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

So my name is Paul Chung. I'm the applied emerging tech analyst here at JPMorgan. Pleased to have with me the CEO and Chairman of Motorola Solutions, Greg Brown. Thanks. Thank you, Greg.

Thank you, Paul.

And I guess just to start, just a brief overview of the firm.

Firm is almost 100 years old, has totally transformed itself from what people would remember to be the cell phone kind of commodity device business to end-to-end public safety communications, end-to-end command center software and now also all things video security and access control. So it's a totally different company. And last I checked, about 2/3 of the employees, believe it or not, Paul, are new to the firm. In the last 5 or 6 years, we've aggressively bought back shares when Motorola is split January 1 of '11, Motorola Solutions was RemainCo. We spun off the cell phone business, the mobility business. And since that split, we have spent about $14.5 billion reducing the float by 51% at a stock price of about $65 or $66, while at the same token, in the last 5 years, spending about $5 billion last 6 years, spending about $5 billion on acquisitions. So we've deployed capital organically, opportunistically, inorganically, and it's a brand-new company, much more software and services-centric but yet with a strong incumbent position in the markets we serve.

So pretty busy. So just a quick update on some macro trends. What are you seeing on the supply side now? Are you seeing kind of constraints ease a bit? And where are you seeing kind of specific shortages?

So I would say, taking a step back, right, kind of 30,000 feet. This is an interesting time for the firm and in general. On the positive side, we exited Q1 with record backlog, had record sales, had record Q1 orders and demand is, as I've said, Paul, in the last couple of earnings calls, but demand is as strong as I've seen it, maybe ever. And then you look at the funding environment for public safety, particularly in North America. And with the American Rescue plan, funding is extremely robust. That, too, is probably better than I've ever seen it. And that funding for the U.S., depending upon the category and type of funding actually goes through the end of 2024. So you think about demand, you think about orders, you think about organic investment, you think about an incredibly healthy funding environment, the flip side to your question is semiconductor constraints. I don't see it getting worse. We are planning on it to be consistently challenged throughout 2022. What happened in Q1 on the positive side, I wouldn't say supply increased per se. I think it moved forward. We were able to get certain allocations from critical chip suppliers a little earlier, which allows us to -- which allowed us to overperform. At the same time, in this environment, we're raising prices surgically and responsibly, but we started last year. We continued in Q1, and we're continuing this quarter for price increases to make sure that we keep pace and continue to financially perform within the envelope of expectations. We've had and implemented some targeted cost reductions in real time to, again, more -- very modest, but at the same time appropriate. And then lastly, given, Paul, the supply constraints, really semiconductor constraints, we're prioritizing mix to some of the higher-priced products, particularly in North America, APX NEXT devices, where if we can only ship a certain fixed amount of product, we're going to index towards the higher ASP and the higher margin to ensure we deliver on the profitability and revenue expectations that we've guided both for the quarter and the year. All things said, tremendously good things going on. Obviously, semiconductor remains a challenge. The unpredictability of Russia, Ukraine -- by the way, we're out of Russia. We did about $23 million or $25 million last year in Russia, we're out. And then we also kind of keep our eye on the COVID lockdowns in China, although I'm also pleased to say and we did this over the last several years. We're effectively out of China. We have about 50 people there, $50 million or $60 million of revenue. If I rewind the tape for mother Motorola back in the day, Motorola was one of the most consequential investors in China. Given our and my experiences with intellectual property theft and patents, we made that decision a decade ago. no manufacturing, no software engineering, no product development, product management, exit that theater given the nature of what we do. It doesn't make sense to deploy capital there given the risk return.

And then, I guess, sticking on some of the macro talk about freight and FX, and you talked about some price increases, but how are you seeing those trends as we sit here today and through the year?

Yes. So since our February call on the end of the year and then to our earnings call a few weeks ago, FX is a bad guy to the incremental tune of $110 million on revenue headwinds according to spot rates that day. Freight's higher to the tune of $40 million or $45 million. We made an acquisition and access in cloud access control, which is dilutive to about $0.10. So those are the bad guys. On the positive, we are continuing to raise price. We think the pricing actions taken last year, this year and that we continue to take, get better traction in the second half of this year as we burn through backlog that was priced at previous rates. And so pricing, mix, targeted cost reductions are the way we're navigating to get from here to there, while we -- even with those incremental headwinds held the full year on revenue and earnings guidance for 2022.

Okay. Great. Yes. You kept gross margins kind of flat for the year, which is pretty impressive given all those headwinds. So you just announced kind of a long-term supply agreement with GlobalFoundries. Can you talk about what that means for Motorola?

Yes, I think it's -- I wouldn't call it a material announcement per se. I think Tom Caufield does a good job at GlobalFoundries. They provide us a low single digit, if I took our chip volume of production -- sorry, of procurement. I think they are in the low single digits in terms of size, but they have many common components that go throughout our radio portfolio. So the LSA, the long-term supply agreement, I'm pleased with. I think it's a representation of the relationship that the 2 companies enjoy. I wish we had a few more long-term service agreements in the semiconductor space, but I was pleased with the 1 or 2 companies were able to strike.

Okay. Great. So let's jump into LMR. Talk about your kind of current footprint how you've built this to have such high barriers to entry and very sticky relationships here?

Yes. I love LMR, or land mobile radio because a lot of people just still to this day, don't understand it. So you think of all these public safety networks or LMR networks, there's thousands of them installed. They're not cellular networks. They're not Verizon, AT&T, T-Mobile or Vodafone or others. They're private, encrypted, dedicated, reliable, redundant, architected in a unique way so that every public safety official has always on constant reliability, superior audio quality. The bigger the footprint, the more opportunity for growth. You then put devices on those networks, radios. Those radios on average in the U.S. have a life cycle of about 7 or 8 years. So then we continually refresh the devices, much like cellular devices, Samsung, Apple and others refresh their devices. So we have these dedicated networks, they're purpose-built. Cellular today, 4G, even 5G cannot do what those public safety networks do. So we grow the number of networks. We put the number of subscribers or devices on that. We then refresh those devices, and then we add services to that as well and monetize the services. In some cases, we manage public safety networks for our customers. Airwave, Norway, parts of Australia, South Carolina, the state of Illinois. So sometimes we're owning and operating the network as well. But the durability, predictability, criticality, land mobile radio networks are a need to have not a nice to have and they're the communications foundation that protect communities, counties, states and some case countries.

That's right. What kind of tech innovations are you doing in the space? And do you see any kind of emerging competition at all?

The tech emergence is pretty impressive. We just announced a high-tier APX NEXT device. The APX NEXT device, which Jack Molloy mentioned on the earnings call is probably in its second inning. If you look at the -- it's a high-tier device primarily North America-centric. So it's refresh and replaceability are in the early innings. The ASPs of the APX NEXT are comparable to slightly higher. So you get a more fully featured radio, more spectrally efficient. You can do over-the-air software programming, and it's got LMR and LTE dual band. So if a first responder in the U.S. or wherever he or she is located, need situational video or data pumped to that device, even though it's on an LMR network, it's got a dual band that can take that 4G feed and provide situational awareness to the device. It's got great traction. We had 170 million of orders, I believe, to date, and then the other innovation is we will refresh those P25 devices, and we'll have an APX mid-tier device by the end of the year. We've also refreshed some of the devices on the TETRA side and PCR, professional commercial and radio. So we continually update, modernize and refresh the device portfolio that serves these thousands of dedicated public safety communications and enterprise communications network, and that's a favorable trend to us.

Yes. And it sounds like you have a very strong position, but there's -- on the competition side, it's pretty low.

Competition in the U.S. is primarily on public safety, Harris, which is now L3Harris. On the TETRA side, on the device side, it's Sapura which is a Chinese company, by the way, owned by Hytera, and we can talk about that, too. We're in litigation with Hytera for trade secret misappropriation source code copying, patent infringement. We've had rulings here that have awarded us in excess of $650 million judgment against this company, Chinese company Hytera, most recently a ruling by the judge in Chicago for historical royalties that are owed to us July 31 of about $45 million that would go into escrow subject to the final hearing on appeals. But Hytera systematically stole, cheated, it was a multiyear campaign. It involved many individuals. By the way, separate from our civil case, the Department of Justice just released a 111 page criminal case against Hytera that is totally separate, but Hytera's bad actors. We're going to hold them accountable. I think we're the only U.S. multinational company to sue 2 Chinese companies for patent infringement and trade secrets, which is also correspondingly why we made the decision a decade ago to exit the Chinese theater. But Hytera is still a competitor and is still infringing on our product and the PCR business, Kenwood and Icom is a competitor as well. on the radio side for the enterprise side. So we've got competition on the radio side and of course, different competitors in command center software, think of more companies like Tyler and CentralSquare on a much smaller level, Mark43 for cloud-based CAD. And on fixed video and access control, we compete with Access which is owned by Canon, AXIS, Hanwha, South Korean company, Bosch. But one last thing, and sorry for the long-winded answer, but under the National Defense Authorization Act, I mean, you all know about U.S. versus China, the NDAA bands of a U.S. federal agency from buying or using grant money for Huawei, ZTE, Hytera and Hikvision and Dahua. Hikvision and Dahua are 2 of the largest video surveillance companies in the world, fixed video, and they are banned by the NDAA for use in the U.S. federal agency or with grant money used by the federal government. And the FCC currently is considering rules as a byproduct of the Secure Equipment Act that they may take action as well against those banned companies that could, if they did those -- if they promulgated rules that we're replicating the NDAA could also limit or ban the use of Hikvision, Dahua and Hytera for enterprise use as well. So we're the market leader in land mobile radio. We're the #1 provider in fixed video -- North America fixed video and access control. We have a very strong position in command center software. And I think more and more companies or countries rather U.S., U.K., Australia and others, New Zealand that are concerned about the deployment of certain Chinese electronics or Chinese gear in mission-critical industries is a tailwind to us over time.

Got you. Can you also provide an update on the CMA investigation in the U.K.?

Yes. So CMA, the Competition Markets Authority in the U.K. is looking at our role with both Airwave and ESN. Think of ESN as kind of the U.K. version of FirstNet loosely, but that's how I would describe it. We've been actively engaged with the CMA for the last several months. We're educating them on our role in both Airwave and ESN. Airwave is a company we bought in 2016. We expect a provisional decision in June by the CMA with a final decision in September. At the same time, we, Motorola Solutions continue to deploy capital and invest in both Airwave and ESN. We're working as closely as we can with them. The only other thing I'd say is whatever ultimately they decide and we have to work with and have conversations with them, it's prospective, it's not retrospective, but more work to be done with them, and we've stayed actively engaged.

Got you. And then sticking on the international front, you kind of already touched on it, but where do you see the most strong potential there and discussions accelerating?

I think we have good engagement throughout Europe as well as the Middle East. So I would say EMEA. Of course, Australia has remained a stall work foundational theater for Motorola Solutions for quite some time, parts of Latin America as well. But as Europe has been destabilized with the war, while we've exited Russia, we also have had and seen some uplift in the deployment of public safety communications within certain countries or regarding border control, but think about the deployment of infrastructure to improve safety overall. But I think EMEA remains a quite attractive theater for us. Australia, certain parts of Asia and certain countries in Latin America as well. Of course, North America is our anchor tenant.

Right. So I guess for LMR, can we talk about kind of the revenue and profitability over the life, the setup of the network, the devices sold kind of software and how that trends over time and how it kind of becomes very, very sticky for you?

Well, I mean, land mobile radio networks are installed for a long time, in some cases, decades. And we also have services contracts often that are 7, 10, 15 sometimes 20 years in duration. So they're installed for a long time. They are upgraded with more current software releases that we put out to the systems and they're also upgraded with more modernized and feature-rich devices that capitalize on the feature functionality of the system or in some cases, spectral efficiency. So they're installed a long time. They're very sticky. They allow platforms for us to invest, modernize, improve and provide increased security for the customers we serve.

Cool. Let's switch to video. So video security and analytics, very strong demand trends. Talk about kind of the evolution of the business from when you acquired Avigilon to kind of now?

Yes, about 8 -- 4, 5 years ago, we were 0 in video security and access control. We've made about, I think, 9 acquisitions started by Avigilon in 2018. And take a step back and say, what do you mean by video security. Think about fixed video security, mobile video, prem-based video, cloud video, access control. And we have built up, in my opinion, the broadest and deepest video security and access control portfolio compared to anybody else. We have competitors, obviously, in different points of the world and in different categories, but we have the deepest and widest product portfolio. And we measure the business along 3 technologies. We have -- we report 2 segments, products and systems integration, software and services, but we unpack them to 3 technologies, all things land mobile radio, product and services. We expect that to grow mid-single digits. Video security and access control, we expect to grow 20% this year, and we are -- we continue to take share because we're growing at a multiple of that market. And then command center software, North America-centric, we expect to grow low double digits. That's also higher than the market rate as well. So I think the trends around video security. I mean, you see it. We talk about device refresh on radios. All these black globes you see deployed either in a city or in an enterprise like this hotel, those cameras typically are older in duration, their refresh cycles more 3 or 4 years. All of that device and camera refresh were eligible for, but we're also providing the VMS, the video management software, the edge devices, i.e., the camera and the analytics to go with that. The thing I love about our position there is we can -- it's the largest addressable market that we have. It's $18 billion plus this year, that's zeroing out China. So we have no illusions about competing in Mainland China. So we zero out that addressable market. It's the largest addressable market growing the fastest with us taking share, and we continue to invest both organically and through acquisition. We have prem solutions. We have cloud solutions. And I also think, and yes, I'm biased, but we have super talented people running that organization. One of the executives homegrown and Motorola, but also the Chief Technical Officer and architect for the firm actually came from our first acquisition Avigilon in Canada, Mahesh Saptharishi, and Mahesh continues to do a fantastic job on architecting, integrating and ensuring that our analytics on top of that infrastructure, on top of that product portfolio is distinguished and competitive.

And where are you kind of seeing relative strength across kind of the industry verticals that you play in?

Education is strong. We kind of see them throughout most verticals. Education is probably one of the strongest, but really, really strong growth. North America, Europe, parts of Middle East, video security, there's an insatiable demand for it right now, and I think we're in a really good position, and we'll continue to invest and deploy capital, I think, both organically and inorganically to capitalize on those trends.

And how are you taking share? I mean, judging by your kind of revenue strength seems like you do have some pricing power here. So could expand on that?

Well, I think there's a couple of things. So let's start with when we bought Avigilon, an end-to-end fixed video provider and access control, they were basically 100% enterprise. They didn't sell to public safety. On the other hand, you think of Motorola Solutions, particularly in North America, with our go-to-market direct organization, direct sales. And all of the sophisticated and robust indirect channels, we take that product, put it on the conveyor belt of common sales motion into public safety and now at least the last year, I think Jack Molloy said about $330 million of our total fixed video -- of our total video security and access control revenue was government derived. So one is take a best-in-class asset, invest in it with more R&D, expand the go-to-market by 40% or 50% with more feet on the street, drop it into the relationship infrastructure that we enjoy on the government side and watch that growth get traction. In addition to that, simultaneously, we had the structural tailwind and with the Hikvision and Dahua ban with the U.S. federal government to be deployed in those agencies, then secondarily to have U.S. grant money fund Hikvision or Dahua, and we'll see what the FCC does. So number one, the overall market is really hot and growing. Number two, we've refreshed and put more R&D to refresh the product portfolio of some of the acquisitions. Number three, we've added go-to-market. Number four, there's a structural tailwind with anti-Hikvision and Dahua references in the deployment of certain video security and access control. Those ingredients into the blender lend itself well for us to continue to grow.

Yes. That's great. Let's switch to body cams. Talk about the focus there against a pretty strong incumbent. How are you looking to take share there?

I think -- I mean, obviously, a very strong incumbent. I think over 2/3 of the officers in the U.S. probably have a body-worn camera already, might even be a little bit higher. On the other hand, the market wants an alternative. They don't want a sole-source dominant provider. They want a better priced alternative. I think we've been doing that. I think you'll see us do a little bit more competitive pricing against that incumbent. And quite frankly, there's a lot more growth to be had internationally as well, and we have a very competitive offer there with an acquisition we made of a company called Edesix. We reported last year, I think, was the largest body-worn camera sale that we were aware of in -- with the French MOI. But we look to capitalize on international opportunities, continually stay aggressive on price, have a very competitive alternative where people want it. And in secondary and rural markets that may not have body-worn camera, we think we're a viable alternative to be considered, and Mahesh also continues to work on ensuring that the back-end digital evidence management that stores and captures, redacts and manages all that video is as competitive as it can be as well.

Great. Let's switch to command center software kind of overview of the offerings and where you see growth in that business?

Well, there's about 6,500 PSAPs, public safety answering points in the U.S., our command center software strategy is anchored in the U.S. We have about 3,500 of the 6,500 where they are using a module or some software product from Motorola. Mahesh continues to build out the suite. It takes a long time, a longer sales cycle, probably the longest one we sell into is command center software because that software is uniquely customized around workflow by city, by county, by municipality and any replacement needs to be seamless. Obviously, lives matter. You can't drop a 911 call. You can't have any dislocation or disruption. So the sales cycle is longer, and it's very purposeful in command center software. We have prem solutions. We're building a cloud solution. We see, Paul, that market growing about 7%, maybe 8%, but I think it's anchored around 7% this year, and our expectation for this year around command center software is low double digits. So that too is a technology where we expect to continue to take share. I think you'll see us use our incumbent position, where we have a foothold in -- or at least a presence in 3,500 of the 6,500 and look along the time line of migration that's conducive to the customer to have more and more end user customers buy additional modules to add to that 3,500.

Got you. Let's jump into the P&L. So you kind of touched on this earlier, but how are you kind of keeping margins flat for the year? And then as some of these temporary costs kind of go away, do we hit 50% plus? And what are you kind of doing structurally to change the margin profile there?

Well, I mean, the bad news is there's a lot higher cost this year, but I also think -- and Jason and I think many of them are temporary. As an example, take semiconductors, still a challenging environment. We have to buy parts on the open market where we can in the broker market. Second, we have to look for product substitution. And third, where possible and if there's enough time, we do product redesign. The purchase price variance we said at the beginning of the year, we, the firm would have $120 million of higher incremental PPV cost for semiconductors. $50 million in Q1, $50 million this quarter in Q2, $20 million on the back half. We think most -- overwhelmingly, most of that $120 million is temporary and will mitigate over time as the semiconductor situation normalizes. We don't know when that is. But the reason we absorbed $50 million of higher PPV, we're absorbing $50 million of higher PPV in Q2. Hence, the margin contraction. How do we gain it back in the second half? Well, one, PPV is mitigated to a much lower number as we lap previous year higher comps. Two, we're prioritizing mix into the higher ASP, higher tier devices. Three, pricing increases take hold largely in the back half as we burn through some of the existing backlog. And lastly, we'll do targeted cost reductions. So our expectation is that gross margins will be comparable this year even with all of those interesting headwinds, but we also -- our expectation is to have operating margin slightly up all in for the year, fiscal '22 over fiscal '21. A lot of hard work. I think Jason Winkler and finance, the supply chain team, a lot of people doing some great things. But I kind of like where we are.

Got you. So on the product side, you mentioned kind of these price increases. And then what about on the services side, is there more kind of fluid dynamic price changes kind of available on your services side?

I think we're very mindful of managing multiyear relationships on the services side. Many of our services, long-term managed services contracts have cost of living increases. We expect software and services to grow high single digit, I think, this year is the overall segment perspective. Services was a little bit -- it was actually mostly flat in Q1, but we expect that services growth, particularly for the back half to return nicely to more historical growth rates.

Okay. Let's talk about cash flow. So super consistent, on track for another annual record despite some elevated inventory. Talk about how you've been able to consistently kind of drive this reliable cash flow?

By the way, just so Tim Yocum doesn't kill me, software and services is approximately 10% growth this year. I don't want to -- people were like, what he guided down. No, I didn't, it's staying at 10%. Jason and I work really hard at capital deployment and cash flow. We've obviously built up working capital and are carrying higher inventories given the volatility and some of the uncertainty to mitigate semiconductor supply between now and the rest of the year. But we are always looking at the discounted cash flow of the business against the backdrop of the LRP with the rising cost of capital, obviously, as interest rates go up, and we decide whether we're going to deploy capital buying back shares or we're going to buy companies. It's constant. We're always looking at it. Now in Q1, we bought -- we spent about $500 million on acquisitions and about $500 million on share repo. Now we don't have the free cash flow to continue share repurchases at that level. So it was indexed and kind of front-end loaded. But on the other hand, I would say, and I think some of you heard me say this, this is -- these are interesting times, right? Markets continuing going down, what's going to happen with Russia, Ukraine. Is the Fed going to get the soft landing right or not? What about China lockdowns and Xi Jinping, no COVID policy, when do semiconductors alleviate blah, blah, blah, blah, blah, blah. At the same time, that uncertainty and turbulence presents us great opportunity to deploy capital. And I think with turbulence comes opportunity, and we will continue to deploy the capital along those lines. The best thing you can do with capital is to invest in the business, and we have great businesses to continue to invest in and grow above market rates, then return it to the shareholder and also make accretive, sustainably differentiated acquisitions to keep our competitiveness going forward.

Great. Well, we're out of time here, but thank you for your time today. And that's a wrap. Appreciate it.

Thank you, Paul. Thanks for coming.