Ericsson Lm Telephone Co Q4 FY2023 Earnings Call

Hello, everyone, and welcome to Ericsson's Fourth Quarter and Full Year Results of 2023. With me today, I have, as usual, our CEO, Börje Ekholm; and our CFO, Carl Mellander. And we will end this presentation as normal with Q&A. In order to ask questions, you will need to join the conference by phone. Details can be found on today's press release or on our website, ericsson.com/investors. Please be also advised that this conference is recorded. Before handing over to Börje, I would like to read the following. During today's presentation, we will be making forward-looking statements. These statements are based on our current expectation and certain planning assumptions, which are subject to risks and uncertainties. The actual result 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 an earnings report today as well as in the annual report. With that said, I would like to hand over the word to Börje. So please, Börje.

Thanks, Peter, and good morning, everyone. Thanks for joining us today. In 2023, we navigated a difficult mobile networks market marked by persistent headwinds and an unprecedented slowdown in the North American market, which saw customers significantly reducing CapEx. With the rapid growth in India, we encountered a dramatic change in business mix. Overall, the total mobile networks market fell in size. Notwithstanding these challenges, we continue to execute our strategy, and I'm pleased to say that we concluded 2023 with a solid quarter, generating an EBITA of SEK 21.4 billion for the full year. Through our strong focus on gross margin that we've had for many years, we generated almost 40% gross margin for the year. While our actions to improve performance are paying off, we are not satisfied with our profitability, so we have much more work to do. As we look ahead, 2024 will be a difficult year, and market conditions will prevail. We currently expect the market outside of China to further decline as our customers remain cautious and the investment pace normalizes in India. With that, we remain laser-focused on managing what's in our control. We are consistently driving operational efficiency while keeping the investments critical to our future growth intact. We remain firmly committed to our long-term goals of 15% to 18% EBITA and 9% to 12% free cash flow. We are seeking to maximize the value for all our stakeholders. Let me walk you through some of the key takeaways from the past year and how our strategy is critical to the industry's long-term success. As expected, 2023 was a difficult year for the mobile network market with an overall decline combined with a dramatic change in market mix. Group sales declined organically by 10%, driven by an overall decrease of 15% in networks, with North America down by almost 50%. We relentlessly worked to strengthen our performance and cost management. We recognized more than a year ago the need to reduce costs. In 2023, we implemented efficiency improvements, including reducing internal and external headcount by over 9,000, enabling us to deliver against our cost savings target of SEK 12 billion gross. About half of that came into effect in 2023, and the remainder will come during 2024. Because of our efforts in past years and the importance we place on gross margin, we delivered a gross margin of 39.6% and an EBITA margin of 8.1% for the year. Given an almost unprecedented market environment with volume declines and business mix changes, this was a very solid performance by the team. Across our business areas, we took critical steps in building a stronger, more profitable Ericsson. In Mobile Networks, we continue to extend our technology leadership. Our technology empowers customers to build high-performance, differentiated, and programmable networks, leading the shift to open cloud-native networks. The contract with AT&T is key proof of how our technology is leveraged to improve the future network architecture and deliver a reduced total cost of ownership for our customers. This deal will create significant value for our customer and for Ericsson. We expect it to start ramping up in the second half of 2024. In Cloud Software and Services, we executed on the turnaround plan and reached our targets. For the full year, we delivered an EBITA of SEK 1.7 billion. Thank you to the entire team for their efforts. From now on, we will continue to increase commercial discipline, automation, and delivery efficiency, focusing on long-term profitability. In Enterprise Wireless solutions, we continue to build out offerings, including the acquisition of Ericom, and we further strengthened our position in private networks. During Q4, we saw slower growth due to macro headwinds. Through our global network platform, we continue to work with front-runner customers to reshape the industry by transforming the network into a platform for innovation. We have also driven our cultural transformation, focusing on integrity and strengthening governance, risk management, and compliance. All these initiatives come with a short-term cost, but are essential to our long-term competitiveness and success. We expect the RAN market outside of China to decline further as our customers are cautious, and investment pace normalizes in India. However, we expect our market share in North America to be helped by the AT&T contract in the second half of 2024. Historically, large declines in the mobile network market are followed by a rebound. Operators can manage assets for a while, but eventually, they’ll need to invest to handle data traffic growth, energy usage, quality, and customer experience needs. We believe this will happen again. We fully anticipate the market will recover to normalized levels, although the timing is hard to predict. This is ultimately in our customers' hands, and their investments will vary by customer, market, and competitive position. We also see slower growth in enterprise due to macroeconomic headwinds. With this outlook, we will continue to manage our balance sheet prudently while keeping sight of investments critical to our long-term strategy. As we focus on fundamental improvements to our cost structure, we expect to take additional actions, including reducing headcount as we pare back some investment areas and concentrate our portfolio where we can win. The Board proposed a dividend of SEK 2.70 per share, corresponding to a total amount of SEK 9 billion, to be paid out in two equal installments, as in previous years. While recognizing the near-term challenges, this reflects the Board's confidence in our long-term outlook as a company. Let me step back to put our achievements in perspective regarding our strategy. The mobile network market provides real value to economies through regular communication for consumers and digitalization for enterprises and society. However, the return on capital has been stagnant, and many operators struggle to earn the cost of capital. To change this, we can either passively wait for the market to improve or proactively reshape how networks are consumed and monetized. We have chosen the latter route. We are transforming the network into an innovation platform, leveraging cellular connectivity in new areas. First, we are building high-performance networks necessary for enterprise digitalization. By horizontalizing the architecture, we allow customers to prioritize investments in different network parts at varied cycles. This offers advanced network architectures and lowers ownership costs. Second, with Enterprise Wireless solutions, we are extending cellular connectivity through private 5G networks and wireless WAN. Third, we are developing a global network platform that enables exposure, consumption, and payment of network APIs, expanding the market beyond consumers to enterprises and developers. This shift in monetization models will take time, but we are encouraged by our progress with partners like DT to offer network APIs to developers and enterprises, and we see strong progress with frontrunner customers. We are confident this will create a more profitable and sustainable future for our industry and our company. Ericsson holds a clear leadership position today with our offerings. With our strategy and actions, we ensure we will be well positioned for market improvements. Before handing over to Carl, I want to comment on our new CFO announcement, Lars Sandström, who will join us from Getinge, bringing extensive experience from various financial and management roles. Lars will join us on April 1st, and Daniel Morris will be appointed Head of IR. Thank you, Carl and Peter, for your time at Ericsson. It's been a privilege to work with both of you. Thank you both. Now, Carl, it's time for you to go through the numbers.

Thanks a lot, Börje. Good morning to everyone. I will address some key items around the financials and provide comments on the outlook going forward. Looking at Q4, I would paraphrase Börje here: the challenging market in telecom and the market mix shift dominated throughout 2023. Reported full-year net sales in the U.S. were down by SEK 35 billion year-over-year, while India grew by over SEK 20 billion, highlighting the powerful shift. The impact on profits and cash flow is clear. We have communicated around this many times. However, this was partly countered by our cost-out efforts and efficiency improvements across the company. Q4 resulted in solid numbers despite current market conditions, demonstrating increased resilience in our company and a good team effort. Group sales declined by 17% organically to SEK 71.9 billion in Q4. Part of the decline was due to retroactive IPR revenue we had in Q4 '22. The primary driver was the continued drop in North America, where sales decreased by 43% year-over-year in the quarter. India, meanwhile, had a 10% year-over-year sales increase in Q4, but sequentially dropped 40%, reflecting the Indian market starting to normalize investment levels after an unprecedented rollout pace earlier in the year. Our gross margin was 41.1%, including restructuring charges, slightly down year-over-year. However, if we adjust for the large retroactive IPR revenue in Q4 '22, it's an improvement in gross margin. Gross margin in Q4 was supported by a higher share of software sales and cost reductions within the mobile networks business. We achieved a gross margin of 43.2% in Networks, excluding restructuring, exceeding the 39% to 41% range we had guided for. EBITA, excluding restructuring, declined to SEK 8.2 billion from SEK 9.3 billion in 2022. Lower sales and the changed mix in networks were key underlying reasons for this decline. Cloud Software and Services continued positively, delivering an EBITA of SEK 2 billion in Q4, driven by operational improvements and a reduction in OpEx. For the full year, we achieved SEK 1.7 billion EBITA, meeting our breakeven ambition. Enterprise grew by 7% organically, with a stable EBITA loss year-over-year, but we had a negative impact from some inventory write-offs in Enterprise Wireless Solutions. Cash flow was strong, delivering SEK 12.5 billion of free cash flow before M&A in Q4, ending the year on a solid note. We had robust cash collection and released working capital from the conclusion of large deployment projects as anticipated. Regarding cost reductions, we achieved the committed run rate savings of SEK 12 billion, half of which impacted the P&L in 2023, with the remainder to affect in 2024. The SEK 12 billion are gross savings, but note we still face cost inflation due to annual salary increases. We expect to return to more normalized variable pay accruals in 2024 after low levels in 2023. Restructuring provisions in Q4 reached SEK 1.5 billion, totalling SEK 6.5 billion for 2023. Turning to full-year numbers, reported sales decreased to SEK 263.4 billion compared to SEK 271.5 billion the previous year. That’s a 10% organic decrease driven by the weak RAN market. Our IPR licensing revenues were positive, growing to SEK 11.1 billion from SEK 10.4 billion the prior year, aided by new 5G license renewals, partly offset by some expiring agreements. Gross margin, excluding restructuring, declined to 39.6% in the full year from 41.8% the previous year due to operators' CapEx reductions and the market mix. In Cloud Software and Services, gross margin reached 36%, up from 33% in 2022. R&D expenses rose about SEK 1 billion to 48.2 billion, impacted by a negative currency effect. Mobile Networks and Cloud Software & Services saw a slight R&D decline. Enterprise increased, along with the full-year consolidation of Vonage. SG&A, excluding restructuring, was SEK 38 billion, also subject to a negative currency impact. Overall, we delivered an EBITA of SEK 21.4 billion for the full year, with an 8.1% margin—a level we cannot find satisfactory in absolute terms, but it shows the resiliency in our operations considering a challenging market. Free cash flow before M&A was SEK 1.1 negative for the full year, as anticipated. We flagged at the outset that we would see negative cash flow in 2023, resulting from the business mix shift toward big rollout projects. We did see improvements in Q4, moving away from the intense rollout phase in those projects, leading to benefits in working capital and free cash flow generation. Looking forward to the first quarter, as Börje mentioned, we expect current market conditions to prevail into 2024. The AT&T contract will begin ramping up in the second half of the year. We expect gross margins in the Networks segment between 39% and 41%. The mix from Q4 to Q1 leads to this guidance. In Cloud Software and Services, we'll keep investing in our 5G portfolio for competitiveness and resilience. Seasonality will negatively impact sales in the Enterprise segment from Q4 to Q1, but profitability will be maintained. Regarding OpEx, Q4 levels were low due to variable pay accruals. We expect these to normalize in Q1, with a rise in OpEx expected due to annual salary increases and investments in Cloud Software and Services and Enterprise. Our capital allocation strategy remains focused on organic investments in technology leadership and building an enterprise go-to-market organization. For M&A, we maintain a prudent approach, seeking opportunistic tuck-in acquisitions. We aim for a stable to progressive dividend over time. The Board considers earnings, the business outlook, and financial position when making decisions. We aim for a gradual return to our free cash flow target of 9% to 12% of net sales. As mentioned, the Board recommends a stable dividend of SEK 2.70 for the year. On a personal note, I want to thank everyone on this call for the great interactions over the years. This is my last of 30 earnings calls as CFO for Ericsson. It’s been a privilege. I look back at an incredible experience and fantastic people in our company and around us. I'm pleased to have my successor, Lars Sandström, now ready to take over, and I wish Peter Nyquist the best of luck in his next chapter.

Thanks, Carl. Yes, 2023 was a challenging year, and we anticipated that at the end of 2022, describing it as choppy. It was a historically weak market, and we expect current market uncertainty to persist into 2024. We do expect the market will recover to more normalized levels, but that will take time and will depend on operators’ need to invest to manage rapid data traffic growth and the ongoing migration to 5G stand-alone. The capacity will be necessary to meet consumer expectations for quality of service. However, as we've said many times, it's really up to our customers to determine the timing of their investments, and we can't predict when the market will turn. In that environment, we remain focused on executing our strategy to strengthen our leadership in mobile networks, grow our enterprise business, and drive cultural transformation. We are concentrated on managing the elements within our control, including cost and operational efficiency. Our actions are designed to navigate the near term while allowing us to invest prudently in technology leadership for long-term success. Our goal is to make Ericsson a more profitable company based on a leading position in mobile infrastructure and a high-growth enterprise platform business. We remain committed to our long-term EBITA margin target of 15% to 18% and our cash flow targets. While 2023 was a challenging year, we took many critical steps in executing our strategy and will continue to do so in 2024. Lastly, I would like to thank all my colleagues for their hard work despite the difficult markets, severe headwinds, and challenges. A big thank you to the team. Now, let’s move to Q&A, Peter.

Thank you, Börje, Carl, and I appreciate your kind words. Let's move on to the Q&A session. Who do we have for the first question? The first question comes from Aleksander Peterc at Societe Generale. Good morning, Aleksander.

Yes. Good morning, everyone. Thank you for taking my questions. Thank you, Carl, for your 30 quarters of reports and great work down there. My first question concerns the impact of the North American open RAN win on your margins, particularly in the early stages. Should we expect initial margin pressure due to the footprint acquisition costs in this case? Or should we not see this because there is no benefit of vendor lock-in over the long run in this contract? The second question is about India—specifically, regarding the shortfall of roughly SEK 4 billion in sales that didn’t materialize in Q4. Will that materialize in the first half, and will it help your top line?

Thanks, Aleksander. I can address those. Concerning India, yes, we have seen the peak in the third quarter, and volumes reduced in the fourth quarter. I can’t comment on specific delays over quarters; however, we've experienced incredible speed in India during 2023. We expect 2024 to be a larger market than prior to 2023, although it will drop significantly compared to 2023. Regarding the AT&T contract, we are extremely pleased with the confidence AT&T has shown us, which will increase our market share in North America. Material revenue from this contract is expected in the second half.

You summarized it well. Thanks, Aleksander.

Good morning, everyone. Thank you for taking my questions. Delaro expects a 17% recovery in North America in 2024, but your commentary appears quite cautious. Can you elaborate on how you expect this recovery to manifest? Is it more tilted towards H2? My second question is on the normalization of free cash flow in 2024. Do you expect the working capital buildup seen in 2023 to fully normalize in '24?

I can start with the market. It's a great question and one we also consider. We are planning for a challenging market to prevail in 2024, allowing us to focus on taking out costs and being disciplined in our investments. It varies by operator, and we see operators evaluating their own investment cadence. Some are already showing indications, as seen in early 5G markets. Our goal remains to be well-positioned for the market recovery.

Regarding cash flow, we target our 9% to 12% free cash flow metric over the long term. We focus strongly on cash flow, and investments have historically led to inventory buildup. We believe a mix shift back to more normal levels can benefit cash flow, as seen in Q4.

Good morning, everyone. I have two quick questions. First, regarding the software mix affecting the quarter. You've indicated a higher share of software. How should we view the mix in 2024 and beyond? My second question regarding Vonage: Can you provide more color about the recent contract loss? How can you reassure regarding Vonage’s future growth?

On the software mix, depending on the cycle, hardware sales may rise, reducing software revenue proportions. This was evident in 2023 with reduced hardware volumes impacting the mix. However, we see long-term trends moving towards increased software portions as new technology stacks are implemented. For 2024, the hardware portion may still increase due to market dynamics, but overall, a shift towards software remains likely.

Reiterating on Vonage, the mentioned contract was low-margin. Our strategic focus is to develop the market for network APIs rather than being restricted by any single contract’s performance. We remain committed to our existing business while working toward higher-margin products. This approach will create a more promising future.

Good morning, everyone, and thank you for taking my question. Looking at the long term, what do you perceive as the main reasons for U.S. operators being more cautious now? What do they need to see to become more active in making investments? Regarding the AT&T contract, could you shed light on how you foresee that ramping up over time?

Addressing the market, mobile infrastructure allows operators to pare back investments at times due to non-linear quality degradation. Operators may hold off until competition or new applications drive the need for investment. Ultimately, operators must recognize that they need to improve capacity and performance to handle growing demands. We believe the market will eventually see recovery, but timing is uncertain.

Thank you, Börje. Would you elaborate on the expected visibility you have in the AT&T contract?

We signed the agreement and are pleased with it. We're preparing for the ramp-up in the second half of the year. Detailed visibility will become clearer over time as we progress.

In your projections, you’ve given Delaro’s guidance for the full year. Is that your view on the U.S. market considering the starting point? If not, is there risk to the top line into '24?

Yes, we believe there's a good chance for North American investments to resume, but we are cautious. We anticipate a reasonable expectation for growth rates as operators recover from record highs in 2022.

I concur with Börje. We’re planning for a challenging market and are thus focused on our cost structure, ensuring we navigate through and remain strong when the market rebounds.

On the networks gross margin, you've seen a nice step-up due to a positive mix in Q4. How should we think about margin moving into 2024? What factors will influence that? Additionally, in Cloud Software & Services, you’ve recovered well in Q4. Looking ahead, where do you anticipate your EBITA margin trending in that segment?

While we haven't issued specific profitability guidance for Cloud Software & Services, we are in a turnaround journey. We delivered SEK 1.7 billion EBITA for the full year, signaling significant progress. Continued investment in the 5G portfolio and operational improvements will drive that segment's growth. As for Networks gross margin, we expect Q1 guidance of 39% to 41%, but overall development will depend on macro conditions.

We understand the complexity of predicting margins and the importance of focusing on gross margin, driving our commercial discipline. We have invested significantly into our technology to mitigate the costs in delivering services, which will help position us strongly for when market conditions normalize.

Thank you, Börje. This concludes my 31st and last earnings call at Ericsson. It has been a pleasure working alongside all my outstanding colleagues here, particularly Börje, Carl, and the IR team. I sincerely appreciate everyone’s engagement, and I wish you all the best for the future.

Thank you, Peter. Thank you, everyone.