Ericsson Lm Telephone Co Q3 FY2023 Earnings Call

Hello, everyone, and welcome to today's Ericsson's Third Quarter 2023 Results. With me today I have our CFO, Carl Mellander, and direct from New York, I have our CEO, Borje Ekholm. Last week, Thursday, we preannounced our Q3 numbers as we announced an impairment of goodwill attributed to our acquisition of Vonage. Today, however, we will not only give you more details around the Q3 report and expectations going forward, we will actually also spend some time talking about our GMP strategy. So we'll start with Borje summarizing Q3 and then we'll talk more about the GMP strategy. The call will then return back to Carl, who will give more details around the Q3 results and expectations going forward. As usual, we will end the presentation with a Q&A session. And in order to ask those questions, you need to join the conference by telephone. Details can be found at today's press release or at our website, ericsson.com/investors. Please be advised that today's conference is being recorded. But before handing over to Borje and Carl, I would like to say the following. During today's presentation, we will be making forward-looking statements. These statements are based on our current expectations and certain planning assumptions, which are subject to risks and uncertainties. The actual results may differ materially due to factors mentioned in today's press release and discussed in this conference call. We encourage you all to read about these risks and uncertainties in the earnings report as well as in the annual report. With that said, I would like to hand over the word to Borje. So please, Borje.

Thanks Peter. First of all, welcome to our report presentation for the third quarter and thanks everyone for joining us. As Peter mentioned, we will spend some more time now on GMP in this presentation. First, let me hit on some key takeaways. So Q3 was in line with our previously indicated expectations, with a bit of a soft top-line in North America than we expected, but we bet the margins in the rest of the business. Despite the uncertain macroeconomic backdrop, we continue to execute against our three key priorities: strengthen our leadership in mobile networks built upon technology leadership, grow our enterprise business, and drive a continued cultural transformation. We're encouraged by the progress we're making, and it's truly a testament to the strength of our team, our strategy, and the excellence of our products and our ability to execute. I would like to use this presentation to describe why we're excited about what we're creating with GMP and the value we believe it'll deliver to our shareholders. Carl will take you through the more financials in detail and the outlook in greater detail. In common with the rest of the industry, rising interest rates and changing demand trends have been headwinds to Vonage's current core business, and the impairment we took last week is simply a consequence of this. Vonage itself remains key to our expansion into enterprise and to the transformation of our business. We believe this is a massive opportunity that can redefine our industry by providing a new source of revenues to the whole industry. But first, let me touch on the market environment. Over the last two decades, we've seen that investments in mobile infrastructure have built-in cycles, and in aggregate, it's been overall flattish. We believe this pattern will continue. We don't believe the peak levels of 2022 will return, but we do believe that investments will normalize from current levels. The reason for this recovery is that data traffic continues to grow, which implies a need for more capacity as well as modernizations of networks. It's important to note that while data traffic continues to grow at a very high rate, this implies market normalization, not incremental market growth. The reason for a flat market for mobile infrastructure is that operator service revenues have only had very limited growth. To achieve growth in our core infrastructure market, we need a catalyst to increase service revenue growth for the operators. We're committed to our long-term EBITDA margin target of 15% to 18% and we aim to get there as soon as possible. However, given that our customers are cautious on investments in the current uncertain market environment, we will not give guidance beyond Q4 of this year. We have started to see more positive discussions with operators about network investments, but it's clearly too early to call this a turning point. We're confident that the recovery will come, but the timing is really in our customers' hands and given that we think it's prudent to plan for current market conditions to prevail into 2024. Therefore, that provides the basis for how we manage our business with a focus on cost control and operational efficiency. With the actions we take when the market recovers, we will see significant operating leverage in the business. So now let me comment on what we're building with Vonage. We are on the journey to fundamentally reimagine our business. While this takes time, we remain confident in our long-term plans and trajectory, and believe that Ericsson has a very exciting future ahead of us. Our enterprise strategy and positive outlook on the global network platform remains unchanged. Positive interactions with customers have further strengthened our belief in the area. Vonage is developing into a platform business and has extended our growth trajectory in new and existing markets, adding to our total return profile for our shareholders. None of this would be possible without the acquisition. This quarter, we were also proud to announce that Vonage was recognized as a leader in the 2023 Gartner Magic Quadrant for CPaaS. So in the coming 5 to 10 years, we will see an acceleration of major trends such as electrification, the green revolution, resilient supply chains, increased efficiency, productivity, and automation. Making this future reality will require ubiquitous high-performance, differentiated networks and the broad ecosystem of businesses and developers who can innovate and build upon the network's powerful capabilities. That's what we're doing through our strategy, making networks fully programmable and globally available with open interfaces and open APIs that enable continuous business growth and innovation. This includes our investments into Cloud RAN. In all of this, we can drive a much-needed transformation of the telecom industry. The global network platform is vital in exposing the capabilities of the mobile network to the full ecosystem around us, including the developers. At the heart of this is 5G, a technology that is 10 times more powerful than previous generations and has the potential to revolutionize society. While previous generations of mobile technology digitalized the consumer and gave rise to the app economy, it was based on best-effort connectivity. However, best-effort connectivity is no longer good enough. Rapidly digitalizing enterprises need more than consumers. They need predictable and reliable connectivity with predetermined SLAs. 5G was designed to provide this with advanced capabilities such as speed, ultra-low latency, and the ability to offer differentiated quality of service. 5G is a critical tool for transforming industries and consumers. To seize on this potential, we must redefine how the telecom industry delivers and captures value. A few years back, we tested speed on demand with a push of a button and saw very strong interest from application developers. However, we realized to commercialize this, all developers would need to individually contract with operators around the world, which is not feasible for commercialization. What was needed was an easy way to expose advanced network capabilities, along with a strong developer community able to use these features to drive the next wave of innovation. This is the underlying reason for our acquisition of Vonage. Vonage provides us with both the platform technology and CPaaS and the developer community of today: 1.4 million developers we need to make our vision a reality. We recently took an important step toward this strategy and launched a global network platform, combining the power of Vonage and network APIs, enabling mobile networks and applications to talk to each other. This platform makes it easy to expose, consume, and pay for advanced network capabilities. Last month, we announced a historic milestone in our network API journey together with Deutsche Telekom. Powered by the global network platform, DT can now offer a globally scalable one-stop shop for communication APIs such as voice, SMS, two-factor authentication, enhanced security, as well as network APIs like location, device status, and quality on demand. Through this global network platform, we're creating a new market for exposing 5G capabilities, with an opportunity estimated by analysts to be about $20 billion by 2028. We aim to capture a sizable share of this market as we are the front runner today. We expect the first revenues for network APIs during 2023, although limited in scale. There is a shift in the market as we discuss network APIs with all our customers, and all see this as a major opportunity to monetize the network and the investments in 5G. With network as a platform, every contributor in the ecosystem adds value to create a flywheel of exponential growth and innovation. This starts with network APIs that allow developers and enterprises to create enhanced services. These solutions combined with performance-based business models offer CSPs new ways to monetize their networks. This attracts more CSPs to join the platform, which fuels network enhancements to meet growing demand for more advanced capabilities, thus supporting demand for our core business in mobile networks. We are also seeing increased interest from the developer community due to network APIs, further reinforcing the flywheel. Wireless networks are truly transformative with this flexibility, broad and global availability, and cost efficiency. By exposing these networks in an easy, scalable way, developers and businesses worldwide can build meaningful applications, making wireless networks the center of enterprise digitalization and transformation. What excites me is that this is just the beginning of an extraordinary opportunity for our industry. This will truly transform the telecom industry. The winners will be those who scale their platforms first. The time is now to seize on this opportunity, and we are very excited about our position. But now, over to Carl for a review of the numbers for Q3.

Thank you, Borje, and very good morning to everyone. Thanks for joining us here. As you saw already last week, our Q3 results align with the guidance we issued back in the Q2 report. But I want to address some key items around the financials for the quarter. Before commenting on the underlying results, I want to refer again to the impairment related to Vonage goodwill that we announced last week. This impairment of SEK 31.9 billion corresponds to 50% of the total goodwill and other intangible assets attributed to Vonage, and now the total goodwill in the group post this impairment amounts to SEK 56.7 billion. I can also mention that we have done rigorous impairment testing and that did not indicate any other impairment needs other than Vonage. Now turning to the underlying business results. If we look at the market and our top line, the financial development we saw in the first and second quarters continued into the third quarter. The telecom market outlook remains uncertain but is expected to recover to more normalized levels over time. We base this on the fundamentals; operators need to continue to invest to manage data traffic growth, energy usage, and network quality for their customer experience. We see a sales mix shift in networks, especially, where sales decreased in North America and increased in India with large rollout projects continuing at a similar pace in the third quarter. We've worked extensively on our resiliency to limit sensitivity to geographical mix changes, but we see an impact on group numbers from this mix change on sales, gross margin, EBITDA, and cash flow. On the top line, group organic sales declined by 10%, primarily driven by a 60% drop in North America in the networks business, where operators continue to adjust inventory and we are seeing a slower deployment pace. It is important to note that Q3 last year in 2022 was a record quarter in North America with large volumes of radios shipped and deployed, making year-over-year comparisons tough. The drop in North America was partly offset by continued rollout in India, which continued at incredible speed, and our sales quadrupled year-over-year to almost SEK 10 billion in the quarter. We also saw that some frontline customers in 5G resumed investments, indicating a second wave of 5G investments. It is encouraging, but it is too early to see this as a trend. We closed another IPR licensing agreement in the quarter that positions us to land additional agreements with previously unlicensed vendors, and IPR net sales landed at SEK 2.8 billion in the quarter, on track to reach the levels that we've discussed before for the longer-term. Regarding gross margin, it came in at 39.2%, excluding restructuring. Networks achieved a gross margin of 39.9%, which was in the upper part of the range we had guided for, at 38% to 40%. This is a testament to the resiliency of our company and demonstrates how the business transformation we've been on for years has made us less sensitive to swings between geographies. Our EBITDA margin exceeded previously mentioned expectations due to early positive effects of our cost-cutting ambitions. For the group, we came in at 7.3%, a decline from last year's 11.3%, driven by gross income in networks. Cloud Software and Services delivered well in the quarter, with EBITDA of SEK 0.4 billion. We are talking about strict commercial discipline, improved software sales, accelerated service delivery automation, as some of the key pillars there. Given the nature of this business, results will fluctuate between quarters, so it's important to assess performance over time. If we look at the free cash flow before M&A, we came in at SEK 0.5 billion negative. This is a result of the same business mix shift, which includes large rollout projects with a longer order to cash cycle. In North America and other early markets, customers largely manage the installation of equipment themselves. Payment terms correlate with hardware and software delivery rather than site completion and equipment installation. Most large rollout projects, like in India, have contracts based on building and installing large-scale networks, resulting in high working capital relative to sales volumes. We expect this situation to taper off next year as the pace of large rollouts decreases. As that happens, we expect working capital to reduce, and gradually, we should return to our long-term free cash flow targets of 9% to 12% of net sales. We've achieved year-to-date run rate savings of SEK 10.5 billion, of which SEK 1.9 billion impacted the P&L in the third quarter. These savings primarily show in the mobile networks segment, while we continue to invest in enterprise for value creation. So now with this track record, we're slightly ahead of our internal plans for cost savings and have raised the ambition to SEK 12 billion in run rate savings by the end of the year. We will continue to take decisive cost actions as needed over time. Moving to the outlook for Q4, we expect gross margin in networks to land between 39% and 41%, up from the guidance we had for Q3. We anticipate that top-line seasonality between Q3 and Q4 in networks will be less than normal, mainly due to India expected to be sequentially flat from Q3 to Q4. In Cloud Software and Services, we expect EBITDA to reach at least breakeven for the full year. We don’t expect a linear result development quarter after quarter. Looking at group EBITDA margin for Q4, we expect to reach around 10%. We see similar market trends from Q3 continuing in Q4 but will benefit from our cost-cutting program. So with that, thank you, and I would like to hand back the word to Borje.

Thank you, Carl. While near-term dynamics are uncertain, our long-term confidence remains undiminished. In the current environment, we focus on what's within our control and executing on our strategy to extend our leadership in mobile networks, grow our enterprise business, and drive a lasting cultural transformation. As we look ahead, we see that mobile networks' investment intensity is on the lower end as our customers are cautious with investments. This gives us confidence that a recovery will come. Until then, we will continue to take actions that position Ericsson in the best way to create value. With the market recovery, we expect to see good operating leverage. I'm very confident in our team and the work they do every day. Our goal is to make Ericsson a more profitable company, return to our cash flow targets, and capture the next major wave of network innovation with a substantial platform business. With that, I think it's time for some Q&A. Peter.

That's correct, Borje. So, we will now then start the Q&A session. Operator Instructions: please raise your hand to ask a question. Let's look at the queue here. I think I have the first question from Aleksander Peterc at Societe Generale.

The first one will be just in broad terms. I know we don't guide on 2024, now that we no longer have this 15% EBITDA margin target, but could you give us a sense of whether you think network's gross margins will plateau around 40% that you held in the third quarter, and also into the fourth quarter despite the adverse developments of the U.S. market? Could you be able to hold this into next year or maybe improve it given the cost actions you're taking? And then just a very quick follow-up on India. Is that now leveling off at high levels and may roll off into decline next year, or do you see further expansion there?

I'll start, yes. I think what we say here in the report is that the tides will turn. The market mix will recover at some point, although the timing is unclear. If you look at the lower forecast, for example, North America would grow by 15% next year. As for India, it will taper off—that is quite clear from this record year in 2022, so it could support our gross margin development in networks.

The next question will come from the line of Joachim Gunell at DnB.

Two questions from my side starting off a bit where Andrew asked. Based on the positive customer discussions here, but of course, low visibility. Can you just comment on the extent to which you have the conservatism in your view of a quarter of 2023 market recovery other than walking away from the margin targets?

I can start. I would say that we believe there will be a recovery in the market, but the timing is unknown. Given that, we think it is prudent to plan for current market conditions to prevail, allowing us to take the right actions on the cost side. So when the market recovery comes, we gain operating leverage.

Perfect. And then one question for Carl. What does the additional SEK 1 billion in cost saving pertain to? And can you also comment on the timing of identifying this at this stage?

Sure, Joachim, I would say this is also a learning from the last time around when we had a large cost out effort. Once you start this machinery, you find more efficiencies and more possibilities to take out structural costs. That has happened here as every manager has been working on this since several quarters. We now see that we can deliver SEK 12 billion of savings. It's not about one area; there are many contributing factors and great momentum.

We will move further to the next question from the line of Francois Bouvignies at UBS.

I have two quick questions. The first one is more high level, but if we look at the current environment, especially in North America, we see quite extraordinary corrections, reverting back to 2018 levels. Given macro uncertainty around recovery, how do you see pricing evolving going forward? Do you see any pressure from the operators, given the challenges they are facing?

That's a highly relevant question. We do believe that investing in technology leadership is crucial for competition globally. There are opportunities to improve our R&D efficiency, and we are focused on that. However, we need to ensure we're competitively positioned against other large investments in the sector.

We will then move to the next question from Daniel Djurberg at Handelsbanken.

My question would be on the CapEx constraints. Given improvements in visibility regarding mobile or congress, is it your ambition to return to guidance with regards to the '24 adjusted EBITDA range, or should we forget about that?

It's fair to say that let's take that discussion when we see changes in market sentiment. Right now, I feel prudent to plan for that current conditions prevail and we can make right operating decisions.

Have you seen changes that suggest project transitions back to you, especially concerning Verizon?

We would never comment on specific customers, but we continue to expand our investments into Cloud RAN and are seeing positive developments there.

We will move to the next question coming from Erik Lindholm-Röjestål from SEB.

Can you discuss the guidance for network seasonality here in Q4? How do you assume North American market developments?

Overall, we expect that the average seasonality is representative of markets excluding India, where we see a flat development. No specific guidance on other markets beyond the normal influencing factors.

We have the next question from Andreas Joelsson at Danske Bank.

Could you share insights on the catalyst needed for operator investments to improve?

We need to tap into new revenue pools to deliver on 5G promises. The digitalization of enterprises leveraging wireless can significantly drive these investments.

We have the next question from Janardan Menon at Jefferies.

Can you give us an indication of timing for the development of 5G network APIs? Should we expect a sharper revenue inflection after 2024?

We expect some early revenues this year, although limited in scale. We believe by 2025, there is potential for meaningful growth as we onboard several operators.

Regarding India, the pace of rollout will be coming down. However, significant working capital demand could lead to a positive cash flow impact during 2024.

So we'll move further in the queue here. I see we have the next question coming from Sandeep Deshpande at JPMorgan.

Are there signs of revival in demand in Europe? What insights can you share about your European customers?

Investments in Europe have been slower than in other markets, and several European operators are under pressure. I worry about Europe's long-term competitiveness without adequate digital infrastructure.

We have the next question from Sebastien Sztabowicz from Kepler Chevreux.

What part of Vonage is slowing down? What's the growth trajectory for the Global Communication platform segment in the coming years?

The slowdown relates to market demand trends, including higher interest rates. We expect the global network platform to provide significant growth opportunities for the future.

In terms of Cloud Software and Services, we are still early in 5G core deployments, and the large-scale ramp-up is not yet visible. We expect positive developments beyond that.

That concludes today's call. Thank you all for listening to this Q3 earnings call in 2023. We look forward to the next call in January. With that, have a great day. Goodbye.

Thank you.

Thank you.