Ericsson Lm Telephone Co Q1 FY2024 Earnings Call

Hello, everyone, and welcome to today's presentation of Ericsson's First Quarter 2024 Results. With me today are Borje Ekholm, our President and CEO; and Lars Sandstrom, Chief Financial Officer. As usual, we'll have a short presentation followed by Q&A. And in order to ask a question, you'll need to join the conference by phone. Details can be found in today's earnings release and on the Investor Relations website. Please be advised that today's call is being recorded, and I also need to advise you that today's presentation may include 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 to read about these risks and uncertainties in our earnings report as well as in our annual report. I'll now hand the call over to Borje and to Lars for their introductory comments.

Thanks, Daniel, and good morning, everyone. So let me first start off by welcoming my two new colleagues, Lars Sandstrom, our new CFO; as well as Daniel Morris, our new Head of IR. So it's great to have both of you joining the call and being on board at Ericsson, so a big welcome. So first, I will cover some key highlights from the quarter before Lars goes through the financials in much greater detail. So during Q1, we continue to execute on our strategy to strengthen our leadership in the mobile networks and drive a focused expansion into enterprise, while of course, continuing to strengthen our culture and operational execution. As expected, our customers remain cautious with their investments, and our organic sales decline and with India slowing following the rapid and unprecedented 5G buildout last year. We continue to view the level of industry investments that's unsustainably low, but we can't in reality impact this in the short term. Though what we work on is what we can control, and that's like the commercial and operational discipline, and of course having a competitive solutions and product portfolio. So despite the market headwinds and difficult market conditions, we maintained our market-leading position and delivered a good improvement in gross margin to 42.7%, excluding restructuring charges. For the rest of the year, we expect the mobile networks market to remain weak. External sources estimate that the global RAN market will decline by minus 4%. That looks a bit optimistic to me. However, we see the potential for sales to start to stabilize on a year-over-year basis during the second half. And the reason for that is, of course, that North America investments are expected to grow for the full year 2024 and in the second part of the year, we should start to see the benefit from this. But we will, of course, also see the benefit from the recent contract win we had that we announced at the end of last year. We continue to be disciplined in our execution, including proactively taking cost savings measures to ensure that we're well-positioned to maximize shareholder value when the market ultimately improves. We're still in the early phases of the build-out of 5G, but the improvement in the market will ultimately be in the hands of our customers, and that will happen when traffic grows and new use cases can be launched. So in the meantime, we remain fully focused to manage what's in our control, but at the same time, making the critical investment that reinforces our long-term competitive positioning. And of course, that includes creating high-performance and programmable networks for the future and exposing their capabilities through a Global Network Platform for network APIs. You've seen that revenues in Vonage fell during the quarter, and that's due to the contract loss we had in Q4, but also our decision to reduce our operations in some countries. Of course, we need to prudently manage the current business in Vonage, but our strategic ambition with Vonage is to build up the Global Network Platform. And during the quarter, we took several steps in our strategy execution by announcing partnerships with Verizon, AT&T, AWS, and KDDI. You heard me say this before, but creating this market will take some time, but we're seeing good traction in building the ecosystem, which will ultimately be crucial to drive the next step of digitalization of enterprise and society, leveraging the capabilities of their mobile networks. And 5G is really a platform technology that allows many different use cases that actually build on that technology. We see very good and solid opportunities on mission-critical networks in many parts of the world. And you have seen that during the quarter, we launched something we call the Ericsson Federal Technology Group. And that's an activity that we can use to serve the different parts of the U.S. government. And we see this as a very interesting opportunity to expand our market for the 5G technology. Let me also briefly touch on the news that our independent monitor has certified our compliance program. This is, of course, a very important step in order to conclude our plea agreement with the DOJ, but our focus on culture and integrity will continue beyond the monitor ship. So with that, I'd like to pass over to Lars to go through the financial details of the quarter.

All right. Thank you, Borje. Let me start by adding a few additional points on the group before we discuss the segments in more detail. In the quarter, we saw an organic sales decline of 14%. This was primarily driven by Networks. In North America, the rate of decline improved in the quarter and customer inventory levels have now stabilized. As Borje already highlighted, we delivered a good expansion in our gross margin, excluding restructuring charges with 42.7% in Q1. OpEx, excluding restructuring charges was down by SEK 0.8 billion in the quarter with the benefit of our cost-saving actions, partially offset by higher variable incentives and inflation. We are working to identify additional efficiencies and believe there is more we can do. EBITDA, excluding restructuring charges was SEK 5.1 billion in the quarter with a margin of 9.6%. This included a one-time gain of SEK 1.9 billion from the resolution of a commercial dispute. With that, let's move to the segments. In Networks, organic sales were down by 19% year-over-year as customers continue to be cautious with their investments, and as India slowed as expected following a rapid 5G build out last year. Despite this, we generated a strong gross margin, excluding restructuring charges of 44.3%. This was driven by our competitive product portfolio as well as our actions on costs. Gross margin was also positively impacted by retroactive IPR licensing revenues. EBITDA, excluding restructuring charges, declined to SEK 4.3 billion compared to SEK 6.4 billion last year and we reached an EBITDA margin of 12.7%. The decrease in EBITDA reflects continuous cautious customer investment levels across multiple geographies, leading to lower sales and lower gross income. As Borje said, we are taking proactive actions to optimize the business and drive efficiencies, and this is already supporting gross margins and driving down operating expenses. In the segment Cloud Software and Services, we continue to execute on our strategy to strengthen delivery performance and commercial discipline. Organic sales decreased by 2% compared to last year primarily driven by de-scoping contracts and contract access in managed network services. While this is impacting the top line, these are strategic actions that will position the segment for attractive profitability levels in the future. We delivered a gross margin, excluding restructuring charges, of 37.4%, and EBITDA margins improved year-on-year for a fifth consecutive quarter. Our IPR revenues grew in the quarter with a new 5G patent license agreement, and we are confident of delivering future growth benefiting from additional 5G agreements and an expansion into additional licensing areas. The timing of growth will vary as we seek to optimize the value of new agreements. In Enterprise, sales were broadly stable overall, with growth in Enterprise Wireless Solutions offset by a decline in the Global Communication Platform. Sales in the Global Communication Platform were negatively impacted by an earlier announced loss of a low-margin customer contract that we lost in Q4 and our decision to reduce our operations in some countries, with the impact expected to continue throughout the year. Gross margin, excluding restructuring charges, increased to 48.1% with improvements in Enterprise Wireless Solutions and technologies and new businesses. Turning to free cash flow, which was SEK 3.7 billion before M&A in the quarter. This strong improvement compared to last year is due to our operational actions on working capital, including lower inventory levels. Cash flow also improved as large customer projects moved out of the intense rollout phase, something that affected working capital last year and is now behind us. Variable incentive payments were also lower compared to last year. Net cash increased sequentially by SEK 3 billion to SEK 10.8 billion, driven by positive free cash flow after M&A and the positive exchange rate effect. And we delivered a return on capital employed of 9.2% in the quarter. Next, I will cover the outlook. Turning first to sales, where we expect seasonality in Mobile Networks to be broadly similar in Q2 to what we have seen in the past. In Networks, average seasonality between Q1 and Q2 has been around plus 8% over the last three years, and includes Software and Services, it has been around 13% plus. For the full year, we expect the RAN market to decline. External sources estimate this decline to be around 4% globally, but as Borje already mentioned, we view this as optimistic. Given our contract win, which will contribute during the second part of the year, we see potential for stabilizing sales on a year-over-year basis during the second half. In Enterprise, we expect sales in the Global Communication Platform to continue to be impacted by the recent low-margin customer loss and our decision to reduce operations in some countries. Next, turning to profitability. In Networks, we expect Q2 gross margin, excluding restructurings, to remain solid between 42% to 44%. Sequential changes will be driven primarily by less favorable market mix compared to Q1, which also benefits from higher IPR revenues. As mentioned before, the benefits from recent contract wins in North America will be seen more in the second half. Regarding OpEx, we expect to see the usual seasonality between Q1 and Q2, which over the last three years has been an increase of some SEK 1.6 billion. And finally, the further cost actions announced during the quarter will bring additional restructuring costs, which we anticipate will be in the range of SEK 3 billion to SEK 4 billion in 2024. We are in the early stages of discussions with unions, and we'll update you on timing once those have been progressed.

Thank you, Lars. Yes, we are facing a tough market environment, but given that we are laser-focused on managing what's in our control through commercial discipline and the strategic actions we're taking, of course, including the cost savings initiatives, we're prudently managing our operations and balance sheet. At the same time, we're focused on executing on our strategy and keeping investments critical to our long-term transformation and future growth intact. It's foundational that we maintain our technology and market leadership. We're also focused on taking important steps to build a stronger Ericsson for the long-term, which will ensure we remain best positioned when the market eventually recovers. In addition to investing in our technology leadership, flexible supply chain, and digitalization of Ericsson, we're investing in Enterprise to help generate the meaningful growth the telecom industry needs, including through our Global Network Platform for network APIs. Creating this new market will take time, but will be crucial in the next step of driving digitalization of enterprises as well as society. And our vision to become the leading networks and enterprise platform is unchanged. And as you've seen, we're taking steps to realize these ambitions. With this, I think we are ready to take your questions.

Thanks, Borje. The first question today is from Andreas Joelsson from Carnegie. Andreas, your line is now open.

Thanks a lot. And good morning everyone. Just a little bit curious on the comments into the second half. It seems like you feel that the visibility for the second half is a little bit higher than normal perhaps, given the contract that you have signed. But can you say something more about the rest of North America and the visibility you have on that part? What you build your expectation on the improved stabilization for the second half? That would be great. Thanks.

What we are observing in North America involves a couple of key factors. First, inventory levels are stabilizing at low levels with our customers, which provides us with more confidence. Additionally, we have secured contract wins that are expected to generate significant revenues in the latter half of the year. These factors contribute to our belief that there is a potential for stabilization in sales during the second half of the year.

Could I have a follow-up on that maybe on that contract? What has the reaction been from other large customers based on that open RAN contract?

It's generating a lot of discussions in the market and with customers about this industry-shaping contract. The customer is examining their total operational and capital expenditure to optimize investments in revenue-generating equipment. This is prompting similar discussions in many customer interactions. We noticed this at the Mobile World Congress a few months ago, where it was a key topic with several customers. We will see how we can deliver on this going forward, and it positions us for interesting discussions with customers.

Thanks a lot, Borje.

Thanks for the question, Andreas. We will move to the next question. The next question comes from Francois Bouvignies from UBS. Francois your line is now open.

Great. Thank you very much. So my question was on the gross margin, which obviously was strong this quarter and looking at your Q1 outlook as well remaining at a high level. So maybe what would be helpful is, can you quantify this cost versus mix versus pricing, in a way, giving more visibility into the gross margin trend? And how should we think about the gross margin, therefore, going forward? Do you have a lot of costs to take out still? And so basically, in other words, the sustainability of this gross margin would be very helpful. Thank you.

I can begin and then you can add to it, Borje. Regarding the gross margin in Q1, it's important to note that there are no significant one-off items, except for the IPR agreement, which provided a slight boost to the margin this quarter. Overall, the product and market mix remains quite stable. There may be some slight weaknesses in the software product mix, but we are observing a general enhancement in our cost structure, positively impacting margins, along with improvements in several markets and product categories. Therefore, there are no major fluctuations in this quarter from that perspective. The cost reductions we have implemented are showing positive results. Additionally, we are emphasizing commercial discipline to focus on profitability in our operations. In response to your question about guidance, we do not provide specific forecasts, but we can give some insights for Q2. In the second half, we are seeing some support from the market mix, particularly with North America increasing and India decreasing somewhat in year-over-year comparisons. However, the overall impact of this is not significant, in my opinion.

And then on the cost measures, I mean, do you have a lot to potential still to work on? Or where are you in these cost measures in the gross margin?

Yes. Regarding the previous program we discussed, we have completed that phase and are observing its impact. Additionally, we announced support initiatives during Q1, which will require some time to implement, especially due to the need for union negotiations, and it will take a while before these efforts are reflected in our financial results.

Thank you.

Yes. Regarding the previous program you mentioned, we have completed it and observed its impact. Additionally, what we announced in Q1 on the supplementary side requires some time to implement, as we need to complete the union negotiations, and it will take a while before we see the effects reflected in the financial results.

Thank you.

Just to add, we know from experience also when we do cost initiatives on the cost of sales, it takes a bit of time before it comes through into the P&L. That's why you also see the support from the cost out we did last year coming through now. It takes a bit longer than you would hope sometimes.

Thanks for this question, Francois. We will move on to our next question. So the next question comes from Joachim Gunell at DNB. Joachim, your line is now open.

Thank you for that. Good morning. I would like some clarification regarding your comments about the second half of the year and the expected stabilization in growth following the year-over-year declines in the first half. Does this support your overall view of the Networks market, or should it be interpreted separately? Specifically, does this include the AT&T contract ramp-up where you anticipate more stable development in the second half, or is that development not accounted for in this context?

We are not indicating stabilization of growth; rather, we are referring to stabilization within the declining market, which is an important distinction. Additionally, when we mention the overall external outlook of minus 4%, we believe that's slightly optimistic. To clarify, this includes the total group, along with the network rollouts in the U.S.

That's clear. Thank you.

Great. Thanks for the question, Joachim. The next question will come from Sandeep Deshpande at JPMorgan. Sandeep, please go ahead.

Thank you for taking my question. I'm curious about the design wins and footprint in North America. How should we view them in terms of their ramp-up and their impact on margins? Will these wins contribute to margins right away, or will it take some time?

I think here, it has not a big impact. It's rather stable over the rollout period. It depends a little bit on the work that we conduct during the project phase and that plan is going on together with the customer now. And so there can be in some periods, a bit of a weaker margin and then it's back to normal again for this market. So that it is a bit early to say in that sense, and we will see that paying out. And this is a long-term contract. It's for '24 into '25 and forward as well.

And you're fairly confident this is going to start in the second half of this year?

Yes.

Thanks, Sandeep. So we'll move to the next question. So the next question is coming from Daniel Djurberg from Handelsbanken. Daniel, your line is now open.

Thank you, operator. And good morning, Borje, Lars and Daniel. A question on the IPR run rate, excluding one-offs entering Q2. How large was the catch-up item? And also, if I may, how many of the larger Tier 1 handset OEMs is still about to close 5G? Have you, for example, done the BBK and also the status of Lenovo would be found to understand. Thanks.

On the financials, the run rate coming out of Q1 is around SEK 11 billion. We previously mentioned that we are targeting a full year of approximately SEK 12 billion to SEK 13 billion, and that target remains unchanged.

A couple of the big handset vendors still remain unlicensed. And you know we have litigation ongoing with one of them you mentioned. So we can't comment really on where that is right now.

Yes, just a super first follow-up on the nonrecurring item of SEK 1.9 billion. It was a noncash, it seems, but it was a commercial dispute resolution. Why is it not cash flow impacting?

It will be cash flow impacting in Q2.

Super, thanks.

Great. Thanks for the question, Daniel. We'll move to the next question. So that's coming from Joe Zhou at Barclays. Joe, please go ahead.

Hello, good morning everyone. And thank you for taking my questions. I have two. I'll go one at a time. So firstly, just to understand, in the second half, you mentioned stabilization, but it just seems to the quarterly phasing of it. Are we expecting to see still some contraction in Q3 before improving year-on-year in Q4? That's my first question.

I believe I understand your question. As you know, we have significant project deliveries on the horizon. If they fall into this quarter or the next, it can be challenging to determine their exact timing. That’s why we focus on discussing only the second half of the year.

Thank you. My second question is about the free cash flow. This quarter saw a significant increase from contract liabilities amounting to SEK 6.5 billion. I understand that most of this typically represents customer advances. Could you provide more details on the reasons behind this increase? Additionally, how much of it can be attributed to the IPR payments when considering future projections?

Yes. I think impacting the working capital is, as I mentioned, we have a reduction in inventories supporting. We also have a significant lower paying out on the incentives this year compared to last year. And then, of course, the whole contract ramp-up that we had last year. So those are, I'd say, the three big components impacting working capital year-over-year.

Yes. Sorry, I get the inventory going down, but contract liabilities is a separate thing. Is that specific item? It's been building up again, I have been following like three or four quarters declines. I just wonder what is driving that?

I will get back to you with the details, and I'm happy to do that. The main fee impacts are inventories, lower incentive payouts, and the contract rollout we had last year. Those are the key items. We are also willing to provide more insights into the different aspects.

That'll be great. Thank you. Super helpful. Thanks. Thanks, Joe. Moving to the next question. Next question is coming from Sebastien Sztabowicz at Kepler Cheuvreux. Sebastien, your line is now open.

Yes, hello and thanks for taking my question. On Vonage, the business is now down by 5% year-on-year in Q1, and the group is trending well behind your and our initial expectations. Are you taking any specific actions to support sales in the coming quarters? And coming back to this, I would say, activities in some countries that you are reducing. What are the reasons behind that exactly? What is happening in those countries with Vonage? Thank you.

Yes. As you saw and as you mentioned there, Vonage is down. And as we mentioned, it is a loss of contract that we had last year in Q4. And also that we look at the different markets where it makes commercial sense to invest. And in some markets, we have said that we reduced our activities there and focus on more of the growth areas where we see there is a better opportunity. And I think there, it is really we are focusing on the long-term investments here to drive this part of the industry.

Yes. As I said, Sebastien, it's in reality, our focus is on driving the Global Network Platform for network APIs. That's where we are tremendously focused. We're trying to, of course, manage the current business as prudently as possible, but it's really the focus on executing the strategic rationale behind the acquisition. That's our key focus. And that's where we allocate most of the time. And that's where we are starting to get the traction. We had DT in the end of last year, followed by Verizon, AT&T, KDDI and AWS now in the first quarter. We're trying to shape that ecosystem. That's really where the criticality is.

We see good commercial traction. But when do you expect more sizable revenue to be recognized on network APIs? Is it one-year horizon or more three to five-year horizon for network APIs?

I think the reality here is it's going to be the next one to two years when this market will be shaped. That's really where our focus is. Then I think we'll see longer-term growth as applications start to develop and use cases start to develop. But to get this first traction, it's about creating that market. That's why it's so important, of course to get operators in, but it's equally important to get application developers, digital natives starting to use what's available. And we see actually an interest now from developers, from the hyperscalers about how do we shape this market, how do we create the applications of the future. It's really up to us now to deliver on that. And that's really where our focus is.

Okay, thank you.

Thanks, Sebastien. So just turning to the next question. The next question will come from Erik Rojestal from SEB. Erik, please go ahead.

Yes, thank you and good morning everyone. So you announced some further cost measures here with a headcount reduction of 1,200 in Sweden. I mean, is it possible to quantify what sort of impact you expect to see from this? And when do you expect it to start contributing? Thank you.

Thank you, Erik. As we mentioned in our outlook, we anticipate restructuring costs for the full year to be between SEK 3 billion and SEK 4 billion. Currently, we are engaged in negotiations in Sweden and exploring options in additional countries as previously indicated. This process typically takes some time to materialize, depending on market conditions and the activities we undertake. Therefore, we do not expect to see significant impact until the end of the year, based on current projections. However, as we make progress, we will provide ongoing updates on this matter in the upcoming quarter to offer more insights.

Thanks for the question, Erik. Turning to the next question, we have Felix Henriksson from Nordea.

Felix Henriksson from Nordea. Thanks for taking my question. I wanted to ask about the free cash flow trajectory moving into the right direction during Q1. So just on the phasing for the rest of 2024, given the sort of working capital release that you expect to witness in India? And also given these additional restructuring charges that you've communicated, how should we think about the free cash flow trajectory for the rest of the year?

I previously mentioned that the working capital buildup from last year decreased at the end of Q4, which will provide some support this year. We already have a portion of it, so there shouldn't be a significant impact for the remainder of the year in that regard. Additionally, we will continue to focus on working capital throughout the year. As you know, EBITDA and the results before working capital are the most critical components of our cash flow.

Perfect, thank you. And as a quick follow-up, could you perhaps clarify which market do you think that Tellaro is too optimistic about in the sort of minus 4% global RAN market forecast for this year? Thank you.

No, we don't go into the different markets as such. What we say is that the total decline of 4% is a bit optimistic as we see it now.

Got it, clear. Thank you.

Thanks for the question, Felix. Moving on to the next. We have Sami Sarkamies at Danske Bank. Sami, please go ahead.

Hi, thanks for taking my question. I would still like to dig a bit deeper into the new cost program. So could you provide some kind of split between COGS and OpEx, the total savings target and maybe mention a couple of areas where you're able to find new savings on top of the measures that you implemented last year?

I cannot provide a breakdown between COGS and OpEx at this moment. We are exploring various areas, but it's definitely present in both categories. A significant portion is related to personnel expenses, including both employees and consultants we have in the organization. Additionally, some savings may come from real estate. These are structured plans we are implementing, and we look forward to sharing more details about our progress and the restructuring efforts as they develop.

Thanks.

We also want to establish a practice of continuous improvement to consistently reduce costs instead of viewing this as just a series of programs. The challenge, especially noted in various countries and particularly in Europe, is that when you consolidate, the figures can appear quite significant. This is why we believed it was necessary to disclose the specifics from Sweden to limit speculation. Ultimately, this will contribute to our ongoing commitment to efficiency. Additionally, we are streamlining some activities, which includes refining our product portfolio.

Okay, thanks and welcome onboard, Lars.

Thank you.

Thanks for the question, Sami. So the final question today comes from Richard Kramer at Arete. Richard, your line is open. Please go ahead.

Okay, thanks very much. Borje, I guess just to wrap up, we've heard you talking for many years now about rising traffic and underinvestment by your large customers. specifically noted that in Europe, where we have a number of consolidations underway. What do you think unlocks that? I mean what are you looking for with your customers to say or to show that they're going to be willing to spend more? Because right now, it just feels like the business is drifting without a catalyst for increased spending by those customers. Is there anything you can point to in the second half of the year or into 2025 that's going to force the issue and raise those relatively low spending levels? Thanks.

Thanks, Richard, for the question. The reality is that we continue to see traffic growth in the networks. In many markets, we're starting to notice congested networks. When the network is crowded, you may receive a signal, but you can't effectively use it due to a lack of network capacity. We are witnessing signs of congestion at various sites. Simultaneously, the industry faces challenges with return on investments, which is why I believe we need to see in-market consolidation begin and gain approval. This consolidation will help us achieve a larger scale. Looking globally, the average European operator has around 4.5 million subscribers, while it's 95 million in the U.S., 300 million in India, and 400 million in China. The scale in Europe is simply too small, underscoring the need for consolidation. Additionally, we aim to change the pricing model in the industry through our global network platform for network APIs. Currently, the pricing model is largely based on a monthly subscription that is somewhat detached from network traffic and investments, which impacts profitability for operators. To encourage investment, we need to find ways to monetize network features such as speed, latency, location, and various quality of service offerings, including network slicing. We must define new use cases that will unlock these revenue streams. If our operators do not see growing revenues, they won't invest, which is a rational decision. Hence, we have an opportunity, or perhaps even a responsibility, to create new revenue streams by leveraging 5G technology more effectively. That’s why our investments in the enterprise sector are so critical.

Okay. Super, thank you. Super thanks, Richard. Thanks Borje, Lars. And this concludes the call for today. Thanks everyone for joining us.