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Earnings Call Transcript 2023-Q1

[Peter Nyquist, executive]

Hello, everyone, and welcome to today's presentation of the first quarter in 2023. With me today here in the studio, I have Carl Mellander, our Chief Financial Officer; and with me on a link from North America, I have Börje Ekholm, our President and CEO. So as usual, we will start this session with a presentation, and then we will end the hour with a Q&A session.

And in order to ask questions, you have to join this conference by phone. Details on that can be found in today's press release as well as on our website, ericsson.com/investors. Please also be advised that today's conference call is recorded.

Before handing over to Börje and Carl, I would like to say the following. During today's presentation, we will be making forward-looking statements. These statements are based on our current expectations and certain planning assumptions, which are subject to risks and uncertainties that actual results may differ materially due to factors mentioned in today's press release and discussed in this conference call. We encourage you all to read about these risks and uncertainties in the earnings report published today as well as in our annual report.

With that, I would like to hand over to you, Börje. So please, Börje.

[Borje Ekholm, executive]

Okay. Thank you, peter, and good morning, everyone. And a big thank you for joining us today. So we're excited to present the quarter in which we're executing on our strategy and we're making progress on our strategic goals, while at the same time delivering on what we set out as expectations for this first quarter. But before I go into the quarterly results, let me take this opportunity to just comment a bit on the news that we sent out last night. After having been almost 7 years on Ericsson's executive team and 25 years with Ericsson, Carl will actually be leaving our company. And it's no exaggeration to say that Carl has been critical in the turnaround of Ericsson and in laying the foundation for the next chapter of our strategy. And he's also been a great colleague and, of course, a great friend.

Now we have come to a mutual agreement that it's a good time or as good as any for a change at Ericsson as we continue, I'll call it a next chapter in our strategic journey. But I'm, of course, very happy that he will stay on in his role until the end of Q1 next year. And of course, that will ensure that we can execute on our cost savings but also a smooth transition. So really a big thank you to Carl for all his achievements and contributions here at Ericsson. You will be truly missed not only by me but all my colleagues at Ericsson. So a big thank you. And anything, Carl, at this point, you would like to comment on?

[Carl Mellander, executive]

Thanks a lot, Börje, and thanks, very kind words also. As you said, I mean, there's not really a good time to leave a fantastic company like Ericsson or a position like the one I've had the privilege or having now for almost 7 years. But we find it's the right time now, and let's see what the future brings. It's been an incredible journey and a fantastic privilege to work with all the great people in Ericsson and of course outside our company with partners, customers and the investors and analysts as well on this call. So thanks all. But luckily, I will be here for almost another year. So we shall see each other again. Thank you, Börje.

[Borje Ekholm, executive]

Thank you, Carl. So back to Q1. So the quarter developed in line with what we communicated during our Q4 report. As we expected, Q1 has been a challenging quarter due to slower deployment pace in some early 5G markets. But this has, of course, been compounded with the fact that customers in those markets are lowering their inventories. And so that's the reason the impact on our sales is bigger than the slowdown in the underlying deployment phase. We will continue to see inventory adjustments during Q2, but we expect less impact after that, but there could be some smaller effect during Q3.

As the inventory adjustments will be completed, we also expect a recovery during the second half, but second half will also be supported by our cost savings initiatives, clearly. So this development impacts growth in Networks negatively as we saw the early 5G market slowdown, we now see a buildup of the next wave of markets. And here, margins are a bit lower due to large service content. We could see that growth in other segments offset the slower -- or the lower sales in networks, but all in all in line with our expectations and what we communicated during the Q4 report.

But let me start now by giving some highlights from the quarter. So we're making progress on our strategy to strengthen our leadership in Mobile Networks, grow our Enterprise business and drive a continued cultural transformation. As you saw and as you all know, in the quarter we reached a resolution with the DOJ regarding contractual noncriminal breaches of our 2019 deferred prosecution agreement. This was, of course, a critical step for us, allowing us to move forward, and we can now continue to make great progress on our compliance program.

Overall, financial performance was in line with what we expected and what we've communicated. So while overall sales were flat, we saw an organic growth of 5% in Cloud Software and Services and 19% in Enterprise. And notably now, the Enterprise segment now represents almost 10% of sales. So we completed also the divestiture of our IoT platform business. This will reduce quarterly losses by about SEK 250 million going forward.

As expected, in Networks, we saw strong growth in India, where we continue to roll out 5G at pace. This growth, however, did not fully offset the slower deployment pace, compounded by the inventory adjustments in the early 5G markets. We see that some customers are reducing the rollout pace somewhat, but the big effect really comes from the ongoing inventory adjustments, and that comes because they build up large inventories when supply chain was tight and those inventory levels are now normalizing. We expect these adjustments to be completed during Q2, but some could slip into Q3 clearly.

In Cloud Software and Services, we continue to execute on our revised strategy and reduced our losses a bit ahead of our plan. So while results would vary between quarters, we are on track to reach our target of breakeven in 2023. We're also making good progress on our cost efficiency initiatives, and we have identified additional savings opportunities of about SEK 2 billion. And now we plan to reduce cost run rate by SEK 11 billion by year-end. The best indicator of cost savings is that we get external and internal headcount down. During the first quarter, overall workforce fell by about 800. But if we adjust for adjustment -- for investments in Enterprise as well as India, the reduction was about 1,700 internal and external headcount. But of course, this is something that we continue to work on and we expect to accelerate during the coming quarters.

In a situation with a choppy outlook, we need of course to focus on what we can impact and cost efficiency is crucial to manage the uncertainties during 2023. But I will also say cost efficiency is critical for our long-term competitiveness. And we will continue to track our development on the cost savings and we'll report on our progress as we move along. Carl will cover more of the financial performance shortly, but let me touch upon some of the critical steps we took in our strategic ambitions in Enterprise.

We are in the midst of a journey where we're leveraging our capabilities in Mobile Networks to shape the future industry landscape by creating network API platform, which will redefine our addressable market and actually redefine our industry. In Q1, it was exciting to see a couple of tangible steps in this ambition. So last year, you all know we tested Ericsson Dynamic and User Boost with SmarTone in Hong Kong, which gave indications of it can be done and it gives -- or which showed that it can be done and gave indications of users' willingness to pay for network API.

And at this year's Mobile World Congress in Barcelona, we showcased the world's first multi-operator, quality of service network API together with Telefonica, Orange and Vodafone on their commercial networks. And this allowed us to demonstrate how advanced mobile network functionality can be exposed to and easily consumed by the global developer community. This was truly a critical step showcasing our ability to drive the evolution of this market, and we actually see a great interest from enterprises as well as operators.

So network APIs were really a big topic at the Mobile World Congress, and we are at the forefront of this new market, which we are defining together with our customers and especially front running customers. The winners in this evolution will be those that are able to first scale their platform. We anticipate the first revenues late this year, which will position us for a revenue ramp and growth during 2024 and '25 as our transformation into a platform company accelerates. Like all new markets, it will take some time to build this new market as well, but we believe it can actually develop faster and grow bigger than the market for traditional communication APIs and it will position Ericsson for a long-term growth and profitability.

Let me now comment a bit on the Enterprise Wireless Solutions as well, which is the other pillar in our Enterprise strategy. Today, all of our losses in Enterprise segment really comes from Enterprise Wireless Solutions. And that's expected for a couple of reasons. First of all, Cradlepoint has a subscription business model with upfront payments for an average 3-year contracts. Revenues and gross profits are deferred and recognized monthly over the contract period. This leads to an initial negative impact on EBITDA as a large part of the gross profit is deferred while the absolute majority of OpEx investments are taken directly in the P&L, and OpEx being both offerings, cost for R&D as well as the go-to-market organization. As we grow, this will basically mean that we will generate a loss for accounting reasons, but long-term, business area -- this business area has a very attractive profitability profile.

But we're also incurring some investments, we're scaling our go-to-market organization globally. We believe it's critical to establish a dedicated go-to-market towards enterprises to be successful in this area but also to leverage the technology we developed in the Mobile Networks business. But we're also investing in new product solutions. And as an example, you saw in this quarter, we acquired Ericom, which we will use to accelerate our security offerings. So we now have the capabilities to build a full stack security solution optimized for 5G. We continue to see good traction with Cradlepoint, showing good organic growth as we work to fully scale this business. And we are starting to see some very interesting use cases for our dedicated networks in manufacturing. But I would still say that's a rather early market and not particularly big yet.

With that, let me hand over to you, Carl, for drilling down into the numbers.

[Carl Mellander, executive]

Thank you, Börje. And again, very good morning to everyone. Thanks for joining the call. So I thought just to reiterate a couple of the key points regarding the business and the result, we can stay perhaps on this title slide for a second while I do that. First of all, this sales mix shift in Networks that we have, so clearly guided for, continued than in the first quarter. And customer CapEx as well as inventory adjustments happened as we forecasted there in some of these early adopter, early 5G markets.

At the same time, we had strong growth in markets where the massive 5G rollouts have begun more recently. And of course, we have a big share of services also in this large rollout projects. And when it comes to this inventory adjustment, we saw a big impact in the first quarter. That's clear. We expect continued inventory adjustments in the second quarter. But now with the visibility we have with customers, not least North America, we expect this then to flatten out or normalize from Q3 and onwards.

And then, of course, a negative impact of this on Networks gross margin was as we expected and as we guided for as well. But I think it's worth noticing the incredible speed of rollout in India. And for us, India now is the second largest market for Ericsson in terms of sales numbers. It has grown by 5x year-over-year, so now almost SEK 7 billion in revenue in India in the first quarter. At the same time, North America decreased by SEK 4 billion. So there you can clearly see the shift in the business mix.

Cloud Software and Service is then better than expectation. That's good. It's really a stepping stone towards the breakeven target for the full year. And then within Enterprise, global communication platform, that's where Vonage belongs. That delivered sales of SEK 3.9 billion in the quarter and a breakeven result of 0 EBITDA from that part. And then the other section of Enterprise, Enterprise Wireless Solutions where Cradlepoint is a part, grew by 60% in the quarter. That's going well. With the loss, as Börje explained then, it's SEK 0.8 billion in the quarter for the reasons that Börje said, and thoughtful investment both in product and go-to-market.

If we go to the next slide and look a little bit at the geographies then. You can very clearly here see what we're talking about in the shift. You see 132% growth in our market area, Southeast Asia, Oceania and India, primarily, of course, driven by the market share gains in India but also other project milestone completions in other -- in Southeast Asian markets there. The decline, on the other hand, then in North America, you see was 26% as a consequence of what we just described. And of course, coming from elevated investment levels both in 2021 but notably in 2022.

Europe declined by 16% organically, also high -- following high investments in 2022. But encouraging to see the growth in Latin America, where we grew by 6% driven by 5G deployments across the continent. Northeast Asia declined organically then by 19%, also compared with elevated 5G investment levels happening this time last year. And then lastly, Middle East and Africa, a decrease of 8%, partly driven by timing of 5G investments but also by some economic challenges in some parts of the African countries.

If we look at how this then came out in the group P&L, you see the sales number here, SEK 62.6 billion. And that's a flat growth organically, and with organic now, I mean excluding investments, acquisitions and divestments but also adjusted for currency fluctuations. But underneath the growth of Enterprise of 19%, a growth in Cloud Software and Services by 5%, but then again 2% down in the Networks for the reasons discussed earlier. And the impact of this shift is visible also on the gross margin. You see down 250 basis points to 39.8% excluding restructuring charges for the same reason. Gross margin, however, was positively impacted, I should also say, in the quarter by higher IPR revenues, where we have good expectations for the future as well, we can come back to that, and also higher software share in the sales mix.

In Cloud Software and Services here, we had a gross margin, excluding restructuring again, 36.1%. That's up from 35% a year ago. And this was supported by a higher share of software, which is obviously exactly in line with our strategy there. And then on Enterprise, gross margin was 47.6%, down from 55%. But that's really due to the consolidation of Vonage into the Ericsson books. But sequentially, and I think that's important, gross margin improved in this segment, not least by improving margins in the Global Communication Platform, which again includes Vonage.

Both R&D and SG&A increased year-over-year. But again, key to understand here is the consolidation of Vonage into the numbers. Obviously, Vonage was not here last Q1. So that needs to be understood. And about 70% of the increase you see here on these 2 OpEx lines comes from the Vonage consolidation. There's also an FX component, and the remainder is really, as discussed before then, the Enterprise Wireless Solution investment we do in future growth of that business.

In the first quarter, we recorded restructuring charges of material size for the first time in a long time, about SEK 1 billion, obviously related to the cost actions that we are taking. So all in all, this resulted in an EBITA excluding restructuring of SEK 4.8 billion, which is in line with the guidance and our expectations there.

On the next slide, we can have a look at how these earnings then convert into cash flow. And you all remember, in Q4, we had an exceptionally strong free cash flow before M&A. Now as expected, Q1 was weaker at minus SEK 8 billion of free cash flow before M&A. A couple of things there that explains this. First of all, as a seasonal effect during the first quarter every year, we do pay out incentives to staff from accrued employee expenses the quarter before. But more importantly and more related to business, the business mix shift that we talk about also comes through in working capital, hence, in cash flow as well. And there are a couple of effects there, of course, with large rollout, projects -- project inventory goes up. But we also have some extended payment terms, and that shows up on customer financing line in the balance sheet. But -- and we also have larger payments to suppliers related to these contracts than in other places of the world. So the mix shift also impacted working capital and therefore cash flow.

I can mention also just for planning purposes, the DOJ payment of USD 207 million was made in Q2. It was on April 6, so that's not included in Q1, but in Q2 numbers.

On a rolling basis, though, free cash flow before M&A was SEK 15.8 billion. But still at 5.7% of net sales versus our target of 9% to 12% for the long term, is, of course, not where we want to be both from a profitability point of view leading into cash flow, but also the working capital situation. And we are working very hard to restore this back to improved levels in line with our target. And of course, our focus on managing working capital continues with full force going forward as well. But again, with large rollout projects and the shifts that we talk about, we do build working capital temporarily. We will, of course, keep the machinery as efficient as we ever can in Ericsson. And I think we have proven that before that we can do that.

If we move now to the outlook for the future, not least second quarter here. And as we have said, and Börje expressed this also, 2023 has some uncertainty. In the second quarter, we expect operators to remain cautious with CapEx similar to Q1 and continue with the inventory adjustment that we have described. On top line, we expect this to be offset to a large extent by these large new rollout projects in 5G, but with a dilutive impact on gross margins short term. Enterprise segment is, of course, a high-growth area with a very strong long-term trajectory. But also that sector is impacted by macroeconomic factors, and we see that continuing in Q2 like it did in the first quarter.

But to mitigate all of this, of course, we are working on what we can control, as Börje said. And we have increased the cost-out effort and ambition from SEK 9 billion to SEK 11 billion as a run rate as we exit 2023. And given now this restructuring program or cost-out program, we have restructuring charges SEK 1 billion in the quarter, as I said. Going forward for the full year, early estimates are that it could amount to about SEK 7 billion, of which half or even more than half might be booked in the second quarter in the books. But we will come back to that, of course. Next year, though, restructuring charges will normalize around 0.5% of net sales according to the plan.

The P&L effect of cost-out will take time to see. We know that from experience, and that's how it works. So of course, we will report on the progress of this every quarter, but expect limited impact in the P&L in the beginning and then a gradual impact over time.

Continuing on this slide, and I'll wrap up soon. Average net sales seasonality from Q1 to Q2 is a growth of 12% if you look at the last 3 years' average. This is applicable both for Networks and Cloud Software and Services. However, this time for Networks, we expect Q2 sales to be in line with Q1, and for Cloud Software and Services, we expect the seasonality to be somewhat lower this year than the normal 12%.

Next, on gross margin, we are specific in the guidance here for Networks, And we say we expect gross margin in Networks to be between 37% and 39% in the second quarter, mainly as a result of the business mix that we have talked about. But we expect a gradual recovery going forward in the second half regarding that gross margin. OpEx, the typical increase Q1 to Q2 is SEK 1.5 billion up, large variations between quarters but that's a reference. And then the result of all of this EBITA excluding restructuring or EBITA margin, I should say, for Q2, we are -- we expect now and we guide for mid-single-digit as a result of this declining margins in Networks due to the changing business mix.

To close off, I want to end with this slide. This is taken from our Capital Markets Day we had in December, updated with actuals though. And this shows the components in the path towards the 2024 target, an EBITDA margin of 15% to 18%, you're well familiar with that already. So uncertainty on 2023, we've said that. But we do believe that the underlying traffic growth in Networks will stimulate and drive continued investments. That's one strong factor here. And therefore, we expect this gradual recovery in 2023 second half and into 2024. And this path, as you see here and know already, is also supported by higher IPR revenues. And then finally, in the other bucket that we have combined a lot of effects, both pluses and minuses there. But we have, of course, changing market mix from footprint gains but also countered by improved profitability across all segments with operational leverage from growth, et cetera.

So in total, we remain steadfast in this target to reach the lower end by 2024 of the target EBITDA margin, 15% to 18%.

With that, thank you so much. And I hand back to you, Börje.

[Borje Ekholm, executive]

Thank you, Carl. So our strategy we continue to implement, and we're starting to see the positive signs that it's working. So we're well positioned now to capture the full value of 5G and to create a stronger and more profitable Ericsson with a larger addressable market. And it's critical for our long-term success that we build out a profitable enterprise business. Executing on our strategy to build technology leadership in Mobile Networks, establish an Ericsson -- or an enterprise business for Ericsson and driving a cultural change are our 3 main priorities going forward.

So we are confident in our strategic position, but we also see that 2023 will be a choppy year, as we have earlier said. We expect a gradual recovery in the second half as we expect the inventory adjustments at our customers to be completed and that we start to see the benefit of our, call it, cost savings initiatives flow through the -- or gradually flow through the P&L. Longer term, based on historic experiences, we also expect to see investments or network investments recover as the underlying traffic growth continues at a very high rate and more capacity will be needed.

So if we look beyond 2023, we see that the expected normalization or recovery of the Mobile Networks market, we see the turnaround of Cloud Software and Services that we can continue to grow our IPR revenues as well as reap the full benefit of the cost initiatives and the other actions we're driving puts us on track to reach the lower end of our long-term targets by 2024. So with that, I just want to end by thanking all the fantastic people at Ericsson, who made this position possible. A big thank you from me.

With that, over to you, Peter.

[Peter Nyquist, executive]

Thanks, Börje, and thank you, Carl, for the presentation. So it's now time for the question-and-answer session. [Operator Instructions] And if you are streaming the webcast, please mute the webcast audio whilst asking questions to minimize any audio feedback.

So I'm now ready for the first question. And with that, I would like to welcome Aleksander Peterc. So Aleksander?

[Alexander Peterc, analyst]

Can you hear me?

[Peter Nyquist, executive]

Yes, perfectly.

[Alexander Peterc, analyst]

Excellent. I'd just like to first touch upon the gross margin trend in Networks. To what extent is that due to any import duties you probably have to pay in India at the moment? And how advanced are you in the progress with the local assembly or part of manufacturing to minimize these import duty cost? Is that part of the reason why things are going south in the second quarter? That's my first question.

Second one, just if you are more specific on restructuring, which areas you're targeting with the new restructuring charges, in which businesses and which geography?

[Peter Nyquist, executive]

If you want to start, Carl?

[Carl Mellander, executive]

Yes. Börje, should I take this one?

[Borje Ekholm, executive]

I think you take it, Carl.

[Carl Mellander, executive]

Yes. Maybe start with the second one then. When it comes to restructuring, it touches on many, if not all parts of our company in many geographies. So it's a wide and we have savings targets on basic virtually all managers. It's about half-half between cost of sales, if you like, with service delivery and supply, et cetera, and OpEx. The increase now that we presented today, the SEK 2 billion, that's more tilted towards the OpEx side, and there's also some R&D components in there. Of course, technology leadership remains our strategy, but we still see that there are productivity improvements and things we can do on the R&D side as well.

On your first question, yes, we are advancing when it comes to local production or assembly in India, and we're building out that together with the partner. So that's going well. The speed of rollout is incredible. So we are ramping up very fast as well in the local production there. And the import duty side, I would not say it's material when we look at the Networks gross margin. But of course, it's sizable enough for us to work really actively on trying to reduce that and localize production. Börje, if you want to add?

[Peter Nyquist, executive]

Thank you, Carl, and thank you, Aleksander. So we will now take the next question. And I think we have the next question from Andrew Gardiner from Citi. Andrew?

[Andrew Gardiner, analyst]

I had one on your visibility into business for the rest of the year. On one hand, Börje, you continue to use the word choppy as pertaining to 2023 and you're saying uncertainty remains. At one point there, Carl, you also said that conversations with customers are giving you some confidence that the inventory correction will be behind us in 2Q or at least early 3Q. Just on that latter point, sort of how broad are these conversations across key operators? How convinced are you that you've got the right level of visibility into what those customers will need in the second half? Where are inventory levels today? What are the indications in terms of deployment plans?

Can you give us any further detail around what you're hearing from the customers that gives you that confidence in an improving second half?

[Peter Nyquist, executive]

Börje?

[Borje Ekholm, executive]

Yes, it's a good question. What gives us the comfort is, of course, it starts with the ongoing deployment pace. And that's the key driver, and that gives us comfort that we will have seen the inventory adjustments during Q2, a bit of slip into Q3, but most of it done during Q2. And again, the reason for keeping the rollout pace up, it's not maybe -- it's down somewhat compared to last year, and you have seen Dell'Oro indicating numbers that are varying here. I think it's minus 7% in North America, for example, But that effect is truly compounded by this inventory adjustment.

And as long as we see the traffic growth we see today, that is ultimately going to require investments in the network to keep the capacity up and keep the user experience up. So based on the discussions we're having, we are -- I will preface it, there is a lot of macroeconomic uncertainty facing our customers, energy cost, it's inflation, it's a lot of different issues. But it gives us comfort to say that the rollout pace continues and ought to deplete the excess inventory by midyear or early Q3. So we're -- we feel good about it. But it's, of course, something that impacts us quite dramatically.

[Andrew Gardiner, analyst]

And you mentioned Dell'Oro there. Do you feel like those estimates still hold given how you've started the year and in particular, sort of much weaker than seasonal trends into the second half?

[Borje Ekholm, executive]

Yes. I think the reason why we're -- it's hard to say. They need to make their summary. I think it -- we will know in a few weeks' time. So let's see what they come out at. But we should remember the big adjustment on our side is actually the inventory adjustment. That's the big impact on our sales on one side. And the other side of that is the rapid growth in some of the new 5G markets. So we're in the middle of that business mix shift, which, of course, makes it always a bit difficult to have 100% visibility. But at least we feel quite good about our position.

[Peter Nyquist, executive]

Thanks, Börje. Thank you, Andrew, for that question. So we are now moving into the third question of this session. And I have that question coming from Sébastien Sztabowicz from Kepler Chevreux. Sebastian?

[Sébastien Sztabowicz, analyst]

One question on IPR. You are still forecasting substantially higher IPR revenue going forward. Have you made any kind of progress on your patent monetization strategy? And also a second one on Vonage. So it seems they have reported quite good growth, talking about 14% in dollar terms despite challenging macro conditions. Could you help understand how the demand is building up at Vonage. But more generally speaking, the Enterprise business has been quite strong in Q1, 19% growth, and you are talking about a weaker macro condition. Can you help us understand what are the dynamics there?

[Peter Nyquist, executive]

Thank you, Sebastian. Maybe, Carl, if you can start the IPR.

[Carl Mellander, executive]

Yes. On IPR, we have a strong position there, of course, with the patent portfolio we have, not least in 5G. And there is a funnel of a number of device players that will need to come on stream as well and sign up for licenses with us. So we are working on those deals, and that's a big part of what is behind our optimism when it comes to IPR revenue. And of course, we will report back once those agreements are eventually signed. As usual, the same as with the agreement with Samsung and then with Apple, we're not rushing into agreements. It's better to get it right, of course, with the right price level. And that keeps being our strategy. Then the next frontier, if that's your question, also maybe on the strategy for monetization. We see a big opportunity also in consumer electronics and IoT, et cetera, automotive. And that's going to be the next frontier for us to capture also license revenue from those sectors with the billions of connected devices who also -- that also use our patented technology. So we will report back on that once we have concrete progress.

[Peter Nyquist, executive]

Maybe, Börje, you want to comment on the Vonage growth development.

[Borje Ekholm, executive]

Yes, you can say -- just touch upon it shortly. Yes, we had 14% growth, about twice that growth rate or almost twice that growth rate in our current communication APIs for Vonage. So it's been a solid quarter. There is a bit of headwind from the general macroeconomic developments. And we should remember when we had the COVID days in '22 and before that, we had a bit higher growth in the use of communication APIs. So that put them on a bit of maybe you can call it an extra high level that we're now on the back end of that. But we're still seeing a very good growth and it's developing very strongly.

Of course, that's something we continue to invest in and drive innovation as well, so we can launch a number of new competitive offerings in the current communication APIs. You see the same thing in Cradlepoint. We've seen good growth during the quarter. But I would also say we are facing macroeconomic headwind and a bit tougher investment levels in enterprise networking, but it still gives a very good growth rate. So I would not, in that sense, be alarmed. But what it does give is confidence that the offering we have is very competitive and solving a real customer need.

[Peter Nyquist, executive]

Thank you, Börje, and thank you, Sebastian, for those questions. So we'll move into the next question, which will come from Peter Kurt Nielsen at ABG. Peter Kurt, can you hear me?

[Peter Nielsen, analyst]

I can, Peter. If I can just return a bit to the outlook for, I guess, Networks margins, et cetera. We're talking about a gradual recovery in the second half, which you also told us at Q4. But it does appear now to be from a somewhat lower, weaker level in Q2. Now you've discussed a bit the various components that will enter into this equation. But can you talk a bit about how far into the India ramp-up we need to go before we will see what you perhaps could call a normalization of margins? And I'm asking also because you are maintaining the longer-term target, 15% to 18% lower end of the range for '24, which, I guess, would thus imply a significant improvement also in the gross margin in Networks as we approach -- going into next year. Could you talk a bit about where the recovery is coming from, how far into India deployment we need to be in order to see these margins in Networks restoring themselves?

[Peter Nyquist, executive]

Do you want to start with that, Carl?

[Carl Mellander, executive]

I can start and, Börje, you can fill in as well, if you like. But -- so what we are so focused on, as you know, is the 2024 financial target, of course. And there are some key components that will start to play in, in the second half of 2023 and then onwards into '24. And of course, your question is on Networks specifically. We do see that certain rebalancing would start to happen. The inventory adjustments we talked about will flatten out, as Börje described well earlier.

The rollout in India will peak around the end of this year but, of course, continue at a high level later on also. But we still see this rebalancing between -- within the mix. Then, of course, we have a cost-out program that we talked about, which will generate also and improve profitability also in the Networks business side. And as you know, also IPR has a big part of the -- sorry, Networks has a big part of the IPR revenues also in the segment results. So as soon as we can land some of those deals, that would also carry Networks forward in terms of gross margin.

[Peter Nyquist, executive]

Börje, anything to add?

[Borje Ekholm, executive]

I think you captured it, Carl. It's the -- I think we see during Q1, Q2, the inventory adjustments at the maximum that we predict will be -- therefore, we expect that to be much less during the second half. And then we'll -- and that, of course, will carry into a better business mix in 2024, which will overall help us on margins. And then you have the cost, as Carl said, you have the IPR, and we have the turnaround of Cloud Software and Services. And then we're also starting to see a payoff. It's not going to be -- it's still going to have a loss-making next year in our Enterprise segment. but we should start to see improvements there. And that allows us to be within the lower end of our long-term targets next year.

[Peter Nyquist, executive]

Thanks, Börje, and thank you, Peter Kurt, for that question. So we will move further in this Q&A session. And the next question will come from Andreas Joelsson at Danske. Andreas?

[Andreas Joelsson, analyst]

One question, if I may, and that's on Networks again but on the top line. Usually, you have a sequential growth between Q1 and Q2. And this year, you'll stay flat. Does that mean that the inventory burden will be more or even higher in Q2? Or is it something else that we should be aware of that is happening between the quarters?

[Carl Mellander, executive]

Andreas, it's exactly the same reasons that we talk about actually on top line. It is the inventory adjustment and the cautiousness on CapEx that we see. So it's the same factors as in Q1. And when we look into Q4 -- sorry, Q2 now, we see that sales in Network will most likely remain on a rather flat level sequentially. So it's exactly the same factors as we have described here.

[Peter Nyquist, executive]

Thanks, Andreas, for that question, and thank you, Carl. We'll move to the next question, and we have that one coming from Sandeep Deshpande at JPMorgan.

[Sandeep Deshpande, analyst]

My question is regarding, Börje, regarding '24. I mean, you're saying that there will be a recovery in the market from '23 to '24. In the past cycles, we've seen that once the reduction in 1 -- in 4G happened, it didn't really recover until 5G came. Why do you think that '24 will see a recovery in the same 5G market that is softer this year?

[Borje Ekholm, executive]

The first reason is back to the inventory adjustments. So the underlying rollout pace continues. So it's inventory adjustments that's happening, that's going to be through, as we have said, during Q2 and possibly slightly into Q3. That gives us confidence about the underlying, call it, demand for network equipment. So that's the most important part.

The second one, and this is more of a longer term, but you have to recognize the growing demand for data, that's continuing at a very high rate. And in order to ensure that you can deliver that with a cost-efficient way as an operator as well as deliver it with the, call it, the user experience you need, there will be a need to keep on investing in capacity in the network. And there is no doubt in my mind that, that will have to happen. You can't really compare here with the previous generations because it's not data-driven.

Today, the generations are data-driven. That's why this is highly likely to look a bit different. So just to the experiment to think how would we cope with the current traffic level if we wouldn't have 5G. So we basically need 5G in order to manage the current demand for data and give the end user the experience they want. Of course, it varies a bit by geography, but just look at the build-out pace in India. It will make India a leading 5G nation and the leading nation for digitalization. And what we see is that the subscribers on 5G are using even more data than on 4G. And that's why we're quite comfortable to say that the inventory adjustments will be through, and therefore, we will see a much more of a normal business mix in '24 and beyond.

But still, even though data growth is 20% plus network CapEx that will be what supports kind of a flattish market. That's why it's important to keep in mind that we've guided for an overall flattish development within Mobile Networks for several years. So that's not anything new. But what it means is basically the inventory adjustment will normalize next year and then you're on that flattish curve. So we're not -- I think it's important to be clear. It's not that we assume you will enter a high growth rate in the Networks business or in Mobile Networks at all next year. It's just that the inventory cycle will have normalized.

[Peter Nyquist, executive]

Thank you for that question, Sandeep. And we will now move to the next question in this call, And that one is coming from Fredrik Lithell at Handelsbanken. So Fredrik, you're online.

[Fredrik Lithell, analyst]

Can you hear me?

[Peter Nyquist, executive]

We can hear you.

[Fredrik Lithell, analyst]

And I have 2, if I may, maybe one for Börje and one for Carl. If we start with the first one for Börje. Cloud Software saw an improvement in Q1, a clear one. So that good. I'm thinking about the fact that you're tuning down the sort of seasonal effects into Q2. Was it so that you had a more positive ending to Q1 and thereby, you had also higher software share in that quarter? Or is it so that you feel you see structural effects from the ongoing changes with the new management are doing in CSS, and that's behind the improved earnings in Q1? So what is what there in CSS? That's the question really.

And then Carl, on -- you talked about the rolling 12 months free cash flow at 5.7. You have a target of 9 to 12. And you say you're going to do everything you can to improve. And what are your levers to accomplish change that will improve? Or is it so that much will come from changed business mix or changed geographical mix and what have you that will improve this free cash flow yield?

[Peter Nyquist, executive]

So we start with Börje.

[Borje Ekholm, executive]

Okay. So if we start with Cloud Software and Services, yes, they had -- we're putting in place a strategy to kind of limiting our subscale development. We're focusing on having the right product portfolio to make sure that we can win in the market. Those efforts continue and, of course, putting profitability ahead of growth, and we have said that. Then in Q1, we saw a bit of effect from higher software sales and we saw a bit more IPR revenues than last year. So part of the improvement comes from that.

But I would also say there is a lot of changes that's underlying in the way we conduct the business in Cloud Software and Services that should allow us to reach the -- or be on the breakeven for the year that we are comfortable with. Then we know from experience, it kind of fluctuates a bit by quarter depending on when we have software deliveries and not. And that's why we say it's going to be less seasonality this coming quarter than we've seen in previous years. But we're very committed to working hard at improving the underlying business, in line with what we did in Q1 and continue into Q2.

[Peter Nyquist, executive]

Thanks. And Carl, on the cash flow development.

[Carl Mellander, executive]

Yes. Thanks, Fredrik. Yes. And you know working capital, cash flow management, very close to my heart. And I think we've done a lot during this year also to reduce working capital to a completely different, much lower level. I think we have the levers to do that. What we're looking at now is really you could say 2 buckets to start with. It's partly the cash flow generation as such, it's about terms and conditions also, both with customers and suppliers and managed discipline in presales and in supplier management to make sure that we balance -- not least in this new rollout projects that we balance in and outflows in a good way. And that will take some hard work and, in some cases, renegotiations as well.

But then, of course, also on the more business side, and you mentioned it yourself, Fredrik, that the same logic applies here as with the business mix. And when we have a rebalancing back to more of the front runner markets, that is good for our cash flow as well. And the final point to mention also related to business is, of course, that when we sign IPR deals, that's typically a good contribution to our cash flow as well. And you know that's normally a retroactive effect also on the cash flow side. So those are some of the levers. We have full focus on this. The entire company is very geared at improving working capital and generate good cash flow going forward.

[Peter Nyquist, executive]

Thank you, Fredrik, for those 2 questions. So we're actually now open for the last question of this session. And that question will come from Janardan Menon from Jefferies. Janardan?

[Janardan Menon, analyst]

My question is really just to narrow down a little bit more on the new communication APIs and as well as just the outlook for the Enterprise division into 2024 and beyond. So you've said that you -- both on the Hong Kong as well as at Mobile World Congress, you've made those announcements which are quite exciting, and you will start seeing revenue coming through into '24, '25. Can you give us some idea of what kind of revenue growth you would be -- we can expect on the new communication APIs into next year and the year after? And if you can't give us an idea of revenue, can you say like how many apps developers do you -- have you signed so far? I presume it's quite a small number. But how many would that grow to by '24 and '25? What is your sort of internal targets on that sort of thing?

And similarly, on the Cradlepoint side, you alluded to the depressing effect on margins because you have upfront OpEx, which you take upfront, and the revenue is sort of staggered. When does that effect start reversing? At what point is there -- on your current modeling, is there a point to where the Cradlepoint stops becoming accretive because the upfront cost or the revenue is more than the cost -- upfront cost? Or is this sort of -- because it's a growing business, that will take quite a long time to happen because you're going on signing new customers and therefore, the upfront cost will continue to be quite high? I mean, how should we think about that over the longer term?

[Peter Nyquist, executive]

Börje, will you take those questions?

[Borje Ekholm, executive]

I would suggest Carl takes those.

[Carl Mellander, executive]

Okay. I can make an attempt. So on Cradlepoint, so the business model is clear. And actually, it's, of course, a very favorable business model because cash upfront and a subscription model which creates a sustainable and recurring revenue also. But we had this phenomenon with, of course, the investments related to capturing those contracts in OpEx coming upfront. Exactly when that will turn around, we have not gone into and disclosed and talked about. But of course, this is a balancing game. How much do we invest short term for the long-term gain and how -- or how prudent are we short term as well to manage the P&L? And this is, of course, a big topic for us in the leadership team and with George who manages this business as well. I'm not able to give you an exact date there. But of course, at a certain point, we will see that being accretive to Ericsson. And we have a very strong release. You saw the 60% growth delivered in the first quarter in this. And of course, that comes out of the investments we are making, and we see that, that will continue.

On the Vonage side, I think we will come back. What I can say now is that we see really great traction among the early adopters and the front runners. You saw the Mobile World Congress with all the Spanish operators. That's one example. But of course, much more is cooking here. And the operator community, I would say, is really eager to work together and collaborate with us on this and developing this as a new business for them. And of course, everyone now in the industry can see the potential of exposing these 5G capabilities for enterprises and developers. It's happening as we speak, but of course, very early stages. And we are not ready to give specific revenue numbers for the future yet. But we'd rather prove that to you when those numbers actually come in. It's going to be limited in the beginning but with a great potential for the longer term.

[Peter Nyquist, executive]

Anything to add, Börje?

[Borje Ekholm, executive]

I would only add on the network APIs. What we see is a very good reception from the operators, but also from enterprises -- front runner enterprises who can leverage these type of APIs in applications. We're starting to see it also from application developers, but it's not a formal market yet. I will be clear to say that the platform we could show at Mobile World Congress is not fully industrialized yet. But at least it allows us to get this first feedback from developers, from enterprises that this is a workable market and actually can make sense. That's why we're confident that we will start to see revenues during this year. But as Carl said, it's too early to put a number on that for this year and into next and the year after. But we'll see a very exciting development.

[Peter Nyquist, executive]

Thank you, Janardan, for that question. And I would also like to thank Carl and Börje for good answers throughout the sessions. And with that question, we are closing the Q1 2023 conference call. Thank you, and have a great day.

[Carl Mellander, executive]

Thank you all.

[Borje Ekholm, executive]

Thank you.