investor AB AB Industrivärden Svenska Handelsbankens Pensionsstiftelse Livförsäkrings AB Skandia Pensionskassan SHB Försäkringsförening Svenska Handelsbankens Personalstiftelse Oktogonen, Stiftelsen Robur Fonder AMF Pension Gamla Livförsäkringsaktiebolaget SEB-Trygg SHB/SPP Fonder Nordea Fonder Tredje AP-fonden Första AP-fonden Fjärde AP-fonden SEB fonder EB Stiftelsen, Skandinaviska Enskilda Banken Svenska Handelsbanken Astoria i Linköping Alecta 2004 Class A Class B shares, shares, percent percent Voting rights, percent 2003 Class A Class B shares, shares, percent percent 2002 Voting rights, percent Class A Class B shares, shares, percent percent Voting rights, percent 39.22 28.42 6.41 4.51 4.84 1.53 0.99 0.51 0.36 2.13 0.24 0.26 0.94 0.57 0.22 0.27 0.39 0.22 0.11 0.19 2.00 – – 0.50 – – – 2.65 2.15 0.39 1.74 1.64 0.97 1.17 1.32 1.25 0.05 0.02 0.00 1.25 19.46 13.33 3.01 2.38 2.27 0.72 0.46 1.62 1.33 1.22 1.05 1.01 0.97 0.90 0.81 0.80 0.21 0.12 0.06 0.75 39.11 28.34 7.38 4.53 4.83 1.52 – 0.00 – 1.98 0.14 – 0.77 0.33 – 0.04 1.19 0.39 – – 3.58 1.15 0.23 1.09 0.20 0.06 – 3.09 – 0.77 1.71 – 1.03 1.31 – 1.52 0.02 0.05 – – 38.29 27.72 7.21 4.45 4.72 1.49 – 0.07 – 1.95 0.17 – 0.78 0.36 – 0.08 1.16 0.38 – – 2.12 – 39.11 28.34 5.41 5.02 4.83 1.52 1.98 – – 1.98 – – 0.29 0.33 0.33 0.08 1.19 0.22 0.11 – 3.93 1.41 0.23 1.67 0.21 0.07 0.08 – – 0.89 – – 1.36 1.41 1.64 1.62 0.06 0.06 0.02 – 38.31 27.73 5.29 4.95 4.72 1.49 1.92 – – 1.95 – – 0.31 0.36 0.36 0.12 1.16 0.22 0.11 – 0.99 – 40.51 – 1.88 – Foreign owners of which Fidelity funds 1.82 – 50.15 5.52 27.48 2.93 1.09 – 45.74 – Others Total 5.85 32.75 20.04 8.36 38.45 9.05 8.27 44.83 9.12 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00 Source: SIS Ägarservice AB and VPC AB, December 31, 2004. We do not know of any arrangements that might result in a change of the control of the Company. As of December , , the total number of voting securities of the Company owned by officers and directors as a group was: Officers and directors as a group (27 persons) 6,080 17,586,280 0.1 For individual holdings, see “Corporate Governance”. Number of Class A shares Number of Class B shares Voting rights, percent 14 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 L E T T E R F R O M T H E C H A I R M A N O F T H E B O A R D Letter from the Chairman of the Board Dear Shareholder, Ericsson’s solid results for reaffirmed the value and effectiveness of our restructuring strategy. We delivered strong operating profit, healthy operating cash flow and our sales growth more than offset the weakness of the U.S. dollar – reinforcing our global market leadership. The Ericsson share price performed well during – outperforming most stock market indexes. We also returned to several blue chip stock indexes, including DJ Euro STOXX and the NASDAQ . Over the last several years, we have strengthened Ericsson, operationally and financially, and we have emerged from the market downturn with the strongest financial position in our history. Now, our ambition is to return value to shareholders in the most sustainable way. Retaining a strong balance sheet is of primary importance. Our solid financial position enables us to pay down debt, make strategic investments and, for the first time since , we are proposing that we pay a dividend to our shareholders. It has also allowed us to successfully manage our way through the challenging environment that we have experienced in recent years. To help protect shareholder value, we are committed to meeting the highest standards of corporate governance. We are confident that we have adequate management controls and we continuously seek ways to make them better. During , the difference in voting rights between the Class A and Class B shares was significantly reduced. We are participating in various industry forums to help further strengthen corporate governance practices including the NASDAQ Issuers Affairs Committee. We are also in the process of implementing the applicable requirements of the Sarbanes- Oxley Act. As a valued shareholder, you are part owner of an extraordinary company, with solid assets, a world-class reputation and some of the best employees in our industry. We have a number of strategic advantages in many areas, from our competitive cost structure and technological expertise to our industry-leading operational scale and customer base. It is a great honor for me to serve as your Chairman. I thank you for your continued support. I would also like to acknowledge the contributions of my fellow board members in setting our strategies and policies. Of course, a good strategy is effective only when properly implemented. For that, I would like to congratulate the management team and all employees for their ongoing commitment to operational excellence. This year’s excellent results are a credit to you all. Sincerely yours, Michael Treschow Chairman of the Board Highlights – 2004 (SEK million) Net sales Gross margin as a percentage of net sales Total operating expenses as a percentage of net sales Share in earnings of JV and associated companies Other operating revenues and costs Operating income operating margin Income after financial items Net Income Earnings per share (SEK) Employees of which in Sweden 2004 131,972 46% –37,105 28% 2,318 2,617 28,938 22% 28,398 19,024 1.20 50,534 21,296 2003 1) 2002 1) 117,738 37% –40,037 34% –252 1,886 5,224 4% 4,360 –10,844 –0.69 51,583 24,408 145,773 32% –56,109 38% –1,450 1,084 –9,337 –6% –10,873 –19,013 –1.51 64,621 30,241 1) 2002 and 2003 excluding restructuring charges, except for the measures Net Income and Earnings per share. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 15 B O A R D O F D I R E C T O R S ’ R E P O R T Board of Directors’ Report The Board of Directors’ Report contains discussion and analysis of the financial statements for earnings, balance sheet and cash flow. In addition to this and other information on past performance, the report includes “forward-looking statements” about future market conditions, strategies and anticipated results. Such statements are based on assumptions and estimates, and are subject to risks and uncertainties. Actual results could differ materially from those described or indicated by such forward-looking statements. For further discussion, please see “Forward-looking Statements”. The terms “Ericsson”, “Group”, “the Company”, “us”, “we”, “our” or similar all refer to Telefonaktiebolaget LM Ericsson, the Parent Company and its subsidiary companies. To facilitate comparisons of operating results, we have excluded restructuring charges for years and , except for the measures Net Income, Earnings per share and Payable days. There were no restructuring charges during . SUMMARY Ericsson’s performance was characterized by recovery, profitable growth and increased market share with good progress in strategically important areas. We believe that a flexible platform for value creation has now been firmly established. The success of our restructuring efforts and focus on operational excellence are evidenced by the solid results in . In addition to improving our operational efficiency beyond what was originally envisioned in , an increased cost awareness has been instilled within all parts of the Group. With the restoration of a healthy operating margin and strong cash flow from operations, we have increased our cash position and repaid a significant portion of our long-term debt ahead of maturity. Our ambition is to maintain the performance levels delivered this year in order to continue generating best-in-class margins. Our leadership in GSM and WCDMA is reinforced with a number of key business wins in strategic markets. Ericsson Mobile Platforms is now a supplier to of the top mobile phone brands representing approximately percent UMTS (G/WCDMA) market share. We have also shown good progress in our professional services business where we have built a leading position in managed services and hosting. Going forward, we believe the company is very well positioned for sustainable performance with competitive profitability. 16 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 MARKET ENVIRONMENT AND TREND INFORMATION After several years of decline, operator spending on mobile network infrastructure equipment rebounded during . The market growth was driven by subscriber additions in developing markets and deployment of G networks, mainly in Western Europe as well as in parts of Asia. There was also a temporary surge of investments in most markets as many operators strived to catch up from under-investing during the market downturn. Following the extraordinarily strong growth in , we expect the mobile systems market, measured in USD, to increase slightly during . Pricing trends remained similar to previous years, in particular regarding strategic pricing necessary to win contracts with new customers and/or new markets. Currency exchange effects, mainly related to a weaker USD, also negatively affected our sales. Operator consolidation is a key trend in several markets. In North America, operator consolidation caused a temporary slowdown in GSM/EDGE investments while the companies involved underwent their merger process. In Latin America, where significant operator consolidation has already taken place, we experienced strong growth, especially from operators expanding their GSM coverage and capacity. In both regions, we have been able to improve our already strong market position due to our longstanding relationships with the consolidating companies. The largest mobile operator in the US has now committed to deploy WCDMA with plans for nationwide coverage by year- end . China is broadly expected to announce their G plans sometime during with volume deployments likely to start during . Even when including the US and China, the footprint of WCDMA is still less than one half of GSM’s. This implies not only good growth opportunities for WCDMA but also continued near-term volume deployment of GSM, especially in developing markets. Within fixed networks, we believe operator spending was flat to slightly up in compared with . However, many operators are contemplating a conversion to an all-IP broadband environment. This would enable more efficient handling of voice, data and image based communications as well as a platform for converged services. Ericsson already has a solid starting position as we offer broadband for mobile and fixed networks, IP Multimedia Subsystem (IMS) based service networks and unique systems integration competence. These are the three key aspects that network operators need to address in order to converge their fixed and mobile services. Several operators have already started such an upgrade process and others are expected to follow. This development could stimulate fixed network capital expenditures over the next several years. In addition to network management and systems integration services, the opportunity to supply managed capacity and hosting services to network operators is increasing. We expect this trend to continue as operators realize the competitive advantages that are made possible when several operators share capacity and operating costs. Smaller operators especially benefit by gaining access to service capabilities and content far beyond what they could normally afford while at the same time lowering their risks and improving their time to market. GOALS AND STRATEGY Our goal is to be the preferred business partner to our customers, especially to the world’s leading network operators. In doing so, we strive to be the market and technological leader by offering end-to-end solutions mainly related to network infrastructure, network management and other service offerings. Our products and services fit into the core and access parts of networks as well as into the increasingly important service layer. In addition, with our mobile platform products and through our Sony Ericsson joint venture for mobile handsets, we extend the scope of our operations for complete end-to-end solutions. Our strategy is to: • Lead market development through innovation and technological leadership; B O A R D O F D I R E C T O R S ’ R E P O R T Sales development Based on our reported sales combined with the publicly reported and estimated sales for our main competitors, we estimate that the mobile systems market grew approximately percent in USD terms during . During this period, our mobile systems sales increased by percent at constant exchange rates. Margin development Our ambition is to deliver best-in-class profit margins. The Company has generated a record level operating margin during . Research and development A robust R&D program is key to our competitiveness and future success. With most of our R&D invested in mobile communications network infrastructure, our program is one of the largest in the industry. Even though total R&D spending has been significantly reduced over the last several years, we have maintained a high investment level in the strategically important areas of broadband access, core networking and service layer. During the same time, we have reduced the number of design platforms within our product portfolio, which has facilitated a higher level of product commonality for improved R&D efficiency. • Leverage our economies of scale to develop superior R&D program products and services and thereby offer our customers competitive advantages; and • Establish operational excellence as a basis for sustainable and best-in-class operating margins. PROGRESS RELATIVE TO GOALS Strong subscriber growth in emerging markets combined with catch-up spending on GSM has fueled a rebound in the mobile systems market during , driving double-digit growth and high profit margins. While the sharp market recovery provided the fuel for the strong performance, it would not have been possible without the restructuring measures that were undertaken during – to position the company for the eventual market rebound. We made good progress on our ongoing financial targets of: • Increasing sales at least in line with the market growth; • Delivering best-in-class operating margins; • Generating positive cash flow before financing; • Restoring our credit ratings to Investment Grade. 2004 2003 2002 Expenditures (SEK billion) As percent of sales Employees within R&D at December 31 Patents 21.8 20.9 26.4 15.8% 18.5% 18.1% 20,500 16,500 16,000 12,000 15,000 16,000 Cash flow development Return on Capital Employed (ROCE) was over percent compared with a negative percent in . Even with the strong sales growth this year, most of the working capital efficiency targets were exceeded in . However, efforts to further improve capital efficiency will continue, especially within inventories. Days Sales Outstanding (DSO) Inventory Turnover (ITO) Payable Days 1) Cash flow before financing activities (SEK billion) Target 2004 2003 2002 <90 >5.5 >45 75 5.7 46 79 6.1 37 92 5.1 40 Positive 17.7 19.5 –7.1 1) Payable days: Accounts payable divided by Cost of sales and multiplied by 90 days. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 17 Sales in Other Operations increased by percent to SEK . billion with most business units showing improvements, especially Mobile Platforms and Power Modules. Sales in Enterprise Systems were essentially flat. To strengthen Enterprise opportunities, we have introduced applications that bridge the enterprise and public mobile worlds and are now offering custom-made solutions that suit the unique demands of individual companies and operators. Gross margin and operating expenses The significantly improved gross margin reflects the benefits of the cost reduction measures, higher volumes with better capacity utilization and a favorable product mix. While sales increased by percent, operating expenses were reduced from SEK . billion, adjusted to exclude restructuring charges, in to SEK . billion. Efficiency improved, with operating expenses measured as a percentage of net sales decreasing from . percent in to . percent in . The net effect of risk provisions and credit losses for customer financing affecting operating expenses amounted to SEK –. (–.) billion. Other Income Statement items Share in earnings of joint ventures and associated companies improved sharply by SEK . billion mainly due to a strong contribution from Sony Ericsson. The financial performance of Sony Ericsson improved dramatically, improving our share in earnings from a loss of SEK –. billion excluding restructuring costs last year to a profit of SEK . billion this year. Other operating revenues increased by percent, mainly as a result of license fees from WCDMA related intellectual property rights. Continued positive cash flow and repayment of debt improved the financial net from SEK –. billion in to SEK –. billion. Income after financial items was SEK . (.) billion, an improvement of SEK . billion on a sales increase of SEK . billion, confirming the success of our cost reduction measures. Net income improved to SEK . (–.) billion and diluted earnings per share improved to SEK . (–.). Diluted earnings per share according to US GAAP were SEK . (–.). B O A R D O F D I R E C T O R S ’ R E P O R T Credit ratings Although Moody’s as well as Standard & Poor’s (S&P) credit rating agencies have raised Ericsson’s credit ratings during , at year-end their ratings were still below what is considered to be investment grade i.e. Baa for Moody’s and BBB– for S&P. Ericsson credit ratings year end 2002–2004 Investment grade 2004 2003 2002 Moody’s Standard & Poor’s Baa3 BBB- Ba2 BB+ B1 BB Ba2 BB FINANCIAL RESULTS Orders and sales Order intake increased sharply during the year, resulting in a book-to-bill ratio of slightly above one for the full year. The increase in orders was driven by particularly strong development in Latin America, Europe, Middle East and Africa as well as parts of Asia. Our largest market, the United States, was down significantly due to a temporary disruption from the merger process involving two of our largest customers. We expect a resumption of more normal levels of investments in the US once their merger integration is completed. A stronger SEK also negatively affected order value when translated from local currencies. Sales growth within the GSM/WCDMA track was approximately percent mainly due to a strong increase in demand for GSM in almost all markets. Although from a much smaller base, WCDMA equipment and associated network rollout services also showed good sales growth with a more than percent increase from SEK . billion in to SEK . billion in . Within fixed networks, we were awarded a number of contracts for broadband access, softswitch and packet switching products, but this was not sufficient to offset the continued sharp decline for circuit switching equipment. Although the business is currently much reduced from prior levels, we are optimistic regarding growth opportunities for public Ethernet access and converged networks. The business development and portfolio build-up within Professional Services continued to be favorable. Sales increased percent in local currencies and now represent percent of Systems sales. Particularly encouraging was the development for hosted and managed services where we have been awarded a significant number of contracts. 18 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 B O A R D O F D I R E C T O R S ’ R E P O R T PARTNERSHIPS AND JOINT VENTURES, ACQUISITIONS/DIVESTITURES Mobile communications networks are becoming increasingly complex and many new types of services will continue to be launched. Since handsets are an important part of the realization of new services, it is important for Ericsson as a systems supplier to also participate in the mobile phone market. With our : mobile phone joint venture with SONY Corporation, we are able to offer complete end-to-end solutions that combine mobile handsets, network infrastructure and services. The Sony Ericsson Mobile Communications (SEMC) joint venture is included in our Phones segment. Their results are accounted for under the equity method with no sales included in Ericsson’s financial statements. During , Sony Ericsson Mobile Communications AB reported sharply increased unit shipments and sales. The cost reduction actions that were initiated during have been successfully completed and contributed to the positive results. With a product portfolio that is geared mostly towards mid and high-end models along with a lower cost base, our ambition for the JV is to create continued profitable growth. In the second quarter of , SEMC increased its equity stake in Beijing Ericsson Putian Communications Company Ltd. to percent. The name of the facility has been changed to Beijing SE Putian Mobile Communications Co. Ltd. (BMC). BMC operations have been consolidated into SEMC since the second quarter, which has had a relatively minor positive effect on their results. For more information on our transactions with SEMC, please also see Notes to the Financial Statements – Note , “Related Party Transactions”. In the second quarter of , we made a public offer to purchase shares of Ericsson S.p.A. in Italy and have increased our ownership from percent to percent. By that we exceeded percent ownership, which according to Italian regulations requires us to launch a Residual Public Offer for the remaining . percent of the shares outstanding. This offer will be launched during the first quarter of . When completed, Ericsson S.p.A. will be delisted from the Milan Stock Exchange. No other significant acquisitions or divestments were made during . Balance Sheet and Cash Flow The capital usage and cash position improved during . Total assets were SEK () billion. Excluding increased cash and cash equivalents of SEK . billion, total assets were reduced by percent. The largest items contributing to the improvements were lower customer financing and deferred tax assets. SEK . billion of long-term debt was repaid. Liabilities and provisions were reduced despite the effect of a SEK . billion increase for new pension accounting rules. Net cash developed favorably, with the excess of cash over debt increasing from SEK . billion to SEK . billion. This year’s strong profit increased equity to SEK . (.) billion and the equity ratio improved to . (.) percent. The extended restructuring programs initiated in early were completed ahead of schedule and have delivered more than the targeted cost reductions. Although there were no restructuring charges in , cash outlays in related to restructuring were SEK –. (–.) billion. Cash flow before financing activities was positive by SEK . (.) billion, driven mainly by the improved income. Capital expenditures The following table sets forth a breakdown of our annual capital expenditures during the four years ended December , : (SEK billion) 2004 2003 2002 2001 Capital expenditures of which Sweden 2.5 1.1 1.8 1.1 2.7 1.2 8.7 3.8 Through downsizing and outsourcing we have been able to significantly reduce our capital expenditures from the higher levels of . Capital expenditures in were mainly for investments in test equipment used to develop, manufacture and deploy systems products. We do not expec our capital expenditures to be significantly different in . We continuously monitor our capital expenditures and evaluate whether adjustments to our budget are necessary in light of market conditions and other economic factors. Off Balance Sheet items Customer financing credits of SEK . (.) billion issued by third parties and guaranteed by Ericsson were outstanding as per December , . Please also see Notes to the Financial Statements – Note , “Financial Risk Management and Financial Instruments”, and Note , “Reconciliation to Accounting Principles Generally Accepted in the United States”. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 19 B O A R D O F D I R E C T O R S ’ R E P O R T Material contracts and contractual obligations Other than contracts entered in the ordinary course of business, we do not have any material contracts. The Company has in the ordinary course of business primary contractual obligations as per the table below. Purchase obligations are related to outsourced manufacturing, R&D and IS/IT operations and for components for our own manufacturing. Contractual Obligations (SEK million) Total Payment due by period <1 year 1-3 years 3-5 years >5 years Long-term debt 1) Capital lease obligations 2) Operating leases Other long-term liabilities Purchase obligations 3) Commitments for customer financing 1) 20,949 764 9,210 6,163 4,812 2,727 12,346 272 2,337 454 3,583 340 2,607 1,661 3,819 1,856 77 426 124 1,229 7,129 7,129 – 2,195 1,691 504 – – – – Total 47,202 12,270 14,177 9,234 11,521 1) See also Notes to the Financial Statements – Note 22, “Financial Risk Management and Financial Instruments”. 2) See also Notes to the Financial Statements – Note 28, “Leasing”. 3) The amounts of purchase obligations are gross, before deduction of any related provisions. Critical accounting policies and estimates The preparation of financial statements and application of accounting policies often involve management’s judgment or the use of estimates and assumptions deemed to be reasonable and prudent. However, other results may be derived using different assumptions or estimates. Following are the accounting policies subject to such estimates or assumptions that we believe have the most significant impact on our reported results and financial position. Revenue recognition A substantial part of our sales is generated from construction- type contracts to supply network equipment configured according to customer specifications. Managerial judgment is applied, among other aspects, regarding contractual performance, estimated total contract costs, degree of completion and conformance with acceptance criteria to define the amounts of revenue to be recognized. The large number of supply contracts that we are a party to generally balances the uncertainty that may be associated with any single contract. Inventory valuation Inventories are valued at the lower of cost or market value. Total inventory reserves as of December , amount to SEK . (.) billion or () percent of gross inventory. 20 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Deferred taxes Deferred tax assets are recognized for temporary differences between reported and taxable income and for unutilized tax loss carry-forwards. The largest amounts of tax loss carry- forwards are in Sweden, with an indefinite period of utilization. The valuation of tax loss carry-forwards and our ability to utilize unused tax losses is based upon our estimates of future taxable income in different tax jurisdictions and involves assumptions regarding the deductibility of costs not yet subject to taxation. At December , , the value of unutilized tax loss carry forwards amounted to sek . (.) billion. The estimated tax loss carry-forwards are reported as assets. Capitalized development costs Development costs for products that will be sold, leased or otherwise marketed as well as those intended for internal use are capitalized. The starting point for capitalization is based upon management’s judgement that the technological and economical feasibility can be confirmed, usually when a product development project has reached a defined milestone according to an established project management model. Amortization of capitalized equipment begins when the product is available for general use with impairment testing performed annually. Provisions Valuation of receivables and exposures in customer financing We monitor the financial stability of our customers and the environment in which they operate to judge their guarantees and the likelihood that we can get paid for individual receivables. Most of our customers have good creditworthiness and the impact of individual receivables is therefore limited when consolidated. Total allowances for doubtful accounts as of December , were SEK . (.) billion or () percent of our gross accounts receivable. Customer financing credits have higher risk than trade receivables because customers requiring financing typically have weaker balance sheets and less liquidity. We regularly assess the credit risk and make appropriate provisions for outstanding customer financing credits and third party credits under our guarantee. Provisions for customer financing as of December , amounted to () percent of gross exposure. Product warranties Reserves for product warranties are based on historic failure rates as well as assumptions on estimated failure rates for new products and costs to remedy the various types of faults predicted. Total reserves for customer warranties as of December , amount to SEK . (.) billion. Pension and other post-employment benefits Accounting for the costs of defined benefit pensions and other applicable retirement benefits is based on actuarial valuations, relying on key assumptions for discount rates, expected return on plan assets, future salary increases, turnover rates and mortality tables. The discount rate assumptions, in turn, are based on rates for high quality fixed income investments with durations similar to our pension plans and considers long- term historical returns, allocation of assets and estimates of future long-term investment returns. At December , , provisions for pensions and other post-employment benefits amounted to SEK . (.) billion with pension obligations reported as provisions on the balance sheet. Other provisions A significant part of other provisions is related to contractual obligations and penalties with most of the rest for risks associated with patent and other litigations as well as changes in techniques and markets. At December , , Other provisions amounted to SEK . (.) billion. FINANCIAL RISK MANAGEMENT We have an established policy governing the Group’s financial risk management, which is carried out by the Treasury function and supervised by the Board of Directors’ Finance Committee. Please see the Corporate Governance chapter for more information about our corporate governance and the responsibilities of the Finance Committee. For further information on our objectives, policies and strategies for financial risk management please see Notes to the Financial Statements – Note , “Interest-Bearing Liabilities” and Note , “Financial Risk Management and Financial Instruments”. Foreign exchange risks With significant revenues, costs, assets and liabilities in currencies other than SEK, Ericsson has a net exposure to a number of currencies. The duration of this exposure is also considerable, as many contracts have long lead times between order and delivery. Assuming our foreign exchange exposure remained the same, a percent plus/minus isolated change in the USD/SEK exchange rate would affect income by SEK . billion before any hedging effects. We manage this exposure through a variety of hedging activities covering on average the forthcoming – months. During , due to the stronger SEK, primarily vs. USD and related currencies such as Saudia Arabian Riyal and Chinese Renminbi, foreign exchange losses of SEK . billion net were recognized. B O A R D O F D I R E C T O R S ’ R E P O R T The net results of foreign subsidiaries and the values of such foreign investments are also exposed to exchange rate fluctuations that can affect the income statement and consolidated balance sheet when translated into SEK. Translation effects of investments in companies affecting the income statement were negative SEK million net. Hedging benefits fully offset these losses. The translation differences reported within equity on the balance sheet were, net of hedging, SEK –. billion. Interest rate risks Ericsson is exposed to interest rate risk through market value fluctuations of certain balance sheet items and through changes in interest expenses and income. Assuming our net cash position remained at SEK . billion and our interest- bearing provisions and liabilities remained at SEK . billion, a sustained change in interest rates of plus/minus . percentage points would have an annual impact on the financial net of approximately SEK million. Credit risk in trade receivables Extended payment terms for trade credits are regularly reviewed with provisions made to cover any expected losses. Trade receivables amounted to SEK . (.) billion less provisions of SEK . (.) billion at year-end. Credit losses have historically been low mainly because our customer base largely consists of well established and financially sound network operators. Customer finance risk Our gross exposure to customer finance, on and off balance sheet, has been continuously reduced since . In most of our customer financing agreements, we maintain security interests, normally in the form of pledges of equipment, certain of customers’ shares or pledges of their shares. To cover the remaining risk exposure, provisions are made as part of selling expenses. These provisions as a percentage of gross exposure reflect the higher risk in a smaller and less geographically diversified portfolio of customer credits. At year-end , percent of our gross exposure was related to Latin America. The remaining exposure is mainly related to Europe, Middle East and Africa. The net effect on operating expenses during from risk provisions and credit losses amounted to SEK –. (–.) billion. Please see “Notes to the Financial Statements – Note , “Financial Risk Management and Financial Instruments” for more information regarding customer financing. Financial credit risk Financial instruments carry an element of risk in that counterparts may be unable to fulfill their payment obligations. During , no credit losses were incurred from such investments. All derivative transactions are covered by ISDA Master agreements to reduce the credit risk. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 21 B O A R D O F D I R E C T O R S ’ R E P O R T Liquidity and refinancing risk Cash and cash equivalents increased by SEK . billion to SEK . (.) billion during mainly due to positive cash flow. We expect our strong cash position to satisfy any short- term liquidity requirements and therefore we have cancelled our committed credit facility of USD . billion and repurchased outstanding bonds of SEK . billion. During , there have been no material defaults in the payment of principle or interest, or any other material default relating to the indebtedness of Ericsson or any of its significant subsidiaries. Despite our currently below investment grade credit ratings, we have been able to amend the terms and conditions of the USD billion revolving credit facility to reflect the company's improved performance. In addition to better pricing, the amended facility does not have any requirement for collateral or an availability test as required under the previous agreement. CORPORATE SOCIAL RESPONSIBILITY Effective management of social, environmental and geopolitical issues can help to assure an enduring capability for value creation and competitive advantage. We are committed to being a responsible member of the global society and to the communities in which we operate. Ericsson supports the UN Global Compact and its ten guiding principles. We see these principles as a prerequisite for sound, long-term business. These are also guiding principles in our work and inspire us to find new ways to deploy our products and services, including in developing countries. In this spirit we continued with our Supplier Code of Conduct program, in close cooperation with local Ericsson organizations. During we had our main focus on China establishing local management of ethical issues in the supply chain, including Code of Conduct Auditors. During Ericsson, as a member of the Global Compact, initiated the first socio- economic investigation in a developing country proving the need for mobile telephony as a catalyst for rural economic growth. This was made together with United Nations Development Program (UNDP) and the Swedish Foreign aid organization SIDA. In , Ericsson was again included in the FTSEGood and the Dow Jones Sustainability Indexes. Additional information about our corporate social responsibility is available on our web site at: www.ericsson.com/about/responsibility. We encourage and empower our employees to make a positive contribution to society. Their contributions are of many kinds, determined by our employees according to local needs. They may, for example, be in the fields of health care, social and humanitarian aid, scholarships and other educational support, art and culture, the environment, children’s welfare as well as many other charitable activities. We have provided a cornerstone donation of USD . 22 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 million to the John F. Kennedy School of Government at Harvard University to help establish a newly endowed Professorship in Global Leadership & Public Policy in memory of Anna Lindh, former Foreign Minister of Sweden. Ericsson Response Ericsson Response is our global initiative to rapidly provide specialist volunteers and communications equipment anywhere in the world in response to human suffering caused by disasters. Ericsson Response assists the disaster relief operations of the United Nations Development Program, the Office for the Coordination of Humanitarian Affairs (OCHA) and the International Federation of Red Cross and Red Crescent Societies (IFRC). Following is a limited summary of Ericsson Response disaster relief activities during : • Helping to establish a new Pan American Disaster Response center, which supports IFRC, operations in Central America, the Caribbean and Latin America. • Supporting the relief operations of IFRC, the Dominican Red Cross and Télécoms Sans Frontières (TSF) following the extensive damage from several hurricanes, floods and mudslides in the Caribbean. • Sending volunteers to Sudan to help support agencies such as the UN Office for the Coordination of Humanitarian Affairs, the World Food Program (WFP) and the Swedish Rescue Services Agency (SRSA) regarding the humanitarian crisis in that country. • Supporting relief efforts in Southeast Asia after a series of tsunamis devastated coastal regions in the area. We are also aiding in reconstruction work in these disaster areas. Environment We continuously improve the environmental performance of our products, services and operations and strive to meet or exceed legal and other requirements to protect the environment. Key areas of progress during 2004 include: • Improvements in nearly every environmental indicator tracked. In particular, our overall energy consumption and carbon dioxide generation, measured per produced capacity, have been significantly reduced. • Remained on schedule to meet the requirements of the EU directive on waste electrical and electronic equipment (WEEE). • Expanded our worldwide Ecology Management recycling program for our customers’ phased-out equipment. • Continued to fund independent research of health and safety issues. Corporate Governance Although our internal rules for governance and other important rules for managing our business activities have long been established through corporate steering policies and directives, we have adapted our work procedure in line with developments in Sweden and the US regarding reporting, disclosure and other requirements for listed companies on the Stockholmsbörsen, London Stock Exchange and NASDAQ as well as changes in legislation, such as the US Sarbanes-Oxley Act. During , actions to further strengthen our corporate governance included: • Communication of a Code of Business Ethics and Conduct that essentially summarizes the most important of our rules to all employees, directors and officers throughout the Group. There have been no amendments or waivers to the Code of Business Ethics and Conduct for any Director or member of our Management. • Initiation of a project to comply with relevant sections of the Sarbanes-Oxley Act. Implementation should be completed by the end of . Board Compensation Members of the Board, who are not employees of the Company, have not received any compensation other than the fees paid for Board duties as outlined in Notes to the Financial Statements – Note , “Information Regarding Employees, Members of the Board of Directors and Management”. Members and Deputy Members of the Board, who are employees, i.e. the and the Employee representatives, have not received any remuneration or benefits other than their normal employee entitlements, with the exception of a small fee paid to the employee representatives on the Board for each meeting attended. Executive Compensation The remuneration committee continues to be mindful of the debates around the world on executive salaries and benefits. Based on the results of an independent review by our external auditors into all aspects of authorization, compliance and control of senior executive compensation, we are confident that current policies and practices at Ericsson are under proper control. For the Group Management team, the maximum level of variable salary as a short term incentive has been reduced from percent to percent of base salary from . This change is compensated in two steps, implying for an increase of percent of fixed salary. In addition, the employee stock purchase plan has been enhanced as a long term incentive to allow investments of up to . percent of fixed salary. The previous version of the plan allowed a maximum investment of the lower of . percent of salary or SEK , per year. For management and key contributors, an acceleration feature has been added where multiple shares, up B O A R D O F D I R E C T O R S ’ R E P O R T to a maximum of six, may be awarded for each share purchased if certain performance targets are met over a three- year period. As of December , , there were no loans outstanding from, and no guarantees issued to or assumed by the Company for the benefit of any member of the Board of Directors or senior management. Employees Every year we conduct an employee satisfaction survey to assess our Human Capital Index and employee empowerment. In over percent of our employees participated in this survey. While there is still considerable room for improvements, the results showed a continued upward trend in almost all indicators with organizational efficiency and leadership showing the largest increases. Not surprising considering the turmoil within the company the last several years due to restructuring and downsizing, the employee empowerment index indicated some employee frustration and alienation. Action plans are in place to improve these areas during . Employee headcount was reduced by , to ,. During the year, , employees departed while , joined the company. The departures were mostly related to sales and adminstration while the additions were mostly to support our growing services business. Please also see Notes to the Financial Statements – Note , “Information regarding employees, members of the Board of Directors and Management”. LEGAL AND TAX PROCEEDINGS As many other companies in the telecommunications industry, we are named a defendant in a number of class actions in the United States where plaintiffs allege that adverse health effects could be associated with the use of mobile phones. Together with the majority of the industry, Ericsson has been named a defendant in six such lawsuits. The court has dismissed five of these cases. Plaintiffs have appealed the decisions. From to the beginning of , Swedish fiscal authorities disallowed, for corporate income tax purposes, the Parent Company and the subsidiary companies Ericsson Telecom AB and Ericsson Radio Systems AB (renamed Ericsson AB) deductions for commission payments via external service companies to agents in certain countries. The increase in corporate income taxes for all group companies have been provisioned for. The decisions covering the income year have been appealed. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 23 B O A R D O F D I R E C T O R S ’ R E P O R T BOARD WORK Board of Directors The Board of Directors is elected yearly at the Annual General Meeting for the period until the end of the next Annual General Meeting. More information regarding the Board Of Directors and its members as well as the Board and its committee activities can be found in the Corporate Governance chapter. Board changes 2004 At the Annual General Meeting on April , , Nancy McKinstry succeeded Peter Sutherland as member of the Board. Lena Torell has informed that she declines to be re- elected as member of the Board at the Annual General Meeting . Board work during 2004 In , seven Board meetings were held. The work of the Board is subject to an established work procedure that defines the distribution of work between the Board and its three committees (Audit, Finance and Remuneration) and between the Board and the President. The work procedure is evaluated each year and revised when deemed appropriate. The Chairman has had individual discussions with each member regarding the work procedure and the evaluation of the Board work. In addition, all board members have answered a written questionnaire. The other members of the board evaluated the work of the Chairman, as well as the President and Chief Executive Officer. Certain Board actions and decisions during : • Amended the work procedure of the Board in order to take into account organizational changes within the Group and new NASDAQ rules regarding related party transactions. • Determined that each of the shareholder elected members of the audit committee qualify as Audit Committee financial expert pursuant to the applicable attributes under the final rules of the Sarbanes-Oxley Act. • The external auditors presented their observations from their audit of our annual report as well as their reviews of interim reports and their assessment of our internal controls and procedures. • Initiated a project to further strengthen internal controls and procedures to comply with applicable requirements of the U.S. Sarbanes-Oxley Act. • Resolved to apply the newly developed Swedish Code on Corporate Governance when it becomes effective. • Resolved to establish and capitalize a Swedish pension trust fund to cover pension obligations under the Swedish ITP plan. Audit Committee The Audit Committee had eight meetings in and reviewed the financial reporting, the scope and execution of audits performed, the independence of the external auditors, the internal audit function and audit fees as well as the progress of the conversion to IFRS reporting. The committee together with the external auditors reviewed each interim report prior to publishing. The committee has continuously followed the development of the rules and regulations of the Sarbanes-Oxley Act and the Company’s implementation. The committee has endorsed a strategy regarding non-audit services and has approved certain services under such pre- approval procedures. The committee has discussed the requirement for audit committee financial experts and has resolved to the Board to decide on the matter. An external expert advisor, Mr. Peter Markborn, has been engaged to assist and advise the committee. A procedure for confidential submission by employees of violations of laws or regulations (and in particular in relation to accounting, internal accounting controls, auditing matters, or any deceptive financial practices) was implemented during . Finance Committee The Finance Committee held ten meetings during the year. The committee resolved issues regarding restructuring of customer credits and trade receivables, guarantees, credit facility agreements, acquisitions, refinancing of Ericsson’s existing credit commitments, the financing strategy and pension liabilities. The committee prepared for resolution by the Board proposals for conditional shareholders’ contributions to subsidiaries, proposals with respect to a public tender in Italy and certain acquisitions as well as a proposal to establish a Swedish pension trust. The Finance Committee also monitored the financial risk exposure and risk limits and reviewed the reporting to the committee in this respect. Remuneration Committee The Remuneration Committee held nine meetings during the year. The committee reviewed and prepared for the Board a proposal for a Long-Term Incentive Plan, which was resolved by the Annual General Meeting. The committee approved certain remuneration packages for the CEO, the members of the Group Management Team and new direct reports to the CEO. The Chairman of the committee was authorized to make an appropriate engagement arrangement with an independent remuneration expert, Mr. Gerrit Aronson. The committee also reviewed proposals for salaries and incentive pay for . 24 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 PARENT COMPANY The Parent Company business consists mainly of corporate management and holding company functions. It also includes activities performed on a commission basis by Ericsson Treasury Services AB and Ericsson Credit AB regarding internal banking and customer credit management. The commission agreement with Ericsson Treasury Services AB has been cancelled as per January , , and the internal banking activities have been transferred to the Parent Company. The Parent Company is the owner of the majority of intellectual property rights and manages the patent portfolio, including patent applications, licensing and cross licensing of patents and defending of patents in litigations. The Parent Company has () branch and representative offices. In total, the Group has () branch and representative offices. Net sales for the year amounted to SEK . (.) billion and income after financial items was SEK . (.) billion. Major changes in the Parent Company’s financial position for the year include decreased investments in subsidiary companies of SEK . billion (see Notes to the Financial Statements – Note , “Financial Assets”). Current and long- term commercial and financial receivables from subsidiary companies increased by SEK . billion. Current and long- term liabilities to subsidiary companies increased by SEK . billion and notes and bond loans, including short-term portions, have decreased by SEK . billion. At year-end, cash and short-term cash investments amounted to SEK . (.) billion. In accordance with the conditions of the Stock Purchase Plans and Option Plans for Ericsson employees, ,, shares from treasury stock were sold or distributed to employees during the year. The nominal value of theses shares is SEK . million, representing less than one percent of capital stock, and compensation received amounts to SEK million. The holding of treasury stock at December , was ,, Class B shares. The nominal value of these shares is SEK . million, representing percent of capital stock, and related acquisition cost amounts to SEK . million. Change of voting Rights At an Extraordinary General Meeting held on August , , the shareholders decided to change the difference in voting rights between Class A and Class B shares as proposed by a group of large shareholders. Following the change each Class A share confers one vote and each Class B share confers one tenth of a vote. The shareholders also decided to implement a conversion clause into the Articles of Association entailing that one Class B share could be converted to one Class A share during the period September – December , by holders of special conversion rights. Conversion rights were thereafter issued to the Class A shareholders. The B O A R D O F D I R E C T O R S ’ R E P O R T conversion rights were traded at the Stockholmsbörsen between September and December , . At the end of the conversion period . percent of the conversion rights had been used to convert B-shares to A-shares. The remaining conversion rights have expired. At year end , the largest shareholders represented . percent of the capital and controlled . percent of the votes. Prior to the change in voting rights, the largest shareholders represented . percent of the capital and controlled . percent of the votes. POST CLOSING EVENTS The Swedish Pension Trust established in December , was funded in January with SEK . billion of cash and cash equivalents. The amount transferred covers and prepays a portion of our obligations under the Swedish ITP defined benefits pension plan. Effective February , , the Ericsson Board of Directors has appointed Hans Vestberg as Executive Vice President in the Ericsson Group. Hans Vestberg is head of Business Unit Global Services. On February , , Standard and Poor’s (S&P) raised their credit rating of Ericsson to investment grade of BBB–, and on March , , Moody’s upgraded their rating from Ba to Ba, one level below investment grade. CHANGED ACCOUNTING PRINCIPLES WITH THE CONVERSION TO IFRS From the first quarter of , we will start reporting financial results according to International Financial Reporting Standards (IFRS) as required when the European Union’s Council of Ministers adopted the so-called IAS in June of . This regulation requires all exchange-listed companies within the EU to prepare and issue consolidated financial statements in accordance with IFRS. Prior to January , , we have prepared our consolidated financial statements in accordance with Swedish GAAP. Because Swedish GAAP, in recent years, has been adapted to IFRS to a high degree and as the rules for first time adopters allows certain exemptions from full retrospective restatements, the transition from Swedish GAAP to IFRS is expected to have a relatively limited effect on our financial statements. Furthermore, we believe the conversion to IFRS will align our reporting more closely with US GAAP. The most significant differences between our results reported in Swedish GAAP and IFRS, net of taxes, for include: • Retrospective capitalization of development costs and amortization of such costs (IAS ) will decrease net income for by approximately SEK . billion. • Cessation of goodwill amortization (IFRS and IAS ) will increase our reported operating profit for by approximately SEK . billion. • The fair value of outstanding employee share options (IFRS ) and the recognition of costs for such share-based E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 25 B O A R D O F D I R E C T O R S ’ R E P O R T employee compensation will reduce our operating profit by approximately SEK . billion in . • Recognition of financial instruments at fair value on the balance sheet (IAS ) through equity affected the opening balance as of January , , by the addition of SEK . billion in assets, SEK . billion in liabilities and SEK . billion in equity, net of deferred tax. The effect in the opening balance of valuing Other Investments at fair value as of January , , was approximately SEK . billion in assets and SEK . billion in equity, net of deferred tax. • A new definition of cash and cash equivalents (IAS ) that includes only highly liquid investments, with original maturity of three months or less, will lower our cash position compared with that previously reported under Swedish GAAP. However, our liquidity, i.e. payment readiness, will not be affected and net cash will continue to significantly exceed interest-bearing liabilities and provisions. In total, the conversion to IFRS will have a net effect of approximately SEK –. billion on Net income for and SEK . billion on equity for January , , including the effect of IAS . These estimates could change since the IFRS rules may be changed during . PROPOSED DISPOSITION OF EARNINGS The Board of Directors proposes that a dividend of SEK . per share is paid to shareholders duly registered on the Record date of April , , and that the Company retains the remaining part of non-restricted equity. The Class B treasury shares held by the Parent Company are not entitled to receive a dividend. Assuming that no treasury shares remain within the Company on the Record date, the Board of Directors propose that earnings be distributed as follows: Amount to be paid to the shareholders Amount to be retained by the Parent Company SEK ,,, SEK ,10,, Total non-restricted equity of the Parent Company SEK ,13,, Stockholm February , Telefonaktiebolaget LM Ericsson (publ) Org. no. - Arne Mårtensson Deputy chairman Michael Treschow Chairman Marcus Wallenberg Deputy chairman Nancy McKinstry Peter L. Bonfield Eckhard Pfeiffer Sverker Martin-Löf Lena Torell Per Lindh Torbjörn Nyman Carl-Henric Svanberg President and CEO Jan Hedlund 26 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 CONSOLIDATED INCOME STATEMENT Years ended December 31, SEK million Net sales Cost of sales Gross margin Research and development and other technical expenses Selling expenses Administrative expenses Total operating expenses Share in earnings of joint ventures and associated companies Other operating revenues and costs Operating income Financial income Financial expenses Income after financial items Income taxes for the year Minority interest Net income Average number of shares, basic (million) Average number of shares, diluted (million) Earnings per share, basic (SEK) Earnings per share, diluted (SEK) The following measures are reported excluding restructuring charges in 2003 and 2002 specified in Note 3 “Restructuring Costs” Gross margin – as percentage of net sales Operating expenses Operating margin Income after financial items 1) Restated for changed accounting principles in 2003. Notes 2, 4 11 5 6 6 7 8 8 F I N A N C I A L S T A T E M E N T S 2004 131,972 –70,864 61,108 –20,861 –9,693 –6,551 –37,105 2,318 2,617 28,938 3,541 –4,081 28,398 –9,077 –297 19,024 15,829 15,859 1.20 1.20 61,108 46.3% –37,105 21.9% 28,398 2003 117,738 –78,901 38,837 –27,136 –15,115 –8,762 –51,013 –604 1,541 –11,239 3,995 –4,859 20021) 145,773 –104,224 41,549 –30,510 –21,896 –9,995 –62,401 –1,220 773 –21,299 4,253 –5,789 –12,103 –22,835 1,460 –201 4,165 –343 –10,844 –19,013 15,823 15,841 –0.69 –0.69 43,627 37.1% –40,037 4.4% 4,360 12,573 12,684 –1.51 –1.51 47,138 32.3% –56,109 –6.4% –10,873 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 27 F I N A N C I A L S T A T E M E N T S CONSOLIDATED BALANCE SHEET December 31, SEK million Assets Fixed assets Intangible assets Capitalized development expenses Goodwill Other intangible assets Tangible assets Financial assets Equity in joint ventures and associated companies Other investments in shares and participations Long-term customer financing Deferred tax assets Other long-term financial assets Current assets Inventories Receivables Accounts receivable – trade Short-term customer financing Other receivables Short-term cash investments Cash and bank Total assets Stockholders’ equity, provisions and liabilities Stockholders’ equity Capital stock Reserves not available for distribution Restricted equity Retained earnings Net income Non-restricted equity Minority interest in consolidated subsidiaries Provisions Pensions Deferred tax liabilites Other provisions Long-term liabilities Notes and bond loans Liabilities to financial institutions Other long-term liabilities Current liabilities Current maturities of long-term debt Current liabilities to financial institutions Advances from customers Accounts payable – trade Income tax liabilities Other current liabilities Total stockholders’ equity, provisions and liabilities 1) Assets pledged as collateral Contingent liabilities Notes 9 10, 28, 29 11 11 11 7 11 13 14 16 22 22 17 19 7 20 21 21 21, 22 21, 22 24 23 25 26 2004 2003 4,343 5,324 748 5,845 4,150 543 2,150 21,815 1,236 46,154 4,784 5,739 687 6,505 2,970 433 3,027 27,130 1,342 52,617 14,003 10,965 32,644 1,446 12,239 64,350 12,204 136,886 183,040 16,132 40,170 56,302 1,973 19,024 20,997 77,299 1,057 10,087 421 24,778 35,286 19,844 1,993 1,856 23,693 781 938 3,390 10,988 1,686 27,922 45,705 31,886 979 12,718 56,622 16,585 129,755 182,372 16,132 40,298 56,430 14,895 –10,844 4,051 60,481 2,299 8,005 462 27,601 36,068 26,312 2,383 1,077 29,772 7,262 2,247 3,297 8,895 1,943 30,108 53,752 183,040 182,372 7,985 1,014 8,023 2,691 1) Of which total interest-bearing provisions and liabilities 33,643 (46,209), of which long-term 31,924 (36,700). 28 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 CONSOLIDATED STATEMENT OF CASH FLOWS Years ended December 31, SEK million Notes 2004 2003 2002 F I N A N C I A L S T A T E M E N T S OPERATIONS Net income Adjustments to reconcile net income to cash Depreciation, amortization and write-downs on tangible assets, intangible assets and other operating long-term receivables Taxes Write-downs on other investments and capital gains(–)/losses on sale of fixed assets excluding customer financing, net Other non-cash items Changes in operating net assets Inventories Customer financing, short-term and long-term Accounts receivable – trade Provisions and pensions Other operating assets and liabilities, net Cash flow from operating activities INVESTMENTS Investments in tangible assets Sales of tangible assets Acquisitions/sales of shares and other investments, net Capitalization of development expenses Net change in capital contributed by minority Other Cash flow from investing activities Cash flow before financing activities FINANCING Changes in current liabilities to financial institutions, net Proceeds from issuance of other long-term debt Repayment of long-term debt Stock issue Sale/repurchase of own stock Dividends paid Cash flow from financing activities Effect of exchange rate changes on cash Net change in cash and cash equivalents 19,024 –10,844 –19,013 4,797 5,228 –121 –899 –3,432 –65 –1,403 –1,990 1,340 22,479 –2,452 358 –1,549 –1,146 71 –70 –4,788 8,395 –2,352 924 –580 2,286 7,999 4,131 5,810 7,098 6,537 –9,171 721 81 8,599 –2,140 9,839 3,576 –9,117 22,867 –10,088 –1,806 1,510 –818 –2,359 1 60 –3,412 –2,738 2,977 2,703 –3,442 503 2,981 2,984 17,691 19,455 –7,104 –1,502 870 –13,649 – 15 –292 –14,558 214 3,347 –854 32 –10,904 158 –150 –206 –11,924 –538 6,993 –17,168 540 –6,072 28,940 2 –645 5,597 –1,203 –2,710 10 27 9 Cash and cash equivalents, beginning of period 73,207 66,214 68,924 Cash and cash equivalents, end of period 22 76,554 73,207 66,214 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 29 F I N A N C I A L S T A T E M E N T S CONSOLIDATED STOCKHOLDERS’ EQUITY Years ended December 31, SEK million Opening Balance Effect of changed accounting principle 1) Opening balance in accordance with new accounting principle Stock issue, net Sale of own stock Stock purchase and stock option plans Repurchase of own stock Changes in cumulative translation effects due to changes in foreign currency exchange rates Adjustment of accrued cost for stock issue 2002 Net income Closing balance 1) Restated due to change in accounting principle RR 29/IAS 19. 2004 60,481 –1,275 59,206 – 15 159 – –1,107 2 19,024 77,299 2003 73,607 – 73,607 158 8 151 –158 –2,444 3 –10,844 60,481 2002 68,587 – 68,587 28,940 2 12 – –4,921 – –19,013 73,607 30 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 PARENT COMPANY INCOME STATEMENT Years ended December 31, SEK million Net sales Cost of sales Gross margin Research and development and other technical expenses Selling expenses Administrative expenses Total operating expenses Other operating revenues and costs Operating income Financial income Financial expenses Income after financial items Transfers to (–)/from untaxed reserves Changes in depreciation in excess of plan Changes in other untaxed reserves Income taxes for the year Net income 1) 2002 restated according to URA 7, Group contributions and shareholders’ contribution. F I N A N C I A L S T A T E M E N T S 2004 2,598 –2,238 360 –8 –613 –981 –1,602 2,890 1,648 11,008 –5,251 7,405 53 1,137 1,190 –1,435 7,160 2003 1,645 –1,278 367 –15 –1,539 –2,920 –4,474 2,408 –1,699 9,177 –6,019 1,459 –40 – –40 –169 1,250 2002 1) 2,017 –2,358 –341 –37 –3,099 –1,345 –4,481 2,769 –2,053 12,997 –8,620 2,324 20 1,977 1,997 –1,639 2,682 Notes 2 5 6 6 18 18 7 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 31 F I N A N C I A L S T A T E M E N T S PARENT COMPANY BALANCE SHEET December 31, SEK million Notes 2004 2003 Assets Fixed assets Intangible assets Tangible assets Financial assets Investments Subsidiaries Joint ventures and associated companies Other investments Receivables from subsidiaries Long-term customer financing Deferred tax assets Other long-term financial assets Current assets Inventories Receivables Accounts receivable – trade Short-term customer financing Receivables from subsidiaries Other receivables Short-term cash investments Cash and bank Total assets Stockholders’ equity, provisions and liabilities Stockholders’ equity Capital stock Share premium reserve Revaluation reserve Statutory reserve Restricted equity Retained earnings Net income Non-restricted equity Untaxed reserves Provisions Pensions Other provisions Long-term liabilities Notes and bond loans Liabilities to financial institutions Liabilities to subsidiaries Other long-term liabilities Current liabilities Current maturities of long-term debt Current liabilities to financial institutions Advances from customers Accounts payable – trade Liabilities to subsidiaries Income tax liability Other current liabilities Total stockholders’ equity, provisions and liabilities Assets pledged as collateral Contingent liabilities 32 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 9 10, 28, 29 11, 12 11, 12 11 15 11 7 11 13 14 15 16 17 18 19 20 21 21 15 24 15 23 25 26 40 344 62 505 48,860 4,474 12 48,535 1,964 2,527 451 58,991 4,507 17 34,046 2,023 1,646 476 107,207 102,273 40 3 194 683 15,667 8,203 63,924 7,772 96,483 84 1,568 22,835 6,523 55,820 12,573 99,406 203,690 201,679 16,132 24,731 20 6,741 47,624 8,979 7,160 16,139 63,763 939 861 2,195 3,056 19,844 116 33,840 106 53,906 699 322 – 175 77,600 – 3,230 82,026 16,132 24,729 20 6,741 47,622 12,385 1,250 13,635 61,257 2,129 848 3,183 4,031 26,312 290 31,911 63 58,576 5,905 1,746 2 230 57,606 149 10,048 75,686 203,690 201,679 807 7,025 698 10,517 PARENT COMPANY STATEMENT OF CASH FLOWS Years ended December 31, SEK million OPERATIONS Net income Notes 27 2004 2003 2002 1) 7,160 1,250 2,682 F I N A N C I A L S T A T E M E N T S Adjustments to reconcile net income to cash Depreciation and amortization Taxes Write-downs and capital gains (–)/losses on sale of fixed assets, net Additions to/withdrawals from (–) untaxed reserves Unsettled dividends Changes in operating net assets Inventories Customer financing, short-term and long-term Accounts receivable–trade Provisions and pensions Other operating assets and liabilities, net Cash flow from operating activities INVESTMENTS Investments in tangible assets Sales of tangible assets Acquisitions/sales of shares and other investments, net Lending, net Other Cash flow from investing activities Cash flow before financing activities FINANCING Changes in current liabilities to financial institutions, net Changes in current liabilities to subsidiaries Proceeds from issuance of other long-term debt Repayment of long-term debt Stock issue Sale/repurchase of own stock Settled contributions from/to (–)subsidiaries Other Cash flow from financing activities Net change in cash and cash equivalents Cash and cash equivalents, beginning of period 27 Cash and cash equivalents, end of period 22 133 1,177 1,009 –1,190 – –37 1,137 495 –975 –3,756 5,153 –50 70 9,136 –5,536 1,446 5,066 152 150 1,479 40 –196 –1 6,335 61 445 5,010 14,725 –653 23 –2,135 9,726 1,809 8,770 49 1,595 3,792 –1,997 –3,108 – –6,164 1,399 –1,469 2,749 –472 –2 7 –1,275 –6,503 –2,219 –9,992 10,219 23,495 –10,464 –1,478 6,852 450 –12,263 – 15 –492 – –6,916 3,303 68,393 71,696 1,930 –1,420 342 –15,083 158 –150 –163 –31 –14,417 9,078 59,315 68,393 –293 –3,666 232 –4,641 28,940 2 477 –287 20,764 10,300 49,015 59,315 1) 2002 restated according to URA 7, Group contributions and shareholders’ contribution, and including all taxes in Adjustments to reconcile net income to cash. E R I C S S O N A N N U A L R E P O R T 2 0 0 4 33 F I N A N C I A L S T A T E M E N T S PARENT COMPANY STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY Years ended December 31, SEK million Opening balance Stock issue, net Sale of own stock Stock purchase and stock option plans Repurchase of own stock Adjustment of accrued costs for stock issue 2002 Contributions from/to subsidiaries Tax on contributions Net income Closing balance 1) Restated according to URA 7, Group contributions and shareholders’ contribution. 2004 61,257 – 15 27 – 2 –6,525 1,827 7,160 63,763 2003 61,862 158 8 3 –158 3 –2,305 436 1,250 61,257 2002 1) 31,810 28,940 2 – – – –2,183 611 2,682 61,862 34 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Notes to the Financial Statements CONTENTS Accounting Policies __________________________________________________________________________36 1. Segment Information ________________________________________________________________________44 2. Restructuring Costs __________________________________________________________________________47 3. Revenues __________________________________________________________________________________47 4. Other Operating Revenues and Costs __________________________________________________________48 5. Financial Income and Expenses ________________________________________________________________48 6. Income Taxes for the Year ____________________________________________________________________49 7. Earnings per Share __________________________________________________________________________51 8. Intangible Assets ____________________________________________________________________________51 9. 10. Tangible Assets ____________________________________________________________________________53 11. Financial Assets ____________________________________________________________________________55 Investments ________________________________________________________________________________57 12. 13. Inventories __________________________________________________________________________________59 14. Accounts Receivable – Trade __________________________________________________________________59 15. Receivables and Payables – Subsidiary companies ______________________________________________59 16. Other Receivables ____________________________________________________________________________59 17. Stockholders’ Equity__________________________________________________________________________60 18. Untaxed Reserves __________________________________________________________________________61 19. Pensions____________________________________________________________________________________62 20. Other Provisions ____________________________________________________________________________64 21. Interest-bearing Provisions and Liabilities ________________________________________________________65 22. Financial Risk Management and Financial Instruments ____________________________________________66 23. Other Current Liabilities ______________________________________________________________________70 24. Accounts and Notes Payable – Trade____________________________________________________________70 25. Assets Pledged as Collateral __________________________________________________________________70 26. Contingent Liabilities__________________________________________________________________________70 27. Statement of Cash Flows ______________________________________________________________________70 28. Leasing ____________________________________________________________________________________71 29. Tax Assessment Values in Sweden ______________________________________________________________72 30. Special Information Regarding the Parent Company ______________________________________________72 31. Information Regarding Employees, Members of the Board of Directors and Management ________________72 32. Related Party Transactions ____________________________________________________________________78 33. Fees to Auditors ____________________________________________________________________________78 34. Reconciliation to Accounting Principles Generally Accepted in the United States ______________________79 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 35 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 1 ACCOUNTING POLICIES The consolidated financial statements of Telefonaktiebolaget LM Ericsson, the Parent Company and its subsidiary companies (“the Company”) are prepared in accordance with accounting principles generally accepted in Sweden, applying all applicable standards (RR) and interpretations (URA) issued by the Swedish Financial Accounting Standards Council (Redovisningsrådet) and the Annual Accounts Act. These accounting principles differ in certain respects from generally accepted accounting principles in the United States (US GAAP). For a description of major differences, with respect to Ericsson’s financial statements, see Note , “Reconciliation to Accounting Policies Generally Accepted in the United States”. In the following standards were adopted: RR 29 – Employee benefits The effect of this standard is a change in timing of pension costs compared to previous Swedish GAAP, so that pension costs for future salary increases are estimated and recognized during the time of service. The effect of the adoption of RR at January , , has been charged to stockholders’ equity while the effect of RR from that date has been charged to income. The Parent Company has not adopted RR in relation to accounting for pensions. URA 43 – Accounting for special payroll tax and tax on investment returns As from we have adopted, only at group level, URA Accounting for special payroll tax and tax on investment returns. At the adoption of RR the effect of URA has been accounted for as a charge to stockholders’ equity. The effect of URA has been charged to income in . Revenue recognition Sales are recorded net of value added taxes, goods returned, trade discounts and rebates. Revenue is recognized with reference to all significant contractual terms when the product or service has been delivered, when the fee is fixed and determinable and when collection is reasonably assured. We do not generally provide extended payment terms but may provide customer financing in construction-type contracts. We offer a comprehensive portfolio of telecommunication and data communication systems and services covering a range of technologies. The majority of our products and services are sold as parts of contracts including several items. The nature of the products and services being sold, and the contractual terms taken as a whole, determine the appropriate revenue recognition method. The contracts are of three main types: • delivery-type • construction-type • contracts for various types of services, for example managed services contracts for several years Large customer frame agreements may include different types of undertakings and may result in a mix of construction-type contracts, delivery-type contracts and service contracts. Different revenue recognition methods are applied based on the solutions provided to our customers, the nature and sophistication of the technology involved and the contract conditions in each case. Specific contractual performance and acceptance criteria impact the timing and amounts of revenue recognized. Revenues from construction-type contracts are generally recognized using the percentage-of-completion method. The degree of completion is measured using either the milestone output method or, to a very limited extent, the cost-to-cost method. The terms of construction-type contracts generally define milestones for progress billing to the customer, which also well reflect the degree of completion of the contract. Revenues from contracts associated with new technology are not recognized until specified functionality has been achieved, customer acceptance has been obtained and other contractual terms have been satisfied. The profitability of contracts is periodically assessed and adjusted, if necessary, based on changes in circumstances. Provisions for losses are made when such losses become known. For delivery-type contracts that have multiple elements, revenue is allocated to each element based on relative fair values. If there are undelivered elements essential to the functionality of the delivered elements, or, if fair values are not available for all elements, we defer the recognition of revenue until all elements essential to the functionality have been delivered or fair values exist for the undelivered elements. 36 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Revenue for period service contracts and managed services contracts is recognized pro rata over the contract period. Revenue for training, consulting, engineering, installation and similar services is generally recognized when the services are performed. Mobile platform license revenues are included in reported Net Sales and contracted based on the number of handsets or components produced by the customer. Revenue is recognized when the customer production has occured. For sales between consolidated companies we apply arm’s length pricing. Capitalized development costs Costs incurred for development of products to be sold, leased or otherwise marketed or that are intended for internal use are capitalized, only at the group level, as from when technological and economical feasibility have been established until the product is available for sale or use. Capitalized costs include direct labor and related overhead. Amortization of capitalized development costs begins when the product is available for general release. Amortization is made on a product or platform basis according to the straight-line method over periods not exceeding five years. Research and development costs directly related to orders from customers are accounted for as a part of cost of sales. Other research and development costs are charged to expense as incurred. Capitalized development costs are subject to regular assessment of recoverability based on anticipated future revenues and changes in technologies. Unamortized capitalized development costs determined to be in excess of net realizable value are expensed immediately. Share-based employee compensation Stock option plans Since the employee’s strike price is equal to the market price at grant date, no compensation cost is recognized for any of our current stock option plans. When the options are exercised, however, social security charges are to be paid in certain countries on the value of the employee benefit; generally based on the difference between the market price of the share and the strike price. During the vesting period, i.e. the period during which the employees have to fulfill vesting requirements, estimated costs for such social security charges are accrued. In some plans, these costs are reduced by income from related hedging arrangements. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Stock purchase plans For stock purchase plans, a compensation cost is recognized during the vesting period, based on the market price of the share at the employee’s investment date. In the balance sheet the corresponding amounts are accounted for as equity. Vesting conditions effect the number of shares that will match. Compensation expenses are based on estimates of the number of shares that will match at the end of vesting period. When shares are matched, social security charges are to be paid in certain countries on the value of the employee benefit. The employee benefit is generally based on the market value of the shares at the matching date. During the vesting period, preliminary social security charges are accrued. Government grants Government grants are recognized when there is a reasonable assurance of compliance with conditions attached to the grants and that the grants will be received. For Ericsson, government grants are linked to performing of research or development work or to subsidized capital expenditures as governmental stimulus to employment or investments in a certain country or region. Overall amounts are not significant. Government grants are normally reported as reductions of development cost or cost of sales or reductions of capital expenditure, depending on their nature. Borrowing costs The Company does not capitalize any borrowing costs, including borrowing cost related to financing of construction of tangible assets. Earnings per share Basic earnings per share are calculated by dividing net income by the average number of shares outstanding during the year. Diluted earnings per share are calculated by dividing an adjusted net income by the sum of the average number of shares outstanding plus all additional shares that would have been outstanding if all convertible debentures were converted and stock options were exercised (potential ordinary shares). Net income is adjusted by reversal of interest expense for convertible debentures net of tax. Potential ordinary shares are treated as dilutive when, and only when, their conversion to ordinary shares decrease earnings per share. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 37 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Principles of consolidation The consolidated financial statements include the accounts of the Parent Company and all subsidiary companies. Subsidiary companies are all companies in which Ericsson has an ownership and directly or indirectly, including effective potential voting rights, has a voting majority or by agreement has control or retains the majority of the residual or ownership risk of the entity. Inter-company transactions have been eliminated. Elimination of unrealized profits in inventory is made in full without consideration of minority interests. Goodwill Goodwill resulting from acquisitions of subsidiary and associated companies is amortized according to individual assessment of each item’s estimated economic life, resulting in amortization periods of up to years. Goodwill in foreign investments is remeasured at year-end exchange rates. Depending on the nature of the acquisition, goodwill amortization is reported under “Research and development and other technical expenses”, “Selling expenses” or ‘‘Administrative expenses”. The consolidated financial statements have been prepared in Goodwill resulting from acquisitions is tested annually for accordance with the purchase method, whereby consolidated stockholders’ equity includes equity in subsidiary companies and associated companies earned only after their acquisition. The Parent Company income includes dividends received from subsidiary companies and other inter-company revenues and costs, which are eliminated in the consolidated accounts. Associated companies and joint ventures Investments in associated companies, including joint ventures, where voting stock interest including effective potential voting rights is at least percent but not more than percent, or where a corresponding influence is obtained through agreement, are accounted for according to the equity method. Ericsson’s share of income is reported in item “Share in earnings of joint ventures and associated companies”, included in Operating Income. Taxes are included in item “Income taxes”. Unrealized internal profits in inventory in associated companies purchased from subsidiary companies are eliminated in the consolidated accounts in proportion to ownership. Investments in associated companies are shown at equity after adjustments for unrealized inter-company profits and un-amortized goodwill (see Goodwill below). Undistributed earnings of associated companies included in consolidated restricted equity are reported as “Equity proportion reserve”, as detailed in Note , “Stockholders’ Equity”. All other equity instruments are accounted for as Other investments and carried at the lower of acquisition cost or fair value. impairment and if there is an indication of potential impairment. Translation of financial statements in foreign currency For most subsidiary companies, joint ventures and associated companies, the local currency is the currency in which the companies primarily generate and expend cash, and is thus considered their functional (business) currency. Their financial statements plus goodwill related to such companies, if any, are translated to SEK using the current method, with translation adjustments reported directly in consolidated stockholders’ equity. When a company accounted for in accordance with these principles is sold, accumulated translation adjustments are included in consolidated income. Financial statements of companies with finance activities and other companies, having such close relations with the Swedish operations that their functional currency is considered to be SEK, are remeasured using the monetary method. Adjustments from remeasurement of financial statements of these companies are included in consolidated income. (See Note , “Stockholders’ Equity”.) For a limited number of companies, the functional currency is another than the local currency. These companies are translated in two steps. In the first step, remeasurement is made into the functional currency and resulting exchange rate gains/losses are reported in income . In the second step, from the functional currency to SEK, the financial statements are translated using the current method. The remeasurement method gives a more fair view of these financial statements than a translation directly to SEK, since these companies operate in de facto USD- or EUR-based economies. 38 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Translation of foreign currency items in individual companies In the financial statements, receivables and liabilities in foreign currencies have been translated at year-end exchange rates. Gains and losses on foreign exchange are divided into operational and financial. Effects of hedging are, in the income statement, reported together with the hedged item. The net difference between foreign exchange gains/losses on operating transactions and gains/losses on hedging through foreign exchange derivatives are included in cost of goods sold. Gains and losses on foreign exchange attributable to financial assets are included in financial income and gains and losses related to financial liabilities are included in financial expenses. Translation effects related to permanent financing of foreign subsidiary companies are reported directly to consolidated stockholders’ equity, net of tax effects. Cash investments, derivative financial instruments and fair value estimation of financial instruments Short-term cash investments in the consolidated accounts are valued at the lower of acquisition cost plus accrued interest and fair value. In the Parent Company, short-term cash investments, interest and “foreign exchange” related derivatives are valued at the lower of acquisition cost plus accrued interest and fair value. Derivative financial instruments are used to hedge foreign exchange and interest rate risks. Foreign exchange derivatives hedging items on the balance sheet are valued at fair value to offset the changed value of hedged items. Foreign exchange derivatives hedging forecasted transactions are not carried on the balance sheet. Derivatives not fulfilling the requirements for hedge accounting are valued at the lower of cost and fair value. Premium/discount on currency forward contracts is amortized during time to maturity. Interest rate-related derivatives linked to specific investments or loans, or which are applied to hedge interest rate positions are valued in the same manner as the hedged position. Gains and losses from derivatives in the Parent Company are reported net as other financial income/expenses. In the consolidated accounts, gains and losses on operational hedges are reported in the same manner as the underlying position. Interest rate-related derivatives and foreign exchange derivatives are in the consolidated accounts valued according to the lower of acquisition cost and fair value, determined on a portfolio basis. Financial assets and liabilities are offset and reported net in the balance sheet when there is a legally enforceable right for setoff and there is intent to settle on a net basis or to realize the asset and settle the liability simultaneously. When calculating the fair values of financial instruments official rates or quoted market prices are used. If official rates or market prices are not available, valuations have been made by discounting the expected future cash flows at prevailing interest rates. When calculating fair values of short-term N O T E S T O T H E F I N A N C I A L S T A T E M E N T S investments, changes in credit spreads are included. Ericsson’s listed debt instruments (outstanding notes and bond loans) are valued at amortized cost. Intangible and tangible fixed assets Intangible and tangible fixed assets are stated at cost less accumulated amortization/depreciation/write-down. Tangible assets are stated with net value of revaluations. Annual depreciation is reported as plan depreciation, generally using the straight-line method, with estimated useful lives of, in general, years on buildings, years on land improvements, to years on machinery and equipment, and up to years on rental equipment. Intangible assets excluding goodwill are amortized over a period of maximum years. See Goodwill above for amortization of goodwill. Amortization and depreciation is included in “Cost of Sales” and in the respective functional operating expenses. Costs for development of products to be sold, leased or otherwise marketed or developed or obtained for internal use are capitalized as intangible assets when technological feasibility has been established and when future economic benefits can be demonstrated. As technological feasibility often cannot be established until late in each project, the capitalized portion of total development costs is limited. Other development costs are charged to the income statement as incurred. See also “Capitalized development costs”. Impairment tests of tangible and intangible fixed assets, including goodwill, are performed on a regular basis whenever there is an indication of possible impairment. However, intangible assets not yet available for use are tested annually. The carrying values of fixed assets, including goodwill related to those assets, are not considered to be recoverable when the expected discounted cash flows from those assets are less than their carrying values. An impairment loss is determined based on the amount by which the carrying value exceeds the fair value of those assets. Losses on fixed assets to be disposed of, are determined in a similar manner, taking into account the selling price reduced by the costs of disposal. Provisions are made for expected costs for restoration of land or buildings due to environmental obligations or obligations in leasing contracts. Leasing Leasing when the company is the lessee Finance leasing contracts are capitalized and reported as tangible assets and as other current liabilities and other long- term liabilities. Operating lease contracts are not capitalized. Leasing when the company is the lessor Leasing contracts with the company as a lessor are classified as financial leases, when the majority of risks and rewards are transferred to the lessee, and otherwise as operating leases, for example when sub-leasing parts of leased properties. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 39 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Deferred taxes Deferred tax assets attributable to temporary differences between the book values of assets and liabilities and their tax values, and also deferred tax receivables attributable to unutilized tax loss carry-forwards, are reported to the extent that it is probable that future taxable profits will be available against which the tax losses can be utilized. The valuation of deferred tax assets involves assumptions regarding the deductibility of costs not yet subject to taxation and regarding sufficient future taxable income to enable utilization of unused tax losses in different tax jurisdictions. All deferred tax assets are subject to annual review of possible utilization. The largest amounts of tax loss carry-forwards are in Sweden, with indefinite period of utilization. The accumulated deferred tax asset/liability is remeasured regularly by applying the current tax rate in each country. Adjustments of deferred tax assets/liabilities attributable to changes in tax rates are included in current year income. Receivables and customer financing Receivables are reported at anticipated net realizable value. Sales of trade receivables and customer financing credits are reflected as a reduction of receivables in the balance sheet and the proceeds received are included in “Cash flows from operating activities”. For sale of receivables with recourse, provisions are recorded for estimated value of recourse liabilities. The excess of the recourse obligation over the recorded provision is included in contingent liabilities. We provide financing to certain customers in connection with significant sales of network infrastructure equipment. Financing may include funding for the direct purchase of our products and services or, in exceptional cases, for working capital purposes. We assess the collectibility of our receivables for purposes of initial revenue recognition and to record receivables at anticipated realizable value. In instances where we have sold credits with recourse or where we have exposure related to guarantees to third parties for customer financing, we have reported the extent of our exposure as contingent liabilities. We accrue risk provisions based on our assessment of the risks relating to these contingent liabilities, and contingent liabilities are reported net of such provisions. 40 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Inventories Inventories are valued at the lower of cost or market on a first- in, first-out (FIFO) basis. Risks of obsolescence has been valued by estimating market value based on future customer demand and changes in technology and customer acceptance of new products. Provisions Provisions are recognized when we have a present legal or constructive obligation as a result of past events and when it is likely that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Our provisions mainly relate to warranty commitments, restructuring, estimated obligations for patent and other litigations, contractual discounts and penalties of uncertain timing or amount, potential supplier and subcontractor claims and unresolved Income Tax and VAT/GST issues. Pensions and other post-employment benefits Pensions are classified either as defined contribution plans or defined benefit plans. Under a defined benefit plan it is the company’s obligation to provide agreed benefits to current and former employees. The related actuarial and investment risks fall on the company, while under a defined contribution plan the company’s obligation is limited to agreed amounts that the company has to contribute to an insurance company. Ericsson adopted RR Employee Benefits in . When applying RR , defined benefit plans in all subsidiary companies within Ericsson are accounted for using the same actuarial method. In the financial reporting for Ericsson before , such plans have been accounted for in accordance with local rules and principles in each country. The present value of the defined benefit obligation for current and former employees is calculated using the Projected Credit Unit Method. The calculations are based upon actuarial assumptions and are as a minimum prepared annually. Actuarial assumptions are the company’s best estimate of the variables that determine the cost of providing the benefits. When using actuarial assumptions it is possible that the actual result differ from the assumed result. These differences are actuarial gains and losses. They are for example caused by unexpectedly high or low rates of employee turnover, salary changes, the effect of changes in the discount rate and differences between actual return on plan assets and the expected return on plan assets. Actuarial gains and losses are amortized over the employees average remaining service period if the gains/losses exceed the greater of percent of the present value of the defined benefit obligation or percent of the fair value of plan assets at the beginning of period (the corridor). The accounting for defined contribution plans has not been affected by the adoption of RR in . The adoption of RR increased the provision for pensions by SEK . billion and decreased the equity by SEK –. billion, net of tax. In the Parent Company the ITP pension plan is accounted for in accordance with FAR . Statement of cash flows Foreign subsidiary companies’ transactions are translated at the average exchange rate during the period. Subsidiary companies purchased and/or sold, net of cash acquired/sold, are reported as cash flow from investment activities and do not affect reported cash flow from operations. Cash and cash equivalents consist of cash, bank and short- term investments. Included are all highly liquid financial instruments which are easily converted to cash and insignificantly affected by changes in value and used by our treasury function for cash management purposes. Segment reporting Our three operating segments are defined based on customers served and inter-dependency of products and services provided. Financial information is provided to the Board based on these three segments: • Systems, addressing operators of mobile and fixed line public telephone networks. • Phones, addressing distributors of mobile handsets to end users. Financial information for this segment consists of our share in earnings of Sony Ericsson. • Other operations, which consists of a number of different operations with different types of customers. Included operations are: Microwave Systems, Network Technologies, Enterprise Systems, Mobile Platform Technology, Power Modules and other. The operating segments operate in five main geographical areas, () Western Europe, () Central and Eastern Europe, Middle East and Africa, () Asia Pacific, () North America and () Latin America. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S New accounting standards 2005 From , Ericsson will report according to International Financial Reporting Standards (IFRS). The implementation of IFRS has been prepared in an internal project. The IFRS standards regarding capitalization of development costs, business combinations, share-based payments and financial instruments are expected to have the most significant impact on the financial position and result. IAS 38 – Intangible assets When adopting the Swedish accounting standard RR Intangible assets in , the standard was implemented prospectively, i.e. no restatement was allowed, whereas IAS Intangible assets shall be implemented retrospectively. The capitalization according to Swedish GAAP during – has been the same as per IFRS. Retrospective application will lead to an increase in the opening balance of intangible assets as of January , , due to capitalized development costs in years prior to , and increased amortizations on such assets during and onwards. The opening balance for will be equal to the closing balance according to US GAAP per December , , since capitalization of development costs has been made for US GAAP purposes historically. Due to the restatement to IFRS, intangible assets will increase by SEK , million, deferred tax assets will decrease by SEK , million and equity will increase by SEK , million respectively. As a result amortization for will increase by SEK , million under IFRS. IFRS 3 – Business combinations including goodwill Rules applying to reporting of business combinations (IFRS ) will result in changes in reporting of acquisitions of companies. A more detailed purchase price allocation is to be made, in which fair value is also assigned to acquired intangible assets, such as customer relations, brands and patents. Goodwill arises when the purchase price exceeds the fair value of acquired net assets. Goodwill arising from acquisitions is no longer amortized but instead subject to impairment review; both annually and when there are indicators that the carrying value may not be recoverable. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 41 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S In Ericsson’s reporting during , acquisitions carried out in will be accounted for in accordance with the new rules. There will be no adjustments for acquisitions prior to the transition date, January , . The value of goodwill will be frozen at January , , and amortization reported under Swedish GAAP for will be reversed in IFRS restatements. For Ericsson, the new standard will result in an increase in reported operating profit for of SEK million. No difference in reported earnings will arise as a result of acquisitions carried out in . IFRS 2 – Share-based Payments Ericsson has chosen not to apply IFRS to equity instruments granted before November , . For one employee option program, granted after November , , and not yet vested by January , , Ericsson recognizes a charge to income representing the fair value at grant date of the outstanding employee options. The fair value of the options was calculated using an option-pricing model. The total costs are recognized during the vesting period ( years). The impact on operating profit is a charge of SEK million in and estimated to SEK million in . For other programs there are no material differences. IAS 32 and 39 – Financial Instruments and Hedging IAS and are standards that deal with disclosure, presentation, recognition and measurement of financial instruments. These standards are applied from January , . A major effect is that derivatives will be recognized at fair value on the balance sheet. Subsequent changes in fair value of derivatives are recognized in the income statement, unless the derivative is a hedging instrument in (i) a cash flow hedge or (ii) a hedge of a net investment in a foreign operation. In those cases, the effective portion of fair value changes of the derivative will be recognized in equity until the hedged transaction affects the income statement, at which moment the accumulated deferred amount in equity is recycled to the income statement. For derivatives assigned as (iii) fair value hedges, fair value changes on both the derivative and the hedged item, attributable to the hedged risk, will be recognized in the income statement and offset each other to the extent the hedge is effective. The opening balance January , , was affected by SEK , million in assets, SEK , million in liabilities and SEK , million in equity net of deferred tax as a result of accounting for derivatives at fair value. Other investments are under Swedish GAAP reported at the lower of acquisition cost or fair value. Those investments will be reported at fair value under IAS , and since they will be classified as Available-for-sale under IAS , changes in the fair value will be recognized directly in equity, unless an impairment is determined. For investments in quoted companies, fair values are determined based on share prices at the balance sheet date and for non-quoted investments, fair values are estimated. The effect in the opening balance January , , was an increase of SEK million in assets and an increase of SEK million in the equity, net of deferred tax. IAS 19 – Employee Benefits Ericsson reports pensions and similar benefits according to IFRS (IAS ), which is similar to RR that was implemented from January , . The effect of adoption of IAS is therefore not considered a transition effect. The reporting of pensions for Ericsson will continue to be in accordance with URA awaiting further guidance. The restatement for RR resulted in an increased pension liability, reduced equity and increased deferred tax assets in the opening balance of under Swedish GAAP. The effect of implementing RR was communicated in the first quarter interim report . After taking into account the tax effects, the impact on stockholders’ equity was a charge of SEK , million. Actuarial gains and losses were recognized in the opening balance. No other impact will occur according to IAS . 42 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Summary of transition effects: The preliminary effects of the adoption of IFRS on the consolidated balance sheet, equity and income statement are shown in the tables below. The effects of IAS are only included in the opening balance for , since no restate of prior periods will be made. Summarized reconciliation of consolidated net profit: (SEK million) Net income under Swedish GAAP IFRS adjustments Amortization of capitalized development costs Reversed amortization of Goodwill 1) Share-based payments 2) Deferred taxes on IFRS adjustments Total IFRS adjustments Net income under IFRS 2004 19,024 –2,660 475 –45 745 –1,485 17,539 1) Including the effect of share in earnings of JV and associated companies due to reversed amortization of goodwill. 2) The net effect in equity is zero. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Impact of IFRS on the Statement of Cash Flows According to IAS “Cash Flow”, Ericsson will define cash and cash equivalents to include only short-term highly liquid investments with remaining maturity at acquisition date of three months or less. Under Swedish praxis, a broader interpretation was earlier made, where also readily marketable securities designated for liquidity management purposes only and with a low risk for value changes and with a maturity exceeding three months were included. The restated statements of cash flow for and the opening balance for the Ericsson group according to IAS will therefore reflect cash and cash equivalents that are different to those previously reported under Swedish GAAP. (SEK million) January 1, 2004 December 31, 2004 Cash and cash equivalents under Swedish GAAP Less: amounts with maturity exceeding three months Cash and cash equivalents under IFRS 73,207 76,554 –20,092 –46,142 53,115 30,412 Summarized reconciliation of consolidated balance sheet and equity: (SEK million) Assets January 1, 2004 Minority interest, provisions and Equity liabilities December 31, 2004 Minority interest, provisions and Equity liabilities Assets January 1, 2005 (IAS 39) Minority interest, provisions and Equity liabilities Assets Swedish GAAP 1) IFRS adjustments Minority interest Capitalization of development costs Goodwill 2) IAS 39 Financial instruments Deferred taxes on IFRS adjustments 182,977 59,206 123,771 183,040 77,299 105,741 186,186 81,502 104,684 – 6,408 – – –1,794 2,299 4,614 – – – -2,299 – – – – – 3,748 447 – –1,049 1,057 2,699 447 3) – – –1,057 – – – – – – – 3,967 –77 – – – 1,489 – – – – 1,952 449 Total IFRS adjustments 4,614 6,913 –2,299 3,146 4,203 –1,057 3,890 1,489 2,401 IFRS Equity ratio, Swedish GAAP 1) Equity ratio, IFRS 187,591 66,119 121,472 186,186 81,502 104,684 190,076 82,991 107,085 – – – – 33.6% 35.2% – – – – 42.8% 43.8% – – – – 43.8% 43.7% 1) 2) Including the effect of changed accounting principle in 2004, RR 29. Figures for January 1, 2005, restated in accordance with IFRS. Including the effect of share in earnings of JV and associated companies due to reversed amortization of goodwill. 3) Reversed amortization of goodwill, including CTA, is included in the equity. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 43 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 2 SEGMENT INFORMATION Business segments 2004 Orders booked Inter segment orders Total Orders Booked Net sales Inter segment sales Total Net Sales Share in earnings of JV and associated companies Operating Income Financial income Financial expenses Income after financial items Taxes Minority interest Net Income Segment assets 1) 2) Associates Total Assets Segment liabilities 3) 4) Total Liabilities Systems Phones Other Operations Unallocated Eliminations Group 123,568 1,403 124,971 121,549 1,348 122,897 90 25,345 – – – – – – – – 2,143 2,143 – – 25,345 2,143 – – – – 25,345 2,143 62,783 961 63,744 54,728 54,728 – 3,092 3,092 – – 9,391 987 10,378 10,423 966 11,389 68 1,469 – – 1,469 – – 1,469 9,452 97 9,549 6,627 6,627 – – – – – – 17 –19 3,541 –4,081 –559 –9,077 –297 –9,933 106,655 – 106,655 43,329 43,329 – –2,390 –2,390 – –2,314 –2,314 – – – – – – – – – – – – – 132,959 – 132,959 131,972 – 131,972 2,318 28,938 3,541 –4,081 28,398 –9,077 –297 19,024 178,890 4,150 183,040 104,684 104,684 1) Segment assets include tangible assets, intangible assets, short and long term customer financing, accounts receivable, inventory, prepaid expenses, accrued revenues and other current assets. 2) Unallocated assets include mainly cash, short term investments and deferred tax assets. 3) Segment liabilities include accounts payable, provisions, accrued expenses and deferred revenues, advances from customers and other current liabilities. 4) Unallocated liabilities include accrued interests, tax liabilities and interest-bearing provisions and liabilities. Other segment items Tangible and intangible assets Additions/capitalization Depreciation Amortization Write-downs Number of employees Operating income Income after financial items Restructuring costs, net 1) Operating income Operating margin (%) Income after financial items 3,881 2,223 2,275 22 45,500 25,345 – – 25,345 21% – – – – – – 2,143 – – 2,143 – – 399 210 42 – 5,034 1,469 – – 1,469 13% – – 1 –11 35 – –19 – – –19 – – – – – – – – – – – – – 4,280 2,434 2,306 57 50,534 28,938 28,398 – 28,938 22% 28,398 1) In 2004 no restructuring costs were recognized. The item is included for comparability. Geographical segments 2004 Western Europe – of which Sweden Eastern Europe, Middle East and Africa Asia Pacific – of which China North America – of which United states Latin America Total – of which EU 44 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Net sales 40,542 6,180 32,929 28,552 12,298 15,471 13,984 14,478 131,972 42,366 Orders booked 40,311 4,769 32,522 31,362 12,987 13,083 11,769 15,681 132,959 42,413 Additions/ capitalization of tangible and intangible assets Number of employees 3,554 2,851 83 230 130 320 165 93 4,280 3,603 32,930 21,296 3,423 7,493 2,897 4,139 2,156 2,549 50,534 33,625 Total assets 145,440 125,306 3,874 14,278 7,018 9,366 8,874 10,082 183,040 145,436 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Systems Phones Other Operations Unallocated Eliminations Group Business segments 2003 Orders booked Inter segment orders Total Orders Booked Net sales Inter segment sales Total Net Sales Share in earnings of JV and associated companies Operating Income Financial income Financial expenses 104,694 748 105,442 107,995 671 108,666 125 –6,163 – – – – – – – – –521 –521 – – 8,306 886 9,192 9,743 836 10,579 65 –3,511 – – Income after financial items –6,163 –521 –3,511 Taxes Minority interest Net Income Segment assets 1) 2) Associates Total Assets Segment liabilities 3) 4) Total Liabilities – – – – – – –6,163 –521 –3,511 65,478 563 66,041 58,536 58,536 – 1,752 1,752 – – 6,649 491 7,140 7,610 7,610 – – – – – – –273 –1,044 3,995 –4,859 –1,908 1,460 –201 –649 107,275 164 107,439 53,446 53,446 – –1,634 –1,634 – –1,507 –1,507 – – – – – – – – – – – – – 113,000 – 113,000 117,738 – 117,738 –604 –11,239 3,995 –4,859 –12,103 1,460 –201 –10,844 179,402 2,970 182,372 119,592 119,592 1) Segment assets include tangible assets, intangible assets, short and long term customer financing, accounts receivable, inventory, prepaid expenses, accrued revenues and other current assets. 2) Unallocated assets include cash, short term investments and deferred tax assets. 3) Segment liabilities include accounts payable, provisions, accrued expenses and deferred revenues, advances from customers and other current liabilities. 4) Unallocated liabilities include accrued interests, tax liabilities and interest-bearing provisions and liabilities. Other segment items Tangible and intangible assets Additions/capitalization Depreciation Amortization Write-downs Number of employees Operating income Income after financial items Restructuring costs, net Operating income 1) Operating margin (%) 1) Income after financial items 1) 1) Exluding restructuring charges. Geographical segments 2003 Western Europe – of which Sweden Eastern Europe, Middle East and Africa Asia Pacific – of which China North America – of which United states Latin America Total – of which EU 1) 1) Restated due to new members in EU as of May, 2004. 6,348 3,028 1,807 1,126 45,176 –6,163 – –12,809 6,646 6.1% – Net sales 36,096 5,868 26,747 27,343 10,473 17,627 16,357 9,925 117,738 38,143 – – – – – –521 – –338 –183 – – 373 699 666 337 6,110 –3,511 – –3,064 –447 –4.2% – 8 26 107 – 297 –1,044 – –252 –792 – – –757 – – – – – – – – – – 5,972 3,753 2,579 1,463 51,583 –11,239 –12,103 –16,463 5,224 4.4% 4,360 Orders booked 30,909 4,417 23,258 29,514 12,701 20,237 18,971 9,082 113,000 33,532 Additions/ capitalization of tangible and intangible assets Number of employees 5,204 4,849 60 96 67 505 301 107 5,972 5,242 36,227 24,408 2,152 6,468 2,850 4,460 2,581 2,276 51,583 36,608 Total assets 143,749 121,832 4,177 14,847 7,625 10,398 9,876 9,201 182,372 143,681 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 45 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Systems Phones Other Operations Unallocated Eliminations Group Business segments 2002 Orders booked Inter segment orders Total Orders Booked Net sales Inter segment sales Total Net Sales Share in earnings of JV and associated companies Operating Income Financial income Financial expenses 114,177 1,164 115,341 130,842 1,113 131,955 161 –12,497 – – – – – – – – –1,331 –1,331 – – 14,174 1,210 15,384 14,931 1,270 16,201 –45 –5,846 – – Income after financial items –12,497 –1,331 –5,846 Taxes Minority interest Net Income Segment assets 1) 2) Associates Total Assets Segment liabilities 3) 4) Total Liabilities – – – – – – –12,497 –1,331 –5,846 88,121 693 88,814 53,435 53,435 – 799 799 – – 9,048 531 9,579 9,470 9,470 – – – – – – –5 –1,625 4,253 –5,789 –3,161 4,165 –343 661 110,109 –188 109,921 70,132 70,132 – –2,374 –2,374 – –2,383 –2,383 – – – – – – – – – – – – – 128,351 – 128,351 145,773 – 145,773 –1,220 –21,299 4,253 –5,789 –22,835 4,165 –343 –19,013 207,278 1,835 209,113 133,037 133,037 1) Segment assets include tangible assets, intangible assets, short and long term customer financing, accounts receivable, inventory, prepaid expenses, accrued revenues and other current assets. 2) Unallocated assets include cash, short term investments and deferred tax assets. 3) Segment liabilities include accounts payable, provisions, accrued expenses and deferred revenues, advances from customers and other current liabilities. 4) Unallocated liabilities include accrued interests, tax liabilities and interest-bearing provisions and liabilities. Other segment item Tangible and intangible assets Additions/capitalization Depreciation Amortization Write-downs Number of employees Operating income Income after financial items Restructuring costs, net Operating income 1) Operating margin (%) 1) Income after financial items 1) 1) Exluding restructuring charges. Geographical segments 2002 Western Europe – of which Sweden Eastern Europe, Middle East and Africa Asia Pacific – of which China North America – of which United states Latin America Total – of which EU 1) 1) Restated due to new members in EU as of May, 2004. 46 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 5,896 4,877 1,049 –612 56,590 –12,497 – –10,441 –2,056 –1.6% – – – – – – –1,331 – – –1,331 – – 553 597 221 – 7,646 –5,846 – –1,438 –4,408 –27.2% – 32 135 365 – 385 –1,625 – –83 –1,542 – – –30 –95 – – – – – – – – – 6,451 5,514 1,635 –612 64,621 –21,299 –22,835 –11,962 –9,337 –6.4% –10,873 Net sales 46,165 8,303 27,959 35,905 12,559 23,068 22,036 12,676 145,773 47,199 Orders booked 37,553 7,620 27,895 30,451 10,852 22,877 21,673 9,575 128,351 37,687 Additions/ capitalization of tangible and intangible assets Number of employees 5,601 4,908 92 294 151 392 357 72 6,451 5,585 45,251 30,241 2,449 7,771 3,034 6,328 4,562 2,822 64,621 45,590 Total assets 161,725 130,572 5,256 16,391 6,189 14,201 13,633 11,540 209,113 161,696 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Net Sales Parent Company Western Europe 1) 2) Eastern Europe, Middle East & Africa Asia Pacific North America Latin America Total 1) Of which Sweden 2) Of which EU 2004 54 2,530 – – 14 2,598 54 54 2003 1 1,403 – – 241 1,645 1 1 2002 – 1,715 – – 302 2,017 – – Parent Company sales are mainly related to business segment Systems. 4 REVENUES The majority of Ericsson’s products and services are sold as parts of contracts including several items. The nature of the products and services being sold, and the contractual terms taken as a whole, determine the appropriate revenue recognition method. The contracts are of three main types: Consolidated Equipment sales Of which: – Construction-type contracts 1) 2) – Delivery-type contracts 1) 2) Service sales Royalties Total Capital gains, license fees and other operating revenues Interest income Dividends 2004 2003 2002 110,985 98,726 125,112 56,012 54,973 19,301 1,686 73,165 25,561 18,458 554 – – 19,493 1,168 131,972 117,738 145,773 3,128 3,346 8 2,645 3,913 7 1,928 3,592 83 1) Figures for 2002 not available. 2) In 2003 multiple-elements contracts were reported within construction-type contracts. In 2004 this type of contracts have been reported as delivery- type. See Note 1, “Accounting Policies”, Revenue recognition for more information about the different types of contracts. 3 RESTRUCTURING COSTS Restructuring 2004 2003 2002 Restructuring charges Asset write-downs Employee redundancy 1) Unused real estate Other Total Of which Cost of sales Research and development Selling expenses Administrative expenses Other operating revenue and costs Share in earnings of JV and associated companies Total Restructuring in Statement of cash flows Charges in Net income, net Share in earnings of JV and associated companies Write-downs Provisions made Provisions utilized Total cash flow effect – – – – – – – – – – – – – 3,966 7,728 3,883 886 1,074 10,556 562 –230 16,463 11,962 4,790 5,361 3,150 2,465 345 5,589 4,124 1,474 694 311 352 –230 16,463 11,962 –16,463 –11,962 – – – –5,651 352 3,966 10,835 –9,146 – 1,074 7,195 –6,593 –5,651 –10,456 –10,286 1) Number of employees at December 31, 2004 were 50,534 (51,583 in 2003 and 64,621 in 2002) Key measurements, excluding restructuring charges Net sales Gross margin – as percentage of net sales Operating expenses – as percentage of net sales Share in earnings of joint ventures and associated companies Other operating revenue and costs Operating income Operating margin (%) Financial net Income after financial items 2004 1) 2003 2002 131,972 117,738 145,773 47,138 43,627 61,108 46.3% 37.1% 32.3% –37,105 –40,037 –56,109 28.1% 34.0% 38.5% 2,318 –252 –1,450 2,617 28,938 21.9% –540 28,398 1,084 1,886 5,224 –9,337 4.4% –6.4% –1,536 –864 4,360 –10,873 1) No restructuring charges reported during 2004. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 47 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 5 OTHER OPERATING REVENUES AND COSTS Parent Company 2004 2003 2002 Consolidated 2004 2003 2002 1) Gains on sales of intangible and tangible assets Losses on sales of intangible and tangible assets Capital losses on tangible assets related to restructuring Gains on sales of investments and operations Losses on sales of investments and operations Sub-total Commissions, license fees and other operating revenues Total 1) Restated for changed accounting principles. 111 213 166 –229 –28 –251 – –345 –311 510 493 267 –273 119 2,498 2,617 –731 –398 –593 –722 1,939 1,496 1,541 773 Parent Company 2004 2003 2002 Commissions, license fees and other operating revenues Net losses (–) on sales of tangible assets Total 2,920 2,441 2,770 –30 –33 –1 2,890 2,408 2,769 6 FINANCIAL INCOME AND EXPENSES Consolidated 2004 2003 2002 Financial Income Result from securities and receivables accounted for as fixed assets Other interest income and similar profit/loss items Total Financial Expenses Interest expenses and similar profit/loss items Financial Net 354 470 1,049 3,187 3,541 3,525 3,995 3,204 4,253 –4,081 –4,859 –5,789 –540 –864 –1,536 The Group’s interest expenses on pension liabilities are included in the interest expenses shown above. Financial Income Result from participations in subsidiary companies Dividends Net gains on sales Result from participations in associated companies Dividends Net gains on sales Result from other securities and receivables accounted for as fixed assets Dividends Net gains on sales Other interest income and similar profit/loss items Subsidiary companies Other 1) Total 6,378 146 1,565 36 5,077 20 120 34 – 2 93 – 4 153 48 – 58 24 1,093 3,235 2,629 4,697 3,346 4,424 11,008 9,177 12,997 1) Of the total amount, SEK 0 million in 2004, SEK 1,384 million in 2003 and SEK 2,161 million in 2002 is attributable to hedge of net investments in foreign subsidiary companies. Parent Company 2004 2003 2002 Financial Expenses Losses on sales of participations in subsidiary companies Write-down of investments in subsidiary companies Write-down of investments in associated companies Write-down of participations in other companies Interest expenses and similar profit/loss items: Subsidiary companies Other Other financial expenses Total Financial Net –295 –21 – –861 –1,526 –3,800 – –5 –86 –35 –2 –2 –1,178 –2,896 –16 –1,680 –2,693 –11 –2,399 –2,370 –14 –5,251 –6,019 –8,620 5,757 3,158 4,377 Parent Company’s interest expenses on pension liabilities are included in the interest expenses shown above. 48 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 7 INCOME TAXES FOR THE YEAR Income Statement The following items are included in Income taxes for the year: Current income taxes for the year Current income taxes related to prior years Deferred income/expense (–) taxes related to temporary differences Share of taxes in joint ventures and associated companies Income taxes for the year 2004 –2,324 –637 –5,382 –734 –9,077 Consolidated 2003 2002 –1,613 –240 3,138 175 –2,579 –1,456 7,996 204 1,460 4,165 Parent Company 2003 2002 –738 205 364 – –169 –799 –493 –347 – –1,639 2004 –2,316 – 881 – –1,435 Deferred tax income and expenses The amounts of deferred tax income and expenses are shown in the following table: Deferred tax income Deferred tax expenses Deferred taxes income/expense, net 2004 3,082 –8,464 –5,382 Consolidated 2003 2002 6,414 –3,276 10,269 –2,273 3,138 7,996 Parent Company 2003 2002 551 –187 364 29 –376 –347 2004 1,180 –299 881 Consolidated Deferred income taxes relate to tax loss carryforwards of SEK , million (SEK , million in , SEK , million in ) and to certain provisions. Deferred tax expenses SEK , million out of SEK , million refer to utilization of tax loss carry forwards. The remaining refer to reversals of temporary differences regarding certain provisions for mainly restructuring and warranty commitments. Parent Company Deferred income taxes refer to loss carry forwards and reserve for doubtful receivables. Deferred tax expenses refer mainly to reversal of temporary differences regarding provisions for customer financing commitments and provision for restructuring costs. A reconciliation between actual tax income (–expense) for the year and the theoretical tax income (–expense) that would arise when applying statutory tax rate in Sweden, percent on income before taxes, is shown in the table: Income before taxes Tax rate in Sweden (28%) Effect of foreign tax rates Current income taxes related to prior years Tax effect of expenses that are non-deductible for tax purpose Tax effect of income that are non-taxable for tax purpose Tax effect of changes in tax rates Tax effect related to write-downs of investments in subsidiary companies Tax effect of tax losses carryforwards, net Income taxes for the year Consolidated Tax effect of expenses that are non-deductible include amortization of goodwill, certain costs related to customer financing and other non-tax deductible expenses. Consolidated 2003 2002 2004 28,398 –12,103 –22,835 –7,951 –286 –637 –1,031 855 –18 – –9 –9,077 3,389 –438 –240 –1,457 556 3 – –353 6,393 39 –1,456 –1,091 365 –21 – –64 1,460 4,165 Parent Company 2003 2002 1,419 –397 – 205 –659 1,143 – –461 – 4,321 –1,210 – –493 –584 1,712 – –1,064 – –169 –1,639 2004 8,595 –2,407 – – –597 1,810 – –241 – –1,435 Parent Company Tax effect of expenses that are non-deductible refer mainly to costs related to customer financing, foreign taxes and net losses on sales of shares. Tax effect of income that is non-taxable refers mainly to dividends. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 49 Investments in subsidiary companies, joint ventures and associated companies Due to losses in certain subsidiary companies, the book value of certain investments in those subsidiary companies, joint ventures and associated companies are less than the tax value of these investments. Since deferred tax assets have been reported with respect also to losses in these companies, and due to the uncertainty as to which deductions can be realized in the future, no additional deferred tax assets are reported. Tax loss carryforwards Deferred tax assets regarding unutilized tax loss carryforwards are reported to the extent that realization of the related tax benefit through the future taxable profits is probable also when considering the period during which these can be utilized, as described below. At December , , these unutilized tax loss carryforwards amounted to SEK , million. The tax effect of these tax loss carryforwards are reported as assets. The final years in which these loss carryforwards can be utilized are shown in the following table: Year of expiration Consolidated Parent Company 2004 2004 2005 2006 2007 2008 2009 2010 or later Total 649 105 157 25 78 33,132 34,146 – – – – – 3,828 3,828 Tax effects reported directly to stockholders’ equity Tax effects reported directly to stockholders’ equity amount to SEK million (SEK million , SEK million ), the amount reported is related to hedges of net investments. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Balance sheet Deferred tax assets and liabilities Tax effects of temporary differences including unutilized tax loss carryforwards have resulted in deferred tax assets and liabilities as follows: Consolidated Parent Company 2004 2003 2004 2003 Deferred tax assets Deferred tax liabilities 21,815 421 27,130 462 2,527 – 1,646 – Consolidated Deferred tax assets relate to tax loss carryforwards and temporary differences due to certain provisions. We estimate that approximately one third of the total deferred tax assets will be recovered within months. Deferred tax assets regarding tax loss carryforwards amount to SEK , million (SEK , million in ). Deferred tax asset are amounts recognized in countries where we expect to be able to generate corresponding taxable income in the future to benefit from tax reductions. The significant tax loss carryforwards are related to countries with long or indefinite periods of utilization, mainly Sweden and the U.S. Of the total deferred tax assets for tax loss carryforwards, SEK , million, SEK , million will expire or later, of which SEK , million relate to Sweden with indefinite time of utilization. With our current strong financial position and profitability during , we have been able to use part of our deferred tax assets during the year, and we are convinced that Ericsson will be able to generate sufficient income in the coming years to utilize these deferred tax assets. Parent Company Deferred tax assets refer mainly to tax loss carryforwards, costs related to customer financing and provisions for restructuring costs. 50 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 8 EARNINGS PER SHARE Consolidated Net income Average number of shares, basic (millions) Earnings per share, basic Net income Interest expenses on convertible debentures, net of income taxes Net income after full conversion Average number of shares after full conversion and exercise of stock options (million) Earnings per share, diluted N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 2004 19,024 15,829 1.20 19,024 – 19,024 15,859 1.20 2003 –10,844 15,823 –0.69 –10,844 105 –10,739 15,841 2002 –19,013 12,573 –1.51 –19,013 219 –18,794 12,684 –0.69 1) –1.51 1) 1) Potential ordinary shares are not considered when their conversion to ordinary shares would increase earnings per share. 9 INTANGIBLE ASSETS Consolidated 2004 Capitalized development costs, to be sold Capitalized acquired development costs, for internal use Capitalized internal development Capitalized costs, for development internal use costs, total Goodwill Licenses trademarks and similar rights Patents and acquired Other research intangible assets, total and develop- ment Accumulated acquisition costs Opening balance Acquisitions/capitalization Balances regarding acquired and sold companies Sales/disposals Translation difference for the year Closing balance Accumulated amortization Opening balance Amortization for the year Balances regarding acquired and sold companies Sales/disposals Translation difference for the year 5,123 1,138 – –302 – 5,959 –823 –1,311 – 302 – 405 5 – – – 410 –97 –137 – – – 273 3 – – – 276 –66 –92 – – – 5,801 1,146 11,508 370 – –302 – – 1 –545 6,645 11,334 1,287 262 122 –646 –3 1,022 –986 –1,540 –5,496 –453 –1,231 –271 – 302 – – 15 166 Closing balance –1,832 –234 –158 –2,224 –5,768 Accumulated write-downs Opening balance Write-downs for the year Translation difference for the year Closing balance Net carrying value –31 –47 – –78 – – – – – – – – –31 –47 – –78 –273 – 31 –242 4,049 176 118 4,343 5,324 121 –37 636 2 –901 – – – – 1,084 50 – –14 –2 1,118 –438 –42 – 3 – 2,371 312 122 –660 –5 2,140 –1,669 –313 –37 639 2 –477 –1,378 –15 – 1 –14 627 –15 – 1 –14 748 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 51 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Consolidated 2003 Capitalized development costs, to be sold Capitalized acquired development costs, for internal use Capitalized internal development Capitalized costs, for development internal use costs, total Goodwill Licenses trademarks and similar rights Patents and acquired Other research intangible assets, total and develop- ment Accumulated acquisition costs Opening balance Acquisitions/capitalization Balances regarding acquired and sold companies Sales/disposals Translation difference for the year Closing balance Accumulated amortization Opening balance Amortization for the year Balances regarding acquired and sold companies Sales/disposals Translation difference for the year Closing balance Accumulated write-downs Opening balance Write-downs for the year Sales/disposals Translation difference for the year Closing balance Net carrying value 3,074 2,049 – – – 5,123 –223 –600 – – – –823 – –31 – – –31 220 185 – – – 405 –11 –86 – – – –97 – – – – – 148 125 – – – 273 –8 –58 – – – 3,442 2,359 12,934 – – – – –19 – –1,407 1,319 53 – –69 –16 1,102 67 – –67 –18 5,801 11,508 1,287 1,084 2,421 120 – –136 –34 2,371 –242 –744 –4,331 –1,636 –1,220 –60 –376 –139 –1,596 –199 – – – –5 – 476 – 36 13 – 62 15 – 98 28 –66 –986 –5,496 –1,231 –438 –1,669 – – – – – – –31 – – –31 – –305 – 32 –273 –4 – 4 – – 56 –15 –1 2 –1 –15 631 –19 –1 6 –1 –15 687 4,269 308 207 4,784 5,739 Patents, licenses, trademarks and similar rights Parent Company 2004 2003 Accumulated acquisition costs Opening balance Acquisitions Closing balance Accumulated amortization Opening balance Amortization for the year Closing balance Net carrying value 222 – 222 –160 –22 –182 40 216 6 222 –137 –23 –160 62 52 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 10 TANGIBLE ASSETS Consolidated 2004 Accumulated acquisition costs Opening balance Additions Balances regarding acquired and sold companies Sales/disposals Reclassifications Translation difference for the year Closing balance Accumulated depreciation Opening balance Depreciation for the year Balances regarding acquired and sold companies Sales/disposals Reclassifications Translation difference for the year Closing balance Accumulated revaluation, net Opening balance Translation difference for the year Closing balance Accumulated write-downs, net Opening balance Write-downs for the year Balances regarding acquired and sold companies Sales/disposals/reversals of write-downs Reclassifications Translation difference for the year Closing balance Net carrying value Parent Company 2004 Accumulated acquisition costs Opening balance Additions Sales/disposals Reclassifications Closing balance Accumulated depreciation Opening balance Depreciation for the year Sales/disposals Reclassifications Closing balance Net carrying value Land and buildings Machinery and other technical assets Other equipment, tools and installations Construction in process and advance payments 2,854 51 –23 –100 –4 –153 2,625 –485 –226 16 66 7 39 –583 34 –2 32 –505 –10 – – – 33 –482 1,592 5,829 267 –625 –332 243 –76 5,306 –4,590 –463 467 268 –122 66 –4,374 – – – –229 – 81 – – – –148 784 16,190 1,699 293 –2,363 15 –484 15,350 –12,294 –1,745 –74 2,102 115 244 –11,652 – – – –585 – 28 25 – – –532 3,166 286 435 –14 –142 –254 –8 303 – – – – – – – – – – – – – – – – – 303 Land and buildings Machinery and other technical assets Other equipment, tools and installations Construction in process and advance payments 23 – – – 23 – – – –2 –2 21 – – – – – – – – – – – 559 6 –49 6 522 –167 –111 32 2 –244 278 90 44 –83 –6 45 – – – – – 45 Total 25,159 2,452 –369 –2,937 – –721 23,584 –17,369 –2,434 409 2,436 – 349 –16,609 34 –2 32 –1,319 –10 109 25 – 33 –1,162 5,845 Total 672 50 –132 – 590 –167 –111 32 – –246 344 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 53 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Consolidated 2003 Accumulated acquisition costs Opening balance Additions Balances regarding acquired and sold companies Sales/disposals Reclassifications Translation difference for the year Closing balance Accumulated depreciation Opening balance Depreciation for the year Balances regarding acquired and sold companies Sales/disposals Reclassifications Translation difference for the year Closing balance Accumulated revaluation, net Opening balance Sales/disposals Translation difference for the year Closing balance Accumulated write-downs, net Opening balance Write-downs for the year Sales/disposals/reversals of write-downs Reclassifications Translation difference for the year Closing balance Net carrying value Land and buildings 1) Machinery and other technical assets Other equipment, tools and installations Construction in process and advance payments 1,945 1,741 –163 –624 36 –81 2,854 –766 –104 66 305 –18 32 –485 36 –1 –1 34 –4 –500 – – –1 –505 1,898 10,170 313 63 –2,094 –2,287 –336 5,829 –6,998 –887 –119 1,519 1,655 240 –4,590 – – – – –179 –131 60 4 17 –229 1,010 20,080 1,202 129 –7,183 2,619 –657 16,190 –14,523 –2,762 –69 6,202 –1,637 495 –12,294 – – – – –102 –495 8 –4 8 –585 3,311 305 237 –8 138 –368 –18 286 – – – – – – – – – – – – – – – – – 286 Total 32,500 3,493 21 –9,763 – –1,092 25,159 –22,287 –3,753 –122 8,026 – 767 –17,369 36 –1 –1 34 –285 –1,126 68 – 24 –1,319 6,505 1) Due to reassessments of the nature of leases, according to the present interpretation of Swedish GAAP/IFRS, financial leases of SEK 1,687 million have been reflected in the balance sheet as tangible assets and long-term liabilities. Parent Company 2003 Accumulated acquisition costs Opening balance Additions Sales/disposals Reclassifications Closing balance Accumulated depreciation Opening balance Depreciation for the year Sales/disposals Closing balance Net carrying value Land and buildings Machinery and other technical assets Other equipment, tools and installations Construction in process and advance payments 23 – – – 23 – – – – 23 – – – – – – – – – – 69 455 –72 107 559 –54 –130 17 –167 392 – 198 –1 –107 90 – – – – 90 Total 92 653 –73 – 672 –54 –130 17 –167 505 54 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 11 FINANCIAL ASSETS Equity in joint ventures and associated companies Consolidated Opening balance Effect of changed accounting principle, RR 29 Opening balance in accordance with new accounting principle Share in earnings Taxes Translation difference for the year Dividends Capital contributions Reclassification Sales N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Joint ventures 2003 2004 1,753 –40 1,713 2,143 –701 –63 – – – – 3,092 799 – 799 –593 199 –36 – 1,384 – – 1,753 Associated companies Total 2004 1,217 – 1,217 175 –33 –52 –97 7 47 –206 1,058 2003 1,036 – 1,036 –11 –24 –64 –150 7 447 –24 1,217 2004 2,970 –40 2,930 2,318 –734 –115 –97 7 47 –206 4,150 2003 1,835 – 1,835 –604 175 –100 –150 1,391 447 –24 2,970 Closing balance Goodwill, net, amounts to SEK million (SEK million in ). Dividends received from companies accounted for under the equity method were SEK million in and SEK million in . Share of assets, liabilities and income in joint venture, Sony Ericsson Mobile Communications Share of assets, liabilities and income in associated company, Ericsson Nikola Tesla d.d. Consolidated Fixed assets Current assets Provisions Long-term liabilities Current liabilities Net assets Net sales Income after financial items Income taxes for the year Minority interest Net income Assets pledged as collateral Contingent liabilities Parent Company Opening balance Acquisitions and stock issues Shareholders’ contribution Write-downs Sales Closing balance 1,056 9,883 1,214 259 6,374 3,092 29,754 2,217 –701 –74 1,442 Consolidated Fixed assets Current assets Provisions Long-term liabilities Current liabilities Net assets Net sales Income after financial items Income taxes for the year Minority interest Net income 10 – Assets pledged as collateral Contingent liabilities 174 802 7 10 222 737 925 149 –17 – 132 – – Subsidiary companies 2003 2004 Joint ventures 2003 2004 Associated companies 2003 2004 58,991 4,443 –7,162 –861 –6,551 48,860 50,600 1 10,512 –1,526 –596 58,991 4,136 – – – – 4,136 2,752 1,384 – – – 4,136 371 – 3 – –36 338 458 – – –86 –1 371 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 55 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Other financial assets Consolidated Accumulated acquisition costs Opening balance Additions Sales/repayments/deductions Reclassifications Translation difference for the year Closing balance Accumulated write-downs/allowances Opening balance Write-downs/allowances for the year Sales/repayments/deductions Reclassifications Translation difference for the year Closing balance Net carrying value Other investments in shares and participations 2003 2004 Long-term customer financing 1) 2004 2003 Other long-term financial assets 2004 2003 2,308 161 –22 –52 –77 2,318 –1,875 44 3 – 53 –1,775 2) 3,144 41 –529 –197 –151 2,308 –901 –1,150 305 –233 104 –1,875 7,950 1,460 –2,234 –2,478 –368 4,330 –4,923 –656 1,115 2,221 63 19,203 2,879 –12,686 –748 –698 7,950 –6,920 –2,313 3,631 660 19 –2,180 3) –4,923 3) 543 4) 433 4) 2,150 3,027 2,138 611 –410 – –27 2,312 –796 –293 – – 13 –1,076 1,236 2,305 507 –581 – –93 2,138 –173 –642 – – 19 –796 1,342 1) From time to time, customer financing amounts may include equity instruments or equity-related instruments in our customers due to reconstruction activities of troubled debt. This is a result of that we sometimes receive such instruments as security for our receivable. Our policy is to sell such instruments as soon as feasible. Reclassification due to consolidation in accordance to URA 20. 2) Write-downs include reversals of write-downs of SEK 80 million, treated as other operationg revenues and costs in the income statement. 3) Write-downs are included in Selling expenses due to the close relation to operations. 4) Market value per December 31, 2004, for listed shares was SEK 234 (373) million with a net carrying value of SEK 80 (83) million. Parent Company Accumulated acquisition costs Opening balance Additions Sales/repayments/deductions Reclassifications Translation difference for the year Closing balance Accumulated write-downs/allowances Opening balance Write-downs/allowances for the year Sales/repayments/deductions Reclassifications Translation difference for the year Closing balance Net carrying value Other investments in shares and participations 2003 2004 20 – –2 – – 18 –3 –5 2 – – –6 12 41 4 –25 – – 20 –2 –2 1 – – –3 17 Long-term customer financing1) 2003 2004 5,593 1,315 –738 –147 –117 5,906 –3,570 –547 109 4 62 –3,942 1,964 12,818 2,123 –9,054 – –294 5,593 –3,719 –1,901 2,050 – – –3,570 2,023 Other long-term financial assets 2004 2003 476 205 –228 – –2 451 – – – – – – 214 309 –37 – –10 476 – – – – – – 451 476 1) From time to time, customer financing amounts may include equity instruments or equity-related instruments in our customers due to reconstruction activities of troubled debt. This is a result of that we sometimes receive such instruments as security for our receivable. Our policy is to sell such instruments as soon as feasible. 56 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 12 INVESTMENTS The following listing shows certain shareholdings owned directly and indirectly by the Parent Company as of December , . A complete listing of shareholdings, prepared in accordance with the Swedish Annual Accounts Act and filed with the Swedish Companies Registration Office (Bolagsverket), may be obtained upon request to: Telefonaktiebolaget LM Ericsson, External & Management Information, SE- Stockholm, Sweden. Shares owned directly by the Parent Company Type Company Reg. No. Domicile Percentage of ownership Par value in local currency, million Carrying value, SEK m. I I I II I I II II I I I II Subsidiary companies Ericsson AB I Ericsson Shared Services AB I Ericsson Shared Services Väst AB I Ericsson Business Innovation AB I Ericsson Enterprise AB I Ericsson Microwave Systems AB I Ericsson Sverige AB I SRA Communication AB II AB Aulis II LM Ericsson Holding AB II Ericsson Gämsta AB III Ericsson Treasury Services AB III Ericsson Credit AB III Ericsson Project Finance AB III Other (Sweden) Ericsson Austria GmbH Ericsson Danmark A/S Oy LM Ericsson Ab Ericsson Participations France SAS Ericsson GmbH Ericsson Hungary Ltd. LM Ericsson Holdings Ltd. Ericsson S.p.A. 1) Ericsson A/S Ericsson Corporatio AO Ericsson AG Ericsson Holding Ltd. Other (Europe, excluding Sweden) Ericsson Holding II Inc. Cía Ericsson S.A.C.I. Teleindustria Ericsson S.A. Other (United States, Latin America) Teleric Pty Ltd. Ericsson Ltd. Ericsson (China) Company Ltd. Nanjing Ericsson Panda Communication Co. Ltd. Ericsson India Private Ltd. Ericsson (Malaysia) Sdn. Bhd. Ericsson Telecommunications Pte. Ltd. Ericsson Taiwan Ltd. Ericsson (Thailand) Ltd. Other countries (the rest of the world) Total II I I I I I I I I II I I 556056-6258 556251-3266 556577-9799 556128-5924 556090-3212 556028-1627 556329-5657 556018-0191 556030-9899 556381-7666 556381-7609 556329-5673 556326-0552 556058-5936 Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Austria Denmark Finland France Germany Hungary Ireland Italy Norway Russia Switzerland United Kingdom United States Argentina Mexico Australia China China China India Malaysia Singapore Taiwan Thailand Joint ventures and associated companies I I Sony Ericsson Mobile Communications AB Ericsson Nikola Tesla d.d. Other Total 556615-6658 Sweden Croatia 100 100 100 100 100 100 100 100 100 100 100 100 100 100 – 100 100 100 100 100 100 100 72 2) 100 100 100 100 – 100 95 3) 100 – 100 100 100 25 4) 100 70 100 80 49 5) – 50 49 – 50 361 100 – 360 30 100 47 14 105 162 1 5 469 – 4 90 13 22 20 1,301 2 10 156 5 – 74 – – 5 n/a – 20 2 50 5 725 2 – 240 90 – – 50 196 – – 20,638 7,216 1,381 683 335 151 102 145 6 130 324 2 5 567 1,275 664 216 195 485 342 120 14 105 194 5 – 757 222 9,516 10 1,549 628 100 2 369 37 147 4 1 19 17 182 48,860 4,136 330 8 4,474 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 57 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 12 INVESTMENTS (CONTINUED) Shares owned by subsidiary companies Type Company Reg. No. Domicile Percentage of ownership Subsidiary companies I II III I I I II II I I I I I I I I I I I I I I I I Ericsson Network Technologies AB Ericsson Cables Holding AB AB LM Ericsson Finans Ericsson France SAS LM Ericsson Ltd. Ericsson Telecommunicazioni S.p.A. Ericsson Holding International B.V. Ericsson Nederland B.V. Ericsson Telecommunicatie B.V. Ericsson España S.A. Ericsson Telekomunikasyon A.S. Ericsson Ltd. Ericsson Canada Inc. Ericsson Inc. Ericsson NetQual Inc. Ericsson Wireless Communications Inc. Ericsson IP Infrastructure Inc. Ericsson Amplified Technologies Inc. Ericsson Telecommunicações S.A. Ericsson Servicos de Telecomunicações Ltda. Ericsson Telecom S.A. de C.V. Ericsson Australia Pty. Ltd. Nippon Ericsson K.K. Ericsson Consumer Products Asia Pacific Pte Ltd. Key to type of company I Manufacturing, distribution and development companies II Holding companies III Finance companies 556000-0365 556044-9489 556008-8550 Sweden Sweden Sweden France Ireland Italy The Netherlands The Netherlands The Netherlands Spain Turkey United Kingdom Canada United States United States United States United States United States Brazil Brazil Mexico Australia Japan Singapore 100 100 100 100 100 93 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 1) The subsidiary Ericsson S.p.A. is listed on the Milan stock exchange in Italy. Ericsson’s share of the market value as per December 31, 2004, was SEK 7,470 million. 2) Through subsidiary holdings, total holdings amount to 93% of Ericsson S.p.A. 3) Through subsidiary holdings, total holdings amount to 100% of Cia Ericsson S.A.C.I. 4) Through subsidiary holdings, total holdings amount to 51% of Nanjing Ericsson Panda Communication Co. Ltd. 5) Through subsidiary holdings, total holdings amount to 100% of Ericsson (Thailand) Ltd. 58 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 15 RECEIVABLES AND PAYABLES – SUBSIDIARY COMPANIES Parent Company Long-term Receivables 1) Financial receivables Current Receivables Commercial receivables Financial receivables Total Long-term Liabilities 1) Financial liabilities Current Liabilities Commercial liabilities Financial liabilities Total 2004 2003 48,535 34,046 874 1,478 14,793 21,357 15,667 22,835 33,840 31,911 85 89 77,515 57,517 77,600 57,606 1) Including non interest-bearing receivables and liabilities, net, amounting to SEK –21,940 million (SEK 15,317 million in 2003). Interest-free transactions involving current receivables and liabilities may also arise at times. 16 OTHER RECEIVABLES Consolidated Parent Company 2004 2003 2004 2003 Receivables from associated companies and joint ventures Prepaid expenses Accrued revenues Advance payments to suppliers Other 115 1,072 1,349 393 9,310 239 1,639 1,782 399 8,659 24 543 893 – 6,743 – 623 683 – 5,217 Total 12,239 12,718 8,203 6,523 13 INVENTORIES Consolidated Parent Company 2004 2003 2004 2003 Raw materials, components and consumables Manufacturing work in progress Finished products and goods for resale Contract work in progress Less advances from customers Inventories, net 5,557 4,332 232 245 3,720 7,278 –2,784 271 9,275 –3,158 14,003 10,965 – – 20 20 – 40 – – – 3 – 3 Reported amounts are net of obsolescence reserves by SEK , million (SEK , million ). Movements in obsolescence reserves Opening balance Additions Utilized Translation difference for the year Closing balance 3,658 533 –976 –69 3,146 Of the total obsolescence reserve, a large portion is due to slow- moving items related to phased-out products, where Ericsson still has contractual commitments to be able to supply spare parts during a number of years. To satisfy such commitments, some inventories are set aside when products with long life cycles in use are phased out. Of net inventories, SEK million are valued at net realizable value. Contract work in progress includes amounts related to construction type contracts as well as other contracts with ongoing work in progress. 14 ACCOUNTS RECEIVABLE – TRADE Consolidated Parent Company 2004 2003 2004 2003 Trade receivables excluding associated companies Provision for impairment of receivables Trade receivables, net Trade receivables from associated companies and joint ventures Total 33,906 33,725 444 347 –1,782 –2,051 32,124 31,674 –275 169 –275 72 520 212 32,644 31,886 25 194 12 84 Retention receivables recognized as revenues were SEK , million at December , (SEK , million in ). Days sales outstanding are in ( in ). In the Parent Company, allowances for doubtful accounts include amounts for estimated losses based on commercial risk evaluations. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 59 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 17 STOCKHOLDERS’ EQUITY Capital stock 2004 Capital stock at December , , consisted of the following: Dividend proposal The Board of Directors will propose to the Annual General Meeting a dividend of SEK , per share. Parent Company Number of shares Aggregate par value Class A shares (par value SEK 1.00) Class B shares (par value SEK 1.00) 1,308,779,918 14,823,478,760 16,132,258,678 1,309 14,823 16,132 Cumulative translation adjustments Opening balance Changes in cumulative translation adjustments Closing balance –5,395 –1,107 –6,502 The capital stock of the Company is divided into two classes: Class A shares (par value SEK .) and Class B shares (par value SEK .). Both classes have the same rights of participation in the net assets and earnings of the Company. Class A shares, however, are entitled to one vote per share while Class B shares are entitled to one tenth of one vote per share. In accordance with the decision by the extraordinary general meeting on August , , the process of changing the difference in voting rights between A and B shares has been finalized. As a result the number of A shares has increased, and the number of B shares has decreased, by ,, shares during . The total number of treasury shares at December , , is ,, (,, in ) Class B shares, corresponding to a negative amount in consolidated Non-restricted equity of SEK – million (SEK – million in ). The decrease in the number of treasury shares is due to delivery and sale of shares in relation to the Stock Purchase Plans and the Stock Option Plans. Changes in cumulative translation adjustments include changes regarding recalculation of goodwill in local currency of SEK – million (SEK – million in ), net gain/loss (–) from hedging of investments in foreign subsidiary companies of SEK – million (SEK , million in ) and SEK . million (SEK . million in ) of realized gains/losses (–), net from sold/liquidated companies. Currency gains/losses resulting from translation of financial statements of integrated companies are included in the following items in the consolidated income statement: Cost of sales Financial income Taxes Total Of which hedged 2004 –24 –11 – –35 35 2003 –68 –139 –4 –211 211 2002 –45 –198 3 –240 240 Changes in stockholders’ equity Consolidated 2004 January 1, 2004 Effect of changed accounting principle 1) Opening balance in accordance with new accounting principle Sale of own shares Stock purchase and stock option plans Transfer between non-restricted and restricted reserves Changes in cumulative translation adjustments due to changes in foreign currency exchange rates Adjustment of cost for stock issue 2002 Net income 2004 Capital stock 16,132 – 16,132 – – – – – – December 31, 2004 16,132 1) Restated due to change of accounting principle RR 29/IAS 19. Equity proportion reserve Other restricted reserves Total restricted equity 658 – 658 – – –51 – – – 607 39,640 – 39,640 – – 1,030 –1,107 – – 39,563 56,430 – 56,430 – – 979 –1,107 – – 56,302 Non- restricted equity 4,051 –1,275 2,776 15 159 –979 – 2 19,024 20,997 2) Total 60,481 –1,275 59,206 15 159 – –1,107 2 19,024 77,299 2) Of retained earnings, SEK 7 million will be appropriated to reserves not available for distribution, in accordance with the proposals of the respective companies’ boards of directors. In evaluating the consolidated financial position, it should be noted that earnings in foreign companies may be subject to taxation when transferred to Sweden and, in some instances, such transfers of earnings may be limited by currency restrictions. Consolidated unrestricted retained earnings are translated at the year-end exchange rate. Cumulative translation adjustments have been distributed among unrestricted and restricted stockholders’ equity. 60 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Total 73,607 158 –158 8 151 – 3 –2,444 –10,844 60,481 Total 68,587 28,940 12 2 – –4,921 –19,013 73,607 Total 61,257 15 27 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Consolidated 2003 January 1, 2003 Stock issue Repurchase of own stock Sale of own stock Stock purchase and stock option plans Transfer between non-restricted and restricted reserves Adjustment of accrued cost for stock issue 2002 Changes in cumulative translation adjustments Net income 2003 December 31, 2003 Consolidated 2002 January 1, 2002 Stock issue Stock purchase plan Sale of own stock Transfer between non-restricted and restricted reserves Changes in cumulative translation adjustments Net income 2002 December 31, 2002 Capital stock 15,974 158 – – – – – – – 16,132 Capital stock 8,066 7,908 – – – – – 15,974 Equity proportion reserve Other restricted reserves Total restricted equity Non- restricted equity 672 – – – – –14 – – – 658 39,278 – – – – 2,806 – –2,444 – 39,640 55,924 158 – – – 2,792 – –2,444 – 56,430 17,683 – –158 8 151 –2,792 3 – –10,844 4,051 Equity proportion reserve Other restricted reserves Total restricted equity Non- restricted equity 491 – – – 181 – – 672 29,102 21,032 – – –5,935 –4,921 – 39,278 37,659 28,940 – – –5,754 –4,921 – 55,924 30,928 – 12 2 5,754 – –19,013 17,683 Share Revalua- Capital stock premium reserve 1) tion Statutory reserve reserve Total restricted equity Disposi- tion reserve Other retained earnings Non- restricted equity Parent Company January 1, 2004 Sale of own stock Stock purchase and stock option plans Adjustment of accrued costs for stock issue 2002 Contributions from/to (–) subsidiary companies Tax on contributions Net income 2004 16,132 – – 24,729 – – – – – – 2 – – – 20 – – – – – – 6,741 – – 47,622 – – 100 – – 13,535 15 27 13,635 15 27 – – – – 2 – – – – – – – – – 2 –6,525 1,827 7,160 16,039 –6,525 1,827 7,160 –6,525 1,827 7,160 16,139 63,763 December 31, 2004 16,132 24,731 20 6,741 47,624 100 1) 1996 and prior years’ share premium are included in Statutory reserve. 18 UNTAXED RESERVES Parent Company Accumulated depreciation in excess of plan Intangible assets Tangible assets Total accumulated depreciation in excess of plan Other untaxed reserves Reserve for doubtful receivables Income deferral reserve Total other untaxed reserves Total untaxed reserves Jan. 1 Withdrawals Dec. 31 17 48 65 1,290 774 2,064 2,129 –1 –52 –53 –363 –774 –1,137 –1,190 16 –4 12 927 – 927 939 Swedish GAAP and tax regulations require a company to report certain differences between the tax basis and book value as an untaxed reserve in the balance sheet of the stand-alone financial statements. Changes to these reserves are reported as an addition to, or withdrawal from, untaxed reserves in the income statement. Changes in other untaxed reserves in the Parent Company in 2003 consisted of: withdrawals from reserve for doubtful receivables, SEK 0 million (SEK 1,977 million in 2002). Deferred tax liability on untaxed reserves, not accounted for in deferred taxes, amounts to SEK 263 million in 2004 (SEK 596 million in 2003 and SEK 585 million in 2002). E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 61 Financial Accounting Standards Council’s interpretations committee defined this plan as a multi-employer defined benefit plan. Ericsson did not have access to information from Alecta that would have made it possible for this plan to be reported as a benefit plan. Therefore, the plan has been reported for the fiscal year as a defined contribution plan. Ericsson has established a Swedish pension trust for the purpose of funding the pension liabilities under the Swedish ITP plan. Cash or cash equivalents of SEK , million were transferred into the trust in January . The main part of total provisions for pensions and similar benefits amounting to SEK , million, are attributable to the Swedish pension plans, of which SEK , million (SEK , million in ) are liabilities to Pensionsregistrerings- institutet (PRI). The Parent Company’s pension liabilities include an obligation in the amount of SEK million (SEK million in ) in accordance with an agreement with PRI. The following table summarizes the total pension cost for the Group: Total annual pension cost Pension cost for defined benefit plans Pension cost for post- employment medical benefits Pension cost for defined contributions plans Total Sweden UK US Other Total 686 71 –93 153 817 – 1,014 1,700 – – 46 –97 71 –144 – 46 183 336 1,100 1,963 The following tables disclose information about defined benefit plans for Ericsson and summarizes changes in the benefit obligation, the plan assets and the funded status of defined benefit plans and postretirement benefit plans as well as key assumptions. Annual pension cost DB-plans Service cost Interest cost Expected return on plan assets Amortization of unrecog- nized past service cost Curtailment cost Net pension cost for the period Sweden 306 380 UK 53 152 US Other Total 82 153 170 118 611 803 – – – –134 –108 –128 –370 – – – –173 6 –14 6 –187 686 71 –46 152 863 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 19 PENSIONS The Ericsson Group participates in local pension plans in countries in which we operate. There are principally two types of pension plans: • Defined contribution plans, where the Company’s only obligation is to pay fixed pension premiums into a separate entity (a fund or insurance company) on behalf of the employee. No provision for pensions is recognized in the balance sheet. • Defined benefit plans, where the Company’s undertaking is to provide pension benefits that the employees will receive on retirement, usually dependent on one or more factors such as age, years of service and compensation. Defined benefit plans may be funded or unfunded and can therefore be managed in two ways: – by setting up a trust to manage the company’s contributions to the plan, in which case the liability recognized in the balance sheet is the net of the benefit obligation and the fair value of plan assets – the total benefit obligation is recognized as a liability on the balance sheet with no assigned plan assets. This method is currently used in Sweden and subject to insurance with Försäkringsbolaget Pensionsgaranti (FPG), which is covered by Swedish law on safeguarding of pension commitments. Ericsson adopted RR Employee Benefits in . When applying RR , defined benefit plans in all the subsidiary companies within Ericsson are accounted for using the same actuarial method. In the financial reporting for Ericsson before , such plans have been recognized using local rules and principles in each country. The present value of the defined obligation for current and former employees is calculated using the Projected Credit Unit Method. The calculations are based upon actuarial assumptions and are prepared annually, as a minimum. The accounting for defined contribution plans has not been affected by the adoption of RR in . In the Ericsson Group, most companies have defined contribution plans and therefore no pension provisions on the balance sheet. In a dozen countries other than Sweden, the subsidiary companies have defined benefit plans with trust funds, and recognize the net of accumulated benefit obligations and plan assets as provisions. In Sweden, the total pension benefits are a mixed solution, with some parts being defined contribution plans and others defined benefit plans. Defined contribution plans are for example plans as death and disability. Some parts of early- retirement plans are also arranged as defined contribution plans. Defined benefit plans are for example the Swedish ITP (Industrins och handelns tilläggspension) pension plan. In the full liability is recognized on the balance sheet. The ITP plan includes a collective family pension, which Ericsson finances through insurance with Alecta. The Swedish 62 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Change in Defined Benefit Obligation, DBO DBO, beginning of the year Service cost Interest cost Employee contributions Pension payments Actuarial gain/loss (–/+) 1) Settlement cost Curtailment cost Other Translation difference for the year Sweden UK US Other Total 6,921 2,794 2,511 2,256 14,482 82 611 153 803 – 38 –189 –365 186 1,084 – –35 –173 –187 22 45 306 380 – –71 654 – – – 53 152 28 –45 87 – – – 170 118 10 –60 157 –35 –14 23 – –51 –230 –87 –368 DBO, end of the year 8,190 3,018 2,362 2,538 16,108 1) Actuarial gains and losses for each plan are recognized when the accumulated amount exceeds the corridor. The income or expenses are then recognized over the expected average remaining service period of the employees. The Group participates in a number of post-employment medical benefit schemes, principally in the U.S. The method of accounting, the assumptions and the frequency of valuations are similar to those used for defined benefit schemes. Post-employment medical benefit schemes are therefore included in the figures above. Change in Plan Assets Sweden UK US Other Total Fair value of Plan Assets beginning of the year Actual return on plan assets Employer contributions Employee contributions Pension payments by fund/ insurance company Settlement cost Other Translation difference for the year Fair value of Plan Assets, end of year – – – – – – – – – 1,846 1,361 125 203 – 164 57 28 2,059 227 158 10 –45 – – –132 – – –53 –32 50 5,266 516 418 38 –230 –32 50 –36 –140 –86 –262 2,014 1,417 2,333 5,764 Accrued/Prepaid pension cost Funded status of the plan Unrecognized actuarial gain/loss (–/+) Unrecognized past service cost Accrued/Prepaid pension cost (–/+) Sweden UK US Other Total –8,190 –1,004 –945 –205 –10,344 654 – 55 – 174 – 16 70 899 70 –7,536 –949 –771 –119 –9,375 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Amount recognized in the consolidated balance sheet Accrued/Prepaid pension cost (–/+) beginning of the year Annual pension cost Benefits paid directly by company Employer contributions Other Translation difference for the year Accrued/Prepaid pension cost (–/+), end of year Sweden UK US Other Total –6,921 –686 –949 –1,151 47 –71 –115 –9,136 –153 –863 71 – – – – 57 – 14 78 203 –22 7 158 –9 156 418 –31 74 –7 81 –7,536 –949 –771 –119 –9,375 The following table summarizes the total provisions for pensions for Ericsson. Provisions for pensions also include similar employee benefits. Provisions for pensions and similar benefits Provision for post- employment benefits Other employee benefits Total Sweden UK US Other Total 7,536 94 7,630 949 – 949 771 – 771 119 618 9,375 712 737 10,087 The principal actuarial assumptions used were as follows: (percent) Sweden UK US Other Discount rate Expected return on plan assets Future salary increases 5.0% 5.3% 6.0% 5.0%–6.5% 7.0% 8.0% 4.7%–7.0% 3.0% 4.0% 4.5% 3.0%–4.0% n/a E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 63 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 20 OTHER PROVISIONS Consolidated 2004 Opening balance Additions Costs incurred Reversal of excess amounts Reclassification Translation difference for the year Closing balance Consolidated 2003 Opening balance Additions Costs incurred Reversal of excess amounts Balances regarding acquired and sold companies Reclassification Translation difference for the year Closing balance Parent Company 2004 Opening balance Additions Costs incurred Reversal of excess amounts Closing balance Parent Company 2003 Opening balance Additions Costs incurred Closing balance Warranty commitments Restruc- turing Customer financing 4,736 4,202 –2,656 – 172 –30 6,424 9,115 661 –5,651 –274 –238 –15 3,598 296 228 –62 –191 – – 271 Warranty commitments Restruc- turing Customer financing 3,554 4,706 –3,105 –329 –3 40 –127 4,736 7,535 10,835 –9,146 –66 5 178 –226 9,115 178 198 –47 –21 – –8 –4 296 Warranty commitments Restruc- turing Customer financing – 1 – – 1 1,465 357 –588 –127 1,107 1,431 103 –593 –463 478 Warranty commitments Restruc- turing Customer financing – – – – 63 1,748 –346 1,465 2,228 660 –1,457 1,431 Other 13,454 7,971 –5,012 –1,867 341 –402 14,485 Other 8,579 13,030 –7,028 –884 –3 424 –664 13,454 Other 287 477 –155 – 609 Other 139 287 –139 287 Total other provisions 27,601 13,062 –13,381 –2,332 275 –447 24,778 Total other provisions 19,846 28,769 –19,326 –1,300 –1 634 –1,021 27,601 Total other provisions 3,183 938 –1,336 –590 2,195 Total other provisions 2,430 2,695 –1,942 3,183 Warranty commitments Warranty provisions include both provisions for faulty products and statistical errors. The best estimate is based on sales, contractual warranty periods and historical failure data of products sold. The actual utilization for was SEK . billion, compared to the expected SEK . billion. The expected utilization of warranty provisions during year is SEK . billion. Restructuring Restructuring provisions amounting to SEK . billion were utilized during compared to the expected SEK . billion. No further restructuring programs were initiated in . However, additional restructuring provisions related to the restructuring activities in amounted to SEK . billion and were charged to operations in . Remaining restructuring provisions are mostly related to unutilized leased real estate. The majority of these leases will expire in between one and five years, and the last one in year . The value of the real estate commitments are calculated based on the net present value of the future lease payments minus the forcasted sublease revenues. The expected utilization of restructuring provisions during is SEK billion. Customer financing Total provisions for off-balance sheet customer financing is the sum of all individual provisions for each risk. The individual provisions are based on a specific evaluation of each risk exposure. 64 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Other Other provisions include estimated obligations related to patent and other litigations, contractual discounts and penalties of uncertain timing or amount, provisions for potential supplier or subcontractor claims and/or disputes, as well as provisions for Income Tax and VAT/GST unresolved issues and estimated losses on construction-type contracts. The actual utilization for was SEK billion, compared to the expected SEK billion. This was due to that SEK billion were delayed and SEK billion were reversed. However, the reversals were almost fully offset by additions to provisions made in previous years. The expected utilization in is SEK billion. 21 INTEREST-BEARING PROVISIONS AND LIABILITIES Ericsson’s outstanding interest-bearing provisions and liabilities were SEK . billion as of December , . Interest-bearing provisions and liabilities Notes and bond loans Issued- mature 1999-2009 2001-2006 2001-2006 2001-2008 2001-2005 2001-2005 2001-2005 2001-2005 2003-2010 2004-2012 Total Book value Coupon Currency (SEK m.) Maturity date (YY-MM-DD) Nominal 483 15 6.500% FRN 1,000 1) 6.375% 226 1) 7.375% FRN 150 6.500% 215 6.400% 50 6.300% 236 471 2) 6.750% FRN 450 USD USD EUR GBP SEK SEK SEK SEK EUR SEK 3,193 99 8,996 2,869 150 215 50 236 4,237 450 20,495 09-05-20 06-03-15 06-05-31 08-06-05 05-07-12 05-08-08 05-08-22 05-08-24 10-11-28 12-12-07 1) The EUR 1000 million and GBP 226 million bonds have interest rates linked to the Company’s credit rating. The interest will increase/decrease 0.25 percent per annum for each rating notch change per rating agency (Moody’s and Standard & Poor’s). The interest rate applicable to these bonds can not be less than the initial interest rates in the loan agreements. 2) The EUR 471 million bond is callable after 2007. Current liabilities to financial institutions Current maturities of long term debt 1) Total current interest- bearing provisions and liabilities Notes and bond loans Liabilities to financial institutions Pensions 2) Total long-term interest- bearing provisions and liabilities Total interest-bearing provisions and liabilities Consolidated Parent Company 2004 2003 2004 2003 938 2,247 322 1,746 781 7,262 699 5,905 1,719 9,509 1,021 7,651 19,844 26,312 19,844 26,312 1,993 10,087 2,383 8,005 116 861 290 848 All outstanding notes and bond loans are issued by the Parent Company under its Euro Medium Term Note program. Bonds issued at fixed interest rate are swapped to floating interest rate using interest rate swaps, resulting in a weighted average interest rate of . percent at December , . In Ericsson redeemed and cancelled bond loans with a total nominal value of SEK . billion, generating a financial expense of SEK million. Notes and bond loans redeemed and cancelled during 2004 31,924 36,700 20,821 27,450 Bond 33,643 46,209 21,842 35,101 6.375% EMTN 31 May 2006 6.900% EMTN 18 July 2005 6.400% EMTN 22 August 2005 6.300% EMTN 24 August 2005 1) Including note and bond loans of SEK 651 million 2004 and SEK 5,856 million 2003. 2) Consolidated pensions are recognized according to IAS 19/RR 29. Redeemed Remaining & cancelled outstanding (nominal) (nominal) 566 300 300 64 1,000 – 50 236 Currency EUR m. SEK m. SEK m. SEK m. Liabilities to financial institutions, interest rate by currency Maturing >1<5 years Interest rate (%) Nominal Maturing >5 years Interest rate (%) Nominal 54 398 327 46 825 1.1% 2.7% 8.4% 0.0% – 122 111 930 5 1,168 0.8% 2.4% 7.8% 0.0% – EUR SEK USD Other currencies Total Current liabilities to financial institutions are mainly denominated in EUR, RMB and SEK and have a weighted average maturity of . years. Current maturities of long-term debt (excl. current maturities of notes and bond loans) are mainly denominated in CAD and EUR and have a weighted average maturity of . years. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 65 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 22 FINANCIAL RISK MANAGEMENT AND FINANCIAL INSTRUMENTS Financial Risk Management Ericsson’s financial risk management is governed by a policy approved by the Board of Directors. The Finance Committee of the Board of Directors is responsible for approving certain matters regarding investments, loans, guarantees and customer financing commitments and is continuously monitoring the exposure to financial risks. The Board of Directors has established risk limits for exposures to foreign exchange and interest rate risks. The market risk mandate of SEK million is based on a five percent change in foreign exchange rates and a one-percentage point change in interest rates of the total position. Ericsson has a treasury function with the principal role to ensure that appropriate financing is in place through loans and committed credit facilities, to actively manage the Group’s liquidity as well as financial assets and liabilities, and to manage and control financial risk exposures in a manner consistent with underlying business risks and financial policies. Hedging activities and cash management are, largely, centralized to the internal bank in Stockholm. Ericsson also has a customer finance function with the main objective to find suitable third-party financing solutions for customers and to minimize recourse to Ericsson. To the extent customer loans are not provided directly by banks, the consolidated subsidiary Ericsson Credit AB provides or guarantees vendor credits. The customer finance function monitors the exposure from outstanding vendor credits and credit commitments. Ericsson classifies financial risks as: • foreign exchange risk • interest rate risk • credit risk • liquidity and re-financing risk • market price risk in own and other listed equity instruments. Foreign exchange risk Ericsson has significant revenues, costs, assets and liabilities in currencies other than SEK, which result in a substantial foreign exchange rate exposure in the income statement, balance sheet and cash flows. When managing foreign exchange risk, Ericsson distinguishes between two types of exposure: transaction and translation exposure. Transaction exposure An analysis of Ericsson’s transaction exposures for shows the following net exposures by currency: Estimated net exposures by currency (SEK billion) USD and related currencies EUR GBP JPY 2004 38 9 2 1 A change in the exchange rate of +/– percent between SEK and USD, and related currencies, would have an annualized impact on the operating income by SEK . billion before tax any hedging effects. Foreign exchange risk is as far as possible carried by Swedish group companies. Sales to foreign subsidiary companies are normally made in their functional currency. In order to limit the exposure to exchange fluctuations on future revenue or expenditure, committed and forecasted future sales and purchases in major currencies were during hedged, on average, for the coming months. Trade receivables and payables in foreign currencies are generally fully hedged. Currency forward contracts are primarily used for hedging future revenues and expenditures. Such forward contracts are designated as cash flow hedges. Other foreign exchange exposures, arising from for example customer financing and having interest-bearing assets or liabilities in foreign currencies, are hedged through offsetting balances or derivatives. During , due to the stronger SEK, primarily vs. USD and related currencies such as SAR and RMB, foreign exchange losses of SEK . billion net were recognized, after hedging effects. As of December , , outstanding foreign exchange derivatives, hedging transaction exposures, had a net positive market value of SEK . (.) billion. The positive market value corresponds to net losses on underlying future sales and purchases, at year-end exchange rates, compared to the exchange rates prevailing when the commitments and forecasts were made. Subject to further changes in exchange rates, these derivatives will affect the income statement during when the underlying transactions occur. Translation exposure Ericsson has many subsidiary companies operating outside Sweden. The net results in foreign subsidiary companies and the value of such foreign investments are exposed to exchange rate fluctuations, which affect the consolidated income statement and balance sheet when translated to SEK. 66 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Translation exposure in foreign subsidiary companies is hedged according to the following policy established by the Board of Directors: • Net monetary assets in companies translated using the temporal method, for which translation effects in investments affect the income statement, is fully hedged. Foreign exchange losses were SEK million net, which was fully offset by hedging gains. • Equity in companies translated using the current method, for which translation effects are reported directly in stockholders’ equity is hedged up to percent in selected companies. The translation differences reported in equity during were negative, SEK . billion, including hedging losses of SEK million. Interest Rate Risk Ericsson is exposed to interest rate risk through market value fluctuations in certain balance sheet items and through changes in interest expenses and revenues. The net cash position was SEK . (.) billion at the end of , consisting of cash and bank, and short-term cash investments of SEK . (.) billion and interest-bearing provisions and liabilities of SEK . (.) billion. Outstanding customer financing credits, net of provisions, were SEK . (.) billion. Ericsson’s aim is to avoid risk in the form of (i) a mismatch between fixed and floating interest rates in interest-bearing balance sheet items and (ii) significant fixed interest rate exposure in Ericsson’s net cash position. As of December , , () percent of Ericsson’s interest-bearing provisions and liabilities and () percent of Ericsson’s interest-bearing assets had floating interest rates, i.e. interest periods of less than months. When managing the interest rate exposure Ericsson uses derivative instruments, such as interest rate swaps. Ericsson’s interest net and cash flows are exposed to interest rate fluctuations. A sustained change in interest rates of +/– . percentage points would, with the current net cash position, have an annual impact on the interest net of SEK million. Credit Risk Credit risk is divided into three categories: credit risk in trade receivables, customer finance risk and financial credit risk. Credit risk in trade receivables Trade receivables amounted to SEK . (.) billion as of December , . Provisions for expected losses are regularly assessed and amounted to SEK . (.) billion as of December , . Ericsson’s credit losses have, however, historically been low. The amounts of trade receivables follow closely the distribution of Ericsson’s sales and do not include any major concentrations of credit risk by customer or by geography. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Customer finance risk We have credit approval procedures where all major customer finance contracts are subject to approval by the Finance Committee of the Board of Directors. As of December , , Ericsson’s total outstanding exposure relating to customer finance credits was SEK . (.) billion. As of that date, Ericsson also had unutilized credit commitments of SEK . (.) billion. The outstanding customer loans and financial guarantees relate to infrastructure projects in different geographic markets and to a large number of customers. As of December , , of a total of customer loans originated by or guaranteed by Ericsson, the six largest customer finance arrangements represented percent of the total credit exposure. Security arrangements for customer credits normally include pledges of equipment, pledges of certain of the borrowers assets and, occaisionally, pledges of shares in the operating company. Restructuring efforts for cases of troubled debt may lead to temporary holdings of such equity interests. The table below summarizes Ericsson’s outstanding customer finance credits as of December , –. Outstanding customer finance credits (SEK billion) 2004 2003 2002 On-balance sheet credits Off-balance sheet credits Total credits Accrued interest Less third-party risk coverage Ericsson’s risk exposure On-balance sheet credits, net value Reclassifications 1) On-balance sheet credits, net book value Credit commitments for customer financing 8.4 0.6 9.0 0.2 –0.3 8.9 3.7 –0.1 10.6 2.0 12.6 0.1 –0.4 12.3 4.0 – 21.1 1.5 22.6 0.2 –1.0 21.8 14.0 – 3.6 4.0 14.0 2.2 6.1 14.0 1) Reclassification due to consolidation in accordance with URA 20. Of Ericsson’s total outstanding customer finance credit exposure as of December , , percent related to Latin America, percent to Western Europe, percent to Eastern Europe, Middle East & Africa, percent to North America and percent to Asia Pacific. As of December , , percent of Ericsson’s total outstanding customer finance was in respect of G networks and the remainder was in respect of G and .G networks. The net effect of risk provisions and credit losses for customer financing affecting operating expenses amounted to SEK . billion in , SEK . billion in and SEK . billion in . In , and , Ericsson incurred credit losses of SEK . billion, SEK . billion and SEK . billion respectively. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 67 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Financial credit risk Financial instruments carry an element of risk in that counterparts may be unable to fulfill their payment obligations. This exposure arises in the investments of cash and cash equivalents and from derivative positions with positive unrealized result against banks and other counterparties. Ericsson mitigates these risks by investing cash primarily in well rated commercial papers, treasury bills and floating rate notes with short-term ratings of at least A-/P- and long-term ratings of at least A-/A and in liquidity funds holding a rating of at least A. Separate credit limits are assigned to each counterpart in order to minimize risk concentration. All derivative transactions are covered by ISDA netting agreements to reduce the credit risk. No credit losses were incurred during , neither on external investments nor on derivative positions. Liquidity Risk Liquidity risk is that Ericsson is unable to meet its short-term payment obligations due to insufficient or illiquid cash reserves. Re-financing risk Re-financing risk is the risk that Ericsson is unable to refinance outstanding debt at reasonable terms and conditions, or at all, at a given point in time. Repayment schedule of long-term debt Current maturities of long term debt Notes and bonds (non-current) Liabilities to financial institutions (non-current) 0.8 – – – – – 0.8 – 9.1 – 2.8 3.2 4.7 19.8 – 0.3 0.2 0.1 0.2 1.2 2.0 Total 0.8 9.4 0.2 2.9 3.4 5.9 22.6 (SEK billion) 2005 2006 2007 2008 2009 2010+ Total Debt financing is mainly carried out through borrowing in the Swedish and international debt capital markets. Bank financing is used for certain subsidiary funding and to obtain committed credit facilities. Ericsson maintains sufficient liquidity through centralized Funding programs Parent Company Euro Medium Term Note program (USD m.) Euro Commercial Paper program (USD m.) 1) Swedish Commercial Paper program (SEK m.) Long-term Committed Credit facility (USD m.) Shot-term Committed Credit facilities (SEK m.) Other Group Companies Short-term Committed Credit facilities (SEK m.) Amount Utilized Unutilized 5,000 2,366 2,634 1,500 5,000 1,000 170 – – – – – – 1,500 5,000 1,000 170 – 1) Currently unavailable due to sub-investment grade rating. The USD billion committed credit facility has interest rates linked to our credit rating as well as certain financial covenants. As of December , , Ericsson fulfilled these covenants. The USD . billion committed credit facility was cancelled by Ericsson in December . In August, , Moody’s upgraded Ericsson’s long-term credit rating to Ba with a positive outlook. In November, , Standard & Poor’s upgraded Ericsson’s long-term credit rating to BB+ and changed the outlook to positive. Ericsson’s current ratings are sub-investment grade. cash management, investments in highly liquid interest- bearing securities, and by having sufficient committed credit lines in place to meet potential funding needs. The current cash position is deemed to satisfy all short-term liquidity requirements. During , cash and bank, and cash investments increased by SEK . billion to SEK . billion mainly due to positive cash flow, which was partly offset by repayment of long-term debt and repurchase of outstanding bonds. Cash and Cash Equivalents Remaining time to maturity < 3 months < 1 > 5 1–5 year years years 2004 2003 – – – – – – – – – 4.0 4.1 9.6 8.8 37.2 8.4 3.7 71.7 12.2 7.6 28.7 7.4 8.4 68.4 4.9 4.8 76.6 73.2 (SEK billion) Parent Company Bank deposits Type of issuer/counterpart Governments Banks Corporations Mortgage institutes Liquidity funds 4.0 4.0 – 3.5 1.4 9.5 4.7 29.8 35.8 4.7 3.7 1.0 3.7 0.1 4.1 1.4 3.7 – 9.3 Total Parent Company 43.4 62.4 Other Group companies (mainly bank deposits) Total Group 4.7 4.9 – 48.1 67.3 9.3 68 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Financial instruments excluded from the tables, such as trade receivables and payables are carried at fair value. When a market price is not readily available and there is insignificant interest rate exposure affecting the value, the carrying value is considered to represent a reasonable estimate of a fair value. Market Price Risk in Own Shares and Other Listed Equity Investments Risk related to our own share price Ericsson is exposed to the development of its own share price through stock option and stock purchase plans for employees. The obligation to deliver shares under these plans is covered by holding Ericsson Class B shares as treasury stock and warrants for issuance of new Ericsson Class B shares. An increase in the share price will result in social security charges, which represents a risk to both income and cash flow. The income statement exposure in one of the option programs is hedged through the purchase of call options. The cash flow exposure is fully hedged through the holding of Ericsson Class B shares in treasury to be sold to generate funds to cover also social security payments, and through the purchase of call options on Ericsson Class B shares. Risk related to the prices of listed equity investments Through investments in equity of listed companies Ericsson is exposed to market value fluctuations of such instruments. Such investments, however, constitute a very limited part of Ericsson’s financial assets and the exposure is deemed insignificant. Financial Instruments Carried at other than Fair Value In the following tables, carrying amounts and fair values of financial instruments, that are carried in the financial statements at other than fair values, are presented. For valuation principles, please see Notes to the Financial Statements – Note 1, “Accounting policies”. Financial Instruments Carried at other than Fair Value Consolidated (SEK billion) Cash and Bank, and Cash Investments Current maturities of long term debt Notes and bonds Parent Company (SEK billion) Cash and Bank, and Cash Investments Current maturities of long term debt Notes and bonds Carrying amount Fair value 2004 2003 2004 2003 76.6 76.6 0.8 19.8 20.6 73.2 73.2 7.3 26.3 33.6 76.6 76.6 0.8 21.6 22.4 73.5 73.5 7.3 27.6 34.9 Carrying amount Fair value 2004 2003 2004 2003 71.7 71.7 0.7 19.8 20.5 68.4 68.4 7.2 26.3 33.5 71.7 71.7 0.7 21.6 22.3 68.8 68.8 7.3 27.6 34.9 Carrying amounts and fair values of derivatives Consolidated (SEK billion) Carrying Fair value amount Positive Negative Net Forward foreign exchange contracts Other financial foreign exchange derivatives Interest rate swaps Other financial interest rate derivatives Total 2.3 0.1 0.6 0.0 3.0 6.3 0.1 1.5 0.0 7.9 2.4 3.9 0.0 0.0 0.0 2.4 0.1 1.5 0.0 5.5 Parent Company (SEK billion) Carrying Fair value amount Positive Negative Net Forward foreign exchange contracts Other financial foreign exchange derivatives Interest rate swaps Other financial interest rate derivatives Total 3.9 0.1 0.6 0.0 4.6 6.3 0.1 1.5 0.0 7.9 2.4 3.9 0.0 0.0 0.0 2.4 0.1 1.5 0.0 5.5 Only external derivatives are included in the tables. internal derivatives are reported as current financial receivables or liabilities in Note 15, Receivables and payables – subsidiary companies. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 69 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 23 OTHER CURRENT LIABILITIES 26 CONTINGENT LIABILITIES Consolidated Parent Company 2003 1) 2004 2004 2003 Consolidated Parent Company 2004 2003 2004 2003 Liabilities to associated companies Accrued interest Accrued expenses of which employee related of which supplier invoices not received other accrued expenses Deferred revenues Other current liabilities 7 846 18,292 6,224 5 1,302 20,336 2) – 7,834 4,234 2,929 5,848 – – 1,377 7,088 7 798 410 203 – 207 254 1,761 6 1,198 470 197 – 273 290 8,084 Total 27,922 30,108 3,230 10,048 1) Other short-term liabilities for the Parent company include liabilities to subsidiary companies of SEK 7,071 million in 2003. 2) Figures for 2003 are not available, however, a large part of accrued expenses are employee related. 24 ACCOUNTS AND NOTES PAYABLE – TRADE Consolidated Parent Company 2004 2003 2004 2003 Accounts and notes payable excluding associated companies and joint ventures Payables to associated companies and joint ventures Total 10,935 8,420 175 230 53 475 10,988 8,895 – 175 – 230 25 ASSETS PLEDGED AS COLLATERAL Consolidated Parent Company 2004 2003 2004 2003 Real estate mortgages Chattel mortgages Bank deposits Total – 7,209 776 7,985 49 6,960 1,014 8,023 – 460 347 807 – 460 238 698 Chattel mortgages are collaterals for the Swedish Ericsson companies’ pension commitments. Bank deposits are collaterals related to legal disputes of SEK million in (SEK million in ) and collateral for subsidiary financing SEK million in (SEK million in ). Of the Parent Company’s assets pledged as collateral, the chattel mortgage is collateral for pension commitments. The major item in bank deposits is for the internal bank’s (Ericsson Treasury Services Aktiebolag) clearing and settlement commitments SEK million in (SEK million in ). 70 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Guarantees for customer financing Other contingent liabilities 348 666 Total 1,014 1,667 1,024 2,691 64 6,961 1,524 8,993 7,025 10,517 Guarantees for customer financing relate to such arrangements, where Ericsson is the guarantor for customers’ payment obligations under credit facilities. A lender under these credit facilities is normally a bank, which thus is the beneficiary of the Ericsson guarantee, covering the entire or part of the outstanding principal amount and accrued interest. The guarantees for customer finance are shown above at their net value (i.e. after provisions). Other contingent liabilities assumed by Ericsson include guarantees of loans to other companies SEK million in ( in ). Other contingent liabilities assumed by the Parent Company include pension commitments SEK , million in (SEK , million in ), and subsidiary companies borrowing from financial institutions SEK million in (SEK , million in ). In accordance with standard industry practice, Ericsson enters into Commercial Contract Guarantees related to contracts for the supply of telecommunication equipment and services. Total amount for was SEK , million (SEK , million in ). Potential payments due under these bonds are related to Ericsson’s performance under applicable contracts. Of the outstanding are SEK million issued to guarantee the performance of a third party. 27 STATEMENT OF CASH FLOWS Consolidated Interest paid in was SEK , million (SEK , million in , SEK , million in ) and interest received was SEK , million (SEK , million in , SEK , million in ). Income taxes paid were SEK , million (SEK million in , SEK , million in ). Included in Other non-cash items under “Adjustments to reconcile net income to cash” are undistributed earnings of associated companies and joint ventures and minority interest in net income. A non-cash transaction under “Cash flow from operating activities” is the net increase in pension liabilities with a positive effect of SEK million (SEK million in , SEK million in ). For more information regarding the disposition of cash and cash equivalents and unutilized credit commitments, see Note – “Financial Risk Management and Financial Instruments”. Cash restricted due to currency restrictions or other legal restrictions in certain countries amounts to SEK , million (SEK , million in ) . Acquisitions/sales of shares and other investments Consolidated 2004 2003 Purchase price for acquired subsidiary companies Other acquisitions/capital contributions Sales Acquisitions/sales, net –39 –1,739 229 –1,549 – –1,432 614 –818 The purchase consideration in cash or cash equivalents for other acquisition was SEK ‒, million (SEK , million in ). Of the consideration received for disposals SEK million (SEK million in ) were in the form of cash or cash equivalents. The cash or cash equivalents in the balance sheets of sold subsidiary companies were SEK million (SEK million in ). Further, the cash and cash equivalents in the balance sheets of acquired subsidiary companies were SEK million (no cash and cash equivalents were acquired in ). Line item “Depreciation, amortization and write-downs of tangible, intangible and other operating long-term receivables” in the Consolidated Statement of Cash Flow includes a write-down of SEK million in related to other operating long-term receivables. No write-downs were recognized in in regard to operating long-term receivables. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S SEK , million in ). Income taxes paid were SEK million (SEK million in , SEK million in ). Major non-cash items in Investments are: Acquisitions/sales of other investments, net, SEK , million in , SEK , million in . 28 LEASING Leasing obligations Assets under financial leases, recorded as tangible assets, consist of: Financial leases Acquisition costs Land and buildings Machinery Other equipment Accumulated depreciation/write-downs Land and buildings Machinery Other equipment 2004 2003 1,459 – 3 1,462 –269 – –1 –270 1,687 – 1 1,688 –500 – – –500 Net carrying value 1,192 1,188 As of December , , future minimum lease payment obligations for leases were distributed as follows: Consolidated Tangible assets Other fixed assets Current assets Cash Total assets Pensions and other provisions Long-term liabilities Current liabilities Total liabilities Acquired subsidiary companies Sold subsidiary companies 149 167 625 33 974 – 279 600 879 – 166 10 10 186 – 128 3 131 Consolidated 2005 2006 2007 2008 2009 2010 and later Total Future finance charges 1) Present value of finance lease liabilities Financial Operating leases leases 272 244 210 193 147 1,661 2,727 –1,056 2,337 1,976 1,607 1,394 1,213 3,819 12,346 – 1,671 12,346 The Group acquired Audiolog, a small French company specializing in system integration in the area of network management. In addition, we acquired Enditel, a major service supplier to Spanish network operators and enterprises to support and manage service contract in Spain. The aquired assets and liabilities from these acquisitions comprise the major part of the amounts shown in the above table. During the year, Ericsson increased its ownership in the Italian subsidiary company Ericsson S.p.A, listed on the Milan stock exchange, by . percent through a public offer. The Group’s total ownership as of December , was . percent. Parent Company Interest paid in was SEK , million (SEK , million in , SEK , million in ) and interest received was SEK , million (SEK , million in , 1) Average effective interest rate on lease payables is 7,36 percent. Expenses in for leasing of assets were SEK , million (SEK , million in and SEK , million in ), of which variable expenses were SEK million (SEK million in and SEK million in ). Most of the Company’s lease agreements contain no contingent payables. In the few cases they occur it relates to payables for heating, linked to the oil price index. Most of the leases of facilities contain terms of renewal giving the right to prolong the agreement in question for a predefined period of time. All of the financial leases of facilities contain purchase options. Only a very limited number of the Company’s lease agreements contain restrictions on stockholders’ equity or other means of finance, the major agreement contains a restriction stating that the Parent Company must maintain a stockholders’ equity of at least SEK billion. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 71 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S At December , , future payment obligations for leases 29 TAX ASSESSMENT VALUES IN SWEDEN for the Parent Company were distributed as follows: Parent Company 2005 2006 2007 2008 2009 2010 and later Financial leases Operating leases Land and land improvements Buildings Total – – – – – – – 1,499 1,362 1,123 960 809 2,213 7,966 Consolidated Parent Company 2004 2003 2004 2003 60 235 295 70 247 317 11 – 11 7 – 7 30 SPECIAL INFORMATION REGARDING THE PARENT COMPANY Sales of the Parent Company in were SEK , million (SEK , million in ). Exports accounted for percent in ( percent in ). No consolidated companies were customers of the Parent Company’s sales in or , while percent ( percent in ) of the Company’s total purchases of goods and services were from such companies. The Parent Company has guaranteed up to SEK . million for loans obtained by employees. 31 INFORMATION REGARDING EMPLOYEES, MEMBERS OF THE BOARD OF DIRECTORS AND MANAGEMENT Average number of employees Consolidated Men Women 2004 Total Men Women 2003 Total Western Europe 1) 2) 24,764 Eastern Europe, Middle East and Africa 2) North America Latin America Asia Pacific 2,291 3,406 2,015 6,624 7,978 32,742 29,300 9,851 39,151 733 1,116 469 2,346 3,024 4,522 2,484 8,970 2,482 3,855 2,128 4,514 844 1,370 522 2,316 3,326 5,225 2,650 6,830 Total 39,100 12,642 51,742 42,279 14,903 57,182 1) Of which Sweden 15,048 2) Of which EU 25,039 5,384 20,432 19,182 7,057 26,239 8,118 33,157 29,517 10,054 39,571 Within the group of the 150 most senior executives the distribution between females and males is 13 percent and 87 percent respectively. Parent Company Men Women 2004 Total Men Women 196 170 366 259 251 2003 Total 510 – – – – – – – 82 68 42 38 27 55 312 Western Europe 1) 2) Eastern Europe, Middle East and Africa Latin America Total 1) Of which Sweden 2) Of which EU 492 – 688 196 196 21 – 191 170 170 513 – 879 366 366 697 18 974 259 259 33 6 730 24 290 1,264 251 251 510 510 Leasing income Leasing income mainly relates to income from sublease of property. Some consolidated companies also lease equipment, mainly telephone exchanges, to customers. These leasing contracts vary in length from to years. At December , , future minimum payment receivables were distributed as follows: Consolidated 2005 2006 2007 2008 2009 2010 and later Total Unearned financial income 1) Uncollectible lease payments Net investments in financial leases Sales-type and Operating leases Financial leases 2 2 2 2 – – 8 –1 –7 2) – 163 136 75 63 47 73 557 N/A N/A N/A 1) Effective interest rate on lease receivables is 5.00 percent. 2) Equipment leased to customers reflected on the balance sheet as customer financing. Leasing income in was SEK million (SEK million in and SEK million in ). Sales-type and Operating leases Financial leases Parent Company 2005 2006 2007 2008 2009 2010 and later The Parent Company’s operating lease income is mainly income from sublease of property. 72 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Number of employees, consolidated Employees by region As per December 31, 2002 2003 2004 Western Europe 1) 2) Eastern Europe, Middle East and Africa 2) North America Latin America Asia Pacific 32,930 3,423 4,139 2,549 7,493 36,227 2,152 4,460 2,276 6,468 45,251 2,449 6,328 2,822 7,771 Total 1) Of which Sweden 2) Of which EU Employees per segment Systems Other operations Unallocated Total 50,534 51,583 64,621 21,296 33,625 24,408 36,608 30,241 45,590 As per December 31, 2002 2003 2004 45,500 5,034 – 45,176 6,110 297 51,390 12,846 385 50,534 51,583 64,621 The majority of our employees in Sweden belong to the following trade unions: Sif (the Swedish Union of Salaried Employees), the Swedish Association of Graduate Engineers, the Swedish Union of Industrial Supervisors and the Swedish Metal Worker’s Union. Many of our employees located outside Sweden, in particular those located in other European countries, also belong to trade unions. Central and industry- wide agreements on wages and salaries in Sweden were renegotiated in March for a period of three years. Ericsson believes that our relations with these unions and our employees in general are good. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Absence due to illness Parent Company (percent of working hours) Absence due to illness for men Absence due to illness for women Employees up to 30 years old Employees 30–49 years old Employees 50 years or older 2004 2003 1% 2% –% 1% 1% 1% 2% –% 1% 3% Long-term absence due to illness 1) 0.4% 0.3% 1) Defined as absence during a consecutive period of time of 60 days or more. Remuneration Wages and salaries and social security expenses Consolidated Parent Company 2004 2003 2004 2003 Wages and salaries Social security expenses Of which pension costs 23,858 8,498 1,181 24,829 11,435 967 453 311 214 769 656 521 Wages and salaries per geographical area Consolidated Parent Company 2004 2003 2004 2003 Western Europe 1) 2) Eastern Europe, Middle East and Africa 2) North America 3) Latin America Asia Pacific Total 16,231 17,297 854 3,158 784 2,831 879 3,718 861 2,074 23,858 24,829 314 139 – – – 453 533 224 – 12 – 769 1) Of which Sweden 533 2) Of which EU 533 3) Of which United States – Remuneration in foreign currency has been translated to at average exchange rates for the year. 9,923 16,095 1,926 11,206 17,140 2,702 314 314 – E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 73 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Compensation policies and remuneration to the Board of Directors, the President and CEO and the Group Management The following information covers the remuneration for the Board of Directors, the President and CEO and the Group Management as required by applicable laws, rules and recommendations. Members of the Board of Directors Board member fee Com- mittee fee Emp- loyee repre- senta- tive (SEK) Gender male 2,500,000 200,000 male 500,000 100,000 male female 500,000 500,000 100,000 100,000 female 500,000 100,000 male 500,000 200,000 male 500,000 300,000 male 500,000 200,000 Board member Michael Treschow Arne Mårtensson Marcus Wallenberg Lena Torell Nancy McKinstry Peter L. Bonfield Sverker Martin-Löf Eckhard Pfeiffer Carl-Henric Svanberg Monica Bergström Göran Engström Anna Guldstrand Jan Hedlund Per Lindh Arne Löfving Torbjörn Nyman Åke Svenmarck Total male female male female male male male male male – – – – – – – – – – – 9,000 9,000 – 3,000 3,000 700 700 – 6,000 9,000 9,000 – 9,000 6,000 9,700 9,700 9,000 500 6,000 6,500 200 4,000 4,200 6,000,000 1,302,100 55,000 7,357,100 Social security fees Total 2,405,772 9,762,872 Comments to the table • The Chairman of the Board received a Board fee of SEK ,,. The Chairman also received SEK , for each Board committee he was serving on. • The other Directors appointed by the Annual General Meeting received a fee of SEK , each. In addition, each Director serving on a Board committee has received a fee of SEK , for each committee. However, the Chairman of the Audit Committee received a fee of SEK , and the other two members of the Audit Committee received a fee of SEK , each. • Members of the Board, who are not employees of the 74 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Company, have not received any compensation other than the fees paid for Board duties. • Members and Deputy Members of the Board who are Ericsson employees received no remuneration or benefits other than their entitlements as employees. However, a fee of SEK , per attended meeting was paid to each employee representative on the Board. Further, employee representatives being also members of a committee of the Board received a fee of SEK for each committee meeting. The President and CEO and the Group Management Total Salary and benefits (SEK) The The Group President Management Total 2,700,000 600,000 600,000 600,000 600,000 700,000 800,000 700,000 Salary Variable pay earned 2003 and paid 2004 Other benefits 12,683,945 42,381,231 55,065,176 9,600,000 22,540,897 14,846,614 43,818 32,140,897 14,890,432 Total received 22,327,763 79,768,742 102,096,505 Provisions for variable pay earned 2004 to be paid 2005 7,560,000 19,038,156 26,598,156 Pensions and social security fees (SEK) The The Group President Management Total Pension premiums Social security fees 5,850,000 8,034,955 20,491,000 29,238,248 26,341,000 37,273,202 – Total pension and social security fees 13,884,955 49,729,248 63,614,202 – – – – – – – – – Comments to the tables • The Group Management included the following persons: Karl-Henrik Sundström, Carl Olof Blomqvist, Marita Hellberg, Torbjörn Nilsson, Bert Nordberg, Henry Sténson, Joakim Westh (from December , ), Håkan Eriksson, Mats Granryd, Kurt Jofs, Björn Olsson and Hans Vestberg. During the year, the Group Management also included Per- Arne Sandström (until July , ) and Per Tjernberg (until October , ), who are included in the table above. • For Per-Arne Sandström and Per Tjernberg Other benefits include severance pay of totally SEK ,,. As no other component of other benefits was significant, these are not reported separately. • For the President and CEO, the above pension premium includes a fee of SEK ,,, corresponding to percent of his pensionable salary above base amounts, for a premium based old age pension. • Included in Pension premiums are changes of commitments made to the President and CEO and the Group Management for benefit based temporary disability and survival’s pensions until retirement age. The Company’s commitments per December , , under IAS /RR amounted to SEK ,, for the President and CEO and SEK ,, for the Group Management. Notice and severance pay For the President and CEO and the current Group Management the following applies: The mutual notice period is months. Upon termination of employment by the Company, severance pay amounting to a maximum of months fixed salary is paid. Notice of termination given by the employee due to significant structural changes or other events occurred that, in a determining manner, affect the content of work or the condition for the position, is equated with notice of termination served by the company. The severance pay is reduced by percent of the salary or corresponding compensation which the employee would be entitled to from another employer or from own or other business during the period severance is paid from Ericsson. Compensation overview No major shifts in compensation policy were made during . While the Remuneration Committee continues to be mindful of the debates around the world on pay and benefits to executives, it is confident that current policies and practices at Ericsson are fair to all stakeholders and under proper control. As the results at Ericsson improve and the telecom sector as a whole rebounds from recession, the Remuneration Committee will track carefully recruitment and retention trends to ensure that compensation remains competitive. Fixed salary Ericsson continues to track fixed salary at around the median of relevant local markets for senior executives while maintaining a balancing interest in international pay levels in the industry. The applied level is set using comparative salary survey data from several recognized independent consultants both in local markets and internationally. Actual increases for individuals are based on a combination of market movement, performance and potential. Variable pay From Ericsson reduced the proportion of variable pay for the most senior executives in Sweden from a maximum of percent to percent of the fixed salary. This was to reflect the practices within the Swedish market. Nevertheless Ericsson remains committed to the principles of performance based pay for meeting set targets. And, together with the fixed salary, the total target pay to senior executives (fixed plus target variable) should be around the upper quartile of the target pay market for talent. In , the variable target level for the Group Management, including the President and CEO, was percent with a maximum of percent. Targets themselves varied for each individual but consisted of a range of financial and operational measures. All were quantifiable and linked directly to the overall business plan of the Company as approved by the Ericsson Board. Since was a year with a strong growth in N O T E S T O T H E F I N A N C I A L S T A T E M E N T S most cases targets, particularly financial ones, were exceeded. Long-term incentive At the Annual general Meeting in a new long-term incentive plan was approved and which is based on the existing all employee stock purchase plan. The new scheme requires participants to invest in Ericsson shares up to a maximum of . percent of gross salary, hold the shares for three years and remain with the Company during that time. At the end of three years each share purchased will be matched by the Company with up to six additional ones for the most senior executives, including the President and CEO and the Group Management Team, and up to additional ones for up to executives. These additional shares are not guaranteed. Certain earnings growth targets must be met over the years to determine the exact match and the Board retains the right to intervene if rewards from the scheme are likely to be disproportionate to the underlying results of the business. This scheme was launched mid year and take up has been very encouraging. By choosing to invest their own money up front the senior management is demonstrating its confidence in the future prospects of Ericsson. Pension Ericsson’s policy regarding pension is to follow the competitive practice in the home country. For the President and CEO and the Group Management a premium based plan is applied. The pensionable salary consists of the annual fixed salary and the target level of the variable pay. For old age pensions, the company pays on salary portions in excess of base amounts a percentage of the executive’s pensionable salary, between and percent per year. For the Group Management, the pension age is normally years and premiums are paid up to the retirement age. From years, the old age pension includes the ITP plan. The President and CEO is included in the ITP plan. According to the premium based plan, Ericsson pays for the President and CEO an annual pension contribution of percent of the pensionable salary above base amounts. The President and CEO has the right to retire at years of age. Benefits As with pensions, Ericsson follows the competitive practice of the home country with respect to benefits. Plan designs vary widely around the world according to the taxation and legal framework in different countries. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 75 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Employee Share Ownership Stock Incentive Plans Stock Purchase Plans Under the Stock Purchase Plans, employees can save up to . percent of the gross salary, for purchase of B shares at Stock- holmsbörsen or ADRs at Nasdaq (contribution shares). If the purchased contribution shares are retained by the employee for three years after the investment and employment with the Ericsson Group continues during that time, the employee will be matched with a corresponding number of B shares or ADRs free of consideration. Employees in countries participate in the plan. The below table shows the periods for employees’ purchase of shares (contribution period) and participation details. Plan Contribution period Number of participants at launch Take-up rate - % of all employees Stock Purchase Plan 2001 Stock Purchase plan 2003 1st year Stock Purchase plan 2003 2nd year February 2002 – October 2002 August 2003 – July 2004 August 2004 – July 2005 27,000 11,000 15,000 36 % 22 % 30 % Enhanced Stock Purchase Plan - LTI 2004 In August , two enhanced programs under the Stock Purchase Plan, the Key Contributor Program and the Performance Matching Program were launched for the second -month investment period of the Stock Purchase Plan . Under the Key Contributor Program, , employees were offered to obtain one extra matching share in addition to the ordinary one matching share for each contribution share purchased during the period. Under the Performance Matching Program ( + ) executives were offered to obtain up to four or six extra shares (performance matching shares) in addition to the ordinary one matching share for each contribution share purchased during the period. The performance matching is subject to the fulfillment of a performance target. The performance target is average annual EPS growth during the period from July up to and including June . If the annual average EPS growth is less than or equal to percent there will be no performance matching ( shares) and if the annual average EPS growth is at or above percent, there will be maximum performance matching ( or shares). Any intermediate figure will be calculated on a linear basis. Stock Option Plans Plan Grant/Expiry date Strike price (SEK) Vesting period from Grant date 1999 Stock Option Plan 1 March 00/28 Feb 07 128.00 Millennium Stock Option Plan 17 Jan 00/18 Jan 07 93.80 Stock Option Plan 2001 – May Grant Stock Option Plan 2001 – November Grant 14 May 01/14 May 08 30.50 19 Nov 01/19 Nov 08 25.70 Stock Option Plan 2002 11 Nov 02/11 Nov 09 7.80 30% after 3 years, 40% after 4 years, 30% after 5 years 1/3 after 1 year, 1/3 after 2 years, 1/3 after 3 years 1/3 after 1 year, 1/3 after 2 years, 1/3 after 3 years 1/3 after 1 year, 1/3 after 2 years, 1/3 after 3 years 1/3 after 1 year, 1/3 after 2 years, 1/3 after 3 years Number of Number of participants participants at grant end 2004 1,800 1,126 8,000 3,120 15,000 9,013 900 674 12,800 10,561 76 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S If all options outstanding as of December , , were exercised, all shares allocated for future matching under the Stock Purchase Plan were transferred, and shares designated to cover social security costs and payments were disposed of as a result of the exercise and the matching, approximately million Class B shares would be issued and approximately million Class B shares, held as treasury stock, would be transferred. The total, approximately million Class B shares, corresponds to . percent of the total number of shares outstanding, , million. The below table shows the number of shares allocated for each plan (options and matching rights) and changes during . Shares for all Stock Incentive Plans All plans, except the Millennium Option Plan, are funded with treasury stock. The Millennium Stock Option Plan is based on warrants, i.e. options entitling the holders to subscribe for B shares. The warrants are held by subsidiary companies to Telefonaktiebolaget L M Ericsson, which companies have granted options to their employees. Treasury stock for the Option Plan was repurchased in on Stockholmsbörsen. Treasury stock for all remaining plans have been issued in a directed cash issue of Class C shares at nominal amount of SEK , purchased under a public offering at SEK per share plus a premium corresponding to the subscribers’ financing costs and converted to B shares. For all plans, additional shares and warrants have been allocated for social security. For the Millennium Stock Option Plan, the warrants designated for social security have been exchanged for a call option issued by a bank in order to hedge income against potential social security costs. For all other plans, treasury stock are sold on Stockholmsbörsen to cover the social security payments when arising due to exercise of options or matching of shares. During , , shares were sold at an average price of SEK .. Plan (million shares) 1999 Stock Option Plan Millennium Stock Option Plan Stock Option Plan 2001– May Grant Stock Option Plan 2001– Nov Grant Stock Option Plan 2002 Stock Purchase Plan 2001 Stock Purchase Plan 2003 and LTI 2004 Originally designated 1) 1.4 71.6 44.9 2.6 53.9 28.0 151.7 1) Adjusted for split, bonus issue and rights offering when applicable. 2) Presuming maximum performance matching under LTI 2004. Out- Exer- cised/ standing Granted matched Forfeited during 2004 beginning of 2004 during 2004 during 2004 0.9 37.2 30.1 1.8 47.0 21.9 3.8 – – – – – – 13.5 – – – – 3.3 1.8 0.5 0.0 3.0 2.2 0.2 2.3 0.4 0.3 Out- Expired standing end of 2004 during 2004 – – – – – – – 0.9 34.2 27.9 1.6 41.4 19.7 16.5 2) Number of options exercis- able 0.6 34.2 27.9 1.6 27.6 – – E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 77 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S 32 RELATED PARTY TRANSACTIONS During , various transactions were executed pursuant to contracts based on terms customary in the industry and negotiated on an arm’s length basis. Sony Ericsson Mobile Communications AB (SEMC) In October , SEMC was organized as a joint venture between Sony Corporation and Ericsson, and a substantial portion of Ericsson’s handset operations was sold to SEMC. As part of the formation of the joint venture, contracts were entered into between Ericsson and SEMC. Major transactions are as follows: • Sales. Ericsson records sales regarding mobile phone platform design and Shared Services. Shared Services were mainly provided in . • Royalty. Both owners of SEMC, Sony Corporation and Ericsson, receive royalties for SEMC’s usage of trademarks and intellectual property rights. • Purchases. Ericsson purchases mobile phones from SEMC to support contracts with a number of customers for mobile systems which also include limited quantities of phones. • Ericsson and Sony Corporation each made a shareholder contribution to SEMC in . • In the second quarter of , SEMC increased its equity stake in Beijing Ericsson Putian Communications Company Ltd. to percent. The name of the facility has been changed to Beijing SE Putian Mobile Communications Co. Ltd. (BMC). BMC operations have been consolidated into SEMC since the second quarter, which has had a relatively minor positive effect on their results. Related party transactions Sales Royalty Purchases Related party balances Receivables Liabilities 2004 2003 725 7 254 130 29 756 56 340 100 28 Other related parties Ericsson continued cooperation with Ericsson’s owners Investor AB and AB Industrivärden in the venture capital vehicle Ericsson Venture Partners. 33 FEES TO AUDITORS Consolidated 2004 Audit fees Audit related fees Tax services fees Other fees 2003 Audit fees Audit related fees Tax services fees Other fees Price- waterhouse- Coopers KPMG Others Total 57 10 31 – 98 50 1 46 4 6 6 2 – 14 6 4 2 – 101 12 1 – – – 1 1 – – 1 2 64 16 33 – 113 57 5 48 5 115 Related party transactions Sales Royalty Purchases Shareholder contribution Related party balances Receivables Liabilities Contingent liabilities 2004 2003 1,532 2,494 501 611 547 1,390 – 1,384 142 16 – 192 447 – Audit related fees in refer to fees for consultations on financial accounting, consultation in connection with conversion to International Financial Reporting Standards (IFRS), services related to issue of reports in connection with the public cash offer related to the listed Italian subsidiary company and due diligence related to acquisitions. Tax services fees comprise: general expatriate services, VAT refund services and Corporate tax compliance work. Audit fees to other auditors consist of local statutory audits for minor companies. Ericsson Nikola Tesla d.d. Ericsson Nikola Tesla d.d. is a joint stock company for manufacturing of telecommunications systems and equipment and an associated member of the Ericsson Group. Ericsson holds . percent of the shares. Major transactions are as follows: • Sales. Ericsson Nikola Tesla d.d. purchases telecommunication equipment from Ericsson. • Royalty. Ericsson receives royalties for Ericsson Nikola Tesla d.d.’s usage of trademarks and intellectual property rights. • Purchases. Ericsson is purchasing development resources from Ericsson Nikola Tesla d.d.. Parent Company 2004 Audit fees Audit related fees Tax services fees Other fees 2003 Audit fees Audit related fees Tax services fees Other fees Price- waterhouse- Coopers KPMG Others Total 24 5 2 – 31 11 – 13 – 24 1 – – – 1 1 1 – – 2 – – – – – – – – – – 25 5 2 – 32 12 1 13 – 26 78 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 34 RECONCILIATION TO ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES As a reporting company with the US Securities and Exchange Commission, the Company is required to reconcile certain financial information to US GAAP. For additional information required by foreign registrants, please refer to our annual report form -F, filed with the US Securities and Exchange Commission. The principal differences between Swedish GAAP and US GAAP that affect our net income (loss), as well as our stockholders’ equity, relate to the treatment of capitalization of development expenses, provisions for restructuring, pension costs, hedge accounting, and goodwill. New US GAAP standards In , the following FASB standards and pronouncements relevant to Ericsson were adopted: • FIN R, Consolidation of Variable Interest Entities, an interpretation of ARB . (The original FIN was partially adopted in in accordance with the revised transition rules.) The following FASB standards and pronouncement will be adopted in : • SFAS R Share Based Payments • SFAS Inventory Costs Significant differences between Swedish GAAP and US GAAP Capitalization of development costs Prior to , and in accordance with Swedish accounting principles, software development costs were charged against income when incurred. In , the Company adopted RR , “Intangible assets”. Consequently, intangible assets arising from internal development have been recognized when the intangible asset can be demonstrated to have technical feasibility and future economic benefits. The Company applies US GAAP SFAS “Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed” and SOP -, “Accounting for the costs of Computer Software Developed or Obtained for Internal use”. According to SFAS, development costs are capitalized after the product involved has reached a certain degree of technological feasibility. Capitalization ceases and amortization begins when the product is ready for its intended use. The Company has adopted an amortization period for capitalized development cost of three to five years. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S The Company’s capitalization of development costs under Swedish GAAP include all development that meets recognition criteria. Under US GAAP only software costs are capitalized. Amortization amounts are higher in US GAAP since restating of prior years, for effects of RR , was not allowed according to Swedish GAAP. Development costs relating to products to be sold, before taxes 2004 Net US adjust- Swedish Swedish GAAP GAAP ment GAAP GAAP 2003 Net US adjust- ment Opening balance Additions Amortizations Write-downs 1) 4,269 10,547 6,278 1,061 1,138 –77 –1,311 –3,779 –2,468 –61 –108 –47 2,851 13,927 11,076 2,049 2,049 – –600 –4,723 –4,123 –706 –675 –31 Closing balance 4,049 7,721 3,672 4,269 10,547 6,278 1) Write-down is made subject to impairment test regarding future revenue for capitalized products. Development costs relating to products for internal use, before taxes Swedish GAAP 515 8 –229 – 294 Opening balance Additions Amortizations Write-downs 1) Closing balance GAAP ment 646 8 –360 – 294 131 – –131 – – 2004 Net US adjust- Swedish 2003 Net US adjust- ment GAAP GAAP 349 310 –144 – 515 835 310 –433 –66 646 486 – –289 –66 131 1) Write-down is made subject to impairment test regarding future revenue for capitalized products. Capital discount on convertible debentures In accordance with Swedish accounting principles, the / convertible debenture loan and its nominal interest payments were valued at present value, based on market interest rate. The difference from the nominal amount, the capital discount, was credited directly to equity. In accordance with US GAAP, convertible debenture loans are reported as liabilities at nominal value. When calculating income and equity in accordance with US GAAP, the effects of the capital discount are reversed. The loan matured on June , , and has no impact on US GAAP from . Restructuring costs The rules for providing for restructuring and onerous contracts differ between US GAAP and Swedish GAAP. As a result, restructuring costs that did not meet the requirements under US GAAP in year have in qualified, reducing the US GAAP net income. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 79 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Pensions Ericsson adopted RR , Employee Benefits in which is similar to IAS , Employee Benefits. At adoption of RR , actuarial gains and losses were recognized in the opening balance. The effect on stockholders’ equity was a charge of SEK –, million, net of tax. For US GAAP, the Company adopted SFAS , “Employer’s Accounting for Pensions” in . The different transition dates for accounting of defined benefit plans between US GAAP and Swedish GAAP impact the balances booked as unrecognized actuarial gains and losses, which impact reported pension liabilities and costs. Different transition dates and additional minimum pension liability according to US GAAP are the main differences for Ericsson between Swedish and US GAAP for accounting of defined benefit plans. Pension premium refund In , Alecta (former SPP), a Swedish insurance company, announced a refund of pension premiums paid, of which a portion was refunded during the year. In accordance with Swedish accounting practice, the total refund was credited to income. In accordance with US GAAP, only the amount Alecta actually paid was credited to income. During the Company received the remaining part not refunded in and . credited to income, if the rent to be paid is in par with market price. In accordance with US GAAP, the part of the gain exceeding present value of future lease payments is credited to income when occurred. The remaining part is distributed during the lease period. Hedge accounting The Company adopted SFAS , ‘‘Accounting for Derivative Instruments and Hedging Activities’’, as amended, on January , , for calculating income and equity according to US GAAP. SFAS requires recognition of all derivatives as either assets or liabilities measured at fair value. Cash flow hedges Under SFAS for qualifying derivatives designated as a cash flow hedge the gain or loss is reported in other comprehensive income and affects net income first when the hedged exposure also affects income. The ineffective portion of the gain or loss affects net income immediately. According to Swedish accounting practice, foreign exchange derivatives, which are used to hedge forecasted cash flows regarding sales and purchases, are accounted for as hedges. Consequently, they are valued in a manner reflecting the accounting for the hedged position and are not valued at market. Sale-leaseback of property During and , the Company sold property, which was leased back to subsidiary companies and reported as an operating lease. In Sweden, the gain on sale of property is Fair value hedges Ericsson uses interest rate derivative instruments to hedge the interest rate risk of the Group’s borrowings. Under Swedish GAAP, Ericsson uses the synthetic method, where all hedged Provisions for pensions according to US GAAP Weighted-average actuarial assumptions as of December 31 In percent Discount rates Expected rates of future salary increases Expected investment return In SEK million Accumulated Benefit Obligation Estimated future salary increases Projected Benefit Obligation Fair value of plan assets Funded status Unrecognized prior service cost Unrecognized actuarial loss, net Unrecognized net asset at initial application of SFAS 87 Pension Provision as per US GAAP Additional minimum pension liability Total Pension Provision as per US GAAP Sweden 5,0% 3,0% – Sweden 6,402 1,788 8,190 – –8,190 –599 1,764 – –7,025 – –7,025 2004 Other 5,4% 3,8% 6,8% 2004 Other 6,830 1,088 7,918 5,764 –2,154 166 1,278 –44 –754 –648 –1,402 Sweden 5.5% 3.0% – Sweden 1) 5,372 1,549 6,921 – –6,921 –649 1,149 – –6,421 – –6,421 2003 Other 5.6% 3.5% 7.0% 2003 Other 6,232 1,329 7,561 5,266 –2,295 64 1,215 –48 –1,064 –268 –1,332 Total 13,232 2,876 16,108 5,764 –10,344 –433 3,042 –44 –7,779 –648 –8,427 Total 11,604 2,878 14,482 5,266 –9,216 –585 2,364 –48 –7,485 –268 –7,753 1) During 2003 SEK 3.5 billion of the Swedish pension obligation has been settled. As an effect SEK 0.6 billion of the unrealized actuarial loss was recognized under US GAAP. 80 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 borrowings are treated as having floating rates and therefore valued at amortized cost. The value of the derivatives is recognized as gains/losses when the hedged interest expenses are recognized. In accordance with US GAAP, all outstanding derivative instruments are valued at fair value. The profits and losses that thereby arise are included in net income. The Groups’ hedges of financial exposure qualify for hedge accounting under US GAAP. In those cases the hedged item is valued at fair value regarding the risk and period being hedged. The effect is included in net income, offsetting the fair value adjustment on derivatives to the extent the hedges are effective. Amortization of goodwill Under Swedish GAAP, goodwill is amortized over its estimated useful life. According to SFAS goodwill is not subject to amortization subsequent to the date of adoption. Goodwill is tested for impairment at least annually. No need for impairment was identified in . The amortization of goodwill made according to Swedish GAAP is reversed under US GAAP. Unrealized gains and losses on securities available-for-sale In accordance with Swedish accounting principles investments are valued at lower of cost and market. Under US GAAP, securities available for sale that have readily determinable fair values are measured at fair value in accordance with SFAS “Accounting for Certain Investments in Debt and Equity Securities”. Unrealized gains and unrealized temporary losses are included in Other comprehensive income. Other than temporary unrealized losses are charged to income. Other Revaluation of assets Certain tangible assets have been revalued at amounts in excess of cost. Under certain conditions, this procedure is allowed in accordance with Swedish accounting practice. Revaluation of assets in the primary financial statements is not permitted under US GAAP. Depreciation charges relating to such items have been reversed to income. Capitalization of interest expenses In accordance with Swedish accounting practice, the Company has expensed interest costs incurred in connection with the financing of expenditures for construction of tangible assets. Such costs are to be capitalized in accordance with US GAAP, and depreciated as the assets concerned are used. N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Provision for social security cost on stock based compensation Under Swedish GAAP, the Company accrues social security costs on stock based compensation during the vesting period. Provisions are adjusted for movements in share price. Under US GAAP, no social security cost is recorded until the options are exercised or matching of shares takes place. FIN 45 FIN requires a liability to be recognized at the time a company issues a guarantee for the fair value of the obligations assumed under certain guarantee agreements. The provisions for initial recognition and measurement of guarantee agreements are effective on a prospective basis for guarantees that are issued or modified after December , . In accordance with Swedish accounting principles, a liability should be recognized to the extent a company expects a loss and economic outflow of resources as a result of the guarantee commitment. No need for adjustment for FIN was identified in . Three main areas fall within FIN for Ericsson: • Product Warranties – see Note , “Other Provisions”. • Performance Guarantees for Third Party: contractual guarantees (performance bonds) for third party performance, mostly subcontractors, range from one to three years. The maximum potential amount of future payments under the guarantees calculated at fair value per December , is SEK million. Historically such guarantees have only been drawn in rare cases, and there is no indication of changes in the future. Therefore, any liability incurred due to contractual guarantees is considered not material and no provisions have been made. • Inventory Guarantees: Inventory guarantees where Ericsson guarantees supplier coverage of inventory related costs due to no usage and incurrence (obsolescence). Inventory guarantees with suppliers including obsolete material are fully provisioned. FIN 46R FIN R addresses the consolidation of entities for which control is achieved through means other than through voting rights or agreements (“variable interest entities” or “VIE”) by clarifying the application of Accounting Research Bulletin No. , “Consolidated Financial Statements” to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN R provides guidance on how to determine when and which business enterprise (the “primary beneficiary”) should consolidate the VIE. In addition, FIN R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. The transition rules required Variable Interest Entities created after January , , where Ericsson was the primary beneficiary to E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 81 Comprehensive Income Comprehensive income includes net income and other changes in equity, except those resulting from transactions with owners. 2004 2003 2002 14,386 –10,597 –19,918 –1,015 –3,525 –6,160 47 1,010 –232 202 –329 160 –157 – –838 1,501 –107 2,057 1,869 234 101 –279 –199 –71 –1,024 –2,806 –3,635 14,229 –13,403 –23,553 2004 2003 2002 77,299 60,481 73,607 949 – – 3,147 –1,028 1,604 3,672 – 88 411 195 –299 – – 2,700 –1,381 3,509 440 – –179 1,064 –2,063 2,744 6,278 131 1,442 11,076 486 217 291 158 –314 146 –1,968 –3,347 –4,021 84,369 69,963 83,203 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S be consolidated in consolidated financial statements. There were no such entities identified. As a result of adopting FIN R, the impact on total assets are SEK . billion with no equity effect. Since it is already consolidated according to Swedish GAAP there is no GAAP difference. Deferred Income Taxes Deferred tax is calculated on US GAAP adjustments, and the US GAAP balance sheet reflects the gross recognition of deferred tax assets and liabilities. Adjustment of Net Income, Comprehensive Income, Equity and Balance Sheet Items Application of US GAAP as described above would have had the following effects on consolidated net income. In arriving at the individual items increasing or decreasing reported net income, consideration has been given to the effect of minority interests. Net income in accordance with US GAAP Other comprehensive income Translation adjustments Translation adjustments for sold/ liquidated companies Net gain on cash flow hedges Hedging for investments Unrealized gains and losses on securities available-for-sale Pensions Deferred income taxes Total other comprehensive income Comprehensive income in accordance with US GAAP Adjustment of Net Income Adjustment of Stockholders’ Equity Equity as reported per Swedish GAAP US GAAP adjustments before taxes: Pensions Pension premium refund Capital discount on convertible debentures Goodwill Sale-leaseback Hedging Capitalization of development costs to be sold for internal use Restructuring costs Unrealized gains and losses on available-for-sale securities Other Deferred tax effect of US GAAP adjustments Stockholders' equity in accordance with US GAAP Net income as reported per Swedish GAAP US GAAP adjustments before taxes: Pensions Pension premium refund Capital discount on convertible debentures Goodwill amortization Sale-leaseback Hedging Capitalization of development costs for products to be sold for internal use Restructuring costs Unrealized gains and losses on available-for-sale securities Other Tax effect of US GAAP adjustments Net income in accordance with US GAAP Earnings per share in accordance with US GAAP Earnings per share per US GAAP, basic Earnings per share per US GAAP, diluted Average number of shares, basic per US GAAP (million) Average number of shares, diluted per US GAAP (million) 2004 2003 2002 19,024 –10,844 –19,013 –245 – – 475 352 –2,915 –840 – 179 1,636 682 1,603 412 47 124 1,064 113 2,884 –2,606 –131 –1,354 –4,798 –355 1,225 –4,018 –922 –1,240 –82 37 1,831 370 12 533 –370 35 966 14,386 –10,597 –19,918 0.91 –0.68 –1.58 0.91 –0.68 1) –1.58 1) 15,829 15,823 12,573 15,855 15,831 12,684 1) Potential ordinary shares are not considered when their conversion to ordinary shares would increase earnings per share. 82 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Balance Sheet Balance sheet items according to Swedish GAAP and US GAAP: Swedish GAAP Dec. 31 Dec. 31 Dec. 31 2004 2004 2003 US GAAP Dec. 31 2003 Intangible assets Tangible assets Financial assets Current assets Total assets Stockholders’ equity Minority interests Provisions Long term liabilities Current liabilities 10,415 5,845 29,894 11,210 6,505 34,902 136,886 129,755 17,234 5,896 30,305 139,428 20,319 5,426 35,193 134,672 183,040 182,372 192,863 195,609 77,299 1,057 35,286 23,693 45,705 60,481 2,299 36,068 29,772 53,752 84,369 1,057 36,304 24,629 46,504 69,963 2,299 39,731 29,493 54,124 Total stockholders’ equity, provisions and liabilities 183,040 182,372 192,863 195,609 Statement of Cash Flows The Company follows SFAS when preparing the Statement of Cash Flows, except that it defines cash and cash equivalents as highly liquid funds that are easily converted to cash and are insignificantly affected by changes in value. Cash and cash equivalents in accordance with SFAS have an initial maturity at the time of acquisition of months or less. Applying this definition would imply making the following adjustments of reported cash, with the offsetting difference reflected in cash flow from investing activities in the Statement of Cash Flows: Consolidated 2004 2003 2002 Short term cash investments, cash and bank, as reported Adjustment for items not compliant with US GAAP Cash and cash equivalents as per US GAAP 76,554 73,207 66,214 –46,142 –20,092 –28,069 30,412 53,115 38,145 Share Based Compensation Up until , the Company, as permitted under SFAS “Accounting for Stock Based Compensation”, applied Accounting Principles Board Opinion (APB ) and related interpretations in accounting for its stock option plans under US GAAP. No compensation expense has been reflected in the consolidated income statement as no compensation expense arises when the strike price of the employee’s stock options equals the market value of the underlying stock at grant date, as in the case of all options granted to Ericsson’s employees. The Company has during adopted SFAS “Accounting for Stock-Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. ”. The adoption method chosen is the “Prospective method”. This method states that the recognition provisions shall be applied to all employee awards granted, modified, or settled after the beginning of the fiscal year in which the recognition provisions are first applied. As the Company has had no changes to it’s N O T E S T O T H E F I N A N C I A L S T A T E M E N T S current stock option plans nor any new stock option plans started after implementing SFAS there will be no effect to the income. Neither has any difference been identified in accounting for the stock purchase plans, except for accounting of the social security costs. Please refer to section above. As the Company has applied the APB model in accounting for both stock option and stock purchase plans, the Stock Purchase Plans have been expensed in the income statement according to both Swedish and US GAAP. In accordance with APB the costs are based on the intrinsic value at investment date and accrued during the vesting period. If the Company had chosen to adopt the optional recognition provisions of SFAS for its stock option plans, net income (loss) and earnings (loss) per share in accordance with US GAAP would have been changed to the amounts indicated below: Consolidated 2004 2003 2002 Net income Net income per US GAAP Adjustment for recognitions of provisions per SFAS123 Net income, adjusted, per US GAAP Earnings per share, diluted Earnings per share per US GAAP Earnings per share, adjusted, per US GAAP 14,386 –10,597 –19,918 –80 –233 14,306 –10,830 –20,319 –401 1) 0.91 –0.68 2) –1.58 2) 0.90 –0.69 2) –1.62 2) 1) The figure for 2002 has been corrected, due to a clerical error. 2) Potential ordinary shares are not considered when their conversion to ordinary shares would increase earnings per share. The fair value of each option grant is estimated on the date of the grant, using the Black & Scholes’ option pricing model with the following weighted-average assumptions: Expected dividend yield Expected volatility Risk-free interest rate Expected life of option (in years) 2004 1) 2003 1) 2002 N/A N/A N/A N/A N/A N/A N/A N/A 0.6% 43.1% 5.4% 5.4 1) No option programs were initiated during 2003 and 2004. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 83 N O T E S T O T H E F I N A N C I A L S T A T E M E N T S Auditors’ Report To the Annual General Meeting of the shareholders of Telefonaktiebolaget LM Ericsson (publ), corporate identity number 556016-0680 We have audited the annual accounts, the consolidated accounts, the accounting records and the administration of the board of directors and the managing director of Telefonaktiebolaget LM Ericsson (publ) for the year . These accounts and the administration of the company and the application of the Annual Accounts Act when preparing the annual accounts and the consolidated accounts are the responsibility of the board of directors and the managing director. Our responsibility is to express an opinion on the annual accounts, the consolidated accounts and the administration based on our audit. We conducted our audit in accordance with generally accepted auditing standards in Sweden. Those standards require that we plan and perform the audit to obtain reasonable assurance that the annual accounts and the consolidated accounts are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the accounts. An audit also includes assessing the accounting principles used and their application by the board of directors and the managing director and significant estimates made by the board of directors and the managing director when preparing the annual accounts and consolidated accounts as well as evaluating the overall presentation of information in the annual accounts and the consolidated accounts. As a basis for our opinion concerning discharge from liability, we examined significant decisions, actions taken and circumstances of the company in order to be able to determine the liability, if any, to the company of any board member or the managing director. We also examined whether any board member or the managing director has, in any other way, acted in contravention of the Companies Act, the Annual Accounts Act or the Articles of Association. We believe that our audit provides a reasonable basis for our opinion set out below. The annual accounts and the consolidated accounts have been prepared in accordance with the Annual Accounts Act and, thereby, give a true and fair view of the company’s and the group’s financial position and results of operations in accordance with generally accepted accounting principles in Sweden. The Board of Directors’ Report is consistent with the other parts of the annual accounts and the consolidated accounts. We recommend to the general meeting of shareholders that the income statements and balance sheets of the parent company and the group be adopted, that the profit for the parent company be dealt with in accordance with the proposal in the Board of Directors’ Report and that the members of the board of directors and the managing director be discharged from liability for the financial year. Stockholm, February , Bo Hjalmarsson Authorized Public Accountant PricewaterhouseCoopers AB Peter Clemedtson Authorized Public Accountant PricewaterhouseCoopers AB Thomas Thiel Authorized Public Accountant 84 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Information on the Company GENERAL Telefonaktiebolaget LM Ericsson (publ) is a limited liability company organized under the Swedish Companies Act. The terms “Ericsson”, “the Company”, “the Group”, “us”, “we”, “our” all refer to Telefonaktiebolaget LM Ericsson, the Parent Company and its subsidiaries. The company was incorporated on August , , as a result of a merger between AB LM Ericsson & Co. and Stockholms Allmänna Telefon AB. Our Class A and B shares are traded on Stockholmsbörsen (the Stockholm Stock Exchange). Our Class B shares are also traded on the London Stock Exchange (LSE). In the United States, our American Depository Shares (ADS), each representing underlying Class B shares, are traded on NASDAQ. Our registered address is Telefonaktiebolaget LM Ericsson, SE– Stockholm, Sweden; our headquarters are located at Torshamnsgatan , Kista, Sweden. Our telephone number in Sweden is + . In the United States, our agent is Ericsson Inc., Vice President Legal Affairs, Legacy Drive, Plano, Texas . Telephone number in the US is + . Our web site is www.ericsson.com. Please note that information on our web site does not form part of this document. DOCUMENTS ON DISPLAY We file annual reports and other information (normally in Swedish only) for certain domestic legal entities with Bolagsverket (Swedish Companies Registration Office) pursuant to Swedish rules and regulations. You may order any of these reports from their web site at www.bolagsverket.se. If you access these reports, please be aware that the information included may not be indicative of our published results in all aspects. Only consolidated amounts for the group totals are included in our reports. We also file annual reports and other information with the Securities and Exchange Commission (SEC) in the United States pursuant to the rules and regulations that apply to foreign private issuers. Electronic access to these documents may be obtained from the SEC’s website at www.sec.gov/edgar/searchedgar/webuser.htm where they are stored in the EDGAR database. You may read and copy any of these reports at the SEC’s public reference facilities at Fifth Street, N.W., Washington, D.C. or obtain them by mail upon payment of their prescribed rates. For further information, you can call the SEC at + . I N F O R M A T I O N O N T H E C O M P A N Y I N F O R M A T I O N O N T H E C O M P A N Y I N F O R M A T I O N O N T H E C O M P A N Y I N F O R M A T I O N O N T H E C O M P A N Y HISTORY AND DEVELOPMENT Our origins date back to when Lars Magnus Ericsson opened a small workshop in Stockholm to repair telegraph instruments. That same year in the United States, Alexander Graham Bell filed a patent application for the telephone. Lars Magnus Ericsson soon recognized the great potential of voice based telecommunications and realized that the technology could be improved. He started to develop and sell his own telephone equipment and within a few years reached an agreement to supply telephones and switchboards to Sweden’s first telecom operator. Stockholm soon had the highest telephone density in the world. Today, Ericsson is a leading provider of telecommunications equipment and related services to mobile and fixed network operators globally. Over , networks in countries utilize our network equipment and we are one of the few companies worldwide that can offer end-to-end solutions for all major mobile communication standards. We invest heavily in R&D and actively promote standardiza- tion and open systems. As a result, we have a long history of innovation and the pioneering of next generation technologies for more efficient and better quality telecommunications. Telegraph to telephone Milestones Manual switching to automatic switching Electro-mechanical to computer control Analog switching to digital switching Narrowband circuit to broadband packet switching G narrowband to G wideband mobile technology Commercialization of CDMA Mass commercial launch of WCDMA G networks in Fixed communications to mobile communications G analog to G digital mobile technology Integration of voice and data in mobile networks Western Europe Also reflecting our ongoing commitment to technological leadership, we have one of the industry’s most comprehensive intellectual property portfolio containing over , patents with an additional , patent applications pending approval by various patent authorities. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 85 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 85 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 85 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 85 I N F O R M A T I O N O N T H E C O M P A N Y Our vision – how we see the world We believe in an “all communicating” world: voice, data and images, conveniently communicated anywhere and anytime, increasing both quality of life and productivity while enabling a more resource-efficient world. Our mission – what we aim to accomplish We are shaping the future of broadband mobile communications through continuous technological leadership. We strive to be the prime innovator of our industry, driving the future of advanced communication and helping our customers to be the most powerful communication companies in the world. Core values – how we act Professionalism, respect and perseverance are the foundation of the Ericsson culture, guiding us in our daily work, both in how we relate to people and how we conduct our business. Results – how we measure our performance We measure three fundamental metrics: customer satisfaction, employee satisfaction and financial returns. We believe that highly satisfied customers, empowered employees and best in class operating margins help to assure an enduring capability for value creation and competitive advantage. BUSINESS OVERVIEW We supply the network equipment and services that enable telecommunications. We also provide our customers with services for network operations and revenue generation. Through our Sony Ericsson Mobile Communications joint venture we offer a range of mobile devices, including those supporting multimedia applications and other personal communication services. In addition, the Company has products for special applications within defense systems, enterprise, cables, mobile platforms and power modules. Primary business offerings Mobile systems We are the market leader with approximately percent global share of the addressable market, i.e. open non-proprietary standards. Our claim of market leadership in mobile systems is based on our reported sales and how they relate to the publicly reported and estimated mobile system sales of our main competitors. Statements from industry and financial analysts also support our estimates. We have an even higher share within GSM/WCDMA. We offer all G mobile standards as well as the three primary G standards – WCDMA, EDGE and CDMA for next generation mobile networks. Our end-to- end solutions offer operators a smooth network migration to G. Products include radio base stations, core network infrastructure and the increasingly important service layer. Mobile network equipment and associated network rollout services account for more than two thirds of our sales. Wireline systems We are a supplier of broadband multi-service communications equipment and services mainly to fixed network operators in Latin America and Europe. By successfully addressing three key operator needs: modernization and expansion of the fixed telephony networks; introduction of IP-based revenue generating services; and cost-efficient rollout of high capacity broadband networks with service differentiation, we have been able to secure a strong position in voice over packet, soft switching and public Ethernet access. Transmission and transport A well-planned and efficient transport network is key for bringing services to market quickly and cost effectively. We offer a complete, end-to-end portfolio of transmission and transport equipment for mobile, fixed and other types of networks. Microwave and optical solutions are important parts of our G, G and multi-service networks offerings. We are the largest supplier of microwave radio links in the world. Sales of transmission and transport products are accounted for within either mobile networks or fixed networks depending on which type of operator is involved. 86 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 I N F O R M A T I O N O N T H E C O M P A N Y Customers We are broadly supplying equipment and services to almost all major network operators globally. However, we derive most of our sales from large, multi-year network build-out agreements with a limited number of significant customers. Out of a customer base of more than network operators, the ten largest customers account for approximately percent of our net sales while the largest customers account for approximately percent of our net sales. Our largest customer accounted for approximately percent of sales during . For more information, see “Risk Factors – Risks Associated with the Industry and Market Conditions”. Competitors In our Systems segment, we compete mainly with large and well-established communication equipment suppliers. Although competition varies depending on the products, services and geographical regions, our most significant competitors in wireless communication include Alcatel, Lucent, Motorola, Nokia, Nortel and Siemens. With respect to wireline communications equipment, the competition is also highly concentrated and includes, among others, Alcatel, Cisco, Lucent, Nortel and Siemens. We also compete with numerous local and regional manufacturers and providers of communication equipment and services. We believe the most important competitive factors in this industry include existing customer relationships, the ability to cost-effectively upgrade or migrate an installed base, technological innovation, product design, compatibility of products with industry standards, and the capability for end-to-end systems integration. Competition in Professional Services not only includes many of our traditional systems competitors but also a number of large companies from other industry sectors such as IS/IT including IBM, EDS, Accenture and electronics manufacturing services companies such as Flextronics as well as a number of smaller but specialized companies operating on a local or regional basis. As this segment grows, we expect to see additional competitors emerge, possibly including some network operators attempting to expand into new segments. In our Other Operations segment, our competitors vary widely depending on the product or service being offered. We face significant competition with regard to substantially all of these products and services. Service layer The service layer is where applications and end-user services are enabled and managed. The service layer is becoming more important with new services that combine voice, data and images. Ericsson has a leading complete service-layer portfolio with products, solutions and services for both fixed and mobile network operators. We have a particularly strong position within pre-paid, billing, intelligent networks and mobile- multimedia services (MMS). Mobility World is an Ericsson initiative that develops content and applications together with industry-wide partners. Sales of Service Layer products are accounted for within either mobile networks or fixed networks depending on which type of operator is involved. Services Our services portfolio includes expertise in consulting, systems integration, managed services, network deployment and optimization, education and technical support services. With over , dedicated Global Services professionals on the ground in countries, our services sales (including network rollout) account for approximately one quarter of our Systems net sales. We offer some of the most comprehensive managed services capabilities within the telecom industry, covering management of day-to-day operations of a customer’s network, sometimes including a managed capacity service for an efficient network build out and on-demand capacity, as well as hosting of applications and content management. The combination of our local expertise, global technology leadership, business understanding, strong delivery capabilities and extensive experience in managing multi-vendor networks, makes Ericsson a leading provider of services to network operators. Our Global Services business unit includes both network rollout and professional services. Sales of network rollout services represent approximately percent of net sales and are consolidated within either mobile networks or fixed networks depending on which type of operator is involved while professional services represents percent of sales and are reported separately. Mobile Phones Sony Ericsson Mobile Communications (Sony Ericsson) delivers leading-edge mobile phones and other mobile communication devices. The / joint venture combines the mobile communications expertise of Ericsson with the consumer electronics and content expertise of SONY Corporation and forms an essential part of our end-to-end capability for mobile multimedia services. Sales for Sony Ericsson are not included in our reported sales while their operating results are reported according to the equity method under “Share in earnings of joint ventures and associated companies” in the income statement. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 87 I N F O R M A T I O N O N T H E C O M P A N Y Within the Phones segment, the primary competitors Our strategy calls for us to: include Nokia, Motorola, Samsung and Siemens plus a number of other companies such as LG Electronics, Sharp and NEC. Competition is intensifying with consumer electronic companies, especially those based in Asia, making significant market share gains. We believe that our mobile phone joint venture with Japan’s SONY Corporation creates a distinctive competitive position. For more information, see “Risk Factors – Risks Associated with the Industry and Market Conditions”. Suppliers We manufacture and assemble a large portion of our products in-house, however, over half of our module production is outsourced to a group of electronics manufacturing services companies including Elcoteq, Flextronics, Sanmina-SCI and Solectron. We also purchase customized and standardized equipment, components and services from several global providers as well as from numerous local and regional suppliers. A number of our suppliers design and manufacture highly specialized and customized components for our end-to-end solutions as well as individual nodes. We generally negotiate global supply agreements with our primary suppliers, but we are not dependent on any one supplier for the provision of standardized equipment or components. Since we try to avoid single source supply situations, we do not believe that any single supplier is material to our aggregated business. Sony Ericsson also outsources a significant part of their production of mobile handsets to Flextronics and other contract manufacturers. For more information, see “Risk Factors – Risks Associated with the Industry and Market Conditions”. BUSINESS STRATEGY AND LONG-TERM GOALS Our overall goal is to be the preferred business partner to our customers, especially to the world’s leading network operators. In doing so, we strive to be the market and technology leader by offering end-to-end solutions mainly related to network infrastructure, network management and other service offerings. We are a major supplier to most of the world’s leading mobile network operators and many of the world’s leading fixed-line operators. We believe that our ability to offer end-to- end solutions – systems, applications, services and core handset technology – together with our in-depth knowledge of consumer requirements, make us well positioned to assist network operators with their network development and operations. We are already a market leader in network systems integration and managed services. Through increased activities in professional services and service layer products, we aim for increased sales in these growing segments. • Lead market development through innovation and technological leadership; • Leverage our economies of scale to develop superior products and services and thereby offer our customers competitive advantages; and • Establish operational excellence as a basis for sustainable and best in class operating margins. Innovation is an important element of our corporate culture and is key to our competitiveness and future success. We have a long tradition of developing innovative communication technologies, including technologies that help to establish industry standards. For example, we helped pioneer the development of industry-wide wireless technology standards such as GSM, GPRS, EDGE, CDMA, WCDMA, HSDPA and Bluetooth. We work closely with our customers to understand their businesses and technology needs and provide tailored solutions to help them fulfill their business objectives. We believe that our ability to meet the diverse technology needs of our customers with high value-added solutions has been instrumental in our being chosen as a provider of wireless communications equipment to the world’s largest mobile network operators. We will continue to devote significant resources to developing end-to-end communications solutions that will stimulate network deployments for geographic coverage as well as traffic capacity and thereby drive demand for our products and services. Our expertise and experience in all major telecommuni- cation standards along with our proven track record for quality and innovation have allowed us to develop our business on a global basis. We have significant sales in all of the largest geographic markets for telecommunications with no individual country accounting for more than percent of sales. We believe that our global presence and the economies of scale associated with market share leadership give us competitive advantages. We are utilizing our strong international presence and core competence in mobile and fixed communications to expand into growth areas such as service applications and managed services. We also use our global reach to develop alliances with suppliers and manufacturers in order to increase our combined effectiveness. We will continue to improve our internal processes and support systems to drive operational excellence as a competitive advantage. In addition, we continue to develop and maintain high levels of competence in our employees to secure our leading market position and to stay at the forefront of technology development. 88 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 BUSINESS SEGMENTS To best reflect our business focus and to facilitate comparability with our peers, we consolidate the results of our operations into three business segments: . Systems consisting of a three-pronged business approach: Mobile Networks, Fixed Networks and Professional Services; . Phones through the / joint venture with SONY; and . Other Operations which comprise a number of small businesses including Microwave Systems (Defense), Enterprise Systems, Network Technologies (Cables), Mobile Platforms and Power Modules. Although we have market units, we group orders and sales into five large geographic regions: Western Europe, Central and Eastern Europe, Middle East and Africa (CEMA), Asia Pacific, North America and Latin America. 2004 Sales by Region and Segment SEK billion Systems percent share Other Operations percent share Total percent share Western Europe CEMA1) Pacific America America Total North Latin Asia 34.0 28% 6.5 63% 40.5 31% 31.5 26% 1.4 14% 32.9 25% 27.1 22% 1.4 13% 28.6 21% 14.8 12% 0.7 7% 15.5 12% 14.1 121.5 12% 0.4 3% 10.4 14.5 132.0 11% 1) Central and Eastern Europe, Middle East and Africa. Note: due to rounding, all rows and columns may not add up exactly to the totals. Please also see “Notes to the Financial Statements – Note , Segment Information.” I N F O R M A T I O N O N T H E C O M P A N Y Seasonality Our quarterly sales, income and cash flow from operations are seasonal in nature and generally lowest in the first quarter of the year and highest in the fourth quarter. This is mainly a result of the seasonal purchase patterns of network operators. Although demonstrating a strong seasonal pattern historically, our seasonal sales variances have not conformed to the longer- term pattern during the market downturn starting in and subsequent recovery during . The table below illustrates the long term average seasonal effect on sales for the period through . 15-year average seasonality First quarter Second quarter Third quarter Fourth quarter Sequential Change Share of annual sales –27% 21% 17% 24% –6% 23% 39% 31% Compared to the year historical pattern, the seasonality over the last three years has generally been less pronounced with a more equal distribution of sales between quarters. The table below illustrates the average seasonal effect on sales for the years , and . Most recent 3-year average seasonality First quarter Second quarter Third quarter Fourth quarter Sequential Change Share of annual sales –30% 23% 9% 25% –5% 24% 20% 28% Systems Segment Mobile Networks We provide mobile systems solutions to network operators that enable reliable, efficient and cost effective wireless networking. Our systems offerings include radio base stations, base station and radio network controllers, mobile switching centers, service application nodes and other nodes for billing and operations support. Each generation of wireless technology is associated with a group of international standards for wireless communications networks. Transitioning from one generation to the next, such as from G to G, requires network operators, equipment suppliers and mobile handset manufacturers to adopt new and emerging technology standards. We believe that the migration from voice services and basic mobile multimedia services to mobile broadband is the primary technological shift facing wireless network operators today. Our expertise in all G standards and our role in developing G standards allow us to offer mobile telecommunications systems that incorporate any of the major G, .G and G mobile technology standards. As a result, we are able to offer tailored solutions to a network operator, regardless of the existing network standard used. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 89 Fixed Networks We have a long history in fixed-line networking with an installed base of access and transit lines equivalent to million lines or approximately percent global market share of the installed base. We supply fixed network operators with systems solutions that allow them to upgrade their legacy networks to more efficiently handle a mix of voice, data, video and Internet traffic. Fixed network operators are moving from single-service networks toward broadband packet-switched multi-service networks that have the ability to simultaneously handle multiple services, such as voice, data and images. Migration to an all IP-based packet-switched network is a necessary step in order to combine broadband Internet, voice and image traffic into one multi-service network. Our solution for such multi-service networks utilizes layered softswitch service and control architecture, combined with broadband access and core network routing and transmission elements. Organizing a network into layers isolates the different functions, i.e., access, core network and services to facilitate easier migration to an all IP environment. Due to our leadership in next generation mobile networks, we are able to leverage our IP-based multimedia subsystem (IMS) developed for G networks for next generation fixed network applications. IMS is an open service layer platform that hosts IP based services such as Voice over IP (VoIP), push-to-talk, etc. Since our IMS solution is common for both fixed and mobile networks, converged services can be transparently provided independent of the type of access. Similar to our mobile network offering, we offer a suite of network services and applications that enable network operators to provide a range of services such as free-phone, virtual private network and other applications as well as billing. Professional Services Services play an increasingly important role in our business. As part of our Global Services business, we offer a comprehensive range of professional services to support operators with the planning, implementation and operation of their networks. These services accounted for percent of our net sales in and include support, advisory, integration and managed services. Our Services organization has technical knowledge to support multi-vendor fixed and mobile networks as well as all major mobile network standards. In addition, we provide network rollout services as part of our network equipment offerings. I N F O R M A T I O N O N T H E C O M P A N Y We offer a complete portfolio of radio base stations ranging from small pico cells (i.e., small cells in a mobile network that boost capacity and coverage within buildings) to high capacity macro cell applications. Radio base stations provide access and interconnection between mobile handsets and the mobile network. Our installed base of GSM radio base stations represents more than one third of all GSM radio base stations in service globally. A central feature of our G GSM radio base stations and base station controllers is their ability to be upgraded on a cost-effective basis to enable .G GPRS and G EDGE transmissions. Similarly, our WCDMA base stations can be upgraded to HSDPA. Other important elements of radio access networks are the controllers for radio base station and radio access networks, which manage the traffic between the radio base stations and core networks. In G, base station controllers, in conjunction with mobile switching centers, effect call handovers between radio base stations as subscribers move between cell sites while engaged in a voice call or data transmission. Similarly, in G networks, a radio network controller effects call handover in conjunction with mobility server nodes within the service layer. The core network nodes interconnect radio access networks with other parts of the network. Many of our core network switching systems, controllers for base stations and radio networks are built from common platforms. Like our radio base station products, our mobile switching products have industry- leading scalability and capacity. We are also a leading supplier of microwave radio links that can be used to backhaul the traffic between radio base stations and base station controllers as well as between base station controllers and mobile switching centers. Wireless backhauling (i.e., transporting data and voice from a network access point to a central switching point in mobile systems) with microwave radio links reduces the need for the operator to lease transmission capacity from fixed network operators, resulting in significant cost savings for the wireless operator. A new generation of microwave transmission systems is now being introduced with expanded capacity to support the increased traffic demands of mobile Internet and G, as well as to serve the market for wireless broadband access to fixed networks. Our mobile systems offerings extend beyond assisting network operators in upgrading their network functionality. We also offer a suite of Mobile Internet services and applications that enable network operators and content providers to bring multi-media messaging, personalization, information, entertainment, location-based and m-commerce services to consumers. We have also established Ericsson Mobility World, a global network of regional centers and local web-based facilities. This open industry-wide initiative is a growing network of more than , registered technology professionals from a diverse base of companies, working in partnership toward successfully implementing the Mobile Internet. 90 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Network operators are reducing operating expenditures by optimizing the operation and maintenance of their networks. As a result, many network operators are increasingly outsourcing network design, operations and maintenance activities. This trend also gives rise to new business models such as managed capacity, where an operator buys coverage, capacity and network performance, or hosted services, where companies like Ericsson provides the network and/or service capability according to agreed service levels. Under such business models, operators gain flexibility in capital employed, resources and time to market – all with an assured quality of service. Other Operations In addition to the areas previously described, Ericsson’s operations include microwave (defense) systems, enterprise systems, network technology (cables), mobile platforms and power modules. Although important, these business units are relatively small compared to those consolidated within Systems. Sales of these units are consolidated within Other Operations and in total amount to percent of net sales, with no single unit representing more than percent. ORGANIZATION Our operational organization is built around a structure of centralized business units responsible for the delivery of products and services to decentralized market units that are responsible for local sales and customer support. A number of group functions are used to perform tasks pertaining to certain Group-wide matters that are not naturally suitable for a specific operational unit. Governance A significant amount of authority and responsibility is assigned to the management of our various operating units for tasks pertaining to daily operations. Governance of our operating units is made through steering boards whose members are representatives of the Group Management Team, the Extended Management Team and the management of the particular operating unit. For more information regarding our corporate governance, please see “Corporate Governance” or visit our web site www.ericsson.com/investors/governance. Changes in organization and management Several organizational changes were made during to promote a simpler structure with more efficient operations and fewer organizational layers. The changes include: • The regional market units now report directly to the Group Management Team replacing a market area organization. For external reporting purposes, we continue to group the orders and sales of the Market Units into five larger geographic regions. I N F O R M A T I O N O N T H E C O M P A N Y • Within the Systems segment, the Mobile Systems business unit was split into a Systems business unit and an Access business unit. The Systems segment’s other three business units (Mobile Systems CDMA, Transmission and Transport Networks and Global Services) remained unchanged. • A new group function, Sales and Marketing, was established to maximize profitable growth and further develop a professional sales culture within the company. In conjunction with this change, Group Function Marketing and Strategic Business Development was changed to Group Function Strategy and Product Management. • Multi-Country Accounts (MCA) were introduced as an extension of the current Customer Account structure. It is designed to serve large operators with smaller geographical coverage than the Global Customer Accounts (GCA). • A new Group Function, Operational Excellence, is being established that will incorporate Group Function Sourcing and Group Function Supply, currently part of Business Unit Access and Group Operational Development, which is currently part of Group Function Finance. In conjunction with this change, responsibility for IT will be transferred to Group Function Finance and the separate Group Function IT and Sourcing has been eliminated. • As of January , , the unit responsible for Radio Network Development within R&D will be split and moved into two business units. The part that works with GSM/WCDMA will be integrated into Business Unit Access while the part that works with CDMA will be integrated into Business Unit Mobile Systems CDMA. • Effective January , , a new Market Unit called Greater China will be established. Taiwan, which is currently part of Market Unit North East Asia, will be grouped with mainland China, Hong Kong and Macau, which currently make up Market Unit China. During , the following changes in the group management team were made: • After the successful completion of the restructuring programs Per-Arne Sandström, First Executive Vice President and Deputy CEO, has retired. • Kurt Jofs, head of business unit Access, Björn Olsson head of business unit Systems, and Bert Nordberg, head of group function Sales and Marketing, were all appointed as executive vice presidents. • Per Tjernberg, Chief Information Officer and head of group function IT and Sourcing decided to leave the company after the dissolution of his group function described above. • Joakim Westh joined the group management team as head of the new group function Operational Excellence also described above. • Mats Olsson currently head of Market Unit China, has been appointed to head the new market unit Greater China. Please see “Notes to the Financial Statements – Note , E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 91 I N F O R M A T I O N O N T H E C O M P A N Y Information Regarding Employees, Members of the Board of Directors and Management” for more information about management. Business units within the Systems segment Access Our Access business unit’s main role is to continuously strengthen our global leadership in G & G radio access networks by offering innovative and cost-effective solutions that provide best in class performance. Business unit Access’ responsibility covers a wide spectrum of activities, from product development to production to customer delivery. Business unit Access is our largest business unit and has operations in Sweden (Stockholm, Nynäshamn, Kumla and Gävle), Brazil, China and India. Systems Business unit Systems is a leading supplier of end-to-end telecom grade network systems and multimedia services. Our offerings include mobile core and fixed network solutions and service layer. We work as a business partner with our customers to better understand their business objectives and provide tailored solutions to fulfill their business requirements. As a key player in the evolution to an all-IP telecom world, we are leading the convergence of fixed and mobile networks and services. Mobile Systems CDMA The primary task of our CDMA business unit is to create end-to- end solutions for CDMA operators that consist of radio access, core network and service layer products that offer best in class performance. Our CDMA business unit’s responsibility covers a wide spectrum of activities, from product development to marketing and customer delivery. This business unit has operations in the United States (San Diego, Ca. and Boulder, Co.), Canada, China and Brazil. Transmission and Transport Networks The transmission and transport networks business unit provides microwave transmission and broadband digital subscriber line, which are essential elements of Ericsson’s end- to-end solutions. These products are based on open standards and often chosen by operators that also utilize other vendor’s network equipment. The unit’s operations in Borås, Sweden, include the largest microwave production plant in the world as well as a customer distribution center for all transmission and transport products. The transmission and transport business unit operates in Sweden, Norway and Italy. Global Services Global Services helps operators to strengthen their competitiveness by offering a complete range of advisory, integration, managed and support services that addresses a major part of their network operations. In addition, network rollout services are often included as part of our network equipment offering. The business unit is represented in countries with , people mainly based within the local Market Units. Business units within the segment Other Operations This segment principally consists of a number of operations deemed too small to be reported as separate segments. Other operations include Microwave Systems (defense), Enterprise Systems, Network Technologies (cables), Mobile Platforms, Power Modules and a few very small units. Ericsson Microwave Systems Our Microwave Systems (defense systems) unit supplies advanced airborne, terrestrial and marine radar systems. Versions of Ericsson defense systems are operational in Sweden and more than other countries. Ericsson Enterprise Systems Enterprise Systems provides communications systems and services that enable businesses, public entities and educational institutions to have seamless access to applications and services across multiple locations. We focus on providing solutions for Voice over IP (VoIP) based PBX, wireless local area networks (WLAN), and Mobile Intranet solutions. Ericsson Network Technologies Our Network Technologies (cables) unit provides a full range of solutions that integrate copper and optical cables and power networks. A large portion of net sales from our Network Technologies group is attributable to inter-segment sales. Ericsson Mobile Platforms Ericsson Mobile Platforms offers end-to-end interoperability tested platforms for GSM/GPRS, EDGE and WCDMA. This enables application portability, stability and security along with state-of-the-art power consumption and physical size. The product offerings are based on our comprehensive intellectual property portfolio and include: reference design, platform software, ASIC designs and development boards, development tools, training, support and documentation. By licensing our technology and platforms, third party mobile handset and wireless device manufacturers can launch new products faster with limited R&D investments and lower technology risks, allowing them to focus more on product differentiation such as applications, industrial design, distribution and branding. 92 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Ericsson Power Modules Ericsson Power Modules is a leading supplier of DC/DC converters and DC/DC regulators mainly to the communications industry, for advanced applications such as multiplexers, switches, routers and radio base stations. In addition, the levels of technology, ruggedness and reliability of Ericsson Power Modules products mean that they often provide excellent solutions for other demanding applications in medical, avionics, computing, military, space, and industrial market sectors. Manufacturing is carried out at facilities in Kalmar, Sweden, and in Shanghai, China. Research & Development A robust R&D program is key to our competitiveness and future success. We invested SEK . billion in R&D during , which represents over percent of sales. The majority of our R&D is invested in mobile communications network infrastructure. Even though total R&D spending has been significantly reduced over the last several years, we have maintained a high investment level in the strategically important areas of broadband access, core networking and service layer. Our R&D organization develops world-class products and performs world-leading research on behalf of the business units. About , employees in countries worldwide are working with R&D in an organization consisting of group functions, development units and Ericsson Research. Ericsson Research conducts applied research in various strategic areas to provide Ericsson with system concepts, technology, and methodology to help secure our long term, strategic position. World-class innovations are achieved through cooperation within Ericsson and with a variety of partners including customers, universities and research institutes. Ericsson Research operates in Sweden, Finland, Japan, Canada, China, Germany, Hungary and the United States. Please see “Risk Factors – Strategic and Operational Risks” and “Board of Directors’ Report – Research and Development” for more information regarding product and technology development. I N F O R M A T I O N O N T H E C O M P A N Y Sales and Marketing We use our own sales organization to market and sell our systems and services to customers in over countries via a worldwide sales and support network consisting of market units. Each market unit represents either a single country or a group of countries, depending on the extent of our business activities in that region. The majority of these market units operate through local subsidiaries that are present in each country. We use our local presence to help our customers achieve greater efficiencies and gain access to recognized world- class support resources wherever they operate. The market units utilize the product expertise of the central business units within the Systems segment in tailoring and integrating our products for delivery to customers. The market units are also responsible for after-sales support and rely in particular on the Global Services business unit in fulfilling this function. Businesses in our Other Operations segment market their products and services through their own specialized direct and indirect sales channels. On occasion, these specialized sales and marketing teams work with our market units in certain markets or when dealing with large customers with whom we have a relationship. Ericsson Group Functions Group Function responsibilities include the formulation of the Group’s strategy, business control, resource allocation and risk management. In addition, Group Functions are also responsible for the consolidation and reporting of financial performance, communications with various stakeholders including employees, investors, press and media, as well as administration of a number of Group-wide issues. Other important Group- wide matters such as Human Resources, Legal and Corporate Social Responsibility are managed by Group Functions in conjunction with a network of experts from various parts of the company. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 93 I N F O R M A T I O N O N T H E C O M P A N Y Phones – Sony Ericsson Mobile Communications In October , we formed Sony Ericsson Mobile Communications as a / joint venture with SONY Corporation. The partnership with SONY leverages our knowledge of mobile telecommunications technologies and their expertise in consumer electronic devices and multimedia technology. Sony Ericsson provides a full range of mobile handsets and also allows us to provide end-to-end solutions to our customers. Sony Ericsson is responsible for product design and development, as well as marketing, sales, distribution and customer services. About one third of Sony Ericsson handsets are produced at their factory in China. The remaining two thirds of production is more or less equally split between contract (EMS) manufacturers and other device (ODM) manufacturers at locations in several countries in Asia, Latin America and Europe. Sony Ericsson’s global management is based in London, has R&D centers in Sweden, Japan, China, US and UK. INTELLECTUAL PROPERTY AND LICENSING Through many years of involvement in the development of new technologies, we have built up a considerable portfolio of intellectual property rights relating to telecommunications technologies, especially mobile communications. As of December , , we held over , (,) patents worldwide, including a substantial number of patents essential to the G/.G standards of GSM, TDMA and CDMA, as well as numerous patents essential to G standards, including WCDMA, HSDPA, CDMA and EDGE. We also hold important patents for many other areas, e.g. Voice over IP (VoIP), ATM, WAP, WLAN, mobile platforms and Bluetooth. Furthermore, we have applied for an additional , patents that are pending approval and we hold a number of trademarks around the world. Our intellectual property rights are valuable business assets. We license these rights to many other companies including equipment suppliers, handset manufacturers and wireless applications developers, in return of royalty payments and/or access to additional intellectual property rights. Sometimes, we acquire rights via licenses to utilize intellectual property rights of third parties. We believe that we have access to all related patents that are material to our business in part or in whole. For more information, see “Risk Factors – Strategic and Operational Risks”. PROPERTY, PLANT AND EQUIPMENT During and , we disposed of the majority of the real estate properties that we owned. We believe the properties we now occupy are suitable for our present needs in most locations, but due to restructuring and reduced headcount, we have certain amounts of excess space, which we are working to reduce. As of December , , no land, buildings, machinery or equipment were pledged as collateral for outstanding indebtedness. Manufacturing and assembly Our Systems manufacturing consists of two basic production activities, module and node. We have significant manufacturing and assembly locations worldwide with a total of approximately , square meters of floor space. We lease all of these facilities except one in China and one in Brazil. The Systems segment consumes more than two-thirds of the total floor space with cables and power modules consuming most of the rest. In addition, we outsource a significant amount of systems module production to several electronic manufacturing service (EMS) companies, who have major sites in Sweden, Poland, Estonia, and Hungary as well as several locations in China. In Sweden, the majority of the floor space within our production facilities is used for module production with the balance mostly used for systems node assembly and testing. Including the EMS production, approximately – percent of Systems module production and – percent of Systems node production is performed in Sweden. We intend to continue to outsource module production where adequate manufacturing capacity and expertise are available on favorable terms. Such outsourcing of the major part of module manufacturing provides us greater flexibility to adapt to economic and market changes. However, the timing and level of outsourcing is a balance between short-term demand and longer-term flexibility. Therefore, we also plan to normally use our own production capabilities to absorb temporary changes in volumes. We manage our own production capacity on a global basis by allocating production to sites where capacity is available and costs are competitive. At year-end , our overall utilization was close to percent as we continuously adjust our production capacity to meet expected demand. The table below summarizes our manufacturing and assembly facilities as well as the total square meters of floor space at year-end. 94 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Manufacturing and assembly facilities 2004 2003 2002 Sites Sq Meters Sites Sq Meters Sites Sq Meters Country Sweden Brazil China USA Other Total 10 1 3 0 0 14 277,415 15,840 15,200 0 0 308,455 10 1 3 0 0 14 310,000 22,100 9,500 0 0 341,600 11 1 3 3 1 19 327,000 22,100 9,500 14,400 6,600 379,600 During , a new , square meter facility in Jaipur, India, will start systems node assembly. During , our approximately , square meter production facility in Nynäshamn, Sweden, will be closed. The production will be absorbed by other Swedish sites. Sources and availability of materials We purchase raw materials, electronic components, ready- made products and services from a significant number of domestic and foreign suppliers. Variations in market prices for copper, aluminum, steel, silicon, precious metals, plastics and other raw materials have a very limited effect on our total cost of goods sold. Our purchases mainly consist of electronic components as well as ready-made products and services. To a limited extent, we are involved in the production of certain components such as power modules and cables, which are used in our systems products as well as sold externally to other equipment manufacturers. Based on our most recent sourcing agreements, the increase in oil prices during did not have a material impact on the costs or affected the availability of the electronic components or ready-made products and services that we require. To the extent possible, we rely on alternative supply sources for the purchased elements of our products to avoid sole source situations and to secure sufficient supply at competitive prices. Assuming there will only be a slight increase in market demand, we do not foresee any supply constraints to meet our expected production requirements during . HUMAN RESOURCES We believe that every employee should be treated with the same respect and dignity. We value the rich diversity and creative potential of people with differing backgrounds and abilities. A culture of equal opportunities in which personal success depends on personal merit and performance is encouraged throughout our operations. We have three core values: Professionalism, Respect and Perseverance. These values form the foundation of how we operate our business. Our core values define how employees treat each other, our customers and our business partners and therefore they define our culture. Characteristics of our culture are exhibited by a passion to win; employee diversity, honesty, trust and support for each other; integrity and high ethical I N F O R M A T I O N O N T H E C O M P A N Y standards; and leadership by example at all levels. We believe the best way to further develop our business is to remain accountable to ourselves and to our customers. We maintain an open management style that involves our employees in both daily decisions that affect them as well as longer term matters. We are fully committed to keeping all employees informed about the implications of major business changes and other relevant matters. Key business priorities are communicated throughout the organization and form part of the basis for employee compensation and incentive plans. Details of these plans appear in “Notes to the Financial Statements – Note , Information Regarding Employees, Members of the Board of Directors and Management”. We also have constructive relationships with a variety of trade unions including formal recognition and active dialogue where appropriate. Employees by gender and age at year end 2004 Female Male Under 25 years old 26-40 years old 41-55 years old Over 55 years old Percent of total 369 8,141 3,421 522 25% 1,120 23,936 11,412 1,613 75% 100% Percent of total 3% 64% 29% 4% Employees by region at year end Western Europe Of which Sweden Asia Pacific North America Latin America Central Eastern Europe, Middle East and Africa Total Employees allocated to CoS and Opex Cost of Sales Operating Expenses Total 2004 2003 2002 32,930 21,296 7,493 4,139 2,549 36,227 24,408 6,468 4,460 2,276 45,251 30,241 7,771 6,328 2,822 3,423 2,152 2,449 50,534 51,583 64,621 2004 2003 2002 19,234 31,300 15,414 36,169 18,606 46,015 50,534 51,583 64,621 CORPORATE SOCIAL RESPONSIBILITY We aim to establish and maintain high standards of corporate social responsibility wherever we operate. A cross-functional committee oversees our activities in this area. Policies and directives relating to corporate responsibility are maintained and widely communicated within the organization. In , Ericsson was again included in the FTSEGood and the Dow Jones Sustainability Indexes. A Sustainability Report is published during the second quarter of each year. Also see our web site at www.ericsson.com/about/responsibility.shtml for more information including economic, social and environmental E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 95 I N F O R M A T I O N O N T H E C O M P A N Y aspects of our strategy and business activities. Information on our web site does not form part of this document. We are subject to certain environmental, health and safety laws and regulations that affect our operations, facilities and products in each of the jurisdictions in which we operate. We strive to comply with environmental requirements and to provide workplaces for our employees that are safe, environmentally sound, and that will not adversely affect the health or environment of the communities in which we operate. We believe that we are in compliance with all material environmental and health safety laws and regulations required by our operations and business activities. PARENT COMPANY OPERATIONS The business of the parent company, Telefonaktiebolaget LM Ericsson, consists mainly of corporate management and holding company functions. Parent company operations also include internal banking and customer credit management activities performed by Ericsson Treasury Services AB and Ericsson Credit AB. As of December , , our parent company had branch and representative offices in countries and had approximately employees. SUBSIDIARIES AND ASSOCIATED COMPANIES For a listing of our significant subsidiaries, please see Notes to the Financial Statements – “Note , Investments”. In addition to our joint venture with Sony, we are engaged in a number of other joint ventures, cooperation arrangements and venture capital initiatives. Please see “Risk Factors – Risks Associated with our Business” for more information regarding risks associated with joint ventures, strategic alliances and third party agreements. 96 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Corporate Governance INTRODUCTION We are committed to meeting the highest standards of corporate governance. Our internal rules for ethical behavior and other important rules for business conduct have since long been established for all directors, officers and employees through our group steering policies and directives. We believe our management controls and procedures generally are in line with global best practices, although we continuously seek ways to make our corporate governance even more effective and reliable. Our continued adherence to high international standards of corporate governance and maintaining Ericsson’s reputation for good corporate citizenship and integrity requires the ongoing support and commitment of all of our employees. Our Code of Business Ethics and Conduct summarizes the policies and directives which we expect all directors, managers and employees of the Ericsson group to follow. The fundamental purpose of the Code is to reaffirm our commitment to the values of good corporate citizenship and integrity. The Code of Business Ethics and Conduct, which has been translated to more than twenty languages and communicated to all employees around the globe, has contributed to a higher awareness of the importance of high ethical standards. All employees, managers and directors are required to periodically review the Code of Business Ethics and Conduct and must acknowledge that they have understood and agree to comply with the principles outlined therein. Our Code of Business Ethics and Conduct satisfies the applicable requirements of NASDAQ and the US Securities and Exchange Commission (“SEC”) pursuant to the Sarbanes-Oxley Act of . The Code can be found at: http://www.ericsson.com/about/code_business_ethics/ We comply with the listing requirements of the stock exchanges we are listed on, that is Stockholmsbörsen, the London Stock Exchange and NASDAQ. We also satisfy the applicable NASDAQ corporate governance requirements, subject to a few exceptions, which principally reflect legal requirements in Sweden. These exceptions have been granted by NASDAQ and are explained under “NASDAQ Corporate Governance Exemptions”. We also comply with the applicable requirements of the Sarbanes-Oxley Act; including the certification of our Annual Report on the SEC’s Form -F by the Chief Executive Officer and Chief Financial Officer. On December , , the Swedish Code Group (Sw. Kodgruppen) presented its final proposal for a Swedish Code on Corporate Governance. The Code is expected to become effective on July , , in any case with respect to larger listed companies. C O R P O R A T E G O V E R N A N C E The Board has resolved that the Company will apply the Code from the day it becomes effective. MEETINGS WITH THE SHAREHOLDERS In accordance with the Swedish Companies Act and Ericsson’s Articles of Association, shareholders who exercise their voting rights at the Annual General Meeting determine the composition of the Board of Directors and all other issues voted on at the General Meetings of Shareholders. At General Meetings of Shareholders each Class A-share carries one vote, each Class B-share one tenth of one vote and each Class C-share one thousandth of one vote. The Annual General Meeting shall be held within six months after the end of the financial year and is normally held at the end of March or beginning of April. In accordance with the Articles of Association, the General Meetings of Shareholders are held in Stockholm. A shareholder may attend and vote at the Meeting in person or by proxy. Proxies are not valid for more than a year from the date of issuance. We publish notices to attend Annual and Extraordinary Meetings. In such notices we provide information about the agenda for the meeting as well as information on how to notify us of attendance. Under the Swedish Companies Act, resolutions are normally passed by simple majority. However, the Act requires special quorums and majorities in certain cases. A shareholder may cast the full number of votes represented by the holder’s shares. The Annual General Meeting offers shareholders the opportunity to raise questions regarding the Company and the results of the year under review. The members of the Board of Directors, the executive management as well as the external auditors are normally all present to answer such questions. Shareholders and other interested parties may communicate directly with the Board of Directors or executive management independent of the Annual General Meeting. All communications should be in writing directed to the Board of Directors’ Secretariat. The sender should indicate in the address whether the communication is intended for the entire Board, an individual Director or any of the management team members. NOMINATION COMMITTEE The main task of the Nomination Committee is to propose candidates for election to the Board of Directors. The Nomination Committee also prepares proposals concerning Directors’ fees, which are presented at the Annual General Meeting for resolution, and presented in“Notes to the Financial Statements – Note , Information Regarding Employees, Members of the Board of Directors and Management”. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 97 C O R P O R A T E G O V E R N A N C E Members The Nomination Committee, elected by the Annual General Meeting, consists of Anders Nyrén (Chairman of the Committee), Industrivärden, Bengt Belfrage, Nordea Fonder, Christer Elmehagen, AMF Pension, Björn Svedberg, Investor, and Michael Treschow (Chairman of the Board of Ericsson) Remuneration The Committee has not received any remuneration. BOARD OF DIRECTORS General According to our Articles of Association, the Board of Directors shall consist of a minimum of five directors and a maximum of twelve directors, with no more than six deputies. The directors shall be elected each year at the Annual General Meeting for the period up to and including the following Annual General Meeting. A director may serve any number of consecutive terms. In addition, under Swedish law, unions have a right to appoint three directors and their deputies to the Ericsson Board of Directors. The Board of Directors is ultimately responsible for the organization of the company and the management of the company’s operations. The President/CEO is charged with the day-to-day management of the company in accordance with guidelines and instructions provided by the Board of Directors. According to the Swedish Companies Act, a member of the Board of Directors and the President/CEO may not participate in decisions regarding agreements between the individual concerned and the company. Nor may such member participate in decisions regarding agreements between the company and third parties where the individual concerned has a material interest in the matter, which may conflict with the interests of the company, or as to agreements between the company and a legal entity which the individual concerned may represent, either individually or together with any other person. The Audit Committee has, further, implemented a procedure for the approval of related party transactions in accordance with NASDAQ’s corporate governance rules. The Annual General Meeting decides on compensation for the Directors of the Board. Board work The Board of Directors has established its work procedure in accordance with the requirements of the Swedish Companies Act. It has been developed to comply with reporting, disclosure and other requirements on listed companies by Stockholmsbörsen, the London Stock Exchange, NASDAQ and the US Securities and Exchange Commission. The Board schedules at least six meetings each year. Training sessions as well as site visits are scheduled in order to enhance the Directors’ knowledge of the company. The Board meets with the external auditors on a regular basis. The auditors present their observations from the audit of the annual report as well as their reviews of interim reports and internal controls. The work of the Board and its Committees during is described in more detail in the Board of Directors’ Report. Work Procedure The Board designates, through the work procedure, how various tasks will be distributed among the Board and its committees as well as between the Board, its committees and the President. This work procedure is reviewed and adopted by the Board whenever necessary, but at least once a year. The work of the committees is principally of a preparatory character, i.e. the committees prepare matters for final resolution by the Board. However, the Board has authorized each committee to decide on certain issues in limited areas and may also provide extended authorization to a committee to decide on specific matters. Committees of the Board The Board of Directors currently has three committees, i.e. the Audit, Finance and Remuneration Committees. The Board appoints Committee members from among its members. The Audit Committee The Audit Committee assists the Board in monitoring the integrity of the financial statements, the compliance with legal and regulatory requirements, the qualification, independence and performance of our external auditors and the effectiveness of our systems of internal controls for financial reporting. The Audit Committee is primarily responsible for reviewing annual and interim financial reports, overseeing the external audit process, including audit fees and the internal audit function, and resolving matters arising during the course of audits. However, the Audit Committee does not itself perform audit work. Pursuant to the Board’s work procedure, the Audit Committee reviews the audited financial statements with management and the external auditors, including conformity with generally accepted accounting principles. The Audit Committee also reviews with management the reasonableness of significant estimates and judgments made in preparing the financial statements, as well as the quality of the disclosures in the financial statements. In addition, the Audit Committee reviews matters and reservations arising from audits performed. The Audit Committee has also implemented approval procedures for audit and non-audit services performed by external auditors in order to safeguard the auditors’ independence from the management and the company. Further details about these procedures are provided under “Audit 98 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Committee Pre-approved policies and Procedures”. During the year, the Committee meets for a strategic C O R P O R A T E G O V E R N A N C E The Audit Committee has also implemented a pre-approval process for transactions with related parties and a procedure for the reporting of suspected violations of, for example, laws, regulations or our Code of Business Ethics and Conduct; a so called whistle-blower procedure. The Audit Committee is authorized to engage and determine funding for independent counsel and other advisors to the Committee. Membership during included Sverker Martin-Löf, Chairman of the Committee, Sir Peter L. Bonfield, Jan Hedlund and Eckhard Pfeiffer. Members of the Audit Committee must be independent from the operational management, financially literate and familiar with the accounting practices of an international company comparable to Ericsson. At least one member must have accounting or financial management expertise. The Board of Directors has determined that each Sverker Martin-Löf, Sir Peter L. Bonfield and Eckhard Pfeiffer satisfy these requirements. The Finance Committee The Finance Committee is primarily responsible for handling matters regarding acquisitions and divestments, capital contributions to companies inside and outside the Ericsson group, raising of loans, issuances of guarantees and similar undertakings and approvals of financing support to customers, as well as continuously monitoring the group’s financial risk exposure. The Finance Committee consists of four members appointed by the Board from among its members. Membership during included Marcus Wallenberg, Chairman of the Committee, Arne Mårtensson, Michael Treschow and Torbjörn Nyman. The Remuneration Committee The Remuneration Committee is primarily responsible for reviewing and preparing proposals of salary and other remuneration, including retirement compensation, to the CEO, the Executive Vice Presidents, and other officers reporting directly to the CEO. These proposals are thereafter presented to the Board for resolution. In addition, the Committee is responsible for strategies and general guidelines with respect to employee compensation, including incentive plans and retirement compensation At the beginning of each year, the Committee approves any short-term incentive payments to be made from the previous year’s plan and prepares for resolution by the Board any long- term incentive plan prior to being presented at a meeting of shareholders. compensation review with representatives of the company. The Committee members consider trends in compensation, legislative changes, disclosure rules and the general global environment surrounding executive pay. The outcome is to agree on the direction Ericsson will follow so that program designs and pay policies all align with the business situation. The Committee schedules a meeting in October each year, entirely dedicated to long-term incentive plans to be presented to the shareholders the following year. At the end of the year, the Committee reviews salary survey data to approve any increase of base pay for the following year for executives. Increases, if any, are effective from the following January. The Remuneration Committee also prepares for resolution by the Board the short-term incentive targets for the following year. The Remuneration Committee consists of four members appointed by the Board from among its members. Peter Sutherland was the Chairman of the Committee until the Annual General Meeting , at which he was replaced by Michael Treschow. Nancy McKinstry has been a member since the Annual General Meeting . In addition, Lena Torell and Per Lindh served on the Committee. Remuneration of the Board The Annual General Meeting of shareholders resolved on April , , that directors’ fees in the total amount of maximum SEK million should be distributed by the Board of Directors among its members elected by the Annual General Meeting not being employees of the company. Out of the SEK million, SEK . million has been utilized. For the distribution of this amount amongst the members of the Board, please be referred to “Notes to the Financial Statements – Note , Information Regarding Employees, Members of the Board of Directors and Management”. Review/self-evaluation The Chairman of the Board has discussions with each member of the Board in order to evaluate the performance of the Board. The Board, exclusive of the Chairman, evaluates the performance of the Chairman and the entire Board evaluates the work of the President/CEO. MEMBERS OF THE BOARD Our Board of Directors consists of nine Directors elected by the shareholders at the Annual General Meeting for the period until the close of the next Annual General Meeting, and three employee representatives, each with a deputy, appointed by the respective trade union. The Chairman is elected by the Board from among its members. The President/CEO of the company may be elected Director, as is the case at present. However, the Swedish Companies Act prohibits the President of a public company to be elected chairman of the Board. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 99 C O R P O R A T E G O V E R N A N C E The Directors participate, with very few exceptions, in all of the Board of Directors’ meetings and are, to the extent possible, also present at the General Meetings of Shareholders. Michael Treschow, Director (since 2002) Chairman of the Board of Directors. Chairman of the Remuneration Committee and member of the Finance Committee. Chairman of the Board of Directors of Electrolux and Member of the Board of Directors of ABB and B-Business Partners. Chairman of the Confederation of Swedish Enterprise. Arne Mårtensson, Director (since 2003) Econ. Dr h.c. Deputy Chairman of the Board of Directors and member of the Finance Committee. Chairman of the Board of Directors of Handelsbanken. Member of the Board of Directors of Holmen, Industrivärden, Sandvik, Skanska and V&S Vin & Sprit. Chairman of the Advisory Board of Stockholm School of Economics. Member of the Swedish Industry and the Commerce Stock Exchange Committee and the International Business Council of the World Economic Forum. Marcus Wallenberg Director (since 1996) Deputy Chairman of the Board of Directors and Chairman of the Finance Committee. President of Investor. Deputy Chairman of Saab and SEB. Member of the Board of Directors of AstraZeneca, Investor, Scania, Stora Enso and the Foundation of Knut and Alice Wallenberg. Sir Peter L. Bonfield, CBE, FREng Director (since 2002) Member of the Audit Committee. Senior Non-Executive Director of the Board of Directors of AstraZeneca, Member of the Board of Directors of Mentor Graphics and T.S.M.C. Member of the International Advisory Board of Citigroup and of the Sony Corporation Advisory Board. Non-Executive Director of the Corporate Board of the Department for Constitutional Affairs. Vice President of the British Quality Foundation. Sverker Martin-Löf, Director (since 1993) Chairman of the Audit Committee. Chairman of the Board of Directors of SCA, SSAB and Skanska. Member of the Board of Directors of Handelsbanken, Industrivärden and the Confederation of Swedish Enterprise. Eckhard Pfeiffer, Director (since 2000) Member of the Audit Committee. Chairman of the Board of Directors of Intershop Communications. Member of the Board of Directors of General Motors, IFCO Systems and Syntek Capital. Member of the Advisory Board of Deutsche Bank. Nancy McKinstry, Director (since 2004) Member of the Remuneration Committee. CEO/Chairman of the Executive Board of Wolters Kluwer nv. Member of the Board of Directors of MortgageIT, Inc. Member of the Advisory Council of the University of Rhode Island. Member of the Advisory Council of ABN AMRO Holding nv. Carl-Henric Svanberg, Director (since 2003) President and CEO of Telefonaktiebolaget LM Ericsson. Member of the Board of Directors of Assa Abloy and Hexagon. Lena Torell, Director (since 2002) Doctor of Physics. Professor. Member of the Remuneration Committee. President of the Royal Swedish Academy of Board of Directors Name Michael Treschow Arne Mårtensson 1) Marcus Wallenberg 1) Peter L. Bonfield Sverker Martin-Löf 1) Eckhard Pfeiffer Nancy McKinstry Carl-Henric Svanberg Lena Torell Jan Hedlund Per Lindh Torbjörn Nyman Monica Bergström Anna Guldstrand 2) Arne Löfving Member since Age Position Number of Class A shares Number of Class B shares Options 2) 2002 2003 1996 2002 1993 2000 2004 2003 2002 1994 1995 2004 1998 2004 2003 61 53 48 60 61 63 45 52 58 58 47 43 44 40 51 Chairman Deputy Chairman Deputy Chairman Director Director Director Director Director & CEO Director Employee Representative Employee Representative Employee Representative Deputy Employee Representative Deputy Employee Representative Deputy Employee Representative – – – – – – – – – – – – – – – 770,000 13,400 704,000 – 52,000 3,040 – 15,584,490 50,000 875 249 3,010 900 2,428 5,326 – – – – – – – – – – – – – 900 – 1) Arne Mårtensson and Sverker Martin-Löf are also Directors of Industrivärden. Marcus Wallenberg is President and Director of Investor. Investor and Industrivärden are Ericsson’s two largest shareholders, based on voting rights. 2) Number of Class B shares assuming full exercise of options under applicable plan. 100 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Engineering Science. Member of the Board of Directors of Gambro, Micronic Laser Systems, Imego, Ireco Holding, Mistra and the European Council of Applied Sciences and Engineering. Lena Torell has declined re-election at the Annual General Meeting of Shareholders . Jan Hedlund, Director (since 1994) Member of the Audit Committee. Employee representative. Per Lindh, Director (since 1995) Member of the Remuneration Committee. Employee representative. Torbjörn Nyman, Director (since 2004) Member of the Finance Committee. Employee representative. Monica Bergström, Deputy Director (since 1998) Employee representative. Anna Guldstrand, Deputy Director (since 2004) Employee Representative Arne Löfving, Deputy Director (since 2003) Employee representative. Carl-Henric Svanberg is the only Director who holds an operational management position at Ericsson. No Director has been elected pursuant to an arrangement or understanding with any major shareholder, customer, supplier or other person. C O R P O R A T E G O V E R N A N C E COMPANY MANAGEMENT The Managing Director and Chief Executive Officer – Operational Management The Board of Directors appoints the President, the Chief Executive Officer and Executive Vice Presidents. Management of day-to-day operations is the responsibility of the Chief Executive Officer and the Group Management Team consisting of, apart from the Chief Executive Officer, the Chief Financial Officer, the heads of Group Functions, Chief Technical Officer & head of Research & Development and the heads of Business Units Access, Systems, Mobile Systems CDMA and Global Services. Information about the Compensation policy is described in Note . Carl-Henric Svanberg Master of Science degree, Linköping Institute of Technology, Sweden, and Bachelor of Science degree in Business Administration, Uppsala University, Sweden. President & Chief Executive Officer and member of the Board of Directors (since April ). Prior to assuming this position, Carl-Henric Svanberg was the President and Chief Executive Officer of the Assa Abloy Group. Member of the Board of Directors of Assa Abloy and Hexagon. Karl-Henrik Sundström Bachelor degree in Finance, Uppsala University and Advanced Management Program, Harvard Business School. Executive Vice President and Chief Financial Officer and head of Group Function Finance (since April ). Prior to assuming this position, Karl-Henrik Sundström was head of Business Unit Global Services. Group Management Team Name Carl-Henric Svanberg Karl-Henrik Sundström Kurt Jofs Bert Nordberg Björn Olsson Carl Olof Blomqvist Joakim Westh Marita Hellberg Mats Granryd Torbjörn Nilsson Henry Sténson Håkan Eriksson Hans Vestberg Appointed year Age Position Class A shares Class B shares Options 1) 2) 2003 2003 2004 2004 2004 1999 2004 2003 2004 1998 2002 2004 2003 52 44 46 48 48 53 43 49 42 51 49 43 39 President & CEO Executive Vice President & CFO and Head of Group Function Finance Executive Vice President and Head of Business Unit Access Executive Vice President and Head of Group Function Sales & Marketing Executive Vice President and Head of Business Unit Systems Head of Group Function Legal Affairs Head of Group Function Operational Excellence Head of Group Function Human Resources & Organization Head of Business Unit CDMA Head of Group Function Strategy & Product Management Head of Group Function Communications Head of Research & Development and Chief Technology Officer Head of Business Unit Global Services – – – – – 6,080 - – – – – – – 15,584,490 7,581 – 328,814 203,446 – 14,407 367,248 12,545 343,835 14,961 100,000 26,530 7,534 51,364 11,965 2,332 322,096 – 135,952 571,923 100,000 283,308 9,897 143,763 1) Aggregate number of Class B shares assuming full exercise of options under applicable plans. 2) No options were granted during 2004. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 101 C O R P O R A T E G O V E R N A N C E Kurt Jofs Master of Science degree, Royal Institute of Technology in Stockholm, Sweden. Executive Vice President and general manager Business Unit Access (since January ). Prior to assuming this position Kurt Jofs has held senior management positions in, among others, Linjebuss and ABB Ventilation Products. Board member of ATEA and Chairman of the Board of Peoples Travel Group. Bert Nordberg Bachelor degree in Electronic Engineering, Malmö, and Engineer in the Marines, Berga and university courses in International Management, Marketing and Finance, Insead University, France. Executive Vice President and head of Group Function Sales & Marketing (since January ). Prior to assuming this position, Bert Nordberg was head of Business Unit Systems. Björn Olsson Master of Science degree in Industrial Engineering and Management, Linköping Institute of Technology, Sweden. Executive Vice President and general manager Business Unit Systems (January ). Prior to assuming this position, Björn Olsson was Chief Information Officer. Marita Hellberg Bachelor degree, University of Stockholm, Sweden, and Advanced Management Program, Cedep, France. Senior Vice President and head of Group Function Human Resources & Organization (since September ). Prior to assuming this position, Marita Hellberg was Senior Vice President of Human Resources of NCC Group. Torbjörn Nilsson Master of Science degree, Lund’s University and Master of Business Administration, University of Stockholm. Senior Vice President (since October ) and head of Group Function Strategy & Product Management. Prior to assuming this position, Torbjörn Nilsson was head of Group Function Marketing & Strategic Business Development. Henry Sténson Studied law, sociology and political science, Linköping University, Sweden, and at the Swedish War Academy, Karlberg, Stockholm. Senior Vice President and head of Group Function Communications (since May ). Prior to assuming this position, Henry Sténson was head of SAS Group Communication, SAS AB. Carl Olof Blomqvist Bachelor’s degree MLL, University of Uppsala, Sweden. Senior Vice President and general counsel and head of Group Function Legal Affairs (since May ). Prior to assuming this position, Carl Olof Blomqvist was a partner of Mannheimer Swartling law firm. Hans Vestberg Bachelor of Business Administration degree, University of Uppsala, Sweden. Senior Vice President and general manager Business Unit Global Services (since January ). Prior to assuming this position, Hans Vestberg was head of Market Unit Mexico. Håkan Eriksson Master of Science degree in Electrical Engineering, Linköping Institute of Technology, Sweden. Senior Vice President and Chief Technology Officer and general manager Research & Development (since January ). Prior to assuming this position, Håkan Eriksson was Vice President & general manager Research & Development. Mats Granryd Master of Science degree, Royal Institute of Technology, Stockholm, Sweden. Senior Vice President and general manager Business Unit Mobile Systems CDMA (since February ). Prior to assuming this position Mats Granryd was head of Core Unit Supply. Board member of Sitel, Algeria (a non-consolidated joint venture, of which Ericsson owns percent). Joakim Westh Master’s degree of science, Royal Institute of Technology, Stockholm, Sweden and Master of Science degree within Aeronautics & Astronautics, MIT, Boston, USA. Senior Vice President and head of Group Function Operational Excellence (since December ). Prior to assuming this position, Joakim Westh was head of J. Westh Företagsutveckling AB. Chairman of the Board of Directors of Absolent AB and member of the Board of Directors of VKR Holding A/S. In addition to the Group Management Team, there is an Extended Management Team consisting of the officers of the Group Management Team and: • Cesare Avenía, Vice President and general manager Market Unit Italy and global customer account executive Telecom Italia; • Sivert Bergman, Vice President and general manager Business Unit Transmission & Transport Networks; • Rory Buckley, Vice President and general manager Market Unit North East Asia; 102 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 • Ragnar Bäck, chairman of the Market Units within the Central Europe, Middle East & Africa (CEMA) regions and acting head of Market Unit Central Europe; • Jan Campbell, Vice President and general manager Market Unit India & Sri Lanka; • Sandeep Chennakeshu, President Ericsson Mobile Platforms AB; • Mats Dahlin, Vice President & general manager Business Unit Enterprise; • Jef Keustermans, Vice President and general manager Market Unit Northern Europe; • Kinson Loo, Vice President and global customer account executive Hutchison; • Ingemar Naeve, Vice President and general manager Market Unit Iberia and global customer account executive Telefónica; • Anders Olin, Vice President and global customer account executive Vodafone; • Mats Olsson, Vice President and general manager Market Unit China; • Torbjörn Possne, Vice President and global customer account executive Deutsche Telekom; • Angel Ruiz, Vice President and general manager Market Unit North America; • Kristian Teär, Vice President and general manager Market Unit South East Asia; and • Gerhard Weise, Vice President and general manager Market Unit Mexico. During , the officers below were members of the Group Management Team of the company: Per-Arne Sandström Former First Executive Vice President and deputy CEO. Per-Arne Sandström left the company on July , . Per Tjernberg Former Senior Vice President and head of Group Function IS/IT & Sourcing. Per Tjernberg left the company on October , . No member of the Extended Management Team has any business activities which compete with or in any other way negatively affect Ericsson’s business, and no member of the Extended Management Team has been appointed on account of any arrangement or understanding with any major shareholder, customer, supplier or other person. C O R P O R A T E G O V E R N A N C E Operational Units Our operational organization is built around a structure of development units, responsible for the development of new products and services. Further, there are centralized business units responsible for the provision of products and services to decentralized market units that are responsible for sales, marketing and customer support. A significant amount of authority and responsibility is assigned to the management of our various operating units for tasks pertaining to daily operations. Governance of our operating units is carried out by steering committees, which members are representatives of the Group Management Team, the Extended Management Team and the management of the particular operating unit. Group Functions A number of Group Functions are used to perform tasks pertaining to certain group-wide matters that are not naturally referable to a specific operational unit. These responsibilities include the formulation of the Group’s strategy, business control, resource allocation and risk management. In addition, Group Functions are also responsible for the consolidation and reporting of financial performance, legal issues, communications with the investment community and administration of a number of Group-wide issues. Other important Group-wide matters such as Corporate Social Responsibility are managed by Group Functions in conjunction with a network of experts from various parts of the Company. The heads of Communications, Finance, Human Resources and Organization, Operational Excellence, Legal Affairs, Strategy & Product Management, and Sales & Marketing, along with the staff of these functions comprise the Group Functions of the company. AUDITORS In Swedish companies, the external, independent auditors are elected by the shareholders at the Annual General Meeting for a period of four years. The auditors report to the shareholders at Shareholders’ Meetings. To ensure that the Board of Directors’ information and control requirements are fulfilled, the auditors report to the Board regarding the planning, scope and content of the annual audit. The auditors then examine the year-end financial statements and report findings including an assessment of the accuracy, completeness of the accounts as well as adherence to appropriate accounting procedures and principles. In addition, the auditors, at least annually, provide information to the Board about assignments performed in addition to auditing services, the consideration paid for such services and other circumstances of relevance for determining the auditor’s independence. All our quarterly reports are subject to limited review by our auditors. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 103 C O R P O R A T E G O V E R N A N C E Statutory auditors Peter Clemedtson Authorized Public Accountant, PricewaterhouseCoopers Elected (as successor for the remaining mandate period of Carl-Eric Bohlin) until . Audit services performed in other large companies such as: OMX, SinterCast, Electrolux, Medivir, KMT, SEB, Gambro Bo Hjalmarsson Authorized Public Accountant, PricewaterhouseCoopers Elected until . Audit services performed in other large companies such as: Sony Ericsson, OMX, portfolio companies to EQT. Thomas Thiel Authorized Public Accountant, KPMG Elected until . Audit services performed in other large companies such as: Handelsbanken, Holmen, Swedish Match, Folksam, Peab. Deputy auditors Jeanette Skoglund Authorized Public Accountant, PricewaterhouseCoopers Elected until . Audit services performed in several large foreign subsidiaries of global companies. Robert Barnden Authorized Public Accountant, PricewaterhouseCoopers Elected (as successor for the remaining mandate period of Peter Clemedtson) until . Audit services performed in other large companies such as: SCA, Seco Tools, Nobia, VSM Group, AcandoFrontec Stefan Holmström Authorized Public Accountant, KPMG Elected until . Audit services performed in other large companies such as: Atlas Copco, Länsförsäkringar, Swedish Meat, Posten, V&S Vin & Sprit. Fees paid to external auditors Ericsson paid the fees (including expenses) listed in the table in Note for both audit-related and non-audit related services. The Audit Committee will review and pre-approve any non- audit services to be performed by the external auditors, in order to assure that the provision of such services does not impair the auditors’ independence. Audit Committee Pre-approval Policies and Procedures The Audit Committee has particular responsibility for preparing recommendations or proposals for resolution on the performance of, and level of the audit fee payable to, the external auditors. The Audit Committee reviews the scope and execution of audits performed (external and internal) and analyzes the result of and the costs for such audits. Our Audit Committee has established pre-approval policies and procedures for non-audit services performed by the external auditors. Under these policies and procedures, proposed non- audit services either (i) may be pre-approved by the Audit Committee without consideration of specific case-by-case services (“general pre-approval”); or (ii) require the specific pre- approval of the Audit Committee (“specific pre-approval”). Tax, transaction, risk management, corporate finance and attestation and accounting services have received a general pre-approval of the Audit Committee, provided that the estimated fee level for the project does not exceed SEK million. All other audit, audit-related, tax and other services must receive specific pre- approval. The Audit Committee has delegated specific pre- approval authority to the Audit Committee Chairman for proposed services with an estimated fee level not exceeding SEK . million per project. The Chairman reports any pre-approval decisions to the Audit Committee at its next scheduled meeting. Pre-approval authority may not be delegated to management. The policies and procedures also include a list of prohibited non-audit services. Applications to provide services that require specific approval by the Audit Committee must be made by an auditor. Such an application shall be submitted to the CFO and if supported by the CFO, submitted by the CFO to the Audit Committee for final approval. Disclosure Controls and Procedures Ericsson maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed pursuant to the Securities Exchange Act of , its listing agreement with Stockholmsbörsen and the on-going listing requirements of the London Stock Exchange and Nasdaq is recorded, processed, summarized and reported within the time periods specified, and that such information is accumulated and communicated to the management, including the CEO and CFO, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, we have investments in certain entities that we do not control or manage. Accordingly, our disclosure controls and procedures with respect to such entities are necessarily substantially more limited than those we maintain with respect to our subsidiaries. We have carried out an evaluation, under the supervision and with the participation of management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this annual report. Based on the foregoing, our CEO 104 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 C O R P O R A T E G O V E R N A N C E and CFO concluded that our disclosure controls and procedures were effective at the reasonable assurance level. There have been no significant changes in our internal controls or in other factors that could significantly affect our internal controls subsequent to the date we completed our evaluation. Our Disclosure Policies The purpose of our financial disclosure policies is to help achieve a fair market value for Ericsson shares through transparent, informative and consistent communications with the investment community on a fair and equal basis. Our aim is to communicate our strategy and results in such a way that shareholders and potential investors can gain sufficient understanding of how our company works, our operational performance, what our prospects are and the risks that we face that these opportunities may not be realized. Prior to the adoption of the amendment, NASDAQ’s Marketplace Rules provided that foreign private issuers may, upon application, be exempt from certain of its corporate government requirements when these requirements were contrary to the laws, rules or regulations, or generally accepted business practices of the issuer’s home jurisdiction. Ericsson has received (and is entitled to continue to rely thereon under the recently adopted amendment) exemptions from NASDAQ’s corporate governance requirements under the Marketplace Rules as follows: • from the requirement that the majority of the Board consist of, and that each of the Audit and Remuneration Committees consist solely of, independent directors, in order to allow for the required participation of employee representatives on the Board and each committee thereof as mandated by Swedish law; To continue to achieve these goals, we apply the following • from the requirement that an issuer’s director nominees be principles in our financial reporting and disclosure: • Transparency: our disclosure is designed to enhance understanding of the economic drivers and operational performance of our business, in order to build trust and credibility • Consistency: we aim to ensure that our disclosure is consistent and comparable within each reporting period and between reporting periods • Simplicity: we try to disclose information in as simple a manner as possible consistent with allowing readers to gain the appropriate level of understanding of our business operations and performance • Relevance: we aim to avoid information overload by focusing our disclosure on what is relevant to Ericsson’s stakeholders, or as required by regulation or listing agreements • Timely: we utilize well established disclosure controls and procedures to ensure that all disclosures are complete, accurate and performed on a timely basis • Fair and equal: we publish all material information via press release to ensure simultaneous dissemination to all market participants • Best practice: we strive to ensure that our disclosure is in line with industry norms, and if possible lead the way to improved best in class standards. Our website (www.ericsson.com/investors) includes comprehensive information about Ericsson, including an archive of our annual and interim quarterly reports, on- demand-access to recent news and copies of presentations that senior management have given at industry conferences. Nasdaq Corporate Governance Exemptions Pursuant to a recently adopted amendment to NASDAQ’s Marketplace Rules, foreign private issuers such as Ericsson may follow home country practice in lieu of certain of NASDAQ’s corporate governance requirements without seeking a formal exemption from NASDAQ. selected, or recommended for the Board’s selection, by either a majority of independent directors or a nomination committee comprised solely of independent directors, in order to allow for the fact that: () under Swedish law, shareholders (not the Board) have the authority to nominate directors for election to the Board; and () in line with common market practice among Swedish public companies, Ericsson’s Nomination Committee is elected by shareholders; and • from the requirement that the independent directors of the Board have regularly scheduled meetings at which only independent directors are present (“executive sessions”), in order to allow for the fact that under Swedish law: () employee representatives on the Board have the right to participate in all Board and Board committee meetings; and () decisions may not be made by the Board unless, where possible, all of the directors have had the opportunity to participate and have received satisfactory information in order to reach a decision. In addition, with respect to the requirements of NASDAQ’s Marketplace Rules relating to quorums, Ericsson relies on the exemption allowed by the recent amendment. NASDAQ requires that an issuer provide, as specified in the issuer’s bylaws, for a quorum for any meeting of the holders of its common stock, such quorum to be not less than . percent of the outstanding shares of the issuer’s voting common stock. This is contrary to Swedish law followed by Ericsson under which: () meetings of shareholders are convened in accordance with the rules of the Swedish Company Act and the articles of association of the issuer; and () the quorum requirements for any specific meeting of shareholders differs based on the subject matter to be decided upon at the meeting. E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 105 F O R W A R D - L O O K I N G S T A T E M E N T S Forward-looking Statements This Annual Report includes “forward-looking statements” about future market conditions, operations and results. Expressions such as “believe”, “expect”, “anticipate”, “intend”, “may”, “could”, “plan” and similar words are intended to help identify forward-looking statements. Forward-looking statements may be found throughout this document, but in particular in the sections captioned “CEO Letter and Operational Review”, “Board of Directors’ Report” and “Information on the Company” and include, statements regarding: • our goals, strategies and performance expectations; • the markets we currently or soon intend to address; • our liquidity, capital resources, capital expenditures and our credit ratings; • the expected demand for our existing as well as new products and services; • our joint venture and strategic cooperation activities; • technology and industry trends including competition and our customer structure, and • our plans for new products and services including research and development expenditures. Although we believe that the expectations reflected in such statements are reasonable, we cannot assure you that these expectations will materialize. Because forward-looking statements are based on assumptions and estimates, and are subject to risks and uncertainties, actual results could differ materially from those described or implied herein. Important factors that could affect whether and to what extent any of our forward-looking statements materialize include, but are not limited to: • our ability to respond to changes in the telecommunications market and general market conditions in a cost effective and timely manner ; • developments in political, economic and regulatory fields in the markets in which we operate, including allegations of health risks from electromagnetic fields and cost of radio licenses for our customers; • effectiveness of our strategies and their execution including partnerships, acquisitions and divestitures; • financial risks include foreign exchange rate changes, interest rate changes, changes in tax liabilities, credit risks in relation to counterparties, customer defaults under significant customer financing arrangements and risks of confiscation of assets in foreign countries; • reduction in the number of customers due to e.g. mergers, and the negative business consequences of a loss of, or significant decline in, our business with a major customer; • impact of changes in product demand, price erosion, competition from existing or new competitors or new technology and the risk that our products and services may not sell at the rates or levels we anticipate; • our ability to develop commercially viable products, systems and services, to acquire licenses of necessary technology, to protect our intellectual property rights through patents and trademarks and to defend them against infringement, and results of patent litigation; • supply constraints, including component or production capacity shortages, suppliers’ abilities to cost effectively deliver quality products on time and in sufficient volumes, and risks related to concentration of proprietary or outsourced production in a single facility or sole source situations with a single vendor; and • our ability to recruit and retain qualified management and other key employees. Certain of these risks and uncertainties are described further in “Risk Factors.” We undertake no obligation to publicly update or revise any forward-looking statements included in this Annual Report, whether as a result of new information, future events or otherwise, except as required by applicable law or stock exchange regulation. 106 E R I C S S O N – A N N U A L R E P O R T 2 0 0 4 Risk Factors You should carefully consider all the information in this annual report and in particular the risks and uncertainties outlined below. Any of the factors described below, or any other factors discussed elsewhere in this report, could have a material negative effect on our business, operational results, financial condition, liquidity and/or our share price. Furthermore, our operational results may have a greater variability than in the past and we may have more difficulty in accurately predicting future developments. Risk associated with the industry and market conditions We conduct business throughout the world and are subject to the effects of general global economic conditions as well as conditions unique to a specific country and region. In particular, we are affected most by the market conditions within the telecommunications industry. We are subject to political, economic and regulatory changes in the various countries in which we operate all of which could impact our operating results. We conduct business in over countries with a significant proportion of our sales originating from developing markets in Asia Pacific, Latin America, Eastern Europe, the Middle East and Africa. We expect that sales to emerging markets will be an increasing portion of total sales as developing nations and regions around the world increase their investments in telecommunications, especially for mobile communications. We already have extensive operations in many of these countries, which involve certain risks, including volatility in gross domestic product, civil disturbances, economic and political instability, nationalization of private assets and the imposition of exchange controls. Changes in regulatory requirements, tariffs and other trade barriers, price or exchange controls or other governmental policies in the countries in which we conduct business could limit our operations and make the repatriation of profits difficult. In addition, the uncertainty of the legal environment in some regions could limit our ability to enforce our rights. We are subject to the market conditions affecting the capital and operating expenditures of our customers for equipment and services making demand for our products and services highly unpredictable. Adverse economic conditions could cause network operators to postpone investments or initiate other cost-cutting initiatives to improve their financial position, which could result in significantly reduced capital expenditures for network infrastructure. Although the historical Compared annual growth rate (CAGR) for telecommunications network investments is – times global GDP, operator spending for R I S K F A C T O R S R I S K F A C T O R S network equipment and associated rollout services declined substantially from through , before returning to growth in . During this period of declining growth, our business, operating results and share price suffered. We have reduced costs and improved efficiency to restore profitability and establish better flexibility to cost effectively accomodate fluctuations in demand. However, if demand were to fall, or were to be significantly weaker than expected, we may experience further material adverse effects and may incur operating losses in the future. Our business essentially depends upon the continued growth of mobile communications. Most of our business depends on continued growth in mobile communications in terms of both the number of subscriptions as well as increased usage, which in turn requires the continued deployment of our products by customers to meet this increasing traffic demand. In particular, we are dependent on operators in highly penetrated markets to successfully introduce services that cause a substantial increase in usage for both voice and data. In lower-income markets, we are, to a certain extent, dependent on the availability of lower-cost handsets in addition to affordable tariffs by operators to support a continued increase of mobile subscribers. If operators are not successful in their attempts to increase the number of subscribers and/or stimulate increased usage, our business and operational results could be materially adversely affected. Changes in the regulatory environment for telecommunications systems and services could negatively impact our business. Telecommunications is a regulated industry and regulatory changes affect both our customers and us. For example, changes in regulation that impose more stringent, time-consuming or costly planning, zoning requirements or building approvals regarding the construction of base stations and other network infrastructure could adversely affect the timing and costs of new network construction or expansion and the commercial launch and ultimate commercial success of these networks. Similarly, tariff regulation that affects the pricing of new services offered by operators could also affect their ability to invest in network infrastructure, which in turn could affect the sales of our systems and services. License fees, environmental, health and safety, privacy and other regulations may increase costs and restrict operations of network operators and service providers. The indirect impact of these changes in regulation could affect our business adversely even though the specific regulations may not directly apply to our products or us. E R I C S S O N A N N U A L R E P O R T 2 0 0 4 107 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 107 We engage in customer financing, which exposes us to credit and other risks relating to our customers’ businesses and operations. We expect demand for customer financing to continue, especially from operators in emerging markets. We believe customer financing is a competitive factor in obtaining business and we sometimes provide financing to our customers, or provide guarantees to banks or other third parties that provide such financing. In addition, some of our customers purchase products and services from us on deferred payment terms. The risks associated with customer financing may be significant, particularly in relation to network operators that do not yet have an established revenue stream or have limited experience or no proven track record. While we evaluate our customer credits on a regular basis and make appropriate risk provisions, if customers to which we have provided financing encounter financial difficulties and are unable to make payments, defaults could occur and could result in restructuring of the financing arrangements and/or credit losses. Such an event could have a material adverse effect on our business, results of operations or financial condition. For more information on our customer financing arrangements, see “Notes to the Financial Statements – Note , Financial Risk Management and Financial Instruments”. Liability claims related to and public perception of the potential health risks associated with electromagnetic fields could negatively affect our business. We are subject to claims that mobile handsets and other telecommunications devices that generate electromagnetic fields expose users to health risks. At present, a substantial number of scientific studies conducted by various independent research bodies have indicated that electromagnetic fields, at levels within the limits prescribed by public health authority safety standards and recommendations, cause no adverse effect to human health. However, any perceived risk or new scientific findings of adverse health effects of mobile communication devices and equipment could adversely affect us through a reduction in sales. Although we comply with all current safety standards and recommendations regarding electromagnetic fields, we cannot assure you that we will not become the subject of product liability claims or be held liable for such claims or be required to comply with future regulatory changes that may have an adverse effect on our business. See also Board of Directors’ Report – Legal and Tax proceedings. R I S K F A C T O R S Consolidation among network operators may increase our dependence on a limited number of key customers. The market for mobile network equipment is highly concentrated, with the largest operators representing more than percent of the total market. Network operators have experienced significant consolidation, especially for companies operating in different countries. This trend is expected to continue while intra-country consolidation is likely to accelerate as a result of competitive pressure. If the combined companies operate in the same geographic market, less network equipment and associated services may be required. Another possible consequence of customer consolidation is that it could cause a delay in their network investments while they negotiate merger/acquisition agreements, secure necessary approvals, or are constrained by efforts to integrate the businesses. Moreover, fewer significant customers will increase our reliance on key customers and, due to the increased size of these companies, may negatively impact our bargaining position and profit margins. Consolidation among equipment and services suppliers may lead to increased competition and a different competitive landscape. Industry consolidation among equipment suppliers could potentially result in stronger competitors that are better able to compete as end-to-end suppliers as well as competitors who are more specialized in particular areas. Consolidation may also result in competitors with greater resources, including technical and engineering resources, than we have. This could have a material adverse effect on our business, operating results, and financial condition. We operate in a highly competitive industry, which is subject to price pressure and rapid technological change. The markets for our products are highly competitive in terms of pricing, functionality and service quality, the timing of development and introduction of new products, customer service and terms of financing. We face intense competition from significant competitors. Our competitors may implement new technologies before we do, allowing them to offer more attractively priced or enhanced products, services or solutions than we provide. Some of our competitors may have greater resources in certain business segments or geographic markets than we do. We may also encounter increased competition from new market entrants, alternative technologies or alternative telecommunications platforms. Our operating results significantly depend on our ability to compete in this market environment, in particular on our ability to adapt to political, economic or regulatory changes, to introduce new products to the market and to continuously enhance the functionality while reducing the cost of new and existing products. 108 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 Strategic and Operational Risks Our business is subject to a wide variety of factors that impact our strategies and operating results. Any of these factors could have a material adverse impact on our operating results. Furthermore, results of operations for any period may not necessarily be indicative of results to be expected in future periods. Consequently, our operating results may fluctuate significantly from period to period and possibly more than they have historically which may lead us to revise our estimates and/or strategies more frequently than in the past. Most of our business is derived from a limited number of customers. We derive most of our business from large, multi-year network build-out agreements with a limited number of significant customers. Although no single customer currently represents more than percent of sales, the loss of, or a reduced role with, a key customer for any reason could have a significant adverse impact on sales, profit and market share for an extended period. Some long-term contracts expose us to risks of cost overruns and extended payment terms. We currently have certain long-term contracts under which the prices are reduced during the life of the contract, according to a pre-negotiated schedule. These long-term contracts are typically awarded on a competitive bidding basis and the profit margins on these contracts may vary from the original estimates as a result of changes in estimated costs, productivity, specifications or timing. In addition, these contracts frequently include extended payment terms, which will require us to recover costs incurred in performing these contracts over the term of the contract. These contracts generally also provide for penalties and termination rights in the event of our failure to deliver on time or if our products do not perform. Should any of these contracts become unprofitable or be terminated due to any or several of these reasons, our operating results will be negatively impacted. We expend significant resources on product and technology R&D which may not be successful in the market. Developing new products or updating existing products and solutions requires significant levels of financial and other commitments to research and development, which may not always result in success. We are also actively engaged in the development of technology standards that we are incorporating into our products and solutions. In order to be successful, those standards must be accepted by relevant standardization bodies and by the industry as a whole. Our sales and earnings may suffer if we invest in developing technologies and technology standards that do not function as expected, are not adopted in the industry or are not accepted in the marketplace within the timeframe we expect, or at all. R I S K F A C T O R S Please also see sections “Research and Development” in the Board of Directors’ Report and “Research and Development” in Information on the Company. We enter into joint ventures, strategic alliances and third party agreements to offer complementary products and services. If our partnering arrangements fail to perform as expected, whether as a result of having incorrectly assessed our needs or the capabilities of our strategic partners, our ability to work with these partners or otherwise, our ability to develop new products and solutions may be constrained and this may harm our competitive position in the market. Additionally, charges relating to our portion of any losses from, or commitments to contribute additional capital to, joint ventures may adversely affect our financial condition or results of operations. In the case of our joint venture with Sony Corporation, if the joint venture is unsuccessful for any reason, we may not be able to compete as successfully in the mobile systems market or at all in the mobile handset market. Our solutions may also require us to license third-party technologies and successfully integrate such technologies with our products. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. Moreover, the inclusion in our products of software or other intellectual property licensed from third parties on a non-exclusive basis could limit our ability to protect our proprietary rights in our products. Our products incorporate intellectual property rights (IPR) developed by us that may be difficult to protect or may be found to infringe on the rights of others. While we have been issued a number of patents and other patent applications are currently pending, there can be no assurance that any of these patents will not be challenged, invalidated, or circumvented, or that any rights granted under these patents will in fact provide competitive advantages to us. We utilize a combination of trade secrets, confidentiality policies, non-disclosure and other contractual arrangements in addition to relying on patent, copyright and trademark laws to protect our intellectual property rights. However, these measures may not be adequate to prevent or deter infringement or other misappropriation. Moreover, we may not be able to detect unauthorized use or take appropriate and timely steps to establish and enforce our proprietary rights. In fact, existing laws of some countries in which we conduct business may offer only limited protection of our intellectual property rights, if at all. Many key aspects of networking technology are governed by industry-wide standards, which are usable by all market participants. As the number of market entrants as well as the complexity of the technology increases, the possibility of functional overlap and inadvertent infringement of intellectual property rights also increases. Third parties have asserted, and E R I C S S O N A N N U A L R E P O R T 2 0 0 4 109 retaining such highly skilled personnel in the future, especially in light of our recent workforce reductions and operational restructuring. Our current and historical operations are subject to a wide range of environmental, health and safety regulations. We are subject to certain environmental and health and safety laws and regulations that affect our operations, facilities and products in each of the jurisdictions in which we operate. We believe that we are substantially in compliance with all material environmental and health safety laws and regulations related to our products, operations and business activities. However, there is a risk that we may have to incur expenditures to cover environmental and health liabilities, to maintain compliance with current or future environmental and health and safety laws and regulations or to undertake any necessary remediation. It is difficult to reasonably estimate the future impact of environmental matters, including potential liabilities due to a number of factors especially the lengthy time intervals often involved in resolving them. As a result of operating globally, we have substantial foreign exchange exposures. With the majority of our cost base being Swedish krona (SEK) denominated and a very large share of sales in currencies other than SEK, and many subsidiaries outside Sweden, our foreign exchange exposure is significant. Currency exchange rate fluctuations, affect our consolidated balance sheet, cash flows and income statement when translated to SEK. Our attempts to reduce the effect of exchange rate fluctuations through a variety of hedging activities may not be sufficient or successful, resulting in an adverse impact on our financial results. A stronger SEK exchange rate would generally have a negative affect on our competitiveness compared to competitors with costs denominated in other currencies. Access to short and long term capital funding is influenced by our credit ratings, operational performance as well as market conditions. Our access to short term funding is currently limited due to sub-investment grade credit rating and may decrease or become more expensive as a result of our operational and financial condition and market conditions. For a discussion of our access to short term funding see “Notes to the Financial Statements – Note , Financial Risk Management and Financial Instruments”. R I S K F A C T O R S in the future may assert, claims against us alleging that we infringe their intellectual property rights. Defending such claims may be expensive, time consuming and divert the efforts of our management and/or technical personnel. As a result of litigation, we could be required to pay damages and other compensation, develop non-infringing products/technology or enter into royalty or licensing agreements. However, we cannot be certain that any such licenses, if available at all, will be available to us on commercially reasonable terms. Adverse resolution of litigation may harm our operating results or financial condition. We are a party to lawsuits in the normal course of our business. Litigation can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have a material adverse effect on our business, operating results, or financial condition. For additional information regarding certain of the lawsuits in which we are involved, see “Legal and Tax Proceedings,” contained in the Board of Directors’ Report. We rely on a limited number of component and electronic manufacturing services suppliers for the majority of our component supply and production. Our ability to deliver according to market demands depends in large part on obtaining timely and adequate supply of materials, components and production capacity on competitive terms. Failure by any of our suppliers could interrupt our product supply and could significantly limit our sales and increase our costs. If we fail to anticipate customer demand properly, an over/undersupply of components and production capacity could occur. In many cases, some of our competitors also utilize the same contract manufacturers, and we could be blocked from acquiring the needed components or increasing capacity if they have purchased capacity ahead of us. This factor could limit our ability to supply our customers or could increase our costs. At the same time we commit to certain capacity levels or component quantities, which, if unused, will result in charges for unused capacity or scrapping costs. We are dependent upon hiring and retaining highly qualified employees. While we have been forced to lay off a number of highly skilled employees over the past few years, we believe that our future success depends in large part on our continued ability to hire, develop, motivate and retain engineers and other qualified personnel needed to develop successful new products, support our existing product range and provide services to our customers. Competition for skilled personnel and highly qualified managers in the telecommunications industry remains intense. We are continuously developing our compensation and benefit policies as well as other measures. However, we may not be as successful at attracting and 110 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 Our business has substantial cash requirements and we may require additional sources of funds if our current sources are unavailable or insufficient to satisfy these requirements. If we do not generate sufficient amounts of capital to support our operations, service our debt, continue our research and development and customer financing programs or we can not raise sufficient amounts of capital at the times and on the terms required by us, our business will likely be adversely affected. We cannot assure you that additional sources of funds will be available or available on reasonable terms. Our access to short term funding in the debt capital market is currently limited due to our sub-investment grade rating. Please also see Notes to the Financial Statements – Note , “Financial Risk Management and Financial Instruments”. A significant failure of our information services/information technology (IS/IT) operations or communications networks could have a material adverse affect on our operations and results. Our business operations rely on complex IS/IT operations and communications networks which are vulnerable to damage or disturbance from a variety of sources. Having outsourced a significant portion of our IS/IT operations, we depend partly on external companies security and reliability measures. Regardless of protection measures, essentially all IS/IT systems and communications networks are susceptible to disruption from equipment failure, vandalism, computer viruses, security breaches, natural disasters, power outages and other events. Although we have experienced disruptions from computer viruses, security breaches, power outages and equipment failures in the past, our operations or results have not been materially affected to date. We will continue to expend significant resources to manage and try to mitigate these risks and we may incur additional costs to remedy damage caused by such disruptions, especially for computer viruses and security breaches. R I S K F A C T O R S Risks associated with owning Ericsson shares Our share price has been and may continue to be volatile. Our share price has been volatile due in part to the high volatility in the securities markets generally, and for telecommunications and technology companies in particular, as well as developments from quarter to quarter which impact our financial results. Factors other than our financial results that may affect our share price include but are not limited to variations between our actual financial results and expectations of financial analysts and investors as well as a result of announcements by our customers, competitors or ourselves regarding capital spending plans of network operators, financial difficulties for network operators for whom we have provided financing or with whom we have entered into material contracts, awards of large supply agreements or contracts for network roll-out. Additional factors include but are not limited to: speculation in the press or investment community about the level of business activity or perceived growth in the market for mobile communications services and equipment; technical problems, in particular those relating to the introduction and viability of next generation network systems like 3G; potential litigation involving ourselves or the markets in which we operate. Even though we may not be directly involved, announcements concerning bankruptcy or other similar reorganization proceedings involving, or any investigations into the accounting practices of, other telecommunications companies may materially adversely affect our share price. Currency fluctuations may adversely affect the trading prices of our Class B shares and ADSs and the value of any distributions we make thereon. Because our shares are quoted in SEK on the Stockholm Stock Exchange (our primary stock exchange) but on the NASDAQ and London Stock Exchange in local currencies, i.e. USD and British Pounds, fluctuations in exchange rates between the SEK and currencies in which our Class B shares or ADSs are quoted may affect the value of your investment. In addition, because we pay cash dividends in Swedish kronor, fluctuations in exchange rates may affect the value of distributions if arrangements with your bank, broker or depositary, in the case of ADSs, call for distributions to you in currencies other than SEK. E R I C S S O N A N N U A L R E P O R T 2 0 0 4 111 S H A R E H O L D E R I N F O R M A T I O N Shareholder Information The Annual General Meeting will take place at the Globe Arena, Globentorget, Stockholm, at p.m. on Wednesday, April 6, 2005. Only those shareholders, who have been entered into the transcription of the share register as of Sunday, March , , kept by VPC AB (the Swedish Securities Register Centre) are entitled to participate in the Meeting, provided notice of attendance has been given to the Company. Since said date will fall on a Sunday (Easter Sunday) shareholders must be registered with VPC AB no later than at the end of bank hours on Thursday, March , . Shareholders, whose shares are registered in the name of a nominee, must be entered temporarily into the share register no later than Sunday, March , , in order to be entitled to participate in the Meeting. The shareholder is requested to inform the nominee well before Thursday, March , , when such registration must be effected. Please observe that this procedure may also be applicable for shareholders who are using a custody account with a bank and/or trading via the Internet. The personal data that Ericsson receives with the notice of attendance will be computer processed for the purpose of the general meeting of shareholders only. Notice of attendance in the Annual General Meeting In addition to the requirements listed above, shareholders shall provide notice of attendance no later than p.m. on Thursday, March , , at the company’s web site www.ericsson.com/investors, at telephone no.: + between a.m. and p.m., at fax no.: + , or by post to: Telefonaktiebolaget LM Ericsson Group Function Legal Affairs Box SE– Stockholm Sweden Proxy Shareholders who are represented by proxy shall issue a power of attorney for the representative. To a power of attorney issued by a legal entity, a copy of the certificate of registration of the legal entity shall be attached. The documents must not be older than one year. In order to facilitate the registration at the Meeting, powers of attorney in its original, certificates of registration and other documents of authority should be sent to the Company at the address above so as to be available by Tuesday, April , . Dividend The Board of Directors has decided to propose the Annual General Meeting to resolve on a dividend of SEK . per share for the year and Monday, April , as record day for dividend. 112 E R I C S S O N A N N U A L R E P O R T 2 0 0 4 Financial information from Ericsson • Interim report January–March : • Interim report January–June : April , July , October , • Interim report January–September : • Full year report January–December : January/February, • Annual report and Form -F for the US market : March, Annual reports and financial reports can be downloaded or ordered on our web site: www.ericsson.com/investors or ordered via e-mail or mail. For printed publications, contact: Pressdata AB P.O. Box SE- Stockholm Sweden Phone: + E-mail: annual.report@pressdata.se. In the United States, Ericsson Transfer Agent Citibank: Citibank Shareholder Services Phone toll free: + E-mail: ericsson@shareholders-online.com Ordering a hard copy of the Annual Report: http://www.sccorp.com/annualreport/ericsson.htm Phone toll free: + Contact information: Investor Relations for Europe, Middle East, Africa and AsiaPacific: Telefonaktiebolaget LM Ericsson SE- Stockholm Sweden Telephone: + E-mail: investor.relations.se@ericsson.com Investor Relations for the Americas: Ericsson Inc. Park Avenue, th floor New York, NY USA Telephone: + E-mail: investor.relations@ericsson.com Design and production: Paues Media, Stockholm Printing: Fagerblads Frank AB, Preetz, Germany EN/LZT 108 7716 R1A © Telefonaktiebolaget LM Ericsson 2005 ISSN 1100 - 8962 Telefonaktiebolaget LM Ericsson Group Function Communications SE-164 83 Stockholm Printed on paper that meets international environmental standards; Munken Lynx, especially produced for Ericsson, is Totally Chlorine Free (TCF).
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