Ericsson Reports Second Quarter Results 2019
Posted by Ericsson
Second quarter highlights
- Sales were SEK 54.8 (49.8) b. Sales adjusted for comparable units and currency increased by 7% driven by growth in Networks in North America and North East Asia. Reported sales grew by 10%.
- Gross margin was 36.6% (34.8%). Gross margin excluding restructuring charges was 36.7% (36.7%).
- Networks gross margin excluding restructuring charges improved to 41.4% (40.2%) YoY. Sequentially, Networks gross margin decreased from 43.2%, mainly due to costs related to a previously communicated license settlement agreement, negative impact from strategic contracts and lower IPR licensing revenues.
- Operating income was SEK 3.7 (0.2) b. and operating margin was 6.8% (0.3%). Operating income excluding restructuring charges was SEK 3.9 (2.0) b. and operating margin excluding restructuring charges was 7.0% (4.1%).
- Net income improved to SEK 1.8 (-1.8) b.
- Free cash flow before M&A was SEK 2.2 (-0.2) b. Net cash amounted to SEK 33.8 (33.1) b.
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.
Non-IFRS financial measures are reconciled to the most directly reconcilable line items in the financial statements at the end of this report.
Comments from Börje Ekholm, President and CEO of Ericsson
Organic sales growth was 7% in the quarter, mainly driven by sales in North America and North East Asia. We see strong momentum in our 5G business with both new contracts and new commercial launches as well as live networks. To date, we have provided solutions for almost two-thirds of all commercially launched 5G networks.
5G momentum is increasing. Initially, 5G will be a capacity enhancer in metropolitan areas. However, over time, new exciting innovations for 5G will come with IoT use cases, leveraging the speed, latency and security 5G can provide. This provides opportunities for our customers to capture new revenues as they provide additional benefits to consumers and businesses.
In the quarter, gross margin was unchanged YoY at 36.7%, with improvements in segment Networks being offset by lower margins in Digital Services and Managed Services.
Networks had another solid quarter with an organic sales growth of 11% YoY, driven by 4G and 5G investments in North America and North East Asia as well as increased volumes related to strategic contracts. While the strategic contracts will be margin accretive in the long term, the impact on near-term profitability is negative. In the quarter we had a negative impact on gross margin and expect this impact to increase during the second half of the year. In addition, costs related to the previously announced license settlement agreement impacted margins negatively. Despite this, gross margin improved to 41.4% (40.2%) YoY mainly due to increased IPR revenues. To ensure we meet customer requirements for fast and agile deliveries, we have decided to invest in a state-of-the-art 5G production site in the US to complement our global supply chain.
In Digital Services we continue to execute on the plan to reach low single-digit margins for 2020. The improvements are not linear and will vary between quarters. Organic sales in Digital Services were down by -3% YoY as a result of rapid decline in legacy products. Gross margin was 37.1% (42.6%). The decline in gross margin was mainly driven by a change in sales mix. The mix may vary between quarters. Our 5G and Cloud native portfolio is gaining customer traction and we are increasing related R&D investments to ensure portfolio readiness. The reshaped BSS strategy is gaining momentum and contracts were signed with several new customers in the quarter. The share of recurrent business is increasing, we are tracking towards having 75% of the 45 critical and non-strategic contracts addressed by year-end and we have cost efficiency programs in place throughout Digital Services.
In Managed Services the strategy is to enhance the customer offering by relying more on automation, machine learning and AI, which will longer-term change and improve the margin profile of the business. Near-term margins are negatively impacted by the increase in R&D investments. Organic sales declined by -6%, mainly explained by the negative effect from the customer contract reviews. Gross margin declined to 12.3% (14.0%) YoY, negatively impacted by timing of costs.
Organic sales growth in Emerging Business and Other was 24% driven by a continued growth in iconectiv. Operating income improved YoY to SEK -0.7 (-1.2) b. supported by increased profits in iconectiv and the divestment of MediaKind. In this segment 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 investment phase.
Driven by improved earnings, free cash flow excluding M&A improved to SEK 2.2 (-0.2) b.
We are in ongoing settlement negotiations with the United States Securities and Exchange Commission (SEC) and the United States Department of Justice (DOJ) in connection with their previously reported investigation under the U.S. Foreign Corrupt Practices Act (FCPA). We are not able to estimate the length of these settlement discussions. Further, as this is an ongoing legal matter we cannot provide any detail. However, it is our current 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.
We continue to take strategic contracts and the large-scale network deployments expected to commence in parts of Asia, will gradually impact margins negatively in the short term but strengthen our position in the long term. Continued technology and market investments, especially in 5G, automation and AI, are fundamental for long-term competitiveness and a key part of our focused strategy to strengthen our long-term business and path to reaching our targets for 2020 and 2022.
President and CEO
 Organic sales growth: Sales growth adjusted for comparable units and currency
 Excluding restructuring charges
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 Q2 and Q3 is 3%. The current sales level in North America is expected to remain 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 margin without jeopardizing the 2020 target. The negative impact is expected to increase in 2H 2019.
- Large 5G deployments in parts of Asia are expected to commence at the end of 2019 and will gradually 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.
- The targeted improvements in Digital Services are not linear and will vary between quarters.
- Operating expenses typically decrease somewhat between Q2 and Q3 due to seasonality.
- Costs for 5G field trials will continue to impact SG&A .
- Networks R&D expenses are expected to flatten out.
- Restructuring charges for full-year 2019 are estimated to be SEK -2 to -4 b. (the previous estimate was SEK -3 to -5 b.).
- Rule of thumb: A change of 10% of USD to SEK would have an impact of approximately +/-5% on net sales and approximately +/-1 percentage point on operating margin.―CT Bureau
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