Ericsson Reports Fourth Quarter And Full Year Results 2018

Fourth quarter highlights

• Sales as reported increased by 10% YoY and sales adjusted for comparable units and currency increased by 4%.
• Networks sales adjusted for comparable units and currency grew by 6% YoY. Digital Services sales adjusted for comparable units and currency grew by 5% YoY.
• Costs related to revised Business Support Systems (BSS) strategy of SEK -6.1 b., of which SEK -3.1 b. were restructuring charges, impacted Digital Services operating income in Q4.
• Gross margin was 25.7% (21.6%). Gross margin, excluding restructuring charges and other costs related to revised BSS strategy, improved to 36.3%, supported by cost reductions, the ramp-up of Ericsson Radio System (ERS) and the contract review in Managed Services.
• Operating margin was -2.9% (-33.3%). Operating margin, excluding restructuring charges and other costs related to revised BSS strategy, was 8.7%.
• Networks operating margin excluding restructuring charges was 17.5% (8.6%). The increase was driven by cost reductions, the ERS ramp-up and reversal of provisions for impairment losses on trade receivables, partly offset by increased investments in R&D.
• Digital Services operating income, excluding restructuring charges and costs related to revised BSS strategy, was SEK -0.6 b.
• Managed Services operating margin excluding restructuring charges increased to 5.2% (-13.0%). The review of all 42 low-performing customer contracts has been completed.

Full-year highlights

• Sales as reported increased by 3% and sales adjusted for comparable units and currency increased by 1%, with Networks growing by 3% – the first year of organic growth for Ericsson since 2013.
• Gross margin was 32.3% (23.3%). Gross margin excluding restructuring charges improved to 35.2% (25.9%), supported by cost reductions, the ramp-up of Ericsson Radio System (ERS) and the review of managed services contracts.
• Operating income was SEK 1.2 (-34.7) b. Operating income excluding restructuring charges was SEK 9.3 (-26.2) b. driven by higher gross margin and sales as well as lower operating expenses.
• Cash flow from operating activities was SEK 9.3 (9.6) b. Free cash flow excluding M&A amounted to SEK 4.3 (4.8) b. Net cash at year-end was SEK 35.9 (34.7) b.
• The Board of Directors will propose a dividend for 2018 of SEK 1.00 (1.00) per share to the AGM.

Non-IFRS financial measures are reconciled to the most directly reconcilable line items in the financial statements at the end of this report.[1] EPS diluted, excl. amortizations and write-downs of acquired intangible assets, and excluding restructuring charges. Potential ordinary shares are not considered when their conversion to ordinary shares would increase earnings per share.
[2] Free cash flow excluding M&A: See Alternative Performance Measures (APM) at the end of the report.

Comments from Börje Ekholm, President and CEO of Ericsson

Our focused strategy has yielded clear results. Ericsson is today a stronger company. Increased investments in R&D for future growth, managed services contract reviews, combined with efficient cost control have proven to be successful, with improved competitiveness and profitability as a result. As the industry moves to 5G and IoT, we will now take the next step, focusing on profitable growth in a selective and disciplined way.

Sales have gradually improved during 2018, resulting in full-year organic sales growth[1] for the first time since 2013. This is partly due to an improved market but also driven by market share gains in Networks as a result of a more competitive radio product portfolio. In parallel, gross margins[2] have improved across all segments, with full-year gross margin[2] of 35% (26%) and operating margin[2] of 4% (-13%).

Segment Networks had another strong quarter with high business activity across multiple regions. Networks organic sales[1] increased by 6% YoY, positively impacted by a recovering RAN market as well as strong performance in the product portfolio. Growth was partly due to a higher than anticipated activity level in North America driven by increased 5G demand among the US operators. Networks gross margin[2] improved to 41% (35%) YoY, mainly due to improved hardware margins driven by the successful shift to Ericsson Radio System (ERS). Strategic contracts and 5G field trials had a negative impact on operating margin in the quarter. R&D investments continued to grow in the quarter, but are now expected to flatten out.

In Managed Services, gross margin[2] improved to 12% (-5%) YoY, supported by efficiency gains and customer contract reviews. We have now addressed all 42 targeted contracts, resulting in an annualized profit improvement of SEK 0.9 b. During the year, we have increased our investments in automation, analytics and AI.

We continue to execute on our plan to turn the Digital Services business around. The focus has been on stabilizing top line, modernizing the portfolio and taking costs out. In Digital Services there has been solid progress in most portfolio areas. Underlying operating expenses[3] in 2018 were SEK 2.6 b. lower than in 2017. However, the Business Support Systems (BSS) area has not shown satisfactory progress and we are now in the process of reshaping the business. To speed up the restructuring of the BSS business, additional measures were communicated on January 10, 2019. These measures include provisions and restructuring charges of SEK -6.1 b., which were taken in Q4. The reshaped strategy will set Digital Services on a stronger path to achieve the 2020 financial targets. Organic sales[1] in Digital Services grew by 5% YoY, driven by Cloud Core and OSS. Gross margin[2], adjusted for above-mentioned provisions, improved to 38%. Operating income, excluding restructuring charges and other costs related to revised BSS strategy, was SEK -0.6 b. in the quarter.

In segment Emerging Business and Other, we invest in initiatives that aim to scale and help create future business for Ericsson. We manage Emerging Business initiatives for growth case by case, based on positive net present value (NPV), within 2022 Group targets. Organic segment sales[1] grew by 1% YoY and operating income[2] was SEK -1.5 (-7.6) b. Sales growth and operating income[2] in the segment, excluding the media business, was 60% and SEK -0.9 (-0.8) b. respectively.

Free cash flow excluding M&A in 2018 was lower than in 2017, primarily due to the return to growth and strong sales development at the end of the fourth quarter. In addition, sale of trade receivables was further reduced. The Board will propose a dividend of SEK 1.00 (1.00) per share to the AGM.

As previously disclosed, we are voluntarily cooperating with an investigation into Ericsson’s compliance with the U.S. Foreign Corrupt Practices Act (FCPA). The discussions with US authorities continue and we will provide updates as appropriate.

Our R&D investments over the past two years have secured a highly competitive and industry-leading offering. We will continue to invest in 5G, automation and AI to create both customer and shareholder value. Even though costs related to strategic contracts and 5G field trials will impact margins short term, they will help to reach our targets for 2020 and 2022 as well as strengthen our business in the long term.

Börje Ekholm
President and CEO

[1] Organic sales growth: Sales adjusted for comparable units and currency
[2] Excluding restructuring charges
[3] Excluding net impact from amortization and capitalization of development expenses, as well as of intangible assets, risk provisions and write-downs.

Planning assumptions going forward

Market-related

• The Radio Access Network (RAN) equipment market is estimated to increase by 2% for full-year 2019 with 2% CAGR for 2018-2023. (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.

Ericsson related

• 5-year average sales seasonality between Q4 and Q1 is -26%.
• The baseline for the current IPR licensing contract portfolio is approximately SEK 8 b. on an annual basis.
• Strategic contracts in Networks, with initially lower margins, taken to strengthen the market position, will continue to have a negative impact on gross margin. The costs may vary between quarters, without jeopardizing 2020 financial targets.
• Costs for 5G field trials mainly in Networks will continue in 2019.
• R&D expenses are expected to flatten out, starting in Q1.
• Operating expenses typically decrease between Q4 and Q1 due to seasonality.
• Restructuring charges for full-year 2019 are estimated to be SEK -3 to -5 b.
• Cost reductions and efficiency improvements will continue in Digital Services aiming to significantly reduce losses in 2019.
• The planned divestment of MediaKind is ongoing: 2018 financials Media Solutions business (MediaKind incl. transaction-related costs etc): Net sales 2018: SEK 2.7 b. and Q4: SEK 0.7 b., operating income excl. restructuring charges 2018: SEK -1.7 b. and Q4: SEK -0.5 b.
• The estimated net impact of amortization and capitalization of development expenses and of recognition and deferral of hardware costs will be approximately SEK -1 b. for 2019, compared with SEK -2.6 b. in 2018.―CT Bureau