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--Ericsson disappoints with bigger than expected drop in net profit

--Earnings hit by low-margin contracts and weak demand in Europe, China

--U.S. sales remains strong

(Adds detail, analyst comment.)

By Gustav Sandstrom and Sven Grundberg

STOCKHOLM--Swedish network equipment vendor Ericsson (ERIC) Wednesday reported a bigger-than-expected drop in second-quarter earnings with profits stunted by a high number of low-margin sales in Europe and slow demand in some markets, but said it expects improvement towards the end of the year.

Ericsson's net profit fell 64% to 1.11 billion Swedish kronor ($159 million) from SEK3.12 billion in the same quarter last year, with the closely watched gross margin down to 32.0% from 37.8% a year ago. Analysts polled by Dow Jones Newswires had expected net profit of SEK1.67 billion and a gross margin of 33.3%.

The weak numbers mirror problems cited by French peer Alcatel-Lucent SA (ALU.FR) Tuesday, which said it will miss its forecasts this year due to thin margins on big contracts and sluggish demand in Europe.

Ericsson has managed to maintain its position as the world's biggest network equipment vendor throughout the global financial crisis, helped by its strong position in the fast-growing U.S. market. Still, the company's profits have been hit in past months by a high proportion of low-margin sales, and as a result of reluctance by telecom operators in Europe to invest in new gear amid the ongoing financial crisis.

Revenue from services, which typically have lower margins than sales of new network equipment, made up a larger part of Ericsson's sales mix in the second quarter. Profit also suffered as a result of a large number of low-margin contracts for network upgrades in Europe, that Ericsson has taken on to regain market share in the region.

"The negative gross margin impact from the network modernization projects in Europe will start to gradually decline end 2012," the company said in a statement

Net sales in the quarter were down to SEK55.32 billion from SEK54.77 billion the same quarter last year, against expectations for SEK54.5 billion.

Ericsson's global services and support solutions businesses saw strong demand, but networks sales fell from a year earlier, mainly due to slow sales of CDMA technology equipment, lower activity in China, and slow third-generation (3G) technology sales in Russia, the company said.

Ericsson repeated that operators in Europe have turned increasingly cautious, as a result of the deteriorating economic situation in the region. Sales in Western and Central Europe tumbled 6% in the quarter compared with a year earlier.

North America remained strong, however. Sales climbed 5% year-on-year and the region remained a bright spot as carriers such as AT&T (T), Sprint Nextel Corp. (S), Verizon Wireless and Deutsche Telecom AG's (DTE.XE) T-Mobile USA invest heavily in increasing third-generation wireless data capacity and building fourth-generation Long Term Evolution networks.

The investments in 4G capability in the U.S. is largely due to the rapid pick-up of phones and tablet PCs enabled with high speed wireless data functionality, such as Apple Inc.'s (AAPL) new iPad that the company launched in March this year.

Ericsson's shares are down around 16% so far this year, underperforming a 3.7% rise in the wider Stockholm market amid concerns that its closely-watched gross margin will remain subdued. The shares Tuesday closed at 58.90.

Write to Gustav Sandstrom at gustav.sandstrom@dowjones.com

Subscribe to WSJ: http://online.wsj.com?mod=djnwires

(END) Dow Jones Newswires

July 18, 2012 03:17 ET (07:17 GMT)

Copyright (c) 2012 Dow Jones & Company, Inc.

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