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Ericsson (ERIC) Q2 Earnings Miss; to Accelerate Cost Cuts

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Ericsson (ERIC - Free Report) reported non-IFRS earnings per share (excluding amortizations, write-downs of acquired intangible assets and restructuring charges) of SEK 83 (10 cents) for the second quarter of 2016, missing the Zacks Consensus Estimate of 14 cents by 28.6%. The bottom line fared even worse on a year-over-year basis, having fallen a whopping 43% from the prior-year tally of SEK 1.45.

Investors were terribly disappointed with the top- and bottom-line miss. Ericsson’s shares were trending down significantly during pre-market trading, falling over 4% at one point.

This is the second consecutive earnings miss for the Swedish communication technology and services giant. Ericsson had missed earnings by over 23% in the first quarter of 2016.

The decline in the bottom line can be attributed to continued weak product demand, which drove 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 for the quarter fell 11% year over year to SEK 54.1 billion ($6.6 billion), lagging the Zacks Consensus Estimate of $6.9 billion.

Weak growth in emerging markets like China and India, completion of major projects in European markets and adverse currency translation hampered revenues. Also, budget cuts by telecom operators constrained the company’s performance, as carriers across Europe, Russia and Brazil curtailed investments in wireless gear.

The decline in sales was all-pervasive, with all three operating segments of the company charting negative revenue growth.

Segmental Performance

On a segmental basis, Networks revenues declined 14% year over year to SEK 26.8 billion ($3.3 billion). Delayed spectrum auction in India, lower 3G sales in China and sustained weakness in the Middle East and Latin America 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, strong mobile broadband sales in South East Asia and North America, coupled with rapid 4G deployment in China, compensated the decline to some extent.

Global Services revenues fell 7% year over year to SEK 24.5 billion ($2.98 billion). Continued decline in Network Rollout sales and negative currency impact led to the unimpressive sales.

Support Solutions revenues also declined 7% year over year to SEK 2.9 billion ($353 million), dragged primarily by lower software licensing sales in transformation projects.

Ericsson’s gross margin (excluding restructuring charges) in the quarter declined 90 basis points year over year to 32.3%. A bigger share of lower margin business like mobile broadband coverage business and services business contributed to the compressed margins.

The decline in Ericsson’s operating margin (excluding restructuring charges) was even more pronounced, plummeting 340 basis points on a year-over-year basis to 7%. The effect of lower gross margin trickled down to operating margins, with lower IPR licensing revenues 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. During the quarter under review, Ericsson reported modest progress in this area.

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 decrease R&D investments in IP and absorb efficiency gains from the new company structure. 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.

Liquidity

During the quarter, cash utilized in operating activities came to SEK 0.7 billion ($85.2 million), compared with cash generated from operating activities of SEK 3.1 billion at the end of second-quarter 2015. Higher inventory levels and huge tax payments adversely affected the cash flow.

Ericsson’s cash and cash equivalents as on Jun 30, 2016 totaled SEK 28.9 billion ($3.4 billion), compared with SEK 33 billion a year back.

Changes in Company Structure

Last quarter, 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 it will be better equipped to cater to the needs of multiple customer segments and leverage market opportunities to drive faster growth.

To Conclude

Ericsson has been grappling with intense competitive pressure from new operators, which compounds the weak demand issues that the company is already facing. Ericsson is struggling to maintain its market share as it waits for a surge in 5G wireless networks investments.

Amid these problems, Ericsson’s shares have lost about a third of their value over the past year. The company expects these demand trends and business mix to persist in the second half of the year as well.

ERICSSON LM ADR Price and EPS Surprise

ERICSSON LM ADR Price and EPS Surprise | ERICSSON LM ADR Quote

To combat such critical industry concerns, Ericsson recently struck a partnership with Cisco Systems Inc. ((CSCO - Free Report) ) to expand 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.

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.

Some better-ranked stocks in the broader computer & technology space include ServiceSource International, Inc. and Adobe Systems Incorporated (ADBE - Free Report) , both sporting a Zacks Rank #1 (Strong Buy).

Note: SEK 1 = $0.1217 (Period average from Apr 1, 2016 to Jun 30, 2016)

         SEK 1 = $0.1179 (As on Jun 30, 2016)

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