Q3 2020 Telefonaktiebolaget LM Ericsson Earnings Call

Thank you Jerry. Good morning, and we're we're good afternoon everyone and welcome to this call today to report with me here today. I have our own president and see your vehicle and or see if call me Lander before starting. I would like to read the following during the call today. We will be making forward-looking statements, statements are based on our current expectation and circumstances options, which are sorry to risk and uncertainties the actual results May differ materially due to factors mentioned in today's press release and discussed in life. Are you current you to read about these risks and uncertainties in our own support as well as in our annual report with that said I would like to hand over the call to see if this word. Thank you Peter and the welcome everyone to this call for our third quarter results. We are continuing to execute on our Focus strategy game.

See increasing evidence that that our strategy is working and it's reinforced by the report to perform.

As for the third quarter we're leaving in five G and that through our significant investments in Orland e that's driving our global technology leadership and really enabling us to provide a cost and performance benefits to our customers.

I remember seeing technology leadership has also allowed us to continue to gain market share and it's worth mentioning that most of these games come from non-chinese competitors. So we're not winning here due to geopolitical situation. It's all about winning in front of the customer and delivering the best and and the best portfolio and cost-competitive port phone number they can choose

We're also seeing that we're making progress on on winning in China and we have already announced that in the second quarter and and that is a result of or increased efforts in or indeed. It is very important for us and strategically important for us to be in China and that's because that's a global Powerhouse for Innovation and technological change and driven by many great entrepreneurs.

We see this in in the many sectors and I'm personally involved in Alabama and I seen that Universal Power firsthand over many many years. No doubt China has Massachusetts and but I think the entrepreneurial Spirit we see there is a key driver of their success in the world today.

5G is being built out very fast in China with good coverage for G drove the consumer economy and China the US and how long it takes. They were the first countries to roll out forty and that allowed entrepreneurs in those region actually innovate on top of the network building world has become their economies. So it's no surprise that we see the call it the consumer app economy today dominated by Chinese and American companies.

Now we're seeing the same thing on 5G so building out 5G will allow Chinese entrepreneurs as well as American and who are very first month on building the network to innovate in these new space and I I I do think here it it's actually important for the rest of the world. Notably Europe to take some Impressions from the fast build-out page. We seeing in China this will lead to in a way new companies being developed by entrepreneurs and Innovative and for us to be part of seeing the emergence of that ecosystem and and realizing what what will that drive for future requirements in the future will be critical. We see 5gs a huge opportunity for four more open and Global Innovation and it's built on this requirement of a high-performance 6 a.m.

wireless network infrastructure

Sure, and the value of running applications on top of the 5G network will be significantly higher and it will be very similar to what we saw in 45 days. And so we see in reality for G was a consumer drive and 5G will now be the backbone for digitalizing the Enterprises and that's what you'll see us also do we continue to work with our service provider customers, but we're also going to build the material business for Enterprise use cases and that's to help with the service providers drive more Revenue growth and and that will ultimately drive more requirements and more benefit for us and network equipment. We already have a couple of old I accelerate being one dedicated networks, but during the quarter we announced the strategically important acquisition of CradlePoint, which will will allow us to build a game.

Association in in the wireless one as well. We look at some of the highlights in the third quarter specifically we see 5G deployments around the world gaining pays off and it's now clearly the faster scaling generation of mobile technology ever. We have 113 commercial contract 65 line networks off using ourselves as a clearly didn't 5G.

During the quarter. We have the inorganic growth of 7% year-over-year and that's despite the challenges we get from COVID-19.

Gross margin reads 43.2% excluding restructuring, and it's improvements across all business segments. Our operating margin was 15.6 excluding restructuring costs one of the highest for a long period of time.

Our growth in China is particularly strong and our 5G contracts are all following the plan. We have discussed earlier. So now the contracts are based is they are contributing to our profit off the third quarter. As I said in the earlier strengthening our position in China is critical for our long-term competitiveness. We have over the last two years worked a lot on our cash flow generated or ability to generate free cash flow. If we look on the rolling 4-quarter basis, excluding our payment to doj and SEC off our free cash flow before m&a was 17.7 billion Swedish kronor.

Yeah, we have also announced the plans require CradlePoint earlier in September and that is one key building block for our Enterprise and patience and we expect to be able close that deal in the next coming weeks.

So if you look now at the end of the third quarter, the forequarter rolly margin is 10.4% which is above our Target for twenty twenty. So we seen with increasing confidence and over our ability to deliver on the financial targets for the full year twenty-twenty. So let's move into the market overview month. We see strong positive growth in Northeast. Asia driven by gains in five G in China in Southeast Asia. We also saw good growth and that several Market Computing most notably Australian Indonesia.

we continue to

See a strong momentum in North America driven by the acceleration. If I did, of course the the consolidation in the operating Market operator Market, did Tom Wood lower sales in managed Services as well as the the Legacy portfolio indicate Digital Services partly offset across Europe and Latin America. That's wrong. Determine makes picture there. We see good growth in Europe on the back of market share gains.

And today you also saw that we announced five-year strategic partnership with telia in our home Market that is important given our significant already present since we don't talk about the progress in Europe that was actually upset by slower sales in Latin America, and that's really driven by uncertainty related to COVID-19 off. I know we're operating Revenue leading to lower operator capex.

We saw more General drop in more General reduction in the sales volume in Middle Eastern Africa. That's also mixed picture 5G grew at a good Pace in Middle East. I had again economic uncertainty from the pandemic delayed investment decisions in some African Market, but overall we continue to progress and if we could go over to our segments in more in detail, you see that networks perform very strongly with Organic growth of 13% that's underpinned by strong faith in China as well as as clearly North America operating margin reach 22.7% driven by a larger share of software sucks.

We continue to execute on the turnaround plan four digits or services and the team is delivering. Well on all our plans, which debated in order to combat this we had increase our investment in the new cloud-native 5G portfolio.

And we are seeing good win ratio on our new portfolio, but it's also fair to say it has not yet generated any significant sales and therefore it can simply not compensate for the four wheel in the Legacy portfolio.

On the weekends that we have over the last six to nine months. It will not be recognized on the 20 21 in sales and beyond that by the way, so once we still a long break even in 20 21, we recognize that that can be a bit of a challenge even where we are today.

In managed Services sales were down 9% organically that's primarily due to lower variable volumes in North America.

at the same time gross margin improved to 20.1%

an investment in R&D continue to drive new Solutions and you automations that will actually have a potential to generate much better more than profile in the future. I'm finding in the morning based since we saw growth in sales and gross margin supported by both volumes as well as cost efficiencies, but the most important part for emerging business is Courtney was I was actually the announcement of cradle point that we expect to close in the coming few weeks with that corn. I give the word to you. Thank you very much and good morning. Good afternoon everyone else. So let's dive into the p&l to start with here net sales and reach 57.5 billion this represents an organic chem FX adjusted growth of 7% over Q3, 2019, really driven by networks. I grew 13% based on the continued high demand for our

By the portfolio and in particular we grew in North East Asia with 49% FX adjusted at the bill you showed earlier but also North America Europe and and Australian to mention a few growth areas across more than you see 43.2. This is an improvement of by 540 basis points year-over-year, excluding restructuring here as well. And of course encouraging to see that all segments improved year-over-year with the main contribution coming from networks, but also Digital Services where we in both cases saw increased the software sites.

Operating income came out at the nine billion excluding restructuring charges and this is an improvement by 38% year-over-year if we exclude a couple of items that affect compatibility in Q3 nineteen and you can see here namely the prediction for the SEC DJ finds, of course, but also positive refund of Social Security cost lost their jobs nine billion of operating income is to an operating margin of 15.6 where again networks is the main driver with its 22.7 operating audience just showed earlier here free cash flow before emanate 3.9 billion vs. 4.5. But here we should also remember that we have absorbed in the 3.9 thousand two billion Capital injection into the Swedish pension trust. So adjusted for that. We are at would have been at five point nine billion.

and then

At the graphs in the bottom to illustrate. What were you mentioned? You see that the adjusted operating margin after well looking back for what is rolling is 10.4 m in line with a financial targets for 20 20 or more than 10% So let's have a look closer. Look at gross. Margin if we take the next one here and you see that on the rolling 4-quarter basis gross margin is 39.6% And this means that we are now for the first time if we look rolling then above the target range of 37 to 39 months for 2020 and we have seen as you see her steady Improvement or the the gross margin over 10 consecutive quarters now in terms of rolling since the start of 2018 and as we have said many times the driver behind this is of course the the investment we make in R&D.

And this clearly demonstrates the value creation logic that we have adopted since the Strategic reorientation back in 2017 investments in R&D to reach technical leadership trade competitiveness and it has helped us win deals with technology technologically very demanding customers, but it also improves the ghost mode in as we can see here. So to repeat the little bit we saw Improvement and growth model and all segments software sales support the higher model in networks Digital Services also benefited from a higher share of software. And in addition to that we had in this quarter very limited impact from the critical contracts that we have had impact earlier. For example, a 2019 where we had a negative impact from those and many services. We still continue decisions against contributing to better and gross margins their birth.

Emerging business and other we seen gross model improving from 20 1/2 to 30 and a half percent year-over-year driven by the new and emerging business part of life. And sequentially you could say the main reason actually for the Improvement is China while cute to this year was impacted by negative audience and and they're also write them in China as we communicate it before now China turn out profitable now in Q3 and will improve further.

So let's look at sg&a and R&D and every cylinder or indeed and landed at 9.9. This is an increased by half a billion mainly following higher investment in networks in in 5 G. But of course now the numbers also include the acquired antenna business, which was not there a year ago back in the Digital Services. We we also transition on the funds from the Legacy to the new portfolio where we invest to capture the business opportunities that we now offer see and that we now can capture without 5G in cloud-native products not least the 5G call area it managed Services the strategies, between St. Not to mention analytics to shorten the offering. So that's about all ready. And then on the estimate side you see we came up at six billion dead.

and if we come

hi we lost we we recorded four point nine but that included the item I mentioned before a positive refund of social cost in Sweden of 0.9 billion so if you adjust for these the increases 0.2 billion year-over-year and as we have said earlier we are investing in digitalization and compliance you know company and again of course we have Incorporated the antenna business during the year as well we move over to cash flow and the financial position and here in the third quarter deliver then as you see a positive free cash flow before M&M's 3.9 and two items to remember here when we compare we lost one again the tube in a pension trust inject Capital injection and this by the way completes and the three billion injection that we have mentioned in previous reports as well

And the second item is again, the Social Security costs refund in nineteen, which had a point four billion positive impact on cash flow. So if you if we adjust for those two lights off the free cash flow before m&a actually improved by 1.9 billion year-over-year.

What you also see here is that net operating assets and liabilities had a -4.4 billion in the quarter and this is partly driven by higher inventories follow up an active decision. We have made to the risk the supply chain here to create improved resilience when it comes to the component Supply, but of course, we continue very high focus on working capital in the in the company. So this leads to cash position that was further strengthened. You can see the numbers 41.5. And that's cash at the end of third-quarter and Rose cash now at 78.2 billion also increased since last year and it's very mentioned earlier on the rolling 4-quarter basis free cash flow before m&a amount of time to 17.7% billion if you exclude the doj SSE fine and that translates into 7.7% off.

Rolling, 4-quarter sales. So one could say that the efforts to create a strong cash flow here in the company's is bearing fruit. Okay, I will round off with a few words on the planning assumptions. First of all again, as usual, please refer to the full report page five, I believe but just a few comments first on the mod battery operating the Laurel now expects to run Market to grow by 8% in 2020, which is an increase from the previous number 4% off China then at the main growth engine at 33% growth and the rest of the world excluding China, then it's last in 2020 and remember that includes in the four percent growth in North America.

Secondly based on where we stand now you have to date and Outlook. We are strengthened in our confidence that we will reach the full your targets for the group. But again, as I did. Mentioned I needed to service it's due to the week to sales but also our added were accelerated or in the advanced. We see further risk of further delay in reaching the 2020 Target as mentioned here before and then some specifics to close often. First of all Q4 is normally our strongest Faith water. If we look back historically the last three years the normal seasonal is says she has been plus 70% on top line from Q3 to Q4 and then important life software sales and the software Cheryl. The sales in networks is expected not to be lower in the fourth quarter after very favorable Q3 and historic wage.

Also, the shuttle service is actually increases in Q4 competitive as we close of project Opex increase normally Q3 to Q4 home and looking at the last three years. There's been an increase of 3 billion on average but with large variation between the years then finally just please note that cradle point, It's likely to close now and closing then we will pay the consideration here to the sellers. It's around 1 billion subject to adjustment for working capital and asset cetera and we will finance that took the cash at home. And then we will consolidate the CradlePoint financials in the Ericsson books in the segment emerging this is another with a certain negative impact of the fourth quarter. And then with that thank you and I hand back to you. Thanks horn. So in summary we see the third quarter.

That's another solid stepping stone. And we are well-positioned now to take the next steps. We leading in 5G with hundred thirteen agreements in place and 65 OLED networks around the world. We see a clear link between our earnings performance and and the financial performance of the company and actually our continued investments in Orange County towards technology leadership. We're we're we continue to increase our market share and you know, that's a very important part to keep wage scale in our business, but we're also doing that and maintaining a good cost control.

We just strong cash flow that we've been able to generate on a very stable cash flow. We're now in a financially strong position to take the next step down and and we can do that in strategic growth Investments. And that's where we see a big opportunity going for four birdies in the Enterprise segment. We think that will help, you know, Drive the demand for Network equipment and it will drive demand for or or traffic into the operators Network that's going to benefit us. But we also look for a stand-alone opportunities in there we go. The economics like CradlePoint acquisition that we think is is a typical example of the type of use cases that we will focus on that both Drive traffic as well as a good Standalone economics.

So we did the results.

Which delivered so far in in the year and and with you three we are confident about our ability to deliver on the group Financial targets for the full year 2025 that thank you give the word over to Peter. Thank you. Damn operators. I would appreciate if you could open up the Q&A session.

Ladies and gentlemen at this time. We will begin the question-and-answer session. If you would like to ask a question, please press zero one on your push-button phone off. If you would like to decline from the polling process, please press zero to as always. Please limit yourself to one question at a time. And please keep your question. It's a broad level detailed information is provided in the report and Ericsson's investor relations and media relations team will be happy to take additional questions and discuss further details with you after all. Our first question comes from the line of Alexander develop of Goldman Sachs, please go ahead good morning and make the same question and congrats and strong results. First question. Just about North America. There's obviously been discussion about Spectrum auctions and you talked about good momentum there. I wondered if you could talk a big game.

About what that means for the first half of next year and just completely interested given that tends to be a strong gross margin region. And as part of that how you're thinking about importance of these, um iPhone Launches on 5G and then second question, you talked about winning market share and Europe and it's quite impressive and grown there despite her declining catch and you have in the past talked about product advantages like Dynamic Spectrum sharing and the materiality of your product. So I wondered if you could give an update on the latest date of birth that you talked about sort of broad share games versus various players. Um, so I wondered if you could talk about what kind of product lead you think you have now bought a bus is let's say six to twelve months ago many times.

thanks for your question if we start with the North American one you know we we see the momentum continued into next year. And the demand being strong but I would also say one more thing when you think about the the gross margin profile you know we've been working quite a lot over the last few years too often used those type of singular exposures that you referred to so so what you see now is much more balanced gross margin profile across the company then that we've had before work and you see our growth in in China this quarter and we still have a very high gross margin development so you you you have to look a little bit dearest on the geographical mix of it but but we see the growth continuing in North America into next year on the bath

the Spectrum auctions and and

Here, I would also say that we believe that the the launch of an apple 5G phone will actually be important to show the the value of 5G for the consumer. So we think that is going to to help you know, the the demand for Network equipment going forward.

I would say, you know, they without getting into too many details. What we see is the Investments we started making already in 2017 and actually to some extent already before that making our portfolio 5G ready enabling the launch of 5G with with software upgrades wage has put us in a fairly unique position. That's why we have been able to launch the dynamic Spectrum sharing that have clearly helped our customers to get a full coverage of ID. It's always very speculative to say how many months or your head what we need to do. We need to continue to invest in R&D to keep the distance. We have lunch. We're going to run as fast as we can providing our customers with new features and new functionalities that we'd allow them to to drive their own Revenue growth and we feel that

The the password on here is what you see in Q3. It is a result of you know, we gain the share as a result of our investments in R&D and will continue to stick to that addicts many. Thanks. Okay will move to next question. Next question comes on the line of Alexander Choy General, please go ahead. Good morning. Good morning. Good morning. Could you come back a little bit on the higher software a conference that you saw in network settings just services in the quarter. Could you be more specific as to which regions benefited the most from and why this amazing and then more generally on this software content. This is now the second quarter of this year. We had we had a pretty positive development in this front and would you say that wage?

Moving into world where this sort of content is structurally higher and this will drive your gross margins to structurally higher levels than what we've seen in the past few years. Thanks.

You won't take that I can I can start at least and you can compliment but yeah, but no but to start with we are not talking about specific geographies here. It's more when we look at the mix between the software hardware and services that we see that the the the share of software was very strong in the quarter. And as you seem planning assumptions, we say that that ratio will most likely change in the fourth quarter. We software coming down and so this coming up but we haven't we haven't decided where disclosed anything around specific geographies at home. I don't know where if you want to come at the structural makes but I wouldn't say that there is a structural change in that mix. Of course. We are we are a big software house phone system software is is a big part. It's about twenty 21% perhaps of on average of our Revenue, uh, and when it comes to Digital Services as well.

of course one one of the

We are driving pursuing. The customers is to get into more of a recurring software setup and which is good for stability in that business as well. But a big structural change, I would not say something unless you were you want to compliment them know I think it is as part of the strategy for example in Digital Services. It is a clear ambition to actually increase our resolve to Asia off so you should expect to see that go up and and that's what we see in regards have good gross margin development, but I I think you should also remember software sales in our business tend to be a bit lumpy. So it comes you.

Individual quarters nothing out there. So so there is an element of that as well. But but we think the industry will be more of a software industry in a longer-term. So so that's critical for us to position ourselves in that.

Great. Thanks. Thank you. Thank you. Next question comes from the line, Hello, Patrick. Hello. Good morning, Charles. Thank you very much for taking my questions. I was wondering if she could share some flavor on the iPad revenues and their progression in the coming years. I understand that their contracts, of course under negotiation, but surely or expectancy for higher figures. They coming 2 years given given your position in five G in critical patterns, and my second question is regarding your closing remarks their body on on the 5D front door price with cradle point now in the portfolio, you will have a more comprehensive offering for Enterprise, but is it enough or they see more opportunities for women a organic investments in in other areas to have more. Offering for Enterprise customers?

Thank you to to good questions. The first one on IPR you saw that we were a bit lower in Q3. Then we were in Q2 life. It's actually one one of our license is having lower sales volume that results in lower royalty revenues for us that that we had seen if you look going forward, I think you should think of it as a it's a question of empathy of a contract with with you know, in in every contract negotiation is actually discussion about that total value. And of course what we are saying here is when we are in the middle of those discussions, we can have a one-time temporary gaps in revenues, but we are going to accept those in order to get the fair value on our IP or agreement. Yep.

So we are determined to make sure that we protect the value we have made in protect the Investments we have made in or indeed in the in the contract terms. We can be realized with their the license horse. So we are we are going to be fighting hard for that. But but we also say that could be gaps. So that's the way it should think of it to maximize the empathy of the contract. We can have trade-offs or gaps in revenues. If you look at the specs on the 5G portfolio, we feel it's always hard to discuss the patent portfolio and and how it Compares but we see with independent wage assessments done by by truly independent firms that have looked at the criticality of our IP or or our patterns. They see that we own no.

Clearly ahead of our competitors on.

The strength of the portfolio and that's what we are going to leverage in those discussions. So that's a very very important part going for but it's it's clearly a key key contributor to our earnings as well. But it's the strength of our patent portfolio nor indeed that drives that

the second question Enterprise the Enterprise. Yeah, you know, the the reality is critical point is one use case Wireless warm still very low penetration and still mostly used for I would say a backup connectivity with increased 5G Wireless one can gain much more significant penetration be used also as the primary connection point. So we see that as a very good long-term growth opportunity very exciting opportunity that's going to help our customers generate more revenues and we have a stand-alone business opportunity that's attracted. But you're absolutely right. We think there are going to be a lot of their use cases where we will continue to invest. Yeah, so that will include both organic as well as inorganic growth, but we will be building up a presence with kind of the two dead.

So what parameters or two criterias to remain the same it has to help our customers generate revenues and it has to be a stand-alone attractive opportunity down here. We have, you know, the iot accelerator as well as dedicated networks today, but we have out there organic opportunities that we pursue in parallel. So we are we're very excited about this area that we see that to contribute to our long-term Revenue growth in a substantial way going forward, but we'll talk more about this at the capital markets day.

Thanks for you. Are you happy with that? Very happy thank you very much. We will move to the next question. Please operator. Our next question comes from the line of actual Sultana of Credit Suisse, please go ahead hi morning Peter morning boy a call just on China just wants just and I guess you've seen very strong momentum in China driven by these 5G contracts. Uh, my understanding is that some of these contracts the phase one is is I'm getting close to completion. Uh, we'll probably have phase two at some point. How should we think about timing of phase two so far? Have you got any indication from your customer and and how should we think about sustainability of that Revenue strength in China going into Q4 and and into next year and then attached to that? Uh, you mentioned that childbirth

Uh has become profitable in this quarter. Can you just

Help send the standard is very high level as to what what are the things going on in those contracts which is allowed you to become profitable from Q2 to Q3 and and and further years profitability should further increase. Um, so is it all about mix is is it more about scale? Like what are the key drivers for the profitability Improvement in China? Thank you, ma'am. Thank you know, you know, first of all if we start with the profitability on the Chinese contract, we already said in Q2 when we announced that they're challenging beginning that they would actually contribute or earnings in the second half of the year. So this is very much in line with the plan we put in place. So we're we're just following that and it had to do with you know, you are you're you're when you do a swap contractor contract to build out your cost have in the beginning. That's what we saw. And and now as we move into more of a

Where you kind of have you have some cost, of course, you will have that during the build-out phase. But but the reality is we're getting more revenues now, so that's that's the simple fact you could have done this by bookkeeping and you know balancing costs Etc. But we think it's better to to take the course when they occur and take the revenues when they occur and that's what you see. You should see that bit of a mismatch in in the numbers, but that's also why we feel very comfortable about the development of the rest of the year on the on those contracts. They will further improve in Q4 off if you look otherwise, you know, we we don't see the build out to stop in China. They will continue to build out and they will continue to build out on the on the Spectrum balance that we have are awarded contracts now, but of course over time, they will award out the Spectrum balance as well we contract and we'll have to compete their wage.

To win there as well and we will do so but we we see, you know, good demand in China and we have no reason to to think that it will not continue.

Thank you. And by the way, I think it's important and this one you may think about you know, in a more of a European contact, which is that the 5G if you think about the strap that that the Chinese operators are deploying it's actually to build out the network because it is a platform for Innovation and it's a platform for driving the rest of the economy sucks and we in Europe tend to focus more on the investments in five G. But the reality is the value of the applications you're going to run on top of 5G is much higher and I think that's where the Chinese wage operators are recognizing that and the Chinese system is recognizing that actually in sending or driving more investment to build out the network infrastructure wage. You almost the opposite in Europe.

Thank you. Thank you. Yeah, thanks. Thanks a lot. A question. Next question operator. Our next question comes from the line of sight of UBS, please. Go ahead.

Good morning is one. I have one quick question. You talked about, you know, the market share gain across different regions. So even if it China is wage, you mentioned that you gain market share in in Europe and and North America, for example, do you think I mean given that you have, you know relatively High market share in those regions in Europe in North America compared to China. Do you think there is a limit to the share? I mean you can gain in a way that your customers as well want to maintain some balance within their own suppliers. So it was just wondering if you think you know that maybe the markets again would be more in China and more limited. In other regions would be great. Thank you.

I often say internally there is a limit of 100% market share and I guess it applies here as well. No, you know the Practical reasons there are of course, you know you I think our customers would like to maintain an event or diversity we have to but I with the winds we see we have not been I'm being at that limit yet. And and actually I I think it's also Worth to say that you know, it may need type of operation. There's a light you see the announcement we made on on an operator today, you know, there is value actually oversold supplier relationship as well because that can help our customers to know where the Opex know where their own costs so to say and we can provide the lower TCO to them. So so I I do think it's yep.

Hard to say where that limit is because in some operators. It's a clear benefit of having those one vendor in the network where you know the and it's a cost-benefit but it's also important that they can launch the same service nationwide at the same time across your whole network. So it's also commercial benefit that customers realize that rely on a vendor. So I think there are a number of benefits here that they can go we need the direction. Of course, you know, we like to have as high as possible so I'm not going to try