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Earnings Call Transcript 2021-Q3

[Peter Nyquist, VP & Head of Investor Relations]

Hello, and good morning, and welcome to the Ericsson Third Quarter 2021 Call. Today's call will be a little bit different from others. We will start with the normal procedures going through the Q3 numbers. The second part, we will actually spend a little bit on strategic topics: one, addressing the path to profitability in Digital Services by Carl; and then we will address the opportunities that we see in enterprise by Börje.And with me here today, as usual, I have our President and CEO, Börje Ekholm; and our CFO, Carl Mellander. So hopefully, anyway, even though we'll have this little bit longer presentation, hopefully, we can spend the second part of this hour on Q&A. And in order to ask these questions, you need to contact or connect to the conference via a telephone, and you could find all the details in the press release on -- all on ericsson.com.During today's presentation, we will be making forward-looking statements. These statements are based on our current expectation and certain planning assumptions, which are subject to risks 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 all to read about these risks and uncertainties in our earnings report as well as in our annual report.With that said, I would like to hand over to our President and CEO, Börje Ekholm. Please, Börje.

[E. Borje Ekholm, President, CEO & Director]

Thank you, Peter. And of course, welcome, everyone, and very happy to have everyone joining us for this call.So the third quarter, we're very happy about the performance that we can deliver based basically on us winning footprint across our portfolio, leveraging our strong 5G portfolio. And I would say that this ability to gain footprint is clearly based on our investments in technology leadership and the substantial commitments we have made to growing our R&D efforts over the last few years. But I would say it's also a show of the commitment our people show to deliver a performance that actually are on the path to becoming a really strong performance in the future.Today, we have 95 live 5G networks. We have 149 commercial 5G agreements across our portfolio with unique operators, I should say. But you have also seen that we have decided to delay our Capital Market -- or postpone our Capital Markets Day, our investor update to instead next year have a full Capital Markets Day with a full management team to participate and update you more in details of the plans we see going forward.We will spend, as Peter said, a little bit of time on updating you all on our strategic thinking at the end of this presentation. But Carl and I will focus the first part here on the Q3 performance and go through a bit more in detail.So if we look at the quarter, we continued to see very good momentum in the U.S., and it's underpinned by our recent signing of a 5G contract with AT&T, which now means that we have 5G contracts with all 3 Tier 1 U.S. operators. And these contracts are, by the way, the largest in our history at Ericsson.We also continued to gain market share overall. However, it's quite clear that our market share in Mainland China has been reduced, and this is a consequence or follows the decision Sweden took to exclude Chinese vendors in the build-out of 5G networks in Sweden, and this is fully in line with the guidance we have offered before. But we also see that we've been able to partly offset that loss of market share by growth in other markets during the quarter. We've seen good growth in Europe and Latin America as well as North America, but I also want to highlight that also Africa saw growth following a very difficult period during the pandemic. But of course, it's quite clear, the loss of sales in China hurts our sales volume in total. And we have -- we need to invest even more to regain that loss of volume by growing in other markets.This quarter also, I would highlight the impact on disruptions to our supply chains that we, I would say, impact many companies across many different industry sectors alike. So for us, we have had very limited to no impact on our customers up until the end of the third quarter. We've taken very proactive efforts, and we have built inventory and created in a way a flexible supply situation. But late in the third quarter, we saw some impact on shortages of individual components. Basically, that resulted to loss of some sales, but it resulted also in higher inventory. And this is a risk that we see can have a bit of impact also on the fourth quarter, of course, or it's highly unlikely it will have no impact, but it will have some impact, we think is likely.Despite the share gains we've had outside of China, the reduced market share in China and the supply issues and lower sales in Managed Services led to a slight negative organic growth rate overall, so we're minus 1%. But if we exclude China, we saw a 6% organic growth year-over-year. We also continued to deliver a strong profitability. Gross margin improved sequentially as well as year-over-year, and it reached 44%. And our EBIT margin increased to 15.7%.On IPR, we saw also good progress, and we increased our IPR revenues to 2.6%. This was driven by new agreements as well as a dispute settlement. Both have some retroactive financial impact, as we have said before. And what we see also is that the significant value of our product portfolio and strong technology position in 5G, and that positions us very well to conclude on future -- well, ongoing as well as future patent license renewals. So we feel quite strongly about our position in IPR. However, you all know that timing of these license agreements may cause temporary gaps in our overall IPR revenues, but we will not waver from trying to maximize the value of our existing patent portfolio.We had very strong cash flow, and the free cash flow before M&A was SEK 13 billion during the quarter. And I would say this is primarily a result of the investments and the commitment we have done in our strategy to improve flexibility, reduce sensitivity to business mix as well as lower our working capital needs. We have now built a robust cash position and gives us a strong foundation to grow by investing further in technology leadership but also from inorganic moves.We have a strong commitment to sustainability. You all know that. And it continues to deliver good value for us but also for our customers. And you saw that we just recently launched a new Massive MIMO portfolio that has gains on energy efficiency. It's much less heavy, and it has a lower wind factor, all-in-all providing clear values to our customers. But we also saw that during the quarter, we signed a $2 billion sustainability-linked revolving credit facility.And finally, I want to say our commitment to strengthening our ethics and compliance program continue. This is a longer-term journey. We are committed to invest what it takes, and we have -- we are increasing and carrying significant costs in improving our ethics and compliance programs, but it's also a cultural journey for us as a company. And here, we are firmly committed to ensuring that we have created a culture built on integrity as a fundamental value.So now let's move on to the market area performance. Sales in North East Asia fell by 33%. That is, of course, due to the significantly lower market share in Mainland China. But sales in other parts of the market area actually improved during the quarter. And as a consequence of the loss of sales in China, we have to rightsize our sales and delivery organizations in China, and that will start in Q4. And we will have some structural cost or restructuring cost to that.In South East Asia, Oceania and India, sales decreased by 16%. This is really due to a lot of accelerated rollouts in the end of last year for Networks but also some timing of orders and projects in Digital Services.If you look at Middle East and Africa, sales declined by 8%. In Networks, we saw the primarily impact of timing of 5G contracts in Middle East, but I would also say that Africa clearly returned to growth. And we see -- primarily in Digital Services, we saw actually a strong software upgrades in the African market.In Europe and Latin America, we saw Europe -- or in total, sales increased by 9%. And if we look at the parts here, Europe grew by 5% basically on the back of market share gains. And the same thing in Latin America, we saw a 29% growth. Of course, it's coming off a very difficult period in COVID, but it's still growing very strongly on the back of our share gains. And we see that in both Networks as well as in Digital Services.5G momentum in North America continued, and sales increased by 13%. And clearly, this demand is driven by demand for 5G solutions.So let's now move on to the business segments. So if we start with Networks, of course, sales was hit by China. But if we adjust for Mainland China, sales actually grew by 8% year-over-year. And this reflects clear gains in other markets that we -- that have been possible, thanks to a strong product portfolio. And we continue to see very good momentum in deployment of 5G around the world. Of course, the impact on the supply chain from the disturbances also, of course, hit Networks, and we expect that to pose a challenge as well during the fourth quarter. Nevertheless, we saw gross margin strengthened to 47.8% compared to 46.7% last year.In Digital Services, it's very encouraging that we now are starting to see revenues from the 5G contracts, and that's, of course, helping them to achieve some growth. We saw the segment grow by 1% in the quarter, and that's despite a significant reduction in Mainland China. If we exclude China, sales actually grew by 6% year-over-year. Gross margin was 42.3% compared to 43.5%. And going forward, we expect profitability to improve gradually and is going to exceed our initial target of an EBIT margin of 10% to 12%.Sales in Managed Services fell by -- or decreased by 7% organically. And clearly, here, Q3 was impacted by reduced variable sales, contract rescoping as well as some planned exits mainly in Europe. We also saw that network optimization grew primarily in Europe, and we continue to invest in developing our portfolio with AI and automation to further strengthen our competitiveness. Gross margin decreased to 18.7% compared to 20.1% last year.In Emerging Business and Other, sales grew by 4% organically. And gross margin actually increased very strongly to 39.4% compared to 30.5% last year. Reported sales grew by 26%, and that's, of course, mainly due to the acquired Cradlepoint business. What I would say here is the strengthening of the gross margin actually came out of -- or is, to a very large degree, explained by Cradlepoint. And it's even encouraging to see that Cradlepoint is one of the key drivers of the overall strengthened gross margin for Ericsson as a group.With that, I want to go over to Carl to go through more details on the report and give some more perspectives on our path to profitability in Digital Services. Carl?

[Carl Mellander]

Thank you, Börje. Thank you. And let's have a closer look at the numbers then.So reported sales, SEK 56.3 billion, negative organic development then of 1%, as Börje described, and this is following 4 consecutive quarters of organic growth. And you saw the 2 largest market areas presented growth in the quarter, and the remaining 3 ones saw a decline.We had some disturbances, of course, in the supply chain, as Börje also mentioned, but the big factor here when it comes to top line is clearly Mainland China and the reduced market share there. And in addition to what Börje said that we would have grown 6% in the quarter if we excluded Mainland China, the corresponding year-to-date number there is 10% growth if China is excluded.On IPR then, SEK 2.6 billion in revenue. Out of that, we have certain retroactive benefits from the contracts or agreements that we signed in the quarter. It is an increase of SEK 0.5 billion year-over-year in IPR revenue. So as you see here now, on a rolling 4-quarter basis, our sales is now tracking around SEK 231 billion.Börje showed the gross margin numbers per segment. If we drill a little bit further into this, 44% on the group level, that's up 80 basis points, really based on continued improvements both in the Networks and as well as the Emerging Business and Other segments. And in Networks, pleased and encouraged to see continued operational leverage contributing to the margin here but also the higher IPR revenues, as we said before. And the gross margin in Networks then now at 47.8% compared with 46.7%.In Digital Services, gross margin and excluding restructuring, again, declined 120 basis points. And this is really connected, again, to what we have discussed before, the higher costs for initial deployment in the 5G Core contracts. And sales there, I must say and again emphasize, sales in 5G Core is really progressing well, and we'll come back to a little bit of a deep dive into that a bit later in the call.On Managed Services gross margin, again, excluding restructuring, declined by 140 basis points, and this mainly comes from a reduction of variable sales on a few customer accounts.And lastly then, Emerging Business, up 9 percentage point in gross margin, fueled by, to a large extent, development in Cradlepoint. Of course, Cradlepoint did not exist in our numbers a year ago.So OpEx, as you see, SEK 16.4 billion, up from SEK 15.9 billion a year ago, again, mainly related to the addition of Cradlepoint business, both in R&D and SG&A. When it comes to R&D, the increase there, in addition to Cradlepoint, comes from more investments into the 5G Core portfolio in Digital Services, as we have reported on before as well.We -- there is one line not visible on the slide here, but it's on other income and other operating income and expenses, where we had a positive development in the Ericsson Ventures investment portfolio this quarter. And the net of that positive development and an impairment contributed with SEK 0.4 billion to EBIT, and this is all in Emerging Business and Other segment. So EBIT then ending up at SEK 8.8 billion or a margin of 15.7% in the quarter, which is up 10 basis points year-over-year. And this, remember, is in spite of the lower sales volume.EBITA, as you know, our EBITA long-term target is 15% to 18% of net sales. And we are now, if we look at the rolling 4-quarter basis, hitting 14% EBITA margin.Taxes, SEK 2.5 billion in the quarter and then effective tax rate of 30%. This is also effective tax rate for the full year to date.And now let's look into how this profit is converted into cash flow. So operating activities cash flow increased by SEK 9.4 billion to a total of SEK 14.7 billion. And we can also remember that last year, Q3 was impacted by a SEK 2 billion contribution to the Swedish pension fund. But we work a lot with working capital in our company. We focus a lot on lead times and efficiencies. And you can see that also this quarter, the resulting free cash flow benefited from that working capital work that we put in. We had good collection from customers, including some prepayments as well.And as Börje also mentioned, we did increase inventory again. This is something we have talked about on previous calls also, in order to create even higher resilience in the supply chain. But that was actually offset partially at least with higher trade payables, so the impact on cash flow was not that big.CapEx net and other investing activities was relatively stable year-over-year, so that all resulted in a free cash flow of SEK 13 billion, up more than 200% year-over-year. And maybe again, on the rolling 4-quarter basis, free cash flow before M&A was now SEK 31.3 billion, which corresponds to 13.6%. And again, that's beating then our long-term free cash flow generation target, which is 9% to 12% of net sales. This all meant that our gross cash and net cash increased by SEK 11 billion and SEK 12 billion, respectively.Okay. If we move on to planning assumptions here finally on the quarter then. First of all, starting with the market that we operate in. Dell'Oro now expects the RAN market to grow by 13% in 2021, which is up then from the 10% that was estimated in the May report. And if we break that down by region, some of the regions then: China, 13%; North America, 15%; Europe, 10%. And looking ahead into 2022, the Dell'Oro forecast for the RAN market is to grow by 2%, or 3% if we exclude China. Second point on the supply chain. We see -- saw some disturbances in the third quarter, as mentioned, including some individual component shortages, and we continue to see this as a risk going into the fourth quarter as well for Networks sales.Over to IPR. We have a run rate in the current portfolio of SEK 7 billion. This is the same number as we stated in the Q2 report as well, and it is -- the contract portfolio currently on an annualized basis. And again, as we have discussed many times before, as these key IPR contracts are approaching expiry, we may see an impact on revenues until those contracts are actually renewed. Lastly then on Digital Services, we expect to reach breakeven in the fourth quarter.So now having gone through the quarter as such, I would like to shift gear and say a few words about Digital Services and the road back to profitability in this segment. And to start with, as we communicated already in the second quarter report, now we expect a limited loss in 2022. One impacting factor is, again, the decreased market share in Mainland China. But the long-term target, 10% to 12%, remains, and of course, our ambition is to even exceed that over the longer term.Before diving in really, I just wanted to start here by reemphasizing again the strength in our 5G Core portfolio, and the business momentum is really here. The stand-alone 5G Core market window is open. Customers now make long-term commitments in their choice of vendors here. And we'll come back to our track record so far, but we are winning a lot of these deals. And this is really a cornerstone in our journey here in Digital Services, 5G Core contracts and what we call attached sales around that, and hence, the investment in R&D in this area.If we look at the chart here, starting on the left side then with our investments in R&D. So earlier in this year, and we have talked about this before, we decided to really prioritize long-term ambitions here rather than going for short-term results. So we have increased R&D significantly when it comes to 5G Core and orchestration. It adds expenses in the P&L, of course, short term but builds value clearly for the mid and long term, very similar to the development we've seen in Networks as well. So we also continue to make R&D investments in automation, and this is really more to drive efficiency in our delivery of software and to become more efficient in our own R&D. And thirdly, we also invest going forward now for the future in service orchestration and in evolving now the portfolio to enable our customers to serve not least their enterprise customers, including 5G, network slicing and edge solutions.Looking at gross margin, here, a couple of aspects. First, just to put in perspective the packet core area, including 5G Core that we talked so much about now, that represents about 20%, 25% of the total revenue in Digital Services. The other 75% or 80% of revenue is delivered from the other areas, which all have a clear trajectory towards improved profitability. And this is underpinned by the transformation that we are driving towards more software-based content and more industrialized solutions. One area which I think is worth to call out here is the BSS because we're actually pleased to see that the BSS strategy that we revised in 2018 is delivering. It's been executed, and now the BSS area is delivering gross margins in line with the group average levels.Another aspect impacting gross margin also positively now is that we are managing all of these 45 critical contracts that we talked about and started to mention back in 2017. However then, the gross margin improvements that I just mentioned and the things we do coming out of technology investment are then partially offset by the initial 5G Core deployment costs for new product introduction. And that's why we see an improved gross margin up to 2022 but not yet enough.However, beyond 2022, we see then that we continue the transformation towards software-based solutions to customers, and this is going to contribute to the improved gross margin that you can see here to the right on the slide. Software share will increase, and the recurring element of software will also grow in our Digital Services business. And you can see here, that is really the most significant contribution to our long-term profitability target.Finally then, if we turn to net sales. The way the 5G Core contracts work is that we start to see revenue in the P&L when the networks go live. And then the net -- the revenue from those contracts grow then with added subscribers to those networks. This means that revenue from those will start now -- start towards the end of the year and then continue to grow over time.So to continue then on the market -- on the sales piece. Of course, the Mainland China reduction has cost us quite a bit of top line, and that's what you can see in the thin sales line leading up to 2022. But of course, our ambition here is to compensate that with market share gains in other markets, and this we already saw actually in -- even in the third quarter that this is happening.Finally, when it comes to our ambitions then on CSP enterprise and service orchestration portfolios, we expect this to start to be visible in terms of revenue by 2023 and onwards. And this is then as things like a dedicated network start to scale up, edge, as I mentioned, the network slicing components are being commercialized.So next slide, and I will finish off with this, shows a bit about the momentum in deals won. So far, we have landed 45 stand-alone 5G Core contracts. You can see that on the left here. And 15 of those are added since October last year, and 8 of them are live and generating revenue. And it's really based on our containerized cloud-native technology that we win these deals and we anticipate that we will continue to lead the 5G Core market and more -- add more customers to this list as well.But as mentioned before, it's not only about 5G Core. To the right here, you see examples from the other parts of the portfolio in Digital Services. Starting with BSS, we have 70 new deals in 2021, all in line with the BSS strategy that we have put in place. And actually, our customers need to modernize their BSS to become more agile in the consumer business but also to meet the enterprise customers' requirements.5G Core, as said, drives attached sales as well. And a good example of that is here, what you see on OSS, where network orchestration is a good example. And last year, we celebrated more than 100 customers here in our Ericsson Orchestrator. And since then, we have added another 30 customers on top of that.Cloud communication, more than 160 customers have chosen our VoLTE solution for their voice offerings, of which about 20 new customers are new since last year. And then on cloud infrastructure, we have about 230 customers already and 29 new customers added so far in 2021.So I hope that gave a little bit more meat on the bone on DGS, our Digital Services segment, and the road to profitability. Essentially, it's about investing in technology leadership, winning us market share and improving the margins through a shift to higher software content.Thank you. And back to you, Börje.

[E. Borje Ekholm, President, CEO & Director]

Thank you, Carl. So now I'd like to shift gear a bit and talk more about our overall strategy as well as what the opportunities we see that we can grow in enterprises.But starting here, and really saying as a result of the focused strategy we launched in 2017, we have now delivered, in a way, a clearly improved performance, including cash flow performance. And it's all based on a very strong commitment to R&D to be technology leaders. But this has also established a strong platform to make strategic choices from going forward. The basis for our performance and the basis for us as a company is, of course, a competitive product portfolio. And that today is built upon the leadership in RAN core as well as management and orchestration, and we can deliver those at a very competitive cost.And for us, continue to drive the performance in the core business is going to be critical. And it's actually the fundamental, call it, ingredient that allow us now to make strategic choices for the future. But I think it's also fair to recognize, and you all do that, that the 5G deployment curve, even though it's been growing sharply now and growing great now, it will flatten out, or it's at least likely to flatten out. And you see that in the blue bars here, the darker blue bars on this chart. And we see that happening in the years ahead, and this is a pattern we've seen in other Gs before.But I would also say that the previous generations of mobile technology really only addressed the consumer market. What is actually different with 5G is that it's also addressing enterprise needs, and it was actually designed to fulfill enterprise needs. So we believe that is going to drive traffic into the networks and actually provide a much longer investment cycle in the networks, but it will also start to open up for new segments to be attacked with mobile communication. So we believe that focusing on maximizing the value in our core mobile networks is the fundamental focus going forward, but we also see that we can make a focused expansion into enterprises. This will open up higher growth markets as well as new value streams that we can realize here.What we see with the new future with 5G is that businesses are increasingly making choices where wireless can be a primary access technology. This is very different, and we believe this opens up new markets for us that could be worth up to USD 25 billion by 2025. And this is, maybe more importantly, a market that is growing very fast already today, achieving growth rates well above 20% per year. But it also offers good gross margin as well as operating margin opportunities for us.The last 18 months, we have seen the importance of mobile network to manage during the COVID situation. And mobile networks now play a key role in societies as well as allowing many people around the world to work remotely. But there is no question that with 5G, we're lifting the performance to a completely new level, where we will have much higher bandwidth, lower latency and much higher capacity. And we think that also will offer new opportunities basically to specify quality of service that, in addition to enterprise -- or consumer applications, will start to allow enterprises to take advantage of the wireless networks.We see that we're already being able to unlock value for enterprises with 5G as we can adjust in a way the digital infrastructure based on the needs, and Carl mentioned it already. We start to see network slicing gaining momentum. We see orchestration and edge clouds, and that is something we are developing together with leading partners in the whole ecosystem. And we see that we are only at the beginning of that development, and the opportunities are clearly ahead of us. So we see that there is a long-term value for us that can be captured by being an enabler as well as orchestrator of that ecosystem that's going to come.What we also know is that from the 4G experience is that really the developers that develop applications on top of the networks, they're actually realizing value that's multiples of the investments that goes into the network itself. And we believe with 5G, that will be even more the case. So let me give a couple of examples.One is, for example, on quality of service where you can have network performance adjusted in real time. This basically enables us to differentiate the service to customers, recognizing each customer may have different quality needs or performance needs. Think, for example, telemedicine or think, for example, a sensitive video conference where you need to adjust and rely on very high-quality performance or high-quality networks. I think this is an opportunity for sustainable growth for us, and I'm very excited about driving this strategy into the future.We, of course, are going to see -- that we are already today starting to offer dedicated enterprise offerings. So we have our dedicated networks. We have mission-critical networks, IoT. But we also have, of course, network near solutions. And here, one that we're clearly investing in is Cradlepoint. It's a network near. It, in a way, is grow -- or it helps. Not only does it provide us with a market opportunity, it actually generates revenues also for the CSPs because with every Cradlepoint installation, there is a network need as well. So we see this to be a win-win together with our CSP customers.But we are also very encouraged about the performance we see in those enterprise applications where we can provide very high growth. For example, we see Cradlepoint growing very rapidly, following well on our plans. But most importantly, we're also seeing the gross margin performance of that business to contribute to us as a company now. And that shows that, to succeed in the enterprise area, we know already that we need to, of course, build on what we have to develop them organically, but we also need to rely on inorganic opportunities. And with the capital situation we have, we have the opportunity to make the acquisitions we need to strengthen our offering in enterprises.But now let's move on to the summary slide. So I'm putting another, I would say, strong quarter to our track record. We continue to be well positioned to take advantage of the market opportunities as 5G continues to be deployed globally. We continue to take proactive steps to manage the supply situation. But we, of course, had some impact this quarter, and we think it could pose a risk for the fourth quarter. The C-band rollout continues in North America, and that's a key opportunity for our customers and therefore also for us. But based on a very competitive 5G portfolio, we continue to see a path towards winning more 5G contracts as we move along, both in North America and in the world.So when we look ahead, we do feel that we're in a good position where we are -- where we can take the next steps strategically. But we're, of course, as an interim step, going to deliver on the 2022 targets as a long term -- as a group target, but we're also very committed to our long-term targets for the group.With that, I give the word back to Mr. Nyquist.

[Peter Nyquist, VP & Head of Investor Relations]

Thank you, Mr. Ekholm for that presentation, and thank you, Carl, for the presentation that was more of a strategic focus. So with that, we have -- still have 20 minutes and maybe a little bit more to answer your questions here. So I would like to give the word to Mark. Can you hear me?

[Operator]

[Operator Instructions] Our first question comes from the line of Edward Snyder at Charter Equity Research.

[Edward Francis Snyder, Managing Director and Principal Analyst]

Congratulations on the gross margin performance which was very impressive. I believe that's the highest we've seen since we started covering Ericsson in 1999, so that's -- I'd like to really commend your turnaround strategy.I had a question on gross margin. As the mix of 5G deployment skews even further from China, especially towards North America, why shouldn't we put an upward -- why shouldn't that put upward pressure on margins? Your 5G systems have a higher software content than past systems, and your chip strategy has proven more successful than any of your competitors. So I'm just curious about why coverage projects wouldn't run close to these levels and then densification perhaps raise them further. And then I have a follow-up.

[E. Borje Ekholm, President, CEO & Director]

Do you want to take it?

[Carl Mellander]

Yes. I think we're seeing in the gross margin -- thank you for your comments, by the way, on the gross margin. And what we're seeing is the fruit of the whole strategy and the entire work we have put in actually since 2017, I would say. I mean, investing in leading technology, that's gaining us market share, and that's also now translating in an ever-improved gross margin. And I think our job is to obviously continue on that path and continue to design costs out of our product, at the same time, make it more and more attractive for customers to win further share.

[E. Borje Ekholm, President, CEO & Director]

Yes, I would only say thanks, again, as Carl said, for your comment first. Now we have spent quite a big effort in actually, in a way, removing the exposure to business mix a bit. But what you see early in the cycle is, of course, more hardware. So we do believe there is -- we're quite comfortable about the future gross margin development, I would say, and see that to be providing an attractive basis for our future performance, clearly.

[Edward Francis Snyder, Managing Director and Principal Analyst]

Great. And then you've mentioned that the IPR annual run rate would be around $7 -- SEK 7 billion for existing contracts. Is it possible to get back to SEK 10 billion without China? Or should we expect this just to remain where it is until some other resolutions should occur there?And then if you could please remind us the foreign exchange impact or your exposure to the U.S. dollar. If all else is held constant, what would -- what should we expect for, say, a 10% decline in the dollar? What would that do to revenue and cost?

[E. Borje Ekholm, President, CEO & Director]

If we start on the IPR, and then Carl comments on the sensitivity to currency. The -- we're -- let's not speculate about how future contracts are going to look like. So we'll communicate once we know how they will be and when we have landed them. But clearly, we're very -- we have a strong portfolio. We have a good IPR portfolio that allows us to negotiate with the license partners, and hopefully, we can realize a good value going forward. That's at least our ambition. But let's not go into the details yet.

[Carl Mellander]

Right. And on FX, if we -- at least if we generalize a bit, our rule of thumb is that 10% change in the U.S. dollar-SEK rate translates into about 5 percentage on -- 5% on top line and 1 percentage point on EBIT. Now this quarter, the impact was not that large from currency. Previous quarters, we have seen a quite more dramatic change, of course.

[Peter Nyquist, VP & Head of Investor Relations]

Great. Thanks, Ed, for those questions. We'll move to the next question, which is from Aleksander Peterc at Societe Generale.

[Aleksander Peterc, Equity Analyst]

Yes. I just have a question on the supply chain risks that you see. I'd just like to understand what kind of visibility you have for the supply chain. Do you have good visibility for the next, let's say, 3 months, and so you might have some impact, but nothing really, really major?And then if you could maybe give a bit more detail on what you're missing exactly in terms of components. Or is it logistics rather that is a problem? And does that also lead to any tangible increase in your input costs? And if so, can that affect your gross margins or your pricing going forward?

[E. Borje Ekholm, President, CEO & Director]

Now what we see during the end of the third quarter is, actually, it's individual components that's been missing. So that has, in a way, driven up our WIP inventory and resulted in some lost sales basically. That's what happened. We think these are disturbances that could happen. I wouldn't exaggerate them because we have reasonably good visibility, and we have quite good management of the supply chain. But these were, late in the quarters, decommits that resulted in this disturbance. I wouldn't exaggerate the risk going forward, but it posed some threat, put it that way. It's very hard to tell you exactly how Q4 is going to look now, but we feel quite comfortable about our supply situation going into the quarter.If you look at logistics costs, et cetera, we -- of course, you have some upward pressure there. But we also think those are manageable as we see today. It's -- we're actually benefiting a bit from our supply chain, which we have created with some flexibility with some new facilities around the world to reduce our exposure a bit to logistics costs. But of course, we need to always be vigilant at how we manage our cost structure and manage our deliveries to customers. But so far, that has had some but very limited impact on our margins, and we kind of absorb that in the margins actually. And you see they are developing quite well anyway.

[Peter Nyquist, VP & Head of Investor Relations]

Thanks, Alex. Thank you. We'll move to Francois Bouvignies from UBS.

[Francois-Xavier Bouvignies]

So my first question is on the global RAN market that you expect or maybe Dell'Oro expect to grow 2% in 2022 and 3% excluding China. So what I wanted to ask you is how you feel Ericsson can be versus this target today. And we saw a stronger market in the U.S., obviously, in the last 6 months with twice your upgraded -- your numbers for '21. So how much do you think is a pull-in? Or is it something that also the strong market that you see towards the end of the year is also going to translate into 2022? So just like to clarify a bit on the 2022 outlook and how Ericsson is comparing to.And my quick follow-up is on the IPR, just a clarification. So you have like SEK 2.6 billion this quarter. So how should we think about Q4? Because I don't understand how much is a one-off or catch-up amount, if you just clarify. I'm sorry if I missed it. So how much we should think about Q4, please?

[E. Borje Ekholm, President, CEO & Director]

You take it.

[Carl Mellander]

Yes. Okay. Now on the RAN market, I think, obviously, Dell'Oro expects now, as you said, 2% growth in 2022, 3% excluding China. Our ambition remains to grow faster than the market. And I think we have proven that in the past that we are gaining share. And of course, some of the deals that we have won, contracts that we have landed are not yet visible in the sales numbers either. So that remains to be seen. U.S., of course, being a very big component here. There, we have very good momentum. And as Börje mentioned before, now with the C-band build-outs, we are seeing good CapEx levels from our customers, and we expect that to continue as well. But we have decided to look at the Dell'Oro and talk about the Dell'Oro forecast for the future market development, so we'll stick to that and then try to grow faster than that number.

[E. Borje Ekholm, President, CEO & Director]

IPR.

[Carl Mellander]

On the IPR, yes, so -- and we haven't disclosed exactly the retroactive element there. But as you know, it's SEK 7 billion on an annualized basis. There is a certain retroactive element here in Q3, but I think that's as far as we can go. So the IPR revenue should come down a little bit from the Q3 numbers because of the retroactive element included in Q3 numbers.

[E. Borje Ekholm, President, CEO & Director]

I know you -- I just want to comment on -- because I know everybody wants to know a lot more about the details on IPR. But there is a commercial element here that we also need to make sure that we maximize the value of the, call it, of our patent portfolio. So disclosing too many of the terms in individual contracts just simply gets too sensitive and may actually hurt our ability for the future. So that's why we're a bit restrictive here but trying to provide a guidance that at least can make you form some sort of opinion about each quarter. I know it might be a bit unsatisfactory, but it's really to -- it's not for lack of willing, it's actually to try to run a better business.

[Peter Nyquist, VP & Head of Investor Relations]

Thanks, Börje, and thanks, Francois. We will move to Morgan Stanley and Dominik Olszewski.

[Dominik P. Olszewski, Research Analyst]

So 2 questions. Firstly, on Digital Services. Could you just talk about what drove better EBIT performance in Q3 specifically? Obviously, a bit better than the comparable performance that you talked about when you were talking about Q2, and Q2 into Q3 being the rough same level of profitability. So what was the difference there? Anything in the customer portfolio or product side?And then second question is on Cradlepoint. Can you talk about the success so far you've had in basically immediately adding value to that acquisition? One of the elements I remember was going international. And you acquired the company, I think 90% of revenues was in North America. So how much success have you had in actually growing that into the rest of the world? And are you still expecting the 25% to 30% top line growth in that business and over 60% gross margins that you talked about before?

[E. Borje Ekholm, President, CEO & Director]

I can -- should I tackle the Cradlepoint first and then give you the Digital Services?

[Carl Mellander]

Yes.

[E. Borje Ekholm, President, CEO & Director]

So if we look at Cradlepoint, we have started now to gain success in the international markets. It's still early in the days, but we're starting to see that to pan out. And the investments we made in SG&A have actually started to contribute today. The gross margin is actually better than what we predicted when we made the acquisition. So we are thereby feeling that we are delivering even a little bit better than we had in our own plans a year ago when we made the acquisition.We have not disclosed over details here. But as we build out the enterprise, we will, of course, see how we're going to disclose more and more of the activities we do in there. So bear with us a bit there. But at least, you can -- we can see that we're going in the right direction, both on top line as well as the bottom line. Growth rates going forward should be at least in what we think the market is. If the market is 20%, 25%, we believe we should be able to grow a bit faster than that because we can add the value of international exposure as well.

[Carl Mellander]

Good. And Dom, on Digital Services, why did it turn out better? It's a combination actually of higher sales volumes than expected. And as you saw, even after the decline in China, we actually grew in that segment with 1%, so that exceeded our expectation. And secondly, gross margin was stronger, and that has to do with the software share of sales, which again is exactly in line with our strategy to drive up software, but it came out stronger in this quarter. So therefore, we beat the expectations then. It's very encouraging, by the way.

[Peter Nyquist, VP & Head of Investor Relations]

Thanks, Carl. Great. Are you happy with that, Dom?

[Dominik P. Olszewski, Research Analyst]

Yes. Perfect.

[Peter Nyquist, VP & Head of Investor Relations]

We'll move to Daniel Djurberg at Handelsbanken.

[Daniel Djurberg, Research Analyst]

And also, congratulation on a solid gross margin and cash flow, truly impressive. I would like to start again on the supply chain constraints that could pose a risk that you mentioned. And my question is really, if you expect the impact to be lost revenues or more of a deferred revenues into future development or deployment, I should say. That is the first question.And then if I may, on the Digital Services, your comment that 75% roughly lies outside packet core and also that you took a good momentum here with 30-plus deals on BSS and some 30-plus on OSS so far. But can you comment a little bit on the revenue model for those? Because I just can't see the full impact from those quite high numbers to me at least. If you could comment more on what we should expect given the 75% sales being outside of packet core. And if possible also, a comment on the percentage of OpEx being tilted to those 75% of sales would be great. That is my questions.

[E. Borje Ekholm, President, CEO & Director]

I'll take the supply chain. Maybe you take the DGS question, Carl.

[Carl Mellander]

Yes.

[E. Borje Ekholm, President, CEO & Director]

So on supply chain, yes, we have seen some disturbances. Our ambition is to work with the customer, of course, to make sure that we fulfill their needs. That's ultimately the only way for us to be successful. And if we can do that, it really will end up being delayed sales, and we can realize it later on. So that's what we're trying to work towards. But it's always a risk when you have a supply disturbance, that you can't satisfy the customer. But we're going to do what we can, and so far, we have not seen that we have lost sales. And our ambition is to keep it that way.

[Carl Mellander]

Okay. And Daniel, on DGS or Digital Services, yes, I would say when it comes to the revenue models and so on, it's really similar to the rest. Of course, it's a change towards -- it's a change versus what we had years ago where we went in, for example, in the BSS area, with the services-led scope sometimes a little bit undefined. And as you know, we had more than 40 contracts of that nature that we have now worked hard to get back to a decent profitability level.Now instead, of course, we lead instead with software with the product. And that goes for all of these categories. There's a certain element of system integration, of course, in there as well, and we charge as we go. But mainly, it's a software business now, and this is also what we're driving for in all of these areas. And that's also, as you saw on the graph before, what is going to improve our overall profitability the most. OpEx percentage, I don't have on top of my mind actually, so that I think we can leave that for now, maybe come back to it. Sorry.

[Daniel Djurberg, Research Analyst]

Yes, yes. May I give a short follow-up on the same topic just on your assumption? Thank you for giving this color. But can you comment on your run rate IPR assumption for Digital Services in 2022? Is it SEK 7 billion that you talked about? Or is it something else because of the litigation ongoing?

[Carl Mellander]

On IPR, what we have said earlier actually is that we assume IPR to stay flat in our business planning activities. So yes.

[Peter Nyquist, VP & Head of Investor Relations]

Great. Thanks, Daniel. And we'll move to the next question. I know we're running over the hour, but I will take 2 more questions because we had a little bit of a longer presentation. So the next one is from Peter Kurt Nielsen at ABG.

[Peter Kurt Nielsen, Lead Analyst]

Can I just turn towards the sales side, the top line side, please? If we look at Networks, even adjusted for the lower sales in China, the organic growth in Networks appears to be a bit below the market growth forecasted for the RAN market sort of overall and even for the regions Europe and North America, and you are talking about gaining market shares, too. Could you elaborate a bit on why we're not seeing better sales momentum given the strong overall momentum in the market?And then just referring to your comments about the 3 large contracts in North America, should we expect to see a step-up here from next quarter and next year onwards at least?And if I may add a follow-up on Digital Services, as was highlighted in the previous question, Q3 EBIT loss is significantly lower than you expected 3 months ago. You're still anticipating a breakeven in Q4. Why is that given the positive trends?

[Carl Mellander]

Should I start with the second one, Börje?

[E. Borje Ekholm, President, CEO & Director]

Yes, you can do that.

[Carl Mellander]

Okay.

[E. Borje Ekholm, President, CEO & Director]

Take the third one also.

[Carl Mellander]

Okay. I can take that. Yes, on Digital Services, yes, we maintain the guidance there or the anticipation on breakeven in the fourth quarter. And the way to look at it, I think, is to look at the second half then that will perform significantly better, thanks to the improvement now that we saw in Q3, but we still maintain the breakeven ambition and guidance for Q4. Look at the full 6 months, and it's then substantially improved.

[E. Borje Ekholm, President, CEO & Director]

And if you take the top line, I think it's a couple of different factors to keep in mind here. One is, of course, the supply chain disturbances we had that have had an impact on network sales in the third quarter. But we should also remember that what we have tried to do is to -- or some part of the gain in footprint have been -- or have very limited attached services. So as we see going forward is that we will have a little bit less of attached services, and thereby, you're going to see sales maybe not developing as fast as necessarily the growth in the underlying market. But at the same time, we do believe our product sales is longer term a much more attractive business than selling the services. So when you look at the growth rate, you need to adjust for that as well.

[Peter Nyquist, VP & Head of Investor Relations]

Great, Peter Kurt. We will actually now move to the last question of this session, and that's Sébastien Sztabowicz from Kepler Cheuvreux.

[Sébastien Sztabowicz, Head of Tech]

Yes. One regarding China because your top line is dropping fast and you now plan to attack a little bit the cost base there to protect your margins. Do you see any opportunity to come back in the country at some point with some additional contracts? That will be the first question.And second one is regarding the rise of input cost everywhere in the market, chips, logistic and so on. Do you see any room to increase the price of your base station in some specific contracts in order to protect so much the margins?

[E. Borje Ekholm, President, CEO & Director]

I'd like to think when you lose a contract, the day after, you start to fight to win it back. The same is the thing with China. I do believe we have a chance to win back the trust to deliver products in the future. So we're focused on regaining that. But of course, short term, we just simply need to adjust the cost structure to rightsize that as much as we possibly can. But we're going to try to be there.I think it's important to remember, yes, we see cost pressure upwards, as you indicate. But what we are also seeing as we counterbalance that is actually that we -- this is an industry where it moves very fast on generations as well. And we're actually introducing new products at a higher pace than we have ever done. That's also a way to combat, call it, input price increases. So we feel quite comfortable about our gross margin profile and the way we run the business right now.

[Peter Nyquist, VP & Head of Investor Relations]

Great, Sébastien. With that, actually, we had -- that was the last question. I see I have more questions on the list here. Please contact the IR team, and we will set up meetings and we can discuss those. But before closing, Börje, maybe a remark from your side.

[E. Borje Ekholm, President, CEO & Director]

I just want to say that we continue to execute on our strategy. It is built upon winning in the core mobile network business. And here, we continue to have a very high intensity on our R&D. That helps us to do 2 things. One is to offer competitive solutions to our customers, but equally important, it also addresses the cost structure, and we can actually continuously become more efficient by investing in R&D. So we feel that with the targets we have committed to for 2022 as well as the long-term targets, we're very comfortable about our ability to deliver on those.

[Peter Nyquist, VP & Head of Investor Relations]

Thank you, Börje, and have a great day.

[Carl Mellander]

Thank you, all.

[E. Borje Ekholm, President, CEO & Director]

Thank you.