Ericsson's second quarter report and the terms of the rights offering
PRO FORMA (excl. EPS)
- Other operations
- Other operations
Adjusted Operating Income 1)
- Other operations
Adjusted Operating Margin 1)
- Other operations
Adjusted Income Before Taxes 1)
Earnings per share, diluted (SEK)
Cash flow before financing activities
Number of employees
1) Adjusted for:
- Capital gain, Juniper Networks
- Non-operational capital gains
- Restructuring charges net
"We continue to plan our operations to return to profit at some point in 2003. In light of our lowered market expectations for this year, we have intensified the cost reductions that we started last year and are substantially ahead of schedule," says Kurt Hellström, President and CEO of Ericsson.
"We will continue reducing our costs until we can breakeven at sales levels around SEK 120 b. By the end of next year, we believe we will have a low enough cost base to return to profit. Our strategy is to focus on the two main systems tracks - GSM/WCDMA and CDMA/CDMA2000 - and the promising market for services. During the quarter, we won two more significant service contracts for network management services.
Although Sony Ericsson reports a loss for the quarter, we believe in the potential of this joint venture.
We have made significant progress toward the successful execution of our rights offering as Investor, Industrivärden and several other investors have committed to subscribe for a total of up to SEK 10 b. Further, a group of banks has agreed to underwrite the remaining SEK 20 b. As a result of these developments, the entire SEK 30 b. is fully underwritten.
With intensified cost reductions, a stronger balance sheet and a premier customer base, we are confident that we have the right strategy to restore profitability and reinforce our leadership in this long-term growth industry," says Kurt Hellström.
We are convinced that global telecommunications, particularly wireless communication, is a long-term growth market.
Though strong subscriber growth continues, the demand for mobile systems and phones is expected to remain weak at least well into next year. Many operators are facing increasingly adverse funding conditions due to lowered credit ratings and pressure from the capital markets to improve cash flow and reduce debt levels. As a result, they are minimizing phone subsidies and limiting network expansion, which negatively affects replacement rates and quality of service.
Based on our preliminary estimates, approximately 45 million new subscribers were added worldwide during the second quarter. At this rate, we expect net subscriber additions this year to be at the lower end of our forecast of 175 to 215 - still in line with our long-term forecast of 1.8 billion subscribers by 2007.
In our first quarter report, we indicated that the market for mobile systems could decline by more than 10% this year. Our judgment of operators' investment plans imply that the market will decline by more than 15% this year. This is also reflected by our order and sales development during the quarter.
With a slow replacement rate, we believe the number of mobile phones sold during the quarter was approximately the same as in the first quarter at 85 million. We now expect the mobile phone market to be flat to down slightly compared to last year's 390 million units. We had previously estimated the market to be 400-420 million this year.
Our overall view of the wireline systems market for 2002 remains unchanged with an anticipated decline of more than 20%. However, we now expect the market for traditional circuit-switching equipment to shrink even more than the previously estimated 40%.
Cost reductions and operational realignment
During 2001, we initiated a company-wide cost reduction program, which was intensified earlier this year and is now ahead of schedule.
We continue to adapt the company to the current market situation. Cost reduction measures under our Efficiency Program were fully implemented by the first quarter 2002 which resulted in savings of SEK 20 b. on an annualized basis. Cost reduction measures targeting a further SEK 20 b. of annual savings are planned for implementation by the first quarter 2003. Additional measures generating SEK 10 b. of annual savings are planned for implementation by the third quarter 2003. By the end of 2003, we expect to have an operating expense run rate that would enable us to break-even at annualized sales levels of around SEK 120 b., although our goal is to return to profit at some time next year.
The total restructuring cost for 2002 and 2003, for actions to reduce operating expenses and cost of sales, is estimated to be SEK 17.5 b. of which the intensification of the initiatives represents an increase of SEK 7.0 b.
Based on the authorization granted by the extraordinary meeting of shareholders on June 6, 2002, the board of Ericsson has now set the terms of the rights offering. One share of series A or series B of Ericsson, held as of the record date of August 13, 2002, carries the right to subscribe for one new share of series B. The subscription price is SEK 3.80 per share. Equivalent terms are offered to holders of the Nasdaq-traded ADSs. The offering will raise approximately SEK 30 billion, before expenses.
Due to the current negative sentiment in stock markets in general and the telecom industry in particular, and in order to ensure the success of the rights issue, the Board of Ericsson has decided to have the rights issue fully underwritten.
Industrivärden and Investor, representing 7.4 percent of the share capital and 66.7 percent of the votes, have together undertaken to subscribe for SEK 8 billion of the rights issue. In addition, Alecta, Skandia Life, Second National Pension Fund and Third National Pension Fund, representing approximately 7.0 percent of eligible shares have undertaken to subscribe for their respective rights in the issue, corresponding to slightly more than an aggregate of SEK 2 billion.
The remaining SEK 20 billion is underwritten by a consortium of banks consisting of Morgan Stanley, SEB/Enskilda Securities, Goldman Sachs International, Handelsbanken Securities and Schroder Salomon Smith Barney.
The timetable and other details of the rights offering are described in a separate press release.
The company will use the proceeds from the offering for repayment of debt and to fund the intensified restructuring activities, after which payment readiness and equity ratio is expected to be at least as strong as today.
OPERATIONAL AND FINANCIAL REVIEW
In addition to the primary format, financial statements are also reported in a pro forma format. The primary format is based on Swedish GAAP (please see section Accounting Principles), and the previous year is restated for consolidation of finance companies previously accounted for according to the equity method. The pro forma format is presented to facilitate comparability between years and portrays results of operations as if capitalization of development costs was made on a continuous basis, and with results of operations transferred to Sony Ericsson October 1, 2001, reported in "Share in earnings of Associated companies and JVs." Comments below refer to pro forma statements unless otherwise indicated.
Orders booked declined by 17% and sales increased 4% compared to the first quarter 2002. Compared to the second quarter last year, orders declined 39% and sales 32%.
Sales of systems integration, network operations outsourcing and advisory services now account for 14% of Systems sales and grew by more than 15% compared to the second quarter last year.
Sales in the GSM/WCDMA track declined 13%, compared to the second quarter last year, maintaining our leading market position.
Sales in the U.S. were up by almost 50% from the first quarter, reflecting the transition from TDMA to GSM/GPRS. In Japan, J-Phone completed a soft-launch of an Ericsson WCDMA network on-schedule and is aiming for commercial launch in December 2002. A growing number of customers have launched MMS services in Europe and Asia. We have won over 30 commercial agreements and more than 90 MMS trials are underway.
Orders and sales continued to decline, primarily driven by weakness in the traditional circuit-switching equipment market in both Latin America and Western Europe. The decline compared to second quarter last year is around 60% for both orders and sales. Our new business unit structure will reduce our exposure to the circuit-switching business while still supporting our customers' migration to next generation packet switching.
Our 50% share of income from Sony Ericsson Mobile Communications is included in "Earnings from Joint Ventures and Associated Companies." The retained activities, including technology licensing and phone manufacturing in China, are reported as part of "Other Operations."
Sony Ericsson Mobile Communications (SEMC)
A high average selling price (ASP) was maintained with sales of SEK 8.8 b. and 5.0 million phones sold. However, the joint venture reported a loss of SEK 0.8 b., due to lower volumes, some product delays and increased marketing costs from the introduction of new products as well as branding activities.
Orders for Other Operations were flat, compared to both the first quarter 2002 and the second quarter 2001. Sales increased slightly sequentially but were down 20% compared to the same period last year with reductions in all areas but Defense systems. The operating margin was -16%, largely driven by unfavorable sales volumes for Microelectronics, Network Technology and Enterprise systems.
Our mobile phone platform business continues to develop with six licensing agreements so far. However, Mobile Platforms and Bluetooth are still below break-even as we continue to invest in these new businesses.
Restructuring activities continue in cables and enterprise systems and we have signed an agreement with Infineon for the sale of a large part of the Microelectronics operations.
The gross margin improved during the quarter to 33%, partly related to reduced excess capacity costs.
Operating expenses excluding restructuring charges were 28% lower than second quarter last year and SEK 2.1 b. lower than in the first quarter this year, which reflects continued good progress in our cost savings activities.
SEK 1.5 b. of restructuring costs net were charged to income in the second quarter. For the ongoing cost reductions, SEK 0.4 b. were charged to cost of sales, and SEK 1.3 b. to operating expenses. A net positive amount of SEK 0.2 b. was related to restructuring of our previous handset business. Lagging costs of SEK 1.6 b. for inventory write downs, scrapping and warranty costs were offset by insurance compensation of SEK 1.8 b. related to damages as a consequence of a fire in a supplier's factory. The compensation, not recognized as revenue in 2001, has now been recognized upon final settlement.
Net effect of capitalization and amortization of development expenses on income before taxes was SEK -0.2 b. in the quarter (SEK 0.2 b.). However, in our primary accounts the net capitalization effect was SEK 1.0 b., due to lower amortizations, as capitalization for primary purposes began January 1, 2002.
Net effect of changes in foreign currency exchange rates compared to the rates one year ago was SEK 0.8 b.
The net capital loss of SEK 0.3 b. is mainly related to equipment scrapping and divestitures of equity investments. Non-operational capital gains were insignificant.
Share in earnings of joint ventures and associated companies amount to SEK -0.5 b., of which SEK -0.4 is related to Sony Ericsson Mobile Communications. The financial net improved to SEK -0.6 b. compared with SEK -0.8 b in the first quarter due to a lower net debt.
Adjusted income before taxes was SEK -3.5 b. in the quarter compared with SEK -5.4 b. in the first quarter and SEK -5.1 b. in the second quarter last year. Due to the effect of capitalization of development expenses, adjusted income before tax in our primary accounts was SEK -2.4 b. (-5.3).
Primary earnings per share, diluted, were SEK -0.72 (-1.75).
Balance sheet and financing
Our total gross customer financing exposure, on- and off-balance sheet, was stable compared to the previous quarter at SEK 27.7 b. Total customer financing risk provisions were SEK 6.6 b. at the end of the quarter.
This quarter we are also disclosing unutilized customer financing commitments. Our commitments are conditioned upon the customers meeting future operational or financial criteria. In some cases, incremental commitments become available to the customers as they sign additional contracts with us.
Our objective is to find alternative funding sources for our customers prior to the time of utilization, which in some cases are secured by Ericsson guarantees to the lending banks. We also seek to place portfolios of credits with third party lenders.
Unutilized commitments at the end of the second quarter were SEK 25.3 b.
Draw-downs of commitments are related to our shipments and are therefore spread over time. In our experience, this level of commitments has not materially increased our net exposure as repayments and transfers of drawn amounts normally balance the draw-down of unutilized facilities.
Repayment of loans and negative cash flow before financing activities resulted in a cash reduction of SEK 8.4 b. Payment readiness was 27% compared with 36%, and the equity ratio was improved by one percentage point compared to the end of the first quarter.
Current long-term ratings from Moody's and Standard and Poor's are Baa3 and BBB, respectively, whereas the short-term ratings are P-3 and A-3 respectively. Both agencies downgraded Ericsson in the second quarter. Downgrades increase our interest expenses and may trigger put options by lending banks of customer financing credits. Certain credit facilities were renegotiated during the quarter to exclude rating triggers.
Cash flow before financing improved by SEK 2.0 b. Working capital improved moderately with further reductions in receivables and we divested certain operating assets.
Days Sales Outstanding (DSO) improved to 101 from 108 days in the first quarter. Inventory turnover (ITO) improved slightly to 4.2, whereas capital turnover remained unchanged. Cash flow related to customer financing was SEK -0.8 b. In connection with finalizing a previous credit portfolio, cash collateral for secured customer financing of SEK 2.1 b. was released.
Net cash from divestitures in the quarter was SEK 0.7 b.
SEK 1.0 b. of the SEK 1.8 b. insurance compensation remains to be received in the third quarter.
In our first quarter report, we indicated that our Mobile Systems sales were expected to be in line with the market development of down by more than 10% during 2002. As described in the market view above, we now believe the market will decline by more than 15% this year. We also indicated that we expected to make a loss this year, excluding restructuring costs and non-operational items, and planned to manage the business to return to profit at some point in 2003 with ongoing cost reductions.
We believe that our sales will develop in line with our updated market outlook, resulting in a loss for 2002. With ongoing cost reductions, we still believe we can return to profit at some point in 2003.
Parent Company information
The Parent Company business consists mainly of corporate management and holding company functions. It also includes activities performed on a commission basis by Ericsson Treasury Services AB and Ericsson Credit AB regarding internal banking and customer credit management. The Parent Company has branch- and representative offices in 16 (15) countries.
Net sales for the period amounted to SEK 0.8 (2.7) b. and income after financial items was SEK 1.1 (9.4) b.
Major changes in the company's financial position were:
- Increased current and long-term commercial and financial receivables from subsidiaries of SEK 17.1 b.
- Increased short-term and long-term customer financing of SEK 4.9 b.
- Decreased cash and short-term cash investments of SEK 12.0 b.
The investments were financed primarily through increased internal borrowing of SEK 11.9 b. At the end of the quarter, cash and short-term cash investments amounted to SEK 37.0 (49.0) b.
In accordance with the conditions of the Stock Purchase Plan for Ericsson employees, 28,020 shares from treasury stock were distributed during the second quarter to employees who left Ericsson. Approximately 6 million shares of treasury stock of the total allotment for the employee stock purchase plan of 35 million shares are now reserved for the matching of employee investments. The holding of treasury stock at June 30, 2002 was 156,775,980 Class B shares.
This interim report has been prepared in accordance with the Swedish Financial Accounting Standards Council's recommendation RR 20, Interim reports.
We have changed accounting principles since our latest annual report.
The following Swedish GAAP recommendations are now implemented:
RR 1:00, Consolidated financial statements
RR 15, Intangible assets
RR 16, Provisions, contingent liabilities and contingent assets
RR 17, Impairment of assets
RR 19, Discontinuing operations
RR 21, Borrowing costs
RR 23, Related party disclosures
The only material effects of these new standards relate to RR1:00, regarding consolidation of controlled companies, and RR 15, regarding capitalization of development costs.
According to RR1:00 we have consolidated as subsidiaries certain finance companies previously accounted for under the equity method. We have restated previous year in our primary statements.
According to RR 15, starting from January 1, 2002 we have capitalized certain development costs. In accordance with this rule, we have not restated our primary accounts.
Since this capitalization generates incomparability between this period and previous periods in the primary accounts, we have decided to also present pro forma statements, where we have assumed that the principle of capitalization of such development costs had been applied in all periods. For this purpose, we have used the amounts for capitalized development costs we already calculated and used in previous periods' reconciliation to US GAAP.
Our pro forma statement is also adjusted to portray our operations as if the mobile phones operations transferred to the Sony Ericsson joint venture on October 1, 2001, were accounted for under the equity method for the whole year 2001.
Stockholm, July 19, 2002
President and CEO
Date for next report: October 18, 2002
We have reviewed the Interim Report as of 30 June 2002 for Telefonaktiebolaget LM Ericsson (publ). We conducted our review in accordance with the recommendation issued by FAR. A review is limited primarily to enquires of company personnel and analytical procedures applied to financial data and thus provides less assurance than an audit. We have not performed an audit and, accordingly, we do not express an audit opinion.
Based on our review, nothing has come to our attention that causes us to believe that the Interim Report does not comply with the requirements in the Swedish Exchange and Annual Account Acts.
Stockholm, July 19, 2002
Authorized Public Accountant
Authorized Public Accountant
Authorized Public Accountant
Safe Harbor Statement of Ericsson under the Private Securities Litigation Reform Act of 1995;
All statements made or incorporated by reference in this release, other than statements or characterizations of historical fact, are forward-looking statements. These forward-looking statements are based on our current expectations, estimates and projections about our industry, management's beliefs and certain assumptions made by us. Forward-looking statements can often be identified by words such as "anticipates", "expects", "intends", "plans", "predicts", "believes", "seeks", "estimates", "may", "will", "should", "would", "potential", "continue", and variations or negatives of these words, and include, among others, statements regarding: (i) strategies, outlook and growth prospects; (ii) positioning to deliver future plans and to realize potential for future growth; (iii) liquidity and capital resources and expenditure, and our credit ratings; (iv) growth in demand for our products and services; (v) our joint venture activities; (vi) economic outlook and industry trends; (vii) developments of our markets; (viii) the impact of regulatory initiatives; (ix) research and development expenditures; (x) the strength of our competitors; (xi) future cost savings; and (xii) plans to launch new products and services.
In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances, including any underlying assumptions, are forward-looking statements. These forward-looking statements speak only as of the date hereof and are based upon the information available to us at this time. Such information is subject to change, and we will not necessarily inform you of such changes. These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, our actual results could differ materially and adversely from those expressed in any forward-looking statements as a result of various factors. Important factors that may cause such a difference for Ericsson include, but are not limited to: (i) material adverse changes in the markets in which we operate or in global economic conditions; (ii) increased product and price competition; (iii) further reductions in capital expenditure by network operators; (iv) the cost of technological innovation and increased expenditure to improve quality of service; (v) significant changes in market share for our principal products and services; (vi) foreign exchange rate fluctuations; and (vii) the successful implementation of our business and operational initiatives.
A registration statement relating to our securities has been filed with the Securities and Exchange Commission but has not yet become effective. The securities may not be sold nor may offers to buy be accepted prior to the time the registration statement becomes effective. This press release shall not constitute an offer to sell or the solicitation of an offer to buy nor shall there be any sale of any securities in any state in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities law of any such state.
Underwriters, may, at any time up to the latest time for acceptance and payment in full of the nil paid rights, engage in trading activity with a view to managing the risk of the rights issue. Such activity may include purchases and sales of securities of the Company (including the nil paid rights and ordinary shares) and related securities or instruments and be effected on any securities market, over the counter market, stock exchange or otherwise, in accordance with applicable law and regulation.
The full report including tables can also be downloaded from the enclosed link.
Ericsson is a world leader in communications technology and services with headquarters in Stockholm, Sweden. Our organization consists of 99,000 experts who provide customers in 180 countries with innovative Solutions and services. Ericsson has the world’s leading patent portfolio in cellular technology, with more than 54,000 granted patents. Together we are building a more connected future where anyone and any industry is empowered to reach their full potential. Net sales in 2019 were SEK 227 billion. The Ericsson stock is listed on Nasdaq Stockholm and on NASDAQ in New York. Read more on www.ericsson.com.