Telefonaktiebolaget LM Ericsson (publ)ERIC more than delivered on its profit warning last week for its third-quarter 2016 results, as it reported its first loss in nearly four years. Its diluted loss came in at SEK 7 (1 penny) in the quarter, compared with earnings of SEK 94 in the prior-year period.
The Swedish wireless equipment maker had released ominous preliminary results last week, indicating a huge decline in top line, citing a steadily weakening mobile broadband business and overall adverse industry trends. The news shocked investors and sent the stock plummeting 20%.
Ericsson reported non-IFRS earnings per share (excluding amortizations, write-downs of acquired intangible assets and restructuring charges) of SEK 34 (4 cents) for the quarter, missing the Zacks Consensus Estimate of 9 cents by a whopping 55.6%. The bottom line fared even worse in year-over-year comparison, having fallen a colossal 75% from the prior-year tally of SEK 1.34.
Investors were terribly disappointed with the top- and bottom-line miss. Ericsson's shares were trending down significantly in pre-market trading , falling 4.3% at one point.
This is the third consecutive earnings miss for the Swedish giant. Ericsson missed earnings by nearly 29% in second-quarter 2016.
The decline in bottom line can be attributed to the consistent weak product demand, which gave rise to weakness across the company's segments. Also, negative revaluation effects of currency hedge contracts and restructuring charges put further pressure on earnings.
Inside the Headlines
Revenues continued their downward spiral and fell 14% year over year to SEK 51.1 billion ($6 billion) for the quarter, lagging the Zacks Consensus Estimate of $6.5 billion.
Sluggish growth in emerging markets like Brazil, Russia, and the Middle East, completion of major projects in European markets and adverse currency translation hampered revenues. Other broader negative trends from the first half of the year accelerated as well, particularly impacting Networks segment.
The decline in sales was all-pervasive, with all three operating segments of the company charting negative revenue growth.
On a segmental basis, Networks revenues were down 19% year over year to SEK 23.3 billion ($2.7 billion). Markets with a weak macro environment recorded softness in both mobile broadband coverage and capacity sales. Delayed spectrum auction in India and lower 3G sales in China proved to be drag on sales in this segment.
Also, lack of revenues on account of completion of major European mobile broadband projects in 2015 compounded the segment's problems. However, rapid 4G deployment in China, along with strong core networks sales compensated the decline to some extent.
Global Services revenues fell 8% year over year to SEK 24.8 billion ($2.9 billion). Continued decline in Network Rollout sales and tepid professional services performance led to the unimpressive sales.
Support Solutions revenues also went down 11% year over year to SEK 2.9 billion ($340 million), dragged primarily by lower software licensing sales in transformation projects.
Ericsson's gross margin (excluding restructuring charges) in the quarter contracted 560 basis points year over year to 28.3%.The company's efforts to curb costs failed to offset the diminishing sales and thus, the company's margins contracted sharply. A bigger share of lower margin business like services business, along with lower sales in Networks and mobile broadband businesses, contributed to the compressed margins.
The decline in Ericsson's operating margin (excluding restructuring charges) was even more pronounced, plummeting 790 basis points on a year-over-year basis to 0.7%. The effect of lower gross margin trickled down to operating margins, with higher R&D expenses further contracting it.
Three-Pronged Growth Plan
Ericsson is presently following a three-pronged strategy to drive growth. The first strategic area is "core business growth," in which the company is focusing on deployment of 4G and promotion of 5G. The company constantly seeks to seize business opportunities as operators shift toward 4G deployment and prepare grounds for the forthcoming 5G revolution.
The second area of focus, which is to improve profitability in the targeted growth areas, is witnessing the company concentrate on "software sales" and "recurring businesses" to drive growth in its thriving Professional Services.
The final growth area is "cost and efficiency program" that has been devised to generate higher cost savings. In fact, to adapt to and counteract the lower demand for mobile broadband investments, Ericsson has mapped a set of significant actions to boost efficiency and cut costs further.
The formerly announced cost and efficiency program, through which Ericsson intends to unlock savings of SEK 9 billion in 2017, is moving ahead per the plan. Ericsson further revealed plans to reduce cost of sales, in order to adapt operations to weaker mobile broadband demand. The company plans to reduce the annual run rate of operating expenses (excluding restructuring charges) to SEK 53 billion in the second half of 2017, through these initiatives. This is comparable to SEK 63 billion in 2014, and equates to double the amount of savings in operating expenses that was previously targeted.
During the quarter, cash utilized in operating activities came to SEK 2.3 billion ($270 million), compared with cash generated from operating activities of SEK 1.6 billion at the end of third-quarter 2015.
Ericsson's cash and cash equivalents as on Sep 30, 2016 totaled SEK 24.4 billion ($2.9 billion), compared with SEK 34 billion a year back.
Changes in Company Structure
In first-quarter 2016, Ericsson announced a set of structural changes to improve strategy execution and drive efficiency. The company plans to design five business units and one dedicated customer group for Industry & Society, in line with its three-pronged growth strategy. With these changes, Ericsson believes that it will be better equipped to cater to the needs of multiple customer segments and leverage on market opportunities to drive faster growth.
Ericsson has been grappling with an industry wide slump in demand and fierce competition from China has further exacerbated this cyclical downturn. Investors have steadily lost faith in this company, which has tanked 49% over the past year.
ERICSSON LM ADR Price and EPS Surprise
Ericsson is contending with stiff competition from Huawei Technologies Co. and Nokia Corp. NOK . Slumping demand in Russia and Brazil, and accelerating negative industry trends have further compounded its problems. Slowing pace of telecom industry, upgrades to 4G standards, and consequent lower spending from clients like Vodafone and Verizon have battered Ericsson's prospects.
To combat such critical industry concerns, Ericsson recently struck a partnership with Cisco Systems Inc. CSCO , to boost its product lineup and sell more complete networks. The company expects that the deal would generate $1 billion or more in annual sales for each company by 2018.
The company is also taking internal steps to stabilize its operations somewhat. It has plans to reduce its operating expenses by 10 billion kronor by 2017 compared with 2014. However, the company has acknowledged that its savings plans and job reductions do not seem enough to weather the swiftly declining demand.
Whether the growth and cost-streamlining efforts of this Zacks Rank #4 (Sell) company will help it beat industry-wide demand blues, remains to be seen.
InterDigital, Inc. IDCC develops and markets advanced digital wireless telecommunications systems, using proprietary technologies for voice and data communications. The Zacks Rank #1 (Strong Buy) company has an excellent earnings surprise history over the trailing four quarters, beating estimates all through, with a robust average positive surprise of 82.4%. You can see the complete list of today's Zacks #1 Rank stocks here.
Note: SEK 1 = $0.1172 (Period average from Jul 1, 2016 - Sep 30, 2016)
SEK 1 = $0.1164 (As on Sep 30, 2016)
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