Item 1: Business
General
We build, market and sell products, services and applications that make simple and seamless connections to people, information and entertainment possible through broadband, embedded systems and wireless networks. Our vision is to provide cutting-edge technologies that empower mobile consumers to go anywhere and do anything without sacrificing connectivity. This is seamless mobility.
Motorola is a market leader in the following businesses:
| • | Mobile Devices: We are one of the world’s premier providers of wireless handsets, which transmit and receive voice, text, images, multimedia and other forms of information, communication and entertainment. | |
| • | Networks and Enterprise: We are a leading provider of wireless communications systems and services for government, enterprise and commercial mobile service providers around the world. We deliver high-availability network infrastructure systems to commercial mobile service providers and mission-critical end-to-end wireless communications networks, primarily for the government and public safety markets. Through our recent acquisition of Symbol Technologies, Inc. coupled with our existing enterprise product portfolio, we will deliver leading-edge mobile computing, mobile office and enterprise wireless local access network solutions. We are also an industry leader in the development of next-generation IP wireless broadband mobility technologies, offering an entire suite of end-to-end WiMAX infrastructure and customer premises equipment products. In addition, we offer a family of point-to-point and point-to-multipoint wireless broadband products to serve WiFi and wireless DSL operators. | |
| • | Connected Home: We are a global leader in developing end-to-end broadband systems that deliver entertainment, communication and information systems into the home. We offer consumer products, including digital video, voice-over-IP, and wireless data gateway devices, and service provider products, including video encoding and distribution systems, content protection solutions, data edge routers, optical networking equipment and remote management software solutions. |
Motorola is a corporation organized under the laws of the State of Delaware as the successor to an Illinois corporation organized in 1928. Motorola’s principal executive offices are located at 1303 East Algonquin Road, Schaumburg, Illinois 60196.
Business Segments
Motorola reports financial results for the following three operating business segments:
Mobile Devices Segment
The Mobile Devices segment (“Mobile Devices” or the “segment”) designs, manufactures, sells and services wireless handsets with integrated software and accessory products, and licenses intellectual property. In 2006, the segment’s net sales represented 66% of the Company’s consolidated net sales.
Principal Products and Services
Our wireless subscriber products include wireless handsets with related software and accessory products. We also sell and license our intellectual property. We market our products worldwide to carriers and consumers through direct sales, distributors, dealers, retailers and, in certain markets, through licensees.
Our Industry
We believe that total industry shipments of wireless handsets (also referred to as industry “sell-in”) increased to approximately 980 million units in 2006, an increase of approximately 20% compared to 2005. Demand from new subscribers was strong in emerging markets, particularly India and China. Replacement sales in highly-penetrated markets were also strong due to generally favorable economic conditions, as well as compelling new handset designs, attractive handset features and the increased roll-out of high-speed data networks, all creating a greater opportunity for personalization. In this environment, we were able to increase our unit shipments faster than the market and we believe we increased our overall market share to approximately 22%.
Industry forecasters predict that the wireless handset industry will continue to grow over the next several years, although the annual rate of growth is expected to be in the 10% range as opposed to the annual growth in the 20% range the industry has experienced over each of the last four years. Continued growth will be driven by demand from new subscribers in emerging markets and replacement sales from the current subscriber base.
Our Strategy
The Mobile Devices segment is focused on profitable and sustainable growth while maintaining a strong commitment to quality and an unrelenting focus on technology and innovation. We recognize the role the mobile device plays in digital convergence by breaking down the boundaries between work, home, business, entertainment and leisure. A central theme to Mobile Devices’ strategy is our vision of seamless mobility, which leverages the trends in digital convergence by enabling the consumer to enjoy simple, rich, compelling experiences regardless of environment, device or network.
We continue to invest in our popular MOTORAZR franchise by refreshing the product line with new designs, cobranding, new features and network extensions. New flagship additions to the franchise were introduced in 2006 with the launch of MOTOKRZR and MOTORIZR Z3, our first quad-band, globally available slider designed for GSM-based networks. The franchise was expanded into 3G technologies with the launch of MOTORAZR V3x which earned “Best 3GSM Handset” at the 2006 3GSM World Congress in February. Further extensions of the franchise into high-speed downlink packet access (“HSDPA”) were accomplished with the launch of MOTORAZR xx and MOTORAZR maxx. We launched the MOTO Q, our first iconic “qwerty”-based device on North America’s largest CDMA EV-DO network. We also introduced the MOTOFONE handset, a value-priced handset that strengthens Motorola’s drive to connect “the next billion” mobile phone users. Across technologies, price tiers and geographies, our objective is to unite “must have” design with “must have” experiences—without compromising quality of design, quality of experience or quality of product performance.
We play an active role in the development of next-generation technologies and believe a strong intellectual property portfolio is critical to our long-term success. We have a substantial investment in UMTS, WiMAX and HSDPA technologies and chipset designs to ensure that we maintain a favorable strategic position in these emerging technologies. We will continue to identify opportunities to generate licensing revenue from these investments.
Our approach to providing rich experiences involves both partnerships and in-house initiatives. To deliver compelling experiences to the mobile user in the productivity, imaging and music categories, it is critical to have the right partners. To that end, we have partnered with Google, Kodak, Microsoft, Warner Music, Yahoo! and other leading brands to create simple and unique rich experiences. Additionally, during 2006, the segment completed the acquisition of TTP Communications plc, a developer of intellectual property used in the design and manufacture of wireless communication terminals and a leading provider of protocol stack software that offers rapid customization of handsets through its AJAR applications framework. In early 2007, Motorola completed the acquisition of Good Technology, Inc. to strengthen our enterprise-productivity offering. Good’s end-to -end content delivery platform expands not only our enterprise and prosumer portfolio but also accelerates the development and richness of our multimedia offering
Delivering advanced services to consumers requires a highly-capable software platform with a large base of development support. In 2006, we continued to invest in our Linux-based platform. Through the formation of the
LiMo (Linux Mobile) Foundation, Motorola along with other mobile industry leaders, pledged to create the world’s first globally adopted open mobile Linux platform. We expect this platform to provide cost advantages to us, flexibility to carriers, and access to the world’s community of application and software developers.
Customers
Mobile Devices continues to focus on strengthening relationships with our top customers. The segment has several large customers worldwide, the loss of one or more of which could have a material adverse effect on the segment’s business.
The largest of the segment’s end customers (including sales through distributors) are China Mobile, Verizon, Sprint Nextel, Cingular and T-Mobile. Sales to these five largest customers represented approximately 39% of the segment’s net sales in 2006. In addition to selling directly to carriers and operators, Mobile Devices also sells products through a variety of third-party distributors and retailers, which account for approximately 38% of the segment’s net sales. The largest of these distributors is Brightstar Corporation.
Although the U.S. market continued to be the segment’s largest individual market, many of our customers, and approximately 65% of our net sales, are outside the U.S. The largest of these international markets are China, Brazil, the United Kingdom, Mexico and Hong Kong. Compared to 2005, the segment experienced sales growth in: High Growth markets (defined as countries in the Middle East, Africa, Southeast Asia and India), North Asia, North America and Latin America. Sales grew as a result of an improved product portfolio, including continued demand worldwide for the MOTORAZR family, continued strong market growth in emerging markets, and high replacement sales in more mature markets.
Competition
The segment believes it increased its overall market share to approximately 22% in 2006 and remains the second-largest worldwide supplier of wireless handsets. The segment experiences intense competition in worldwide markets from numerous global competitors, including some of the world’s largest companies, such as Nokia, Samsung, Sony Ericsson and LG. The wireless handset industry continues to consolidate and, in 2006, the five largest participants together held an aggregate market share of approximately 86%.
Our strategy of driving our seamless mobility vision, creating valuable differentiation of our products through design, and providing compelling, rich experiences to consumers and carriers is intended to further enhance our market position. Establishing and expanding a strong position in the fastest-growing segments, such as emerging markets and 3G/UMTS, will be necessary to retain and enhance our competitiveness. We also believe that it is critical to invest in research and development (“R&D”) of cutting-edge technologies and services to remain competitive. In 2006, the segment’s total investment in R&D again increased to support new product development.
General competitive factors in the market for our products include: design; time-to -market; brand awareness; technology offered; price; product proposition, performance, quality, delivery and warranty; the quality and availability of service; and relationships with key customers.
Payment Terms
The segment’s customers and distributors buy from us regularly with payment terms that are competitive with current industry practices. These terms vary globally and generally range from cash-with-order to 60 days. Extended payment terms beyond 60 days are provided to customers on a limited basis. Payment terms allow the customer or distributor to purchase products from us on a periodic basis and pay for those products at the end of the agreed term applicable to each purchase. A customer’s outstanding credit at any point in time is limited to a predetermined amount as established by management.
Regulatory Matters
Radio frequencies are required to provide wireless services. The allocation of frequencies is regulated in the U.S. and other countries, and limited spectrum space is allocated to wireless services. The growth of the wireless and personal communications industry may be affected if adequate frequencies are not allocated or, alternatively, if new technologies are not developed to better utilize the frequencies currently allocated for such use. Industry
growth may also be affected by the cost of the new licenses required to use frequencies and any related frequency relocation costs.
The U.S. leads the world in spectrum deregulation, allowing new wireless communications technologies to be developed and offered for sale. Examples include wireless local area network systems, such as WiFi, and wide area network systems, such as WiMAX. Other countries have also deregulated portions of the available spectrum to allow these and other new technologies, which can be offered without spectrum license costs. Deregulation may introduce new competition and new opportunities for Motorola and our customers.
Backlog
The segment’s backlog was $1.4 billion at December 31, 2006, compared to $3.0 billion at December 31, 2005. The 2006 backlog is believed to be generally firm and 100% of that amount is expected to be recognized as revenue in 2007. The forward-looking estimate of the firmness of such orders is subject to future events that may cause the amount recognized to change. The decrease in backlog at December 31, 2006, compared to December 31, 2005, is primarily due to an unusually high level of backlog at December 31, 2005 resulting from strong customer demand for new products during the fourth quarter of 2005, certain of which were unable to be shipped in significant quantities due to supply constraints for select components.
Intellectual Property Matters
Patent protection is extremely important to the segment’s operations. The segment has an extensive portfolio of patents relating to its products, technologies and manufacturing processes. The segment licenses certain of its patents to third parties and generates revenue from these licenses. Motorola is also licensed to use certain patents owned by others. Royalty and licensing fees vary from year to year and are subject to the terms of the agreements and sales volumes of the products subject to licenses. The protection of these licenses is also important to the segment’s operations. Reference is made to the material under the heading “Other Information” for additional information relating to patents and trademarks and research and development activities with respect to this segment.
Inventory, Raw Materials, Right of Return and Seasonality
The segment’s practice is to carry reasonable amounts of inventory in manufacturing and distribution centers in order to meet customer delivery requirements in a manner consistent with industry standards. At the end of 2006, the segment had a higher inventory balance than at the end of 2005. The increase reflects a growth in inventory in the fourth quarter of 2006, primarily due to slower than expected initial customer demand for certain products.
Availability of materials and components required by the segment is relatively dependable, but fluctuations in supply and market demand could cause selective shortages and affect results. We currently source certain materials and components from single vendors. Any material disruption from a single-source vendor may have a material adverse impact on our results of operations.
Energy necessary for the segment’s manufacturing facilities consists primarily of electricity and natural gas, which are currently in generally adequate supply for the segment’s operations. In addition, the cost to operate our facilities and freight costs are dependent on world oil prices. A substantial increase in worldwide oil prices could have a negative impact on our results of operations. Labor is generally available in reasonable proximity to the segment’s manufacturing facilities. However, difficulties in obtaining any of the aforementioned items or a significant cost increase could affect the segment’s results.
The segment permits returns under limited circumstances to remain competitive with current industry practices.
The segment typically experiences higher sales in the fourth calendar quarter and lower sales in the first calendar quarter of each year.
Our Facilities/ Manufacturing
Our headquarters are located in Libertyville, Illinois. Our other major facilities are located in Plantation, Florida; Flensburg, Germany; Singapore; Beijing and Tianjin, China; Jaguariuna, Brazil; and Basingstoke, England. We also maintain an interest in a joint venture in Hangzhou, China.
We also use several electronics manufacturing suppliers (“EMS”) and original design manufacturers (“ODM”) to enhance our ability to lower our costs and deliver products that meet consumer demands in the rapidly-changing technological environment. A portion of our handsets are manufactured either completely or substantially by non-affiliated EMS and ODM manufacturers and the percentage of total manufactured unit volume with these manufacturers increased moderately from 2005 to 2006.
In 2006, our handsets were primarily manufactured in Asia. We expect this to continue in 2007. Our largest manufacturing facilities are located in China, Singapore and Brazil. Each of these facilities serves multiple countries and regions of the world.
Networks and Enterprise Segment
The Networks and Enterprise segment (the “segment”) designs, manufactures, sells, installs and services: (i) cellular infrastructure systems and wireless broadband systems to public carriers and other wireless service providers (referred to as the “public networks” market), and (ii) analog and digital two-way radio, voice and data communications products and systems, as well as wireless broadband systems, to a wide range of public safety, government, utility, transportation and other worldwide enterprise markets (referred to as the “private networks” market). In January 2007, the segment completed the acquisition of Symbol Technologies, Inc. (“Symbol”), a leader in providing products and systems used in end-to-end enterprise mobility solutions. Symbol will become the cornerstone of the segment’s enterprise mobility strategy. In 2006, the segment’s net sales represented 26% of the Company’s consolidated net sales.
Principal Products and Services
In the public networks market, the segment provides end-to -end cellular networks, including radio base stations, base station controllers, associated software and services, application platforms and third-party switching for CDMA, GSM, iDEN ® and UMTS technologies. The segment also offers a portfolio of products, collectively known as Motorola MOTOwi4, which includes WiMAX, to create mobile Internet Protocol (“IP”) broadband access. These technologies, especially WiMAX, have the potential to make mobile bandwidth more affordable and accessible for mainstream consumer adoption, yet profitable for the segment’s service provider customers. The segment also provides access points, subscriber modules and backhaul modules for wireless broadband systems, as well as advanced telecommunications architecture (“TCA”) and micro TCA communications servers. These products and services are marketed to wireless service providers worldwide through a direct sales force, licensees and agents.
In the private networks market, the segment primarily designs, manufactures, sells, installs and services two-way radio, voice and data communications products and systems to a wide range of public safety and government customers worldwide.
The segment also serves the enterprise space by providing business-critical wireless mobility devices, networks and applications that enable an enterprise customer to seamlessly connect its people, assets and information. Enterprise customers include utility, courier, transportation, field services and other companies with disseminated workforces. Offerings include mobile office devices, rugged mobile computing handhelds, private and public business communication networks, enterprise-grade wireless security systems, and end-to -end systems and applications that deliver enterprise mobility. The January 2007 acquisition of Symbol unites the two companies’ industry-leading enterprise products.
The segment’s products are sold directly through its own distribution force or through independent authorized distributors and dealers, service operators and independent commission sales representatives. The segment’s distribution organization provides systems engineering and installation and other technical and systems management services to meet its customers’ particular needs. The customer may also choose to install and maintain the equipment with its own employees, or may obtain installation, service and parts from a network of the segment’s authorized service stations (most of whom are also authorized dealers) or from other non-Motorola service stations.
Our Industry
We participate in multiple global markets within the mobile segment of the communications industry, providing wireless equipment and services to public carriers and other wireless service providers, as well as public safety, government and enterprise customers.
Within our public networks market, we primarily provide radio access cellular infrastructure systems. This market grew approximately 5% in 2006, compared to 10% in 2005 and we expect this market to experience flat to low single digit growth in 2007. We are also an early leader in the emerging market for next-generation wireless broadband networks, including WiMAX technology.
The majority of installed cellular infrastructure systems are based upon CDMA, GSM, UMTS and iDEN technologies. We supply systems based on each of these technologies and are the sole supplier of proprietary iDEN networks. Advanced infrastructure systems based on these technologies include GPRS, CDMA-1X and EDGE. In addition, some segments of the cellular infrastructure industry have installed, or are in the process of migrating to, third-generation (“3G”) networks, which are high-capacity radio access wireless networks providing enhanced data services, improved Internet access and increased voice capacity. The primary 3G technologies are W-CDMA (based on either UMTS or Freedom of Mobile Multimedia Access (“FOMA”) technologies) and CDMA2000 1xEVDO. An additional 3G technology standard is TD-SCDMA, driven primarily by the Chinese government and local Chinese vendors. We now expect 3G licenses to be awarded in China during 2008. We supply systems based on UMTS and CDMA 2000 1xEVDO technologies. Advanced infrastructure systems based on 3G technologies include high-speed downlink packet access (“HSDPA”) and high-speed uplink packet access (“HSUPA”). Commercial service of 3G technologies was first introduced in Asia and has expanded to Western Europe and North America.
Industry standards bodies are in the process of defining the next generation of wireless broadband systems after 3G. The Institute of Electrical and Electronics Engineers (“IEEE”) is currently developing fixed and mobile broadband standards (802.16d and 802.16e) based on orthogonal frequency division multiplexing (“OFDM”) technology, which offer systems performance utilizing wider channels enabling triple play services (voice, data, video). Based upon developments in the 802.16e standard, we expect to see the WiMAX market begin to materialize in 2008 as several WiMAX networks come on-line and devices utilizing these networks become widely available. We are an early leader in next-generation wireless broadband products, including WiMAX technology.
The International Telecommunications Union (“ITU”) is also developing next-generation cellular wireless access standards (“4G”) for the cellular infrastructure industry, also anticipated to be based upon OFDM technology.
Within our private networks business, homeland security remains an important issue at the local, state and national levels. We expect this industry to grow in the mid-to -high single digit percentage range in 2007, consistent with industry growth in 2006. We provide solutions for each of the major standards based private network technologies, APCO (Association for Public Safety Communications Officials) 25 and TETRA (terrestrial trunked radio). We expect product sales to continue to grow worldwide as demand for intersystem, interoperable public safety communications grows. As both technologies mature, better frequency utilization has increased the demand and potential for data applications and we expect to see increased demand for data-based products in 2007 and beyond.
In addition, Motorola recognizes a significant market opportunity in the next several years as enterprises increase their deployment of mobile technologies. The enterprise markets in which Motorola competes include enterprise wireless infrastructure, mobile computing solutions, bar code scanning, radio frequency identification (“RFID”) solutions and mobile management platforms. Organizations that are looking to increase productivity and derive benefits from mobilizing their applications and workforce are driving the enterprise mobility market. We expect the overall enterprise mobility market to grow in the high single digits in 2007. With the completion of the Symbol acquisition in January 2007, Motorola’s new enterprise mobility business offers a broad device portfolio which will enable us to compete more effectively in these markets.
Our Strategy
The Networks and Enterprise segment is executing on a strategy to become a category leader in next-generation mobile solutions, thereby enabling seamless mobility for public carriers and their customers, governments and enterprises. It executes on this strategy by offering multiple technologies across several customer sectors.
Public Networks. The segment is investing to be the leader in next-generation wireless broadband technologies with its MOTOwi4 portfolio of offerings, such as WiMAX. Because of its projected early availability, lower cost and superior performance, wireless broadband technology, such as WiMAX, based on the IEEE standard 802.16e represents a compelling offering for existing and new providers. Potential customers in this space range from traditional mobile providers to wireline operators, such as cable companies, who are moving to enhance their offerings to new customers or launch offerings based on wireless broadband. In 2006, the segment announced arrangements for WiMAX networks based on 802.16e technologies with Wateen Telecom in Pakistan and Sprint Nextel and Clearwire in the United States. In addition, at the end of 2006 the segment was participating in 22 WiMAX trials globally.
The segment also has a comprehensive investment strategy to migrate its customers from 2G (second-generation) to next-generation wireless technologies, including 3G (third-generation) technologies. The cellular network technologies, based on protocols developed through the ITU, have advanced from 2G to 3G enabling service providers to move to higher-capacity bandwidth technologies which enable the providers to offer engaging, new and exciting applications that can broaden their revenue stream. Many cellular operators, particularly in emerging markets, have not begun their migration to next-generation access technologies. In 2006, the segment announced a collaboration with Huawei Technologies, Co., Ltd. to bring an enhanced and extensive portfolio of UMTS and HSDPA/HSUPA infrastructure equipment to customers worldwide.
Private Networks. The segment is the leading provider of mission-critical systems worldwide, with more than 65 years of experience in custom, rugged devices; public safety-grade private networks; sophisticated encryption technology; interoperable voice and broadband data; and complex network design, optimization and implementation. Key elements in the segment’s strategy include: (i) providing next-generation integrated voice, data and broadband over wireless systems at the local, state and national levels; (ii) continuing to invest in the ongoing migration from analog to digital end-to -end radio systems; (iii) providing APCO 25 and TETRA standards-based voice and data networking systems around the world; and (iv) implementing interoperable communications and information systems, especially related to global homeland security. In January 2007, the segment completed the acquisition of Symbol, a leader in designing, developing, manufacturing and servicing products and systems used in end-to -end enterprise mobility solutions. Symbol’s offerings feature rugged mobile computing, advanced data capture, RFID, wireless infrastructure and mobility management. Recognized as an industry leader in technology innovation, with a world-class product portfolio and valuable intellectual property, Symbol will be the cornerstone of the segment’s strategy to enable the mobile enterprise in 2007 and beyond. The acquisition unites the two companies’ adjacent assets, expertise, customer bases, supplier bases and industry-leading products. Key elements in the segment’s enterprise mobility strategy include offering a comprehensive portfolio of products and services to help businesses: (i) streamline their supply chains, (ii) improve customer service in the field, (iii) increase data collection accuracy, and (iv) enhance worker productivity.
Customers
Due to the nature of the segment’s business, many of the agreements we enter into are long-term contracts that require sizeable investments by our customers. In 2006, sales to our top five commercial customers (Sprint Nextel; KDDI, a service provider in Japan; China Mobile; Verizon; and Alltel), plus the U.S. government and its public safety agencies, represented approximately 34% of the segment’s net sales. The loss of any of the segment’s large customers, in particular these customers, could have a material adverse effect on the segment’s business. Further, because many of these contracts are long-term, the loss of a major customer would impact revenue and earnings over several quarters.
Sprint Nextel is our largest customer and the segment has been Sprint Nextel’s sole supplier of iDEN network infrastructure equipment for more than ten years. Sprint Nextel uses Motorola’s proprietary iDEN technology to support a critical part of its nationwide wireless service business. Motorola is currently operating under supply agreements for iDEN infrastructure equipment that cover the period from January 1, 2005 through December 31, 2007. The segment’s iDEN revenues decreased in 2006 compared to 2005, and we expect iDEN sales to decline further in 2007.
Competition
The segment experiences widespread competition from numerous competitors, ranging from some of the world’s largest diversified companies to foreign, state-owned telecommunications companies to many small, specialized firms. In the public networks industry, Ericsson is the market leader, followed by Nokia and four
vendors with similar market share positions, including Motorola, Siemens, Alcatel-Lucent and Nortel. Samsung, NEC and local Chinese vendors are also significant competitors. In the private networks industry, the segment provides communications and information systems compliant with both existing industry digital standards, TETRA and APCO 25. Major competitors include: M/ A-Com, EADS Telecommunications, Kenwood, EF Johnson and large system integrators. The segment may also act as a subcontractor to a large system integrator based on a number of competitive factors and customer requirements. As demand for fully-integrated voice, data and broadband over wireless systems at the local, state and national government levels continues, the segment may face additional competition from public telecommunications carriers. In the enterprise market, the segment experiences competition from Cisco, Nokia, and Intermec.
Competitive factors in the market for the segment’s products include: technology offered; price; payment terms; availability of vendor financing; product and system performance; product features, quality, delivery, availability and warranty; the quality and availability of service; company image; relationship with key customers; and time-to -market. Price is a major area of competition and often impacts margins for initial system bids, particularly in emerging markets. Time-to -market has also been an important competitive factor, especially for new systems and technologies.
The segment’s public networks business is confronting several factors that could impact its business, including the consolidation among telecommunications equipment providers and unclear timing for the granting of new licenses for providers in countries like China. In addition, the segment does not believe future iDEN technology revenues are likely to match 2006 levels. In the private networks space, the segment is managing the impact of system integrators seeking to move farther into the public safety area. In the enterprise market, a number of competitors deliver products in certain segments of the enterprise mobility market. The segment believes it has a unique portfolio to seamlessly connect people, assets and information to enable customers to grow their business, increase efficiency and improve customer satisfaction. Security and manageability are common throughout the portfolio.
Payment Terms
Payment terms vary worldwide, depending on the arrangement. Contracts for communication systems typically include implementation milestones, such as delivery, installation and system acceptance, which can take 30 to 180 days to complete. Invoicing the customer is dependent on the completion of the milestone. Customer payments are generally due 30 to 60 days from the invoice date.
As required for competitive reasons, we may provide or work with third-party lenders to arrange for long-term financing in connection with equipment purchases. Financing may cover all or a portion of the purchase price. The segment’s payment terms are consistent with industry practice as many of our contracts are awarded through a competitive bid process.
Regulatory Matters
The use of wireless voice and data communications systems is regulated by a variety of governmental and other regulatory agencies throughout the world. In the U.S., non-Federal users of these systems are licensed by the Federal Communications Commission (“FCC”), which has broad authority to make rules and regulations and prescribe restrictions and conditions to carry out the provisions of the Communications Act of 1934. Similarly, Federal agency operation of wireless communications systems is regulated by the National Telecommunications and Information Agency (“NTIA”). Regulatory agencies in other countries have similar types of authority. Consequently, the business and results of this segment could be affected by the rules and regulations adopted by the FCC, NTIA or regulatory agencies in other countries from time to time. Motorola has developed products using trunking and data communications technologies to enhance spectral efficiencies. The growth and results of the wireless communications industry may be affected by the regulations of the FCC, NTIA or other regulatory agencies relating to the access to allocated spectrum for wireless communications users, especially in urban areas where spectrum is heavily used.
The U.S. leads the world in spectrum deregulation, allowing new wireless communications technologies to be developed and offered for sale. Examples include wireless local area network systems, such as WiFi, mesh technologies and wide area network systems, such as Motorola’s Wi4 portfolio, including WiMAX. Other countries have also deregulated portions of the available spectrum to allow the deployment of these and other technologies. Deregulation may introduce new competition and new opportunities for Motorola and our customers.
In early 2005, Sprint Nextel agreed to a plan by federal regulators designed to address interference from iDEN phones with hundreds of public safety communications systems in the U.S. According to the FCC, the agreement should dramatically reduce the likelihood of interference. Sprint Nextel is required to fund certain costs necessary to relocate those impacted users onto alternate channels in the 800MHz spectrum. Motorola will continue to work with our customers that are impacted by this plan and expects that this will have a neutral to positive impact on the segment’s business over the next several years. However, the short-term impact remains uncertain and is yet to be quantified, as the plan is still being implemented throughout most of the country.
In February 2006, federal legislation was adopted setting February 17, 2009 as the date by which a portion of the spectrum historically used for broadcast television must be cleared throughout the U.S. Segments of this spectrum have been designated for public safety use and other segments for commercial operations, both market segments in which Motorola participates. This spectrum was designated for public safety and commercial use in 1997, however, prior to this new legislation, there was no certainty as to when it actually would be cleared for use in major markets. Clearing broadcast television from this band will significantly increase the spectrum public safety and commercial entities have available for communications systems. The new spectrum is configured to support both voice and data and the FCC has also opened additional rulemaking proceedings to help enable future broadband operations for public safety. Motorola already has public safety infrastructure and mobiles/portables shipping for deployment of voice and data systems in this band and we anticipate the availability of broadband equipment in the future.
Backlog
The segment’s backlog was $4.4 billion as of December 31, 2006, compared to $4.1 billion as of December 31, 2005. The 2006 order backlog is believed to be generally firm and approximately 85% of that amount is expected to be recognized as revenue during 2007. The forward-looking estimate of the firmness of such orders is subject to future events that may cause the amount recognized to change.
Intellectual Property Matters
Patent protection is extremely important to the segment’s operations. The segment has an extensive portfolio of patents relating to its products, systems, technologies and manufacturing processes.
The segment licenses some of its patents to third parties and generates modest revenue from these licenses. Motorola is also licensed to use certain patents owned by others. Royalty and licensing fees vary from year to year and are subject to the terms of the agreements and sales volumes of the products subject to licenses. Reference is made to the material under the heading “Other Information” for information relating to patents and trademarks and research and development activities with respect to this segment.
We actively participate in the development of open standards for interoperable, mission-critical digital two-way radio systems. We have published our technology and licensed patents to signatories of the industry’s two primary memorandums of understanding defined by the Telecommunications Industry Association (“TIA”) Project 25 and European Telecommunications Standards Institute (“ETSI”) Terrestrial Trunked Radio (“TETRA”). Royalties associated with these licenses are not expected to be material to the segment’s financial results.
Inventory, Raw Materials, Right of Return and Seasonality
The segment’s practice is to carry reasonable amounts of inventory in order to meet customer delivery requirements in a manner consistent with industry standards. At the end of 2006, the segment had a higher inventory balance than at the end of 2005, primarily due to a larger amount of inventory to fulfill longer-term projects.
Our private networks business provides custom products based on assembling basic units into a large variety of models or combinations. This requires the stocking of inventories and large varieties of piece parts and replacement parts, as well as a variety of basic level assemblies in order to meet delivery requirements. Relatively short delivery requirements and historical trends determine the amounts of inventory to be stocked. To the extent suppliers’ product life cycles are shorter than the segment’s, stocking of lifetime buy inventories is required. In addition, replacement parts are stocked for delivery on customer demand within a short delivery cycle.
Availability of materials and components required by the segment is relatively dependable, but fluctuations in supply and market demand could cause selective shortages and affect results. We currently source certain materials and components from single vendors. Any material disruption from a single-source vendor may have a material adverse impact on our results of operations.
Natural gas, electricity and, to a lesser extent, oil are the primary sources of energy for the segment’s operations, which are currently in generally adequate supply for the segment’s operations. In addition, the cost to operate our facilities and freight costs are dependent on world oil prices. A substantial increase in worldwide oil prices could have a negative impact on our results of operations. Labor is generally available in reasonable proximity to the segment’s manufacturing facilities. However, difficulties in obtaining any of these items or a significant cost increase could affect the segment’s results.
Generally the segment’s contracts do not include a right of return, other than for standard warranty provisions. For new product introductions, we may enter into milestone contracts providing that the product could be returned if we do not achieve the milestones.
Due to government buying patterns, private networks sales tend to be somewhat higher in the fourth quarter. The business does not have seasonal patterns in the public networks market.
Our Facilities/ Manufacturing
Our headquarters are located in Arlington Heights, Illinois. Major design, integration, manufacturing and distribution centers are located in: Arlington Heights and Schaumburg, Illinois; Chandler and Tempe, Arizona; Fort Worth, Texas; Swindon, England; Arad, Israel; Hangzhou and Tianjin, China; Munich, Taunusstein and Berlin, Germany; and Penang, Malaysia. In addition to our own manufacturing, we utilize EMS manufacturers, primarily in Asia, in order to enhance our ability to lower costs and deliver products that meet consumer demands.
Connected Home Solutions Segment
The Connected Home Solutions segment (the “segment”) designs, manufactures, sells and services: (i) cable television, Internet Protocol (“IP”) video and broadcast network set-top boxes (“digital entertainment devices”), (ii) end-to -end digital video system solutions, (iii) broadband access networks, and (iv) IP-based data and voice products (including modems). In 2006, the segment’s net sales represented 8% of the Company’s consolidated net sales.
Principal Products and Services
The segment is a leading provider of end-to -end networks used for the delivery of video, voice and data services over hybrid fiber coaxial networks. We also provide products for IP television (“IPTV”) — multichannel television service using IP-based fiber-to -the premises and fiber-to -the-node access networks — to wireline carriers.
Our products are marketed primarily to cable television operators, satellite television programmers, telephone carriers and other communications providers worldwide and are sold primarily by our skilled sales personnel. We have also expanded our traditional distribution channels by selling directly to consumers in a variety of retail markets. Through retail, we market and sell primarily cable modems and cordless telephones.
Our Industry
Demand for our products depends primarily on: (i) capital spending by providers of broadband services for constructing, rebuilding or upgrading their communications systems, and (ii) the marketing of advanced communications services by those providers. The amount of spending by these providers, and therefore a majority of our sales and profitability, are affected by a variety of factors, including: (i) the continuing trend of consolidation within the cable and telecommunications industries, (ii) the financial condition of cable television system operators and alternative communications providers, including their access to financing, (iii) the rate of digital penetration, (iv) technological developments, (v) standardization efforts that impact the deployment of new equipment, (vi) new legislation and regulations affecting the equipment sold by the segment, and (vii) general economic conditions. In 2006, the business benefited from increased spending by cable television operators on our products, due to the increase in digital video and data subscribers and the deployment of advanced video platforms by cable operators for high-definition television (“HD”) and digital video recording (“DVR”) (together “HD/
DVR”) applications, as well as from spending by telephone companies upgrading their networks and adding video services.
Our Strategy
The Connected Home Solutions segment is focused on becoming the global leader in broadband connected home solutions and services, enabling customers to be seamlessly informed, connected and entertained. Key elements in the segment’s strategy include: (i) providing for convergence of services and applications across delivery platforms within the home and across mobile applications, (ii) innovating and enhancing our end-to-end network portfolio, and (iii) developing new services that leverage our platforms.
We are focused on accelerating the rate of digital penetration by broadband operators in North America through the introduction of an enhanced suite of digital set-top boxes. Our product offerings include more cost-effective products designed to increase the number of set-top boxes per household, as well as higher-end products for advanced services, including supporting the growing HD/ DVR markets. During 2006, we shipped our 50 millionth digital entertainment device for broadband cable networks, approximately 10 years after shipment of our first such device.
We are capitalizing upon the introduction of IPTV by telecommunication operators to their subscribers with products that support delivery of video content using both copper-outside-plant and fiber-to-the-premises (“FTTP”) networks. During the year, the segment provided end-to-end video equipment and FTTP access network equipment for the launch of Verizon’s FiOS service and is supplying IP interactive set-top boxes to leading telecommunication companies around the world, including AT&T, Telefonica S.A., KPN International, Lyse Energi AS, and ViaSat, Inc.
We are expanding our position in end-to-end video networks as well as increasing our offerings to wireline carriers through several strategic acquisitions. During 2006, we acquired Kreatel Communications AB to enhance our portfolio of IPTV set-top boxes and software and extend our customer relationships with leading IPTV providers in Europe. We grew our presence in the video core network through the acquisitions of: (i) Broadbus Technologies, Inc., a leading supplier of content-on-demand technologies, also called video on demand (“VOD”), and (ii) Vertasent LLC, a software developer for managing technology elements for switched digital video networks. In February 2007, we completed the acquisition of Netopia, Inc. (“Netopia”), a leading provider of data gateways and subscriber equipment management technology. We also announced our intention to acquire Tut Systems, Inc. (“Tut Systems”), a leading developer of edge routing and video encoders. Together, Netopia and Tut Systems will enhance our position with global carriers as they deploy advanced services. We expect these acquisitions to: (i) enhance our capability to provide complete solutions to cable television operators as they grow their on-demand content offerings and deploy switched digital video (“SDV”) technology, which delivers programming only when and where requested by subscribers versus delivering programming to all subscribers all the time, and (ii) provide end-to-end video solutions to telephone companies as they add video to their service offerings.
We are focused on enhancing and expanding our voice and data offerings to offer end-to-end solutions for fixed-mobile convergence and next-generation converged IP-based voice, data and video delivery. These solutions include: (i) stand-alone and integrated voice/data/ WiFi gateways with support for handing off a mobile voice or data call to a WiFi access point and a carrier’s VoIP network, and (ii) next-generation infrastructure products in the cable modem termination system (“CMTS”) and fiber optic network markets which expand the bandwidth delivered to a home or business. We introduced our first seamless mobility voice gateway in 2006, which enables our customers to support handoff of voice traffic between wireline networks and wireless networks using dual mode handsets.
We also continue to focus on growing our business in regions outside of North America, including the development of digital video products compliant with technology required in these regions. During 2006, the segment launched digital video in Argentina with Cablevision; launched video on demand in the Netherlands with UPC; and provided video set-top boxes to a number of operators in China. Although sales in North America accounted for 83% of the segment’s sales in 2006, shipments to markets outside North America have grown over 60% the last three years.
Customers
The vast majority of our sales are in the U.S., where a small number of large cable television multiple system operators (“MSOs”) own a large portion of the cable systems and account for a significant portion of the total capital spending in the industry. We are dependent upon a small number of customers for a significant portion of our sales. Comcast Corporation (“Comcast”) accounted for approximately 29% of the segment’s net sales in 2006. Collectively, our five largest customers represented 54% of the segment’s net sales in 2006. The loss of business in the future from Comcast or any of the other major MSOs could have a material adverse effect on the segment’s business. Sales of video headend equipment and set-top boxes to telephone carriers accounted for approximately 11% of our revenue in 2006. The opportunity in this market segment is expected to continue to grow as carriers around the world expand to offer video services.
Competition
The businesses in which we operate are highly competitive. The rapid technological changes occurring in each of the markets in which we compete are expected to lead to the entry of many new competitors. Competitive factors for our products and systems include: technology offered; product and system performance; features; quality; delivery and availability; and price. We believe that we enjoy a strong competitive position because of our strong relationships with major communication system operators worldwide, technological leadership and new product development capabilities.
We compete worldwide in the market for digital set-top boxes for broadband and satellite networks. Based on 2006 annual sales, we believe we are the leading provider of digital cable set-top boxes in North America. Our digital cable set-top boxes compete with products from a number of different companies, including: (i) those that develop and sell products that are distributed by direct broadcast satellite (“DBS”) service providers through retail channels, (ii) those that develop, manufacture and sell products of their own design, and (iii) those that license technology from us or other competitors. In North America, our largest competitor is Cisco, which completed the acquisition of Scientific-Atlanta in 2006. Other competitors in North America include ARRIS, Harmonic and C-COR. Outside of North America, where we have a smaller market position, we compete with many equipment suppliers, including several consumer electronics companies.
The traditional competitive environment in the North American cable market continues to evolve. As further described below, the FCC has enacted regulations requiring separation of security functionality from set-top boxes by July 1, 2007 to increase competition and encourage the sale of set-top boxes in the retail market. To meet this requirement, we have developed security modules for sale to cable operators for use with our own and third-party set-top boxes. As a step towards this implementation, in 2002, the cable industry and consumer electronic manufacturers agreed to a uni-directional security interface that allows third-party devices to access broadcast programming (not pay-per-view or VOD) with a security device. These devices became widely available in 2004 and to date have seen limited use. The limited use of the devices has not had a significant impact on our business. A full two-way security interface specification continues to be refined. These changes are expected to increase competition and encourage the sale of set-top boxes to consumers in the retail market. Traditionally, cable service providers have leased the set-top box to their customers.
We also compete worldwide in the market for broadband data and voice products. We believe that we are the leading provider of cable modems worldwide, competing with a number of consumer electronic companies and various original design manufacturers worldwide.
Payment Terms
Generally, our payment terms are consistent with the industry and range from 30 to 60 days in North America, and are typically limited to 90 days in regions outside North America. Extended payment terms are provided to customers from time to time on a limited basis. Such extended terms are isolated in nature and historically have not related to a significant portion of our revenues.
Regulatory Matters
Many of our products are subject to regulation by the FCC or other communications regulatory agencies. In addition, our customers and their networks, into which our products are incorporated, are subject to government regulation. Government regulatory policies affecting either the willingness or the ability of cable operators and
telephone carriers to offer certain services, or the terms on which the companies offer the services and conduct their business, may affect the segment’s results.
Currently, reception of digital television programming from the cable broadband network requires a set-top box with certain technology. This security technology has limited the availability of set-top boxes to those manufactured by a few cable network manufacturers, including Motorola. The FCC has enacted regulations requiring separation of security functionality from set-top boxes to increase competition and encourage the sale of set-top boxes in the retail market by July 1, 2007. Traditionally, cable service providers sold or leased the set-top box to their customer. As the retail market develops for set-top boxes and televisions capable of accepting the security modules, sales of our set-top boxes may be negatively impacted. In addition, we risk lost sales if competitors bring set-top boxes with separable security to market before we do.
Backlog
The segment’s backlog was $792 million at December 31, 2006, compared to $430 million at December 31, 2005. The increase in backlog and related orders primarily reflects increased orders from our customers for digital and HD/DVR set-top boxes. The 2006 order backlog is believed to be generally firm and 100% of that amount is expected to be recognized as revenue in 2007. The forward-looking estimates of the firmness of such orders is subject to future events, which may cause the amount recognized to change.
Intellectual Property Matters
We seek to build upon our core enabling technologies, such as digital compression, encryption and conditional access systems, in order to lead worldwide growth in the market for broadband communications networks. Our policy is to protect our proprietary position by, among other methods, filing U.S. and foreign patent applications to protect technology and improvements that we consider important to the development of our business. We also rely on our proprietary knowledge and ongoing technological innovation to develop and maintain our competitive position, and will periodically seek to include our proprietary technologies in certain patent pools that support the implementation of standards. We were a founder of MPEG LA, the patent licensing authority established to foster broad deployment of MPEG-2 compliant systems. We have also licensed our digital conditional access technology, DigiCipher(R) II, to other equipment suppliers and have formed joint ventures with Comcast for development and licensing of conditional access technology. We also enter into other license agreements, both as licensor and licensee, covering certain products and processes with various companies. These license agreements require the payment of certain royalties that are not expected to be material to the segment’s financial results.
Inventory, Raw Materials, Right of Return and Seasonality
The segment’s practice is to carry reasonable amounts of inventory in order to meet customer delivery requirements in a manner consistent with industry standards. At the end of 2006, the segment had higher inventory balances than at the end of 2005 due to the timing of transitions to EMS manufacturers and business acquisitions.
Availability of materials and components required by the segment is relatively dependable, but fluctuations in supply and market demand could cause selective shortages and affect results. We currently source certain materials and components from single vendors. Any material disruption from a single-source vendor may have a material adverse impact on our results of operations.
Electricity is the primary source of energy required for our manufacturing operations, which is currently in generally adequate supply for the segments operations. In addition, the cost to operate our facilities and freight costs are dependent on world oil prices. A substantial increase in world-wide oil prices could have a negative impact on our results of operations. Labor is generally available in reasonable proximity to the segment’s manufacturing facilities. However, difficulties in obtaining any of the aforementioned items or a significant cost increase could affect the segment’s results.
Generally, we do not permit customers to return products, other than for standard warranty provisions. We have not recently experienced seasonal buying patterns for our products. However, as our retail cable modem and digital set-top box sales increase, we may have increased sales during the holiday season at the end of each year.
Our Facilities/ Manufacturing
Our headquarters are located in Horsham, Pennsylvania. We have several offices throughout North America, Europe, Latin America and Asia, and we operate manufacturing facilities in Taipei, Taiwan and Nogales, Mexico. We also use contract manufacturers, primarily in China, for a portion of our cable modem/voice module production in order to enhance our ability to lower our costs and deliver products that meet consumer demand. The amount of this activity has increased slightly throughout 2006 and is projected to increase further in future years.
Other Information
2006 Change in Organizational Structure. Effective as of the second quarter of 2006, the automotive electronics business was presented as a discontinued operation and the segments were realigned into three operating business groups: (i) Mobile Devices, (ii) Networks and Enterprise, and (iii) Connected Home Solutions.
Financial Information About Segments. The response to this section of Item 1 incorporates by reference Note 11, “Information by Segment and Geographic Region,” of Part II, Item 8: Financial Statements and Supplementary Data of this document.
Customers. Motorola has several large customers, the loss of one or more of which could have a material adverse effect on the Company. Motorola’s largest end customers (including sales through distributors) are Sprint Nextel, China Mobile, Verizon, Cingular and T-Mobile. No single customer accounted for more than 10% of the Company’s net sales in 2006.
Approximately 1% of Motorola’s net sales in 2006 were to various branches and agencies, including the armed services, of the U.S. Government. All contracts with the U.S. Government are subject to cancellation at the convenience of the Government.
Government contractors, including Motorola, are routinely subjected to numerous audits and investigations, which may be either civil or criminal in nature. The consequences of these audits and investigations may include administrative action to suspend business dealings with the contractor and to exclude it from receiving new business. In addition, Motorola, like other contractors, reviews aspects of its government contracting operations, and, where appropriate, takes corrective actions and makes voluntary disclosures to the U.S. Government. These audits and investigations could adversely affect Motorola’s ability to obtain new business from the U.S. Government.
Backlog. Motorola’s aggregate backlog position for all Motorola segments, as of the end of the last two fiscal years was approximately as follows:
December 31, 2006
$6.6 billion
December 31, 2005
$7.5 billion
Except as previously discussed in this Item 1, the orders supporting the 2006 backlog amounts shown in the foregoing table are believed to be generally firm, and approximately 90% of the backlog on hand at December 31, 2006 is expected to be recognized as revenue in 2007. The forward-looking estimate of the firmness of such orders is subject to future events that may cause the amount recognized to change.
Research and Development. Motorola’s business segments participate in very competitive industries with constant changes in technology. Throughout its history, Motorola has relied, and continues to rely, primarily on its research and development (“R&D”) programs for the development of new products, and on its production engineering capabilities for the improvement of existing products. Technical data and product application ideas are exchanged among Motorola’s business segments on a regular basis. Management believes, looking forward, that Motorola’s commitment to R&D programs, both to improve existing products and services and to develop new products and services, together with its utilization of state-of -the-art technology, should allow each of its segments to remain competitive.
R&D expenditures relating to new product development or product improvement were $4.1 billion in 2006, compared to $3.6 billion in 2005 and $3.3 billion in 2004. R&D expenditures increased 14% in 2006 as compared to 2005, after increasing 9% in 2005 as compared to 2004. Motorola continues to believe that a strong commitment
to research and development is required to drive long-term growth. Approximately 27,000 professional employees were engaged in such research activities during 2006.
Patents and Trademarks. Motorola seeks to obtain patents and trademarks to protect our proprietary position whenever possible and practical. As of December 31, 2006, Motorola owned approximately 8,652 utility and design patents in the U.S. and 12,024 patents in foreign countries. These foreign patents are mostly counterparts of Motorola’s U.S. patents, but a number result from research conducted outside the U.S. and are originally filed in the country of origin. During 2006, Motorola was granted 735 U.S. utility and design patents. The numbers of patents reported exclude patents sold to Continental AG in its acquisition of the automotive electronics business and include patents assigned to companies acquired by Motorola during 2006. Many of the patents owned by Motorola are used in its operations or licensed for use by others, and Motorola is licensed to use certain patents owned by others. Royalty and licensing fees vary from year to year and are subject to the terms of the agreements and sales volumes of the products subject to licenses.
Environmental Quality. Compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has no material effect on capital expenditures, earnings or the competitive position of Motorola.
Employees. At December 31, 2006, there were approximately 66,000 employees of Motorola and its subsidiaries, as compared to approximately 69,000 employees at December 31, 2005.
Financial Information About Foreign and Domestic Operations. The response to this section of Item 1 incorporates by reference Note 10, “Commitments and Contingencies” and Note 11, “Information by Segment and Geographic Region” of Part II, Item 8: Financial Statements and Supplementary Data of this document, the “Results of Operations—2006 Compared to 2005” and “Results of Operations—2005 Compared to 2004” sections of Part II, “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item A: Risk Factors” of this document.
Available Information
We make available free of charge through our website, www.motorola.com/investor, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, other reports filed under the Securities Exchange Act of 1934 (“Exchange Act”) and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission (“SEC”). Our reports are also available free of charge on the SEC’s website, www.sec.gov. Also available free of charge on our website are the following corporate governance documents:
| • | Motorola, Inc. Restated Certificate of Incorporation | |
| • | Motorola, Inc. Amended and Restated Bylaws | |
| • | Motorola, Inc. Board Governance Guidelines | |
| • | Motorola, Inc. Director Independence Guidelines | |
| • | Principles of Conduct for Members of the Motorola, Inc. Board of Directors | |
| • | Motorola Code of Business Conduct, which is applicable to all Motorola employees, including the principal executive officer, the principal financial officer and the controller (principal accounting officer) | |
| • | Audit and Legal Committee Charter | |
| • | Compensation and Leadership Committee Charter | |
| • | Governance and Nominating Committee Charter |
All of our reports and corporate governance documents may also be obtained without charge by contacting Investor Relations, Motorola, Inc., Corporate Offices, 1303 East Algonquin Road, Schaumburg, Illinois 60196, E-mail: investors@motorola.com , phone: 1-800 -262-8509. Our Internet website and the information contained therein or incorporated therein are not intended to be incorporated into this Annual Report on Form 10-K.
Item 1A: Risk Factors
We wish to caution the reader that the following important risk factors, and those risk factors described elsewhere in this report or our other Securities and Exchange Commission filings, could cause our actual results to differ materially from those stated in forward-looking statements contained in this document and elsewhere.
The demand for our products depends in large part on the continued growth of the industries in which we participate. A market decline in any one of these industries could have an adverse effect on our business.
The rate at which the portions of the telecommunications industry in which we participate continue to grow is critical to our ability to improve our overall financial performance and we could be negatively impacted by a slowdown. Our business was very negatively impacted by the economic slowdown and the corresponding reduction in capital spending by the telecommunications industry from 2001 to 2003.
Our customers and suppliers are located throughout the world and, as a result, we face risks that other companies that are not global may not face.
Our customers and suppliers are located throughout the world and more than half of our net sales are made to customers outside of the U.S. In addition, we have many manufacturing, administrative and sales facilities outside the U.S. and more than half of our employees are employed outside the U.S. Most of our suppliers are outside the U.S. and most of our products are manufactured outside the U.S.
As with all companies that have sizeable sales and operations outside the U.S., we are exposed to risks that could negatively impact sales or profitability, including but not limited to: (1) tariffs, trade barriers and trade disputes; (2) regulations related to customs and import/export matters; (3) longer payment cycles; (4) tax issues, such as tax law changes, variations in tax laws from country to country and as compared to the U.S., and difficulties in repatriating cash generated or held abroad in a tax-efficient manner; (5) currency fluctuations, particularly in the Euro, Chinese renminbi and Brazilian real; (6) foreign exchange regulations, which may limit the Company’s ability to convert or repatriate foreign currency; (7) challenges in collecting accounts receivable; (8) cultural and language differences; (9) employment regulations and local labor conditions; (10) difficulties protecting IP in foreign countries; (11) instability in economic or political conditions, including inflation, recession and actual or anticipated military or political conflicts; (12) natural disasters; (13) public health issues or outbreaks; and (14) the impact of each of the foregoing on our outsourcing and procurement arrangements.
Many of our products that are manufactured outside of the U.S. are manufactured in Asia. In particular, we have sizeable operations in China, including manufacturing operations, and 11% of our net sales are made to customers in China. The legal system in China is still developing and is subject to change. Accordingly, our operations and orders for products in China could be adversely impacted by changes to or interpretation of Chinese law. Further, if manufacturing in the region is disrupted, our overall capacity could be significantly reduced and sales or profitability could be negatively impacted.
We also are increasing our presence and/or selling more of our products in emerging markets such as India and Russia. We face challenges in emerging markets, including creating demand for our products and the negative impact of changes in the laws, or the interpretation of the laws, in those countries.
If the quality of our products does not meet our customers’ expectations, then our sales and operating earnings, and ultimately our reputation, could be adversely affected.
Occasionally, some of the products we sell have quality issues resulting from the design or manufacture of the product, or from the software used in the product. These issues may be caused by the components we purchase from other manufacturers. Often these issues are identified prior to the shipment of the products and may cause delays in shipping products to customers, or even the cancellation of orders by customers. Sometimes, we discover quality issues in the products after they have been shipped to our distributors or end-user customers, requiring us to resolve such issues in a timely manner that is the least disruptive to our customers. Such pre-shipment and post-shipment quality issues can have legal and financial ramifications, including: delays in the recognition of revenue, loss of revenue or future orders, customer-imposed penalties on Motorola for failure to meet contractual requirements, increased costs associated with repairing or replacing products, and a negative impact on our goodwill and brand name reputation.
In some cases, if the quality issue affects the product’s safety or regulatory compliance, then such a “defective” product may need to be recalled. Depending on the nature of the defect and the number of products in the field, it can cause the Company to incur substantial recall costs, in addition to the costs associated with the potential loss of future orders, and the damage to the Company’s goodwill or brand/reputation. In addition, the Company may be required, under certain customer contracts, to pay damages for failed performance that might exceed the revenue that the Company receives from the contracts. Recalls involving regulatory agencies can also result in fines and additional costs. Finally, recalls can result in third-party litigation, including class action litigation by persons alleging common harm resulting from the purchase of the products.
We operate in highly-competitive markets and our financial results will be affected if we are not able to compete effectively.
The markets for our products are highly competitive with respect to, among other factors: pricing, product and service quality, and the time required to introduce new products and services. The markets for many of our products are characterized by rapidly changing technologies, frequent new product introductions, short product life cycles and evolving industry standards. We are constantly exposed to the risk that our competitors may implement new technologies before we do, or may offer lower prices, additional products or services or other incentives that we cannot or will not offer. We can give no assurances that we will be able to compete successfully against existing or future competitors.
The uncertainty of current economic and political conditions makes budgeting and forecasting difficult and may reduce demand for our products.
Current conditions in the domestic and global economies are uncertain. The U.S. involvement in Iraq and other global conflicts, including in the Middle East, as well as public health issues, have created many economic and political uncertainties that have impacted the global economy. As a result, it is difficult to estimate the level of growth for the world economy as a whole. It is even more difficult to estimate growth in various parts of the world economy, including the markets in which we participate. Because all components of our budgeting and forecasting are dependent upon estimates of growth in the markets we serve and demand for our products, the prevailing economic uncertainties render estimates of future income and expenditures difficult.
We have sizable manufacturing operations and engineering resources in Israel that could be disrupted as a result of hostilities in the region. We also sell our products and services throughout the Middle East and demand for our products and services could be negatively impacted by hostilities.
The future direction of the overall domestic and global economies will have a significant impact on our overall performance. The potential for future terrorist attacks, increased global conflicts and the escalation of existing conflicts and public health issues has created worldwide uncertainties that have negatively impacted, and may continue to negatively impact, demand for certain of our products.
Our future operating results depend on our ability to purchase a sufficient amount of materials, parts and components to meet the demands of our customers.
Our ability to meet customers’ demands depends, in part, on our ability to obtain timely and adequate delivery of quality materials, parts and components from our suppliers. We have experienced shortages in the past that have adversely affected our operations. Although we work closely with our suppliers to avoid these types of shortages, there can be no assurances that we will not encounter these problems in the future. Furthermore, certain of our components are available only from a single source or limited sources. We may not be able to diversify sources in a timely manner. A reduction or interruption in supplies or a significant increase in the price of supplies could have a material adverse effect on our businesses.
Our success depends in part on our timely introduction of new products and technologies and our results can be impacted by our significant investments in new products and technologies.
The markets for our products are characterized by rapidly changing technologies, frequent new product introductions, short product life cycles and evolving industry standards. Our success depends, in substantial part, on the timely and successful introduction of new products and upgrades of current products to comply with emerging industry standards and to address competing technological and product developments carried out by our
competitors. The research and development of new, technologically-advanced products is a complex and uncertain process requiring high levels of innovation, as well as the accurate anticipation of technological and market trends. We may focus our resources on technologies that do not become widely accepted and are not commercially viable. In addition, products may contain defects or errors that are detected only after deployment. If our products are not competitive or do not work properly, our business will suffer.
Our results are subject to risks related to our significant investment in developing and introducing new products, such as: seamless mobility products; advanced wireless handsets; WiMAX and other advanced technologies for wireless broadband networks; products for transmission of telephony and high-speed data over hybrid fiber coaxial cable systems; integrated digital radios; and integrated public safety systems. These risks include: (i) difficulties and delays in the development, production, testing and marketing of products; (ii) customer acceptance of products; (iii) the development of, approval and compliance with industry standards; (iv) the significant amount of resources we must devote to the development of new technology; and (v) the ability to differentiate our products and compete with other companies in the same markets.
Our success, in part, will be affected by the ability of our wireless businesses to successfully compete in the ever-evolving markets in which we participate. We face intense competition in these markets from both established companies and new entrants. Product life cycles can be short and new products are expensive to develop and bring to market.
Our success is dependent, in part, upon our ability to form successful strategic alliances. If these arrangements do not develop as expected, our business may be adversely impacted.
We currently partner with industry leaders to meet customer product and service requirements and to develop innovative advances in design and technology. Some of our partnerships allow us to supplement internal manufacturing capacity and share the cost of developing next-generation technologies. Other partnerships allow us to offer more services and features to our customers. If such arrangements do not develop as expected, our business could be adversely impacted.
We rely on third-party distributors, representatives and retailers to sell certain of our products.
In addition to our own distribution force, we offer our products through a variety of third-party distributors, representatives and retailers. Certain of our distributors or representatives may market products that compete with the Company’s products. The loss, termination or failure of one or more of our distributors or representatives to effectively promote our products, or changes in the financial or business condition of these distributors, representatives or retailers, could affect the Company’s ability to bring its products to market.
Our business will be harmed if we are found to have infringed intellectual property rights of third parties, or if our intellectual property protection is inadequate to protect our proprietary rights.
Because our products are comprised of complex technology, we are involved in litigation regarding patent and other intellectual property rights. Third parties have asserted, and in the future may assert, claims against us alleging that we have infringed their intellectual property rights. If we do not succeed in any such litigation, we could be required to expend significant resources to pay damages, develop non-infringing intellectual property or to obtain licenses to the intellectual property that is the subject of such litigation. However, we cannot be certain that any such licenses, if available at all, will be available to us on commercially reasonable terms. Also, defending these claims may be expensive and divert the time and efforts of our management and employees.
Our patent and other intellectual property rights are important competitive tools and may generate income under license agreements. We regard our intellectual property rights as proprietary and attempt to protect them with patents, copyrights, trademarks, trade secret laws, confidentiality agreements and other methods. We also generally restrict access to and distribution of our proprietary information. Despite these precautions, it may be possible for a third party to obtain and use our proprietary information or develop similar technology independently. In addition, effective patent, copyright, trademark and trade secret protection may be unavailable or limited in certain foreign countries. Unauthorized use of our intellectual property rights by third parties and the cost of any litigation necessary to enforce our intellectual property rights could have an adverse impact on our business.
As we expand our business, including through acquisitions, and compete with new competitors in new markets, the breadth and strength of our intellectual property portfolio in those new areas may not be as developed as in
our longer-standing businesses. This may expose us to a heightened risk of litigation and other challenges from competitors in these new markets.
Our future operating results may be negatively impacted if we are not successful in licensing our intellectual property.
As part of business strategy, primarily in our Mobile Devices business, we strategically license our intellectual property. Our existing intellectual property may not continue to generate sales and operating earnings at current levels and we may not be successful at licensing new intellectual property.
Many of our components and products are manufactured by third parties and if third-party manufacturers lack sufficient quality control or if there are significant changes in the financial or business condition of such third-party manufacturers, it may have a material adverse effect on our business.
We rely on third-party suppliers for many of the components used in our products and we rely on third-party manufacturers to manufacture many of our assemblies and finished products. If we are not able to engage such manufacturers with the capabilities or capacities required by our business, or such third parties lack sufficient quality control or if there are significant changes in the financial or business condition of such third parties, it could have a material adverse effect on our business.
We also have third-party arrangements for the design or manufacture of certain products, parts and components. If we are not able to engage such parties with the capabilities or capacities required by our business, or these third parties fail to deliver quality products, parts and components on time and at reasonable prices, we could have difficulties fulfilling our orders and our sales and profits could decline.
There is no guarantee that design wins will become actual orders and sales.
A “design win” occurs when a customer or prospective customer notifies us that our product has been selected to be integrated with the customer’s product. There can be delays of several months or more between the design win and when a customer initiates actual orders. The design win may never become an actual order or sale. Further, if the customer’s plans change, we may commit significant resources to design wins that do not result in actual orders.
We have taken, and continue to take, cost-reduction actions. Our ability to complete these actions and the impact of such actions on our business may be limited by a variety of factors. The cost reduction actions, in turn, may expose us to additional production risk and have an adverse effect on our sales and profitability.
We have been reducing costs and simplifying our product portfolios in all of our businesses. We have discontinued product lines, exited businesses, consolidated manufacturing operations, increased manufacturing with third parties and reduced our employee population.
The impact of these cost-reduction actions on our sales and profitability may be influenced by factors including, but not limited to: (1) our ability to successfully complete these ongoing efforts; (2) our ability to generate the level of cost savings we expect or that are necessary to enable us to effectively compete; (3) delays in implementation of anticipated workforce reductions in highly-regulated locations outside of the United States, particularly in Europe and Asia; (4) decreases in employee morale and the failure to meet operational targets due to the loss of employees; (5) our ability to retain or recruit key employees; (6) our manufacturing capacity, including capacity from third parties; and (7) the performance of other parties under contract manufacturing arrangements on which we rely for the manufacture of certain products, parts and components.
An important cost-reduction action has been to reduce the number of our facilities, including manufacturing facilities. All of our businesses have exited certain facilities or consolidated facilities so that our products are manufactured in fewer facilities. While we have business continuity and risk management plans in place in case capacity is significantly reduced or eliminated at a given facility, the reduced number of alternative facilities could cause the period of any manufacturing disruptions to be longer. As a result, we could have difficulties fulfilling our orders and our sales and profits could decline.
We may not continue to have access to the capital markets to obtain long-term and short-term financing on acceptable terms and conditions, particularly if our credit ratings are downgraded.
From time to time we access the long-term and short-term capital markets to obtain financing. Although we believe that we can continue to access the capital markets in 2007 on acceptable terms and conditions, our access and the availability of acceptable terms and conditions are impacted by many factors, including: (i) our credit ratings; (ii) the liquidity of the overall capital markets; and (iii) the current state of the economy, including the telecommunications industry. There can be no assurances that we will continue to have access to the capital markets on terms acceptable to the Company.
The Company’s debt ratings are considered “investment grade”. If our credit ratings were to decline three levels from the current rating, we would no longer be considered investment grade and our financial flexibility would be reduced and our cost of borrowing would increase. Some of the factors that impact our credit ratings, including the overall economic health of the telecommunications industry, are outside of our control. There can be no assurances that our current credit ratings will continue.
Our commercial paper is rated “A-1/ P-2/ F-1.” Although we continue to issue commercial paper, there can be no assurances that we will continue to have access to the commercial paper markets on terms acceptable to the Company.
We may not be able to borrow funds under our credit facility if we are not able to meet the conditions to borrowing in our facility.
We view our existing five-year revolving domestic credit facility as a source of available liquidity. This facility contains various conditions, covenants and representations with which we must be in compliance in order to borrow funds. We have never borrowed under this facility or previous domestic revolving credit facilities. However, if we wish to borrow under this facility in the future, there can be no assurance that we will be in compliance with these conditions, covenants and representations.
We may continue to make strategic acquisitions of other companies or businesses and these acquisitions introduce significant risks and uncertainties, including risks related to integrating the acquired businesses and achieving benefits from the acquisitions.
In order to position ourselves to take advantage of growth opportunities, we have made, and may continue to make, strategic acquisitions that involve significant risks and uncertainties. These risks and uncertainties include: (1) the difficulty in integrating newly-acquired businesses and operations in an efficient and effective manner; (2) the challenges in achieving strategic objectives, cost savings and other benefits from acquisitions; (3) the risk that our markets do not evolve as anticipated and that the technologies acquired do not prove to be those needed to be successful in those markets; (4) the potential loss of key employees of the acquired businesses; (5) the risk of diverting the attention of senior management from our operations; (6) the risks of entering new markets in which we have limited experience; (7) risks associated with integrating financial reporting and internal control systems; (8) difficulties in expanding information technology systems and other business processes to accommodate the acquired businesses; and (9) future impairments of goodwill of an acquired business.
In 2006 and early 2007, we made several strategic acquisitions. In January 2007, we acquired Symbol Technologies, Inc. (“Symbol”). Symbol, which is now a wholly-owned subsidiary of Motorola, is being integrated with Motorola and will form the core of Motorola’s enterprise mobility business within our Networks and Enterprise segment. As a result of the acquisition, approximately 5,200 employees joined Motorola. In light of the size of this transaction, some of the risks described above may be more significant.
Acquisition candidates in the industries in which we participate may carry higher relative valuations (based on their earnings) than we do. This is particularly evident in software and services businesses. Acquiring a business that has a higher valuation than Motorola may be dilutive to our earnings, especially when the acquired business has little or no revenue. In addition, we may not pursue opportunities that are highly dilutive to near-term earnings and have, in the past, foregone certain of these acquisitions.
Key employees of acquired businesses may receive substantial value in connection with a transaction in the form of change-in -control agreements, acceleration of stock options and the lifting of restrictions on other equity-based compensation rights. To retain such employees and integrate the acquired business, we may offer additional retention incentives, but it may still be difficult to retain certain key employees.
The value of our investments in the securities of various companies fluctuates and it may be difficult for us to realize the value of these investments.
We hold a portfolio of investments in various companies. Since the majority of these securities represent investments in technology companies, the fair market values of these securities are subject to significant price volatility. In addition, the realizable value of these securities is subject to market and other conditions.
We also have invested in numerous privately-held companies, many of which can still be considered in startup or developmental stages. These investments are inherently risky as the market for the technologies or products they have under development are typically in the early stages and may never materialize. We could lose all or substantially all of our investments in these companies, and in some cases have.
We purchase a large amount of credit insurance to mitigate some of our credit risks.
Our ability to sell certain of our receivables could be negatively impacted if we are not able to continue to purchase credit insurance in certain countries and in sufficient quantities. In addition, our success in certain countries may be dependent on our ability to obtain sufficient credit insurance.
It may be difficult for us to recruit and retain the types of highly-skilled employees that are necessary to remain competitive.
Competition for key technical personnel in high-technology industries is intense. We believe that our future success depends in large part on our continued ability to hire, assimilate, retain and leverage the skills of qualified engineers and other highly-skilled personnel needed to compete and develop successful new products. We may not be as successful as our competitors at recruiting, assimilating, retaining and utilizing these highly-skilled personnel.
The unfavorable outcome of litigation pending or future litigation could materially impact the Company.
Our financial results could be materially adversely impacted by unfavorable outcomes to any pending or future litigation. See “Item 3 — Legal Proceedings.” There can be no assurances as to the favorable outcome of any litigation.
We are subject to a wide range of environmental, health and safety laws.
Our operations and the products we manufacture and/or sell are subject to a wide range of global environmental, health and safety laws. Compliance with existing or future environmental, health and safety laws could subject us to future costs, liabilities, impact our production capabilities, constrict our ability to sell, expand or acquire facilities and generally impact our financial performance.
Some of these laws relate to the use, disposal, clean up of, and exposure to hazardous substances. In the United States, laws often require parties to fund remedial studies or action regardless of fault. Motorola continues to incur disposal cost and has ongoing remediation obligations. Changes to U.S. environmental laws or our discovery of additional obligations under these laws could have a negative impact on Motorola.
Over the last several years, environmental laws focused on the energy efficiency of electronic products and accessories; electronic products and packaging, recycling; and reducing or eliminating certain hazardous substances in electronic products have expanded dramatically. These laws impact our products and make it more expensive to manufacture and sell product. It may also be difficult to comply with the laws in a timely way and we may not have compliant products available in the quantities requested by our customers, thereby impacting our sales and profitability. For example, electronic products sold into Europe were required to meet stringent chemical restrictions by July 1, 2006 under the EU RoHS Directive. China is adopting similar requirements, the first of which require labeling and chemical content disclosure for all electronic products sold into or within China after February 28, 2007. We expect these trends to continue. In addition, we anticipate increased consumer demand for the voluntary reduction or elimination of certain hazardous constituents from our wireless handsets.
We may provide financing and financial guarantees to our customers, some of which may be for significant amounts.
The competitive environment in which we operate may require us to provide long-term customer financing to a customer in order to win a contract. Customer financing arrangements may include all or a portion of the purchase price for our products and services. In some circumstances, these loans can be very large. We may also assist customers in obtaining financing from banks and other sources and may also provide financial guarantees on behalf of our customers. Our success, particularly in our infrastructure businesses, may be dependent, in part, upon our ability to provide customer financing on competitive terms and on our customers’ creditworthiness.
We also provide revolving, short-term financing to certain customers and distributors that purchase our equipment. Our success may be dependent, in part, on our ability to provide this financing. Our financial results could be negatively impacted if our customers or distributors fail to repay this revolving, short-term debt and/or our sales to such customers or distributors could be reduced in the event of real or perceived issues about the credit quality of the customer or distributor.
When we lend our customers money in connection with the sale of our equipment, we are at risk of not being repaid.
While we have generally been able to place a portion of our customer financings with third-party lenders, a portion of these financings are supported directly by us. There can be higher risks of default associated with some of these financings, particularly when provided to start-up operations such as local network providers, customers in developing countries, or customers in specific financing-intensive areas of the industry (such as 3G wireless operators). Should customers fail to meet their obligations on new or existing loans, losses could be incurred and such losses could negatively impact our financial results.
Our large system contracts for infrastructure equipment and the resulting reliance on large customers may negatively impact our business.
We are exposed to risks due to large system contracts for infrastructure equipment and the resulting reliance on large customers. These include: (1) the technological risks of such contracts, especially when the contracts involve new technology, and (2) financial risks under these contracts, including the estimates inherent in projecting costs associated with large contracts and the related impact on operating results. We are also facing increasing competition from traditional system integrators and the defense industry as system contracts become larger and more complicated. Political developments can impact the nature and timing of these large contracts.
It is important that we are able to obtain many different types of insurance, and if we are not able to obtain insurance we are forced to retain the risk.
The Company has many types of insurance coverage and also self-insures for some risks and obligations. The insurance market was disrupted after the events of September 11, 2001 and the 2005 hurricanes. While the cost and availability of most insurance has stabilized, there are still certain types and levels of insurance that remain unavailable. Natural disasters and certain risks arising from securities claims and public liability are potential self-insured events that could negatively impact our financial performance.
Government regulation of radio frequencies may limit the growth of the wireless communications industry or reduce barriers to entry for new competitors.
Radio frequencies are required to provide wireless services. The allocation of frequencies is regulated in the U.S. and other countries throughout the world and limited spectrum space is allocated to wireless services. The growth of the wireless and personal communications industry may be affected if adequate frequencies are not allocated or, alternatively, if new technologies are not developed to better utilize the frequencies currently allocated for such use. Industry growth has been and may continue to be affected by the cost of new licenses required to use frequencies and any related frequency relocation costs.
The U.S. leads the world in spectrum deregulation, allowing new wireless communications technologies to be developed and offered for sale. Examples include wireless local area network systems, such as WiFi, and wide area network systems, such as WiMAX. Other countries have also deregulated portions of the available spectrum to allow these and other technologies, which can be offered without spectrum license costs. Deregulation may introduce new competition and new opportunities for Motorola and our customers.
Changes in government policies and laws or economic conditions may adversely affect our financial results.
Our results may be affected by changes in trade, monetary and fiscal policies, laws and regulations, or other activities of U.S. and non-U.S. governments, agencies and similar organizations. Our results may also be affected by social and economic conditions, which impact our operations, including in emerging markets in Asia, India, Latin America and Eastern Europe, and in markets subject to ongoing political hostilities and war, including the Middle East.
In addition, there are currently few laws or regulations that apply directly to access to, or commerce on, the Internet. We could be adversely affected by any such regulation in any country where we operate. The adoption of such measures could decrease demand for our products and at the same time increase the cost of selling such products.
Consolidations in both the cable and telecommunication industries may adversely impact our business.
The cable and telecommunication industries have experienced consolidation, and this trend is expected to continue according to industry estimates. Industry consolidation could result in delays of purchases or in the selection of new suppliers by the merged companies to equipment suppliers such as Motorola and our competitors.
Due to continuing consolidation within the cable industry worldwide, a small number of operators own a majority of cable television systems and account for a significant portion of the capital spending made by cable television system operators. Net sales to the Connected Home Solutions segment’s largest customer, Comcast represented approximately 29% of the Connected Home Solutions segment’s total net sales in 2006.
Regulatory changes impacting our cable products may adversely impact our business.
Currently, reception of digital television programming from the cable broadband network requires a set-top box with certain technology. This security technology has limited the availability of set-top boxes to those manufactured by a few cable network manufacturers, including Motorola. The FCC has enacted regulations requiring separation of security functionality from set-top boxes to increase competition and encourage the sale of set-top boxes in the retail market by July 1, 2007. Traditionally, cable service providers sold or leased the set-top box to their customer. If the retail market develops for set-top boxes and televisions capable of accepting the security modules, sales of our set-top boxes may be negatively impacted. In addition, we risk lost sales if competitors bring set-top boxes with separable security to market before we do.
We rely on complex information technology systems and networks to operate our business. Any significant system or network disruption could have a material adverse impact on our operations, sales and operating results.
We rely on the efficient and uninterrupted operation of complex information technology systems and networks. All information technology systems are potentially vulnerable to damage or interruption from a variety of sources, including but not limited to computer viruses, security breach, energy blackouts, natural disasters, terrorism, war and telecommunication failures. There also may be system or network disruptions if new or upgraded business management systems are defective or are not installed properly. We have implemented various measures to manage our risks related to system and network disruptions, but a system failure or security breach could negatively impact our operations and financial results. In addition, we may incur additional costs to remedy the damages caused by these disruptions or security breaches.
Our share price has been and may continue to be volatile.
Our share price has been volatile due, in part, to generally volatile securities markets, and the volatility in the telecommunications and technology companies’ securities markets in particular. Factors other than our financial results that may affect our share price include, but are not limited to, market expectations of our performance, capital spending plans of our customers, and the level of perceived growth in the industries in which we participate.
The level of returns on pension and retirement plan assets could affect our earnings in future periods.
The funding obligations for our pension plans are impacted by the performance of the financial markets, particularly the equity markets, and interest rates. Funding obligations are determined under government regulations and are measured each year based on the value of assets and liabilities on a specific date. If the financial markets do not provide the long-term returns that are expected under the governmental funding calculations we could be
required to make larger contributions. The equity markets can be, and recently have been, very volatile, and therefore our estimate of future contribution requirements can change dramatically in relatively short periods of time. Similarly, changes in interest rates can impact our contribution requirements. In a low interest rate environment, the likelihood of required contributions in the future increases.
Compliance with changing regulation of corporate governance and public disclosure may result in additional expenses.
Compliance with changing laws, regulations and standards relating to corporate governance and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and changes to the New York Stock Exchange rules, has required us to expend significant resources and incur additional expenses and will continue to do so. We are committed to maintaining the highest standards of corporate governance and public disclosure. As a result, we will continue to invest necessary resources to comply with evolving laws, regulations and standards, and this investment may continue to result in increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities.
The outcome of currently ongoing and future examinations of our income tax returns by the IRS.
We are subject to continued examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuing examinations will not have an adverse effect on future operating results.
Item 1B: Unresolved Staff Comments
None.
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