Q2 2019 Earnings Call - Second Call
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[noise] they seem to welcome to Ericsson's analyst and media conference call for the second quarter reports of 2019. Please say your full name and your company name off the tone and then pressed fashion.
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The conference is now being recorded.
Customers.
So we see that digital services is progressing well towards.
No single digit margins next year.
Managed services had a flat, saying if you adjust for the plan called time to exit.
Gross margin declined due to timing between quarters on cost basically.
And he had we are taking some short term.
<unk> cost as we increase R&D investments in order to to to drive our operations and that builds up on automation and they <unk>.
Emerging businesses, our area, where we invest for new innovative solutions and results here improved.
Driven by our profitable like connected business and as I said free cash was 2.2 billion. After having had a 3.7 billion in cash outlays for provisions on restructuring.
The next.
Yeah, we have gotten quite a lot of questions about the gross margin development on and you can see from this graph that we have a a sequential decline in gross margin.
We chase, but when you look quarter over quarter.
That deep base is really due to a couple of reasons. One is of course that we had.
Larger than usual IP or revenues during the first quarter.
Which helped the gross margin and gave a boost on gross margin.
While we in the second quarter to have a large IP are set than men.
Of course, putting pressure on gross margin in Q2.
And.
And then we have some other effect on on a little bit lower software portion in digital services and some timing all cost in managed services.
But if we leave that they'd be it outside and jump to the next slide.
Which is focusing on the the movements in networks.
So if we look at the Q1 gross margin it was 43.2.
Yeah, what we have here is a is a.
On on seasonably large.
IP our revenues in Q1.
Which of course then.
You know kinda, yeah relates to beat to two some old cone <unk> or catch up payments on old contracts.
And that if you remove that you'll get to a adjusted Q1 margin are we.
You do even though we haven't given the detailed numbers here with which they can look at the size of the bars and kind of.
Estimate them, but the but they are not.
And they all know populate the real numbers, but I'm not that it's actually due to the.
I would go back to that later, but the adjusted Q on margin then comes back a little bit lower if you look at Q2. It is reported 41.4, we have a license or set the month basically patent dispute that reset button, which hurt their short term margins.
And so if you look there.
If you would put them in numbers out to give you a a size comparison the nice sunset that meant a it's about the.
1%.
And the so it would be about 42.4 and the IP all revenue that the Q1 to Q2, it's about 0.6.
So if you were to look at the underlying change in gross margin it's about 8.2%.
On that 0.2% is actually the impact those strategic contracts and operating leverage.
So what were trying to say here is we use part of the operating leverage to invest into strategic contracts.
On the strategic cone factory be somewhat more during the second half than during Q2.
But we don't see a diminished operating leverage.
So so their whole notion here is we will manage the over one.
PNM statement, but we are going to have some of these.
One time effects on on on my P. or revenues that that will vary by quarter.
And of course, it's very hard for us to predict when we have a license settlement to be illness.
Or lose the revenue side or or outflow side, but that's why you see and the underlying gross margin quarter over quarter shows a very little and very small and then by Bob 0.2%.
They are okay.
[noise] could be.
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To to cancel and as always please limit yourself to one question at a time and please keep your questions at a broad level.
How information is provided in the report and Ericssons Investor Relations and media relations team will be happy to take additional questions and discuss any further details with you after the call and sort of the first when we go to the line of Ed Schneider Charter equity research. Please go ahead.
Thank you very much good morning.
Good afternoon as it is.
A question on your strength in North America, and always talked about this at length before and you mentioned fiveg and different variants of it but if we could maybe get a high level view is the vast majority of that due to fiveg build out or are you seeing capacity expansions in fourg and to the extent that this fiveg is it mostly millimeter wave or the low bands.
You know to to get into that would also start to disclose a different strategies are different than all of our customers. So we're not going to do that.
Up there what I will say is that we see and met our capacity expansion in North America.
And Bob this is cool.
A.
The most important part but of course, we see as ran Fiveg deployment and that's why the free so it's significant growth.
Great. Thank you and then.
And your stated.
Well this fall in the last call that Fiveg will probably more about enterprise and private networks and just draw consumer demand. So fourg, we saw big capacity expansions in consumer demand and in Fiveg. I know you mentioned initially mobile broadband, but that would be followed by M. Flex It enterprise private cloud Nokia's, especially said about the same thing isn't that a fundamental change in the addressable market from like a mass market horizontal product to more of a vertical.
And as a result, we'll shouldn't we see some sort of variation on the profile of your revenues a higher gross margin, but lower growth given verticals tend to go slower, but you've got better pricing power.
No no.
We're still so early in its development.
But what these.
According to the Indian enterprise sector, increasing import them.
And wireless connectivity.
That is reliable and secure is very hard to get on this on your your license spectrum.
So we see a increasing interest from enterprises, and we see that with our partnerships and we just recently for example had a booth.
Room in Germany, we they are automotive company.
So so we are seeing that the change the fundamentals of the business.
So the way we think about it is that we have a consumer business out that you said that the bread and butter, but on top of that we are starting to see a and enterprise segments emerging but it's too early to talk about it as a big market. It just in its infancy.
Would you anticipate any.
Yes. Thank you I guess the last question related to that is that given the emergence of the enterprise is more private client network do you see any change in revenue profile at all I understand it's small and it has.
Got large at this point, but should we naturally expect some difference in the profile the revenue because the revenue growth of the margins are.
How how it evolves.
I think we you know it it would be speculative yet, but what you are likely to see some.
Larger share.
Hardware software with a bit there.
Gross margins and so these revenues.
Less so the rollout revenue slid down.
So Randy.
They're going to end up it's too early to tell.
Thank you.
Operator, we are ready for the next question.
Thank you and that's if there's line of.
At Goldman Sachs. Please go ahead your line is now.
Yes, hi, Thank you for the question and thus can you just want to ask in your free cash flow it seems especially strong in the quarter and take you. When you factor in per unit, even taking so wondering if you could talk us through the moving parts there is that improvement and how sustainable that is.
Listen you talked about profitability, but any other drivers of that would be interesting.
Second of all there was some news report in the last month or two about ericsson's market share on one of the Chinese telco is going up significantly.
And I realize you can't talk about specific customers, but wondered if you could just talk about the broader situation in markets like China, and how you feel about your connected positioning and opportunity.
So I think thats flow first hi, Alex.
So if we break it down a bit that and you're right to say that.
The majority of the improvement that comes from the improved profit that's not but if we look at working capital them.
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Given the high business activity, we have and we may see some build up in the quarter of inventory.
And that's a follow up to some extent by by payables as well because it it goes together of them with him and three build up as well because it's sort of business.
From third parties to a large extent.
What what a good part here in working capital of the world or trade receivables for accounts receivable, which came down following good collections in the quarter.
So I think that that pretty much summarizes the most important point pattern that generate the then as Brady said before.
These positive cash flow 2.2, which we havent really seen in the second quarter for a long time and also looking at.
Year to date, we are at 5.7 billion that there.
Then 28.
Okay, then market here.
Well the teacher is.
And.
You know Dan so far in China, we're very early in the in the Fiveg cycle.
So it's a little too early to have the phone view.
Well, we are clearly aiming for is that we would be having a stronger market share.
Empire GE, then in Fourg and we have invested for that then conducting field trials for that.
But we win them.
We will have to see.
And make sure that we're competitive do you see that we end up there.
We will know more in them.
Next.
A few months and then then then we can talk more about it but thats, where we are right now.
That's great and maybe just I think we'd still say we are we are we have.
It's always to be hard to know exactly what the macro data when show once they come. So we we will see that but we believe that we have is already a competitive offering and that we are.
Gaining market share in several geographies.
Many thanks.
Okay, that's great. Thanks.
Okay, We'll now open the line Sandeep Deshpande D.
JP Morgan. Please go ahead your line is open.
Hi, Thanks for letting me and I have a question on Fiveg, how old how do you think worried that fiveg is going to be different from the fourg rollout because initially as you said that it is being used as a capacity addition.
In terms of technology in a few areas, but is this going to become a mainstream coverage technology and at some point and does this rollout continue from a multiple.
Water or multiple European it and particularly in some of these early markets such as the United States that Korea, Japan et cetera, or is this going to be appoint technology.
Yeah, we.
You know wrong, we actually ultimately think all frequency bands will be fiveg enable.
Which means you know all operators want to leverage the full spectrum portfolio in the end of whom.
Great and then the full coverage.
And that's what's ultimately going to provide the long term value Oh fiveg. So even when you talk about the.
Factory conductivity.
Yeah, it's very interesting that when we talk to a industrial companies, yes, the interested into indoor coverage and providing that in a.
Understood and with a very high degree of reliability, but equally interested in having it connected to the outside world.
So yes, I do think there are going to be.
Initial deployments that are clearly point to even where you benefit the fiveg characteristics, but ultimately its going to be connected to a broader macro network is when.
So the way we think about this is that.
That it it will be a anyway similar type of beamed out overtime as you see with Fourg.
But that is going on clearly taken time and I'm just going to be focused initially on where you have big capacity needs and big industrial applications.
You now for questions, Yes, Brett just a follow up to that would be so does that mean based on what you're saying that you see you see you know given that you're seeing such a strong ups I couldn't tell if your revenue growth in Netflix the fear that this could be a might be a process.
Well without getting into two guidance, but yes, we do believe that the the technology cycle. It is both gonna go faster than historic cycles, and probably last a bit longer and the reason for that is the base business is going to be consumer business, but we also see a big growth potential in the enterprise.
Area. So so.
Networks are going to be built out first for consumer, but ultimately for enterprise and that's why we are.
Were rather optimistic over the long term outlook of the the need for Fiveg technology.
Thank you.
And they also for next question. Please.
[noise].
We are ready for the next yes. The next question is over the line of Simon hold at Raymond James. Please go ahead. Your line is now open.
Okay, great. Thank you. Thank you for taking the question I wanted to drill down on the northeast Asia region, specifically want to understand what your assumptions are in terms of the it the timing for that China five G.
And the question is rooted in the the potential that maybe given the trade tensions between the U.S. in China that that maybe some of the project activity slides out in time, so I want to I want to understand what you're thinking about that and then also within the northeast Asia region I want to get a better understanding of the materiality of your business outside of China, specifically, South Korea, Japan, which I am assuming are included in that region. Thank you.
Let's start by China, I can comment on that and what we have said that we believe large scale deployments will be 2020 .
But we will see some emerging deployments in the second half.
That is still the best judgment, we hub.
And you know I think it is fair to say that.
Trade tensions geopolitical uncertainty and that will bring its very hard to speculate on.
I'm, so sorry about the impact we really don't know right now.
But we we plan for for seeing bigger deployments implanted trends.
We're also seeing of course the.
No really participant in the five year old notes in Korea, and that's been going on for quite some time.
Yeah. So so we have networks does well in mid band.
So so that is clearly one of the key reasons why the region actually growth.
We have not yet seen a major deployments in Japan.
But oney out there on the old but those that have just been given spectrum and and are in the process of getting up so total flu impact so I'm sure it will help.
Ah ones Dot coms.
Side, I think we're going to see a.
Good development or as they also build out fiveg to capture the opportunities. So so overall we're quite.
Quite excited about the prospects in northeast Asia.
As we see that bodies, the leading technology region as well as Seamap monthly.
And how big have have Korea, and Japan been in general with within the business overall or they combined kind of low single digit percent or is that too low an estimate.
Oh it they are sizable markets, we don't provide you with a breakdown oh the countries.
And so so except that we have said that I believe creates a top five market right now.
So you can see that.
Call. It it's about a 4% also offline offline.
So thank you for taking the questions. Aside then all the old Japan once it's in full swing.
Yep. Thank you.
I think we know a lot of actual so Tony Yeah. It's credit Suisse. Please go ahead, Sir your line is now open.
Hi.
Thanks for taking my question so on media solutions.
I see that you still have an operating loss of a couple of hundred million kronor into quarter, Oh, I thought that this was already a deconsolidated and and from the business. After the divestment. So can you help us understand that Oh why that number is the law still and should we expect that to continue in the second half.
And then secondly on the gross margin again, so well you obviously tanks for expanding the moving parts in the gross margin up so the way I think about it going forward is up like you had about 20 basis points of it in your gross margins in networks business due to the strategic contracts some of which you said was partly offset by operating leverage.
I guess as we move into the second half of the year, you probably expect more of these contracts to ramp up.
So the headwind probably accelerate.
But then equally are there any other positive moving parts for gross margins that we should also think about going into the second half.
Okay. Thank them in the United States Army, they're kinda, but outside of the <unk> you're right. It's.
Coming in all of them in your timing that meant that the 49% of our name. It comes on the on the line you know shot of earnings in a joint ventures in associated companies.
And you're right there was a a lost them in the company and we get to 49% of that.
We're not guiding specifically on how that's been developed and obviously the intention of the two shareholders is to.
Improve on this business sometime it around as well.
Sorry, just to clarify called so the 200 million losses, 49% of the total loss is equal to 200 million loss that you that you report.
Yeah.
Okay.
The coast or higher than revenues in that business.
So far but the but the intention is does it clearly would improve.
On the gross margin, yes, the the net effect of.
Operating leverage on strategic contracts or about a 20 basis points for the second for the second quarter.
We expect the operating leverage to continue and be significant into business, but we also say that we are using part of the operating leverage too.
To actually reinvesting some of these.
You know.
Strategic contract are important contract and that the that sort of so you can see some more more than the 20 basis points, but not dramatically more.
Okay. Thank you.
Yeah, Thanks for that.
The next question please.
Is over to the line of Richard Kramer at Aerotech Research. Please go ahead. Your line is open.
Thank you very much my two questions are first of all if we look at the portion of sales in North America.
Especially networks and rain remains very high and can you talk a little bit about the difference in gross margin that have long been understood to be much higher in the north American market than in other markets and could that be and the north American market starts to normalize from the thing Fiveg rollout that we see now would that be part of your thinking around second half gross margins or.
[noise] potentially growth margin next year and second if we step back from that is just the corners moved in gross margins the networks and we removed the IP our income from both network sales and margins over the last year and a half your core networks business margin seems to be around 10, or 11% roughly and given that nearly all of those networks. They all come from telcos is that sort of key car or reasonable margin you can expect in negotiations with one of our very large customers and obviously now very well accustomed to a long term procurement and and how much margin. They leave on the table for their vendors or do you see material upside beyond your near term targets.
To try to get more margin out of those capital costs.
Thanks.
[noise].
You free if we start with the first one what we see or you saw or what you're trying to say is that you'll see a larger service portion in the second half.
And of course that is helping.
Or hurting gross margins India into into the second half in North America, but I would caution you to say that it's a.
You know we have multiple geographies with similar margin profiles as North America.
So the dependence in our current structure is less than it might have been understood to have been historically.
I know I made that point to a bit earlier also but that that is a unfortunately, the fact and their knowledge from before may not be as relevant.
So so that's the that's the one thing or the other is if you look at the guidance for the second half, yes, we say that North America is running at a very high rate and we don't see the same growth rate continuing but we do we also see a increasing service portion or in the second part of that is going to two.
Better on gross margins a bit.
But over one where we're not trying to say that the gross margin second half is it.
It's no in any way a dramatically deviating from the guidance we've given.
So so we're not we're not trying to.
Give a give a profit warning in any way on that.
If you look longer term.
I I mean, I do think that the interesting part here is.
So far the business being exclusively focused on the consumer business.
And we see that that is a changing into becoming a enterprise business and that's why it's a little bit speculative to think about how the margin profile is going to look longer term.
[noise] junior up there.
Yeah. Thank you.
And we will continue to the next question. Please.
Okay. The next question is a function of Stephens Salinsky of Exane BNP Paribas. Please go ahead.
Yes, hi, it just starts to deliver on the on the margin, but on the gross margin I'm sure you've kind of quantified here with a new slide.
The 20 basis points of sequential impact kind of the net of the operating leverage and the strategic projects headwinds I'm understanding the second half maybe there's a slight more of a headwind on the strategic project side. I guess the question is does that sort of continue into 2020 on the strategic project front or should we expect that to to kind of run. Its course, obviously there will be other.
Puts and takes on the margin in 2020 in terms of a geographic contribution and business mix, but from a strategic project standpoint that kind of 20 basis point headwind that you just talked about will that continue into next year or is that something that will go away. Thank you.
I mean they will.
Our view of the reason why we take those is to position ourselves for Fiveg.
So so we are Oh of course, taking those contracts in the in the knowledge all.
You know that's not come but the impact of those I'm not going to be with us on the negative grown.
For for more than.
A few quarters.
So we are surely going to deliver on some of the.
Strategic contracts in.
In 2020 about being called with us the operating leverage remains.
But then the negative part dissipates. So so you know if you're.
If you would make that.
You know there is an underlying improvement that today is not visible because we reinvested in strategic contract that underlying improvement will start to become visible.
And that's been happening until 2020 .
Got it thank you.
Thank you then we're actually hoping for the last question of this session. So please operator.
Yes of course, the last question for stays cool is over to the line of Dan Leoni at Bank of America. Thank you very much your line is open.
Thank you. This just house Oh from Bank of America I have two questions. The first one is we spoke about market share versus why wait.
But.
You did speak about market share versus Nokia, how do you see them in the market and second can you can you elaborate on it.
Kind of advantages versus Nokia technology et cetera second question is about North America.
What happens if there are delays in in allocating.
Ah spectrum on the train the half gig in North America up do you expect the fiveg to kind of slowed down the waiting for spec true or is there enough juice, if I can call. It in the low band and millimeter wave to continue and grow for few years. Thanks.
Yeah, you know the we don't comment on competitors and that's kind of.
You know we're here with their Xone, that's my focus on the eye if they run a cold month, they can do it but I'm not going to do it.
Yeah on the if you look in the U.S., yes, there is a lack of mid band spectrum, that's quite clear.
There are many thrace its own going on how to really spectrum.
And that would help for a national rollout perspective.
But from our demand perspective, we think where where you know the current type of spectrum will drive the car and type of Buildout. So we don't see that to impact.
Dramatically actually for us.
In the near term I should say longer term, we need the mid band in order to capitalize on on new opportunities for five year, new use cases for Fiveg.
Got it.
So if I can go back mainly.
Maybe to my first question, Alan Hoskins, Lorne general not versus a specific competitor.
What drives your share gains or do you have do you think you have a sustainable technical advantage that can take you to a sustainable share gains over the next few years or did you just have a head start versus competitors and this is why we're seeing strong performing go in and do you expect it to kind of even out in the next few quarters.
We took the steps to invest in.
Making our technology leadership to make our portfolio a competitive and that's you know in order to to invest to stay ahead.
So it could drive new innovation, new spectrum utilization technologies.
And and create a sustainable advantage versus competition you know they like in most the technology area.
They will they will they will be a where we are at some point in time, but then we have also moved ahead.
So you know, it's it's increasingly difficult to catch up for example on dynamic spectrum sharing that we can do on our base band from 2015 and onwards. So of course for our customers like sweets come in Switzerland. They can actually achieve 90% population coverage by year end by leveraging our infrastructure and that's of course, not do a bill unless you have a technology leadership mindset and continuously investing in technology.
And that's what we are intending to do.
Yeah. The partner here is actually to get the continuous cost cadence.
So by introducing new platforms and new technologies, we can bring the cost down on our equipment and that makes you know.
It's a it's a kind of a double whammy, where we get the product benefits as well as cost benefit helping us and that's what you see in the gross margin expansion. During 2018, it's really those two factors coming through.
Got it thank you.
Oh, sorry, I thought that the freight and before we close this oh you want to have the.
The last remark no I want to just thank you for listening in a we are.
Continuing to invest for technology leadership.
That will help us drive of course, a market position and competitiveness, but also our cost position.
Yeah, we see ways second quarter with solid growth driven by networks and predominantly northeast Asia and North America.
Yeah, we saw a profitability negatively impacted by IP or contract and IP or swing swings versus Q1.
And we continue to execute on the plan and digital services to gradually and sequentially improved profit or lowered the loss turning that into a profitable business next year.
Managed services as a bit of a lower margin in second quarter due to timing of course, but we see that the our investments in automation and machine learning is starting to pay off in operations ending that longer term going to drive a very different margin profile.
Emerging business saw good growth driven by our profitable I connected business.
So we are overall confidence in reaching the targets, we set out for 22 and that's why the 2020 two.
So again, thank you for listening to the Q2 report.
Thank you.
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