Ericsson Annual Report 2005

Plain-text annual report

A N N U A L R E P O R T 2 0 0 5 ERICSSON ANNUAL REPORT 2005 Communication is a basic human need. Telefonaktiebolaget LM Ericsson Group Function Communications SE-164 83 Stockholm, Sweden www.ericsson.com Printed on Scandia 2000 and Ideal volym – totally chlorine free (TCF) paper that meets international environmental standards. ISSN 1100-8962 © Telefonaktiebolaget LM Ericsson 2006 CONTENTS 2005 MILESTONES LARGEST CONTRACTS IN 129 YEAR HISTORY Ericsson signs multi-year agreements to manage 3’s networks in Italy and UK, covering more than eight million subscribers. EXCLUSIVE SUPPLIER FOR THE “BRAINS” OF ‘‘NEXT GENERATION’’ NETWORK Ericsson’s Softswitch selected to play a key strategic role in the development of BT’s 21st Century Network. FIRST MOBILE BROADBAND (HSDPA) NETWORKS IN COMMERCIAL SERVICE During 2005, Ericsson deployed HSDPA in 21 networks in 17 countries in Asia, the Middle East, Africa, Europe and North America. This includes the world’s first commercial HSDPA launch for Cingular in the US. ERICSSON INSIDE Ericsson’s 3G/WCDMA platforms are now in more than 15 million mobile phones, representing an industry-leading market share. EXPANDING OUR PRODUCT AND MARKET PORTFOLIO Marconi aquisition strengthens Ericsson’s position in the accelerating optical transmission and broadband access markets. BRINGING MULTIMEDIA CONTENT TO OPERATORS AND CONSUMERS Ericsson entered into distribution agreements with major record labels and Napster to enhance the availability of mobile music, and launched a mobile TV application to bring interactive television to mobile devices. ANNUAL REPORT 2005 1 OPERATIONAL REVIEW 25 SHARE INFORMATION 30 TWO-YEAR SUMMARY 32 LETTER FROM THE CHAIRMAN 33 BOARD OF DIRECTORS’ REPORT (AUDITED CHAPTER) 41 CONSOLIDATED FINANCIAL STATEMENTS (AUDITED CHAPTER) 45 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (AUDITED CHAPTER) 89 PARENT COMPANY FINANCIAL STATEMENTS (AUDITED CHAPTER) 95 NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS (AUDITED CHAPTER) 108 AUDITORS’ REPORT 109 INFORMATION ON THE COMPANY 118 FORWARD-LOOKING STATEMENTS 119 RISK FACTORS 123 SHAREHOLDER INFORMATION CORPORATE GOVERNANCE REPORT 2005 INTERNAL CONTROL REPORT 2005 Project management Ericsson Investor Relations Design and production Publicis Stockholm and Paues Media Photography Andreas Lind and Dan Kullberg (page 24) Reprographics C2 Printing Elanders, Falköping, Sweden EN/LZT 108 8181 R1A FINANCIAL HIGHLIGHTS * SEK million Net sales Operating income – operating margin Net income Earnings per share, diluted, SEK Cash dividends per share, SEK 2005 2004 1) 151,821 33,084 21.8% 24,460 1.53 0.45 2) 131,972 26,706 20.2% 17,836 1.11 0.25 YEAR-END POSITION, SEK million 208,829 Total assets 86,980 Working capital 133,621 Capital employed 6,966 Property, plant and equipment 104,677 Stockholders’ equity Minority interests 850 Interest-bearing provisions and liabilities 28,094 53,411 Net cash RATIOS Return on equity Return on capital employed Equity ratio Capital turnover Inventory turnover Accounts receivable turnover 26.2% 28.7% 50.5% 1.2 5.0 4.1 186,186 69,268 115,144 5,845 80,445 1,057 33,643 42,911 24.2% 26.4% 43.8% 1.2 5.7 4.1 STATISTICAL DATA, YEAR-END Number of employees – Worldwide – Of which in Sweden Export sales from Sweden, SEK million 56,055 21,178 93,879 50,534 21,296 86,510 * This year, there is only a two-year comparison due to the change to IFRS. NET SALES: Strong growth in global services and mobile networks fueled the 15 percent increase. OPERATING MARGIN: Record operating margin reflects our commitment to operational excellence. NET INCOME: Net income grew by 37 percent making 2005 the most profitable year in Ericsson’s history. NET CASH: Net cash increased by 24 percent to our highest level ever. This strong cash generation allowed our Board of Directors to propose an 80 percent dividend increase. RETURN ON EQUITY AND EQUITY RATIO: Record profits lead to strong returns for shareholders and 26.2 percent ROE. Equity ratio now above 50 percent. 1) 2004 has been restated in accordance with IFRS. 2) For 2005, as proposed by the Board of Directors. OUR 10 LARGEST MARKETS NET SALES (SEK billion) REGIONAL UPDATE 2005 Ericsson net sales (SEK billion) and growth (%) year-over-year �� * Excludes phones which are now part of Sony Ericsson Mobile Communications. �� F I N A N C I A L H I G H L I G H T S 1 WHAT IT MEANS TO BE THE PRIME DRIVER IN AN ALL- COMMUNICATING WORLD 2 WHAT IT MEANS TO BE THE PRIME DRIVER IN AN ALL- COMMUNICATING WORLD From the time our first cry announces our arrival into the world, our need to communicate starts to grow. Interacting with our parents and friends and sharing ideas, we develop our social skills and communication be- comes a fundamental part of our lives. We soon want to communicate over longer distances and while on the move. Mobile communication is now a part of the everyday lives of some two billion people. New ways to enjoy media are emerging with news, music, gaming, television and other experiences conveniently available any time and any place via fixed and mobile broadband. Communication is also improving our profes- sional lives with greater working efficiency, smarter business processes and increased flexibility in blending private and professional life. These are all vital elements of our vision that motivate us as we lead the way into the all-communicating world of the future. “ Putting appealing, easy to use services in the hands of users is a great challenge.” However, two-thirds of the world’s population still do not benefit from communication services. Making communication available and affordable for everybody is an equally important dimension of our vision. Putting appealing, easy-to-use communication services in the hands of billions of users is a great challenge. It requires not only innovation and technology leadership but also a deep understanding of consumer require- ments, market conditions and the ability to undertake large scale assign- ments. Only a few companies can make this work end-to-end, all the way from one person to another, regardless of which devices and networks they are using. Ericsson thrives on such technical challenges, but being the prime driver also requires people working together to create new services, new solutions, new ways of communicating for the benefit of all people. At Ericsson we have all of this, and that’s one reason why operators choose to partner with us more than with any other supplier. That’s also why we can confidently say that we are uniquely positioned to be the Prime Driver in an All-Communicating World. O U R V I S I O N 3 TO MY FELLOW SHAREHOLDERS, Carl-Henric Svanberg President & CEO 4 TO MY FELLOW SHAREHOLDERS, 2005 was a tremendous year for Ericsson and for the communications industry as a whole. A record number of people signed up for mobile services, raising the total number of mobile subscriptions by 450 million. Almost 800 million mobile phones were sold and shipments of radio network equipment reached an all-time high. With Ericsson’s 15 percent sales growth outpacing the rate of the mobile systems market, we clearly benefited from these strong industry trends. Our large installed base enabled us to leverage our position with existing customers to gain market share as we entered into new business agreements in all regions of the world. Financially, we delivered solid profitability with group operating margins of 21.8 percent and a net income increase of 37 percent. This ability to increase our net income significantly faster than sales, demonstrates the importance of scale and our commitment to operational excellence. 2005 was exciting from other perspectives as well. During the year we started to manufacture GSM systems in India and expanded our research and development capacity in the US and China. Our Marconi acquisition extends our market share “ Collaboration and insight build the trust that fortiﬁes our business relationships.” and customer base with fixed-line operators worldwide. It also strengthens our offering in the strategically important areas of optical transmission, broadband access and related services, providing us with a new base for growth as operators continue their migration to ‘‘next generation’’ networks. Our rapidly growing global services business now accounts for 28 percent of systems’ sales. This business consists of more recurring revenues and provides a relationship enhancing offering to our customers. As the year drew to a close, we announced the largest contract in the history of our company - an agreement with the operator 3 to build, manage and develop their 3G/WCDMA network in the United Kingdom. This follows similar contracts with the operator 3 in Australia and Italy. These and other agreements with major global operators demonstrate the power of M E S S A G E F R O M T H E C E O 5 our end-to-end capabilities. We have now publicly announced By year end, we had already deployed 21 HSDPA networks in more than 60 managed services contracts around the world. 17 countries and expect that most existing WCDMA operators Our progress during the year positions us to bring better com- will upgrade to HSDPA during 2006. We are excited about lead- munication solutions to more people in all regions of the world. ing this next era of mobile communications. Most of the new mobile subscriptions this year came from On the mobile phone side of the business, our mobile plat- emerging markets, with China and Russia reporting the largest forms technology is included in more WCDMA handsets than number of additions. The continuing strong growth of mobile any other suppliers’. And Sony Ericsson Mobile Communications communications throughout most of Africa, Eastern Europe, reported a record year of volumes, sales and profitability, ending Latin America and Asia Pacific contributes to global economic the year with a very competitive product portfolio and strong and social development, illustrating the vitality of what we do. momentum. The significance of this should not be underestimated. Putting Throughout our 129-year history, we have consistently been these statistics in human terms means that in the near future, at the forefront of innovation, responding to our customers’ more than 3 billion people, or almost half the world’s population, needs and leading the industry into the future. As we continue will be able to instantly connect to each other, essentially con- to pursue our vision, I believe that we are entering 2006 as well quering the obstructions of time and distance. It means that a positioned as we have ever been. This ability to be the prime mother, miles from medical care can quickly get advice on how driver of our industry is attributable to three crucial elements – to treat a sick child, farmers in rural India can check on com- Our long-term customer relationships, Our commitment modity prices in New Delhi, an artist in Tanzania can market his to technology leadership and Our passion for operational products outside of his village. It means that people throughout excellence. I believe that it will be these same three things that the world have equal access to information in real time when- will keep us on top in the years to come. ever and wherever they are. There are few inventions that have such a profound effect on the lives of so many. As we enter 2006, operators in the US, Japan and other markets are in the early stages of the world’s first HSDPA mobile broadband rollouts, bringing data speeds of several megabits per second to mobile subscribers. We are there, as well as in many other markets, helping to bring communications and new capabilities to the world. Over 90 WCDMA networks have been launched around the world, of which we are a supplier to 49. We expect to deploy this technology in more than a dozen new markets in the year ahead. Carl-Henric Svanberg President & CEO 6 M E S S A G E F R O M T H E C E O LONG-TERM CUSTOMER RELATIONSHIPS Strong, long-term customer relationships are integral to the suc- cess of our business. We have been building the foundations of today’s relationships for over 100 years and the benefits are still being seen by our shareholders, our customers and consumers. Dannie Botha from Transtel’s Head Office in Johannesburg South Africa, Only by having local resources on the ground and access to experts around the world, can we understand and respond to with Charl Gous and Kryn Haak from Transtel Western Cape Region. the unique needs and specific challenges of each customer. This together, from the core network to the radio base stations, all is one reason why all of the world’s top ten mobile operators are the way to the subscriber. Our managed services business has our customers, including the largest operators on six continents. been a particularly strong relationship builder during 2005, as Though our top 20 customers account for the majority of our handling the day-to-day operations of a customer’s network sales, in total we have more than 425 customers in over 140 creates a true partnership. countries, and many of these customers have been with us for The mutual trust we build with our customers not only trans- decades. Why do operators choose Ericsson? When we survey lates into business wins today but it enables us to better meet our customers, the responses we most often hear are the most their future needs as well. Bringing us into the network planning basic: we listen, we are responsive, we are innovative, we process early enables us to coordinate our development efforts understand the consumers and we deliver on our promises. to correspond with where operators see their businesses going Of course it is also advantageous to consistently bring new in the years ahead. While we receive valuable feedback from our technologies to market, to provide end-to-end solutions including customers, we are able to provide equally valuable consumer mobile systems, fixed networks and a far-reaching services port- research back to them through Ericsson Consumer & Enterprise folio as well as cutting-edge mobile platforms and handsets. Lab. And through our Mobility World unit we have created a glob- In this way we ensure that all elements of the network function al network of over 100,000 content providers, application devel- opers and operators to bring all elements of the communications value chain together to help drive the future of mobile data. ERICSSON AND MAXIS HELPING MAXIS INTRODUCE NEW DATA APPLICATIONS “Maxis is deploying 3G services to capitalize on the growth potential of new broadband applications and address the competitive dynamics of the Malaysian market. To do this effectively, we needed to work with a partner with a clear vision - Ericsson’s global reputation made them the obvious choice. We did not want to sit around and wait for the content market to develop - we wanted to create demand. Ericsson’s personalized mobile music portal and existing content relationships helped us to move forward. Ericsson’s ability to host, manage and integrate networks enabled us to reduce initial spending and focus on our core competencies. We are very pleased with the reliability of the network. Usage and revenue growth have exceeded our expectations and we foresee mobile music being a growth catalyst for the industry.” Kugan Thirunavakarasu, head of Mobile Data, Maxis L O N G -T E R M C U S T O M E R R E L AT I O N S H I P S 7 THE ADVANTAGE OF TECHNOLOGY LEADERSHIP Bringing faster, more reliable and cost-efficient networks to the world is what we do best. When operators choose their equipment suppliers they are often selecting a partner for the next 10-15 years to take them through not only the initial deployment but also the subsequent expansion and upgrade phase as new solutions come to market. Our early involvement with, and substantial contribution toward, creating the world’s leading technology standards enable us to be first-to-market with many of these solutions. This is a key differen- tiator for Ericsson and a significant advantage for operators that choose Ericsson as their network partner. With nearly one-third of our employees working in Research 2003 Ericsson launches world’s first commercial EDGE network, increasing data speeds and capacity in GSM networks. 2004 Ericsson is first to launch a network with IMS (IP Multimedia Subsystem), the initial step towards a converged all-IP network. 2005 Ericsson is the first to rollout HSDPA technology in a live commercial network, bringing broadband access to mobile subscribers. and Development and one of the industry’s largest mobile sys- In addition to both mobile and fixed networks, we also develop tems R&D programs, we are a technology leader. We hold over and license technology platforms, including the chip design and 20,000 patents worldwide and are a leading contributor to the software that are inside many of the world’s most advanced standards of GSM and WCDMA technologies, as well as a con- GPRS and WCDMA handsets. siderable holder of Intellectual Property Rights (IPRs) in many We have become much more efficient in recent years as we other technologies. While our ability to license IPRs to other have consolidated R&D centers and focused our investments vendors generates additional profits for Ericsson, our deep com- on fewer core technologies. This has enabled us to improve mitment to developing technology based on open standards is time-to-market and invest in new areas, such as multimedia key to our success. solutions, while decreasing R&D as a percentage of sales. This is yet one more aspect of our technology leadership and a key component of our drive for operational excellence. �� R&D 2004 23.4 R&D expenses: (SEK billion) 2005 24.5 R&D employees 2005 16,500 16,000 R&D as percentage of sales 2005 16.1% 2004 17.7% 2004 �� 2004 numbers are restated according to IFRS. PASSION FOR OPERATIONAL EXCELLENCE Operational Excellence comes naturally in our day-to-day We believe that our business processes must be simple, efficient tasks. We must all think about and better than those of our competitors and thus our opera- how we can do things better tional excellence will be a competitive advantage. As a result of – in everything from our own this focus and the dedication of our employees, this past year roles to how our business our operating expenses increased by only five percent while processes and the organiza- generating sales growth of 15 percent, resulting in record profit- tion works as a whole.’’ Joakim Westh Head of Operational Excellence ability. We also improved our on-time delivery to an all-time high while significantly increasing our radio base station volumes. These are some of the results of operational excellence, but the daily effort it takes to get there is much more complex. As we entered 2005 we introduced a new senior management position tasked with driving operational excellence throughout the company. By focusing on operational excellence and creat- ing a more efficient organization we can shorten lead times, im- prove quality, reduce costs and motivate employees, all of which have helped us to generate very positive feedback from our customers in our annual satisfaction survey. �� ON TIME DELIVERY �� Some of the actions that we have taken include moving parts Operational Excellence requires innovation and long-term of our development function closer to the customer by including planning to ensure that we are all working in the simplest and it within our business units. In this way we ensure that we are efficiently applying our resources to those areas that are most smartest way possible. We will continue to pursue this in all of our business processes. This will enable us to meet the customers’ �� important for our customers. We have also created a new Multi- needs and outperform the competition, a prerequisite for media Solutions group that is focused on leveraging our end-to- Ericsson to achieve true world leadership. end capabilities to generate new consumer-focused solutions. We have made strides toward streamlining our organization with a focus on improving clarity and purpose in every unit and simplicity in every process. It is apparent in our interaction with customers, in the quality of our products and in the pride that our employees take in developing those products faster than our competitors and delivering on-time with our commitments. There is still much work to be done. In the year ahead, one important area will be to ensure operational excellence as we integrate the recently acquired Marconi operations, particularly in relation to sourcing, sales and delivery precision. PA S S I O N F O R O P E R AT I O N A L E X C E L L E N C E 9 UNDERSTANDING OUR MARKETS �� Mobile penetration; the number of subscriptions divided by the total population in a geographical area. Our long-term presence in many of the world’s markets trans- lates into a deep understanding of local market conditions for EMERGING MARKETS* (45 PERCENT OF ERICSSON’S SALES) business and insights into the global trends driving change. For people in many parts of the world, access to traditional fixed Consolidation has picked up momentum in recent years, cre- network services is very limited. Here mobile networks are the ating larger multinational operators. This is primarily driven by best solution for rapid large-scale deployment. While GSM net- the need for improved economies of scale, business growth, works have been rolled out in most big cities, there is still much expansion into new markets and the desire to better serve sub- work to do to increase coverage in rural areas and boost capac- scribers. More complex technology and the need to reduce ity in larger cities. With subscriber penetration still low in most costs have increasingly led operators to outsource network man- of these markets, we are working with our customers to shrink agement to vendors like Ericsson. While these drivers are constant the “digital divide.” We are doing this by reducing the total cost throughout many parts of the world, markets are in different stages of developing their communications sector. * The GSM Association (GSMA) defines an emerging market as a country with a GNP per capita index below the World Bank average and a mobile penetration below 60 percent. 10 U N D E R S TA N D I N G O U R M A R K E T S of ownership for operators and developing relevant local applica- tions. Progress is being made as Africa has been doubling its subscriber base every two years and India is adding well over two million subscribers per month. Despite the fact that many of the new users are coming from areas with much lower average income than today’s subscribers, their collective purchasing power is significant. In some of these markets, the rollout of mobile broadband is leading to an acceleration of data usage. We expect that this will spread to many more markets in the years ahead as governments award 3G licenses and locally relevant content continues to be developed. DEVELOPED MARKETS (55 PERCENT OF ERICSSON’S SALES) Despite high penetration levels, there is still room to grow. Operators are focused on retaining subscribers, stimulating in- creased usage and introducing attractive new data services to generate additional revenues. This is driving capacity additions to existing GSM networks and the rollout of WCDMA/HSDPA. As of year-end, there were almost 50 million WCDMA subscrip- tions worldwide and this number is expected to grow signifi- cantly in the years ahead. Operators are now beginning to upgrade their WCDMA networks to HSDPA to further improve speed and efficiency. As usage is on the rise and both fixed and mobile data are experiencing rapid growth, many of these operators will need to make additional investments into capacity and transmission. Meanwhile, operators are in the initial stages of making the evo- lution to all-IP converged networks. This will enable operators �� OUR MARKET-SPECIFIC APPROACH Regardless of the individual market and the level of development, our approach is the same - we leverage our local presence, consumer understanding, global scale and technology leader- ship to win business and serve the customer. Being able to understand the local markets and rely on the knowledge and expertise of a global organization brings a very powerful propo- sition to our customers. It is the Ericsson people that make the who operate both fixed and mobile networks to cost-effectively difference. deliver multimedia content including pictures, music, video and television over either of these access points. CONSUMER & ENTERPRISE LAB: UNDERSTANDING THE END USER Consumer & Enterprise Lab is our specialized unit for understanding consumer behavior, which is crucial to successfully bring new products and services to market. To help gain such knowledge, we annually conduct over 20,000 consumer interviews in key markets. Henrik Pålsson, Head of Consumer & Enterprise Lab, emphasizes the importance of understanding market trends; “In most countries, adoption of new services is driven by teenagers and young adults, so knowing their habits and attitudes towards different products and services is vital. For operators to be successful they must define the segments they are targeting and package their offerings accordingly. Our long-term presence in most markets and our understanding of consumer behavior are key differentiators that enable us to provide market-specific solutions to our customers as we work to develop revenue-generating services.” U N D E R S TA N D I N G O U R M A R K E T S 11 OUR BUSINESS STRATEGY To ensure that we are focusing our resources on the most important solu- tions needed to drive the industry forward, we prioritize our work around five clear areas that have been discussed and agreed to by Ericsson’s 200 top managers at our annual Global Management Conference. These con- cepts are then shared with the entire organization and put into practice in our daily business. This is one more way that we ensure that all of us at Ericsson are working toward the same goals: LEAD WIRELESS IN 2G, 3G AND BEYOND We will reinforce our market leadership and further develop our wireless technology to make 2G more efficient and 3G more advanced. DRIVE COMPLETE SOLUTIONS USING TELECOM GRADE STANDARDS Working end-to-end and being a major contributor to the world’s leading technology standards means that we see the whole picture, ensuring opera- tors have access to everything they need to launch consumer services. �� 12 O U R B U S I N E S S S T R AT E G Y CREATE MORE EFFICIENT AND FLEXIBLE NETWORKS USING IP AND IMS Internet Protocol (IP) is transforming telecommunications, and our invest- ments into IMS are starting to be rewarded. We will continue to lead the industry in migrating both fixed and mobile operators towards converged IP-based networks which are able to handle all forms of communications traffic. EXPAND INTO HIGH POTENTIAL BUSINESS AREAS Over the last several years we have built the largest global services busi- ness in our sector and in 2005 clearly anchored our leadership with a number of strategic wins. Our Marconi acquisition will also expand our offerings in optical transmission and broadband access, areas where we see strong opportunities going forward. INNOVATE TO DEVELOP THE MARKET-LEADING PRODUCTS AND SERVICES OF TOMORROW Our technology leadership enables us to play a significant role in defining standards, developing technologies, growing our patent portfolio and launching innovative products and services. ERICSSON AND TELEFONICA LEADING THE WAY TO THE FUTURE As one of the world’s largest multinational operators, with net- networks of the future, where new and enriched services and works in 18 countries, Telefonica is a valued customer of Ericsson common functions will be reused for multiple fixed and mobile and a prime example of how we can leverage our global footprint applications. In this way, operators that have both fixed and and end-to-end solutions to expand our business opportunities. mobile operations can add additional revenue streams and Ericsson is the prime vendor for Telefonica’s GSM/WCDMA net- reduce their operating costs while delivering exciting new work in their home country of Spain. So when it came time to applications to their subscribers. This includes video telephony, rollout GSM in their Latin American markets, they chose Ericsson conference calling, presence management, instant messaging, to supply most of their equipment and services once again. But email and much more. Telefonica and Ericsson are leading the it didn’t stop there. In April 2005, Telefonica announced that it way to the converged world of the future, where consumers have had turned to Ericsson for its most ambitious project yet - the access to richer content and advanced applications on the device world’s first commercial launch of an IP Multimedia Subsystem that best suits their individual needs. (IMS). IMS is an important step on the road toward the converged O U R B U S I N E S S S T R AT E G Y 13 13 WINNING PROPOSITIONS Our winning propositions address growth opportunities as well connected and enjoy these Internet services while on the move. as cost savings for our customers. Our approach is to apply our Evolving today’s voice and data networks into more adapt- competence, technology and large-scale efficiency with innovative able, cost-efficient all-IP networks is a critical challenge to the business solutions. Focus is on optimized total cost of ownership future success of many operators. But operators cannot afford for operators - lowering financial hurdles while providing new to abandon their existing investments and convert to all-IP in services to encourage subscriber growth and increased usage. one giant step. They need an incremental step-by-step ap- proach. ENTERING NEW GEOGRAPHIC TERRITORIES – Our evolution path to an all-IP network combines the best of EXPANDER SOLUTIONS today’s telephony services with broadband data and entertain- In many countries, operators face the challenge of cost effec- ment services. Application of our softswitch solution can reduce tively addressing new geographic markets where subscriber core network operating costs by 50 percent while preserving density may initially be very low. Our studies show that consumers existing services and prior investments in transmission and in these markets have similar needs as those in more developed switching nodes. The addition of Ericsson IMS enables new IP- markets with higher penetration levels. The main differences are based services for both mobile and fixed access users, and found in monthly spending and affordability of handsets. facilitates the smooth introduction of new services in parallel to To serve this segment, operators must be able to profitably legacy services supported by softswitch. run operations at much lower revenue levels. An operator’s net- work cost is mainly driven by the number of radio base station INCREASED OPERATIONAL EFFICIENCY – SERVICES sites needed to provide the coverage and capacity for the Operators are continuously challenged to keep spending under required quality of service. control while launching a wider range of services for new revenue Applying the advanced functionality and flexibility of our high streams. Many operators are considering outsourcing non-core performance radio base stations, we can reduce the number of sites an operator needs by one-third. With capital expenditures as well as operating costs some 30 percent lower than tradi- business operations to increase their flexibility in meeting these challenges. As an industry leader in this area, we are well placed to advise operators on the strategies and solutions that best tional configurations, operators can offer services at prices support their goals. affordable to a much larger population. Cost reductions of some 15–20 percent can typically be Taking a total cost of ownership approach also means that achieved with our managed services offerings. Our approach our Expander solutions have been designed to not only provide basic services at low cost, but also to prepare for the rollout of more advanced services and increased capacity in a simple and scalable way, without having to add more sites. targets the operator’s business objectives, seeking powerful and flexible solutions with consumer benefits. For operators, this means reduced risks, lower costs and a faster time to market. Consumers enjoy attractive, reliable services, strengthening the operator’s market position. BROADBAND EVERYWHERE – EFFICIENT EVOLUTION TO ALL-IP The Internet community, with more than one billion users, is driving the rapid growth of broadband access. With faster speed and better performance, Internet users are discovering new ways to communicate and easy access to content. Now, the introduction of mobile broadband is making it possible to stay 14 W I N N I N G P R O P O S I T I O N S ’’ Ericsson has consistently provided high-quality, wireless network equip- ment and services for Rogers and our customers across the country. Their global experience, technology leadership and on-the-ground exper- tise make them an invaluable part of our success in the Canadian market.” Bob Berner, Chief Technical Officer, Rogers Communications Inc. ERICSSON AND ROGERS COMMUNICATIONS INC. LAUNCHING NEW SERVICES and Rogers have cultivated a strong partnership which has helped position Rogers as a leader in the Canadian market, providing a high-quality network and innovative service offerings to their customers. We provide expertise that assists Rogers in a wide variety of areas including consumer understanding, deployment services, and network integration and optimization. This value-added support demonstrates Ericsson’s understand- ing of the end-user trends, requirements and opportunities. Recently, Rogers chose Ericsson as its exclusive systems integrator and supplier for the deployment of its high-speed Our end-to-end approach brings us closer to our customers. WCDMA/HSDPA voice and data network. With the introduction Nowhere is this more evident than with Canadian-based Rogers of HSDPA, Rogers extends its leadership as Canada’s largest Communications. Rogers is known for its unique asset mix of supplier of wireless data services. By aligning our efforts with mobile wireless, broadband data, digital cable services, tele- Rogers specific needs at specific points in time, we have created a phony, and media properties. For the past 20+ years, Ericsson partnership that enables us to help drive the customer’s strategy. ERICSSON IN NIGERIA services. According to Leif Edwall, Managing Director of Ericsson Nigeria, ‘‘Nigeria is a perfect example of Ericsson’s ability to use our local presence and global scale to win new business. When South Africa based MTN entered the Nigerian market our existing relationship with them through our previous work in many other markets put us in an excellent position to be their primary sup- plier here as well. Our hard-working team in Nigeria enables us to be the supplier of choice, not only for MTN, but also for M-Tel, VMobile and Nitel. Our dedicated local team maintains very good business relations with our customers.” RAPID SUBSCRIBER GROWTH Nigeria is the largest country in Africa with a population of more than 140 million. Though Nigeria currently has less than 10 percent mobile penetration, this number is growing rapidly. Five years ago Nigeria represented limited business opportunity, but the beginning of the GSM rollouts in 2001 changed that. Nigeria is now a top 20 market in terms of sales and we have a leading market share, supplying more than two-thirds of the country’s network equipment. We provide a variety of solutions to four of the top operators in Nigeria including GSM, GPRS and EDGE networks, softswitch, mobile applications and professional OUR MARKET POSITION MARKET SHARE OF THE GSM/ WCDMA FAMILY MOBILE TECHNOLOGY LEADERSHIP We are the world’s leading supplier of GSM, GPRS, EDGE, WCDMA and HSDPA equipment and services, the technology family that connects more than 80 percent of the world’s mobile subscribers. We are also leading the market in upgrading net- works to mobile broadband via WCDMA/HSDPA. IMS 18 contracts for commercial launch Softswitch Mobile networks – in more than 35 GSM & WCDMA networks Fixed networks – for more than 40 customers UPGRADING NETWORKS TO IMS AND SOFTSWITCH Ericsson has comprehensive solutions for upgrading networks to IMS and Softswitch architectures. Ericsson Mobile Platforms includes IMS client architecture in their new releases. We have a leading position in IMS and Softswitch, with solutions for both fixed and mobile networks. GLOBAL SERVICES AS PERCENT OF SYSTEMS’ SALES GLOBAL SERVICES SALES SEK billion �� GROWING WITH GLOBAL SERVICES Our Global Services include network rollout, systems integration, technical support and managed services (network operation �� and hosting). As a result of our world-class expertise, Ericsson was entrusted to plan, build and integrate over 800 networks during 2005. �� Ethernet-based broadband access – in more than 90 networks EMPOWERING FIXED BROADBAND Our IP-solutions for upgrading fixed networks to accommodate broadband traffic enable operators to offer their subscribers richer data content and a faster, lower-cost experience. We have a strong position in Ethernet-based broadband access and with Marconi’s ATM-based broadband access we will establish a top-tier global position. 16 O U R M A R K E T P O S I T I O N SONY ERICSSON – OUR LINK TO THE CONSUMER Sony Ericsson Mobile Communications is a 50/50 joint venture that combines our technology leadership with Sony’s consumer electronics expertise. These complementary strengths enable Sony Ericsson to bring innovative products to market and These successful 2005 launches helped to propel Sony Ericsson provide us with valuable insight into consumer trends. In 2005, to new heights in 2005. The joint venture reported record sales Sony Ericsson once again started a mobile phone trend with the and profitability and enhanced its position with a number of introduction of several Walkman®-branded music phones. The leading operators and distributors. W800 was the first in the industry to offer a quality digital music �� experience and a high-performance 2 mega pixel auto-focus �� camera, combined with a full-feature mobile phone. Another innovative and popular model, the K750, raised the bar for imaging quality in mobile phones, winning a number of industry awards including the coveted TIPA (Technical Image Press Association) award for Best Mobile Imaging Device. �� Sony Ericsson continues to expand its portfolio by adding a �� variety of handsets designed and priced for different market segments. In the emerging WCDMA market, the K600 offers an �� attractive and affordable handset with no compromise on size �� or design. Additions to the 2G portfolio include basic affordable �� models, camera phones and sleek clamshell designs. This �� broadening phone portfolio, combined with Sony Ericsson’s �� accessories, PC-cards and Machine-to-Machine solutions, � �� demonstrate the company’s progress in becoming a leading supplier of a full range of innovative and feature-rich products. �� S O N Y E R I C S S O N – O U R L I N K T O T H E C O N S U M E R 17 COMMITMENT TO OUR EMPLOYEES Ericsson is a knowledge company and, as such, we depend on the competence and productive engagement of all of our em- ployees. This is brought into the business context every day through technology leadership, customer responsiveness and operational excellence. Though over 20,000 patents have been registered under Ericsson’s name, the true power of this accomplishment is that each of these patents represents an innovation created by an Ericsson employee. Our ways of working are based on our core values of profes- sionalism, respect and perseverance. Together they form an essential part of the Ericsson brand and are a key contributor to the company’s continued success. We strive to foster an orga- nization and culture where employees meet challenges with confidence, passion, responsiveness and accountability. They are also well prepared with the most up-to-date industry prac- tices and technological expertise that support the company’s goals and strategies. To facilitate this, we have built an efficient infrastructure to access and share information including knowledge networks and training centers with customized web-based learning tools. solicit employee input through an annual survey and in 2005 almost 93 percent of our employees participated. This extra- ordinarily high level of participation reflects our commitment to employee development and our employees’ strong commit- ment to help continuously improve our preparedness for future To ensure the level of expertise of individual employees as well opportunities. as the company as a whole, we regularly assess our compe- tency requirements and the capabilities of our workforce. We Motivated and competent employees, working for a common cause and acting as one company, are the foundation of our success and the prerequisite to achieve our ultimate goals – customer satisfaction and strong profitability. We strive to provide a stimulating work environment characterized by continu- ous learning and commitment to innovation. In return, our em- ployees take pride in their work and make the difference with our customers. It is important for Ericsson to be the employer of choice. We work hard to ensure that employees feel that they are making a real contribution to something important and that their efforts are recognized and appreciated. Only by clearly understanding what the company stands for and where our opportunities lie, can we work in unison to ensure success. 18 C O M M I T M E N T T O O U R E M P L O Y E E S ’’ ERICSSON AND 3 Though we are a very innovative company with excellent technology and strong service delivery, at the end of the day our biggest strength is the people we have on the ground.” Jacqueline Hey, Head of Ericsson Northwest Europe MANAGING NETWORKS FOR OPERATOR 3 When the operator 3 of the Hutchison Whampoa Group asked us in the case of 3 UK Ericsson was not an infrastructure supplier to manage their U.K. network in a 7-year deal signed this past before the managed services agreement. That is one more reason December, it was celebrated throughout our company. This is why 3 UK is particularly rewarding. As a result of this partnership, true not only because this partnership represents the largest con- a supply of equipment, additional technology and related ser- tract in our 129-year history, but because it was the 3rd country vices will also be part of our future relationship. where 3 decided to trust us with this critical function. The size and breadth of these agreements are prime examples This is not a decision that an operator takes lightly as it requires of how our industry leading services organization, technology a great deal of trust to commit to this handover. Yet when 3 asked leadership, geographic reach and consistent performance themselves who do they trust to run their network, Ericsson was make us the supplier of choice for most of the world’s leading the answer all three times – first in Australia, then in Italy and now operators. in the United Kingdom. Unlike the previous two managed services deals where we were actively supplying the equipment for their network buildout, E R I C S S O N A N D 3 19 OUR BUSINESS HELPS CREATE A BETTER WORLD Ericsson is committed to making positive contributions to the communities in which we work and the world in which we live. Corporate Responsibility encompasses everything we do to build an enduring value-creation capa- bility for all our stakeholders; customers, employees, investors and society as a whole. We strive to maintain the necessary controls to minimize risk, and we link our products and services to an overall business goal of sus- tainable growth. Our corporate responsibilities are founded on three main principles: Economic Prosperity: Pursuing sustainability based on sound eco- nomic principles. We contribute to growth in the communities in which we do business; we reduce our customers’ operating costs with an energy- lean portfolio; we help to bridge the “digital divide” by making com- munication affordable to all. Environmental Performance: Designing products and services to minimize impacts. We use design for environment (Df E) to avoid hazard- ous substances and decrease power consumption. Also, telecommunica- tion reduces the need for personal transportation. Social Equity: Supporting the UN Global Compact. Ericsson was one of the first companies to commit to the Compact’s ten principles, covering human rights, fair labor practices, the environment and anti-corruption. Ericsson supports the UN Global Compact. In 2005, we were again included in the FTSE4Good and the global DJSI World indexes. And 2005 we were also included in the European DJSI STOXX Index for the first time, where we were named the Technology Equipment Supersector Leader. We are also listed as one of the top 100 most sustainable companies by Global 100. 20 C O R P O R AT E R E S P O N S I B I L I T Y 2005 HIGHLIGHTS We adopted a risk-based approach to supply chain management to better govern implementation of our code of conduct. Ericsson launched a new business model in Tanzania, designed to provide affordable and profitable mobile services to rural users, further building on our partnership with the United Nations Development Program (UNDP) and the Swedish International Development Cooperation Agency (SIDA) in Tanzania. Ericsson Response is our global initiative to rapidly establish communications anywhere in the world in response to human suffering caused by disasters. We provided support following many natural disasters, including tsunamis, earthquakes and hurricanes in Asia, the Middle East and the Americas. Ericsson employees made numerous positive contributions to society in the countries where they work and live. These activities were determined by employees according to local needs. We improved our focus on product energy efficiency. Our 2005 WCDMA radio base stations consume 60 percent less energy than 2001 models. And we plan to reach another 50 percent reduction from 2005 levels by 2008. From August 13, 2005 Ericsson complies with the EU Directive on Waste Electrical and Electronic Equipment (WEEE). Our Ecology Management Take-Back implementation has begun in more than 30 markets to reduce waste and promote recycling. We worked to ensure compliance with the EU RoHS (Restriction of the Use of Certain Hazardous Substances) directive by July 1, 2006. RoHS concerns the use of certain substances in electrical and electronic equipment. For more information, see www.ericsson.com/corporate_responsibility C O R P O R AT E R E S P O N S I B I L I T Y 21 ANTICIPATING THE FUTURE Over the past decade, developments in computers, telecommunications and television have been remarkable – leading to a new era of social and economic progress. While these changes may seem to have occurred overnight, in reality, they were many years in the making. Looking back at forecasts from the mid-1990’s, the International Telecommunications Union (ITU) expected one billion mobile subscribers by 2005. In actuality, the two billion subscriber mark was passed during 2005 and is now on the way to three billion before 2010, making mobility ‘‘Key to success is an insightful long-term perspective supported by ﬁnancial strength, global reach and technology leadership.” the preferred and more often, the only method of telecommunications. Consumer demographics are shaping the market. Today’s teenagers and young adults spend more on mobile, Internet and entertain- ment services than previous generations. As this “mobile generation” matures, and new generations are born into a mobile world, con- sumer spending on mobile communications should increase. This is a great opportunity for our customers to attract new subscribers and grow their business, but only if they have a good technology partner – one that understands the consumer and is prepared for the future. Our products have very long life cycles, often stretching 20 years or more. Volume deployments of GSM started in the mid 1990’s and 2005 saw the highest ever shipments. While volume deployments of WCDMA are just beginning, we are already investing R&D into the development of even more advanced technologies so that we will be ready for the next technology wave. Looking ahead, fixed and mobile networks will converge around a com- mon core network and service layer, providing operators with substantial cost savings. Broadband access combined with an all-IP network environ- ment will offer consumers transparent access to services in the most convenient way. This combined with the rapidly increasing subscriber base and consumer demographics bodes well for our business. With a long-term-plan and a guiding vision to be the prime driver in an all-communicating world, we will continue to lead our customers into the future as we drive the growth of this fascinating industry. 22 A N T I C I PAT I N G T H E F U T U R E Members of the Group Management Team (from left to right): Henry Sténson , Head of Group Function Communications. Shares held: 19,533 Class B. Bert Nordberg, Executive Vice President and Head of Group Function Sales & Marketing. Shares held: 31,794 Class B. Torbjörn Nilsson, Head of Group Function Strategy & Product Management. Shares held: 62,127 Class B. Hans Vestberg, Executive Vice President and Head of Business Unit Global Services. Shares held: 20,241 Class B. Karl-Henrik Sundström, Executive Vice President, CFO and Head of Group Function Finance. Shares held: 20,472 Class B. Carl-Henric Svanberg , President and CEO. Shares held: 15,635,599 Class B*. Marita Hellberg, Head of Group Function Human Resources & Organization. Shares held: 35,755 Class B. Håkan Eriksson , Chief Technology Officer and Head of Research & Development. Shares held: 11,313 Class B. Carl Olof Blomqvist , General Counsel and Head of Group Function Legal Affairs. Shares held: 6,080 Class A, 28,633 Class B. Björn Olsson, Executive Vice President and Head of Business Unit Systems. Shares held: 24,298 Class B. Kurt Jofs, Executive Vice President and Head of Business Unit Access. Shares held: 216,714 Class B. Joakim Westh, Head of Group Function Operational Excellence. Shares held: 107,941 Class B. Sivert Bergman , Head of Business Unit Transmission & Transport Networks. Shares held: 4,825 Class B. *The number of Class B shares includes holding by related natural and legal persons. G R O U P M A N A G E M E N T T E A M 23 ’’Delivering telecommunication service to a country as large and diverse as India, though challenging, is imperative if we are to further develop our infrastructure and to grow our economy. Ericsson’s associa- tion with India, which started way back in 1896, stands fur- ther reinforced with their re- cent opening of a new manu- facturing facility. They have not only brought global ex- pertise but also developed local competence needed to support our operators with solutions to meet the chal- lenges. In this sense, Ericsson is a strategic partner and a valuable member of our in- dustrial community.” DAYANIDHI MARAN Minister of Communications and Information Technology Government of India E R I C S S O N A N N U A L R E P O R T 2 0 0 5 SHARE INFORMATION STOCK EXCHANGE TRADING Ericsson’s Class A and Class B shares are traded on the Stockholm Stock Exchange (Stockholmsbörsen) 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 repre- sents 10 Class B shares. Approximately 43 (62) billion shares were traded in 2005, of which about 73 (74) percent on the Stockholm Stock Exchange, about 16 (15) percent on NASDAQ, and 11 (11) percent on the London Stock Ex- change. Trading volume in Ericsson shares decreased by approximate- ly 31 percent on the Stockholm Stock Exchange and by approximate- ly 31 percent on NASDAQ as compared to 2004. In 2005, Ericsson was included in the Dow Jones STOXX Sustain- ability Index. SHARE PRICE TREND In 2005, Ericsson’s total market value increased by about 29 percent to approximately SEK 441 billion (SEK 343 billion in 2004). The OMX SPI index on the Stockholm Stock Exchange increased by 31 percent, the NASDAQ telecom index decreased by approximately 7 percent and the NASDAQ composite index increased by approximately 2 percent in 2005. SHARE CAPITAL As of December 31, 2005, Ericsson’s share capital was SEK 16,132,258,678 (16,132,258,678) represented by 16,132,258,678 shares. The par value of each share is SEK 1.00. As of December 31, 2005, the shares were divided into 1,308,779,918 (1,308,779,918) Class A shares, each carrying one vote, and 14,823,478,760 (14,823,478,760) Class B shares, each carrying one-tenth of one vote. As of December 31, 2005, Ericsson held 268,065,241 of its Class B shares. No Class C shares, each carrying one-thousandth of one vote, are outstanding. SHARE TREND, THE STOCKHOLM STOCK EXCHANGE, 2003–2005 SHARE TURNOVER 2005 (MILLION SHARES) 30 25 20 15 10 5 0 2003 2004 2005 Source: Svensk Börsinformation B share, SEK OMX SPI-index 6,000 5,000 4,000 3,000 2,000 1,000 0 London NASDAQ Stockholm Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec S H A R E I N F O R M AT I O N 25 SHARE DATA Earnings per share, diluted (SEK) 1)2) P/E ratio, Class B shares 2) Dividend (SEK) 3) 1) For 2001 adjusted for stock dividend element of stock issue. 2) For 2004 restated in accordance with IFRS. 3) For 2005 as proposed by the Board of Directors. SHARE PRICES ON THE STOCKHOLM STOCK EXCHANGE (SEK) Class A at last day of trading Class A high for year (October 4, 2005) Class A low for year (February 22, 2005) Class B at last day of trading Class B high for year (October 4, 2005) Class B low for year (February 22, 2005) 2005 1.53 18 0.45 2005 27.50 28.70 19.80 27.30 29.00 19.40 2004 1.11 19 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 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 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, mark- downs or commissions, and do not necessarily represent actual trans- actions. Principal trading market the 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 the Stockholm Stock Exchange for the last five years. The equity securities listed on the A-list of the Stock- holm Stock Exchange’s Official Price List of Shares currently comprise the shares of 53 companies. Trading on the exchange generally con- tinues until 5:30 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 5:30 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 arbitraging between the Swedish market and foreign markets, and foreign buyers and sellers purchasing shares from or selling shares to Swedish institu- tions. The exchange publishes a daily Official Price List of Shares which includes the volume of recorded transactions in each listed stock, to- gether with the prices of the highest and lowest recorded trades of the day. The Official Price List of Shares reflects price and volume informa- tion for trades completed by the members. The annual high and low market prices on these markets were as follows: ANNUAL HIGH AND LOW MARKET PRICES Period 2001 2002 2003 2004 2005 NASDAQ USD per ADS1) Low 22.03 3.40 5.20 17.93 27.78 High 97.50 43.33 18.85 34.57 37.19 THE STOCKHOLM STOCK EXCHANGE SEK per Class A share Low High 23.98 91.00 3.80 42.89 5.55 16.80 14.00 26.10 19.80 28.70 SEK per Class B share Low 23.18 2.96 4.11 12.70 19.40 High 88.11 44.78 14.60 24.50 29.00 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.) 26 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Quarterly high and low market prices The table below states the high and low sales prices for each quarter of 2004 and 2005. Period 2004 First Quarter Second Quarter Third Quarter Fourth Quarter 2005 First Quarter Second Quarter Third Quarter Fourth Quarter 1) One ADS = 10 Class B shares NASDAQ USD per ADS1) Low THE STOCKHOLM STOCK EXCHANGE SEK per Class A share Low High SEK per Class B share Low High 17.93 24.72 23.18 27.76 27.78 27.80 31.74 32.17 25.10 26.10 24.50 24.10 22.40 26.10 28.40 28.70 14.00 20.50 19.50 20.70 19.80 19.80 24.30 25.30 23.50 24.50 23.20 23.80 22.10 26.30 28.50 29.00 12.70 19.10 17.40 19.80 19.40 19.70 24.30 25.20 High 31.41 32.32 31.37 34.57 32.49 33.87 36.99 37.19 Monthly high and low market prices The table below states the high and low sales prices for each of the last six months (August 2005 to January 2006). Month August 2005 September 2005 October 2005 November 2005 December 2005 January 2006 1) One ADS = 10 Class B shares NASDAQ USD per ADS1) Low 33.50 34.75 32.19 32.17 32.86 33.63 High 36.99 36.87 37.19 33.91 35.15 37.00 THE STOCKHOLM STOCK EXCHANGE SEK per Class A share Low High 25.50 27.70 25.70 28.40 25.30 28.70 25.80 27.50 26.50 28.30 25.80 28.90 SEK per Class B share Low 25.30 25.70 25.20 25.60 26.40 25.60 High 27.80 28.50 29.00 27.50 28.10 28.80 CHANGES IN NUMBER OF SHARES AND CAPITAL STOCK 2001–2005 2001 Conversions of convertible debentures 2001 New issue (Class C shares) (later converted to Class B) 2002 Conversions of convertible debentures 2002 New issue (Class B shares) 1:1 2003 New issue (Class C shares) (later converted to Class B) 2003 December 31 2004 December 31 (no changes) 2005 December 31 (no changes) Number of shares 168,395 155,000,000 560 7,908,754,111 158,000,000 16,132,258,678 16,132,258,678 16,132,258,678 Capital stock 168,395 155,000,000 560 7,908,754,111 158,000,000 16,132,258,678 16,132,258,678 16,132,258,678 S H A R E I N F O R M AT I O N 27 SHAREHOLDERS As of December 31, 2005, we had 869,861 shareholders registered at VPC (the Swedish Securities Register Center). According to information provided by Citibank, there were 119,361,288 ADSs outstanding as of December 31, 2005 and 6,298 registered holders of such ADSs. A significant number of the ADSs are held of record by banks, brokers and/or nominees for the accounts of their customers. As of December 31, 2005, banks, brokers and/or nominees held ADSs on behalf of 224,696 accounts. According to information known by year-end 2005, approximately 81 (80) percent of our Class A and Class B shares were owned by Swedish and international institutions. TEN LARGEST COUNTRIES OF OWNERSHIP Percent of capital Sweden United States United Kingdom Luxembourg Switzerland Germany France Netherlands Belgium Denmark Japan Other countries Source: SIS Ägarservice AB The following table sets forth share information, as of December 31, 2005, with respect to our largest shareholders registered at VPC and known by us, ranked by percentage of voting rights: LARGEST SHAREHOLDERS BY VOTING RIGHTS, DECEMBER 31, 2005 Identity of person or group 1) Investor AB AB Industrivärden Svenska Handelsbankens Pensionsstiftelse Livförsäkrings AB Skandia Pensionskassan SHB Försäkringsförening Alecta Robur Fonder SEB-Trygg Försäkring SHB/SPP fonder AMF Pension Nordea Fonder Tredje AP-fonden Första AP-fonden Fjärde AP-Fonden SEB fonder Svenska Handelsbankens Personalstiftelse Andra AP-fonden AFA Försäkring Number of Class A shares 513,320,192 372,000,000 83,903,000 58,960,986 63,360,000 13,725,000 7,438,773 27,923,095 664,089 4,763,682 2,593,202 11,945,095 7,472,938 2,812,755 3,541,090 20,000,000 1,367,271 – Percentage of total Class A shares 39.22 28.42 6.41 4.51 4.84 1.05 0.57 2.13 0.05 0.36 0.20 0.91 0.57 0.22 0.27 1.53 0.10 – Number of Class B shares 297,073,324 5,100,000 – 81,258,181 – 371,160,279 376,867,325 58,045,000 315,040,121 268,000,000 247,448,828 151,570,735 167,206,311 208,305,145 189,561,780 – 173,646,901 140,203,301 Percentage of total Class B shares 2.00 0.03 – 0.55 – 2.50 2.54 0.39 2.13 1.81 1.67 1.02 1.13 1.41 1.28 – 1.17 0.95 Foreign owners 2) of which Capital Group of which Fidelity funds 16,239,472 – – 1.24 7,391,350,675 477,804,643 339,540,793 – – Others Total 96,749,278 1,308,779,918 7.40 4,381,640,854 100% 14,823,478,760 1) Sources: SIS Ägarservice AB and VPC AB, December 31, 2005 and Capital Precision, December 2005. 2) Including Nats Cumco as Nominee: 1,122,692,601 Class B shares. 49.86 3.22 2.29 29.56 100% 28 As of December 31, 2004 53.7% 26.9% 4.7% 4.1% 1.7% 1.2% 0.9% – 0.9% 0.8% – 4.1% 2005 54.1% 26.5% 4.3% 3.8% 1.8% 1.1% 1.1% 0.9% 0.9% 0.9% 0.6% 4.0% Voting rights, percent 19.46 13.35 3.01 2.40 2.27 1.82 1.62 1.21 1.15 1.13 0.98 0.97 0.87 0.85 0.81 0.72 0.67 0.50 27.06 1.71 1.22 19.17 100% Percentage of capital 5.02 2.34 0.52 0.87 0.39 2.39 2.38 0.53 1.96 1.69 1.55 1.01 1.08 1.31 1.20 0.12 1.08 0.87 45.90 2.96 2.10 27.78 100% E R I C S S O N A N N U A L R E P O R T 2 0 0 5 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 31, 2003, 2004 and 2005. Person or group (percent) Investor AB AB Industrivärden Svenska Handelsbankens Pensionsstiftelse Livförsäkrings AB Skandia Pensionskassan SHB Försäkringsförening Alecta Robur Fonder SEB Trygg Försäkring SHB/SPP Fonder AMF Pension Nordea Fonder Tredje AP-fonden Första AP-fonden Fjärde AP-fonden SEB fonder Svenska Handelsbankens Personalstiftelse Andra AP-fonden AFA Försäkring 2005 Class A Class B shares shares 2.00 39.22 0.03 28.42 6.41 - 0.55 4.51 4.84 - 2.50 1.05 2.54 0.57 0.39 2.13 2.13 0.05 1.81 0.36 1.67 0.20 1.02 0.91 1.13 0.57 1.41 0.22 1.28 0.27 1.53 – 1.17 0.10 0.95 – Voting rights 19.46 13.35 3.01 2.40 2.27 1.82 1.62 1.21 1.15 1.13 0.98 0.97 0.87 0.85 0.81 0.72 0.67 0.50 2004 Class A Class B shares shares 2.00 39.22 – 28.42 – 6.41 0.50 4.51 – 4.84 1.25 0.19 2.65 0.51 0.39 2.13 1.74 0.24 2.15 0.36 1.64 0.26 0.97 0.94 1.17 0.57 1.32 0.22 1.25 0.27 – 1.53 Voting rights 19.46 13.33 3.01 2.38 2.27 0.75 1.62 1.22 1.05 1.33 1.01 0.97 0.90 0.81 0.80 0.72 2003 Class A Class B shares shares 3.58 39.11 1.15 28.34 0.23 7.38 1.09 4.53 0.20 4.83 – – 3.09 0.00 0.77 1.98 1.71 0.14 – – – – 1.03 0.77 1.31 0.33 – – 1.52 0.04 0.06 1.52 Voting rights 38.29 27.72 7.21 4.45 4.72 – 0.07 1.95 0.17 – – 0.78 0.36 – 0.08 1.49 Foreign owners of which Capital Group of which Fidelity funds Others Total 1.24 – – 49.86 3.22 2.29 27.06 1.71 1.22 1.82 – – 50.15 2.54 5.52 27.48 1.35 2.93 1.09 – – 45.74 0.00 5.51 2.12 0.00 2.93 7.40 19.17 29.56 100.00 100.00 100.00 5.85 20.04 32.75 100.00 100.00 100.00 8.36 9.05 38.45 100.00 100.00 100.00 Source: SIS Ägarservice AB and VPC AB, December 31, 2005, Ilios and Capital Precision, December 2005. Our major shareholders do not have different voting rights than other shareholders. As far as we know, the Company is not directly or indirectly owned or controlled by another corporation, by any foreign government or by any other natural or legal person(s) severally or jointly. As of December 31, 2005, the total number of voting securities of the Company owned by officers and directors as a group was: Number of Class A shares Number of Class B shares Voting rights, percent Officers and directors as a group (27 persons) 6,080 17,863,398 0.06 For individual holdings, see “Corporate Governance Report”. S H A R E I N F O R M AT I O N 29 TWO-YEAR SUMMARY SEK million Net sales Operating income – operating margin Financial net Net income Year-end position Total assets Working capital Capital employed Property, plant and equipment Stockholders’ equity Minority interests Interest-bearing provisions and liabilities Other information Earnings per share, basic, SEK Earnings per share, diluted, SEK Cash dividends per share, SEK Stockholders’ equity (SEK per share) Number of shares (in millions) – outstanding, basic, at end of period – average, basic – average, diluted Additions to property, plant and equipment Depreciation on property, plant and equipment R&D and other technical expenses – as percentage of net sales 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, SEK million – as percentage of net sales Net cash, SEK million Statistical data, year-end Number of employees – Worldwide – Of which in Sweden This year, there is only a two-year comparison due to the change to IFRS. 1) 2004 has been restated in accordance with IFRS. 2) For 2005, as proposed by the Board of Directors. 30 2005 151,821 33,084 21.8% 251 24,460 208,829 86,980 133,621 6,966 104,677 850 28,094 1.53 1.53 0.45 2) 6.60 15,864 15,843 15,907 3,365 2,804 24,454 16.1% 26.2% 28.7% 50.5% 0.3 1.9 1.2 5.0 4.1 23.5% 78,647 51.8% 53,411 2004 1) 131,972 26,706 20.2% –540 17,836 186,186 69,268 115,144 5,845 80,445 1,057 33,643 1.11 1.11 0.25 5.08 15,832 15,829 15,895 2,452 2,434 23,421 17.7% 24.2% 26.4% 43.8% 0.4 2.0 1.2 5.7 4.1 22.9% 81,447 61.7% 42,911 56,055 21,178 50,534 21,296 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Working capital: Current assets less current non-interest-bearing provisions and liabilities. Debt-equity ratio: Defined as total interest-bearing provisions and liabilities divided by Equity. Capital employed: Capital employed is defined as total assets less non-interest-bearing provisions and liabilities. Current ratio: Current assets divided by the sum of current provisions and liabilities. Earnings per share: See Notes to the Consolidated Financial Statements – Note C1, “Significant Accounting Policies”, for information on principles for calculation of earnings per share. Capital turnover: Net sales divided by average Capital employed. Inventory turnover: Cost of sales divided by average Inventory. Cash dividends per share: Defined as dividends paid divided by average number of shares, basic. Accounts receivable turnover: Net sales divided by average Accounts receivable. Stockholders’ equity (SEK per share): Defined as Stockholders’ equity divided by the Number of shares outstanding, basic, at the end of the period. Return on sales: Operating income plus Financial income expressed as a percentage of net sales. Return on equity: Defined as Net income as a percentage of average Stockholders’ equity (based on the amounts at January 1 and December 31). Payment readiness: Defined as cash and cash equivalents 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. 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 1 and December 31). Net cash: Defined as cash and cash equivalents plus short-term cash investments less interest-bearing provisions and liabilities. Equity ratio: Defined as Equity, expressed as a percentage of total assets. T W O -Y E A R S U M M A R Y 31 LETTER FROM THE CHAIRMAN Dear Shareholder, Ericsson performed well during 2005 – generating the highest profit- ability and largest net cash position in its history. The strong sales growth and healthy profit levels signify the ongoing benefits of restruc- turing and the hard work of employees around the world. Ericsson shares also performed well during 2005 – appreciating 29 percent in value and outperforming the most relevant stock market indices. Continued robust financial performance convinced all credit rating agencies to restore their investment grade ratings for Ericsson. The financial community has acknowledged our sustainable devel- opment efforts. Ericsson was not only named the Supersector leader in the Dow Jones STOXX Sustainability Index but also included in the FTSE4Good Europe 50 index and listed among the Global 100 Most Sustainable Corporations. This recognition reflects our ongoing efforts to build an enduring value-creation capability for all stakeholders: inves- tors, customers, employees and society. The Board of Directors works to ensure that Ericsson adheres to high standards of corporate governance and that business is con- ducted in an ethical manner. Although I believe that our management controls are generally in line with best practices, we continuously strive to make them even better. Along these lines, steering documents and work procedures have been evaluated and adapted to the recently in- troduced Swedish Code of Corporate Governance. Implementation of the applicable requirements of the U.S. Sarbanes-Oxley Act remains well on track to meet the required effective dates. In addition to the financial and operational performance, there was good progress on a number of strategic initiatives. Ericsson’s leading position in “next-generation” network technology was reinforced with the early introduction of mobile broadband as well as softswitch and IP Multimedia Subsystem (IMS) based networks for fixed and mobile operators. This includes the world’s first commercial launches of each of these technologies. While these accomplishments demonstrate Ericsson’s leadership in delivering “next-generation” networks, the Group is creating significant value in other areas as well. During 2005, Ericsson was awarded two record-breaking managed services agreements, which increased the total number of subscribers in networks managed by the Company to 53 million – establishing Er- icsson as a market leader in this increasingly important area. Sony Ericsson Mobile Communications significantly improved their position with a number of award winning models and popular Walkman® brand- ed music phones. In addition to these organic developments, we also agreed to ac- quire key assets from Marconi to strengthen the Company’s position in rapidly growing markets such as optical transmission and broadband access. All in all, we are building on Ericsson’s competitive advantages to expand the Company’s market position and invest in key growth areas for the future. On behalf of the Board of Directors, I would like to thank the manage- ment team and all Ericsson employees for their accomplishments dur- ing the year. This year’s solid performance is also a testament to your valued support as a shareholder. I thank you for allowing me to serve as your Chairman during 2005 and look forward to the continued suc- cess of our Company. Sincerely yours, Michael Treschow Chairman of the Board 32 L E T T E R F R O M T H E C H A I R M A N E R I C S S O N A N N U A L R E P O R T 2 0 0 5 BOARD OF DIRECTORS’ REPORT This Board of Directors’ Report contains discussion and analysis of the financial statements and operational results. This report also includes “forward-looking statements” about future market conditions, strategies and anticipated results. Such statements are based on assumptions and estimates, which 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”, or similar all refer to Telefonaktiebolaget LM Ericsson and its consolidated subsidiary companies. Unless otherwise noted, numbers in parenthesis indicate prior year, i.e. 2004. As of January 1, 2005, Ericsson changed accounting principles to International Financial Reporting Standards (IFRS) as required by all publicly listed companies within the EU (European Union). Our consolidated financial statements for 2004 have been restated according to IFRS. However, the Parent Company is required by Swedish regulations to continue reporting according to Swedish GAAP. SUMMARY With sales increasing 15 percent and net income 37 percent, the Com- pany’s 2005 performance can be characterized by profitable growth and good progress in strategically important areas. Ericsson supplied the first 3G/HSDPA mobile broadband network in commercial service. Ericsson is the first and only supplier with an IMS-based service layer in commercial operation. BT named Ericsson as the exclusive supplier of softswitching functions for their 21st Century Network in the UK. These achievements reinforce Ericsson’s leading position in “next gen- eration” networks. Professional services operations were expanded considerably with a number of multi-year managed services agreements, including the two largest agreements in the Company’s history. The majority of all 3G handsets sold outside of Japan are based on technology supplied by Ericsson Mobile Platforms. The Sony Ericsson Mobile Communications joint venture also reported solid progress and has now reached positive accumulated earnings. The acquisition of Marconi’s optical transmission, broadband access and other strategic operations is expected to significantly improve the Company’s position in these high-growth markets. All in all, we have strengthened the Company’s ability to benefit from a number of growth opportunities beyond those offered by the mobile systems equipment market. MARKET ENVIRONMENT AND TREND INFORMATION 2005 was a record year in terms of net subscriber additions: some 450 million new mobile subscriptions and almost 800 million mobile phones were sold. Network equipment markets also developed positively dur- ing 2005 with particularly strong growth in mobile systems, fixed broad- band access and optical transmission. contracts. A number of major contracts for new network rollouts are expected to be awarded in the near term and price competition is like- ly to intensify during the bidding process. The price/performance trend in both mobile phones and network infrastructure is significantly ex- panding the addressable market with resulting unit volume increases more than offsetting lower average selling prices. New mobile subscriptions, mainly in emerging markets, increased usage in almost all regions and expanding deployment of 3G networks drove growth within the mobile systems market. There are now some two billion mobile subscribers worldwide and global subscription pen- etration was 34 (27) percent at year-end. We expect another billion net subscription additions before the end of this decade, which will drive a significant increase in the number of initial network build outs and cre- ate opportunities for network rollout services and professional services in addition to mobile network systems offerings. Total traffic on mobile networks worldwide grew an estimated 30% in 2005, driven by subscriber additions and increased average minutes of use (MOU). Western Europe is among the highest penetrated mobile markets in the world in terms of subscriptions. However, Western Eu- ropean usage is significantly lower than the average for the rest of the world. Increased tariff competition among operators is expected to stimulate Western European usage closer to the global average over the coming few years, requiring continued expansion of mobile network capacity. At year-end, there were 91 3G/WCDMA networks in commercial service of which Ericsson is a supplier to 49. The number of WCDMA subscriptions almost tripled during 2005 and now exceeds 47 million. Net subscriptions are expected to increase rapidly as more 3G networks are placed in service and as lower-cost handsets become available. Operator consolidation continues to be a key trend in a number of markets. In North America, operator consolidation caused a temporary slowdown in GSM/EDGE investments during 2004 and early 2005 while the companies involved underwent their merger process. In Latin Amer- ica, where significant operator consolidation occurred in 2003 and earlier, we experienced extraordinarily strong growth for the second consecutive year, especially from operators converting to GSM technol- ogy. In Europe, we see an acceleration of cross border expansion as operators there seek revenue growth and economies of scale. In other regions, operator consolidation is ongoing with the emergence of a number of rapidly growing pan-regional operators. Within fixed networks, many operators are contemplating a conver- sion to an all-IP (Internet Protocol) broadband environment. This will enable more efficient handling of fixed and mobile voice, data and image based communications as well as provide a platform for converged services. Several operators have already started such an upgrade pro- cess with many others expected to follow soon. While we believe that fixed network operators’ spending for network equipment in total was up slightly in 2005, certain segments essential to “next generation” networks – optical transmission, broadband access and IMS/softswitch – showed stronger growth. Excluding the effects of technological developments, pricing trends remained similar to previous years with competition continuing to be especially intense regarding strategic pricing necessary to win new In addition to network rollout and systems integration services, the opportunity to supply network management and hosting of services for network operators is growing strongly. The market for such managed B O A R D O F D I R E C T O R S ’ R E P O R T 33 services is estimated at USD 8 billion in 2005 with good growth pros- pects going forward as operators realize the competitive advantages that are made possible when outsourcing operations and other non- strategic activities. Smaller operators especially benefit by gaining ac- cess to service capabilities and content far beyond what they could normally afford while at the same time lowering their risks and improv- ing their time to market. GOALS, STRATEGY AND FINANCIAL RESULTS Our ultimate goal is for the Company to generate growth and com- petitive profit that is sustainable over the longer term. Ericsson’s strat- egy is to be the preferred business partner to customers, especially the world’s leading network operators. Ericsson strives to be the market and technology leader for the supply and operation of network infra- structure. Being a market leader allows the Company to leverage econ- omies of scale to develop superior products and services and thereby offer customers competitive advantages. In addition, when systems integration is combined with mobile platform products and the Sony Ericsson joint venture for mobile handsets, the scope of Ericsson’s operations extends to complete end-to-end solutions. Progress relative to financial targets The Company performed in line with its financial targets of: • Increase sales at least in line with the market growth; • Deliver best-in-class operating margins, i.e. better than the main • Generate positive cash flow before financing; • Maintain Investment Grade credit ratings. competitors; Sales Group sales grew 15 percent mainly driven by increased sales within our systems segment, which consists of network equipment and re- lated services. The effect of fluctuations in foreign exchange rates was not significant on reported sales. Unit volume increases drove mobile network sales growth while network buildout projects and profession- al services drove Global Services growth. Based on Ericsson’s report- ed sales combined with the publicly reported and estimated sales for Ericsson’s main competitors, we believe the mobile systems market grew approximately 11 percent in USD terms during 2005. During this period, Ericsson’s mobile systems sales increased by 15 percent mea- sured in constant currencies, indicating that Ericsson grew faster than the market. were particularly encouraging as the Company was awarded a number of contracts for network management, including the largest contracts in Ericsson’s history. Within fixed networks, Ericsson was awarded a number of contracts for “next generation” converged networks that include broadband ac- cess, IMS/softswitch and packet switching products. We are optimistic regarding growth opportunities for broadband access, optical transmis- sion and converged networks and are increasing our focus in these areas with the acquisition of key assets of Marconi. Positive sales developments within Mobile Platforms and Cables (Network Technologies) were not sufficient to compensate for lower sales by the other units within Other Operations. Total sales declined by 4 percent and operating income was SEK 1 billion lower mainly due to losses in Enterprise Systems, Microwave Systems and Power Mod- ules. Operating margin within Other Operations was also negatively affected by approximately SEK 0.2 billion due to one-off payments for breach of contract damages following an arbitration award. During the year, we announced 78 new or expanded agreements to supply network equipment and/or related services to operators around the world. This compares with 59 in 2004 and 58 in 2003. Although we do not book frame agreements as firm orders, such customer commit- ments reassure the robustness of our order backlog, which is at the highest level in three years. Margins and operating expenses Our ambition is for Ericsson to generate competitive margins. With best-in-class operating margins, the Company continued to perform at record levels. The lower gross margins were mainly a reflection of a product mix that has a significantly higher proportion of services sales. Operating margin was improved by tight cost control of operating ex- penses, especially selling, general and administrative expenses. While sales increased 15 percent, operating expenses increased only 5 percent. Operating expenses measured as a percentage of net sales decreased from 30 percent in 2004 to 27 percent in 2005 reflect- ing ongoing efficiency improvements as well as the continued benefits of the cost reduction measures completed in 2004. Going forward, we want the Company to continue to deliver com- petitive profit. We must also ensure a healthy balance between short- term profit and longer-term growth. Reinvesting more profits now will strategically position Ericsson to better benefit from a number of op- portunities in the future. Sales of services grew 29 percent during 2005, reflecting strong market growth and our market position. Sales of professional services Other income statement items Share in earnings of joint ventures and associated companies before SALES BY SEGMENT AND GEOGRAPHIC REGION 2005 (SEK m.) Western Europe Central and Eastern Europe, Middle East and Africa Asia Pacific North America Latin America Total 34 Systems 35,705 38,781 29,914 18,773 18,813 141,986 Percent change 6% Other Operations 6,235 Percent Change –3% 21% 10% 27% 33% 17% 1,167 1,512 659 262 9,835 –23% 8% –9% –26% –6% Total 41,940 39,948 31,426 19,432 19,075 151,821 Percent change 5% 19% 10% 26% 32% 15% Percent of total 28% 26% 21% 13% 12% 100% tax were stable with continued solid contribution from Sony Ericsson Mobile Communications. Ericsson’s 50 percent share in earnings of the joint venture increased from SEK 2.1 billion in 2004 to SEK 2.3 billion. During the year, the joint venture also achieved the significant milestone of retained earnings exceeding cumulative losses. The strong cash position and repayment of debt improved the finan- cial net from SEK –0.5 billion in 2004 to SEK 0.3 billion. Income after financial items was SEK 33.3 (26.2) billion. This was an improvement of SEK 7.2 billion on a sales increase of SEK 19.8 billion. Net income attributable to the stockholders of the parent company improved to SEK 24.3 (17.5) billion and diluted earnings per share im- proved to SEK 1.53 (1.11). Diluted earnings per share according to US GAAP were SEK 1.54 (0.91). Balance Sheet and Cash flow Capital usage and cash position improved during 2005. Total assets were SEK 208.8 (186.2) billion at year-end, an increase of 12 percent compared to 2004. The largest items contributing to the increase were higher accounts receivable and inventories reflecting the increased business activity. SEK 0.9 billion of non-current borrowings was repaid. Post-employ- ment benefits were funded by SEK 8.3 billion with the establishment of a pension trust. Net cash developed favorably, with the excess of cash over debt increasing from SEK 42.9 billion to SEK 53.4 billion. Equity increased to SEK 105.5 (81.5) billion and the equity ratio improved to 50.5 (43.8) percent. Return on Capital Employed (ROCE) was 29 percent compared with 26 percent in 2004. Cash flow before financial investing activities Cash flow before financial investing activities was SEK 11.3 (17.7) billion, driven mainly by improved income. SEK 8.3 billion was used to fund the Swedish pension trust and netted against a corresponding liability on the balance sheet. Excluding this item, cash flow before financial invest- ing activities was SEK 19.6 billion. Cash outlays regarding restructuring amounted to SEK 2.0 (5.7) billion, where SEK 1.5 billion relates to re- structuring programs initiated during 2001–2003. Due to the strong sales growth this year involving significant network rollouts with long project intervals in markets with slower payment pat- terns, working capital efficiency, although still healthy, declined com- pared with 2004. Efforts to further improve capital efficiency will con- tinue, especially within inventories. WORKING CAPITAL EFFICIENCY MEASURES Target <90 >5.5 >45 Days Sales Outstanding (DSO) Inventory Turnover (ITO) Payable Days 1) 2005 81 5.0 52 2004 75 5.7 51 1) Payable days: Accounts payable divided by Cost of sales and multiplied by 365 days. Capital expenditures We continuously monitor the Company’s capital expenditures and evaluate whether adjustments are necessary in light of market condi- tions and other economic factors. Capital expenditures were mainly for investments in test equipment used to develop, manufacture and deploy E R I C S S O N A N N U A L R E P O R T 2 0 0 5 network equipment. The increase in capital expenditures from 2004 to 2005 was mainly due to investments needed to support the rapidly growing services business. Capital expenditures in relation to sales is not expected to be significantly different in 2006. However, in addition to these capital expenditures there are commitments to repay SEK 9.8 billion of debt and SEK 16.8 billion for the purchase of certain assets from Marconi. With a net cash position at year-end of SEK 53.4 billion, we expect the Company to be able to cover all 2006 capital expenditure with no additional borrowings, by using funds generated from opera- tions. The following table summarizes annual capital expenditures during the five years ended December 31, 2005: CAPITAL EXPENDITURES 2001–2005 2004 SEK billion 2.5 Capital expenditures 1.1 of which Sweden 2005 3.4 1.0 2003 1.8 1.1 2002 2.7 1.2 2001 8.7 3.8 Off Balance Sheet items Customer financing credits of SEK 0.1 (0.6) billion issued by third parties and guaranteed by Ericsson were outstanding as per December 31, 2005. Also see Notes to the Consolidated Financial Statements – Note C21, “Financial Risk Management and Financial Instruments.” Credit ratings Moody’s as well as Standard & Poor’s (S&P) credit rating agencies raised Ericsson’s credit ratings during 2005. At year-end, their ratings of Ericsson’s creditworthiness were Baa3 for Moody’s and BBB– for S&P, both considered to be Investment Grade. ERICSSON CREDIT RATINGS YEAR END 2004–2005 Moody’s Standard & Poor’s 2005 Baa3 BBB– 2004 Ba2 BB+ Research and development A robust R&D program is key to Ericsson’s competitiveness and future success. With most R&D invested in mobile communications network infrastructure, Ericsson’s program is one of the largest in the industry. We have increased investments in the strategically important areas of broadband access, core network and service layer for fixed and mobile networks. With the acquisition of Marconi, we will broaden R&D invest- ments to include optical transmission and further strengthen broadband access, softswitch/IMS and IP routing capabilities. R&D PROGRAM Expenses (SEK billion) As percent of sales Employees within R&D at December 31 Patents 2005 24.5 16.1% 16,500 20,000 2004 23.4 17.7% 16,000 16,000 During 2006, R&D expenses, excluding effects from the Marconi ac- quisition, are expected to remain at about the same level in absolute terms as in 2005. B O A R D O F D I R E C T O R S ’ R E P O R T 35 During 2005, there were several small acquisitions to increase ca- pacity mainly to handle growing systems integration business. The Company also made two technology acquisitions, Netspira and Axxes- sit, to expand the systems product portfolio. There were no material acquisitions or divestitures completed during 2003 or 2004. Material contracts and contractual obligations Primary contractual obligations are outlined in the table below. Operat- ing leases are mainly related to offices and production facilities. Pur- chase obligations are mainly related to outsourced manufacturing, R&D and IS/IT operations and for components for our own manufacturing. With the exception of the Marconi acquisition, Ericsson has not been a party to any material contracts over the last two years other than those entered in the ordinary course of business. CONTRACTUAL OBLIGATIONS 2005 (SEK million) Long-term debt 1) Capital lease obligations 2) Operating leases 2) Other non-current liabilities Purchase obligations 3) Commitments for customer financing 1) Total Payment due by period Total 21,964 <1 year 9,739 1–3 years 3,279 3–5 years 8,360 >5 years 586 2,697 10,807 199 2,134 389 3,321 324 2,409 1,785 2,943 2,740 32 781 7,398 7,398 – 3 – 1,924 – 3,643 49,249 3,643 23,145 – 7,770 – 11,096 – 7,238 1) See also Notes to the Consolidated Financial Statements – Note C21, “Financial Risk Management and Financial Instruments.” 2) See also Notes to the Consolidated Financial Statements – Note C27, “Leasing.” 3) The amounts of purchase obligations are gross, before deduction of any related provisions. Critical accounting estimates The preparation of financial statements and application of accounting policies often involve management’s judgment and/or the use of esti- mates and assumptions deemed to be reasonable and prudent. How- ever, other results may be derived using different assumptions or esti- mates. There are a number of accounting policies subject to such estimates or assumptions. Please see Notes to the Consolidated Fi- nancial Statements – Note C2, ”Critical Accounting Estimates and Judg- ments” for more information about the policies that we believe have the most significant impact on Ericsson’s reported results and financial position. Acquisitions/divestitures, partnerships and joint ventures During 2005, Sony Ericsson Mobile Communications AB (SEMC) re- ported strong unit volume and sales increases. Income before tax im- proved during the year with the higher volumes and sales. The improved performance is mainly a result of focusing on imaging, music and en- terprise phones while increasing the number of more affordable and attractively designed models. SEMC’s ambition is continued profitable growth by leveraging the opportunities created by the combination of the parent companies’ technologies in the joint venture. The joint ven- ture results are accounted for under the equity method with no sales included in Ericsson’s financial statements. For more information see Notes to the Consolidated Financial Statements – Note C1, “Significant Accounting Policies.” SONY ERICSSON RESULTS 2004–2005 Shipments (unit millions) Sales (EUR m.) Income before tax (EUR m.) Net income (EUR m.) Ericsson share of earnings (SEK billion) 2005 51.2 7,268 514 356 2.3 Percent 2004 change 21% 42.3 11% 6,525 6% 486 13% 316 5% 2.1 SEMC invested approximately USD 14 million to purchase a controlling stake in Beijing Suohong Electronics Co, Ltd (BSE). The investment increased SEMC’s ownership from 10 percent to 74.5 percent and strengthened its in-house manufacturing capacity. BSE will be con- solidated into SEMC from the first quarter of 2006 with minor effects on reported results. Local minority shareholder ownership remains un- changed. For more information on transactions with SEMC, please also see Notes to the Consolidated Financial Statements – Note C30, “Related Party Transactions.” During 2004, Ericsson made a public offer to purchase shares of Ericsson S.p.A. in Italy, increasing Ericsson’s ownership to 93 percent. In the first quarter of 2005, a Residual Public Offer was launched for the remaining shares and subsequently Ericsson S.p.A. was delisted from the Milan Stock Exchange. In total SEK 2.2 billion was paid out for the shares of which SEK 0.6 billion in 2005. On October 25, 2005, Ericsson announced the intention to acquire key assets of Marconi’s telecommunications operations for SEK 16.8 bil- lion in cash. The acquisition strengthens Ericsson’s position in the ac- celerating transmission segment and expands Ericsson’s platform for leadership in “next generation” converging networks. As fixed and mo- bile services converge, Ericsson’s customers will benefit from the ac- quisition. Ericsson is acquiring assets expected to generate 2005 sales of approximately SEK 14.0 billion (GBP 1.0 billion). The acquired opera- tions had net tangible assets of approximately SEK 1.4 billion (GBP 0.1 billion) as of September 30, 2005. The remaining acquisition cost will mainly be allocated to intellectual property rights (patents, brands, trade marks, etc). The acquisition is expected to have a neutral effect on earnings per share in 2006 and contribute positively to earnings per share from 2007. 36 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 CORPORATE GOVERNANCE Although internal policies and directives for governance and other im- portant rules for managing the Company’s business activities have long been established, we have adapted our work procedures in line with relevant developments in Sweden and the United States regarding re- porting, disclosure and other requirements for listed companies as well as changes in legislation, such as the new Swedish Companies Act and the US Sarbanes-Oxley Act. In accordance with the recently introduced Swedish Code of Cor- porate Governance, a separate Corporate Governance Report as well as an Internal Control Report have been prepared. There have been no amendments or waivers to Ericsson’s Code of Business Ethics and Conduct for any director or member of management. Foreign exchange risks With significant transaction volumes in currencies other than SEK, the Company 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. A variety of hedging activities, cover- ing on average the forthcoming 6–9 months, are used to managed foreign exchange risks. The largest foreign exchange exposure is to the US dollar and related currencies, which represented 46 percent of sales in 2005. Assuming other foreign exchange exposures remained the same, a 10 percent plus/minus change in the USD/SEK exchange rate would affect operat- ing income by plus/minus SEK 3.3 (3.6) billion before any hedging ef- fects. RISK MANAGEMENT Risk taking is an inherent part of doing business. To manage risks, a coordinated process is used whereby risks are identified, probability of occurrence assessed and potential consequences estimated. Actions are then taken to reduce or mitigate the risk exposures and limit poten- tial unfavorable consequences. We broadly categorize risks into operational risks and financial risks. Our approach to risk management leverages the scale and diversity of our business activities and balances central coordination with well- defined risk management responsibilities within each operational unit. Operational risk management Risk management has been integrated within the Ericsson Group Man- agement System and business processes. The operational risk man- agement framework applies universally across all business activities and is based on the following principles: Each risk is owned and managed by an operational unit that is held accountable with oversight made through unit steering boards and Group Management. Risks are dealt with on three levels: in the strategy process, in an- nual target setting and within ongoing operations by transaction (cus- tomer bid/contract, acquisition, investment, product development project, etc). Approval limits are clearly established with escalation according to a well-defined delegation of authority. A central security and risk management unit coordinates manage- ment of certain risks, such as business interruption, information secu- rity/IT risks and physical security as well as insurable risks. A crisis management council deals with ad hoc events of a serious nature. Financial risk management We have an established policy governing the Group’s financial risk man- agement, which is carried out by the Treasury function within the Parent Company and supervised by the Board of Directors’ Finance Commit- tee. For further information on objectives, policies and strategies for fi- nancial risk management please see Notes to the Consolidated Finan- cial Statements – Note C20, “Interest-Bearing Provisions and Liabilities” and Note C21, “Financial Risk Management and Financial Instru- ments.” Interest rate risks Ericsson is exposed to interest rate risk through market value fluctua- tions of certain balance sheet items and through changes in interest expenses and income. Assuming the net cash position remained at SEK 53.4 billion, a sustained change in interest rates of plus/minus 0.25 percentage points would have an annual impact on the financial net of approximately plus/minus SEK 135 million. Credit risk in trade receivables At year-end 2005, trade receivables amounted to SEK 41.2 (32.6) billion, less allowances of SEK 1.4 (1.8) billion. Extended payment terms for trade credits and overdue accounts receivable amounts are regularly reviewed with provisions made to cover any expected losses. Histori- cally, credit losses have been minimal mainly because the customer base largely consists of well established and financially sound network operators. Customer finance risk At year-end 2005, gross exposure to customer financing amounted to SEK 7.0 (8.9) billion of which one percent was off-balance sheet. Latin America accounts for 58 (60) percent with the remaining exposure mainly related to Central and Eastern Europe, Middle East and Africa. Risk provisions amount to 29 (32) percent of the gross exposure. In most customer financing agreements, credit risks are covered by security arrangements, normally in the form of pledges of equipment, pledges of certain of the borrower’s assets and/or pledges of shares in the operating company. Provisions are made and reported as part of selling expenses. Unutilized but outstanding customer financing commitments amounted to SEK 3.6 (2.2) billion at year-end. New credits are only given on a very selective basis for strategic reasons. Financial credit risk Financial instruments carry an element of risk in that counterparts may be unable to fulfill their payment obligations. All derivative transactions are covered by ISDA Master agreements to reduce the credit risk. Dur- ing 2005, no credit losses were incurred from such instruments. B O A R D O F D I R E C T O R S ’ R E P O R T 37 Liquidity and refinancing risk We expect the Company’s strong cash position to satisfy any short-term liquidity requirements. During 2005, there have been no material de- faults in the payment of principle or interest, or any other material default relating to the indebtedness of Ericsson or any of its subsidiaries. From August 13, 2005, Ericsson complies with the EU directive on Waste Electrical and Electronic Equipment (WEEE). Work continues to ensure compliance by July 1, 2006 of the EU directive on Reduction of Hazardous Substances (RoHS). CORPORATE RESPONSIBILITY Effective management of social, environmental and geopolitical issues can help to assure an enduring capability for value creation and com- petitive advantage. Ericsson supports the UN Global Compact and its ten guiding principles. We see these principles not only as a prerequisite for sound, long-term business but also as guiding principles and as such, we are committed to responsible business practices for sustain- able economic growth that benefit all of our stakeholders. Our commit- ment to employees, customers, shareholders and the broader global community is underscored by external recognition of our efforts. Ericsson was again included in the FTSE4Good and the Dow Jones Sustainability indices. And for 2005, we were named the Technology Supersector leader for the DJSI STOXX sustainability index. Ericsson publishes a separate Sustainability Report annually, usu- ally during the second quarter, which provides comprehensive informa- tion about corporate responsibility and our related activities. Employees Every year an employee satisfaction survey is conducted to assess our Human Capital Index (HCI) and Empowerment Index (EI). In 2005 over 92 (90) percent of employees participated in this survey. The results show a marked improvement from last year with both indices exceeding our target levels. The Human Capital Index as well as the Empowerment Index improved by 7 points. HCI measures the employees’ contribution in adding value for our customers and meeting business goals. EI ad- dresses how employees act on their own initiative to achieve the Com- pany’s goals. Employee headcount at year-end was 56,055 (50,534). Most of the additions were to support the growing services business. During the year, 2,377 employees departed while 7,898 joined the company. Please also see Notes to the Consolidated Financial Statements – Note C29, “Information Regarding Employees, Members of the Board of Directors and Management.” Community Involvement We are committed to being a responsible member of the global society and of the communities in which the Company operates. Employees are encouraged and empowered to make a positive contribution to the world around them. 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, chil- dren’s welfare as well as many other charitable activities. Ericsson Response is a global initiative to rapidly provide specialists 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 (UNDP), the Office for the Coordination of Humanitarian Affairs (OCHA) and the International Federation of Red Cross and Red Crescent Soci- eties (IFRC). During 2005, Ericsson Response provided relief support for many natural disasters around the world, including the tsunami in South East Asia, earthquakes in the Middle East as well as hurricanes in the Americas. Ericsson is also aiding reconstruction work in these disaster areas. Environment and health We believe that the Company is in compliance with all material environ- mental, health and safety laws and regulations required by its operations and business activities. Ericsson provides public information on radio waves and health and supports independent research to further in- crease knowledge in this area. Ericsson currently co-sponsors more than 40 different ongoing research projects related to electromagnetic fields (EMF), radio waves and health. Public health authorities and in- dependent expert groups have reviewed the total amount of research and they have consistently concluded that the balance of evidence does not demonstrate any health effects associated with radio wave exposure from either mobile phones or radio base stations. Executive Compensation The remuneration committee continues to be mindful of the debates around the world on executive salaries and benefits. We remain confi- dent that current policies and practices concerning authorization, com- pliance and control of senior executive compensation within Ericsson are appropriate and reasonable. As of December 31, 2005, there were no loans outstanding from, and no guarantees issued to or assumed by Ericsson for the benefit of any member of the Board of Directors or senior management. LEGAL AND TAX PROCEEDINGS Together with most of the mobile communications industry, Ericsson has been named a defendant in five class actions in the United States where plaintiffs allege that adverse health effects could be associated with the use of mobile phones. Three of those cases are pending in federal court and the other two are pending in state court in New York and the District of Columbia. Ericsson is engaged in litigation with an Australian company, QPSX, in the Federal Court of Australia. QPSX’s claim relates to an alleged breach by Ericsson of a patent license agreement. Ericsson has con- tested the claim. Atmel Corporation was awarded approximately USD 43.1 million in damages after the International Centre for Dispute Resolution, Interna- tional Arbitration Tribunal found Ericsson liable for breaches of contract and misappropriation of trade secrets relating to Atmel’s proprietary AVR microcontroller technology. This lawsuit came about as a result of reorganizing our Phones segment, i.e. formation of the Sony Ericsson Mobile Communications joint venture and establishment of Ericsson Mobile Platforms. We believed the new structure was covered by the original agreement with Atmel. Ericsson Mobile Platforms no longer uses this technology and the ruling will not affect either unit’s business going forward. 38 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Ericsson filed a complaint to the European Commission requesting that it investigate and stop Qualcomm’s anti-competitive conduct in the licensing of essential patents for 3G mobile technology. At the same time, Broadcom, NEC, Nokia, Panasonic Mobile Communications and Texas Instruments each filed similar complaints claiming Qualcomm is violating EU competition law and failing to meet the commitments Qual- comm made to international standardization bodies around the world that it would license its technology on fair, reasonable and non-dis- criminatory terms. The Swedish National Economic Crimes Bureau has added to the indictment against some current and former employees of Ericsson for evasion of tax control. The addition concerns the way the accounting of some payments from Ericsson to Bank Austria during the years 1999 and 2000 was handled. From 2001 to the beginning of 2005, Swedish fiscal authorities dis- allowed, 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 sales commission payments via external service companies to sales agents in certain countries. Most of these taxes have been paid with the rest provisioned for. BOARD OF DIRECTORS More information regarding the Board Of Directors and its members as well as the Board and its committee activities can be found in the Cor- porate Governance Report. Changes to the Board membership The Board of Directors is elected yearly at the Annual General Meeting for the period until the end of the next Annual General Meeting. At the Annual General Meeting on April 6, 2005, Ulf J. Johansson was elected to succeed Lena Torell. Sir Peter L. Bonfield, Sverker Martin-Löf, Nancy McKinstry, Eckhard Pfeiffer and Carl-Henric Svanberg were re-elected as members of the Board. Michael Treschow was re-elected chairman of the Board. Arne Mårtensson and Marcus Wallenberg were re-elect- ed deputy chairmen. 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 du- ties as outlined in Notes to the Consolidated Financial Statements – Note C29, “Information Regarding Employees, Members of the Board of Directors and Management.” Members and Deputy Members of the Board, who are employees, i.e. the CEO and the employee representa- tives, 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 for each board meeting attended. PARENT COMPANY The Parent Company business consists mainly of corporate manage- ment, holding company functions and, from January 1, 2005, internal banking activities previously performed on a commission basis by Ericsson Treasury Services AB. The Parent Company business also includes customer credit management performed on a commission basis by Ericsson Credit AB. The Parent Company is the owner of the majority of intellectual property rights and manages the patent portfolio, including patent ap- plications, licensing and cross licensing of patents and defending of patents in litigations. The Parent Company has 8 (11) branch offices. In total, the Group has 51 (45) branch and representative offices. Net sales for the year amounted to SEK 1.1 (2.6) billion and income after financial items was SEK 14.0 (7.4) billion. Exports accounted for 96 percent of net sales in 2005 (98 percent in 2004). No consolidated companies were customers of the Parent Company’s sales in 2005 or 2004, while 27 percent (21 percent in 2004) of the Company’s total purchases of goods and services were from such companies. Profits from disposal of shares to a subsidiary contributed SEK 6.8 billion to income. Major changes in the Parent Company’s financial position for the year include increased current and non-current receivables from sub- sidiaries of SEK 11.3 billion, increased investments in subsidiaries of SEK 4.2 billion and decreased other current receivables of SEK 4.5 billion. At year-end, cash and short-term cash investments amounted to SEK 75.0 (71.7) billion. In accordance with the conditions of the Stock Purchase Plans and Option Plans for Ericsson employees, 31,649,876 shares from treasury stock were sold or distributed to employees during the year. The nom- inal amount of these shares is SEK 31.6 million, representing less than one percent of capital stock, and compensation received amounted to SEK 179.1 million. The holding of treasury stock at December 31, 2005 was 268,065,241 Class B shares. The nominal amount of these shares is SEK 268.1 million, representing 2 percent of capital stock, and re- lated acquisition cost amounts to SEK 596.5 million. POST CLOSING EVENTS Change in accounting principles for pensions 2006 Effective January 2006, Ericsson will adopt the new option in IAS 19, Employee benefits, on how to recognize actuarial gains and losses. The currently used method to recognize actuarial gains and losses – to the extent that they fall outside the 10 percent corridor – is that they are amortized over the average remaining service time of plan participants. Instead, all actuarial gains and losses will effective January 1, 2006, be recognized directly to equity, net of deferred tax, in the period they occur. Earlier reporting-periods will be restated accordingly. The adop- tion of the new option will increase provision for post-employment ben- efits with approximately SEK 3.5 billion, accruals for social security with SEK 0.8 billion and will affect equity by approximately SEK 3.1 billion net of tax as per January 1, 2006. Marconi acquisition Marconi shareholder and relevant regulatory approvals have been ob- tained and closing took place on January 23, 2006, with the exception of a few smaller subsidiaries. The acquired operations will be consoli- dated into Ericsson’s accounts starting with the first quarter of 2006. The integration process has started with the Marconi products and solutions planned to be fully integrated into Ericsson’s portfolio. Under the transaction approximately 6,660 employees have been transferred to Ericsson in January 2006. B O A R D O F D I R E C T O R S ’ R E P O R T 39 PROPOSED DISPOSITION OF EARNINGS The Board of Directors proposes that a dividend of SEK 0.45 (0.25) per share be paid to shareholders duly registered on the Record date of April 13, 2006, 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 dis- tributed as follows: Amount to be paid to the shareholders Amount to be retained by the Parent Company SEK 7,259,516,405 SEK 21,709,793,259 Total non-restricted equity of the Parent Company SEK 28,969,309,664 As basis for its proposal for a dividend, the Board of Directors has made an assessment in accordance with Chapter 18, Section 4 of the Swed- ish Companies Act of the Company’s and the Group’s need for financial resources as well as the Company’s and the Group’s liquidity, financial position in other respects and long-term ability to meet its commit- ments. The company reports an equity ratio of 50.5% and net cash amounts to SEK 53.4 bilion. The Board of Directors has also considered the Company’s and the Group’s position in general. In this respect, the Board of Directors has taken into account known commitments that may have an impact on the Company’s financial position. Such commitments are for example the acquisition of certain operations from Marconi and repayment of debts during 2006. The proposed dividend does not limit the Company’s ability to make investments or its need of funds. It is the Board of Directors’ assessment that the proposed dividend is well-balanced considering the type, scope and risks of the business activities and the Company’s and the Group’s capital requirements. BOARD ASSURANCE In accordance with section 3.6.2 of the Swedish Code of Corporate Governance, assurance is hereby given by the Board of Directors and the President and CEO that, to the best of our knowledge, the annual accounts and the consolidated accounts have been prepared in accordance with generally accepted accounting principles (GAAP) for a publicly listed company, the information presented is consistent with actual conditions and nothing of material value has been omitted that would affect the picture of the company presented in this annual re- port. Stockholm February 24, 2006 Telefonaktiebolaget LM Ericsson (publ) Org. no. 556016-0680 Arne Mårtensson Deputy chairman Michael Treschow Chairman Marcus Wallenberg Deputy chairman Nancy McKinstry Peter L. Bonfield Eckhard Pfeiffer Sverker Martin-Löf Ulf J. Johansson Per Lindh Torbjörn Nyman Carl-Henric Svanberg President and CEO Jan Hedlund 40 B O A R D O F D I R E C T O R S ’ R E P O R T E R I C S S O N A N N U A L R E P O R T 2 0 0 5 CONSOLIDATED INCOME STATEMENT Years ended December 31, SEK million Net sales Cost of sales Gross margin Research and development and other technical expenses Selling and administrative expenses Operating expenses Other operating income Share in earnings of joint ventures and associated companies Operating income Financial income Financial expenses Income after financial items Taxes Net income Of which: Net income attributable to stockholders of the parent company Net income attributable to minority interest Other information Average number of shares, basic (million) Earnings per share, basic (SEK) Earnings per share, diluted (SEK) Notes C4, C5 C7 C13 C8 C8 C9 C10 C10 2005 151,821 –82,369 69,452 –24,454 –16,800 –41,254 2,491 2,395 33,084 2,653 –2,402 33,335 –8,875 24,460 2004 131,972 –70,864 61,108 –23,421 –15,921 –39,342 2,617 2,323 26,706 3,541 –4,081 26,166 –8,330 17,836 24,315 145 17,539 297 15,843 1.53 1.53 15,829 1.11 1.11 C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 41 CONSOLIDATED BALANCE SHEET December 31, SEK million ASSETS Non-current assets Intangible assets Capitalized development expenses Goodwill Other Property, plant and equipment Financial assets Equity in joint ventures and associated companies Other investments in shares and participations Customer financing, non-current Other financial assets, non-current Deferred tax assets Current assets Inventories Financial assets Accounts receivable – trade Customer financing, current Other current receivables Short-term investments Cash and cash equivalents Total assets EQUITY AND LIABILITIES Equity Stockholders’ equity Minority interest in equity of consolidated subsidiaries Non-current liabilities Post-employment benefits Other provisions, non-current Deferred tax liabilities Borrowings, non-current Other non-current liabilities Current liabilities Other provisions, current Borrowings, current Accounts payable Other current liabilities Total equity and liabilities 1) Assets pledged as collateral Contingent liabilities 1) Of which interest-bearing provisions and liabilitites 28,094 (33,643). 42 Notes 2005 2004 C11 C12, C27, C28 C13 C9 C14 C15 C16 C21 C21 C17 C18 C19 C20,C21 C19 C20, C21 C23 C22 C24 C25 6,161 7,362 939 8,091 5,766 748 6,966 5,845 6,313 805 1,322 3,514 17,294 50,676 4,155 543 2,150 1,236 20,766 49,300 19,208 14,003 41,242 3,624 12,574 39,767 41,738 158,153 208,829 104,677 850 105,527 3,125 904 391 14,185 2,740 21,345 17,764 10,784 12,584 40,825 81,957 208,829 549 1,708 32,644 1,446 12,239 46,142 30,412 136,886 186,186 80,445 1,057 81,502 10,087 1,146 421 21,837 1,856 35,347 23,632 1,719 10,988 32,998 69,337 186,186 7,985 1,014 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 CONSOLIDATED STATEMENT OF CASH FLOWS Years ended December 31, SEK million OPERATIONS Net income attributable to stockholders of the parent company Notes 2005 2004 Adjustments to reconcile net income to cash C26 C12 C26 C11 Operating net assets Inventories Customer financing, current and non-current Accounts receivable Provisions and post-employment benefits Other operating assets and liabilities, net Cash flow from operating activities Investing activities Investments in property, plant and equipment Sales of property, plant and equipment Acquisitions and sales of shares and other investments, net Product development Net change in capital contributed by minority Other investing activities Cash flow from operating investing activities Cash flow before financial investing activities Short-term investments Cash flow from investing activities Cash flow before financing activities Financing activities Changes in borrowings, current, net Proceeds from issuance of non-current borrowings Repayment of non-current borrowings Sale/repurchase of own stock Dividends paid Cash flow from financing activities Effect of exchange rate changes on cash Net change in cash 24,315 17,539 10,845 35,160 10,490 28,029 –3,668 –641 –5,874 –15,574 7,266 16,669 –3,365 362 –957 –1,174 20 –230 –5,344 –3,432 –65 –1,403 –1,990 1,340 22,479 –2,452 358 –1,549 –1,146 71 –70 –4,788 11,325 17,691 6,375 1,031 –26,050 –30,838 17,700 –8,359 –1,216 93 –947 117 –4,133 –6,086 –288 11,326 –1,502 870 –13,649 15 –292 –14,558 214 –22,703 Cash and cash equivalents, beginning of period 30,412 53,115 Cash and cash equivalents, end of period C21 41,738 30,412 C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 43 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Years ended December 31, SEK million Opening balance Adjustment for IAS 39, net Adjusted opening balance Changes in hedge reserve, net Revaluation of other investments in shares and participations, net Changes in cumulative translation effects due to changes in foreign currency exchange rates Business combinations Net income Total income and expenses for the period Stock issue, net Sale of own shares Stock Purchase and Stock Option Plans Dividends paid Adjustment of cost for stock issue 2002 Total transactions with owners Closing balance Stock- holders’ equity 1) 80,445 1,489 81,934 –1,859 –150 4,037 – 24,315 26,343 – 117 242 –3,959 – –3,600 104,677 2005 Total equity 81,502 1,489 82,991 –1,859 –150 4,184 –342 24,460 26,293 17 117 242 –4,133 – –3,757 105,527 Minority interest 1,057 – 1,057 – – 147 –342 145 –50 17 – – –174 – –157 850 2004 Stock- holders’ Minority interest 2,299 – 2,299 equity 1) 63,820 – 63,820 Total equity 66,119 – 66,119 – – – – – – –1,135 – 17,539 16,404 – 15 204 – 2 221 80,445 –65 –1,182 297 –950 –1,200 –1,182 17,836 15,454 – – – –292 – –292 1,057 – 15 204 –292 2 –71 81,502 1) For further information, please see “Notes to the consolidated statements, Note C17, “Stockholders’ equity”. 44 C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S E R I C S S O N A N N U A L R E P O R T 2 0 0 5 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTENTS C1 Significant Accounting Policies ................................................................................................................................................................................................. 46 C2 Critical Accounting Estimates and Judgments ................................................................................................................................................................ 50 C3 Transition to IFRSs ............................................................................................................................................................................................................................. 52 C4 Segment Information ........................................................................................................................................................................................................................ 57 C5 Revenues ................................................................................................................................................................................................................................................. 59 C6 Expenses by nature ........................................................................................................................................................................................................................... 59 C7 Other Operating Income ................................................................................................................................................................................................................. 59 C8 Financial Income and Expenses ............................................................................................................................................................................................... 59 C9 Taxes ........................................................................................................................................................................................................................................................... 59 C10 Earnings per Share ............................................................................................................................................................................................................................ 60 C11 Intangible Assets ..................................................................................................................................................................................................................................61 C12 Property, Plant and Equipment .................................................................................................................................................................................................. 63 C13 Financial Assets ................................................................................................................................................................................................................................... 65 C14 Inventories ............................................................................................................................................................................................................................................... 67 C15 Accounts Receivable – Trade ...................................................................................................................................................................................................... 67 C16 Other Current Receivables ........................................................................................................................................................................................................... 67 C17 Stockholders’ Equity ........................................................................................................................................................................................................................ 68 C18 Post-employment Benefits ........................................................................................................................................................................................................... 69 C19 Other Provisions .................................................................................................................................................................................................................................. 72 C20 Interest-bearing Provisions and Liabilities .......................................................................................................................................................................... 73 C21 Financial Risk Management and Financial Instruments ............................................................................................................................................. 73 C22 Other Current Liabilities .................................................................................................................................................................................................................. 77 C23 Accounts and Notes Payable – Trade .................................................................................................................................................................................... 77 C24 Assets Pledged as Collateral ...................................................................................................................................................................................................... 77 C25 Contingent Liabilities ........................................................................................................................................................................................................................ 77 C26 Statement of Cash Flows ............................................................................................................................................................................................................... 77 C27 Leasing ...................................................................................................................................................................................................................................................... 78 C28 Tax Assessment Values in Sweden ......................................................................................................................................................................................... 79 C29 Information Regarding Employees, Members of the Board of Directors and Management ............................................................... 79 C30 Related Party Transactions .......................................................................................................................................................................................................... 84 C31 Fees to Auditors ................................................................................................................................................................................................................................... 84 C32 Reconciliation to Accounting Principles Generally Accepted in the United States .................................................................................. 85 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 45 C1 SIGNIFICANT ACCOUNTING POLICIES in shares and participations and carried at fair value. Fair values are based on quoted market prices or rates. If official rates or market pric- es are not available, fair values are calculated by discounting the ex- pected future cash flows at prevailing interest rates. The consolidated financial statements of Telefonaktiebolaget LM Eric- sson, the Parent Company and its subsidiary companies (“the Com- pany”) for 2005 and 2004 are prepared in accordance with Interna- tional Financial Reporting Standards. IFRS below refer to all these standards. For Ericsson, there is no difference between IFRS and IFRS as adopted by the EU by December 31, 2005 and the Swedish Annual Accounts Act. We have also applied URA 43 Accounting for special payroll tax and tax on investment returns and URA 46 IFRS 2 and ac- counting for social security expenses, issued by the Swedish Financial Accounting Standards Council (Redovisningsrådet). IFRSs differs in certain aspects 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 C32, Reconciliation to Accounting Principles Generally Accepted in the United States. Ericsson has applied IFRSs since January 1, 2005. All amounts related to 2004 have been restated in accordance with IFRSs, except for IAS 39 which has been applied as from January 1, 2005. In Note C3, Transition to IFRSs, a reconciliation of the restatement is made for the transition to IFRSs. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Par- ent Company and all subsidiary companies. Subsidiary companies are all companies in which Ericsson has an ownership and directly or indi- rectly, including effective potential voting rights, has a voting majority or Ericsson by agreement has control or retains the majority of the re- sidual or ownership risk of the entity. Inter-company transactions have been eliminated. Elimination of unre- alized profits in inventory is made in full without consideration of minor- ity interests. The consolidated financial statements are prepared in accordance with the purchase method. Accordingly, consolidated stockholders’ equity includes equity in subsidiary companies and associated com- panies earned only after their acquisition. ASSOCIATED COMPANIES AND JOINT VENTURES Investments in associated companies and joint ventures, where voting stock interest including effective potential voting rights is at least 20 percent but not more than 50 percent, or where a corresponding influ- ence is obtained through agreement, are accounted for according to the equity method. IFRS 3 has been applied for the accounting of these companies. Ericsson’s share of income before taxes is reported in item “Share in earnings of joint ventures and associated companies”, includ- ed in Operating Income. Taxes are included in item “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 goodwill (see “Goodwill” below). Undistributed earnings of associated companies included in con- solidated equity are reported as Retained earnings, as detailed in Note C17, Stockholders’ equity. All other equity instruments are accounted for as Other investments 46 GOODWILL At the acquisition of a business, an allocation is made of the purchase price in which fair values are assigned to acquired assets, for example intangible assets such as customer relations, brands and patents, based upon appraisals made. Goodwill arises when the purchase price exceeds the fair value of recognizable acquired net assets. Goodwill resulting from acquisitions of businesses is subject to im- pairment review at least annually in the fourth quarter and when there are indications that the carrying value may not be recoverable. The carrying values are not considered to be recoverable when the ex- pected discounted cash flows are less than the carrying values. An impairment loss is determined based on the amount by which the car- rying value exceeds the recoverable amount. Goodwill related to assets in foreign currency is remeasured at period-end exchange rates. TRANSLATION OF FINANCIAL STATEMENTS IN FOREIGN CURRENCY For most subsidiary companies, joint ventures and associated compa- nies, the local currency is the currency in which the companies pri marily 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 by translating assets and liabilities to the closing rate at the balance sheet day and income state- ment items at average exchange rates, with translation adjustments reported directly in consolidated equity. When a company is sold, ac- cumulated translation adjustments are included in consolidated in- come. For a limited number of companies, the functional currency is a cur- rency other than the local currency. The financial statements of such 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 as above. Ef- fective portion of foreign exchange gains and losses on hedge instru- ments designated to hedge the net investments in foreign entities are reported directly in consolidated equity, net of tax effects, to offset the translation adjustments above. Ineffective and undesignated portions of foreign exchange gains and lossed are reported in operating income. REVALUATION OF FOREIGN CURRENCY ITEMS IN INDIVIDUAL COMPANIES In the financial statements, receivables and liabilities in foreign curren- cies are revalued at year-end exchange rates. Foreign exchange gains and losses are divided into operational and financial. Effects of hedging are in the income statement reported to- gether with the hedged item. The net difference between foreign exchange gains/losses on op- erating transactions and gains/losses on hedging through foreign ex- change 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. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 IAS 39 was adopted as from January 1, 2005 with early adoption of the amendment related to hedging of group internal transactions. In 2004, Foreign exchange derivatives hedging off-balance exposures were treated off-balance, also referred to as ”Deferral hedge account- ing”. When the hedged transaction occurred, the hedged spotrate was used for the transaction and the derivative was moved on-balance. The theoretical interest portion was accrued over the life of the derivative. Interest rate derivatives used as hedges were valued at amortized cost, which was in-line with the underlying transaction. period. Revenue for training, consulting, engineering, installation and similar services is generally recognized when the services are provid- ed. Mobile platform license revenues are included in reported Net Sales and contracted based on the number of handsets or components pro- duced by the customer. Revenue is recognized when the customer production has been made. For sales between consolidated companies, associated companies, joint ventures and segments we apply arm’s length pricing. 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 revenue amount is fixed or determinable and when collection is reasonably assured. 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 ap- propriate revenue recognition method. The contracts are of three main types: • delivery-type • construction-type • contracts for various types of services, for example multi-year man- aged services contracts SHARE-BASED EMPLOYEE COMPENSATION Stock option plans Ericsson has chosen to not apply IFRS 2 to equity instruments granted before November 7, 2002, in accordance with IFRS 1 and IFRS 2. IFRS 2 is applied for one employee option program granted after November 7, 2002. The vesting period for this program ended during 2005, and Ericsson recognized compensation costs representing the fair value at grant date of the outstanding employee options. In the balance sheet the corresponding amounts are accounted for as equity. The fair value of the options was calculated using an option-pricing model. The total costs were recognized during the vesting period (3 years), i.e. the period during which the employees had to fulfil vesting requirements. When the options are exercised, 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. Until exercise, estimated costs for such social security charges are accrued. Large customer frame agreements may include different types of un- dertakings and may result in a mix of construction-type contracts, de- livery-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. Spe- cific contractual performance and acceptance criteria impact the timing and amounts of revenue recognized. Revenues from construction-type contracts are generally recog- nized 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 construc- tion-type contracts generally define deliverables or milestones for prog- ress billing to the customer, which also well reflect the degree of com- pletion of the contract. The profitability of contracts is periodically assessed and adjusted, if necessary, based on changes in circumstances. Provisions for losses, with full amounts, are immediately made when losses are probable. For delivery-type contracts revenue is recognized when risks and rewards have been transferred to the customer, normally stipulated in terms of trade. 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. Revenue for period service contracts and managed services con- tracts, covering longer periods is recognized pro rata over the contract Stock purchase plans For stock purchase plans, compensation costs are recognized during the vesting period, based on the fair value of the share at the employee’s investment date. The fair value is based upon the share price at invest- ment date adjusted for that no dividends will be received prior to match- ing. The investment date is considered as the grant date. In the balance sheet the corresponding amounts are accounted for as equity. Vesting conditions affect the number of shares that Ericsson will match. For shares under performance-based matching programs, the Company assesses the probability of meeting the performance targets when calculating the compensation costs. Compensation expenses are based on estimates of the number of shares that will match at the end of the vesting period. When shares are matched, social security charg- es 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, esti- mated social security charges are accrued. BORROWING COSTS The Company does not capitalize any borrowing costs, including bor- rowing cost related to financing of construction of tangible assets. Costs are expensed as incurred. NON-CURRENT ASSETS HELD FOR SALE Non-current assets held for sale are valued at the lower of carrying amount and fair value less cost to sell. At present, the occurrence of assets held for sale are very limited. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 47 EARNINGS PER SHARE Basic earnings per share are calculated by dividing net income attribut- able to shareholders of the parent company by the average number of shares outstanding during the year. Diluted earnings per share are calculated by dividing net income attributable to shareholders of the parent company by the sum of the average number of ordinary shares outstanding and potential ordinary shares. Potential ordinary shares are treated as dilutive when, and only when, their conversion to ordinary shares decrease earnings per share. CLASSIFICATION AND MEASUREMENT OF FINANCIAL INSTRUMENTS IAS 39 was adopted as from January 1, 2005 with early adoption of the amendment related to hedging of group internal transactions. • Short-term investments are valued at fair value through profit and • Loans and borrowings are valued using the amortized cost method. loss in the consolidated accounts. Derivative financial instruments are used to hedge foreign exchange and interest rate risks. • Foreign exchange derivatives are valued at fair value through profit and loss. However, those foreign exchange derivatives fulfilling the requirements for cash flow hedge accounting are valued at fair value and effective portions of the designated risk are deferred in consolidated stockholders’ equity net of tax effects. Ineffective and undesignated portions are reported through profit and loss. The amount deferred in equity is released to profit or loss when the hedged transaction affects consolidated profit or loss, affecting net sales or cost of goods sold based on the nature of the hedge. • Interest rate-related derivatives are valued at fair value through • Ericsson’s listed debt instruments (outstanding notes and bond profit and loss. loans) are valued at amortized cost, unless designated as hedged item in a fair value hedge, when the hedged risk is valued at fair value through profit and loss. Foreign exchange gains and losses on operating assets and liabilities are reported as adjustments to Cost of Sales. The corresponding re- porting for financial items is adjustments to financial income and ex- penses respectively. In the consolidated accounts, gains and losses on operational hedges are reported together with losses and gains on the underlying position. Financial assets and liabilities are offset and reported net in the balance sheet when there is a legally enforceable right for offset and there is an intent to settle on a net basis. Fair values of financial instruments are based on quoted market prices or rates. If official rates or market prices are not available, fair values are calculated by discounting the expected future cash flows at prevailing interest rates. 48 INTANGIBLE ASSETS OTHER THAN GOODWILL These assets consist of capitalized development expenses and aquired intangible assets, such as patents and software, and are stated at cost less accumulated amortization/write-down. Amortization, depreciation and any write-downs are included in “ Research and development and other technical expenses” and “Cost of Sales” . Costs incurred for development of products to be sold, leased or otherwise marketed or intended for internal use are capitalized as from when technological and economical feasibility has been established until the product is available for sale or use. These capitalized costs are mainly generated internally and 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. Impairment tests 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 are not considered to be recoverable when the expected discounted cash flows are less than the carrying values. An impairment loss is determined based on the amount by which the carrying value exceeds the recover- able amount. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is stated at cost less accumulated de- preciation and any write-down due to impairment. Annual depreciation, based upon the component approach, is gen- erally made using the straight-line method, with estimated useful lives of, in general, 40 years on buildings, 20 years on land improvements, 3 to 10 years on machinery and equipment, and up to 5 years on rental equipment. Depreciation and any write-downs are included in “Cost of Sales” and in the respective functional operating expenses. Impairment tests of property, plant and equipment are made when- ever there is an indication of possible impairment. Impairment losses occur, as for intangible assets, when the carrying value exceeds the recoverable amount. The recoverable amount is based upon either expected discounted cash flows or the selling price reduced by the costs of disposal. Provisions are made for expected costs for restora- tion of land or buildings due to environmental obligations. LEASING Leasing when the company is the lessee Finance lease contracts are capitalized and reported as property, plant and equipment and as other current and non-current liabilities. Depre- ciations are made as for property, plant and equipment. Operating lease contracts are not capitalized. Leasing when the company is the lessor Leasing contracts with the company as a lessor are classified as finance leases when the majority of risks and rewards are transferred to the lessee, and otherwise as operating leases. Under a finance lease, we recognize a receivable at an amount equal to the net investment in the lease and recognize revenue in accordance with our revenue recogni- tion principles. For operating leases, an asset is reported as property, E R I C S S O N A N N U A L R E P O R T 2 0 0 5 plant and equipment and revenues and depreciation are recognized on a straight-line basis over the lease term. DEFERRED TAXES Deferred tax assets consist of (i) temporary differences between the book values of assets and liabilities and their tax values and (ii) unuti- lized tax loss carry-forwards. These assets are recoqnized to an amount not larger than probable future taxable profits, against which the tax deductions can be utilized. The valuation of deferred tax assets involves assumptions regarding the deductibility of costs not yet subject to taxation and regarding suf- ficient future taxable income to enable utilization of unused tax losses in different tax jurisdictions. All deferred tax assets are subject to an- nual review of possible utilization. The largest amounts of tax loss carry-forwards are in Sweden, with indefinite period of utilization. The accumulated deferred tax assets/liabilities are 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 amortized cost, less allowances for impair- ment charges. When selling a receivable we de-recognize the receivable if we have transferred substantially all the risks and rewards of ownership of the receivable and recognize separately as assets or liabilities any rights and obligations created or retained in the transfer. We assess the collectibility of our receivables for purposes of initial revenue recognition and to record receivables at fair value. In instances where we have exposures related to guarantees to third parties for customer financing, we have reported the extent of our exposure as contingent liabilities. These contingent liabilities are reported net of risk provisions. INVENTORIES Inventories are valued at the lower of cost or net realizable value on a first-in, first-out (FIFO) basis. Risks of obsolescence have been measured by estimating market value based on future customer demand and changes in technology and customer acceptance of new products. PROVISIONS Provisions are made when we have legal or constructive obligations as a result of past events and when it is probable that an outflow of re- sources will be required to settle the obligations and the amounts can be estimated reliably. However, the actual outflow as a result of the obligation may vary from that estimate. Our provisions mainly relate to warranty commitments, restructuring, customer financing guarantees and other obligations, such as litigation obligations, contractual discounts, customer contract loss provisions, penalties or claims as well as unresolved income tax and value added tax issues. In the ordinary course of business, the company is subject to pro- ceedings, lawsuits and other unresolved claims, including proceedings under laws and government regulations and other matters. These mat- ters are often resolved over long periods of time. We regularly assess the likelihood of any adverse judgments in or outcomes of these matters, as well as potential ranges of possible losses. Provisions are recognized when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated based on a detailed analysis of each individual issue. For losses on customer contracts we record provisions when a loss from a contract is anticipated and is possible to estimate reliably. We provide for the estimated future settlements related to patent infringe- ments based on the probable outcome of each infringement. The ulti- mate outcome or actual cost of settling an individual infringement may vary from our estimates. We estimate the outcome of all potential patent infringements made known to us through assertion and through our own monitoring of patent-related cases in the relevant legal systems. To the extent that we determine that an identified potential infringement will probably than not result in an outflow of resources, we record a provision based on our best estimate of the expenditure required to settle infringement proceedings. At various intervals we give our suppliers and/or subcontractors fore- casts of expected purchases and also sometimes commit to minimum levels during a certain period. The agreements often include compensa- tion clauses for the event that material deviations from original plans regarding production volumes or product mix should occur. As a result of actual deviations from committed purchase levels or of received ac- tual claims from these suppliers and/or subcontractors, we make provi- sions for estimated compensation to such suppliers and/or subcontrac- tors. Additionally, provisions are estimated and accrued for charges as a result of known changes in design specifications that are provided to production subcontractors. Amounts for provisions and subsequent net amounts at settlements are charged to the corresponding item in the income statement (i.e. costs related to component suppliers, production subcontractors and installation subcontractors are included in “Cost of Sales”. Costs regarding development subcontractors are included in “R&D and other technical expenses”, and costs related to IT-providers and other services are included in operating expenses or “Cost of Sales” depending on the nature of the service. Such provisions are monitored closely on a regular basis, with any additions/reversals charged to the same account as the initial provision. PENSIONS AND OTHER POST-EMPLOYMENT BENEFITS Pensions and other post-employment benefits are classified as either defined contribution plans or defined benefit plans. Under a defined contribution plan, the company’s only obligation is to pay a fixed amount to a separate entity (a fund), and will have no obligation to pay further contributions if the fund does not hold sufficient assets to pay all em- ployee benefits. The related actuarial and investment risk falls on the employee. Under a defined benefit plan it is the Company’s obligation to provide agreed benefits to current and former employees. The re- lated actuarial and investment risks fall on the Company. The present value of the defined benefit obligations for current and former employees is calculated using the Projected Unit Credit 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 ac- tual result will differ from the estimated result. These differences are reported as actuarial gains and losses. They are for example caused by unexpectedly high or low rates of employee turnover, changed life N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 49 expectancy, 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 expected average remaining service period if the gains/ losses exceed the greater of 10 percent of the present value of the defined benefit obligation or 10 percent of the fair value of plan assets at the beginning of period (the corridor). The net of return on plan assets and interest on pension liabilities is reported as financial income or expense. STATEMENT OF CASH FLOWS Foreign subsidiary companies’ amounts are translated at the average exchange rate during the period. Subsidiary companies purchased and/or sold are reported as cash flow from investment activities, net of cash acquired/sold, and do not affect reported cash flow from opera- tions. Cash and cash equivalents consist of cash, bank and short-term investments and are highly liquid financial instruments that have a re- maining maturity of three months or less at the date of acquisition. SEGMENT REPORTING Primary segments Ericsson has the following business segments: • Systems, addressing operators of mobile and fixed line public tele- • Phones, addressing distributors of mobile handsets to end users. phone networks. Financial information for this segment consists of our investment and share in earnings of Sony Ericsson. • Other operations, which consists of a number of different operations with different types of customers. Each included operation repre- sents, however, less than 10 percent of total net sales and is there- fore considered too small to be reported separately. Included op- erations are: Microwave Systems, Network Technologies, Enterprise Systems, Mobile Platform Technology, Power Modules and other. When determining our business segments, we have looked at which market and to what type of customers our products are aimed and through what distribution channels they are sold, as well as to com- monality regarding technology, research and development. We regard the Systems segment as on business segment, where the business units Access, Systems, Global Services and Transmission and Trans- port Networks represent different product lines within the segment. This is due to the close technical relation between included products – they are all integrated components in public telecommunications net- works for fixed or mobile communication, subject to common technical systems standards for e.g. GSM, TDMA, CDMA and WCDMA – and due to the common supply and sales through our own sales organization to operators of public networks, with contracts that as a rule include a mix of products and services as well as installation from several prod- uct lines. Our second segment, Phones, is carried out through a joint venture with Sony and develops and sells handsets for mobile telecommunica- tions to distributors. Our segment Other Operations is composed of a number of small- er operating units, each too small to be reported individually as a sep- arate segment, and each with different characteristics in terms of prod- ucts, customers and distribution channels. 50 Secondary segments Ericsson operates in five main geographical areas: (1) Western Europe, (2) Central and Eastern Europe, Middle East and Africa, (3) Asia Pa- cific, (4) North America and (5) Latin America. These areas represent our geographical segments. Financial information is provided to the Board for both primary and secondary segments. These are subject to risk and returns that are different from those of other segments. GOVERNMENT GRANTS Government grants are recognized when there is a reasonable assur- ance of compliance with conditions attached to the grants and that the grants will be received. For Ericsson, government grants are linked to performance of re- search or development work or to subsidized capital expenditures as governmental stimulus to employment or investments in a certain coun- try or region. The occurance of government grants is very limited. Gov- ernment grants are normally reported as reductions of development costs or reductions of capital expenditure, depending on their nature. NEW IFRSs STANDARDS, AMENDED IAS STANDARDS AND IFRIC INTERPRETATIONS AS FROM JANUARY 1, 2006 • IAS 19 Employee Benefits. As from January 1, 2006, the company will apply the option for recognition of actuarial gains and losses in equity. The amendment will be applied retrospectively as from January 1, 2004. The effect of the application is an increase of pen- sion liability of approximately SEK 3.5 b. and accruals for social security of SEK 0.8 billion at January 1, 2006. The effect on stock- holders’ equity net of tax is approximately SEK 3.1 b, as per January 1, 2006. • IAS 39 Financial instruments: Recognition and Measurement. An amendment requires a company to include liabilities resulting from financial guarantee contracts in the balance sheet. This amendment is not expected to have a significant impact on the financial position and result. • IFRIC 4 Determining whether an Arrangement contains a Lease. This interpretation is not expected to have a significant impact on the financial position and result. • IFRIC 6 Liabilities arising from Participating in a Specific Market – Waste of Electric and Electronical Equipment. This interpretation is not expected to have a significant impact on the financial position and result. C2 CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS The preparation of financial statements and application of accounting standards often involve management’s judgment or the use of estimates and assumptions deemed to be reasonable and prudent at the time they are made. 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 could have the most significant impact on our reported results and financial position. REVENUE RECOGNITION Parts of our sales is generated from large and complex customer con- tracts. Managerial judgment is applied, among other aspects, regard- ing contractual performance, estimated total contract costs, degree of completion and conformance with acceptance criteria to determine the amounts of revenue to be recognized and any loss provisions to be made. INVENTORY VALUATION Inventories are valued at the lower of cost or net realizable value. Total inventory reserves as of December 31, 2005 amount to SEK 2.5 (3.1) billion or 12 (18) percent of gross inventory. Of the total inventory of SEK 19.2 billion, SEK 11.6 billion is contract work in progress and SEK 7.6 billion is mainly related to components and finished goods. For the contract work in progress inventory, risks are related to the judgements made in relation to revenue recognition, while for the component and finished goods parts, the inventory risks are more related to techno- logical obsolescence and estimates of net realizable values. 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 (i.e. with no expiry date). The valuation of tax loss carry-forwards and our ability to utilize tax losses is based upon our estimates of future taxable income in different tax juris dictions and involves assumptions regarding the deductibility of costs not yet subject to taxation. At December 31, 2005, the value of unutilized tax loss carry forwards amounted to SEK 28.0 (34.1) billion. The deferred tax amounts related to loss carry-forwards are reported as non-current assets. ACCOUNTING FOR INCOME-, VALUE ADDED- AND OTHER TAXES Accounting for these items is based upon evaluation of income, value added tax rules and other taxes in all jurisdictions where we perform activities. The total complexity of all rules related to taxes and the ac- counting for these require management involvement in estimates and judgments of probable outcomes. 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 judgment that the technological and economical feasibility is confirmed, usually when a product development project has reached a defined milestone according to an established project management model. Capitalization ceases and amortization of capitalized development amounts begins when the product is available for general use with impairment testing performed annually. The definition of amortization period also requires management’s judgment. At December 31, 2005, the amount of capitalized development costs amounted to SEK 6.2 (8.1) billion. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 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 will get paid for individual receivables. Most of our customers have good creditworthiness. Total allowances for doubtful accounts as of December 31, 2005, were SEK 1.4 (1.8) billion or 3.3 (5.3) percent of our gross accounts receivable. We regularly assess the credit risk and based on these assessments, we record provisions for outstanding customer financing credits and contingent liabilities, i.e. third party credits under our guarantees. These risk provisions are included in “Selling and administrative expenses”. Warranty commitments Provisions for product warranties are based on historic quality rates as well as assumptions on estimated quality rates for new products and costs to remedy the various types of faults predicted. Total provisions for product warranties as of December 31, 2005, amounted to SEK 4.8 (6.4) billion. Pension and other post-employment benefits Accounting for the costs of defined benefit pension plans and other applicable post-employment 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 are based on rates for high-quality fixed- income investments with durations similar to our pension plans. Ex- pected return on plan assets consider long-term historical returns, al- location of assets and estimates of future long-term investment returns. At December 31, 2005, provisions for pensions and other post-employ- ment benefits amounted to net SEK 2.0 (10.1) billion. Other provisions Other provisions are mainly comprised of contractual obligations and penalties with most of the rest for risks associated with patent and other litigations, contractual discounts and penalties of uncertain timing or amount, supplier or subcontractor claims and/or disputes, as well as provisions for income tax and value added tax unresolved issues and estimated losses on customer contracts. The nature and type of risks for these provisions differ and judgments related to them receive special attention from the management. At December 31, 2005, Other provisions amounted to SEK 11,5 (14.5) billion. HEDGE ACCOUNTING AND FOREIGN EXCHANGE RISKS Foreign exchange risk in highly probable sales in future periods are hedged using foreign exchange derivative instruments designated as cash-flow hedges. Establishing highly probable sales volumes involves gathering and evaluating sales forecasts for future periods as well as analyzing ac- tual outcome on a regular basis in order to fulfill effectiveness testing requirements for hedge accounting. Deviations in outcome of sales might result in that the requirements for hedging accounting is not fulfilled. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 51 C3 TRANSITION TO IFRSs FROM SWEDISH GAAP The International Financial Reporting Standards (“IFRSs”) were ad- opted in 2005. New IFRSs standards, amended IAS standards and IFRIC Interpretations up to December 31, 2005, as endorsed by EU have been applied. In the transition to IFRSs, IFRS 1 First-time Adoption of Interna- tional Financial Reporting Standards has been applied. January 1, 2004, is the date of transition to IFRSs for Ericsson. IAS 32 and IAS 39 were adopted as from January 1, 2005, as allowed by IFRS 1. The compari- son year 2004 is restated in accordance with IFRSs. Of the IAS and IFRSs standards, intangible assets, business com- binations, share-based payment and financial instruments have had the most significant impact on the financial position and result. IAS 38 – INTANGIBLE ASSETS When adopting the Swedish accounting standard RR 15 Intangible assets in 2002, the standard was implemented prospectively only, i.e. no restatement of previous periods was allowed, whereas IAS 38 In- tangible assets was implemented retrospectively. The capitalization according to Swedish GAAP during 2002–2004 was the same as per IFRSs. Retrospective application under IFRSs lead to an increase in the opening balance of intangible assets as of January 1, 2004, due to capitalized development costs in years prior to 2002, and increased amortizations on such assets during 2004 and onwards. The opening balance for 2004 was equal to the closing balance according to US GAAP per December 31, 2003, since capitalization of development costs has been made for US GAAP purposes historically. Due to the restatement to IFRSs, intangible assets increased by SEK 6,408 million, deferred tax assets decreased by SEK 1,794 million and equity in- creased by SEK 4,614 million respectively. As a result, amortization for 2004 increased by SEK 2,660 million under IFRSs. IFRS 3 – BUSINESS COMBINATIONS INCLUDING GOODWILL The standard for reporting of business combinations (IFRS 3) has re- sulted in changes in reporting of acquisitions of companies. Compared to previous standard, IFRS 3 requires a more detailed purchase price allocation, in which fair values to a larger extent are assigned to acquired intangible assets, such as customer relations, brands and patents. Goodwill arises when the purchase price exceeds the fair value of ac- quired net assets. Goodwill arising from acquisitions is no longer am- ortized but instead subject to impairment review; at least annually and when there are indicators that the carrying value may not be recover- able. In Ericsson’s reporting during 2005, acquisitions carried out in 2004 have been accounted for in accordance with IFRS 3. As allowed by IFRS 1, no adjustments for acquisitions prior to the transition date, January 1, 2004, were made. The value of goodwill has been frozen at January 1, 2004, and amortization reported under Swedish GAAP for 2004 has been reversed in IFRSs restatements. IFRS 2 – SHARE-BASED PAYMENT As allowed by IFRS 1, Ericsson has chosen not to apply IFRS 2 to equity instruments granted before November 7, 2002. For one employee op- tion program, granted after November 7, 2002, and not yet vested by January 1, 2005, 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 over the vesting period (3 years). The impact on operating profit was a charge of SEK 45 million in 2004. For other programs there are no material differences. IAS 32 AND 39 – FINANCIAL INSTRUMENTS AND HEDGING IAS 32 and 39 are standards that deal with disclosure, presentation, recognition and measurement of financial instruments. These stan- dards are applied prospectively from January 1, 2005. A major effect is that all derivatives are 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 ac- cumulated deferred amount in equity is recycled to the income state- ment. For derivatives assigned as (iii) fair value hedges, fair value changes on both the derivative and the hedged item, attributable to the hedged risk, are recognized in the income statement and offset each other to the extent the hedge is effective. The opening balance January 1, 2005, was affected by SEK 3,556 million in assets, SEK 1,952 million in liabilities and SEK 1,155 million in equity net of SEK 449 million deferred tax as a result of accounting for derivatives at fair value. Other investments in shares and participations are classified as available-for-sale in accordance with IAS 39 and will thus be reported at fair value. 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. As disclosed under “Revaluation of foreign currency items in indi- vidual companies” in note C1, “Significant Accounting Policies”, IAS 39 was adopted as from January 1, 2005. The effect on the opening bal- ance January 1, 2005, was an increase of SEK 411 million in assets and an increase of SEK 334 million in equity, net of deferred tax of SEK 77 million. IAS 19 – EMPLOYEE BENEFITS Ericsson reports pensions and other post-employment benefits ac- cording to IFRSs (IAS 19), which is similar to RR 29 that was imple- mented from January 1, 2004. Actuarial gains and losses were recognized in the opening balance January 1, 2004. For Ericsson, the new standard has resulted in an increase in re- ported operating profit for 2004 of SEK 475 million. No difference in reported earnings has arisen as a result of acquisitions carried out in 2004. RECLASSIFICATION OF PROVISIONS In accordance with IAS 1 Presentation of Financial Statements, provi- sions need to be presented as both current and non-current. A liability shall be classified as current when it satisfies any of the following cri- 52 teria: a) it is expected to be settled in the entity’s normal operating cycle; b) it is held primarily for the purpose of being traded; c) it is due to be settled within twelve months after the balance sheet date; or d) the entity does not have an unconditional right to defer settlement of the liability for at least twelve months after the balance sheet date. All other liabilities shall be classified as non-current. Accordingly, Ericsson has reclassified provisions in the balance sheet to current and non-cur- rent liabilities under IFRSs. RECONCILIATION OF CONSOLIDATED INCOME STATEMENT SEK million Net sales Cost of sales Gross margin Research and development and other technical expenses Selling expenses and administrative expenses Operating expenses Other operating income Share in earnings of joint ventures and associated companies Operating income Financial income Financial expenses Income after financial items Taxes Minority interest Net income Of which: Net income attributable to stockholders of the parent company Net income attributable to minority interest Other information Average number of shares, basic (million) Earnings per share, basic (SEK) Earnings per share, diluted (SEK) Reconciliation of Net income from Swedish GAAP to IFRSs Net income, Swedish GAAP Reclassification of minority interest Reversal of amortization of goodwill Stock option plans Amortization of capitalization of development costs Taxes Net income, IFRSs E R I C S S O N A N N U A L R E P O R T 2 0 0 5 SUMMARY OF TRANSITION EFFECTS: The effects of the adoption of IFRSs on the consolidated income state- ment, balance sheet, cash flow and equity are shown in the tables below. Jan – Dec 2004 IFRSs adjustments Swedish GAAP 131,972 –70,864 61,108 –20,861 – 16,244 –37,105 2,617 2,318 28,938 3,541 –4,081 28,398 –9,077 –297 19,024 –2,558 323 –2,235 5 –2,230 –2,230 745 297 –1,188 15,829 1.20 1.20 –0.09 –0.09 IFRSs 131,972 –70,864 61,108 –23,421 –15,921 –39,342 2,617 2,323 26,706 3,541 –4,081 26,166 –8,330 17,836 17,539 297 15,829 1.11 1.11 19,024 297 475 –45 –2,660 745 17,836 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 53 RECONCILIATION OF CONSOLIDATED BALANCE SHEET JAN 1, 2004 SEK million ASSETS Non-current assets Intangible assets Capitalized development expenses Goodwill Other Property, plant and equipment Financial assets Equity in joint ventures and associated companies Other investments in shares and participations Customer financing, non-current Other financial assets, non-current Deferred tax assets Current assets Inventories Financial assets Accounts receivable - trade Customer financing, current Other current receivables Short-term investments Cash and cash equivalents Total assets EQUITY AND LIABILITIES Equity Stockholders’ equity Minority interest in equity of consolidated subsidiaries Minority interest in equity of consolidated subsidiaries Non-current liabilities Post-Employment benefits Other provisions, non-current Deferred tax liabilities Borrowings, non-current Other non-current liabilities Current liabilities Other provisions, current Borrowings, current Accounts payable Other current liabilities Jan 1, 2004 IFRSs Swedish GAAP 1) adjustments Jan 1, 2004 IFRSs 6,408 –1,794 4,614 4,784 5,739 687 6,505 2,970 433 3,027 1,342 27,735 53,222 10,965 31,886 979 12,718 73,207 129,755 182,977 20,092 –20,092 4,614 59,206 59,206 2,299 9,827 520 27,001 2,771 40,119 27,601 9,509 8,895 35,348 81,353 4,614 2,299 6,913 –2,299 2,095 2,095 –2,095 –2,095 11,192 5,739 687 6,505 2,970 433 3,027 1,342 25,941 57,836 10,965 31,886 979 12,718 20,092 53,115 129,755 187,591 63,820 2,299 66,119 9,827 2,095 520 27,001 2,771 42,214 25,506 9,509 8,895 35,348 79,258 Total equity and liabilities 1) Restated for changed accounting principle, IAS 19 182,977 4,614 187,591 54 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 RECONCILIATION OF CONSOLIDATED BALANCE SHEET DEC 31, 2004 AND JAN 1, 2005 SEK million ASSETS Non-current assets Intangible assets Capitalized development expenses, net Goodwill Other Property, plant and equipment Financial assets Equity in joint ventures and associated companies Other investments in shares and participations Customer financing, non-current Other financial assets, non-current Deferred tax assets Current assets Inventories Financial assets Accounts receivable - trade Customer financing, current Other current receivables Short-term investments Cash and cash equivalents Total assets EQUITY AND LIABILITIES Equity Stockholders' equity Minority interest in equity of consolidated subsidiaries Minority interest in equity of consolidated subsidiaries Non-current liabilities Post-employment benefits Other provisions, non-current Deferred tax liabilities Borrowings, non-current Other non-current liabilities Current liabilities Other provisions, current Borrowings, current Accounts payable Other current liabilities Dec 31, 2004 Swedish GAAP IFRSs Dec 31, 2004 IFRSs adjustments IAS 39 adjustments Jan 1, 2005 IFRSs 4,343 5,324 748 5,845 4,150 543 2,150 1,236 21,815 46,154 14,003 32,644 1,446 12,239 3,748 442 5 -1,049 3,146 8,091 5,766 748 5,845 4,155 543 2,150 1,236 20,766 49,300 14,003 32,644 1,446 12,239 76,554 136,886 183,040 46,142 -46,142 3,146 46,142 30,412 136,886 186,186 77,299 77,299 1,057 10,087 421 21,837 1,856 34,201 24,778 1,719 10,988 32,998 70,483 3,146 1,057 4,203 -1,057 1,146 1,146 –1,146 –1,146 80,445 1,057 81,502 10,087 1,146 421 21,837 1,856 35,347 23,632 1,719 10,988 32,998 69,337 8,091 5,766 748 5,845 4,155 954 2,150 2,173 20,689 50,571 14,003 31,688 1,446 15,814 46,142 30,412 139,505 190,076 81,934 1,057 82,991 10,087 1,146 870 22,774 1,856 36,733 23,632 1,719 10,782 34,219 70,352 411 937 -77 1,271 -956 3,575 2,619 3,890 1,489 1,489 449 937 1,386 -206 1,221 1,015 Total equity and liabilities 183,040 3,146 186,186 3,890 190,076 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 55 IMPACT OF IFRSs ON THE STATEMENT OF CASH FLOWS According to IAS 7 “Cash Flow”, Ericsson defines cash and cash equiv- alents to include only short-term highly liquid investments with remain- ing maturity at acquisition date of three months or less. Under Swedish accounting standards, 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 matu- rity exceeding three months were included. The restated statements of cash flow for 2004 and the opening balance for the Ericsson group according to IAS 7 therefore reflects cash and cash equivalents that are different to those previously reported under Swedish GAAP. (SEK million) Cash and cash equivalents under Swedish GAAP Less: amounts with maturity exceeding three months Cash and cash equivalents under IFRSs January 1, December 31, 2004 2004 73,207 76,554 –20,092 –46,142 53,115 30,412 RECONCILIATION OF EQUITY Reconciliation of equity, Dec 31, 2003, according to Swedish GAAP and Jan 1, 2004, according to IFRSs Closing balance, Swedish GAAP Effect of changed accounting principle, IAS 19 Opening balance according to Swedish GAAP Reclassification of minority interest Capitalization of development costs, net Opening balance, IFRSs 60,481 –1,275 59,206 2,299 4,614 66,119 Reconciliation of equity, Dec 31, 2004, from Swedish GAAP to IFRSs Closing balance, Swedish GAAP Reclassification of minority interest Capitalization of development costs, net Goodwill Closing balance, IFRSs Reconciliation of equity Dec 31, 2004 according to IFRSs and Jan 1, 2005 including IAS 39 Closing balance, IFRSs Hedge reserve, net Revaluation of other investments, net Opening balance Jan 1, 2005 77,299 1,057 2,699 447 81,502 81,502 1,155 334 82,991 56 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 C4 SEGMENT INFORMATION BUSINESS SEGMENTS (PRIMARY) 2005 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 Net income Of which: Net income attributable to stockholders of the parent company Net income attributable to minority interest Segment assets 1) 2) Associates Total assets Segment liabilities 3) 4) Total liabilities Systems 141,986 113 142,099 118 30,885 – – 30,885 – 30,885 30,914 – 85,958 1,185 87,143 60,670 60,670 Phones – – – 2,257 2,257 – – 2,257 – 2,257 2,257 – – 5,044 5,044 – – Other operations 9,835 1,061 10,896 20 283 – – 283 – 283 Unallocated – – – – –341 2,653 –2,402 –90 –8,875 –8,965 Eliminations – –1,174 –1,174 – – – – – – – 270 – 10,541 84 10,625 6,461 6,461 –9,126 145 106,017 – 106,017 36,171 36,171 – – – – – – – Group 151,821 – 151,821 2,395 33,084 2,653 –2,402 33,335 –8,875 24,460 24,315 145 202,516 6,313 208,829 103,302 103,302 1) Segment assets include property, plant and equipment, intangible assets, current and non-current customer financing, accounts receivable, inventory, prepaid expenses, accrued revenues, derivatives and other current assets. 2) Unallocated assets include cash and cash equivalents, 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 Property, plant and equipment and intangible assets Additions/capitalization Depreciation Amortization Write-downs/reversals of write-downs Number of employees Operating income Operating margin (%) Income after financial items 5,166 –2,676 –2,976 271 50,107 30,885 22% 30,885 GEOGRAPHICAL SEGMENTS (SECONDARY) 2005 Western Europe – of which Sweden Central and Eastern Europe, Middle East and Africa Asia Pacific – of which China North America – of which United States Latin America Total – of which EU – – – – – 2,257 – 2,257 438 –127 –377 – 5,948 283 3% 283 – –1 84 – – –341 – –90 – – – – – – – – 5,604 –2,804 –3,269 271 56,055 33,084 22% 33,335 Additions/ capitalization of PP&E and intangible assets 4,565 3,502 107 291 123 552 453 89 5,604 4,628 Total assets 153,155 132,442 7,421 20,867 8,964 13,974 13,207 13,413 208,829 153,101 Number of employees 35,679 21,178 4,360 8,723 3,601 3,911 2,113 3,382 56,055 36,482 Net sales 41,940 6,110 39,948 31,426 11,544 19,432 17,904 19,075 151,821 45,288 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 57 BUSINESS SEGMENTS (PRIMARY) 2004 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 Net income Of which: Net income attributable to stockholders of the parent company Net income attributable to minority interest Segment assets 1) 2) Associates Total assets Segment liabilities 3) 4) Total liabilities Systems 121,549 1,348 122,897 90 23,187 – – 23,187 – 23,187 23,187 – 66,973 961 67,934 54,728 54,728 Phones – – – 2,143 2,143 – – 2,143 – 2,143 2,143 – – 3,092 3,092 – – Other operations 10,423 966 11,389 68 1,298 – – 1,298 – 1,298 Unallocated – – – 22 78 3,541 –4,081 –462 –8,330 –8,792 Eliminations – –2,314 –2,314 – – – – – – – 1,298 – 9,452 97 9,549 6,627 6,627 –9,089 297 105,606 5 105,611 43,329 43,329 – – – – – – – Group 131,972 – 131,972 2,323 26,706 3,541 –4,081 26,166 –8,330 17,836 17,539 297 182,031 4,155 186,186 104,684 104,684 1) Segment assets include property, plant and equipment, intangible assets, current and non-current customer financing, accounts receivable, inventory, prepaid expenses, accrued revenues, derivatives and other current assets. 2) Unallocated assets include cash and cash equivalents, 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 Property, plant and equipment and intangible assets Additions/capitalization Depreciation Amortization Write-downs Number of employees Operating income Operating margin (%) Income after financial items 3,898 –2,224 –4,381 –22 45,500 23,187 19% 23,187 GEOGRAPHICAL SEGMENTS (SECONDARY) 2004 Western Europe – of which Sweden Central and 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. 58 – – – – – 2,143 – 2,143 399 –209 –82 –61 5,034 1,298 11% 1,298 – –1 11 –35 – 78 – –462 – – – – – – – – 4,297 –2,434 –4,452 –118 50,534 26,706 20% 26,166 Additions/ capitalization of PP&E and intangible assets 3,571 2,868 83 230 130 320 165 93 4,297 3,620 Total assets 148,532 128,398 3,874 14,282 7,018 9,360 9,115 10,139 186,186 148,528 Number of employees 32,826 21,296 3,527 7,493 2,897 4,139 2,156 2,549 50,534 33,625 Net sales 40,542 6,180 32,929 28,552 12,298 15,471 13,984 14,478 131,972 42,366 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 C5 REVENUES C7 OTHER OPERATING INCOME The majority of Ericsson’s products and services are sold as parts of contracts including multiple elements. The nature of the products and services being sold, and the contractual terms taken as a whole, de- termine the appropriate revenue recognition method. The contracts are of three main types: Equipment sales Of which: – Construction-type contracts – Delivery-type contracts Service sales Licenses Total Capital gains, license fees and other operating revenues Interest income Dividends 2005 2004 125,856 110,985 107,844 23,477 2,488 18,012 23,319 87,666 19,301 1,686 151,821 131,972 2,760 2,310 9 3,119 3,346 8 C6 EXPENSES BY NATURE Employee benefits expenses 1) Depreciation and amortization expense 1) 2005 2004 34,458 32,356 7,004 5,802 1) Booked amount prior to adjustments for recognition and derecognition in inventory and capitalized development costs. Gains on sales of intangible assets and PP&E Losses on sales of intangible assets and PP&E Gains on sales of investments and operations Losses on sales of investments and operations Capital gains/losses, net Other operating revenues mainly including license fees Total other operating income 2005 29 –120 205 –149 –35 2004 111 –229 510 –273 119 2,526 2,491 2,498 2,617 C8 FINANCIAL INCOME AND EXPENSES Financial income Result from securities and receivables accounted for as non-current assets Other interest income and similar profit/loss items Total Financial expenses Interest expenses and similar profit/loss items Financial net 2005 2004 293 354 2,360 2,653 3,187 3,541 –2,402 251 –4,081 –540 C9 TAXES INCOME STATEMENT The following items are included in Taxes: Current income taxes for the year Current income taxes related to prior years Deferred tax income/expense (–) related to temporary differences Share of taxes in joint ventures and associated companies Taxes 2005 –3,635 138 2004 –2,324 –637 –4,753 –4,635 –625 –8,875 –734 –8,330 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 tax income/expense, net 2005 1,888 –6,641 –4,753 2004 3,082 –7,717 –4,635 Deferred tax income refers mainly to certain provisions and consolida- tion adjustments on group level. Deferred tax expenses SEK 2,666 million out of SEK 6,641 million refer to utilization of tax loss carry forwards. The remaining amount refers to reversals of temporary differences regarding certain provisions for mainly warranty commitments, provisions for customer financing commitments and inventory write-downs. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 59 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, 28 percent on income before taxes is shown in the table: Income after financial items 2005 33,335 2004 26,166 Tax rate in Sweden (28%) Effect of foreign tax rates Current income taxes related to prior years Benefits from temporary differences of prior periods used to reduce deferred tax expense Tax effect of expenses that are non- deductible for tax purpose Tax effect of income that are non-taxable for tax purpose 1) Tax effect of changes in tax rates Tax effect of tax loss carryforwards, net Taxes –9,334 –489 138 –7,327 –286 –637 380 – –515 –910 944 4 –3 –8,875 855 –18 –9 –8,330 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 associ- ated 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 re- ported. 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 31, 2005, these unutilized tax loss carryforwards amounted to SEK 28,034 million. The tax effect of these tax loss car- ryforwards are reported as assets. The final years in which these loss carryforwards can be utilized are 1) Income that is non-taxable includes R&D credits and other non-taxable income. shown in the following table: BALANCE SHEET Deferred tax assets and liabilities Tax effects of temporary differences, including unutilized tax loss carry- forwards, have resulted in deferred tax assets and liabilities as fol- lows: Deferred tax assets Deferred tax liabilities 2005 2004 17,294 20,766 421 391 Year of expiration 2006 2007 2008 2009 2010 2011 or later Total 2005 499 163 32 33 49 27,258 28,034 Deferred tax assets relate to tax loss carryforwards, temporary differ- ences due to certain provisions and consolidation adjustments on group level. We estimate that approximately 40 percent of total deferred tax assets will be recovered within 12 months. Deferred tax assets regarding tax loss carryforwards amount to SEK 8,187 million (SEK 9,865 million in 2004). 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 carryfor- wards are related to countries with long or indefinite periods of utiliza- tion, mainly Sweden and the U.S. Of the total deferred tax assets for tax loss carryforwards, SEK 8,187 million, SEK 7,965 million will expire 2011 or later, of which SEK 6,363 million relate to Sweden with indefinite time of utilization. With our strong current financial position and profitability during 2005, we have been able to use part of our tax loss carryforwards dur- ing the year, and we are convinced that Ericsson will be able to gener- ate sufficient income in the coming years to utilize these deferred tax assets. Tax effects reported directly to stockholders’ equity Tax effects reported directly to stockholders’ equity amount to SEK 807 million (negative SEK 384 million for 2004 restated to IFRSs), the amount reported is related to hedge accounting. C10 EARNINGS PER SHARE Net income attributable to stockholders of the parent company (SEK million) Average number of shares, basic (millions) Earnings per share, basic (SEK) Net income attributable to stockholders of the parent company (SEK million) Average number of shares after exercise of stock options (million) 2005 2004 17,539 24,315 15,843 15,829 1.53 1.11 24,315 17,539 15,907 15,895 Earnings per share, diluted (SEK) 1.53 1.11 60 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 C11 INTANGIBLE ASSETS Capitalized Capitalized Capitalized acquired development development development internal Capitalized develop- costs, for ment costs, internal use total Goodwill Licenses trademarks and similar Patents and acquired Other research intangible assets, total and rights development 2005 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 1) 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 costs, to be marketed costs, for internal use 11,876 1,174 – –1,067 – 11,983 –3,458 –2,801 – 1,067 – –5,192 –621 –95 – – –716 6,075 1,638 – – – – 1,638 –1,424 –125 – – – –1,549 –38 – – – –38 51 1,094 – – – – 1,094 –950 –83 – – – –1,033 –26 – – – –26 35 14,608 1,174 5,766 512 – –1,067 – 14,715 –5,832 –3,009 – 1,067 – –7,774 –685 –95 – – –780 6,161 – – 1,084 7,362 – – – – – – – – – – – 7,362 1,022 38 11 –73 67 1,065 –901 –8 –7 78 –44 –882 – – – – – 183 1,118 515 – –276 16 1,373 –477 –252 – 134 –8 –603 –14 – – – –14 756 2,140 553 11 –349 83 2,438 –1,378 –260 –7 212 –52 –1,485 –14 – – – –14 939 1) No intangible assets other than goodwill have indefinite useful lives. Amortization and write-downs for capitalized development cost is reported as research and development and other technical expenses. The goodwill is allocated to the business segment Systems, represent- ing one cash-generating unit. The estimates used for measuring the recoverable amounts for goodwill per cash-generating unit include mainly assumptions for growth, profit development and capital expen- diture requirements, including working capital. The assumptions we have made are based on available industry sources that provide estimates of the number of mobile subscribers. The number of global subscribers will grow from 2 billion to 3 billion within five years. The minutes of usage per user will also continue to increase. Our impairment testing is based on the premise that changes for the main assumptions are in line with the development for the glob- al subscriber growth, with a slight decrease for the periods greater than three years. The impairment test for goodwill has not resulted in any need for write-down. A number of tests of sensivity have been made, for example the effect of growth of just one percent. None of these tests indicate requirement of impairment write-down. A discount rate of 12 percent has been applied for the discounting of projected cash flows. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 61 Capitalized Capitalized Capitalized acquired development development development internal Capitalized develop- costs, for ment costs, internal use total Goodwill Licenses trademarks and similar Patents and acquired Other research intangible assets, total and rights development 1,091 3 – – – 1,094 –806 –144 – – – –950 –26 – – – – –26 118 14,998 1,146 5,739 387 – –1,536 – 14,608 –3,036 –4,139 – 1,343 – –5,832 –770 –108 – 193 – –685 8,091 – 16 –376 5,766 – – – – – – – – – – – – 5,766 1,287 262 122 –646 –3 1,022 –1,231 –271 –37 636 2 –901 – – – – – – 121 1,084 50 – –14 –2 1,118 –438 –42 – 3 – –477 –15 – – – 1 –14 627 2,371 312 122 –660 –5 2,140 –1,669 –313 –37 639 2 –1,378 –15 – – – 1 –14 748 2004 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 Balances regarding acquired and sold companies Sales/disposals Translation difference for the year Closing balance Net carrying value costs, to be marketed costs, for internal use 12,274 1,138 – –1,536 – 11,876 –1,022 –3,779 – 1,343 – –3,458 –706 –108 – 193 – –621 7,797 1,633 5 – – – 1,638 –1,208 –216 – – – –1,424 –38 – – – – –38 176 62 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 C12 PROPERTY, PLANT AND EQUIPMENT 2005 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 write-downs, net Opening balance Write-downs for the year Reversals of write-downs Balances regarding acquired and sold companies Sales/disposals Translation difference for the year Closing balance Net carrying value Machinery and other technical assets Real estate Other Construction in process and advance payments equipment, tools and installations 2,657 461 14 –196 229 347 3,512 –583 –366 –3 96 –4 –259 –1,119 –482 – 43 –1 – 81 –359 2,034 5,306 405 –14 –582 –121 206 5,200 –4,374 –489 13 562 173 –170 –4,285 –148 –14 – – – 17 –145 770 15,350 1,745 24 –2,001 659 1,369 17,146 –11,652 –1,949 –21 1,685 –169 –1,000 –13,106 –532 – 337 – – 30 –165 3,875 303 754 – –17 –767 14 287 – – – – – – – – – – – – – – 287 Total 23,616 3,365 24 –2,796 – 1,936 26,145 –16,609 –2,804 –11 2,343 – 1,429 –18,510 –1,162 –14 380 –1 – 128 –669 6,966 Contractual commitments for the acquisition of property, plant and equipment as per December 31, 2005, amounted to SEK 1,448 million. The reversal of write-downs has been reported under Cost of Sales. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 63 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 write-downs, net Opening balance Write-downs for the year Balances regarding acquired and sold companies Sales/disposals/reversals of write-downs Translation difference for the year Closing balance Net carrying value Machinery and other technical assets Real estate Other Construction in process and advance payments equipment, tools and installations 2,888 51 –23 –100 –4 –155 2,657 –485 –226 16 66 7 39 –583 –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 Total 25,193 2,452 –369 –2,937 – –723 23,616 –17,369 –2,434 409 2,436 – 349 –16,609 –1,319 –10 109 25 33 –1,162 5,845 64 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 C13 FINANCIAL ASSETS EQUITY IN JOINT VENTURES AND ASSOCIATED COMPANIES Opening balance Share in earnings Taxes Translation difference for the year Change in hedge reserve Dividends Capital contributions Reclassification Sales Closing balance Goodwill, net, amounts to SEK 21 million (SEK 19 million in 2004). Joint ventures Associated companies 2004 2005 1,217 3,092 180 2,257 –33 –604 –52 286 – 7 –97 – 7 – 47 – –206 – 1,063 5,038 2005 1,063 138 –21 92 – –32 33 2 – 1,275 2004 1,713 2,143 –701 –63 – – – – – 3,092 2005 4,155 2,395 –625 378 7 –32 33 2 – 6,313 Total 2004 2,930 2,323 –734 –115 – –97 7 47 –206 4,155 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. Non-current assets Current assets Non-current liabilities Current liabilities Net assets Net sales Income after financial items Income taxes for the year Net income Minority interest 1) Assets pledged as collateral Contingent liabilities 1,201 13,619 92 9,690 5,038 33,715 2,383 –604 1,653 –126 1 58 Non-current assets Current assets Non-current liabilities Current liabilities Net assets Net sales Income after financial items Income taxes for the year Net income Minority interest Assets pledged as collateral Contingent liabilities 1) Share in earnings is reported net of minority interest. Both these companies apply IFRSs in the reporting to Ericsson. 298 918 18 267 931 998 165 –20 145 – 7 143 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 65 OTHER FINANCIAL ASSETS Accumulated acquisition costs Opening balance Effect of changed accounting principle, IAS 39 Additions Sales/repayments/deductions Reclassifications Revaluation Translation difference for the year Closing balance Accumulated write-downs/allowances Opening balance Effect of changed accounting principle, IAS 39 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 2004 2005 Customer financing, non-current 2005 2004 Derivatives hedging non-current liabilities with a positive value 2004 2005 Other financial assets, non-current 2004 2005 2,318 256 26 –467 –2 – 205 2,336 2,308 – 161 –22 –52 – –77 2,318 4,330 – 689 –2,215 –697 – 265 2,372 7,950 – 1,460 –2,234 –2,478 – –368 4,330 –1,775 155 –1 225 – –135 –1,531 805 2) –1,875 – 44 3 – 53 –4,923 –2,180 – – –656 –128 1,115 807 2,221 559 63 –108 –1,775 –1 050 1) –2,180 1) 2,150 1 322 543 2) – 937 – – –401 180 – 716 – – – – – – – 716 – – – – – – – – – – – – – – – – 2,312 – 2,606 3) –1,191 – – 190 3,917 2,138 – 611 –410 – – –27 2,312 –1,076 – 12 – – –55 –796 – –293 – – 13 –1,119 –1,076 1,236 2,798 1) Write-downs are included in Selling expenses due to the close relation to operations. 2) Market value per December 31, 2005, for listed shares was SEK 8 (234) million with a net carrying value of SEK 8 (80) million. 3) Additions include funded pension plans with net assets of SEK 1,170 million. For further information, see Note C18, “Post-employment benefits”. 66 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 C14 INVENTORIES 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 2005 2004 4,699 5,557 139 232 2,770 3,720 12,753 7,278 –1,153 –2,784 19,208 14,003 C15 ACCOUNTS RECEIVABLE – TRADE Trade receivables excluding associated companies Allowances for impairment of receivables Trade receivables, net Trade receivables related to associated companies and joint ventures Total 2005 2004 42,198 33,906 –1,782 32,124 –1,382 40,816 426 520 41,242 32,644 Reported amounts are net of obsolescence allowances of SEK 2,519 million (SEK 3,146 million 2004). Days sales outstanding were 81 in December, 2005 (75 in December, 2004). MOVEMENTS IN OBSOLESCENCE ALLOWANCES Retention receivables recognized as revenues were SEK 3,940 mil- lion as of December, 2005 (SEK 3,749 million as of December, 2004). Opening balance Additions Utilized Translation difference for the year Closing balance 2005 3,146 785 –1,560 148 2,519 2004 3,658 533 –976 –69 3,146 Contract work in progress includes amounts related to construction- type contracts as well as other contracts with ongoing work in prog- ress. The cost of inventories recognized as an expense and included in Cost of Sales is SEK 44,662 million. For construction-type contracts in progress, as per December 31, 2005: Aggregate amounts of costs incurred Aggregate amount of recognized profits (less recognized losses) Gross amount due from customers 2) Gross amount due to customers 3) 2005 23,244 1) 6,416 1) 537 4,118 1) 1) A significant part of these amounts relate to defense contracts. 2) For all contracts in progress for which costs incurred plus recognized profits (less recognized losses) exceeds progress billings. 3) For all contracts in progress for which progress billings exceed costs incurred plus recognized profits (less recognized losses). MOVEMENTS IN ALLOWANCES FOR IMPAIRMENT OF RECEIVABLES Opening balance Additions Utilized Reversal of excess amounts Reclassification Translation difference for the year Closing balance C16 OTHER CURRENT RECEIVABLES Receivables from associated companies and joint ventures Prepaid expenses Accrued revenues Advance payments to suppliers Derivatives with a positive value Other Total 2005 1,782 916 –1,185 –185 –60 114 1,382 2004 2,051 1,073 –951 –566 17 158 1,782 2005 2004 – 1,997 1,998 517 1,347 6,715 12,574 115 1,072 1,349 393 2,615 6,695 12,239 The major items within “Other” are value added tax and withholding tax. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 67 C17 STOCKHOLDERS’ EQUITY CAPITAL STOCK 2005 The capital stock of the Company is divided into two classes: Class A shares (par value SEK 1.00) and Class B shares (par value SEK 1.00 being the same as the quota value). 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. CHANGES IN STOCKHOLDERS’ EQUITY The total number of treasury shares at December 31, 2005, is 268,065,241 (299,715,117 in 2004) Class B shares. The decrease in the number of treasury shares is due to delivery and sale of shares in rela- tion to the Stock Purchase Plans and the Stock Option Plans. Dividend proposal The Board of Directors will propose to the Annual General Meeting a dividend of SEK 0.45 per share. Additional paid in capital Capital stock Hedge reserve Revaluation of other investments in shares and participations Cumulative translation adjustments Total other Retained earnings reserves Total 2005 January 1, 2005 Effect of changed accounting principle, IAS 39, net Adjusted opening balance Changes in hedge reserve, net Revaluation of other investments in shares and participations, net Changes in cumulative translation adjustments Net income 2005 Total income and expenses for the period Sale of own shares Stock purchase and stock options plans Dividends paid Total transactions with owners December 31, 2005 2004 January 1, 2004 Changes in cumulative translation adjustments Net income 2004 Total income and expenses for the period Sale of own shares Stock purchase and stock options plans Adjustment of cost for stock issue 2002 Total transactions with owners December 31, 2004 16,132 24,731 –6,530 –6,530 46,112 80,445 – 16,132 – – 24,731 – 1,155 1,155 –1,859 155 155 – – –6,530 – 1,310 –5,220 –1,859 179 1,489 46,291 81,934 –1,859 – – – – –150 1) – –150 – –150 – – – – – – – 16,132 – – – – – – – 24,731 – – –1,859 – – – – –704 – – –150 – – – – 5 4,037 2) – 4,037 – – – – –2,493 4,037 – 2,028 – – – – –3,192 – 4,037 24,315 24,315 24,315 26,343 117 117 242 242 –3,959 –3,959 –3,600 –3,600 67,006 104,677 16,132 24,729 –5,395 –5,395 28,354 63,820 – – – – – – – 16,132 – – – – – 2 2 24,731 – – – – – – – – – – – – – – – – –1,135 – –1,135 – – – – –6,530 –1,135 – –1,135 – – – – –6,530 – –1,135 17,539 17,539 17,539 16,404 15 204 2 221 46,112 80,445 15 204 – 219 1) Due to sale, SEK 147 million is realized in Income statement. 2) Changes in cumulative translation adjustments include changes regarding revaluation of goodwill in local currency of SEK 1,084 million (SEK –376 million in 2004), net gain/loss (–) from hedging of investments in foreign subsidiary companies of SEK –142 million (SEK –167 million in 2004) and SEK 127 million (SEK 47 million in 2004) of realized gains/ losses (–), net from sold/liquidated companies. 68 C18 POST-EMPLOYMENT BENEFITS In summary, during 2005 the funded status, the relation between the defined benefit obligation (DBO) and plan assets has improved signifi- cantly due to the establishment of a Swedish pension trust and the value of the DBO has increased due to a change from 5 percent to 3.5 percent for the discount rate in Sweden. 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 insur- ance company) on behalf of the employee. Under this type of plan, no provision for pensions is recognized in the Company’s balance sheet. • Defined benefit plans, where the Company’s undertaking is to pro- vide 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 with assets to manage the company’s contributions to the plan, in which case the liability recognized on the balance sheet is the net of the benefit obligation and the fair value of plan assets. Plans with net assets are recognized as financial assets in the balance sheet. the total benefit obligation is recognized as a liability on the balance sheet with no assigned plan assets. ° E R I C S S O N A N N U A L R E P O R T 2 0 0 5 consolidation level at Alecta amounted to 128.5 percent at year-end 2005 (128.0 percent 2004). Ericsson has established a Swedish pension trust for the purpose of funding benefit obligations in Sweden. SEK 8,338 million were transferred into the trust in January 2005. The cap- ital injection turned the level of funding from an unfunded position at the end of 2004 to a substantial funded status at the end of 2005. The total value of Ericsson shares in the Swedish pension trust amounted to SEK 13 million at year-end. The following tables summarize the total pension cost for the Group: TOTAL ANNUAL PENSION COST Sweden UK US Other Total 2005 Pension cost for defined benefit plans Pension cost for post- employment medical benefits Pension cost for defined contributions plans Total 2004 Pension cost for defined benefit plans Pension cost for post- employment medical benefits Pension cost for defined contributions plans Total 417 71 57 307 852 – – 44 – 44 929 1,346 – 71 83 184 257 564 1,269 2,165 686 71 –93 153 817 – – 46 – 46 1,014 1,700 – –97 71 –144 183 336 1,100 1,963 Costs for post-employment benefits within Ericsson are evenly distrib- uted between defined contribution plans and defined benefit plans, with a slight overweight towards defined contribution plans. For companies with defined benefit plans, almost all companies with material plans have trust funds which are fully or partly funded and recognize the net of defined benefit obligations and plan assets as either provisions or financial assets. The present value of the defined benefit obligation for current and former employees is calculated using the Projected Unit Credit Method (PUC). The calculations are based upon actuarial as- sumptions and are prepared annually, as a minimum. In Sweden, the total pension plans are a mixed solution, with some parts being defined contribution plans and others defined benefit plans. All plans for blue-collar workers are defined contribution plans. Salaried employees’ plans are comprised of the defined benefit plan, ITP, supple- mentary pension plan for salaried employees in manufacturing indus- tries and trade, (retirement pension and collective family pension), which are complemented by a defined contribution plan, ITPK, supplemen- tary retirement benefits. Some parts of early-retirement plans are also arranged as defined contribution plans. The collective family pension within the ITP plan is financed via an insurance at the insurance com- pany Alecta. The Swedish Financial Accounting Standards Council’s interpretations committee has defined this plan as a multi-employer defined benefit plan. For Ericsson, however, information was not avail- able from Alecta that would have made it possible to report the collec- tive family pension part as a defined benefit plan. Therefore, the plan has been reported as a defined contribution plan. Fees during 2005 for the collective family pension amount to SEK 350 million. The collective ANNUAL PENSION COST FOR DEFINED BENEFIT PLANS Sweden UK US Other Total 2005 Service cost Interest cost Expected return on plan assets Amortization of unrecog- nized past service cost Amortization of actuarial gains and losses Curtailment cost Settlement cost Net pension cost for the period 2004 Service cost Interest cost Expected return on plan assets Amortization of unrecog- nized past service cost Amortization of actuarial gains and losses Curtailment cost Net pension cost for the period 275 407 62 169 78 148 281 154 696 878 –267 –160 –128 –156 –711 – 2 – – – – – – – 3 – – 7 7 – 14 7 12 – 14 417 71 101 307 896 306 380 53 152 82 153 170 118 611 803 – –134 –108 –128 –370 – – – – – – – 6 6 – –173 – –14 – –187 686 71 –46 152 863 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 69 CHANGE IN PLAN ASSETS Sweden UK US Other Total 2005 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 Balances regarding acquired and sold companies Other Translation difference for the year Fair value of Plan Assets, end of year 2004 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 Balances regarding acquired and sold companies Other Translation difference for the year Fair value of Plan Assets, end of year – 2,014 1,417 2,333 555 212 12 267 352 30 124 43 22 471 8,338 – 5,764 1,417 8,945 64 – – – – – –74 – –126 – –65 –63 –265 –63 – – – 108 38 –5 38 103 165 292 324 781 8,809 2,754 1,880 3,341 16,784 – 1,846 1,361 2,059 227 – 158 – 10 – 125 203 – 164 57 28 5,266 516 418 38 – – – – – –45 – –132 – –53 –32 –230 –32 – – – – – 50 – 50 –36 –140 –86 –262 – 2,014 1,417 2,333 5,764 The tables below and on the next page present information about de- fined benefit plans for Ericsson and summarize changes in the benefit obligation, the plan assets and the funded status of defined benefit plans and the amount recognized in the balance sheet as well as key assumptions. CHANGE IN DEFINED BENEFIT OBLIGATION, DBO 1) Sweden UK US Other Total 2005 DBO, beginning of the year Service cost Interest cost Employee contributions Pension payments Actuarial gain/loss (–/+) 2) Settlement cost Curtailment cost Balances regarding acquired and sold companies Reclassifications Other Translation difference for the year DBO, end of the year 2004 DBO, beginning of the year Service cost Interest cost Employee contributions Pension payments Actuarial gain/loss (–/+) 2) Settlement cost Curtailment cost Balances regarding acquired and sold companies Reclassifications Other Translation difference for the year DBO, end of the year 78 148 22 8,190 3,018 2,362 3,250 16,820 696 878 64 –406 3,300 –49 – 281 154 12 –161 –100 272 –148 –49 – – – 275 407 – –71 2,830 – – 62 169 30 –74 346 – – – – 1 – – – – 65 – –127 –37 91 65 –127 55 – 1,018 11,632 3,795 2,863 4,024 22,314 303 244 471 6,921 2,794 2,511 2,256 14,482 611 803 38 –365 1,084 –35 –187 82 153 – –189 186 – –173 306 380 – –71 654 – – 170 118 10 –60 157 –35 –14 53 152 28 –45 87 – – – – – – – – – – 22 – 712 23 – 712 45 – –368 8,190 3,018 2,362 3,250 16,820 –51 –230 –87 1) The Group participates in a number of post-employment medical benefit schemes. 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. 2) Actuarial gains and losses for each plan are reported when the accumulated amount exceeds the corridor. The income or expenses are then recognized over the expected average remaining service period of the employees. 70 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 ACCRUED/PREPAID PENSION COST Sweden UK US Other Total AMOUNT RECOGNIZED IN THE CONSOLIDATED BALANCE SHEET, 2004 2005 Fair value of plan assets DBO Funded status of the plan Unrecognized actuarial gain/loss (–/+) Unrecognized past service cost Accrued/Prepaid pension cost (–/+) 2004 Fair value of plan assets DBO Funded status of the plan Unrecognized actuarial gain/loss (–/+) Unrecognized past service cost Accrued/Prepaid pension cost (–/+) 8,809 2,754 1,880 3,341 16,784 11,632 3,795 2,863 4,024 22,314 –2,823 –1,041 –983 –683 –5,530 3,278 – 455 301 – 37 –133 92 – 3,483 92 –740 –946 –724 –1,955 – 2,014 1,417 2,333 5,764 8,190 3,018 2,362 3,250 16,820 –8,190 –1,004 –945 –917 –11,056 654 – 55 – 174 – 16 70 899 70 –7,536 –949 –771 –831 –10,087 AMOUNT RECOGNIZED IN THE CONSOLIDATED BALANCE SHEET, 2005 Sweden UK US Other Total 2005 Accrued/Prepaid pension cost (–/+) beginning of the year Annual pension cost Benefits paid by company, net Employer contributions Balances regarding acquired and sold companies Reclassification Other Translation difference for the year Accrued/Prepaid pension cost (–/+), end of year –7,536 –417 71 8,338 –949 –771 –831 –10,087 –101 –307 –896 –71 – 352 35 43 36 212 142 8,945 – – –1 – – – – – 3 –46 127 42 –46 127 44 – –72 –155 43 –184 455 –740 –946 –724 –1,955 Total accrued/prepaid pension cost, SEK –1,955 (–10,087) million are reported gross by plan in the balance sheet. Plans with net assets are reported as Other financial assets, non-current, total SEK 1,170 (0) million and plans with net liabilities are reported as Post-employment benefits, total SEK 3,125 (10,087) million. Sweden UK US Other Total 2004 Accrued/Prepaid pension cost (–/+) beginning of the year Annual pension cost Benefits paid directly by company Employer contributions Balances regarding acquired and sold companies Reclassification Other Translation difference for the year Accrued/Prepaid pension cost (–/+), end of year –6,921 –686 –949 –1,151 –115 –9,136 47 –153 –863 –71 71 – – 57 78 203 7 158 156 418 – – – – – – – – – – –712 –9 –22 – –712 –31 14 74 –7 81 –7,536 –949 –771 –831 –10,087 The principal actuarial assumptions used were as follows: Sweden UK US Other 2005 Discount rate Expected return on plan assets Future salary increases Health care cost inflation, current year 2004 Discount rate Expected return on plan assets Future salary increases Health care cost inflation, current year 3.5% 4.7% 5.5% 5.5% 3.2% 3.0% 7.0% 4.0% 8.0% 4.5% 6.7% 4.2% n/a n/a 10.0% n/a 5.0% 5.3% 6.0% 6.0% n/a 3.0% 7.0% 4.0% 8.0% 4.5% 6.2% 4.4% n/a n/a 10.0% n/a The developments of medium and long-term interest rates have been closely monitored during the year. Consequently we have adjusted the discount rate downwards in order to reflect the applicable interest rate for our benefit obligations at the balance sheet day. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 71 C19 OTHER PROVISIONS 2005 Opening balance Additions Costs incurred Reversal of excess amounts Balances regarding acquired and sold companies Reclassification Translation difference for the year Closing balance 2004 Opening balance Additions Costs incurred Reversal of excess amounts Reclassification Translation difference for the year Closing balance 1) Both current and non-current provisions. Warranty commitments Restruc- turing Customer financing Total other Other provisions 1) 6,424 2,858 –3,181 –1,390 6 3 101 4,821 4,736 4,202 –2,656 – 172 –30 6,424 3,598 1,323 –1,983 –480 – –322 178 2,314 9,115 661 –5,651 –274 –238 –15 3,598 271 – 19 –315 – – 55 30 296 228 –62 –191 – – 271 14,485 5,564 –6,913 –2,608 – 224 751 11,503 13,454 7,971 –5,012 –1,867 341 –402 14,485 24,778 9,745 –12,058 –4,793 6 –95 1,085 18,668 27,601 13,062 –13,381 –2,332 275 –447 24,778 WARRANTY COMMITMENTS Warranty provisions are based on quality statistics and are calculated considering sales, contractual warranty periods and historical quality data of products sold. The actual warranty costs have been lower than anticipated therefore parts of the provisions have been reversed. The actual utilization for 2005 was SEK 3.2 billion, compared to the ex- pected SEK 2.5 billion. The expected utilization of warranty provisions during year 2006 is SEK 2.9 billion. RESTRUCTURING Restructuring provisions amounting to SEK 2.0 billion were utilized during 2005 compared to the expected SEK 2.0 billion. Due to a more favourable outcome, parts of the provisions have been reversed. However, the reversals were largely offset by additions to provisions made in previous years. 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 2028. 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 2006 is SEK 1.5 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. OTHER Other provisions include estimated obligations related to patent and other litigations, contractual discounts and penalties of uncertain timing or amount, supplier or subcontractor claims and/or dispute, as well as provisions for unresolved income tax and value added tax, issues and estimated losses on customer contracts. The actual utilization for 2005 was SEK 6.9 billion, compared to the estimated SEK 8.0 billion. Rever- sals amount to SEK 2.6 billion due to a more favourable outcome. These reversals are partly offset by increases to provisions made in previous years reported under additions. The expected utilization in 2006 is SEK 7,0 billion. 72 C20 INTEREST-BEARING PROVISIONS AND LIABILITIES Ericsson’s outstanding interest-bearing provisions and liabilities were SEK 28.1 billion as of December 31, 2005 (33.6). INTEREST-BEARING PROVISIONS AND LIABILITIES Borrowings, current 1) Total current borrowings Borrowings, non-current Post-employment benefits Total non-current interest-bearing provisions and liabilities Total interest-bearing provisions and liabilities 2005 10,784 10,784 14,185 3,125 2004 1,719 1,719 21,837 10,087 17,310 31,924 28,094 33,643 1) Including note and bond loans of SEK 9,614 million 2005 and SEK 651 million 2004. NOTES AND BOND LOANS Issued- mature 1999-2009 2001-2006 2001-2006 2001-2008 2003-2010 2004-2012 Total Book value Maturity date Nominal Coupon Currency (SEK m.) (YY-MM-DD) 09-05-20 06-03-15 06-05-31 08-06-05 10-11-28 12-12-07 483 6.500% FRN 1,000 1) 6.375% 226 1) 7.375% 471 2) 6.750% FRN 450 USD USD EUR GBP EUR SEK 15 3,187 119 9,496 3,167 4,671 450 21,890 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 LIABILITIES TO FINANCIAL INSTITUTIONS, INTEREST RATE BY CURRENCY Maturing >1<5 years Maturing >5 years Book value (SEK m.) 226 192 39 40 497 Interest rate (%) 3.9% 2.2% 9.2% 1.0% – Book value (SEK m.) 128 141 1,181 14 1,464 Interest rate (%) 1.9% 2.0% 7.7% 0% – EUR SEK USD Other currencies Total Current liabilities to financial institutions are mainly denominated in INR, JPY and USD and have a weighted average maturity of 0.3 years. Cur- rent maturities of non-current debt (excl. current maturities of notes and bond loans) are mainly denominated in CAD and EUR and have a weighted average maturity of 0.1 year. C21 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 Di- rectors is responsible for approving certain matters regarding invest- ments, loans, guarantees and customer financing commitments and is continuously monitoring the exposure to financial risks. The Board of Directors has established risk limits for defined expo- 1) The EUR 1,000 million and GBP 226 million bonds have interest rates linked to the sures to foreign exchange and interest rate risks. 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 cannot be less than the initial interest rates in the loan agreements. 2) The EUR 471 million bond is callable after 2007; the fair value of the embedded derivative is included in the book value of the bond. All outstanding notes and bond loans are issued by the Parent Com- pany under its Euro Medium Term Note program. Bonds issued at a fixed interest rate are swapped to a floating interest rate using interest rate swaps, resulting in a weighted average interest rate of 5.12 percent at December 31, 2005. These bonds are revalued based on changes in benchmark interest rates according to the Fair Value hedge method- ology stipulated in IAS 39. 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 fi- nancial 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 large- ly centralized to the treasury function in Stockholm. Ericsson also has a customer finance function with the main objec- tive 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 Parent Company provides or guarantees vendor credits. The customer finance function monitors the exposure from outstanding vendor credits and credit commitments. No notes or bond loans have been redeemed or cancelled in Ericsson classifies financial risks as: 2005. • foreign exchange risk • interest rate risk • credit risk • liquidity and refinancing risk • market price risk in own and other listed equity instruments. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 73 Foreign exchange risk Ericsson has significant revenues, costs, assets and liabilities in cur- rencies 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 2005 shows the following net exposures by currency: ESTIMATED NET EXPOSURES BY CERTAIN MAJOR CURRENCIES (SEK billion) USD and related currencies EUR JPY 2005 33 8 2 A change in the exchange rate of +/– 10 percent between SEK and USD, and related currencies, would have an annualized impact on the oper- ating income by SEK 3.3 billion before tax and hedging effects. Foreign exchange risk is as far as possible borne by Swedish group companies. Sales to foreign subsidiary companies are normally in- voiced in the functional currency of the receiving entity. In order to limit the exposure toward exchange fluctuations on future revenue or expenditure, committed and forecasted net exposure by period of fu- ture sales and purchases in major currencies were hedged, on average, for the coming 6–9 months in 2005. Trade receivables and payables in foreign currencies are generally fully hedged. Currency forward contracts are primarily used for hedging future revenues and expenditures on company level. External forward con- tracts are designated as cash flow hedges of the net exposure for the main currencies and companies of the Group. Other foreign exchange exposures in balance sheet items are hedged through offsetting balances or derivatives. As of December 31, 2005, outstanding foreign exchange derivatives, hedging transaction exposures, had a negative net market value of SEK 2.6 (positive 4.0) billion. The negative market value is partly de- ferred in hedge reserve to offset the gains on hedged future sales in foreign currency. The remaining balance corresponds to appreciation of Accounts Receivable balances being originated at higher rates com- pared to the exchange rates prevailing when the commitments and forecasts were made. HEDGE RESERVE (SEK billion pre-tax) January 1, 2005 Revaluation of derivatives Released to profit and loss December 31, 2005 1.6 –4.0 1.4 –1.0 Translation exposure Ericsson has many subsidiary companies operating outside Sweden. The net results in foreign subsidiary companies and the value of such 2005 2004 SEK million unless otherwise stated Interest rate Derivatives Basis Swap Basis Swap Basis Swap Interest Rate Swap Interest Rate Swap Interest Rate Swap Interest Rate Swap Interest Rate Forwards Foward Rate Agreement Swaption Other Total Interest rate Derivatives Foreign Exchange Derivatives Foreign Exchange Forwards Foreign Exchange Forwards Foreign Exchange Forwards Foreign Exchange Forwards Total Foreign Exchange Derivatives Derivatives Total Trans- action currency Nominal amount in transaction currency –383 3,855 –47 2,733 226 11,885 583 –2,105 25,500 471 Fair value Book value 131 –267 46 475 188 270 215 –2 –6 –45 3 1,008 131 –267 46 475 188 270 215 –2 –6 –45 3 1,008 –5,537 –2,082 –42 –3,679 –224 –1,845 –204 –2,552 –1,544 –2,082 –42 –224 –204 –2,552 –1,544 Nominal amount in transaction currency Fair value Book value – – – – – – 1,471 226 515 483 –2,010 22,000 471 –4,272 –4,093 –1,603 – – – 325 108 10 118 –18 4 – –1 546 909 169 19 394 –18 4 7 –1 1,483 3,131 193 460 240 4,024 5,507 1,734 232 225 229 2,420 2,966 EUR SEK USD EUR GBP SEK USD SEK SEK EUR USD EUR SAR Other All derivatives are short term except for the Interest Rate Swaps and Swaptions hedging Longterm Borrowing and derivatives embedded therein 74 foreign investments are exposed to exchange rate fluctuations, which affect the consolidated income statement and balance sheet when translated to SEK. Translation exposure in foreign subsidiary companies is hedged according to the following policy established by the Board of Direc- tors: Equity in companies is translated using the current method, for which translation effects are reported directly in stockholders’ equity, and is hedged up to 20 percent in selected companies. The translation differences reported in equity during 2005 were positive, SEK 4.0 billion, including hedging losses of SEK 142 million. Interest Rate Risk Ericsson is exposed to interest rate risk through market value fluctua- tions in certain balance sheet items and through changes in interest expenses and revenues. The net cash position was SEK 53.4 (42.9) billion at the end of 2005, consisting of cash and bank, and short-term cash investments of SEK 81.5 (76.6) billion and interest-bearing provi- sions and liabilities of SEK 28.1 (33.6) billion. Outstanding customer financing credits, net of provisions, were SEK 4.9 (3.6) billion. Ericsson seeks 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 31, 2005, 94 (94) percent of Ericsson’s inter- est-bearing provisions and liabilities and 99 (99) percent of Ericsson’s interest-bearing assets had floating interest rates, i.e. interest periods of less than 12 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 +/– 0.25 percentage points would, with the current net cash position, have an annual impact on the interest net of SEK +/– 135 million. Credit Risk Credit risk is divided into three categories: credit risk in trade receiv- ables, customer finance risk and financial credit risk. Credit risk in trade receivables Trade receivables amounted to SEK 41.2 (32.6) billion as of December 31, 2005. Provisions for expected losses are regularly assessed and amounted to SEK 1.4 (1.8) billion as of December 31, 2005. Ericsson’s nominal 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. Customer finance risk All major customer finance commitments are subject to approval by the Finance Committee of the Board of Directors according to the credit approval procedures. As of December 31, 2005, Ericsson’s total outstanding exposure relating to customer finance credits was SEK 7.0 (8.9) billion. As of that date, Ericsson also had unutilized credit commitments of SEK 3.6 (2.2) 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 31, 2005, there was a total of E R I C S S O N A N N U A L R E P O R T 2 0 0 5 76 customer loans originated by or guaranteed by Ericsson. The five largest customer finance arrangements represented 60 percent of the total credit exposure. Security arrangements for customer credits nor- mally include pledges of equipment, pledges of certain of the borrow- ers assets and pledges of shares in the operating company. Restructur- ing efforts for cases of troubled debt may lead to temporary holdings of equity interests. The table below summarizes Ericsson’s outstanding customer fi- nance credits as of December 31, 2004–2005. OUTSTANDING CUSTOMER FINANCE CREDITS (SEK billion) 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 2005 7.0 0.1 7.1 0.1 –0.2 7.0 5.0 –0.1 2004 8.4 0.6 9.0 0.2 –0.3 8.9 3.7 –0.1 4.9 3.6 3.6 2.2 1) Reclassification due to consolidation in accordance with SIC 12. Of Ericsson’s total outstanding customer finance credit exposure as of December 31, 2005, 58 percent related to Latin America, 14 percent to Western Europe, 23 percent to Central and Eastern Europe, Middle East & Africa, 1 percent to North America and 4 percent to Asia Pa- cific. The net effect of risk provisions for customer financing affecting operating expenses, amounted to a positive impact of SEK 1.0 billion in 2005, compared to a negative impact of SEK 0.2 billion in 2004. In 2005 and 2004, Ericsson incurred credit losses of SEK 0.4 billion and SEK 1.8 billion. 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 posi- tions with positive unrealized result against banks and other counter- parties. 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-2/P-2 and long-term ratings of at least A-/A3 and in liquidity funds with a rating of at least A. Separate credit limits are assigned to each counterpart in order to minimize risk con- centration. All derivative transactions are covered by ISDA netting agreements to reduce the credit risk. No credit losses were incurred during 2005, neither on external investments nor on derivative posi- tions. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 75 The USD 1 billion committed credit facility has interest rates linked to our credit rating. In April 2005, Moody’s upgraded Ericsson’s long-term credit rating to Baa3 with a positive outlook. In February 2005, Standard & Poor’s upgraded Ericsson’s long-term credit rating to BBB– with a positive outlook. Subsequent to the Marconi announcement in October 2005, Standard & Poor’s changed the outlook to stable. Ericsson’s current ratings are investment grade. 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 Note C1, “Significant accounting policies”. FINANCIAL INSTRUMENTS CARRIED AT OTHER THAN FAIR VALUE (SEK billion) Cash and Bank, and Term Deposits Current maturities of non-current borrowings Notes and bonds Carrying amount 2004 2005 Fair value 2004 2005 81.5 81.5 9.6 12.3 21.9 76.6 76.6 0.8 19.8 20.6 81.5 81.5 9.7 13.0 22.7 76.6 76.6 0.8 21.6 22.4 Financial instruments excluded from the tables, such as trade receiv- ables and payables are carried at amortized cost which is deemed to be equal to fair value. When a market price is not readily available and there is insignificant interest rate exposure affecting the value, the car- rying 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 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. Liquidity Risk Liquidity risk is that Ericsson is unable to meet its short-term payment obligations due to insufficient or illiquid cash reserves. Ericsson maintains sufficient liquidity through centralized cash man- agement, 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 2005, cash and bank, and short-term cash investments in- creased by SEK 4.9 billion to SEK 81.5 billion mainly due to positive cash flow, which was partly offset by repayment of non-current debt and payment to the pension trust. CASH AND SHORT-TERM CASH INVESTMENTS Remaining time to maturity >5 < 3 years months 1.0 53.1 (SEK billion) Total Group 1–5 years 12.2 < 1 year 15.2 2005 81.5 2004 76.6 Re-financing risk Re-financing risk is the risk that Ericsson is unable to refinance out- standing debt at reasonable terms and conditions, or at all, at a given point in time. REPAYMENT SCHEDULE OF LONG-TERM BORROWINGS Current maturities of long- term debt 9.8 – – – – – 9.8 Notes and bonds (non-current) – – 3.1 3.8 4.4 0.5 11.8 Liabilities to financial institutions (non-current) – 0.1 0.1 0.1 0.1 1.5 1.9 Total 9.8 0.1 3.2 3.9 4.5 2.0 23.5 (SEK billion) 2006 2007 2008 2009 2010 2011 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. FUNDING PROGRAMS Amount Utilized Unutilized 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.) Short-term Committed Credit facilities (SEK m.) 5,000 2,303 2,967 1,500 5,000 1,000 353 – – – – 1,500 5,000 1,000 353 1) Currently unavailable due to low short-term rating. 76 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 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 of SEK 186 million in 2005. Ericsson has SEK 760 million in 2005 issued to guarantee the performance of a third party. C26 STATEMENT OF CASH FLOWS Interest paid in 2005 was SEK 2,577 million (SEK 3,492 million in 2004) and interest received was SEK 2,142 million (SEK 3,662 million in 2004). Income taxes paid were SEK 865 million (SEK 2,944 million in 2004). For more information regarding the disposition of cash and cash equivalents and unutilized credit commitments, see Note C21 – “Finan- cial Risk Management and Financial Instruments”. Cash restricted due to currency restrictions or other legal restric- tions in certain countries amounts to SEK 3,773 million (SEK 2,156 million in 2004). C22 OTHER CURRENT LIABILITIES Income tax liabilities Advances from customers Liabilities to associated companies Accrued interest Accrued expenses, of which employee related other accrued expenses Deferred revenues Derivatives with a negative value Other current liabilities Total 2005 1,260 4,059 34 770 2004 1,686 3,390 7 846 20,379 18,292 6,224 12,396 12,068 2,929 316 5,532 40,825 32,998 3,558 3,607 7,158 7,983 C23 ACCOUNTS AND NOTES PAYABLE – TRADE Accounts and notes payable excluding associated companies and joint ventures Payables to associated companies and joint ventures Total 2005 2004 ACQUISITIONS/SALES OF SHARES AND OTHER INVESTMENTS 2004 2005 12,233 10,935 351 53 12,584 10,988 Purchase price for acquired subsidiary companies Other acquisitions/capital contributions Sales Acquisitions/sales, net –578 –691 312 –957 –39 –1,739 229 –1,549 C24 ASSETS PLEDGED AS COLLATERAL Real estate mortgages Chattel mortgages Bank deposits Total 2005 10 166 373 549 2004 – 7,209 776 7,985 The decrease of chattel mortages is attributable to the funding of the Swedish pension trust. Bank deposits are collaterals related to legal disputes which have been cleared in 2005 (SEK 373 million in 2004) and collateral for subsidiary financing SEK 151 million in 2005 (SEK 180 million in 2004). C25 CONTINGENT LIABILITIES Guarantees for customer financing Other contingent liabilities Total 2005 2004 348 67 666 1,641 1,708 1,014 Guarantees for customer financing relate to arrangements where Eric- sson 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 The purchase consideration in cash or cash equivalents for other ac- quisition was SEK –691 million (SEK –1,739 million in 2004), a consider- able amount is related to Ericsson’s increased ownership in the Italian subsidiary company. Of the consideration received for disposals SEK 312 million (SEK 229 million in 2004) were in the form of cash or cash equivalents. The cash or cash equivalents in the balance sheets of sold subsidiary com- panies were SEK 27 million (SEK 10 million in 2004). Further, the cash and cash equivalents in the balance sheets of acquired subsidiary companies were SEK 16 million (SEK 33 million in 2004). Property, plant and equipment Other non-current assets Current assets Cash Total assets Other provisions and Post-employment benefits Non-current liabilities Current liabilities Total liabilities Sold Acquired subsidiary subsidiary companies companies 3 3 46 27 79 15 526 58 16 615 135 14 41 190 8 – 30 38 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 77 C27 LEASING LEASING WITH THE COMPANY AS LESSEE Assets under finance leases, recorded as property, plant and equip- ment, consist of: FINANCE LEASES Acquisition costs Real estate Machinery Other equipment Accumulated depreciation Real estate Machinery Other equipment Accumulated write-downs Real estate Machinery Other equipment Net carrying value 2005 2004 1,948 – 5 1,953 –502 – –1 –503 –417 – – –417 1,033 1,459 – 3 1,462 –148 – –1 –149 –413 – – –413 900 As of December 31, 2005, future minimum lease payment obligations for leases were distributed as follows: 2004 2,434 10 2,444 4,139 313 4,452 108 – 108 4,560 2,804 –366 2,438 3,009 260 3,269 95 – 95 3,364 5,802 5,518 7,004 4,483 35 –510 –121 –876 2006 2007 2008 2009 2010 2011 and later Total Future finance charges 1) Present value of finance lease liabilities Finance Operating leases 2,134 1,762 1,559 1,294 1,115 2,943 10,807 n/a 10,807 leases 199 186 203 169 155 1,785 2,697 –1,130 1,567 10,845 10,490 1) Average effective interest rate on lease payables is 7.43 percent. Expenses in 2005 for leasing of assets were SEK 2,686 million (SEK 2,961 million in 2004), of which variable expenses were SEK 11 million (SEK 6 million in 2004). The leasing contracts vary in length from 1 to 23 years. Most of the Company’s lease agreements contain no contingent rents. In the few cases they occur it relates to charges for heating, linked to the oil price index. Most of the leases of real estate 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 25 billion. Acquisitions made by Ericsson in 2005 were: • NetSpira Networks, S.L., a Spanish software company. The com- pany’s technology will be integrated into Ericsson’s offering for mo- bile data allowing operators to provide easily understandable charg- ing for services such as Java downloads, web access and MMS. • Axxessit AsA, a Norwegian based advanced technology company that develops, produces and markets integrated access devices and multi-service provisioning platforms for next generation access and metro networks. • Ericsson has also increased its ownership in the Italian subsidiary company Ericsson S.p.A., which gives Ericsson a total ownership as of December 31, 2005, of 99 percent. ADJUSTMENTS TO RECONCILE NET INCOME TO CASH 2005 Property, plant and equipment Depreciation Write-downs/reversal of write-downs Total Intangible assets Amortization Capitalized development costs Other Total amortization Write-downs Capitalized development costs Other Total write-downs Total Total depreciation, amortization and write-downs on property, plant and equipment and intangible assets Taxes Write-downs on other investments in shares and participations and capital gains (–)/losses on sale of fixed assets, excluding customer financing, net Other non-cash items Total adjustments to reconcile net income to cash 78 LEASES WITH THE COMPANY AS LESSOR Leasing income mainly relates to income from sublease of real estate. These leasing contracts vary in length from 1 to 6 years. At December 31, 2005, future minimum payment receivables were distributed as follows: 2006 2007 2008 2009 2010 2011 and later Total Unearned financial income Uncollectible lease payments Net investments in financial leases Finance Operating leases 57 43 30 19 1 1 151 n/a n/a n/a leases – – – – – – – – – – Leasing income in 2005 was SEK 114 million (SEK 237 million in 2004). C28 TAX ASSESSMENT VALUES IN SWEDEN Land and land improvements Buildings Total 2005 60 235 295 2004 60 235 295 C29 INFORMATION REGARDING EMPLOYEES, MEMBERS OF THE BOARD OF DIRECTORS AND MANAGEMENT AVERAGE NUMBER OF EMPLOYEES Men Women 2005 Total Men Women 2004 Total Western Europe 1) 2) Central and Eastern Europe, Middle East and Africa 2) North America Latin America Asia Pacific Total 1) Of which Sweden 2) Of which EU 25,188 8,516 33,704 24,511 7,860 32,371 898 3,258 992 3,129 2,549 568 6,544 2,553 851 3,395 4,156 2,544 1,116 4,522 4,121 3,406 3,117 2,015 469 2,484 9,097 6,624 2,346 8,970 40,668 13,527 54,195 39,100 12,642 51,742 15,378 5,120 20,498 15,048 5,384 20,432 8,118 33,157 25,712 8,687 34,399 25,039 Within the group of the 150 most senior executives the distribution between females and males is 14 percent and 86 percent respectively. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 NUMBER OF EMPLOYEES Employees by region Western Europe 1) 2) Central and Eastern Europe, Middle East and Africa 2) North America Latin America Asia Pacific Total 1) Of which Sweden 2) Of which EU As per December 31, 2005 35,679 4,360 3,911 3,382 8,723 56,055 21,178 36,482 Employees per segment Systems Other operations Total As per December 31, 2005 50,107 5,948 56,055 2004 32,826 3,527 4,139 2,549 7,493 50,534 21,296 33,625 2004 45,500 5,034 50,534 UNION REPRESENTATION We respect the rights of our employees to form unions and collective bargaining. We operate according to local legislative requirements and other local standards and circumstances for each individual work- place. The majority of our employees in Sweden belong to the following trade unions: Sif (the Swedish Union of Salaried Employees), the Swed- ish Association of Graduate Engineers, the Swedish Union of Indus- trial 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. REMUNERATION WAGES AND SALARIES AND SOCIAL SECURITY EXPENSES Wages and salaries Social security expenses Of which pension costs 2005 25,567 8,891 2 165 WAGES AND SALARIES PER GEOGRAPHICAL AREA Western Europe 1) 2) Central and Eastern Europe, Middle East and Africa 2) North America 3) Latin America Asia Pacific Total 1) Of which Sweden 2) Of which EU 3) Of which United States 2005 17,706 1,301 3,184 1,007 2,369 25,567 10,721 17,779 1,823 2004 23,858 8,498 1,963 2004 16,030 1,055 3,158 784 2,831 23,858 9,923 16,095 1,926 Remuneration in foreign currency has been translated to SEK at average exchange rates for the year. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 79 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 re- quired by applicable laws, rules and recommendations. Members of the Board of Directors • 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 1,000 per at- tended 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 100 for each commit- tee meeting. Board Emp- loyee re- member Commit- presen- tative tee fee fee Gender Total male 3,000,000 250,000 – 3,250,000 male male female male male male male male SEK Board member Michael Treschow Arne Mårtensson Marcus Wallenberg Nancy McKinstry Peter L. Bonfield Sverker Martin-Löf Eckhard Pfeiffer Ulf J Johansson Carl-Henric Svanberg Monica Bergström Anna Guldstrand Jan Hedlund Per Lindh Arne Löfving Torbjörn Nyman Total Social security fees Total female female male male male male 600,000 125,000 – 725,000 600,000 125,000 – 725,000 600,000 125,000 – 725,000 600,000 250,000 – 850,000 600,000 350,000 – 950,000 600,000 250,000 – 850,000 600,000 125,000 – 725,000 – – – – – – – – – – 12,000 12,000 – 11,000 800 12,000 800 12,000 – 12,000 11,000 12,800 12,800 12,000 – 1,300 12,000 13,300 7,200,000 1,602,900 71,000 8,873,900 2,880,468 11,754,368 The The Group President Management The President and CEO and the Group Management Salary and benefits, SEK Salary Variable pay earned 2004 and paid 2005 Other benefits Total received 18,071,501 25,631,501 5,109,883 5,145,310 22,167,646 64,354,342 86,521,988 Total 41,172,958 55,745,177 7,560,000 35,427 14,572,219 Comments to the table • The Group Management included the following persons: Karl-Hen- rik Sundström, Carl Olof Blomqvist, Marita Hellberg, Torbjörn Nils- son, Bert Nordberg, Henry Sténson, Joakim Westh, Håkan Eriksson, Kurt Jofs, Björn Olsson and Hans Vestberg. During the year, the Group Management also included Mats Granryd (until July 17, 2005), who is included in the table above. • “Other benefits” include the value of stock options exercised during 2005 and the value of matching shares received during 2005 under the Stock Purchase Plan 2001. Based on the share price at excercise respectively at matching, the value for the Group Management was SEK 2,141,997 for stock options excercised and SEK 473,612 for matched shares. The number of options exercised is 110,000 and the number of matched shares corresponds to 17,876 Ericsson B shares. The President and CEO did not participate in any option plan or in the Stock Purchase Plan 2001. Total costs, SEK Salary Provisions for variable pay earned 2005 to be paid 2006 Other benefits Pension premiums Social security fees Total The The Group President Management 14,572,219 Total 41,172,958 55,745,177 8,700,000 1,663,080 6,935,475 9,907,708 22,801,575 31,501,575 6,879,058 8,542,138 17,819,936 24,755,411 27,962,846 37,870,554 41,778,482 116,636,373 158,414,855 Comments to the table • The Chairman of the Board received a Board fee of SEK 3,000,000. The Chairman also received SEK 125,000 for each Board committee he was serving on. • The other Directors appointed by the Annual General Meeting re- ceived a fee of SEK 600,000 each. In addition, each Director serving on a Board committee has received a fee of SEK 125,000 for each committee. However, the Chairman of the Audit Committee received a fee of SEK 350,000 and the other two members of the Audit Com- mittee received a fee of SEK 250,000 each. • Members of the Board, who are not employees of the Company, have not received any compensation other than the fees paid for Board duties. 80 Comments to the table • Other benefits include the compensation cost during 2005 for share based programs. For the President and CEO the cost was SEK 1,627,653 and for the Group Management SEK 4,384,784, which represent their part of total compensation costs as disclosed under “Shares for all Long Term Incentive Plans”. Stock option and stock purchase programs are a part of the total remuneration package as a compensation for the services rendered by employees. Ericsson shall recognize the value of services re- ceived as compensation costs in the income statement at consump- tion of the services. • For the President and CEO, the above pension premium includes a fee of SEK 6,404,358 corresponding to 35 percent of his pension- able salary above 20 base amounts (1 base amount 2005 was SEK 43,300), for a premium based old age pension and a fee of SEK 454,317 for the ITP plan. • Included in the above pension premiums are changes of commit- ments 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 31, 2005, under IAS 19 amounted to SEK 4,108,800 for the President and CEO and SEK 21,687,900 for the Group Management. • Social security fees include payroll tax on pension premiums. Outstanding stock options and matching rights as per December 31, 2005 Number of B shares 1999 Stock Option Plan Millenium Stock Option Plan Stock Option Plan 2001 – May Grant Stock Option Plan 2002 Stock Purchase Plan 2003, LTI 2004 and LTI 2005 The The Group President Management 13,816 1,238,240 625,000 690,000 – – – – 361,020 888,648 Comments to the tables plans. Term Incentive Plans.” • For the definition of matching rights, see description under “Long- • The number of options presumes full exercise under applicable • For strike prices for option plans, see Long-Term Incentive Plans. • The number of matching rights presumes maximum performance matching under LTI 2004 and LTI 2005. The matching under the Performance Matching Programs will start in 2007. COMPENSATION OVERVIEW The Remuneration Committee monitors pay trends within and outside Sweden to find competitive and performance driven remuneration packages for the top executives. Fixed salary is set to be competitive. Its absolute level is determined by the size and complexity of the job and year-on-year performance of the individual job holder. Performance is specifically reflected in the variable components - both in an annual incentive and in a long-term incentive portion. Al- though this may vary over time to take account of pay trends, cur- rently the target level of the annual component for Swedish top executives is around 20% of the total compensation (fixed salary, an- nual incentive and long-term incentive). The long-term component is also set to achieve a target of around 20% of total compensation. In both cases the incentive pay is measured against the achievement of specific business objectives. Together, the incentive component is set to a target of around 40% of total compensation and the remaining part of 60% for the fixed sal- ary, reflecting the judgment of the Board of Directors as to the right balance between fixed and variable pay and the market practice for compensation of executives. The annual short-term incentive is a cash program based on spe- cific business targets derived from the annual business plan approved E R I C S S O N A N N U A L R E P O R T 2 0 0 5 by the Board of Directors. The exact nature of the targets will vary depending on the specific job but may include financial targets at either corporate level or at a specific business unit level, operational targets, employee motivation targets and customer satisfaction targets. Share-based long-term incentive plans are submitted each year for approval by the shareholders at the Annual General Meeting. The value for the receivers is determined by three specific variables, the individu- als’ own investment in shares, a long-term financial target at corporate level, and the share price development. 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 ex- cess of 20 base amounts a percentage of the executive’s pensionable salary, between 10 and 35 percent per year. For the Group Manage- ment, the pension age is normally 60 years and premiums are paid up to the retirement age. From 65 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 an- nual pension contribution of 35 percent of the pensionable salary above 20 base amounts. The President and CEO has the right to retire at 60 years of age. NOTICE AND SEVERANCE PAY For the President and CEO and the Group Management the following applies: The mutual notice period is 6 months. Upon termination of employ- ment by the Company, severance pay amounting to a maximum of 18 months fixed salary is paid. Notice of termination given by the em- ployee due to significant structural changes or other events occurred that, in a determining manner, affect the content of work or the condi- tion for the position, is equated with notice of termination served by the company. The severance pay is reduced by 50 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. 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 coun- tries. LONG-TERM INCENTIVE PLANS The Stock Purchase Plan The Stock Purchase plan is designed to offer an incentive for all em- ployees to participate in the Company, which is consistent with our industry and with our ways of working. Under the plans, employees can save up to 7.5 percent of the gross salary, for purchase of class B shares at the Stockholm Stock Exchange or ADRs at NASDAQ (contribution shares). If the contribution shares are retained by the employee for three years after the investment and the employment with the Ericsson Group N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 81 continues during that time, the employee’s shares will be matched with a corresponding number of class B shares or ADRs free of consider- ation. Employees in 86 countries participate in the plan. The below table shows the periods for employees’ purchase of shares (contribution period) and participation details. Number of Contribution participants at launch Take-up rate – % of all employees Plan Stock Purchase Plan 2001 Stock Purchase plan 2003 1st year Stock Purchase plan 2003 2nd year Stock Purchase plan 2005 period February 2002 – October 2002 August 2003 – July 2004 August 2004 – July 2005 August 2005 – July 2006 27,000 11,000 15,000 16,000 36% 22% 30% 29% The Key Contributor Program The Key Contributor Program is designed to give recognition as a method of retention to key employees. Under the program, about 10 percent of the employees (2004: up to 4,500 and 2005: up to 5,000) have been selected to obtain one extra matching share in addition to the ordinary one matching share for each contribution share purchased under the Stock Purchase Plan during a twelve-month program period. The first program was introduced in August 2004 and the second in August 2005. The Performance Matching Program for executives The Performance Matching Program is designed to focus the manage- ment on driving earnings and provide competitive compensation based on Swedish practice. Under the program, executives (2004: up to 200 executives and 2005: up to 220 executives) have been selected 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 under the Stock Purchase Plan during a twelve-month pro- gram period. The performance matching is subject to the fulfillment of a performance target. Several possible measures have been evaluated but earnings per share (EPS) growth during a three-year period has been found to best suit the company. The first program was introduced in August 2004 and the second in August 2005. The performance target for the first program is annual average EPS growth between five (0 performance matching shares) and 25 percent (maximum performance matching shares). The performance target for the second program is annual average EPS growth between three (0 performance matching shares) and 15 percent (maximum perfor- mance matching shares). The Board may reduce the number of perfor- mance matching shares to be matched if deemed appropriate by the Board considering the company’s financial results and position, condi- tions on the stock market and other circumstances at the time of match- ing. It is the Board of Directors’ intention to repeat the Stock Purchase Plan, including the Key Contributor Program and the Performance Matching Program for next year. STOCK OPTION PLANS Plan 1999 Stock Option Plan Grant/Expiry date 1 March 00/28 Feb 07 Strike price (SEK) 128.00 Millennium Stock Option Plan 17 Jan 00/17 Jan 07 93.80 Stock Option Plan 2001 – May Grant Stock Option Plan 2001 – November Grant 1) 14 May 01/14 May 08 30.50 19 Nov 01/19 Nov 08 25.70 Stock Option Plan 2002 1) 11 Nov 02/11 Nov 09 7.80 1) For stock options exercised during 2005, the weighted average share price was SEK 25.37. Number of participants at grant 1,800 Number of participants end 2005 1,070 8,000 2,892 15,000 8,526 900 609 12,800 9,120 Vesting period from Grant date 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 82 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Shares for all Long-Term Incentive Plans All plans, except the Millennium Option Plan, are funded with treasury stock. Sale of shares is recognized directly in equity. The Millennium Stock Option Plan is based on warrants, i.e. options entitling the hold- ers to subscribe for Class B shares. The warrants are held by subsidiary companies to Telefonaktiebolaget L M Ericsson, which have granted options to their employees. Treasury stock for the 1999 Option Plan was repurchased in year 2000 on the Stockholm Stock Exchange. Trea- sury stock for all remaining plans was issued in a directed cash issue of Class C shares at a nominal amount of SEK 1, and purchased under a public offering at SEK 1 per share plus a premium corresponding to the subscribers’ financing costs and then converted to Class B shares. For all plans, additional shares and warrants have been allocated for financing of social security expenses. 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 also equity against potential social security payments. For all other plans, treasury stock is sold on the Stockholm Stock Exchange to cover the social security payments when arising due to exercise of options or matching of shares. During 2005, 4,429,987 shares were sold at an average price of SEK 25.9. If all options outstanding as of December 31, 2005, were exercised, all shares allocated for future matching under the Stock Purchase Plan were transferred, and shares designated to cover social security pay- ments were disposed of as a result of the exercise and the matching, approximately 38 million Class B shares would be issued and approx- imately 153 million Class B shares, held as treasury stock, would be transferred. The total, approximately 191 million Class B shares, cor- responds to 1.2 percent of the total number of shares outstanding, 15,864 million. The below table shows the number of shares allocated for each plan (options and matching rights) and changes during 2005. Plan 2005 (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 LTI 2005 Out- standing Originally beginning of 2005 0.9 34.2 27.9 1.6 41.4 19.7 16.5 – designated 1) 1.4 71.6 44.9 2.6 53.9 28.0 151.7 31.5 Out- Exer- cised/ Number of Compen- sation costs Granted matched Forfeited Expired standing options charged end of exercis- during 2005 – – – – 14 41 3) 178 3) 5 3) during 2005 – – – – – – – – during 2005 – – – 0.1 7.1 19.4 0.6 0.0 during 2005 0.1 3.1 2.0 0.0 1.0 0.3 0.8 0.0 during 2005 – – – – – – 18.2 5.9 2005 0.8 31.2 25.9 1.5 33.3 0 33.3 2) 5.9 2) able 0.8 31.2 25.9 1.5 33.3 – – – 1) Adjusted for split, bonus issue and rights offering when applicable. 2) Presuming maximum performance matching under the Performance Matching Program. 3) Fair value is calculated as the share price on the investment date reduced by the net present value of the dividend expectations during the three year vesting period. Net present value calculations are based on data from external party. For shares under the performance matching programs, the Company assesses the probability of meeting the performance targets when calculating the compensation costs. Fair value of Class B share at each investment date during 2005 was: February 15 SEK 19.59, May 16 SEK 21.13, August 15 SEK 26.09 and November 15 SEK 25.28. N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 83 Related party transactions Sales Royalty Purchases Related party balances Receivables Liabilities 2005 2004 880 9 364 132 50 725 7 254 130 29 OTHER RELATED PARTIES Ericsson continued cooperation with Ericsson’s owners Investor AB and AB Industrivärden in the venture capital vehicle Ericsson Venture Partners. C31 FEES TO AUDITORS Price- waterhouse- Coopers KPMG Others Total 2005 Audit fees Audit related fees Tax services fees Other fees 2004 Audit fees Audit related fees Tax services fees Other fees 2003 Audit fees Audit related fees Tax services fees Other fees 58 24 43 – 125 57 10 31 – 98 50 1 46 4 101 6 – 1 1 8 6 6 2 – 14 6 4 2 – 12 3 – 1 – 4 1 – – – 1 1 – – 1 2 67 24 45 1 137 64 16 33 – 113 57 5 48 5 115 During the period 2003–2005 PricewaterhouseCoopers and KPMG provided the Company with certain audit related services and tax ser- vices in addition to audit services. The audit related services provided during the period include consultation on financial accounting, consul- tation in connection with conversion to International Financial Report- ing Standards (IFRS), services related to acquisitions and assessments of internal control. The tax services include general expatriate services, VAT refund services and Corporate tax compliance work. Audit fees to other auditors consist of local statutory audits for minor companies. C30 RELATED PARTY TRANSACTIONS During 2005, 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 2001, SEMC was organized as a joint venture between Sony Corporation and Ericsson, and a substantial portion of Ericsson’s hand- set 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: sign. • Sales. Ericsson reports sales regarding mobile phone platform de- • 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 sup- port contracts with a number of customers for mobile systems which also include limited quantities of phones. Related party transactions Sales Royalty Purchases Shareholder contribution Related party balances Receivables Liabilities Contingent liabilities 2005 2004 1,742 654 827 – 197 33 – 1,532 611 547 – 142 16 – 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 49.07 percent of the shares. Major transactions are as follows: equipment from Ericsson. • Sales. Ericsson Nikola Tesla d.d. purchases telecommunication • Royalty. Ericsson receives royalties for Ericsson Nikola Tesla d.d.’s • Purchases. Ericsson is purchasing development resources from usage of trademarks and intellectual property rights. Ericsson Nikola Tesla d.d.. 84 C32 RECONCILIATION TO ACCOUNTING PRINCIPLES GENERALLY ACCEPTED IN THE UNITED STATES As a reporting company with the US Securities and Exchange Com- mission, the Company is required to reconcile certain financial informa- tion to accounting principles generally accepted in the United States (US GAAP). For additional information required by foreign registrants, please refer to our annual report form 20-F, filed with the US Securities and Exchange Commission. The principal differences between IFRSs and US GAAP that affect our net income, as well as our stockholders’ equity, relate to the treat- ment of pensions, hedge accounting, restructuring, sale-lease back, reversals of impairment losses, goodwill and capitalization of develop- ment expenses. NEW US GAAP STANDARDS In 2005 no new FASB standards and pronouncements relevant to Er- icsson were adopted. The following FASB standards and pronouncements will be adopted in 2006: • SFAS 123R Share-Based Payments • SFAS 151 Inventory Costs • SFAS 154 Accounting Changes and Error Corrections SIGNIFICANT DIFFERENCES BETWEEN IFRSs AND US GAAP For a full description of the adoption of IFRSs, see note C3. Capitalization of development costs According to IFRSs development costs are capitalized after the prod- ucts have reached a certain degree of technological feasibility. Capi- talization 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. Under US GAAP, The Company applies US GAAP SFAS 86 “Accounting for the Cost of Computer Software to be Sold, Leased or Otherwise Marketed” and SOP 98-1, “Accounting for the costs of Computer Software Developed or Obtained for Internal use”. According to SFAS 86, software develop- ment costs are capitalized after the product involved has reached a certain degree of technological feasibility similarly to IFRSs. However, under US GAAP non-software related development costs may not be capitalized as per IFRSs, and is therefore expensed under US GAAP. Restructuring costs Under IFRSs a provision for severance pay is recognized when a con- structive obligation to restructure arises which requires that a detailed formal plan has been communicated to those affected by it. Its imple- mentation needs to be planned to begin as soon as possible and to be completed in a timeframe that makes significant changes to the plan unlikely. Under US GAAP provisions for severance pay is recognized on the remaining service period when a company has a detailed formal plan which has been communicated to those affected. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 If an entity under IFRSs has a contract that is onerous, the present obligation under the contract shall be recognized and measured as a provision. Under US GAAP, costs to terminate a contract before the end of its term should be recognized as a liability and measured at fair value when the entity terminates the contract in accordance with the contract terms. A liability for costs that will continue to be incurred under a contract for its remaining term without economic benefit to the entity should be recognized and measured at its fair value when the entity ceases to use the right conveyed by the contract. Ericsson has identified a difference between US GAAP and IFRSs of SEK 112 million related to leasehold property that has not yet been vacated and thus not qualified as provisions in accordance with US GAAP, and SEK 95 million related to severance pay not recognized per US GAAP. Pensions Ericsson adopted IAS 19, Employee Benefits in January 1, 2004. At adoption of IAS 19, actuarial gains and losses were recognized in the opening balance. For US GAAP, the Company adopted SFAS 87, “Employer’s Ac- counting for Pensions” in 1989. The different transition dates for ac- counting of defined benefit plans between US GAAP and IFRSs impact the balances of unrecognized actuarial gains and losses, which impact reported pension liabilities and costs. US GAAP requires recognition of the unfunded accumulated pension benefit obligation on the balance sheet. The minimum liability is the amount by which the plan is un- funded on a basis that does not take future salary increases into con- sideration. Different transition dates and additional minimum pension liability according to US GAAP are the main differences for Ericsson between IFRSs and US GAAP for accounting of defined benefit plans. Sale-leaseback of real estate During 2000 and 2001, the Company sold real estate assets, which was leased back to subsidiary companies and reported as an operating lease. Under IFRSs the gain on sale of property is 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 pay- ments is credited to income when incurred. The remaining part is rec- ognized on a straight line basis during the lease period. Financial instruments Derivatives: Ericsson adopted IAS 39 “Financial Instruments; Recognition and Mea- surement” January 1, 2005. According to IAS 39, all derivatives should be recognized at fair value on the balance sheet Under US GAAP, the Company adopted SFAS 133, ‘‘Accounting for Derivative Instruments and Hedging Activities’’, as amended, on Janu- ary 1, 2001, for calculating income and equity. SFAS 133 requires rec- ognition of all derivatives as either assets or liabilities measured at fair value similarly to IAS 39. As a result of different opening balances in the Hedge Reserve relat- ing to cash flow hedging, the effect in the income statement differ between IFRSs and US GAAP. The closing balances 2005 of the Hedge Reserve were the same as cash flow hedge accounting and applied to the same extent under US GAAP and IFRSs. In the end of 2005 fair value hedge accounting was applied to the same extent under both standards. Under SFAS 133 the shortcut N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 85 method is used, as critical terms of the hedging instruments and hedged items are the same. Hereby all hedge relationships are assumed to be 100-percent effective and no ineffectiveness is recognized. Under IAS 39 a detailed hedge effectiveness testing is performed and actual inef- fectiveness is identified and reported in the income statement. Unrealized gains and losses on securities available-for- sale In accordance with IAS 39 available-for-sale investments that can be reliably determined are measured at fair value. The unrealized move- ments in fair value are recognized in equity until disposal or sale, at which time, those unrealized movements from prior periods are recog- nized in profit or loss. For losses other than temporary, that reduce the carrying amount below acquisition cost should be recognized in profit or loss. Investments in equity instruments that do not have a quoted market price in an active market and whose fair value cannot be reliably measured may be measured at cost. Under US GAAP, the Company’s listed marketable securities are classified as available-for-sale and measured at fair value in accordance with SFAS 115 “Accounting for Certain Investments in Debt and Equity Securities”. Investments in equity instruments not publicly traded are carried at cost. Unrealized gains and temporary losses are reported as a separate component of stockholders’ equity included in other com- prehensive income. Other than temporary unrealized losses are charged to income. Goodwill Ericsson adopted IFRS 3 “Business Combinations” January 1, 2004. Under IFRS 3, goodwill is not subject to amortization, but requires an impairment review at least annually. Under US GAAP, the Company applies SFAS 142. According to SFAS 142 goodwill is not subject to amortization subsequent to the date of adoption, but instead tested for impairment at least annually similarly to IFRS 3. No need for impairment was identified in 2005 in either of the two standards. The presented difference pertains to different transition dates for IFRS 3 and SFAS 142. Reversals of impairment losses IFRSs requires reversal of impairment losses when there has been a change in economic conditions or in the expected use of an asset. Under IFRSs Ericsson has reversed impairment losses for test plants. This is prohibited under US GAAP which reduces the US GAAP net income. OTHER Capitalization of interest expenses Under IFRSs, an entity can choose to capitalize the borrowing costs where they are directly attributable to the acquisition, construction or production of a qualifying asset. The Company has chosen to expense the interest costs incurred. Such costs should be capitalized in ac- cordance with US GAAP, and depreciated as the assets concerned are used. As amortization exceed the capitalization during the year, the net income is reduced by SEK 28 million according to US GAAP. Provision for social security cost on stock based compensation Under IFRSs, the Company accrues social security costs on stock based compensation during the vesting period. Provisions are adjust- ed 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, which increases net income by SEK 52 million. FIN 45 In accordance with IFRSs, 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. Under US GAAP, FIN 45 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 31, 2002. Three main areas; product warranties, inventory guarantees and performance guarantees, fall within FIN 45 for Ericsson. For perfor- mance guarantees, the maximum potential amount of future payments under the guarantees calculated at fair value per December 31, 2005 was SEK 759 million. Historically such guarantees have only been drawn in rare cases, and there is no indication of changes in the future. The application of FIN 45 did not have a material effect on the Com- pany’s earnings and financial position under US GAAP during 2005. FIN 46R FIN 46R 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 Ac- counting Research Bulletin No. 51, “Consolidated Financial Statements” to certain entities in which equity investors do not have the character- istics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordi- nated financial support from other parties. FIN 46R provides guidance on how to determine when and which business enterprise (the “primary beneficiary”) should consolidate the VIE. In addition, FIN 46R requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. The application of FIN 46R during 2005 did not have a material effect on the Company’s consolidated financial state- ments under US GAAP. 86 Deferred tax effect related to intercompany profits in inventory According to IFRSs, deferred tax effect related to intercompany profits in inventory is recognized at the buyer’s tax rate, whereas under US GAAP the seller’s tax rate is used. The effect of this difference decreased net income according to US GAAP in 2005 by SEK 35 mil- lion. 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 fol- lowing 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. Adjustment of Net Income Net income attributable to stockholders of the parent company per IFRSs US GAAP adjustments before taxes: Pensions Sale-leaseback Hedging Capitalization of development costs Restructuring costs Unrealized gains and losses on available-for-sale securities Reversals of impairment losses 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) 2005 2004 24,315 17,539 –64 191 408 –78 120 – –380 56 –73 –245 352 –2,915 –76 –1,354 –82 – 82 1,085 24,495 14,386 1,55 0.91 1,54 0.91 15,843 15,829 15,907 15,855 Comprehensive Income Comprehensive income includes net income and other changes in equity, except those resulting from transactions with owners. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 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 Stockholders’ Equity Equity attributable to stockholders of the parent company per IFRSs US GAAP adjustments before taxes: Pensions Goodwill Sale-leaseback Derivatives Capitalization of development costs Restructuring costs Unrealized gains and losses on available-for-sale securities Reversals of impairment losses Other Deferred tax effect of US GAAP adjustments Stockholders' equity in accordance with US GAAP 2005 2004 24,495 14,386 4,052 –1,015 127 –2,991 –197 –208 –3,344 1,936 –625 47 1,010 –232 202 –329 160 –157 23,870 14,229 2005 2004 104,677 80,445 –2,458 2,705 –837 – –154 208 – –380 246 949 2,705 –1,028 1,604 –76 88 411 – 190 631 –919 104,638 84,369 Balance Sheet Balance sheet items according to IFRSs and US GAAP: IFRSs US GAAP Dec. 31 Dec. 31 Dec. 31 Dec. 31 2004 2005 53,435 50,676 158,153 136,886 158,153 139,428 208,829 186,186 211,042 192,863 2005 52,889 2004 49,300 104,677 850 21,345 81,957 80,445 104,638 850 22,680 82,874 1,057 35,347 69,337 84,369 1,057 36,880 70,557 208,829 186,186 211,042 192,863 Non-current assets Current assets Total assets Stockholders’ equity attributable to stockholders of the parent company Minority interests Non-current liabilities Current liabilities Total stockholders’ equity and liabilities N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S 87 2004 2005 14,386 24,495 Consolidated 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 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: –15 24,480 –80 14,306 1.54 1.54 0.90 0.91 Expected dividend yield Expected volatility Risk-free interest rate Expected life of option (in years) 1) No option programs were initiated during 2004 and 2005. 2005 1) 2004 1) N/A N/A N/A N/A N/A N/A N/A N/A Stock Purchase Plans For the stock purchase plans, Ericsson has applied SFAS 123 accord- ing to US GAAP and IFRS 2 according to IFRSs. The stock purchase plans have been expensed in the income statement according to both IFRSs and US GAAP. The costs are based on the fair value at investment date and charged against equity and accordingly we have not identified any differences between IFRS and US GAAP. Share Based Compensation Stock Option Plan Ericsson adopted IFRS 2 “Share-based Payments” in January 1, 2004 with the optional exception to apply IFRS 2 only to equity instruments granted after November 7, 2002. For one employee option program, granted after this date, and not yet vested by January 1, 2005, Ericsson recognized a charge to income representing the fair value at grant date of the outstanding employee options. The impact on the operating profit was a charge of SEK 45 million in 2004 and SEK 14 million in 2005. Up until 2003, the Company, as permitted under SFAS 123 “Ac- counting for Stock Based Compensation”, applied Accounting Princi- ples Board Opinion 25 (APB 25) and related interpretations in account- ing for its stock option plans under US GAAP. No compensation expense was reflected in the consolidated income statement as no compensation expense arose when the strike price of the employee’s stock options equaled the market value of the underlying stock at grant date, as in the case of all options granted to Ericsson’s employees. Ericsson adopted during 2003 SFAS 148 “Accounting for Stock- Based Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123”. The adoption method chosen was the “Pro- spective 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 current stock option plans nor any new stock option plans started after imple- menting SFAS 148 there has been no effect to the income according to US GAAP. If the Company had chosen to adopt the optional recognition provi- sions of SFAS 123 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: 88 N O T E S T O T H E C O N S O L I D AT E D F I N A N C I A L S TAT E M E N T S PARENT COMPANY INCOME STATEMENT Years ended December 31, SEK million Net sales Cost of sales Gross margin Selling expenses 1) Administrative expenses 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 Taxes 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 5 Note P2 P3 P4 P4 P15 P15 P5 2005 1,096 –621 475 148 –796 –648 3,365 3,192 13,535 –2,700 14,027 10 –57 –47 –581 13,399 2004 2,598 –2,238 360 –613 –989 –1,602 2,890 1,648 11,008 –5,251 7,405 53 1,137 1,190 –1,435 7,160 1) Selling expenses included the net effect of risk provisions for customer financing of SEK 782 million in 2005 (SEK –343 million in 2004). PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 89 PARENT COMPANY BALANCE SHEET December 31, SEK million ASSETS Fixed assets Intangible assets Tangible assets Financial assets Investments Subsidiaries Joint ventures and associated companies Other investments Receivables from subsidiaries Customer financing, non-current Deferred tax assets Other financial assets, non-current Current assets Inventories Receivables Accounts receivable – trade Customer financing, current Receivables from subsidiaries Other current receivables Short-term cash investments Cash and bank Total assets Note 2005 2004 P6 P7, P26 P8, P9 P8, P9 P8 P12 P8 P5 P8 P10 P11 P12 P13 P19 P19 18 318 40 344 53,066 4,474 18 54,413 1,231 877 357 114,772 48,860 4,474 12 48,535 1,964 2,527 451 107,207 60 40 27 1,285 21,076 3,656 64,172 10,790 101,066 215,838 194 683 15,667 8,203 63,924 7,772 96,483 203,690 90 December 31, SEK million 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 Non-current liabilities Notes and bond loans Liabilities to financial institutions Liabilities to subsidiaries Other non-current liabilities Current liabilities Current maturities of long-term borrowings Current liabilities to financial institutions Accounts payable – trade Liabilities to subsidiaries Other current liabilities Total stockholders’ equity, provisions and liabilities Assets pledged as collateral Contingent liabilities E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Note P14 P15 P16 P17 P18 P18 P12 P18 P18 P21 P12 P20 P22 P23 2005 2004 16,132 – 20 31,472 47,624 15,570 13,399 28,969 76,593 986 415 1,391 1,806 11,811 67 41,011 134 53,023 9,582 – 161 68,528 5,159 83,430 215,838 421 7,545 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 82,026 203,690 807 7,025 PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 91 PARENT COMPANY STATEMENT OF CASH FLOWS Years ended December 31, SEK million OPERATIONS Net income Adjustments to reconcile net income to cash Changes in operating net assets Inventories Customer financing, current and non-current 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 and sales of shares and other investments, net Lending, net Other Cash flow from investing activities Notes P24 P24 2005 13,399 –5,966 7,433 –20 757 27 –1,250 7,276 14,223 –76 – 2,498 –4,127 124 –1,581 2004 7,160 1,129 8,289 –37 1,137 495 –975 –3,756 5,153 –50 70 9,136 –5,536 1,446 5,066 Cash flow before financing activities 12,642 10,219 FINANCING Changes in current liabilities to financial institutions, net Changes in current liabilities to subsidiaries Proceeds from issuance of other non-current borrowings Repayment of non-current borrowings Sale of own stock Dividends paid Settled contributions from/to (–)subsidiaries Other Cash flow from financing activities Net change in cash and cash investments –322 –2,207 – –699 119 –3,959 –2,299 –9 –9,376 3,266 –1,478 6,852 450 –12,263 15 – –492 – –6,916 3,303 Cash and cash investments, beginning of period 71,696 68,393 Cash and cash investments, end of period P19 74,962 71,696 92 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 PARENT COMPANY STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY Years ended December 31, SEK million Opening balance Sale of own stock Stock Purchase and Stock Option Plans Contributions from/to subsidiaries Tax on contributions Dividends paid Adjustment of accrued costs for stock issue 2002 Net income Closing balance Note P14 2005 63,763 117 62 4,465 –1,254 –3,959 – 13,399 76,593 2004 61,257 15 27 –6,525 1,827 – 2 7,160 63,763 PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 93 94 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS CONTENTS P1 Significant Accounting Policies ................................................................................................................................................................................................ 96 P2 Segment Information ....................................................................................................................................................................................................................... 96 P3 Other Operating Revenues and Costs ................................................................................................................................................................................. 96 P4 Financial Income and Expenses .............................................................................................................................................................................................. 96 P5 Taxes ......................................................................................................................................................................................................................................................... 97 P6 Intangible Assets ................................................................................................................................................................................................................................ 97 P7 Tangible Assets ................................................................................................................................................................................................................................... 98 P8 Financial Assets .................................................................................................................................................................................................................................. 99 P9 Investments ........................................................................................................................................................................................................................................ 100 P10 Inventories ........................................................................................................................................................................................................................................... 102 P11 Accounts Receivable – Trade ................................................................................................................................................................................................. 102 P12 Receivables and Payables – Subsidiary companies ................................................................................................................................................ 102 P13 Other Current Receivables ....................................................................................................................................................................................................... 102 P14 Stockholders’ Equity .................................................................................................................................................................................................................... 102 P15 Untaxed Reserves .......................................................................................................................................................................................................................... 103 P16 Pensions ............................................................................................................................................................................................................................................... 103 P17 Other Provisions .............................................................................................................................................................................................................................. 104 P18 Interest-bearing Provisions and Liabilities ...................................................................................................................................................................... 104 P19 Financial Risk Management and Financial Instruments ......................................................................................................................................... 104 P20 Other Current Liabilities ............................................................................................................................................................................................................. 105 P21 Accounts Payable – Trade ........................................................................................................................................................................................................ 105 P22 Assets Pledged as Collateral .................................................................................................................................................................................................. 105 P23 Contingent Liabilities .................................................................................................................................................................................................................... 105 P24 Statement of Cash Flows ........................................................................................................................................................................................................... 106 P25 Leasing .................................................................................................................................................................................................................................................. 106 P26 Tax Assessment Values in Sweden ..................................................................................................................................................................................... 106 P27 Information Regarding Employees ...................................................................................................................................................................................... 106 P28 Fees to Auditors ...............................................................................................................................................................................................................................107 N O T E S T O T H E PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 95 STATEMENT OF CASH FLOWS Cash and cash equivalents include financial instruments with maturity up to 12 months from the balance sheet date. P2 SEGMENT INFORMATION NET SALES Western Europe 1) 2) Eastern Europe, Middle East & Africa Latin America Total 1) Of which Sweden 2) Of which EU 2005 41 1,047 8 1,096 41 41 2004 54 2,530 14 2,598 54 54 Parent Company sales are mainly related to business segment Systems. P3 OTHER OPERATING REVENUES AND COSTS Royalties, license fees and other operating revenues Subsidiary companies Other Net losses (–) on sales of tangible assets Total P4 FINANCIAL INCOME AND EXPENSES 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 Total 2005 2004 1,728 1,641 –4 3,365 1,683 1,237 –30 2,890 2005 2004 3,804 6,774 6,378 146 25 – 120 34 6 – – 2 1,267 1,659 13,535 1,093 3,235 11,008 P1 SIGNIFICANT ACCOUNTING POLICIES The Parent Company, Telefonaktiebolaget LM Ericsson, has adopted RR32 “Reporting in separate financial statements” from January 1, 2005. RR32 requires the Parent Company to use similar accounting principles as for the Group, i.e. IFRS to the extent allowed by RR32. The adoption of RR32 has not had any effect on reported profit or loss for 2004 and 2005. The main deviations between accounting policies adopted for con- solidation and accounting policies for the Parent Company are: SUBSIDIARIES, ASSOCIATED COMPANIES AND JOINT VENTURES The investments are accounted for according to the acquisition cost method. Investments are carried at cost and only dividends are ac- counted for in the income statement. An impairment test is performed annually and write-downs are made when permanent decline in value is established. CLASSIFICATION AND MEASUREMENT OF FINANCIAL INSTRUMENTS Short term cash investments, interest and foreign exchange derivatives are carried at lowest of amortized cost and fair value. Derivative instruments are used to hedge foreign exchange and interest rate risk. Foreign exchange derivatives are recognized in the balance sheet at fair value to offset value changes in the hedged item. Effects from foreign exchange derivatives hedging future transactions are deferred to offset the hedged transaction. Interest rate derivatives hedging loans or investments are valued in the same way as the underlying transaction. Bonds issued by Ericsson are carried at amortized cost. IAS 39 “Financial Instruments, Recognition and Measurement” will be adopted, to the extent allowed by the Annual Accounts Act, from January 1, 2006. LEASING The Parent Company has one rental agreement which is accounted for as a finance lease in the consolidated statements and as an operating lease in the Parent Company. DEFERRED TAXES The accounting of untaxed reserves in the balance sheet result in dif- ferent accounting of deferred taxes as compared to the principles ap- plied in the consolidated statements. Swedish GAAP and tax regula- tions 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 re- ported as an addition to, or withdrawal from, untaxed reserves in the income statement. PENSIONS Pensions are accounted for in accordance with the recommendation FAR 4 “Accounting for pension liability and pension cost” from the Swedish Insitute of Authorised Public Accountants. According to RR 32, IAS 19 shall be adopted regarding supplementary disclosures when applicable. 96 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Financial Expenses Losses on sales of participations in subsidiary companies Write-down of investments in subsidiary companies Losses on sale of participations in other companies Write-down of participations in other companies Interest expenses and similar profit/loss items Subsidiary companies Other Other financial expenses Total Financial Net 2005 2004 –14 –295 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, 28 percent, on income before taxes, is shown in the table: –106 –861 Income before taxes –7 – – –5 –1,115 –1,445 –13 –2,700 10,835 –1,178 –2,896 –16 –5,251 5,757 Tax rate in Sweden (28%) 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 related to write-downs of investments in subsidiary companies Taxes 2005 13,980 2004 8,595 –3,914 326 –2,407 – –35 –597 3,072 1,810 –30 –581 –241 –1,435 Interest expenses on pension liabilities are included in the interest expenses shown above. Tax effect of expenses that are not deductible refers mainly to net losses on sales of shares and other non-tax deductible expenses. Tax effect of income that is non-taxable refers mainly to dividends, profit on sales of shares and foreign taxes. P5 TAXES INCOME STATEMENT The following items are included in Taxes: Current inome tax on contributions, net Other current income taxes for the year Current income taxes related to prior years Deferred tax income/expense (–) related to temporary differences Taxes 2005 1,254 –511 326 2004 –1,827 –489 – BALANCE SHEET Deferred tax assets and liabilities Tax effects of temporary differences have resulted in deferred tax assets as follows: Deferred tax assets 2005 877 2004 2,527 –1,650 –581 881 –1,435 Deferred tax assets refer mainly to costs related to customer financing and provisions for restructuring costs. Deferred tax income and expenses The amounts of deferred tax income and expenses are shown in the following table: At December 31, 2005 unutilized tax loss carryforwards amounted to SEK 0 million (SEK 3,828 million 2004). The tax effect of these tax loss carryforwards are included in deferred tax assets. Deferred tax income Deferred tax expenses Deferred tax income/expense, net 2005 2 –1,652 –1,650 2004 1,180 –299 881 P6 INTANGIBLE ASSETS PATENTS, LICENSES, TRADEMARKS AND SIMILAR RIGHTS Deferred tax expenses refer mainly to utilized tax loss carryforwards and reversal of temporary differences regarding provisions for cus- tomer financing commitments and provision for restructuring costs. Accumulated acquisition costs Opening balance Closing balance Accumulated amortization Opening balance Amortization for the year Closing balance Net carrying value 2005 2004 222 222 –182 –22 –204 18 222 222 –160 –22 –182 40 N O T E S T O T H E PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 97 Total 590 76 –24 – 642 –246 –97 19 –324 318 672 50 –132 – 590 –167 –111 32 – –246 344 P7 TANGIBLE ASSETS Land and buildings Other equipment, tools and installations Construction in process 23 – – – 23 –2 – – –2 21 23 – – – 23 – – – –2 –2 21 522 15 –24 67 580 –244 –97 19 –322 258 559 6 –49 6 522 –167 –111 32 2 –244 278 45 61 – –67 39 – – – – 39 90 44 –83 –6 45 – – – – – 45 2005 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 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 98 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 P8 FINANCIAL ASSETS INVESTMENTS IN SUBSIDIARY COMPANIES, JOINT VENTURES AND ASSOCIATED COMPANIES Opening balance Acquisitions and stock issues Shareholders’ contribution Write-downs Sales Closing balance OTHER FINANCIAL ASSETS 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 Subsidiary companies 2004 58,991 4,443 –7,162 –861 –6,551 48,860 2005 48,860 6,959 63 –106 –2,710 53,066 Joint ventures 2004 4,136 – – – – 4,136 2005 4,136 – – – – 4,136 Associated companies 2004 371 – 3 – –36 338 2005 338 – – – – 338 Other investments in shares and participations 2004 2005 Customer financing, non-current1) 2004 2005 Other financial assets, non-current 2004 2005 18 13 –7 – – 24 –6 – – – – –6 18 20 – –2 – – 18 –3 –5 2 – – –6 12 5,906 496 –3,763 –697 233 2,175 –3,942 –52 2,596 560 –106 –944 1,231 5,593 1,315 –738 –147 –117 5,906 –3,570 –547 109 4 62 –3,942 1,964 451 788 –650 –236 4 357 – – – – – – 357 476 205 –228 – –2 451 – – – – – – 451 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 receivables. We sometimes receive such instruments as security for our receivable and our policy is to sell them as soon as feasible. N O T E S T O T H E PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 99 P9 INVESTMENTS The following listing shows certain shareholdings owned directly and indirectly by the Parent Company as of December 31, 2005. A complete listing of shareholdings, prepared in accordance with the Swedish An- nual Accounts Act and filed with the Swedish Companies Registration SHARES OWNED DIRECTLY BY THE PARENT COMPANY Office (Bolagsverket), may be obtained upon request to: Telefonak- tiebolaget LM Ericsson, External & Management Information, SE-164 83 Stockholm, Sweden. Domicile Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Sweden Austria Denmark Finland France Germany Hungary Ireland Italy The Netherlands Norway Russia Switzerland United Kingdom United States Argentina Brazil Mexico Australia China China China India Malaysia Singapore Taiwan Thailand Par value in local currency, million Carrying value, SEK m. Percentage of ownership 100 100 100 100 100 100 100 100 100 – 100 100 100 100 100 100 100 53 1) 100 100 100 100 100 – 100 95 2) 22 3) 100 – 100 100 100 25 4) 100 70 100 80 49 5) – 50 361 360 30 100 14 105 162 5 – 4 90 13 26 20 2,552 2 – 222 156 5 – 74 – – 5 – n/a – 20 2 65 5 725 2 – 240 90 – – 20,645 7,216 335 152 102 6 131 324 5 2,028 665 216 196 524 343 120 15 3,151 3,200 237 5 – 758 218 9,531 10 368 1,550 59 100 2 475 37 147 4 1 20 17 153 53,066 Reg. No. 556056-6258 556251-3266 556090-3212 556028-1627 556329-5657 556030-9899 556381-7666 556381-7609 556326-0552 I I I II I I II I II I I I II Type Company Subsidiary companies Ericsson AB I Ericsson Shared Services AB I Ericsson Enterprise AB I Ericsson Microwave Systems AB I Ericsson Sverige AB I AB Aulis II LM Ericsson Holding AB II Ericsson Gämsta AB III Ericsson Credit 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.r.l. Ericsson Holding International B.V. 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. Ericsson Telecommunicações S.A. 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 I 100 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 SHARES OWNED DIRECTLY BY THE PARENT COMPANY (CONTINUED) Type Company Joint ventures and associated companies I I Sony Ericsson Mobile Communications AB Ericsson Nikola Tesla d.d. Other Total Reg. No. Domicile 556615-6658 Sweden Croatia SHARES OWNED BY SUBSIDIARY COMPANIES Par value in local currency, million Carrying value, SEK m. Percentage of ownership 50 49 – 50 131 – – 4,136 330 8 4,474 Company Type Subsidiary companies I II I I I I II I I I I I I I I I I I I I I Ericsson Network Technologies AB Ericsson Cables Holding AB Ericsson France SAS LM Ericsson Ltd. Ericsson Telecommunicazioni S.p.A. Ericsson S.p.A 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 IP Infrastructure Inc. Ericsson Amplified Technologies Inc. Ericsson Servicos de Telecomunicações Ltda. Ericsson Australia Pty. Ltd. Ericsson (China) Communications Co. Ltd. Nippon Ericsson K.K. Ericsson Consumer Products Asia Pacific Pte Ltd. Reg. No. Domicile Percentage of ownership 556000-0365 556044-9489 Sweden Sweden France Ireland Italy Italy The Netherlands The Netherlands Spain Turkey United Kingdom Canada United States United States United States United States Brazil Australia China Japan Singapore 100 100 100 100 99 99 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 Key to type of company 1) Through subsidiary holdings, total holdings amount to 100% of Ericsson S.r.l. I Manufacturing, distribution and development companies 2) Through subsidiary holdings, total holdings amount to 100% of Cia Ericsson S.A.C.I. II Holding companies III Finance companies 3) Through subsidiary holdings, total holdings amount to 100% of Ericsson Telecommunicações S.A. 4) Through subsidiary holdings, total holdings amount to 51% of Nanjing Ericsson Panda Communi- cation Co. Ltd. 5) Through subsidiary holdings, total holdings amount to 100% of Ericsson (Thailand) Ltd. N O T E S T O T H E PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 101 P13 OTHER CURRENT RECEIVABLES Receivables from associated companies and joint ventures Prepaid expenses Accrued revenues Derivatives with a positive value Other Total 2005 2004 171 741 820 1,516 408 3,656 24 543 893 6,144 599 8,203 P14 STOCKHOLDERS’ EQUITY CAPITAL STOCK 2005 Capital stock at December 31, 2005, consisted of the following: Class A shares 1) Class B shares 1) Number Aggregate of shares par value 1,309 14,823 16,132 1,308,779,918 14,823,478,760 16,132,258,678 1) Class A shares (par value SEK 1.00) and Class B shares (par value SEK 1.00 being the same as the quota value). P10 INVENTORIES Finished products and goods for resale Contract work in progress Inventories, net 2005 2004 47 13 60 20 20 40 P11 ACCOUNTS RECEIVABLE – TRADE Trade receivables excluding associated companies Provision for impairment of receivables Trade receivables, net Trade receivables from associated companies and joint ventures Total 2005 2004 38 444 –13 25 –275 169 2 27 25 194 P12 RECEIVABLES AND PAYABLES – SUBSIDIARY COMPANIES Non-current Receivables 1) Financial receivables Current Receivables Commercial receivables Financial receivables Total Non-current Liabilities 1) Financial liabilities Current Liabilities Commercial liabilities Financial liabilities Total 2005 2004 54,413 48,535 1,013 20,063 21,076 874 14,793 15,667 41,011 33,840 85 135 68,393 77,515 68,528 77,600 1) Including non interest-bearing receivables and liabilities, net, amounting to SEK –29,051 million (SEK –21,940 million in 2004). Interest-free transactions involving current receivables and liabilities may also arise at times. 102 CHANGES IN STOCKHOLDERS’ EQUITY Share Revalua- tion Statutory restricted equity reserve reserve Total Disposi- tion reserve 20 – – – – – – – 20 20 – – – – – – 20 Capital premium reserve 1) stock 2005 January 1, 2005 Sale of own stock Stock purchase and stock option plans Dividends paid Transfer to statutory reserve Contributions from/to (–) subsidiary companies Tax on contributions Net income 2005 December 31, 2005 16,132 – – – – – – – 16,132 24,731 – – – –24,731 – – – – 2004 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 December 31, 2004 16,132 – – 24,729 – – – 2 – – – 16,132 – – – 24,731 1) 1996 and prior years’ share premium are included in Statutory reserve. P15 UNTAXED RESERVES 2005 Accumulated depreciation in excess of plan Intangible assets Tangible assets Total accumulated depreciation in excess of plan Other untaxed reserves Reserve for doubtful receivables Total other untaxed reserves Total untaxed reserves Changes in other untaxed reserves in 2004 consisted of: withdrawals from reserve for doubtful receivables, SEK 363 million and withdrawals of income deferred reserve SEK 774 million. Deferred tax liability on untaxed reserves, not accounted for in deferred taxes, amounts to SEK 276 million in 2005 (SEK 263 million in 2004). P16 PENSIONS Cash of SEK 524 million was transferred into the Swedish pension trust in January 2005, of which SEK 104 million is accounted for as prepaid expenses. Pension obligations are calculated annually, on the balance sheet date, based on actuarial principles. FPG/PRI pensions Other pension commitments Total Pension trust plan assets Reclassification Total E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Other Non- retained restricted equity earnings 16,039 117 62 –3,959 – 4,465 –1,254 13,399 28,869 16,139 117 62 –3,959 – 4,465 –1,254 13,399 28,969 Total 63,763 117 62 –3,959 – 4,465 –1,254 13,399 76,593 13,535 15 27 13,635 15 27 61,257 15 27 6,741 – – – 24,731 – – – 31,472 47,624 – – – – – – – 47,624 6,741 – – 47,622 – – 100 – – – – – – – 100 100 – – – 2 – – – 2 – – – 6,741 – – – 47,624 – – – 100 –6,525 1,827 7,160 16,039 –6,525 1,827 7,160 16,139 –6,525 1,827 7,160 63,763 Additions/ Jan. 1 withdrawals (–) Dec. 31 16 –4 12 927 927 939 – –10 –10 57 57 47 16 –14 2 984 984 986 2004 419 442 861 – – 861 2005 449 415 864 –553 104 415 N O T E S T O T H E PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 103 P17 OTHER PROVISIONS 2005 Opening balance Additions Costs incurred Reversal of excess amounts Reclassification Closing balance 2004 Opening balance Additions Costs incurred Reversal of excess amounts Closing balance Warranty commitments Restruc- turing Customer financing 1 – – – – 1 – 1 – – 1 1,107 178 –305 –126 –91 763 1,465 357 –588 –127 1,107 478 39 –113 –94 – 310 1,431 103 –593 –463 478 Other 609 – – –292 – 317 287 477 –155 – 609 Total other provisions 2,195 217 –418 –512 –91 1,391 3,183 938 –1,336 –590 2,195 P19 FINANCIAL RISK MANAGEMENT AND FINANCIAL INSTRUMENTS CASH AND BANK AND SHORT-TERM CASH INVESTMENTS During 2005, cash and bank and short-term cash investments in- creased by SEK 3.3 billion to SEK 75.0 billion mainly due to positive cash flow, which was partly offset by repayment of long-term borrowings and payment to the Swedish Pension Trust. SEK billion Bank deposits Type of issuer/ counterpart Governments Banks Corporations Mortgage institutes Liquidity funds Total Remaining time to maturity < 1 > 5 year years years 2005 2004 4.0 < 3 months 6.3 1–5 6.3 – – – 3.5 0.2 32.0 0.2 4.5 3.1 – 11.4 0.7 – 46.7 15.2 – – 9.7 2.4 – 12.1 – – 9.6 6.6 8.8 0.2 1.0 54.1 37.2 3.3 8.4 3.7 4.5 1.0 75.0 71.7 – – RE-FINANCING RISK Re-financing risk is the risk that Ericsson is unable to refinance out- standing borrowings at reasonable terms and conditions, or at all, at a given point in time. P18 INTEREST-BEARING PROVISIONS AND LIABILITIES The Parent Company’s outstanding interest-bearing provisions and li- abilities, excluding liabilities to subsidiaries, were SEK 21.9 billion as of December 31, 2005. INTEREST-BEARING PROVISIONS AND LIABILITIES Current liabilities to financial institutions Current maturities of long term borrowings 1) Total current interest-bearing provisions and liabilities Notes and bond loans Liabilities to financial institutions Pensions Total non-current interest-bearing provisions and liabilities Total interest-bearing provisions and liabilities 2005 2004 – 322 9,582 699 9,582 1,021 11,811 19,844 67 415 116 861 12,293 20,821 21,875 21,842 1) Including note and bond loans of SEK 9,535 million 2005 and SEK 651 million 2004. LIABILITIES TO FINANCIAL INSTITUTIONS, INTEREST RATE BY CURRENCY Maturing >1<5 years Interest rate (%) 2.6% – Nominal 67 67 SEK Total 104 REPAYMENT SCHEDULE OF LONG-TERM BORROWINGS Current maturities of long Notes and bonds term debt (non-current) – – 3.1 3.8 4.4 0.5 11.8 9.6 – – – – – 9.6 Liabilities to financial institutions (non-current) – 0.1 – – – – 0.1 Total 9.6 0.1 3.1 3.8 4.4 0.5 21.5 SEK billion 2006 2007 2008 2009 2010 2011+ Total Debt financing is mainly carried out through borrowing in the Swedish and international debt capital markets. FUNDING PROGRAMS Euro Medium Term Note program (USD m.) Euro Commercial Paper program (USD m.) 1) Swedish Commercial Paper program (SEK m.) 1) Long-term Committed Credit facility (USD m.) Shot-term Committed Credit facilities (SEK m.) Amount Utilized Unutilized 5,000 2,303 2,697 1,500 5,000 1,000 183 – – – – 1,500 5,000 1,000 183 1) Currently unavailable due to low short term rating. 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 Parent Company Financial Statements – Note P1, “Significant Accounting policies”. FINANCIAL INSTRUMENTS CARRIED AT OTHER THAN FAIR VALUE SEK billion Current maturities of long term borrowings Notes and bonds Carrying amount 2004 2005 Fair value 2004 2005 9.6 11.8 21.4 0.7 19.8 20.5 9.7 13.0 22.7 0.7 21.6 22.3 Financial instruments excluded from the tables, such as trade receiv- ables and payables are carried at fair value. When a market price is not readily available and there is insignificant interest rate exposure affect- ing the value, the carrying value is considered to represent a reasonable estimate of a fair value. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 P20 OTHER CURRENT LIABILITIES Liabilities to associated companies and joint ventures Accrued interest Accrued expenses, of which employee related supplier invoices not received other accrued expenses Deferred revenues Derivatives with a negative value Other current liabilities Total 2005 2004 74 737 7 798 246 203 44 – 112 3,570 376 5,159 – 207 254 1,564 197 3,230 P21 ACCOUNTS PAYABLE – TRADE Accounts and notes payable excluding associated companies and joint ventures Total 2005 2004 161 161 175 175 P22 ASSETS PLEDGED AS COLLATERAL Chattel mortgages Bank deposits Total 2005 – 421 421 2004 460 347 807 The chattel mortgage was collateral for pension commitments 2004. The major item in bank deposits is for the internal bank’s clearing and settlement commitments SEK 165 million in 2005 (SEK 149 million in 2004). P23 CONTINGENT LIABILITIES Guarantees for customer financing Other contingent liabilities Total 2005 67 7,478 7,545 2004 64 6,961 7,025 Other contingent liabilities include pension commitments SEK 6,918 million in 2005 (SEK 6,282 million in 2004), and subsidiary companies borrowing from financial institutions SEK 98 million in 2005 (SEK 73 million in 2004). 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 2005 was SEK 15,412 million (SEK 13,292 million in 2004). Potential payments N O T E S T O T H E PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 105 due under these bonds are related to Ericsson’s performance under applicable contracts. LEASING WITH THE PARENT COMPANY AS LESSOR At December 31, 2005, future minimum payment receivables were dis- tributed as follows: 2006 2007 2008 2009 2010 2011 and later Operating leases 39 28 26 18 – – 111 The operating lease income is mainly income from sublease of prop- erty. P26 TAX ASSESSMENT VALUES IN SWEDEN Land and land improvements Total 2005 11 11 2004 11 11 P27 INFORMATION REGARDING EMPLOYEES AVERAGE NUMBER OF EMPLOYEES 2005 2004 Men Women Total Men Women Total 366 108 159 267 196 170 Western Europe 1) 2) Eastern Europe, Middle East and Africa 705 Total 813 1) Of which Sweden 108 2) Of which EU 108 21 726 180 993 159 267 159 267 492 688 196 196 21 191 170 170 513 879 366 366 P24 STATEMENT OF CASH FLOWS Interest paid in 2005 was SEK 3,215 million (SEK 4,302 million in 2004) and interest received was SEK 3,151 million (SEK 4,363 million in 2004). Income taxes paid were SEK 65 million (SEK 259 million in 2004). Major non-cash items in Investments are: Acquisitions and sales of shares and other investments, net, SEK 3,214 million in 2005. ADJUSTMENTS TO RECONCILE NET INCOME TO CASH 2005 2004 Tangible assets Depreciation Total Intangible assets Amortization Total Total depreciation and amortization on tangible and intangible assets Taxes Write-downs and capital gains (–)/ losses on sale of fixed assets, excluding customer financing, net Additions to/withdrawals from (–) untaxed reserves Unsettled dividends Total adjustments to reconcile net income to cash 97 97 22 22 111 111 22 22 119 516 133 1,177 –6,643 1,009 47 –5 –1,190 – –5,966 1,129 P25 LEASING LEASING WITH THE PARENT COMPANY AS LESSEE At December 31, 2005, future payment obligations for leases were distributed as follows: Operating leases 1,253 1,096 972 796 727 1,703 6,547 2006 2007 2008 2009 2010 2011 and later 106 E R I C S S O N A N N U A L R E P O R T 2 0 0 5 P28 FEES TO AUDITORS Price- waterhouse- Coopers KPMG Others Total 2005 Audit fees Audit related fees Tax services fees Other fees Total 2004 Audit fees Audit related fees Tax services fees Total 2003 Audit fees Audit related fees Tax services fees Other fees Total 21 18 1 – 40 24 5 2 31 11 – 13 – 24 2 – – – 2 1 – – 1 1 1 – – 2 – – – – – – – – – – – – – – 23 18 1 – 42 25 5 2 32 12 1 13 – 26 ABSENCE DUE TO ILLNESS 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 Long-term absence due to illness 1) 2005 1% 2% – 2% 1% 0.5% 2004 1% 2% –% 1% 1% 0.4% 1) Defined as absence during a consecutive period of time of 60 days or more. REMUNERATION WAGES AND SALARIES AND SOCIAL SECURITY EXPENSES Wages and salaries Social security expenses Of which pension costs 2005 484 251 129 2004 453 311 214 WAGES AND SALARIES PER GEOGRAPHICAL AREA Western Europe 1) 2) Eastern Europe, Middle East and Africa 2) Total 1) Of which Sweden 2) Of which EU 2005 302 2004 314 182 484 302 302 139 453 314 314 Remuneration in foreign currency has been translated to SEK at average exchange rates for the year. COMPENSATION POLICIES AND REMUNERATION TO THE BOARD OF DIRECTORS AND THE PRESIDENT AND CEO See Notes to the Consolidated Financial Statements, Note C29 – “In- formation Regarding Employees, Members of the Board of Directors and Management”. LONG TERM INCENTIVE PLANS The Stock Purchase Plan Compensation costs for all employees of the Parent Company amounts to SEK 8.9 million in 2005. N O T E S T O T H E PA R E N T C O M PA N Y F I N A N C I A L S TAT E M E N T S 107 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 President and CEO of Telefonaktiebolaget LM Ericsson (publ) for the year 2005. The Board of Directors and the President and CEO are responsible for these accounts and the administration of the Com- pany, as well as for the application of the Annual Accounts Act when preparing the annual accounts and the application of international fi- nancial reporting standards (IFRSs) as adopted by the EU and the Annual Accounts Act when preparing the consolidated accounts. 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 misstate- ment. An audit includes examining, on a test basis, evidence support- ing 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 President and CEO and significant estimates made by the Board of Directors and the President and CEO 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 deter- mine the liability, if any, to the Company of any Board Member or the President and CEO. We also examined whether any Board Member or the President and CEO has, in any other way, acted in contravention of the Companies Act, the Annual Accounts Act or the Articles of Asso- ciation. We believe that our audit provides a reasonable basis for our opinion set out below. The annual accounts have been prepared in accordance with the Annual Accounts Act and give a true and fair view of the company’s financial position and results of operations in accordance with gener- ally accepted accounting principles in Sweden. The consolidated ac- counts have been prepared in accordance with international financial reporting standards (IFRSs) as adopted by the EU and the Annual Ac- counts Act and give a true and fair view of the Group’s financial position and results of operations. The statutory Board of Directors’ report is consistent with the other parts of the annual accounts and the con- solidated accounts. We recommend to the Annual General Meeting of shareholders that the income statements and balance sheets of the Parent Company and the group be adopted, that the profit of 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 President and CEO be discharged from liability for the financial year. Stockholm, February 24, 2006 Bo Hjalmarsson Authorized Public Accountant PricewaterhouseCoopers AB Peter Clemedtson Authorized Public Accountant PricewaterhouseCoopers AB Thomas Thiel Authorized Public Accountant 108 A U D I T O R S ’ R E P O R T E R I C S S O N A N N U A L R E P O R T 2 0 0 5 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 Telefonaktiebo- laget LM Ericsson, the Parent Company and its subsidiaries. The com- pany was incorporated on August 18, 1918, 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 Stock- holm Stock Exchange, OMXS). Our Class B shares are also traded on the London Stock Exchange (LSE). In the United States, our American Depository Shares (ADS), each representing 10 underlying Class B shares, are traded on NASDAQ. Our registered address is Telefonaktiebolaget LM Ericsson, SE– 164 83 Stockholm, Sweden; our headquarters are located at Torsham- nsgatan 23, Kista, Sweden. Our telephone number in Sweden is +46 8 719 0000. In the United States, our agent is Ericsson Inc., Vice President Legal Affairs, 6300 Legacy Drive, Plano, Texas 75024. Our telephone number in the U.S. is +1 972 583 0000. 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 Compa- nies 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 numbers 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/webusers.htm where they are stored in the EDGAR database. You may read and copy any of these reports at the SEC’s Public Reference Branch at 100 F Street, N.E., Washington, D.C. 20549, or obtain them by mail upon payment of their prescribed rates. For further information, you can call the SEC at +1 800 732 0330. HISTORY AND DEVELOPMENT Our origins date back to 1876 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 op- erator. Stockholm soon had the highest telephone density in the world. Today, Ericsson is a leading provider of telecommunications equip- ment and related services to mobile and fixed network operators glob- ally. Over 1,000 networks in more than 140 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 stan- dards. We invest heavily in R&D and actively promote standardization 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 1878 1923 Manual switching to automatic switching 1968 Electro-mechanical to computer control 1978 Analog switching to digital switching 1981 Fixed communications to mobile communications 1991 1G analog to 2G digital mobile technology 1998 1999 Narrowband circuit to broadband packet switching 1999 Introduction of fixed telephony softswitch 2001 2G narrowband to 3G wideband mobile technology 2003 2004 Mass commercial launch of WCDMA (3G) networks in Western Integration of voice and data in mobile networks Introduction of mobile softswitch Europe 2005 Commercial launch of HSDPA mobile broadband networks in North America Also reflecting our ongoing commitment to technology leadership, we have one of the industry’s most comprehensive intellectual property portfolios containing over 20,000 patents. Our vision – how we see the world Our vision is to be the Prime Driver in an all-communicating world. Core values – how we act Professionalism, respect and perseverance are the cornerstones 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, em- ployee satisfaction and financial returns. We believe that highly satisfied customers, empowered employees and best-in-class operating mar- gins help to assure an enduring capability for value creation and com- petitive advantage. BUSINESS STRATEGY AND LONG-TERM GOALS Our overall goal is to be the preferred business partner to our custom- ers, especially to the world’s leading network operators. In doing so, we strive to be the market and technology leader by offering superior end-to-end solutions mainly related to network infrastructure, network management and other service offerings. I N F O R M AT I O N O N T H E C O M PA N Y 109 We are a major supplier to most of the world’s leading mobile net- work operators and many of the world’s leading fixed-line operators. We believe that our ability to offer end-to-end solutions – systems, ap- plications, services and core handset technology – together with our in-depth knowledge of consumer requirements, make us well posi- tioned to assist network operators with their network development and operations. We are already a market leader in network systems integra- tion and managed services. Through increased activities in profes- sional services and service layer products, we aim for increased sales in these growing segments. Our strategy is to: leadership; • Lead market development through innovation and technological • Leverage our economies of scale to develop superior products and • Utilize operational excellence as a basis for sustainable and best-in- services and thereby offer our customers competitive advantages; 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 tech- nologies that help to establish industry standards. For example, we helped pioneer the development of industry-wide wireless technologies 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 will continue to devote significant resources to developing end- to-end communications solutions that will stimulate network deploy- ments for geographic coverage as well as traffic capacity and thereby drive demand for our products and services. Our expertise and experience in all major telecommunication stan- dards along with our proven track record for quality and innovation have allowed us to develop our business on a global basis. We have signifi- cant sales in all of the largest geographic markets for telecommunica- tions, with no individual country accounting for more than 12 percent of sales. We believe that our global presence and the economies of scale associated with market share leadership give us competitive advan- tages. Global presence is an important factor particularly when working as a business partner to operators working in multiple markets or glob- ally. We are utilizing our strong international presence and core compe- tence in mobile and fixed communications to expand into growth areas such as systems integration, service applications and managed ser- vices. 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 will continue to develop and maintain high levels of com- petence in our employees to secure our leading market position and to stay at the forefront of technological development. 110 BUSINESS OVERVIEW Primary business offerings We supply the network equipment and services that enable telecom- munications. We offer end-to-end solutions for all major mobile com- munication standards. We also provide our customers with services for network operations and revenue generation. Through our Sony Erics- son Mobile Communications joint venture we offer a range of mobile handsets and other mobile devices, including those supporting multi- media applications and other personal communication services. In addition, the Company has products for special applications within microwave (defense) systems, enterprise systems, network technolo- gies (cables), mobile platforms and power modules. For more Information on product offerings, see “Business Seg- ments” Customers We are 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 sig- nificant customers. Out of a customer base of more than 425 network operators, the ten largest customers account for approximately 50 percent of our net sales, while the 20 largest customers account for approximately 64 percent of our net sales. Our largest customer ac- counted for approximately 9 percent of sales during 2005. 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-es- tablished 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/NEC. With re- spect 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 re- gional manufacturers and providers of communication equipment and services. We believe the most important competitive factors in this in- dustry include existing customer relationships, the ability to cost-ef- fectively 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, Accen- ture and electronics manufacturing services companies such as Flex- tronics, 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 de- pending on the product or service being offered. We face significant competition with regard to substantially all of these products and ser- vices. Within the Phones segment, the primary competitors include Nokia, Motorola, Samsung, Siemens (BenQ) plus a number of other companies such as LG Electronics, NEC and Sharp. 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 distinct- ive competitive advantage. 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. Most of our node production, i.e., assembly, integration and testing of modular subsystems into complete system nodes such as radio base stations, mobile switching centers etc., is done in-house. About half of our module production, i.e., production of subsystems such as circuit boards, radio frequency (RF) modules, antennas etc., is outsourced to a group of electronics manufacturing services companies including Elcoteq, Flextronics, Sanmina-SCI and Solectron, of which the vast majority in low-cost countries. We also purchase customized and stan- dardized 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 indi- vidual nodes. We generally attempt to negotiate global supply agree- ments with our primary suppliers. While we are not dependent on any one supplier for the provision of standardized equipment or compo- nents and seek to avoid single source supply situations, a need to swith to an alternative supplier may require us to allocate additional resourc- es to ensure that our technical standards and other requirements are met. This process could take some time to complete. Accordingly, a need to switch to an alternative supplier could potentially have an ad- verse effect on our operations in the short term For more information, see “Risk Factors – Risks Associated with the Industry and Market Conditions”. Seasonality Our quarterly sales, income and cash flows from operations are sea- sonal in nature and generally lower in the first and third quarters of the year and highest in the fourth quarter. This is mainly a result of the seasonal purchase patterns of network operators. Although demon- strating a strong seasonal pattern historically, our seasonal sales vari- ances have not conformed to the longer-term pattern during the market downturn starting in 2001 and subsequent recovery during 2004. The table below illustrates the long-term average seasonal effect on sales for the period 1991 through 2005. 15-YEAR AVERAGE SEASONALITY Sequential Change Share of annual sales First quarter –27% 21% Second quarter 17% 24% Third quarter –5% 23% Fourth quarter 37% 32% Compared to the 15-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 2003, 2004 and 2005. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 MOST RECENT 3-YEAR AVERAGE SEASONALITY Sequential Change Share of annual sales First quarter –24% 21% Second quarter 15% 25% Third quarter –2% 24% Fourth quarter 26% 30% BUSINESS SEGMENTS Ericsson is a telecommunications company developing and selling a variety of products aimed largely at customers in the telecommunica- tions industry. When determining our operating segments, we have looked at which market and to what type of customers our products are aimed, and through what distribution channels they are sold as well as to commonality regarding technology, research and development. To best reflect our business focus and to facilitate comparability with our peers, we consolidate the results of our operations into three busi- ness segments: 1. Systems, consisting of a three-pronged business approach: Mobile Networks, Fixed Networks and Professional Services; 2. Phones, carried out through the 50/50 joint venture with SONY Cor- poration; 3. Other Operations, which comprise a number of smaller businesses including Microwave Systems (Defense), Enterprise Systems, Net- work Technologies (Cables), Mobile Platforms and Power Mod- ules. We group sales into five large geographical segments as shown be- low: 2005 SALES BY REGION AND SEGMENT SEK billion Western Europe CEMA 1) Asia Pacific North America Latin America Total percent share Other Systems Operations 6.2 1.2 1.5 0.7 0.3 9.8 6% 35.7 38.8 29.9 18.8 18.8 142.0 94% Total 41.9 39.9 31.4 19.4 19.1 151.8 100% 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 Consolidated Financial Statements – Note C4, Segment Information.” Segment Systems 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 and service application nodes. We are the market leader with approximately 30 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 the GSM/EDGE/WCDMA or GSM family. Our installed base I N F O R M AT I O N O N T H E C O M PA N Y 111 of GSM radio base stations represents more than one-third of all GSM radio base stations in service globally. Each generation of wireless technology is associated with a group of international standards for wireless communications networks. Tran- sitioning from one generation to the next, such as from 2G to 3G, re- quires 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 multi- media services to mobile broadband is the primary technological shift facing wireless network operators today. Our end-to-end solutions offer operators a smooth network migration to 3G. Our expertise in all 2G standards and our role in developing 3G standards allow us to offer mobile telecommunications systems that incorporate any of the major 2G (GSM, TDMA, CDMA), 2.5G (GPRS) and 3G (EDGE, WCDMA, HSDPA, CDMA2000, TD-SCDMA) mobile technology standards. As a result, we are able to offer tailored solutions to a network operator, regardless of the existing network standard used. 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 mo- bile handsets and the mobile network. A central feature of our 2G GSM radio base stations and base station controllers is their ability to be upgraded on a cost-effective basis to enable 2.5G/GPRS and 3G/EDGE transmissions. Similarly, our WCDMA base stations can be upgraded to HSDPA. Other important elements of radio access networks are the control- lers for radio base stations and radio access network, which manage the traffic between the radio base stations and core networks. In 2G, 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 3G networks, a radio network controller effects call hando- ver 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 upon common platforms. Like our radio base station products, our mobile switching products have industry-leading scalability and capacity. Mobile network equipment and associated network rollout services account for approximately three-quarters of our sales. Fixed Networks We are a supplier of broadband multi-service communications equip- ment and services mainly to fixed network operators in Latin America and Europe. We have a long history in fixed-line networking with an installed base of access and transit lines equivalent to 180 million lines or approximately 10 percent global market share of the installed base. 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. Fixed network operators are moving from single-service networks toward broadband packet-switched multi-service networks that have 112 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 a layered soft- switch service and control architecture, combined with broadband ac- cess and core network routing and transmission elements. Organizing a network into layers isolates the different functions, i.e., access, core network and services and facilitates easier migration to an all-IP envi- ronment. Due to our leadership in “next generation” mobile networks, we are able to leverage our IP-based multimedia subsystem (IMS) de- veloped for 3G networks for “next generation” fixed network applica- tions. IMS is an open service layer platform that hosts IP based ser- vices 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 ac- cess. 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 oth- er applications as well as billing. Professional Services As part of our Global Services business, our professional services portfolio includes expertise in consulting, education, systems integra- tion, managed services, network deployment and optimization and technical support services. Network operators are reducing operating expenses by optimizing the operation and maintenance of their networks. As a result, many network operators are increasingly outsourcing network design, op- erations 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 provide 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. We offer some of the most comprehensive managed services ca- pabilities within the telecom industry. Our offerings cover management of day-to-day operations of a customer’s network, including a managed capacity service for an efficient network build out and on-demand capacity, as well as hosting of applications and content management. Ericsson’s Internet Payment eXchange (IPX) service, which is the glob- al payment and messaging delivery solution for SMS, MMS, Web and WAP that facilitates payment and distribution of content by intercon- necting content providers, media companies, governments and con- sumer brands with operators. 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 lead- ing provider of services to network operators. With over 19,000 dedicated Global Services professionals represent- ed in 140 countries, our services sales (including network rollout) account for almost one-third of our Systems segment net sales. Sales of network rollout services represent approximately 11 percent of our Systems seg- ment net sales and are consolidated within either Mobile Networks or Fixed Networks depending on which type of operator is involved. Segment Phones Phones Sony Ericsson Mobile Communications (Sony Ericsson) delivers in- novative and feature-rich mobile phones, accessories, PC-cards and M2M (machine to machine) solutions, which allow us to provide end-to- end solutions to our customers. The 50/50 joint venture, formed in October 2001, combines the mobile communications expertise of Er- icsson with the consumer electronic devices and content expertise of SONY Corporation and forms an essential part of our end-to-end ca- pability for mobile multimedia services. Sony Ericsson is responsible for product design and development, as well as marketing, sales, distribution and customer services. About one-third of Sony Ericsson’s handsets are produced at their factory in China. The remaining two-thirds of production is more or less equally split between contract manufacturers (EMS) and other device manu- facturers (ODM) at locations in several countries in Asia, Latin America and Europe. Sony Ericsson’s global management is based in London and R&D centers are located in Sweden, Japan, China, the U.S. and the U.K. Sony Ericsson has expanded their in-house production with the aquisition of a controlling stake in Beijing Suohong Electronics Co, Ltd (BSE). Sales for Sony Ericsson are not included in our reported sales, as their operating results are reported according to the equity method under “Share in earnings of joint ventures and associated companies” in the income statement. Segment Other Operations In addition to the areas previously described, Ericsson provide several other business offerings. 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 6 percent of net sales, with no single unit representing more than 2 percent. Ericsson Microwave Systems Microwave Systems provide national security and public safety solu- tions to defense, government and security agencies in Sweden and to more than 20 countries around the world. The unit supplies advanced airborne, terrestrial and marine radar systems, that are integrated with command, control and communication functionality. Manufacturing is centralized in Sweden (Gothenburg). Ericsson Enterprise Enterprise provides communications systems and services that enable businesses, public entities and educational institutions to have seam- less access to applications and services across multiple locations. We address a wide variety of enterprise needs through segmented offerings for both small and large enterprises. We focus on providing solutions for Voice over IP (VoIP) based private branch exchanges (PBX), Wireless Local Area Networks (WLAN), and Mobile Intranet solutions. With Mo- bile Enterprise, users on the move are able to access a range of busi- ness-critical communications and information applications from a va- riety of devices over private or public, fixed or wireless networks. Ericsson Enterprise operates mainly from Sweden but has a global presence through the market units and other partners/distributors. Manufacturing is outsourced. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 Ericsson Network Technologies Our Network Technologies unit (Cables) provides a full range of cable related solutions for telecom and power networks. Ericsson is a leading player in the passive fiber access network field and our expertise in- cludes integration of copper, fiber optic and wireless technologies. A large portion of net sales from our Network Technologies group is attributable to intersegment sales. Manufacturing is carried out in Swe- den (Hudiksvall and Falun) and in China, India and Malaysia. Ericsson Mobile Platforms Ericsson Mobile Platforms is a leading platform supplier for GSM/GPRS, EDGE and WCDMA platforms used in devices such as mobile handsets and PC cards. Through Ericsson Mobile Platforms, Ericsson was one of the first companies in the world to license open-standard end-to-end interoperability tested GSM/GPRS, EDGE and WCDMA technology platforms. The product offerings are based on our comprehensive intel- lectual property portfolio and include: reference designs, platform software, ASIC (application specific integrated circuit) designs and development boards, development and test tools, training, support and documentation. By licensing our technology and platforms, mobile phone manufacturers will be able to launch new products faster, with limited R&D investments and lower technology risks, allowing them to focus on product differentiation in areas such as applications, indus- trial design, manufacturing, distribution and branding - getting ad- vanced and attractive products with short time to market. Ericsson Mobile Platforms has operations at seven global locations, with main operations in Sweden (Lund). During the year, Ericsson Mobile Platforms successfully verified seamless handover between EDGE and WCDMA in live commercial networks, demonstrating key 3G capabilities of both packet data and voice calls. As per December 2005, more than 15 million WCDMA (3G) handsets in the market were based on Ericsson Mobile Platforms’ technology. Ericsson Power Modules Ericsson Power Modules is a leading supplier of direct current DC/DC converters and DC/DC regulators, mainly to the communications in- dustry, for advanced applications such as multiplexors, switches, rout- ers and radio base stations. In addition, the levels of technology, rug- gedness 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 centralized to Shanghai in China. ORGANIZATION Our operational organization is built around a structure of business units responsible for the development and delivery of products and services to market units that are responsible for local sales and cus- tomer support. A number of group functions responsible for estab- lishing of strategies, policies and directives and managing resource allocation, coordination of operations, mergers and acquisitions and 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 I N F O R M AT I O N O N T H E C O M PA N Y 113 daily operations. Governance of our operating units is carried out 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 the Corporate Governance Report or visit our web site http://www. ericsson.com/ericsson/corpinfo/corp_governance/index.shtml. Information on our web site does not form part of this document. Changes in organization and management Some organizational changes were made during 2005, where synergies were found to promote a simpler structure with more efficient opera- tions and fewer organizational layers. The changes include: • A new Market Unit called Greater China was established. Taiwan, previously part of Market Unit North East Asia, was grouped with mainland China, Hong Kong and Macau, which previously made up Market Unit China. • Austria was moved from the Market Area Western Europe to the Market Area Central & Eastern Europe, Middle East and Africa (CEMA). • As per January 2006, Pakistan will be moved from the Market Area Asia Pacific to the Market Area Central & Eastern Europe, Middle East and Africa (CEMA). • Business Unit (BU) Mobile Systems CDMA was streamlined to im- prove efficiency. As a result, the head office in San Diego was closed and operations moved to other Ericsson sites. • The Radio Network Development unit within R&D was split and • As per January 2006, three development units, IP Networks, Core transferred into BU Systems and BU Access respectively. Network Evolution and Service Layer Development, will be trans- ferred to BU Systems and BU Access to bring development closer to the business, improving time to market and ensuring that Erics- son’s products and solutions meet user needs. • As per January 2006, certain assets and staff of Marconi will be acquired and integrated within BU Transmission and Transport Net- works, BU Global Services and BU Systems. During 2005, the following changes in the Group Management Team were made: up the position as market unit head of India and Sri Lanka. • Mats Granryd, previously head of BU Mobile Systems CDMA, took • Hans Vestberg, head of business unit Global Services, was ap- • As per January 2006, Sivert Bergman, head of business unit Trans- pointed executive vice president. mission and Transport, is appointed integration manager for the Marconi acquisition and included in the Group Management Team. For more information about management, please see “Notes to the Consolidated Financial Statements – Note C29, Information Regarding Employees, Members of the Board of Directors and Management”. 114 Business units within the Systems segment Access Our Access business unit’s main role is to continuously strengthen our global leadership in 2G & 3G radio access networks by offering innova- tive and cost-effective products and solutions that provide best-in-class performance. Business unit Access’ responsibility covers a wide spec- trum of activities, from product development to production and supply. Business unit Access is our largest business unit and has manufactur- ing in Sweden (Stockholm, 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. The system offerings include tailored mobile core and fixed network solutions and service layer products. As a key player in the evolution to all-IP networks, we are a leader in the convergence of fixed and mobile networks and services. Business unit Systems has manufacturing in Sweden (Ka- trineholm), Brazil, China and India. Transmission and Transport Networks The Transmission and Transport Networks business unit offers one of the world’s most widely deployed microwave radio system (MINI-LINK) together with metro optical networks in customized and managed trans- port solutions. The products are essential elements of Ericsson’s end- to-end solutions but are also often chosen by operators utilizing other vendors’ network equipment. The unit’s operations include one of the largest microwave production plant in the world in Borås, Sweden, 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 Our Global Services business unit includes both network rollout and professional services. We enable operators to strengthen their com- petitiveness by offering a complete range of advisory, systems integra- tion, managed, hosting and support services as well as network rollout services that address a major part of their network operations. The business unit is represented in 140 countries with 19,000 employees mainly based within the local Market Units. Sales and Marketing We use our own sales organization to market and sell our systems and services to customers in over 140 countries via a worldwide sales and support network consisting of 24 market units. Each market unit rep- resents 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 prod- ucts 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. Our customers have different needs in interacting with Ericsson as a supplier, ranging from support in identifying and capturing business E R I C S S O N A N N U A L R E P O R T 2 0 0 5 opportunities to “do-it-yourself” fulfillment. We use three different sales approaches that acknowledge these different needs; Project Sales (interactive relationship selling with high involvement of the customer to identify and capture business opportunities, where the solution is not known at the point of sales), System Sales (interactive relationship selling of solutions configured for specific customer needs) and Prod- uct Sales (the outcome of relationship sales and frame agreements where customers may call of well-defined products and services elec- tronically). System Sales has historically been our most common sales approach to best meet our customers’ needs, however, as their needs evolve the two other sales approaches will grow in importance. 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 in- clude Microwave Systems (defense), Enterprise, Network Technologies (cables), Mobile Platforms, Power Modules and a few very small units. For more information please see “Business Segments”. 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 A number of Group Functions perform tasks pertaining to certain group- wide matters that are not naturally referable to a specific operational unit: Communications, Finance, Human Resources and Organization, Legal Affairs, Operational Excellence, Research & Development, Sales & Marketing and Strategy & Product Management. Their responsibilities include the formulation of the Group’s strategy, issuing of policies and directives, business control, resource allocation and risk management. In addition, Group Functions are responsible for the consolidation and reporting of financial performance, financing and cash management, legal issues, communication with various stake- holders including employees, investors, press and media as well as coordination and administration of a number of Group-wide issues. Other important Group-wide matters, such as Corporate Responsibil- ity, are managed by Group Functions in conjunction with a network of experts from various parts of the Company. RESEARCH & DEVELOPMENT A robust R&D program is key to our competitiveness and future success. We spent SEK 24.5 billion on R&D and other technical expenses during 2005, which represents over 16 percent of sales. The vast majority of our R&D is invested in product development of which the majority in mobile communications network infrastructure. We have continued to invest in strategically important areas of broadband access, core net- working and service layer. Our R&D organization develops world-class products and performs world-leading research on behalf of the business units. About 16,500 (16,000) employees in 17 (16) countries worldwide are working with R&D in an organization consisting of group functions, development units and the Ericsson Research unit. Ericsson Research conducts applied research in various strategic areas to provide Ericsson with system concepts, technology, and meth- odology 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. For more information regarding product and technology develop- ment, please see “Risk Factors – Strategic and Operational Risks” and “Board of Directors’ Report – Research and Development”. INTELLECTUAL PROPERTY AND LICENSING Through many years of involvement in the development of new tech- nologies, we have built up a considerable portfolio of intellectual prop- erty rights relating to telecommunications technologies, especially mobile communications. As of December 31, 2005, we held over 20,000 (16,000) patents worldwide, including a substantial number of patents essential to the 2G/2.5G standards of GSM, GPRS and CDMA, as well as numerous patents essential to 3G standards, including EDGE, WCD- MA, HSDPA, TD-SCDMA, CDMA2000 and OFDM. We also hold impor- tant patents for many other areas, e.g. Voice over IP (VoIP), ATM, WAP, WLAN, mobile platforms and Bluetooth. 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 for royalty payments and/or access to additional intellectual property rights. In addition, we acquire rights via licenses to utilize intel- lectual 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 Opera- tional Risks”. PROPERTY, PLANT AND EQUIPMENT In 2000 and 2001, we disposed of the majority of the real estate prop- erties that we owned. We believe the properties we now occupy are suitable for our present needs in most locations. As of December 31, 2005, no material 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. Module production is production of subsystems such as circuit boards, radio frequency (RF) modules, antennas etc. How- ever we outsource about half of our systems module production to several electronic manufacturing service (EMS) companies. Most of our node production, i.e., assembly, integration and testing of modular subsystems into complete system nodes such as radio base stations, mobile switching centers etc., is done in-house. We have 14 significant manufacturing and assembly locations worldwide with a total of ap- proximately 290,000 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 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 35–40 (40-45) percent of Systems’ module production and 75–80 (75–80) percent of Systems’ node production is performed in Sweden. We intend to continue to outsource module production where ad- I N F O R M AT I O N O N T H E C O M PA N Y 115 equate 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 chang- es. However, the timing and level of outsourcing is a balance between short-term demand and longer-term flexibility. Therefore, we generally plan to use our own production capabilities to absorb temporary chang- es in volumes. We manage our own production capacity on a global basis by al- locating production to sites where capacity is available and costs are competitive. At year-end 2005, our overall utilization was close to 100 percent as we continuously adjust our production capacity to meet expected demand. The table below summarizes our major manufacturing and assembly facilities as well as the total square meters of floor space at year-end. PRIMARY MANUFACTURING AND ASSEMBLY FACILITIES 2004 2005 2003 Sites Sq Meters Sites Sq Meters Sites Sq Meters 310,000 22,100 9,500 0 341,600 277,415 15,840 15,200 0 308,455 256,615 15,840 15,200 5,364 293,019 10 1 3 0 14 10 1 3 0 14 9 1 3 1 14 Sweden Brazil China India Total During 2005, a new 5,400 square meter facility in Jaipur, India, was started for systems node assembly. During 2005, an approximately 20,000 square meter production facility in Nynäshamn, Sweden, was closed. The production was absorbed by other Swedish sites. Sources and availability of materials We purchase raw materials, electronic components, ready-made prod- ucts and services from a significant number of domestic and foreign suppliers. Variations in market prices for copper, aluminum, steel, sili- con, 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 manu- facturers. Based on our most recent sourcing agreements, the increase in oil and copper prices during 2005 did not have a material impact on our costs or affect 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 moderate increase in market demand, we do not foresee any supply constraints to meet our expected production requirements during 2006. HUMAN RESOURCES We believe that every employee should be treated with 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 Persever- ance. These values form the foundation of how we operate our business. 116 Our core values define how we treat each other, our customers and our business partners and therefore how they define our culture. Charac- teristics of our culture are exhibited by a passion to win; employee di- versity, honesty, trust and support for each other; integrity and high ethical 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. Every year we conduct an employee satisfaction survey to assess our Human Capital Index and employee Empowerment Index. 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 Consolidated Financial Statements – Note C29, 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 2005 Under 25 years old 26-40 years old 41-55 years old Over 55 years old Percent of total Percent Female 469 Male of total 4% 1,652 62% 8,489 26,443 30% 12,871 3,675 4% 1,880 576 100% 76% 24% EMPLOYEES RELATED TO COST OF SALES AND OPERATING EXPENSES Cost of Sales Operating Expenses Total 2005 2004 22,477 19,234 31,300 33,578 56,055 50,534 2003 2002 15,414 18,606 46,015 36,169 64,621 51,583 CORPORATE RESPONSIBILITY Ericsson manages its CR activities through a cross-functional compe- tence network from relevant parts of the organization. This enables us to secure a focus for expertise globally as well as to facilitate coopera- tion across Ericsson. The work of this network is guided by the CR Steering Committee, which was established in 2005. The Chairman of the steering committee reports to the CEO. Ericsson’s approach in the area of CR is two-pronged: • we strive to have the necessary controls in place in order to minimize • we see an opportunity to link our products and services to an over- risk all business goal of sustainable, profitable growth Ericsson supports the UN Global Compact and its ten principles. We continue with our Supplier Code of Conduct program, in close coop- eration with local Ericsson companies. A cross-functional committee oversees our activities in this area. Ericsson is a committed and responsible member of the global society, and as such is committed to supporting the needs of local communities. We have a number of local CR projects that are run by the Ericsson Market Units. Ericsson Response is a global initiative to rapidly provide specialists 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 World Food Programme (WFP), the UN Office for the Coordina- tion of Humanitarian Affairs (OCHA) and the International Federation of Red Cross and Red Crescent Societies (IFRC). 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. It is our policy to comply with environmental requirements and to provide workplaces for employees that are safe, environmentally sound, and that will not adversely affect the health or environment of communities in which we operate. We believe that we are in compliance with environmental, health safety laws and regulations required by our operations and business activities. According to our environmental policy, Ericsson “shall meet or ex- ceed legal and other requirements to protect the environment.” In order to fulfil this statement Ericsson has extensive coverage and follow-up of global environmental legislation. We will be compliant to the EU Directive on the restriction of the use of certain hazardous substances in electrical and electronic equipment (RoHS) as of the required timeline of July 1, 2006. From August 13, 2005, Ericsson complies with the EU WEEE direc- tive on waste of electrical and electronic equipment in all member coun- tries that have implemented the WEEE. A Sustainability Report is published during the second quarter of each year. Please see our web site at www.ericsson.com/about/re- sponsibility.shtml for more information. Information on our web site does not form part of this document. PARENT COMPANY OPERATIONS The business of the Parent company, Telefonaktiebolaget LM Ericsson, consists mainly of corporate management, holding company functions and internal banking activities. Parent company operations also include customer credit management activities performed by Ericsson Credit AB. SUBSIDIARIES AND ASSOCIATED COMPANIES For a listing of our significant subsidiaries, please see Notes to the Parent Company Financial Statements – Note P9, “Investments”. In addition to our joint venture with SONY Corporation, we are en- gaged in a number of other minor joint ventures, cooperative arrange- ments and venture capital initiatives. For more information regarding risks associated with joint ventures, strategic alliances and third party agreements, please see “Risk Factors – Strategic and Operational Risks”. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 I N F O R M AT I O N O N T H E C O M PA N Y 117 FORWARD-LOOKING STATEMENTS electromagnetic fields and cost of radio licenses for our custom- ers; • effectiveness of our strategies and their execution including partner- • financial risks, including foreign exchange rate changes, interest rate ships, acquisitions and divestitures; changes, changes in tax liabilities, credit risks in relation to coun- terparties, customer defaults under significant customer financing arrangements and risks of confiscation of assets in foreign coun- tries; • 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 prod- ucts on time and in sufficient volumes, and risks related to concen- tration 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 re- quired by applicable law or stock exchange regulation. This Annual Report includes “forward-looking statements” about future market conditions, operations and results. Expressions such as “be- lieve”, “expect”, “anticipate”, “intend”, “may”, “could”, “plan” and similar words are intended to help identify forward-looking statements. For- ward-looking statements may be found throughout this document, but in particular in the sections captioned “Operational Review”, “Board of Directors’ Report” and “Information on the Company” and include state- ments regarding: ratings; • our goals, strategies and performance expectations; • the markets we currently or soon intend to address; • our liquidity, capital resources, capital expenditures and our credit • the expected demand for our existing as well as new products and • our joint venture and strategic cooperation activities; • technology and industry trends including competition and our cus- • our plans for new products and services including research and tomer structure, and services; development expenditures. Although we believe that the expectations reflected in such statements are reasonable, we cannot assure you that these expectations will ma- terialize. Because forward-looking statements are based on assump- tions 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 man- ner; • developments in political, economic and regulatory fields in the mar- kets in which we operate, including allegations of health risks from 118 F O R W A R D - L O O K I N G S TAT E M E N T S 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 ef- fects of general global economic conditions as well as conditions unique to a specific country and region. In particular, we are affected by market conditions within the telecommunications industry. We are subject to political, economic and regulatory changes in the various countries in which we operate. We conduct business in more than 140 countries, with a significant proportion of our sales originating from emerging markets in Asia Pa- cific, Latin America, Eastern Europe, the Middle East and Africa. We expect that sales to such emerging markets will be an increasing portion of total sales as developing nations and regions around the world in- crease their investments in telecommunications. We already have ex- tensive 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 coun- tries 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, making demand for our products and services highly unpredictable. Adverse economic conditions could cause network operators to post- pone investments or initiate other cost-cutting initiatives to improve their financial position, which could result in significantly reduced cap- ital expenditures for network infrastructure. Although the historical compounded annual growth rate (CAGR) for telecommunications net- work investments is 2–3 times the growth rate of global GDP, operator spending for network equipment and associated rollout services de- clined substantially during the years 2001–2003, before returning to growth in 2004. During this period , 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 accommodate fluctuations in demand. However, if demand were to fall, or were to be significantly weaker than expected, we may experience E R I C S S O N A N N U A L R E P O R T 2 0 0 5 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 com- munications in terms of both number of subscriptions and usage per subscriber, which in turn requires the continued deployment of our network systems by customers. In particular, we are dependent on operators in highly penetrated markets to successfully introduce ser- vices that cause a substantial increase in usage for both voice and data. In emerging 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 regulations 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 regulations that affect the pricing of new services offered by operators could also affect their ability to invest in network infra- structure, which in turn could affect the sales of our systems and ser- vices. License fees, environmental, health and safety, privacy and other regulation changes may increase costs and restrict operations of net- work operators and service providers. The indirect impact of such changes could affect our business adversely even though the specific regulations may not directly apply to our products or us. 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 10 largest operators representing more than 40 percent of the total market. Network operators have undergone significant consolidation, especially among companies operating in different countries. This trend is expected to continue, while also intra-country consolidation is likely to accelerate as a result of competitive pressure. A market with fewer and larger operators 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. More- over, if the combined companies operate in the same geographic mar- ket, less network equipment and associated services may be required. Another possible consequence of customer consolidation is that it R I S K FA C T O R S 119 Our current and historical operations are subject to a wide range of environmental, health and safety regulations. 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 believe that we are in compli- ance with all material environmental, health and safety laws and regula- tions related to our products, operations and business activities. How- ever, 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, health and safety laws and regulations or to undertake any necessary remediation. It is difficult to reasonably esti- mate 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. 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 which may lead us to revise our estimates and/or strategies. 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 10 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 frame agreements expose us to risks related to agreed future price reductions or penalties. Long-term agreements are typically awarded on a competitive bidding basis. In some cases such agreements also include commitments to future price reductions. In order to maintain gross margin even with lower prices, we continuously strive to reduce the costs of our products through design improvements and other changes in costs related to e.g. component prices, productivity in production, etc. We can not assure you that our cost reduction actions will be sufficient to maintain our gross margin. Frame agreements often also provide for penalties and termination rights in the event of our failure to deliver ordered products on time or if our products do not perform as promised, which may affect our re- sults negatively. 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. 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 competing as end-to-end sup- pliers as well as competitors more specialized in particular areas. Con- solidation may also result in competitors with greater resources, includ- ing technical and engineering resources, than we have. This could have a material adverse effect on our business, operating results, and finan- cial condition. We operate in a highly competitive industry, which is subject to competitive pricing 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 intro- duction of new products and services 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 operat- ing 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. 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 telecommu- nications devices that generate electromagnetic fields expose users to health risks. At present, a substantial number of scientific studies con- ducted 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 Ericsson’s products are designed to comply with all current safety standards and recommendations regarding electromag- netic 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 “Legal and Tax proceedings” in the Board of Directors’ Report . 120 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 re- search 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 stan- dardization bodies and by the industry as a whole. Our sales and earn- ings may suffer if we invest in development of technologies and technol- ogy 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. Please also see section “Research and Development” in the Board of Directors’ Report and 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 other- wise, our ability to develop new products and solutions may be con- strained and this may harm our competitive position in the market. Ad- ditionally, our share of any losses from, or commitments to contribute additional capital to, joint ventures may adversely affect our financial position 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 technologies from other companies 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 assur- ance that the necessary licenses would be available on acceptable terms, or 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 prod- ucts. We cannot be certain that we will be successful in integrating the recently acquired Marconi operations with our existing operations Our success depends in part upon the successful integration of the Marconi operations that we recently acquired. Although we believe that the consummation of the Marconi acquisition will result in significant benefits and synergies, the integration of these operations will also present significant challenges, including: • realizing economies of scale and eliminating duplicative overheads; • integrating internal communications networks, financial systems and and operational systems. E R I C S S O N A N N U A L R E P O R T 2 0 0 5 We cannot assure you, with respect to our recent acquisition of the Marconi assets, that we will realize any anticipated benefits or will suc- cessfully integrate any of the acquired operations with our existing operations. The Marconi operations may not have the disclosure controls and procedures or internal controls over financial reporting that are as thor- ough or effective as those required by U.S security laws for public companies. While we intend to implement appropriate controls and procedures as we integrate the Marconi operations, we cannot provide assurance as to the effectiveness of their disclosure controls and pro- cedures or internal controls over financial reporting until we have fully integrated them. 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 large 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 com- petitive advantages to us. The European Union recently considered placing restrictions on the patentability of software. Although the European Union ultimately re- jected this proposal, we cannot guarantee that they will not revisit this issue in the future. We rely on many software patents, and any limita- tions on the patentability of software may materially affect our busi- ness. We utilize a combination of trade secrets, confidentiality policies, non-disclosure and other contractual arrangements in addition to rely- ing 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 offer only limited protection of our intellectual property rights, if at all. Many key aspects of telecommunications and data network technol- ogy 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 may assert in the future, 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 com- mercially 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. Litiga- tion can be expensive, lengthy and disruptive to normal business op- erations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable resolution of a particular lawsuit could have R I S K FA C T O R S 121 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” in the Board of Direc- tors’ Report. We rely on a limited number of suppliers for the majority of our components and electronic manufacturing services. 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 or 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 employ- ees 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 suc- cessful new products, support our existing product range and provide services to our customers. Competition for skilled personnel and high- ly qualified managers in the telecommunications industry remains in- tense. We are continuously developing our compensation and benefit policies as well as other measures. However, we may not be as suc- cessful at attracting and retaining such highly skilled personnel in the future. As a Swedish company operating globally, we have substantial foreign exchange exposures. With the majority of our cost base being Swedish krona (SEK) de- nominated 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 consoli- dated balance sheet, cash flows and income statement when foreign currencies are exchanged or 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 results. A stronger SEK exchange rate would generally have a negative affect on our competitiveness compared to competitors with costs denomi- nated in other currencies. A significant interruption or other failure of our information technology (IT) operations or communications networks could have a material adverse affect on our operations and results. Our business operations rely on complex IT operations and communi- 122 R I S K FA C T O R S cations networks which are vulnerable to damage or disturbance from a variety of sources. Having outsourced a significant portion of our IT operations, we depend partly on security and reliability measures of external companies. Regardless of protection measures, essentially all IT systems and communications networks are susceptible to disruption from equipment failure, vandalism, computer viruses, security breach- es, natural disasters, power outages and other events. Although we have experienced disruptions from computer viruses, security breach- es, 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. 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 technol- ogy companies in particular, as well as developments from quarter to quarter which impact our financial results. Factors other than our finan- cial 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 com- munications services and equipment; technical problems, in particular those relating to the introduction and viability of new network systems like 3G; potential litigation involving ourselves or the markets in which we operate. Even though we may not be directly involved, announce- ments concerning bankruptcy or other similar reorganization proceed- ings 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 Swedish kronor (SEK) on the Stock- holm Stock Exchange (our primary stock exchange) but on NASDAQ and the London Stock Exchange in local currencies, i.e. USD and GBP, fluctuations in exchange rates between SEK and these 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 SEK, 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 5 SHAREHOLDER INFORMATION The Annual General Meeting of Shareholders will take place at the Globe Arena, entrance from Globentorget, Stockholm, at 3.00 p.m. on Mon- day, April 10, 2006. Only those shareholders, who have been entered into the transcrip- tion of the share register kept by VPC AB (the Swedish Securities Reg- ister Centre) as of April 4, 2006, are entitled to participate in the Meet- ing, provided notice of attendance has been given to the Company. Shareholders, whose shares are registered in the name of a nomi- nee, must be entered temporarily into the share register no later than April 4, 2006, in order to be entitled to participate in the Meeting. The shareholder is requested to inform the nominee well before April 4, 2006, when such registration must have been affected. 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 2006 only. NOTICE OF ATTENDANCE IN THE ANNUAL GENERAL MEETING OF SHAREHOLDERS In addition to the requirements listed above, shareholders shall give notice of attendance no later than at 4 p.m. April 4, 2006, at the Company’s web site www.ericsson.com/investors, at telephone no.: +46 8 775 01 99 between 10 a.m. and 4 p.m., at fax no.: +46 8 775 80 18, or by post to: Telefonaktiebolaget LM Ericsson Group Function Legal Affairs Box 47021 SE–100 74 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 origi- nal, certificates of registration and other documents of authority should be sent to the Company at the address above so as to be available by Friday, April 7, 2006. DIVIDEND The Board of Directors has decided to propose the Annual General Meeting of Shareholders to resolve on a dividend of SEK 0.45 per share for the year 2005 and April 13, 2006 as record day for dividend. July 21, 2006 April 21, 2006 FINANCIAL INFORMATION FROM ERICSSON • Interim report January–March 2006: • Interim report January–June 2006: • Interim report January–September 2006: • Full year report January–December 2006: • Annual report and Form 20-F for the US market 2006: January/February, 2007 October 19, 2006 March, 2007 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: Strömberg Distribution i Huddinge AB SE - 120 88 STOCKHOLM Sweden Phone: +46 8 449 89 57 E-mail: ericsson@strd.se In the United States, Ericsson Transfer Agent Citibank: Citibank Shareholder Services Registered holders: +1 877 881 5969 Interested investors: +1 800 808 8010 E-mail: ericsson@shareholders-online.com www.citibank.com/adr Ordering a hard copy of the Annual Report: http://www.sccorp.com/annualreport/ericsson.htm Phone toll free: +1 866 216 0460 Contact information: Investor Relations for Europe, Middle East, Africa and AsiaPacific: Telefonaktiebolaget LM Ericsson SE-164 83 Stockholm Sweden Telephone: +46 8 719 00 00 E-mail: investor.relations.se@ericsson.com Investor Relations for the Americas: Ericsson The Grace Building 1114 Ave of the Americas, Suite #3410 New York, NY 10036 USA Telephone: +1 212 685 4030 E-mail: investor.relations@ericsson.com S H A R E H O L D E R I N F O R M AT I O N 123 C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 CORPORATE GOVERNANCE REPORT 2005 INTRODUCTION We are committed to meeting high standards of corporate governance within the legal and regulatory frameworks that we are subject to. Our internal rules for ethical behavior and other important rules for business conduct have long since been established for all directors and employ- ees through our group steering policies and directives. We believe our management controls and procedures are generally in line with best practices, although we continuously seek ways to make our corporate governance even more effective and reliable. We need the support and commitment of all our employees in order to continue to adhere to high standards of corporate governance and to maintain Ericsson’s reputation for integrity and good corporate citi- zenship. Professionalism, respect and perseverance are our core val- ues, which define how we treat each other, our customers and our business partners. Our core values are the cornerstones of our ways of working and prerequisites for true market leadership. ERICSSON’S CORE VALUES PROFESSIONALISM through innovation • Listen – lead • Keep commitments • Seek the truth – – be responsive know your numbers RESPECT through a shared vision • Build strength • Qualify everyday • Diversity as a strength – generate energy – provide equal opportunities – shape the future PERSEVERANCE • Lead change • Always deliver • Trusted global – walk the extra mile partner for more than a century! Our Code of Business Ethics and Conduct summarizes the policies and directives which we expect all directors and employees of the Ericsson group to follow. The fundamental purpose of the Code of Business Ethics and Conduct is to reaffirm our commitment to a high level of integrity in the conduct of business. As part of our commitment to meeting high corporate governance standards, we hold corporate gov- ernance workshops for executives. The Code of Business Ethics and Conduct, which has been trans- lated into more than twenty languages and communicated to all em- ployees around the globe, has contributed to a higher awareness of the importance of high ethical standards. All employees are required to periodically review the Code of Busi- ness Ethics and Conduct and must acknowledge that they have under- stood and agree to comply with the principles outlined therein. Our Code of Business Ethics and Conduct satisfies the applicable require- ments of the Sarbanes-Oxley Act of 2002 and NASDAQ. The Code can be found at: www.ericsson.com/ericsson/corpinfo/doc/code_business_ethics.pdf. Information on our website does not form part of this document. We comply with the listing requirements of the stock exchanges we are listed on, that is Stockholm Stock Exchange, the London Stock Ex- change and NASDAQ. We also satisfy the applicable NASDAQ corpo- rate governance requirements, subject to a few exemptions principally reflecting mandatory Swedish legal requirements. These exemptions have been granted by NASDAQ and are explained under “NASDAQ Corporate Governance Exemptions” below. We also comply with the applicable requirements of the Sarbanes-Oxley Act; including the cer- tification of our Annual Report on the SEC’s Form 20-F by the Chief Executive Officer and Chief Financial Officer. The Swedish Code of Corporate Governance Further, Ericsson applies the Swedish Code of Corporate Governance, which is part of the Stockholm Stock Exchange’s listing requirements. To ensure Ericsson’s compliance with the Code, our group steering documents and procedures have been evaluated and adapted to reflect also the requirements of the Code. The Board of Directors has issued an Internal Control Report. In accordance with a statement from the Swedish Corporate Governance Board dated 15 December 2005, the 2005 Internal Control Report has not been examined by the auditors and the report has been limited to describing how the internal controls are organized. Consequently, the report does not include a statement as to the effectiveness of the in- ternal controls regarding the financial reporting. The Company is in the process of implementation of detailed controls, documentation and testing procedures based on the COSO framework for internal control, issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), to ensure compliance with the Sarbanes-Oxley Act, Section 404 as from 2006, and when submitting the report for 2006 it will be possible to make an assessment on a consistent basis in ac- cordance with an established framework. The corporate governance, direction and management of Ericsson is described in this Corporate Governance Report, including informa- tion on how the Code of Corporate Governance has been applied and information on how the Board of Directors ensures the quality of the financial reports and communicates with the Company’s auditors. The auditors have not reviewed Ericsson’s 2005 Corporate Gover- nance Report. C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 1 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 General Meetings of Share- holders. 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. For more information on the shares of Ericsson, please see “Share Information” in the Annual Report. 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 issu- ance. We publish notices to attend Annual and Extraordinary Meetings of Shareholders. In such notices we provide information about the agenda for the meeting as well as information on how to notify us of attendance. In accordance with our Articles of Association, such no- tices are published in Svenska Dagbladet, Dagens Nyheter and Post- och Inrikes Tidningar. Notices are also published at the Company’s website. Under the Swedish Companies Act, resolutions at General Meetings of Shareholders are normally passed by simple majority. However, the Act requires special quorums and majorities in certain cases. 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 di- rectly with the Board of Directors or executive management indepen- dent 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 of Directors, an individual director or any of the management team members. For contact details of the Board of Direc- tors’ Secretariat, please see the Company’s website: www.ericsson. com/ericsson/corpinfo/corp_governance/agm/index.shtml. Informa- tion on our website does not form part of this document. NOMINATION COMMITTEE Members The Nomination Committee, elected by the 2005 Annual General Meet- ing, consists of Björn Svedberg (Chairman of the Committee, Investor), Bengt Belfrage (Nordea Fonder), Christer Elmehagen (AMF Pension), Curt Källströmer (Handelsbankens Pensionsstiftelse, Pensionskassa and Personalstiftelse), and Michael Treschow (Chairman of the Board of Ericsson). The tasks of the Nomination Committee The main task of the Nomination Committee is to propose candidates for election to the Board of Directors including the Chairman and the Deputy Chairmen of the Board, and, where applicable, candidates for election of auditors. In addition, the Nomination Committee is to pro- OUR CORPORATE GOVERNANCE STRUCTURE Shareholders’ Meeting Annual General Meeting/ Extraordinary General Meeting Nomination Committee Unions Board of Directors 9 Directors elected by the Shareholders’ Meeting 3 Directors and 3 Deputies appointed by the Unions External auditors President and CEO Management 2 C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 pose a candidate for election of Chairman of the General Meeting of Shareholders. The Nomination Committee also prepares proposals concerning directors’ fees to directors not employed by Ericsson, audi- tors’ fees and remuneration to the members of the Nomination Com- mittee (if any), which fees are presented at the Annual General Meeting for resolution. The directors’ fees are presented in “Notes to the Con- solidated Financial Statements – Note C29, Information Regarding Employees, Members of the Board of Directors and Management” in the Annual Report. Recommendations to the Nomination Committee may be submitted to the Nomination Committee by e-mail or by postal mail to the ad- dresses indicated at the Company’s website: www.ericsson.com/eric- sson/corpinfo/corp_governance/agm/index.shtml. Information on our website does not form part of this document. The tasks of the Nomination Committee have been resolved by the Annual General Meeting of the shareholders. The 2005 Annual Gen- eral Meeting resolved that the Company should reimburse fair costs reasonably related to the performance of the Nomination Committee’s assignment and that the Nomination Committee should not receive any remuneration. It follows from the Swedish Code of Corporate Governance that, when nominating persons for election to the Board of Directors, the Nomination Committee is to determine whether, in its view, the persons nominated for election are considered to be independent of the com- pany and its senior management as well as of major shareholders in the company. BOARD OF DIRECTORS General According to Ericsson’s 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 elect- ed 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 but is elected for one year at a time. 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 and CEO is charged with the day-to-day management of the Company in accordance with guidelines and instructions pro- vided by the Board of Directors. The President and CEO shall ensure that the Board regularly receives reports regarding the development of the business of the Group, such as the development of the results, fi- nancial position and liquidity as well as information regarding events of importance to the Group. According to the Swedish Companies Act, a member of the Board of Directors and the President and CEO may not participate in decisions regarding agreements between the individual concerned and the Com- pany. Nor may a member of the Board of Directors or the President and CEO participate in decisions regarding agreements between the Com- pany and third parties where the individual concerned has a material interest in the matter, which may conflict with the interests of the Com- pany, or regarding agreements between the Company and a legal en- tity, which the individual concerned may represent, either individually ORGANIZATION OF THE BOARD WORK Audit Committee (4 directors) Board of Directors 12 directors financial reporting • Oversight over • Oversight over • Oversight over internal control auditing Remuneration Committee (4 directors) • Remuneration policy • Incentive programs • Executive compensation Finance Committee (4 directors) • Financing • Investing • Customer credits C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 3 or together with any other person. Further, the Audit Committee has 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 Direc- tors of the Board elected by the Annual General Meeting who are not employees of the Company. Work of the Board of Directors The Board schedules at least six meetings each year and in 2005, twelve Board meetings were held. With very few exceptions, the Directors participate in all of the Board of Directors’ meetings and are, to the extent possible, also present at the General Meetings of Shareholders. The Directors’ attendance at Board of Directors’ meetings and Com- mittee meetings during 2005 is reflected in the table “Directors’ at- tendance.” Training sessions are scheduled on a revolving basis, normally twice a year, in order to enhance the Directors’ knowledge of the operations of the Group. In addition, specific training sessions are scheduled if and when appropriate and in particular for newly elected Directors. The training session in October 2005 mainly covered sales, processes and procedures including pricing. Certain matters addressed by the Board during 2005 include: • Continued focus on development of operational excellence. • Resolution to enter into an agreement with Marconi Corporation plc to acquire strategic parts of Marconi’s telecommunications busi- ness. • Three Board Meetings have been dedicated to strategy discussions, including discussion on development of “next generation” con- verged networks. • Resolution to acquire Axxessit AsA and Netspira Networks, S.L. to • Intellectual property strategy. expand the product portfolio. COSO framework. • Capital structure strategy. • Enhancement of enterprise risk management model based on the • Corporate governance, including adoption and implementation of • Optimization of production resources. • Large managed service contracts in Europe. various corporate governance rules applicable to the Company. The Board and its Audit Committee meet with the external auditors on a regular basis. The Board normally meets with the auditors twice a year and at least once without the President and CEO or any other person from management being present. The Audit Committee meets with the auditors at the Audit Committee meetings. During 2005, the auditors were represented at all Audit Committee meetings, except for one meeting per capsulam regarding approval of a related party trans- action. The auditors present their observations from the audit of the annual report as well as their reviews of interim reports and internal controls. Work Procedure The Board of Directors has established its work procedure in accor- dance with the requirements of the Swedish Companies Act. Through the work procedure, the Board designates how various tasks will be distributed among the Board and its Committees as well as between the Board, its Committees and the President and CEO. The work pro- cedure is reviewed, evaluated 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 mat- ters 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 spe- cific matters. The Board of Directors as well as each of the Committees DIRECTORS’ ATTENDANCE Michael Treschow Arne Mårtensson Marcus Wallenberg Peter L. Bonfield Sverker Martin-Löf Eckhard Pfeiffer Nancy McKinstry Carl-Henric Svanberg Ulf J. Johansson Lena Torell Jan Hedlund Per Lindh Torbjörn Nyman Monica Bergström Anna Guldstrand Arne Löfving 4 Board meetings Possible 12 12 12 12 12 12 12 12 8 4 12 12 12 12 12 12 Attended 12 12 12 12 12 12 11 12 8 4 12 12 12 12 11 12 Audit Committee meetings Possible Attended – – – – – – 8 8 8 8 8 7 – – – – – – – – 8 8 – – – – – – – – – – Finance Committee meetings Possible Attended 13 13 13 13 13 13 – – – – – – – – – – – – – – – – – – 13 13 – – – – – – Remuneration Committee meetings Possible Attended 8 8 – – – – – – – – – – 8 7 – – 6 6 2 2 – – 8 8 – – – – – – – – C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 have the right to engage external expertise in general or in respect of specific matters, if and to the extent required or deemed appropriate. Committees of the Board The Board of Directors has established three Committees, i.e. the Audit, the Finance and the Remuneration Committees. The Board appoints Committee members from among its members. The Audit Committee General The Audit Committee assists the Board in monitoring the integrity of the financial statements, the compliance with legal and regulatory re- quirements, the qualification, independence and performance of our external auditors and the effectiveness of our systems of internal con- trols 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 mat- ters arising during the course of reviews and audits. However, the Audit Committee itself does not perform audit work. The Company has an internal audit function, which reports to the Audit Committee and per- forms independent audits. Pursuant to the Board’s work procedure, the Audit Committee re- views the audited financial statements with management and the ex- ternal auditors, including conformity with generally accepted account- ing principles. The Audit Committee also reviews with management the reasonableness of significant estimates and judgments made in prepar- ing the financial statements, as well as the quality of the disclosures in the financial statements. In addition, the Audit Committee reviews mat- ters arising from reviews and audits performed. The Audit Committee has implemented approval procedures for audit and other services performed by the external auditors in order to safeguard the auditors’ independence from the management and the Company. Further details about these procedures are provided under “Audit Committee Pre-ap- proval Policies and Procedures.” In addition, the Audit Committee has implemented a pre-approval process for transactions with related parties and a procedure for the reporting of suspected violations, for example violations in relation to accounting, internal accounting controls and auditing matters; a so called whistle-blower procedure. Ericsson’s Group Security and Risk Management function reviews and investigates reported suspected violations and, when necessary, the reported suspected violations are investigated together with the relevant Group Function. The Group Security and Risk Management function summarizes suspected viola- tions in reports including information on the relevant matter, the mea- sures taken with respect to the matter, the responsible Group Function and information on current status. The reports are presented at each regular Audit Committee meeting. The Audit Committee has appointed an external expert advisor, Mr. Peter Markborn, to assist and advise the Committee. Members of the Audit Committee The Audit Committee consists of four members appointed by the Board from among its members. Membership during 2005 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 ac- counting practices of an international company comparable to Ericsson. At least one member must be an audit committee financial expert. The Board of Directors has determined that each of Sverker Martin-Löf, Sir Peter L. Bonfield and Eckhard Pfeiffer satisfy these requirements. The work of the Audit Committee The Audit Committee held eight meetings during 2005 and the Directors’ attendance at the meetings is reflected in the table “Directors’ atten- dance.” The work of the Audit Committee during the year included re- view of financial reports, 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 recent conversion to IFRS reporting as from January 1, 2005. The Audit 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 of 2002 and the Swedish Code of Corporate Governance and the Company’s implementation of the said rules and regulations. Certain services other than audits have been approved by the Audit Committee under the pre-approval policies and procedures. Further, the Audit Committee has approved certain related-party transactions in accordance with the pre-approval process implemented by the Committee. The Finance Committee General The Finance Committee is primarily responsible for handling matters regarding acquisitions and divestments, capital contributions to com- panies inside and outside the Ericsson group, raising of loans, issu- ances of guarantees and similar undertakings and approvals of financ- ing support to customers, as well as continuously monitoring the group’s financial risk exposure. The Finance Committee has been au- thorized by the Board of Directors to decide, with power to delegate power to decide, on certain matters of the Board including direct or indirect financing, provision of credits and the granting of security and guarantees and certain investments, divestments and financial com- mitments. Members of the Finance Committee The Finance Committee consists of four members appointed by the Board from among its members. Membership during 2005 included Marcus Wallenberg (Chairman of the Committee), Arne Mårtensson, Torbjörn Nyman and Michael Treschow. Work of the Finance Committee The Finance Committee held thirteen meetings during the year and the Directors’ attendance at the meetings is reflected in the table “Direc- tors’ attendance.” The Committee resolved issues regarding customer financing, guarantees, credit facility arrangements, conditional share- holders’ contributions, acquisitions and divestments. After authoriza- tion from the Board, the Committee resolved to appoint Hans Ragne- malm member of the Board of Trustees of the Company’s Pension Trust. The Finance Committee also monitored the financial risk exposure and risk limits and reviewed the reporting to the Committee in this re- spect. C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 5 The Remuneration Committee General The Remuneration Committee is primarily responsible for reviewing and preparing for resolution by the Board of Directors proposals on salary and other remuneration, including retirement compensation, to the President and CEO. The Remuneration Committee has been given authority to approve proposals on salary and other remuneration, in- cluding retirement compensation for the Executive Vice Presidents and other managers reporting directly to the President and CEO. In addition, the Committee is responsible for strategies and gen- eral guidelines with respect to employee compensation, including in- centive plans and retirement compensation. At the beginning of each year, the Committee approves any variable pay to be made from the previous year’s plan and prepares for resolu- tion by the Board any long-term incentive plan prior to being presented at a meeting of shareholders. During the year, the Committee meets for a strategic 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 during the fall of 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 Remu- neration Committee also prepares for resolution by the Board the tar- gets for variable pay for the following year. Members of the Remuneration Committee The Remuneration Committee consists of four members appointed by the Board from among its members. Membership during 2005 includ- ed Michael Treschow (Chairman of the Committee), Nancy McKinstry, Per Lindh, Lena Torell and Ulf J. Johansson. Ulf J. Johansson has been a member since the Annual General Meeting 2005 when he replaced Lena Torell, who was a member of the Remuneration Committee until the Annual General Meeting 2005. Work of the Remuneration Committee The Remuneration Committee held eight meetings during 2005 and the Directors’ attendance at the meetings is reflected in the table “Directors’ attendance.” The Committee reviewed and prepared for the Board a proposal for a long-term incentive plan, which was resolved by the 2005 Annual General Meeting. The Committee approved a structure for vari- able pay for the Group Management Team and the Extended Manage- ment Team. The Committee has assigned an independent remuneration expert, Mr. Gerrit Aronson, to help in obtaining an independent opinion and advice on remuneration issues, including the pension benefits of the President and CEO. The Committee also approved proposals for salaries and incentive pay for 2005. For further information on compen- sation, fixed and variable pay, please see “Notes to the Consolidated Financial Statements – Note C29, Information Regarding Employees, Members of the Board of Directors and Management” in the Annual Report. 6 Remuneration of the Board In accordance with the proposal of the Nomination Committee, the Annual General Meeting of shareholders resolved on April 6, 2005, that the directors’ fees should total SEK 8.8 million and that the directors’ fees should be distributed among the members of the Board elected by the Annual General Meeting who are not employees of the Com- pany as follows: • The Chairman SEK 3 million; • The Deputy Chairmen and the other Directors SEK 600,000 each; • The Chairman of the Audit Committee SEK 350,000 and the other • The members of the Finance Committee and the Remuneration Audit Committee members SEK 250,000 each; Committee SEK 125,000 each. Review/self-evaluation The Chairman of the Board is responsible for annually initiating and leading a thorough evaluation of the Board work and the Board proce- dure. The evaluation process may include written questionnaires, as well as interviews and discussions. During 2005, the Chairman of the Board had individual discussions with each Member of the Board of Directors regarding the work procedure and the evaluation of the Board work. In addition, all Directors have answered a written questionnaire. The Chairman and the President and CEO are not present when their respective performance is evaluated. MEMBERS OF THE BOARD Our Board of Directors consists of nine Directors elected by the share- holders 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 Chair- man of the Board is elected by the Annual General Meeting. The Pres- ident and CEO of the Company may be elected director, as is the case at present. However, the Swedish Companies Act prohibits the Presi- dent of a public company to be elected Chairman of the Board. Michael Treschow, Director (since 2002) Chairman of the Board of Directors. Chairman of the Remuneration Committee and member of the Finance Committee and the Nomination Committee. Chairman of the Confederation of Swedish Enterprise and Chairman of the Board of Directors of AB Electrolux. Member of the Board of Directors of ABB Ltd and B-Business Partners. Member of the Royal Academy of Engineering Sciences. Master of Science degree from the Institute of Technology in Lund, Sweden. Prior to his position as Chairman of the Board of Directors, Michael Treschow was the President and CEO of the Electrolux Group, a position to which he was appointed in 1997. Before joining Electrolux, Michael Treschow was President and CEO of Atlas Copco AB. Earlier positions mainly include positions with Atlas Copco. Arne Mårtensson, Director (since 2003) Deputy Chairman of the Board of Directors and member of the Finance Committee. Chairman of the Advisory Board of Stockholm School of Economics and Chairman of the Board of Directors of Svenska Handelsbanken. Member of the Board of Directors of Holmen, Industrivärden, Sandvik, C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 Skanska and V&S Vin & Sprit. Member of the International Business Council of the World Economic Forum. Econ Dr. h c. Graduate from Stockholm School of Economics and PMD, Harvard Business School, USA. Arne Mårtensson has previously been President and Group Chief Executive of Svenska Handelsbanken and Executive Vice President and head of Svenska Handelsbanken, Regional Unit Western Sweden. Earlier positions include positions with Handelsbanken. Arne Mårtensson has declined re-election at the Annual General Meeting 2006. Marcus Wallenberg, Director (since 1996) Deputy Chairman of the Board of Directors and Chairman of the Finance Committee. Chairman of the Board of Directors of Skandinaviska Enskilda Bank- en. Deputy Chairman of the Board of ICC (International Chamber of Commerce) and Saab. Member of the Board of Directors of AstraZen- eca PLC, AB Electrolux, Stora Enso Oy and the Knut and Alice Wal- lenberg Foundation. Bachelor of Science of Foreign Service degree from Georgetown University, Washington D.C., USA. In 1993 Marcus Wallenberg was employed by Investor AB as Ex- ecutive Vice President and he was the President and CEO of the com- pany between 1999 and 2005. Before joining Investor AB, Marcus Wallenberg was a Director of Stora Feldmühle AG. Earlier positions include positions with Skandinaviska Enskilda Banken, Citicorp and Citibank. Inc., Sony Corporation and T.S.M.C. Member of the International Advi- sory Group of Citigroup and of the International Advisory Panel, Uni- versity of London. Non-Executive Director of Actis Capital LLP and HMG Department for Constitutional Affairs. Senior Executive Advisor of Permira. Trustee of Cutty Sark Trust. Honors degree in Engineering from Loughborough University, Leicestershire, UK. From 1996 to 2002, Sir Peter L. Bonfield was CEO and Chairman of the Executive Committee of British Telecommunications plc. Before assuming this position, Sir Peter L. Bonfield was Chairman and CEO of ICL plc. Earlier positions include positions with STC plc and Texas In- struments Inc. Sverker Martin-Löf, Director (since 1993) Chairman of the Audit Committee. Chairman of the Board of Directors of Skanska, Svenska Cellulosa Aktiebolaget SCA and SSAB. Vice Chairman of the Board of Directors of Industrivärden. Member of the Board of Directors of the Confedera- tion of Swedish Enterprise and Svenska Handelsbanken. Doctor of Technology and Master of Engineering degree from the Royal Institute of Technology, Stockholm, Sweden. Honorary Doctor at Mid-Sweden University, Sweden. Sverker Martin-Löf was employed by Svenska Cellulosa Aktiebo- laget SCA from 1977 to 1983 and again from 1986 to 2002. From 1990 to 2002, Sverker Martin-Löf was the President and CEO of Svenska Cellulosa Aktiebolaget SCA. Earlier positions include positions with Sunds Defibrator and Mo och Domsjö AB. Sir Peter L. Bonfield, CBE, FREng, Director (since 2002) Member of the Audit Committee. Eckhard Pfeiffer, Director (since 2000) Member of the Audit Committee. Vice Chairman of the Board of the British Quality Foundation. Mem- ber of the Board of Directors of AstraZeneca PLC, Mentor Graphics Chairman of the Board of Directors of Accoona Corporation. Mem- ber of the Board of Directors of General Motors Corporation and Syntek BOARD OF DIRECTORS Name Michael Treschow Arne Mårtensson 1) Marcus Wallenberg Peter L. Bonfield Sverker Martin-Löf 1) Eckhard Pfeiffer Nancy McKinstry Carl-Henric Svanberg Ulf J. Johansson Jan Hedlund Per Lindh Torbjörn Nyman Monica Bergström Anna Guldstrand Arne Löfving Member since 2002 2003 1996 2002 1993 2000 2004 2003 2005 1994 1995 2004 1998 2004 2003 Age 62 54 49 61 62 64 46 53 60 59 48 44 44 41 52 Number of Number of Position Class A shares Class B shares 2) Options 3) 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 – – – – – – – – – – – – – – – 820,000 13,400 704,000 – 52,000 30,400 – 15,635,599 2,176 1,497 203 7,612 2,848 3,986 6,031 – – – – – – – – – – – – – 900 – 1) Arne Mårtensson and Sverker Martin-Löf are also Directors of Industrivärden. Industrivärden is one of Ericsson’s largest shareholders, based on voting rights. 2) In accordance with the Code of Corporate Governance, the number of Class B shares includes holding by related natural and legal persons. Details available at www.fi.se. 3) Number of Class B shares assuming full exercise of options under applicable plan (including holding of options by related natural and legal persons in accordance with the Code of Corporate Governance). C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 7 Capital AG. Board Advisor to Hitachi Data Systems. Member of the Advisory Board of Deutsche Bank and the Advisory Council of Univer- sity of Houston College of Natural Sciences and Mathematics. Master of Business Administration (MBA) degree from Southern Methodist University, Dallas, Texas, USA. Honorary Doctor of Engineer- ing degree from the Stevens Institute of Technology, New Jersey, USA. Eckhard Pfeiffer was President and CEO of Compaq Computer Cor- poration from 1991 to 1999. Prior to this, Eckhard Pfeiffer held other management positions with Compaq. Before joining Compaq in 1983 he spent nineteen years with Texas Instruments. Nancy McKinstry, Director (since 2004) Member of the Remuneration Committee. CEO and Chairman of the Executive Board of Wolters Kluwer n.v. Member of the Board of Directors of MortgageIT, Inc. Member of the Advisory Council of ABN AMRO Holding n.v. and the Advisory Council of the University of Rhode Island. Member of the Board of Directors of the American Chamber of Commerce in the Netherlands and Tias Busi- ness School. Master of Business Administration (MBA) degree in Finance and Marketing from Columbia University, New York, USA, and a bachelor’s degree (BA) in Economics from the University of Rhode Island, Kingston, Rhode Island. Currently Nancy McKinstry is CEO and Chairman of the Executive Board of Wolters Kluwer n.v. From 2000 to 2003, Nancy McKinstry was President and CEO of Legal, Tax and Business, North America, Wolters Kluwer n.v. and a member of the Executive Board. In 1999–2000 Nan- cy McKinstry was CEO and President of SCP Communications. Prior to this she was President and CEO of CCH Legal Information Services from 1996 to 1999. Earlier positions include positions with CCH Incor- porated, Booz, Allen & Hamilton and New England Telephone Com- pany. Carl-Henric Svanberg, Director (since 2003) President and CEO of Telefonaktiebolaget LM Ericsson and member of the Board of Directors. Member of the Board of Directors of Assa Abloy, the Confederation of Swedish Enterprise and Hexagon. Master of Science degree from Linköping Institute of Technology, Sweden, and Bachelor of Science degree in Business Administration from Uppsala University, Sweden. Prior to assuming his position at Ericsson, Carl-Henric Svanberg was the President and CEO of the Assa Abloy Group. Ulf J. Johansson, Director (since 2005) Member of the Remuneration Committee. Chairman of the Board of Directors of AcandoFrontec AB, Eurostep Group AB, Novo A/S and Novo Nordisk Foundation. Member of the Board of Directors of Trimble Navigation Ltd. Member of the Royal Swedish Academy of Engineering Sciences. Doctor of Technology and Master of Science in Electrical Engineer- ing from the Royal Institute of Technology, Stockholm, Sweden. Ulf J. Johansson is a founder of Europolitan Vodafone AB where he was the Chairman of the Board between 1990 and 2005. Earlier posi- tions include President and CEO of Spectra-Physics and Executive Vice President of Ericsson Radio System AB. 8 Jan Hedlund, Director (since 1994) Member of the Audit Committee. Employee representative. Appointed by the union Svenska Metallindustriarbetareförbundet. Per Lindh, Director (since 1995) Member of the Remuneration Committee. Employee representative. Appointed by the union Sif. Torbjörn Nyman, Director (since 2004) Member of the Finance Committee. Employee representative. Appointed by the union CF. Monica Bergström, Deputy Director (since 1998) Employee representative. Appointed by the union Sif. Anna Guldstrand, Deputy Director (since 2004) Employee Representative Appointed by the union CF. Arne Löfving, Deputy Director (since 2003) Employee representative. Appointed by the union Svenska Metallindustriarbetareförbundet of which he is Deputy Chairman of the Gothenburg division. Arne Löfving is em ployee representative of the Board of Ericsson Microwave Sys- tems. At the Annual General Meeting on April 6, 2005, Ulf J. Johansson re- placed Lena Torell as member of the Board. Lena Torell had been a member of the Board since 2002. Carl-Henric Svanberg is the only Director who holds an operational management position at Ericsson. No Director has been elected pursu- ant to an arrangement or understanding with any major shareholder, customer, supplier or other person. COMPANY MANAGEMENT Operational Units Our operations are carried out in three business segments; Systems, Phones and Other operations. The largest segment, Systems, is orga- nized in business units that are responsible for the provision of products and services, and market units that are responsible for marketing, sales, and customer support. For more information regarding our business segments, please see “Information on the Company” in the Annual Report. A significant amount of authority and responsibility for tasks pertaining to daily operations is assigned to the management of our various operating units. Governance of our operating units is carried out by steering committees, with members who 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 perform tasks pertaining to certain group- wide matters that are not naturally referable to a specific operational unit: Communications, Finance, Human Resources and Organization, Legal Affairs, Operational Excellence, Research & Development, Sales & Marketing and Strategy & Product Management. C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 Their responsibilities include the formulation of the Group’s strategy, issuing of policies and directives, business control, resource allocation and risk management. In addition, Group Functions are responsible for the consolidation and reporting of financial performance, financing and cash management, legal issues, communication with various stake- holders including employees, investors, press and media as well as coordination and administration of a number of Group-wide issues. Other important Group-wide matters, such as Corporate Responsibil- ity, are managed by Group Functions in conjunction with a network of experts from various parts of the Company. The President and Chief Executive Officer – Operational Management The Board of Directors appoints the President and CEO and the Ex- ecutive Vice Presidents. Management of day-to-day operations is the responsibility of the President and CEO and the Group Management Team consisting of, apart from the President and CEO, the Chief Finan- cial Officer, the Chief Technology Officer and head of Research & De- velopment, the heads of Group Functions and the heads of Business Units Access, Systems, Global Services and Transmission and Trans- port Networks. Compensation policies, other terms of employment for senior man- agement and outstanding incentive schemes for senior management are described in “Notes to the Consolidated Financial Statements – Note C29, Information Regarding Employees, Members of the Board of Directors and Management” in the Annual Report. Carl-Henric Svanberg President and CEO and member of the Board of Directors (since April 2003). Member of the Board of Directors of Assa Abloy, the Confederation of Swedish Enterprise and Hexagon. Master of Science degree from Linköping Institute of Technology, Sweden, and Bachelor of Science degree in Business Administration from Upp sala University, Sweden. Prior to assuming his position at Ericsson, Carl-Henric Svanberg was the President and CEO of the Assa Abloy Group. Karl-Henrik Sundström Executive Vice President and Chief Financial Officer and head of Group Function Finance (since April 2003). Bachelor degree in Finance from Uppsala University, Sweden, and Advanced Management Program, Harvard Business School, USA. Prior to assuming his position as above, Karl-Henrik Sundström was head of Business Unit Global Services. GROUP MANAGEMENT TEAM Name Carl-Henric Svanberg Karl-Henrik Sundström Appointed year 2003 2003 Age 53 45 Kurt Jofs 2004 47 Bert Nordberg 2004 49 Björn Olsson 2004 49 Carl Olof Blomqvist 1999 54 Joakim Westh 2004 44 Marita Hellberg 2003 50 Torbjörn Nilsson 1998 52 Henry Sténson Håkan Eriksson 2002 2004 50 44 Hans Vestberg 2005 40 Sivert Bergman 2006 59 Position 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 General Counsel and Head of Group Function Legal Affairs Head of Group Function Operational Excellence Head of Group Function Human Resources & Organization Head of Group Function Strategy & Product Management Head of Group Function Communications Chief Technology Officer and Head of Research & Development Executive Vice President and Head of Business Unit Global Services Head of Business Unit Transmission & Transport Networks Number of Class A shares – Number of Class B shares 15,635,599 1) – – – – 20,472 216,714 31,794 24,298 6,080 28,633 – – – – – – – 107,941 35,755 62,127 19,533 11,313 20,241 4,825 Options and matching rights are reported in Notes to the Consolidated Financial Statements – Note C29, Information Regarding Employees, Members of the Board of Directors and Management in the Annual Report. 1) In accordance with the Code of Corporate Governance, the number of Class B shares includes holding by related natural and legal persons. Details available at www.fi.se. C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 9 Kurt Jofs Executive Vice President and head of Business Unit Access (since January 2004). Board member of ATEA and Chairman of the Board of Peoples Travel Group. Master of Science degree, Royal Institute of Technology in Stock- holm, Sweden. Prior to assuming his position as above, Kurt Jofs has held senior management positions in, among others, Linjebuss and ABB Ventilation Products. Bert Nordberg Executive Vice President and head of Group Function Sales & Market- ing (since January 2004). Bachelor degree in Electronic Engineering, Malmö, Sweden, and Engineer in the Marines, Berga, Sweden, and university courses in International Management, Marketing and Finance, Insead University, France. Prior to assuming his position as above, Bert Nordberg was head of Business Unit Systems. Prior to assuming his position as above, Torbjörn Nilsson was head of Group Function Marketing & Strategic Business Development. Henry Sténson Senior Vice President and head of Group Function Communications (since May 2002). Studied law, sociology and political science, Linköping University, Sweden, and at the Swedish War Academy, Karlberg, Stockholm, Swe- den. Prior to assuming his position as above, Henry Sténson was head of SAS Group Communication, SAS AB. Hans Vestberg Executive Vice President and head of Business Unit Global Services (since February 2005). Bachelor of Business Administration degree, University of Uppsala, Sweden. Prior to assuming his position as above, Hans Vestberg was Senior Vice President and head of Business Unit Global Services (since Janu- ary 2004) and prior to assuming that position, Hans Vestberg was head of Market Unit Mexico. Björn Olsson Executive Vice President and head of Business Unit Systems (since January 2004). Master of Science degree in Industrial Engineering and Manage- Joakim Westh Senior Vice President and head of Group Function Operational Excel- lence (since December 2004). ment, Linköping Institute of Technology, Sweden. Chairman of the Board of Directors of Absolent AB and member of Prior to assuming his position as above, Björn Olsson was Chief the Board of Directors of VKR Holding A/S. Information Officer. Carl Olof Blomqvist Senior Vice President, general counsel and head of Group Function Legal Affairs (since May 1999). Master of Laws, LLM, University of Uppsala, Sweden. Prior to assuming his position as above, Carl Olof Blomqvist was a partner of Mannheimer Swartling law firm. Håkan Eriksson Senior Vice President and Chief Technology Officer and head of Group Function Research & Development (since January 2004). Master of Science degree in Electrical Engineering, Linköping Insti- tute of Technology, Sweden. Prior to assuming his position as above, Håkan Eriksson was Vice President and head of Research & Development. Marita Hellberg Senior Vice President and head of Group Function Human Resources & Organization (since September 2003). Bachelor degree in Social Studies, University of Stockholm, Sweden, and Advanced Management Program, Cedep, France. Master of Science degree, Royal Institute of Technology, Stockholm, Sweden, and Master of Science degree within Aeronautics & Astronau- tics, MIT, Boston, USA. Prior to assuming his position as above, Joakim Westh was head of J. Westh Företagsutveckling AB and before that, Joakim Westh held various senior management positions within Assa Abloy. Sivert Bergman Senior Vice President (since January 1, 2006) and head of Business Unit Transmission and Transport Networks (since 2002). Bachelor degree of electric engineering complemented with studies in mathematics, Trollhättan, Sweden. Prior to assuming his position in 2002, Sivert Bergman was Re- search and Development Manager for transmission activities and head of Business Unit Transmission Solutions. During 2005, the officer below was also a member of the Group Man- agement Team of the Company: Mats Granryd Former Senior Vice President and head of Business Unit Mobile Sys- tems CDMA, Prior to assuming her position as above, Marita Hellberg was Senior Since July 18, 2005 Vice President and head of Market Unit India & Vice President of Human Resources of NCC Group. Sri Lanka and member of the Extended Management Team. Torbjörn Nilsson Senior Vice President (since October 1998) and head of Group Function Strategy & Product Management. Master of Science degree, Lund’s University, Sweden, and Master of Business Administration, University of Stockholm, Sweden. 10 C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 planning, scope and content of the annual audit. The auditors then examine the year-end financial statements and report findings, includ- ing an assessment of the accuracy and completeness of the accounts as well as adherence to appropriate accounting procedures and prin- ciples. In addition, the auditors, at least annually, provide information to the Board about assignments performed in addition to auditing ser- vices, the consideration paid for such services and other circumstanc- es of relevance for determining the auditor’s independence. For further information on the contacts between the Board and the auditors, please see “Work of the Board of Directors” above. All our quarterly reports are subject to review by our auditors. Statutory auditors Peter Clemedtson Authorized Public Accountant, PricewaterhouseCoopers. Elected 2004 (as successor for the remaining mandate period of Carl-Eric Bohlin) until 2007. Audit services performed in other large companies such as: Elec- trolux, KMT, Medivir, OMX, SEB, SinterCast. Bo Hjalmarsson Authorized Public Accountant, PricewaterhouseCoopers. Elected 2003 until 2007. Audit services performed in other large companies such as: portfo- lio companies to EQT, OMX, Sony Ericsson. Thomas Thiel Authorized Public Accountant, KPMG. Elected 2003 until 2007. Audit services performed in other large companies such as: Folksam, Handelsbanken, Holmen, Peab, Ratos, SKF, Swedish Match. In addition to the Group Management Team, there is an Extended Management Team consisting of the officers of the Group Management Team and: Asia; rope; Lanka; Europe; global customer account executive Telecom Italia; Eastern Europe, Middle East & Africa (CEMA) regions; • Cesare Avenía, Vice President and head of Market Unit Italy and • Rory Buckley, Vice President and head of Market Unit North East • Ragnar Bäck, Chairman of the Market Units within the Central and • Jan Campbell, Vice President and head of Market Unit Central Eu- • Sandeep Chennakeshu, President Ericsson Mobile Platforms AB; • Mats Granryd, Vice President and head of Market Unit India & Sri • Jef Keustermans, Vice President and head of Market Unit Northern • Kinson Loo, Vice President and global customer account executive • Ingemar Naeve, Vice President and head of Market Unit Iberia and • Anders Olin, Vice President and global customer account executive • Mats Olsson, Vice President and head of Market Unit Greater Chi- • Torbjörn Possne, Vice President and global customer account exec- • Angel Ruiz, Vice President and head of Market Unit North Ameri- • Jan Signell, Vice President and head of Market Unit South East Asia; • Gerhard Weise, Vice President and head of Market Unit Mexico. global customer account executive Telefónica; utive Deutsche Telekom; Hutchison; Vodafone; and na; ca; During 2005, the officers below were also members of the Extended Management Team of the Company: Deputy auditors Jeanette Skoglund Authorized Public Accountant, PricewaterhouseCoopers. Kristian Teär Former Vice President and head of Market Unit South East Asia. Elected 2003 until 2007. Audit services performed in several large subsidiaries of global com- Kristian Teär left the company on June 1, 2005. panies such as TDC Song. Mats Dahlin Former Vice President and head of Business Unit Enterprise. Robert Barnden Authorized Public Accountant, PricewaterhouseCoopers. Mats Dahlin left the company on April 30, 2005. Elected 2004 (as successor for the remaining mandate period of 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 under- standing with any major shareholder, customer, supplier or other per- son. 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’ Meet- ings. To ensure that the Board of Directors’ information and control re- quirements are fulfilled, the auditors report to the Board regarding the Peter Clemedtson) until 2007. Audit services performed in other large companies such as: Acando- Frontec, Nobia, SCA, Seco Tools, VSM Group. Stefan Holmström Authorized Public Accountant, KPMG. Elected 2003 until 2007. Audit services performed in other large companies such as: Atlas Copco, Länsförsäkringar, Posten, Swedish Meat, V&S Vin & Sprit. Fees paid to external auditors Ericsson paid the fees (including expenses) listed in the table in “Notes to the Consolidated Financial Statements – Note C31, Fees to auditors” in the Annual Report for audit-related and other services. The Audit Committee will review and pre-approve any services C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 11 other than audits to be performed by the external auditors, in order to assure that the provision of such services does not impair the auditors’ independence. The scope of services other than audit services pro- vided by the auditors during the period 2003 to 2005 is described in “Notes to the Consolidated Financial Statements – Note C31, Fees to auditors” in the Annual Report. Audit Committee Pre-approval Policies and Procedures The Audit Committee has particular responsibility for preparing recom- mendations or proposals for resolution on the performance of, and level of the audit fee payable to, the external auditors. The Audit Com- mittee 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 pro- cedures for other services than audits performed by the external audi- tors. Under these policies and procedures, proposed such services either (i) may be pre-approved by the Audit Committee without consid- eration 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, attestation and accounting services and general services have received a general pre-approval of the Audit Committee, provided that the esti- mated fee level for the project does not exceed SEK 1 million. The Audit Committee will be informed of services rendered in compliance with this general pre-approval policy. 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 Chair- man for proposed services with an estimated fee level not exceeding SEK 2.5 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 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 de- signed to ensure that information required to be disclosed pursuant to the Securities Exchange Act of 1934, its listing agreement with Stock- holm Stock Exchange and the ongoing listing requirements of the Lon- don Stock Exchange and NASDAQ is recorded, processed, summa- rized 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 disclo- sure controls and procedures, management recognizes that any con- trols 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 evalu- ating 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 12 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 re- port. Based on the foregoing, our CEO and CFO concluded that our disclosure controls and procedures were effective at the reasonable assurance level. There have been no changes in our internal control over financial reporting identified in connection with our evaluation thereof that oc- curred during the period covered by this annual report that have mate- rially affected, or are reasonably likely to materially affect, our internal control over financial reporting. 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 perfor- mance, what our prospects are and the risks we face that these op- portunities may not be realized. To continue to achieve these goals, we apply the following principles in our financial reporting and disclosure: • Transparency: our disclosure is designed to enhance understanding of the economic drivers and operational performance of our busi- ness, 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 perfor- mance • Relevance: we aim to avoid information overload by focusing our disclosure on what is relevant to Ericsson’s stakeholders, or as re- quired by regulation or listing agreements • Timely: we utilize well established disclosure controls and proce- dures to ensure that all disclosures are complete, accurate and performed on a timely basis • Fair and equal: we publish all material information via press releases • Best practice: we strive to ensure that our disclosure is in line with to ensure simultaneous dissemination to all market participants 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 in- terim reports, on-demand-access to recent news and copies of pre- sentations that senior management have given at industry conferenc- es. Independence requirements on the Board The Ericsson Board of Directors is subject to a variety of independence requirements, summarized below. The Board complies with these re- quirements except for certain NASDAQ requirements which are con- tradictory to Swedish Law and for which exemption has been granted, see “NASDAQ Corporate Governance Exemptions” below. The Stockholm Stock Exchange listing requirements • Not more than one person from the senior management may be a member of the board (applies also to senior management in the company’s subsidiaries). • A majority of the directors elected by the shareholders’ meetings (employee representatives not included) are to be independent of the company and its management. An overall assessment should be made in each case in order to consider whether a director is independent or not. • At least two of the directors who are independent of the company and its management shall also be independent of the company’s major shareholders and one of these directors should have experi- ence in the requirements placed on a listed company. The Swedish Code of Corporate Governance Independence requirements on the board of directors (excluding em- ployee representatives): member of the board. • Not more than one person from the senior management may be a • A majority of the directors elected by the shareholders’ meetings • At least two of the directors who are independent of the company are to be independent of the company and its management. and its management shall also be independent of the company’s major shareholders. Independence requirements on the audit committee: of the company and senior management. • The majority of the audit committee members are to be independent • At least one member of the committee is to be independent of the • A board member who is part of senior management may not be a company’s major shareholders. member of the committee. Independence requirements on the remuneration committee: • The members of the committee are to be independent of the com- pany and the senior management. The NASDAQ Market Place Rules Independence requirements on the board of directors: • A majority of the members of the board of directors must be inde- pendent within the meaning of the NASDAQ rules. Ericsson has obtained an exemption from NASDAQ allowing for em- ployee representative directors to be exempt from NASDAQ’s indepen- dence requirements. Sarbanes-Oxley Act of 2002 and corresponding NASDAQ rules Independence requirements on the audit committee: • All members of the audit committee must be independent within the meaning of the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 includes a specific exemption for non- executive employee representatives. C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 NASDAQ Corporate Governance Exemptions Pursuant to an amendment to NASDAQ’s Marketplace Rules adopted in 2005, foreign private issuers such as Ericsson may follow home country practice in lieu of certain of NASDAQ’s corporate governance requirements. Prior to the adoption of the 2005 amendment, NASDAQ’s Market- place Rules provided that foreign private issuers may, upon application, be exempt from certain of its corporate governance requirements when these requirements were contrary to the laws, rules or regulations, or generally accepted business practices of the issuer’s home jurisdic- tion. Ericsson has received (and is entitled to continue to rely thereon under the 2005 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 participa- tion of employee representatives on the board and each committee thereof as mandated by Swedish law; • from the requirement that an issuer’s director nominees be selected, or recommended for the board’s selection, by either a majority of independent directors or a nomination committee comprised sole- ly of independent directors, in order to allow for the fact that: (1) un- der Swedish law, shareholders (not the board) have the authority to nominate directors for election to the board; and (2) 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 direc- tors are present (“executive sessions”), in order to allow for the fact that under Swedish law: (1) employee representatives on the board have the right to participate in all board and board committee meet- ings; and (2) 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 deci- sion. In addition, Ericsson relies on the exemption provided by the 2005 amendment with respect to the requirement of NASDAQ’s Marketplace Rules relating to quorums. 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 33.3 percent of the outstanding shares of the issuer’s voting common stock. This is contrary to Swedish law followed by Ericsson under which: (1) meetings of shareholders are convened in accordance with the rules of the Swedish Company Act and the articles of association of the is- suer; and (2) the quorum requirements for any specific meeting of share- holders differ based on the subject matter to be decided upon at the meeting. C O R P O R AT E G O V E R N A N C E R E P O R T 2 0 0 5 13 I N T E R N A L C O N T R O L R E P O R T 2 0 0 5 INTERNAL CONTROL REPORT 2005 The Board of Directors’ Report on Internal Control over Financial Reporting for year 2005 According to the Swedish Companies Act and the Swedish Code of Corporate Governance, the Board of Directors is responsible for ensuring that the Company has satisfactory internal control. This report has been prepared in accordance with the Swedish Code of Corporate Governance, section 3.7.2, and is thereby limited to internal control over financial reporting. This report is not a part of the annual report. The Swedish Corporate Governance Board has made a pronounce- ment regarding the Board of Directors’ reporting on internal control under the Code of Corporate Governance to the effect that, for 2005, it is not necessary for the Board of Directors to make a statement of how well the internal control over financial reporting has worked, and the Internal Control Report for 2005 does not have to be examined by the auditors. In accordance with this pronouncement, we do not make any such statement in this report for 2005 and this report is not exam- ined by the auditors. INTERNAL CONTROL OVER THE FINANCIAL REPORTING Ericsson has integrated risk management and internal control in its business processes. As defined in the COSO framework for internal control, issued by the Committee Of Sponsoring Organizations of the Treadway Commission (COSO), components of internal control are: a control environment, risk assessment, control activities, information and communication, and monitoring. Control environment The Company’s internal control structure is based on: tees and the company president • the division of work between the Board of Directors and its commit- • the Company’s organization and mode of operations, with well- • steering documents such as policies and directives, including a code • a management system based on a number of well-defined planning, defined roles and responsibilities and delegations of authority of business ethics and conduct operational and support processes. The most essential parts of the control environment regarding the financial reporting are included in steering documents related to accounting and financial reporting. Such steering documents are updated regularly for changes e.g. in laws, financial reporting standards and listing requirements, such as IFRS and the Sarbanes-Oxley Act (SOX) in the United States. Risk assessment Risks related to financial reporting are fraud and loss or embezzlements of assets, undue favorable treatment of counter-parties at the expense of the Company, and other risks of material misstatements in the financial statements, e.g. related to recognition and measurement of assets, liabilities, revenue and cost or insufficient disclosure. Ericsson is managed through common processes, where risk management is integrated in each process, applying various methods for risk assess- ment and control, to ensure that the risks the Company is exposed to are managed according to established policies. Accounting and reporting policies and directives cover areas of particular significance to support correct accounting, reporting and disclosure. Control activities The Company’s business processes include financial controls regarding approval and accounting for business transactions. The financial closing and reporting process has controls regarding recognition, measure- ment and disclosure, including the application of critical accounting policies and estimates, in consolidated companies as well as on group level. All legal entities, business units and market units in Ericsson have their own controller functions participating in planning and evaluation of each unit’s performance. Their regular analysis of the financial reports for their respective units, together with analysis performed at group level, is an important element of the internal control to ensure that the financial reports do not contain material errors. For external financial reporting purposes, additional controls that all disclosure requirements are fulfilled are performed by a Disclosure Committee established by the Company management. The Company has implemented controls to ensure that the financial reports are prepared in accordance with IFRS. The Company also largely completed implementation of detailed documentation of internal controls related to accounting and financial reporting as well as moni- toring of the performance and results of such controls to ensure that Ericsson will be able to assess the effectiveness of the internal control in such a way as to be compliant with SOX requirements. A thorough review of materiality levels related to the financial reports has resulted in implementation of detailed control documentation in a number of subsidiaries with significant scale of operations. For other subsidiaries, overall controls related to their control environment and compliance with policies and directives related to the financial reporting are imple- mented. Information and communication The Company has information and communication channels supporting completeness and correctness of the financial reporting, e.g. by making internal instructions and policies regarding accounting and financial reporting known and accessible to all employees concerned, as well as regular updates and briefing documents regarding changes in accounting policies and reporting and disclosure requirements. There is regular financial and management reporting by legal and operational units to internal steering groups and Company management, with analysis and comments of financial performance and risks. The Board of Directors receives financial reports monthly. The Audit Committee has established a routine for anonymous reporting by employees any suspected violations of laws, regulations, policies or directives, a so-called “whistleblower” procedure. Monitoring The Company’s financial performance is reviewed at each Board meeting. The committees of the Board fulfill important monitoring functions regarding remuneration, borrowing, investments, customer I N T E R N A L C O N T R O L R E P O R T 2 0 0 5 1 financing, cash management, financial reporting and internal control. The Audit Committee and the Board of Directors review all interim and annual financial reports before they are released to the market. The Company’s process for financial reporting is reviewed annually by the Management and forms a base for the evaluation of the internal management system and internal steering documents to ensure that these cover all significant areas related to financial reporting. The compliance with policies and directives is also monitored through annual self-assessments and representation letters from heads and controllers in all consolidated companies as well as from business units and market units. The Company has an internal audit function, reporting to the Audit Committee, which performs independent audits. ASSESSMENT OF THE INTERNAL CONTROL OVER FINANCIAL REPORTING As the Company is listed in the United States, the requirements in SOX section 404 regarding assessment of the effectiveness of internal con- trols over financial reporting are applicable as from the fiscal year 2006. The Company is in the process of implementation of detailed controls, documentation and testing procedures according to the COSO frame- work to ensure compliance with SOX 404 as from 2006. Stockholm February 24, 2006 Telefonaktiebolaget LM Ericsson (publ) Org. no. 556016-0680 THE BOARD OF DIRECTORS 2 I N T E R N A L C O N T R O L R E P O R T 2 0 0 5 CONTENTS 2005 MILESTONES LARGEST CONTRACTS IN 129 YEAR HISTORY Ericsson signs multi-year agreements to manage 3’s networks in Italy and UK, covering more than eight million subscribers. EXCLUSIVE SUPPLIER FOR THE “BRAINS” OF ‘‘NEXT GENERATION’’ NETWORK Ericsson’s Softswitch selected to play a key strategic role in the development of BT’s 21st Century Network. FIRST MOBILE BROADBAND (HSDPA) NETWORKS IN COMMERCIAL SERVICE During 2005, Ericsson deployed HSDPA in 21 networks in 17 countries in Asia, the Middle East, Africa, Europe and North America. This includes the world’s first commercial HSDPA launch for Cingular in the US. ERICSSON INSIDE Ericsson’s 3G/WCDMA platforms are now in more than 15 million mobile phones, representing an industry-leading market share. EXPANDING OUR PRODUCT AND MARKET PORTFOLIO Marconi aquisition strengthens Ericsson’s position in the accelerating optical transmission and broadband access markets. BRINGING MULTIMEDIA CONTENT TO OPERATORS AND CONSUMERS Ericsson entered into distribution agreements with major record labels and Napster to enhance the availability of mobile music, and launched a mobile TV application to bring interactive television to mobile devices. ANNUAL REPORT 2005 1 OPERATIONAL REVIEW 25 SHARE INFORMATION 30 TWO-YEAR SUMMARY 32 LETTER FROM THE CHAIRMAN 33 BOARD OF DIRECTORS’ REPORT (AUDITED CHAPTER) 41 CONSOLIDATED FINANCIAL STATEMENTS (AUDITED CHAPTER) 45 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (AUDITED CHAPTER) 89 PARENT COMPANY FINANCIAL STATEMENTS (AUDITED CHAPTER) 95 NOTES TO THE PARENT COMPANY FINANCIAL STATEMENTS (AUDITED CHAPTER) 108 AUDITORS’ REPORT 109 INFORMATION ON THE COMPANY 118 FORWARD-LOOKING STATEMENTS 119 RISK FACTORS 123 SHAREHOLDER INFORMATION CORPORATE GOVERNANCE REPORT 2005 INTERNAL CONTROL REPORT 2005 Project management Ericsson Investor Relations Design and production Publicis Stockholm and Paues Media Photography Andreas Lind and Dan Kullberg (page 24) Reprographics C2 Printing Elanders, Falköping, Sweden EN/LZT 108 8181 R1A A N N U A L R E P O R T 2 0 0 5 ERICSSON ANNUAL REPORT 2005 Communication is a basic human need. Telefonaktiebolaget LM Ericsson Group Function Communications SE-164 83 Stockholm, Sweden www.ericsson.com Printed on Scandia 2000 and Ideal volym – totally chlorine free (TCF) paper that meets international environmental standards. ISSN 1100-8962 © Telefonaktiebolaget LM Ericsson 2006

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