Here’s the entire text of the prepared remarks from Ericsson’s (ticker: ERICY) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
Karl-Henrik Sundstrom, CFO
Carl-Henric Svanberg, CEO
Gary Pinkham, Vice President Investor Relations
Tim Boddy, Goldman Sachs
Stuart Jeffrey, Lehman Brothers
Mats Nystrom, Enskilda.
Alexandre Peterc, Exane BNP Paribas
Brian Moldoff, Deutsche Bank
Wojtek Uzdelewicz, Bear Stearns
Jeffrey Schlesinger, UBS
Richard Kramer, Arete Research
Ittai Kidron, CIBC World Markets
Peter Dionisio, Morgan Stanley
Jeff Walkenhorst, Bank of America Securities
Ed Bell, Cazenove
Mark Davies-Jones, JP Morgan
Welcome to the Ericsson analysts and media conference call for their third quarter report for 2005. To view visual aids for this call, please log on to www.ericsson.com/press or www.ericsson.com/investors [OPERATOR INSTRUCTIONS]. As a reminder, replay will be available one hour after today's conference. Mr. Gary Pinkham, Vice President Investor Relations, will now open the call.
[Gary Pinkham, Vice President Investor Relations]
Thank you, operator. And Hello, everyone, and welcome to our conference call for the third quarter of 2005. We're starting a few minutes late today, because we wanted to make sure everyone was on board and there was a few late people dialing in, but hopefully everyone is there now. With me here in Stockholm is CEO Carl-Henric Svanberg and Karl-Henrik Sundstrom, our Chief Financial Officer.
Before we get started, I'd like to inform you that we will be making forward-looking statements during the call today and these statements are based on our current expectations and certain planning assumptions. The actual results may be different, due to a number of reasons, and the risks and uncertainties associated with these planning assumptions are described in our Annual Report, which we encourage you to read. With that out of the way, I'd like to hand over to Carl-Henric for comments about our performance during the quarter and our plans going forward.
[Carl-Henric Svanberg, CEO]
Well, ladies and gentlemen, welcome to this conference call, again. Let me start by saying that this quarter was a milestone for our industry. We passed 2 billion mobile subscribers in the world and I think we are aligned with other analysts in our assumption that we will pass 3 billion within five years or so. That is a pretty fascinating thought for us as a Company with a vision of an all-communicating world.
It is driven by the fact that communication is a basic human need and mobile technology is serving this need best into every single village around the world. The primary growth drivers right now is, of course, mobile voice and data, as we know, but also broadband in general, with a lot of new services coming on board and also generally increased minutes of use, much driven also by the intense tariff competition.
There is also strong momentum in emerging markets. And it speaks for itself the fact that we, as an industry, thought that 2 billion subscribers was a goal and saturation level only a couple of years ago, whereas we now think we can go 50% higher than that.
Convergence is on everybody's agenda, especially in mature markets, of course, where we bring mobile and fixed telephony into one seamless network. It's not going to happen overnight, but it's certainly something that is on the agenda for technology development and positioning for future business.
A couple of words on mobile broadband here, HSDPA really offers a new level of services. It is not simply that, when we download our mail, we can do it faster than before and enjoy the speed, but it's also that music downloads or music streaming or video downloads or even TV or enterprise services. There are a number of services that are suddenly very attractive and possible on the HSDPA networks.
And that, HSDPA in itself is not so much of a technology as a different way of handling the signal and the system in a much more efficient way. And it's done by smart software, which means that it's basically the existing networks, if you build them smart, but you can update with the downloads of the software. And we expect all Wideband CDMA networks over time to be upgraded. And very little that is being sold from now on is going to be anything else than with that capability. We're seeing a couple of million add-ons of new subscribers every month, in the worldwide Wideband CDMA networks. Today, on 34 million as a whole.
Our mobile platform company continues to be very successful. You'll find a platform for 3G in the majority of all handsets outside Japan and present in the 10m of the handsets sold this year.
We are also seeing accelerating demand for services. We have a 30% increase year on year, a quite impressive number actually, and certainly coming up as one of our the strong growth drivers in Ericsson. There is a growing interest in all markets, all, from the traditional what we call support services, which is simply maintaining and updating and making sure that all the networks out there run efficiently, to hosting, is the offer we go to operators and set up contracts with different content providers and therefore, after a fixed fee down payment, an operator will pay as he grows with the usage of his subscribers. It's also about system integration, where we have very qualified resources throughout the world helping operators to make everything work from end to end. And there is quickly growing demand for that in the more complex networks.
But finally, also, managed services, where we are taking over running networks with quite compelling savings that we can make. And this is an effect of that we can leverage synergies and overlaps between our own support organization and then and the network operation that the operator runs. This is driven, on one hand, in the markets, mature markets, where everybody's seeking more cost efficient models of operating, but it's also driven in emerging markets simply by startup companies, operators that need to focus on their customers and are very glad when they can offload any of the work to somebody else.
Let me then go through the regional update and let me then start by saying a few words on Western Europe. Already, back in after Q4 last year, we said that we looked forward to a more flattish Europe this year, because we had so strong upgrades and the catch up investment that we spoke about several times last year, where we are comparing with pretty strong numbers last year. It has been like that in the second and third quarter. The first quarter, as you remember, was strong, but the catch up investment didn't start in the first quarter a year before, so that's more a relative difference.
This is, as I said, it's an area of increased interest for managed services. We see a lot of tariff competition in Europe. And we're also seeing a lot of increase in data traffic. But also, this is maybe jointly with the U.S., a lot of focus on convergence and next generation networks. You're all familiar with the BT 21C network, but we have similar projects going on in seeing similar projects in with KPN or France Telecom or Deutsche Telecom or Telecom Italia or Telefonica.
The CEMA region that grew quite strongly in Q2 has not seen as strong a growth in Q3, but the underlying business activity is stable, so there is more swings between quarters. Strong subscriber growth and network expansions. One particular milestone that we reached was 100 million subscribers, now, in Africa, and there is a obviously a lot of potential in that continent as well. We have also see, we are also seeing 3G and HSDPA deployment getting started and of course we'll see more and more of that, as well, in this region.
If we then go to Latin America, that is our strongest growth region. It is clear that GSM is the winning standard. There is very little left of CDMA networks there. And 40% up is a, it's an inspiring number. It's a lot of market share gains there, but it's a strong growing region. Maybe numbers that, we can't hold up those percentages numbers going forward. That gets increasing difficult, obviously. Brazil and Mexico are two countries that are pulling the growth strongly, here, and even Argentina is actually doing well here.
If we then go to Asia Pacific, that is a region where we see 20% growth, which is a healthy number, but we see a lot of variations in the region. There is a high activity level in countries like Australia, India, Indonesia, Japan and so on. But, at the same time, we're seeing China in a bit of a waiting mood.
We should remember, though, there is a bit of contradictions here, because China adds on still some 5million and will continue to do so, 5million subscribers every month. Traffic is increasing. You see almost all-time high pickup rates in new subscribers on some of the operators in China. But everyone is waiting now for the green light to start the rollout for 3G. And there will be 3G three licenses for 3G is what everybody expects, for four operators. And one has to get that mathematics together and everyone isn't really sure what their role is going to be. And therefore there is this, a bit of a waiting mood.
We expect that to come in the, maybe, first quarter or so. I guess we have been guessing over the years, have been wrong all the time, but I think we're getting closer and closer to the rollout green light there. But that is also holding back a bit on the 2G side, because nobody wants to spend too much if they're going to go into 3G.
If we go to North America, we see a very healthy rebound after the consolidation there. It is very interesting, now, to follow Cingular's 3G HSDPA rollout, where we are the lead supplier. We just launched HSDPA commercially a week ago. And it's a very intense competition there between, primarily, I would say, Cingular and Verizon, where everybody's fighting with service quality and service offering. And with the new technology that Cingular rolls out, they will certainly be in a technology lead there. But it's all a no questions asked, no doubt kind of project here. It's really pulling the entire industry and pulling the handset manufacture and so on in the biggest rollout that the world has seen so far.
Just a couple of words on the financial highlights. At sales of 36.2, we are some 15% up, year-over-year and year to date, which is a, quite a healthy number, considering where the market growth is. We are clearly taking market share.
Gross margin is at 45.2%, which is 0.7 down from the second quarter, but primarily an effect of a mathematical effect from the growing service business that has a lower gross margin, but still an equally healthy bottom line. So if we will continue to see services outgrow the rest of the Company, we will continue to see a similar mathematical effect on gross margin.
On the operating expenses side, I think we have, we feel fairly satisfied. We are 3% up year to date, in a year when we're growing 15% or 17%, even, in constant currencies. And that growth, in itself, is smaller than the growth in R&D, which means that operating expenses excluding R&D is actually slightly down. And that's the effect of continuous work on operational excellence and working smarter and more efficiently.
Then, if we look at the income, we are at $8 billion. An operating margin of 21.6%, which is in level where we were last quarter. Cash flow is minus 1.1 billion and I'm sure you will have some questions there. We have $2 billion that is a reported effect is an effect from foreign exchange differences that affects the reported cash flow but not really the, has no real cash flow effect. There is no money leaving the Company there.
We have also an increased proportion of large projects. If we go back only two years, if we go back to 2003, when we were at the low point of this industry, there was basically a business of small additions, upgrading cores quick projects, quick installations, quick invoicing and billing. Now, we are, a lot of the growth is coming from larger projects, large rollouts of networks, longer projects, and therefore tying up more working capital. That is simply a logical effect. And to some extent, also, that some of these projects or many of these projects are happening in countries with where we have longer payment terms.
So that is simply a mathematical effect or a logical effect of the type of business we're running. But there is also an increasing number of days outstanding, and that is something that we're not too happy with and we'll work very hard to get back into where we were in Q4.
Our net debt situation, we are debt free. We have a strong net cash position and an equity ratio that is now close to 50%.
A couple of words on Sony Ericsson. We had a sales increase of 22%. Sony Ericsson is actually, we said after Q1, when we saw a bit of weaker development, where we had very few launches, that, because of few launches, there isn't really much growth. But we said that, through second quarter, we'll start to launch some very attractive products. And that has happened, with the walkman phones and the new 3G phones. And it's been received, even if we had high expectations, it's been received well above that, so Sony Ericsson is really enjoying great growth, right now, and really popular phones here.
We had an income before tax of €151 million. And, for us that are working with this joint venture so intensely, it was really a milestone that we could pass positive the point of positive accumulated earnings since the start of the joint venture. And those of you that have followed us for a while know that we struggled a bit in the beginning with pretty big losses. So we're now on positive accumulated earnings.
When it comes to the market outlook, we expect and we're now starting to look into 2006. We expect the global mobile systems market, in U.S. dollar terms, to continue to show moderate growth. And we also expect the addressable market for professional services to continue to show good growth in 2006. The outlook for 2005 is very much unchanged. So with those words, I will hand over to Karl-Henrik Sundstrom, here, who will take us through some more details on the financials.
[Karl-Henrik Sundstrom, CFO]
Yes, hello and good morning, good afternoon, ladies and gentlemen. I just wanted to comment a little bit on the sales by the region. And I think this slide here demonstrates, really, some of the key assets of Ericsson of having a very strong regional distribution of sales of basically one quarter of the sales in every corner of the world and compensating a flattish Europe by growth in Latin America, Asia Pacific, North America and CEMA. I also would like to point out that, despite that we are having lower sales in China, it's well compensated by sales in Australia, Japan, India and Indonesia.
I also would like to comment a little bit by this slide, to focus a little bit what Carl-Henric said before. As you can see, the total of services, which is network rollout and professional services, has a growth year-over-year with almost 30%. It is interesting to see that the growth in network rollout is actually 35% and that is exactly what Carl-Henric said in his previous presentation. We are rolling out a number of huge projects in many markets, and that's why we've had a capital working capital increase in especially in this quarter.
When it comes to the operational efficiency trends, we are having, as Carl-Henric said, an increase in DSO days. As you can see, the day sales outstanding have increased from 90 days in the second quarter to 102, which is both a function of that we have been having a lot of sales to emerging markets, where you in general have slightly longer payment terms than you have in some other markets. Also, it is a huge quantity of network rollout projects with fairly complicated acceptance criteria. But this is an area where we're putting a lot of focus on during the coming we need to improve our collections.
Inventory turnover is slightly better, from 4.4 to 4.5 sequentially, but we still have to work quite hard to make sure that we get close to the target, reaching target of 5.5, which is the target that we have. I don't want to make any comments regarding the accounts payable, because I think they're in line. However, I would like to take the opportunity to make some comments regarding the Sony Ericsson. Regarding Sony Ericsson, as Carl-Henric said, they had a very strong quarter. They have a year on year sales increase of 22%, sequentially 27% and they reached a very healthy net income before taxes of €161 million. And I think this, that we mentioned that the accumulated earnings is a huge milestone for the joint venture and for its owners. With that, I would like to hand over for Q&A.
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