Ericsson Reports Q1 Growth
STOCKHOLM -- First quarter highlights:
Comments from Börje Ekholm, President and CEO of Ericsson (NASDAQ:ERIC)
For the third consecutive quarter we showed organic sales growth, this quarter by 7%. Growth was mainly driven by North America. Our strategy, to work with lead customers in lead markets, is generating both 5G business and hands-on experience in 5G rollout and commercialization. To date we have publicly announced commercial 5G deals with 18 named operator customers, which, at the moment, is more than any other vendor.
5G services, including mobility, have been launched in South Korea and North America. While Switzerland has released spectrum allowing Swisscom to offer commercial 5G services, using our equipment, the development in other parts of Europe is considerably slower primarily due to lack of spectrum, poor investment climate and additional uncertainties related to future vendor market access.
Gross margin improved to 38.5% (35.9%) YoY, driven by improvements in segments Networks and Managed Services, and also by the recently signed patent license agreement with OPPO.
Segment Networks had a strong quarter with an organic sales growth of 10% YoY, driven by increased investments in North America. Networks gross margin improved to 43.2% (40.4%) YoY, mainly due to higher hardware capacity sales and IPR revenues. In the quarter we announced our intent to acquire the German company Kathrein’s antenna and filters business. This will further expand our capabilities in the advanced active and passive antenna domains, which are growing in importance as 5G evolves.
In Managed Services, sales fell organically by -5% due to headwind from contract exits. In the quarter, our Operations Engine was launched with good response from our customers. Gross margin improved to 17.7% (9.1%) YoY, supported by efficiency gains and customer contract reviews. Excluding a non-recurrent positive effect of SEK 0.7 b. from a customer settlement, the operating margin was 8.6%, exceeding the higher range of our financial target for 2020.
Organic sales in Digital Services were stable YoY. We continue to see a good business momentum for the new portfolio of 5G-ready and cloud-native products, with many important contract wins in the quarter. Gross margin excluding restructuring charges and the BSS provision in Q4 2018 was stable QoQ and operating income improved YoY driven by reductions in operating expenses. Gross margin declined YoY as Q1 2018 was supported by a favorable business mix. We continue to execute on our plan to turn the Digital Services business around. Implementation of the revised BSS strategy, announced in January 2019, is progressing well.
Organic sales growth in segment Emerging Business and Other was 38% YoY driven by growth in iconectiv. Gross margin was stable YoY. In the quarter 51% of MediaKind was divested, generating a gain of SEK 0.7 b. In segment Emerging Business and Other we invest in initiatives that aim to scale and help create future business for Ericsson. With the exception of iconectiv, the portfolio is still in an early phase. We are also incurring extra costs as we restructure some of the older innovation investments.
Driven by improved earnings, free cash flow excluding M&A amounted to SEK 4.1 (0.7) b. in the quarter and with a strong cash position we are well positioned to grow the company in a profitable way.
As previously disclosed, we have been voluntarily cooperating since 2013 with an investigation by the United States Securities and Exchange Commission (SEC) and, since 2015, with an investigation by the United States Department of Justice (DOJ) into Ericsson’s compliance with the U.S. Foreign Corrupt Practices Act (FCPA). We continue to cooperate with the SEC and the DOJ, and have recently begun settlement discussions. These discussions are in a very early stage and therefore we are not able to estimate their length. Further, as this is an ongoing legal matter we cannot provide any detail. However, based on the current status of the discussions it is our assessment that the resolution of these matters will result in material financial and other measures, the magnitude and impact of which cannot be reliably estimated or ascertained at this time.
As previously communicated, we continue to take strategic contracts and incur costs for 5G field trials and, in addition, by end of 2019 we expect large-scale deployments of 5G to commence in parts of Asia. Combined, this will gradually impact short-term margins but strengthen our position in the long term. The impact of strategic contracts and 5G field trials was limited in Q1. The 5G market is gaining momentum and we are well positioned to capture opportunities. We will continue to make substantial investments in R&D, especially in 5G, automation and AI. This is a key part of our focused strategy to strengthen our long-term business and path to reaching our targets for 2020 and 2022.
Börje Ekholm, President and CEO
 Organic sales growth: Sales growth adjusted for comparable units and currency
 Excluding restructuring charges
 BSS (Business Support Systems) provision in Q4 2018 was SEK 5.9 b.
Planning assumptions going forward
The Radio Access Network (RAN) equipment market is estimated to increase by 3% for full-year 2019 with 2% CAGR for 2018-2023. (Source: Dell’Oro.)
Two-year average sales seasonality between Q1 and Q2 is 10%. However, the current sales level in North America is expected to remain, leading to lower effects from seasonality between quarters than normally throughout 2019.
The revenues for current IPR licensing contract portfolio is approximately SEK 9 b. on an annual basis.
Strategic contracts in Networks, with initially low margins, taken to strengthen the market position, will have a negative impact on gross margins without jeopardizing the 2020 target. The impact was limited in the quarter but is expected to start to impact gross margin in Q2. Large 5G deployments in parts of Asia are expected to commence at the end of 2019 and will impact gross margin negatively in the short term.
The share of services sales in North America is expected to gradually increase, impacting gross margin negatively.
Operating expenses typically increase between Q1 and Q2 due to seasonality.
Costs for 5G field trials will impact SG&A and will increase in the next few quarters.
Networks R&D expenses are expected to flatten out.
Restructuring charges and Tax
Restructuring charges for full-year 2019 are estimated to be SEK -3 to -5 b.
Tax rate in Q1 2019 was 44%. The rate is a result of forecasted geographical distribution of profits for full-year 2019.
Rule of thumb: A change by 10% of USD to SEK would have an impact of approximately +/-5% on net sales and approximately +/-1 percentage point
Ericsson AB (Nasdaq: ERIC)