Ericsson warns North American market will 'remain slow in the short term'

Ericsson (NASDAQ: ERIC) reported continued weakness in the North American market in the first quarter as carriers continue to hold back on investing heavily in networks as they pay for spectrum licenses and other expenses. The Swedish vendor reported drops in net income and operating profit despite a jump in top-line sales that benefited from currency moves. Meanwhile, Ericsson's licensing revenue took a hit due to an ongoing patent dispute with Apple (NASDAQ: AAPL).

Ericsson said sales in the quarter increased by 13 percent year-over-year to around $6.14 billion (SEK 53.5 billion), coming in just ahead of analysts' estimates, according to the Wall Street Journal. However, when adjusted for comparable units and currency, sales actually fell 6 percent year-over-year, driven by slower mobile broadband activity in North America. Ericsson's nominal sales increase was largely a result of the dollar's appreciation against the Swedish krona. 

Meanwhile, Ericsson's net income fell 38 percent to $151.5 million from around $243 million a year ago. Its operating profit in the quarter fell to around $241 million from $298.5 million a year ago and was below analysts' average forecast of $379 million, according to a Reuters poll of analysts.

The vendor's gross margin, a key measure of profitability, fell to 35.4 percent from 36.5 percent a year ago, as spending from carriers and other customers moved to lower-margin projects. Ericsson CEO Hans Vestberg said at a news conference that the lower margin "should not be seen as trend," as Ericsson expects profitability to jump again as it recovers from restructuring costs and currency-driven losses, according to the WSJ

Sales in North America, Ericsson's largest region by far, were flat year-over year at $1.4 billion and down 6 percent from the fourth quarter. The company had expected its mobile broadband business in North America to continue to be slow in the quarter "as operators remained focused on cash flow optimization in order to finance major acquisitions and spectrum auctions." Major Ericsson customers, including AT&T Mobility (NYSE:T), Verizon Wireless (NYSE: VZ) and T-Mobile US (NYSE:TMUS), spent heavily in the AWS-3 spectrum auction, which concluded at the end of January. AT&T spent $18.2 billion in the auction, Verizon spent $10.4 billion and T-Mobile spent $1.77 billion.

"The decline in North America was partly offset by a continued fast pace of 4G deployments in Mainland China," Ericsson noted. "As a consequence, the business mix shifted to a higher share of coverage projects in the quarter."

Looking ahead though, Ericsson is forecasting continued weakness in North America, which is troubling to analysts. "Consumer demand and mobile data traffic growth continued to be strong in North America, creating further need for quality and capacity investments," Ericsson said. "However, with current visibility, we anticipate the fast pace of 4G deployments in Mainland China to continue and the North American mobile broadband business to remain slow in the short term."

"The report was soft, especially on gross margin," Hannu Rauhala, an analyst at Pohjola Bank in Helsinki, told Bloomberg. "Ericsson indicating that the U.S. will remain slow in the short term is a bit of a concern since it's such a key market."

In an interview with FierceWireless, Ericsson CFO Jan Frykhammar said that although Ericsson has seen a sharp drop in North American mobile broadband spending--down 40 percent year-over-year in terms of U.S. dollars--Ericsson still has a strong position in the services market, including billing and OSS/BSS contracts. He noted Ericsson still has a substantial market share in North America.  

Additionally, Frykhammar noted Ericsson could still be called on to provide solutions for carriers to expand capacity, which typically can happen on short notice, of perhaps several weeks. Those projects include things like adding more antennas or small cells, he said. "It's not a structural thing, which I thinks is important," Frykhammar said. "It's more a short term situation that we have right now." 

Meanwhile, Ericsson and Apple remained locked in a legal dispute over patent royalties. Ericsson believes Apple owes it for using Ericsson technologies in the iPhone and iPad. As a result of the battle, Ericsson said that its patent licensing revenues declined in constant currencies in the first quarter. Vestberg said that resolving the dispute with Apple might take a long time. "Our ambition is to settle outside court as soon as possible," he said, according to the Journal.

In March, to boost profitability and better compete with Huawei, Nokia (NYSE:NOK) and Alcatel-Lucent (NYSE: ALU), Ericsson said it would cut 2,200 jobs in Sweden, mainly in research and development and its supply chain. The cost-cutting program will run through 2017 globally. 

Nokia just agreed to buy Alcatel-Lucent in a $16.6 billion deal that would form a powerhouse to rival Ericsson in mobile and fixed networks, though that deal will likely not be completed until the first half of 2016.

Vestberg noted that 10 years ago there were 15 competitors that could compete in mobile network infrastructure, and that with the Nokia/Alcatel-Lucent deal the number will likely be reduced to three. "It's just an enormous change in strategies for many players in this industry," he said in a TV interview with Bloomberg.

"We execute on what we can control," Vestberg continued. "We'll have our ears and eyes open [on] what it means to us, but right now it doesn't change our strategy. We are executing on our transformation to an IT and telecoms company with much more software and services and we're well ahead on that execution."

Ericsson thinks that by 2020, 20 to 25 percent of its revenues will come from other types of customers than operators, up from 15 percent in 2014. In addition to embracing the shift to Software-Defined Networking and Network Functions Virtualization like other vendors, Ericsson is targeting non-carrier customers in the cloud, IP networks, TV and media and OSS/BSS segments.

Frykhammar echoed Vestberg's comments and said that the Nokia/Alcatel-Lucent deal will not change Ericsson's strategy, and the company still considers North America a key market. "Customers will have to talk [internally about] how they will react to this," he said. 

For more:
- see this release
- see this Ericsson report (PDF)
- see this WSJ article (sub. req.)
- see this Reuters article
- see this Bloomberg article

Special Report: Wireless in the first quarter of 2015

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