Ericsson reports changed business mix and lower income
[Ericsson discloses the information provided herein pursuant to the Swedish Securities Exchange and Clearing Operations Act and/or the Swedish Financial Instruments Trading Act. The information was submitted for publication at 07.30 CET, on October 25, 2007.]
CEO COMMENTS
"The sharp decline in profit this quarter is mainly due to weaker sales of mobile network upgrades and expansions combined with continued high sales of new network buildouts," said Carl-Henric Svanberg, President and CEO of Ericsson (NASDAQ:ERIC). "This changed business mix within Networks affected Group margins negatively. All other businesses performed as expected.
Our networks business continues to develop most rapidly where new network buildouts and break-in contracts are predominant and pricing pressure is most intense. This has so far been offset by higher margin sales of software, expansions and upgrades to our installed base. While we expect such higher margin sales to gradually resume, new network buildouts will continue to weigh on Networks' margins for several quarters.
The Professional Services segment continued to show strong growth and stable margins. The Multimedia segment also showed a strong growth with operating income slightly above breakeven level, reflecting the mix of businesses with healthy margins and investments in new business areas.
In infrastructure, scale is critical for success. In this period of vendor consolidation, we have chosen to secure our scale advantage in mobile networks through organic growth. This strategy has been effective but comes at a certain cost. Now that we have reestablished our scale advantage we will now capitalize on our gains and leading position," said Carl-Henric Svanberg.
FINANCIAL HIGHLIGHTS
Income statement and cash flow
| Third quarter | Second quarter | Nine months | ||||||
| SEK b. | 2007 | 2006 | Change | 2007 | Change | 2007 | 2006 | Change |
| Net sales | 43.5 | 41.3 | 6% | 47.6 | -9% | 133.3 | 125.6 | 6% |
| Gross margin | 35.6% | 38.2% 1) | - | 43.0% | - | 40.6% | 41.5% 1) | - |
| EBITDA margin | 17.4% | 25.4% | - | 23.9% | - | 21.8% | 23.2% | - |
| Operating income | 5.6 | 8.8 | -36% | 9.3 | -39% | 23.0 | 23.6 | -3% |
| Operating margin | 12.9% | 21.2% | - | 19.4% | - | 17.3% | 18.8% | - |
| Operating margin ex Sony Ericsson | 9.0% | 16.5% | - | 16.4% | - | 13.7% | 16.0% | - |
| Income after financial items | 5.6 | 8.9 | -37% | 9.3 | -40% | 23.1 | 23.8 | -3% |
| Net income 2) | 4.0 | 6.2 | -36% | 6.4 | -38% | 16.2 | 16.5 | -2% |
| EPS, SEK 2) | 0.25 | 0.39 | -36% | 0.40 | -38% | 1.02 | 1.04 | -2% |
| Cash flow from operating activities | -1.6 | 4.8 | - | 4.2 | - | 7.2 | 7.5 | - |
1) Including cost for Marconi restructuring and career change program of SEK 2.9 b that took place in third quarter 2006 of which SEK 1.7 b. affected gross margin.
2)Attributable to stockholders of the parent company, excluding minority interest.
The year-over-year sales increase amounted to 6%, of which 4% was organic growth. The USD has continued to weaken during the quarter and affected reported sales growth negatively.
The decline in gross margin is mainly due to the business mix. In addition, the year-over-year growth in network rollout affected Group gross margins negatively.
Operating income amounted to SEK 5.6 (8.8) b. in the quarter and SEK 23.0 (23.6) b. year-to-date. The lower operating income and margin is the result of a mix shift with lower high margin upgrade sales and increased lower margin roll outs of new networks. Sony Ericsson's pre-tax profit contributed 4% to Group operating margin in the quarter.
Cash flow from operating activities reached SEK -1.6 (4.8) b. in the quarter and SEK 7.2 (7.5) b. year-to-date. Working capital increased by SEK 7.7 b. as a result of ongoing larger projects and in preparation for a seasonally strong fourth quarter. Cash conversion for the first nine months decreased to 30%, mainly due to lower net income and increased working capital. With regards to cash flow from operations, the capital redemption from Sony Ericsson of SEK 1.4 b. was offset by a similar amount of reduction of the advance payment to Ericsson Mobile Platforms.
Balance sheet and other performance indicators
| | Nine months | Six months | Three months | Full year |
| SEK b. | 2007 | 2007 | 2007 | 2006 |
| Net cash | 11.5 | 16.1 | 29.1 | 40.7 |
| Interest-bearing provisions and liabilities | 32.5 | 32.6 | 22.6 | 21.6 |
| Trade receivables | 56.8 | 55.3 | 52.4 | 51.1 |
| Days sales outstanding | 115 | 106 | 107 | 85 |
| Inventory | 25.6 | 24.6 | 24.1 | 21.5 |
| Of which work in progress | 14.0 | 14.1 | 14.9 | 14.2 |
| Inventory turnover | 4.5 | 4.4 | 4.2 | 5.2 |
| Payable days | 59 | 64 | 67 | 54 |
| Customer financing, net | 3.8 | 3.7 | 3.8 | 3.7 |
| Return on capital employed | 21% | 24% | 24% | 27% |
| Equity ratio | 56% | 54% | 57% | 56% |
Deferred tax assets decreased in the quarter by SEK 1.2 b. to SEK 11.5 (14.3) b.
During the quarter, approximately SEK 1.3 b. of provisions was utilized related to restructuring, product warranties, customer projects and other. Additions of SEK 0.9 b. and reversals of SEK 0.7 b. have been made, leading to a net negative impact on the income statement of SEK 0.2 b. in the quarter and SEK -1.1 b. year-to-date. Net impact on the income statement has been negative every quarter since 2003.
SEGMENT RESULTS
| | Third quarter | Second quarter | Nine months | |||||
| SEK b. | 2007 | 2006 1) | Change | 2007 | Change | 2007 | 2006 1) | Change |
| Networks sales | 28.5 | 29.2 | -2% | 33.7 | -15% | 91.5 | 88.7 | 3% |
| Of which network rollout | 4.0 | 3.5 | 14% | 4.3 | -7% | 12.1 | 10.9 | 11% |
| Operating margin | 8% | 9% | - | 19% | - | 15% | 15% | - |
| EBITDA margin | 13% | 14% | - | 24% | - | 20% | 21% | - |
| Professional Services sales | 11.0 | 8.7 | 26% | 10.3 | 7% | 30.8 | 26.3 | 17% |
| Of which managed services | 3.4 | 2.2 | 50% | 2.9 | 15% | 8.9 | 7.0 | 27% |
| Operating margin | 15% | 12% | - | 15% | - | 15% | 14% | - |
| EBITDA margin | 17% | 13% | - | 16% | - | 16% | 15% | - |
| Multimedia sales | 4.0 | 3.1 | 31% | 3.6 | 10% | 11.0 | 9.3 | 18% |
| Operating margin | 1% | 3% | - | 0% | - | 3% | 2% | - |
| EBITDA margin | 6% | 4% | - | 5% | - | 7% | 3% | - |
| Unallocated sales | - | 0.3 | - | - | - | - | 1.3 | - |
| Total sales | 43.5 | 41.3 | 6% | 47.6 | -9% | 133.3 | 125.6 | 6% |
| Of which Mobile Systems | 28.5 | 28.0 | 2% | 32.7 | -13% | 89.6 | 85.5 | 5% |
1) Including cost for Marconi restructuring and career change program of SEK 2.9 b that took place in third quarter 2006.
Networks
Sales in Networks declined mainly due to lower sales of expansions and upgrades of mobile networks as well as software. Sales of lower margin network buildouts and break-ins currently represent an increasing part of the networks business. It is this shift in business mix that is negatively affecting group gross margin rather than a change in the underlying margins of the different types of businesses. Adjusted for Marconi and career change program restructuring costs Networks' operating margin was 18% and EBITDA margin was 23% in the third quarter 2006.
Sales of optical and radio transmission systems for back/long-haul showed good growth.
The alignment of Ericsson's and Redback's sales channels is running according to plan, however with some negative effects on Redback's sales during this transition. Significant resources have been redeployed from other parts of Ericsson to support Redback's rapid expansion, including integrating their technology into other Ericsson products.
Sales in Professional Services grew by 26% year-over-year and continue to outpace the market. Managed services grew by 50% year-over-year. More than two thirds of Professional Services revenues are currently of a recurring nature. Operating margins were stable mainly due to good performance in other product areas within services, which helped to offset startup costs for several new managed services contracts.
Multimedia
Sales growth was 31% year-over-year of which 14% is acquired. Operating income in the quarter was slightly above breakeven level. The areas mobile platforms, service delivery platforms, Tandberg television and charging are all showing strong growth with healthy margins. IPTV, IMS and Messaging are new business development areas with significant R&D investments but with limited sales.
Sony Ericsson Mobile Communications
For information on transactions with Sony Ericsson Mobile Communications, please see Financial statements and Additional information.
| Third quarter | Second quarter | Nine months | ||||||
| EUR m. | 2007 | 2006 | Change | 2007 | Change | 2007 | 2006 | Change |
| Number of units shipped (m.) | 25.9 | 19.8 | 31% | 24.9 | 4% | 72.6 | 48.8 | 49% |
| Average selling price (EUR) | 120 | 147 | -18% | 125 | -4% | 126 | 147 | -14% |
| Net sales | 3,108 | 2,913 | 7% | 3,112 | 0% | 9,145 | 7,177 | 27% |
| Gross margin | 31% | 31% | - | 30% | - | 30% | 29% | - |
| Operating margin | 13% | 15% | - | 10% | - | 12% | 11% | - |
| Income before taxes | 384 | 433 | -11% | 327 | 17% | 1,073 | 796 | 35% |
| Net income | 267 | 298 | -10% | 220 | 21% | 741 | 550 | 35% |
Units shipped in the quarter reached 26 million, a 31% increase compared to the same period last year. Sales for the quarter were EUR 3,108 m., representing a year-on-year increase of 7%. Income before taxes for the quarter was EUR 384 m., representing a year-on-year decrease of 11% and reflecting the exceptional third quarter the company experienced in 2006. Net income for the quarter was EUR 267 m. In line with Sony Ericsson expectations, the increase in low and mid-tier priced phones in the product portfolio in the third quarter resulted in a decline in ASP to EUR 120.
As communicated by Sony Ericsson at the beginning of the year a capital redemption of total EUR 300 million was paid to the parent companies in the third quarter.
Ericsson invoiced Sony Ericsson EUR 156 million in the quarter, mainly for mobile platforms, which was deducted from the balance of the advance payment made to Ericsson in the first quarter.
Ericsson's share in Sony Ericsson's income before tax was SEK 1.7 (2.0) b. in the quarter.
REGIONAL OVERVIEW
| Third quarter | Second quarter | Nine months | ||||||
| Sales, SEK b. | 2007 | 2006 | Change | 2007 | Change | 2007 | 2006 | Change |
| Western Europe | 12.3 | 11.7 | 6% | 12.4 | -1% | 37.3 | 36.0 | 4% |
| Central and Eastern Europe,Middle East and Africa | 12.0 | 10.9 | 10% | 11.5 | 4% | 34.4 | 32.1 | 7% |
| Asia Pacific | 12.0 | 11.6 | 3% | 16.6 | -28% | 40.9 | 33.9 | 21% |
| Latin America | 4.2 | 4.2 | 1% | 4.1 | 4% | 11.6 | 11.7 | 0% |
| North America | 3.0 | 2.9 | 3% | 3.0 | -1% | 9.1 | 11.9 | -24% |
The market in Western Europe showed a year-over-year sales growth of 6%, primarily driven by managed services and increased demand for broadband transmission. Sales of mobile networks were down somewhat due to less than expected sales of upgrades and expansions, especially in the UK and Italy.
Central and Eastern Europe, Middle East and Africa returned to good growth, 10% year-over-year. Sales were mainly driven by network rollout and expansions as well as managed services.
Asia Pacific was flattish due to lower mobile systems sales in China. The underlying business activity is ongoing at a stable level, but invoicing varies quarter by quarter due to the nature of the Chinese market. Australia was down compared to same period last year when a nation-wide HSPA network was rolled out. Excluding China and Australia, sales growth was 17% in the region.
Latin American sales were up 1% year-over-year. The market is driven by continued 2G expansions as well as initial 3G rollouts. There is also an increased demand for managed services. North American sales have returned to growth, primarily as a result of a more favorable comparison year-over-year.
MARKET DEVELOPMENT
Growth rates based on Ericsson and market estimates.
Mobile subscriptions grew with some 156 million in the quarter to 3.16 billion. 2.7 billion are GSM/WCDMA subscriptions. 157 million are WCDMA subscriptions, growing by some 18 million in the quarter. There are 179 WCDMA networks in 80 countries, of which 138 are upgraded to HSPA services.
In the twelve-month period ending June 30, 2007, fixed broadband connections grew by some 14 million per quarter to a total of approximately 300 million.
PLANNING ASSUMPTIONS
For the fourth quarter of 2007, our planning assumptions are Group sales of SEK 53-60 b. and operating margins in the mid-teens, including Sony Ericsson.
MARKET OUTLOOK FOR MOBILE INFRASTRUCTURE AND SERVICES
All estimates are measured in USD and refer to market growth compared to previous year.
For 2007, we continue to believe that the GSM/WCDMA track within the global mobile systems market, measured in USD, will continue to show mid-single digit growth.
We also continue to believe that the addressable market for professional services will show good growth in 2007.
For 2008, our early expectation is that the current market conditions will prevail.
PARENT COMPANY INFORMATION
Net sales for the nine-month period amounted to SEK 2.5 (1.9) b. and income after financial items was SEK 13.2 (12.5) b. Patent license fees have been included in net sales from 2007, instead of in other operating revenues, and 2006 has been restated accordingly.
Major changes in the Parent Company's financial position for the nine-month period include: increased investments in subsidiaries of SEK 23.4 b., mostly attributable to the Tandberg, Redback, Entrisphere and LHS acquisitions; decreased other current and non-current receivables from subsidiaries of SEK 4.3 b.; decreased cash and bank and short-term investments of SEK 19.7 b., mainly related to the acquisitions mentioned, payment of dividend for 2006 of SEK 7.9 b. to shareholders and cash from new non-current borrowings; increased notes and bond loans by SEK 11.0 b. through the bond issue program; decreased current and non-current liabilities to subsidiaries by SEK 19.3 b.
As per September 30, 2007, cash and bank and short-term investments amounted to SEK 34.3 (54.0) b.
Major transactions and balances with related parties include the following with Sony Ericsson Mobile Communications: revenues of SEK 1,753 (899) m.; liabilities of SEK 489 (0) m.; dividend and capital redemption of SEK 3,949 (1,160) m.
In accordance with the conditions of the Stock Purchase Plans and Option Plans for Ericsson employees, 4,178,626 shares from treasury stock were sold or distributed to employees during the third quarter. The holding of treasury stock at September 30, 2007, was 238,400,384 Class B shares.
OTHER INFORMATION
Acquisitions and public offerings
On September 28, 2007, Ericsson announced that it had purchased shares and received acceptances representing together approximately 85% of the outstanding shares and voting rights of LHS. The additional statutory acceptance period was closed on October 8, 2007, resulting in additional 0.04% of the outstanding shares. All conditions to the offer have been fulfilled. Ericsson intends to complete the offer in accordance with the procedure described in the offer document.
Assessment of risk environment
Ericsson's operational and financial risk factors and exposures are described under "Risk factors" in our Annual Report 2006 and we have determined that the risk environment has not materially changed. However, the increased activities related to the new Multimedia segment may result in a more volatile quarterly sales pattern. Specific additional risks for the near term are associated with the acquisitions made during 2007, as a timely and effective integration of these is essential to make them accretive as planned.
Risk factors and exposures in focus for the Parent Company and the Ericsson Group for the forthcoming six-month period include: unfavorable product mix in our Networks segment with reduced sales of software, upgrades and extensions and an increased proportion of new network build-outs and break-in contracts, which may result in lower gross margins and/or working capital build-up which in turn puts pressure on our cash conversion rate; variability in the seasonality could make it more difficult to forecast future sales; effects of the ongoing industry consolidation among our customers as well as between our largest competitor, e.g. intensified price competition; changes in foreign exchange rates, in particular a continued weakness or further deterioration of the USD/SEK rate; increases in interest rates and the potential effect on our customers' willingness to invest in network development;
Ericsson conducts business in certain countries which are subject to trade restrictions or which are focused on by certain investors. We stringently follow all relevant regulations and trade embargos applicable to us in our dealings with customers operating in such countries. Moreover, Ericsson operates globally in accordance with Group level policies and directives for ethics and conduct. In no way should our business activities in these countries be construed as supporting a particular political agenda or regime. We have activities in such countries mainly due to that certain customers with multi-country operations put demands on us to support them in all of their markets.
Please refer further to Ericsson's Annual Report 2006, where we describe our risks and uncertainties along with our strategies and tactics to mitigate the risk exposures or limit unfavorable outcomes, which remains valid also for 2007.
Stockholm, October 25, 2007
Carl-Henric Svanberg
President and CEO
Telefonaktiebolaget LM Ericsson (publ)
Date for next report: February 1, 2008
REVIEW REPORT
We have reviewed this report for the period January 1 to September 30, 2007, for Telefonaktiebolaget LM Ericsson (publ). The board of directors and the CEO are responsible for the preparation and presentation of this interim financial information in accordance with IAS 34 and the Annual Accounts Act. Our responsibility is to express a conclusion on this interim financial information based on our review.
We conducted our review in accordance with the Standard on Review Engagements SÖG 2410, Review of Interim Financial Information Performed by the Independent Auditor of the Entity, issued by FAR. A review consists of making inquiries, primarily of persons responsible for financial and accounting matters, and applying analytical and other review procedures. A review is substantially less in scope than an audit conducted in accordance with Standards on Auditing in Sweden, RS, and other generally accepted auditing practices. The procedures performed in a review do not enable us to obtain a level of assurance that would make us aware of all significant matters that might be identified in an audit. Therefore, the conclusion expressed based on a review does not give the same level of assurance as a conclusion expressed based on an audit.
Based on our review, nothing has come to our attention that causes us to believe that the accompanying interim financial information is not, in all material respects, in accordance with IAS 34 and the Annual Accounts Act.
Stockholm, October 25, 2007
| PricewaterhouseCoopers AB | |
| Bo Hjalmarsson | Peter Clemedtson |
| Authorized Public Accountant | Authorized Public Accountant |
| Lead partner |
EDITOR'S NOTE
To read the complete report with tables, please go to: www.ericsson.com/investors/financial_reports/2007/9month07-en.pdf
Ericsson invites media, investors and analysts to a press conference at the Ericsson boat yard, Torshamnsgatan 21, Stockholm, at 09.00 (CET), October 25.
An analysts, investors and media conference call will begin at 14.00 (CET).
Live webcasts of the press conference and conference call as well as supporting slides will be available at www.ericsson.com/press and www.ericsson.com/investors.
FOR FURTHER INFORMATION, PLEASE CONTACT
Henry Sténson, Senior Vice President, Communications
Phone: +46 8 719 4044
Investors
Gary Pinkham, Vice President,
Investor Relations
Investor Relations
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E-mail: investor.relations.se@ericsson.com
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Investor Relations
Investor Relations
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E-mail: investor.relations.se@ericsson.com
Media
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Head of Media Relations
Åse Lindskog, Vice President,
Head of Media Relations
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Ola Rembe, Vice President
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E-mail: press.relations@ericsson.com
Telefonaktiebolaget LM Ericsson (publ)
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