Ericsson reports fourth quarter and full-year results 2019

Fourth quarter highlights

• Sales were SEK 66.4 (63.8) b. Sales growth was 1% adjusted for comparable units and currency. A reduction in North America was compensated by growth in other markets, primarily in the Middle East and North East Asia. Reported sales grew by 4%.
• Operating income[1] improved to SEK 6.5 (2.6) b., corresponding to an operating margin of 9.7% (4.0%) excluding restructuring charges. Reported operating income[1] was SEK 6.1 (-1.9) b.
• Gross margin was 37.1% (32.0%) excluding restructuring charges. Reported gross margin was 36.8% (25.7%).
• Networks gross margin excluding restructuring charges was 41.1% (41.0%). Operating margin excluding restructuring charges was 14.5% (17.5%) following the addition of the Kathrein[2] business and investments in R&D, digitalization, compliance and security.
• Digital Services reported a positive operating income excluding restructuring charges.
• Net income was SEK 4.5 (-6.5) b.
• Free cash flow excluding M&A was SEK -1.9 (3.0) b. including payments of SEK 10.1 b. related to the resolution of the US SEC and DOJ[3] investigations. Net cash decreased to SEK 34.5 (35.9) b.

Full-year highlights

• Sales increased by 4%, adjusted for comparable units and currency, with Networks growing by 6%. Reported sales increased by 8%.
• Reported operating income improved to SEK 10.6 (1.2) b. Operating income was SEK 22.1 b. (operating margin 9.7%) excluding restructuring charges and SEK -10.7 b. in costs related to the resolution of the US SEC and DOJ investigations.
• Gross margin was 37.5% (35.2%) excl. restructuring charges, with improvements in Networks, Digital Services and Managed Services.
• Free cash flow excluding M&A amounted to SEK 7.6 (4.3) b. including payments of SEK 10.1 b. related to the resolution of the US SEC and DOJ investigations. Net cash at year-end was SEK 34.5 (35.9) b.
• The Board of Directors will propose a dividend for 2019 of SEK 1.50 (1.00) per share to the AGM.

[1] Includes a positive impact of SEK 0.7 b. from a partial release of the cost provisions made in Q3 2019 related to the resolution of the SEC and DOJ investigations. Includes a non-cash cost of SEK -0.3 b. related to wind-down of the ST-Ericsson legal structure.
[2] The acquisition of the Kathrein antenna and filter business is hereinafter referred to as the acquired Kathrein business.
[3] United States Securities and Exchange Commission (SEC) and the United States Department of Justice (DOJ).
[4] Operating income excludes restructuring charges in all periods and cost provisions related to the resolution of the SEC and DOJ investigations of SEK -11.5 b. in Q3 2019 as well as a partial release of the same provision of SEK 0.7 b. in Q4 2019.

Non-IFRS financial measures are reconciled to the most directly reconcilable line items in the financial statements at the end of this report.

Comments from Börje Ekholm, President and CEO of Ericsson (NASDAQ:ERIC)

Our performance during 2019 puts us on track to reach our targets for 2020 and 2022. Our focused strategy with increased investments in R&D combined with operational efficiency is paying off. We have regained technology leadership, recovered previously lost ground in several markets and improved the financial results. Today, we are a leader in 5G with 78 commercial 5G agreements with unique operators and 24 live 5G networks on four continents. Operating margin[1] excluding costs related to the resolution of the US SEC and DOJ investigations and restructuring charges was 9.7% for full-year 2019, almost reaching the target of more than 10% one year early.

Operating income was impacted by increased operating expenses. The increase is related to the Kathrein business acquisition, increased investments in digitalization and added resources to strengthen security as well as our Ethics and Compliance program. For 2020 we expect somewhat higher operating expenses, which will not jeopardize our financial targets.

Networks gross margin[2] was solid in the quarter at 41% including effects from strategic contracts which reflects the strong business fundamentals. Due to the uncertainty related to an announced operator merger, we saw a slowdown in our North American business in Q4, resulting in North America having the lowest share of total sales for some time. However, the underlying business fundamentals in North America remain strong. The negative growth in North America was more than offset by growth in Asia and the Middle East. It is still too early to assess possible volumes and price levels for the expected deployment of 5G in China, and we expect that the initial challenging margins will shift to positive margins over the lifespan of the contracts.

The Kathrein acquisition and increased investments were the main reasons why Networks operating margin[2] declined to 14.5% in Q4. The acquisition is strategically important to strengthen our capabilities in antennas. While we are executing on the integration plan, temporarily lower production and sales had a negative impact on margins in the quarter. We expect a gradual improvement as the integration progresses and a new antenna portfolio is developed, however we expect a negative contribution full-year 2020.

In segment Digital Services we continued the execution of our plan to turn around the business and showed a positive result[2] in Q4, despite a continued negative impact from the remaining critical projects (provisions of SEK -0.3 b. in Q4). We see strong development in the market, driven by the momentum in 5G resulting in good sales growth in Packet Core and OSS. While rationalization of the legacy portfolio will continue, we are re-investing R&D in our 5G and cloud-native portfolio.

The resolution of the US SEC and DOJ investigations highlights serious shortcomings in our otherwise proud history. The events described in the resolution are totally unacceptable. However, the resolution represents an important step for Ericsson. We are now fully focused on strengthening the company and making sure we are equipped to deal with compliance challenges. We have already put in place many important changes to our Ethics and Compliance program, including adding further compliance and assurance competence as well as strengthening our third-party management, leadership vetting and internal controls. This work will not stop; our zero-tolerance policy requires constant oversight and renewal, and we are confident that we are on the right path.

Free cash flow in 2019 excluding M&A amounted to SEK 7.6 (4.3) b., after payments of SEK 10.1 b. related to the resolution of the US SEC and DOJ investigations. The Board will propose a dividend of SEK 1.50 (1.00) per share to the AGM. The increase underlines the Board’s confidence in Ericsson delivering on its financial targets and building a strong financial position.

Our strategy aims at building a stronger company longer term and we do not trade long-term strengths for short-term gains. The foundation is our investments in R&D for both technology and cost leadership. This has secured us a competitive advantage as operators accelerate their 5G investments. We continue to execute on our focused strategy. The investments in digitalizing our business processes will increase costs in 2020 and will result in improved productivity in 2021 and beyond, supporting improved margins. Our competitive portfolio and cost position combined with the current market dynamics present a unique opportunity for us and we will continue to invest in order to further strengthen our market position.

Our product portfolio in Networks and Digital Services continues to gain good traction in a highly competitive market undergoing a technology shift to 5G. We see opportunities to further strengthen our position through our strong product offering in a market driven by the momentum in 5G. While we are confident that these opportunities will be value accretive in the long term, initial margins are challenging. Our competitive product offering and improved cost structure in hardware and services make our position and profitability much stronger than at the time of the European network modernization.

In 2019, we saw leading operators switch on their 5G networks. We are tracking well towards our targets for 2020 and 2022, but most importantly, we are making progress towards building a stronger company long term.

Börje Ekholm

President and CEO

[1] Excluding restructuring charges and costs related to the resolution of the US SEC and DOJ investigations.
[2] Excluding restructuring charges.

Planning assumptions going forward

Market related

• The Radio Access Network (RAN) equipment market is estimated to grow by 4% for full-year 2020 with 2% CAGR for 2018-2023. (Source: Dell’Oro)

Ericsson related

The financial targets for 2020 and 2022 presented at the Investor Update in October 2019 remain unchanged.

Sales and gross margin

• Three-year average Group sales seasonality between Q4 and Q1 is -25%. Q1 is expected to have slightly less seasonality, as the base was lower following a weak Q4 in North America. The underlying business fundamentals in North America remain strong.
• The revenues from current IPR licensing contract portfolio are approximately SEK 10 b. on an annual basis.
• Strategic contracts, with an overall long-term positive gross margin, but with initially low or negative margin, are expected to continue to impact Networks.
• Large 5G deployments in China are expected to commence in 2020. Ericsson has invested in R&D and supply chain capacity, aiming to increase market share. Based on experience, margins are initially challenging but turn positive over the lifespan of a contract.
• The acquired Kathrein business is expected to have a negative impact on Networks margins during 2020, with a gradual improvement 2H.
• The improvements in Digital Services continue, but earnings will vary between quarters depending on business mix, sales seasonality and impact of the remainder of the 45 critical contracts.

Operating expenses

• Operating expenses typically decrease between Q4 and Q1 due to seasonality. Somewhat higher operating expenses are expected for full-year 2020 due to investments in digitalization, compliance and security.

Restructuring charges

• Restructuring charges for full-year 2020 are estimated to be ~1% of sales.

Currency exposure

• Rule of thumb: A change by 10% of USD to SEK has an impact of approx. +/-5% on net sales and approx. +/-1 percentage point on operating margin.

NOTES TO EDITORS

You find the complete report with tables in the attached PDF or by following this link https://www.ericsson.com/assets/local/investors/documents/financial-reports-and-filings/interim-reports-archive/2019/12month19-en.pdf or on www.ericsson.com/investors

Conference call for analysts, investors and journalists

President and CEO Börje Ekholm and CFO Carl Mellander will comment on the report and take questions. The conference call will begin at 9:00 AM CET (8:00 AM GMT London, 3:00 AM EST New York).

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This information is information that Telefonaktiebolaget LM Ericsson is obliged to make public pursuant to the EU Market Abuse Regulation. The information was submitted for publication, through the agency of the contact person set out above, at 07:00 AM CET on January 24, 2020.

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