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Motorola Solutions, Inc. (NYSE:MSI)

Q1 2014 Earnings Conference Call

May 1, 2014 08:00 ET

Executives

Shep Dunlap - Vice President, Investor Relations

Greg Brown - Chairman and Chief Executive Officer

Gino Bonanotte - Executive Vice President and Chief Financial Officer

Mark Moon - Executive Vice President and President, Sales and Product Operations

Analysts

Tavis McCourt - Raymond James

Pierre Ferragu - Bernstein

Simona Jankowski - Goldman Sachs

Ehud Gelblum - Citigroup

Keith Housum - Northcoast Research

Tim Long - BMO Capital Markets

Peter Misek - Jefferies

Brian Modoff - Deutsche Bank

Operator

Good morning and thank you for holding. Welcome to the Motorola Solutions’ First Quarter 2014 Earnings Conference Call. Today’s call is being recorded. If you have any objections, please disconnect at this time.

The presentation material and additional financial tables are currently posted on the Motorola Solutions Investor Relations website. In addition, a replay of this call will be available approximately 3 hours after the conclusion of this call over the Internet. The website address is www.motorolasolutions.com/investor. At this time, all participants have been placed in a listen-only mode and the line will be opened for your questions following the presentation.

I would now like to introduce Mr. Shep Dunlap, Vice President of Investor Relations. Mr. Dunlap, you may begin your conference.

Shep Dunlap

Thanks, Aaron and good morning. Welcome to our call to discuss first quarter results. With me this morning are Greg Brown, Chairman and CEO; Gino Bonanotte, Executive Vice President and CFO; and Mark Moon, Executive Vice President and President, Sales and Product Operations. Greg and Gino will review our results, along with commentary, and Mark will join for the Q&A portion of the call.

We have posted an earnings presentation and press release in motorolsolutions.com. These materials include a GAAP to non-GAAP reconciliation for your reference, which we encourage you to review. In addition, we will post an historical view of the combined Government and iDEN business for the past eight quarters on our site later today.

A number of forward-looking statements will be made during this presentation. Forward-looking statements are any statements that are not historical facts. These forward-looking statements are based on the current expectations of Motorola Solutions and we can give no assurance that any future results or events discussed in these statements will be achieved. Any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date. Forward-looking statements are subject to a variety of risks and uncertainties that could cause our actual results to differ materially from the statements contained in this presentation.

And with that, I would like to now turn it over to Greg.

Greg Brown

Thanks, Shep and good morning and thanks for joining us today. I’d like to share a few thoughts with you relative to our overall business and specifically to the quarter. First, following the sale of our Enterprise business, our remaining business will be positioned as a singularly focused leader in mission-critical communications to public safety and commercial customers. I believe our government business is truly differentiated with an outstanding product portfolio, a vast and global install base, R&D leadership, a great sales and partner network and people that wake up everyday thinking about mission-critical communications. And I am excited about the opportunities that lie ahead of us and believe this business is positioned for solid, profitable growth over the long-term.

I wanted to highlight some key points relative to the Enterprise transaction itself. First, we expect the deal to close by the end of the year or sooner generating cash proceeds of $3.45 billion, which we intend to return to shareholders in a timely manner. This transaction is effectively tax free to us and preserves our deferred tax assets. The deal will include our reported Enterprise segment with the exception of iDEN, which will remain with Motorola Solutions. Approximately 4,500 people will transition to Zebra along with other Enterprise assets and liabilities. Approximately $100 million of stranded costs allocated to our Enterprise segment will remain with MSI following the sale. We are moving swiftly to eliminate or offset these stranded costs and Gino will cover that in more detail in a few minutes.

Now, moving on to the quarter, there are three key points I would like to emphasize. First, sales were lower than we expected during the quarter. Approximately $20 million of the difference is attributable to the Government business, while Enterprise made up the balance as we originally anticipated growth in Enterprise for the quarter. As we previously indicated, aged backlog in Q1 was the primary driver for the year-on-year decline. We also saw additional weakness in overall North America market demand.

Second, we plan to reduce our cost structure to reflect both the Enterprise sale impact as well as the current business environment. While we made solid progress on taking cost and inefficiencies out of our business since we launched MSI at the beginning of 2011, we will accelerate our cost reduction actions in 2014. We have a number of opportunities that we will look at, including reducing our real estate footprint, reducing IT complexity, reducing manufacturing costs, and improving overall supply chain efficiency.

And third and finally, the fundamentals of our Government business remain strong. Our pipeline remains robust and we continue to grow multi-year services backlog in core business – in our core business year-on-year while posting another quarter of services growth. These factors coupled with investments in growth such as areas as public safety LTE, geographic and vertical market expansion and smart public safety have us positioned well for long-term growth.

I will now turn the call over to Gino to provide additional details on our Q1 results and then I will return to provide additional thoughts and color on the quarter.

Gino Bonanotte

Thank you, Greg. Today, we reported first quarter GAAP sales of $1.8 billion, a decrease of 9% from last year. Sales in Government declined 11%, while Enterprise sales were down 4% and less than 1% when excluding the iDEN business. Non-GAAP operating earnings were $212 million or 12% of sales and operating cash flow improved by $77 million over the prior year quarter. On a GAAP basis, net earnings were $0.49 per share compared to $0.68 in the year ago quarter. Non-GAAP net earnings were $0.50 per share compared to $0.66 per share in Q1 of last year. For the remainder of this call, we will reference non-GAAP financial results unless otherwise noted.

Turning to our Government reporting segment, Government sales in Q1 were $1.2 billion, a decrease of 11% from the prior year. The biggest driver of Q1 revenue decline was our North America business primarily due to lower aged backlog, a challenging federal business comparison and lower than expected subscriber orders during the quarter. And while we planned for North America government to be down in Q1 and for the year, overall market demand fell below those expectations.

Our Europe and Africa region grew due to strong TETRA product and services performance driven by a number of large contracts. Asia-Pacific and the Middle East declined low single-digits, approximately $4 million. And our professional and commercial radio business grew high single-digits in the all regions with the exception of North America, which declined by $39 million, reflecting overall market demand weakness.

Operating income in the Government segment was $140 million, down $77 million to 11.7% of revenue driven by the impact of lower sales. Enterprise revenue, excluding iDEN were down $4 million or less than 1% to $573 million as certain deals moved out of Q1. We remain encouraged by the continued customer engagement and momentum in our new products. Operating income in the Enterprise business was $72 million, or 12%, up from the year ago quarter. Improved gross margins and lower OpEx drove the improved earnings.

For total MSI, operating expenses were $639 million, which is down $45 million from the year ago quarter driven by actions taken in 2013 as well as additional actions taken in Q1. These actions include a reduction of our real estate footprint by almost 1 million square feet since the beginning of 2013. This comprises nearly 25 sites, including the sale of a portion of our headquarters in Schaumburg during Q1, which generated $25 million in cash and also the sale of our Reynosa, Mexico manufacturing facility, which closed just a few days ago. The Enterprise sale will provide additional opportunities for optimizing our footprint and fixed costs to align with our more focused business needs.

Giving the Enterprise sale, the pending enterprise sale and current market environment, we are moving swiftly to simplify our corporate structure and reduce additional costs. As such, we plan to reduce approximately $200 million of cost. $100 million which offsets the stranded costs Greg talked of will be reduced in 2014. An incremental $100 million will be removed over the next 18 to 24 months. These savings will come from G&A as well as select areas within R&D and sales and marketing.

Shifting to other income and expense, this line item was a net expense of $19 million in the quarter compared to a net expense of $11 million in the year ago quarter. Our interest expense of $25 million was partially offset by $7 million of gains on the sale of several investments within our ventures portfolio during the quarter. We expect this line item to be an expense of approximately $45 million in Q2. For the remainder of the year, we continue to expect this line item to be an expense of approximately $40 million per quarter, which is primarily driven by $35 million of quarterly interest expense. We expect the Q2 tax rate to be 33% to 34%. Upon the close of the Enterprise sale, we expect our ongoing effective tax rate to be 32% to 33%. Based on our current outlook, we expect our cash tax rate to be in the range of 10% to 15% for the full year 2014. As a result of the Enterprise sale, we now expect a cash tax rate of approximately 15% through 2019, an additional two years.

Moving on to cash flow, cash generated by operating activities in the first quarter was $46 million, a $77 million improvement from the prior year, primarily from the timing of our long-term contract milestone buildings and the return of cash that was seized by the Government of India related to a tax dispute in the first quarter of 2013. Partially offsetting these items, we saw an uptick in inventory at quarter end due to lower than expected sales in both segments. We ended Q1 with $3.1 billion in total cash and $2.5 billion in debt.

With respect to capital return, we repurchased $57 million or approximately 1 million shares at an average price of $66.32 per share. This lower repurchase activity was a result of trading restrictions due to the ongoing discussions leading to the Enterprise sale announcement. In addition to repurchase activity, we paid $79 million in dividends during the quarter. As a reminder, we have approximately $1.7 billion remaining under our current share repurchase authorization. We have repurchased 26% of the net share count outstanding since Q3 of 2011 at an average price of $50.13 per share.

Now turning to our outlook, we expect total company sales for Q2 to decline 5% to 8% with non-GAAP earnings per share between $0.58 and $0.64. For total MSI, we expect 2014 sales to be down low-single digits with operating margins of approximately 18.5%, consistent with our prior outlook. We expect government revenues to be down 8% to 11% for the second quarter. For the full year, we expect government sales to decline low to mid-single digits. iDEN sales are expected to decline by $20 million in Q2 compared to Q2 2013 and approximately $100 million for the full year.

I will now turn it back to Greg.

Greg Brown

Thanks Gino. Now I would like to spend some time on the Q1 results and business units. Our Q1 ASTRO contract wins continued. Some of the large notable contracts included a $113 million system refresh and services contract with the State of Indiana, multiple Latin America military customers worth nearly $60 million, several Canadian first responder and city contracts and Asia Police and Middle East Defense departments. The wins also spanned our portfolio with wins in Phase 2 TDMA systems, APX radios, services, software upgrades and consoles. In Q1, we added three new models to our industry leading APX 25 portfolio and now have a number of product families with targeted derivatives of each product to meet customer needs. The additional radio models include new, small, value based, ruggedized form factors as well as our dual band P25 LTE radio that enables LMR voice and faster over the air data transfer.

On the systems side, we added key software and systems enablement that includes automatic vehicle tracking, a command center application for geographic top group management and software enablement for migrating customer transitions from analog to digital. Our TETRA business grew double digits, driven by strong subscriber shipments and services. Our portfolio position and customer focus continue to drive current success and positive momentum for the future. In Q1 we successfully demonstrated live video streaming over Norway’s Nodnett TETRA network using TETRA enhanced data services. We also earned awards at 2014 TETRA International for best TETRA innovation and best use of TETRA utilities. Our global momentum and TETRA wins continued in multiple verticals such as government, corrections and railroad.

Our professional and commercial radio business declined single digits compared to the year ago quarter driven by lower sales in North America and reflecting lower overall market demand. We had solid single-digit growth in all other regions. Additionally, we are continuing to demonstrate our leadership in this market with our best in class digital portfolio and we continued to invest for growth. For example, we acquired Twisted Pair Solutions, a recognized leader in push to talk over broadband applications for secure, real time communication anywhere and on any device. And finally we see encouraging engagement in both the government and commercial PCR businesses winning major deals with the railroad, a major automotive manufacturer and a multi-million dollar deal in retail.

In addition, we continue to invest for the long-term in our growth areas including public safety LTE, services and smart public safety. In Q1 we expanded our public safety LTE portfolio with the refresh of our LEX 700 to utilize the Android operating system. Additionally, we launched the APX 7000L, a converged device that utilizes LTE for fast data transfer on a land mobile radio voice device. And we are seeing marketplace validation of this focus with the recent wins such as the $175 million LA-RICS contract as well as the previously announced international public safety LTE contract for $100 million.

Additionally we continue to grow our services business that includes traditional network management as well as expanded offerings to include managed service offerings and smart public safety solutions. In Q1 alone we closed eight large service deals with durations as long as 20 years. Additional significant support agreements were also signed with the Public Building Commission of Chicago and the Minnesota Department of Transportation. Lastly three European police departments selected us for multi-year life cycle services as well. These service contracts demonstrate our ability to secure various recurring revenue streams built on our mission critical platforms and services.

Turning to the Enterprise business, which will be reported in discontinued operations beginning in Q2 the Enterprise business excluding iDEN declined $4 million or approximately 1% versus Q1 of 2013. Globally mobile computing declined single digits, offset by single-digit improvements in advanced data capture and double-digit growth in WLAN. In North America, mobile computing was down double digits due to fewer large orders and channel softness, while advanced data capture was up double digits. Europe and Africa was up single digits on strong mobile computing demand and growth across the portfolio. Asia-Pac Middle East was down low double digits primarily in enterprise global computing against strong comps in Q1 of 2013 and several deals being pushed out of the quarter.

The Enterprise product portfolio continues to evolve its industry leading position with the growth of the Android portfolio. We continue to see strong demand for the Android based TC55 and we have recently won a significant multi-million dollar order with a large U.S. retailer for nearly 4,000 units. Additionally, the adoption of Android has been robust with the strengthening partner ecosystems, supported by a significant uptick in partners going from Gingerbread to Jelly Bean and 135 Android applications now certified on our devices. The traction on other new product wins was also notable with a major contract win for 10,000 units of our Smart Badge 1 to CVS. Likewise, we expanded our MP6000 rollout with a major global retailer. And finally, our focus on transitioning our WLAN solution to a more services based model has helped drive a significant double-digit jump in WLAN revenue. Lastly, our product innovation received numerous industry awards as well including the HC1, as an Edison Award finalist, and the VC70, which was chosen for the 2013 Good Design Award and the TC55 Red Dot Award.

Now having said all that let me close with four points on our Government business. First, even though we planned for North America to be down for the quarter and for the year, the overall market demand is lower than we expected. So as a result, I am obviously disappointed in the recent challenges we have had in calling the business. But second, despite this environment we gained worldwide market share in each of our major products in 2013. Third, we still believe in the long-term growth and fundamentals of this business given our pipeline and strong backlog. Our backlog is growing year-on-year, driven largely by multi-year services contracts and we are very well positioned with recent wins in public safety LTE. And fourth and finally, our singularly focused company will enable greater operational efficiency and improved agility. We intend to streamline our corporate structure that improves our operating leverage as we return to growth and given our excess capital, the pending Enterprise transaction and operating cash flow potential, the opportunity still remains for a healthy return of capital.

I will now turn it back over to Shep before we open it up for questions.

Shep Dunlap

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

Question-and-Answer Session

Operator

The floor is now open for questions. (Operator Instructions) Our first question is coming from Tavis McCourt with Raymond James. Your line is open.

Tavis McCourt - Raymond James

Hi guys. I guess my two questions are your – you expected North America business to be down this year, what was the rationale for the expectation, it looks like your biggest competitor in North America is also seeing double digit declines, is there something inherent in the market right now that causing this weakness whether it’s a pause in front of LTE or are we still coming off narrow band I was just trying to understand why it doesn’t seem to be an MSI issue, it seems to be an industry issue? And then secondly just a clarification on the full year guidance, is the full year guidance, including Enterprise or is that with Enterprise as a disco op? Thanks.

Greg Brown

Tavis, thanks. On the first question, I think it’s primarily a North America government issue and I think we underestimated the overhanging impact from narrowbanding. I think that we are still very well positioned for the long-term fundamentals, but to your point, I think it’s more of an industry issue. I don’t think it’s a structural issue. I think it’s a temporary issue given the narrowbanding and quite frankly perhaps even iDEN Sprint network shutdown, because we had record years in 2011 and 2012 in state and local, in ASTRO subscriber and PCR and that’s really what I think it is. We still plan for North America to be down for both the quarter and the year in 2014, but knowing what we know now, I think narrowbanding had a greater impact than we originally thought. In terms of full year guidance, I will turn it to Gino.

Gino Bonanotte

Tavis, in terms of full year guidance, the low to mid single-digit for government that we stated is not inclusive of iDEN. We mentioned iDEN before, mentioned $100 million reduction in iDEN revenue. Was that the question, Tavis?

Tavis McCourt - Raymond James

Let me clarify, so that low to mid single-digit, that doesn’t include the iDEN decline? That’s correct?

Gino Bonanotte

It does not.

Tavis McCourt - Raymond James

It does not. And then the 18.5% operating margin is that inclusive of enterprise or is that government and iDEN combined or just government?

Gino Bonanotte

It’s government and iDEN combined.

Tavis McCourt - Raymond James

But not enterprise?

Gino Bonanotte

Well, it’s actually the same number.

Tavis McCourt - Raymond James

Okay, either way.

Gino Bonanotte

Right.

Tavis McCourt - Raymond James

Got it. Okay, cool. Thanks.

Operator

And our next question comes from Pierre Ferragu with Bernstein. Your line is open.

Pierre Ferragu - Bernstein

Good morning. Thank you for taking my question. So, first of all, Greg could you give us a bit more color on what happened, how things played out between late January when you guided for the first quarter and like a couple of months later when you realized you would not – you would have to announce numbers below your guidance. On my rough mark, you had a shortfall in revenue like in the 3%, 4% region and if you think about 80% of your business being something in which you have a bit of clarity with your backlog as a percentage of the 20% of revenues you had to go after in this quarter, it’s quite a big number. And so any color you could give us on where like the disappointment came from and why you have that much visibility on that? And then from there, if you could tell us how you have been building out your guidance for Q2 in terms of this 20% of the business you have to go after, how much – how do you feel about that, how much risk do you see on that number? And then your full year guidance for government implies quite a second half after all if I am not wrong in my early calculations. And so I am just curious to invest in where you get this confidence from in terms of the second half, where do you think you will have better visibility and if that’s the case, why?

Greg Brown

So, Pierre, I will do my best to recount. You asked a few questions. First of all, on the 80% visibility coming into the quarter, approximately 80% that remains unchanged. You described it well that in any one quarter, we have about 20% to go get coming into a quarter. Given the size of the business of MSI that’s still about $400 million roughly per quarter, what’s different than January is we underestimated the overhang impact of narrowbanding, and as a result, we had the $20 million government shortfall, speaking to government now in Q1, and then we had movement in orders in Q1 and Q2, then I will turn it over to Mark Moon for additional commentary. I think as it relates to our Q2 guidance, it’s our best estimate that we have incorporated into some of the things that we are seeing now, hence the negative 8%, the negative 11% for the Government segment itself. And then on the full year, I will ask Mark to provide some color.

Mark Moon

Thanks, Greg. And I think when we talk about Q1, as we said obviously we knew that we have the gap – we had to convert some orders in Q1 to be able to make the revenue guidance that we have provided. The piece that we had also called out was the impact of narrowbanding, which we underestimated. And Greg also briefly mentioned the Nextel shutdown, which actually led to strong growth in our PCR business the last couple of years and even in the first quarter of last year that spilled over. Gino called out, that was $39 million is well of a miss that we had underestimated. So, as a result of those things and orders not only converting in the quarter, so we were expecting to convert orders that would provide revenue in Q2 and for the rest of year. Now, on re-look, we see many of those orders, approximately $300 million in the first half that have been pushed to the second half.

Now, with that said, the pipeline and our visibility to those orders and orders in the second half is very good. In fact, we continue to have very good engagements and our second half pipeline is over $1 billion stronger than the first half pipeline. So, when you talked at the end about what would give us confidence or risk and the comments that you made around the second half, it is really that pipeline, the fact that we have got a number of contracts that we have received in hand, a couple in particular like LA-RICS and the State of Maryland, that we now have $75 million that is not currently aged in our backlog. And as we move for the full year, remember the second half of last year had a huge decline in federal government. We talked about $150 million decline in the second half. It was the worst second half and the worst full year we have ever had in federal government.

Now, we have budget certainty, which was approved in January, which we didn’t have last year. The pipeline is reflecting a ramp up from the government shutdown and some pent up demand. So, at the end of the day, we really have good visibility to what we are calling throughout the rest of the year. And from a federal perspective, we are really only assuming modest growth for the full year. Even though it will be a $70 million increase in the second half, only very modest, less than 20% growth for the full year again coming off the worst year we have had.

Greg Brown

Next question.

Operator

Thank you. We will next go to Simona Jankowski with Goldman Sachs. Your line is open.

Simona Jankowski - Goldman Sachs

Hi, thanks very much. I have just a couple of questions. The first one is as I recall for most of last year, you were seeing a higher mix shift of infrastructure sales. I think you might have said that it was a double-digit increase and historically we see a follow-on effect with higher device sales, which were in fact weak in the quarter you just reported. Can you just walk us through that dynamic a little bit? Would you still expect those follow-on device sales and there might have been some reason for why they didn’t come through, but they should still come through in the rest of the year or there is something different about those infrastructure sales last year?

Mark Moon

Simona, this is Mark. We don’t really see anything different about infrastructure sales. And as you talked about into the comments that we made early, was that subscribers were less than we had anticipated in the quarter. In fact, we continue to have stronger infrastructure sales which we are positive about. We also continue to have stronger multi-year services sales, which are building very strong backlog, but not necessarily feeding revenue in the very short-term. When we talk about the Nextel shutdown and when we also talk about narrowbanding, which pulled a lot of new infrastructure or accelerated infrastructure into the year that also led to some subscriber acceleration, which led to the piece that we talked about here in Q1 and Q2. As an overall result, we still expect we believe our portfolio is in wonderful shape. We mentioned a couple of new models of our industry leading APX portfolio. We still expect subscriber growth to return as we move forward.

Simona Jankowski - Goldman Sachs

Okay. And then my second question was on the new APX 7000L, which I think is your first converged device that handles both LTE data and LMR voice. So, that seems to be a change relative to how you initially were approaching this market with separate LMR and LTE devices. And so I was hoping you can talk about the strategy there a little bit? And also if we think about this device relative to an equivalent LMR-only device, what would be the like-for-like ASP list?

Mark Moon

There is really no change in strategy. In fact, we have always talked about we will continue to lead in our mission-critical voice portfolio. And as we have talked about, we believe we will also lead in public safety LTE portfolio, both in infrastructure and devices. We have often talked about the end to end portfolio and services component that we believe we will offer that none of our other competitors will. This first converged device we think is what the industry will ultimately want to go to. We know that customers, as Greg mentioned LA-RICS earlier will look to have devices like that that are able to both handle LMR and LTE. There will also be the need for collaborative devices and most customers will like that, dual devices LMR device and a LTE only device, which will also feed that portfolio both with devices and with modems as we go forward. So all in all, it’s strictly own our strategy of record. We actually, again believe we are leading. We are excited about this new product. And the ASPs will be slightly, again as you would think, this is complementary to having more features, more capabilities and the ASPs will be slightly higher than what you would see in a traditional LMR or P25 device.

Simona Jankowski - Goldman Sachs

So just to clarify, I think in the past you had talked about LTE as kind of an incremental multi-billion opportunity, which if it was an incremental device I can sort of see how that could happen, if this is really still the same device but with more features and a slightly higher ASPs, would that still support that kind of large incremental opportunity or should we just think of it as more of a slight ASP mix shift effect over time but not really a multi-billion increment?

Greg Brown

I will let Mark answer, but Simon I think we still see it as an incremental multi-billion dollar opportunity over the long term both infrastructure and subscriber devices. There are people but – some that will keep different devices, video or data only and voice LMR. There are some that will go with converged devices. And for some with converged devices it’s not just necessarily an ASP potential lift but it could also be an event over time to upgrade subscriber radios. So it really doesn’t change the way we have looked at it and we still see LTE and public safety LTE as being incremental to the land mobile radio business.

Mark Moon

Yes. Just complementing, I think it’s just – this new announcement is another device in our overall portfolio. As you are aware we had announced last year a LEX 700 device that was actually Microsoft based. We have now come back with a Google upgrade of that as well or Android upgrade. We will also announce this device and there will be a series of devices just like we do in the LMR portfolio, we will continue to build out that subscriber and device portfolio for public safety LTE.

Simona Jankowski - Goldman Sachs

Great. Thank you very much.

Operator

And our next question comes from Ehud Gelblum with Citigroup. Your line is open.

Ehud Gelblum - Citigroup

Hey guys. Can you hear me?

Greg Brown

Yes.

Ehud Gelblum - Citigroup

Awesome. Thanks. So first thing on narrowbanding, I am glad that you are starting to see that it probably had more of an impact. It did kind of end a year and a half ago mostly in 2012 even though there is a little bit of an impact probably in 2013, when you are looking at your long-term growth rate and you are basing it on historical numbers, narrowbanding obviously didn’t just happen in 2012, it was something that was out there for a number of years five, six, seven years and kept being pushed out, so there is a chance that narrowbanding may have had an impact to your growth rate numbers for five, six years even before you split off from Motorola Mobility, how do you get a handle on what the true underlying growth rate is to give you confidence on your long-term growth rate of 2% to 3% versus thinking that maybe all the historical numbers that you have looked at may actually not be necessarily indicative of what’s going forward putting aside LTE. And then I have got a follow-up on operating margins. Thanks.

Greg Brown

So maybe we will tag team it. But I think if you normalize the way we think about it is normalize for the record years of 2011 and ‘12. And then maybe even to your point, maybe it’s a little bit longer than that in anticipation. It’s still from last 7 years or last 10 years, the average historical compounded annual growth rate is about 4%, 4.5%. But forgetting the rear view mirror looking forward, we still believe really the long-term fundamentals remain sound. We still believe that mission critical communications remains an utmost priority. We still look at the multi-billion dollar install base internationally as an addressable market opportunity to upgrade. We have talked about the fact that there is about 10,000 plus systems, 16% more than 10 years old. When you look at the PCR radio business and that base 35 million or 40 million PCR radios worldwide, 90% analog, 10% digital. There is the opportunities for growth that are geographical and vertical market expansion in our core mission critical business. As we provide more long-term services contract and lock a customer up for the long-term, it protects the customer base. It allows for technology refresh. It allows for more long-term annuity revenue streams. And then lastly is public safety LTE, which we believe as earlier stated is incremental. The U.S. and other countries are taking a business model that dedicates or allocates the spectrum, which is the model we believe is appropriate that will allow for public safety LTE infrastructure and incremental subscriber demand on top of that. So that’s what we believe – not just historically, but we believe in the longer term growth drivers to get this to a low to mid-single digit business.

Ehud Gelblum - Citigroup

So you think it’s about let’s say about two or three?

Greg Brown

I mean we – I don’t want to be that precise given some of the recent challenges we have had I would just say low to mid.

Ehud Gelblum - Citigroup

Okay. On operating margin, if you just look historically at the pattern, Enterprise in 2010 and ‘11 had a higher operating margin than Government did, primarily because iDEN was in that mix, 2012 Government took over and was higher in terms of margin, more profitability and same with 2013, it looks like from, Gino your comments that both Enterprise and Government will have the same 18.5% operating margin this year. When you say that I am not 100% sure from the prior question whether where you are putting that corporate overhead, the $100 million dollars, is that in the Government that get – when you said they both have 18.5%, is that...?

Gino Bonanotte

Yes. So Ehud, just so I am clear when we talked about 18.5% we talked about approximately 18.5% for total MSI and approximately 18.5% for Remainco. In Remainco, in Government, the stranded costs are in Government. The $100 million of actions to offset those stranded costs that we will execute on in 2014 are predominantly Government segment actions.

Ehud Gelblum - Citigroup

So then the $100 million additional in the next 12 to 18 months on roughly a $6 billion Remainco total gives you another 150 basis points with no – assuming no revenue growth of operating margin expansion, we would assume that going forward that as revenue grows therefore, so is that $100 million taking your OpEx from now and taking $100 million out, and that’s your OpEx number or is OpEx going to grow from revenue growth and then $100 million off of what it would have been otherwise, because if you grow 3%, you will grow the top line about $100 million and you will expand operating margin that way in which case we could be go 200 to 300 basis points of operating margin expansion. If you can just help us understand what happens to OpEx as revenue grows, I guess, vis-à-vis the $100 million OpEx…?

Greg Brown

Clearly as revenue grows, there is opportunity for operating leverage. The commentary around cost reduction was the $200 million you think about it in terms of Remainco, $200 million is approximately a 10% BGM reduction on Remainco. Obviously with revenue growth, we have the opportunity for operating margin expansion.

Ehud Gelblum - Citigroup

On the current OpEx level though, can you handle 3% revenue growth or will operating margin – operating expenses have to grow with a 3% top line, let’s say?

Gino Bonanotte

Without getting into modeling ‘15 and ‘16, there may be slight OpEx increases, but we believe that we will be able to expand operating margin and we will have operating leverage when we return to growth.

Greg Brown

Yes, Ehud, as Gino said, $100 million is to be taken out. The target is to take it out this year. There is another $100 million beyond that. We are targeting about $200 million. By the way, there could be more than that. If there is, we will pursue that accordingly, but it’s a below gross margin target. And Gino is right. There could be some uptick as the business returns to growth. But our goal is to size the business to a lower fixed cost model and a cost basis that’s a reflection of more of a pure play simplified corporate structure. So since we are the Remainco business that spun off Mobility, which is mobile devices and set-top boxes, we monetized the network business and sold it to Nokia Siemens. We are doing what we think we are very excited about the Enterprise transaction to Zebra. We have had good customer feedback on putting those assets together for a pretty compelling end-to-end Enterprise Mobility play. We are simply saying that while we have taken action, there is room for more in the areas that we talked about, real estate, IT, supply chain, G&A and we are going to size the business as a reflection of our more simplified structure. And this is the time to do that.

Ehud Gelblum - Citigroup

Great. Appreciate it. Thanks guys.

Greg Brown

Yes.

Operator

And our next question comes from Keith Housum with Northcoast Research. Your line is open.

Keith Housum - Northcoast Research

Thanks guys. I appreciate the opportunity to ask question. I guess first question on your gross margins, gross margins were down for the quarter. Hoping you can give me a little bit of color on that? I am assuming a little bit is probably due to just the lower volume, but yet I see services are down significantly, I guess quarter-over-quarter. If it’s Government-related, Enterprise-related, just any color you can offer there?

Greg Brown

Sure. With respect to gross margin, it’s really a function of – we are not seeing ASP erosion in the Government segment within any specific products. So, it’s a function of higher infrastructure and deployment services versus subscribers as well as higher TETRA volumes versus ASTRO and services growing faster than the overall business, which has an impact on gross margin, but with a similar OE profile. As well, the impact of a lower iDEN number impacts the gross margin percentage as well.

Keith Housum - Northcoast Research

Got it. So, in general, does TETRA have a lower gross margin than ASTRO?

Greg Brown

Yes.

Keith Housum - Northcoast Research

Okay, got it, got it. And then next question, I guess is more on competitive threats going forward and perhaps I don’t understand the acquisition of Twisted Pair Solutions and what they do so much, but can you speak to I guess a competitive threat or is there a competitive threat with public safety forces, who perhaps don’t need the mission-critical device, but have used one historically say like a police chief or fire chief, is there a threat of those guys using a consumer device, where previously they perhaps did not? Is that a concern going forward?

Mark Moon

I think if you look at those type of executives in policing as you just kind of described, most of them are carrying dual devices today. They carry a radio. They also carry a cell phone. So primarily, when you think about the Twisted Pair acquisition, it really wasn’t targeted at that executive level of public safety even though it could be, but take a similar example in the commercial space, where you have a plant manager that may not want to carry a radio, that carries a cell phone, but maybe more to make from that cell phone, a push-to-talk call back to folks within the plant or within the manufacturing facility. That Twisted Pair combined with our MOTOTRBO Anywhere gives that capability. So, that could also be applied to an executive within public safety. And as we look at the Twisted Pair technology, we certainly are also leveraging that capability and technology as we move in our public safety LTE direction. But all-in-all, mission-critical voice is still a constant, it’s still a priority. And throughout the world, public safety still is moving and continuing to see the importance of mission-critical voice.

Greg Brown

Just one additional item, Keith is probably the closest substitute to mission-critical voice that was available has been available historically was really the Nextel, the iDEN technology in terms of setup time, in terms of one to many groups. And through the Nextel period, we saw growth in mission-critical voice. So, we believe that mission-critical voice continues to be very important. And there is really, from a substitution perspective, there is nothing available that really shares the attributes in terms of a hardened network, call setup time, one-to-many that we offer in our voice.

Keith Housum - Northcoast Research

So, if I understand correctly from what you are saying, it is not asked by a threat of those, I guess, unique individuals who perhaps have previously had a radio, they can now use a consumer device like a phone with a software solution? As you are saying that’s not necessarily a threat to the overall sale of devices?

Greg Brown

As a matter of fact, I think it’s an opportunity to combine, as Mark said, someone who traditionally perhaps would not interact with a fleet, with an LMR fleet, they have the ability on their device to talk to a plant manager that leaves the plant or anyone who leaves the coverage area would have the ability to interface on an LMR network.

Mark Moon

So, there is a lot of conversations, Keith about over-the-top push-to-talk exactly what you are just describing. And where we are saying that application if it’s getting any traction is in the commercial space, we are seeing almost zero traction in mission-critical voice because of the attributes that Gino described.

Keith Housum - Northcoast Research

Got it. Alright, I appreciate it guys. Thank you.

Operator

And our next question comes from Tim Long with BMO Capital Markets. Your line is open.

Tim Long - BMO Capital Markets

Thank you. One for Gino, one for Greg. Gino, you talked a little bit about the gross margin in the quarter, understanding mix going forward, that will change around, but it sounds like some of Greg’s initial comments talked about supply chain manufacturing costs and some efficiencies to be gained more on the gross margin line. So, just talk to us a little bit about mix aside what type of benefits we could see from some of the more gross margin-focused actions? And then Greg, I am just – this is certainly at least the second year in a row where we are seeing pretty backend loading of the year. So, do you think that’s the trend or that’s the norm from now on and maybe have to plan the business accordingly or do you think it’s just a coincidence that it’s been two in a row where we have gotten off to pretty weak starts in the year? Thank you.

Greg Brown

Well, let me do the second one and then Gino will talk gross margin. I think they are different. I think if we look at last year, the challenge we had was the unprecedented second half drop of our federal business. We have never seen it decline to levels in 10 years plus on the second half of last year. This is a Government business comment. And that being of course, no budget and the government shutdown, which happened – hasn’t happened in about 20 years. That was a unique pressure point on the Government business in the second half. And then last year, of course, we had the Enterprise business and the cyclicality of that and trying to call its recovery. I think this is different. I think about this Government business and this is more of a narrowbanding, we believe overhang. So, I think the causes are necessarily different last year and this year. And I wouldn’t necessarily conclude, Tim, that it’s a trend longer term. We are just trying to comment on what we see this year and I think the factors are different – a little bit different this year than last.

Tim Long - BMO Capital Markets

Okay.

Gino Bonanotte

Tim, on gross margin we talked about Q1 and we talked about some of the differences between products and products versus services and the impact in Q1. Going back to Greg’s comments on additional opportunities, we are around this idea of becoming singularly focused on one segment and reducing our structure and reducing fixed costs. An example of that would be I mentioned the Reynosa, Mexico facility, manufacturing facility that we had that we sold just announced a few days ago. So, we believe there are opportunities within IT to reduce complexity and simplify within our real estate footprint, manufacturing footprint to reduce complexity and simplify that will lead to a lower breakeven and a better cost profile. I mentioned the million square foot reduction since the beginning of 2013, I think it’s instructive to note that since spin, we have had a 5 million square foot reduction, about 40% of our total square footage from spin to now has been reduced as well as 40 sites that have been closed since that timeframe. So, that work will continue and it will continue at an accelerated pace given the new MSI profile.

Tim Long - BMO Capital Markets

Okay, thank you.

Operator

And our next question comes from Peter Misek with Jefferies. Your line is open.

Peter Misek - Jefferies

Good morning. Maybe go back to the long-term growth rate and try and tackle it a different way, maybe you can give a sense for the install base of physical equipment and infrastructure domestically, any kind of rough age you can give us on that and maybe how that relates to LTE and FirstNet? And then I had a question on cash return.

Mark Moon

So, when you think about the age of the infrastructure, I think Greg may have mentioned it, but about 60% of the infrastructure that’s deployed is over 10 years old, so relatively aging. 90% of the devices that are out there today are still analog have not moved to digital. As you know, the new technology is moving all to digital. So, the install base that is there is certainly in a position to be churned. And given our portfolio, we think there are capabilities that will also besides just aging push for some of that churn because of new features and functionality, new capabilities that are now available in our portfolio and through digital technology. As far as the LTE piece of that what we are seeing today is no impact on the traditional mission critical technologies from LTE. In fact, LA-RICS is a wonderful example where they just procured in a similar time the LTE network and a mission critical P25 network. The customer that’s in Europe that we described a quarter ago for $100 million also is deploying a mission critical P25 technology. So the capabilities of each are different. One is about big data and being able to have video and situational awareness. The other is primarily about mission critical voice and the other features and capabilities that we have talked about for many years.

Peter Misek - Jefferies

Any way you can give us a size of that install base that is, you said over 60% of the install base is 10 plus years old, any way that we could sort of size that install base?

Mark Moon

Yes. Pete, it’s several billion. But I would leave it at several billion. We will try to give some more color I think as we go forward.

Peter Misek - Jefferies

Because I think if you step back and you try and get a sense for that size, how much longer they could extend that life, what the savings are by moving to some of the newer mission critical voice and then by layering in the advantages of LTE, maybe that can help us get a sense for whether that long term growth rate you have put out there is really easily achievable or stretchable. Just in terms of cash return, obviously you are hoping the Enterprise deal is going to close here sooner rather than later, maybe you can articulate how you are thinking of splitting up that cash return, is it a bulk in terms of share repurchase and should we think of a tender offer for your shares as a way of using that cash up appropriately or are you going to hold it on your balance sheet and divvy it up over time in dividends and share repurchases and small acquisitions? Thank you.

Greg Brown

So Peter, I think the – as we stated in the call a couple weeks ago, the intent is to return the proceeds of the transaction in a timely manner. We haven’t articulated and we will continue to work through exactly what form that takes and we will update you on that soon. But it is not our intent to hold that cash on the balance sheet.

Peter Misek - Jefferies

So you would anticipate that shortly after the close of the enterprise transaction there would be a capital return on that?

Greg Brown

Yes. We will return it in a timely manner and we will update you when the time is appropriate.

Peter Misek - Jefferies

Perfect. Thank you, guys.

Operator

And our next question comes from Rod Hall with JPMorgan. Your line is open. Rod Hall, your line is open. And we will now move to Brian Modoff with Deutsche Bank. Your line is open.

Brian Modoff - Deutsche Bank

Good morning, guys. Just one question, really can you give an update on FirstNet, where do you see it at, when do you – are we still looking at early next year for an impact on that, just any color you could provide would be appreciated? Thank you.

Greg Brown

I think we continue to work pretty closely with FirstNet and we are successful in working with them and the customer for LA-RICS. We continue to stay closely engaged with them. Mark Hacker is our lead General Counsel and one of the key operating executive interface points into the FirstNet group. And I will have Mark maybe make a little additional commentary on where we are, as well.

Mark Moon

So as Greg indicated, I think they continue to move down a path from their original plans to deploy this nationwide network. Their current announced intent is to release additional RFPs towards the end of the year which would say the response would move into next year, so it would probably be late next year, later in the next year for real activities to take place. I will let FirstNet speak to the timing but that’s just extrapolating from their announced RFPs, a response and evaluation from those RFPs and then the direction they would need from that point.

Brian Modoff - Deutsche Bank

So we are looking at more of a ‘16 timeframe for when we really start to see the ramp in that business?

Mark Moon

Again, I think when we think of the LTE, we have talked about both FirstNet but also internationally. So we have talked about the real ramp being in the latter part of next year and into ‘16, I think FirstNet will fall into that same equation.

Brian Modoff - Deutsche Bank

Okay, thank you.

Operator

And this does conclude the question-and-answer session. I would now like to turn the floor back over to Mr. Shep Dunlap, Vice President of Investor Relations for additional or closing remarks.

Shep Dunlap

Thanks. I just want to remind everyone that details outlining the highlighted items, our GAAP to non-GAAP P&L reconciliations and other financial information can be found on our website. An audio replay, together with a copy of today’s slides will also be available on the site shortly after the conclusion of this call.

As mentioned at the outset, during this call, we made a number of forward-looking statements. Within the meaning of applicable federal securities laws, such forward-looking statements include, but are not limited to comments and answers relating to the following topics: long-term growth and profitability of government, sale of our Enterprise business, including timing and return of proceeds, cost reductions and their impact, outlook relating to sales, EPS operating margins, OpEx and gross margin, amount of other income and expense, amount of quarterly interest expense, future tax rates, share repurchases and dividends, time and impact of new product solutions, services introductions, including public safety LTE, timings of orders and contracts and impact on future revenue. Because forward-looking statements involve risks and uncertainties, MSI actual results could differ materially from those stated in these forward-looking statements. Information about the factors that could cause and in some cases have caused such differences can be found in the morning’s press release on Pages 10 through 21 on Item 1-A of our 2013 Annual Report, Form 10-K, and in our other SEC filings. Thanks. And we will be looking forward to speaking with you soon.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. A replay of this will be available over the Internet in approximately 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. Have a wonderful day.

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