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Ericsson Sees Networks Progress Despite Mounting Losses

Iain Morris

Ericsson claimed to have seen the green shoots of a recovery at its networks business despite reporting another decline in overall sales and a widening of its net loss for the July-to-September quarter.

The ailing Swedish equipment maker reported a 6% year-on-year fall in revenues for its third quarter, to 47.8 billion Swedish kronor ($5.9 billion), and saw its net loss grow to SEK4.8 billion ($590 million) from SEK200 million ($24.5 million) a year earlier. (See Ericsson Reports Revenue Dip in Q3 .)

But Ericsson AB (Nasdaq: ERIC) said the organic decline in sales was just 3% in the quarter, representing a big improvement on previous results, and insisted there had been "slight growth" in sales at its all-important networks business, after adjusting results for currency and other factors.

Markets reacted positively to the update and Ericsson's share price was trading up nearly 4% in Stockholm at the time of publication.

Table 1: Ericsson Headline Figures (SEK Billions)

Q3 2017 Q3 2016 YoY change
Net sales 47.8 51.1 -6%
−Networks 35.5 37.0 -4%
−IT and cloud 10.3 11.7 -12%
−Other 2.0 2.3 -13%
Gross income 12.1 14.5 -16%
Gross margin 25.4% 28.3% -2.9 percentage points
Operating income -4.8 -0.3 N/A
Operating margin -10.0% -0.7% -9.3 percentage points
−Networks 1.0% 8.0% -7 percentage points
−IT and cloud -41.0% -15.0% -26 percentage points
−Other -48.0% -32.0% -16 percentage points
Net income -4.3 -0.2 N/A
Source: Ericsson.

Hit by a downturn in its main equipment markets -- as well as relentless competition from rivals Nokia Corp. (NYSE: NOK), Huawei Technologies Co. Ltd. and ZTE Corp. (Shenzhen: 000063; Hong Kong: 0763) -- Ericsson has taken an axe to its business with the aim of restoring profitability and narrowing its focus.

Chief executive Börje Ekholm has set an immediate target of boosting Ericsson's operating margin to around 12% beyond 2018 from just half that level in 2016.

Yet despite cost-cutting efforts -- which included a net reduction in headcount of 3,000 employees in the third quarter, or about 3% of total staff numbers at the end of June -- Ericsson saw its operating margin turn negative, reporting a figure of -0.1% compared with 3.1% a year earlier, even after restructuring charges were excluded.

Ekholm blamed the impact of "higher amortization than capitalization of development expenses" linked to the company's technology and portfolio shifts.

At SEK4.8 billion ($590 million), the final operating loss was much worse than financial analysts had expected, with mainstream press reports putting average analyst estimates at about SEK3.5 billion ($430 million).

Profitability was hit by restructuring charges of about SEK2.8 billion ($340 million), including a writedown of SEK1.6 billion ($200 million) related to the closure of one of the company's three global ICT centers. "We're closing the one in Canada and taking a bit of a restructuring charge but that will reduce the annual run rate cost by SEK300 million [$36.8 million] from the second half of 2018," said Carl Mellander, Ericsson's chief financial officer.

Ericsson said that "customer project adjustments" had cost it another SEK2.3 billion ($280 million).

Ekholm tried to highlight the few positives in the latest report, noting an increase at the networks business in the adjusted operating margin, which rose to 11% from 9% a year earlier.

But he also warned investors that a new strategic push to gain market share in China could have short-term ramifications for that division's profitability.

"We are seeing that big [4G] investment peak in China is now over and levels are normalizing and so demand is softer, but we are targeting an increase in market share in preparation for 5G and that will have a dilutive effect on gross margins in the fourth quarter," Ekholm told analysts during a call about the latest figures.

The company cited growing customer interest in its Ericsson Radio System, which it claims can be "software-upgraded" to support both 5G and NB-IoT services as those become available.

Cloudy future
There was less to shout about at the loss-making IT and cloud division, which recorded a 12% fall in sales, to SEK10.3 billion ($1.3 billion), and saw its operating loss widen to SEK4.2 billion ($510 million) from SEK1.7 billion ($210 million) a year earlier.

Now reported as "other," the media business also continued to struggle, with sales declining 13%, to SEK2 billion ($250 million), and the operating loss growing 25%, to SEK1 billion ($120 million).

Ericsson appears to be trying to sell both its media business and a cloud hardware division, and has already sold its power modules business to Asia's Flex.

Further divestments could help to boost profitability and allow Ericsson to concentrate on its core networks business, through which it hopes to build a leadership position in the nascent 5G market.

Ericsson is reportedly looking to cut about 25,000 jobs, or about 23% of its total workforce at the end of June, and is already slashing headcount throughout Europe. (See Ericsson Plans 25,000 Job Cuts – Report.)

Senior executives have not confirmed the vendor's ultimate targets for staff reductions, although Ericsson has indicated that it wants to cut annual operating expenses by at least SEK10 billion ($1.2 billion) by mid-2018.

Ericsson is also reviewing what it calls "underperforming contracts" under its latest profitability-focused strategy. So far it claims to have either exited or renegotiated 13 of 42 contracts that were put up for review.

That has led to an annualized profit improvement of SEK400 million ($49 million), said the company.

Nevertheless, analysts today suggested that Ericsson might need to raise cost-cutting targets given the sales pressure it is under. It is now forecasting an 8% decline in the market for radio access network (RAN) equipment this year and expects its narrower focus to reduce full-year sales in 2019 by SEK10 billion ($1.2 billion), from about SEK223 billion ($27.3 billion) last year.

Ekholm shrugged off those comments during the call. "We have a competitive product portfolio in the RAN market and we're confident about our cash position as well," he said, ruling out any possibility of a rights issue in the near future.

— Iain Morris, News Editor, Light Reading

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