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Sony Ericsson Mobile Communications AB (NYSE:SNE)

Q2 2010 Earnings Call Transcript

July 16, 2010 2:00 am ET

Executives

Aldo Liguori – VP & Head of Global Communications & Public Relations

Bert Nordberg – President

Bill Glaser – CFO

Rikko Sakaguchi – EVP and Chief Creation Officer

Kristian Tear – EVP and Head of Sales & Marketing

Analysts

Mark Sue – RBC Capital Markets

Johannes Schaller [ph] – Deutsche Bank

Rod Hall – JPMorgan

Richard Kramer – Arete Research

Anuj Krishan – UBS

Patrick Standaert – Morgan Stanley

Janardan Menon – Liberum Capital

Mats Nystrom – SEB Enskilda

Kulbinder Garcha – Credit Suisse

Andrew Griffin – Bank of America/Merrill Lynch

Didier Scemama – RBS

Olof Swahnberg – Reuters

Zahid Hussein – Citigroup

Thomas Langer – WestLB Equity Securities

Nicolas von Stackelberg – Macquarie Research

Operator

Welcome to Sony Ericsson’s media and analysts conference call. To view a visual aids for this call today, please log on to www.sonyericsson.com/press, or www.ericsson.com/investor, or www.sony.net/IR.

(Operator instructions) as a reminder, a replay will be available one hour after today's conference. Aldo Liguori, Corporate VP and Head of Global Communications and PR for Sony Ericsson will now open the call.

Aldo Liguori

Hello, good morning, and welcome to our second quarter call today. With me here today are Bert Nordberg, President of Sony Ericsson, Kristian Tear, Executive Vice President, Rikko Sakaguchi, Chief Creation Officer, Bill Glaser, Chief Financial Officer and Ulf Lilja, our outgoing Chief Financial Officer. Today, we will be making forward-looking statements during the call.

These statements are based on our current expectations and certain planning assumptions, which are subject to risks and uncertainties. The actual results may differ due to factors mentioned in today’s press release and discussed in this call. We therefore encourage you to read about these risks and uncertainties in our press release. I would now like to hand the call over to Bert Nordberg.

Bert Nordberg

Good morning and welcome to the Sony Ericsson business update for the second quarter. As you will have seen from our announcement this morning, it has been another good quarter for the company, continuing the positive momentum we saw in the first quarter, with income before taxes, excluding restructuring charges, increasing to EUR63 million.

We saw the company generate a positive cash flow from its operating activities; another key indicator that Sony Ericsson has turned the corner and is heading in the right direction. The good results were underpinned by a strong sales of our new, higher value Smartphone portfolio that saw an average selling price of EUR160 in the quarter. We believe that the challenging market condition will continue in the second half of the year, and see no evidence to make us revise our earlier market forecasts of a slight global volume growth in 2010.

However, we believe that the Smartphone sector of the market will grow more than 10% in volume this year and see a good business opportunity for Sony Ericsson to target this area of the market. Sony Ericsson’s primary focus has been to target the value sector of the market with a wide range of smartphones across a broad range of prices and product propositions.

This strategy is already beginning to bear results, and we now estimate that value share of the market to be double our volume share. And roughly 50% of the revenue this quarter is generated by Smartphone sales.

In the second quarter, we announced and launched a number of exciting products. The Xperia X10 launched in more markets, including South Korea, the Xperia X10 mini and mini pro started shipping and, in Japan, we launched two new products with KDDI.

We also announced five new handsets that we ship in the third quarter, all focused on the mid-tier of the market. This clearly illustrates that we are not solely focused on the high-end sector, but intend to maintain a broad portfolio that address different price points in the market. Three of the new phones announced in the second quarter were announced at the Communication and Telecoms Show in Singapore. These include the Xperia X8, the lower priced Android touch screen device that brings the unique X10 mini for – new user interface to a lower price point, and the first touch screen Walkman phone that brings touch screen functionality to our global recognized mobile phones – music phones, sorry.

At Communication, we also announced the Android upgrade schedule for Xperia X10, Xperia X10 mini and mini pro. This will not only upgrade the Android platform during the third quarter, it will also bring HD video to Xperia X10 in the third quarter and DLNA connectivity to the devices in the fourth quarter, further delivering in our promise to make it a most entertaining Smartphone.

The key element of the company is to return to profitability with the launch of our new Smartphone portfolio. This had been added with the announcement – added to with the announcement of the Xperia X8, and our portfolio now covers a range of platform, form factors, screens and product sizes, plus different product propositions.

In the second quarter, we launched the Xperia X10 mini and mini pro, which have been both well received by operators and consumers. Although the phones only came to market in the end of the quarter, the X10 mini is already the best initial launch Sony Ericsson phone ever had in the Nordics, and the number one Carphone, Warehouse Phones, phone. It’s early days still, but the initial media reviews and consumer – and customer responses have been very good.

We are now in the final stage of the business transformation program started in the mid-2008, and are confident on delivering on the target promised by the end of 2010. As we have seen from the earlier slides, we have now successfully launched a realigned product portfolio with a clear focus on delivering the most entertaining smartphones in the market. And we are happy to see that these new phones are coming to market with significant improved quality.

As we look forward to the second half of the year, our priority will be to continue this focus on efficiency and profitability, to create a stable platform to develop the business going forward.

We will be launching the new mid-tier products, I spoke about earlier in the presentation, and this will extend the reach of the Xperia range of smartphones to new customer segment, and bring the touch screen form factor to the Walkman line up. We will continue to focus on quality improvement and work closer with our parent company to fully leverage the unique advantages they both bring to Sony Ericsson in terms of telecom technology expertise, consumer electronics insight, and entertainment content.

Thank you for listening. I will be back on the call later answering your questions, but I would like to hand over to Bill Glaser, our new CFO, and he can talk to you about the numbers for the second quarter. Bill.

Bill Glaser

Thanks, Bert. It is a pleasure to be here today for my first quarterly call, but even more of a pleasure to be able to discuss Sony Ericsson’s second quarter results with you. Sony Ericsson’s income before taxes, excluding restructuring charges, nearly tripled during the quarter to EUR63 million, an increase by nearly EUR350 million year-on-year showing, I think, that our value strategy, combined with the savings generated by our transformation program, are showing signs of success. Even including the restructuring charges we incurred as our transformation program reaches its final stage, income before taxes nearly doubled during the quarter, and cash flow from operations turned positive.

Let me now go into more details in the quarterly figures and try to put them into some context for you. Units shipped in the quarter came to 11 million units, a decrease year-on-year by 20%, as a result of inventory closeouts in 2009 and our purposeful shift focusing on the value sector of the market as we work to return the company to profitability.

The quarter-on-quarter growth of 5% can be attributed mainly to strong shipments of smartphones, including the Xperia X10 and Vivaz models, which were launched in more markets throughout the quarter, and the launch of X10 mini and X10 mini pro towards the end of the second quarter. We achieved an average selling price of EUR160 in the second quarter, up from EUR134 last quarter and EUR122 last year, driven mostly by product and geographic mix.

Favorable foreign exchange rates had a positive impact, estimated at the low single digits during the second quarter. Net sales of nearly EUR1.8 billion for Q2 resulted in year-on-year and sequential growth of 4% and 25% respectively, and followed from the previously high led volume in ASP drivers.

Sony Ericsson’s introduction of a broader Smartphone portfolio was apparent during the quarter. As Bert mentioned earlier, nearly 50% of our net sales in Q2 came from smartphones, up from being a low, single-digit contribution last year.

As you would expect, our reported gross margins in Q2 of 30% showed significant improvement over the prior year, our reported margin declined sequentially to 28%. However, if the positive impact of the royalty matter included last quarter and the restructuring charges included this quarter are excluded, the gross margin percentage would actually show slight improvement from Q1 to Q2 as we continued to experience a very favorable product and geographic mix.

Operating expenses from Q1 to Q2 were due to unfavorable foreign exchange rates, as well as higher marketing expenses, and are in line with our increased net sales. As a percentage of net sales, operating expenses declined from 30% last quarter to 26% this quarter. Operating expenses also declined year-on-year with the benefits of the transformation program more than offsetting a negative foreign exchange trend. Speaking of the transformation program, during the second quarter, we incurred restructuring charges of EUR32 million, mostly as a result of settling certain contractual obligations, while some activities are ongoing, the transformation program is now complete.

In the two years the program has run, we have incurred total restructuring charges of approximately EUR374 million. With the transformation program now nearing its conclusion, we expect the transformation charges to be well within the EUR400 million figure mentioned last quarter.

The transformation program has delivered significant reduction in cost of sales, and will enable us to reduce annual operating expenses by EUR880 million, in line with our original target. This has been achieved through headcount reduction of approximately 4,000 people worldwide, as well as the consolidation of facilities in nearly every area and region of our business.

With this, we do not expect to be talking about this transformation program going forward. The EUR32 million restructuring charge recorded in Q2, along with the – an increase in our effective tax rate, resulted in a quarter-on-quarter decline in net income of EUR9 million. Year-on-year, net income increased by EUR225 million. Thanks to the positive operational cash flow and favorable exchange rates, our net cash increased by EUR46 million to 609 million at the end of June.

Borrowings remained flat during the quarter, with the increase shown attributable to exchange rate fluctuations.

With that, I will conclude my prepared comments and hand back to Aldo.

Aldo Liguori

Operator, we are now ready to open the Q&A session.

Question-and-Answer Session

Operator

(Operator instructions) As always, please limit yourself to one question at a time, and please keep your questions at a broad level. Detailed information is provided in the report and Sony Ericsson’s corporate communications team will be happy to take additional questions and discuss further details with you after the call.

I will now move to our first question from Mark Sue from RBC Capital Markets. Please go ahead.

Mark Sue – RBC Capital Markets

Thank you. Recognizing your strong commitment to Android, what happens to the support for the other operating systems? And within Android, do you feel that Sony Ericsson has enough points of differentiation so that a consumer is more likely to choose Sony Ericsson versus the 30 or 40 other Android devices that will soon come to market?

Rikko Sakaguchi

Hello. This is Rikko Sakaguchi. Yes, we'll continue to support other platforms like Symbian and Windows. Primarily, we have made (inaudible) Android platform and that has really had taken place. We are very confident our user experience platform, which is a whole new concept of bringing user interface as well as new features. And one good example is Timescape/Mediascape, which is completely unique for Sony Ericsson, which has been hitting the market, and we will be consolidating new ideas on top of Android.

So we're very confident we can differentiate ourselves, and also the breadth of portfolio in Android, in our case, will be a significant differentiator. And needless to say, our design, the human curvature design, has been really, really been accepted very well. So we continue this momentum and really bring the great products to market.

Mark Sue – RBC Capital Markets

And just on your point of going into the mid tier a little bit more aggressively, is that necessary, considering the strength that you're seeing at the high end? Why not just play in the high end of the market, or do you feel that it is just important to just kind of broaden your market tier?

Rikko Sakaguchi

I think we, this year, we started from X10 and expanded into the high end, so we are confident there. But our outer strength from the heritage of our proprietary solution, we know how to make all the user experience consistent within the portfolio. And we will probably expand in the mid-end or even lower, because that is the traditionally our biggest strength. So we will combine all that with the consistent (inaudible).

Mark Sue – RBC Capital Markets

Okay. Thank you and good luck, gentlemen.

Operator

Thank you. And we will now move to our next question from Johannes Schaller [ph] from Deutsche Bank. Please go ahead.

Johannes Schaller – Deutsche Bank

Yes, good morning. I have a quick question. Do you have a sort of target range of volumes in terms of the smartphones versus feature phones? And then secondly, once you've reached that target, what would be sort of the target ASP be for Sony Ericsson? Thank you.

Bert Nordberg

Bert Nordberg here. We haven't set the target on the mix, actually, between the feature phone and the Smartphone. But it is quite clear, on the market, that there is a favorable margin on the smartphones, and we don't intend to have a lower mix than we have today. And looking at the target ASP, of course, we are launching a number of mid-tier phones in the lower segment, and that will sort of push the ASP down if we are successful as planned with this product. And we are watching that carefully and make sure that we have a control over where the ASP is going, but we are not pointing it on any certain direction. We haven't put a target price, because it is so dependent on the product mix.

Johannes Schaller – Deutsche Bank

Okay, thank you.

Operator

Thank you. We now move to our next question from Rod Hall from JP Morgan. Please go ahead.

Rod Hall – JP Morgan

Yeah, thanks for taking my question. First of all, nice job turning this business around, guys. Just a couple of questions for you. The euro impact on the ASP, can you give us some quantification of that, number one? Number two, do you guys – I mean, I see that you've got net cash going up this quarter, which is good news. Can you talk to us about the plans for resuming dividends to the parents, given that they've extended additional financing to you, and so on?

And then lastly, can you talk to us about your market assumptions? Because your numbers imply something like 275 [ph] million handsets shipped market-wide and that number would be significantly lower than what we estimate, and I think a lot of people in the market estimate, but those estimates include white label handsets. So could you just remind us what you're assuming about white label handsets in your market estimate? And that’s it for me.

Bill Glaser

This is Bill. I'll take the first couple of questions, Rod. On the Euro impact, it’s a little bit of an art to estimate exactly what that is, but we estimating it around EUR6 in the quarter. On your cash flow question, it’s, I think, very premature to speculate dividend payments and things like that. We're really focusing on keeping cash flow going positive, and we will take it from there, I think, in the future. On the market assumptions question, I think I'll defer to Kristian Tear.

Kristian Tear

Okay, if you look at the market size, we don't include the unlicensed markets and the suppliers that are providing cheap sets based on some – that we can't account for. Our estimate for quarter one was very, very accurate when we estimated the market size for that quarter; we were within a variance of 2%. And, as Bert already said, we have a moderate outlook with slight growth in volume and value for the full year.

Rod Hall – JP Morgan

Okay. And can you guys – just one other thing, can you talk to us about, it doesn't look like there was any demand weakness regionally or generally. I mean you guys, you shipped less units, but you're saying that because you ranged less handsets, which makes sense. Can you just you know that we have got a lot of concern about Europe and what is happening with the consumers there; can you just comment on the European demand situation?

Kristian Tear

If you look at the new portfolio that we have launched, it has been very, very well received by operators and by consumers. And if you look at the market shares in Western Europe, we have actually had a significant increase in market share, or in volume, in Western Europe during this quarter.

Rod Hall – JP Morgan

So it’s fair to say, in Q2 you haven't seen any consumer demand weakness coming through in Europe? (inaudible)

Aldo Liguori

Operator?

Operator

Thank you. And we will now move to our next question from Richard Kramer from Arete. Please go ahead. Thank you.

Richard Kramer – Arete Research

Thanks very much, guys. I wonder if you could just, Bert, specifically talk through two issues; one is the US market. I've asked you a several calls ago about your commitment there, and we still don't see the sort of high-end range planning slots with the large operators that we might expect to see Sony Ericsson come back in that market. And also, could you talk through the countries, and in particular which drove the sequential increase in your Asia business, and whether or not there’s a fair component of a Japanese improvement there, and maybe your longer term plans for the Japanese market? Thanks very much.

Bert Nordberg

Many questions, Richard, in one, but let’s start with the US. And we don't launch product for our customers in this call, but our estimation on product launch is in August in the US; that’s what I can say for the moment. And looking at the Japanese market, we are very strong. And in Japan, it has been an extremely strong quarter and we are delivering to KDDI and DOCOMO, and we have plans to continue a strong movement in the Japanese market. We have launched new product with KDDI, and there are more operators in Japan so we see continuously very strong performance in our Japanese organization. Then, regarding Asia, I hand over to Kristian.

Kristian Tear

We have also had success in many other Asian markets, and we will continue to do, I think, well in Asia.

Richard Kramer – Arete Research

Okay. And was the majority of the increase in sales coming from the Japanese market this quarter in Asia?

Kristian Tear

Mostly [ph], yes.

Richard Kramer – Arete Research

Okay. Thanks, guys.

Operator

Thank you. We'll now move to our next question from Anuj Krishan from UBS. Please go ahead.

Anuj Krishan – UBS

Hi. Thanks for taking my question. If you could just maybe elaborate upon your expectations for mix going forward in Q3 and Q4, and how should we look at your gross margin progression based on the mix expectations? And then secondly, also just if you can maybe talk about your aspirations for EBIT margins longer term; what’s the kind of ambitions that you think, or structurally, what the company is capable of achieving? Thank you.

Bert Nordberg

I'll start with the last question, talking about the EBIT expectation. We are not satisfied until we reach 10% EBIT margin in this company, so that’s very clear goal from us. When we reach that, we will talk about what we do next, but that’s the target we have set, for us to reach 10%. And looking at the mix going forward, I think we will have a sort of a slight increase on the mid-tier market with the new product launches. That doesn't mean that the mix between smartphones and mid-tier will differ very much from this quarter, depending on that we also have some ambition in doing well on the Smartphone market. So but still, I wouldn't estimate sort of that the product mix would leave the ASP untouched, because it will probably take it down.

And remember also that, during the next two quarters, you will see a flood of Smartphone being launched from competition. And it is a brutal competition out there that we expect that we have to meet, so that’s my guidance in that sense.

Anuj Krishan – UBS

All right. Thank you very much.

Operator

Thank you. We'll now move to our next question from Patrick Standaert from Morgan Stanley. Please go ahead.

Patrick Standaert – Morgan Stanley

Hi, thank you. The question comes really in terms of how you see the breakdown in your margin. I remember, in World Mobile Congress you mentioned that if you could reach 30% gross margin that would be the aim to reach 10% operating margin. That’s where we are, but the operating margins are below, so my guess is the improvement are now going to come more from the OpEx side, and SG&A was quite high. Can you help us understand a bit what is coming next on the OpEx side, and how you're going to drive further improvements there now that you have mainly completed your restructuring plans? Thank you.

Bill Glaser

Yes, Patrick, I think I'll look at it a couple of different ways. I think, one, when we have talked about our OpEx targets, we're talking about getting to a run rate, where we're not quite at that run rate yet; we have talked about completing the program towards the end of the year. It doesn't mean we have captured every cost savings quite yet. Secondly, during the quarter, I think you'll see, as with any business, our operating expenses will be choppy. They'll go up and down with the business. So it’s not (inaudible) what will occur.

And finally, the 30% margin, two comments on that. It’s the margin dollars that pay for the OpEx, so it’s not just the percentage; it’s predicated upon certain volume assumptions that we need to continue to see.

And we'll see what happens going forward. We had exceptional growth this quarter. I certainly don't think any of us can expect anything near a 25% quarterly growth going forward. We had some great launches during the quarter; we're very, very proud of those. And I'm looking forward to the second half.

Bert Nordberg

I think also in this quarter we had an exceptional push, marketing campaigns, because in the launch of the mini and mini pro, we did a worldwide marketing that we had planned for, so that is why we had a jump in the marketing costs that is exceptional for this quarter.

Patrick Standaert – Morgan Stanley

Can you quantify a bit how much on that marketing was exceptional?

Bert Nordberg

I think I won't comment that.

Patrick Standaert – Morgan Stanley

And maybe a final question for me. In terms of your Android-based phones, would it be fair, and I know you don't want to comment on the number of units, but could you give us some indication of whether you have reached a number which is above 1 million?

Bert Nordberg

Yeah, that’s correct.

Patrick Standaert – Morgan Stanley

Okay, thank you.

Operator

Thank you. We'll now move to our next question from Janardan Menon from Liberum Capital. Please go ahead.

Janardan Menon – Liberum Capital

Yeah, hi. Thanks for taking the question. Your ASP jumped quite strongly in the quarter. Given that new products you're launching in the coming quarters as well, and how you're seeing the mix going, can we assume that you can roughly maintain the sort of 150-plus range going forward? Or is there any reason to believe that, with more mid-range phones coming, etc., that you could go back to a lower level than that?

And the second question is, you've said that you are now well positioned for long-term growth, and also you said that the Smartphone market is growing well over 10%. So when can we start seeing that reflected in your unit volume numbers, which is to say that when can we see you growing your volumes faster than the market and to gain back some volume share? Can that be expected in the second half of this year?

Bert Nordberg

Yeah, I think that the portfolio – if we take the ASP question, I won't give any guidance how that would develop, of course. But we are – we have announced, and we have launched, phones that are, of course, below that ASPs' point today. And we expect to sell a lot of them, because in those segments the market is much bigger, and that indicates that we can grow the volume and start to grow in the volume market share also. Nevertheless, I think that it’s very important for us to keep the positioning and being strong in the volume segment, which we estimate to continue.

But you have to draw your conclusion also that the competition is launching a number of phones. But I haven't put a target for ASP. But I can say, I do what I can and my sales management do what they can to keep this up. But the sort of product mix, the competition, is affecting the ASP going forward.

Janardan Menon – Liberum Capital

And on the unit volume?

Bert Nordberg

The unit volume, I have said, that we go into segment that has a bigger volume, so we expect that to grow.

Janardan Menon – Liberum Capital

So we can expect some market share improvement into the second half of the year?

Bert Nordberg

That – I would stick with that statement.

Janardan Menon – Liberum Capital

Thank you very much.

Operator

Thank you. We'll now move to our next question from Mats Nystrom from SEB Enskilda. Please go ahead.

Mats Nystrom – SEB Enskilda

Yes, hello. And congratulations to a very strong set of results. Bert, you commented a little bit in the call about product launch, but could you be more specific about the pace of product launches in second half versus first half, perhaps, in number of products? And secondly, perhaps to the CFO, the R&D level of EUR218 million, almost in line with Q1 but for higher sales level; is this the new level of R&D, so to speak? Or was there some exceptional low level of various reasons in Q2? Thank you.

Bert Nordberg

Yeah, I would love to talk about the second half’s product launches but, I'm sorry, we have a policy; we announce product when we want to announce them. We don't do it in – we don’t do any pre-announcement, so I can't do that. But I think we have launched some very, very, very good propositions now for the mid-tier segment. And they, I expect, to sell the full half-year. If there is any good product launches in the autumn, I'm sorry, you have to wait until we do them.

Bill Glaser

On your R&D question, the 218, I'm not going to get into the business of predicting new lows and new highs; I don't think that helps any of us. As with all of our OpEx, R&D is a bit choppy. It’s driven very much by the projects, and the launches, and expenses we incur. I think I'll leave my comments with that; that we will continue to invest R&D at an appropriate levels to drive the business.

Mats Nystrom – SEB Enskilda

Okay. Thank you.

Operator

Thank you. We'll now move to our next question from Kulbinder Garcha from Credit Suisse. Please go ahead.

Kulbinder Garcha – Credit Suisse

Hi, thanks. A question on the OpEx and on the cost cutting; could you give us an idea of how much is left to be done? I understand there is some seasonality, but if you all could give us some idea, I guess, as to what kind of leverage you might see as the sales pick up in the second half. And then the next question is, would it be fair to assume that we have seen virtually all of your Smartphone portfolio for this year that would probably impact this year’s shipments? Thanks.

Bill Glaser

Could I maybe ask you to clarify your OpEx question again?

Kulbinder Garcha – Credit Suisse

Yeah, what I'm asking is, in terms of you've got this EUR880 million target from mid-'08 by until the end of this year, I'm just wondering how much more cost savings have yet to come out of the business in the back-half from, let’s say, the Q2 run rate. I know there will be some seasonality, but how many more cost savings have you yet to actually deliver on?

Bill Glaser

Yes, this is Bill then; I'm sorry. I won't comment on specific numbers in specific quarters. As I said, it’s choppy and it will, you know, go up and down with marketing expenses, stuff like that. But I do expect that we do have more savings to be captured going forward. I think you can count on that a little bit, as we'll see that occur, barring the nature of the business. If we need to invest more in selling and marketing, we will certainly do so.

Bert Nordberg

And we continue that we won't pre-launch any products for autumn in this call, so we have no comments to that question on launching more smartphones.

Kulbinder Garcha – Credit Suisse

Okay.

Operator

Thank you. We'll now move to our next question from Andrew Griffin from Bank of America/Merrill Lynch. Please go ahead.

Andrew Griffin – Bank of America/Merrill Lynch

Hi, thanks. Just another question to help us on working out your mix, how far through the ending of the low-end traditional phone portfolio are you now? Is there still, do you think, some volume decline to come there which would obviously hurt volumes that raise ASP? Or is that pretty much done by now?

Kristian Tear

We are introducing – this is Kristian here. We are introducing, I mean five new phones now. And we expect, of course, those phones to replace other phones and be successful out in the market, so we expect to do more volumes on those phones. When you look at the ASP mix then, these phones have an ASP that is below the EUR160, so we expect then obviously that affects the ASP downwards when we have success with the volume.

Andrew Griffin – Bank of America/Merrill Lynch

Okay, thank you very much.

Operator

Thank you. We'll now move to our next question from Didier Scemama from RBS. Please go ahead.

Didier Scemama – RBS

Yeah, good morning, gentlemen, and congratulations on the operational improvement. I know Patrick tried to ask the question, but I'd like to be a bit more granular, if possible. Would it be fair to say that you're even closer to 2 million smartphones in the quarter, please?

Bert Nordberg

I don't know. We have been quite clear that 50% of our revenue is coming from the smartphones, and we sold 11 million phones. I'm sorry, that’s how far I'm going in (inaudible).

Didier Scemama – RBS

Okay, no problem. And secondly, I just want to look at the sort of medium-term picture for the company. Obviously, you've taken the multi OS route; also we see Android starting to penetrate other class of devices, such as TVs and set-top boxes. So my question would be, number one, do you intend to penetrate those new class of devices in order to leverage Android? And secondly, when it comes to the other OS, do you think that in the longer term you will maintain a three OS strategy, or whether you're going to focus maybe on just two? Thank you.

Kristian Tear

(inaudible) that we are actually working on. And of course, our approach is not really about whether we go into a consumer electronic device or a bigger device. I think our focus is communication entertainment. It’s a most entertaining Smartphone, and the size can be fit into the new demand, which is diversion today. We will put a lot of focus on creating something that’s new. And, obviously, I can't comment on what it is now, but we have plans to excite the market. To your question about the OS, yes, as we have said, we will have a tremendous focus on Android. That does not mean that we give up others because, in the end, it’s the consumer that decides. So we are pretty much open to adjusting our approach.

Actually, this year, the Symbian-based phones, Vivaz/Vivaz pros, are really hitting the market. And obviously, part of the reason is, of course, that is accepted by the market, and partly the Symbian offering is good, and also the product itself, regardless of the OS, is good. So we take the OS as the enabler – one of the enabler for the product, as well as marketplace and (inaudible). We take – rather than picking up which OS is good or bad, we want to – approach to the more realistic approach what is best for the consumers. But again, we will continue to sell the Symbian-based phones to create more (inaudible).

Didier Scemama – RBS

Okay, many thanks.

Operator

Thank you. We'll now move to our next question from Olof Swahnberg from Reuters. Please go ahead.

Olof Swahnberg – Reuters

Hi. I am just wondering if you could clarify the fall in gross margin. I'm sorry, maybe I missed this earlier, but gross margin seems to be down slightly quarter-on-quarter and I would be – be very grateful if you could clarify what were the elements in that.

Bill Glaser

Yes, this is Bill again, Olof. Actually, it is a number of – a couple of factors. But the simplest go I would give at it is that, if you recall from our call last quarter, we had certain royalty items that were in. When you exclude those royalty items from last quarter and you take out the restructuring charges included this quarter, the royalty reserves were positive last quarter, restructuring negs this quarter. Take those out and, I'll say, normalized, but that’s too strong a word, the margin is actually going to be about flat.

Olof Swahnberg – Reuters

Okay, excellent. Thanks very much.

Operator

Thank you. We'll now move to our next question from Zahid Hussein from Citigroup. Please go ahead.

Zahid Hussein – Citigroup

Yes, thanks for taking my question. And just a quick query one on your margin guidance. You sort of said that you might [ph] be happy to have a 10% margin. Could you give us any idea as to when you're hoping to achieve that? It’s clearly not going to be this year, but is it a 2011 story? Is it a 2012 story? And also on components, could you just give us any idea if you're seeing any component constraints anywhere else? We've obviously heard other sorts of manufacturers talk about issues sorting components, and just to see what your take is on that. Thank you.

Bert Nordberg

We have said 10% as a long-term target, and there is sort of no date set. And I usually say I would like to reach it tomorrow, but it sort of – it takes time to change the market and so on. So we actually don't have a target date, but we have a target goal and the sooner we can reach it, the better. But I actually don't have a date. We're coming from a condition in the company and the turnaround is tremendous so far. And we have a bit to go, as we say.

So we will continue to work on operational excellence efficiencies to reach the target of 10%. But it’s very hard to predict the date of that when we will reach that. But I want you to know that sort of we will not rest until we reach that.

Zahid Hussein – Citigroup

And are you under any pressure from your parent companies to achieve that within any timeframe? Have they just given you enough leeway?

Bert Nordberg

What do you think? Of course we are, but we're doing what we can. We're doing what we can in improving the company’s performance. At the same time, we of course, need to invest in attractive products. So there is a plan with our parents on how to do it, but we don't disclose any dates when we're going to reach it. But the plan is to take us towards the 10% margin.

Operator

Thank you. We'll now move to our next question from Thomas Langer from WestLB. Please go ahead.

Thomas Langer – WestLB Equity Securities

Yes, thank you so much. I just want to come back to the obviously good reception of new products across the globe. Maybe you can talk a little bit about how that perception differs across certain regions. And I think what I want to get at is, have operators in different regions, different expectations from Sony Ericsson? And might that be a reason why you might want to penetrate the mid range much stronger maybe than over the past six months? And maybe you can also comment whether some, let’s say, slots in the ultra high end are already taken and you simply have to react to operator requirements. Thank you.

Kristian Tear

Kristian here. Obviously, the market conditions are very different across the world. You have operator markets dominated by operators. You have retail markets and trade markets which are very, very different. Our products are well received, I would say, across the globe. We do introduce them at different timings, since we introduce them together with operators in many cases and we need to fit in with their timing before it comes to market. It is also so, to a large extent, in the operator market that the operators will certainly select a tariff and obviously, that tariff also will have an impact on how successful the product will be. So it’s quite complex in that respect.

But we have had success with local operators in local places. We have talked about Japan before; we have talked about Canada; we're looking at the Nordics, it’s going really well. We talked about France already before. So there is a lot of success happening out there. We want to make more success, and we're working hard in order to fix the places where we are still not yet successful.

When it comes to the mid range and when it comes to the slots, there is, of course, a demand from the operator side to get the cost of connect down and to provide new services to the larger mid segment. And we're, of course, bringing them the functionality and the smartphones downwards to provide also these consumers with really, really good experiences. Of course, also there is growing demand for phones in India and in Africa. And they are also looking for other types of phones and more intelligent phones, more Smartphone-like phones, which is, of course, something we are very, very interested in.

Your last question with regard whether the slots are taken, I don't think so. If you have a very, very interesting proposition, and I think we have a very interesting proposition and a compelling proposition, the slots will be made and are made available for us.

Thomas Langer – WestLB Equity Securities

Thank you very much.

Operator

Thank you. And we'll now move to our final question today from Nicolas von Stackelberg from Macquarie. Please go ahead.

Nicolas von Stackelberg – Macquarie Research

Yes, thanks for taking my question. Rikko, I'd like to follow up on one of your comments regarding Symbian phones really hitting the market later in the year, if I've got that right. Obviously, we had some comments from one of your competitors regarding timing of Symbian 3 and Symbian 4 devices. Do you think this is a company-specific issue, or is it due to the state of the development path of that operating system? And then secondly, could you also give us an update on your content strategy and how you feel about that? Thank you.

Rikko Sakaguchi

Yes, I'm not sure if I understood you correctly. My comment about the Symbian-based product, Vivaz, Vivaz pro this year, yes have been hitting the market. It’s one of the most volume and margin driver this year and particularly Vivaz, the size and HD and all the full package capability has been really, really – actually that’s probably one of the highest ranging also from the operators. That’s what the product has done.

Of course, it has been based on Symbian, so we made it fit on the Symbian platform. Going forward, of course, we will carefully plan or be re-planning what is best for the market, so we will continue with that, of course, in relation to other portfolio in Android. So I can't comment how we will be doing it and also comment on the version of Symbian specs. But you will see that in the (inaudible).

Regarding content, we have been shaping up our operation starting from the organizational change driven by our Silicon Valley organization now, because it’s much more closer to where we should be, in the engagement of the content publishers, developers. That’s how our organization is set up.

And then we're reinforcing offerings in the local market implementation about the web services, user services; the user service, web services continues to be on the play now. And obviously we are looking into partnering or collaborating with the Sony. Going forward, we'll hope to see much more tighter collaboration or whatever you call it offerings emerge. That’s what we (inaudible).

Nicolas von Stackelberg – Macquarie Research

But I suppose you're not ready to share with us a number on – a sales figure how much content currently it represents?

Rikko Sakaguchi

No.

Nicolas von Stackelberg – Macquarie Research

Hello?

Aldo Liguori

Hello, I'm sorry, you may have heard Rikko Sakaguchi say that no, we're not prepared to give that information at this time.

Nicolas von Stackelberg – Macquarie Research

Sorry I've got a bad line. That’s why I didn't hear it. I'm sorry about this. And then maybe a final quick follow-up on cash flow. You've delivered positive free cash flow for the first time since quarter one 2009, so that’s very welcome, that movement. Maybe William, you could comment on how you see the cash flow pattern or the free cash flow pattern, in particular, shape up over the coming quarters?

Bill Glaser

Certainly, it’s something that I focus on all the time. And as you can well understand, we don't give guidance; I can't be specific. But our goal is to certainly stay in that positive range. We will, of course, grow the balance sheet when we need to, to support the business, but certainly our goal is to keep this trend going.

Nicolas von Stackelberg – Macquarie Research

Maybe just one of the elements there, how should we think about working capital needs going forward?

Bill Glaser

It’s something I think about a lot, to be honest with you. It’s fair to say that this will follow the needs of business. We think we manage working capital fairly tightly, and we'll continue to try to do that. I think it’s fair to say, like anything, we'll have some spikes now and again. But we're going to try to keep with where we are and the metrics that we chase.

Nicolas von Stackelberg – Macquarie Research

And what are those key metrics?

Bill Glaser

I think they're the standard ones you'd expect, having the AR, inventories payable.

Nicolas von Stackelberg – Macquarie Research

Are there any metrics that you would like to share with us maybe, or update us on?

Bill Glaser

I don't think we go into that level of detail on these calls, I'm sorry.

Nicolas von Stackelberg – Macquarie Research

Okay, thank you.

Aldo Liguori

Thank you for participating in our call today. And if you have any additional questions, please call our respective investor relations team at the parent companies or the PR team at Sony Ericsson Global. Thank you very much for your attention, and please enjoy the rest of the day.

Operator

Thank you. That will conclude today’s conference call. Thank you for your participation, ladies and gentlemen, you may now disconnect.

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Source: Sony Ericsson Mobile Communications AB Q2 2010 Earnings Call Transcript
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