Ericsson reports third quarter results 2019

Third quarter highlights  

• Sales were SEK 57.1 (53.8) b. Sales adjusted for comparable units and currency increased by 3% driven by strong growth in North America and North East Asia. Reported sales grew by 6%.
• Operating income was impacted by cost provisions of USD -1.2 b. (SEK -11.5 b.) related to a resolution of the investigations by SEC and DOJ in the US and a refund of social security costs of SEK 0.9 b., referred to as “items affecting comparability” in the report.
• Operating income was SEK 6.5 b. (11.4% operating margin) when excluding restructuring charges and items affecting comparability. Reported operating income was SEK -4.2 (3.2) b.
• Gross margin excluding restructuring charges was 37.8% (36.9%) with improvements in Managed Services, Digital Services and Networks. Reported gross margin was 37.7% (36.5%).
• Net income was SEK -6.9 (2.7) b., negatively impacted by items affecting comparability.
• Free cash flow excluding M&A was SEK 5.5 (0.7) b. Net cash increased to SEK 37.4 (32.0) b.

Investor Update key messages

Focused business strategy remains and the Company is tracking towards the new financial targets:

• Sales ambition of SEK 230-240 b. for 2020 (previously SEK 210-220 b.), based on a SEK/USD rate of 9.50.
• Operating margin target for 2020, excluding restructuring charges, remains unchanged at >10% of sales. This incorporates continued dilutive impact from strategic contracts, an initially higher cost level for newly introduced 5G products and a target adjustment for segment Emerging Business and Other to SEK -1.5 to -2.0 b. (previously break-even).
• Operating margin target of 12-14% for 2022 (previously >12%), excluding restructuring charges, based on an ambition to grow faster than the market in combination with leverage from investments in market position and R&D.

[1] Operating income excluding restructuring charges in all periods. Excluding cost provisions related to resolution of the SEC and DOJ investigations of SEK -11.5 b. and refund of social security costs of SEK 0.9 b. in Q3 2019. Excluding a capital gain related to the divestment of MediaKind of SEK 0.7 b. and a reversal of a provision for impairment of trade receivables of SEK 0.7 b. in Q1 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)

We continue to see strong momentum in our business, based on the strategy to increase our investments for technology leadership, including 5G. We saw organic sales growth[1] of 3% in the quarter, driven by the early adopters of 5G, in North America and North East Asia. Our operating income was SEK 6.5 b., corresponding to a margin of 11.4% excluding restructuring costs, the SEC and DOJ provision of USD -1.2 b. (SEK -11.5 b.) and the refund of social security costs of SEK 0.9 b. Free cash flow before M&A was SEK 5.5 (0.7) b. adding to our strong financial position.

Our focused strategy, introduced in 2017, is aimed at building a stronger Ericsson longer term. With clear focus on our operator customers the strategy stands on a foundation of increased investments in R&D for technology and cost leadership, and growing market footprint. Increased R&D efforts, which will continue, have resulted in a competitive portfolio driving improved gross margin. In addition, we have been able to record several important wins improving market footprint for future business. We are disciplined in the deals we take and target opportunities where we have a clear competitive advantage through technology leadership, supported by our improved cost structure in hardware and software. While we believe the strategic contracts are attractive long term, the initial margins may be challenging. This is due to high associated costs as operators change vendors.

An important indicator for our execution of the strategy is the improvement in gross margin. The gross margin[2] in the quarter ended at 37.8% compared with 36.9% last year and 36.7% last quarter. Within the 0.8 percentage point[3] sequential decline in Networks gross margin, we have absorbed the margin impact and inventory provisions related to strategic contracts.

The largest market for 5G infrastructure will be China where deployments are expected to start near term. We have invested to increase our market share, however it is still too early to assess possible volumes and price levels. Based on historic experience we expect to have challenging margins initially but positive margins over the lifespan of a contract.

With an organic sales growth[1] of 4%, segment Networks delivered another solid quarter, with strong development in North America. Operating margin improved YoY, with continued good traction for the Ericsson Radio System.

The turnaround of Digital Services is on track for low single digit margins in 2020. Driven by strong improvement in the underlying business, the losses were substantially reduced QoQ, in spite of a negative impact from the remainder of the 45 critical contracts of SEK 0.5 b. (slightly more than in the second quarter). The negative impact of these contracts will continue to vary between quarters as they are addressed. We continue to focus on developing a full 5G and cloud-native portfolio. It is encouraging to see that the sales growth in our new product portfolio improved from 13% to 19% rolling 12 months.

5G is taking off faster than earlier anticipated and we see initial 5G buildout as a capacity enhancer in metropolitan areas. However, over time, new exciting innovations for 5G will come with industrial and IoT use cases, leveraging the speed, latency and security characteristics of 5G. This provides opportunities for our customers to capture new revenues as they provide additional benefits to consumers and businesses.

Our IoT business is growing almost twice as fast as the estimated market growth of 20-25% per year. We have more than 4,500 enterprises on our IoT platform and the number of connected devices on the platform has more than doubled year to date. To fully leverage our position and capture new recurring revenue streams we are increasing our investments in IoT within Emerging Business. With this investment, we do not expect to reach breakeven for the segment next year, and instead incur losses of SEK -1.5 to -2.0 b.

Investor Update

In conjunction with today’s report we are hosting an Investor Update where we will discuss company strategy, including financial targets. Continued technology and market investments will remain key for long-term competitiveness and for reaching our targets for 2020 and 2022. A solid financial position and continued strong cash flow are important for our ability to deliver on our focused strategy. As a consequence of currency movements and a stronger 5G market, our sales ambition for 2020 is to reach SEK 230-240 b. compared with the previous estimate of SEK 210-220 b. Our 2020 target of reaching an operating margin of more than 10% remains. This includes the changed target for Emerging Business and Other, short-term dilutive impact from strategic contracts and the initially higher cost level for newly introduced 5G products. For 2022 the operating margin target is 12-14%[2] (previously >12%) based on an ambition to grow faster than the market in combination with leverage from investments in market position and R&D.

Börje Ekholm

President and CEO

[1] Organic sales growth: Sales growth adjusted for comparable units and currency.
[2] Excluding restructuring charges.
[3] Excluding restructuring. Networks gross margin adjusted for a license settlement cost in Q2 2019.

Planning assumptions going forward

Market related

• The Radio Access Network (RAN) equipment market is estimated to increase by 5% for full-year 2019 with 2% CAGR for 2018-2023. (Source: Dell’Oro)

Ericsson related

Net sales

• Two-year average sales seasonality between Q3 and Q4 is 18%. However, uncertainty regarding the announced operator merger in North America is likely to impact operators’ spending negatively short term.
• The revenues for current IPR licensing contract portfolio are approximately SEK 9 b. on an annual basis.

Gross margin

• Strategic contracts in Networks, with initially low margins, taken to strengthen the market position, are expected to have a somewhat increased negative impact on gross margin short term without jeopardizing the 2020 target.
• 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 historic experience margins are initially challenging but turn positive over the lifespan of a contract.
• The acquired Kathrein antenna and filter business will initially have a negative impact on Networks margins without jeopardizing the 2020 targets.
• 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 increase between Q3 and Q4 due to seasonality.

Restructuring charges

• Restructuring charges for full-year 2019 are estimated to be ~1% of sales.

Currency exposure

• Rule of thumb: A change by 10% of USD to SEK would have an impact of approximately +/-5% on net sales and approximately +/-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/2019/9month19-en.pdf or on www.ericsson.com/investors

Q3 conference call for journalists, analysts and investors 

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 CEST (8:00 AM BST London, 3:00 AM EDT New York).

To join the conference call, please phone one of the following numbers:

Sweden: +46 (0)8 56642651 (Toll-free Sweden: 0200 883 685)

International/UK: +44 (0)333 300 0804 (Toll-free UK: 0800 358 9473)

US: +1 631 913 1422 (Toll-free US: +1 855 85 70686)

PIN code: 24181250#

Please call in at least 15 minutes before the conference call starts.

A live audio webcast of the conference call will be available at www.ericsson.com/investors and www.ericsson.com/press 

A replay of the conference call will be available from about one hour after the conference call has ended until October 24, 2019.

Sweden replay number: +46 (0)8 519 993 85

International replay number: +44 (0)333 300 0819

US replay number: + 1 (866) 931 1566

PIN code: 301300190#

Investor Update – online-only digital event 

The Investor Update on Ericsson’s overall strategic direction and business development, presented by President and CEO Börje Ekholm and CFO Carl Mellander, will be held on the same date at 3:00 to 5:00 PM CEST (2:00 PM BST London, 9:00 AM EDT New York). The Investor Update will also include a brief summary of the third quarter results.

The link to the webcast will be available at www.ericsson.com/investors and www.ericsson.com/press before the event.

To join the Q&A session, please phone one of the following numbers:

Sweden: +46 (0)8 566 42651 (Toll-free Sweden: 0200 883 685)

International/UK: +44 (0)333 300 0804 (Toll-free UK: 0800 358 9473)

US: +1 631 913 1422 (Toll-free US: +1 855 85 70686)

PIN code: 42814345#

An on-demand webcast will be available at www.ericsson.com/investors approximately one hour after the webcast ended.

FOR FURTHER INFORMATION, PLEASE CONTACT

Contact person

Peter Nyquist, Head of Investor Relations
Phone: +46 10 714 64 99
E-mail: peter.nyquist@ericsson.com 

Additional contacts

Stella Medlicott, Senior Vice President, Marketing and Corporate Relations
Phone: +46 10 713 65 39
E-mail: media.relations@ericsson.com

Investors

Stefan Jelvin, Director, Investor Relations
Phone: +46 10 714 20 39
E-mail: stefan.jelvin@ericsson.com 

Rikard Tunedal, Director, Investor Relations
Phone: +46 10 714 54 00
E-mail: rikard.tunedal@ericsson.com

Media

Ola Rembe, Vice President, Head of External Communications
Phone: +46 10 719 97 27
E-mail: media.relations@ericsson.com 

Corporate Communications
Phone: +46 10 719 69 92
E-mail: media.relations@ericsson.com

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 CEST on October 17, 2019.  

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