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Ericsson's Numbers Ultimately Disappointing

The company's earnings confirmed that its handset business is still in dire straits.

At least

Ericsson

(ERICY)

is consistent.

The world's third-largest maker of cell phones and the largest maker of wireless service equipment released

earnings Friday that were ostensibly in line with expectations but ultimately disappointing, confirming that the company's handset business is still in dire straits.

And despite the seeming strength and inviolability of the

infrastructure business, there were signs too that all may not be as rosy as the company indicated.

Ericsson shares recently were off $1.88, or 14%, to $11.13, reflecting investor disappointment in the numbers and outlook.

Ericsson -- which lags behind

Nokia

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of Finland and

Motorola

(MOT)

of the U.S. in the handset game -- also said it expects full-year 2001 sales to grow 15% to 20%, down from an earlier estimate of over 20%, with operating profit margins of 6% to 8%.

The Numbers

The company reported fourth-quarter net income of 2.25 billion Swedish krona ($234 million), or 0.28 krona a share (equal to 3 cents a share). However, Ericsson included a gain from the sale of its shares in network equipment maker

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that "artificially enhances" the company's operating, pretax and net operating margins, according to Philip Townsend, an analyst with

Arnhold and S. Bleichroeder

.

Townsend estimates that if the share sale had been accounted for as an extraordinary gain, Ericsson actually would have reported a loss "during probably the best year the cellular industry has seen." (He rates Ericsson a sell, and his firm doesn't participate in underwriting.)

No surprise, the blame for the greatest portion of the Stockholm-based company's problems goes to the consumer products division, which is comprised largely of the handset operation and recorded a 10.3 billion Swedish krona loss for the quarter and a 16.2 billion Swedish krona loss for the fiscal year. (The company didn't provide equivalent U.S. dollar figures.)

"This is an area that we are working with intensely," Kurt Hellstrom, Ericsson's president and chief executive, said during a conference call Friday morning. "We are definitely not satisfied with our performance."

Run Away

Many analysts think Ericsson should cut its substantial losses and get out of the handset business altogether. But the company is stubbornly forging ahead, proclaiming that handsets will be profitable by the second half of the year and insisting that a divorce of its systems and handset operations would weaken its systems offering -- a view greeted with great skepticism by many on Wall Street.

As part of its ongoing restructuring program, Ericsson said Friday that it will outsource its mobile phone manufacturing unit to

Flextronics International

(FLEX) - Get Flex Ltd. Report

, a Singapore-based electronics manufacturer. That move will result in the loss of 11,000 employees, almost two-thirds of the division.

It's doubtful that outsourcing will prove enough of a boon, especially since the handset market has entered a markedly challenging period. Like Motorola earlier this month, Ericsson reduced its estimate for worldwide handset sales in 2001, to between 500 million and 540 million units, from 525 million to 575 million. The decline stems largely from consumers

not replacing their handsets as quickly as originally thought and because penetration rates in some parts of the world, notably western Europe, are rather high.

The Slowdown

The high level of penetration of cellular subscribers goes hand-in-hand with a slowdown in demand that Ericsson acknowledged for second-generation wireless network systems in Europe as well as North America -- an acknowledgement that doesn't bode well for its profitable network operators business. That business recorded 9.4 billion Swedish krona in operating income last quarter and 33.1 billion Swedish krona last year.

At the same time, Ericsson recorded a 22% increase in infrastructure orders from the third quarter, while operating profit margins deteriorated to 15% from 17% in the same period. Townsend of Arnhold and S. Bleichroeder sees a disconnect between those two figures and concludes that operating profit margins for its GSM (global system for mobile) base stations "must be under severe pressure." After all, Ericsson's

Engine

software switch upgrade product, which accounted for 20% of Ericsson's infrastructure revenue, typically enjoys margins of anywhere from 30% to 70%.

That, combined with Ericsson's admission that the impact of third-generation wireless service equipment will be minimal this year, given the delay in installing 3G networks, means there will be "a hold on Ericsson's earnings going forward," says Townsend.