Swedish telecommunications equipment giant LM Ericsson Telephone (ERIC.US) reported its second-quarter results for 2026 on Tuesday. Weighed down by a reduction in patent licensing revenue, net sales for the quarter fell 6.1% year-over-year to SEK 52.69 billion (approximately $5.61 billion), missing market expectations of SEK 53.61 billion. However, the adjusted gross margin defied the trend, rising to 48.4% and surpassing the market estimate of 47.9%. Adjusted EBITA reached SEK 6.9 billion, exceeding the consensus forecast of SEK 6.71 billion, with the adjusted EBITA margin of 13.1% also beating the expected 12.5%. Net profit declined by 12% to SEK 4.1 billion.

Outgoing CEO Börje Ekholm stated in a release, "The second quarter results fully demonstrate the strength of our product portfolio and strict execution."

Revenue Misses, Profit Falls, But Margins Surprise

The report shows LM Ericsson Telephone's second-quarter net sales decreased 6% year-over-year to SEK 52.69 billion (approx. $5.4 billion), below the analyst forecast of SEK 53.61 billion. Organic sales declined by 1%, primarily reflecting lower patent licensing revenue—a one-time gain from the settlement of a portion of intellectual property rights was recorded in the same period last year, with no such contribution this quarter.

Nevertheless, the profit side demonstrated unexpected resilience. The adjusted gross margin increased from 48% a year ago to 48.4%, exceeding the highest analyst forecast of 48.2%. Adjusted EBITA was SEK 6.9 billion (approx. $710 million), above the market consensus of SEK 6.71 billion. The adjusted EBITA margin was 13.1%, higher than the consensus expectation of 12.5%. However, net profit fell 12% year-over-year to SEK 4.1 billion (approx. $420 million).

Free cash flow plummeted 85% to SEK 0.4 billion from SEK 2.6 billion in the prior-year period. Although the profit bottom line was maintained, the sharp deterioration in cash generation raises questions about the sustainability of the capital return policy.

AI 'Steals' Chips: Memory Shortages Drive Up Telecom Equipment Costs

A notable signal in the report is the "unexpected transmission" of the AI boom's impact on telecom equipment cost structures. Ekholm stated that the company took measures during the quarter to address component cost inflation. CFO Lars Sandström also confirmed in an interview that component costs were "reduced through measures across the entire supply chain"—a statement that precisely confirms the existence of pressure.

The booming development of AI data center construction has driven demand for memory chips, leading to supply constraints and rising costs. Omdia analyst Ronan de Renesse warned earlier this year, "The telecom industry is facing severe shortages of memory chips and copper, affecting network deployment, decommissioning costs, and smartphone pricing." Industry publication Light Reading also reported in June that both Nokia and LM Ericsson Telephone had warned that AI is pushing up component prices and extending delivery times.

The pressure from rising memory chip prices is being transmitted throughout the industrial chain. According to memory giant SK Hynix, the global memory industry is expected to face its most severe supply shortage in history by 2027. A report from semiconductor research firm SemiAnalysis indicates that memory, flash, and HBM collectively account for 30% of global hyperscale cloud data center capital expenditures in 2026. This suggests that telecom equipment manufacturers' chip cost pressures are far from over.

Jefferies analysts have previously pointed out that "given continued strength in memory prices, gross margins may still face pressure in the fourth quarter of 2026." J.P. Morgan also noted in its earnings preview that AI-driven chip cost increases are squeezing profits, with pressures potentially becoming more pronounced in the second half of the year. The company has taken measures this quarter to mitigate component cost inflation. As cost pressures accumulate in the coming quarters, the company will continue to offset the impact through internal measures and pricing actions.

North American Slowdown and Global Divergence: A 'Two-Sided Story' for Business Outlook

LM Ericsson Telephone's business outlook shows clear regional divergence. The North American market—which Ekholm significantly expanded during his tenure by winning contracts with operators like AT&T and Verizon—saw a slight decline this quarter. J.P. Morgan analysts noted that the retreat in North American 5G investment is the biggest drag, as investment in the U.S. is slowing with most 5G deployment complete.

However, growth hopes are pinned on the European and Indian markets. Among LM Ericsson Telephone's four market areas, three recorded organic sales growth. The North American market continues to be sluggish as the peak of 5G construction has passed, with U.S. business slightly declining in the second quarter. Europe and India have become the main growth engines.

Yet, the improved growth expectations come with warnings of margin pressure. Ekholm explicitly stated that the adjusted gross margin for the Networks business will face some pressure in the third quarter due to increased volumes in network deployment projects. The company's third-quarter forecast for the Networks business adjusted gross margin is a range of 48% to 50%, whereas the market's previous expectation was 49.5%. This forecast implies that despite an improved demand outlook, pressure on the cost side is compressing profit margins.

J.P. Morgan noted in its earnings preview that the timing of volume ramp-up in the European and Indian markets remains uncertain.

Strategic Divergence: Ericsson Sticks to 'Pure Equipment' Path, Nokia Bets on AI Data Centers

Amid cost pressures and demand divergence, LM Ericsson Telephone and its Finnish rival Nokia are moving towards different strategic paths. Nokia has restructured its business to prioritize network equipment for AI data centers. Reports indicate that Nokia has fully embraced Nvidia GPU solutions and launched the AI Aerial platform, already achieving AI-driven 5G calls. In contrast, LM Ericsson Telephone remains committed to being a pure supplier of mobile network equipment to telecom operators.

On the technology front, LM Ericsson Telephone has chosen a self-developed ASIC route, partnering with Intel on a CPU+AI accelerator solution, emphasizing cost, power consumption, and supply chain security advantages. The divergence in these two strategic paths reflects different responses within the telecom equipment industry to the AI wave. Nokia has chosen to actively embrace the incremental AI data center market, while LM Ericsson Telephone prefers to deepen its presence in the existing mobile network core—the former may gain a new growth driver, while the latter faces the challenge of finding a new engine after saturation in the North American market.

Ekholm's 'Final Quarter': Challenges for the Incoming CEO

This earnings report is also the final quarterly report of Ekholm's tenure. He will officially step down as CEO on September 30, 2026, to be succeeded by current Executive Vice President and Head of Networks, Per Narvinger. Ekholm will continue to serve as an executive advisor until June 15, 2027, to assist with the transition.

Jefferies analysts expect no major strategic shifts upon Narvinger's appointment. However, the challenges facing the new CEO are significant: how to find new growth engines after the North American 5G investment retreat, how to cope with ongoing AI-driven chip cost increases, and how to find a sustainable balance between profit margins and cash flow—these will be Narvinger's primary tasks upon taking office.

Ålandsbanken analyst Lars Söderfjell described Ekholm's final earnings report as "exceptionally calm"—but perhaps that is precisely the issue. During his nine-year tenure, Ekholm raised LM Ericsson Telephone's Networks business gross margin from 29% to 48%, but now new challenges are emerging from the outside. As the voracious demand for memory chips from AI data centers continues to push up component prices, LM Ericsson Telephone has delivered a mixed report card of "profits exceeding expectations, revenue missing expectations." The 13.1% EBITA margin held the line, but the 85% collapse in free cash flow and the lowered third-quarter gross margin guidance reveal deeper structural pressures. The dual squeeze of the North American 5G retreat and rising AI costs is pushing the Swedish telecom giant into a more complex operating environment. For the incoming Narvinger, finding a new growth narrative on the "pure equipment" path will be a more severe test than any earnings report.

Shareholder Returns and Business Outlook

This quarter, LM Ericsson Telephone returned SEK 8.2 billion to shareholders, including SEK 3.2 billion through share buybacks. The company's net cash position remains strong. For the third quarter, LM Ericsson Telephone expects Networks business sales growth to be higher than the average seasonal pattern of the past three years, with an adjusted gross margin forecast range of 48% to 50%. Pre-M&A free cash flow fell 85% year-over-year to SEK 0.4 billion this quarter, and the cash flow situation still requires attention.

Market ratings for LM Ericsson Telephone are divided. Current analyst recommendations include 6 Buys, 13 Holds, and 8 Sells, with an average target price of approximately SEK 101.52. Handelsbanken reiterated a "Buy" rating before the earnings but lowered its target price from SEK 132 to SEK 123. J.P. Morgan had previously forecast a Q2 EBITA margin of 13.3%, above the consensus expectation.

LM Ericsson Telephone stands at a critical inflection point: the end of the Ekholm era and the beginning of the Narvinger era, superimposed with AI-driven component cost pressures and the shift in the 5G investment cycle. Whether the third-quarter gross margin can hold within the 48%-50% guidance range will be a key test of the Swedish telecom giant's cost control capabilities and pricing power.