Ericsson

Hello and good morning and welcome to the Ericsson Third Quarter 2021 call. Today's call will be a little bit different from others. We will start with the normal procedures, going through the QFRON numbers. The second part, we will actually spend a little bit on strategic topics. One, addressing the path to profitability in digital services by Carl, and then we will address the opportunities that we see in enterprise by Börje. And with me here today, as usual, I have our president and CEO, Bård Ekholm, and our CEO, Carl Melander. So hopefully anyway, even though we'll have this little bit longer presentation, hopefully we can spend the second part of this hour on Q&A. And in order to ask these questions, you need to contact or connect to the conference via a telephone. And you could find all the details in the press release or on ericsson.com. During today's presentation, we will be making forward-looking statements. These statements are based on our current expectations and certain planning assumptions, which are subject to risk and uncertainties. The actual results may differ in material due to factors mentioned in today's press release and discussed in this conference call. We encourage you all to read about these risks and uncertainties in our earnings report as well as in our annual report. With that said, I would like to hand over to our President CEO, Börje Ekholm. Please, Börje.

Thank you, Peter. And of course, welcome everyone and very happy to have everyone joining us for this call. So the third quarter, we're very happy about the performance that we can deliver based basically on us winning footprint across our portfolio, leveraging our strong 5G portfolio. And I would say that this ability to gain footprint is clearly based on our investments in technology leadership and the substantial commitments we have made to growing our R&D efforts over the last few years. But I would say it's also a show of the commitment our people show to deliver a performance that actually are on the path to becoming a really strong performance in the future. Today, we have 95 live 5G networks. We have 149 commercial 5G agreements across our portfolio with unique operators, I should say. But you have also seen that we have decided to delay our capital market or postpone our capital markets day investor update to instead next year have a full capital markets day with a full management team to participate and update you more in details of the plans we see going forward. We will spend, as Peter said, a little bit of time on updating you all on our strategic thinking at the end of this presentation. But Carl and I will focus the first part here on the Q3 performance and go through a bit more in detail. So if we look at the quarter, we continue to see very good momentum in the U.S., and it's underpinned by our recent signing of a 5G contract with AT&T, which now means that we have 5G contracts with all three Tier 1 U.S. operators. And these contracts are, by the way, the largest in our history at Ericsson. We also continue to gain market share overall. However, it's quite clear that our market share in mainland China has been reduced. And this is a consequence or follows the decision Sweden took to exclude Chinese vendors in the build out of 5G networks in Sweden. And this is fully in line with the guidance we have offered before. But we also see that we've been able to partly offset that loss of market share by growth in other markets during the quarter. We've seen good growth in Europe and Latin America as well as North America. But I also want to highlight that also Africa saw growth following a very difficult period during the pandemic. But of course, it's quite clear the loss of sales in China hurts our sales volume in total. And we need to invest even more to regain that loss of volume by growing in other markets. This quarter also, I would highlight the impact on disruptions to our supply chains that I would say impacts many companies across many different industry sectors alike. So for us, we have had very limited to no impact on our customers up until the end of the third quarter. We've taken very proactive efforts and we have built... inventory and and created in a way a flexible supply situation but late in the third quarter we saw some impact on shortages of individual components basically that resulted to loss of some sales but it resulted also in higher inventory and this is a risk that we see can have a of an impact also on the fourth quarter of course, or it's highly unlikely it would have no impact, but it would have some impact that we think is likely. Despite the share gains we've had outside of China, the reduced market share in China and the supply issues and lower sales in managed services led to a slight negative organic growth rate overall, so we're minus 1%. But if we exclude China, we saw a 6% organic growth year over year. We also continued to deliver a strong profitability. Gross margin improved sequentially as well as year over year, and it reached 44%, and our EBIT margin increased to 15.7%. On IPR, we saw also good progress, and we increased our IPR revenues to 2.6%. This was driven by new agreements as well as dispute settlement. Both have some retroactive financial impact, as we have said before. And what we see also is that the significant value of our product portfolio and strong technology position in 5G, and that positions us very well to conclude on future, well, ongoing as well as future patent license renewal. So we feel quite strongly about our position in IPR. However, you all know that timing of these license agreements may cause temporary gaps in our overall IPR revenues, but we will not waver from trying to maximize the value of our existing patent portfolio. We had very strong cash flow, and the free cash flow before M&A was 13 billion during the quarter. And I would say this is primarily a result of the investments and the commitment we have done in our strategy to improve flexibility, reduce sensitivity to business mix, as well as lower our working capital needs. We have now built a robust cash position and gives us a strong foundation to grow by investing further in technology leadership, but also from inorganic moves. have a strong commitment to sustainability you all know that and it continues to deliver good value for us but also for our customers and you saw that we just recently launched a new massive mimo portfolio that has gains on energy efficiency it's much less heavy and it it has a lower wind factor all in all providing clear values to our customers But we also saw that during the quarter, we signed a $2 billion sustainability-linked revolving credit facility. And finally, I want to say our commitment to strengthening our ethics and compliance program continue. This is a longer-term journey. We are committed to invest what it takes, and we are increasing and carrying significant costs in the in improving our ethics and compliance programs, but it's also a cultural journey for us as a company. And here we are firmly committed to ensuring that we have created a culture built on integrity as a fundamental value. So now let's move on to the market area performance. Sales in Northeast Asia fell by 33%. That is, of course, due to the significantly lower market share in mainland China. But sales in other parts of the market area actually improved during the quarter. And as a consequence of the loss of sales in China, we have to right-size our sales and delivery organizations in China. And that will start in Q4. And we will have some structural cost or restructuring cost to that. In Southeast Asia, Oceania and India, sales decreased by 16%. This is really due to a lot of accelerated rollouts in the end of last year for network, but also some timing of orders and projects in digital services. If you look at Middle East and Africa, sales declined by 8%. In networks, we saw the primarily impact of timing of 5G contracts in Middle East. But I would also say that Africa clearly returned to growth. And we see primarily in digital services, we saw actually a strong software upgrades in the African market. In Europe and Latin America, we saw Europe, or in total, sales increased by 9%. And if we look at the parts here, Europe grew by 5%, basically on the back of market share gains. And the same thing in Latin America, we saw a 29% growth. Of course, it's coming off a very difficult period in COVID, but it's still growing very strongly on the back of our share gains. And we see that in both networks as well as in digital services. 5g momentum in north america continued and sales increased by 13 percent and clearly this demand is driven by a demand for 5g solutions so let's now move on to the business segments so if we start with networks of course sales was hit by china but if we adjust for mainland china sales actually grew by eight percent year over year And this reflects clear gains in other markets that have been possible thanks to a strong product portfolio. And we continue to see very good momentum in deployment of 5G around the world. Of course, the impact on the supply chain from the disturbances also, of course, hit networks. And we expect that to pose a challenge as well during the fourth quarter. Nevertheless, we saw gross margins strengthen to 47.8% compared to 46.7% last year. In digital services, it's very encouraging that we now are starting to see revenues from the 5G contracts. And that's, of course, helping them to achieve some growth. We saw the segment grow by 1% in the quarter, and that's despite a significant reduction in mainland China. If we exclude China, sales actually grew by 6% year over year. Gross margin was 42.3% compared to 43.5%. And going forward, we expect profitability to improve gradually, and it's going to exceed our initial target of an EBIT margin of 10-12%. Sales in managed services decreased by 7% organically. And clearly here, Q3 was impacted by reduced variable sales, contract rescoping, as well as some planned exits, mainly in Europe. We also saw that network optimization grew, primarily in Europe, and we continue to invest in developing our portfolio with AI and automation to further strengthen our competitiveness. Gross margin decreased to 18.7% compared to 20.1% last year. In emerging business and others, sales grew by 4% organically, and gross margin actually increased very strongly to 39.4% compared to 30.5% last year. Reported sales grew by 26%, and that's, of course, mainly due to the acquired Cradlepoint business. What I would say here is the strengthening of the gross margin actually came out of, or is to a very large degree explained by Cradlepoint, and it's even encouraging to see that Cradlepoint is one of the key drivers of the overall strengthened gross margin for Ericsson as a group. With that, I want to go over to Carl to go through more details on the report and give some more perspectives on our path to profitability in digital services. Carl.

Thank you, Börje. Thank you. And let's have a closer look at the numbers then. So reported sales 56.3 billion, negative organic development and of 1%, as Boje described. And this is following four consecutive quarters of organic growth. And you saw the two largest market areas presented growth in the quarter and the remaining three ones saw a decline. We had some disturbances, of course, in the supply chain, as Börje also mentioned, but the big factor here when it comes to top line is clearly mainland China and the reduced market share there. And in addition to what Börje said, that we would have grown 6% in the quarter if we excluded mainland China, the corresponding year-to-date number there is 10% growth if China is excluded. On IPR, then, 2.6 billion in revenue. Out of that, we have certain retroactive benefits from the contracts or agreements that we signed in the quarter. It is an increase of 0.5 year-over-year in IPR revenue. So as you see here now, on a rolling four-quarter basis, our sales is now tracking around 231 billion. Berger showed gross margin numbers per segment. If we drill a little bit further into this, 44% on the group level, that's up 80 basis points, really based on continued improvements, both in the networks as well as the emerging business and other segments. And in networks, pleased and encouraged to see continued operational leverage contributing to the margin here, but also the higher IPR revenues, as we said before. And gross margin in networks then now at 47.8% compared with 46.7%. in digital services gross margin and excluding restructuring again declined 120 basis points and and this is really connected again to what we have discussed before the higher costs for initial deployment in the 5g core contracts and sales there i must say and again emphasize sales in 5g core is really progressing well and we'll come back to a little bit of a deep dive into that a bit later in the call On managed services, gross margin, again, excluding restructuring, declined by 140 basis points. And this mainly comes from a reduction of variable sales on a few customer accounts. And lastly, then, emerging business, up 9 percentage points in gross margin, fueled by, to a large extent, development in cradle point. Of course, cradle point did not exist in our numbers a year ago. So OPEX, as you see, 16.4 billion, up from 15.9 billion a year ago. Again, mainly related to the addition of cradle point business, both in R&D and SG&A. When it comes to R&D, the increase there, in addition to cradle point, comes from more investments into the 5G core portfolio in digital services, as we have reported on before as well. There is one line not visible on the slide here, but it's on other income and other operating income and expenses where we had a positive development in the Ericsson Ventures investment portfolio this quarter. And the net of that positive development and an impairment contributed with 0.4 billion to EBIT. And this is all in emerging business and other segments. So EBIT then ending up at 8.8 billion or a margin of 15.7% in the quarter, which is up 10 basis points year over year. And this, remember, is in spite of the lower sales volume. EBITDA, as you know, our EBITDA long-term target is 15% to 18% of net sales. And we are now, if we look at the rolling four-quarter basis, hitting 14% EBITDA margin. Taxes, 2.5 billion in the quarter and an effective tax rate of 30%. This is also effective tax rate for the full year to date. And now let's look into how these profits converted into cash flow. So operating activities cash flow increased by 9.4 billion to a total of 14.7. And we can also remember that last year Q3 was impacted by a 2 billion contribution to the Swedish pension fund. But we work a lot with working capital in our company. We focus a lot on lead times and efficiencies. And you can see that also this quarter, the resulting free cash flow benefited from that working capital work that we put in. We had good collection from customers, including some prepayments as well. And As Burri also mentioned, we did increase inventory again. This is something we have talked about on previous calls also, in order to create even higher resilience in the supply chain. But that was actually offset partially at least with higher trade payables, so the impact on cash flow was not that big. CapEx net and other investing activities was relatively stable year over year, so that all resulted in a free cash flow of 13 billion, up more than 200% year over year. And maybe again on a rolling four-quarter basis, free cash flow before M&A was now 31.3 billion Swedish kronor, which... corresponds to 13.6%. And again, that's beating then our long-term free cash flow generation target, which is 9% to 12% of net sales. This all meant that our gross cash and net cash increased by 11 billion and 12 billion respectively. Okay, if we move on to planning assumptions here, finally on the quarter then. First of all, starting with the market that we operate in. Deloro now expects the run market to grow by 13% in 2021, which is up then from the 10% that was estimated in the May report. And if we break that down by region, some of the regions, then China, 13%, North America, 15%, Europe, 10%. And looking ahead into 2022, the Deloro forecast for the run market is to grow by 2% or 3% if we exclude China. Second point on the supply chain, we saw some disturbances in the third quarter as mentioned, including some individual component shortages. And we continue to see this as a risk going into the fourth quarter as well for networks sales. Over to IPR, we have a run rate in the current portfolio of 7 billion. This is the same number as we stated in the Q2 report as well, and it is the contract portfolio currently on an annualized basis. And again, as we have discussed many times before, as these key IPR contracts are approaching expiry, we may see an impact on revenues until those contracts are actually renewed. Lastly, then, on digital services, we expect to reach breakeven in the fourth quarter. So now, having gone through the quarter as such, I would like to shift gear and say a few words about digital services and the road back to profitability in this segment. And to start with, as we communicated already in the second quarter report, now we expect a limited loss in 2022. One impacting factor is again the decreased market share in mainland China. But the long term target 10 to 12 percent remains. And of course, our ambition is to even exceed that over the longer term. Before diving in, really, I just wanted to start here by reemphasizing again the strength in our 5G core portfolio. And the business momentum is really here. The standalone 5G core market window is open. Customers now make long-term commitments in their choice of vendors here. And we'll come back to our track record so far, but we are winning a lot of these deals. And this is really a cornerstone. in our journey here in digital services, 5G core contracts and what we call attached sales around that, and hence the investment in R&D in this area. If we look at the chart here, starting on the left side and with our investments in R&D, Earlier in this year, and we have talked about this before, we decided to really prioritize long-term ambitions here rather than going for short-term results. So we have increased R&D significantly. when it comes to 5G core and orchestration. It adds expenses in the P&L, of course, short term, but builds value clearly for the mid and long term, very similar to the development we've seen in networks as well. So we also continue to make R&D investments in automation. And this is really more to drive efficiency in our delivery of software and to become more efficient in our own R&D. Thirdly, we also invest going forward now for the future in service orchestration and in involving now the portfolio to enable our customers to serve not least their enterprise customers, including 5G network slicing and edge solutions. Looking at gross margin, here are a couple of aspects. First, just to put in perspective, the packet core area, including 5G core that we talk so much about now, that represents about 20-25% of the total revenue in digital services. The other 75-80% of revenue is delivered from the other areas, which all have a clear trajectory towards improved profitability and this is underpinned by the the transformation that we are driving here toward more software-based content and more industrialized solutions One area which I think is worth to call out here is the BSS. Because we're actually pleased to see that the BSS strategy that we revised in 2018 is delivering. It's been executed and now the BSS area is delivering gross margins in line with the group average levels. Another aspect impacting gross margin also positively now is that we are managing all of these 45 critical contracts that we talked about and started to mention back in 2017. However, then, the gross margin improvements that I just mentioned and the things we do coming out of technology investment are then partially offset by the initial 5G core deployment cost for new product introduction. And that's why we see an improved gross margin up to 2022, but not yet enough. However, beyond 2022, we see then that we continue the transformation towards software-based solutions to customers. And this is going to contribute to the improved gross margin that you can see here to the right on the slide. Software share will increase and the recurring element of software will also grow in our digital services businesses. And you can see here that is really the most significant contribution to our long-term profitability target. Finally, then, if we turn to net sales, the way the 5G core contracts work is that we start to see revenue in the P&L when the networks go live. And then the revenue from those contracts grow then with added subscribers to those networks. This means that revenue from those will start now, start towards the end of the year, and then continue to grow over time. To continue then on the market, on the sales piece, of course, the mainland China reduction has cost us quite a bit of top line. And that's what you can see in the thin sales line leading up to 2022. But of course, our ambition here is to compensate that with market share gains in other markets. And this we already saw actually in even in the third quarter that this is happening. Finally, when it comes to our ambitions then on CSP enterprise and service orchestration portfolios, we expect those to start to be visible in terms of revenue by 2023 and onwards. And this is then as things like dedicated networks start to scale up. Edge, as I mentioned, the network slicing components are being commercialized. So next slide, and I will finish off with this, shows a bit about the momentum in Deals 1. So far, we have landed 45 standalone 5G core contracts. You can see that on the left here. And 15 of those are added since October last year, and eight of them are live and generating revenue. And it's really based on our containerized cloud native technology that we win these deals and we anticipate that we will continue to lead the 5G core market and add more customers to this list as well. But as mentioned before, it's not only about 5G core. To the right here, you see examples from the other parts of the portfolio in digital services. Starting with BSS, we have 70 new deals in 2021, all in line with the BSS strategy that we have put in place. And actually, our customers need to modernize their BSS to become more agile in the consumer business, but also to meet the enterprise customers' requirements. 5G core, as said, drives attached sales as well. And a good example of that is here what you see on OSS where network orchestration is a good example. And last year we celebrated more than 100 customers here in our Ericsson orchestrator. And since then we have added another 30 customers on top of that. Cloud communication. More than 160 customers have chosen our Volte solution for their voice offerings, of which about 20 new customers are new since last year. And then on cloud infrastructure, we have about 230 customers already and 29 new customers added so far in 2021. So I hope that gave a little bit more meat on the bone on DGS, or digital services segment, and the road to profitability. Essentially, it's about investing in technology leadership, winning as market share, and improving the margins through a shift to higher software content. Thank you, and back to you, Börje.