Q4 2022 Telefonaktiebolaget LM Ericsson Earnings Call

Speaker 1: our business.

Speaker 2: back of significant market share gains.

Speaker 3: As we said at Q3, as well as our Capital Markets Day, the growth from share gains in several markets could not fully compensate for reduced operator spending and inventory reduction in other markets, including North America.

Speaker 4: As is always the case and we've said in the past, market share gains results in higher service revenues.

Speaker 5: from large roll-out or higher share of service revenues as a result of large roll-out contracts.

Speaker 6: These contracts are profit accretive, however they are initially margin dilutive.

Speaker 7: And of course these contracts are important for us and we took them consciously because they are strengthening our strategic market position and build the scale to be competitive long term.

Speaker 8: Gross margin came in at 44.6% which is mainly due to the change in business mix. And we expect gross margin to be 40-42% in Q1 of this year due to the change in business mix.

Speaker 9: In cloud software and services we saw sales growth in North America, mainly from 5G core contracts.

Speaker 10: But this was offset or was more than offset by declines in other market areas.

Speaker 11: The performance in this segment has clearly not been satisfactory historically and at our Capital Markets Day we introduced an updated and revised strategy to turn the segment around which included priorities to limit subscale software development.

Speaker 12: Accelerating automation to lower deployment and maintenance costs.

Speaker 13: changing focus from market share gains

Speaker 14: profitability as well as realizing cost synergies from combining the two prior segments.

Speaker 15: So in the quarter we started to execute on this strategy and that included to exit some subscale businesses and we're confident that the business is on path to reaching operating profit breakeven for the full year of 2023.

Speaker 16: in parallel in our core mobile infrastructure business we're continuing to execute on our enterprise strategy.

Speaker 17: This is organized around two pillars, each leveraging our strength in mobile networks.

Speaker 18: First, Enterprise Wireless Solutions focused on capturing the multi-billion dollar enterprise market opportunity.

Speaker 19: So first of all Enterprise Wireless Solutions

Speaker 20: So Enterprise Wireless Solutions is focused on capturing the multi-billion dollar enterprise market opportunity for 5G optimized networking and security solutions. And the second pillar is the global communication platform business.

Speaker 21: where we will be able to monetize 5G in new ways by transforming how network features such as speed, latency are globally exposed, consumed and paid for.

Speaker 22: During Q4, sales in the Enterprise segment represented 8% of total sales.

Speaker 23: Enterprise is a growth engine for Ericsson and we continue to fine-tune our portfolio to maximize profitability. And this included an agreement to divest our loss-making IoT business. After this divestiture, our emerging technology area is expected to be profitable.

Speaker 24: We are investing in building up strong go-to-market organization for enterprises.

Speaker 25: and we're investing to broaden our product offerings as well as bringing network APIs to the market. These investments are a foundation for profitable growth after 2023, but they will weigh clearly on profits in the coming year.

Speaker 26: In the quarter we also announced the 2.3 billion kroner provision related to a potential resolution with the US authorities regarding the previously announced deferred prosecution agreement breaches or breach notices.

Speaker 27: The provision also includes costs associated with the extension of the compliance monitorship that we announced in December .

Speaker 28: While we are now in a position to make a sufficiently reliable estimate of the financial penalty, we have not yet reached a resolution with the DOJ and discussions are ongoing.

Speaker 29: Separately, and with respect to the past matters described in the company's 2019 Iraq investigation report, we continue to thoroughly investigate the facts in full cooperation with the DOJ and the SEC to determine if there is any merit to the allegations.

Speaker 30: But it's not appropriate for me to comment further as this is an ongoing investigation at this point in time.

Speaker 31: We continue to focus on building a culture of ethics and integrity throughout our business and our company. And that includes the board and remains a top priority for Ericsson.

Speaker 32: I will now share a little more detail about the development in our market areas.

So this high level summary slide highlights how sales increase significantly in market areas in Southeast Asia, Oceania and India.

In Europe and Latin America sales remain stable.

We saw a decline in other market areas as operator capex were reduced due to macroeconomic pressures but also from operator slowdown or rollout plans. And in addition we've seen supply chain easings that enable some operators to optimize their inventories.

Digging a little bit deeper into this, I'd like to highlight a couple of things.

As you can see in market area, Southeast Asia, Oceania and India sales increased by 21%.

Of course, as you're aware, this was primarily driven by 5G market share gains in India.

which of course we're extremely happy with.

We did

though experience a slowdown of investment in certain other countries in Southeast Asia, which negatively impacted states.

In market area Northeast Asia, sales declines after the elevated 5G investment levels we've seen for the first three quarters of the year.

In market area North America we saw 7% decline year over year.

And as stated in our Q3 report as well as at our Capital Markets Day, we have during the year seen accelerated CapEx investments.

But we've also seen customers holding relatively large inventories. During Q4, our operator customers guided around reducing the capex investments. This is further compounded by their need to optimize inventories as supply constraints.

actually, ESIS.

Market area under primarily includes IPR revenues.

IPO licensing revenues and a major part of our segment enterprises. The growth here was mainly driven by the acquisition of Vonage.

impact in the quarter by 4.1 billion kroner and the retroactive part of the IPR licensing revenues for unlicensed periods.

With that, I'd like to give the word to Carl, our CFO . Thank you, Burya, and I'm glad your voice recovered as well. I'll try to...

do the same here. But so good morning everyone and thank you for joining the call.

I wanted to start by coming back to some of the one-offs that we have recorded in the quarter. First of all, of course, we landed this major IPR agreement.

which meant retractive revenue from the expiry of that agreement, which was in early January 2022.

And all of that revenue was recorded in the fourth quarter, which brought the IPR as a total up to 6 billion of revenue in Q4.

Second of all, we agreed with a buyer or acquirer to divest our IoT business.

And we took a related charge there of 1 billion Swedish kronor in the quarter related to that and that impacts the enterprise segment.

Then in cloud software and services we decided, also per the strategy that we have in turning around this business, we decided to exit certain subscale businesses and here we also recorded a charge in the fourth quarter amounting to 0.8 billion Swedish kronor.

And then finally, also as Buri mentioned, last week we announced that we were now in a position to reliably estimate the financial penalty from the DOJ regarding DPA breaches, and hence we made a provision then amounting to 2.3 billion in the quarter.

that including the extended monitorship cost.

I also wanted to reiterate around what we see happening in the market and the market shift. In the Q3 report and the call back then but also even more in this capital markets day in New York in December .

We discussed this mix shift.

that we expected to start in the fourth quarter, but also continue into the first half of 2023. And we really see, and I'm really reiterating a bit what Bury had explained, but I think it's a valid point here that some CSPs, especially front-runner markets,

are now taking down their capex in some cases from record levels previously and some are also adjusting down their inventory levels.

At the same time, of course, we ramp up in other markets where we have gained significant market share which often comes with a large services share in big roll-out projects.

And altogether we expected this to impact both top line but also gross margin in the networks. This came through as anticipated in the Q4 numbers.

But with this overall intro, I'd like to dive into the numbers a bit more then for the quarter to start with and then a bit later into the full year.

But in Q4 we reached sales of 86 billion which is actually the highest sales for Ericsson in a single quarter ever.

And the organic growth here as you see is 1% supported by catch up IPR revenue which drove growth by about 5% point if you look at the total IPR revenue.

And we saw Southeast Asia, Asia Oceania and India grow and you saw the market area slide that we represented before. This is a result of those market share gains that we talked about. Europe , Latin America flat and the other three market areas declined notably than North America also expected.

Gross income, excluding restructuring charges, grew by 4.6 billion year over year to 35.7.

of course supported also again by the IPR revenue growth to 6 billion from 2.4 in Q4 last year but also the addition of the Vonage into the Ericsson family.

The margin and gross margin of course again excluding restructuring charges while supported by by IPR declined still by 200 basis points than 241.5% year over year primarily due to the business mix shift that we talk about in the networks.

also related to this previously announced charges for contract portfolio exits in cloud and cloud software and services.

R&D increased, you know that investment in technology leadership is absolutely key for Ericsson. Increased to 13.2. The FX effect year over year is approximately 45% of that increase.

So quite big impact from FX but other than FX and the increase is really a result of the decision or decisions we make to invest in our 5D portfolio and offering across the company but also includes investments in enterprise wireless solutions.

as well to enhance the offering there and bring 5G into that not least but also the additional bondage of course.

Other operating income, just to highlight that, was negative 2.8 billion and there is where you find provisions and charges related to the UJ monitorship and IOT.

All in all, EBITDA then, again excluding restructuring charges, declined by 27% to 9.3 billion Swedish kronor. That corresponds to a margin of 10.8%.

Again, as a result of the charges of around in total 4 billion.

but also increased expenses, not least in the enterprise side, which in turn comes from bringing Vonage a full quarter into our business. Obviously, they were not part of Ericsson Q4 2020.

competition.

So from that overall view on the group, let's look at the segments. Here we can start with networks where Q4 organic sales grew by 1%.

supported by IPR of course again and the double digits growth that we saw in market area Southeast Asia Oceania and India

Gross incoming networks, excluding restructuring, increased.

primarily driven by retroactive IPR licensing revenue.

And the gross margin then a similar pattern on the group level of course decreased to in this case 44.6%

This is mix shifts that we talked about and that we had anticipated and mentioned at the CMD not least. This is mix shifts that we had anticipated and that we had anticipated and mentioned at the CMD not least.

EBIT came out at 12.5 billion. This is an EBIT margin of 21.4.

And moving over to cloud software and services. Organically we grew by 2% here.

North America grew as Buria said while sales in other market areas were down. And that has mainly to do with the timing of project milestones and similar but also some contract de-scoping in the managed services part of that business.

Gross income increased following the higher sales volume.

But again, of course, negatively impacted by the charges that we have talked about several times already.

In the cloud software and services 0.7 billion.

stable a bit more, you know, 3.4%, again impacted by one-off charges.

Finally then, Enterprise on the right side here. The total share of total Ericsson sales at Enterprise stands for now is 80% in the quarter.

We saw a strong growth here in several parts of this business. Organically, we grew by 15%. Of course, reported much more to 65%, but that obviously has to do with the addition of Vonage contributing with 4.1 billion in sales in the quarter.

Gross income increased by 2.1 billion to 2.9 billion in total. And that's again driven mainly by the Vonage acquisition.

That leads to an EBITDA level in enterprise, excluding restructuring of negative 1.7 billion Swedish kronor.

You can compare that with 0.6 the previous year, mainly due to the charges related to the IoT divestment that we talked about, but also growing investments in R&D and SDNA, not listed in Enterprise Wireless Solutions.

That's about the quarter and now if we zoom out and look at the 2022 full year numbers instead, sales of 271.5 billion.

which is up close to 40 billion year over year.

If we look at the reported numbers not considering a currency in this case

But if we do it just for comparable units and the currency growth was 3% year over year for the full year.

Gross margin, excluding restructuring, declined to 41.8%, impacted again by the same items. I will not repeat all of those again.

And here you can also see the R&D expense increase is about 5.3 billion in increased R&D. And one sort of that is FX movement related.

In networks where we add investment is really in the Cloud Run area but also in what we call Ericsson silicon or our A6.

Also, enterprise saw an increase in R&D.

So yeah, a bit more in here as you can see.

You can see the numbers here, but excluding the one-offs and the non-organic, so the Vonage acquisition, we came out at 12.9% in EBIT margin, again within the range for 2022, the target range that we had put up earlier of 12 to 14%.

Gross margin is a metric that many follow in our industry and let's look at that. Here you can see the gross margin development from Q1 2020 and we decided to start this graph there but of course earlier we have shown also developments from 2016-2017 when

Ross Maudians were at 30% and we remember that time as well. Now we have surpassed 40% since sometime.

And now on a rolling four quarter basis cross margin is forty one point eight percent

So the improvement you can see in the blue line here from 2020.

is really driven by the investments in technology leadership and competitiveness.

And as you know, the improvement you see there in the blue line is really also accompanied by market share gains over the same period.

Now, we see a certain decline in gross margin and it comes as a result of inflationary pressure and this business mix shift that we talk about in the networks. And specifically in the fourth quarter, and I mentioned this already, we saw that this shift.

as expected, impacted our growth margin.

When it comes to inflation, I would say that we have managed well.

to offset that in the quarter with commercial initiatives like product substitution.

Of course without inflation you could say that this operational leverage coming out of technology leadership as well would have.

contributed to a stronger gross margin, but in this quarter now we have managed to offset that inflation.

So

Aside from those effects that I talked about, of course we again have these one-off charges that we should not forget when we look at this to better understand the underlying business. One-off charges here affecting Ross Mardin amount to 0.6 percentage points on group level.

So from there let's move into how our earnings have converted into cash flow.

And of course, as you know, free cash flow before M&A is a key metric for us.

We came up at 16.9 billion in the quarter.

and 22.2 billion for the full year, which is

8.2% of net sales. As you know, we have a long-term target of 9 to 12% of net sales. So we came in just below that range now for the full year 2022.

There I think we should remember that this was a year with significant global challenges when it comes to supply chain and of course that has impacted our working capital.

And I think it's in this context we should see the year-over-year development of free cash flow.

2021 was a very strong cash flow quarter for us, where free cash flow before M&A reached even 14% of net sales.

So that creates a bit of a tough comparison when we look at 22

But we can also see this over the two years and then in average we have generated free cash flow of 27 billion between the two years on average per year.

So what happened in the quarter was that now as the supply chain situation globally is easing up

We were able to reduce the inventory just as we said would happen. Exactly that happened as well so that's good both in component but also in project inventory.

So this improvement in inventory together with very strong cash collection including the collection from the IPR licensee where we have the new agreement.

They leave it a positive contribution for working capital and therefore generated a strong free cash flow in the quarter.

I can add also that of course there is an impact from currency between quarters and over the years, but if we look at reported numbers, this

cash flow of 16.9 is actually the highest that we have delivered at least during the last seven years in Ericsson's history.

We continue with the focus on working capital of course. It's a big important drive in our company and we continue that with full force. I said before though the large rollout projects that we are happy to have won tend to build up working capital initially at least and that's normal and expected.

as an effect of winning business of that nature. So that we believe will continue. However, the inventory side should still continue down.

So on the back of this strong cash slowdown, we managed to increase the net cash.

Positioned by 10 billion now it's a bit more than 23 billion of net cash and this is after having paid out of course the second dividend installment of 4.2 billion.

Gross cash now 56.2 billion.

And then the proposed dividend from the board of directors at 2,70 R per share corresponds to a total amount of 9 billion. And it's proposed to be paid out in two installments just like it is years ago.

Now before I hand back to you, Burya, I just wanted to present a couple of the key data points for the future.

So my last piece for today here covering the outlook for the first quarter and also the the full year 2023 to some extent. But first some specific comments regarding first quarter then starting with top line and we we look at average seasonality for for networks and the cloud software services.

For networks, this is minus 23% on average, historical numbers. And for cloud software and services, this is minus 35%.

I'm talking now about the delta, the difference between Q4 and Q1.

And for networks then, we expect that the seasonal decline, Q4 to Q1, will be more pronounced in Q1, even when adjusting them for the retroactive EPR licensing revenue in Q4. And for cloud software and services, we expect a normal...

seasonality to play out in the first quarter when adjusting for their retroactive IPR again.

the first quarter when adjusting for the retractive IPR again.

So next when it comes to Gross Smart Info Networks

We are specific now in the guidance for the first quarter where we say that given this change in business mix resulting from market share gains and what we have explained now and earlier we expect to see a range of gross margin in networks between 40 and 42 percent in the first quarter.

And then when it comes to operating expenses in Q1, there is a typical decrease in our company if you look at historic averages.

by 3.3 billion Swedish kronor from Q4 to Q1. I believe this is a good indication also this time and that's why I have said that of course there might be large variations between the quarters.

Then amortization of intangibles expected to be around 0.9 billion per quarter for the Ericsson Group in 2023, of which 0.8 billion in the enterprise segment.

And lastly for Q1 we expect a beta for the group

to be somewhat lower than a bit last year, same period, but then with an improvement during the rest of the year as a result of declining margins in networks that we guide for due to the changing business mix-up.

So that concludes this part and I hand back to you, Brien. Thank you, Corz.

So to sum up, we took several important steps during the quarter in achieving our strategic and financial goals during the last quarter. And in a choppy world, I would say we focus on manage what we can manage. And this includes, of course, saving costs.

of 9 billion kroner that will have full effect by year end of 2023. And we expect to start seeing the...

the reduced cost to come through during the second quarter of 23.

We're also executing on the plan for cloud software and services that will allow us to improve profitability and reach break even for the full year 2023.

We see great traction in our expansion into enterprise and we continue to invest in broadening our product portfolio and build a strong enterprise go-to-market organization.

These investments will create a strong platform for profitable growth going forward, while weighing, of course, on the costs in 2023.

And we expect to be able to showcase what we can do with the global communication platform during the coming quarters. So I encourage you to stay tuned for Barcelona this year.

Our basic premise for our business is basically that anything that can go wireless will go wireless.

I'm truly excited about Ericsson's future as we continue to execute on our strategy.

As we go forward, the investments in and growth from our enterprise business will be a major driver of Ericsson's long-term growth and profitability and we remain committed to reaching the lower end of our long-term EBITDA target of 15-18% by 2024.

I would like to thank everyone, each and every one of our customers, partners and employees. This has truly been a team effort. Thank you.

Finally, I would like to welcome all of you to our annual General Meeting at the end of March and as you have seen and Karl described, the board is suggesting a dividend of 2 kroner and 70 euro per share.

slipped into parts as it was the past year.

And with that, I would like to conclude this part of the presentation and hand back to you, Peter.

Thanks, Borye. As we leave it late, I will give you actually five minutes extra for Q&A, so we'll have some.

So it's now the end time for the Q&A session and as a reminder you have to when you ask questions you need to press store 1

at your phone.

and one and you will wait for your name to be announced.

If you are on the streaming, please mute the webcast audio while asking the question to minimize any sort of audio feedback and disturbance.

So let's look here who we have on the first part of the question. I would like to welcome

Andrew Gardner asked the first question. Hi Andrew from Citi.

Good morning Peter. Thanks very much to you all for taking the question.

Really, my question comes down to the unusual approach you're now taking, or at least unusual for you guys. So when I think about this area I see I had my Scallions since we've been using them

in terms of giving near-term guidance, so being quite quantified in terms of what you're...

telling us in one cue for margins in particular. I think to many of us on the call that's going to be quite appreciated. It's been a long time, decades since Ericsson has done that. And hopefully it helps us find a flaw in terms of our estimate revisions here given the near term challenges. But of course for that to be a flaw.

the estimates need to be conservative enough. I'm just hoping you can give us a better sense as to how much you have risk adjusted those 1q targets, you know, so you know worst case type modeling to give us conviction that this indeed is hopefully the final cut in terms of the estimate.

Can you give us some color around how you set those near-term targets? Thank you.

Should I stop, Priya?

No, but thanks for the question, Andrew. I would say we wouldn't express it in this way if we didn't have the confidence about it. And as we provide a range also 40 to 42, we think that different scenarios can be covered in there. And with the visibility we have now.

on customer demand, on project rollouts, on our own cost situation etc. In cost of sales we deem that this is the level where we expect to land in the quarter. So we have confidence.

I think that's, you know, we recognize Andrew the repeated questions about near-term guidance, so we've helped.

this may be the right thing to do. So we took that step, so it was really to help, but we've been, I would say, as Carl described.

trying to be providing you with the best estimates we can do. At the same time there are of course always developments but this is based on an assumption of the...

the inventory adjustments in networks. And I think that's important to remember. We're taking a rather conservative look on that, what we feel is conservative today. So I feel very good about the estimates.

that we provide you.

Thanks, Gloria.

Yeah, I got a quick specific follow up in terms of the first quarter EBIT are guidance of it to be quote somewhat below last year just so that we're getting the reference point correct. I mean, you are referring to the 5 billion corona. EBIT are reported in Q1 22 and there's no there any sort of one offs or things that we should be aware of or is it just

below 5 billion is what you're going to. Yes that's correct, nothing specific around one of them or anything like that to comment on.

Thank you.

Thanks, Andrew. That was the first question, so we are now ready to go ahead with the second question and that is from Alexander Treck.

from the Association. Hello, Alexander.

Yes, hello, good morning. Thank you for taking my question. I hope you can hear me well.

Yes.

Great. Yeah, so I'd just like to come back a little bit on Marj's again following up on Aankanj's question earlier. So, I'm going to go ahead and turn it over to Aankanj.

Can you give us a sense of whether…

margins will bottom out in the first quarter of the year, that 40 to 42 percent range, or should we model, broadly speaking, a similar range for the second quarter, because you said that these pressures will persist, and then we'll see an improvement. And then just broadly speaking, do you think that networks can longer-term return to a 40 percent range?

in both terms. Thank you very much.

I can start on that. As we have said, the first half is really where we'll see the sizable inventory adjustments that are impacting primarily front runner markets and front runner markets around the world.

So we think that those effects are going to be there for the first two quarters.

and from there you'll start to see an improved

market environment during the second part and the reason why we believe that the market will improve is actually the underlying traffic growth. So that gives us the comfort and this is what we've seen by the way in previous swings you've had in CapEx.

So when you've had those big adjustments operators can sweat assets for a couple of quarters but it cannot be done for much more because simply traffic grows fast underneath. So that's why what we are seeing is a gradual improvement in the second part of the year.

that your main deals have been renegotiated. Could you provide us with an estimate at this stage? Thank you.

Yeah, so current portfolio is around 9 billion. We ended up with 10.4 now during 2022.

What we have also said, as you know, we expanded on that at Capital Martis Day, is that we expect IPR to grow significantly. There are more device players in the ecosystem that are currently unlicensed, especially for 5D.

And so we're targeting those now on the back of the large agreement that we have just signed. But there's also other growth opportunity there. Consumer electronics, IoT as we have mentioned before. So we believe that we cannot talk exactly about the timing because this is about negotiations obviously with the licenses.

Alfredo Wilson Au revoir Place du Sylva l'2006?

Hi and good morning. A question on Vonage please. If you could elaborate a little bit how the business model is actually working. Is it a subscription based model? Is it a license based models for getting sort of access to the API's or how does that work really?

Thanks.

Well if you look at the current model in Bonnet you have both subscription based model that's the UCAS CCAS solutions but you also have a transaction model on the CPAS.

Over time as we launch now the new part.

and call it the network APIs. How, you know, there are still more work to be done on the business model. So right now the focus is to make sure that we technically solve the issues and that we can actually present those type of network APIs on the CPaaS platform.

strength in mobile networks. First Enterprise Wireless Solutions focused on capturing the multi-billion dollar enterprise market opportunity for five years. So first of all Enterprise Wireless Solutions focus on Enterprise Wireless Solutions it's focused on capturing the multi-billion dollar enterprise market opportunity for 5G optimized networking and security solutions and the second pillar is the global communication platform business where we will be able to monetize 5G in new ways by transforming how network features such as speed latency are globally exposed consumed and paid for. During Q4 sales in the enterprise segment represented 8% of total sales. Enterprise is a growth engine for Ericsson and we continue to fine-tune our portfolio to maximize profitability and this included an agreement to divest our loss making IOT business. After this divestiture our emerging technology area is expected to be profitable. We are investing in building up a strong go-to-market organization for enterprises and we're investing to broaden our product offerings as well as bringing network APIs to the markets. These investments are a foundation for profitable growth after 2023 but they will weigh clearly on profits in the coming year. In the quarter we also announced a 2.3 billion kroner provision related to a potential resolution with the US authorities regarding the previously announced deferred prosecution agreement breaches or breach notices. The provision also includes cost associated with the extension of the compliance monitorship that we announced in December . While we're now in a position to make a sufficiently reliable estimate of the financial penalty we have not yet reached a resolution with the DOJ and discussions are ongoing. Separately and with respect to the past matters described in the company's 2019 Iraq investigation report we continue to thoroughly investigate the fact in full cooperation with the DOJ and the SEC.