Motorola Solutions, Inc. — Form 10-Q Summary
Reporting period: Third quarter and nine months ended September 30, 2017; comparisons are with the three and nine months ended October 1, 2016. Amounts are in millions of dollars except per-share data. The filing is unaudited.
Business context
Motorola Solutions provides mission-critical communications products, software and services to government, public safety, commercial and industrial customers. It reports two segments: Products (devices and systems) and Services (integration, managed and support, and legacy iDEN services). In Q3 2017, Products represented 60% of sales and Services 40%.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $1,645 | $1,532 | $4,423 | $4,155 |
| Gross margin | $794; 48.3% | $762; 49.7% | $2,054; 46.4% | $1,941; 46.7% |
| Operating earnings | $338; 20.5% | $341; 22.3% | $770; 17.4% | $664; 16.0% |
| Net earnings attributable to Motorola Solutions | $212 | $192 | $420 | $317 |
| Diluted EPS | $1.25 | $1.13 | $2.48 | $1.82 |
- Revenue and segments: Q3 sales increased 7% year over year. Products sales rose 8% to $989 and segment operating earnings increased 12% to $253. Services sales rose 7% to $656, while segment operating earnings fell 27% to $85, primarily due to lower gross margin and higher expenses. For the nine months, Products sales increased 5% and operating earnings 26%; Services sales increased 9% while operating earnings were unchanged at $260.
- Margins and earnings: Q3 gross margin percentage declined as Services margins returned to normalized levels. Q3 operating earnings were slightly lower despite sales growth; higher net earnings and diluted EPS reflected higher sales, a lower effective tax rate and fewer shares outstanding following repurchases. Nine-month operating earnings and net earnings increased year over year.
- Cash flow: Operating cash flow was $585 for the first nine months, versus $652 in 2016. Investing used $415 and financing used $537. Cash and cash equivalents, including restricted cash, declined to $717 from $1,030 at December 31, 2016. Management attributed weaker operating cash flow partly to a temporary working-capital increase during the ERP implementation and expected it to reverse by year-end 2017.
- Debt and liquidity: Long-term debt, including current portion, was approximately $4,470 at September 30, 2017, versus $4,396 at year-end 2016. The company had a $2.2 billion unsecured revolving credit facility maturing in April 2022 and was in compliance with its covenants. Q3 borrowings of $150 used for the Kodiak acquisition were repaid from operating cash during the quarter. The filing does not provide a clear figure for remaining revolver availability.
- Capital returns: During the first nine months, the company paid $230 in common dividends and repurchased 4.3 million shares for $358, returning $588 in total. It had $1.8 billion of repurchase authorization remaining at quarter-end.
Material changes and notable items
- Q3 sales growth reflected demand across regions; Products growth came from both devices and systems. Services growth included acquisitions and organic managed/support and integration services growth, partly offset by lower Airwave revenue in EMEA due to unfavorable currency movements.
- Q3 other charges were $67, including $39 of intangible amortization, a $21 non-U.S. pension settlement loss and $6 of reorganization charges. Nine-month other charges were $146, including $112 of intangible amortization, a $46 pension settlement loss, $22 of reorganization charges and an $8 building impairment, partly offset by a $44 legal-settlement gain. The gain included recovery of receivables from a former legacy Networks customer.
- Acquisitions completed in 2017 included Interexport and Kodiak Networks. The company announced its intention to acquire Plant Holdings, parent of Airbus DS Communications, to expand its Command Center and Next Generation 9-1-1 software portfolio; the announced transaction had not been completed as of the filing.
- Inventory increased to $364 from $273 at year-end. Management said it maintained higher inventory to support customer demand during the ERP implementation, launched in April 2017; the system was described as functioning as designed.
Outlook, risks and contingencies
- No specific numerical earnings or revenue guidance is provided in the filing. Management cited historically higher fourth-quarter revenue due to customer purchasing patterns, continued opportunity in managed services and software, and expected operating-margin expansion as Services grows.
- Management noted continuing political and economic uncertainty, including Brexit and conditions in parts of Latin America and Europe. Foreign exchange exposure remains relevant; outstanding foreign-exchange contracts had $541 of notional value at quarter-end. Management said such contracts generally offset underlying exposures.
- Risks include potential customer claims under certain contracts with uncapped damages that could exceed contract revenue, ongoing legal matters, and the possibility that unfavorable litigation outcomes could materially affect results or liquidity. Management did not expect current legal matters to have a material adverse effect, but cannot assure the outcome.
- The company had $135 of commitments to provide long-term customer financing. It also retained servicing obligations related to $780 of sold long-term receivables. Convertible notes with $1.0 billion principal mature in September 2020 and became fully convertible in August 2017; the company intends to settle principal in cash.
- Revenue recognition changes effective January 1, 2018 are expected to accelerate recognition for distinct devices and accessories in certain network-integration contracts and to present certain third-party representative transactions gross, with a corresponding increase in SG&A. Management did not expect significant revenue acceleration under the described software arrangements; the company expected modified-retrospective adoption.
Important facts for investors to verify
- Whether the ERP-related working-capital increase reverses as management expected by year-end 2017, and whether operating cash flow improves.
- Whether Services margin and operating earnings recover after the Q3 decline, and how much Services growth comes from acquisitions versus organic performance.
- The final purchase accounting and ongoing contribution of Kodiak and Interexport, and the status and terms of the planned Airbus DS Communications acquisition.
- The cash, dilution and refinancing implications of the convertible notes, alongside debt levels, revolver availability and continued covenant compliance.
- The realized effects of 2018 revenue-standard adoption, including timing changes, gross-versus-net presentation and capitalized commissions.
- Exposure to foreign exchange, legal claims and potentially uncapped contractual damages, as well as the timing and cash cost of restructuring obligations.