Motorola Solutions, Inc. (MSI) Q3 2020 Earnings Call Transcript

Motorola Solutions, Inc.  (NYSE: MSI) Q3 2020 earnings call dated Oct. 29, 2020

Corporate Participants:

Tim Yocum — Vice President, Investor Relations

Greg Brown — Chairman and Chief Executive Officer

Jason J. Winkler — Executive Vice President and Chief Financial Officer

Jack Molloy — Executive Vice President, Products & Sales

Kelly S. Mark — Executive Vice President, Software & Services

Analysts:

Sami Badri — Credit Suisse — Analyst

George C. Notter — Jefferies — Analyst

Keith Housum — Northcoast Research — Analyst

Adam Tindle — Raymond James — Analyst

Tim Long — Barclays — Analyst

Paul Silverstein — Cowen and Company — Analyst

Fahad Najam — MKM Partners — Analyst

Josh Kehoe — Citigroup Global Markets — Analyst

Presentation:

Operator

[Operator Instructions] Thank you. The first question today is from Sami Badri of Credit Suisse. Please go ahead.

Sami Badri — Credit Suisse — Analyst

Hi there, thank you and congrats on the solid results in 3Q. I first wanted to ask about the $120 million 911 contract that you guys signed that was the highest in the company’s history, and maybe two pieces to this. How will that that be recognized over time, kind of like the first question? And then I know there’s probably going to be similar deals like this in the future, probably not at the same magnitude, but maybe could you give us a little bit of an idea on how popular this type of specific large deal could potentially be in demand in the medium- to long-term?

Kelly S. Mark — Executive Vice President, Software & Services

Sure, hey, Sami, it’s Kelly. So on the NGCS I think I would say three things about it. First off, look, we’re really excited about that part of the business. It is the entry point for all 911 calls, and as I think I may have referenced on a prior call, what that effectively does is creates the EazzyNet multi-lane highway entry point to 911 centers, where they can now handle video, audio, pictures, text, versus the single-lane highway of voice that they could handle before. The second thing I’d say about this deal is when you think about it, this and other similar deals like that will get on NGCS. There’s always an installation component that’s upfront, and then there’s a longer tale of as a service, where we’ll run the system for our customers, and that’s similar to what we have here in the multi-year contract.

The third thing I’d just remind you about — around NGCS, is while we have some of our own software and componentry in it, we are also acting a systems integrator. So we are, in effect, reselling backhaul and other components as an offering for the entire solution, which is a bit different than what we do in our 911 call-taking software or our CAD software, where we are the entirety of the software solution. But we’re excited about this. We think that NGCS and EazzyNet is — I would call it, if you’re looking at a nine inning baseball game, I think we’re somewhere around maybe the second or the third inning, so we’re early in the conversion of EazzyNet across the United States. So there’s certainly other deals out there, and we’ll just continue to fight for those and update you on those as they come.

Greg Brown — Chairman and Chief Executive Officer

And Sami, this contract, $120 million plus, will be rev-recognized over a multi-year, long-term contract.

Sami Badri — Credit Suisse — Analyst

Got it. Thank you. And then Greg, just one question for you. We still have the $9 billion of revenue and $10 EVP, EPS guideposts laid out for 2021, and obviously COVID may have shifted this around a little bit, but I was hoping you’d give us a little bit of an update around this guidepost or this framework on how we should be thinking about what’s to come in the medium to long-term.

Greg Brown — Chairman and Chief Executive Officer

Yeah, well, obviously COVID was the ultimate disrupter, but I would say is I’m pleased with the momentum of how the business is performing. We talked about Q2 of this year, Sami, being a low point. We would improve in Q3. We expect to improve in Q4. I think the print for this quarter reflects some of that improvement. All I would say look, I’m not going to guide 2021. I think that would be premature. But I would say as we sit here today and I don’t have a crystal ball, I would expect us to grow and return to overall revenue growth next year, and I would also expect us to grow in both segments for next year, but again, we’ll update you a quarter from now on the next earnings call.

Sami Badri — Credit Suisse — Analyst

Appreciate it. Thank you.

Greg Brown — Chairman and Chief Executive Officer

Thanks, Sami.

Operator

Our next question is from George Notter of Jeffries. Please go ahead.

George C. Notter — Jefferies — Analyst

Hi guys, thanks very much. I was really interested in some of your comments, Greg, on the software business. I think you mentioned a $500 million run rate at this point. Can you talk a little bit more about how that– I would imagine that run rate is getting cannibalized to some degree as you move customers from perpetual software licenses to a subscription, and can you talk about potential cannibalization on that revenue run rate, or maybe talk about the mixture of customers that are converting to subscription, or anything you can that give us more insight in that transition. Thanks.

Kelly S. Mark — Executive Vice President, Software & Services

Sure, George. So the majority of the software revenue today is license revenue. Kelly and Andrew have done a good job Cloud-enabling the suite. The only component left to Cloud-enable is Records, which will be done in the first half of 2021. So we’re incrementally moving more and more customers to as a service. But again, I think we’re still going to be able to manage that transition from perpetual license incrementally to more as a service without any major dislocation or disruption of top line revenues. Said another way, you see that, Software & Services will perform this year in the high single digits and I expect Software & Services in total in the segment and both sub segments, Software & Services, to continue to grow in 2021 as well, even while we’re transitioning those clients gradually to as a service. I do that as a multiyear transition.

Greg Brown — Chairman and Chief Executive Officer

And George, the only thing I might add to Kelly is, we’re really excited about the command center software suite we just announced, which now fully cloud enables CAD, records, and our mobile. That is in addition to already what we do in Aware, our vast license plate recognition is as a service, and also our Kodiak part of the portfolio as well. The only part of the entirety of what we have that won’t be cloud-enabled yet is our 911 call taking. That should happen in the first half of next year. And in addition to that, we’re excited about what we just did with Callyo, the acquisition we just did, which picks up a very large customer base of folks that are using that mobile application, which is also an as a service part of the portfolio.

George C. Notter — Jefferies — Analyst

Got it. Okay. And then one just quick housekeeping item. I didn’t see it in the press release or the presentation, but was there an FX impact on top line in the quarter and can you tell us what that was? Thanks.

Greg Brown — Chairman and Chief Executive Officer

It was pretty small.

George C. Notter — Jefferies — Analyst

Okay.

Operator

Our next question today is from Keith Housum of Northcoast Research. Please go ahead.

Keith Housum — Northcoast Research — Analyst

Good morning, guys. I was hoping you could shed a light on the ability to do sales this quarter, in terms of last quarter, I think what we heard was about challenges in terms of getting in to see the customers. How did that develop over the third quarter and is that a challenge going into the fourth quarter?

Jack Molloy — Executive Vice President, Products & Sales

Sure. Hey, Keith, it is Jack. Good afternoon. Yeah, so we saw sequential improvement in terms of our ability to engage in customers and just to kind of give you the geographic around the world. First of all, in North America, in government, we’ve been able to engage in person with customers and we’ve seen that manifest in terms of increase in proposals and sequential increase in terms of our LMR business and, as Kelly pointed out, command center and video. In Europe, it’s important to point out 55% of our revenue in Europe is recurring revenue. But we are starting to see, we saw certainly in Q3, both in the enterprise market and government, the ability of our customers to actually come and extend and meet us virtually.

So that’s been an improvement. Asia-Pac, same thing. The one area of the world where we’re having essentially lockdown, continues to be locked down and we’ve got very much diminished expectations is Latin America. But I would certainly say it’s improved. Been really proud of the resilience of the team in terms of use of videoconferencing and really trying to engage our customers and pull them along. We’ve been heavy in terms of virtual trade shows and demonstrations. And as I said in government, particularly in public safety, we engage with our customers in person masked up, etc.

Greg Brown — Chairman and Chief Executive Officer

And Keith, just one other anecdote I’d give you is we just completed Kelly’s team, the annual software summit, just a few days ago. We did it in person a year ago. We just completed the virtual multi-day engagement just a few days ago, and attendance was literally double virtually. So I think Molloy’s team and Kelly’s team, and our customers quite frankly, have been good in transitioning virtual engagement, digital engagement, business continuity. It depends on the theaters Jack referenced internationally, but we’ve been able to navigate that much better than we were doing a quarter ago.

Keith Housum — Northcoast Research — Analyst

Got you. Appreciate that. And just a follow-up there. In terms of changing gears, actually, in terms of FirstNet and Airwave, can you give us the latest on where LTE versus LMR kind of stands in terms of around the world?

Greg Brown — Chairman and Chief Executive Officer

I think the high level answer is no change from the last time we spoke to you. 4G and ultimately as it transitions here in North America to 5G, LTE or 5G is a complimentary technology to mission critical land mobile radio. I think the awards that Winkler went through on state awards and upgrades, particularly in state and local reinforce and reference the criticality need to have dimensions of land mobile radio. As it relates to Airwave, I think it’s the same thing. We believe– we remain in active discussions with the customer, and we do have an expectation that that Airwave contract will get another extension. But that timing will be dictated largely by the customer. But again, I think LMR, LTE, or if you want to substitute that and say LMR 5G coexist, and quite frankly, we think the upgrade in faster speeds domestically and in the UK are good for command center, good for our video security business, and overall, are a net positive.

Keith Housum — Northcoast Research — Analyst

Great, thank you.

Greg Brown — Chairman and Chief Executive Officer

Thank you.

Operator

Our next question is from Adam Tindle with Raymond James. Please go ahead.

Adam Tindle — Raymond James — Analyst

Okay. Thanks. Good afternoon. Greg, I just wanted to start with a question on margins. Between the two segments, it’s been a little Tale of Two Cities. In Products and SI, that’s been the drag on overall performance, but probably the biggest opportunity moving forward. So hoping you can maybe just walk through some of the moving parts to get this segment back to the 22% to 23% operating margin range from years past. Does revenue need to get back above $5 billion? Are there things you can do from an opex standpoint and just a timing to that?

Greg Brown — Chairman and Chief Executive Officer

Yeah, Adam, so kind of taking– let’s take a look at opex overall. For the full year, we’ll remove about $250 million of opex out of this business this year, year-over-year. If you net that to include acquisitions, it’s a net $170 million reduction. So I think the team has moved quickly and did a good job on expense structure, both structural and variable, to adapt to the COVID environment we got hit with a couple of quarters ago. So think of opex this year, all in, year-over-year, being down net $170 million, about approximately $100 million of that returns next year in the form of incentive compensation.

Operating margins for the two segments, we still expect Software & Services to be consistent with what we told you last time, with operating margins for the full year 2020 of being about 34%. Obviously, the product segment declines this year, given the top-line volume decline. I expect the operating margins obviously to improve with volume. And even though $100 million of opex returns next year, that’s as we sit here today, we’ll always look to see if we can refine or further improve that cost structure. But that’s kind of a composite view.

Adam Tindle — Raymond James — Analyst

Okay. And maybe just as a follow-up, I’d imagine from a top-line standpoint, one of the big drivers in that segment is going to be the PCR business. If you could just maybe just update us on where that business fits today, and into 4Q, so that we can kind of think about the opportunity moving forward into 2021 as it potentially rebounds?

Greg Brown — Chairman and Chief Executive Officer

Yeah, I think that PCR has been incrementally– it clearly was an extreme low-point in Q2. It’s performed a little bit better in Q3, and we expect it to improve a little bit better that’s informed into our overall Q4 guidance. PCR, as you know, has been hit with primarily the critical industries that have gotten slammed by COVID the most: hospitality, entertainment, transportation, oil and gas, and quite frankly, I think that we expect PCR to return to some form of growth in 2021. And that’s in part what informs our expectations for the product segment to return to growth as well. It also might be worth noting that even in this environment, North America, which represents our largest theater and is sold primarily through channels, the channel inventory in North America is down. So that’s another good indicator in terms of potential foundation for us to continue to print improvement as time goes on.

Jack Molloy — Executive Vice President, Products & Sales

And maybe one other thing, Greg. Just historically as we look at PCR, new product introduction, even in challenging times, equates to growth, and we do have some product refresh on the slate for 2021 as well.

Adam Tindle — Raymond James — Analyst

Got it. Thanks, Greg. Thanks, Jack.

Operator

Our next question is from Tim Long of Barclays. Please go ahead.

Tim Long — Barclays — Analyst

Thank you. Yeah, two if I could, here. Greg, maybe first, just talk a little bit high level about the state of your customers, state and local budgeting, given the macro and stimulus and anything of note there, any changes? And then secondly, if you could talk a little bit on the video side? You mentioned that getting good traction with the government to maybe just give us a little bit more color there, how much video is ramping there, and are you seeing kind of any level of cross-selling across that video business? Thank you.

Greg Brown — Chairman and Chief Executive Officer

Sure, Tim. Just to take them in reverse order, on video specifically, let’s start out with body-worn video. We had the strongest quarter we’ve had. Really good demand for a lot of the obvious demand driver reasons you would suspect, but I think Molloy and John Kedzierski and the team are doing a good job with the acquisition we made there in the form of WatchGuard. Quite frankly, also another impetus behind the body-worn video growth is international performance, which came through an acquisition as a part of WatchGuard called Edesix. So I like our performance there and also, I like the increased demand. We also did have strong growth in fixed video to government, solid double-digit growth. I think a reflection of –we’ve said the sales cycle is always longer in state and local and fed, but very good performance on fixed video into the government.

By the way, Pelco being a benefit to that as well, given the fact that that acquisition came with a lot of contractual government clearances that allowed us to move right in to further fed government purchases that were beneficial. In terms of state and local customers, Jack mentioned it. I think that our customers have found a good way to engage during these challenging times. Many of them do meet in person. We also meet digitally or virtually. And remember, the state and local budgets have been largely set. So that’s a good thing that moves us well into next year. We’ve also been the beneficiaries of CARES Act money from the feds, and I think that has had a favorable impact as well. So I don’t know, Jack, if you want to add anything on the state and local budgets beyond that?

Jack Molloy — Executive Vice President, Products & Sales

No, Tim, I think it’s just prioritization, prioritization, prioritization. As you’ve heard me mention before, we’re not in the business of a nice to have, we’re in the business of a need to have in terms of emergency response. So really, we continue to see our customers drive projects through. The other thing is, I think that sometimes losses, there’s just a multitude of different funding sources. Greg talked about CARES Act, but there’s also things like special purpose local option taxes, which are still getting passed. And so we remain highly engaged with our customers. We see great demand across the portfolio and government and as we know with what’s happening in the world right now, security means a great deal to cities, to states, and I think to our federal government. So more to follow, but we’re encouraged with what we see.

Tim Long — Barclays — Analyst

Okay. Thank you very much.

Greg Brown — Chairman and Chief Executive Officer

Thanks, Tim.

Operator

The next question is from Paul Silverstein of Cowen and Company. Please go ahead.

Paul Silverstein — Cowen and Company — Analyst

Greg, I think I heard somebody mention that your business is 55% recurring. What is recurring revenue for the overall company?

Greg Brown — Chairman and Chief Executive Officer

No, I think Molloy’s reference was that the majority of our European revenue is recurring, largely because of the Airwave contract.

Paul Silverstein — Cowen and Company — Analyst

My fault.

Greg Brown — Chairman and Chief Executive Officer

No, that’s all right, Paul, but if you look at overall, Software & Services, which we view as largely a proxy for recurring. This year, in full year 2020, Software & Services will be higher than 35% for this year, which we view as a favorable byproduct of the year, I guess, so that’s good.

Paul Silverstein — Cowen and Company — Analyst

Then as a follow-up. On the government’s use [Phonetic] of video, looking out to next year, coming off this year, any quantification you can provide us, ballpark in terms of how big– I know you just started selling over a year ago, but how big can that business be next year, and how big will it be this year?

Greg Brown — Chairman and Chief Executive Officer

Well, so just to kind of– if you take all of the video assets that we have, fixed, body-worn, in-car, license plate recognition, domestically and internationally, this business, all-in for assets, hardware, software, is likely to be about $940 million, Paul, for this year. You’ve heard us talk about growing it 3 times the market. That 3 times the market is around the fixed video and access control piece, which we still believe we can achieve. If you take the size of the video market, all-in, worldwide, and we always zero China out, given their indigenous competitors, this is about an $18 billion– $17 billion to $18 billion business, addressable market. It’s actually the largest addressable market we have. So, I think there’s room to run here with the assets we’ve accumulated along with the analytics that our team is developing and intelligent edge devices as well.

Paul Silverstein — Cowen and Company — Analyst

Greg, I appreciate that. I was actually focused on the government piece market that you entered back about a year ago.

Kelly S. Mark — Executive Vice President, Software & Services

I think he’s — hey, Paul. So I think we had mentioned probably maybe three calls ago, probably nine months ago, the question was asked, hey, how big is your government video business? And really, we said approximately $200 million at the time, and that’s an aggregation of two things. It’s the mobile video market that’s come through vis-a-vis, the WatchGuard acquisition, as well as Greg had mentioned, the Edesix that also came as an acquisition. The remnants of it are fixed video security sales into all governments, and I would tell you, both of those businesses are growing strong double-digits right now. Both fixed video into government, we’ve talked about the success we had in Q3, both in the feds and state and local, but also, we highlighted some of the success we had in body-worn in terms of unit and dollar bookings substantially up in the strong double digits there. So hopefully, that helps.

Paul Silverstein — Cowen and Company — Analyst

I appreciate that. Thank you.

Greg Brown — Chairman and Chief Executive Officer

Thank you, Paul.

Operator

Our next question will come from Fahad Najam of MKM. Please go ahead.

Fahad Najam — MKM Partners — Analyst

Thanks for taking my question. Greg, I want to ask you a big picture question. In light of the view that most of your government customers are very slow to move and they tend to be not driven by — like usually, enterprises are driven by profits and maximizing profits, your government customers tend to be more slower. Are you noticing any kind of an inflection point in your government customers’ decision-making when it comes to whether it’s Next Gen 911 command center solutions or video? Are we beginning on a new trend and that’s going to accelerate going forward?

Greg Brown — Chairman and Chief Executive Officer

I would say this. I mean, in the command center software, Next Gen 911 is a new opportunity for us, and that’s obviously a favorable trend. The other thing I’d say, in terms of decision cycles is command center software, historically has had some of the oldest legacy technology and workflow processes literally over several years, 10, 15 years plus. So I actually think that the inflection point is COVID-induced in part that’s accelerating decisions to the cloud. Traditionally state and local customers would prefer control, and they’d confer — they’d prefer on-prem. I actually think that this pandemic has been a positive accelerant to decision-making around command center software, particularly around cloud.

I think this suite that Kelly and Andrew’s team has built also can be an accelerant to decision-making because instead of trying to decide a forklift process and an all or nothing, you can get an anchor tenant module in place and then upgrade those modules for additional components along the suite. On land mobile radio, we literally have tens of thousands of different contracts that are at different lengths and the systems are in different ages. The pandemic and the civil unrest has been an accelerant to some older systems here in North America that needed to be upgraded to digital and with state-of-the-art encryption to protect the communities and the local law enforcement better. I think as Molloy and his team have built new devices, APX NEXT, in TETRA, the MPX600 that’s just announced, those two represent events and opportunities for our customers to make decisions to refresh as well.

Kelly S. Mark — Executive Vice President, Software & Services

Greg, you hit it really well. I think the other thing that — we have a compelling ecosystem for our customers. That’s an overused term, but I say that under the lens of Greg nailed it. Devices that work with command center, how do you extract, how do you disseminate information in a mobile environment? Those are the expectations that we’ve seen, frankly, for a number of years in the enterprise space and government is certainly catching up to that. And I think those will be accelerants moving forward for us in public safety.

Fahad Najam — MKM Partners — Analyst

Thanks. You touched upon a follow-up piece that I wanted to ask, which is, as your government customers migrate command and control infrastructure to Next Gen digital platforms, is that creating a resulting opportunity in new applications like mission critical push to talk features on the radio? And if that’s the case, are you beginning to see that and can you quantify that opportunity?

Kelly S. Mark — Executive Vice President, Software & Services

This is Kelly. I would say, it’s not that it’s offering up those type of opportunities in the mission critical push to talk, but it offers up the opportunity to enrich the whole workflow with multimedia. And at the edge, officers today carry a mobile device with them. They can receive now from the command center video, images, and data that they couldn’t receive before. But the radio as part of the workflow is instrumental in regards to its uniqueness of its communication that it provides. So it’s not so much about mission-critical push to talk as much as it’s about enriching the entire command center workflow with all the information that we’re very used to dealing with today in our day-to-day lives. It’s now enabling that across that mission critical operational workflow so they can manage that information from 911 call intake to record in case management at the end.

Fahad Najam — MKM Partners — Analyst

If I can rephrase my question, which was a little bit more simpler, I wasn’t particularly honing in on mission critical push to talk. What I was trying to get at is are you beginning to see a refresh of your devices business as a result of the upgrade in the new command and control software that you’re now selling?

Kelly S. Mark — Executive Vice President, Software & Services

Yeah, we are. So we announced last October the APX NEXT device. We’ve already built north of $100 million in terms of funnel opportunities for that. We’re very encouraged. Remember, we introduced devices at the top end. So as we get through 2021, we’ll start to broaden the reach of those devices. We see great demand for those devices because it’s not only purpose built P25 communications, which is truly bedrock of how cities and states and public safety communicate, but to bring in LTE capabilities for back up push to talk, the ability to do on the fly programming and those kinds of things, it brings a number of those different things, so excited about that. Greg talked about, just this week, we announced a collaborative device for the TETRA market in Europe, and essentially we’re booked out for the year this year, so we’re really encouraged about that as well. So we see a need for devices that can do more for our customers as I said earlier in terms of aggregating, disseminating, and really intelligence within their ecosystem.

Fahad Najam — MKM Partners — Analyst

Appreciate the answers. Thank you.

Greg Brown — Chairman and Chief Executive Officer

Thank you.

Operator

[Operator Instructions] Our next question is from Jim Suva of Citi. Please go ahead.

Josh Kehoe — Citigroup Global Markets — Analyst

Hi, this is Josh Kehoe on for Jim Suva. Thanks for taking our questions. Can you provide any more color on the headwinds you’re facing in the public safety LMR business and when you expect to be through them? And is it largely due to COVID-19 or is there more to it? Thank you.

Greg Brown — Chairman and Chief Executive Officer

I think the headwinds we talked about when COVID hit us back in March were PCR and the industries that were affected by it and public safety LMR, quote-unquote, being pushed to the right. The push to the right largely around sales engagement and deployments, I don’t think that’s changed at all. That’s still the primary reason for the push to the right. Although I will tell you, it performed — its public safety LMR performed better than our expectations in Q3, and we expect it to improve again in Q4, which informs our guide. And I think public safety LMR and PCR, as I referenced earlier, I think will both improve, which will primarily drive why we expect the product segment to return to growth next year. There’s a lot of still budget sources that Molloy referenced, we’ve been the beneficiaries of The CARES Act as well, but that’s what I would say.

Jack Molloy — Executive Vice President, Products & Sales

Yeah, the only thing I’d just piggyback onto Greg’s comments there, the one issue that we’ve been challenged with is actually physical deployment of systems in the Middle East and Africa and in Latin America. So we’re completely impaired to go do anything, and that’s really elongated our ability to recognize revenues in those theaters.

Josh Kehoe — Citigroup Global Markets — Analyst

Okay. And as a follow-up, as we look into 2021, how are you thinking about prioritizing M&A versus share repurchases? Thank you.

Greg Brown — Chairman and Chief Executive Officer

I think that our capital allocation framework is 50-30-20. 50% of the cash flow being available for either acquisitions or share repurchase. It’s a fungible amount, depending upon the opportunities that are in front of us. 30% is dividend, and 20% is capex. So that framework, loosely, is that it’s not meant to be a prescription, but it’s a framework. We were active in buying back shares at these levels, as you’ve seen in Q3. We think these are attractive levels to buy the stock in Q3. And we’ll evaluate opportunities as they come. We’ve done tuck-in acquisitions on the video side, on the software side. I think that in regards to acquisitions next year, it will be, in part, a reflection of what opportunities come our way. But that’s the thinking around the deployment of capital at this point.

Josh Kehoe — Citigroup Global Markets — Analyst

Thank you.

Greg Brown — Chairman and Chief Executive Officer

Thanks, Josh.

Operator

This concludes our question-and-answer session. I will now turn the floor back over to Mr. Tim Yocum, Vice President of Investor Relations, for any additional or closing remarks.

Tim Yocum — Vice President, Investor Relations

No additional comments. Thanks for joining us today.

Operator

[Operator Closing Remarks]