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Ericsson realigns operations to strengthen position in prolonged market downturn

Press release  |  Apr 22, 2002 05:34 (GMT +00:00)

PRO FORMA First quarter Twelve months
(excl. EPS)
SEK b. 2002 2001 Change 2001

Orders 41.9 69.3 -40% 201.8
- Systems 37.7 62.8 -40% 183.3
- Other operations 6.3 9.0 -30% 27.4
Sales 37.0 49.8 -26% 210.8
- Systems 33.3 44.4 -25% 188.7
- Other operations 5.7 8.0 -29% 31.8
Adjusted Operating Income 1) -4.5 -4.2 -19.5
- Systems -2.9 2.0 1.1
- Phones 0.0 -5.5 -14.6
- Other operations -1.3 -0.4 -4.3
- Unallocated -0.3 -0.3 -1.7
Adjusted Operating Margin 1) -12% -8% -9%
- Systems -9% 4% 1%
- Phones - - -
- Other operations -24% -5% -13%

Adjusted Income
Before Taxes 1) -5.4 -4.9 -23.2

Net Income -3.7 0.4 -22.8

Earnings per share,
diluted (SEK) -0.38 0.05 -2.69

Earnings per share,
diluted per
U.S. GAAP (SEK) -0.36 -0.29 -3.14

Cash flow before
financing activities -4.1 -18.1 6.9

Number of employees 82,012 94,960 85,198

1) Adjusted for:
- Capital gain, Juniper - 5.5 5.5
- Non-operational
capital gains 0.1 0.0 0.3
- Restructuring charges - - -15.0


"As expected, this past quarter was very challenging. Many operators have recently lowered investment plans further. As sales will be lower than anticipated, with ongoing aggressive cost cutting we plan to return to profit at some point in 2003," says Kurt Hellström, President and CEO of Ericsson.
"Our order intake demonstrates that the world's leading operators continue to choose our equipment to build-out and upgrade their networks. At the same time, we are expanding our Services business by providing solutions that reduce our customers' operating expenses."
"Our handset strategy is proving successful. Sony Ericsson has now reached a break-even result and at the same time our new Mobile Platforms business is gaining speed with many important licensing agreements."

"In the prolonged industry downturn, there will be winners and losers. We are stronger than ever in 2G and 3G, and we are winning market share in systems and services. With our drive for efficiency, unique competence and premier customer base we will emerge with an expanded position."

"With the proposed rights offering, we will have the financial strength to fully leverage our strong competitive advantage. At the same time, we will also have a robust financial position with increased security if poor market conditions continue or deteriorate further."


Comments below refer to pro forma statements unless indicated.

Orders were down 40% and sales were down 25% compared to the first quarter last year. However, orders increased 10% sequentially from the fourth quarter.

Our Services business continued to grow and now represents 24% of sales. About half of this was systems integration, network operations outsourcing and advisory services, which grew more than 25% reflecting our growing position in this segment.

Adjusted operating income for Systems was negative at SEK -2.9 b. (2.0), resulting in an operating margin of -9% (4%). The change is attributable mainly to lower sales and excess capacity costs, with particularly unfavorable development in Multi-Service Networks. The Efficiency Program has delivered the cost savings we planned, but with the rapid market decline, it has been impossible to reduce cost at the same rate.

Cost reductions and operational realignment
During 2001, we carried out company-wide cost reductions, which are now yielding SEK 20 b. savings on an annual basis. We continue to realign our operations and further reduce our cost base by SEK 10 b. at the end of this year and an additional SEK 10 b. planned for next year. At the end of 2003 our cost base will be SEK 40 b. lower than at the beginning of 2001. Restructuring costs will be taken as incurred with SEK 8.5 b. this year and SEK 2.0 b. in 2003. With the further measures, we expect savings of SEK 28 b. this year, SEK 38 b. next year and the full SEK 40 b. from 2004.

We see an emerging demand for integrated wireless and wireline solutions to achieve common service platforms and transport networks. To address this opportunity we are forming a new business unit by merging Mobile Systems with Multi-Service Networks, including ENGINE.

There is also an increasing demand for our Services offerings as operators seek to reduce cost of running their legacy networks, while transitioning to next generation technology. We are now expanding our Services business to also include a smaller remaining part of Multi-Service Networks as well as TDMA and PDC. This enables us to capitalize on our large installed base in these mature businesses and reduce costs.

Mobile Systems
While Mobile Systems orders declined year-over-year, they increased 11% sequentially which may indicate a moderation of the market decline. The US, China and Sweden as well as several emerging markets, like Saudi Arabia and India improved year-over year. Western Europe, Japan and most of Latin America remained weak.

Sales declined 19% driven mainly by lower demand for TDMA and PDC as operators are migrating to GSM and next generation networks. The GSM/WCDMA track, which excludes CDMA, TDMA and PDC, declined 15%, which is less than the industry. This demonstrates an increased market share and our lead in the North American transition to GSM/GPRS/EDGE. We have been installing 3G/EDGE capable networks for major US operators since September with commercial launch planned during 2003.
MMS services with color pictures and sounds will be significant drivers of GPRS and 3G traffic. We are also taking the lead in this area as demonstrated last week by the world's first nationwide MMS launch and the upcoming multi-national MMS roll-out for a leading global operator.

Multi-Service Networks
Orders and sales continued to decline. The development was driven by the significantly lower demand for traditional circuit-switching equipment, especially in Latin America.

Our ENGINE solution for upgrading circuit-switching networks to next generation packet-switching capability continued to develop favorably with ten new supply agreements during the quarter. We had break through contracts in China, Germany and Africa.
However, it was not sufficient to offset the downturn in the circuit-switching part of the business.

The new business unit structure strengthens our unique position and supports our customers' migration to all-IP networks by helping to upgrade their legacy circuit-switching business - of which Ericsson has about 170 million installed lines and trunks.
Our overall role remains unchanged as a key supplier of systems and end-to-end solutions to the world's leading wireline operators.

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)
The new company continues to gain momentum and reports a break-even result for the first quarter, which is earlier than anticipated.
The joint venture shipped 5.8 million phones, generating sales of SEK 10.3 b. A favorable product mix gave a higher than expected average selling price (ASP) and faster return to profit, which reflects the success of models with color screens like the T68 as well as the C1002S in Japan.

The achievement to reach a break-even result with lower volumes than last year demonstrates the success of the restructuring of our phones operations. With a lower cost base we now have a greater flexibility for market fluctuations. The number of employees remained at approximately 4,000. The objective to be profitable for the full year remains.

Other Operations
Adjusted operating income was SEK -1.3 (-0.4) b. reflecting further decline in demand for microelectronic components, cables and enterprise systems. Restructuring activities continue in these areas to restore profitability. The Defense business was profitable also with a minor decline in sales. Mobile Platforms and Bluetooth are still below break-even as we continue to invest in these new businesses.


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 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 were made on a continuous basis, and with results of operations transferred to Sony-Ericsson reported in "Share in earnings of Associated companies and JVs".

Comments below refer to pro forma statements unless otherwise indicated.

Sales were SEK 37.0 b., at the lower end of our expectations and 26% down from last year. The decline in gross margin percentage to 32% from 41% last year is mostly related to product and market mix and capacity costs. However, gross margin improved 5 percentage points compared to the previous quarter as a result of reduced excess capacity.

Operating expenses were SEK 16.8 b. This corresponds to a reduction of SEK 4.6 b. for comparable units year-over-year (excluding expenses from now consolidated finance companies, remaining commitments in mobile phones, higher risk provisions than last year and effects of foreign exchange rates). Adjusted for first quarter seasonality, this reduction confirms the planned SEK 20 b. lower run-rate from the Efficiency Program.

According to new Swedish accounting principles valid from January 1, 2002, certain development expenses shall be capitalized. Net effect of capitalization and amortization of development expenses on income before taxes was insignificant, SEK -0.1 (0) b. However, the capitalization effect in our primary accounts was SEK 1.0 b., due to lower amortizations, as capitalization for primary purposes began January 1, 2002.

Net effects of changes in foreign currency exchange rates was SEK 0.4 b.

Net capital gains of SEK 0.3 b. includes non-operational gains of SEK 0.1 b. from real estate divestitures. Last year's capital gains included 5.5 b. from the sale of shares in Juniper Networks.

Financial net declined to -0.8 (-0.5) b., due to increased net debt.

Adjusted income before tax (pro forma) was -5.4 (-4.9) b., in line with our fourth quarter 2001 guidance. Adjusted income before tax in our primary accounts was higher, -4.3 (-4.9) b., due to the effect of capitalization of development expenses (see section Accounting principles).

Primary earnings per share, diluted, were SEK -0.38 (0.05). Earnings per share diluted according to US GAAP were SEK -0.36 (-0.29).

Balance sheet and financing
In accordance with the new Swedish GAAP valid from January 1, 2002, certain finance companies, which were previously accounted for under the equity method are now consolidated as subsidiaries. As a consequence, customer financing receivables of SEK 8.4 b. that were previously off balance sheet are now reported on balance sheet. It should be noted that this accounting change has not affected the total exposure.

Our total customer financing exposure on- and off-balance increased by SEK 1.3 b. in the quarter to SEK 27.7 b.

In the pro forma balance sheet, intangible assets from capitalization of development costs, SEK 18.8 b., are also included in the opening balance, as if capitalization was made on an ongoing basis. The related tax amount is included among provisions for taxes, and the net value after depreciation and taxes, SEK 13.2 b., is included in stockholder's equity. The effect on the equity ratio was 3 percentage points.

Capitalization of development expenses in our primary accounts was SEK 1.0 b. at the end of the first quarter.

Repayment of loans and negative cash flow before financing activities resulted in a reduction in cash on hand of SEK 13.0 b. Payment readiness was 36% compared to 28% at year-end, maintaining our flexibility to operate under the current market uncertainty. The equity ratio remained at 31% despite the loss in the quarter, benefiting from a reduction in working capital. Net debt increased in the period from SEK 21.0 b. to SEK 25.0 b.

During the first quarter, Moody's reduced our long-term credit rating from Baa1 with negative outlook to Baa2 with negative outlook. Standard and Poor's long-term rating remained unchanged at BBB+ with negative outlook. Our short-term ratings remained at P-2 and A-2 respectively.

Cash flow
Cash flow before financing activities was SEK -4.1 b. Improvements in working capital of SEK 3.5 b. partially balanced the negative cash flow from the loss in the quarter and investments of SEK 1.2 b.

In working capital, we achieved positive cash flow effects from receivables, customer financing and payables. This was, however, partially offset by negative effects related to income taxes, VAT payables, accrued expenses and derivatives. Some of these cash flow effects are normally unfavorable in first quarters due to high sales in fourth quarters.
Although trade receivables had a positive cash flow effect, the development was still unsatisfactory with Days Sales Outstanding (DSO) increasing to 108 days from 88 in the previous quarter. Inventory turns also declined, due to the low sales, from 4.7 times last quarter to 4.1. This is however an improvement compared to Q1 last year at 3.4.
No significant divestitures were made in the quarter.

Proposed authorization for rights offering
The board of Ericsson has resolved that an Extraordinary General Meeting of shareholders be called for 6 June 2002, to authorize the Board to launch a rights offering to the company's shareholders. The intention is that the rights offering shall raise approximately SEK 30 billion. It is proposed that the Board be authorized to formulate the final terms and conditions of the rights offering in order to provide for flexibility in the time table, especially as Ericsson is subject to regulatory approval in several jurisdictions. The terms will be set at the formal launch of the rights issue taking account of the prevailing share price, market conditions and prudent market practice. The proposal is that shares of both series A and series B will carry rights to subscribe for new shares of series B. The rights offering is expected to be carried out before the end of the third quarter 2002. For further details, please refer to the separate press release for the proposed rights offering.

This announcement is not an offer for sale of any securities in any jurisdiction.


We strongly believe that the global telecom equipment market, particularly wireless communication, is a long term growth market. However, 2001 was a challenging year for the whole industry. An improvement in the telecommunications equipment market during the second half of this year was generally anticipated. However, as many operators have recently announced reduced investment plans, we now believe that market conditions will remain weak well into next year.

The mobile systems market is now expected to be down by more than 10% this year compared to our previous estimate of flat to down 10%.
The wireline systems market is expected to continue to shrink during 2002 with traditional circuit-switching declining by about 40%. Wireline infrastructure demand is expected to be especially weak in Latin America and Western Europe.

The actual number of mobile subscribers at year-end 2001 was 935 million. With approximately 45-50 million new subscriptions added during the first quarter, we expect between 175 and 215 million new subscribers during 2002. This reflects an annual growth rate of 18-23% that is close to our previous estimate of 20-25%.

We estimate that approximately 85 million mobile phones were shipped during the first quarter. We expect 400-420 million phones to be shipped this year. Replacement phones with color screens and multi-media capabilities are expected to be the growth drivers.


In our fourth quarter report, we indicated that sales of our Mobile Systems were expected to be at least in line with the market development of flat to down 10% during 2002. We also indicated an objective of an operating margin over 5% for the full year, even if net sales declined by as much as 10% compared to 2001.

With our revised view of the outlook for the market in which we operate we now expect to make a loss this year, excluding restructuring costs and non-operational items. With ongoing cost cutting we plan to manage the business to return it 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 15 (15) countries.
Net sales for the period amounted to SEK 0.3 (0) b. and income after financial items was SEK 0.3 (0.6) b.

Major changes in the company's financial position were:

Increased current and long-term commercial and financial receivables from subsidiaries of SEK 21.4 b.

Decreased cash and short-term cash investments of SEK 5.1 b.

The investments were financed primarily through increased internal borrowing of SEK 18.8 b. Short- and long-term external borrowing decreased by SEK 4.1 b. At the end of the quarter, cash and short-term cash investments amounted to SEK 43.9 (49.0) b.

The Annual General Meeting decided, in accordance with the proposal from the Board of Directors, that no dividend will be paid in 2002.

Accounting principles
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 RR 1:00, regarding consolidation of controlled companies, and RR 15, regarding capitalization of development costs.

According to RR 1:00 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, we have, starting from January 1, 2002, - without restating of previous years, which is not allowed - capitalized certain development costs.

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 income 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, April 22, 2002

Kurt Hellström
President and CEO
This interim report is unaudited.
Uncertainties in the Future

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.

Date for next report: July 19, 2002
A glossary of all technical terms is available at: and in the annual report.

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The full report including tables can also be downloaded from the enclosed link.