Motorola Solutions, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended April 2, 2016; comparisons are with the three months ended April 4, 2015. Financial amounts are in millions of U.S. dollars, except per-share data.
Business context
Motorola Solutions supplies mission-critical communications products and services. Products include radios and communications systems; Services includes integration, managed and support services, and legacy iDEN support. The quarter included the February 19 acquisition of Guardian Digital Communications Limited, parent of Airwave, which operates a public-safety network and is reported in Services.
Financial results and key metrics
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $1,193 | $1,223 |
| Gross margin | $502; 42.1% | $548; 44.8% |
| Operating earnings | $100; 8.4% | $119; 9.7% |
| Continuing-operations earnings attributable to Motorola Solutions | $17 | $87 |
| Net earnings attributable to Motorola Solutions | $17 | $74 |
| Diluted EPS | $0.10 | $0.40 |
| Operating cash flow from continuing operations | $13 | $156 |
| Capital expenditures | $51 | $33 |
- Products sales were $702, down 7%; segment operating earnings were $51, down 20%. Services sales were $491, up 6%; segment operating earnings were $49, down 11%. Airwave contributed $61 of sales and $3 of net earnings during the quarter.
- Cash and cash equivalents were $1,940 at quarter-end, versus $1,980 at December 31, 2015. Long-term debt, including current portion, was $5,027, versus $4,349; total stockholders’ equity was a deficit of $137.
- Net cash used in investing was $623, including $1,053 of acquisitions and investments, partly offset by $481 of proceeds from asset and investment sales. Financing activities provided $577, including $673 net proceeds from the new term loan. Cash decreased by $40 overall.
Material changes versus the prior period
- Sales declined 2% overall: Products fell $56, while Services grew $26. Foreign exchange, lower Products volumes, and macroeconomic pressure in Latin America weighed on results; North America growth partly offset declines elsewhere.
- Gross margin fell $46 and margin rate contracted 2.7 percentage points, primarily because of weaker Products margins. Services margin rate improved, supported by managed-services growth and completion of a large system integration project.
- Operating earnings fell $19. Lower SG&A and R&D spending provided offsets, but higher acquisition-related costs and amortization, and lower gross margin, reduced earnings.
- Continuing-operations earnings declined $70, also reflecting the swing from a $46 gain on investment and business sales in 2015 to a $21 loss in 2016, and $9 higher net interest expense. The 2016 loss included a $19 loss on UK treasury securities and a $7 loss on the Penang facility sale, partly offset by $5 in equity-investment gains.
- Operating cash flow decreased $143, which management attributed to lower earnings, higher working-capital needs and incentive compensation, and increased interest and tax payments. Weighted-average diluted shares fell to 177.0 million from 217.8 million, primarily reflecting prior share repurchases; EPS still declined.
Outlook, commentary, risks and unusual items
- Management expected 2016 SG&A and R&D expenses to be about $120 lower than in 2015, citing cost-reduction initiatives. It expected Services to grow faster than Products and consolidated operating margins to continue expanding, while noting Services has a lower gross-margin percentage than Products.
- Management expected continued declines in iDEN sales as legacy service contracts expire and customers move to newer technology; this may pressure Services revenue and gross margin because iDEN services generally have higher margins than the rest of the Services portfolio.
- The Airwave acquisition had approximately $1.1 billion of total consideration: $1.0 billion net cash consideration and $82 million deferred consideration due November 15, 2018. It was funded with a $675 million variable-rate, LIBOR-indexed term loan and about $400 million of international cash. Purchase accounting remained preliminary.
- The company recorded $33 of other charges, including $13 of Airwave transaction fees, $13 of intangible amortization, and $7 of reorganization charges. It also recorded $23 of net reorganization charges across cost of sales and other charges, including employee separation costs and a corporate-aircraft impairment. Remaining reorganization accruals were $57.
- Foreign exchange and weaker economic conditions and commodity prices were cited as pressures, particularly in Latin America and Eastern Europe. Foreign-exchange contracts had $708 of notional value. The company said their gains and losses generally offset underlying exposures.
- The $2.1 billion revolving credit facility was undrawn, and the company was covenant-compliant. Management said term-loan borrowing could partially limit revolver capacity during Q2 2016 but believed liquidity remained sufficient. Capital-market volatility or lower credit ratings could increase funding costs or constrain access.
- Of $1.9 billion in cash, approximately $551 was held outside the U.S. The company had $1.4 billion of indefinitely reinvested foreign earnings and no current plan to repatriate them; a future decision to remit funds could result in additional tax expense.
- Management said ordinary-course lawsuits were not expected to materially affect results or liquidity, while acknowledging an unfavorable resolution could be material. Certain customer contracts have uncapped damages provisions that could expose the company to claims exceeding contract revenue. No accruals were recorded for the described indemnification obligations.
- There was no formal numerical earnings or revenue guidance in the supplied filing text. Management cautioned that results are subject to risks and may differ materially from forward-looking statements.
Important facts for investors to verify
- Whether Airwave’s operating contribution, integration costs, and final purchase-price allocation meet management’s expectations; the valuation was still preliminary.
- Whether Products sales and gross margins stabilize, and whether Services growth offsets iDEN declines and foreign-exchange or regional economic pressure.
- Whether operating cash flow recovers from the quarter’s $13 level and working-capital demands remain manageable after the acquisition.
- The impact of higher debt and variable-rate term-loan costs, and the actual availability of the revolver after the company’s leverage increased.
- Whether the announced cost savings and margin-expansion expectations are achieved without impairing growth or execution.
- Potential tax consequences if foreign earnings are repatriated, and developments in legal matters or uncapped contractual-damages exposures.