Second quarter highlights
- Sales as reported and sales adjusted for comparable units and currency both decreased by -1% YoY. Segment Networks showed a sales growth of 2% YoY, both in reported sales and sales adjusted for comparable units and currency, with strong sales growth in North America.
- Gross margin was 34.8% (29.1%). Gross margin excluding restructuring charges improved to 36.7% (30.9%), driven mainly by cost reductions and the continued ramp-up of Ericsson Radio System (ERS).
- Operating expenses were SEK 17.2 (15.4) b. Operating expenses excluding restructuring charges increased to SEK 16.3 (14.8) b. Cost reductions in SG&A were offset by increased investments in R&D, higher provision for variable compensation and an increase in provision for overdue trade receivables.
- Operating income was SEK 0.2 (-0.5) b. Operating income excluding restructuring charges was SEK 2.0 (1.0) b.
- Networks operating margin excluding restructuring charges was 13.3% (13.4%), with an improved gross margin offset by increased investments in R&D.
- Digital Services operating income (loss) excluding restructuring charges improved to SEK -1.5 (-1.8) b. due to improved gross margin to 42.6% (35.7%), mainly driven by cost reductions.
- Managed Services operating margin excluding restructuring charges improved to 6.5% (-2.1%) as a result of cost reductions and customer contract reviews.
- Cash flow from operating activities was SEK 1.4 (0.0) b. and free cash flow was SEK -0.6 (-1.3) b. Net cash increased to SEK 33.1 (24.0) b.
1) EPS diluted, excl. amortizations and write-downs of acquired intangible assets, and excluding restructuring charges. When a company reports a loss, the number of shares used for calculating earnings diluted per share shall be the same as for basic calculation. 2) Free cash flow: Cash flow from operating activities less net capital expenditures and other investments, see Alternative Performance Measures (APM) at the end of the report.
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 (NASDAQ:ERIC)
We continue to execute on our focused business strategy and are tracking well towards our 2020 target of an operating margin1) of at least 10%. The investments in technology leadership have resulted in increased gross margin1) to 37% (31%) and growth in segment Networks.
Customers turn to new technology in order to manage growing demand for data with sustained quality and without increasing costs. This, together with fixed wireless access, represent the first business cases for 5G. We will continue to invest in securing leadership in 5G. This includes further investments in R&D, to solidify our complete 5G portfolio, and investments in field trials. We also intend to selectively capture new business opportunities, through our 5G-ready 4G portfolio, to extend our footprint as operators prepare for 5G. We provide solutions for all frequency bands for 5G, which strengthens our global competitiveness.
We have good market traction in Networks, with a sales growth of 2%, particularly in North America where all major operators are preparing for 5G. Networks gross margin1) improved to 40% (36%). Digital Services is tracking towards a turnaround and gross margin1) improved to 43% (36%) YoY, and was stable QoQ. However, while losses decreased both YoY and QoQ, we still have a lot of work to do. The top priority is to turn around performance in the segment, but we are in parallel accelerating investments to make the portfolio 5G ready and cloud native. In Managed Services, gross margin1) improved to 14% (2%) supported by continued efficiency gains and customer contract reviews, resulting in a positive operating income. We have also on-boarded several new contracts in the quarter.
In segment Emerging Business and Other, we invest in strategic future growth areas such as Internet of Things (IoT). We see increasing momentum with several important customer wins with our connectivity platform in the quarter. However, sales are still low. Our media business generated a loss of SEK -0.4 b. in the quarter. We expect to close the announced divestment of Media Solutions, recently renamed MediaKind, by the end of the third quarter.
The SEK 10 b. cost reduction program, launched in Q2 2017, has been successfully completed. We reduced the total workforce by more than 2,000 in the quarter and by 20,500 in total as part of the program. These are tough but necessary actions to ensure competitiveness. Run-rate savings to date amount to more than SEK 10 b., and the effect is gradually becoming visible in the earnings, mainly through lower service delivery costs and common costs. Even though the cost reduction program is completed, our estimate for restructuring charges of SEK 5-7 b. for the full year remains, as we will continue our efficiency activities throughout the year.
Free cash flow improved to SEK -0.6 (-1.3) b. and our cash position remains strong. Our work to further strengthen the balance sheet continues.
We see strengthened momentum for 5G in the quarter and it is clear that our 5G-ready portfolio is attractive and competitive in the market. We have gradually improved the cost position and will continue to have a strict cost focus in order to further increase competitiveness and efficiency. We are confident in reaching our long-term target of at least 12% operating margin1) beyond 2020.
1) Excluding restructuring charges
Planning assumptions going forward
- The Radio Access Network (RAN) equipment market is estimated to decline by -2% for full-year 2018 with 2% CAGR for 2017-2022. In 2018, the Chinese market is expected to decline due to reduced LTE investments, while there is positive momentum in North America
- 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). For historical rates, see www.ericsson.com/en/investors
Ericsson related, 2018
- Sales: Seasonality (5-year average sales) is -2% between Q2 and Q3 and 23% between Q3 and Q4.
- The current annual revenue baseline of the IPR licensing contract portfolio is approximately SEK 7 b.
- Restructuring charges for full-year 2018 are estimated to be SEK 5-7 b.
Actual and estimated net impact from amortization and capitalization of development expenses and from recognition and deferral of hardware costs
The divestment of Media Solutions is expected to be closed by the end of Q3 2018 with estimated additional expenses of SEK -0.3 b. in Q3, related to the divestment. Results after the divestment will be reported as share of earnings according to the equity method. Ericsson’s holding will be 49% of the shares. Media Solutions sales were SEK 3.2 b. in 2017.
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