Telefonaktiebolaget LM Ericsson (ERIC) 0 Q0 法說會逐字稿

Welcome to Ericsson's analyst and media conference call.

To view visual aids for this call, please follow the link provided in today's press release.

(Operator Instructions).

Peter Nyquist will now open up the call.

Thank you, operator; and hello, everyone, and welcome to our call handling the announcement of our preliminary Q3 earnings.

With me today I have our CEO, Jan Frykhammar, and our CFO, Carl Mellander.

During the call today, we will be making 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 these uncertainties in our report as well as in our annual report.

With that said, I would like to hand over to Jan.

Okay.

Good morning to all of you.

So want to give some color to why we have decided to release the preliminary earnings early.

The Q3 result is significantly lower than we expected and deviates from what we previously have communicated then regarding market development.

In the second quarter, we did gather the most relevant planning assumptions, and one of those planning assumptions was that we said that the current sales trends and business mix that we saw in the second quarter, which were then negative for especially networks already in the second quarter, that those sales strengths and business mix were expected to prevail also for the second half of this year.

However, what we see now is that these negative industry trends have accelerated further, and the way to think about this is to look at the networks' sales numbers which then in the second quarter had a year-over-year decline of 14%, and in constant currencies then approximately 11%.

And now, we have a decline of 19% and the preliminary estimates then on the constant currency is basically on the 19% to 20% level.

So it is an acceleration of the negative trend that we saw and we foresee for second half of the year, and that is why we have -- and these churns have then a material impact on our own expectations and, therefore, we decided to do an immediate disclosure based on that.

We also saw capacity sales in Europe that were somewhat lower than what we expected, but the main part of the reason for the weaker performance is the markets that already in the second quarter had a weak trend, a weakening trend, driven mainly by macroeconomic factors.

Those macroeconomic factors had a little bit different reasons.

You know that these are countries such as Brazil, Russia, parts of Middle East and so forth.

So it's the same cluster of countries as we stated in the second-quarter report, but the decline has accelerated in those countries.

It's not only the coverage business, but it's also the capacity business that you will know comes very late in the quarters that has been reduced.

I think by that, I hand over to Carl for a few comments on the preliminary earnings.

Thank you, Jan.

So Jan has described the underlying business reasons then for this lower result, but let's look at the numbers that we have announced today.

So our sales declined by 14% year over year to SEK51.1 billion compared to SEK59.2 billion in Q3 2015; and as Jan said, this is really driven by the slower development in the networks segment where we have a decline of 19%.

And due to this business mix change then, with lower share of capacity sales and higher services share, the gross margin declined to 28%, which is a drop from 34% Q3 last year.

Operating income then declined down to SEK0.3 billion, down from SEK5.1 billion, and this includes then the restructuring charges in the quarter of SEK1.3 billion.

And we can also turn to the table for some more detail.

I just want to underline again that the numbers are preliminary and unaudited, and that the final and full report will be published on October 21, as planned originally.

If we turn to the table, there is a little bit more detail.

Here we can also see the networks sales development then down to SEK23.3 billion in the quarter, which is as mentioned, a 19% decrease; and this leads to a gross income then of SEK14.5 billion, which equals 28.3% gross margin.

The operating expenses have been reduced some SEK800 million as we execute on the cost program.

And this all leads then to an operating income, as mentioned, of SEK0.3 billion, of which networks segment had an operating income of a negative SEK0.3 billion.

Finally then, excluding restructuring charges, this will give an operating income of SEK1.6 billion, down from SEK6.1 billion quarter 3, 2015.

Thank you.

Okay.

Then on the next steps before we open up for questions and answers, we will now proceed with the remaining part of the closings which obviously is linked to audits, but also the finalization of the balance sheet, and all the items related to balance sheet and operating cash flow and investing cash flow, and so forth.

The full report, as Carl said, will be published on October 21, and we will run a normal Q report day there with a press conference and analyst calls, and will of course then be prepared to update you in a better way on the trends and what we see for Q4 and early indications of 2017, and so forth.

We will also run the investor update in New York where we will also discuss the segment structures for next year's reporting, and also show some numbers related to past performance of those segments.

And in addition to that, we will also run a good section on Q&A; small meetings with different subsets of the leadership team.

So I think it will be a good event where we really would like to see your participation.

With that, I hand back to Peter.

Thank you, Jan.

And then, operator, we can now start the Q&A session, so please, you can open up.

Thank you.

Ladies and gentlemen, at this time, we will begin the question and answer session.

(Operator Instructions).

Gareth Jenkins, UBS.

A couple, if I could.

Firstly, I just wondered whether at this stage it's premature to talk about additional restructuring measures over and above what you're already doing around services and the SEK9 billion fixed-cost takeout, and if you've had any thoughts around that.

And then just secondly, I wondered if you could talk about the underlying drivers a little bit more, whether there's any structural issues that you do not see recovering in these markets affected; i.e., will the mix prevail from here in markets like Russia, Brazil, etc.?

Thank you.

Okay, Gareth.

Thank you.

So on the cost-reduction question then, what we will do is to focus on of course delivering the commitments that we have made to all of you in regards to the net [SEK9 billion] plan that was announced in Q4 2014, as well as the additional doubling of operating expense reductions that we announced in Q2.

Of course, since we now are in a situation where volumes are dropping, we have to adjust the cost of sales resources, both external and internal.

That's clear given the volume reductions.

We can give -- we can provide more details on that later on, but that's given because that's linked to top line.

Then the underlying drivers, it's -- this is not in my book a structural issue.

It is the same markets or countries that we had challenges with in -- starting in Q1 but was more accentuated in the second quarter.

The recovery then is linked obviously to those specific countries, so the situation in Brazil, I think we all are aware of the Brazilian economy, what is impacting us here is the operators and our customers' business.

These markets, all of these countries, are obviously important to Ericsson.

We have a strong position in many of these countries whether we talk about Brazil, some countries in Middle East, Russia, and so forth.

So it's -- we have important positions, but it also means that we are impacted when operators are reducing their CapEx in these markets.

That's given, but I don't see any other structural issues than that.

And I think on your question around mix, Gareth, we have to acknowledge, of course, that we have a challenging market situation at the moment.

We said that also in Q2.

But, of course, this is an indication that it's further challenges.

We think that these more uncertain and challenging markets driven by these countries that I mentioned will -- the situation will prevail short term; and short term in our book here is with the visibility we have, so it's two to three quarters.

Okay, Gareth.

Happy with that?

Thank you.

Next question, please, operator.

Johannes Schaller, Deutsche Bank.

You talked in the past a little bit, I think over the last two or three years sometimes, about improving pricing in some of these markets, I think, for example, in Africa, as some of your Chinese competitors have maybe pulled out of these markets a little bit.

Can you just comment maybe in the markets where you see weakness at the moment what the pricing behavior is, not just of the Chinese but in general in the market?

That would be quite interesting given the backdrop you're seeing here.

And related to that, the lower sales that you're seeing, are we right to assume this is mostly on 3G products, or is there really also a slowdown on the small 4G rollouts that we're seeing in those regions?

Thanks.

So, Johannes, thank you for the question.

I haven't made a point as far as I can remember on competition and competition from our main competitor coming from China slowing down in these markets.

Perhaps what I've said is that we have -- they have a strong position in many of these countries, and so -- which means that we compete with similar strategies which is very much linked around performance rather than price reductions.

This is not -- we haven't seen any new trend on pricing environment.

We are still having a -- we are still acting in a competitive market.

We all know that.

But, of course, the purchasing power, or the ability to buy in US dollars in many of these countries, have been reduced because of the significant devaluations that have occurred in local currency typically versus US dollars, and also in some of these countries a lack of US dollars.

So that's an issue and, of course, that cannot lead to price reductions, but it can lead to a lowering of the total market size, which is really what we see now.

So I think that's the -- and when it comes to coverage here in these countries, it varies a bit.

But you can say as a general theme, 4G coverage is going to be built in many of these countries and it's being built in many of these countries.

And for me, whether in the end of the day an operator puts in a multi-standard radio and they utilize that multi-standard radio for 4G or 3G doesn't really matter.

But it's really 4G that is driving the build-outs in most of these countries, not in all, but in most of these countries.

But again, this is multi-standard radio so it doesn't really matter.

But 4G is the driving force, and I think what you see here is that customers have really been trying to hold up their investments in the networks, more so for coverage than for capacity, actually, and that is a fact as well.

Understood.

Thanks, Jan.

Thank you, Johannes.

Next question, please.

Johanna Ahlqvist, SEB.

Two questions, if I may.

The first one is related to you don't comment anything on the development in China and North America in Q3.

Have you seen any slowdown in those markets?

And secondly, given the weak result, how do you --?

Are you worried about your net cash position, which has been a hot topic lately, that is shrinking even more now and the dividend according to that?

Okay.

Thank you, Johanna.

No.

It's correct that we do no comment on China and North America particularly.

The reason that we went out early is that we felt that we had given a very strong planning assumption that was linked to the countries, specific countries that we have mentioned here, and it's a further deterioration in those countries.

And, obviously North America and China is not mentioned in the press release.

So we'll come back to more details around the development in those countries when we have the Q earnings here in eight to 10 days, or whenever it is.

But -- so I think the message is that where we see a change and a reason to go out early is in the countries we have talked about or the markets we have talked about.

On the second point then on the dividend and the dividend policy, the dividend policy that we have is that the Board obviously looks at the past year's performance and also the business plan outlook when they assess the dividend.

And it's also a reality that we have an operating cash flow that varies very much by quarter, and that is typically very strong in the first quarter.

So we'll come back to more details on the balance sheet when we have the full earnings and balance sheet release here in a week, give or take.

Great.

Thank you.

Thank you, Johanna.

Next question, please.

Fredrik Lithell, Danske Bank.

Jan, could you please again talk a little bit on what you will need to do when it comes to your COGS?

You talked a little bit about internal/external measures.

You've done a lot on your capacities in factories, and so on, and you also announced a little bit of cutting back on two of the Swedish fabs that you still have.

What more can you do?

Can you talk a little bit about that to meet this gross margin level?

Thank you.

Thank you, Fredrik, for your question.

There are two elements to that.

One is, of course, that when volumes are coming down and volumes are becoming more challenging, we have to adjust operations linked to delivering that volume.

That's a given fact.

That's what we need to do.

The more structural work that is ongoing in cost of sales is linked to the Ericsson radio system and the very important product substitution that have commenced but will be more bigger in volume during the course of 2017, but it has already commenced here in Q3.

And it will be the most important structural work that we do on cost of sales.

And it's not only on the hardware platform as such.

It's also, of course, that this platform enables a more effective way of working end to end, meaning both services as well as product.

And if you have looked at the Ericsson radio system compared to the RBS6000, it's obviously a product that is easier to install so it has a better, if you can say, serviceability from that point of view.

That's the most important structural work we do.

And the second very important structural work we do is on the supply chain cost.

And, yes, you have already mentioned a few of the things we are doing in terms of the capacity in the factories being one thing, but also the fact that the new organization then that we have implemented, and are still, of course, implementing on lower levels, that will enable a better way to do resource planning, especially for service delivery [intent].

So there are a couple of very important structural things.

Having said that, again, you come back to the fact that if you have a declining volume, of course you have to adjust the size of the operations, both external and internal.

Yes.

Thank you.

Can I just have a follow-up?

In terms of business mix changes that seems to be bigger than what you have foreseen, what are the elements in there, and how do you see that that will develop?

Could we see a reversal of that and that the capacity business is coming back in the next 12 months?

Is that something you're planning for, or how would you talk about that?

Thanks.

I think that given the fact that we have, we are in a challenging market environment, we've said that clearly already in the second quarter, and the reason obvious in the background for this call is that that challenging market environment, for the reasons that we have talked about, have become more challenging recently.

I think that given that, the way we think about the measures we take is, of course, that we try to be as resilient as we can, and we try to do the structural cost reductions as fast as we can.

And we also believe and say that the current challenging market situation will prevail short term.

Now if that means that top line in networks and related services can go up and down a few percentage points in the coming quarter, of course, we all know that that's a reality.

But I think the underlying theme that I'm trying to convey is that we are at the moment in a challenging market situation.

The leadership of the Company will take measures and are already implementing measures based on that.

Okay.

Perfect.

Thank you.

Thanks, Fredrik.

Operator, next question, please.

[Jan Neulanden, SVG].

I have a question about Sweden.

Will there be some more cost reductions in Sweden, and can you say some more details about that?

Thank you, Jan, for the question.

As you are fully aware of, last week, Tuesday, we went out with our [intent] in Sweden and how the operation in Sweden will be impacted by the global cost reduction and efficiency program.

And that is the plan that we are working on and executing upon, and we don't have any more plans than what we communicated a week ago in regards to Sweden as a country.

Are you happy with that, Jan?

Thank you.

Thank you.

Operator, next question, please.

Sandeep Deshpande, JPMorgan.

My question is, the first question is on mix, Jan.

When we talk about the hardware/software mix, you clearly -- the Brazil, Russia, Middle East is where you did not see the revenues.

But can you comment on the overall mix in the business, because your earnings itself has -- in the existing business seems to have seen some deterioration?

So is it that the mix in the existing business within networks has been much weaker than you had previously expected?

And then secondly, with regard to your ongoing cost cutting, when should we be expecting that we will actually see a visible effect of the cost cutting on the OpEx or on the gross margin?

Thank you.

Okay, Sandeep.

Thank you for the questions.

So if we then come back to the mix in networks question, what you see here is three main impacts.

One is that the volume of coverage deployment in countries, especially the ones that have a weak macroeconomic development, and especially the countries or regions that we have mentioned, that has been further reduced.

Also what we have seen is that the hardware capacity business in those same countries has also been reduced.

So from that point of view, it is a worsening of the mix in those -- related to those countries.

In addition to that, we also said that we had a slightly lower capacity business in Europe, and hardware capacity business for us is a combination.

Sometimes it can be densification of networks, as you know, and it can also be that our customers are buying more capacity on the base stations themselves, which is then softer-like business.

So the impact we have here is the latter, so it's more -- it's less of the capacity on the base stations itself.

It's linked both to the countries that we talked about and also partly to Europe.

So you are correct in your assessment that the mix in networks has become slightly worse than we expected, and that is also why we have decided to go out early with Q3.

And then on the ongoing cost reductions, as I've said many times, we are executing cost reductions both in cost of sales as well as in operating expense.

And we have informed the employees in many countries during the quarter.

We have made announcements in Silicon Valley; we have made announcements in Sweden.

I got a question on that.

We have made announcements in Finland, and so forth.

And the principle we have is that we always try to inform our employees the people that will be concerned and impacted by the reductions first.

So there is a significant amount of cost reductions that have already been implemented and are in implementation phase.

Depending on the country, it takes -- it varies in terms of time before we get the impact.

If we do reductions in a country such as the US, it goes pretty fast, so we can foresee some impact of the reductions there in the fourth quarter.

But if you do reductions in a country like Sweden, it takes time because of the labor rules that we have here.

[Jonas Fideon], Sveriges Radio.

I'd like to ask you a question in Swedish just for Swedish radio listeners.

It's the same question that's been asked before, so English speakers are not missing out anything.

(spoken in Swedish).

(spoken in Swedish).

(spoken in Swedish).

(spoken in Swedish).

(spoken in Swedish).

(spoken in Swedish).

(spoken in Swedish).

Thank you.

Next question, please, operator.

Kai Korschelt, Merrill Lynch.

My Swedish is a bit rusty, so apologies.

I'll switch back to English.

I really wanted to just drill down on the gross margin.

So if you could just confirm please that the 28%, that is presumably post-restructuring?

So do you have the number pre-restructuring?

And then my question is really on the severity on a sequential basis.

I don't think your gross margin has ever declined by more than 400 basis points from one quarter to another, and I think the last time that happened was during the European network modernizations that we've seen and that you I think knew about the pricing level here.

So I'm just really trying to understand the incremental surprise.

How can the gross-margin profitability in new networks contracts really drive such a severe sequential decline?

Or is there maybe also something on the services side that we should be aware of?

Thank you.

No.

I think -- thank you for the question.

So the income that we present today is lower than our expectation, and it is for the reasons that we have explained.

And that is also why we are making an immediate disclosure despite the fact that the numbers are still preliminary.

So just to be clear on that.

If you start to dig down in the gross margin, which is post restructuring, and you will get the details on restructuring at the earnings day and the split between OpEx and cost of sales, but if you look at this, of course, the share of services has increased significantly, so that has an impact on the overall gross margin.

And so that has one impact here.

The other impact is exactly what we have explained.

It is a volume reduction in countries with a macroeconomic challenge with both coverage and capacity in those markets.

And in addition to that, we also have an impact on capacity business in Europe.

So it is a gross margin decline for the Company that is higher than our expectation, and that is why we go early with this release, Kai.

Okay.

Understood.

Thank you.

Thank you, Kai.

We will take now the last question, please.

So, operator, the last question for this event.

Thank you.

Lena Osterberg, Carnegie.

Yes.

So a question on how long is short term, because in Q2, you said that the weaker trends, you expected them to prevail sometime into 2017.

Is that the still the visibility you have; so, say, first second quarter 2017?

And then also on China, because that's, I guess, the main question mark on volumes for next year.

You say now that China remains stable, which is a comment you gave in Q2 as well.

What are your thoughts on China into next year?

Okay, Lena.

Thank you for those questions.

The reason that we announce today and we announce early is that we feel that we are deviating significantly from our own expectation for the reasons that we have explained.

We have not highlighted neither North America nor China in the press release because they obviously do not deviate significantly from our expectation.

We will come back when we have the earnings call next Friday and debate the specific markets in more detail, I promise.

We also have a process in the Company whereby we now really start to look at -- every month and every quarter, we have the reviews with all our regions and all our business units looking at the midterm developments, and so forth.

So we haven't done that yet.

We will do that here during the latter part of this week and over the next week.

So I think it's wise for me not to guess but rather follow the process we have and work through that so that we can have better insights and clearer statements to you when we have the formal release.

So I think that -- and short term typically for us with the visibility we have is about two to three quarters.

With that, I don't want to comment any more, Lena.

Thank you.

Thank you, Lena.

Okay.

Thank you, all, for participating in this call.

I don't know, Jan, if you want to say any closing remarks?

No.

I think first, so thank you for taking the time to with this short notice listen into and be part of this Q&A session.

We will come back and have a more normal earnings day then in give or take eight/nine days from now where we will be able to answer questions in a more thorough way.

Thank you very much.

Thank you.