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Ericsson Reports Improved Margins in Third Quarter

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10/18/2018
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KISTA, Sweden -- Third quarter highlights:

  • Sales as reported increased YoY by 9% and sales adjusted for comparable units and currency increased by 1%.
  • Segment Networks showed a sales growth adjusted for comparable units and currency of 5% YoY with strong sales growth in North America as well as in Europe and Latin America.
  • Gross margin was 36.5% (26.9%). Gross margin excluding restructuring charges improved to 36.9% (28.5%), driven mainly by cost reductions, the continued ramp-up of Ericsson Radio System (ERS) and good progress in reviewing Managed Services contracts.
  • Operating margin was 6.0% (-7.4%). Operating margin excluding restructuring charges was 7.0% (-1.7%).
  • Networks operating margin excluding restructuring charges was 16.1% (11.9%) driven by cost reductions and ERS ramp-up, partly offset by increased investments in R&D.
  • Digital Services operating margin excluding restructuring charges was -15.9% (-29.9%) supported by a gross margin excluding restructuring charges of 36.9% (32.0%). Sequentially, gross margin declined from 42.6% mainly due to increased provisions related to transformation projects.
  • Managed Services operating margin excluding restructuring charges improved to 6.8% (-9.5%) as a result of cost reductions and customer contract reviews.
  • Cash flow from operating activities was SEK 2.0 (0.0) b. and free cash flow excluding M&A was SEK 0.7 (-0.8) b. Net cash increased YoY to SEK 32.0 (24.1) b.

    Comments from Börje Ekholm, President and CEO of Ericsson (NASDAQ:ERIC)

    "We continue to execute on our focused strategy, tracking well towards our 2020 targets. We see improvements across our businesses resulting in a gross margin[1] of 36.9% (28.5%) and an operating margin[1] of 7.0% (-1.7%). Organic [2] sales growth was 1% for the Group, despite headwind from exited non-strategic contracts.

    We continue to invest in our competitive 5G-ready portfolio to enable our customers to efficiently migrate to 5G. Operators around the world plan for launching 5G services, led by North America. The strong customer interest in 5G generates a gradual increase in costs for field trials. We expect the costs to remain on high levels, at least for the coming 12-18 months, and they are included in our 2020 profitability target of at least 10%.

    Networks gross margin[1] improved to 41.5% (34.8%) with an organic[2] sales growth of 5%. The strong sales were mainly driven by a continued high activity level primarily in North America. Due to the strong sequential sales increase in the third quarter we expect lower effects from seasonality than normal in the fourth quarter in Networks.

    Digital Services gross margin[1] improved to 36.9% (32.0%) YoY, but declined QoQ. We see clear results of our cost-out activities and good progress in large parts of the business. At the same time, provisions related to large digital transformation projects increased in the quarter, explaining the sequential drop in gross margin. We are not satisfied with the development in these digital transformation projects and are thus increasing our efforts to turn them around.

    In Managed Services, gross margin[1] improved to 12.9% (-4.0%) supported by efficiency gains and customer contract reviews. We have finalized 40 of the targeted 42 contracts, with an annualized profit improvement of SEK 0.9 b. We are increasing our investments in R&D to reshape the offering based on automation and artificial intelligence. We see strong customer interest in the coming solutions, but sales are so far limited as we are in early stages.

    In segment Emerging Business and Other, sales grew by 22% driven by growth in the iconectiv business. We continue to invest in strategic future growth areas such as Internet of Things (IoT) and saw increasing momentum with one important customer win with our connectivity platform solutions in the quarter. As parts of the portfolio in Emerging Business are in an early phase, sales are so far limited. We will remain disciplined in our investments in Emerging Business by tracking each venture against delivery milestones.

    Even though the cost reduction program, announced in July 2017, has been completed, we continue our efforts to drive efficiency and cost reductions to further increase competitiveness. Our estimate for restructuring charges of SEK 5-7 b. for the full year remains. Free cash flow excluding M&A improved to SEK 0.7 (-0.8) b. and our cash position remains strong. Our work to further strengthen the balance sheet continues.

    As previously disclosed, we have been voluntarily cooperating since 2013 with an investigation by the SEC and, since 2015, with an investigation by the DOJ into Ericsson’s compliance with the U.S. FCPA. While we cannot comment in detail we can provide the following update on the process. We have identified facts that are relevant to the investigations and these facts have been shared with the authorities. We continue to cooperate with the SEC and the DOJ and are engaged in discussions with them to find a resolution. While the length of these discussions cannot be determined, based on the facts that we have shared with the authorities, we believe that the resolution of these matters will likely result in monetary and other measures, the magnitude of which cannot be estimated currently but may be material. We continue our efforts to improve on our compliance program. See further details in “Other information”.

    There is strong momentum in the global 5G market with lead markets moving forward. The global radio access market is recovering from several years of negative growth and our investments in R&D have positioned us well to benefit from this development. More work remains, however, to get all parts of the business to a satisfactory performance level. We remain confident in reaching our long-term target of at least 12% operating margin beyond 2020.”

    Börje Ekholm, President and CEO

    [1] Excluding restructuring charges
    [2] Organic sales growth: Sales adjusted for comparable units and currency

    Planning assumptions going forward Market related

    The Radio Access Network (RAN) equipment market is estimated to decline by -2% for full-year 2018 with 2% CAGR for 2017-2022. (Source: Dell’Oro)

    Currency exposure
    Rule of thumb: A weakening by 10% of USD to SEK would have a negative impact of approximately -5% on net sales and approximately -1 percentage point on operating margin (based on 2017 full-year currency exposure).

    Ericsson related 2018; Sales
    Sales growth in 2017 between Q3 and Q4 was 17%. Due to strong sequential sales increase in the third quarter, lower effects from seasonality than normal are expected in the fourth quarter in Networks.

    Ericsson related 2018; Operating expenses
    Gradually increased cost for field trials.

    Operating expenses typically increase between Q3 and Q4 due to seasonality.

    To further strengthen technology leadership, R&D expenses will increase primarily in Networks in Q4.

    The divestment of Media Solutions is expected to be closed around year-end 2018 with estimated additional expenses of SEK -0.2 b. in Q4.

    Ericsson related 2018; Other
    Restructuring charges for full-year 2018 are estimated to be SEK 5-7 b.

    Ericsson AB (Nasdaq: ERIC)

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