Motorola Solutions, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended October 1, 2016; comparisons are to the periods ended October 3, 2015. Dollar amounts are in millions unless stated otherwise. Motorola Solutions provides mission-critical communications products and services through its Products and Services segments.
Financial performance
| Metric | Q3 2016 | Q3 2015 | First 9 months 2016 | First 9 months 2015 |
|---|---|---|---|---|
| Net sales | $1,532 | $1,422 | $4,155 | $4,013 |
| Gross margin | $762; 49.7% | $685; 48.2% | $1,941; 46.7% | $1,881; 46.9% |
| Operating earnings | $341; 22.3% | $231; 16.2% | $664; 16.0% | $605; 15.1% |
| Continuing-operations earnings attributable to Motorola Solutions | $192 | $126 | $317 | $363 |
| Diluted continuing-operations EPS | $1.13 | $0.63 | $1.82 | $1.74 |
| Cash provided by operating activities | Not presented for quarter | Not presented for quarter | $652 | $607 |
Q3 sales rose 8%; Products sales declined 1% to $920, while Services sales increased 23% to $612. For the first nine months, Products sales fell 5% to $2,423 and Services sales rose 18% to $1,732. Q3 gross margin improvement reflected stronger Services margins; year-to-date gross margin percentage edged down, principally due to lower Products volume and global systems margins.
Q3 operating earnings benefited from higher Services gross margin and lower SG&A and R&D costs. For the nine-month period, higher gross margin and lower operating expenses were more than offset at the net income level by increased other charges and a less favorable result on investment and business sales. Diluted EPS increased year to date despite lower continuing-operations earnings, in part because average diluted shares declined to 174.0 million from 209.2 million after share repurchases.
Cash, liquidity and capital structure
- Cash and cash equivalents were $1,687 at October 1, 2016, down $293 from year-end 2015; $63 was restricted. Approximately $1.0 billion of cash was held in the U.S. and $680 million abroad.
- Long-term debt was $5,044, versus $4,345 at December 31, 2015. The company borrowed a $675 term loan to help fund Airwave; it bears variable interest indexed to LIBOR and matures in February 2019. Net interest expense rose to $157 for the first nine months from $122.
- The company had a $2.1 billion revolving credit facility maturing in May 2019, with no borrowings under it during the first nine months. It reported compliance with its financial covenants.
- Operating cash flow was $652; capital expenditures were $211. Cash used in investing activities was $721, including the Airwave acquisition, and cash used in financing activities was $191. Dividends and repurchases returned $941 to shareholders during the first nine months.
- Stockholders’ equity was a deficit of $648, compared with a deficit of $96 at year-end 2015. The company repurchased 10.5 million shares for $728 during the first nine months and had $2.3 billion of repurchase authorization remaining.
Material changes and notable items
- Motorola Solutions acquired Guardian Digital Communications Limited, parent of Airwave, on February 19, 2016. Airwave contributed $338 of sales and $71 of net earnings from operations during the first nine months; Q3 sales contribution was $131. The acquisition added substantial intangible assets and related amortization: $83 of intangible amortization was recorded in the first nine months.
- Other charges were $144 in the first nine months, versus $39 in 2015. 2016 items included $83 of intangible amortization, $48 of reorganization charges in operating expenses, and $13 of acquisition-related transaction fees. Reorganization charges across operating expenses and cost of sales totaled $74, including employee separations and asset impairments.
- The company recorded a $19 loss on sale of U.K. treasury securities and a $7 loss on the sale of its Penang manufacturing operations; these were partly offset by equity investment gains. The prior-year period included $60 of net gains on investment and business sales and a $32 pension curtailment gain in other charges.
- In the first nine months, approximately 600 employees were associated with new severance charges; the remaining separation-cost accrual was $46, expected to be paid primarily within one year. The company also completed the sale of its remaining Schaumburg campus parcels and relocated headquarters to Chicago.
Outlook, management commentary and risks
- Management expected to reduce SG&A and R&D expenses in 2016 by approximately $120 compared with 2015, excluding incremental operating expenses from acquisitions in the second half; $97 of savings had been realized in the first nine months.
- Management expected Services to grow faster than Products and consolidated operating margins to continue expanding, while noting Services has a lower gross margin percentage overall than Products. Management also noted that fourth-quarter revenue has historically been higher because of customer purchasing patterns.
- Foreign exchange and weaker economic conditions were weighing on sales, particularly in Latin America, parts of Europe and China, and on customer purchasing power and government budgets. Management expected declining legacy iDEN sales to continue, pressuring Services revenue and gross margins.
- On November 3, 2016, the board approved an increase in the quarterly dividend from $0.41 to $0.47 per share. A purchase agreement for public-safety software provider Spillman Technologies was signed, with closing expected in Q4 2016.
- Risks include foreign exchange exposure, variable-rate term-loan interest, access to capital markets and potential rating deterioration, contract damage claims that could exceed contract revenue, and ordinary-course litigation. Management did not expect current legal matters to materially affect results, but noted an unfavorable resolution could do so. Foreign-exchange contracts had $744 of notional exposure; management said they generally offset underlying exposures.
Most important facts for investors to verify
- Whether Services growth and Airwave integration continue to offset weakness in Products, iDEN, and challenged international markets.
- How much of reported earnings and margin performance reflects recurring operations versus acquisition amortization, restructuring, impairment, and investment-sale items.
- Debt, variable-rate interest expense, cash balances, and covenant headroom following the Airwave acquisition and shareholder distributions.
- Progress against the stated 2016 cost-savings target and management’s expectation for continued consolidated operating-margin expansion.
- Spillman acquisition timing and terms, the higher dividend’s sustainability, and any changes in litigation, contractual, or foreign-exchange exposures.