Ericsson - Q2 2023

Transcript

Operator (participant)

Hello everyone, and welcome to this call covering Ericsson's Q2, 2023. With me today, as usual, I have our President and CEO, Börje Ekholm, and our CFO, Carl Mellander. As usually, we will start this with a presentation and end with a Q&A session. In order to ask question, you need to join the conference by phone. Remember that. Details can be found in today's press release and on our website, ericsson.com/investors. Please advise that today's conference is recorded. Before handing over to Börje and Carl, I would like to read the following. During today's presentation, we will make forward-looking statements. These statements are based on our current expectations and certain planning assumptions, which are subject to risk 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 to read about this risk and uncertainties in the earnings report, as well as in the annual report. With that said, I would like to leave the word to you, Börje. Please, Börje.

Börje Ekholm (President and CEO)

Well, thank you, Peter, and good morning, everyone. Big thank you all for joining us for this Q2 report. I'm happy to present a quarter where we continue to execute on our strategy to build a stronger and more profitable Ericsson for the long term. Based on our strategy and our strong position, we're able to deliver a solid quarter despite challenging market condition. We see a changed business mix, with North America representing one of the lowest shares we've seen in many years. On the other hand, we see India growing very, very fast. Our strategy, as you all know, is focused on three priorities. The first one, to bolster our leadership in mobile networks. Second, is to grow our enterprise business, and thirdly, drive a cultural transformation of the company.

Mobile networks continues to be the bedrock of Ericsson, with about half of the world's 5G traffic outside of China carried through our radios. We are a leader in the market, and we remain fully focused on continuing to strengthen this leadership position. In parallel, we're using our expertise in advanced cellular networks to expand into the fast-growing enterprise market. That will substantially increase our addressable market, diversify our portfolio, and puts us on a higher growth trajectory. In our platform business, we're developing new ways to monetize 5G's unique features like speed, latency, et cetera. Operators and enterprises are showing great interest in this area. It will allow them to differentiate their offerings and start to develop completely new use cases. We're also continuing our relentless focus on enhancing our compliance program to make sure that it's fully embedded throughout the company.

With that, let me now go through some of the key takeaways from the quarter. As we said before, 2023 is a choppy year, and Q2 developed much in line with our expectations and what we have said to the market. We continue to execute with discipline and focus. Our overall sales declined by 9%. The decline in Networks was partially offset by organic growth in Cloud Software and Services, and a 20% organic growth in Enterprises. The EBITDA margin, excluding restructuring charges, was 5.7%. In Networks, India continued its strong development and network rollout, and by delivering a record build-out, we now have a leading market share in India as well. As expected, we saw a softening in other markets, primarily front-running 5G markets, and that includes, of course, North America.

That's something that we have discussed with you before as well, where we see the build-out pace being moderated, but we also see customer inventory levels being rebalanced. Despite this big mix shift between our geographies, we could deliver a Networks gross margin of over 39%. In Cloud Software and Services, we continue to execute on our revised strategy to reach profitability, and we are on track to reach at least break even for the full year. In Enterprise, we saw a strong growth in Enterprise Wireless Solutions, and we're also happy to see a positive EBITDA in Global Communications Platform. We saw sales from Vonage, current Communications APIs offerings, to grow by 19%.

You all know the importance of IPR for our or to reach our long-term financial targets, and of course, that's built upon our strong technology leadership position. In the quarter, we were able to secure another important 5G licensing agreement with a device vendor. That puts us well on track to further strengthening our IPR revenue base into 2024. We're also addressing areas that's in our control. When we are in the market, as we are today, that's challenging, we are intensifying our efforts on the cost out initiatives, and we are well on track to reduce our annual run rate by at least SEK 11 billion, and then this will start to positively impact the P&L over the coming quarters, already now in the Q3, but have full effect during 2024.

The overall performance in the quarter is really a testament to the underlying strength and resilience of our business, and our ability to adapt and execute in a challenging macro environment. With that, let me hand over to our CFO, Carl Mellander, to really go into the numbers. Carl?

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

Thank you, Börje. Very good morning to everyone on the call. As you saw this morning, the results that we published came out according to our expectations and per the guidance that we had issued in connection with the Q1 report. I'll start by having a look at the development in the different market areas. I'll comment on some of them. If we go to the next slide, please. Looking here at the geographies, as Börje said, we saw rapid 5G rollout in India. It's very clear, and network sales in India doubled year-over-year. This resulted in an organic growth in our market area, called Southeast Asia, Oceania and India, by 71% organically year-over-year.

Our strong growth in this market area partly offset the softening, as we have discussed many times, in the North American market. This was as expected, the decline there in North America was 42% year-over-year, organically. Due to lower CapEx spend, as anticipated, and also reductions of customer inventory, following the very high investment levels in 2021 and 2022. However, Cloud Software and Services grew 10% in the North American market area, driven by 5G. In Europe and Latin America, which actually was the largest market area for us in terms of sales in this quarter, we saw a decline in Europe by 6% organically. In Latin America, we recorded a growth of 3% organically, mainly driven by additional 5G deployments in Brazil.

Overall, this resulted in a 3% decline for the market area as a whole. If we leave this and then zoom in on how all of this came together in the group P&L. Our reported sales in the quarter were SEK 64.4 billion, and that is a decline by 9% organically, due to all the reasons discussed on the previous slide. I will not repeat that, but let me jump directly to gross margin. Gross margin, excluding restructuring, declined by 390 basis points year-over-year to 38.3%. This is primarily due to the lower sales and lower gross margin in Networks due to the...

this continued change in business mix, combined with large rollout projects, which come with initially lower margins, because there is a large portion of service content in those, but they also improve the margins over time. In gross margin, we also see positive impact from the increased IPR revenues. IPR revenue increased by 1.7 billion year-over-year to SEK 3.2 billion in the quarter. This increase was mainly driven by one contract signed in Q4 2022, but also the new licensing contract signed in this quarter that Börje already mentioned. Our Q2 numbers, I should say, that also include revenue for the past unlicensed quarters in accordance with this new IPR contract. Cloud Software and Services gross margin, excluding restructuring, was 33.9%.

This is a slight increase, 40 basis points year-over-year, supported by higher sales, but also improved delivery performance, and the higher IPR revenues helps as well in this segment. In enterprise, gross margin, excluding restructuring, decreased to 46.3% from 52.8%, and this is really due to the consolidation of Vonage into Ericsson with a lower gross margin than the remaining part of the enterprise segment. Further down the P&L, R&D and SG&A increased year-over-year. Aside from the FX impact here, which stands for about 25% of the increase, this mainly comes from the addition of Vonage, but also further investments in R&D, as well as go-to-market activities in Enterprise Wireless Solutions.

All in all, group EBITDA margin, excluding restructuring, was 5.7%, which is, again, in line with our expectations. The year-over-year decline that you see, again, mainly impacted by lower gross income from networks, also the increased investments that we undertake in enterprise and the consolidation of Vonage. Can also mention restructuring charges, SEK 3.1 billion in the quarter. This is mainly for redundancy costs related to the cost reduction activities. We still estimate restructuring costs to amount to SEK 7 billion for the full year. As a result of this amount of restructuring as well, combined with the other factors in the P&L, we reported a net loss this quarter of SEK 0.6 billion, compared with net income last year of SEK 4.7 in the corresponding quarter.

Want to mention that if you look on a rolling 4-quarter basis, sometimes that's a better metric, then our EBITDA margin was 9.1%, as you know, the long-term target is 15%-18% EBITDA margin. We can move to the next slide to have a look at cash flow now. Cash flow from operating activities decreased to SEK 2.9 billion from SEK 6.3 billion, SEK 2.9 billion negative. This is mainly due, of course, one, to lower EBIT, but also increase in working capital year-over-year. Why did working capital increase? Well, it's primarily driven by the business mix shift, the same aspects that impact the P&L, including this very large rollout projects, which have longer order-to-cash cycles than the front runner 5G markets have had.

This is an impact on a working capital, but temporary. Also cash flow was impacted by the payment of the fine related to the resolution with the U.S. Department of Justice of SEK 2.1 billion, which was provisioned in an earlier period, but paid in the Q2. We saw small reduction of inventory, so that's good to see inventory coming down. This is driven both by the components coming down and finished goods as well, and of course, this supported cash flow in itself. Result of all of this is a free cash flow before M&A at minus SEK 5 billion. To that, we can add M&A activities, SEK 0.9 billion, which was a result of Cradlepoint's acquisition of Ericom, which we have announced earlier.

We do that acquisition to strengthen the 5G offering in the Cradlepoint or Enterprise Wireless Solutions portfolio. Rolling four quarter basis, I return to that's on free cash flow, was SEK 6.4 billion, which corresponds to a 2.3% of net sales, again, compared to a long-term target of 9%-12%. As I believe I mentioned also in the previous quarter, of course, we are not satisfied with where we are in terms of cash generation, and this really remains key focus area for us. For Q3, we don't expect any significant changes in working capital, but in the second half of 2023, we do expect a positive free cash flow before M&A, with Q4 as a strong cash flow quarter in line with our historical patterns.

can only also mention here that we paid out the first dividend installment in the quarter as well, amounting to totally SEK 4.6 billion. Summing that up, closing that net cash position then ended up at SEK 1.9 billion, while gross cash is at SEK 35.7 billion. Here, we continue, of course, to execute on the funding plan. We have to refinance the maturities we have in the debt portfolio and add also new sources. Among many activities in corporate finance, we have launched a commercial paper program in the quarter, and we signed an additional facility for half a billion US dollars for general corporate purposes as well. Finally, from me, let's look at the outlook for next quarter, the Q3, 2023. Couple of items to pay attention to.

First of all, we expect gross margin for networks to be in the range of 38%-40% in this Q3, with very similar trends and mix as we saw in Q2. We have less IPR revenue due to the catch-up revenue in Q2. On the other hand, some support from cost out. OPEX, here we exclude Vonage, typically decreases seasonally with SEK 0.7 billion from Q2-Q3. Of course, as usual, we have large variation between quarters. We expect now cost reduction activities to start to have an effect in Q3, but still rather small, but increasing over time, quarter by quarter, going forward.

It's going well in terms of executing on cost out, and we are aiming at the run rate saving of at least SEK 11 billion by end of this year, of which 45% is related to OPEX. For Cloud Software and Services, we expect the Q3 EBITDA to be in line with Q2, and we will, according to our estimate here, and we're committed to that, reach at least break even for full year 2023. Group EBITDA margin, again, excluding restructuring, of course, in Q3, is expected to be in line with or slightly better than Q2. Again, similar trends, similar business mix, early benefits of the cost out execution, and then followed by a seasonally stronger Q4. Thank you all for that, and with that, I hand it back to you,Börje.

Börje Ekholm (President and CEO)

Thank you, Carl. Our strategy is really working, and we are leveraging our technology leadership in mobile networks, as well as taking the critical steps in our ambition to grow in enterprises. As we look ahead, I think it's important to single out that the fundamental driver of network CapEx is really the continued data traffic growth. We see that 5G really continues to grow very fast. We currently forecast, you know, 5G subscriptions to be about 1.5 billion by end of 2023 and reach 4.6 billion by 2028. We also see that the data traffic in the network continues to grow, and we also start to see new type of use cases, call it fixed wireless access, but we're also starting to see enterprise use cases.

Data traffic is growing, and with the operators' desire to meet the, I would say, the user's expectation for network quality, but adding on cost and energy efficiency, and you know, CO2 footprint starts to be more and more important. We see that that will stimulate further investments. In addition, we see that 3 quarter of all base station sites outside of China are not yet updated with 5G mid-band. The, this, in combination with the migration to 5G standalone, will basically continue to drive the need for investments in 5G networks around the world. We are confident that the market will recover, and that's what we have said for several quarters, and as a consequence of these factors. Of course, the exact timing of the recovery will be in the hands of our customers.

We are encouraged by the discussions we've had with the several customers, where we see a recognition of the need to strengthen capacity in the network. That said, we expect a gradual recovery towards late in 2023, and then improve in 2024. When that happens, Ericsson is really well positioned to benefit. Based on the, on an expected recovery of the mobile network market, we remain focused on reaching the lower end of the 15%-18% EBITDA margin target in 2024. To sum up, we continue to navigate the current environment with discipline and focus. We're delivering on the Cloud Software and Services turnaround. We do portfolio adjustments. We will enhance the R&D productivity. We see IPR revenue growth, and we will continue to execute on our cost reductions.

Of course, in an uncertain market, to really impact what we can impact that's under our control is critical. We have accelerated our efforts on the cost out, like we spoke about last quarter, in preparation for a tougher market condition. We remain ultimately focused on our key strategic priorities to drive technology leadership in mobile networks, expand or leverage the capabilities we have from cellular networks into expanding in the enterprise space. That increases our addressable market and growth potential. Finally, to strengthen our culture. With that, I would really like to thank all the fantastic people in Ericsson who has made this position we've achieved today possible. A big thank you to all of you. With that, back to you, Peter.

Operator (participant)

Thank you, Börje. It's now time for the question and answer session. As a reminder, again, to ask a question, you need to press star 1 and 1 on your telephone and wait for your name to be called out. If you're streaming the webcast, please, mute the webcast, audio whilst asking question, to minimize any kind of sort of audio feedback. Our first question now comes from the line of Aleksander Peterc. Good morning, Alexander.

Aleksander Peterc (Director & Head of Tech Hardware Equity Research)

Yes, good morning. Good morning to all of you, and thank you for taking my question. I would just have a first one, which is a bit denser, then a very small follow-up, if I may?

Operator (participant)

Sure.

Aleksander Peterc (Director & Head of Tech Hardware Equity Research)

My first question is really, you know, there's a disconnect between your guidance of 15% EBITA margins in 2024 and the consensus, which is currently at 11.5%. The jump in EBITA that is implied in your ambition or guidance is almost SEK 20 billion now, and that's almost double your planned annual cost savings run rate, which is SEK 11 billion, some of which will already be in the 2023 numbers, already in the base. I'd just like to understand where exactly is consensus getting it so wrong? Is it the market mix? Do you see much more substantial growth into 2024? Where are we all getting it so badly wrong? Thank you so much.

Börje Ekholm (President and CEO)

Maybe I can start. The, the fundamental premise for our targets for 2024 has been the, what we see as a recovery in the market, and you have to factor that in. That, to me, is of course. It's impossible to say exact timing, when that will happen, but we're very confident it will happen, and that will provide a basic support for the market. Our cost out ambition is at least SEK 11 billion. We, we should be reaching that. That will provide support. In addition, there are a couple of things which, I'm not sure is factored in. One is IPR revenues. That we see will continue to grow into next year.

We also see that the fundamental turnaround of our Cloud Software and Services will provide a strong support next year, and we will also see some portfolio adjustments that we have already spoken about before to provide support. Yes, we do continue to focus on reaching that target for next year. We've said we should be in the lower end of that range. We are focused on reaching that, and that's why we're trying to be as aggressive as we can on the items we can control right now.

Operator (participant)

You had a second question, Aleksander, as well, right?

Aleksander Peterc (Director & Head of Tech Hardware Equity Research)

Just a quick follow-up. I do feel that your message for the recovery has slipped by about a quarter. You mentioned before, I think in Q1, you spoke of a gradual recovery in the second half, and now basically Q3 is very similar to the second, with a slight improvement in EBITA margins, but not that material, and the real recovery is in Q4, seriously in 2024. Can you tell us which markets are a little bit weaker than you previously thought? Is it a longer slump in the US primarily or anything else? Thank you.

Börje Ekholm (President and CEO)

We-

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

Börje?

Börje Ekholm (President and CEO)

We see overall a softer market that we've said since the end of last year. Of course, it's very hard to predict the exact timing when customers will buy. What we see is the network quality around the world, actually, many markets starting to deteriorate. Of course, that provides the basics for the investments. Exactly when that's gonna happen, I feel that, you know, it's really in the hands of the customers, so it's in the hands of their view of capital market, their view of prospects in the business for increasing revenues, et cetera. That's a little bit difficult to say. With our current visibility, we believe it's realistic to plan for that to happen later in 2023. Is it later or earlier than we have said before?

I don't really know. If anything, probably fair to say that it's slightly later. It's not a dramatic change in outlook that we tried to say already last year. In the end of last year, we spoke about the slower build-out pace that we expected. We spoke about the inventory adjustments our customers are making. Of course, as this quarter continues, there will be less and less of the inventory adjustments. That will provide a, a support for the market recovery and kind of looking better towards the end of the year.

Aleksander Peterc (Director & Head of Tech Hardware Equity Research)

Okay.

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

Very clear. Thank you very much.

Börje Ekholm (President and CEO)

Thank you, Alexander. For that question. Let's go to the next question, and we'll see. We'll have the next question from François Bouvignies from UBS. Good morning, François.

François Bouvignies (Executive Director and Head of the European Tech Hardware and Semiconductor Team)

Good morning. I have two quick ones as well. The first one is on a follow-up to Alex's question on or Börje, what you said on the inventories. You were impacted by inventories correction, and you are still now in Q3. Do you have any estimates of where we are in this inventory correction? I mean, in other words, versus a normal level at your customers, where is it now? Do you have any, you know, intelligence to provide some color around this?

Aleksander Peterc (Director & Head of Tech Hardware Equity Research)

Mm-hmm.

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

François, maybe I take that one. As you said, we saw this happening in Q1 as anticipated, and also in Q2. It will continue to some extent in Q3 as well, and that's why we talk about a very similar trend and similar market mix. This part of that story, the inventory reductions. From that point, we also see, with the visibility we have now and the customer dialogues, that that will flatten out towards the latter part of the year. As Börje just said, this will support, of course, the overall recovery, and making the second half a stronger half than the first half this year.

François Bouvignies (Executive Director and Head of the European Tech Hardware and Semiconductor Team)

Okay, thank you. Maybe a longer term, Börje, you talked about the 75% of all base stations, outside China, not yet updated with the midband. The question is not, if, like you mentioned, we don't know, you know, if, it will happen, but, I'm questioning more the how it's gonna, it's gonna go back up, if you like. I mean, are we gonna see a strong traction, of upgrade, or is it gonna be like a very granular, you know, phase to upgrade all these, the base stations to midband, especially in the context of, you know, current macro environment, lack of maybe you can argue, applications. How, how should we think about this pace, basically, of upgrade that you foresee? Thank you.

Börje Ekholm (President and CEO)

Yeah. you know, the first, I think we need to recognize that for a full, fully built out 5G network, there is probably gonna be need for more sites than it was in a 4G world. Even if we benchmark to the total size of 4G base stations, we're probably gonna see more sites on 5G. Then what we see will happen is ultimately the, you know, when you talk about 5G from a Non-standalone basis, you don't get access to the features that are gonna be needed for future digitalization and future use cases. If you need the ultra-low latency, higher speed, capacity on demands, et cetera, you will need to get 5G standalone. That migration is really only in its early phases.

What we see will happen here is that we will start to get new use cases. It can be generative AI, but it can also be XR, and those will start to drive new type of traffic that will require the 5G to be built out. It's all about how you monetize that, and that's why I want to tie it into the discussion about network APIs. We think that's gonna be critical. When you are gonna call up, so you put on your XR devices, and you say, "Okay, now I need super low latency, and I can do that through a network API." You start to drive a completely new upgrade cycle of the network, you drive new monetization, and you drive a new way for us also to create revenues. That's why we invest quite heavily in the network APIs.

You see that this start to come together in order to drive the network upgrades. Of course, how will that exact upgrade cycle look like? Well, we do believe it's gonna be a gradual build-out, that it will be nationwide, like it's happening in India right now, in every country. I think it's, you know, borderline to unlikely to assume, and I wouldn't do that. If you look at how you would build out the network, of course, you're gonna build it out where you have customers first, and then you gradually expand from there. I want to add one more thing, which I think is critical, and if you look at fixed wireless access. Look at net broadband additions in the most developed fixed wireless access market in the world, is the U.S.

Actually, over the last few quarters, almost all growth in broadband connections comes from fixed wireless access. That's why we see that this kind of drive for, you know, cost-efficient rollout and cost-efficient deployment of broadband to the citizens of a country, fixed wireless access will play a big role. We see numbers in India being very large, and one of the operators talking about 100 million connections there. We see those to be built out. That's gonna drive new revenue streams for the operators as well. We see this build-out to happen, and it's gonna happen, of course, over several years.

Operator (participant)

Thank you, Börje.

Alexander Duval (Head of Europe Tech Hardware & Semiconductors Equity Research)

Thank you very much.

Operator (participant)

Thank you, François, for that question. We are now going to the next question in this Q&A session. The next question is from Alexander Duval at Goldman Sachs. Please, Alexander, good morning.

Alexander Duval (Head of Europe Tech Hardware & Semiconductors Equity Research)

Good morning, many thanks for the question. I just had a clarification on market outlook. You're talking today about scope for gradual market recovery this year and improvements next year. Just want to understand the main factors to drive that kind of recovery. I would note, for example, in U.S., you talk about 50% decline in the market, or at least in revenues, and that's obviously one of the front runners on 5G. One would assume that that would be followed by other markets that are a bit farther behind, also declining. Just want to understand what would drive that improvement into next year. I've got a quick follow-up.

Operator (participant)

Go on.

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

Yeah. Hi, Alexander. I think actually Börje talked about a lot of those key drivers for exactly what you're asking about, the recovery. I mean, we see data traffic growth continuing at very, very high speeds in North America and in other markets as well. That's a key driver, of course, because for an operator to be able to deliver the customer experience that they need to, investments in the network will be required to cater for this. 5G, of course, also happens to be the most cost-effective way of delivering those gigabytes through the networks. You have the energy side and CO2 side of it as well, driving investments in more modern technology to get your energy bill down.

Not to mention the new applications that are coming on stream. We have seen new XR, VR devices launched by several players now. Of course, Once they become a bigger part of the ecosystem, of course, will drive very high demands on the network. All these fundamentals are there, and that's what we believe will drive the long-term recovery of the market.

Börje Ekholm (President and CEO)

You also have to add... that's the long-term drivers, and those are the fundamental drivers, right? Short-term, we also have the inventory adjustments, which is working its way through. In several markets around the world, you saw over 2021 and 2022, our customers to build up inventory to manage an uncertain supply chain, call it that. That led them to have excessive inventory, and those have been working its way through their systems over this year. Of course, those will run its course. Once they've run its course, then we're back to the fundamental drivers of the demand for CapEx, that's why we are confident that that will come back.

Exact timing is, of course, in the hands of customers and depends on many considerations they have to do. Ultimately, if you're gonna deliver customer service, I think you, for example, you would like to have connectivity most of the time. But if you run out in a network where you have capacity constraints, you may see bars on your device, but in reality, you have no data connectivity. That's typically when you're starting to run out of capacity or you simply cannot make a phone call. I think in our day and age, we are not gonna be happy with that, and we would expect a better service as a user, and that's ultimately what's going to drive the demand.

Operator (participant)

Thanks, Börje. You had a second question as well, Alexander?

Alexander Duval (Head of Europe Tech Hardware & Semiconductors Equity Research)

Yeah. Greatly appreciate the clarification. Thank you so much. Just a quick second one. You talk in your release about the Q4 being seasonally strong from a margin perspective. Just wanted to understand all of the factors that sort of feed into that. Obviously, you talk about around market, which is now weaker, according to the release, both on a global basis and in North America, which is a very profitable market. At the same time, you're talking about normal seasonality in Q3 on top line. That would imply worse than normal seasonality in Q4. Just wanted to understand what are the factors that sort of give you comfort there. You just referenced, for example, the fact that there won't be as much of an adjustment in inventory.

I'm wondering if there are other factors that give you confidence. Many thanks.

Börje Ekholm (President and CEO)

That is one for sure, the inventory adjustments where that depletion is coming to an end and normalizing. But we see also a mix effect here in Q4. This is the traditional seasonality we see also. It's better mix of business, typically in the Q4. It depends on, of course, how customers, what spending patterns customers have and so on, but we always see that improvement in the Q4. It's about how projects are concluded, and how we deliver to customers to close the year. We typically see that. Inventory is one thing, and then the normal seasonality of our entire industry. As long as I've been working here, we've always seen a stronger Q4, many, many years.

Operator (participant)

Okay, thanks. Thanks, Alex.

Börje Ekholm (President and CEO)

Many thanks.

Operator (participant)

For the question. We'll move further in the queue here, I'll see. I have the next question from Andreas Joelsson at Danske Bank. Good morning, Andreas.

Andreas Joelsson (Equity Research Analyst)

Good morning, everyone. Maybe a slight shift in the questions, looking into the enterprise side. If you could explain a little bit more on the reception you have got from this, the strategy that you have in this area from your customers, especially in the US, but also how to leverage this portfolio outside the US. Any comment on pipeline and if we can expect this, the growth that you have now to continue also for the coming quarters? That would be great. Thanks.

Operator (participant)

Börje?

Börje Ekholm (President and CEO)

Maybe we divide it into the 2 components. Enterprise Wireless Solutions continues to have a good growth rate. Of course, a little bit tougher market conditions due to the general economy, I will say. But we see also very strong development with a strong pipeline of products that we are bringing to the market now. We're still in the, I would say, in the early phases of building up our go-to-market organization there. We will, of course, pace that with sales, so it's not about increasing the cost per se, but we're still not getting the full efficiency of our sales force in, on the enterprise side.

We see a very good collaboration with our CSP customers, they are actually very excited about bringing these type of products to the market, as it drives revenues for them as well. Here we have more work to do. Please remember that it's a different business model with a large part of deferred revenues. We create a recurring business there, will impact the P&L initially, but over time, it will be a highly profitable part. I would also say on dedicated networks, we are still early outside of China. There are some use cases in ports, some basic early in manufacturing, it's still a relatively small market around the world.

If you compare it to China has, by the end of last year, they had more than 6,000 dedicated networks deployed in China. We see in, call it the Western world, Europe and the U.S., maybe we have about 1,000, maybe 1,500, but it's significantly smaller than it is in China. That, I think, points to the actual opportunity here being much larger than we're servicing now. Of course, this will depend on establishing the use cases and the way we approach the market. We see that as a good potential for growth going forward, but we're still early on in that.

If we look at our platform business in Global Communications Platform, there we're having a good traction, as you can see on the Communications APIs that we're in the market with today, and that's the old Vonage business growing 19% in Q2. Of course, that is impacted by the general economic conditions, so it has been growing a bit slower than it did 2021 and 2022. We still see a fairly good growth rate continuing. What we're very excited about is the network APIs, and we launched the first, or launched, it's a bit exaggeration, but we showcased the first network APIs at Mobile World Congress, together with three operators in Spain: Vodafone, Telefónica, and Orange.

We are continuing dialogue with a number of leading operators on how to establish this network API market. When we have more development there, we will talk about it, but what we see is it's an excitement in the industry, and here we are shaping the industry landscape by driving the whole adoption of network APIs. What we see here is that that's the way network resources will be consumed in the future. They will be called up by applications, and paid for through a CPaaS platform. We're very excited about that, but it's still early in the development. Give us a few quarters here, and you will start to see some progress.

Operator (participant)

Thanks, Börje.

Andreas Joelsson (Equity Research Analyst)

Thanks. Maybe a follow-up, just on what the Chinese enterprises see in these dedicated networks, as a benefit that you are not seeing outside of China, and how can you help the enterprises seeing that benefit?

Börje Ekholm (President and CEO)

Yeah. That's a great question, Andreas. As a matter of fact, what we see in China is that they are developing completely new use cases. You know, what is unique with cellular connectivity, and 5G in particular, is that you get reliable, always available, and secure connectivity, and that's critical in an enterprise application. Take a manufacturing site. What we see is a full deployment of sensors, so you can develop a full digital twin of the factory and basically make adjustments in the digital twin, and then implement it very quickly and very flexibly. That's one use case. Another use case that's also gaining traction is the in-line inspection. You actually do image processing of in-line inspection going much faster than manual and with much higher precision.

You see more traditional use cases, you know, connect self-guided vehicles. As a matter of fact, there are some front-running manufacturing sites outside of China where we see deployment of dedicated networks, resulting in much higher cycle time-

Operator (participant)

Mm-hmm.

Börje Ekholm (President and CEO)

or much reduced, cycle time. Speed in the manufacturing goes up, as well as higher quality levels. We're starting to see some early signs outside of China, but I will say China is ahead of the new type of applications here.

Operator (participant)

Thanks, Börje.

Börje Ekholm (President and CEO)

Thanks.

Operator (participant)

Thank you, Andreas, for those two questions. We'll move further in the Q&A session, and we have the next question from Peter Kurt Nielsen at ABG. Good morning, Peter.

Peter Kurt Nielsen (Lead Analyst)

Good morning, Peter. Thank you very much for taking my questions. My first question relates to the network's growth margins, please. You've obviously spoken extensively about the mix impact, and with the decline in North America, growth in India, that's plain for us to see. As Carl said earlier, the initial phase, the ramp-up phase in India, the deployment primarily comes with low margins, which should then gradually improve as you move further in that process. My question is: When will we start to see the underlying margins, growth margins in India improve and contribute, how shall I say, to a better overall growth margin, irrespective of the mix changes we are seeing? i.e., when will growth margins in India improve in this rollout phase?

My second quick question is just, Carl, could you tell us what the underlying run rate in IPR revenues is now, adjusted for the one-off payment in Q2, please? Thank you very much.

Operator (participant)

Carl, should?

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

Yeah, I can start with the IPR piece. And we say this also. The IPR expectation for the Q3 is somewhere between SEK 2.5 billion and SEK 2.8 billion. And that's the number that we give. And obviously, with the new signed contract there, we are on our way towards this substantial growth of the IPR portfolio that we have talked about before, some SEK 12 billion, SEK 13 billion as an aim for next year, thanks to this new contract. SEK 2.5 billion-SEK 2.8 billion next quarter, that's where we aim.

Peter Kurt Nielsen (Lead Analyst)

Thank you.

Börje Ekholm (President and CEO)

Then the gross margin question. You know, the reality is, we're going from about a 35-ish% share of North America to about a 25% share of sales. India goes from, I believe, four-

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

3-16.

Börje Ekholm (President and CEO)

Yeah, 3%-16%. It's a big mix shift.

Operator (participant)

Mm-hmm.

Börje Ekholm (President and CEO)

We can still execute with a, you know, a growth margin that's about 39% in network. There is a big change here in our sales mix. Of course, the details on contracts, we're not gonna discuss here. We're already seeing a strengthening of the growth margin profile, delivering well according to our plans.

Operator (participant)

Okay. Are you good with that, Peter Kurt?

Peter Kurt Nielsen (Lead Analyst)

Thank you.

Operator (participant)

Okay, thank you for that question, Peter Kurt, and we'll move to the next question. That question is from Andrew Gardiner at Citi. Morning, Andrew.

Andrew Gardiner (Managing Director and Head of European Technology Equity Research)

Good morning, Peter. Good morning, guys. Thank you for taking the question. I had another one on sort of your visibility into the recovery that you're calling for later this year and into 2024. Yeah, I hear what you're saying in terms of the need for additional deployment, mid-band coverage, you know, networks perhaps deteriorating a bit under the traffic load. All of that sort of makes theoretical sense to me, but I'm just wondering if you're not yet seeing it in terms of firm orders from the customers, you know, by when would you need to in order to see a reasonable recovery in the Q4? I know you don't have the longest lead times, and you will have inventory on hand, but, you know, there's...

I suppose I just worry that if we're here in the middle of July and you're still not seeing the firm orders coming in, are we not setting ourselves up for a risk of disappointment come sort of September and October, if indeed they haven't arrived? Just by when would you need to see the customers react and place the orders in order to see that full Q recovery? Thank you.

Operator (participant)

Börje?

Börje Ekholm (President and CEO)

Historically, when we've seen these type of market situations, it's a very short lead time.

Operator (participant)

Mm-hmm.

Börje Ekholm (President and CEO)

That's why, you know, it also depends on software. Can we upgrade with only software, et cetera? It depends a lot about the specific network situation for the customer. That's why it's hard to give you a specific answer. At least we know from the customer discussions we're having now, that a lot of the customers are starting to see, you know, deteriorating network performance that actually leads to churn. That's why we're also confident that it will come. I can't predict exactly, and as a matter of fact, that's why we never discuss backlog in our industry, because it is a relatively short delivery cycle on those type of contracts, where you buy capacity.

Operator (participant)

Thanks, Börje. Did you have a follow-up, Andrew?

Andrew Gardiner (Managing Director and Head of European Technology Equity Research)

No, that's fine. Thank you.

Operator (participant)

Thank you. Thank you, Andrew, for that question. We will then move to the next question, and I would have Daniel Djurberg at Handelsbanken. Good morning, Daniel.

Daniel Djurberg (Equity Research Analyst)

Good morning, good morning, Börje and Carl, and thank you. Thank you for taking my questions. Two question, if I may, starting coming back to the market recovery in North America again, would it be fair to assume that this recovery that you anticipate will come about a bit earlier for some of your peers, including your neighbors, in your profit warning today? Is this because of that you have more wins into the urban areas versus the rural areas that might come a bit later? Thanks.

Operator (participant)

Börje?

Börje Ekholm (President and CEO)

You know, that, I think you're better off asking our customers about that. I mean, I think we started to talk about this situation in North America already in the end of last year. It's developing a bit like we have predicted and actually assumed, and that's why we said also early on that we need to take the cost items and the actions on the cost side. We have tried to not predict, this is a bit to exaggerate, but at least plan for this type of market situation we're seeing in North America. I would also say, of course, they have built out networks in urban areas first, but I would also say that's where traffic growth is the fastest as well.

How that is going to ultimately pan out, you know, I think that that's a bit difficult to predict. What we see, and that's what gives me comfort, is that there is a need for network capacity. There is also a need to deal with the energy cost challenges that comes out. Simply, you need more modern equipment to lower your energy bills, for the operator. You will need more newer equipment to deal with the CO2 challenges and the CO2 commitments. Ultimately, when I put that together, it gives me comfort that it will come back. If you extrapolate to historic experience, we've seen this happen in the past. It's been tough and then a very quick recovery. Does the future always look like the past? No, it doesn't.

At least when you put all of those factors together, it's a reasonable assumption that we said already in the, you know, in the end of last year, that we would see a recovery during the second half, and that's what we think is still a reasonable assessment.

Daniel Djurberg (Equity Research Analyst)

Mm-hmm.

Börje Ekholm (President and CEO)

Then, does it-

Daniel Djurberg (Equity Research Analyst)

Perfect.

Börje Ekholm (President and CEO)

Look the same for our competitor or not? I mean, I don't know their business mix. I don't know their situation, so I let them speak for that themselves. From my point of view, we saw this coming and planned for it.

Daniel Djurberg (Equity Research Analyst)

Fair enough. I agree there. A question also, if I may, coming back to the enterprise, and, you talked about the Open Gateway initiative with your Quality on Demand that you showcased in Barcelona. How, have you come any further in terms of, you know, monetization, the revenue models, and both things and the progress there, if you could be a little bit more specific?

Börje Ekholm (President and CEO)

Yeah. It's, we continue the very deep engagement with a number of front runner customers around the world. We work very intensively on that. What is, you know, call it one of the things that needs to happen is we need to have an abstraction layer in the network that basically allows, say, a CPaaS to call up functionalities from the network. That's, you know, it's not a surprise, so but that's where we have a lot of work to be done. We continue that work, and that's why, you know, when we'll get the first revenues, I think we have said that we should have a network API more in the market by year end. That still would be my best estimate. Will it be Q4?

Hopefully, it could, of course, slip into early next year. That's the time frame we're working on, and it's a lot of groundwork that needs to happen here before we are at the situation of creating a launch. We'll hopefully here again, come back and talk much more in detail about this towards the end of the year.

Operator (participant)

Thanks, Börje.

Daniel Djurberg (Equity Research Analyst)

We'll stay touched. Thank you.

Operator (participant)

Thank you, Daniel. We are actually now moving into the last question of this Q&A session. That question is from Sandeep Deshpande at JPMorgan. Morning, Sandeep.

Sandeep Deshpande (Equity Research Analyst)

Hi, good morning.

Operator (participant)

Good morning.

Sandeep Deshpande (Equity Research Analyst)

Can you hear me?

Operator (participant)

We can hear you.

Sandeep Deshpande (Equity Research Analyst)

Hi.

My question is, Börje, you talked about the build-up into an improvement in sales, and one of the points you made on the build-up of improvement is that there will need to be further densification of the base stations. Given that we are seeing that the U.S. telcos are cutting spending at the moment, have you had conversations with them that gives you any confidence that they're going to actually densify their 5G sales going forward? I have one more quick follow-up on the software businesses.

Börje Ekholm (President and CEO)

You know, I'm not gonna go into the details about the customer engagements, what we see is, we are an increasing amount of discussions is on the network quality and the need for network quality. That is what gives me the comfort that at some point in time here, we will see that recovery coming back. It's, you know, in reality, it's back to consumer satisfaction. You know, the consumer, the user, and we often think about it as a device for, you know, a smartphone. The reality is, in the future will be many new type of applications. Enterprise applications, if it is AI use cases, they will all require connectivity and reliable, always available connectivity.

we see quite a lot of use cases here that will drive network traffic. I think it is here. We're in a phase where, of course, if you're a customer, you're facing uncertainty right now, you're gonna adjust accordingly. but I'm also convinced that at the end of the day, the end user will need a certain service, and that's what's gonna create the market. Is it uncomfortable now? Yes, it is uncertain, right? I think it's fair to say that. the reality is, connectivity is a need. if you go today to a sporting event, I don't, you know, as far as I know, in many parts of the world, I cannot upload a picture because it's simply capacity constraints.

We need to put more capacity in stadiums, more capacity indoors, in shopping malls, in office buildings, et cetera. Those are massive use cases that will be deployed over the coming several years, and they will be needed in order to digitalize society, digitalize enterprises, and further digitalize the consumer.

Operator (participant)

You had a final sort of software question, Sandeep, as well?

Sandeep Deshpande (Equity Research Analyst)

Yeah, just quick follow-up on your Software and Services business. Where are we now in terms of the restructuring? I mean, you've taken some charges in the first half of the year. We've seen some improvements in terms of the earnings in that business. Have all the actions been taken and the results waiting to be seen, or are there certain more results, I mean, in the certain more actions need to be taken in the second half to reach your goals there?

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

Sandeep, I can say, of course, actions are ongoing. We have exited from some subscale businesses. We talked about that before, took some charges for that earlier. We are focusing on automating service delivery. We are taking out costs as part of the overall cost reduction effort. We have commercial discipline to make sure that new contracts are well scoped and well priced. All of that is happening, of course, continuously. We see clearly that break even, as we've had as a target or commitment for the year, is what we'll reach. We say, as you saw, at least break even for 2023.

Of course, 2024, we expect to see improved profitability coming out of all of these actions that the current leadership, there in Cloud Software and Services are undertaking.

Operator (participant)

Thank you, Sandeep, and thank you, Carl, and thank you, Börje. We're coming to the end to this Q&A session, I would like to thank you all for the good questions. For those who are going on summer vacation, I wish you all a nice vacation, and we'll see each other again during autumn. Thank you, and goodbye.

Carl Mellander (CFO and SVP, Head of Group Function Finance and Common Functions)

Thank you.

Börje Ekholm (President and CEO)

Thank you.