Motorola Solutions, Inc. (MSI) Earnings Call Transcript & Summary

Okay. Thank you, everyone, for joining us. We're going to restart to close that door. It's okay. Thank you, everyone, for joining us. I'm Sami Badri with Credit Suisse research. And we have Greg Brown, Chairman and CEO of Motorola Solutions. Thank you, Greg, for joining us.

Thank you, Sami. Appreciate it.

So I wanted to kick start with just kind of framing the budget environment that you guys are in, right? And we talked -- or you've historically talked about the NDAA. We've talked about the America's rescue plan, the CARES Act, various sources of funding. And now there's a new funding bill -- or sorry, a new policy that may be favorable for Motorola, the Secure Equipment Act. Can you just go through those and then just break them down? And just maybe help us characterize how those are actually drivers for Motorola. And just how should people connect the dots?

Sure. Well, as we've talked about in the past, this -- from a funding environment standpoint, this is as good an environment as I've seen. We've had -- if you take them in the order that you went through them, we had CARES Act, which was 2020 and got extended through the end of this year. CARES Act, our estimation, funded about $150 million of revenue last year, $50 million this year. Clearly, a positive program. Our customers have taken advantage of that. The American Rescue Plan, unprecedented, $1.9 trillion; of which, we think, over $0.5 trillion is beneficially eligible for our end-user customers. The important thing, Sami, about that is the size of it, $350 billion to state and local, billions to FEMA, billions to education, but it's also the multiyear duration of that which is pretty significant. The state and local funds of $350 billion are available through the end of 2024. So between CARES Act, American Rescue Recovery Act, unprecedented. Then you take, on the legislative side, the NDAA, the National Defense Authorization Act, that codifies and legislates that the U.S. federal government cannot use or procure, by name, Huawei, ZTE, Hytera, Hikvision and Dahua. It also legislates by those 5 names that grant money -- federal grant money cannot flow for the procurement of those 5 companies either. Clearly, that's a structural tailwind. The Secure Equipment Act is more recent. It's only about 4 weeks old, passed by the House and Senate, signed by Biden. That directs the FCC within 12 months to promulgate rules around what equipment can and can't be used on RF spectrum throughout the United States. Think of this as potentially an enterprise or corporate play. NDAA restricts the use of those 5 Chinese companies for government purchase. Depending upon what the FCC does on the Secure Equipment Act with the authority delegated them by the president, that could restrict some of those companies as well. That too would be a structural tailwind for us.

Got it. And then the numbers are big. This is probably the first time you've seen numbers of this size or this magnitude benefiting or flowing into the industry and eventually to Motorola. But when we think about timing, as this -- all these dollars make their way into the numbers, how long do the numbers get -- or how long does it take to get budgets announced, allocated to states, municipalities, et cetera, eventually into police budgets and then into Motorola? What's the time frame we're looking at here?

I think it will be a multiyear process. In terms of the recovery plan, I think it's early innings. We're seeing the pipeline of our engagements with end users grow. I think in large part that's because the funding environment is so strong. But I think, Sami, we're beginning to see traction, but we'll see it throughout '22, '23, '24. Early days though for the most part.

Got it. Got it. So Greg, you guys published an 8-K today. Jack Molloy might be waking up a little bit happier today than he did yesterday. Could we just go over the changes you guys made on the corporate side?

Yes, Jack Molloy and Mahesh. So we announced this morning that as a logical extension and expansion of Jack's responsibilities -- he recently just got responsibility for global services in the last few months. Kelly Mark's impending departure is in a few weeks. With that formal change, Jack has the added title of Chief Operating Officer to Executive Vice President. He has all of sales, systems integration, global services, fixed video and access control, and he has the LMR product management and engineering. Jack probably has -- he has more than half the head count of the company. So I think it's just a logical extension and recognition of his expanded operating role by taking on global services. Mahesh, this morning, is elevated to Executive Vice President and Chief Technology Officer. He has responsibility for mobile video, command center software, unified communications, cybersecurity and the overall technical architecture of the company. So it's positive for Jack and Mahesh. And Sami, what I would say is we're running the company as a unified team. So if you think of the 3 legs of the stool: Molloy with an operating role, Chief Operating Officer; Winkler running finance and supply chain, Chief Financial Officer; Mahesh as the Chief Technology Officer. And by the way, that's enabled by the support functions with Hacker -- Mark Hacker running HR, legal, government affairs, real estate as Chief Administrative Officer. It's a strengthening of the team, and I'm proud of both of them. I'm proud of the whole team. This is an exceptionally strong team that I've had in my tenure here, and it's a perfect time to have this kind of talent.

Got it. Got it. So happy -- a lot of happy people today. I want to shift gears over to video surveillance and security. Talk about all the acquisitions you've made in that market. And maybe for everyone who has been tracking Motorola over time and watching these acquisitions get announced and integrated, what inning are you guys in from an M&A perspective, right, adding to that specific segment of the company?

Well, 3 years ago, plus or minus, we weren't even in Video Security & Access Control. We love it because it's a vibrant, large addressable market adjacency to what we do in public safety, and it utilizes the brand and the same sales channels so we could take that -- those product and services and those assets from acquisitions and put it in the flywheel of distribution, both direct and indirect, for us to bend the curve up on revenue growth. We have the widest portfolio of anybody else on Video Security & Access Control because we have fixed video through 3 acquisitions of Avigilon, IndigoVision, Pelco. We have mobile video, body-worn camera, in-car dash cam. We have license plate recognition video. We have the analytics to go with that, and we will continue to build out that portfolio. I like the body-worn market because the historical incumbent hasn't really had competition, and now we're a vibrant alternative for a #2 here in the U.S. and internationally. We had great traction with a big order with the French MOI, to our knowledge, the second largest order ever on body-worn camera. So I love the traction we're getting on that, and mobile video falls in the purview of Mahesh. But I think we've made a number of acquisitions. The addressable market is now $18 billion in 2022. That's zeroing out for China because we've effectively exited China for everything we do. I think we will still look for video, software and services assets to acquire. But right now, we're digesting and integrating what we've got.

Got it. And then maybe just to revisit growth. You're going to grow at least 30% total revenue in VSS, and I think organic is 22%. Are those the right numbers? What do you think about the next couple of years and the growth trajectory there?

Yes. So we love the business. We're estimating a little over 30%, as you said, for 2021, over 20% organic. Our goal, Sami, is to always grow faster than the market so we take share. I haven't seen the growth projections for Video Security & Access Control. We'll take a look at what those are for 2022, obviously get Q4 in the rearview mirror and on the earnings call on Q1, give you a little bit more color on the dimensions of growth for that segment or that technology in 2022. But it's very attractive for us.

Got it. Got it. Let's enter the fun topic of supply chain. So supply chain impacts in 2021, you've given us some numbers. And the guidance -- or preliminary guidance you issued in 2022 does include some supply chain dynamics in there. Could we just go over that? And just maybe summarize the 2021 impacts first and then we could lean into 2022.

Sure. Well, Q3 and Q4, this current quarter, are -- continue to be very challenging on the supply chain front. There's no doubt about it. It's fluid and it's dynamic. That's what makes it particularly challenging. The color around top line revenue growth of around 7% next year all in for the company does include continued supply constraints. We've talked about, Sami, that I expect the supply component challenges to be with us through at least the first half of 2022. I call this, in Q4, a knife fight on supply, on components. I will say that we try to secure as many components as we can from key suppliers given the depth of our relationships. We will also do open market purchases even if we're playing -- paying a multiple and typically do for sourcing on component and input costs. Our engineering team will also, if they can and have enough time, do product redesign. And by the way, the supply component challenges are primarily land mobile radio. So we've got land mobile radio product and services. You talked about video security, access control and the software business. But they're primarily LMR. We continue to fight the good fight, but I think it will be a challenging environment at least through the first half of '22 as well, which informs kind of a view of around 7% for the year at this point, given where we are.

And then that 7%, that's the -- think of this as maybe like the base level or the minimum growth that you're seeing, assuming the first half of 2022 sees impact?

I would say it's the estimate of revenue growth that incorporates a challenging supply environment for at least 6 to 9 months. We'll see if it mitigates, alleviates or changes in contour, but that's what we look at. And by the way, the only other color we gave on '22 is that the software -- around 7% total and software and services around 10% to kind of shape some baseline view of what we think at this point in time.

And then maybe just unpacking the supply chain issues more on the product level. LMR or at least public safety LMR seems a bit more insulated and less affected versus PCR or public commercial radio. That seems to be impacted a little bit more. Could we just compare and contrast why that's the case? Why is PCR significantly more impacted?

Well, it's interesting because there's common components that go to both the public safety radio and a professional and commercial radio. Think about a public safety radio or enterprise radio, they're actually both constrained. We are choosing to prioritize given the mission criticality and the public safety nature of a public safety radio. We're mixing and matching. And if we have a fixed allocation of components, we're indexing to satisfy the delivery of public safety radios, and the enterprise radios are the one that are second in line. That's why the challenges in growth around PCR for '21 and '22 are more acutely felt, because we're making that component decision to prioritize the public safety radio. But they're common components oftentimes.

Got it. And -- but if there was like some pieces of the puzzle missing or the device missing from PCR perspective, those are far more challenging to acquire, get integrated and ship the product. Is that kind of at the end of the day?

Generally, yes.

Got it. All right. And then I wanted to shift gears -- well, before we shift gears out, the idea that you have to go out there and acquire components on the open market sometimes more expensive than you'd prefer. What is Motorola's ability to push these increased prices on customers? As they -- as these prices come in, right, and as you guys have to essentially update list pricing on radios, how are -- what's customer willingness to actually pay these increased pricing?

Yes. We've absorbed a lot of these higher input costs in Q3, and in Q4, they're included obviously within the envelope of our financial guidance. I think we've been surgical around areas where we can modestly increase price. It's primarily North America. It's in product and services. We also look at opportunities when we're introducing a new product to see if we can increase the price incrementally to absorb for higher input costs. I think overall, Jason Winkler and the product management teams have done a good job shock-absorbing those higher costs into the firm.

Got it. Got it. I want to shift gears to software. And your 2021 guidance for software did get revised at 3Q '21 results. Could we just maybe unpack what really -- like what happened? Maybe just give us kind of a summary. And one of -- some deals may have been pushed out. Maybe why did the deals get pushed out is kind of my first question. And are customer requirements for software deployments getting more complex or more involved, which is creating maybe a little bit longer for bigger deals to get executed?

I think that the -- to answer the last part first, the command center software deployments are always complex. They have the custom nature to them. And depending upon the size and scale of the deployment, they're pretty intricate and involved. The couple of projects we're referencing that were particularly large and got pushed out are around Next Gen 911. And we were expecting deployments a little bit earlier. And for a variety of reasons within and outside of our control, they moved out, which puts the revenue growth projection compressed. The other thing though we're also seeing, Sami, is, and this is a good thing, more and more customers are engaging on the command center software side to procure as a service. So what we may have thought would have been either a perpetual license for a higher revenue rec for a particular deal gets amortized, as you know, multiyear on a subscription basis, which is good for the firm. We love annual recurring revenue. The more that we can get, the better the value, the higher the stickiness with the customer. And obviously, that has residual multiple benefits in the value of the stock as well. So I think that between a couple of those projects, the target was probably overly ambitious to begin with and didn't appreciate that potential mix shift. But by the way, we're still going to grow at 1.5x the market, so I like that. We're still taking share in command center software, so that's a good thing. And if we can move even more revenues to ARR, that's an even better thing.

And then you're going to be growing 1.5x the command center market this year. And then when you think about the out-years, you do have existing customers that do have command center software deployed.

We do.

What about their upgrades within those suites -- those software suites? Are they buying or acquiring or turning on more services, more modules? Can we just talk about kind of that vector that's also occurring on the first responder side?

Sure. We think -- by the way, command center software for 2021 is going to grow about 6% to 7%, to dimensionalize the growth rate of the market that I'm referencing, 1.5x. The good thing is, in the U.S., there's about 6,000 911 public safety answering points. We are in -- centers. We are in 3,500 of those 6,000 that have one or more modules of software for Motorola Solutions. So we like having a footprint of incumbency. And as Mahesh talked about just this last quarter, for Q3, 75% of the Q3 orders were either more than one module or a customer that had a module that's adding a second. So that incumbency, that suite interoperability, I think, serves us well as an anchor tenant for growth in the out-years as well. So I like our position there.

And a typical road map for command center software customers is they're probably going to be consuming or turning on more modules over time. As a general kind of principle, they turn on more features. That's generally the trajectory, right?

It is.

If you were to give us kind of an average number of modules that customers have, is there like a ballpark number that you can remember? Is it 1, 2, 3? Like what's the...

I don't know. But what I would say is while it sounds easy to say, "Well, you have 1 module, just turn on another," and we talked about this, the inertia -- command center software is, in effect, customized software around the mobile workflows of a 911 center. So when you tweak it or you change it or you upgrade it, you're changing the way potentially something is dispatched. You're changing the way evidence may or may not be recorded. So there's more of an inertia of the very careful to change the behavior in existing 911 workflow and be more measured and methodical, which is why I think that over time, we'll get more and more modules added to this installed base. But I think it's going to be more elongated and deliberate over time.

Got it. Got it. I wanted to shift gears to body-worn cameras. In 1Q and 2Q of 2021, we were actually given some fairly constructive and impressive growth numbers for that segment. I think Jack was championing that on the earnings calls. But in 3Q, we weren't really given a same quantitative frame of reference. Could you just give us an update on what that segment is actually growing at or how it's doing?

Sure. So we've taken share in the first half of this year, fiscal 2021, and we expect to take share for the full year, Q1 through Q4. In Q3, orders were slightly down on body-worn camera. But Sami, I remind you that was against the previous year comp of 67% orders growth, which had a couple of large orders from the year-ago comp. I like our execution. I like what we're doing with the product. We're a viable, competitive, affordable #2 in the U.S. And by the way, I'm optimistic about our ability to grow on body-worn camera, particularly internationally, with a brand that we market under the brand name Edesix, a strong brand, Richie McBride, very good team, solid evidence management solution, easy to install. And I think we're going to continue to do well internationally on that front.

All right. All right. Great. Thank you for that. I wanted to talk about margins. And internally, I guess, at Motorola, every year, we get annual guidance, right? But from a trajectory perspective, what is like the bogey or the objective that you're always trying to hit?

Well, kind of higher level, I think some of the best run companies, of course, they grow top line revenue but they're also growing cash flow and they're expanding operating margins. We will have handsome operating margin expansion at the software and services level, probably incrementally up in product in a supply-constrained environment. But I wouldn't give you a target per se, but operating leverage is very important. Our bonuses and all of the annual bonuses of every employee of the company are derived with operating earnings and free cash flow. So we're very mindful of the importance of continued margin expansion. I think we've done a pretty solid job of that to date. And it would certainly be my expectation we continue on that trend. I wouldn't give you a number yet. And we'll obviously guide on the February earnings call for the envelope for '22.

Got it. Got it. One -- well, I can leave that one out. Well, I was going to ask you about the Products and Systems Integration segment. If you were to unpack that to address the operating margin move, is that coming from ASP increases? Or is that just volume that's benefiting the segment and lifting?

It's primarily volume.

Volume, okay. Got it. Got it. So you are targeting a lot more free cash flow generation in the next coming year as well. You haven't guided to this, but you're probably going to generate -- assuming all else equal, everything kind of goes as planned, what are you going to do with all that cash, right?

Well, we -- our operating framework for capital allocation is 50-30-20. 50% is fungible between acquisitions and share repurchase. 30% goes toward the dividend. And we've -- since the split of Motorola now 10 years ago, we've had double-digit increases on the dividend every year, which is a tradition we're proud of. And then 20% is CapEx. We're going to generate more cash. Our net debt-to-EBITDA continues to improve. So we -- our firepower increases, and we'll deploy that capital within the operating framework that I outlined, depending upon what opportunities avail themselves.

Got it. Got it. If you were to give us kind of an idea on which places you want to initially target from an M&A perspective, which parts of the industry, market or even in your actual segments, how would you kind of rank -- force rank, I guess, priorities?

I would say probably software services at the top. And by the way, when I talk about software -- and we do talk about command center software. But when I look at the software profile for 2021, the software number all in, about 55% will be command center software, 45% is going to be video management software. So we don't talk as much about the video software, but that's a very key ingredient for us going forward. I would say, Sami, software and services. Services is -- by that I mean LMR services, things like we do with Airwave or Denmark or the State of Illinois or parts of Australia. But those opportunities to acquire from a services standpoint are few. I think there'll be more opportunities in the larger software area.

And then you mentioned Airwave so we're going to segue into Airwave. The U.K. CMA has messaged investigation or they want to look into it basically. But can you just give us any kind of comments on what you could on what's going on in the U.K. and the Airwave contract as it stands today?

Sure. So the Airwave contract runs through all of next year. It's contracted for, number one. Number two, the customer has indicated they want a 4-year extension. We'll work with them, of course, on extending that agreement 4 years. The CMA, the Competition Markets Authority, did a consultation -- consultative review that has then led to a market investigation, which is more common -- once you start a consultative review, it is more common than not that it leads to a market investigation. And I think that they are primarily interested in the pricing levels of Airwave and the fact that we, Motorola Solutions, also participate in ESN. Think of ESN as the U.K.'s version of FirstNet. It's not exactly the same analogy, but it's similar enough. So they want -- they, the CMA, want to be sure that we're doing everything we are obligated to do on ESN, which we are, and we're charging reasonably for on the Airwave pricing. They've outlined a process that goes into the summer of 2022, of which then, at that point, mid- to late summer, they will give us their perspective on remediation. We're engaged with the CMA. We continue to be engaged in the U.K. home office. We're investing significant amounts of capital and continue to do that on Airwave to keep it modernized, complete, competitive and performing at the superior service levels that we've delivered so far. So stay tuned. And we'll work with them over the next several quarters.

Yes. And separately from the Airwave and CMA topic, when we just think about ESN itself, what is the likelihood that ESN is actually viable within the next 2 to 3 years, right? Because hasn't there been issues with product testing and device compatibility and interoperability? It seems to be that shutting down Airwave is really not much of an option at this point just from a mission-critical communications perspective.

Well, I think by the fact that they're already engaged in extending Airwave 4 years, and they've been very public about that, is a proxy for the admission of the criticality of what Airwave does, its coverage, its reliability, its redundancy, so I think we all know that Airwave needs to stay for several years longer. As it relates to ESN, the customer, the U.K. home office project manages that initiative, and we'll work with them on whatever way they see fit to deploy and provision that at the end of the day.

Got it. Got it. I wanted to go back to a conversation that we've prior had or, I guess, you've had on many earnings calls, the APX NEXT rollout and how that product is differentiated, different, a higher price point and how that's actually been winning some mind share at least with customers. Can we just go over the traction you've been having with that specific product line?

Yes. So the interesting thing with the model of our business is as we put in these public safety networks here in the U.S., Astro or P25 infrastructure, you then want to provide services on top of those networks, and you want to fill those networks with devices. You all have a smartphone. You replace it every 1, 2 or 3 years. On average, public safety first responders in the U.S. replace their radio every 8 years. We are just in the early innings of a device refresh for public safety users here in the U.S. I think Jack Molloy on the earnings call for APX NEXT referenced it in the second inning. And APX NEXT is a high-tier public safety radio that does private LMR, land mobile radio, for P25. It also can do and roam on an LTE network. It also can provision through a display situational awareness. So it's a full feature-rich, high-end radio that we've had a lot of interest in. And our goal is to refresh the U.S. P25 device portfolio through its tiers, not just the high-tier APX NEXT but then mid-tier and low tier. That's a positive structural tailwind for us, for public safety users here in the U.S. And we'll continue to develop those products with Scott Mottonen's engineering team. It's a positive thing.

Got it. Got it. Well, we're out of time. Greg, thank you very much for spending time with us and telling us more about your company and the business. And thank you again.

Thanks, Sami. Thank you, everybody.