20-F 1 d20f.htm FORM 20-F ANNUAL REPORT Form 20-F Annual Report
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


Form 20-F

 


 

¨ Registration statement pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934

or

 

x Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2006

or

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from/to

or

 

¨ Shell company report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Date of event requiring this shell company report:

Commission file number 000–12033

 


TELEFONAKTIEBOLAGET LM ERICSSON

(Exact Name of Registrant as Specified in Its Charter)

LM ERICSSON TELEPHONE COMPANY

(Translation of Registrant’s Name Into English)

 


Kingdom of Sweden

(Jurisdiction of Incorporation or Organization)

SE-164 83 Stockholm, Sweden

(Address of Principal Executive Offices)

 


Securities registered or to be registered pursuant to Section 12(b) of the Act:

Title of Each Class   Name of Each Exchange on Which Registered  
American Depositary Shares   The NASDAQ Stock Market LLC  
B Shares   The NASDAQ Stock Market LLC *

 

* Not for trading, but only in connection with the registration of the American Depositary Shares representing such B Shares pursuant to the requirements of the Securities and Exchange Commission.

Securities registered pursuant to Section 12(g) of the Act:

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

None

 


Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the Annual Report:

 

B shares (SEK 1.00 nominal value)

   14,823,478,760

A shares (SEK 1.00 nominal value)

   1,308,779,918

C shares (SEK 1.00 nominal value)

   0

Indicate by check mark if the registrant is a well-seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.

x  Large accelerated filer            ¨  Accelerated filer            ¨  Non-accelerated filer

Indicate by check mark which financial statement item the registrant has elected to follow.    Item 17  x    Item 18  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

 



Table of Contents

ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

CONTENTS

 

Form 20-F 2006 Cross Reference Table

   ii

Operational Review*

  

Letter from the Chairman

   21

Three-Year Summary

   23

Board of Directors’ Report*

   25

Report of Independent Registered Public Accounting Firm

   42

Consolidated Financial Statements

   44

Notes to the Consolidated Financial Statements

   48

Risk Factors

   126

Information on the Company

   133

Forward-Looking Statements

   149

Share Information

   150

Shareholder Information

   156

Compensation

   158

Corporate Governance Report 2006

   160

Management’s Report on Internal Control Over Financial Reporting

   186

Supplemental Information

   187

*) In this chapter, we use a non-GAAP financial measure called “cash flow before financial investing activities”. We believe that “cash flow before financial investing activities” is a measure that provides relevant information for analysts, investors and other interested parties in the telecommunications industry. Accordingly, we have presented “cash flow before financial investing activities” to enhance the reader’s understanding of our performance in 2006, 2005 and 2004. “Cash flow before financial investing activities” is defined as cash flow from operating activities less cash used to acquire intangible assets and property, plant and equipment. However, our definition of “cash flow before financial investing activities” may not be directly comparable to other similarly titled measures used by companies.


Table of Contents

ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

FORM 20-F 2006 CROSS REFERENCE TABLE

Our Annual Report on Form 20-F consists of the Swedish Annual Report for 2006, with certain adjustments to comply with U.S. requirements, together with certain other information required by Form 20-F which is set forth under the heading Supplemental Information. The following cross reference table indicates where information required by Form 20-F may be found in this document.

 

Form 20-F Item Heading

  

Location in this document

   Page
Number

PART I

     

1

  

Identity of Directors, Senior Management and Advisors

  

Not applicable

  

2

  

Offer Statistics and Expected Timetable

  

Not applicable

  

3

  

Key Information

     
  

A

  

Selected Financial Data

  

Three-Year Summary

   23
        

Supplemental Information

  
        

Exchange Rates

   187
        

Five-Year Summary

   198
  

B

  

Capitalization and Indebtedness

  

Not applicable

  
  

C

  

Reason for the Offer and Use of Proceeds

  

Not applicable

  
  

D

  

Risk Factors

  

Risk Factors

   126

4

  

Information on the Company

     
  

A

  

History and Development of the Company

  

Board of Directors’ Report

  
     

Summary

   25
        

Acquisitions and Divestitures

   102
        

Capital Expenditures

   31
        

Notes to the Consolidated Financial Statements

  
        

Note C26 Business Combinations

   102
        

Note C32 Events After the Balance Sheet Date

   117
        

Information on the Company

  
        

General Facts on the Company

   133
        

History and Development

   134
  

B

  

Business Overview

  

Information on the Company

   133
  

C

  

Organizational Structure

  

Information on the Company

  
        

Organization

   137
        

Supplemental Information

  
        

Investments

   199
  

D

  

Property, Plant and Equipment

  

Information on the Company

  
     

Manufacturing and Assembly

   147

4A

  

Unresolved staff comment

  

Not applicable

  

5

  

Operating and Financial Review and Prospects

     
  

A

  

Operating Results

  

Board of Directors’ Report

  
        

Goals, Strategy and Financial Results

   27

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

Form 20-F Item Heading

  

Location in this document

   Page
Number
  

A

  

Operating Results Cont’d

  

Notes to the Consolidated Financial Statements

  
        

Note C20 Financial Risk Management and Financial Instruments

   93
         Supplemental Information   
        

Operating Results

   187
  

B

  

Liquidity and Capital Resources

  

Board of Directors’ Report

  
        

Balance Sheet and Cash Flow

   30
        

Notes to the Consolidated Financial Statements

  
        

Note C19 Interest-Bearing Liabilities

   92
        

Note C20 Financial Risk Management and Financial Instruments

   93
        

Note C25 Statement of Cash Flows

   101
  

C

  

Research and Development, Patents and Licenses

  

Board of Directors’ Report

  
        

Research and Development

   32
     

Information on the Company

  
     

Research and Development

   142
        

Intellectual Property and Licensing

   143
  

D

  

Trend Information

  

Board of Directors’ Report

  
        

Market Environment and Trend information

   26
        

Goals, Strategy and Financial Results

   27
  

E

  

Off-Balance Sheet Arrangements

  

Notes to the Consolidated Financial Statements

  
        

Note C20 Financial Risk Management and Financial Instruments

   93
  

F

  

Tabular Disclosure of Contractual Obligations

  

Board of Directors’ Report

  
        

Material Contracts and Contractual Obligations

   33

6

  

Directors, Senior Management and Employees

     
  

A

  

Directors and Senior Management

  

Corporate Governance Report 2006

  
        

Members of the Board of Directors

   171
        

Company Management

   175
        

Notes to the Consolidated Financial Statements

  
        

Note C32 Events after the Balance Sheet Date

   117
  

B

  

Compensation

  

Notes to the Consolidated Financial Statements

  
        

Note C29 Information Regarding Employees, Members of the Board of Directors and Management

   105

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

Form 20-F Item Heading

  

Location in this document

   Page
Number
  

C

  

Board Practices

  

Corporate Governance Report 2006

  
        

Board of Directors

   164
     

Members of the Board of Directors

   171
     

Company Management

   175
        

Notes to the Consolidated Financial Statements

  
        

Note C29 Information Regarding Employees, Members of the Board of Directors and Management

   105
        

Note C32 Events after the Balance Sheet Date

   117
  

D

  

Employees

  

Board of Directors’ Report

  
        

Employees

   38
        

Information on the Company

  
        

Human Resources

   146
        

Notes to the Consolidated Financial Statements

  
        

Note C29 Information Regarding Employees, Members of the Board of Directors and Management

   105
  

E

  

Share Ownership

  

Share Information

  
        

Shareholders

   153
        

Corporate Governance Report 2006

  
        

Members of the Board

   171
        

Company Management

   175
        

Notes to the Consolidated Financial Statements

  
        

Note C29 Information Regarding Employees, Members of the Board of Directors and Management

   105

7

  

Major Shareholders and Related Party Transactions

     
  

A

  

Major Shareholders

  

Share Information

  
        

Shareholders

   153
  

B

  

Related Party Transactions

  

Notes to the Consolidated Financial Statements

  
        

Note C30 Related Party Transactions

   115
  

C

  

Interests of Experts and Counsel

  

Not applicable

  
8    Financial Information      
   A    Consolidated Statements and Other    Consolidated Financial Statements    42
      Financial Information   

Please see also Item 17 cross references

  
         Board of Directors’ Report   
        

Legal and Tax Proceedings

   38
         Supplemental Information   
        

Dividends

   190

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

Form 20-F Item Heading

  

Location in this document

   Page
Number
   B    Significant Changes   

Notes to the Consolidated Financial Statements

  
        

Note C32 Events after the Balance Sheet Date

   117
9    The Offer and Listing      
   A    Offer and Listing Details    Share Information   
        

Offer and Listing Details

   151
   B    Plan of Distribution    Not applicable   
   C    Markets    Share Information   
        

Stock Exchange Trading

   150
   D    Selling Shareholders    Not applicable   
   E    Dilution    Not applicable   
   F    Expenses of the Issue    Not applicable   
10    Additional Information      
   A    Share Capital    Not applicable   
   B    Memorandum and Articles of Association    Supplemental Information   
        

Memorandum and Articles of Association

   189
   C    Material Contracts    Board of Directors’ Report   
        

Material Contracts and Contractual Obligations

   33
        

Acquisitions and Divestitures

   32
        

Notes to the Consolidated Financial Statements

  
        

Note C32 Events After the Balance Sheet Date

   117
   D    Exchange Controls    Supplemental Information   
        

Exchange Controls

   193
   E    Taxation    Supplemental Information   
        

Taxation

   194
   F    Dividends and Paying Agents    Not applicable   
   G    Statement by Experts    Not applicable   
   H    Documents on Display    Information on the Company   
        

Documents on Display

   134
   I    Subsidiary Information    Not applicable   
11   

Quantitative and Qualitative Disclosures

   Board of Directors’ Report   
      About Market Risks   

Risk Management

   35
        

Notes to the Consolidated Financial Statements

  
        

Note C20 Financial Risk Management and Financial Instruments

   93
12   

Description of Securities Other than Equity Securities

   Not applicable   

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

Form 20-F Item Heading

  

Location in this document

   Page
Number
PART II      
13   

Defaults, Dividend Arrearages and Delinquencies

   Not applicable   
14   

Material Modifications to the Rights of Security Holders and Use of Proceeds

   Not applicable   
15    Controls and Procedures      
   A    Disclosure Controls and Procedures   

Corporate Governance Report 2006

  
        

Disclosure Controls and Procedures

   181
   B    Management’s annual report on internal control over financial reporting   

Management’s Report on Internal Control Over Financial Reporting

   186
   C    Attestation report of the registered public accounting firm    Report of Independent Registered Public Accounting Firm    42
   D    Changes in internal control over financial reporting not applicable   

Corporate Governance Report 2006

Disclosure Controls and Procedures

   181

16

  

Reserved

     
  

A

  

Audit Committee Financial Expert

   Corporate Governance Report 2006   
        

The Audit Committee

   168
  

B

  

Code of Ethics

   Corporate Governance Report 2006   
        

High Standards in Business Ethics

   160
  

C

  

Principal Accountant Fees and Services

  

Notes to the Consolidated Financial Statements

  
        

Note C31 Fees to Auditors

   117
         Corporate Governance Report 2006   
        

Audit Committee Pre-Approval Policies and Procedures

   180
  

D

  

Exemptions from the Listing Standards for Audit Committees

   Corporate Governance Report 2006   
        

Independence Requirements of the Board

   182
  

E

  

Purchase of Equity Securities by the Issuer and Affiliated Purchasers

   Not applicable   

PART III

     

17

  

Financial Statements

   Consolidated Income Statement    44
         Consolidated Balance Sheet    45
         Consolidated Statement of Cash Flows    46
         Consolidated Statement of Recognized   
         Income and Expense    47
        

Notes to the Consolidated Financial Statements

   48

18

  

Financial Statements

   Not applicable   

19

  

Exhibits

     
     

Exhibit 1

  

Articles of Association, incorporated by reference to our Form 6-K dated May 16, 2006.

  
     

Exhibit 2

   Not applicable   
     

Exhibit 3

   Not applicable   

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

Form 20-F Item Heading

  

Location in this document

   Page
Number
     

Exhibit 4.1

  

Memorandum of Agreement, dated 25 October 2005, Telefonaktiebolaget LM Ericsson and Marconi Corporation plc incorporated by reference to our Form 20-F dated May 18, 2006

  
     

Exhibit 4.2

  

Agreement and Plan of Merger Between Telefonaktiebolaget LM Ericsson (Publ), Maxwell Acquisition Corporation and Redback Networks Inc. Dated as of December 19, 2006

  
     

Exhibit 5

   Not applicable   
     

Exhibit 6

  

Please see Notes to the Consolidated Financial Statements, Note C1 Significant Accounting Policies

   48
     

Exhibit 7

  

For definitions of certain ratios used in this report, please see Three-Year Summary

   23
     

Exhibit 8

  

Please see Supplemental Information, Investments

   199
     

Exhibit 9

   Not applicable   
     

Exhibit 10

   Not applicable   
     

Exhibit 11

  

Our Code of Business Ethics and Conduct is included on our web site at http://www.ericsson.com/about/code_business_ethics/index.shtml

  
     

Exhibit 12

   302 Certifications   
     

Exhibit 13

   906 Certifications   
     

Exhibit 14

   Not applicable   
     

Exhibit 15.1

  

Consent of Independent Registered Public Accounting Firm

  

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

FINANCIAL HIGHLIGHTS

 

SEK million

   2006     Change
from 2005
    20051)     20042)  

Net sales

   177,783     17.1 %   151,821     131,972  

Operating income

   35,828     8.3 %   33,084     26,706  

—Operating margin

   20.2 %     21.8 %   20.2 %

Net income

   26,436     8.1 %   24,460     17,836  

Earnings per share, diluted, SEK

   1.65     7.8 %   1.53     1.11  

Cash dividends per share, SEK

   0.50     11.1 %   0.45     0.25  

YEAR-END POSITION

                        

Total assets

   214,940     2.7 %   209,336     186,186  

Working capital

   82,926     -3.8 %   86,184     69,268  

Capital employed

   142,447     6.8 %   133,332     115,144  

Stockholders’ equity

   120,113     18.2 %   101,622     80,445  

Interest-bearing liabilities and post-employment benefits

   21,552     -30.2 %   30,860     33,643  

Net cash

   40,728     -19.6 %   50,645     42,911  

RATIOS

                        

Return on equity

   23.7 %     26.7 %   24.2 %

Return on capital employed

   27.4 %     28.7 %   26.4 %

Equity ratio

   56.2 %     49.0 %   43.8 %

Capital turnover, times

   1.3       1.2     1.2  

Inventory turnover, times

   5.1       5.0     5.7  

Accounts receivable turnover, times

   3.9       4.1     4.1  

STATISTICAL DATA, YEAR-END

                        

Number of employees

        

—Worldwide

   63,781     13.8 %   56,055     50,534  

—Of which in Sweden

   19,094     -9.8 %   21,178     21,296  

Export sales from Sweden, SEK million

   98,694     5.1 %   93,879     86,510  

1) Ericsson has adopted the new option in IAS 19 as from January 1, 2006. 2005 has been restated accordingly.
2) 2004 has been restated in accordance with IFRS, using the optional exemptions in IAS 39. Selected financial data for 2003 and 2002 have been omitted because such information cannot be restated in accordance with IFRS without unreasonable effort and expense.

NET SALES:

Good growth, mainly driven by mobile networks, professional services and acquired Marconi sales.

OPERATING MARGIN:

Best-in-class operating margin reflects scale advantage and operational excellence.

NET INCOME:

SEK 26.4 billion is the highest in Ericsson’s history.

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

CASH DIVIDENDS:

SEK 0.50 proposal is double the level paid for 2004.

NET CASH:

Strategic acquisition of Marconi assets reduces net cash.

LOGO

LOGO

LOGO

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

THIS IS ERICSSON

Founded in 1876, Ericsson is a leading provider of communications networks, related services and handset technology platforms. Through our Sony Ericsson joint venture, we are also a major provider of handsets. Our experience building networks in more than 175 countries gives us unique customer and consumer insights, and our extensive portfolio of telecommunication solutions and intellectual property offer a true business advantage. We are committed to working with our customers and partners to expand the borders of telecommunications for the benefit of people everywhere.

OUR VISION

Our vision is to be the prime driver in an all-communicating world.

This means a world in which all people can use voice, data, images and video to share ideas and information whenever and wherever they want.

WHY INVEST IN ERICSSON?

Global leader

We are a leading supplier of systems and services to most of the world’s largest mobile and fixed network operators. Ericsson has a long history of innovation and an industry-leading R&D program that focuses on being first to market with new solutions based on open standards.

Solid financial performance

2006 is the third consecutive year in which Ericsson has reported good sales growth and best-in-class operating margin. Cash flow before financial investing activities was SEK -2.6 billion. Excluding major acquisitions/divestitures, we generated however a healthy cash flow from operations of SEK 12.2 billion. The dividend has increased over each of the past two years and the Board has proposed a further 11 percent increase for 2006.

Long-term growth

We are gaining market share in mobile and fixed networks as well as in services. Our professional services business is experiencing particularly strong growth and generating a return on capital employed well above the group average. Moreover, we anticipate that our Sony Ericsson joint venture, our industry-leading patent portfolio and our newly-formed multimedia business unit will increasingly contribute favorably to our overall financial performance.

KEY ACHIEVEMENTS 2006

We were awarded contracts to build mobile networks in many areas of Asia, Africa and the Middle East, bringing telecoms to millions of people for the first time.

Fixed-line operators, including T-Com and Telefonica, increasingly selected our broadband access and optical transmission solutions.

We won 23 new IMS (IP Multimedia Subsystem) contracts for fixed and mobile networks and led the industry forward by putting six new IMS networks into commercial operation.

We deployed our one millionth microwave MINI-LINK used to transport traffic in mobile and fixed networks.

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

We exceeded our goal to reduce R&D lead times by an additional 20 percent during the year.

Our 3G (WCDMA/HSPA) solution was selected by leading operators around the world including eMobile and Softbank (Japan), AT&T and T-Mobile (US) and Telstra (Australia).

We extended our lead in services, now supporting networks with one billion subscribers.

Vodafone Group named us Supplier of the Year and designated us as a preferred IMS supplier.

Our solution for fixed broadband access (VDSL2) was named Best Access Technology at Broadband World Forum 2006.

Our acquisition and successful integration of Marconi further strengthened our ability to deliver end-to-end solutions.

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

TO MY FELLOW SHAREHOLDERS,

2006 was a year of great change, enabling us to capture current opportunities and open the door to new ones. Our 17 percent sales growth outpaced the industry and extended our leading position in systems and services.

Change Creates Opportunities

Our market leadership and scale advantage have stimulated increased merger activity among our main competitors. We believe that this is a positive development, as over the long term this will create fewer but stronger competitors and a healthier market. Our customers’ needs are also changing as they move toward all-IP networks and high-speed broadband. Our recent reorganization and the acquisitions of Marconi in 2006 and Redback Networks in 2007 have put us in a stronger position than ever to address the evolving needs of the world’s leading operators. Our ability to lead the telecommunications industry through times of change is one of our greatest strengths and has made Ericsson a driving force behind the industry’s evolution for the past 130 years.

The world of communications is driven by consumers’ desire for mobility and broadband. Today, there are more than 2.7 billion mobile subscriptions in the world, and in a few years this figure is expected to pass four billion, fueled by high-growth markets. As most of these markets have limited fixed-line networks, the mobile networks will be the way for many new subscribers to access the Internet for the first time.

We rolled out almost one half, and the vast majority in terms of users, of all HSPA mobile broadband networks that were put into commercial service during 2006, enabling our customers to launch a new generation of mobile data services. The combination of rapid subscriber growth, increased usage, and new applications, such as Internet surfing, music downloads and mobile TV, will require ongoing operator investments to improve network coverage, capacity and functionality.

The Prime Driver in an All-Communicating World

By supporting operators to expand their mobile and fixed networks to reach a broader population, we are helping to improve quality of life, spur socio-economic development, and foster mutual understanding. By evolving and improving the networks, and bringing new multimedia services to market, we are also creating a world in which all people can have access to information, entertainment, social communities and more, whenever and wherever they want. At the same time, our Sony Ericsson joint venture is introducing feature-rich and attractive mobile handsets to facilitate simple use of these services.

Striving for Operational Excellence

These achievements would not have been possible without our focus on operational excellence. By identifying best practices in key dimensions of our operations and striving to work smarter and gain a better understanding of customer needs, we have fostered an environment dedicated to serving our customers better than anybody else. Ericsson is a company of outstanding talent. I take pride in our employees and the work that we do around the world. As we close the book on 2006 and enter 2007, I am excited about the prospects for telecommunications and the significance our industry plays in global development. Supplying the technology and services that enrich the everyday lives of billions of people around the world… what a fantastic company to work for!

Carl-Henric Svanberg

President & CEO

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

OUR BUSINESS FOCUS 2006

1. REACHING MORE PEOPLE

Ericsson brought telecommunications to more people in more parts of the world than ever before, deploying rural networks and boosting capacity in many high-growth markets. The number of global subscriptions grew by a record 500 million, ending the year at 2.7 billion. Our cost-efficient and scalable solutions require fewer radio sites while maintaining high-quality network performance. In this way, we help our customers to reduce their operating costs, enabling them to expand coverage to reach more users in new geographic areas.

2. INCREASING SPEED AND CAPACITY

Our fixed and mobile broadband solutions dramatically improve network speed and capacity. Network evolutions are enhancing quality of service and enabling operators to launch new data services for their subscribers. On the mobile side of the business, we have supplied 46 of the 96 3G/HSPA (high-speed packet access) networks launched to date. On the fixed side, we delivered IP-DSL networks to more than 100 customers around the world during 2006, putting Ericsson among the global leaders in broadband access.

3. PREPARING FOR THE FUTURE

With the introduction of broadband access, subscribers can enjoy a wide variety of multimedia applications. To accommodate this traffic, however, many operators will have to overhaul their core networks as well. During 2006, Ericsson took the lead in supporting operators to prepare their networks for an all-IP environment by deploying softswitch, IMS, and optical and microwave transport solutions. We also worked with partners via Ericsson Mobility World to bring new multimedia content to the mobile environment.

4. EXPANDING OUR ROLE

By providing operators with innovative offerings and reducing their cost of operations, we support our operators in evolving their businesses. We are taking increased responsibility as a prime integrator and managed services partner for our customers. Our 24,000 service professionals in more than 140 countries provide local competence and global expertise in consulting, network rollout, systems integration, managed services, education and support. In 2006, we provided 24-hour network support for one billion subscribers.

Opportunities in a converging world

Many of the world’s leading operators are beginning to converge their mobile and fixed networks into one. For consumers this means a richer experience with easier access to a wide range of content and applications. For operators it means reduced costs and shorter time to market with new services. This, in turn, creates new opportunities for suppliers, like Ericsson, with both mobile and fixed expertise.

During 2006, we complemented our established leadership in mobility by strengthening our fixed-line portfolio. Our technology leadership, global presence, consumer understanding and extensive experience in integrating and managing networks make Ericsson an attractive partner for operators seeking support to reliably and cost-effectively evolve their networks to accommodate multiple technologies.

Same services on all devices

IP Multimedia Subsystem (IMS) is the key that enables subscribers to access the same content and services from a multitude of devices. We are the world’s leading supplier of IMS with 34 contracts for commercial launch and more than 70 trials.

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

An impressive customer base

We serve a broad base of more than 600 customers in over 175 countries, including the largest mobile operators in Europe, North America, Latin America, Asia, Middle East and Africa. The world’s ten largest operators are all our customers and together represent almost 50 percent of all mobile subscriptions worldwide.

Diversity Reduces Risk

The diversity of our customer base and the broad appeal of our offerings are reflected in the fact that, during 2006, no single customer accounted for more than 7 percent of Group sales. Our sales were also evenly divided between emerging and developed markets.

Winning New Business

We continued to expand our addressable market and gain market share, with 48 new and expanded agreements for supply of network equipment and/or services during the year. Recent acquisitions will enable us to expand our offerings even further, enhancing our ability to attract new customers and to deliver increased value to the many we already serve.

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

 

THE ERICSSON ADVANTAGE

1. DEDICATION TO LONG-TERM CUSTOMER RELATIONSHIPS

We have been present in most of our markets for more than 100 years, building strong, long-term relationships with the world’s leading operators. Our significant scale advantage, end-to-end offerings and a local presence in every major market enable us to serve as a true partner for cost-effective delivery of solutions and support to a diverse base of customers. As operators are increasingly reducing the number of different suppliers they rely on, the responsiveness of our employees and the power of our portfolio of products and services that have built a trust over many decades, will be key to our future success.

2. COMMITMENT TO TECHNOLOGY LEADERSHIP

Ericsson has earned a reputation for innovation and technology leadership by developing open standards and bringing reliable, cost-effective network solutions to market. Our early involvement in creating new technologies often enables us to be first to market with new solutions—a distinct competitive advantage for operators that choose us as their primary supplier. Our extensive portfolio of approximately 22,000 patents covers a variety of fixed and mobile technologies, including GSM and WCDMA—the technologies that connect more than 80 percent of the world’s mobile subscribers.

3. PASSION FOR OPERATIONAL EXCELLENCE

Our mission to take our customers forward in the best possible way requires simple, efficient and effective processes that consistently yield high-quality products and services with low cost of ownership. This, combined with our core values of professionalism, respect and perserverance, are key to our ways of working. During the past three years, our emphasis on operational excellence has enabled us to increase sales without increasing operating expenses at the same rate. Furthermore, we reduced R&D lead times in 2006 by more than 20 percent. As a result, we can bring products to market faster than ever at a lower R&D cost.

 

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OUR PRODUCTS AND SERVICES

SEGMENT SYSTEMS: MOBILE AND FIXED NETWORKS

Mobile access

Ericsson is the global leader in the area of 2G (GSM) and 3G (WCDMA/HSPA) mobile networks. By deploying our scalable Ericsson Expander solutions in new coverage areas, operators can profitably serve low-spending users as the total cost of ownership is at least 30 percent lower. More than 40 percent of the operators who have begun rolling out mobile broadband technology have chosen Ericsson’s WCDMA/HSPA radio network. This evolution from GSM to HSPA means that tasks which once took minutes to accomplish in the mobile network (e.g. downloading a song) will now take seconds. GSM and WCDMA/HSPA share a common core network, meaning that previous investments are preserved as operators transition from voice-centric to multimedia networks.

We are now actively involved in the development of standards for the Long-Term Evolution (LTE) of 3G which will further enhance the consumer experience.

Fixed broadband access

The acquisition of Marconi strengthened our IP-DSL offering for fiber- and copper-based broadband access networks. The expansion of our fixed broadband offering has been an important step in reinforcing our ability to address network operators as they begin integrating their fixed and mobile networks.

IP core network (switching, routing, control and transport)

The evolution to Internet Protocol (IP) starts in the core. Our core network solutions include industry-leading softswitch, IP infrastructure, IMS, media gateways and microwave and optical transport solutions to provide cost-effective management of voice and data traffic. Our acquisition of Redback Networks will further strengthen our IP product portfolio.

Multimedia services and applications

A broadband network with an IP core provides operators with almost everything they need to begin offering multimedia services. The last pieces of the puzzle are multimedia applications and devices to attract subscribers, increase usage and generate revenues.

While multimedia applications and content have flourished in the world of fixed communications, operators are just now beginning to launch attractive features for the mobile subscriber. Our ability to understand the needs of consumers and enterprises, and our relationships with content and application partners enable us to deliver such solutions and drive the future of mobile multimedia.

Working end-to-end

Sony Ericsson’s cutting-edge multimedia handsets and our handset technology platforms and global services team complete our end-to-end proposition. By ensuring that all elements of the communication chain—the phone, the access and core networks, the applications and the services—work together, we provide a powerful offering for our customers.

 

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SERVICES

By outsourcing certain activities to Ericsson, operators can focus on their core business of attracting, serving and retaining customers. We realized the strategic importance of services early on, and by the end of the 1990s we were the first supplier to form a services business unit. Today, our services organization leads the industry with 24,000 professionals in 140 countries. We use our experience, skills and scale to support customers in growing their business.

Professional services

Managed services

We provide high-quality operations of fixed and mobile networks at a predictable cost. In addition, as a leading provider of hosting solutions, we enable operators to launch multimedia services in a simple, fast and cost-effective manner. We are the industry leader in managed services, managing networks with more than 100 million subscribers.

Systems integration

Operators can minimize risk by engaging Ericsson to integrate equipment from multiple suppliers and handle technology change programs, as well as to design and integrate new solutions. More and more operators who face challenging technology transformations or introductions of multimedia services are asking us to serve as a prime integrator.

Consulting and education

As technologies and business models become more complex in the evolution towards broadband and all-IP, our customers rely on our consultants to support them in selecting technologies, identifying multimedia services for growth and developing the competence of their employees.

Customer support

Having experienced professionals available around-the-clock to provide customer support is a crucial part of our service offering. Giving advice on how to maximize efficiency in day-to-day operations ensures network uptime and lowers total cost.

Network rollout

Our ability to effectively roll out networks generates significant revenues. In 2006, we raised the bar on network rollout efficiency, launching the world’s geographically largest national HSPA network for Telstra (Australia) in only ten months.

 

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SEGMENT OTHER OPERATIONS

Ericsson provides several other important and complementary technical solutions.

The units included in Other Operations are small but strategically important.

Ericsson Mobile Platforms is a leading supplier of technology platforms (GSM/GPRS, EDGE and WCDMA/HSPA) for mobile handsets and PC cards. During 2006, more than 17 million 3G/WCDMA handsets were based on our technology. We currently license these platforms to 19 handset providers, enabling them to launch new products faster, with lower technology risks.

Ericsson Network Technologies (Cables) is a leading provider of copper and fiber cables for telecommunications and power networks.

Ericsson Enterprise provides communications systems and services that enable businesses, public entities and educational institutions to have seamless access to applications and services across multiple locations.

Ericsson Power Modules is a leading supplier of DC/DC power converters and regulators, mainly to the communications industry.

Ericsson Microwave Systems was sold to Saab AB in September 2006.

 

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A RECORD YEAR FOR SONY ERICSSON

Sony Ericsson Mobile Communications is a 50/50 joint venture, combining Ericsson’s technology leadership with Sony’s consumer electronics expertise to create a powerful partnership that brings innovative products to market and provides us with a valuable link to the consumer.

A record year

In 2006, Sony Ericsson Mobile Communications celebrated their 5th anniversary by delivering record-breaking results. Sony Ericsson reported 46 percent unit growth, 51 percent sales growth and profits that more than doubled. The joint venture’s success is partly attributable to its broadened portfolio, including the introduction of the 3.2 mega pixel Cyber-shotTM imaging phone and a wide range of Walkman® music phones.

A complete product portfolio

While Sony Ericsson’s multimedia Cyber-shot and Walkman® line-up captured most of the headlines, the joint venture shipped more than 75 different phones in all during the year, including a wide variety of models in the mid- and entry-level segments. Over recent years, Sony Ericsson has developed into a full portfolio player and this is reflected in their market share gain during 2006.

3G phones

Some of Sony Ericsson’s best selling WCDMA phones during 2006 were the K800, K610 and W850. The success of these feature-rich and attractively designed 3G models has enabled Sony Ericsson to capture a market share in 3G that is almost double its position in the overall market. This is promising for the future as 3G phones are expected to represent a much larger share of the market in the years ahead.

Gaining share in a growing market

Sony Ericsson’s ability to differentiate itself with attractive, feature-rich phones has enabled the joint venture to enter 2007 with strong momentum. The popularity of Sony Ericsson’s high-end models has generated brand awareness across the portfolio, encouraging more users in all categories to choose Sony Ericsson as their brand of choice. With more than 980 million handsets sold industry wide in 2006 and the market expected to break the one billion mark in 2007, Sony Ericsson is well positioned to capitalize on continued market growth.

Cyber-shot™ is a trademark of Sony Corporation

WALKMAN® is a registered trademark of Sony Corporation

 

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AN ALL-COMMUNICATING WORLD

—MORE PEOPLE COMMUNICATING IN MORE WAYS

Communication for all

Following the record growth in new mobile subscriptions during 2006, we expect that the total number of mobile subscriptions will surpass three billion already in 2007. This rapid growth is possible thanks to the introduction of cost-effective solutions, such as Ericsson Expander. This far-reaching and scalable radio base station enables operators to profitably launch networks in sparsely populated or developing areas that typically generate ARPU (average revenue per user) well below USD 10. We also offer solutions that enable operators to enhance capacity without having to add new radio base stations. Apart from being a case for good business, these solutions enhance quality of life by helping to eliminate the impact of distance and to establish the foundation for more advanced data services.

Taking broadband mobile

During the past ten years, the Internet has revolutionized the world, connecting more than a billion homes and offices into one massive global network. In the early 1990s, analog modems and narrowband dial-up connections made surfing the web and downloading content possible but often frustrating due to slow response times over these connections. Then came digital subscriber lines and broadband!

Fixed broadband is today expanding its reach throughout the world, and as it does, an exciting thing has happened… broadband has broken away from the home and office and is going mobile! In 2006, the number of 3G/WCDMA subscriptions nearly doubled to approximately 100 million globally.

We anticipate that this figure will grow significantly over the next five years. The traffic increase in fixed broadband networks will be greater still.

Multimedia

Thanks to HSPA and the transformation to all-IP networks, the mobile broadband genie is out of the bottle and there is no end to what it can do: high-speed downloads of music, photos, streaming television and other multimedia applications. Operators are making great strides in this area as they seek to introduce attractive offerings and generate increased revenues in a very competitive marketplace. In 2006, the multimedia market was estimated to be approximately USD 25 billion and is expected to exceed USD 100 billion by 2011.

Our end-to-end approach includes our Consumer and Enterprise Lab, through which we conduct more than 20,000 face-to-face interviews annually, providing valuable insights for ourselves and our customers. It also includes our access to unique content through the more than 250,000 developers linked to Ericsson Mobility World. These assets combined with our network and handset technology expertise and our charging, messaging and provisioning solutions put us in a very strong position to support operators in launching the new services needed to capture the multimedia opportunity.

 

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LEADING, CHANGING, GROWING

Ericsson has led the evolution of telecommunications. From the introduction of fixed-line networks in the late 1800s to fixed and mobile broadband today, we have built an unparalleled track record that is a result of our ability to predict, respond to and capitalize on change.

As of January 1, 2007, we have realigned our organization to reflect market trends, strengthen our leadership and expand our market reach. Through efficiently applying our resources into three key business units we are sharpening our focus on the markets that we believe will enable us to capture emerging opportunities and best meet the needs of our global customer base.

Business Unit Networks—With our robust portfolio of mobile and fixed broadband access technologies, core networks, transport and next-generation IP networks, we will effectively meet the coverage, capacity and network evolution needs of our customers.

Business Unit Global Services—Our expertise in network roll-out, consulting, education, integration, customer support and managed services enables us to capitalize on the trend among operators to outsource a broader range of activities to network suppliers.

Business Unit Multimedia—Our applications and content management solutions help our customers to increase their sales. Ericsson Mobility World brings a broad array of music, images, games and global positioning applications to operators and to their subscribers. Ericsson Consumer and Enterprise Lab and the complementary strengths of Sony Ericsson Mobile Communications further enhance our consumer perspective for superior end-to-end offerings.

NETWORKS

“Ericsson has been #1 in mobile networks for many years and has now re-emerged as a leading contender in fixed networks as well. This has enabled us to expand our business with existing customers and to enter into important new relationships with others. In the years ahead, fixed and mobile broadband will be deployed in more and more areas of the world and Ericsson Networks will be a driving force behind this evolution.”

Kurt Jofs

Executive Vice President

and head of Business Unit Networks

GLOBAL SERVICES

“Whether measured by numbers or by performance, we are the global leader in both professional services and network roll-out. In 2006, operators spent an estimated USD 61-65 billion on services and the market has shown consistent growth over the years. Our ability to support our customers in growing their business and in significantly reducing network operations costs explains why our services are in such high demand. With our services offering, our customers gain significant efficiencies.”

Hans Vestberg

Executive Vice President

and head of Business Unit Global Services

 

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MULTIMEDIA

“The future is here and now—it’s about music on the move, mobile TV, Internet and e-mail access wherever you want it. Ericsson is helping to drive the multimedia experience by enabling our customers to develop successful businesses that energize consumers’ lives by providing rich, exciting, differentiated content. Our innovative technology, application platforms, cutting-edge Sony Ericsson phones and relationships with leading content developers and application providers make us a valuable partner for operators and other industry players seeking to access more revenue streams.”

Jan Wäreby

Senior Vice President

and head of Business Unit Multimedia

 

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QUESTIONS AND ANSWERS

Why is Ericsson expanding headcount?

As a knowledge company, our employees are our greatest asset. During the year we added a net of 7,726 employees. This increase was primarily a result of the Marconi acquisition and the remaining additions were largely in Services to accommodate the 33 percent growth in that area. Going forward we expect to increase our headcount in line with our business needs. We have already announced plans to hire 500 new research engineers over the next few years to further strengthen Ericsson’s technology leadership and accelerate research, especially in the area of IP-networks and multimedia technology.

What is Ericsson’s acquisition strategy?

Over the past three years we have consistently grown our business faster than the market while maintaining best-in-class profitability. This has been achieved primarily through organic growth, complemented by bolt-on acquisitions that have brought us cutting-edge technology or expertise. Going forward our strategy remains the same.

What is Ericsson’s most significant challenge going forward?

Keeping pace with change, bringing cost-efficient, revenue-generating solutions to market, and meeting the needs of our customers better than our competitors are our primary challenges and key to our future success. Although we have been a telecommunications leader for many decades, this industry is always evolving and we must evolve along with it if we are to stay in the lead. The last 20 years have seen tremendous growth in mobile subscriptions. Looking to the future, the pace of new subscriber additions will eventually slow and growth will need to be driven in new ways. Growing minutes of use and a rapid increase in both mobile and fixed broadband data traffic are changing our business. Our recent acquisitions have expanded our technology portfolio and our growing services business will play an even more important role in meeting the challenges in the future.

What is Ericsson’s Intellectual Property position?

With around 22,000 patents, we believe that we hold leading patent portfolios in a number of key technology standards including GSM, EDGE, WCDMA, HSPA and MBMS. We also hold strong portfolios of essential patents in a variety of other fixed and mobile technologies including Voice over IP (VoIP), ATM, WAP, WiMAX, WLAN and TD-SCDMA. These patents are very valuable, reducing our cost and creating an additional source of income for our Company.

What does Ericsson mean by Operational Excellence?

At Ericsson we use the term operational excellence to refer to our philosophy of striving to do things smarter today than yesterday and to do it in a smarter way than our competitors. By driving excellence and innovation in everything that we do, we create a competitive advantage. Much was achieved through operational excellence in 2006, including improved R&D lead times and the successful integration of Marconi operations. We also reorganized our operations into three business units, creating a more customer-oriented organization and paving the way for continuous efficiency improvements in the years ahead.

How will Ericsson utilize its net cash of SEK 40.7 billion?

Maintaining a strong cash position is essential to us and we intend to keep it at a robust level for the foreseeable future. Our cash provides us flexibility in this competitive and capital-intensive business. It will be used to fund organic growth, to execute large network projects, to provide selective customer financing, to make bolt-on acquisitions, and to pay the annual dividend to shareholders. The dividend payout has increased from SEK 0.25 for 2004, to SEK 0.45 for 2005 and the Board has proposed a dividend of SEK 0.50 for 2006.

 

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CORPORATE RESPONSIBILITY

—OUR CONTRIBUTION TO A BETTER WORLD

Corporate Responsibility is about building enduring value—economic, environmental and social—for our Company and our stakeholders. Our goal is to generate positive business impacts and ensure that controls are in place to minimize risks.

GENERATE POSITIVE BUSINESS IMPACTS

We are committed to solutions that increase our own and our customers’ positive impact on the planet. During 2006:

 

   

We introduced new “green site” concepts, promoting the use of a variety of renewable energy sources to power our radio base stations. We announced our pioneering biofuel project with pan African-operator MTN and the GSMA Development Fund in Nigeria.

 

   

Ericsson Consumer and Enterprise Lab conducted studies in Kenya and Nigeria, deepening the industry’s understanding of how mobile communications can serve as a major catalyst of socio-economic development in very low-income villages.

 

   

We are driving market penetration and subscriber growth in emerging economies by introducing new technologies and business models which lower operators’ costs of network rollout in rural and low-income areas. In this way, we are narrowing the “digital divide” by increasing the accessibility and affordability of services.

 

   

Ericsson Response, our employee volunteer disaster relief program, provided on-the-ground support in Pakistan for nine months following the devastating earthquake.

 

   

As one of the founding partners of the KTH Center for Sustainable Communications in Sweden, we are exploring the role of advanced communication technologies in a sustainability context.

MINIMIZE RISKS

Our approach ensures that controls are in place to deepen stakeholder trust and to minimize operational risks.

 

   

Our Code of Business Ethics outlines expectations Ericsson has on its employees. This Code is periodically reviewed, and in 2006 all employees were asked to review and acknowledge understanding of this Code.

 

   

Ericsson was an early signatory to the UN Global Compact principles which cover human rights, fair labor practices, environment and anti-corruption. These principles are reflected in our Code of Conduct and are valid for all employees and all suppliers.

 

   

During 2006, we completed a pilot project using a risk-based approach to the Code’s implementation to evaluate supplier performance and to reduce operational risks.

 

   

We joined the Business Leaders Initiative on Human Rights (BLIHR), a business-led initiative designed to help lead and develop the corporate response to human rights.

 

   

Ericsson is in compliance with the EU Directive on Restriction of the use of certain Hazardous Substances in Electrical and Electronic Equipment (RoHS).

 

   

We have begun global implementation of our Ecology Management Provision (first introduced in 2002), offering take-back of customers’ decommissioned equipment for all products, in all markets.

 

   

Ericsson’s goal is to exceed the European Union’s WEEE (Waste Electrical and Electronic Equipment) Directive’s ambition of recycling or reusing 75 percent of equipment taken back and ensure that less than 25 percent ends up in landfill sites.

 

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LETTER FROM THE CHAIRMAN OF THE BOARD

Dear Shareholder,

Five years ago, Ericsson embarked on an important process of change. It started with the formation of the Sony Ericsson Mobile Communications joint venture, followed by an extensive revamping of Ericsson’s entire operations. Today these actions have resulted in a powerful and unique combination of scale and diversity. In 2006, Ericsson reported record profits and Sony Ericsson marked its fifth anniversary with record shipments, sales and income. This transformation would not have been possible without strong shareholder support, particularly the positive response to Ericsson’s stock issue in 2002 that provided the financial security to successfully complete the change process.

Our ambition is to return value to shareholders in the most sustainable way. This requires maintaining a strong balance sheet for the financial flexibility to capture opportunities and further strengthen Ericsson’s market position. Organic growth is the Company’s primary intention but acquisitions to speed time to market may be necessary. You can be assured that we will rigorously apply the management oversight needed to ensure acquisitions are in line with Ericsson’s needs and means.

Today’s telecommunications market is both promising and challenging, offering opportunities that are bigger but also more demanding than in the past. The market is more global; with customers as well as competitors becoming more concentrated and stronger. Ericsson must continuously adapt to such market dynamics if it is to continue its leadership and management has done a good job to make sure Ericsson is strategically, operationally and financially prepared for a new stage of development.

The underlying strength of Ericsson is the quality of the work-force. Their commitment to Ericsson’s core values and willingness to embrace change underpins the outstanding results achieved this year. On behalf of the Board of Directors, I would like to express our appreciation to all employees for their dedicated efforts and special contributions.

The ability to attract and retain the best talent at all levels of the Company, especially in leadership roles, is crucial to Ericsson’s growth and future performance. Executive compensation is one of the most widely debated issues in business today and suitable remuneration is important to the Company. Ericsson’s executive compensation must be competitive and reflect the high demands we put on the Company’s leadership. We believe the compensation plan that the Remuneration committee oversees with the assistance of external experts is fair, robust and in line with industry norms.

The Board is committed to ensuring that Ericsson’s governance framework supports the Company’s main purpose of shareholder value creation. Enhancements made during the year are described in the Corporate Governance Report which I encourage you to read. Along with the Company’s executive management, we continue to foster Ericsson’s culture of integrity, respect and professionalism; integral parts of effective governance.

Your Board of Directors has been particularly busy during 2006, meeting 10 times on a broad range of issues from acquisitions to strategies to a new organization for the Company. In addition we had a number of training sessions including R&D, Human Resources and Corporate Responsibility. We will continue our work with a commitment to progressively enhance the Company’s performance for the benefit of the employees, for society in general and, of course, for all Ericsson shareholders.

 

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The telecom industry is one with long-term growth prospects and one that has an increasingly positive effect on our daily lives. As the world’s leading supplier of communications networks and services, Ericsson has a vital role in the industry and I am proud to be associated with such an exciting company. I thank you for allowing me this privilege.

Yours sincerely,

LOGO

Michael Treschow

Chairman of the Board

 

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THREE-YEAR SUMMARY

 

SEK million

   2006     20051)     20042)  

Net sales

   177,783     151,821     131,972  

Operating income

   35,828     33,084     26,706  

—operating margin

   20.2 %   21.8 %   20.2 %

Financial net

   165     251     –540  

Net income

   26,436     24,460     17,836  
                  

Year-end position

      

Total assets

   214,940     209,336     186,186  

Working capital

   82,926     86,184     69,268  

Capital employed

   142,447     133,332     115,144  

Property, plant and equipment

   7,881     6,966     5,845  

Stockholders’ equity

   120,113     101,622     80,445  

Minority interests

   782     850     1,057  

Interest-bearing liabilities and post-employment benefits

   21,552     30,860     33,643  
                  

Other information

      

Earnings per share, basic, SEK

   1.65     1.53     1.11  

Earnings per share, diluted, SEK

   1.65     1.53     1.11  

Cash dividends per share, SEK

   0.50     0.45     0.25  

Stockholders’ equity (SEK per share)

   7.56     6.41     5.08  

Number of shares (in millions)

      

—outstanding, basic, at end of period

   15,881     15,864     15,832  

—average, basic

   15,871     15,843     15,829  

—average, diluted

   15,943     15,907     15,895  

Additions to property, plant and equipment

   3,827     3,365     2,452  

Depreciation on property, plant and equipment

   3,007     2,804     2,434  

R&D and other technical expenses

   27,921     24,454     23,421  

—as percentage of net sales

   15.7 %   16.1 %   17.7 %
                  

Ratios

      

Return on equity

   23.7 %   26.7 %   24.2 %

Return on capital employed

   27.4 %   28.7 %   26.4 %

Equity ratio

   56.2 %   49.0 %   43.8 %

Capital turnover

   1.3     1.2     1.2  

Inventory turnover

   5.1     5.0     5.7  

Trade receivables turnover

   3.9     4.1     4.1  

Return on sales

   21.3 %   23.5 %   22.9 %

Payment readiness, SEK million

   67,454     78,647     81,447  

—as percentage of net sales

   37,9 %   51.8 %   61.7 %

Net cash, SEK million

   40,728     50,645     42,911  
                  

Statistical data, year-end

      

Number of employees

   63,781     56,055     50,534  

—Of which in Sweden

   19,094     21,178     21,296  

Export sales from Sweden

   98,694     93,879     86,510  
                  

1) Ericsson has adopted the new option in IAS 19 from January 1, 2006. 2005 has been restated accordingly.
2) 2004 has been restated in accordance with IFRS, using the optional exemptions in IAS 39. Selected financial data for 2003 and 2002 have been omitted because such information cannot be restated in accordance with IFRS without unreasonable effort and expense.

 

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Working capital: Current assets less current non-interest-bearing provisions and liabilities.

Capital employed: Capital employed is defined as total assets less non-interest-bearing provisions and liabilities.

Earnings per share: See Notes to the Consolidated Financial Statements—Note C1, “Significant Accounting Policies”, for information on principles for calculation of earnings per share.

Cash dividends per share: Defined as dividends paid divided by average number of shares, basic.

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 equity: Defined as Net income as a percentage of average Stockholders’ equity (based on the amounts at January 1 and December 31).

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).

Equity ratio: Defined as Equity, expressed as a percentage of total assets.

Capital turnover: Net sales divided by average Capital employed.

Inventory turnover: Cost of Sales divided by average Inventory.

Accounts receivable turnover: Net sales divided by average Accounts receivable.

Return on sales: Operating income plus Financial income expressed as a percentage of Net Sales.

Payment readiness: Defined as cash and 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.

Net cash: Defined as cash and cash equivalents plus short-term cash investments less interest-bearing liabilities and post-employment benefits.

Compound annual growth rate (CAGR): Used to describe the growth rate over a period of time.

 

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BOARD OF DIRECTORS’ REPORT

This Board of Directors’ Report contains a discussion and analysis of Ericsson’s consolidated financial statements and operational results. This report also includes forward-looking statements regarding a variety of matters including 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 implied by such forward-looking statements. For further discussion, please see “Forward-looking Statements” and “Risk Factors.”

The terms “Ericsson”, “Group”, “the Company”, and similar all refer to Telefonaktiebolaget LM Ericsson and its subsidiaries. Unless otherwise noted, numbers in parenthesis refer to prior year, i.e. 2005.

SUMMARY

Ericsson performed well in 2006, increasing sales 17 percent and generating operating income of SEK 35.8 (33.1) billion and a cash flow before financial investing activities of SEK—2.6 (11.3) billion. Excluding the Marconi and Netwise acquisitions and the divestiture of the defense business, the cash flow was SEK 12.2 billion.

In addition to delivering solid financial results, Ericsson also made good progress in strategically important areas, strengthening the Company’s position within the Systems segment business in a number of related areas such as mobile and fixed broadband and professional services. Services sales in particular showed strong growth, and we believe that scale for continued profitable growth has now been established.

The Marconi acquisition was completed with the acquired operations integrated and profitability established before year end. The combined Ericsson and Marconi business has secured several significant new contracts as a result of the expanded product line.

Ericsson’s leading systems position was further expanded with a number of major contracts for new mobile network deployments in all regions of the world, including in Australia, Brazil, India, Japan and the United States. The development in China was unfavorably affected by the timing and operator investment requirements for 3G licenses.

During the year, 48 new or expanded agreements to supply network equipment and/or related services to operators around the world were publicly announced by the Company. This compares with 78 in 2005, 59 in 2004 and 58 in 2003. Although the number of contract announcements was lower this year than in the previous three years, the aggregate value of orders from these agreements along with existing ones lifted our order backlog for systems to the highest level in four years.

The Sony Ericsson Mobile Communications joint venture showed record performance, profitably gaining market share and ending the year as the fourth largest mobile device supplier with strong momentum toward their ambition of becoming a top three mobile phone supplier.

 

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The Company’s progress during 2006 indicates that the strategy of maintaining a healthy balance between profit and growth has already strengthened Ericsson’s prospects for a number of opportunities in growth areas such as services and next-generation networks for fixed and mobile operators.

LOGO

MARKET ENVIRONMENT AND TREND INFORMATION

2006 was a record year in terms of new mobile subscriptions: some 500 (450) million new mobile subscriptions and approximately 980 (800) million mobile phones were sold. The network equipment market also developed positively during 2006, particularly for mobile systems, fixed broadband access and optical transmission.

Price competition was especially intense this year regarding strategic pricing necessary to win certain new contracts. However, with the merger of several of our competitors, we expect pricing going forward to be more in line with historical trends. The historical price/performance trend in both mobile phones and network infrastructure has significantly expanded the addressable market with resulting unit volume increases more than offsetting lower average selling prices.

Although GSM represents the majority of the systems market, growth of GSM is slower than 3G/WCDMA, which is accelerating. The market for new GSM networks is mainly in emerging markets, especially Asia, Africa and Latin America. If the current trend continues, the market for 3G/WCDMA will surpass that of GSM within the next several years.

The ongoing equipment supplier consolidation is a healthy process, driven by the competitive need for critical mass in R&D, production and support. As a market leader, Ericsson’s expansion strategy is based on organic growth supplemented with complementary acquisitions. With Ericsson’s scale advantage within mobile systems exposed to potential reduction, the Company will increasingly focus on innovation and operational excellence as well as expansion of fixed networks and professional services sales along with new areas within multimedia.

Operator consolidation continues to be a key trend in a number of regions. In the Americas, significant operator consolidation has occurred with the number of operators reduced by more than half over the last several years. One result of this consolidation is that a number of operators in Latin America have chosen the GSM/WCDMA technology track, where Ericsson is the market leader. 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.

Increased usage driven by new mobile subscriptions, mainly in emerging markets, and accelerating deployments of 3G networks around the world generated growth in the mobile systems market. At year-end, the

 

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2.7 billion mobile subscriptions worldwide represented a global subscription penetration of 41 (34) percent. The Company expects the number of mobile subscriptions to exceed three billion before the end of 2007. This will drive a significant number of initial network build-outs and create opportunities for network deployment and professional services in addition to mobile network systems offerings.

Total voice traffic on mobile networks worldwide grew an estimated 30 (30) percent in 2006, 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 European usage is significantly lower than the average for the rest of the world. Increased tariff competition among operators is starting to stimulate Western European usage to a level closer to the global average. This is expected to require expansion of mobile network capacity over the coming years.

At year-end, there were 146 (91) 3G/WCDMA networks in commercial service, of which Ericsson is a supplier to 91 (49). The High Speed Packet Access (HSPA) enhanced version of 3G/ WCDMA is now commercially deployed within 96 networks in 51 countries. Ericsson is a supplier of 46 of these networks, which represent the vast majority of HSPA users. The number of WCD-MA subscriptions almost doubled during 2006 to nearly 100 million and HSPA deployments are rapidly picking up speed. However, the number of 3G/WCDMA networks in commercial service is less than one fourth that of 2G/GSM—a significant opportunity for 3G/WCDMA equipment suppliers when 2G networks are upgraded.

Within fixed networks, many operators are converting 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. While fixed network operators’ spending for network equipment in total was up slightly in 2006, certain areas essential to next-generation networks—optical transmission, IP broadband access, IP routing and IMS/softswitch—showed stronger growth. The Company believes the demand for IP broadband equipment will increase to meet the higher traffic requirements and user expectations for broadband multimedia services.

In addition to network deployment and systems integration services, the opportunity to supply network operation and hosting services is growing rapidly. The market for such managed services is expected to continue to show good growth prospects going forward, as operators realize the competitive advantages and cost savings made possible when outsourcing certain network operations. With hosting services, smaller operators especially benefit by gaining access to service capabilities and content far beyond what they could normally afford, while at the same time lowering their risks and improving their time to market.

GOALS, STRATEGY AND FINANCIAL RESULTS

Our ultimate goal is for the Company to generate growth and a competitive profit that is sustainable over the longer term. Ericson’s ambition 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 infrastructure. Being a market leader allows the Company to leverage economies of scale to develop superior products and services and thereby offer customers competitive advantages. In addition, when our network equipment and associated services within Systems are combined with our mobile platform technology and the Sony Ericsson joint venture for mobile handsets, the scope of Ericsson’s operations extends to complete end-to-end solutions.

Performance relative to financial objectives

The Company performed in line with the following financial targets:

 

   

Increase sales at a faster rate than the market growth. The GSM/WCDMA mobile systems market grew an estimated 5 percent, while Ericsson increased their mobile systems sales by almost 10 percent;

 

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Deliver best-in-class operating margin, i.e. better than the main competitors. With an operating margin of 16 percent for Ericsson Systems segment and 20 percent for the Group, Ericsson operating margins were the highest among its main competitors;

 

   

Maintain “Investment Grade” credit ratings;

However, the Company did not meet the following target “Generate positive cash flow before financial investing activities”. However, excluding the major acquisitions/divestitures the cash flow was SEK 12.2 billion.

In addition to these objectives, the shareholder-approved long-term variable pay programs for executives is based on a certain EPS growth over a three-year period for each program. Please see also Notes to the consolidated statements—Note C29, “Information Regarding Employees, Members of the Board of Directors and Management”.

Sales

Group sales grew 17 percent mainly driven by higher Systems sales, where services increased by 33 percent and the Marconi acquisition added an estimated 7 percent. Fluctuations in foreign exchange rates had an insignificant effect on reported sales.

Segment Systems

Within Systems, unit volume increases drove mobile network sales growth. Sales of network deployment services related to Systems grew 39 percent during 2006, reflecting increased demand for turn-key projects and our strong market position in mobile systems. Sales of professional services were particularly encouraging, growing at 30 percent, as the Company continued to be awarded contracts for network operation and hosting services. At year end 2006, Ericsson-managed network operations served approximately 100 (53) million users.

Based on Ericsson’s reported sales combined with the publicly reported and estimated sales for Ericsson’s main competitors, we believe the mobile systems market grew approximately 5 (11) percent in reported currencies during 2006. During this period, Ericsson’s mobile systems sales increased by almost 10 percent, measured in SEK, indicating that Ericsson grew faster than the market.

The successful integration of the Marconi operations significantly strengthened Ericsson’s systems offering, especially to operators of fixed networks, where sales grew by 162 percent. The Company was awarded a number of contracts for broadband access and optical transmission equipment due to the competitiveness of the combined product offering. We are optimistic regarding growth opportunities for IP routing, broadband access, optical transmission and next-generation networks. The Company continues to invest in these areas, with the acquisition of Redback Networks expanding the scope of the product portfolio to also include IP routing.

Segment Other Operations

Sales and operating income developed positively within Mobile Platforms and Cables (Ericsson Network Technologies) and overall sales within Other Operations increased by 6 (–4) percent and operating income was SEK 0.9 (0.3) billion. The divested Defense business is reflected in sales and operating income of Other Operations up until the divestiture in early September, 2006. Sales up until date of divestment were approximately SEK 1.4 billion, compared with full year 2005 of approximately SEK 2 billion.

Segment Phones

See Sony Ericsson Mobile Communications on page 33 under Partnerships and Joint Ventures.

 

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SALES BY SEGMENT AND GEOGRAPHIC REGION 2006

 

(SEK million)

   Systems    Percent
change
    Other
Operations
   Percent
change
    Total    Percent
change
    Percent
of total
 

Western Europe

   45,396    27 %   6,542    7 %   51,938    24 %   29 %

Central and Eastern Europe, Middle East and Africa

   48,699    23 %   1,602    36 %   50,301    23 %   28 %

Asia Pacific

   41,991    45 %   1,211    -16 %   43,202    42 %   25 %

Latin America

   16,234    -14 %   246    2 %   16,480    -14 %   9 %

North America

   15,250    -19 %   612    -7 %   15,862    -18 %   9 %
                                       

Total

   167,570    18 %   10,213    6 %   177,783    17 %   100 %
                                       

LOGO

Margins and operating expenses

Our ambition is for Ericsson to generate a competitive return on sales. With best-in-class operating margins of 20.2 (21.8) percent, the Company continued to perform at industry-leading levels. Sony Ericsson contributed 3.3 (1.5) percentage points to the operating margin, while Marconi negatively affected Systems margins until profitability was established at the end of the third quarter. The lower gross margin of 41.2 (45.7) percent was mainly a reflection of a business mix within Systems that had a significantly higher proportion of service sales as well as the impact of the businesses acquired from Marconi, as both have a lower than group average gross margin.

Operating margins have remained robust, with Group sales showing a 16.1 percent compound annual growth rate (CAGR) over the last three years while operating expenses have a CAGR of only 12.0 percent. Operating expenses, measured as a percentage of net sales, increased from 27 percent in 2005 to 28 percent in 2006. The acquired Marconi operations had a negative effect on operating expenses during the first nine months, until they were successfully integrated and streamlined.

Cost savings programs have been carried out within a number of areas, such as creating scale advantages through the establishment of several shared service centers in a number of regions which provide financial and human resource services to the sales organization. The number of employees in support functions was reduced through improved utilization of IT applications. By focusing on operational excellence (i.e. process efficiency), we have been able to grow sales without having to increase S&A head-count and costs at a corresponding rate.

 

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Other income statement items

Share in earnings of joint ventures and associated companies before tax increased by SEK 3.5 billion, mainly due to a larger contribution from Sony Ericsson Mobile Communications. Ericsson’s 50 percent share in earnings of the joint venture before tax increased from SEK 2.3 billion in 2005 to SEK 5.9 billion in 2006.

The financial net decreased slightly from SEK 0.3 billion in 2005 to SEK 0.2 billion in 2006.

Income after financial items was SEK 36.0 (33.3) billion. Net income attributable to the stockholders of the Parent Company increased to SEK 26.3 (24.3) billion, with diluted earnings per share of SEK 1.65 (1.53).

Balance Sheet

Total assets amounted to SEK 214.9 (209.3) billion at year-end. The main item contributing to the 3 percent increase was higher trade receivables reflecting the high business activity in the last quarter of the year in markets with longer payment terms.

Deferred tax assets decreased by SEK 5.0 billion, due to utilization of tax loss carry forwards and timing differences.

SEK 9.3 billion of non-current borrowings were repaid.

Net cash decreased from SEK 50.6 billion to SEK 40.7 billion, mainly as a result of the Marconi acquisition. The major part of the acquired assets were intellectual property rights.

Equity increased to SEK 120.9 (102.5) billion and the equity ratio improved to 56.2 (49.0) percent.

Return on Capital Employed (ROCE ) was 27 percent compared to 29 percent in 2005.

RETURN ON CAPITAL EMPLOYED 2004-2006

 

     Percent

2004

   26.4

2005

   28.7

2006

   27.4

Cash flow before financial investing activities

Cash flow before financial investing activities was SEK–2.6 (11.3) billion. SEK 17.6 billion was used to acquire certain assets from Marconi. Excluding major acquisitions/divestitures, the underlying cash flow was SEK 12.2 billion. Increases in working capital for work in progress in the field and trade receivables, reflecting the growth in large network roll-out projects, also had negative effects. Cash outlays regarding restructuring amounted to SEK 2.3 (2.0) billion, where SEK 0.8 (1.5) billion relates to restructuring programs initiated during 2001–2003.

Through the efforts to improve capital efficiency, Inventory Turnover (ITO) improved compared to 2005. Days Sales Outstanding (DSO) increased due to growth in emerging and other markets with longer payment terms. Efforts to further improve capital efficiency will continue.

 

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WORKING CAPITAL EFFICIENCY MEASURES

 

     Target    2006    2005    2004

Days Sales Outstanding (DSO)

   <90    86    81    75

Inventory Turnover (ITO)

   >5.5    5.1    5.0    5.7

Payable Days 1)

   >45    54    52    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 conditions and other economic factors. Most capital expenditures are normally investments in test equipment used to develop, manufacture and deploy network equipment. However, the increase in capital expenditures from 2005 to 2006 was mainly due to investments for data and network operation centers, needed to support the rapidly growing services business.

The following table summarizes annual capital expenditures during the five years ended December 31, 2006:

CAPITAL EXPENDITURES 2002-2006

 

SEK billion

   2006    2005    2004    2003    2002

Capital expenditures

   3.8    3.4    2.5    1.8    2.7

of which Sweden

   1.0    1.0    1.1    1.1    1.2

as percent of net sales

   2.2    2.2    1.9    1.5    1.9

Excluding acquisitions, capital expenditures in relation to sales are not expected to be significantly different in 2007, remaining at roughly two percent of sales. However, in addition to the normal capital expenditures there are commitments to repay SEK 0.1 billion of debt and to purchase Redback Networks for USD 1.9 billion, or SEK 13.4 billion, as well as to acquire Entrisphere. With a net cash position at year-end of SEK 40.7 billion, we expect the Company to be able to cover all capital expenditure plans and customer financing commitments for 2007 by using funds generated from operations with no additional borrowings required.

In 2000 and 2001, we disposed of the majority of the real estate properties that we owned. We believe the properties that we now occupy are suitable for our present needs in most locations. As of December 31, 2006, no material land, buildings, machinery or equipment were pledged as collateral for outstanding indebtedness.

Credit ratings

Moody’s credit rating agency raised Ericsson’s credit rating during 2006, while Standard & Poor’s (S&P) last upgraded their ratings in 2005. At year-end, their ratings of Ericsson’s creditworthiness were Baa2 (Baa3) for Moody’s and BBB– for S&P, both considered to be “Investment Grade”.

ERICSSON CREDIT RATINGS YEAR END 2004-2006

 

     2006    2005    2004

Moody’s

   Baa2    Baa3    Ba2

Standard & Poor’s

   BBB–    BBB–    BB+

 

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RESEARCH AND DEVELOPMENT

A robust R&D program is essential 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. The efficiency of the R&D activities has been improved, enabling a faster time to market for new products and increased investments in new areas such as multimedia solutions, while decreasing R&D as a percentage of sales. The Company reduced R&D lead time by more than 20 percent this year and has an ambition to reduce R&D lead times by an additional 30 percent over the next several years, as well as adding as many as 500 research engineers in the areas of multimedia and IP technology.

R&D PROGRAM

 

         2006             2005             2004      

Expenses (SEK billion)

   27.9     24.5     23.4  

As percent of sales

   15.7 %   16.1 %   17.7 %

Employees within R&D at December 31 1)

   17,000     16,500     16,000  

Patents 1)

   22,000     20,000     16,000  

1) The number of employees and patents are approximate.

R&D expenses during 2007, excluding the effects of the acquisition of Redback Networks, are expected to remain at roughly the same level in absolute terms compared with 2006, including the additional research engineers and the amortization of the intangible assets acquired from Marconi.

PARTNERSHIPS AND JOINT VENTURES

During 2006, Sony Ericsson Mobile Communications AB reported strong unit volume and sales increases, which caused income before tax to improve significantly during the year. The improved performance is mainly a result of focusing on imaging, music and enterprise phones, while increasing the number of more affordable models. Sony Ericsson’s ambition is to achieve continued profitable growth by leveraging the opportunities created by the combination of technologies and expertise from the parent companies. The joint venture results are accounted for in accordance with the equity method. For more information, see also Notes to the Consolidated Financial Statements—Note C1, “Significant Accounting Policies”.

SONY ERICSSON RESULTS 2004-2006

 

     2006    Percent
change
    2005    2004

Shipments (unit millions)

   74.8    46 %   51.2    42.3

Sales (EUR m.)

   10,959    51 %   7,268    6,525

Income before tax (EUR m.)

   1,298    154 %   512    486

Net income (EUR m.)

   997    185 %   350    316

Ericsson’s share of earnings (SEK billion)

   5.9    157 %   2.3    2.1

For more information on transactions with Sony Ericsson, please see also Notes to the Consolidated Financial Statements—Note C30, “Related Party Transactions”.

ACQUISITIONS AND DIVESTITURES

The acquisition of certain assets relating to broadband access, optical and radio transmission systems, data networking and service layer from Marconi was completed on January 23, 2006, with a cash payment equivalent

 

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to SEK 17.6 billion. With net assets of SEK 4.0 billion, most of the acquisition costs were related to intellectual property rights, e.g. patents, brands, trade marks, etc., which will be amortized over a ten year period. The acquired businesses were consolidated into Ericsson’s accounts as per January 1, 2006.

During the year, the acquired Marconi businesses were streamlined and fully integrated within Ericsson’s operations. This resulted in a 24 percent reduction of the former Marconi workforce for an estimated annual cost savings of approximately SEK 2.0 billion, with full effect from the fourth quarter of 2006. Restructuring charges were SEK 2.2 billion, of which about one third was utilized during 2006, with the remainder expected to be utilized during the first half of 2007. Of this charge, SEK 1.4 billion relates to the layoff of 1,600 employees and SEK 0.8 billion relates to the termination of IT agreements and facilities contracts that are no longer needed but were pre-paid as part of the acquisition.

During 2006, there were also several small acquisitions made to increase capacity mainly to support the growing systems integration business. To expand the systems product portfolio, the Company also made several small technology acquisitions with Netwise of Sweden, acquired for SEK 0.3 billion, being the largest.

Ericsson’s defense business, Ericsson Microwave Systems AB, and its 40 percent holding in Saab Ericsson Space was sold to Saab AB for SEK 3.8 billion in cash with a capital gain of SEK 3.0 billion. The Ericsson defense business that Saab acquired had sales of approximately SEK 2 billion in 2005 and employed 1,250 employees when ownership was transferred.

In December, Ericsson launched a tender offer to acquire Redback Networks of the US for USD 1.9 billion. The tender offer was successfully concluded on January 25, 2007.

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. In 2006, the remaining shares were purchased for SEK 0.1 billion, and the ownership in Ericsson S.P.A. is now 100 percent.

Other than the transactions described above, there were no material acquisitions or divestitures completed during 2004, 2005 or 2006.

MATERIAL CONTRACTS AND CONTRACTUAL OBLIGATIONS

Primary contractual obligations are outlined in the following table. Operating leases are mainly related to offices and production facilities. Purchase obligations are mainly related to outsourced manufacturing, R&D and IT operations and to components for our own manufacturing. Except for those transactions previously described in this report, Ericsson has not been a party to any material contracts over the last three years other than those entered into during the ordinary course of business.

 

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CONTRACTUAL OBLIGATIONS 2006

 

     Payment due by period

(SEK million)

   Total    <1 year    1-3 years    3-5 years    >5 years

Long-term debt 1) 2)

   12,020    427    6,689    4,401    503

Capital lease obligations 3)

   2,207    180    334    253    1,440

Operating leases 3)

   11,225    2,198    3,318    2,205    3,504

Other non-current liabilities

   2,868    187    991    15    1,676

Purchase obligations 4)

   8,238    8,238    —      —      —  

Commitments for customer financing 2)

   6,795    6,795    —      —      —  
                        

Total

   43,353    18,025    11,332    6,874    7,122
                        

1) Including interest payments.
2) See also Notes to the Consolidated Financial Statements—Note C20, “Financial Risk Management and Financial Instruments”.
3) See also Notes to the Consolidated Financial Statements—Note C27, “Leasing”.
4) The amounts of purchase obligations are gross, before deduction of any related provisions.

CRITICAL ACCOUNTING ESTIMATES

The discussion and analysis of our results of operations and financial condition are based on our consolidated financial statements which have been prepared in accordance with IFRS. The preparation of these financial statements requires management to apply accounting methods and policies that are based on difficult, complex or subjective judgments or on estimates based on past experience and assumptions determined to be reasonable and realistic based on the related circumstances. The application of these estimates and assumptions affects the reported amounts of assets and liabilities and contingent assets and liabilities at the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions.

Please see Notes to the Consolidated Financial Statements—Note C2, “Critical Accounting Estimates and Judgments” for more information about the accounting policies that we believe have the most significant impact on Ericsson’s reported results and financial position.

NEW ORGANIZATION

The development of broadband capabilities for both mobile and fixed operators combined with the move toward next-generation networks are expected to create demand for richer multimedia services and accelerate growth opportunities. In this environment, we see the possibility to further strengthen Ericsson’s market and technology leadership by implementing a more customer-oriented organization with three business units, each optimized for a specific, but related, market segment.

Networks includes access, core and transport, as well as cables and power modules, previously reported within Other Operations.

Global Services, consisting of network rollout and professional services, remains unchanged.

Multimedia includes Multimedia systems, as well as mobile platforms and enterprise solutions, both previously reported within Other Operations.

The new organization is in effect as from January 1, 2007.

 

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CORPORATE GOVERNANCE

Although internal policies and directives for governance and other important 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 reporting, disclosure and other requirements for listed companies as well as changes in legislation, such as the Swedish Companies Act and the US Sarbanes-Oxley Act.

In accordance with the Swedish Code of Corporate Governance, a separate Corporate Governance Report, including an Internal Control section, has been prepared. There have been no amendments or waivers to Ericsson’s Code of Business Ethics for any Director or member of management.

RISK MANAGEMENT

Risk-taking is an inherent part of doing business. Risks are managed in our operational processes where risks are identified, probability of occurrence assessed and potential consequences estimated. Actions are then taken to reduce or mitigate the risk exposures and limit potential 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.

For more information on risk management, see also page 121, Risk Factors.

Operational risk management

Risk management has been integrated within the Ericsson Group Management System and each business process. The operational risk management 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, and monitored through unit steering boards and Group Management.

Risks are dealt with on three levels: in the strategy process, in annual target setting and within ongoing operations by transaction (customer bid/contract, acquisition, investment, product development project, etc).

Approval limits are clearly established with escalation according to a well-defined delegation of authority.

Certain risks, such as information security/IT risks and physical security as well as insurable risks are centrally coordinated. A crisis management council deals with ad hoc events of a serious nature, as necessary.

Financial risk management

We have an established policy governing the Group’s financial risk management, which is carried out by the Treasury function within the Parent Company and by a Customer finance function. These are both supervised by the Board of Directors’ Finance Committee.

For further information on objectives, policies and strategies for financial risk management, please see Notes to the Consolidated Financial Statements—Note C19, “Interest-Bearing Liabilities” and Note C20, “Financial Risk Management and Financial Instruments”.

 

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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, covering on average the forthcoming 6–9 months, are used to manage foreign exchange risks.

The largest foreign exchange exposure is to the US dollar and related currencies, which represented 49 (46) percent of sales in 2006. Assuming that other foreign exchange exposures remained the same, a 10 percent plus/minus change in the USD/ SEK exchange rate would affect operating income by an estimated plus/minus SEK 3.8 (3.3) billion before any hedging effects. However, these effects may be compensated over time with new contracts with adjusted prices and costs.

Interest rate risks

Ericsson is exposed to interest rate risk through market value fluctuations of certain balance sheet items and through changes in interest expenses and income. Assuming the net cash position remained at SEK 40.7 (50.6) 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 72 (135) million.

Credit risk in trade receivables

At year-end 2006, trade receivables amounted to SEK 51.1 (41.2) billion, less allowances of SEK 1.4 (1.4) billion. Extended payment terms for trade credits and overdue amounts are regularly reviewed, and allowances are made to cover any potential losses. Historically, credit losses have been minimal, mainly due to a customer base that largely consists of well established and financially sound network operators.

Customer finance risk

At year-end 2006, gross exposure for customer financing amounted to SEK 4.1 (7.0) billion, of which less than one percent was off-balance sheet. Operators in Central and Eastern Europe, Middle East and Africa represented half of the exposure, with Latin America accounting for most of the rest.

Credit risks are covered by security arrangements in most customer financing agreements, 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. In addition to these security arrangements provisions are made and reported as part of selling expenses. Risk provisions amounted to 13 (29) percent of the gross exposure.

Unutilized outstanding customer financing commitments amounted to SEK 6.8 (3.6) billion at year-end.

Financial credit risk

Financial instruments carry an element of risk in that counterparties may be unable to fulfill their payment obligations. All derivative transactions are covered by ISDA Master Agreements to reduce the credit risk. During 2006, no credit losses were incurred from such instruments.

Liquidity and refinancing risk

We expect the Company’s cash-generating capabilities and strong cash position to satisfy any short-term liquidity requirements. During 2006, there have not been any defaults in the payment of principal or interest, or any other material default relating to the indebtedness of Ericsson or any of its subsidiaries.

 

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CORPORATE RESPONSIBILITY

Effective management of social, environmental and ethical issues can help to assure an enduring capability for value creation and competitive advantage. Ericsson supports the UN Global Compact and its ten guiding principles. We see these principles not only as guiding principles, but also as a prerequisite for sound, long-term business and as such, we are committed to responsible business practices for sustainable economic growth that all our stakeholders benefit from. Our commitment to employees, customers, shareholders and the broader global community is underscored by external recognition of our efforts. During 2006, Ericsson was again included in the FTSE 4Good, the Dow Jones Sustainability Index and the 100 Global Most Sustainable Corporations.

Ericsson publishes a separate Corporate Responsibility Report annually, which provides comprehensive information about our corporate responsibility and related activities.

Human Rights

Ericsson believes that publicly available and affordable telecommunications is a fundamental prerequisite for social and economic development. As one of the world’s largest providers of communications equipment and services, the Company plays a vital role in this process, especially in emerging markets. Ericsson joined The Business Leaders’ Initiative on Human Rights (BLIHR), which aims to find practical applications of the Universal Declaration of Human Rights within a business context and to inspire other businesses to do likewise. Ericsson’s participation in BLIHR reinforces a longstanding commitment to human rights and corporate responsibility activities.

Community Involvement

The Company is committed to being a responsible member of the global society and of the local communities in which we operate. 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, children’s welfare as well as many other charitable activities.

We believe that telecom by its very nature has a constructive role to play in the proactive engagement in local economic, environmental and social challenges. We are encouraging economic growth in emerging markets through our Communications for All program, which we are convinced will contribute substantially to poverty reduction.

Ericsson Response is a global initiative to rapidly provide IT, communication solutions and telecom experts anywhere in the world in response to human suffering caused by disasters. Ericsson Response assists the disaster relief operations of the UN Office for the Coordination of Humanitarian Affairs (OCHA), UN World Food Programme (WFP) and the International Federation of Red Cross and Red Crescent Societies (IFRC). During 2006, Ericsson Response continued its 2005 support for an additional six months to the earthquake-hit Pakistan. During the crisis in Lebanon, Ericsson Response supported the Telecom Sans Frontiers operations in the country through our office in Lebanon.

Environment and Health

Our most significant environmental impact relates to the energy consumed by our products during their use phase, and we have set ambitious targets in this area. By 2008, the Company intends to improve the energy efficiency of the 3G/WCDMA base station portfolio by a total of 50 percent, compared with 2005 levels. During 2006, the annual incremental improvement target of 25 percent was significantly exceeded.

 

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The Company is also working actively with green site solutions, including solar, wind, fuel cell and biofuel technologies. Ericsson recently teamed up with the GSM Association’s Development Fund in Nigeria to show that biofuel is a viable option for powering rural base stations. A second biofuel pilot, on a larger scale, is now starting in India. Biofuel-powered networks have the potential to bring socio-economic and environmental benefits to a society, while lowering operators’ total cost of ownership.

We believe that the Company is in compliance with all material environmental, 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 increase knowledge in this area. Ericsson currently co-sponsors more than 45 different ongoing research projects related to electromagnetic fields (EMF), radio waves and health, and has since 1996 supported more than 80 studies with a total cost of more than EUR 40 million. Public health authorities and independent 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.

From August 13, 2005, Ericsson has complied with the EU Directive on Waste Electrical and Electronic Equipment (WEEE). Our global end-of-life treatment program is called the Ecology Management Provision, and was initiated three years before the WEEE requirements became law in the EU. This proactive approach gives Ericsson an effective tool to meet waste-management challenges in all our markets around the world. From July 1, 2006, Ericsson is in compliance with the EU Directive on Reduction of Hazardous Substances (RoHS).

Employees

Every year, an employee satisfaction survey is conducted with a high level of employee participation. In 2006, over 90 (92) percent of employees participated in this survey. The results show improvements in, among others, the areas of Operational Excellence, Work Empowerment & Company Engagement, Co-operation, Learning and Leadership.

Employee headcount at year-end was 63,781 (56,055). Most of the additions were due to the acquisition of Marconi and to support the growing services business. During the year, 6,432 (2,377) employees departed while 14,158 (7,898) joined the company. Please see also Notes to the Consolidated Financial Statements—Note C29, “Information Regarding Employees, Members of the Board of Directors and Management”.

Executive Compensation

The Remuneration Committee continues to be mindful of the debates around the world on executive salaries and benefits. We remain confident that current policies and practices concerning authorization, compliance and control of senior executive compensation within Ericsson are appropriate and reasonable. Principles for remuneration and other employment terms for top executives were approved by the Annual General Meeting 2006, and are further described in Notes to the Consolidated Financial Statements—Note C29, “Information Regarding Employees, Members of the Board of Directors and Management”.

As of December 31, 2006, 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. Please see also Notes to the Consolidated Financial Statements—Note C29, “Information Regarding Employees, Members of the Board of Directors and Management”.

LEGAL AND TAX PROCEEDINGS

Ericsson and Sony Ericsson Mobile Communications are engaged in multiple patent litigations in the US, UK, Germany and the Netherlands, involving GSM/GPRS/EDGE/WCDMA standards against the Korean

 

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handset manufacturer Samsung, including proceedings in the US International Trade Commission (ITC) under Section 337 of the Tariff Act of 1930. In ITC, both sides’ complaints are based on respondents’ alleged unlawful importation and sales within the United States of products, that—according to the complainants—infringe several of their US patents. Ericsson and Sony Ericsson, as well as Samsung, seek exclusion orders to stop respondent’s importation of such products into the US.

In October 2005, Ericsson filed a complaint to the European Commission requesting that it investigate and stop US-based Qualcomm’s anti-competitive conduct in the licensing of essential patents for 3G mobile technology. At the same time, Broad-com, 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 Qualcomm made to international standardization bodies around the world that it would license its technology on fair, reasonable and non-discriminatory terms. In December, 2005, The Commission opened a first-phase investigation. The complainants are still waiting for the Commission’s decision to open a second-phase investigation.

Together with most of the mobile communications industry, Ericsson has been named as a defendant in six class action lawsuits in the United States, where plaintiffs alleged that adverse health effects could be associated with the use of mobile phones. In 2006, plaintiffs voluntarily dismissed four of those lawsuits. The two remaining cases are currently pending in the United States District Court for the District of Maryland and the Superior Court of the District of Columbia.

In another suit filed in the US, Freedom Wireless Inc., a technology company, sued Cingular Wireless LLC and Ericsson, claiming the two defendants built their prepaid wireless telephone service on Freedom Wireless’ patents that allow mobile telephone customers to purchase increments of airtime for any mobile phone.

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 contested the claim.

In December, 2006, the Stockholm City Court acquitted all current or former employees of the Parent Company who had all been indicted by the Swedish National Economics Crimes Bureau for evasion of tax control. The judgment has in part been appealed by the prosecutor.

Swedish fiscal authorities have disallowed, for 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. The decision covering the fiscal year 1999 was appealed. In December, 2006, the County Administrative Court in Stockholm rendered a judgment in favor of the fiscal authorities.

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 Corporate Governance Report.

Changes to the Board membership

The Board of Directors is elected each year at the Annual General Meeting for the period until the next Annual General Meeting. At the Annual General Meeting on April 10, 2006, Michael Treshow was re-elected Chairman of the Board and Marcus Wallenberg Deputy Chairman. Sverker Martin-Löf was also elected Deputy

 

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Chairman. Sir Peter L. Bonfield, Ulf J. Johansson, Nancy McKinstry and Carl-Henric Svanberg were re-elected. Börje Ekholm, Katherine Hudson and Anders Nyrén were elected as new members of the Board of Directors.

Board compensation

Members of the Board, who are not employees of the Company, have not received any compensation other than the fees paid for Board duties as outlined in Notes to the 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 representatives, have not received any remuneration or benefits other than their normal employee entitlements, with the exception of a small fee paid to the employee representatives for each Board meeting attended.

PARENT COMPANY

The Parent Company business consists mainly of corporate management, holding company functions and internal banking activities. 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 applications, licensing and cross-licensing of patents and defending of patents in litigations.

The Parent Company has 7 (8) branch offices. In total, the Group has 51 (51) branch and representative offices.

Net sales for the year amounted to SEK 0.6 (1.1) billion and income after financial items was SEK 13.6 (14.0) billion. Exports accounted for 100 percent of net sales in 2006 (96 percent in 2005). No consolidated companies were customers of the Parent Company’s sales in 2006 or 2005, while 29 percent (27 percent in 2005) of the Company’s total purchases of goods and services were from such companies. Net profits from disposals and write-downs of shares, including Ericsson Microwave Systems AB, contributed SEK 2.9 (6.6) billion to income.

Major changes in the Parent Company’s financial position for the year include decreases in current and non-current receivables from subsidiaries of SEK 31.4 billion and decreases in cash and bank and short-term investments of SEK 21.0 billion. Current and non-current liabilities to subsidiaries decreased by SEK 41.9 billion and current maturities of long-term borrowings decreased by SEK 9.7 billion. At year-end, cash and bank and short-term investments amounted to SEK 54.0 (75.0) billion.

In accordance with the conditions of the Stock Purchase Plans and Option Plans for Ericsson employees, 17,051,349 shares from treasury stock were sold or distributed to employees during the year. The quota value of these shares is SEK 17.1 million, representing less than one percent of capital stock, and compensation received amounted to SEK 124.9 million. The holding of treasury stock at December 31, 2006 was 251,013,892 Class B shares. The quota value of these shares is SEK 251.0 million, representing 2 percent of capital stock, and related acquisition cost amounts to SEK 558.6 million.

POST-CLOSING EVENTS

Acquisition of Redback Networks

On December 20, 2006, Ericsson and Redback Networks Inc. (NASDAQ:RBAK) announced the signing of a definitive agreement under which Ericsson would acquire Redback for USD 25.00 per share, or an aggregate price of approximately USD 1.9 billion (SEK 13.4 billion). The acquisition was completed on January 25, 2007.

 

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Redback has over 700 carrier customers in more than 80 countries and employs about 800 people, including 500 R&D engineers. Fifteen of the top 20 network operators worldwide use Redback’s technology, including broadband routers to manage IP-based data, voice and video services. Redback has a strong position in multi-service edge routing technology, which helps carriers deliver broadband, telephony, TV and mobility services over Internet-based infrastructures.

The combination of Redback’s intelligent routing technology and Ericsson’s leading IMS (IP Multimedia Subsystem), optical transport and broadband access puts Ericsson in a leading position in end-to-end IP solutions for both fixed and mobile operators.

Acquisition of Entrisphere

Ericsson announced on February 12, 2007, the acquisition of Entrisphere, a company providing fiber access technology. Entrisphere was founded in 2000 in Santa Clara, California, and employs about 140 people, including important R&D resources.

The Entrisphere acquisition brings a leading IP-based broadband access platform ready for volume deployment compliant with both North American and international standards.

Since its first deployment of fiber access solution in 2003, Entrisphere has worked with major operators to deliver IP-based services to customers across North America. With its GPON solution (Gigabit Passive Optical Network) already in service in North America and the system being evaluated for deployment by leading network operators around the globe, the acquisition forms an important cornerstone in Ericsson’s full service broadband offering.

PROPOSED DISPOSITION OF EARNINGS

The Board of Directors proposes that a dividend of SEK 0.50 (0.45) per share be paid to shareholders duly registered on the Record date of April 16, 2007, 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 proposes that earnings be distributed as follows:

 

Amount to be paid to the shareholders

   SEK 8,066,129,339

Amount to be retained by the Parent Company

   SEK 24,920,658,097
    

Total non-restricted equityof the Parent Company

   SEK 32,986,787,436

As a basis for its proposal for a dividend, the Board of Directors has made an assessment in accordance with Chapter 18, Section 4 of the Swedish Companies Act of the Parent Company’s and the Group’s need for financial resources as well as the Parent Company’s and the Group’s liquidity, financial position in other respects and long-term ability to meet their commitments.

The Group reports an equity ratio of 56.2 (49.0) percent and net cash amounts to SEK 40.7 (50.6) billion.

The Board of Directors has also considered the Parent 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 financial positions of the Parent Company and its subsidiaries.

The proposed dividend does not limit the Group’s ability to make investments or raise funds and it is our assessment that the proposed dividend is well-balanced considering the nature, scope and risks of the business activities as well as the capital requirements for the Parent Company and the Group.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of Telefonaktiebolaget LM Ericsson (publ),

We have completed an integrated audit of Telefonaktiebolaget LM Ericsson (publ)’s 2006 consolidated financial statements and of its internal control over financial reporting as of December 31, 2006, and audits of its 2005 and 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements

In our opinion, the accompanying consolidated balance sheet and the related consolidated income statement, statement of recognized income and expense and cash flow statement present fairly, in all material respects, the financial position of Telefonaktiebolaget LM Ericsson and its subsidiaries at December 31, 2006, and December 31, 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006 in conformity with International Financial Reporting Standards as adopted by EU. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in the accounting policies, note C1, the Group adopted International Accounting Standards (IAS) 32 Financial Instruments: Disclosure and Presentation and IAS 39 Financial Instruments: Recognition and Measurement in accordance with IFRS as adopted by the EU. The change has been accounted for prospectively from January 1, 2005. Additionally, the Company has adopted the amendment to IAS 19 Employee Benefits as from January 1, 2006, and applied the option for recognition of actuarial gains and losses directly in equity. The option has been applied retrospectively as from January 1, 2004.

International Financial Reporting Standards vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in C33.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in “Management’s Report on Internal Control over Financial Reporting”, appearing under Item 15 (b) of the 2006 Annual Report on Form 20-F, that the Company maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December, 31 2006, based on criteria established in Internal Control-Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the

 

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Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

PricewaterhouseCoopers AB

Stockholm, June 7, 2007

 

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CONSOLIDATED INCOME STATEMENT

 

Years ended December 31, SEK million

   Notes    2006    2005    2004

Net sales

   C3, C4    177,783    151,821    131,972

Cost of sales

      -104,487    -82,369    -70,864
                 

Gross margin

      73,296    69,452    61,108

Research and development and other technical expenses

      -27,921    -24,454    -23,421

Selling and administrative expenses

      -21,422    -16,800    -15,921
                 

Operating expenses

      -49,343    -41,254    -39,342

Other operating income

   C6    5,941    2,491    2,617

Share in earnings of joint ventures and associated companies

   C12    5,934    2,395    2,323
                 

Operating income

      35,828    33,084    26,706

Financial income

   C7    1,954    2,653    3,541

Financial expenses

   C7    -1,789    -2,402    -4,081
                 

Income after financial items

      35,993    33,335    26,166

Taxes

   C8    -9,557    -8,875    -8,330
                 

Net income

      26,436    24,460    17,836
                 

Net income attributable to:

           

Stockholders of the parent company

      26,251    24,315    17,539

Minority interest

      185    145    297

Other information

           

Average number of shares, basic (million)

      15,871    15,843    15,829

Earnings per share, basic (SEK)

   C9    1.65    1.53    1.11

Earnings per share, diluted (SEK)

   C9    1.65    1.53    1.11

 

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CONSOLIDATED BALANCE SHEET

 

December 31, SEK million

   Notes    2006    2005 1)

ASSETS

        

Non-current assets

        

Intangible assets

   C10      

Capitalized development expenses

      4,995    6,161

Goodwill

      6,824    7,362

Intellectual property rights

      15,649    939

Property, plant and equipment

   C11, C26, C27    7,881    6,966

Financial assets

   C12      

Equity in joint ventures and associated companies

      9,409    6,313

Other investments in shares and participations

      721    805

Customer financing, non-current

      1,921    1,322

Other financial assets, non-current

      2,409    2,796

Deferred tax assets

   C8    13,564    18,519
            
      63,373    51,183

Current assets

        

Inventories

   C13    21,470    19,208

Trade receivables

   C14    51,070    41,242

Customer financing, current

      1,735    3,624

Other current receivables

   C15    15,012    12,574

Short-term investments

   C20    32,311    39,767

Cash and cash equivalents

   C20    29,969    41,738
            
      151,567    158,153

Total assets

      214,940    209,336
            

EQUITY AND LIABILITIES

        

Equity

        

Stockholders’ equity

   C16    120,113    101,622

Minority interest in equity of subsidiaries

   C16    782    850
            
      120,895    102,472

Non-current liabilities

        

Post-employment benefits

   C17    6,968    5,891

Provisions, non-current

   C18    602    904

Deferred tax liabilities

   C8    382    391

Borrowings, non-current

   C19, C20    12,904    14,185

Other non-current liabilities

      2,868    2,740
            
      23,724    24,111

Current liabilities

        

Provisions, current

   C18    13,280    17,764

Borrowings, current

   C19, C20    1,680    10,784

Trade payables

   C22    18,183    12,584

Other current liabilities

   C21    37,178    41,621
            
      70,321    82,753

Total equity and liabilities 2)

      214,940    209,336
            

1) Ericsson has adopted the new option in IAS 19 to charge actuarial gains/losses directly to equity, as from January 1, 2006. Earlier periods have been restated accordingly. For further information please see Notes to the consolidated statements—Note C17, “Post-employment benefits”.
2) Of which interest-bearing liabilities and post-employment benefits 21,552 (30,860).

 

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CONSOLIDATED STATEMENT OF CASH FLOWS

 

Years ended December 31, SEK million

   Notes    2006    2005    2004

OPERATIONS

           

Net income attributable to stockholders of the parent company

      26,251    24,315    17,539

Adjustments to reconcile net income to cash

   C25    6,245    10,845    10,490
                 
      32,496    35,160    28,029

Operating net assets

           

Inventories

      -2,553    -3,668    -3,432

Customer financing, current and non-current

      1,186    -641    -65

Trade receivables

      -10,563    -5,874    -1,403

Provisions and post-employment benefits

      -3,729    -15,574    -1,990

Other operating assets and liabilities, net

      1,652    7,266    1,340
                 

Cash flow from operating activities

      18,489    16,669    22,479
                 

Investing activities

           

Investments in property, plant and equipment

   C11    -3,827    -3,365    -2,452

Sales of property, plant and equipment

      185    362    358

Acquisitions of subsidiaries and other operations

   C26    -18,078    -1,210    -1,648

Divestments of subsidiaries and other operations

   C26    3,086    30    14

Product development

   C10    -1,353    -1,174    -1,146

Other investing activities

      -1,070    13    86

Short-term investments

      6,180    6,375    -26,050
                 

Cash flow from investing activities

      -14,877    1,031    -30,838
                 

Cash flow before financing activities

      3,612    17,700    -8,359
                 

Financing activities

           

Proceeds from issuance of borrowings

      1,290    657    1,100

Repayment of borrowings

      -9,510    -2,784    -15,407

Sale of own stock and options exercised

      124    174    41

Dividends paid

      -7,343    -4,133    -292
                 

Cash flow from financing activities

      -15,439    -6,086    -14,558
                 

Effect of exchange rate changes on cash

      58    -288    214
                 

Net change in cash

      -11,769    11,326    -22,703
                 

Cash and cash equivalents, beginning of period

      41,738    30,412    53,115
                 

Cash and cash equivalents, end of period

   C20    29,969    41,738    30,412
                 

 

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CONSOLIDATED STATEMENT OF RECOGNIZED INCOME AND EXPENSE

 

     Stock-
holders’
equity
   Minority
interest
   2006    Stock-
holders’
equity
   Minority
interest
   2005 1)    Stock-
holders’
equity
   Minority
interest
   2004 1)

Years ended December 31,
SEK million

         Total
equity 2)
         Total
equity 2)
         Total
equity 2)

Income and expenses recognized directly in equity:

                          

Actuarial gains and lossed related to pensions including payroll tax

   440    —      440    -3,221    —      -3,221    -1,059    —      -1,059

Revaluation of other investments in shares and participations

                          

Fair value remeasurement reported in equity

   -2    1    -1    -3    —      -3    —      —      —  

Transferred to income statement at sale

   —      —      —      -147    —      -147    —      —      —  

Cash Flow hedges:

                          

Fair value remeasurement of derivatives reported in equity

   4,100    —      4,100    -3,961    —      -3,961    —      —      —  

Transferred to income statement for the period

   -1,990    —      -1,990    1,404    —      1,404    —      —      —  

Transferred to balance sheet for the period

   99    —      99    —      —      —      —      —      —  

Changes in cumulative translation effects due to changes in foreign currency exchange rates

   -3,028    -91    -3,119    4,118    147    4,265    -1,200    -65    -1,265

Tax on items reported directly in/or transferred from equity

   -769    —      -769    1,523    —      1,523    384    —      384
                                            

Total transactions reported in equity

   -1,150    -90    -1,240    -287    147    -140    -1,875    -65    -1,940

Net income

   26,251    185    26,436    24,315    145    24,460    17,539    297    17,836
                                            

Total income and expenses recognized for the period

   25,101    95    25,196    24,028    292    24,320    15,664    232    15,896
                                            

1) Ericsson has adopted the new option in IAS 19 to charge actuarial gains/losses to equity, as from January 1, 2006. Earlier periods have been restated accordingly. For further information, please see Notes to the consolidated statements—Note C17, “Post-employment benefits”.
2) For further information, please see Notes to the consolidated statements—Note C16, “Equity”.

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

CONTENTS

 

C1

   Significant Accounting Policies    48

C2

   Critical Accounting Estimates and Judgments    61

C3

   Segment Information    64

C4

   Revenues    69

C5

   Expenses by nature    70

C6

   Other Operating Income    70

C7

   Financial Income and Expenses    70

C8

   Taxes    71

C9

   Earnings per Share    72

C10

   Intangible Assets    73

C11

   Property, Plant and Equipment    75

C12

   Financial Assets    76

C13

   Inventories    78

C14

   Trade Receivables    79

C15

   Other Current Receivables    80

C16

   Equity    80

C17

   Post-employment Benefits    83

C18

   Provisions    91

C19

   Interest-bearing Liabilities    92

C20

   Financial Risk Management and Financial Instruments    93

C21

   Other Current Liabilities    100

C22

   Trade payables    100

C23

   Assets Pledged as Collateral    100

C24

   Contingent Liabilities    100

C25

   Statement of Cash Flows    101

C26

   Business Combinations    102

C27

   Leasing    104

C28

   Tax Assessment Values in Sweden    105

C29

   Information Regarding Employees, Members of the Board of Directors and Management    105

C30

   Related Party Transactions    115

C31

   Fees to Auditors    117

C32

   Events after the Balance Sheet Date    117

C33

   Reconciliation to Accounting Principles Generally Accepted in the United States    119

C1    SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements comprise Telefonaktiebolaget LM Ericsson, the Parent Company, and its subsidiaries (“the Company”) and the Company’s interest in associated companies and joint ventures. The Parent Company is domiciled in Sweden at Torshamnsgatan 23, 164 83 Stockholm.

The consolidated financial statements as at and for the year ended December 31, 2006, have been prepared in accordance with International Financial Reporting Standards (IFRS) as endorsed by the EU, RR 30:05 Additional rules for Group Accounting and related interpretations issued by the Swedish Financial Accounting Standards Council (Redovisingsrådet) and the Swedish Annual Accounts Act. For the Company, there is no difference between IFRS and IFRS endorsed by the EU, nor is RR 30:05 or the Swedish Annual Accounts Act in conflict with IFRS.

 

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The financial statements were approved by the Board of Directors on February 23, 2007. The balance sheets and income statements are subject to approval by the annual general meeting of share-holders.

IFRS differ in certain respects from generally accepted accounting principles in the United States (US GAAP). For a description of major differences with respect to Ericsson’s financial statements, information will be provided in a separate note “Reconciliation to Accounting Principles Generally Accepted in the United States” in the annual report on form 20F. The 20F will be filed with SEC in the second quarter of 2007.

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, as allowed by IFRS 1.

In 2006, the following amendments to IFRS and new IFRIC:s were adopted:

 

   

IAS 19 Employee Benefits. As from January 1, 2006, the Company has applied the option for recognition of actuarial gains and losses directly in equity. The option has been applied retrospectively as from January 1, 2004. In note C17 Post Employment Benefits, the effect of the application of the option is disclosed.

 

   

IAS 21 The Effects of Changes in Foreign Exchange Rates. IAS 21 has been amended in relation to the accounting treatment of Net Investments in a Foreign Operation. This amendment has not had a significant impact on the financial position or result.

 

   

IAS 39 Financial Instruments: Recognition and Measurement. An amendment to IAS 39 requires a company to include liabilities resulting from financial guarantee contracts in the balance sheet at fair value. This amendment has not had a significant impact on the financial position or result.

 

   

IFRIC 4 Determining whether an Arrangement contains a Lease. This interpretation has not had a significant impact on the financial position or result.

 

   

IFRIC 6 Liabilities arising from Participating in a Specific Market—Waste of Electric and Electronical Equipment. This interpretation has not had a significant impact on the financial position or result.

BASIS OF PRESENTATION

The financial statements are presented in millions of Swedish kronor (SEK). They are prepared on a historical cost basis, except for certain financial assets and liabilities that are stated at fair value; derivative financial instruments, financial instruments held for trading, financial instruments classified as available-for-sale and plan assets related to defined benefit plans. Non-current assets and disposal groups held for sale are stated at the lower of carrying amount and fair value less cost to sell.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements are prepared in accordance with the purchase method. Accordingly, consolidated stockholders’ equity includes equity in subsidiaries, associated companies and joint ventures earned only after their acquisition.

Subsidiaries

The consolidated financial statements include the accounts of the Parent Company and all subsidiaries and the Companys’ interest in associated companies and joint ventures. Subsidiaries are all companies in which

 

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Ericsson has an ownership interest and directly or indirectly, including effective potential voting rights, has a voting majority or in which Ericsson by agreement has control of or retains the majority of the residual or ownership risk of the entity. This means that the Company has the power to govern the financial and operating policies generally accompanying a shareholding of more than one half of the voting rights. At acquisitions, consolidation is performed from the date control is transferred. At divestments, deconsolidation is made from the date when control ceases.

Intra-group balances, and any unrealized income and expense arising from intra-group transactions, are fully eliminated in preparing the consolidated financial statements. Unrealized losses are eliminated in the same way as unrealized gains, but only to the extent that there is no evidence of impairment.

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 influence is obtained through agreement, are accounted for according to the equity method. Ericsson’s share of income before taxes is reported in item Share in earnings of joint ventures and associated companies, included in Operating Income. Taxes are included in item Taxes. Unrealized internal profits in inventory as well as other assets in associated companies and joint ventures purchased from subsidiary companies are eliminated in the consolidated accounts in proportion to ownership. Losses in transactions with associated companies and joint ventures are eliminated in the same way as profit unless there is evidence of impairment.

Also when associated companies and joint ventures sell to the Company, unrealized internal profits and losses occur. Eliminations are made also for these profits and losses.

Undistributed earnings of associated companies and joint ventures included in consolidated equity are reported as Retained earnings, subsequent to acquisition.

BUSINESS COMBINATIONS

At the acquisition of a business, an allocation is made of the cost of the business combination in which fair values are assigned to acquired assets, liabilities and contingent liabilities, 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.

As from the acquisition date, goodwill acquired in a business combination is allocated to each of the cash-generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the combination. Corporate assets are allocated to cash-generating units in proportion to each unit’s proportion of net sales. An annual impairment test for the cash-generating units to which goodwill has been allocated is performed in the fourth quarter, or when there is an indication of impairment. An impairment loss is recognized if the carrying amount of the cash-generating unit exceeds its recoverable amount. Impairment losses are recognized in the income statement. Impairment losses recognized in respect of cash-generating units are allocated first to reduce the carrying amount of the goodwill allocated to the units and then to reduce the carrying amounts of the other assets in the unit on a pro rata basis. The recoverable amount of an asset or a cash-generating unit is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discount-ed to their present value. An impairment loss in respect of goodwill is not reversed.

 

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TRANSLATION OF FINANCIAL STATEMENTS IN FOREIGN CURRENCY

For subsidiary companies, joint ventures and associated companies, the functional (business) currency is the currency in which the companies primarily generate and expend cash. Their financial statements plus goodwill related to such companies are translated to SEK by translating assets and liabilities at the closing rate on the balance sheet day and income statement items at average exchange rates, with translation adjustments reported directly in consolidated equity. When a company is disposed of, the corresponding accumulated translation adjustments are recognized in consolidated income.

Effective portions of foreign exchange gains and losses on hedge instruments 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 portions of foreign exchange gains and losses are reported in operating income.

REMEASUREMENT OF FOREIGN CURRENCY ITEMS IN INDIVIDUAL COMPANIES

In the financial statements, receivables and liabilities in foreign currencies are measured at year-end exchange rates.

Foreign exchange gains and losses are reported either as operational cost or in financial net. Effects of hedging are reported in the income statement together with the foreign currency exchange gains/losses of the hedged item.

The net difference between foreign exchange gains/losses on operating transactions and gains/losses on hedging through foreign exchange derivatives are reported as adjustments to Cost of sales. 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.

IAS 39 was adopted as from January 1, 2005, with early adoption of the amendment related to cash flow hedge accounting of forecast intragroup transactions.

STATEMENT OF CASH FLOWS

The cash flow statement is prepared according to the indirect method. Cash flows from foreign subsidiaries are translated at the average exchange rate during the period. Subsidiaries purchased and/or sold are reported as cash flow from operating investing activities, net of cash.

Cash and cash equivalents consist of cash, bank and short-term investments and are highly liquid financial instruments that have a remaining maturity of three months or less at the date of acquisition.

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 appropriate revenue recognition method. The contracts are of four main types:

 

   

delivery-type

 

   

construction-type

 

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contracts for various types of services, for example multi-year managed services contracts

 

   

licenses

Large customer frame agreements may include different types of undertakings and may result in a mix of construction-type contracts, delivery-type contracts and service contracts.

Different revenue recognition methods are applied based on the solutions provided to our customers, the nature and sophistication of the technology involved and the contract conditions in each case. Specific contractual performance and acceptance criteria impact the timing and amounts of revenue recognized.

The profitability of contracts is periodically assessed and provisions for losses are immediately made, with full amounts, when losses are probable.

For delivery-type contracts revenue is recognized when risks and rewards have been transferred to the customer, normally stipulated in contractual terms of trade. For delivery-type contracts that have multiple elements, revenue is allocated to each element based on relative fair values. If there are undelivered elements essential to the functionality of the delivered elements, or, if fair values are not available for all elements, the Company defers the recognition of revenue until all elements essential to the functionality have been delivered or fair values exist for the undelivered elements.

Revenues from construction-type contracts are generally recognized using the percentage-of-completion method. The degree of completion is measured using either the milestone output method or, to a very limited extent, the cost-to-cost method. The terms of construction-type contracts generally define deliverables or milestones for progress billing to the customer, which also well reflect the degree of completion of the contract. In construction-type contracts where the milestone output method is applied, costs incurred pending the completion of milestones are reported as contract work in progress and included in Inventory. Such milestones are in most contracts frequent. The extent to which milestones have been met varies from period to period, and as a consequence the amount of contract work included in inventory may also vary significantly.

Revenue for period service contracts and managed services contracts, covering longer periods is recognized pro rata over the contract period. Revenue for training, consulting, engineering, installation and similar services is generally recognized when the services are provided.

Licenses relate to Mobile platform license revenues which are included in reported Net Sales based on the number of handsets or components produced by the customer. Revenue is recognized when the customer production has been made. License revenues related to third party contracts for utilization of our patents are reported as Other operating revenues.

For sales between consolidated companies, associated companies, joint ventures and segments we apply arm’s length pricing.

EARNINGS PER SHARE

Basic earnings per share are calculated by dividing net income attributable to shareholders of the parent company by the average number of shares outstanding (total number of shares less treasury stock) 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 dilutive potential ordinary shares. Potential ordinary shares are treated as dilutive when, and only when, this reduces earnings per share.

 

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CLASSIFICATION AND MEASUREMENT OF FINANCIAL INSTRUMENTS

IAS 39 was adopted as from January 1, 2005, with early adoption of the amendment related to cash flow hedge accounting of forecast intragroup transactions.

 

   

Short-term investments are measured at fair value through profit or loss.

 

   

Investments in equity instruments are recognized at fair value. Subsequent changes in fair value are recognized in equity, adjusted for impairment, which is recognized in the income statement.

 

   

Loans and borrowings are recognized at fair value, net of transaction costs incurred. Subsequently, loans and borrowings are measured using the amortized cost method less impairment.

 

   

All derivatives are recognized at fair value. 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 of a highly probable forecasted transaction. The effective portion of fair value changes of the derivative is recognized in equity until the hedged transaction affects the income statement, at which moment the accumulated deferred amount in equity is recycled to the income statement.

 

  ii) a cash flow hedge of a highly probable forecasted transaction that result in the recognition of a non-financial asset or liability. The effective portion of fair value changes of the derivative is recognized in equity until the hedged transaction affects the balance sheet, at which moment the accumulated deferred amount in equity is included in the initial measurement of the acquisition cost of the asset or liability

 

  iii) a hedge of a net investment in a foreign operation. The effective portion of fair value changes of the derivative is recognized in equity until the hedged investment affects the income statement, at which moment the accumulated deferred amount in equity is recycled to the income statement.

 

   

For derivatives assigned as fair value hedges, fair value changes of 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 Company only applies fair value hedge accounting for hedging fixed interest risk on borrowings.

 

   

Ericsson’s listed debt instruments (outstanding notes and bond loans) are measured at amortized cost, unless designated as a hedged item in a fair value hedge, when its hedged risk is measured at fair value.

A financial instrument is recognized if the Company becomes a party to the contractual provisions of the instrument. Regular purchases and sales of financial assets are recognized on settlement date. Investments are initially recognized at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss. Financial assets carried at fair value through profit or loss are initially recognized at fair value, and transaction costs are expensed in the income statement. Financial assets are derecognized when the rights to receive cash flows from the investments have expired or have been transferred and the Group has transferred substantially all risks and rewards of ownership. Financial liabilities are derecognized when they are extinguished.

Foreign exchange gains and losses on operating assets and liabilities are reported as adjustments to Cost of sales. The corresponding reporting for financial items is credited/charged to financial income and expenses respectively.

Gains and losses on derivatives held to offset balance sheet items are reported together with losses and gains on the underlying position.

 

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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.

Each balance sheet date, the Company assesses whether there is objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity securities with changes in fair value recognized in equity, a significant or prolonged decline in the fair value of the security below its cost is considered an indicator that the security is impaired. If any such evidence exists for these financial assets, the cumulative loss—measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognized in profit or loss—is removed from equity and recognized in the income statement. Impairment losses recognized in the income statement on equity instruments are not reversed.

RECEIVABLES AND CUSTOMER FINANCING

Receivables are initially recognized at fair value and subsequently measured at amortized cost, less allowances for impairment charges. Impairment of receivables is assessed when there is objective evidence that the Company will not be able to collect all amounts due according to the original contractual terms. Significant financial difficulties of the debtor, probability that the debtor will enter bankruptcy or financial reorganization, and default or delinquency in payments are considered indicators that the trade receivable is impaired. The amount of the allowance is the difference between the asset’s carrying amount and the present value of estimated future cash flows, discounted at the effective interest rate at inception. The amount of the provision is recognized in the income statement within selling expenses.

When selling receivables, they are derecognized if substantially all the risks and rewards of ownership of the receivable have been transferred. Separate assets or liabilities are recognized if any rights and obligations are created or retained in the transfer.

Collectibility of the receivables are assessed for purposes of initial revenue recognition. In instances where the exposures are 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.

FINANCIAL GUARANTEES

Financial guarantee contracts are initially recognized at fair value (i.e usually the fee received). Subsequently, these contracts are measured at the higher of

 

   

the amount determined as the best estimate of the expenditure required to settle the obligation according to the guarantee contract, and

 

   

the recognized fee less cumulative amortization when amortized over the guaranteed period using the straight line method.

INVENTORIES

Inventories are measured 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.

 

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INTANGIBLE ASSETS OTHER THAN GOODWILL

These assets consist of capitalized development expenses and acquired intangible assets, such as patents, customer relations, brands and software, and are stated at cost less accumulated amortization/impairment. Amortization and any impairment losses are included in Research and development and other technical expenses, mainly for capitalized development expenses and patents, Selling and administrative expenses, mainly for customer relations and brands, 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.

Amortization of acquired intangible assets, mainly intellectual property rights, is made according to the straight-line method over the useful life, normally not exceeding ten years.

The Company has not recognized any intangible assets with indefinite lifetime other than goodwill.

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. An impairment loss is recognized if the carrying amount of an asset or its cash-generating unit exceeds its recoverable amount. The recoverable amount is the higher of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. Corporate assets have been allocated to cash-generating units in relation to each unit’s proportion of total net sales. Impairment losses recognized in prior periods are assessed at each reporting date for any indications that the loss has decreased or no longer exists. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount, An impairment loss is reversed only to the extent that the asset’s carrying amount does not exceed the carrying amount that would have been determined, net of amortization, if no impairment loss had been recognized.

PROPERTY, PLANT AND EQUIPMENT

Items of property, plant and equipment are stated at cost less accumulated depreciation and impairment losses.

Depreciation is charged to income, generally on a straight-line basis, over the estimated useful life of each part of an item of property, plant and equipment. Estimated useful lives are, in general, 40 years for buildings, 20 years for land improvements, 3 to 10 years for machinery and equipment, and up to 5 years for rental equipment. Depreciation and any impairment are included in Cost of sales, Research and development and other technical expenses and Selling and administrative expenses.

Impairment testing is performed in the same manner as for Intangible assets other than goodwill as well as recognition or reversal of impairment, see description under Intangible assets other than goodwill above.

 

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LEASING

Leasing when the Company is the lessee

Leases on terms in which the Company assumes substantially all the risks and rewards of ownership are classified as finance leases. Upon initial recognition, the leased asset is measured at an amount equal to the lower of its fair value and the present value of the minimum lease payments. Subsequent to initial recognition, the asset is accounted for in accordance with the accounting policy applicable to that asset, although the depreciation period would not exceed the lease term. Other leases are operating leases, and the leased assets under such contracts are not recognized on the balance sheet.

Costs under operating leases are recognized in the income statement on a straight-line bases over the term of the lease. Lease incentives received are recognized as an integral part of the total lease expense, over the term of the lease.

Leasing when the Company is the lessor

Leasing contracts with the Company as 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, a receivable is recognized at an amount equal to the net investment in the lease and revenue recognized in accordance with the revenue recognition principles.

Under operating leases, an item of property, plant and equipment is reported and revenue as well as depreciation are recognized on a straight-line basis over the lease term.

INCOME TAXES

Income taxes in the consolidated financial statements include both current and deferred taxes. Income taxes are reported in the income statement unless the underlying item is reported directly in equity. For those items the related income tax is also reported directly in equity. A current tax liability or asset is recognized for the estimated taxes payable or refundable for the current year or prior years.

Deferred tax assets are recognized for (i) deductible temporary differences between the book values of assets and liabilities and their tax values and (ii) unutilized tax loss carryforwards. A deferred tax asset is recognized to the extent that it is probable that future taxable profits will be available against which the temporary differences can be utilized. Temporary differences related to the following are not provided for: goodwill not deductible for tax purposes, the initial recognition of assets or liabilities that affect neither accounting nor taxable profit, and differences related to investments in subsidiaries to the extent that they will probably not reverse in the foreseeable future.

The valuation of deferred tax assets involves assumptions regarding the deductibility of costs not yet subject to taxation and regarding sufficient future taxable income to enable utilization of unused tax losses in different tax jurisdictions. All deferred tax assets are subject to annual review of probable utilization. The largest amounts of tax loss carryforwards are in Sweden, with indefinite period of utilization.

Deferred tax is measured at the tax rate that is expected to be applied to the temporary differences when they reverse, based on the tax laws that have been enacted or substantively enacted by the reporting date. An adjustment of deferred tax asset/liability balances due to a change in the tax rate is recognized in the income statement unless it relates to a temporary difference earlier recognized directly in equity, in which case the adjustment is also recognized in equity.

 

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PROVISIONS

Provisions are made when there are legal or constructive obligations as a result of past events and when it is probable that an outflow of resources will be required to settle the obligations and the amounts can be reliably estimated. However, the actual outflow as a result of the obligation may differ from such estimate.

The 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 proceedings, lawsuits and other unresolved claims, including proceedings under laws and government regulations and other matters. These matters 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 possible to estimate reliably. We provide for the estimated future settlements related to patent infringements based on the probable outcome of each infringement. The ultimate outcome or actual cost of settling an individual infringement may vary from our estimate. We estimate the outcome of any potential patent infringement 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 more 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 forecasts of expected purchases and also sometimes commit to minimum purchase levels during a certain period. The agreements often include compensation 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 actual claims from these suppliers and/or subcontractors, we make provisions for estimated compensation to such suppliers and/or subcontractors. 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 Research & development 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 or credited to the same account as the initial provision.

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 employee benefits. The related actuarial and investment risks fall on the employee. The expenditures for defined contribution plans are recognized as costs during the period when the employee provides service. Under a defined benefit plan it is the Company’s obligation to provide agreed benefits to current and former employees. The related actuarial and investment risks fall on the Company.

 

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The present value of the defined benefit obligations for current and former employees is calculated using the Projected Unit Credit Method. The discount rate for each country is determined by reference to market yields on high-quality corporate bonds that have maturity dates approximating the terms of the Company’s obligations. In countries where there is no deep market in such bonds, the market yields on government bonds are used. The calculations are based upon actuarial assumptions and are as a minimum prepared annually. Actuarial assumptions are the Company’s best estimate of the variables that determine the cost of providing the benefits. When using actuarial assumptions, it is possible that the actual result 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 expectancy, salary changes, changes in the discount rate and differences between actual and expected return on plan assets. Actuarial gains and losses are recognized in equity in the period in which they occur. The Company’s net commitment for each defined benefit plan consists of the present value of pension commitments less the fair value of plan assets and is recognized net on the balance sheet. When the result is a benefit to the Company, the recognized asset is limited to the total of any cumulative past service cost and the present value of any future refunds from the plan or reductions in future contribution to the plan.

The net of return on plan assets and interest on pension liabilities is reported as financial income or expense, while the current service cost and any other items in the annual pension cost are reported as operating income or expense.

Pension cost calculated according to IAS 19 differs from pension cost calculated according to Swedish GAAP. A special payroll tax is calculated on the difference between IAS 19 and local practice. Payroll taxes are recorded as other current liabilities and are recognized as cost in the income statement. Payroll tax related to actuarial gains and losses are reported in equity together with the recognition of actuarial gains and losses.

SHARE-BASED EMPLOYEE COMPENSATION

Share based compensation only relates to remuneration to employees, including key management personnel.

Stock option plans

Ericsson has chosen not to 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 equity settled 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 fulfill 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. Such social security charges are accrued during the vesting period.

Stock purchase plans

For stock purchase plans, compensation costs are recognized during the vesting period, based on the fair value of the Ericsson share at the employee’s investment date. The fair value is based upon the share price at investment date adjusted for that no dividends will be received on matching shares prior to matching. The employees pay a price equal to the share price at investment date for the investment shares. The investment date is considered as the grant date. In the balance sheet the corresponding amounts are accounted for as equity. Vesting conditions are

 

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non-market based and 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 charges are to be paid in certain countries on the value of the employee benefit. The employee benefit is generally based on the market value of the shares at the matching date. During the vesting period, estimated such social security charges are accrued.

SEGMENT REPORTING

Financial information is provided to the Board for both primary and secondary segments. These segments are subject to risks and returns that are different from those of other segments.

Primary segments

Ericsson has the following business segments:

 

   

Systems, addressing operators of mobile and fixed public telephone networks. In this segment is included since January 1, 2006, businesses acquired from Marconi.

 

   

Phones, addressing distributors of mobile handsets to end users. Financial information for this segment consists of our investment in and share in earnings of Sony Ericsson.

 

   

Other Operations, which consists of a number of different operations addressing different types of customers. Each included operation represents, however, less than 10 percent of total net sales and is therefore considered too small to be reported separately. Included operations are: Network Technologies, Enterprise Systems, Mobile Platform Technology, Power Modules and other. As per September 1, 2006, the major part of the Defense operations was sold and revenue and costs are included in Other operations until that date.

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 commonality regarding technology, research and development. The Systems segment is regarded as one business segment, where the business units Access, Systems, Global Services and Broadband Networks represent different product lines. This is due to the close technical relation between included products—they are all integrated components in public telecommunications networks for fixed or mobile communication, subject to common technical systems standards, 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 from several product lines as well as installation.

Our second segment, Phones, is carried out through a joint venture with Sony and develops and sells handsets for mobile telecommunications to distributors.

Our segment Other Operations is composed of a number of smaller operating units, each too small to be reported individually as a separate segment, and each with different characteristics in terms of products, customers and distribution channels.

Secondary segments

Ericsson operates in five main geographical areas: (1) Western Europe, (2) Central and Eastern Europe, Middle East and Africa, (3) Asia Pacific, (4) North America and (5) Latin America. These areas represent our geographical segments.

 

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BORROWING COSTS

The Company does not capitalize any borrowing costs. These costs are expensed as incurred.

NON-CURRENT ASSETS HELD FOR SALE

Non-current assets held for sale are measured at the lower of carrying amount and fair value less cost to sell. At present, the amounts related to assets held for sale are insignificant.

GOVERNMENT GRANTS

Government grants are recognized when there is a reasonable assurance of compliance with conditions attached to the grants and that the grants will be received.

For Ericsson, government grants are linked to performance of research or development work or to subsidized capital expenditures as governmental stimulus to employment or investments in a certain country or region. Government grants linked to research and development are normally deducted in reporting the related expense whereas grants related to assets are accounted for deducting the grant in arriving at the carrying amount of the asset.

NEW OR AMENDED STANDARDS (IAS/IFRS)

The new or amended standards relate to changes in disclosure or presentation and will therefore have no impact on financial result or position.

 

   

IFRS 7, Financial Instruments: Disclosures, and a complementary amendment to IAS 1, Presentation of Financial Statements—Capital Disclosures (effective from January 1, 2007). IFRS 7 introduces new disclosure requirements to improve the information about financial instruments.

The amendment to IAS 1 introduces disclosures about the level of an entity’s capital and how it manages capital. The Company will apply IFRS 7 and the amendment to IAS 1 from annual periods beginning January 1, 2007.

 

   

IFRS 8 Operating Segments. This standard prescribes measurement and presentation of segments and replaces IAS 14 Segment reporting. An entity shall apply this IFRS in its annual financial statements for periods beginning on or after January 1, 2009. The Company plans to apply this new standard as from January 1, 2009.

NEW INTERPRETATIONS (IFRIC:s)

None of the new IFRIC:s are expected to have a significant impact on financial result or position.

The following IFRIC:s shall be applied as from January 1, 2007:

 

   

IFRIC Interpretation 7 Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies. This Interpretation provides guidance on how to apply the requirements of IAS 29 in a reporting period in which an entity identifies the existence of hyperinflation in the economy of its functional currency.

 

   

IFRIC Interpretation 8 Scope of IFRS 2. This interpretation applies to transactions when the identifiable consideration received appears to be less than the fair value of the equity instruments granted.

 

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IFRIC Interpretation 9 Reassessment of Embedded Derivatives. Determines when an entity shall reassess the need for an embedded derivative to be separated.

 

   

IFRIC Interpretation 10 Interim Financial Reporting and Impairment. An entity shall not reverse an impairment loss recognized in a previous interim period in respect of goodwill or an investment in either an equity instrument or a financial asset carried at cost.

The following IFRIC:s shall be applied as from January 1, 2008:

 

   

IFRIC Interpretation 11 IFRS 2—Group and Treasury Share Transactions. This interpretation addresses issues in relation to such transactions when grants to equity instruments of the entity are made to employees and treatment of these grants in individual companies.

 

   

IFRIC Interpretation 12 Service Concession Arrangements. This Interpretation gives guidance on the accounting by operators for public-to-private service concession arrangements.

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 and outcomes may occur within the next financial year that could require a material adjustment to the carrying amount of the asset or liability affected. 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 contracts. Managerial judgment is applied regarding, among other aspects, 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, 2006 amount to SEK 2.6 (2.5) billion or 12 (13) percent of gross inventory. Of the total inventory of SEK 21.5 (19.2) billion, SEK 10.6 (11.6) billion is contract work in progress and SEK 10.9 (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 technological 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 carryforwards. 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 carryforwards and our ability to utilize tax losses is based upon our estimates of future taxable income in different tax jurisdictions and involves assumptions regarding the deductibility of costs not yet subject to taxation.

At December 31, 2006, the value of unutilized tax loss carryforwards amounted to SEK 23,1 (28,0) billion. The deferred tax amounts related to loss carry-forwards are reported as non-current assets.

 

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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 accounting for these require management’s 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 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. Impairment testing is performed thereafter whenever there is an indication of impairment. Intangible assets not yet available for use are tested annually. The definition of amortization period as well as evaluation of future cash flows also requires management’s judgment.

At December 31, 2006, the amount of capitalized development costs amounted to SEK 5.0 (6.1) billion.

INTELLECTUAL PROPERTY RIGHTS AND OTHER ACQUIRED INTANGIBLE ASSETS, OTHER THAN GOODWILL

At initial recognition, future cash flows are calculated, ensuring that the initial carrying values do not exceed the discounted cash flows for the items of this type of assets. Impairment tests are made sub-sequent to initial recognition whenever there is an indication of impairment. At initial recognition and subsequent measurement, management judgements are made, both for assumptions and outcomes of calculations.

At December 31, 2006, the amount of intellectual property rights and other acquired intangible assets, other than goodwill amounted to SEK 15.6 (0.9) billion.

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 evaluate the likelihood that the individual receivables will be paid. Total allowances for doubtful accounts as of December 31, 2006, were SEK 1.4 (1.4) billion or 2.7 (3.4) percent of our gross trade receivables.

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, 2006, amounted to SEK 3.0 (4.8) billion.

 

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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. Expected return on plan assets consider long-term historical returns, allocation of assets and estimates of future long-term investment returns. At December 31, 2006, provisions for pensions and other post-employment benefits amounted to net SEK 6.1 (5.4) 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 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, 2006, Other provisions amounted to SEK 8.6 (11.5) 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 actual 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 hedge accounting are not fulfilled.

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

C3    SEGMENT INFORMATION

BUSINESS SEGMENTS (PRIMARY)

 

2006

   Systems     Phones    Other
operations
    Unallocated     Eliminations    Group  

Net sales

   167,570     —      10,213     —       —      177,783  

Inter-segment sales

   141     —      1,376     —       –1,517    —    
                                  

Total net sales

   167,711     —      11,589     —       –1,517    177,783  
                                  

Share in earnings of JV and associated companies

   65     5,852    17     —       —      5,934  
                                  

Operating income

   26,824     5,852    895     2,257 5)   —      35,828  
                                  

Operating margin (%)

   16 %   —      8 %   —       —      20 %

Financial income

               1,954  

Financial expenses

               –1,789  
                  

Income after financial items

               35,993  
                  

Taxes

               –9,557  
                  

Net income

               26,436  

Net income attributable to:

              

stockholders of the parent company

               26,251  

minority interest

               185  
                                  

Assets 1) 2)

   119,453     —      8,463     77,615     —      205,531  

Equity in joint ventures and associated companies

   1,106     8,041    262     —       —      9,409  
                                  

Total assets

   120,559     8,041    8,725     77,615     —      214,940  
                                  

Liabilities 3) 4)

   60,003     —      3,962     30,080     —      94,045  
                                  

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 mainly 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, interest-bearing liabilities and post-employment benefits.
5) Unallocated operating income includes the effect of the divesture of the Defense business by SEK 2,963 million.

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Other segment items

 

2006

   Systems     Phones    Other
operations
   Unallocated    Eliminations    Group

Property, plant and equipment and intangible assets

                

Additions/capitalization

   20,888  1)   —      1,207    —      —      22,095

Depreciation

   -2,874     —      -132    -1    —      -3,007

Amortization

   -3,991     —      -209    –37    —      -4,237

Impairment, net of reversals

   -225     —      -47    —      —      -272

Restructuring expenses

   -2,908     —      —      —      —      -2,908

Gains/losses from divestments

   —       —      2,963    -18    —      2,945

Number of employees

   59,484     —      4,297    —      —      63,781

1) Of which related to the Marconi acquisition SEK 15.4 billion.

GEOGRAPHICAL SEGMENTS (SECONDARY)

 

2006

   Net sales    Total assets   

Additions/
capitalization of

PP&E and

intangible assets

  

Number of

employees

Western Europe

   51,938    158,773    20,653    38,432

—of which Sweden

   6,566    125,578    17,819    19,094

Central and Eastern Europe, Middle East and Africa

   50,301    8,598    151    6,325

Asia Pacific

   43,202    24,394    415    10,388

—of which China

   11,766    9,088    206    3,938

North America

   15,862    10,893    798    4,138

—of which United States

   13,873    10,231    739    2,582

Latin America

   16,480    12,282    78    4,498
                   

Total

   177,783    214,940    22,095    63,781
                   

—of which EU

   55,888    159,310    20,709    39,818
                   

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

BUSINESS SEGMENTS (PRIMARY)

 

2005

   Systems     Phones    Other
operations
    Unallocated5)    Eliminations    Group5)  

Net sales

   141,986     —      9,835     —      —      151,821  

Inter-segment sales

   113     —      1,061     —      -1,174    —    
                                 

Total net sales

   142,099     —      10,896     —      -1,174    151,821  
                                 

Share in earnings of JV and associated companies

   118     2,257    20     —      —      2,395  
                                 

Operating income

   30,885     2,257    283     -341    —      33,084  
                                 

Operating margin (%)

   22 %   —      3 %   —      —      22 %

Financial income

                2,653  

Financial expenses

                -2,402  
                   

Income after financial items

                33,335  
                   

Taxes

                -8,875  
                   

Net income

                24,460  

Net income attributable to:

               

stockholders of the parent company

                24,315  

minority interest

                145  
                                 

Assets1) 2)

   85,958     —      10,541     106,524    —      203,023  
                                 

Equity in joint ventures and associated companies

   1,185     5,044    84     —      —      6,313  
                                 

Total assets

   87,143     5,044    10,625     106,524    —      209,336  
                                 

Liabilities3) 4)

   60,670     —      6,461     39,733    —      106,864  
                                 

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 mainly 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, interest-bearing liabilities and post-employment benefits.
5) Ericsson has adopted the option in IAS 19 to recognize actuarial gains or losses directly to equity, and year 2005 figures have been restated accordingly.

 

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Other segment items

 

2005

   Systems    Phones    Other
operations
   Unallocated5)    Eliminations    Group5)

Property, plant and equipment and intangible assets

                 

Additions/capitalization

   5,166    —      438    —      —      5,604

Depreciation

   -2,676    —      -127    -1    —      -2,804

Amortization

   -2,976    —      -377    84    —      -3,269

Impairment, net of reversals

   271    —      —      —      —      271

Number of employees

   50,107    —      5,948    —      —      56,055

GEOGRAPHICAL SEGMENTS (SECONDARY)

 

2005

   Net sales    Total assets2)   

Additions/

capitalization of

PP&E and

intangible assets

  

Number of

employees

Western Europe

   41,940    154,159    4,565    35,679

— of which Sweden

   6,110    133,448    3,502    21,178

Central and Eastern Europe, Middle East and Africa1)

   40,911    7,891    113    4,533

Asia Pacific1)

   30,463    20,290    285    8,550

— of which China

   11,544    8,964    123    3,601

North America

   19,432    13,754    552    3,911

— of which United States

   17,904    12,988    453    2,113

Latin America

   19,075    13,242    89    3,382
                   

Total

   151,821    209,336    5,604    56,055
                   

— of which EU

   45,288    154,075    4,628    36,482

1) Restated for change of geographical segment for Pakistan.
2) Ericsson has adopted the option in IAS 19 to recognize actuarial gains or losses directly to equity, and year 2005 figures have been restated accordingly.

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

BUSINESS SEGMENTS (PRIMARY)

 

2004

   Systems     Phones    Other
operations
    Unallocated    Eliminations    Group  

Net sales

   121,549     —      10,423     —      —      131,972  

Inter-segment sales

   1,348     —      966     —      –2,314    —    
                                 

Total net sales

   122,897     —      11,389     —      –2,314    131,972  
                                 

Share in earnings of JV and associated companies

   90     2,143    68     22    —      2,323  
                                 

Operating income

   23,187     2,143    1,298     78    —      26,706  
                                 

Operating margin (%)

   19 %   —      11 %   —      —      20 %

Financial income

                3,541  

Financial expenses

                -4,081  
                   

Income after financial items

                26,166  
                   

Taxes

                -8,330  
                   

Net income

                17,836  

Net income attributable to:

               

stockholders of the parent company

                17,539  

minority interest

                297  
                                 

Assets1) 2)

   66,973     —      9,452     105,606    —      182,031  

Equity in joint ventures and associated companies

   961     3,092    97     5    —      4,155  
                                 

Total assets

   67,934     3,092    9,549     105,611    —      186,186  
                                 

Liabilities3) 4)

   54,728     —      6,627     43,329    —      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 mainly 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, interest-bearing liabilities and post-employment benefits.

Other segment items

 

2004

   Systems    Phones    Other
operations
   Unallocated    Eliminations    Group

Property, plant and equipment and intangible assets

                 

Additions/capitalization

   3,898    —      399    —      —      4,297

Depreciation

   -2,224    —      -209    -1    —      -2,434

Amortization

   -4,381    —      -82    11    —      -4,452

Impairment, net of reversals

   -22    —      -61    -35    —      -118

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

GEOGRAPHICAL SEGMENTS (SECONDARY)

 

2004

   Net sales   

Additions/

capitalization of

PP&E and

intangible assets

Western Europe

   40,542    3,571

—of which Sweden

   6,180    2,868

Central and Eastern Europe, Middle East and Africa2)

   33,075    86

Asia Pacific2)

   28,406    227

—of which China

   12,298    130

North America

   15,471    320

—of which United States

   13,984    165

Latin America

   14,478    93
         

Total

   131,972    4,297
         

—of which EU1)

   42,366    3,620
         

1) Restated due to new members in EU as of May, 2004.
2) Restated for change of geographical segment for Pakistan.

C4    REVENUES

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, determine the appropriate revenue recognition method. The contracts are of three main types:

 

         2006            2005            2004    

Sales of equipment and network rollout

   142,191    125,856    110,985

Of which:

        

—Delivery-type contracts

   127,639    107,844    87,666

—Construction-type contracts

   14,552    18,012    23,319

Service sales

   32,380    23,477    19,301

Licenses

   3,212    2,488    1,686
              

Net sales

   177,783    151,821    131,972
              

Other revenues

        

Capital gains and other operating revenues

   6,192    2,760    3,119

Interest income

   1,774    2,310    3,346

Dividends

   7    9    8

 

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C5    EXPENSES BY NATURE

 

         2006            2005            2004    

Goods and services

   108,033    86,630    71,842

Amortization and depreciation

   7,244    6,073    6,886

Impairments, net of reversals

   876    508    2,786

Employee remunerations

   42,821    34,458    32,356

Interest expenses

   1,789    2,402    4,081

Taxes

   9,557    8,875    8,330
              

Expenses incurred

   170,320    138,946    126,281

Less:

        

Inventory changes1)

   3,791    2,872    2,526

Additions to Capitalized development

   1,353    1,174    1,138
              

Expenses charged to the Income Statement

   165,176    134,900    122,617
              

1) The inventory changes are based on changes of inventory values prior to allowances (gross value).

C6    OTHER OPERATING INCOME

 

         2006            2005            2004    

Gains on sales of intangible assets and PP&E

   27    29    111

Losses on sales of intangible assets and PP&E

   -158    -120    -229

Gains on sales of investments and operations

   3,038    205    510

Losses on sales of investments and operations

   -93    -149    -273
              

Capital gains/losses, net

   2,814    -35    119
              

Other operating revenues

   3,127    2,526    2,498
              

Total other operating income

   5,941    2,491    2,617
              

The gains on sales of investments and operations for 2006 mainly relate to the sale of Ericsson Microwave Systems in the third quarter.

C7    FINANCIAL INCOME AND EXPENSES

 

         2006            2005            2004    

Financial income

        

Income from securities and receivables accounted for as non-current assets

   369    293    354

Other interest income and similar Profit/loss items

   1,585    2,360    3,187
              

Total

   1,954    2,653    3,541
              

Financial expenses

        

Interest expenses and similar profit/loss items

   -1,789    -2,402    -4,081
              

Financial net

   165    251    -540
              

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

C8    TAXES

INCOME STATEMENT

The following items are included in Taxes:

 

         2006            2005            2004    

Current income taxes for the year

   -4,565    -3,635    -2,324

Current income taxes related to prior years

   -169    138    -637

Deferred tax income/expense (–) related to temporary differences

   -3,582    -4,753    -4,635

Share of taxes in joint ventures and associated companies

   -1,241    -625    -734
              

Taxes

   -9,557    -8,875    -8,330
              

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:

 

         2006            2005            2004    

Income after financial items

   35,993    33,335    26,166

Tax rate in Sweden (28%)

   -10,078    -9,334    -7,327

Effect of foreign tax rates

   -156    -489    -286

Current income taxes related to prior years

   -169    138    -637

Benefits from temporary differences of prior periods used to reduce deferred tax expense

   505    380    —  

Tax effect of expenses that are non-deductible for tax purpose

   -1,333    -515    -910

Tax effect of income that are non-taxable for tax purpose

   1,608    944    855

Tax effect of changes in tax rates

   66    1    -27
              

Taxes

   -9,557    -8,875    -8,330
              

BALANCE SHEET

Deferred tax assets and liabilities

Tax effects of temporary differences, including unutilized tax loss carryforwards, have resulted in deferred tax assets and liabilities as follows:

 

         2006            2005    

Deferred tax assets

   13,564    18,519

Deferred tax liabilities

   382    391

Deferred tax assets relate to tax loss carryforwards of SEK 6,756 million and temporary differences of SEK 6,808 million, which are related to deferred tax on eliminated group adjustments SEK 1,391 million, warranty commitments SEK 787 million, obsolescence allowance SEK 609 million, allowance for receivables SEK 375 million and other provisions and accruals SEK 3,646 million.

Deferred tax asset are amounts recognized in countries where we expect to be able to generate corresponding taxable income in the future to benefit from tax reductions. The significant tax loss carryforwards are related to countries with long or indefinite periods of utilization, mainly Sweden and the US. Of the total deferred tax assets for tax loss carryforwards, SEK 6,756 million, SEK 5,271 million relate to Sweden with indefinite time of utilization.

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

With our strong current financial position and profitability during 2006, we have been able to use part of our tax loss carryforwards during the year, and we are convinced that Ericsson will be able to generate sufficient income in the coming years to utilize also remaining parts.

Deductible temporary differences and unused tax losses for which no deferred tax asset is recognized in the balance sheet amounted to approximately SEK 80 million.

Investments in subsidiaries

Due to losses in certain subsidiary companies, the book value of certain investments in those subsidiaries are less than the tax value of these investments. Since deferred tax assets have been reported with respect also to losses in these companies, and due to the uncertainty as to which deductions can be realized in the future, no additional deferred tax assets are reported.

Tax loss carryforwards

Deferred tax assets regarding unutilized tax loss carryforwards are reported to the extent that realization of the related tax benefit through the future taxable profits is probable also when considering the period during which these can be utilized, as described below.

At December 31, 2006, these unutilized tax loss carryforwards amounted to SEK 23,137 (28,034) million. The tax effect of these tax loss carryforwards are reported as an asset.

The final years in which these loss carryforwards can be utilized are shown in the following table:

 

Year of expiration

   Tax loss
carryforwards
   Tax
effect

2007

   33    6

2008

   100    32

2009

   128    41

2010

   388    125

2011

   350    114

2012 or later

   22,138    6,438
         

Total

   23,137    6,756
         

Tax effects reported directly to stockholders’ equity

Tax effects reported to equity amount to SEK –769 (1,523 )million, of which hedge accounting SEK –676 million and actuarial gains/losses on pensions SEK –93 million.

C9    EARNINGS PER SHARE

 

         2006            2005            2004    

Net income attributable to stockholders of the parent company
(SEK million)

   26,251    24,315    17,539

Average number of shares outstanding, basic (millions)

   15,871    15,843    15,829

Earnings per share, basic (SEK)

   1.65    1.53    1.11
              

Net income attributable to stockholders of the parent company
(SEK million)

   26,251    24,315    17,539

Average number of shares outstanding, diluted (millions) 1)

   15,943    15,907    15,895
              

Earnings per share, diluted (SEK)

   1.65    1.53    1.11
              

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 


1) Includes the sum of the average number of ordinary shares outstanding and dilutive potential ordinary shares for Ericsson’s stock option and purchase plans.

The number of dilutive shares for option programs was 17.5 million and for stock purchase programs 54.7 million, as per December 31, 2006.

C10    INTANGIBLE ASSETS

 

    Capitalized development costs   Goodwill   Intellectual property rights

2006

  To be
marketed
  Acquired
costs for
internal use
  Internal
costs, for
internal use
  Total       Licenses
trademarks
and similar
rights
   

Patents and
acquired

research and

development

    Total

Accumulated acquisition costs

               

Opening balance

  11,983   1,638   1,094   14,715   7,362   1,065     1,373     2,438

Acquisitions

  1,353   —     —     1,353   163   792     363     1,155

Balances regarding divested/ acquired businesses

  —     —     —     —     —     3,711 1)   11,937 1)   15,648

Sales/disposals

  -948   -36   -24   -1,008   —     -173     -188     -361

Translation difference for the year

  —     —     —     —     -701   -78     -6     -84
                                   

Closing balance

  12,388   1,602   1,070   15,060   6,824   5,317     13,479     18,796
                                   

Accumulated amortization

               

Opening balance

  -5,192   -1,549   -1,033   -7,774   —     -882     -603     -1,485

Amortization for the year2)

  -2,195   -49   -33   -2,277   —     -452     -1,508     -1,960

Sales/disposals

  948   36   24   1,008   —     110     155     265

Translation difference for the year

  —     —     —     —     —     44     3     47
                                   

Closing balance

  -6,439   -1,562   -1,042   -9,043   —     -1,180     -1,953     -3,133
                                   

Accumulated impairment losses

               

Opening balance

  -716   -38   -26   -780   —     —       -14     -14

Impairment losses for the year

  -242   —     —     -242   —     —       —       —  
                                   

Closing balance

  -958   -38   -26   -1,022   —     —       -14     -14
                                   

Net carrying value

  4,991   2   2   4,995   6,824   4,137     11,512     15,649
                                   

1) As per January 1, 2006, Ericsson acquired assets of Marconi telecommunications operations. The acquisition consists of IPR, SEK 11.7 billion, and brands and customer relationships, SEK 3.6 billion. The remaining amortization period related to the intellectual property rights acquired from Marconi is nine years.
2) No intangible assets other than goodwill have indefinite useful lives.

Amortization and impairment losses for capitalized development costs is reported as research and development and other technical expenses.

 

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The goodwill is allocated to the business segment Systems, representing one cash-generating unit due to that the goodwill is related to acquisitions of internet protocol (IP) competence and know-how. IP technology is an integrated part of the products within Systems and separate prices are not defined or invoiced to the customers for this technology. The estimates used for measuring the recoverable amounts for goodwill per cash-generating unit include mainly assumptions for the following key parameters:

 

   

sales growth,

 

   

development of operating margin, reduced with estimated tax expense,

 

   

capital expenditure requirements, including working capital

The assumptions, approved by management, are based on available industry sources that provide estimates of the number of mobile subscribers. The number of global subscriptions is estimated to grow from 2.7 billion to more than 4 billion within five years. The minutes of usage per user will also continue to increase. Impairment testing is based on the premise that changes for the main assumptions are in line with the development for the global subscriber growth, based on detailed assumptions for four years, with a slight decrease thereafter. The impairment test for goodwill has not resulted in any impairment. A number of tests of sensivity have been made, for example the effect of a growth of just one percent per year. None of these tests indicate impairment. The management’s view is that it is unlikely that an outcome for the key parameters will occur that would result in impairment. A pre-tax discount rate of 12 percent has been applied for the discounting of projected cash flows.

 

    Capitalized development costs   Goodwill   Intellectual property rights

2005

  To be
marketed
  Acquired
for internal
use
  Internal
costs, for
internal use
  Total      

Licenses
trademarks

and similar

rights

 

Patents and
acquired

research and

development

  Total

Accumulated acquisition costs

               

Opening balance

  11,876   1,638   1,094   14,608   5,766   1,022   1,118   2,140

Acquisitions

  1,174   —     —     1,174   512   38   515   553

Balances regarding divested/ acquired businesses

  —     —     —     —     —     11   —     11

Sales/disposals

  -1,067   —     —     -1,067   —     -73   -276   -349

Translation difference for the year

  —     —     —     —     1,084   67   16   83
                               

Closing balance

  11,983   1,638   1,094   14,715   7,362   1,065   1,373   2,438
                               

Accumulated amortization

               

Opening balance

  -3,458   -1,424   -950   -5,832   —     -901   -477   -1,378

Amortization for the year

  -2,801   -125   -83   -3,009   —     -8   -252   -260

Balances regarding divested/ acquired businesses

  —     —     —     —     —     -7   —     -7

Sales/disposals

  1,067   —     —     1,067   —     78   134   212

Translation difference for the year

  —     —     —     —     —     -44   -8   -52
                               

Closing balance

  -5,192   -1,549   -1,033   -7,774   —     -882   -603   -1,485
                               

Accumulated impairment losses

               

Opening balance

  -621   -38   -26   -685   —     —     -14   -14

Impairment losses for the year

  -95   —     —     -95   —     —     —     —  
                               

Closing balance

  -716   -38   -26   -780   —     —     -14   -14
                               

Net carrying value

  6,075   51   35   6,161   7,362   183   756   939
                               

 

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NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

C11    PROPERTY, PLANT AND EQUIPMENT

 

2006

   Real estate   

Machinery and

other technical

assets

  

Other

equipment,

tools and

installations

  

Construction in

process and

advance

payments

   Total

Accumulated acquisition costs

              

Opening balance

   3,512    5,200    17,146    287    26,145

Additions

   772    931    1,264    860    3,827

Balances regarding divested/acquired businesses

   624    8    -337    11    306

Sales/disposals

   -47    -1,036    -2,448    -45    -3,576

Reclassifications

   21    59    552    -632    —  

Translation difference for the year

   -331    -157    -1,042    -24    -1,554
                        

Closing balance

   4,551    5,005    15,135    457    25,148
                        

Accumulated amortization

              

Opening balance

   -1,119    -4,285    -13,106    —      -18,510

Depreciation for the year

   -206    -706    -2,095    —      -3,007

Balances regarding divested/acquired businesses

   —      156    542    —      698

Sales/disposals

   40    1,043    2,178    —      3,261

Reclassifications

   28    2    -30    —      —  

Translation difference for the year

   45    111    773    —      929
                        

Closing balance

   -1,212    -3,679    -11,738    —      -16,629
                        

Accumulated impairment losses, net

              

Opening balance

   -359    -145    -165    —      -669

Impairment losses for the year

   —      -11    -50    —      -61

Reversals of impairment losses

   —      —      31    —      31

Balances regarding divested/acquired businesses

   —      —      —      —      —  

Sales/disposals

   —      —      —      —      —  

Translation difference for the year

   53    2    6    —      61
                        

Closing balance

   -306    -154    -178    —      -638
                        

Net carrying value

   3,033    1,172    3,219    457    7,881
                        

Contractual commitments for the acquisition of property, plant and equipment as per December 31, 2006, amounted to SEK 190 (1,448) million. The reversal of impairment losses have been reported under Cost of sales.

 

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2005

   Real estate   

Machinery and

other technical

assets

  

Other

equipment,

tools and

installations

  

Construction in

process and

advance

payments

   Total

Accumulated acquisition costs

              

Opening balance

   2,657    5,306    15,350    303    23,616

Additions

   461    405    1,745    754    3,365

Balances regarding divested/acquired businesses

   14    -14    24    —      24

Sales/disposals

   -196    -582    -2,001    -17    -2,796

Reclassifications

   229    -121    659    -767    —  

Translation difference for the year

   347    206    1,369    14    1,936
                        

Closing balance

   3,512    5,200    17,146    287    26,145
                        

Accumulated amortization

              

Opening balance

   -583    -4,374    -11,652    —      -16,609

Depreciation for the year

   -366    -489    -1,949    —      -2,804

Balances regarding divested/acquired businesses

   -3    13    -21    —      -11

Sales/disposals

   96    562    1,685    —      2,343

Reclassifications

   -4    173    -169    —      —  

Translation difference for the year

   -259    -170    -1,000    —      1,429
                        

Closing balance

   -1,119    -4,285    -13,106    —      -18,510
                        

Accumulated impairment losses, net

              

Opening balance

   -482    -148    -532    —      -1,162

Impairment losses for the year

   —      -14    —      —      -14

Reversals of impairment losses

   43    —      337    —      380

Balances regarding divested/acquired businesses

   -1    —      —      —      -1

Sales/disposals

   —      —      —      —      —  

Translation difference for the year

   81    17    30    —      128
                        

Closing balance

   -359    -145    -165    —      -669
                        

Net carrying value

   2,034    770    3,875    287    6,966
                        

C12    FINANCIAL ASSETS

EQUITY IN JOINT VENTURES AND ASSOCIATED COMPANIES

 

     Joint ventures    Associated companies    Total
         2006            2005            2006            2005            2006            2005    

Opening balance

   5,038    3,092    1,275    1,063    6,313    4,155

Share in earnings

   5,852    2,257    82    138    5,934    2,395

Taxes

   -1,237    -604    -4    -21    -1,241    -625

Translation difference for the year

   -422    286    -9    92    -431    378

Change in hedge reserve

   -30    7    —      —      -30    7

Dividends

   -1,160    —      -102    -32    -1,262    -32

Capital contributions

   —      —      201    33    201    33

Reclassification

   —      —      -8    2    -8    2

Disposals

   —      —      -67    —      -67    —  
                             

Closing balance

   8,041    5,038    1,368    1,275    9,409    6,313
                             

Goodwill, net, amounts to SEK 18 (21) million.

 

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ERICSSON ANNUAL REPORT ON FORM 20-F 2006

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

ERICSSON’S SHARE OF ASSETS, LIABILITIES AND INCOME IN JOINT VENTURE SONY ERICSSON MOBILE COMMUNICATIONS

 

Non-current assets

   1,963

Current assets

   21,268

Non-current liabilities

   87

Current liabilities

   15,103
    

Net assets

   8,041
    

Net sales

   50,770