Earnings Call Transcript - MSI Q1 2024

Operator, Operator

Good afternoon, and thank you for joining us. Welcome to the Motorola Solutions First Quarter 2024 Earnings Conference Call. This call is being recorded, so if you do not wish to be part of the recording, please disconnect now. You can find the presentation materials and additional financial information on the Motorola Solutions Investor Relations website. A replay of this call will be available on our website within 3 hours of its conclusion at www.motorolasolutions.com/investor. I would now like to introduce Mr. Tim Yocum, Vice President of Investor Relations. Mr. Yocum, please proceed with the conference.

Tim Yocum, Vice President of Investor Relations

Good afternoon. Welcome to our 2024 First Quarter Earnings Call. With me today are Greg Brown, Chairman and CEO; Jason Winkler, Executive Vice President and CFO; Jack Molloy, Executive Vice President and COO; and Mahesh Saptharishi, Executive Vice President and CTO. Greg and Jason will review our results along with commentary, and Jack and Mahesh will join for Q&A. We've posted an earnings presentation and news release at motorolasolutions.com/investor. These materials include GAAP to non-GAAP reconciliations for your reference. During the call, we reference non-GAAP financial results, including those in our outlook, unless otherwise noted. A number of forward-looking statements will be made during this presentation and during the Q&A portion of the call. These statements are based on current expectations and assumptions that are subject to a variety of risks and uncertainties. Actual results could differ materially from these forward-looking statements. Information about factors that could cause such differences can be found in today's earnings news release and the comments made during this conference call in the Risk Factors section of our 2023 annual report on Form 10-K or any quarterly report on Form 10-Q and any other reports and filings with the SEC. We do not undertake any duty to update any forward-looking statements. And with that, I'll turn it over to Greg.

Gregory Brown, Chairman and CEO

Thanks, Tim. Good afternoon, and thanks for joining us today. I'm going to share a few thoughts about the overall business before Jason takes us through our results and outlook. First, Q1 was an outstanding start to the year. We achieved revenue growth of 10%, earnings per share growth of 27%, expanded operating margins by 220 basis points, and generated record Q1 operating cash flow of $382 million. We also finished the quarter with $14.4 billion of backlog, up $300 million versus last year. Second, our outstanding Q1 performance was broad-based. In our Products and SI segment, revenue was up 14% and operating margins increased 590 basis points as we continue to see strong demand for our feature-rich LMR products, including APX NEXT and our refreshed PCR portfolio. In Software and Services, revenue was up 4%, inclusive of the Airwave charge control and our exit from the ESN contract. Excluding U.K. home office revenues, Software and Services revenues increased double digits, driven by continued strong demand for our LMR service offerings and our software applications in Video Security and Command Center. And finally, based on our strong start to the year and continued robust demand, we're raising both our revenue and earnings guidance for the full year. I'll now turn the call over to Jason.

Jason Winkler, Executive Vice President and CFO

Thank you, Greg. Revenue for the quarter grew 10% and was above our guidance with strong growth in all three technologies. GAAP operating earnings were $519 million or 21.7% of sales, up from 18.4% in the year-ago quarter. Non-GAAP operating earnings were $638 million, up 20% from the year-ago quarter, and non-GAAP operating margin was 26.7%, up 220 basis points. The strong year-over-year increase in both GAAP and non-GAAP operating earnings was driven by higher sales, a favorable mix shift as our customers invest in more feature-rich LMR products, and improved operating leverage, offset by the U.K. CMA charge control related to Airwave. GAAP earnings per share was a loss of $0.23 and included a $585 million charge, resulting in a $3.42 per share pretax nonoperating loss due to the accounting treatment for the settlement of the Silver Lake convertible notes. We settled these notes entirely in cash for approximately $1.59 billion inclusive of the conversion premium, which eliminated potential dilution to our share count and reflected a favorable negotiated settlement price compared to the indenture terms. As a result, we recognized a nonoperating loss for the settlement during the quarter. According to the current accounting rules for convertible notes, which were updated in 2022. Non-GAAP EPS was $2.81, up 27% from $2.22 last year. This strong growth in EPS was driven by higher sales and margins, lower interest costs and a lower diluted share count. OpEx in Q1 was $568 million, up $38 million versus last year, primarily due to higher employee incentives and acquisitions. Turning to cash flow, operating cash flow was a Q1 record of $382 million, up $390 million versus last year, and free cash flow was $336 million, up $398 million. The strong increase in cash flow was driven by improved working capital and higher earnings net of noncash charges. Capital allocation for Q1 included $163 million in cash dividends, $46 million of CapEx, and $39 million of share repurchases. We also used $593 million of cash to settle the Silver Lake conversion premium, and we closed the acquisition of Silent Sentinel, a provider of specialized long-range cameras for $37 million net of cash required. Moving to segment results, in Products and SI, sales were up 14% versus last year, driven by continued strong demand, combined with improved supply availability and a favorable mix shift in LMR products. Operating earnings were $370 million or 24.8% of sales, up from 18.9% in the prior year, driven by higher sales, favorable mix and improved operating leverage. Some notable Q1 wins and achievements in this segment include a $22 million P25 device order for a large U.S. customer, a $16 million LMR order for an international customer, a $13 million order for the State of Tennessee and a $13 million mobile video order for North Carolina State Highway Patrol. In Software and Services, revenue was up 4% compared to last year. S&S revenues, excluding the U.K. home office were up 12%, driven by strong growth in all three technologies. Operating earnings in the segment were $268 million or 29.8% of sales, down from the 32.9% of sales last year due to the impact of the Airwave charge control. Excluding the impact of the U.K. Airwave charge control, Software and Services margins increased year-over-year, driven primarily by higher sales and improved operating leverage. Some notable Q1 highlights in this segment include a $25 million LMR services order for Douglas County, Colorado, a $25 million LMR services order for U.K. Department of Health, an $18 million Command Center order for the city of San Francisco, a $14 million LMR services order for Lithuania and an $11 million services order for São Paulo State Police in Brazil. Moving next to our regional results, North America Q1 revenue was $1.7 billion, up 13% on strong double-digit growth in both segments. International Q1 revenue was $696 million, up 3% versus last year with growth in video and LMR, offset by lower U.K. home office revenues related to the U.K. home office Airwave charge control and our exit of ESN. International revenue, excluding the U.K. home office impact increased double digits year-over-year in both segments. Moving to backlog, the ending backlog was a record $14.4 billion, up $331 million versus last year, driven primarily by strong demand for multiyear Software and Services contracts in both regions. The year-over-year increase is inclusive of the reduction of $777 million booked in the fourth quarter of 2023 related to the Airwave charge control and revenue recognition for Airwave and ESN over the last year. Additionally, in the first quarter of 2024, we recorded $748 million of backlog related to the receipt of a 3-year extension notice from the U.K. home office for years 2027 through 2029. Our total backlog, excluding the U.K. Home Office was up over $500 million compared to last year. Sequentially, backlog was up $138 million, driven by the extension notice related to Airwave that I just mentioned, partially offset by our typical Q4 to Q1 order seasonality in North America and some unfavorable FX. In the Products and SI segment, ending backlog was down $74 million, primarily due to unfavorable FX. Sequentially, backlog was down $354 million due to the Q4 to Q1 North America order seasonality that I mentioned. And then Software and Services backlog was up $404 million compared to last year, driven by strong demand for multiyear services contracts in both regions. Our S&S backlog, excluding the U.K. Home Office was up almost $600 million compared to last year. Sequentially, backlog was up $492 million, driven primarily by the extension notice related to Airwave, partially offset by Q4 to Q1 order seasonality. Turning to our outlook, we expect Q2 sales to be up between 7% and 8% with non-GAAP earnings per share between $2.97 and $3.02 per share. This assumes a weighted average diluted share count of approximately 170 million shares and an effective tax rate of approximately 24%. And for the full year, we are increasing both our revenue and EPS guidance. We now expect revenue growth of approximately 7%, up from our prior guidance of approximately 6%. And with that, we expect non-GAAP earnings per share between $12.98 and $13.08 per share, up from our prior guidance of $12.62 to $12.72 per share. In addition, with the U.S. dollar strengthening since our last call, this full-year outlook now assumes an FX headwind of $30 million, primarily in the second half. It also includes a weighted average diluted share count between 170 million and 171 million shares and an effective tax rate of 23% to 24%. And finally, as a result of the debt issuance and Silver Lake settlement we completed in Q1, we now expect full-year interest expense to be approximately $240 million, up $25 million year-over-year. Before turning the call back to Greg, I want to highlight just a couple of balance sheet-related items. During the quarter, we used $593 million to settle in cash the premium for the Silver Lake notes that I mentioned. We also repurchased $39 million of shares, resulting together in a combined total of $632 million targeted at reducing our diluted share count. Also, during the quarter, both S&P and Fitch upgraded our credit ratings to BBB underlying the strength of our business and the balance sheet. Following the upgrades, we issued $1.3 billion of debt, $900 million of 10-year and $400 million of 5-year notes, further extending our average debt maturity, which is now over 8 years, all fixed at an average rate below 4.5%. We used a portion of the proceeds from the new debt issuance to pay off the $1 billion convertible notes and plan to use the remainder to settle the approximately $300 million of debt maturity coming due later this year. I'll now turn the call back to Greg.

Gregory Brown, Chairman and CEO

Thanks, Jason. And let me just close with a few thoughts. First, Q1 was outstanding across the board. We achieved strong revenue growth in all three technologies. We significantly increased operating margins. We generated record Q1 operating cash flow, and our strong ending backlog positions us well going forward. As a result, we're raising our expectations for both revenue and earnings for the full year. Second, during the quarter, we announced that we mutually agreed with Silver Lake to settle the convertible notes. Silver Lake has been a great partner since their initial investment in 2015, and I'm very pleased that Greg Mondre is remaining on our Board. And finally, as I look forward, I'm exceptionally pleased with how well we're positioned. The investments we've made in our LMR product portfolio are driving meaningful revenue growth and margin expansion. Our recurring revenues are increasing as a result of the continued strong demand for our services. We continue to see accelerated adoption of our cloud offerings, including Rave and Command Center and Avigilon Alta in Video Security, and our strong balance sheet positions us well to invest both organically and inorganically for continued growth. We ended the quarter with $1.5 billion in cash, still expect to generate $2.2 billion of operating cash flow for the year. We refinanced and extended a portion of our debt portfolio, and we received upgrades from two credit rating agencies during the quarter. All of this provides us with significant continued flexibility in how we deploy capital going forward. I'll now turn the call over to Tim and look forward to your questions.

Tim Yocum, Vice President of Investor Relations

Thank you, Greg. Before we begin taking questions, I'd like to remind callers to limit themselves to one question and one follow-up to accommodate as many participants as possible. Operator, would you please remind our callers on the line how to ask a question?

Operator, Operator

The first question is from Tim Long with Barclays.

Timothy Long, Analyst

Maybe the first question would be about video, and then I have a follow-up on LMR. On the video side, there was decent growth in the quarter. I'm hoping you could discuss a couple of things there. First, what is the status of the impact from the shift to cloud and how it affected the quarter? Secondly, Jason, the software services percentage of the Video business was over 40%. Are we starting to see an inflection point there, or was it just an anomaly due to a dip in the hardware segment this quarter? After that, I'll follow up with my LMR question.

Gregory Brown, Chairman and CEO

Yes. Tim, on Video, pleased with the results in Q1. As you know, we remain confident around the 10% for the full year. We did talk about last quarter that we are seeing increased adoption to Avigilon Alta and cloud adoption. We talked last quarter and it remains unchanged. That's probably about a $40 million estimated headwind in terms of the top-line growth number that informs the 10%, but feel very good about Q1's performance. And by the way, in particular, the orders for video were strong, both in fixed and mobile.

Jason Winkler, Executive Vice President and CFO

And Tim, on the second part of your question, you're right, software within video is growing faster than the product side. That's a trend we've been seeing. And keep in mind, it's not just Alta; it’s all of the exciting developments that we have around analytics. Both of our VMSs, our software products are recorded there. Mobile video is also there, all complemented by cloud subscription. So that's a very important and fast-growing part of our business. Now the LMR piece.

Timothy Long, Analyst

Could you provide an update on the progress of LMR? You mentioned a number of investments in that area, and it appears to be yielding positive results with growth rates exceeding expectations. I would appreciate your insights on our current position in the cycle related to this.

Gregory Brown, Chairman and CEO

Yes, I am very pleased with the performance of LMR products and services. Jack mentioned the continued strong demand from last quarter, which has carried over into this quarter. For example, with APX NEXT, many customers have started indexing to more feature-rich devices in Q1, which has helped boost revenue and margin expansion. I believe it's important to view LMR growth as part of the broader APX segment for APX Radio. These products are newer and have been upgraded. We discuss APX NEXT, which is at the high end, but the entire portfolio, including APX Originals, is performing exceptionally well. Additionally, we've updated devices in TETRA and PCR, and that has been very successful. In fact, we now anticipate PCR to show slight growth from last year's record levels. I would say we're still in the midst of the device refresh cycle, with much more potential ahead. I'm very pleased with this progress.

John Molloy, Executive Vice President and COO

The only thing Tim, I'd add on top of that is, as just Greg pointed out, it's the breadth of the portfolio is a strength. But what's particularly driving the APX NEXT adoption are the applications. So in the quarter, in Q1, we secured two large state patrols as well as one Department of Transportation. As you think about what drives those, it's location. It's the ability to extend the network via SmartConnect and SmartProgramming with large fleets and their ability to reprogram and the like in a more expeditious fashion.

Jason Winkler, Executive Vice President and CFO

Jack, you've seen customers embrace a blended fleet too.

John Molloy, Executive Vice President and COO

Exactly, right. In fact, all three of those customers have APX Original, and like one-third of those are APX NEXT.

Operator, Operator

The next question is from the line of George Notter with Jefferies.

George Notter, Analyst

Congrats on the strength here. I guess I'll go back to kind of the Airwave situation. I saw the renewal and the extension of the contract. Anything new there in terms of the CMA situation? Obviously, you guys adjusted your financials to reflect the negative outcome, but I know there's a court case, an appeal that's going on? I mean, any expectations or anything you can tell us about what's going on there would be great.

Gregory Brown, Chairman and CEO

Yes. Thank you, George. We noted the backlog for the extensions in years '27, '28, and '29 because in March we received notification from the U.K. Home Office regarding the extension of Airwave. Setting aside our disputes for now, this reinforces our long-held belief in the durability, longevity, and essential nature of mission-critical LMR, particularly in the case of Airwave. It highlights the ongoing need for this vital technology, which is among the top-performing emergency networks globally. Regarding the backlog, we accounted for it under the worst-case scenario, meaning it reflects the control rates we are still contesting. Concerning the Court of Appeal, the CMA delivered their final decision. We appealed to the Competition Appeals Tribunal and lost, leading us to appeal to the U.K. Court of Appeal to determine if they will hear our case. We anticipate receiving clarity on that situation either in May or June. Nonetheless, we will continue to advocate for our position on the conditions surrounding the Airwave extension and defend ourselves accordingly.

George Notter, Analyst

Got it. And then just as a quick follow-up. Any evidence that there's any spread of other managed services customers looking at trying to reprice contracts with you guys anywhere else in the world?

Gregory Brown, Chairman and CEO

No. No. I think the U.K. is very, very unique in many ways, but the answer is no.

Operator, Operator

The next question is from Meta Marshall with Morgan Stanley.

Unknown Analyst, Analyst

You've got Jamie Reynolds on for Meta. I appreciate you taking the questions. I think last quarter, you guys highlighted a $100 million headwind from less business in Ukraine. I guess, has your thinking changed there as it relates to the recent aid package that got passed?

Gregory Brown, Chairman and CEO

Our view on the full year and what's informing our raise does not change from what we updated you on the Ukraine situation last year. We did talk about $100 million; Jack referenced that about a $100 million headwind. By the way, that headwind still exists. It's primarily in the second half of this year, which informs kind of the seasonality that's implied in both Q2 and our full year guide. By the way, we remain in game, I'm thrilled. We're thrilled that the Foreign Aid Bill got passed for $95 billion, and Molloy's team remains actively engaged on multiple fronts. But our view in terms of the full year guide is unchanged from what we said last time.

Unknown Analyst, Analyst

Got it. And then just as a quick follow-up. Is the thinking changed around what you expect from the Command Center piece of the business to contribute to growth this year?

Gregory Brown, Chairman and CEO

Still very enthusiastic about Command Center overall as a category. We still expect 10% growth for the full year. By the way, I might add that remember, ESN in the way we record revenue was in the Command Center technology bucket. So Q1 would have grown handsome double digits normalized for U.K. Home Office. And quite frankly, when you look at the 10% guide implied for Command Center for the full year, it's a number higher than that when you normalize for ESN as well. And you may want to mention just some of the other things going on.

Mahesh Saptharishi, Executive Vice President and CTO

We recently concluded our summit, which was our largest ever, with over 1,300 customers in attendance. We introduced our refreshed VESTA NEXT products for both cloud and on-premises, along with several other new launches, including our responder mobile app. The traction has been remarkable, and we now see over 60% of our Command Center customers adopting a cloud-connected product, with Rave and our other Command Center cloud solutions performing exceptionally well beyond expectations.

Operator, Operator

The next question is from the line of Adam Tindle with Raymond James.

Adam Tindle, Analyst

I just want to start maybe first for Jason. Great performance on margins in the Product segment. Just wondering how much of the pricing benefit and supply chain cost is reflected in this versus how much is left in future quarters? I know Q1 is typically the low point for margins in that segment. I'm wondering if that's still going to hold for 2024 and improve from there. And Greg, just conceptually on the topic of margins, I know expanding margins is important to you. The drivers are very clear to us in fiscal '24 price cost, etc. But it's a little bit less obvious as we think about fiscal '25 and beyond. Just if you could help us maybe with conceptual levers to continue to drive margin expansion beyond this year? Or do you think we're sort of at optimal margin, and the focus might be more on growth, how to balance that equation.

Jason Winkler, Executive Vice President and CFO

Sure. So I'll take the first one. We remain seeing the $60 million of lower broker costs, what we call the PPV that we guided to 90 days ago. That's a full year number. Q1 included some of that benefit. There's more to go in getting to the total $60 million. We're on path for that. We are seeing certainly the need to use far less, and the supply improvements from our direct vendors are helping us get the parts we need at the price we need. That's in part what informed our Q1 as well as our expectations for the year, complemented by the continued strong demand. So on plan in terms of the margin improvements related to lower supply chain costs, I would also point to what we talked about on the call is the continued benefit of customers adopting more feature-rich portions of the portfolio. That comes with a margin improvement for us as well.

Gregory Brown, Chairman and CEO

In terms of margins, we expect gross margins to increase slightly this year, and we also anticipate operating margins to rise by around 75 basis points. Considering everything holistically and on a pro forma basis, we believe the factors of volume mix are beneficial at present, along with some targeted price increases primarily in services where we have contracts with cost-of-living adjustments incorporated. As these contracts come due, we will ensure we are recovering necessary cost increases that impact the firm. We also assess our pricing for new products, continue to update our device lineup, and manage fixed and mobile video offerings. Regarding operating expenses, we anticipate an increase of about $100 million this year compared to last year, which is a rise from the previously estimated $80 million. This $20 million increase indicates our commitment to investing more in the business, particularly in video, and we expect to provide higher sales commission incentives that reflect the increased revenue outlook for the full year. Additionally, we have some legal costs, which I view as investments in our defense strategy involving the U.K. Home Office and our ongoing situation with Hytera. We hope to share further updates on that matter by year-end. On the operating expenses front, we also recently acquired Silent Sentinel. Our balance sheet allows for disciplined yet broad potential acquisitions. We pursue such opportunities only if they are financially beneficial, strategically significant, culturally compatible, and operationally integratable, with anticipated synergies. As a company, we believe that simple growth isn't sufficient; we must also enhance top-line revenue, boost margins, increase operating cash flow, and capture market share to know that our firm is performing optimally. While we take pride in our operating margins, we acknowledge that there is still more work to be done.

Adam Tindle, Analyst

Okay. And maybe just a quick follow-up. I know that was a 2-parter, but I'll do a quick follow-up since I'm going to get asked on this tonight. Backlog trends. Obviously, we've got a record here. But correct me if I'm wrong, I think that $14.4 billion includes $748 million of incremental backlog on Airwave. It may be unfair to strip that out, but if we do, it's down about $500 million sequentially. And I know there's some seasonality to that, but that's kind of 2x its normal seasonality. What would that concern of stripping that out and looking at kind of a worse than typical seasonal decline in backlog be missing? And how do you think about backlog trends from here?

Jason Winkler, Executive Vice President and CFO

So Adam, as I mentioned earlier, if we exclude the impact of the Home Office over multiple quarters, the total backlog has increased by over $500 million, and the S&S backlog has risen by more than $600 million. We recorded $748 million in this first quarter related to the extension for 2027, 2028, and 2029. Additionally, in the previous quarter, we reduced the backlog due to the pricing controls implemented for 2024, 2025, and 2026. This caused some cancellations, but the core business at the Home Office is definitely experiencing growth.

Operator, Operator

I will pause for a few seconds to see if we have any additional questions. This concludes our question-and-answer session. I will now turn the floor over to Mr. Greg Brown, Chairman and Chief Executive Officer, for any additional comments or closing remarks.

Gregory Brown, Chairman and CEO

Thank you. First and foremost, I want to express my gratitude to the Motorola Solutions employees worldwide and our channel partners. It's a great team, and I am very proud of our performance this quarter and optimistic about what we can achieve by the end of the year. I would like to emphasize the significant events we had in Q1, particularly the Solutions Summit in Dallas, where a week ago we welcomed 1,300 customers, the largest turnout for such an event. We showcased our operational public safety and enterprise security ecosystem, which received positive feedback. Additionally, we held our first joint channel partner executive forum in February in Orlando, which successfully brought together Land Mobile Radio channel partners and Video Security and Access Control under one roof, fostering valuable relationships. Molloy's emphasis on cross-selling and upselling was prominent, making it an excellent catalyst for developing our culture and focus on expanding our broader portfolio through the end of the year. We also had a strong presence at ISC West, which featured our Video Security and Access Control initiatives and our enterprise body-worn camera, which is gaining significant traction. Overall, while Q1 showed great results, I am even more excited about our momentum, the robust backlog, a strong funnel of opportunities, and a solid balance sheet. I couldn't be prouder. Thank you all for listening, and I look forward to speaking with you next quarter.

Operator, Operator

This does conclude today's teleconference. A replay of this call will be available over the Internet within 3 hours. The website address is www.motorolasolutions.com/investor. We thank you for your participation and ask that you please disconnect your lines at this time.