ARRIS Group Inc. Q4 2008 Earnings Call Transcript

Feb.11.09 | About: ARRIS International (ARRS)

ARRIS Group Inc. (NASDAQ:ARRS)

Q4 2008 Earnings Call

February 11, 2009; 5:00 pm ET

Executives

Bob Stanzione - Chairman & Chief Executive Officer

Dave Potts - Executive Vice President and Chief Financial Officer

Bruce McClelland - President of the Broadband Communication Group

Larry Margolis - Executive Vice President

Jim Bauer - Vice President of Investor Relations

Analysts

Todd Cooper - Stephens & Co.

Blair King - Avondale Partners

Mark Sue - RBC Capital

Greg Mesniaeff - Needham & Co.

Simon Leopold - Morgan, Keegan

Larry Harris - C.L. King

George Notter - Jefferies

Ehud Gelblum - J.P. Morgan

John Vinh - Collins Stewart

Operator

Good day ladies and gentlemen and welcome to the fourth quarter 2008 ARRIS Group Incorporated earnings conference call. My name is Jerry and I’ll be your operator for today. At this time all participants are in a listen-only mode. We will be conduct a question-and-answer session towards the end of the conference. (Operator Instructions)

I would now like to turn the call over to Mr. Jim Bauer, Vice President of Investor Relations; you may proceed sir.

Jim Bauer

Thank you Jerry and welcome all to the ARRIS conference call with management today. We’re going to discuss our fourth quarter and full year 2008 financial results, which you probably seen we released after the close of markets today. We’ll also be using a series of slides during the webcast and they’re posted on the ARRIS website, in the Investor Relations section.

With us here at the ARRIS headquarters are Bob Stanzione, Chairman and CEO; Dave Potts, our Executive Vice President and Chief Financial Officer; Bruce McClelland, President of Broadband Communication or the MCS Group and ARRIS Executive Vice President, Larry Margolis. There will be a replay of this entire call available approximately two hours after the conclusion of this call and the replay of the call will then be available on our corporate website for the next 12 months.

Before we begin, I’d like point out that during the call we will be making or we maybe called upon to make forward-looking statements, including statements regarding our outlook and expectations for the industry in general, estimated revenue and earnings for the first quarter of 2009, our outlook for 2009, certain operating metrics, estimated future goodwill impairment charges, the timing and introduction of certain new products and technologies and as well as spending patterns by some of our customers.

It’s important to note that the actual results may differ materially from those suggested by any forward-looking statements which may be made today during the call, but for any further information in this regard and for specific examples of risks that could cause actual results to differ, please check with our recent filings with the Securities and Exchange Commission.

Well Bob and Dave are now going to provide their comments on our results and any other topics that you may wish to discuss this afternoon, after which we’ll open up for your questions-and-answers, but lets turn this session over to Bob Stanzione.

Bob Stanzione

Thanks Jim and welcome everyone to the call this afternoon. I am pleased to report today that our December quarter turned out quite well. We had a late surge of orders coming in from Comcast, the Liberty Media companies and a few others and in spite of the overall environment, our business faired well in the second half of 2008, primarily because of the strong DOCSIS 3.0 sales.

Now let’s look at chart four. In the fourth quarter, our CMTS business set more new records. By any measure, whether its downstream ports, revenue, market share or profitability, this business put in a really strong performance in the quarter.

Downstream shipments rose 12% sequentially to just shy of 33,000 ports and the international CMTS sales were 37% of the total, with notable expansions into Germany, Japan, several Eastern European countries and Latin America. The strong performance of our CMTS business comes after a stiller third quarter, for which Infonetics Research group reported that our market share had continued to grow reaching 40% worldwide.

Total CPE sales for the quarter of just below 1.6 million units were comparable to the third quarter volumes. Our market share in this category continues to be above twice that of our nearest competitor. These CPE shipments included a small number of our new DOCSIS 3 units and we do see a large DOCSIS 3 upgrade cycle coming, but probably not until late in the year.

As we’ve seen in previous periods, our ATS business segment continues to be impacted negatively by the weak economy, which is resulting in very little infrastructure spending. Nevertheless, margins in the ATS segment were up in the net in the quarter, due to the relative strength of our optical product sales and actions that we’ve taken to reduce factory costs.

Within our MCS segment, revenues were down about $1 million and margins decreased due to delays in the official acceptance of a large work assurance project and a mix shift toward our On-Demand and Ad insertion products.

Now turning to chart six, Dave Potts is going to go over the financial results, including the goodwill impairment estimate, but I do want to draw your attention to the underlying performance on gross margins and cash generation in the quarter. Gross margins reached another new record of 37.2%. These improved margins are a result of the strong mix of CMTS sales, as well as our continued cost reduction efforts and the stable pricing for our key products.

Cash from operations of just over $100 million was just outstanding and of course as you know, cash doesn’t come in to ARRIS evenly throughout the year, but it’s very encouraging to note that even in these tough economic times our receivables are in excellent shape and DSOs actually decreased by two days in the quarter. As you can see, the team’s done a really great job of managing working capital.

Now to chart seven; we certainly accomplished a lot in 2008 and the integration of C-COR was certainly a headline. With C-COR we’ve diversified our customer base and expanded our product lines. We’ve achieved the promised energies and financial profile improvements. Now, we’ve clearly raised the stature of our company in the industry and in 2008 we exceeded $1 billion of sales for the first time in our history.

We generated a $189 million of cash from operations compared to $63 million in 2007 and we used $35 million to pay down some debt and we used $76 million of our cash to repurchase 10% of our shares. Before at year end, we passed the $1 billion milestone for worldwide installed base of our C4 CMTS and we led the industry in the introduction of DOCSIS 3.0 which is a new generation of high speed data equipment and we improved our market share all around the world.

It’s also notable that within our MCS segment, our Ad insertion, our Video-on-Demand and our assurance OSS businesses all recorded record revenues in 2008. I am particularly proud of the fact that our gross margins for the full year increased by 670 basis points and fourth quarter gross margin was up 1160 basis points over the fourth quarter of 2007.

We achieved excellent operational efficiencies with overhead expenses including SG&A and R&D at just 22.4% of sales. This focus that we have on operational fixed efficiency is one of our best competitive advantages and it serves us well in these tough times.

Chart eight; I’d like to summaries on 2008, by saying that we enter 2009 with a strong balance sheet, a solid cash position, leading market shares in our key product lines and a sustainable business model with great growth potential and we have just a fantastic talented and experienced employee team that’s focused on the continued growth of our company.

Now let’s looks at the chat nine for the Q1 outlook. As you’ve seen from the guidance we anticipate the slow start during the first quarter of 2009. In general, our customers are taking a very careful look at their capital expenditures and they’ve been slow to start deployment of capital.

We expect Comcast, which accounted for almost 42% of our Q4 revenues to take a breather in Q1, while they deployed a large amount of equipment that we shipped to them at the end of last year. However, the biggest factor effecting our first quarter is the weak economy. In 2008 as the year-ended, we saw diminishing net ads of Voice over IP and high speed data subscribers, as well as continued weakness in the infrastructure parts for our business.

Let’s go to chart 10 and look beyond Q1 to the rest of 2009. We believe though, that in spite of these macro factors, a number of signs indicate that the pace of our business will increase as the year goes on. For example, Comcast again, continues to publicly assert their intent to have DOCSIS 3 service available throughout their network by mid to late 2010 and therefore their business with us should accelerate beyond the first quarter.

We see similar signs with other domestic and international operators and we anticipate they’ll follow a similar path as internet traffic and the need for additional capacity continues to grow at a phenomenal rate.

This summer we’re going to be introducing a new smaller version of our C4 CMTS; it’s called the C4C or the Compact C4. Our flagship C4 addresses a large majority of the operator’s network. However, there is still a substantial footprint that doesn’t require the port counts of such a dense product. The C4 reuses the line cards in the software on the C4, but as a smaller form factor perfectly suited for smaller head-ends.

Our customer have told us that there is a substantial installed base of legacy equipment that needs to be upgraded to DOCSIS 3 and we think this will be the perfect solution for them. We’re showing this first version of this product at the Cable Labs Winter Conference earlier this week and the feedback has been very encouraging.

We also have several OSS assurance projects in the hopper, as MSO’s continue to look for ways to increase customer satisfaction without adding expense. This trend continues unabated despite the economy and we expect to close several new deployments as well as add a lot of new licenses to existing one’s as the year unfolds.

Sales in Latin America should continue to growth as competition between Telmex, Telefonica and many of the others continue. Similar to the U.S. environment, triple-play service offerings are the main weapons in the battle for the consumers entertainment and communication dollars and as the penetration of PCs in these countries increases, so will the demand for more bandwidth.

We are also excited about the growth of our business in Japan. Clearly the bandwidth war there is on a totally different level with direct fiber alternatives, much more prevalent than in the U.S. As a result our CMTS business in Japan has grown to serve over 40 operators and we’re working hard to grow on that very solid base of business. As I mentioned earlier, we expect the adoption of DOCSIS 3, CPE to begin in earnest later in the year.

So, in summary the fundamental factors driving our future growth remained as strong as ever; the intense competition that our customers are facing and the phenomenal growth of internet traffic. So we believe that despite the slow start 2009 can and will be another good year for ARRIS.

Okay, Dave would you present the financials.

Dave Potts

Sure, thanks Bob and thank you everybody for joining us this afternoon. Let’s start by reviewing some financial highlights on chart 12, if we could please. Now, sales were $292.4 million in the fourth quarter, up approximately 17% from $249.6 in the fourth quarter of last year. The increase reflects the addition of C-COR. Including the revenues which C-COR reported last year, sales in the fourth quarter of 2007 was $311.9 million.

Gross margin was 37.2% in the fourth quarter, up from 35.7% in the third quarter of ’08 and 25.6% in the fourth quarter of 2007. Including C-COR, the fourth quarter 2007 gross margin was 28.2%; it’s obviously we’re just very, very pleased with that result.

SG&A and R&D totaled $66.2 million in the fourth quarter and was up approximately $23 million year-over-year, primarily as a result of the acquisition. SG&A and R&D in the fourth quarter of 2008 were down approximately $15 million as compared to the estimated combined expenditures of ARRIS and C-COR for the same period in 2007. Included in this estimated expenditure, were certain deal related costs that C-COR incurred prior to the close.

Our adjusted non-GAAP EPS was $0.25 in the fourth quarter, which compares to $0.16 a year ago and $0.24 in the third quarter and providing guidance on our last call, I mentioned that our fourth quarter GAAP and non-GAAP results will include about a $0.02 per share for tax benefit from the passage of the R&D tax credit legislation; now this of course has come to fruition. Our Q4 2008 GAAP EPS was a loss of $1.09 per share, in comparison to a profit of $0.08 per share in the fourth quarter of 2007.

Some significant things to note; first, is a $175 million or $1.41 per share preliminary estimate of goodwill impairment we recorded in the fourth quarter of 2008. In 2007, we had a $6 million or a $0.05 per share write-off of in-process R&D, associated with the acquisition of C-COR, which do not repeat in 2008.

Next is the amortization of intangibles related to the C-COR acquisition, which was an after-tax expense of approximately $0.05 per share in the quarter. One last large item to note is a preliminary tax benefit of approximately $18 million or $0.14 per share related to deferred taxes associated with the goodwill impairment. I’ll touch on taxes a little bit more in a moment. The reconciliation of our GAAP to non-GAAP earnings is attached to the press release and can also be found in our website.

Cash and short term investments ended the fourth quarter at $427 million, up approximately $98 million from the end of last quarter. We generated approximately $103 million from net operating activities in the quarter, a stellar result which I’ll elaborate on in a few minutes.

Let’s turn to chart 13 where we provided some year-to-date highlights. For clarity, in addition to providing year-over-year GAAP comparisons, we again have provided comparisons to estimated 2007 combined results of ARRIS and C-COR. Let me touch briefly on a few of the line items.

First, reported sales were up just over a $150 million year-over-year, as a result of the C-COR acquisition. When compared to the estimated combined sales of ARRIS and C-COR, sales are down approximately $129 million year-over-year.

Operating expenses decreased $26 million year-over-year including C-COR. Please note that approximately $15 million of that decrease relates to cost of C-COR recorded pre-close that are related to the acquisition. Of the remaining $11 million, SG&A is down $17 million, while R&D is up approximately $6 million.

With respect to GAAP EPS, it is important to note that certain items have a very large impact; in particular the goodwill impairment in 2008, the write-off in process R&D in 2007 and the significant gains from the Tandberg deal in 2007. Once again, I refer you to the reconciliation of our GAAP to non-GAAP earnings which I think will provide you with some very good insight.

Let’s move to chart 14 and review some of the details with respect to sales. Our reported results compare our new combined company in 2008 to the former ARRIS standalone in 2007. To help you better understand the trends, on our website is a summary of sales and gross margin by segment as reported and including the former C-COR results.

Let’s first focus on the sales by segment bar chart on the top-left comparing our reported sales by segment. BCS sales were $225 million in Q4, up from the third quarter of $217.8 million, primarily as a result of strong sales of CMTS. Versus the same period last year BCS sales were up by $8 million as a result of higher CMTS sales offset by lower EMTA sales.

ATS sales were $50.5 million in Q4 2008 and compared to $62.1 million in the third quarter of 2008. We continue to see a decline in infrastructure spend by our customers. MCS sales were $16.9 million in Q4 ’08 when compared to $17.7 million in the third quarter.

Let's move to the bar chart on the bottom left. Here, we provide a comparison of the combined sales of the former ARRIS and C-COR and we also adjust for estimated purchase accounting impacts, which at this point are minor. ATS sales were $50.5 million in the fourth quarter and compared to $78.3 million in the fourth quarter 2007 on a combined basis. Both AT and Supplies are down. The economy is fighting the center; the slowdown in housing activity has led to less new plant and plant extension projects.

MCS sales were $16.9 million in the fourth quarter of 2008, including the estimated deferred revenue purchasing accounting impacts, compares to $16.7 million in the fourth quarter of 2007 on a combined basis.

The pie charts on the top right provide domestic versus international splits. Please note that this analysis includes the former C-COR sales in prior periods. As you can see, our international mix is up from the third quarter of 2008. International sales were $83.5 million in the fourth quarter when compared to $77.5 million in the third quarter.

One final comment on sales, we have three 10% customers in the quarter; Time Warner, Comcast and Liberty Media. Sales to Time Warner were $45 million in the fourth quarter and compared to $44 million in the third quarter of ‘08. Sales to Comcast were $119 million, up from $101 million in the third quarter of 2008 and compared to $97 million on a combined basis in Q4 2007. Liberty Media was a 10% customer in the fourth quarter largely due to the launch of the DOCSIS 3.0 services.

With respect to our order backlog and book-to-bill ratio, we ended the fourth quarter with a backlog of $115 million, which compares to $144 million at the end of Q3. Our book-to-bill ratio in Q4 was 0.9, which compares 0.79 in the third quarter.

Let’s turn to chart fifteen where we provided some year-to-date sales highlights. On this slide we’ve provided the same sales data for you for the full year. Some takeaways; as reported our sales were $1.145 billion, which of course is up year-over-year as a result of the acquisition. On a combined basis and adjusted for deferred revenue impacts, our full year sales are down approximately $113 million, within that there is some key items to note.

First, sales to Comcast are down about $100 million year-over-year. The decline is primarily a result of the reduction in their EMTA purchases from us in the first half of the year. ATS sales are down $85 million year-over-year as our customers are spending less on infrastructure product. Sales to Time Warner are up $32 million year-over-year, in particular as a result of higher CMTS sales.

Let’s move to slide 16 and review gross margin. As you know gross margin is being a very keen focus of the management team and we’re really pleased with our progress. Gross margin percentage improved to 37.2% in Q4 up from 35.7% in the third quarter 2008 and from 25.6% in the fourth quarter of 2007. The increase in gross margin percentage can be attributed to a retro product mix and cost reduction success, just terrific results.

Let me touch on the individual segments, BCS margin improved to 38.4% in Q4 ’08, up from 36.4% in the third quarter of 2008 and 27.1% in the same period last year. The improvement is the result of product and customer mix. ATS margin was 27.7% in the fourth and compares to 26.8% in the third quarter. MCS margin was 50.3% in the fourth quarter and compares to 57.7% in the third quarter.

In the quarter we had a bit less rich product and customers mix for this segment. Again we are very pleased with the results, but of course our future results will be depended upon mix and the continued success of our cost reduction programs.

Let’s turn to operating expenses on chart 17. We have provided both fourth quarter and full year data for you. On a reported basis, R&D and SG&A are up as a result of the acquisition; similarly amortization of intangibles is up as a result of the transaction.

In the far right column of both blocks we show what estimated spending was on a combined basis in 2007. As you can see, on a combined basis, SG&A is down by about $17.7 million in the fourth quarter and down $32.3 million for the year. Of that decrease, approximately $15 million relates to cost with C-COR recorded prior to the close of our transaction in December last year.

R&D is up; as we stated we’ve intended and we have invested slightly more in R&D. Looking forward we anticipated a slight decline in OpEx. Included in operating expense in the fourth quarter of 2008 is a non-cash goodwill impairment of $175 million. With the current and the continuing decline in the market value of communications equipment suppliers in general and then coupled with the macroeconomic conditions similar to many companies in these volatile times, our annual testing resulted in impairment. Please note that this a preliminary estimate as we’ve not quite finished our analysis at this stage.

Let’s move to slide 18, please. I’ve included a chart on taxes this quarter to help explain some key items. The most significant impacts result from the goodwill write-off. There are two key pieces; first the write-off itself is not tax deductible and as a result is a permanent difference. In other words, there is no corresponding tax benefit recorded, which impacts the effective tax rate.

Secondly, a portion of the goodwill impairment leads to an adjustment of deferred taxes. The impact was a reduction of income tax expense of $18 million in the fourth quarter. One other key item, as I’ve reported in our previous calls, we’ve be awaiting the passage of the R&D tax credit extension bills. This was actually included in the TARP.

As a result, we’ve recorded the cumulative impact in the fourth quarter. Had the bill been passed at the beginning of the year, we would have had approximately $3 million less benefit in the fourth quarter, which would of course been recorded in Q1 to Q3. Obviously, Q4 ’08 is not indicative of our tax rate in the future. We’re planning on a tax rate of about 33% to 34% for 2009, which is similar to our 2008 rate excluding the goodwill impacts.

Let’s turn to some balance highlights on chart 19. We ended the quarter with $427 million of cash and short term investments, up $98 million from the third quarter. There are several things to note: First, we generated approximately $103 million of cash from operating activities in Q4. Let me touch on some of the pieces.

The elements of earnings which are cash based are approximately $43 million, which were the foundation of our cash generation. Coupled with the earnings, we have favorable working capital movement. Our accounts receivable were lower by about $20 million. We had good if not great collections and favorable billing skews in the quarter. Our inventory declined $10 million. This is partially timing, but also it’s a partial effort to be able to reduce some of the levels.

Our accounts payable increased by $22 million, this reflects some better terms we’ve been able to negotiate with some key suppliers and it also reflects some timing. I anticipate that this favorable movement may reverse in the first quarter.

For the year, we generated approximately a $189 million of cash from operating activities, just an outstanding result. CapEx was $5 million in the quarter, which was inline with our plans and as I’ve been saying, cash is king in this environment. We’re pleased with our fourth quarter and year-to-date cash generation and we continue to be very, very focused on prudent working capital management.

Let’s turn to guidance on chart 20. At this point for the first quarter of 2009, we estimate that sales will be in the range of $245 million to $265 million and that non-GAAP EPS will be in the range of $0.14 to $0.19 per diluted share and GAAP EPS will be in the range of $0.06 to $0.11 per diluted share.

The reconciliation of our GAAP to non-GAAP EPS guidance can be found on chart 22 and is also attached to the press release. Reconciling items include amortization of intangibles, equity compensation expense and non-cash interest on the convertible debt. Finally, on chart 21 we’ve included a reconciliation of our GAAP to non-GAAP earnings per share for the fourth quarters and full year of 2008 and 2007.

So with that, let me turn it back over to Jim Bauer for your questions-and-answers. Thanks for your attention.

Jim Bauer

Thank you Dave, and Jerry if you could just come back online and tell the participants how to start the questions-and-answers we’ll have a go at it.

Question-and-Answer Session

Operator

Certainly sir. (Operator Instructions) Your first question comes from the line of Todd Cooper with Stephens & Company. You may proceed.

Todd Cooper – Stephens & Co.

Yes, thanks for taking my question. From your experience with CableLabs and its qualification process, would you expect for ARRIS, Cisco and Motorola to get the silver level, CMTS qualification at the same time or do you see those coming at different times?

Bruce McClelland

Hey Tod, this is Bruce McClelland. I think most of the focuses of all three of the vendors are really on the customer operational features required for deployment. The silver level is an important interoperability milestone, but gosh, I’m not sure whether we’re all going to line up or not. I mean all of us really focused on the deployment requirements. The key thing in silver is upstream channel bonding, that’s certain a key feature that’s on people’s list, but as far as timing I can’t really speculate on whether we’re all going to lineup or not for sure.

Todd Cooper – Stephens & Co.

Can you deploy products with the upstream channel bonding capability without the silver level qualification?

Bruce McClelland

Most of the customers like to see that check mark through the CableLabs process to really prove the interoperability. Having said that, a lot of them put an awful lot of effort in themselves and their own certification process, so I think it varies quite a bit. The easy answer is yes, absolutely we can deploy without havening to get the actual certification.

Todd Cooper – Stephens & Co.

And one more if I may. Do you sense any negative or positive bias to the modular CMTS approach by your customers?

Bruce McClelland

Nothing to speak of; I mean we’ve talked about this I guess on previous calls and I guess it’s fairly clear at this point. The solutions we have has been adopted pretty widely and in all of the attributes of the integrated chassis, the redundancy that I’ve talked about before have been pretty well accepted. So, we don’t have real long discussions on I versus him at this point.

Todd Cooper – Stephens & Co.

Okay, thanks very much and congratulations.

Operator

Your next question comes from the line of Blair King with Avondale Partners. You may proceed.

Blair King - Avondale Partners

Hi, thanks guys for taking my question. I guess the first question would just be on which I’m sure is permanent on everybody’s mind, its all things considered. At what rate do you guys think the CMTS products can really sustain growth over the next 12 months or so and if it’s to pretty mature to be specific, generalities would probably suffice. I know Bob you mentioned that 2009 would be a good year, but I guess there if is anyway to put any more color around what that means it would be great?

Bruce McClelland

Hey Blair, this is Bruce. So, some of our customers have been fairly public and open about what their plans, additional levels and those sorts of things and a vast majority haven’t been as public about it. Overall over a long period of time 12, 18, 24 months from now, I think they all look fairly similar.

As you know they all need to continue to add bandwidth and capacity and I think in general they are all at a point where they’re going to spend additional CapEx dollars. They want to do that with 3.0 capable product and not 2.0 and so I think you’ll see that transition happen throughout the year or by the end of the year. I think it’s almost all 3.0 equipment being deployed.

In some cases it’s being deployed for 2.0 services, for higher speed tiered 2.0 based services, the vast majority is that way today, but you will see as we talked. Bob mentioned earlier, a transition to 3.0 devices later in the year we think, and I know I’m not really answering your question, but I think over the cycle, over the say 24 months period a substantial amount of the network gets upgraded to 3.0 capabilities.

Bob Stanzione

I would just add Blair that everywhere we look, when we talk with our customers, when we read studies that have been issued, the growth of internet traffic is just unbelievable; you here a lower 50% growth per year. We were at a customer two weeks ago who said that their traffic growth was 100% over the past year. All this over the top video and the quality of the video that’s being demanded is just putting lot of strain on the network and so for if no other reason than to handle the capacity needs of these operators, I think the outlook is quite good.

Blair King - Avondale Partners

Okay, would it be fair to say you think that 2009 is a growth year for CMTS’s?

Bruce McClelland

I think it could be. Again we’re not in the business of giving full year, especially in this choppy environment that we are in, but I think it could be.

Blair King - Avondale Partners

Got it, okay. Lastly, just you had mentioned some good comments on the OSS efforts being made and perhaps if you could also just elaborate a little bit on the VOD business and particularly in light of the reseller agreement that you guys announced this quarter? If you could help us understand where the VOD business might go in 2009?

Bruce McClelland

On the first part of the question, the OSSP’s, that’s a business I just think, has got tremendous potential. As you know we have two elements to that business, one is called ServAssure, which is software that’s used to monitor and servile the network and increase the reliability of the network and the other piece is called WorkAssure, which is Workforce Management software program that we’re deploying literally around the world.

In both cases, these products save money for the operators. They improve customer satisfaction, they make the workforce more efficient and they make the network run more smoothly and so I think that the growth potential there is quite good and although 2008 was a pretty tough year in terms of selling products into the industry, that product actually grew at a fairly healthy rate.

On the on-demand side of our business, where we’re seeing the biggest strength is in the Ad Insertion piece of that. As you know we have a unified platform that’s used for both, video on-demand and Ad Insertion and we’re doing a strong business. As I said in my comments, we had a record year in terms of sales of our on-demand platforms, but it was driven primarily by the Ad Insertion side. The VOD sided didn’t do quite as well last year.

Bob Stanzione

What I’d like to do as we go forward is, we got a lot of folks in queue here this afternoon and if we could limit our questions to one person and then we’ll recycle if there’s additional folks that may have additional questions.

Blair King - Avondale Partners

Okay. Thanks guys for your questions or your answers, I appreciate it.

Operator

And gentleman, are you ready for an additional question?

Bob Stanzione

Yes, we’re ready to have.

Operator

Great, your next question comes from the line of Mark Sue with RBC Capital. You may proceed.

Mark Sue - RBC Capital

Thank you. I have a ten part question; just kidding Jim. David maybe for you, just on the working capital improvements, how much better can it get and what should we assume for cash generation in the first quarter and maybe perhaps for all of 2009 and then I’ll get back into queue. Thank you, David.

Dave Potts

So, I think the first quarter will certainly not come close to that. In fact it’s possible that we could use some cash in the first quarter. In the first quarter, I think receivables will be higher. If we look at our billing pattern so far I think it will be more heavily skewed to the backend of the quarter, hence it will be in receivables that will be one piece and we do pay our annual bonuses in the first quarter of each year.

So I think that will be a usage of cash, which is actually part of just the built-up through the year and just in the accounts payable and accrued liabilities, but I will say, Bruce’s team and others have done a dynamite job in just being able to manage our vendor base to have great working capital metrics. So, I’m very optimistic on that front.

Our earnings piece is that the foundation of it should continue, so I think we will be certainly a positive cash generator in 2009 and I guess we shall see, but hopefully our track record has spoken for itself as well. We, I think have done a very job as a management team in managing the balance sheet.

Mark Sue - RBC Capital

At least the minimum for ’09 and in terms of what you did for ’08, I guess?

Bob Stanzione

Oh, well. I think. Next question please.

Operator

And your next question comes from the line of Greg Mesniaeff with Needham & Company. You may proceed.

Greg Mesniaeff - Needham & Co.

Yes, thank you. My question is on the recent strength in the CMTS business. The way I understand it and correct if I’m wrong; the very early stage 3.0 deployments or upgrades are most software intensive and then that’s kind of Phase I that follows a more blade intensive, I guess you can say Phase II if you will. Is that a fair assessment and are we entering this kind of second stage where it’s more blades and less of the initial software upgrade to set the stage for the 3.0 upgrade.

Dave Potts

Greg, they actually happened pretty much at the same time. There is a process where you will upgrade the software and add the necessary new hardware in the down stream basically and it will happen really at the same time. There’s obviously extensions and upgrades and things like that after that additional blades, but typically the software and a few new hardware elements all go in at the same movement.

I think you’re probably remembering the reuse story of the existing capital, which is obviously very prevalent, but I think 90% of the hardware that they have purchased previously that provided the 2.0 service is reusable and a new software load goes onto those blades to reuse that existing hardware.

Greg Mesniaeff - Needham & Co.

I guess I’m trying to correlate gross margin trends going forward with the ratio of software to blades. If you maybe can just give us a little more on that if you can?

Bob Stanzione

We’re typically selling the hardware and software as a bundle and we’re not again typically selling software as a standalone element.

Greg Mesniaeff - Needham & Co.

And just as a corollary, any comment on headcount trends in the fourth quarter? I didn’t hear anything on the call?

Bob Stanzione

Headcount trends of the company are stable. The only changes we made the last year were in our factory done in Mexico where we did have a headcount reduction that took place at the end of the third quarter, otherwise very stable.

Greg Mesniaeff - Needham & Co.

Got you. I asked because of the increased commitment to R&D; I thought maybe there was some additional headcount involved?

Bob Stanzione

There have been a few, but nothing remarkable.

Greg Mesniaeff - Needham & Co.

Great. Thank you.

Operator

And your next question comes from the line of Simon Leopold with Morgan, Keegan. You may proceed.

Simon Leopold - Morgan, Keegan

Great thanks. Probably a two part question that I think you can give me one answer to, but sort of following along the lines of figuring out about your operating in gross trends. It looks to me that your gross margin was quite good this quarter, but your OpEx was a bit higher. So, I’m trying to get a sense of whether this is accounting changes in the quarter and what I’d like you to address is the trends going forward between gross margin sustainability and the OpEx, which I think Dave Potts said would be down sequentially. Just a little more color. Thanks.

Dave Potts

Yes, so indeed the OpEx in the fourth quarter versus the third was up some. I do have a couple of pieces that we’re certified; I think isolation. We’ve had higher legal bills in having to defend some of the litigation that we’ve had out there, that was something that did hit this in the fourth and with really patent litigations, which of course you know of is out there and we also had some higher healthcare costs.

As we get to the end of the year, we just said higher claims which came in, in the fourth, which did have a little bit of spick and a little higher variable compensation mostly in the commission side. If I look into the first quarter, I do believe it will come down a bit and so off of what, was it $66 million I guess it was in the fourth, it should down somewhat off of that.

The gross margins again its products mix and it’s going to be customer mix, so the more of the MCS stuff we actually can sell that helps us, because we’re talking 60 points of margin with the good customer exit. A little bit lumpy because you have to wait for acceptance on those particular deals to hit. So, you probably saw it in old C-COR day as it can be that it comes in a bit fits and starts in terms of revenue recognition through the year.

In Bruce’s side I actually think that the margins are in the zone that will be at and should be able to maintain. So, within that of course how many MTAs versus CMTS hit can have. So, to your question on the sustainability, I think that as we look forward in the mid to little bit higher 30s, something that I still think is very doable.

Simon Leopold - Morgan, Keegan

So, is it fair to think the gross margin in Q1 is down slightly on lower volume, but maybe similar mix?

Dave Potts

It all depends upon that mix, but I don’t thing directionally you’re too far off.

Simon Leopold - Morgan, Keegan

Great thank you very much.

Operator

And your next question comes from the line of Larry Harris with C.L. King. You may proceed.

Larry Harris – C.L. King

Yes, thank you. Question about the about the DOCSIS 3.0 EMTAs. Is the period where we think that is going to start ramping, has that moved to the right. I was under the impression that we might see it in the middle of 2009 and do we have a sense as to the point in time say where DOCSIS 3.0 EMTAs will be the standard and we will not see in a significant purchase of 2.0 EMTAs.

Bob Stanzione

Hi, Larry I think the transition is going to take some time. We have started to ship 3.0 EMTAs to customers. There’s a furious amount of activity in customer labs certifying the product, as was I guess similar in the 2.0 environment, the complexity of the EMTA in the software and interoperability is substantially higher than the data modem and so it’s just going to take sometime to get that to come to volume.

We obviously are also a provider of standard data modems and so there is a lot of focus around that product as well, in making sure that we try and improve on our market share for standard data modems over what we’ve been in 2.0 markets.

Dave Potts

I guess we’ve just not been a real participant in that market.

Larry Harris – C.L. King

Do you think that it maybe exiting 2009 or it might be sometime in 2010 or even if someone orders a slower speed that they’ll be given a DOCSIS 3.0 EMTA.

Bob Stanzione

From your lips to their ears, but there is a price delta still between the 2.0 and 3.0 device and I think there needs to be a compelling reason to do that before you’ll see it happen in volume. So we’ll just have to watch it.

Larry Harris – C.L. King

Okay. Thank you.

Operator

And your next question comes from the line of George Notter with Jefferies. You may proceed.

George Notter – Jefferies

Hi, thanks. I wanted to ask about, continuing on the EMTA discussion, what kind of volume growth or declines do you think you would get overall in EMTAs this year. I guess I ask, because I know the Time Warner cables VoIP sub ads are down about 50% I think year-on-year; what’s the outlook for unit volumes there?

Bob Stanzione

That’s a great question. I mean clearly we’ve seen a plateau over the last six months and a decline in the net ads and I think there’s a significant amount of churn happening as you’ve seen the marketing really pickup for Verizon in the U-Verse product and people are moving back and forth and so trying to keep up with net ads and then deal with the churn and everything is becoming a bigger struggle.

I think alternately that 3.0 service and the higher speeds are going to be a key part of that bundle in that package though. That battle for the subscriber is going to intensify as year goes on. So, you put all that together and look at your crystal ball and try and figure out what those numbers look like going forward.

It’s going to be challenge, but I guess what we’re focused on as making sure, particularly in this time, that we’re focused on customer satisfaction and really helping them drive the OpEx down in the product and drive the churn down. That can be lead nothing, but good things for us and so we’ve got several programs focused on that. Clearly the OSS products are focused on that, it’s about OpEx reduction, workforce management and more optimizations there.

So, we’re just not sitting back ideally watching it happen to us, I think we’re trying to be real active in trying to help be part of the solution.

George Notter - Jefferies

I guess I’ll ask the question in a slight different way. Where do you think you are in the adoption curve? I mean, again it seems like it’s harder to get new VoIP sounds onto these networks? Is it that we’re just biting down into a segment of the population of later adapters, do you have any perspective there?

Bob Stanzione

While we’re certainly past the early adopter phase and into the mass market face, there is plenty of roads to go here. I think if you look at the penetration rates of the large operator, they are still long ways to get to say the 35% to 40% penetration rate, that you’ve seen operator such as Cox and Cablevision achieved. So, lots more units to be sold out there and then if we get the magic right on the 3.0 upgrade cycles, just a substantial amount of opportunity there for us.

Dave Potts

There’s a lot of growth opportunities Latin America too right. I think we also had to focus a lot on the U.S. market, because we know that we’re more familiar with it, but we just started really shipping significant volumes, what last year.

Bob Stanzione

Right. I mean there are countries like Argentina were they’re just starting to deploy Voice over IP over Cable and the telephone operators have just been allowed to start offering video services and so markets like that, I mean it’s just starting the cycle that we’ve been in here for four years now, so.

George Notter – Jefferies

Thanks.

Operator

And your next question comes from the line of Ehud Gelblum with J.P. Morgan. Please proceed.

Ehud Gelblum - J.P. Morgan

Hi guys, how are you. It’s Ehud. I apologize if some of these have been asked. My line had a lot of static on it and it was hard to hear, but international revenue was obviously very strong, so the complement to that was the domestic which was a little weak.

Despite Comcast being strong, Time-Warner being roughly stable, did you see in other MSOs and some sort of fall off as you got to the end of the year, sort of opposite to what Comcast and Liberty did with you at the end of the year and is that what in Q1 comes down again, is it the other? I know you’ve mentioned Comcast comes down a lot as well, but what about the other non big three or four MSOs given what happened this quarter?

Bob Stanzione

Well, I think you got it. I think the big ones of course above 10%; you can see exactly what happened there. One of the things that will come off in the first quarter I think is, we just had a wonderful fourth quarter with Liberty and they bumped up above 10% for the first time in quite a few quarters. Of course, that’s the sum of the Liberty affiliates in Europe, in Japan and in South America and so we had good solid end of year business with all of those operators at the end of the year and I think that will be down somewhat in the first quarter.

Ehud Gelblum - J.P. Morgan

So, that the international pipe that comes down a little bit; when you look at the domestic pipe that came down in this quarter, that was not the Comcast or Time-Warner part of it, was there any trend that you saw in those non-Comcast and Time-Warner customers to read into?

Bob Stanzione

I think, certainly some of it is the voice over IP slowness that we already talked about. I think there was managing the typical year end inventory levels in EMTAs and those sorts of products, hard to put your figure on any other real specific time.

Bruce McClelland

Well I guess, if you look at the center point of our guidance, it would be what 255 and we did 293, so lower than 10%. A lot of that is accounted for by the two comments that we’ve made the Liberty and the Comcast piece. I think otherwise business is going to be fairly stable.

Ehud Gelblum - J.P. Morgan

Well, I’d like to turn a little more at Q4 rather than the look forward in the Q1, I blur two things together in trying to understand what happened at the other parts of the business in Q4, but this Liberty probably looks better than you thought it was going to be and the others parts in the U.S. therefore were worse. I was wondering, if there was something to do with that and was that some of the late issues that we are looking at or did some cable companies run out of money as the year went on?

Bob Stanzione

No, I don’t think anybody ran out of money, in fact we did have a little surge of business at the end of the year where they were not running out of money and wanted us to ship additional quantities. I think the balance sheets are in pretty good shape.

Ehud Gelblum - J.P. Morgan

Okay, that surge came mainly from Comcast and Liberty, is that correct?

Bob Stanzione

As well as a few others, yes.

Ehud Gelblum - J.P. Morgan

Okay. One last question -- sorry go ahead.

Bob Stanzione

Those are big operators; of course they swamp some of the others.

Ehud Gelblum - J.P. Morgan

Right, how large was that surge and was in the last week or two? Can you give us a sense it how much came?

Dave Potts

It was in the December timeframe. Between thanksgiving and Christmas business was very brisk I guess I should say it that way.

Ehud Gelblum - J.P. Morgan

And that was in the EMTA side of CMTS side?

Dave Potts

Both.

Ehud Gelblum - J.P. Morgan

Okay. Lastly when you look at the CMTS business, someone touched on this earlier and you look forward into 2009, not necessarily trying to get a sense as to where we are in the life cycle DOCSIS 3.0, but whey you look at what Time Warner has said and what they are planning do, they haven’t really set their schedule in stone yet. Do you expect the CMTS market in ’09 to be larger than it was in 2008 and during 2010 is another growth year on 2009 in CMTS?

Bruce McClelland

Yes, I think Bob said earlier, it has the potential it certainly has the potential and I think there is some studies out there that actually indicate that, but there are perhaps a little data and maybe don’t take into account all the economic jitter that’s happening. So the potential is certainly there. We just have to make sure we get our own fair share of it.

Bob Stanzione

Yes, it’s just hard for anybody right now to judge which is the stronger force; this growth in internet traffic and need to the operator to get the capacity out there, otherwise their network slowdown, against the malaise so to speak in the market place.

So, I tend to optimistic about it. I think we could have a very good year in CMTS based on the fact that the operators have got a keep that capacity in good shape in order to compete well against their competitors and just what Netflix is doing an Apple TV and all of these other things is just incredible.

Ehud Gelblum - J.P. Morgan

Okay and finally is there any life in the D5 Edge QAM business.

Bob Stanzione

Yes, there is. Bruce.

Bruce McClelland

Yes, we had I think a fairly decent Q4, shipping into both VOD and MCMTS applications and we have some fairly decent outlook for the first quarter here. So we just got to keep running hard and make sure we’re extolling the virtues of the products.

Ehud Gelblum - J.P. Morgan

Okay, thank you very much.

Operator

And there are no additional questions in queue at this time.

Bob Stanzione

And we’re just about out of time; it works out pretty well.

Operator

And gentlemen, we did get one more question in queue and my apologies for the interruption.

Bob Stanzione

Okay, go right ahead.

Operator

Your next question is from John Vinh with Collins Stewart. You may proceed.

John Vinh - Collins Stewart

Hey, thanks for taking my question. Just a follow-up question on the Q1 guidance; can you help us with some of the moving parts as it relates to BCS on CMTS versus EMTA, as it relates to your Q1 guidance? I’m trying to understand, if you’ve got kind of weakening VoIP trends.

Obviously Time Warner talked about kind of wireless substitution being an issue and if you expect continued deployments of CMTS, is there any reason why your gross margins on BCS could continue to improve and potentially could you see some gross margin expansion through ’09 as your mix becomes more favorable towards CMTS and then also you mentioned Comcast taking a breather? Does that also materially affect your mix in anyway in Q1? Thank you.

Bob Stanzione

I think I’d like to call Dave Potts. It all depends on the mix as you point out really and it’s too early in a quarter for us to really be definitive about that. I think all of those what ifs are kind of built into the guidance ranges that we’ve given.

John Vinh - Collins Stewart

In terms of DOCSIS 3.0 capacity given where we are currently with the current deployments with some of the major MSO’s. It appears that the DOCSIS 3.0 capacity as we see it seem some pretty under utilize and some of the operators are still keeping their subscription rates for DOCSIS 3.0 bandwidth artificially high, $150 and above and it seems to me that to get that inflection point they’re going to have to comedown on those price points.

So, I was just wondering if you can just give us your perspective on what you see going on right now? Because obviously, you’ve got pretty meaningful deployment and coverage out there, but in term of our visibility to DOCSIS 3.0 subscriptions we’re still quite under utilized right here in the near term?

Bob Stanzione

Yes, so I want to make sure you don’t walk away with the perception that it’s under utilized. The upgrades that happened in the additional capacity that’s being put in, is backwards compatible with today 2.0 environment; so all of the existing subscribers end up being the tough to the new DOCSIS 3.0 down streams and equipment that gets deployed. It’s getting used immediately and I think what you’ll see as the actual higher speed services become more marketed and more deployed, there is going to be a need for additional capacity on top of what’s being put in today. Does that make sense, John?

John Vinh - Collins Stewart

Yes, thank you. Yes.

Operator

And that’s your final question gentleman. I will now turn the call over to Jim Bauer for closing comments. You may proceed sir.

Jim Bauer

Yes, and I’ll turn it over to Bob for closing comments and thank you.

Bob Stanzione

Before I sign off I just want to remind everyone, we’re hosting on March 3 and March 4 an Investor and Analyst Conference here at our headquarters near Atlanta and we’d love to have you come and meet the leaders of the business, because we’re going to be going into depth on what our growth strategy is and some of the product initiatives that are in the business and just why customers are buying ARRIS products throughout this period. So, I just like to reiterate our invitation for you to attend and I hope to see you here. We’ve got a lot of people that have already signed-up and I think it’s going to be a great event. So, I look forward to seeing you there and with that we will sign off. Thank you.

Jim Bauer

Thank you and that concludes the call for today.

Operator

Thank you for your participation in today’s conference. That concludes your presentation. You may now disconnect. Have a good day.

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