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Ericsson Feels Networks Squeeze in Q3

Ray Le Maistre

Global economic and telecom sector trends continue to put pressure on Ericsson AB (Nasdaq: ERIC)'s Networks division, which suffered a 17 percent year-on-year decline in revenues to 26.9 billion Swedish kronor (US$4 billion) during the third quarter.

Sales of network equipment are down in key markets such as China, South Korea, Russia and a number of other European countries. Strong sales in North America, despite the ongoing (and expected) slump in CDMA equipment sales, saved the division from even greater declines. That decline in overall network equipment revenues, in turn, is putting pressure on the vendor's gross margin level, which dipped to 30.4 percent in the quarter, down from 35 percent a year ago. The company's operating margin is also much lower than a year ago, as the table below shows, though it did improve on the previous quarter.

Investors were spooked by those margins, as Ericsson's share price dipped by 4.2 percent to SEK57.95 by late morning on the Stockholm exchange.

In total, Ericsson reported third-quarter revenues of SEK54.6 billion ($8.13 billion), down 2 percent from a year ago, and a net profit of SEK2.2 billion ($328 million).

Table 1: Ericsson Q3 2012 Key Financials

In billions of Swedish kronor Q3 2011 Q3 2012 Y/Y change Q2 2012 Q/Q change
Revenues 55.5 54.6 -2% 55.3 -1%
Gross margin 35.0% 30.4% Decrease of 4.6 percentage points 32.0% Decrease of 1.6 percentage points
Operating margin excluding joint ventures and sale of Sony Ericsson 11.3% 6.7% Decrease of 4.6 percentage points 5.9% Increase of 0.8 percentage points
Net income 3.8 2.2 -42% 1.2 81%

But CEO Hans Vestberg and CFO Jan Frykhammar, while recognizing that the numbers are of concern and profitability levels are "not satisfactory," are consistent in their explanation of what is happening with Ericsson's business.

As they have said previously and repeated today during the morning webcast press conference, the company made a strategic decision to take on board large network rollout and transformation projects that, in the case of the largest contracts, involve thousands of staff and contractors and generate low margin sales. (See Ericsson Sets Q2 Benchmark and Ericsson Retrenches in Q1.)

Those sorts of projects are still dominating Ericsson's business and will continue to do so in the near future. But the combined scale and longer-term potential of these projects is exciting Vestberg: "In my time at Ericsson I have never seen so many big projects ... the number is unprecedented," said the CEO. "I believe this is the right strategy," he added.

That's because Vestberg believes that higher-margin business, in the form of capacity and software sales, will follow once the network coverage and transformation projects are completed. And while the CEO and CFO are reluctant to pin down when the tide will turn, it seems that the shift away from low-margin projects should start in the coming months and then accelerate during 2013, so there will be a big spotlight on the execution of Ericsson's strategy next year.

In the meantime, the company is still the world's biggest mobile networks vendor, is still generating a profit and is investing in areas it regards as key for the future, such as OSS and BSS capabilities and edge routing (for service delivery and backhaul). It's also planting its flag in the software-defined networking (SDN) ground. (See Ericsson CTO: Let's Redefine SDN, The Lowdown on Service Provider SDN and Ericsson Buys More OSS Smarts .)

Ericsson is as much a Service Provider Information Technology (SPIT) company as a network infrastructure company these days. (See The SPIT Manifesto 2.0.)

There's a great deal of detail in the company's third-quarter report, which you can read in full here. Here are a few points of interest that caught our eye:

  • With lower network equipment sales, the Global Services and the Support Solutions divisions now collectively account for more than half of Ericsson's revenues.
  • CDMA equipment sales were down more than 50 percent year-on-year to SEK1.6 billion ($238 million).
  • The vendor signed 13 new contracts for its Smart Services Router products in the third quarter, compared with seven in the previous quarter. No financial details are given for this business line, though.
  • Ericsson's gross margin was lower in the third quarter than that of fierce rival Nokia Networks -- noteworthy as it is a first. (See APAC Boosts NSN's Q3.)
  • Ericsson believes its market share of 4G-related business in Latin America will be greater than 50 percent, much higher than its 3G share in that region. (See Ericsson Lands LTE Deal in Brazil.)
  • While rivals such as NSN and Alcatel-Lucent (NYSE: ALU) look to reduce the number of managed services deals they have, Ericsson continues to add more, with 11 deals (including 5 expansion or extension deals) signed in the July-September quarter.
  • Ericsson's headcount at the end of September was 109,214, of which 59,000 are in services roles. The company has been hiring more services staff for its Global Service Center in India to support its new managed services customers.
  • The Telcordia business contributed revenues of SEK1.1 billion ($164 million) in the third quarter. Recent acquisition ConceptWave will be integrated into the Telcordia team.
  • Ericsson believes that of the world's 6.4 billion mobile connections, 1.4 billion are mobile broadband connections.

    — Ray Le Maistre, International Managing Editor, Light Reading

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