Telefonaktiebolaget LM Ericsson (publ) Q2 2024 Earnings Call Transcript

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Provided by Quartr
July 12, 2024

There are 16 speakers on the call.

Operator

Hello, everyone, and welcome to today's presentation of Ericsson's Q2 2024 Results. Today, Borje Ekholm, our President and CEO, joins us by video And Lars Sandstrom, Chief Financial Officer, is here in the studio with me. As usual, we'll have a short presentation followed by Q and A. And in order to ask a question, you'll need to join the conference by phone. Details can be found in today's earnings release and on the Investor Relations website.

Operator

Please be advised that today's call is being recorded and that today's presentation may include 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 materially due to factors mentioned in today's press release and discussed in the conference call. We encourage you to read about these risks and uncertainties in our earnings report as well as in our annual report. I'll now hand the call over to Borje and Lars for their introductory comments.

Speaker 1

Well, thanks, Daniel, and good morning, everyone. First, I'd like to cover some of the key highlights from the quarter before Lars really goes through all the financials in more detail. So in Q2, we continue to work with our customers and focus on leveraging our leading technology as well as optimizing our business through our strategic initiatives, which of course includes our cost reduction actions that we have taken. All these actions made it possible to deliver a very strong performance, and we saw an expansion of the gross margin despite a very challenging overall RAN and Mobile Networks market. So gross margin for the Group came in at 43.9%, and this was supported by the proactive actions and our competitive portfolio.

Speaker 1

It was, of course, positively impacted by a new 5 gs licensing agreement, and we're now clearly on track to deliver our NOK 12,000,000,000 to NOK 13,000,000,000 revenue target for IPR for 2024. Our IPR portfolio clearly illustrate how our technology leadership is creating value. Let me also briefly touch upon the impairment we recorded last week. This relates mainly to Vonage and reflects lower anticipated market growth rates in Vonage portfolio. However, the strategic rationale for the Vonage acquisition remains, and that is really to create new ways to monetize the network capabilities and the network features.

Speaker 1

And long term, we see this to be crucial for the telecom industry. And actually, if we cannot generate the extra revenues from the features of the network, it's very hard to justify the future investments in late generations as well. So we believe this is a critical initiative for us and for the industry. Network APIs and the Global Network Platform we're creating remain central to this portfolio and O2D strategy. And we continue to see good traction.

Speaker 1

We had 2 additional mobile operator partnerships announced in Q2, and we are now at the 12% in total. But let's move to the next slide and look at the market development. In Q2, we saw North America returning to growth for the first time actually since 2022. This was, of course, driven by the end of the inventory adjustments that we had predominantly last year and into the beginning of this year, but also driven by some larger customers selectively increasing their network investments. We benefited also from the recent and large contract win that we announced late last year, and we started to have some deliveries in Q2, but that will provide further support during H2 this year.

Speaker 1

But when you look at the rest of the market areas, we see they're all declining. So it's really a challenged market environment. In Europe and Latin America, sales decreased by 3%. And that's and I would highlight here, and it's in contrast to what many on the outside think, we're actually seeing a sharply increased competition from Chinese vendors. That includes both in Europe, but particularly in Latin America.

Speaker 1

In Southeast Asia, Oceania and India, sales decreased by 44%. This follows the normalization in India compared to the record pace 5 gs rollout of last year. And finally, both Northeast Asia, Middle East and Africa saw declining sales due to the slowdown in operator investments and an additional macro pressure. With that, I would say it's time for Lars to go through the numbers more in detail.

Speaker 2

All right. Thank you, Berje. Let me start by adding a few additional points on the Group before discussing the segments in more detail. Organic sales declined by 7% in the quarter, and this was primarily driven by Networks. Some of our larger customers in North America did selectively increase their investments, supporting a return to sales growth in this key market, but our other markets declined.

Speaker 2

And as Berri already highlighted, we delivered good expansion in our adjusted gross margin at 43.9% in Q2. This benefited from our strategic actions on costs as well as strong IPR revenue. Also as Berg mentioned, we signed a new IPR contract in the quarter, which includes some retroactive revenue. And reported OpEx was significantly distorted by the Vonage impairment charges in Q2. In the slide, you can see the underlying development.

Speaker 2

Including the impairment, OpEx was up by SEK1.2 billion year on year. Savings from our cost actions were balanced by salary increases and higher bonus accruals, and we also increased investments in 2 areas, in R and D for technology leadership and operational resiliency, and in SG and A to drive operational efficiency in enterprise. We are continuing to take action on cost, including sizing our organization to serve the new level of customer demand, and we recently announced or recently concluded the union negotiation in Sweden on planned headcount reductions. Adjusted EBITDA increased to SEK4.1 billion in the quarter

Speaker 3

with a margin of 6.8%.

Speaker 2

With that, let's move to the segments. Next slide, please. In Networks, organic sales were down by 11% year on year as customers continue to be cautious with their investments. The largest slowdown was in India following the rapid 5 gs build out last year. But as I already mentioned, we did see return to growth in North America with sales up 20%.

Speaker 2

And there were also a benefit from the new IPR licensing agreement signed in the quarter, which included a retroactive element. We generated a strong adjusted gross margin of 46.1% with a favorable business mix, IPR licensing revenue and costs actions all contributing. Adjusted EBITA increased to SEK5.3 billion compared to SEK4.9 billion last year, and we reached an EBITDA margin of 13.9%. The increase in EBITA was delivered despite lower sales and despite significant headwinds from salary increases and bonus accrues. This shows the benefit of our cost actions, technology leadership and competitive product portfolio.

Speaker 2

In segment Cloud Software and Services, we continue to execute on our strategy to strengthening delivery performance and commercial discipline. Organic sales were stable year on year with slight growth in core offset by lower sales in other parts of the portfolio. We delivered an adjusted gross margin of 37.2 percent and the EBITA margins continue to improve on a rolling basis. As I already mentioned, our IPO revenues increased to SEK3.9 billion in the quarter with the new agreement, and we continue to see further growth opportunities with additional 5 gs agreements and potential to expand into additional licensing areas. The revenue run rate is now at SEK12 1,000,000,000, so we are on track to reach a target of SEK12 1,000,000,000 to SEK13 1,000,000,000 for 20 24.

Speaker 2

The timing of growth will vary as we seek to optimize the value of new agreements. Next slide, please. In Enterprise, sales were broadly stable overall. Sales increased in Enterprise Wireless Solutions with good customer demand for private cellular network solutions, and sales also increased in Technologies and New Businesses. Sales in Global Communications Platform declined, impacted by decisions to reduce activities in some countries, which we talked about last quarter, as well as the low margin customer contract loss from Q4.

Speaker 2

Adjusted gross margin increased to 51.1 percent with improved margins in all business areas. Adjusted EBITA was a loss of SEK1.2 billion with higher adjusted gross income offset by higher operating expenses. The operating expenses increase was mainly in Global Communications Platform for two reasons. 1st, non cash accounting impact from the discontinuation of capitalization of development expenses. This started already in Q1, and we expect this to have approximately SEK1 1,000,000,000 negative impact on OpEx this year.

Speaker 2

And second, increased investments in operations, so we can efficiently meet contractual and regulatory requirements. As Barry already mentioned, we continue to invest in the global network platform for network APIs. Then let's move to the next, please. Turning to free cash flow then, which was SEK7.6 billion before M and A in the quarter. This strong improvement compared to last year is a result of significant improvement in working capital.

Speaker 2

This benefited from favorable change in market mix, substantial reduction in inventory levels and lower accounts receivables due to lower sales volume. There was also a benefit from inflow of the SEK1.9 billion related to the one time gain we reported in Q1. So net cash increased sequentially by SEK2.3 billion here to SEK13.1 billion. Next then I will cover the outlook. So turning first to sales.

Speaker 2

We have delivered above normal seasonality in Q2, both in networks in cloud software and services by around 4 percentage points in network and free in Cloud Software and Services. So we have a bit of a higher starting point. We expect to carry this outperformance into the second half, so normal seasonality is a good assumption for Q3 for both sales to be further impacted by our decision to reduce operation in some countries. And then turning to profitability. In Networks, we expect Q3 gross margins to be in the range of 45% to 47%.

Speaker 2

And as mentioned before, the total market is in decline, but we will benefit from continued growth in North America, but also on the other hand, we will not have the IPR benefit. Finally, on OpEx, it's worth noting that we won't see the usual seasonality this year because of the changes in phasing here and as we will also start to see further benefits from our cost actions later in the year. With that, I will hand back to you, Berje.

Speaker 1

Thanks, Lars. So to conclude, we're facing a tough market environment at the moment. However, I would say the results in Q2 underscore the underlying strength in our business as well as our competitive portfolio. Going forward, we remain fully focused on executing on our strategy to strengthen leadership in mobile networks, driving a focused expansion into enterprise and pursue a cultural transformation. We continue to leverage our technology leadership while prudently managing our business.

Speaker 1

The actions we've taken, including our focus on costs, will allow us to keep investments critical to protect our leadership position and long term competitiveness. This will ensure that Ericsson remains well positioned going forward. At the same time, for the industry to grow long term, it's necessary to find new revenue streams for our customers beyond the mobile broadband subscriptions. We need to create new opportunities to monetize the networks and the net, the investments our customers make in the networks through differentiated offerings. And that's what our enterprise strategy is targeting.

Speaker 1

And Network APIs is, of course, one of the key opportunities for us. Of course, creating a market and new monetization models and the associated ecosystem will take time, but we are seeing some very good traction. So our vision to become a leading And here, we will, of course, take every action needed to ensure that we keep our leading position as well as our strong cost position and competitive position in the industry. With that, Daniel, I think we're ready to take all your questions.

Operator

Thanks, Bir. We'll now move to Q and As a reminder, to ask a question, you'll need to press star 1 and 1 on your telephone and wait for your name to be announced. Super. I can see the first question on the line is from Francois Bouvignet from UBS. Francois, your line is now open.

Operator

Please go ahead.

Speaker 4

Thank you very much. So my question would be on this Slide 8 that you show in the presentation where you show the adjusted EBITDA margin and adjusted gross margin. So what we see in the chart, we can clearly see, I think, a correlation between the gross margin and EBITDA margin since 2022. And I checked in 2019, 2021 2020, I think it's the same correlation directionally. But for some reason, from Q4, 2023, we see the gross margin going up, but the EBITA margin going down.

Speaker 4

And I was wondering why because we see the in Q2, for example, the top line increasing, so should they help the scale? You have the North America increasing, should help the JUO mix. And you have the IPR, which is almost all time high, which should help the margins. So I'm wondering why you have a disconnection between the Thanks, Francois. I'll pass that to Lars.

Operator

Yes. Thanks, Thanks, Francois. I'll pass that to Lars. Yes.

Speaker 2

Thanks. I think it is that we have a somewhat higher cost base compared to what we had a couple of years ago when it comes to especially on the R and D side. We have had an increased level of that. And now this is on a quarterly basis, so it's not a rolling 12%. So that's why the significant lower revenue base is also impacting quite a lot on the OpEx ratio there.

Speaker 2

So that is what is, so let's say, kicking through. And also somewhat higher, the difference there coming from the enterprise business that is impacting to some extent as well compared to where we were in 2022.

Speaker 5

So if

Speaker 2

you do the same, looking at the pure mobile networks and the enterprise side, you will see it's a bit a little bit different.

Speaker 4

Do you move cost of sales into OpEx at all? I mean because when I look at the chart, it looks like you are the cost base. And you always invested a lot in OpEx, increasing R and D in the last few years. So why would you invest even more now than before?

Speaker 2

It is not more, it's the relative. With a significant lower revenue base that impacts the ratios, It's not more cost per in absolute levels in that sense. It's the revenue that gives the impact.

Speaker 4

Even if you

Speaker 1

think about it

Speaker 4

Thank you.

Speaker 1

I think you should think about it in a bit of a different way. The our cost base is in reality a base to drive the competitiveness. It depends on which markets we're in as well as our R and D intensity. And the R and D is driven by the future. So it's actually oriented towards in here then programmable networks.

Speaker 1

So we are there to lead into developing the programmable networks for the future. That allowed us to win with AT and T. So that win in reality doesn't translate to revenues until time after we make the investments. So what you see right now is a situation where sales have fallen and we have kept the R and D intensity to be able to compete in the future and be successful longer term. So you will get this it's not that the cost base can follow revenues in R and D, because that's simply not the it doesn't become the relevant timing to think about it in.

Speaker 4

Understood. Thank you very much.

Operator

Great. Thanks for the question, Francois. We're now ready for the next question. So the next question will come from Alex Duval at Goldman Sachs.

Speaker 6

Take this for modeling purposes as the right quarter on quarter growth rate for the next few quarters. Clearly, you have the AT and T win, but then in your report, you talk about some of the dynamics in markets like Europe being tough. So just trying to understand if AT and T should be added on top of that seasonality or if that's already included? Many thanks.

Operator

Sure. Lars, I think one for you.

Speaker 2

I think what we say in Q3 here is we show the seasonality, and I think that is including the growth rate that we see in North America. And then, of course, we have a weaker situation in all regions outside North America. So that's why we say that the seasonality is probably a good indicator for Q3.

Operator

Q3. We can move on to the next question now. So that will come from Andreas Jolson at Carnegie. Andreas, your line will now be open. Please go ahead.

Speaker 7

A follow-up on the former or the previous question, but maybe give a little bit more flavor into the various regions on the network side. So North America, I understand the improvement is a sort of a mix between the AT and T contract and improvement from others. But how do you see that play out going forward? Are the customers a little bit more forward leaning now than a year ago perhaps? And then also on the other regions, except the obvious headwind from India, where do you see the main reason for the customers holding back their investments currently?

Operator

Thanks. Borje, maybe one this is we can pass to you and you can give a little bit of flavor around the various markets. Thanks.

Speaker 1

Yes. If we start in the U. S, we had a big inventory adjustment and that really came out of the big supply chain disturbance from COVID. So our customers built up a larger than normal inventory levels. That started to be depleted fully in the beginning of this year, which has led to a bit of this, call it, normalization in our sales.

Speaker 1

We're also seeing, of course, some customers here. And the investment levels in the market has been very, very low for a number of years following the rapid build out of C band. So, as network capacity starts to be used, we are seeing a different discussion. But I don't want to say that this is a turn, you know, that's too early. I but as you can see, at least it's a positive indication that sales start to come back.

Speaker 1

So I let's continue to focus on the longer term. This market is ultimately going to come back, but it will and we've said that for quite some time, but don't be too optimistic every quarter, let's put it that way. If you look outside of North America, you know, the overall, I would say, this is a problem in the industry where our customers, if you would generalize, and that's not entirely accurate because you have some customers doing better than others. But if you look as an industry, return on capital employed has been under pressure for quite some time. That has driven our customers to actually cut down investments and sweat assets, which is something you can do for a period of time.

Speaker 1

The good thing for us is that traffic continues to grow, continues to grow at a very healthy rate. And I would even argue now that we overlay fixed wireless access, for example, we see actually growth rate coming back in the networks as well, quite a lot, again quite positive. That will, you know, either you get deteriorating customer experience, so customers basically can't use the network and therefore, you are going to be busy that investments come back, But the overall industry problem remains, which is really that unless we can monetize the new capabilities of the network, it doesn't really become a new source of revenue for the operators. And thus, marginal investments only will only be done to manage capacity in the network. If you're going to see this kind of rollout of 5 gs, we actually need to see new monetization start to come.

Speaker 1

And that's why we are excited about our enterprise efforts in both in enterprise wireless solutions, where we see a fairly healthy growth rate, but also into network APIs, where we have a real opportunity to create this new market. We're starting to see very good traction on getting supplies sorted out. That's what our partnerships do. And we are seeing an emerging interest from application developers. Still early, will take time, but that's what's needed.

Speaker 1

So overall, the industry is actually in a very difficult spot. And then if you look more globally, of course, India had a very rapid rollout last year and that is tapering off like we have said and that's what we see there. So that again, underlying traffic continues to grow, etcetera, but that's why you see the slowdown. If you look outside, you see a bit of a macro challenge in Africa and parts of Middle East, where predominantly Africa has had currency movements, etcetera, that actually makes it very painful for our customers. Same parts of Latin America.

Speaker 1

So when you look, it is a subdued environment right now where, you know, let's I think for us, it's that's why we're a bit prudent in our planning and say that we need to control what we can control on our side, that is work on the cost side.

Speaker 7

Perfect. That is very helpful. And may I also wish a great summer?

Speaker 1

Thank you. Same to you.

Operator

Thanks for the question, Andreas. So we're now ready to move to the next question. So the next question will come from Andrew Gardiner at Citi. Andrew, your line should now be open. So please go ahead.

Speaker 8

If I could just do 2 quick follow ups on the last points that you were making, Boyer. First, on the U. S, can I take it that when you say, quote, selective investment, you weren't really expecting it? It's come sort of short lead time orders from customers, perhaps refilling a little bit of capacity here and there where they've needed it. But they're not yet giving you visibility beyond AT and T perhaps, which is obviously quite specific, but they're not the others aren't really giving you visibility into the sustainability of that into the second half.

Speaker 8

Is that a fair characterization?

Speaker 1

Yes, that's a fair characterization. But I would say though that given the, you know, when you have a, if you operate in a rolling out, you try to keep that at a relatively constant And they've been buying less from us to deplete their own inventories. That just needed to adjust. A bit of that is what you see.

Speaker 8

Okay. And then also on the point you made particularly in Europe and Latin America where you're seeing increased competition from the Chinese vendors once again. Do you feel like you're losing share as a result of this competitive activity? Or are you able to hold share, but perhaps it's coming at the expense of price and margin?

Speaker 1

We like to be managing our overall pricing and profitability and gross margin. So it will all depend on specific situations. I'm sure we will lose some, but we'll do that because we think it's right for the overall gross profit in the company. So you don't expect us to be the most aggressive in the market.

Speaker 8

Understood. Thank you.

Operator

Thanks for the question, Andrew. So we'll now move on to the next question. That will come from the line of Sandeep Deshpande from JPMorgan. Sandeep, your line should now be open. Please go ahead.

Speaker 9

Thank you, Daryl. My question is on your IPR deals in the 1st two quarters. You've had 2 deals in Q1 and in Q1 and Q2 as well. What has been the one offs associated with these deals? And what is the ongoing run rate associated with the IPI revenues?

Speaker 9

And I have a follow-up after

Operator

that. Last point.

Speaker 2

We don't comment on the leases. They have always, as you know, a retroactive part and then it's forward leaning, but you can see the jump in revenue that is, of course, partly to a large part explained by the one offs there. And for the run rate, we are at around SEK12 1,000,000,000 now coming out of Q2. And as we said, we are the target of SEK 12,000,000,000 to SEK 13,000,000,000 is well enriched.

Speaker 9

Okay. Thank you. And my follow-up is quickly on the United States and the U. S. Market.

Speaker 9

You've seen this recovery in the U. S. Market. Is this mainly coming from that the U. S.

Speaker 9

Market now those inventories of parts that they were holding are not there anymore? Or is it that they are actually now starting up new projects? There are some new movement in terms of where the investments are occurring? Or it is to do with inventory replenishment or AT and T new contract?

Operator

Mario, maybe we can pass that one over to you.

Speaker 1

Yes. I think it's fair to say it's a combination of those, right? But that's why we also say, let's not let we know that the investment level has been if you look at the underlying traffic growth and the growth of Fixed Wireless Access, we know that traffic has grown. So that requires a certain level of investment. So we knew that, but we had the inventory adjustment.

Speaker 1

And of course, now that they have run out of room to adjust that, they need to buy a bit more from us. So that one thing that's clearly happening, but we're also seeing that they need to manage the network quality. And that's the, you know, that's what give us comfort that the you have a bit of a cyclical behavior in the investments, if you look historically. We've been at a low point and now that starts to come back. That's a bit what you should expect.

Speaker 1

And of course, you have the big contract win as of last year. That starts to contribute in Q2, but it will be more in H2.

Speaker 9

Thank you.

Operator

Thanks, Sandeep. We can move now to the next question. The next question on the line will come from Joakim Goel from DNB. Joakim, your line should now be open.

Speaker 5

Thank you. So can you just comment a bit on where you are in India and the U. S. In relation to what you would consider normalized sales levels at this stage?

Operator

Sure. Borje, do you want to provide some high level thoughts on those two markets? Thanks.

Speaker 1

Yes. If you look at the U. S, I mean, the we think if you look historically, we're at the lower end of the of more of a normal cycle. So that's what we feel. India is more normalized now.

Speaker 5

Understood. And if I may, just a quick comment here in light of the competitive environment comments you made. What is your view of the component availability situation for your Chinese competitors?

Speaker 1

I the honest answer is they should comment on that. But at least we see them quite aggressive in the market. And ultimately, it's a choice customers will have to make, right, how they think about their network resilience, decisions for the future, etcetera. It's really in the customer's hand to choose. This is more a comment that we see them increasingly aggressive.

Speaker 5

Thank you and have a great summer.

Speaker 1

Thank you, Un. The same to you.

Operator

Thanks for the question, Jochem. We'll move on to the next question, which is going to come from the line of Daniel Jurgen at Hanselbanken. Please go ahead, Daniel.

Speaker 10

Thank you, Daniel, and hi, Borje and Lars. I would like to just ask

Speaker 11

a little bit to give

Speaker 10

a healthy network gross margin ambition here for Q3 45% to 47 percent. My question is if it's also relevant to see this positive similar uptick also for Q4 or also into next year on back of the mix you expect? That's the first question.

Speaker 2

As you know, we have the uncertainty going forward on volumes, etcetera. So that's why we try to keep and stay on to the Q3. That's where we guide now with the SEK45 billion to SEK47 billion. And so it is the cost on the positive side, we have the cost out activities that we are doing that is helping us, but we also have a downturn in the market in total that we when you do the calculation around the seasonality on Q4, you see. So that are, I'd say, the big impact.

Speaker 2

So we don't see that we should give you a guidance going after Q3. So but that's why we are cautious still.

Speaker 10

I see. And just a follow-up on the harsher competition in sub Saharan, is it mainly your number one competitor Huawei? Or is it also more broad based at the set the some signing fees, etcetera, that are also more aggressive? Or is it mostly

Speaker 3

the one?

Speaker 1

It's you're seeing an aggressive I mean, a competitive market, right? That I think is fair to say. The I am more mentioning the I've gotten the impression over the last few months that everyone thinks that the Chinese vendors have kind of disappeared. And that's not true. That's why we wanted to bring it up.

Speaker 1

It's always been very competitive, right? So but I almost felt that everyone thinks they're gone and that's not true.

Speaker 10

They should go to Barcelona in February, I guess. That they will learn. Okay, thanks and have a great summer.

Speaker 1

Thank you.

Operator

Thanks for the question, Daniel. We'll move on to the next question now, please. So the next question is going to come from Erik Lindholm at SEB. Erik, your line should now be open.

Speaker 3

Yes. Thank you and good morning everyone. So you mentioned taking some cost actions here both in enterprise and outside enterprise. Is it possible to quantify these actions? And what is your meaning here for the second half?

Speaker 3

And especially maybe in the light of not expecting normal OpEx seasonality? Thank you.

Speaker 2

Sure. Just to help you a little bit on the guidance before we dive into the as we said, the normal seasonality, you should not it does not really apply since we are continuous having impacts of the cost reductions. But they are on the other end, we have salary inflation coming in. And also last year, we had rather or very low provisioning for incentives. So those are, I'd say, counterbalancing.

Speaker 2

And then we have some dedicated investments in the R and D area. So that is a little bit just to try to help you to understand. So if you look at H1 where we also had the similar development with cost out offset by salary increases and provisionings that we see that for the remainder half of the year as well.

Speaker 3

All right. Any comment on where you're taking up costs, which area sort of thing both in enterprise and outside of enterprise?

Speaker 2

Yes. I think the cost base is, of course, significantly larger in the mobile network side. So and we need to adapt too. We are still in a declining market, so that requires us to adapt accordingly over time. So we don't point out specific area.

Speaker 2

It is broad based in the different markets and activities where we are active.

Speaker 3

All right. Thank you.

Operator

Great. Thanks for the question, Erik. We will now move on to the next question. The next question will come from the line of Sami Sarkomis from Danske Bank. Sami, your line is now open.

Operator

Please go ahead.

Speaker 12

Hi, thanks. I would actually like to continue on the cost topic we just discussed. Could you provide additional color on the OpEx development during the Q2 and provide some color on outlook for the rest of the year. If you look at Q2, OpEx was somewhat higher than what you had guided for. It seems that Enterprise was offering some sort of surprise here.

Speaker 12

And then why have you chosen not to provide OpEx guidance for the Q3 as what has been customary in the past?

Speaker 2

Yes. Now if you look at the cost in the Q2 on the guidance that we gave for the mobile networks part, it's actually not so far off. But we had some additional investments in the R and D side there. And then we had higher costs on the enterprise side, where as I mentioned there, we are not we have stopped capitalizing R and D. So that is around SEK 1,000,000,000 on an annual basis.

Speaker 2

We did that already we started that already in Q1. So that continues for the rest of the year. And then we have some higher costs and investments that we are doing connected to some of the market exits, but also to increase the operational efficiency and ensure that we are following all or following the development when it comes to different regulations, etcetera. So that is building some cost in the enterprise part. So that so the big deviation here actually in Q2 is more connected to that.

Speaker 2

And then going forward, we took out the seasonality because we see that it doesn't really apply here. We see more of a stable cost development, you can say, if you look at from the first half of this year. So where we have continued cost out activities delivering, but also then that is offset by some salary inflation and some higher provisioning. So that is more to help you to see what is happening. On the enterprise side, there we are, so I'd say, more stable on the cost base going into the rest of the second half.

Speaker 12

Okay. Thanks. And I would have a follow-up on IPR licensing guidance. I mean, if we do the math, you're basically already at SEK 13,000,000,000 for the full year if run rate amounts to SEK 12,000,000,000 as you earlier discussed. So why have you chosen not to raise the hyper licensing guidance?

Speaker 12

You did mention that there is still a possibility for additional deals.

Speaker 2

Yes. We aim to get the best economic outcome of any agreements that we are working on. So therefore, we keep, so I'd say the guidance now for the SEK 12,000,000,000 to SEK 13,000,000,000 for the full year. And then if there is more to come, then we will announce that.

Speaker 11

Okay. Thank you.

Operator

Super. Thanks for the question, Sami. And just as a clarification, in terms of the base, think about the H1 in terms of overall OpEx when we talk about similar sort of levels rather than the single quarter, just to clarify on that in case it's helpful. Super. Ready to move to the next question.

Operator

That's going to come from Joseph Xu at Barclays. Joe, your line is now open.

Speaker 11

Hi. Thank you. Thanks for taking my questions. And my first one is on the gross margin for network business and it's at a good level. And if I look at the business historically, only in 2021, you had a kind of higher gross margin at around, I think, something like 47%.

Speaker 11

And you're guiding to 45% to 47% for Q3. And obviously, there is an element of structural improvement with IPR. But my question is, is it as good as it gets in the second half when you have this kind of around 47% gross margin considering in 2021 you obviously had a very, very high level of sales in North America with a 5 year out. And I think it's safe to say we are not going back to that level of volume. And so is that a fair understanding that this level of gross margin is as good as it gets?

Speaker 11

Or am I missing anything?

Speaker 2

Yes. Norway, it's a good question. We are of course quite happy with the margins that we saw now and also what we're trying to guide for here and it is good levels as you say. If it's as good as it gets that we are continuously working to improve, But it is reaching a good or a high level now I would say.

Speaker 1

Yes. I think also there you should think about where are we going as an industry, right? You will see less hardware, more software. So as you think about the longer term, the product mix hasn't changed dramatically now, but that's going to look different as we move forward.

Speaker 11

That's very clear. Thank you. And my small follow-up is just on IPL. It's just the new contract, can I assume it's with a, say, a Chinese smartphone maker that you probably didn't have a kind of 4 gs or 5 gs license with? Is that fair to assume?

Speaker 2

We normally don't disclose these kind of contracts, but we will see if there is if there is you will see it, but normally we do not share who we sign up contracts with.

Speaker 3

Okay. Thank you.

Operator

Thanks for the question, Joe. We'll move to the next question. The next question is going to come from Felix Henriksen from Nordea. Felix, your line should now be open.

Speaker 11

Hi, thanks for taking my question. I wanted to touch on the game plan for Vonage and the Global Communications platform. You've now had the write down under your belt, organic growth has been negative and the business is loss making. So just wanted to hear your thoughts about the timeline. So when do you have to achieve profitable growth in this business area to be somewhat satisfied with the acquisition here?

Operator

Super. Lars, do you want to start with any financial comments, albeit probably limited on our side? But and then, Burry, we can talk a little bit about the strategic rationale as well.

Speaker 2

So I think we are continuously working with managing the current business and improving that. And that will require a return to growth. There has been some decisions now to step out of some of the low margin deals that we have had and then to get back to a more of a profitable growth in the especially in the Global Communication Platform part, whereas Enterprise Wireless Solutions there, it's more full steam ahead to capture the opportunities there. So that is clearly the targets. I will not give you a timeline today on that, but that is what we are definitely working on.

Speaker 2

And I think then for you, Burry, to add a little bit on, let's say, the full the longer term picture.

Speaker 1

Yes. I think on the if we start on the Global Network Platform, it falls down in 2 buckets, right? It's the strategic reason why we acquired Vonage. And that's what we're actually investing in. So, you know, we need to manage the existing business better than we have, that's for sure.

Speaker 1

But we have also seen a decline in growth rates that we didn't expect or didn't plan for. That's to be honest. And that, I think, is what you see on the current performance. What we are trying to do still is actually the North Star, if you put it that way. That's to build a new marketplace for network APIs.

Speaker 1

And when we talk about network APIs, it becomes a technical language. But think about it, that you can have 3 d positioning, for example. You have new ways of authenticating devices. You have speed on demand. If you have a broadcasting camera that uses capacity, they can actually order the capacity with milliseconds latency.

Speaker 1

There are a number of these things that are now started to be implemented. That's a new way for the industry to drive a new type of revenue source the industry has not had. And in reality, the if you simplify it a bit, you can say it's monthly subscriptions and it's basically not linking revenues to neither to network investments or to costs in reality. So we think that paradigm has to change. There are part monetization on 5 gs for operators.

Speaker 1

You see operators that have rolled out 5 gs, they typically have a bit higher ARPU and they have a bit lower cost, so they get actually gross margin expansion. But it's not a new investment case. What we can see with Network APIs is that we think that is the investment case. That's actually what we are focused on. That's not to detract from, we need to run the business better than we have.

Speaker 1

So that's an element of improvement that we need to do. And that's what Lars said here, we review where we are, what products we offer, how we offer them, etcetera, to actually optimize the current business. But that's also why when we talk about it, it's actually our focus is on the Global Network Platform, not on the per se existing business of Vonage. Then on Enterprise Wireless Solutions, it's full steam ahead. We have a product offering of wireless ones as well as dedicated networks.

Speaker 1

And we're seeing, it's been it's been actually some interesting customer wins. So I think that is an emerging market as well. So of course, we're working on 2 emerging opportunities here, which are will require some more time before you see the contribution in the P and L. But it's all part of the notion, how do we leverage the cellular technology for new applications and for driving new revenues to the industry?

Operator

Great. Thanks for the question, Felix. We will move on to the next question. The next question will come from the line of Chanadan Menon at Jefferies. Your line is now open.

Operator

Please go ahead.

Speaker 13

Hi, good morning and thanks for taking the question. I have one question and a short follow-up. The question is on the Q3 gross margin in Networks again on the 45% to 47

Speaker 3

percent.

Speaker 13

I'm just wondering what are the specific upward drivers of that gross margin because I would calculate roughly between 102 100 basis points of sort of IPR impact, which you're sort of guiding that you will cover in the current quarter. So is that coming from a better mix because of more U. S. Revenue versus sort of lower margin revenue? Or is it coming from further cost reduction?

Speaker 13

That's my first question. And the follow-up is just on the competitive environment, you were talking about Latin America, Africa, etcetera. But in Germany, there was recently some news flow about them excluding Chinese vendors from their core network. Does that signal any improvement in the European environment, which also you've said has been competitive in the past more than what the market thinks? Or is that not really yet coming through to the rand side and just still on the core side, etcetera?

Operator

Thanks, Gennad. And so Lars first on the margin drivers into Q3.

Speaker 2

I think you have done the calculation, so I'd say we had a bit of positive impact in Q2. So taking that off, that shows a bit of an underlying improvement. And we have the cost out activities that we expect to support. And then of course also a bit of the geographical mix as you mentioned. So I think that is you're capturing it rather well in that sense.

Speaker 2

And then of course on the downside, we have still a declining market that compared to last year. So those are the key components. And on the other question, I think it's better for you, Berge, to give your point of view.

Speaker 1

Yes. I think it's still a bit too early to have a view on what's going to happen in Europe. I we saw the legislation being passed or announced the I think we'll have to see how that impacts the market.

Speaker 13

Understood. All right. Thanks.

Operator

Thanks for the question. We've got time just for a couple more questions. So the next question will come from the line of Richard Kramer, Richard Arate. Your line is now open. Please go ahead.

Speaker 14

Thanks very much. Oria, I want to go back to Vonage and given the further write downs, which are now over $4,000,000,000 I want to ask you, who is ultimately accountable for this level of value destruction and sort of what conclusions should investors draw that the management has learned lessons from this level of losses, which I mean it's really the largest that we've seen since shortly after you arrived in 2017. And maybe alongside that with Lars, do you need to adjust your EBITDA targets given that they had been changed from EBIT to EBITDA to include the larger amortization post Vonage and now you'll obviously have much lower amortization? Thanks.

Speaker 1

No, it's clearly, I'm accountable as CEO, no choice about that. So you can have that there. But hold your horses a bit before you assess the overall transaction until we know if we can create a separate new market for network APIs. I think that's where our focus was the whole time. Maybe we have not delivered on the current performance of the existing business.

Speaker 1

Take that, we need to improve that. So let's take a look at this in a few once we see how the market for Network API pans out.

Speaker 2

Yes. And on the EBITDA, as you state, we will have less to amortize, but as it does not impact EBITDA, it will not impact the EBITDA level as such. But there will be somewhat lower amortization going forward. I think that's also part of the outlook guidance we give.

Operator

And we will move to our final question today. So final question today is coming from the line of Didier Semauma at Bank of America. Didier, your line should now be open. Please go ahead.

Speaker 15

Yes. Good morning, Daniel. Thank you for taking my question and good morning, everyone. Just a quick one. It's on this comment you made on the increased China competition or Chinese vendors competition.

Speaker 15

I've got a simple question. Should we conclude from your commentary and the guidance you've given on revenue and margins that you're happy to give up market share to protect your gross margins? And related to that, if you don't, are you prepared to provide vendor financing in those emerging markets as we've seen in the past, given the FX headwinds that some of your customers are facing? Thank you.

Operator

Sure. Berri, some high level thoughts on that one. Thank you.

Speaker 1

Yes. There isn't. This is very dependent on how the customer situation looks like. It depends also on choice. I mean, this is overall in the customers' hands.

Speaker 1

The customers need to make a choice of vendor balance, what the risk profile they take with different vendor balances, etcetera. So it's very hard to give you a generic answer, right. And then so but I would say for us, what we know is that we need to be able to deliver a healthy gross profit in order to be able to invest in technology leadership. So for us, if that requires us to be disciplined, and we're going to continue to be that on how we take market share. I think you've seen that over the last few years that we've been rather disciplined in managing the overall gross profit of the company.

Speaker 1

We've been able to do that and still gain market share. So, it actually comes back to another question, which is the technology leadership we have with the type of portfolio we can offer, we're actually able to do both. Is that always you can take that for granted? No, you can't. You need to make sure you invest in leadership and invest in the portfolio.

Speaker 1

And that's why we try to manage the total business with the gross profit and the need to invest in technology and trading those 2 off in order, again, to win in the marketplace in the long run. It's always expensive to give up footprint. I know that and you know that as well. So we need to manage both.

Speaker 2

And how

Speaker 1

it looks will depend on individual situations. But we're not unless we get paid for our technology, why should we taken off a contract?

Speaker 13

Brilliant. Thank you. May I ask a follow-up?

Operator

If it's very brief, Didier, we're just about out of time. Very brief.

Speaker 15

Very brief. Your main competitor in Europe just acquired an optical vendor to a sort of a bigger footprint in data center and sort of AI. I know it's not your focus. How should we think about Ericsson's role, if any, in data center in the future? Thank you.

Speaker 1

Yes. I think that I think they're in a very different position than we are. They already have a business there. So for them, it's kind of a rational acquisition. For us that I think that's a market we serve through the access technology and we but seeing us to directly sell to data centers is rather unlikely.

Speaker 15

Great. Enjoy your summer.

Speaker 1

Thanks. You too.

Operator

Super. Concludes today's conference call. Thanks, everyone, for joining, and we'll catch up after the summer.

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Earnings Conference Call
Telefonaktiebolaget LM Ericsson (publ) Q2 2024
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