Ericsson (ERIC) Q3 2022 Earnings Call Transcript

Ericsson (NASDAQ: ERIC) Q3 2022 earnings call dated Sep. 20, 2022

Corporate Participants:

Peter Nyquist — Vice President, Head of Investor Relations

Carl Mellander — Senior Vice President, Chief Financial Officer

Analysts:

Jesper Dugamon — Handelsbanken Capital Markets — Analyst

Alexander Peterc — Societe Generale — Analyst

Adithya Metuku — Credit Suisse — Analyst

Didier Scemama — Bank of America Securities — Analyst

Presentation:

Peter Nyquist — Vice President, Head of Investor Relations

Hello, everyone, and welcome to today’s presentation Covering the Restate Related to our New Organization Setup that will be Implemented in our Upcoming Q3 report. On this call today is Carl Mellander, our CFO. And as usual, we will end with a question-and-answer session, and we will focus these questions only on to issues related to the restate. And specific and detailed questions on the spreadsheet that you probably have received, we can handle those from the IR department later this afternoon.

[Operator Instructions] Details can be found in today’s press release and on our website, ericsson.com/investors. Please be advised that today’s conference is being recorded. 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 risks and uncertainties. The actual results may differ materially 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 the word to Carl. So please Carl.

Carl Mellander — Senior Vice President, Chief Financial Officer

Thank you, Peter, and good morning or good afternoon, good evening to everyone. Thanks for participating in the call. And as Peter said, the background of what we are publishing today is the reorganization that we executed here in Ericsson on the 1st of July this year. And as a consequence of the reorg, we are also changing the reporting structure now from the Q3 earnings report and onward. So if we look at the slides here, the new segment structure consists of the four segments, Networks, Cloud Software and Services, Enterprise and Other.

The largest segment is Networks, and that currently accounts for more than 70% of our revenue in the Ericsson Group. This segment remained unchanged and Fredrik Jejdling continues to head up the networks part of our business. The segment Cloud Software and Services is the merger of the two previous segments, digital services on the one hand and managed services on the other hand. And here, we will leverage the investments we do in R&D to increase the cloud-native expertise and will build combined offerings for automation and AI for service delivery.

The solutions here will help customers automate what is becoming an increasingly complex network for cost advantages and speed to market. And here, Mr. Per Narvinger is the head of this Public segment, Cloud Software and Services. The new segment Enterprise consists of three business areas, enterprise wireless solutions, technologies and new businesses and global communication platform, and we’ll come back in a minute to expand on that. The business area heads here in enterprise will report to our CEO, Borje Ekholm, as the segment head for Enterprise.

And finally, we have the fourth segment called Other, which includes media business and one-offs. So what we have published today and you’ve seen it most likely is then the restated financials according to this new structure. And we published and restated full year numbers for 2020 and also quarterly numbers for 2021 and up to the second quarter of 2022. We will report net sales, gross income, gross margins EBITA and EBITA margin, EBIT and EBIT margin for these segments, and we will also report profitability, excluding restructuring charges.

So let’s move to the next slide, and let’s then look at what the segment will consist of. Starting again with segment Networks, which is unchanged, as I mentioned before, and this is comprised of radio access networks, transport solutions, site solutions, network rollout and tuning and also customer support. No change. Secondly then, in segment Cloud Software and Services, we will help operators to succeed in the transition to cloud-native software and automated operations as they all prepare their networks for the future. And we will do so through four main product groups, and I will explain a little bit more in this segment, what is contained in the various parts.

So first, its core network and automation. And here, I can say the background here is that core networks must support an evolution from today’s deployments to cloud native environment. And secondly, it must support several deployment options. For example, central and edge deployments that are needed to enable low latency and edge computing use cases. Automation is required also to handle magnitude of tailor-made services, use cases and network slices that will be introduced. So that’s the first one, core network and automation.

Second, Managed Services. And here, as you know, we are continuing with the managed services business. And here, AI and data-driven solutions will now actually benefit from the merger between the two units here from mutual development and evolution of services to create an even more efficient service delivery machinery. Thirdly, service orchestration, and this is about creating a programmable network open for the consumer and enterprise application ecosystems.

And the key capability here is secure and automated end-to-end management across multi-cloud, network domains and even multi-vendor. And to succeed here, service automation is foundational to remove manual tasks in design ordering, fulfilling, assuring services, et cetera, to increase efficiency for our customers. And then the fourth part is Telecom BSS or business support systems. And here, the background is — or the background here for BSS is really monetizing new and different services for consumers and across industry verticals as well to serve enterprises.

And to do that, the BSS, the business support systems, must be agile and flexible, robust and resilient. And here, of course, digitalization is critical for the customers. And as is the journey to cloud BSS in enabling operators to fully monetize investments in the networks. So this is key also for our customer community. And with that, we can move to the segment Enterprise here. So a couple of parts, as I mentioned before. First one is enterprise wireless solutions. That is comprised of the current Cradlepoint business, together with dedicated networks.

And here, we develop solutions for enterprises, and we will create a dedicated go-to-market organization for enterprise customers, including, I should say, leveraging operator relationship that we have. And here, George Mulhern is heading Enterprise wireless solutions. And George was, as you know, the CEO of Cradlepoint, the company acquired a couple of years ago. Then secondly, in technologies and new businesses, we will continue to focus on developing new business solutions to accelerate growth across Ericsson’s core and Enterprise businesses with an established incubator model that we have.

And here, Asa Tamsons is heading up Technologies and New Businesses. Then the newly acquired company, Vonage, will be reported here in business area, global communication platform, and this is where we combine the communication API business, which is providing key capabilities such as messaging, voice, video and conversational AI with — on the other hand, Unified Communication and Contact-Center-as-a-Service capabilities. And here Rory Read, Vonage’s, CEO, is heading up the business area, global communication platform.

And so in segment Enterprise, we also have a program for the evolution and development of the global network platform that we have talked about. And this is about building a new market based on widespread utilization of advanced APIs in both 5G and 4G communications solutions. And the focus of this program then is to continue to develop the offerings that Vonage has but also, of course, develop new offerings to create a new value segment for open innovation to help ensure monetization and new value for the full ecosystem. And finally, segment other than, which includes the media businesses and one-offs.

And also changes in holdings or revaluations and so on in our Ericsson Ventures portfolio will be reported in Other. Next slide, please. So you have all the numbers in the PDF we published today, but let me comment some highlights per segment. First of all, as you see, we have a group in here, group networks and Cloud Software and Services together to form mobile infrastructure business. And next to that, we have the Enterprise segment but again, starting with Networks. Looking back then on this period, our top line has grown as a result of underlying growth in the RAN market.

And on top of that, we have increased market share, especially in Europe, in line with strategy. And our margin has over this period also improved as a result of operational leverage. I can also mention here that we made a provision related to Russia earlier in this segment, but we have moved that into segment other. Other is not visible on the slide, but anyway, since — that was a one-off item caused by the invasion of Russia in Ukraine and is really unrelated to the business in networks as such. And lastly, on networks and the IPR share that goes to networks will continue to be 82% as before.

Moving to Cloud Software and Services. Here, we have had declining sales in both Digital Services and Managed Services. In Digital Services, the decline is mainly due to lower sales in Northeast Asia, primarily related to Mainland China. And in Managed Services, the decline is mainly due to reduced sales in a large contract in North America. And also rescoping and Plan exits primarily Europe. All of these things we have communicated earlier. And for the full year 2020, we were breakeven on an EBITDA level, including restructuring charges.

Since then, the margin has declined due to the higher R&D investment within 5G core that we decided to do at the same time as sales declined. And lastly, we have the Enterprise segment. Again, sales and gross margin improvement has been driven by Cradlepoint. And speaking about Cradlepoint, I wanted to say a few words on CradlePoint and the accounting treatment here to comply with IFRS principles, which leads to a time gap between billing and revenue recognition because in Cradlepoint’s business model, they — or we, in the Cradlepoint, I should say, we invoice and get paid for 100% of the subscription services for the contract period upfront.

However, that revenue is then deferred and is recognized during the contract period, which is typically three to five years. And that leads to a gap between invoice sales or call it billings. On the one hand, and reported net sales. And consequently, this also impacts the timing of recognition of gross profit. Then we have global communication platform, which includes Vonage then as mentioned. And yeah, this is not part of the restatement here, of course, since we acquired this business on the 21st of July this year.

I just want to say also that going forward in the reporting here, we will be transparent about the performance of the parts of Enterprise segment to the extent permitted by the regulatory framework regarding segment reporting, this is the IFRS 8 part. And so we will come back to the final disclosure structure in the Q3 report. One more thing to mention here on slide 18 in this presentation pack, which we have published. We cite the numbers from Vonage’s official SEC filings. This is for your reference. And obviously, these numbers are all from the period prior to Vonage being acquired by Ericsson.

And Vonage has, of course, been reporting per U.S. GAAP. Now that Vonage is part of Ericsson, we will apply IFRS in the accounting. And that impacts accounting treatment in several ways. For example, how lease arrangements are accounted for and how certain cost elements are or rather are not capitalized. And furthermore, the PPA or, the purchase price allocation, will impact for example, the valuation of the deferred net sales balances.

And we will also have intangible assets here created, which will be amortized over the P&L. Those, of course impact, but not EBITDA. And these — all of these numbers, of course, will be visible in the Q3 report once we published that in October. My final slide is around the market area, distribution. And here, you see the chart here, this is the sales split year-to-date 2022 by market area and the market area structure is unchanged as compared to before, with top line breakdown into five geographical areas, plus market area, Other.

And here, it could be good to know that the majority of our Enterprise business will be reported in market area Other with some exception for sales related more to the geographical market area. And also our IPR revenues as well as the Media business will be reported in market area other, which is really no change since before.

And that is it for me for the moment. And with that, we can open up for Q&A. So back to you, Peter.

Peter Nyquist — Vice President, Head of Investor Relations

Yeah. Thanks, Carl. So it’s now time for the question-and-answer session. And as I said before, we will focus the questions only to issues related to the restate and detailed questions related to the spreadsheet where you would find all the numbers going back in time, we can handle from the IR department later on this afternoon or whenever convenient.

So with that, operator, we will open up for the first question, please.

Questions and Answers:

Operator

[Operator Instructions]

Peter Nyquist — Vice President, Head of Investor Relations

Yeah. I think we have the first question from Daniel Djurberg.

Operator

The first question is coming from Daniel Djurberg from Handelsbanken.

Carl Mellander — Senior Vice President, Chief Financial Officer

Hello Daniel.

Jesper Dugamon — Handelsbanken Capital Markets — Analyst

Good afternoon. This is Jesper Dugamon [Phonetic] on behalf of Daniel Djurberg and Fredrik Lithell.

Carl Mellander — Senior Vice President, Chief Financial Officer

Hi Jesper.

Jesper Dugamon — Handelsbanken Capital Markets — Analyst

I have question regarding the amortization. That has fallen from SEK464 million as MAX in Q3 ’21 to SEK158 million in Q2 ’22. It has been stable at enterprise lifting from SEK81 million to SEK89 million, given Vonage consolidation, what is the guidance for enterprise coming quarters? Thank you.

Carl Mellander — Senior Vice President, Chief Financial Officer

Yeah. I think, as Peter said, some of the specific details, I think the IR team is well positioned to answer. But in general, we will have a significant intangible amount in the balance sheet coming from the Vonage acquisition, and we will amortize that over time. The exact amounts will be visible in the Q3 report because we have now — we are in preliminary PPA territory here. So I’m not at a position to give you specific numbers on that right now. When it comes to your question on the historical numbers and how they have fluctuated, I actually think it’s better for the IR team to really look into that and come back with a good, prepared answer.

Peter Nyquist — Vice President, Head of Investor Relations

We will do that, Jesper.

Jesper Dugamon — Handelsbanken Capital Markets — Analyst

Alright. Thank you so much.

Peter Nyquist — Vice President, Head of Investor Relations

Thank you. I think the next question is from Alexander Peterc from Societe Generale.

Operator

Yeah. The next question come from the Aleksander Peterc.

Alexander Peterc — Societe Generale — Analyst

Question I just yes, hi. Thank you for the question. Hi — can you hear me alright?

Carl Mellander — Senior Vice President, Chief Financial Officer

We can hear you Aleksander, yeah.

Alexander Peterc — Societe Generale — Analyst

Good, thank you. So I’d just like to clarify, are you going to continue to disclose or continue or start disclosing Vonage separately also in terms of earnings at any level. I didn’t quite understand the comment there. It’s part of enterprise, but then it’s bundled also with Cradlepoint and all of the start-up businesses as well. So will we get a clear read on how you’re doing on that front?

Carl Mellander — Senior Vice President, Chief Financial Officer

Yes. Our ambition here is to be transparent with that and show specifics. And we’ll come back, however, to the — really the specifics on how we do it and on what level in P&L and so on, and we are looking at currently then, as I mentioned, because you see the IFRS stipulates how segments can and should be reported. And we have to consider that before we finally create the disclosure structure. So we will come back to it in Q3. But our intention and desire is to be transparent with the sub parts of enterprise.

Alexander Peterc — Societe Generale — Analyst

Okay. Okay. That’s helpful. And the second question, I think you mentioned the fact that you’re going to have a dedicated go-to-market team. So that probably also means more costs for wireless solutions. Is that how we should understand it? So are you going to see more SG&A in that area as a result?

Carl Mellander — Senior Vice President, Chief Financial Officer

There is a certain element of investment in SG&A in the go-to-market. Yeah, of course, and we — but that is part of the plan already in terms of the Cradlepoint business now in enterprise wireless solutions. And the go-to-market is a combination of resellers and various setups in direct channels also partly actually through the operators. So we will set up that whole structure, of course, for maximum sales efficiency and so on globally.

Alexander Peterc — Societe Generale — Analyst

Okay. So that means initially a higher fixed cost base, but hopefully, that will drive revenue higher as well. So you anticipate that to be accretive longer term.

Carl Mellander — Senior Vice President, Chief Financial Officer

No. Exactly, absolutely. So the investment in sales should give I mean, that’s the ambition to fast returns, of course, in terms of sales volume as we expand on Cradlepoint of our very successful portfolio into new markets. So yeah.

Alexander Peterc — Societe Generale — Analyst

Maybe just — I mean this is a far etched one, but where would you like to see the enterprise businesses gross margin when it becomes a little bit more mature because there’s a lot of stuff now that’s in a start-up phase. So where would you think that should land? What kind of business should be in terms of gross margins?

Carl Mellander — Senior Vice President, Chief Financial Officer

Yeah. I think we should come back to that. I mean you see some of the restated numbers here, but then, of course, we will add Vonage into the mix in Q3. So let’s come back to that question when we see the first actual including all of the enterprise components, if that’s okay?

Alexander Peterc — Societe Generale — Analyst

Okay. Well understood. Thank you very much. Very helpful. Thank you.

Peter Nyquist — Vice President, Head of Investor Relations

Thank you. Thank you Alexander. Thanks. Operator, we’re ready for the next question.

Operator

Sure. [Operator Instructions] The questions come from the line of Adithya Metuku from Credit Suisse. Please ask your question. Your line is open.

Adithya Metuku — Credit Suisse — Analyst

Yeah. Good afternoon. Thank you. Good afternoon guys. Thank you for taking my questions. Just firstly, I just wanted to clarify, when I look at the sum of digital and managed services, there is a small difference between what is disclosed as CSS and the sum of digital and managed services disclosed previously. Is there a slight change in the reporting structure?

Are you moving something out of maybe digital services into enterprise or something like that? Is there any color you can give around this? And then secondly, I just wondered with this new reporting structure, can you give us some color on how this will affect your day-to-day operations in addition to what you’ve already said on having a dedicated go-to-market on the enterprise side?

Carl Mellander — Senior Vice President, Chief Financial Officer

Well spotted on your first question, it’s true. We have moved — it’s actually a smaller business that we have moved from what used to be digital services into the Enterprise segment. Yeah, it’s a mobile money business, mobile financial services business that we have. So that explains that delta. When it comes to a change of the daily work, as you said, I mean I think in general, of course, Ericsson’s move now into enterprise is significant for us. We build it to a large extent on completed acquisitions with Cradlepoint. Cradlepoint has managed their business very successfully, and that now continues, I would say, within Ericsson.

And in combination with the resources of Ericsson as well. And the same will be true for Vonage, which is, of course, is just coming to the group. I think for — I’m not sure if that is your question, but of course, for many of us, who have spent, I mean, in group functions and so on, we are, of course, mainly dedicating talent to the mobile infrastructure business so far. And now we are coming into the Enterprise segment as well, which sometimes has very different business models. So there’s quite a lot of change going on in the whole company, I would say, and as we adjust to this new reality. But it’s going very well so far, and everyone here is very excited also about the opportunity within the enterprise space as a second strong growth engine or as a new growth engine for Ericsson’s business I’m not sure if that’s answered your question, Adithya [Phonetic].

Adithya Metuku — Credit Suisse — Analyst

It did on the first bit. Just on the second, I mean I was just trying to understand the rationale behind changing the reporting structure, is there something operationally changing? It doesn’t feel like it maybe with the exception of a little bit more investment into the go-to-market on the enterprise side. It doesn’t feel like a whole lot is going to change. Am I right in my understanding?

Carl Mellander — Senior Vice President, Chief Financial Officer

But I think what we want to do with the restructure and the reorganization here and the new reporting structure is really to emphasize our strategic move into enterprise and collect the enterprise-related businesses into one segment, so that can be followed up and understood. And because it has a different logic than the mobile infrastructure business, we want to separate it out and show it separated, including the growth that we expect there, etc.

So I mean we’ve had an internal reorganization, which, of course, has brought in a couple of new members of the executive team as well with Rory Read and George Mulhern, certainly providing a lot of new perspectives on the enterprise business as well. So I mean, the things are changing, and I think it signals and illustrate underlines perhaps the strategic shift that Ericsson is undertaking now with more emphasis on the enterprise side and really wanting to show also to you and the financial community how we perform over time in the Enterprise segment.

Adithya Metuku — Credit Suisse — Analyst

Understood. Thank you.

Peter Nyquist — Vice President, Head of Investor Relations

Thank you Adithya. We’ll move to the next question, please.

Operator

[Operator Instructions] The next questions come from the line of Didier Scemama from Bank of America. Please ask your question. The line is open.

Didier Scemama — Bank of America Securities — Analyst

Good afternoon everyone. Thank you for taking my questions. I’ve got two quick ones. Maybe related to the new divisional breakdown. So first of all, thank you, it’s very useful. Second, I wanted to ask you if you could give us a rough breakdown of the — in the non-network part of the business of the split between services and revenues because [Technical Issues] as Alex pointed out earlier, those gross margins are probably much closer to a services business to a software business yet.

You’ve got a lot of software in there. So just trying to understand where we are in that journey from pruning services into higher gross margin software revenues. That’s first question. And second, maybe Carl, can you just remind us when you might if at all, need to take an impairment on Vonage. Is that just you do that when you close your books on an annual basis or do you have a bit more leeway you can review that on multiyear basis if and when those KPIs are met or not met?

Carl Mellander — Senior Vice President, Chief Financial Officer

Yes. The impairment testing is routine. Every quarter, of course, we have to go through all the assets to test the valuation. And we always do that, of course, even more emphasis in the fourth quarter. And obviously, this is reviewed by auditors and so on. Right now, there’s no indication of impairment and so on. But again, so I mean this we will do every quarter to test the business plan, the expected cash generation versus the value that we sit on in the balance sheet.

Didier Scemama — Bank of America Securities — Analyst

Got it. And on the mix roughly software services, is that something you can talk about?

Carl Mellander — Senior Vice President, Chief Financial Officer

Yeah. I mean I think maybe we can come back to specific numbers and breakdown. But in general, I can say that, I mean, all our businesses are striving for an increased software proportion. And as I mean, back down all the way down to back to 2017, one of the strategic changes there was to go for more product-led and less services-led offerings to customers.

It doesn’t mean that services is not something we pursue or something we want to get out of. But it’s a matter of how you lead not least in what used to be digital services now Cloud Software and Services. But the demand is going and our offering is going towards more and more software, I would say, in all these businesses. And of course, that’s something we — that benefits the margins as well.

Peter Nyquist — Vice President, Head of Investor Relations

And I think also overall, Didier, we have talked about being a little bit neutral on the — if you look at the business mix that we currently also have sufficient margins in the hardware side and improve margins in the services side as well, which I think is important.

Didier Scemama — Bank of America Securities — Analyst

Got it. And then maybe one quick one, if I squeeze in one final one. At the CMD in December do you think you could provide us from — for financial targets, either op margins or gross margins or revenue growth for each division as you’ve done in the past or is it too early to talk about that?

Carl Mellander — Senior Vice President, Chief Financial Officer

We’ll come back to it. I mean, what we — there was, I think, a very good reason to break down the targets by segment earlier because we were really in this turnaround phase. Let’s see if the relevance is here now. But we definitely stick to the 15% to 18% EBITA target for the long term that we have stated before. Let’s see, at the CMD, if we want to expand on that or break it down.

Didier Scemama — Bank of America Securities — Analyst

Okay, brilliant. Thank you very much.

Peter Nyquist — Vice President, Head of Investor Relations

Thank you. Operator, do we have any other questions?

Operator

We have no further questions at this time. Thank you. I hand back the call to you.

Peter Nyquist — Vice President, Head of Investor Relations

Yeah. Thank you. And maybe, Carl, if you want to say some final words before we close the call?

Carl Mellander — Senior Vice President, Chief Financial Officer

No, I just — thanks a lot for your interest, and great. We are now, of course, looking forward to reporting also in this new structure. Now you have the basics here, the historical numbers to understand more or less where we have been — where we would have been in the new structure historically.

And of course, with Q3, you will get the data set that provides actual data from which to draw conclusions and ask additional questions so looking forward to that at the next occasion that we will meet. Except for one call, which will happen on Monday, which is really around tutorial, if we call it that, on the Vonage business, where we will have — explain a bit more what Vonage is all about. And I think the invitation for that has been published as well. Back to you Peter.

Peter Nyquist — Vice President, Head of Investor Relations

No. Thank you all and I will speak to some of you on Monday. And then we have the report coming up on the 20th of October and then later on clearly, as was mentioned by Didier, we have the Capital Markets in New York, December 15.

Carl Mellander — Senior Vice President, Chief Financial Officer

Looking forward to seeing you there, hopefully, as well. Thank you so much.

Peter Nyquist — Vice President, Head of Investor Relations

Bye-bye.

Carl Mellander — Senior Vice President, Chief Financial Officer

Bye.

Operator

[Operator Closing Remarks]