Ericsson (Ericsson (ERIC)) stock took a beating Tuesday after the telecom gear maker reported second-quarter numbers that missed revenue expectations, showed shrinking margins in its core business, and came with a cautious outlook that spooked investors.

The company posted earnings per share of 13 cents, right in line with what analysts were expecting. But quarterly sales came in at 52.7 billion Swedish kronor ($5.42 billion), down 6% from a year ago and below the $5.84 billion consensus estimate. Organic sales, which strip out the effects of acquisitions, divestitures, and currency swings, fell 1%.

Networks Business Drives the Revenue Decline

Ericsson's core Networks division, which is the heart of the company, saw sales drop 8%. The Enterprise segment fell 19%, largely because of the divestment of iconectiv in 2025. Cloud Software and Services was a rare bright spot, with revenue up 3%.

On an organic basis, Networks sales declined 4%, mainly due to lower IPR licensing revenue. Cloud Software and Services organic sales rose 5%, with growth across all market areas. Enterprise organic sales increased 3%, helped by growth in Global Communications Platform and Enterprise Wireless Solutions.

Margins and Cash Flow Weaken

Profitability took a hit during the quarter. Adjusted gross margin ticked up to 48.4% from 48.0% a year earlier, but adjusted EBIT margin slipped to 12.4% from 12.6%, and adjusted EBITA margin fell to 13.1% from 13.2%.

Free cash flow before mergers and acquisitions dropped to 0.4 billion kronor from 2.6 billion kronor a year earlier. Ericsson ended the quarter with a net cash position of 59.8 billion kronor.

AI-Driven Component Costs Are the Big Worry

Here's the real story: the AI boom is making components more expensive, and Ericsson is feeling the pinch. Executives and analysts flagged rising component costs as a key pressure point, even though management said supply-chain actions helped limit the near-term damage.

CEO Börje Ekholm said the company is "not immune" to the inflationary pressure and expects the financial impact to build gradually over the coming quarters and into 2027. To offset the higher costs, Ericsson is raising prices, redesigning products, pursuing supply chain efficiencies, and renegotiating customer contracts. But management acknowledged that fully mitigating the pressure will take time.

Analysts See Longer-Term Cost Risks

Citi analyst Andrew Gardiner told Bloomberg that the main challenge for Ericsson isn't the immediate impact of higher component costs but the pressure that could build into 2027. CFO Lars Sandström said in an interview that Ericsson mitigated component cost pressure through measures across the supply chain.

The cost concerns come as AI data center demand tightens memory chip supply and pushes prices higher, forcing companies to raise prices for their own products and services. Ericsson has also faced weak telecom-equipment demand for years as expected 5G network upgrade spending failed to materialize. The company has responded by cutting costs, including eliminating about 5,000 jobs worldwide in 2025, and it plans to reduce expenses at a similar pace this year.

Outlook: Seasonal Recovery With Margin Pressure

Ericsson forecasts that third-quarter sales growth for Networks will be above the 3-year average seasonality. It also expects quarterly Cloud Software and Services sales to be broadly in line with the 3-year average seasonality. The company anticipates a quarterly adjusted gross margin of 48% to 50% for Networks.

However, the company expects 2026 restructuring charges to remain elevated. Ekholm said Ericsson took steps in the quarter to mitigate the impact of component cost inflation and will continue using internal measures and pricing actions as those pressures build in the coming quarters. He also said Networks' adjusted gross margin could face some pressure in the third quarter due to higher volumes of network rollout projects.

Management Sees AI Connectivity as a Long-Term Growth Driver

Looking ahead, Ekholm said Ericsson enters its next phase from a position of strength. The company has strengthened its portfolio in recent years to capture the next wave of AI-driven connectivity and expand beyond mobile network leadership into growth areas tied to AI moving into the physical world.

Ericsson executives said the company is entering its next phase from a stronger position, with AI-driven connectivity, progress in Cloud Software and Services, and disciplined cost actions shaping its outlook as Ekholm prepares to step down as CEO after nearly 10 years in the role.

CEO Transition Underway

Per Narvinger, head of Networks and incoming CEO, will take over on Oct. 1, 2026. Narvinger said Ericsson holds a strong market position and portfolio, and he pointed to progress in Cloud Software and Services after earlier turnaround work.

Executives Outline Future Growth Opportunities

Ekholm said Ericsson is preparing for the next phase of AI adoption, when AI spreads into industrial and physical-world applications. That shift should increase demand for high-performance mobile connectivity, stronger indoor coverage, low latency, and higher uplink capacity.

Ekholm said Ericsson sees growth opportunities in enterprise connectivity, network APIs, mission-critical networks, and defense applications. He also said the company remains focused on strengthening its core mobile Networks business through R&D investments in high-performing programmable networks.

ERIC Price Action: Ericsson shares were down 13.82% at $10.10 at last check on Tuesday.