Motorola Solutions, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 29, 2018; comparative periods ended September 30, 2017. Unless otherwise stated, amounts are in millions of U.S. dollars. Motorola Solutions provides mission-critical communications products, systems, services and software to public-sector and commercial customers.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $1,862 | $1,645 | $5,089 | $4,423 |
| Gross margin | $901; 48.4% | $794; 48.3% | $2,392; 47.0% | $2,054; 46.4% |
| Operating earnings | $294; 15.8% | $347; 21.1% | $739; 14.5% | $781; 17.7% |
| Net earnings attributable to Motorola Solutions | $247 | $212 | $544 | $420 |
| Diluted EPS | $1.43 | $1.25 | $3.17 | $2.48 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $263 | $585 |
Q3 sales rose 13% year over year; attributable earnings rose about 17%, and diluted EPS rose about 14%. Nine-month sales increased 15%, while attributable earnings increased about 30%. Q3 gross margin percentage was broadly stable, but operating earnings and operating margin declined. The nine-month operating margin also fell.
Q3 segment sales were $1,288 for Products and Systems Integration, up 10%, and $574 for Services and Software, up 22%. Segment operating earnings were $183 (down 31%) and $111 (up 37%), respectively. For the first nine months, segment sales were $3,429 and $1,660, while operating earnings were $449 and $290, respectively.
Cash, debt and liquidity
- At September 29, cash and cash equivalents, including restricted cash, totaled $851; total debt was $5,432, including $337 current and $5,095 long-term. Approximate net debt was $4,581.
- Nine-month operating cash flow was $263, investing cash outflow $1,196 and financing cash inflow $534. Cash declined $417 from year-end 2017 to $851.
- Management attributed lower operating cash flow mainly to a $500 U.S. pension contribution, a legacy Networks settlement payment and higher incentive payments, partly offset by improved working capital. The pension contribution moves the next anticipated required contribution to 2024 or beyond.
- Investing outflows included $1,158 for acquisitions and investments, primarily Avigilon and Plant, and $128 in capital expenditures. Financing included $1,295 of debt issuance proceeds, $412 of debt repayments, $252 of dividends, and $66 of share repurchases.
- The company reported a $2.2 billion revolving credit facility maturing in April 2022 and was in compliance with its covenants. It stated that liquidity was sufficient for operations and potential market volatility. Stockholders’ equity was a deficit of $1,395.
Material changes and unusual items
- Q3 reported sales included $145 from acquisitions and $19 from ASC 606 adoption, partly offset by $9 of unfavorable foreign currency. Nine-month sales included $347 from acquisitions, $58 from ASC 606 and $56 from favorable currency. The company did not restate prior-period revenue under ASC 606; adoption also changed revenue timing, contract balance presentation and commission accounting. On the company’s ASC 605 comparison, ASC 606 increased reported sales by $19 and operating earnings by $1 in Q3, and sales by $58 and operating earnings by $11 for nine months.
- Acquisitions included Avigilon, completed March 28 for a purchase price of $974, and Plant Holdings/Airbus DS Communications, completed March 7 for $237. Purchase accounting for these acquisitions was not yet complete.
- Other charges were $126 in Q3 and $263 for nine months, versus $47 and $100 in the prior-year periods. Q3 included a $57 environmental reserve charge, $46 of intangible amortization and $21 of reorganization charges. The environmental liability rose to $107, reflecting additional remediation requirements and an estimated 30-year remediation timeline.
- Reorganization charges were $62 for nine months, including severance costs related to approximately 700 employees; about 500 employees remained severed or notified of severance at quarter-end.
- The effective tax rate was 8% in Q3 and 14% for nine months, versus 26% and 31%, respectively, a decline attributed mainly to the U.S. Tax Act, share-based compensation tax benefits and return-to-provision adjustments. The company continued evaluating provisional Tax Act accounting.
- The company agreed to repurchase $200 of principal of convertible notes for $369 in cash, including the conversion premium. It paid $169 during Q3; the remaining $200 was paid October 15. Separately, an additional $200 of 4.60% senior notes due 2028 was settled after quarter-end, with proceeds used for that payment.
Outlook, commentary and risks
The filing provides no specific numeric earnings or revenue guidance. Management noted that fourth-quarter revenues have historically been higher because of customer purchasing patterns. Remaining performance obligations totaled $6.1 billion at quarter-end; $1.9 billion of the Products and Systems Integration portion and $1.2 billion of the Services and Software portion were expected to be recognized over the next 12 months.
Management reported agreement with the UK Home Office on the new direction of the Emergency Services Network and on extending the Airwave contract through 2022. Key risks and uncertainties include execution and integration of acquisitions, system-contract cost estimates and project delivery, the environmental remediation estimate, foreign currency movements, debt and capital-market access, and legal proceedings. Management said ordinary-course litigation was not expected to materially affect results, but acknowledged an unfavorable resolution could have a material effect. The company expects lease accounting adoption in 2019 to materially increase balance-sheet assets and liabilities.
Most important facts for investors to verify
- Whether sales growth and future margins are sustainable after separating acquisition, foreign-exchange and ASC 606 effects.
- Drivers of the decline in Products and Systems Integration operating earnings and consolidated operating margin, including the $57 environmental charge and acquired-business costs.
- Cash conversion after the $500 pension contribution, acquisition spending and scheduled debt and other payments.
- Final remediation scope, timing, discount assumptions and potential changes to the $107 environmental reserve.
- Final purchase accounting for Avigilon and Plant, and realization of the $6.1 billion remaining performance obligations.
- Debt repayment, convertible-note dilution and settlement terms, and any subsequent-period impacts of transactions disclosed after quarter-end.