Ericsson Sinks on Q2 Profit Dip

Ericsson AB (Nasdaq: ERIC) took a hit on the Stockholm exchange today as it announced a worse than expected fall in second quarter profits. (See Ericsson Reports Q2.)

A slump in earnings had been expected (see Ericsson Dips On Q2 Concerns), but a 70 percent year-on-year fall in net income to 1.9 billion Swedish Kronor (US$319 million) was a bigger hit than the financial markets had anticipated.

The news sent the Swedish vendor's share price down by 8.8 percent to SEK68.50 in morning trading. (Please note that differences in historical share price figures are due to a 1:5 reverse stock split on June 4, 2008.)

Four factors contributed to the decline in profits.

First, device joint venture Sony Ericsson Mobile Communications only broke even in the second quarter, so there were no profits flowing through to the parent companies. The handset vendor, which "overall faces a very challenging year," stated Ericsson CEO Carl-Henric Svanberg on today's media conference call, has initiated a cost-cutting strategy to address its profitability issues. (See Sony Ericsson Cuts Jobs.)

Second, Ericsson is undergoing some restructuring itself, and the costs are hammering its profits. The company is shedding around 4,000 jobs and is pruning its product line in a bid to cut its annual expenses by SEK4 billion ($673 million). (See Ericsson Cuts Jobs as H2 Bites.)

That process will cost around SEK4 billion to implement, though, with SEK1.8 billion ($303 million) of that cost hitting the second quarter's profit line. The process has cost Ericsson a total of SEK2.6 billion ($437 million) during the first half of this year.

Third, the weak U.S. dollar is hitting Ericsson's top and bottom lines, as it is with every major international vendor.

Fourth, the "business mix" is still weighted toward low-margin emerging markets, where many new networks are being built, and that is depressing Ericsson's margins as network expansion or upgrade deals are much better money-spinners. In the second quarter its gross margin was 37 percent, down from 43 percent a year earlier, and down from 38.6 percent in the first quarter.

And while margins may be down, revenues are up by 2 percent year on year and by 10 percent sequentially at SEK48.5 billion ($8.2 billion).

Services and Multimedia grow
That rise in revenues comes from growth in Ericsson's Services and Multimedia divisions, while Networks saw a 1 percent decline compared with a year earlier. (See table below).

Table 1: Ericsson Q2 Financial Performance by Business Division
Revenues in billions of Swedish Kronor Q2 2008 Q2 2007 Year-on-year % change Q1 2008 Sequential % change
Networks revenues 33.3 33.7 -1% 30.0 11%
Networks operating margin +10% 19% - 9% -
Professional Services revenues 11.0 10.3 +7% 10.0 10%
Professional Services operating margin +14% 15% - 14% -
Multimedia revenues 4.2 3.6 +16% 4.2 2%
Multimedia operating margin -1% 0% - -12% -
Total revenues 48.5 47.6 +2% 44.2 10%

Sales in the Networks division have been particularly affected by the weak U.S. dollar, while the growing weight of sales in India particularly has hit the division's operating margins. Svanberg said India would be Ericsson's largest single market by revenues in the third quarter.

Svanberg noted that the company's business is "still driven by GSM, much more so than we would have thought a few years ago." But there is also "accelerating" uptake of HSPA (high speed packet access) technology and "growing interest" in LTE. "We will have all three technologies [deployed] in parallel in a few years... our latest base stations are upgradeable in hardware and software" all the way through to LTE, noted the CEO.

Svanberg also highlighted the growing shift toward IP in fixed and mobile networks, and said Ericsson was building Redback's IP technology into its base station platform.

The Multimedia division is still a high cost and relatively low sales business, noted the CEO, who picked out video systems unit Tandberg Television and billing specialist LHS (in which Ericsson holds an 87 percent stake) as the top performers, contributing to a 16 percent increase in revenues.

Professional Services also increased its sales, with the CEO noting six new managed services contracts during the second quarter, with notable deals struck in Latin America. Ericsson says it now runs networks that serve 210 million subscribers around the world, around half of which are in emerging markets. (See Ericsson Wins Telefónica Deal and Ericsson Supplies Mexico.)

North American bright spot
Ericsson's sales increase was helped by continued stronger spending in North America, just as in the first quarter, where HSPA coverage and capacity expansion helped revenues climb by 47 percent to SEK4.4 billion ($740 million), though that was compared with a grim year-ago second quarter. (See Ericsson Spreads Q1 Joy and table below for geographic split of sales.)

Table 2: Ericsson sales by geographic region
Revenues in billions of Swedish Kronor Q2 2008 Q2 2007 Year-on-year change Q1 2008 Sequential change
Western Europe 12.1 12.4 -3% 11.7 4%
Central and Eastern Europe, Middle East and Africa 11.2 11.5 -2% 11.1 1%
Asia Pacific 15.8 16.6 -5% 12.9 22%
Latin America 5 4.1 +21% 4.2 19%
North America 4.4 3 +47% 4.3 2%

The mature Western European market continues to shrink for Ericsson, while Central and Eastern Europe (CEE) dragged down the performance in CEEMA (CEE plus Middle East and Africa), though Africa is delivering growth: Svanberg noted there will soon be 200 million mobile users on the continent.

Asia/Pacific also registered a year-on-year fall in revenues, though the comparative second quarter in 2007 was particularly strong due to some large deals in China. The CEO noted that while the Japanese market had seen a drop in sales in the second quarter, this was expected to pick up following the striking of a new contract with SoftBank Mobile Corp. (See Ericsson Wins Softbank Deal.)

— Ray Le Maistre, International News Editor, Light Reading

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