Motorola Earnings Preview: Government Business, Margins In Focus

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Motorola Solutions

Motorola Solutions (NYSE:MSI) is expected to announce its Q2 2014 results on August 5. The company’s last few quarters have been challenging, as both its government and enterprise businesses have suffered due to macroeconomic uncertainties. In the last quarter, government revenues declined 11% and operating profits dropped by 21% over the same period last year due to a higher-than-expected overhanging impact of narrowbanding in North America. A sustained decline in the federal business also had an impact on government revenues, and the company expects only a modest improvement this year from the government shutdown-related lows of last year. Considering the near-term challenges in the demand environment, the company expects sales to decline by 8-11% in the second quarter.

The company’s enterprise revenues, excluding iDEN, declined just 1% in Q1 over the same period last year – recovering gradually from recent macroeconomic uncertainties and offsetting some of the impact of the under-performing government division. However, the company announced in its earnings call last quarter that it intends to sell off its enterprise division to focus singularly on its government business, which accounts for almost 70% of its total revenues. Apart from focusing solely on its government business, an enterprise sale would provide Motorola with an opportunity to reduce costs in keeping with the current business environment. Motorola expects to cut around $200 million in operating costs over the next 18-24 months.

Our $65 price estimate for Motorola is about in line with the current market price.

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See our complete analysis for Motorola Solutions here

Near-Term Growth Concerns In Government Business

One of the biggest reasons that Motorola mentioned for its top line under-performance last quarter was its lower-aged government backlog in North America. The company acknowledged that it underestimated the impact of narrowbanding in previous years, which had led to record performances in 2012 and 2011. Motorola’s government revenues in those years were boosted by the narrowbanding mandate issued by the Federal Communications Commission (FCC), which necessitated a switch to a more efficient spectrum band for public safety operations. With most of the narrowbanding-related equipment upgrades now complete and government agencies going slow on their capital spending, Motorola’s government business faces near-term growth concerns.

The difficult year-over-year comparison was accentuated by a challenging federal environment in the aftermath of the recent government shutdown in September. The federal slump should continue in the near term, with government sales expected to decline by about 9.5% at the mid-point of guidance. However, for the full-year, the company expects a solid back-half recovery to help stem the slide to the low-to-mid single digits. The downside is limited by the fact that public safety is usually down the priority list of areas in which governments will look to cut their spending. As a result, we think that any further impact to government revenues from sequestration are likely to be fairly muted.

Gross Margins Likely to Improve

The company has been successful in driving efficiency through its operations over the last couple of years, and expects to accelerate those efforts in the coming quarters. Despite the top-line concerns and significant operating leverage in the business, Motorola expects operating margins to improve by almost a percentage point to 18.5% in 2014, benefiting mostly from the cost controls in place as well as the $200 million in cost cuts expected over the next two years. Going forward, we expect the improving operational efficiency to more than offset the margin decline that could result from rising competition in the coming years as rivals increasingly address the ongoing transition of public safety networks from analog to digital.

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