Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Arris Enterprises (NASDAQ:ARRS)

Q2 2013 Earnings Call

August 07, 2013 5:00 pm ET

Executives

Robert Puccini - Vice President of Investor Relations

Robert J. Stanzione - Chairman and Chief Executive Officer

David B. Potts - Chief Financial Officer, Chief Accounting Officer, Chief Information Officer and Executive Vice President

Larry Robinson - Corporate Vice President and General Manager of Home Devices

Bruce W. McClelland - Group President

Analysts

Mark Sue - RBC Capital Markets, LLC, Research Division

James M. Kisner - Jefferies LLC, Research Division

Amitabh Passi - UBS Investment Bank, Research Division

Richard Valera - Needham & Company, LLC, Research Division

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 ARRIS Earnings Conference Call. My name is Ayesha, and I will be your coordinator for today's call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I'd now like to turn the conference over to your host for today, Mr. Bob Puccini, ARRIS' Investor Relations. You may proceed, sir.

Robert Puccini

Thank you, Ayesha. Welcome, everyone, to the ARRIS conference call with management. This afternoon, we will be discussing our second quarter 2013 results, which were released after close of markets today. We will be using a series of slides during our webcast, which are also posted on the ARRIS website in the Investor Relations section. With us here at the ARRIS corporate headquarters are Bob Stanzione, ARRIS's Chairman and CEO; David Potts, Executive Vice President and Chief Financial Officer; Bruce McClelland, President, Network & Cloud; and Larry Robinson, President, Customer Premises Equipment. There will be a replay of this entire call available several hours after the conclusion of the call. And a replay of the call and the slides will be available on our corporate website for the next 12 months.

Before we begin, please go to Chart 2.

During this call, we will be making forward-looking statements, including our outlook and expectations for our industry in general, estimated revenue and earnings, certain financial operating metrics, the timing and introduction of new products and technologies, anticipated spending patterns by some of our customers and expected sales levels of various product categories. It is important to note that actual results may differ materially from those suggested by any forward-looking statements, which may be made during today's call. For more information in this regard and for specific examples of risks that could cause actual results to differ materially from these forward-looking statements, please see our recent filings with the SEC.

Now if we could go on to chart 3, Bob and Dave will provide their comments on the quarter results, after which we'll open up for questions. Bob?

Robert J. Stanzione

Thanks, Bob, and good evening, everyone. Let's go on to Chart 4. I'm pleased to report that the integration of Motorola Home and ARRIS is going well, and the results for the first quarter of the new ARRIS were better than we expected. As you know, we closed our acquisition of Motorola Home on April 17, so the results we're presenting this evening reflect both post closing operations, as well as a view of the businesses had they been combined from the beginning of the quarter.

The June quarter sales of $1 billion were above the midpoint of our guidance and exclude approximately $66 million of pre-acquisition Motorola Home Q2 sales. Domestic sales were 66% and international sales represented 34% of the total. Non-GAAP earnings were $0.46 per share. This excludes operating losses that occurred at Motorola during the 16 days prior to the closing of the acquisition. Those losses, had they occurred within ARRIS, would have been the equivalent of about $0.15 per share.

These earnings far exceeded the high end of our guidance of $0.21 to $0.28. The reasons for these better-than-expected earnings were that sales came in a little better than we expected, but margins were stronger due to mix and ongoing cost reduction efforts, and OpEx was lower as we moved quickly to achieve the synergies and exercise strict expense controls during the quarter.

Cash flow was solid, but there are a number of puts and takes as Dave is going to explain in a moment. Also in the quarter, the TiVo litigation that some were concerned about was settled. As a result of the settlement, we have a fully paid license to the involved patents. And as you know, our agreement with Google limited our exposure in the settlement, and Dave will explain how this will affect our financials going forward.

Now to Chart 5. I wanted to just quickly define the segments that we're reporting once again for you. The Network & Cloud segment was created by combining the Access Transport and Supplies segment of the former ARRIS, along with the Media and Communication Systems segment of the former ARRIS, and the network-related pieces of the broadband segment of the former ARRIS, and combined those with similar products in the Motorola Home network infrastructure unit and the converged experiences businesses. So that's how we got to Network & Cloud. The CPE segment is comprised of the CPE portion of the former broadband segment in ARRIS, combined with the Home Devices business in Motorola Home. That's a lot to say, but it's all there on the chart that you can refer to in the future. Now let's go to Chart 6, please.

In the Network & Cloud segment, which is comprised of 5 product lines, as shown on the chart, we're not reporting results on each of these, but I will say that the first 3 are similar in size, with CMTS being the largest of the 3. The cloud and global services businesses are quite a bit smaller. And onto Chart 7.

The Network & Cloud segment had significant product line overlaps to deal with. The team, led by Bruce McClelland, really dug in and made decisions on how to combine the programs and is quickly moving forward with revised product roadmaps.

In the CMTS product line, it's notable that we had the first significant shipments of our E6000, next-generation CCAP-ready cable Edge Router. Deployments and trials are underway across all geographies. And Comcast took significant volumes as they continue to optimize their network for increasing IP capacity.

The launch of the E6000 is an important milestone for us because it represents our cable routing platform for the future. We also saw solid shipments of both C4 and BSR CMTSs, and we announced to our customers our commitment to continue delivery of new features and support for our C4 and BSR current generation CMTSs.

In the Access and Transport product line, we saw a continued strength as operators extend fiber deeper to increase capacity for growing high-speed data, IP video and VOD traffic. The Access and Transport team announced general availability of a new, cost-optimized fiber node aimed at the European market, and we also saw a continued momentum in Metro Wi-Fi. Now please go to Chart 8.

Within the video infrastructure product line, continued deployments of the new Apex 3000 CCAP Edge QAM took place in the quarter. We also launched a new high-density GT-3 transcoder platform targeted at multiscreen IP video applications. And we had solid sales of MPEG-4 compression and encryption equipment. It's notable that this year, we're reducing our exposure to an unprofitable and declining GPON product line.

In the Cloud business, we made excellent progress on expanding deployment of our multiscreen software solutions. These include elements of our Medios+ portfolio, including the Dream Gallery User Interface, the Secure Media Digital Rights Manager, the Merchandiser offer management system and the Video Flow Content Management Systems. And last, we delivered a significant capacity management enhancement for our WorkAssure workforce management platform. On to Chart 9, please.

The CPE segment consists of 3 product lines, as shown on this chart. Each of these are of significant size, although the digital video is the largest of the 3.

And now I'll go to Chart 10. In the CPE segment, which is led by Larry Robinson, overlaps in DOCSIS CPE have been addressed, the teams have been combined, and revised product road-mapping is essentially complete.

Parts of the segment are doing very well, but other parts are undergoing the stresses of transition that are taking place within the set-top market and its associated technologies. As I mentioned during our call, after the close of the Motorola Home transaction, there was a loss of momentum caused by disruptions and distractions within Motorola, as well as a parent customer reluctance to fully engage our new product initiatives, given some of the uncertainties surrounding the business. This has resulted in the traditional core set-top business being down from last year.

That being said, we do see momentum rebuilding with a pipeline full of new products that are scheduled for deployment later this year and early next, and the fundamental surrounding the CPE business remains solid. One new engagement that we recently announced is our agreement with Comcast to launch our XG1 video gateway later this year, leveraging the RDK software platform targeted to greater deployments of Comcast next generation X1 television experience.

We have similar design wins with 3 additional prominent service providers, and those programs are well underway. Moxi Home Solution deployments are accelerating, and we've recently launched new IPTV and DVD set-top solutions at Bell Canada and at Vectra in Poland, respectively. We also shipped a record number of DOCSIS devices in the quarter, leveraging our Touchtone and our SURFboard product portfolios with continued strong demand for DOCSIS 3.0 and Wi-Fi enabled devices. And we're very pleased to be recognized by AT&T with the Supplier of the Year Award, and we continue to work closely with them on the innovative products and services in an effort to win this award again next year.

Onto Chart 11. I'd like to comment a little bit on some of the details of the integration efforts here. As I said earlier, the integration has gone well and some of the savings have been achieved ahead of schedule contributing to the better than expected Q2 results. The Sales force and the product line integrations are substantially complete, and as a result, we were able to reduce headcount by about 550 during the quarter. We announced several facility consolidations that are going to result in savings in future periods. And with Jim Brennan in the lead, we're off to a good start on supply chain efficiencies. His organizational integration is complete, and we have started to accrue some of the benefits through the combination of our purchasing activities.

We've also begun work toward consolidating and optimizing our manufacturing footprint, which will result in more savings in the future. And Dave Potts is making great progress in the finance and the IT integration. This one is a big job, and it will extend into early next year when we'll be transitioning off the TSAs with Google and onto our own systems.

Now to Chart 12 for a bit of the outlook.

We continue to see operators around the world consolidate into large, well-financed service providers. Recent examples include Televisa acquiring Cablemas in Mexico, Vodafone intending to acquire KDG in Germany, and KDDI consolidating operators in Japan.

We believe that these large players will be investing aggressively to deploy rich, next-generation video solutions, supported by high-speed, high-bandwidth networks. And it's no secret that service providers are facing more competition, not only among themselves, but also from increasingly strong, over-the-top threats. Consumer behavior and technology are rapidly driving bandwidth consumption up and stressing network capacity. These factors, along with an improving macroeconomic climate, are leading to an increasing investments and a tailwind for our business.

These external factors are in our favor, and we're well positioned to take advantage of the trends. However, as our Q3 guidance indicates, we have work to do, particularly in getting new products out of the pipeline and into the market. That said, I feel very good about our prospects for improved earnings and increasing sales over the next few quarters.

We continue to believe that with the talent and the scale that we have in the new Arris and with the progress that we've made so far, this company will generate the target model results that we spoke of when we announced the acquisition of Motorola Home last year. Now over to Dave.

David B. Potts

Thanks, Bob, and thanks, everyone, for joining us this afternoon. Now before I go into some of the details, I just want to remind everyone that given this is the first quarter that we report post the acquisition of Motorola Home, in that we did not own Home for the full quarter, in some cases, comparative data may not be that meaningful. Where we could, we've tried to bridge some of the gaps for you. So let's turn to financial highlights in Chart 14, please.

Sales in the second quarter were $1 billion. These sales exclude Motorola Home from April 1 to April 16, which we estimate to be approximately $66 million, and this compares to $349 million in the second quarter of last year, which of course excludes Home. Gross margin was approximately 23% in the second quarter. I'll touch more on this in just a moment, because there are certain items that need to be considered, which we have adjusted for in our non-GAAP results.

Non-GAAP EPS was $0.46 in the quarter. This was better than what we guided to. Relative to the guidance, we have favorable margin, lower operating expenses, as well as favorable taxes. With respect to the operating expenses, we did implement some synergy actions in the quarter, which we realized benefits from in quarter. More on that in just a moment.

The GAAP EPS was a loss of $0.37. The loss includes restructuring and various deals costs, as well as the impacts from purchase accounting. And there's always a reconciliation of our GAAP to non-GAAP results as attached to the press release and can also be found on our website. We ended the quarter with $764 million of cash resources, and we generated $294 million of cash from operating activities in the quarter. The cash from operating activities was primarily the results of change in working capital, some of which will reverse in subsequent quarters. There are some very key points to understand, which I'll get to in just a few minutes.

Our short and long-term debt was approximately $2.1 billion in the quarter. We issued about $1.9 billion of new debt in the quarter to complete the acquisition of Motorola Home, and we have $232 million of face value of convertible debt that is due in November. We anticipate paying that debt through variable cash resources. Now weighted average basic share count was approximately 135 million in the second quarter, which reflects the shares issued to both Google and Comcast in conjunction with the acquisition. And our backlog at the end of the first quarter was $535 million, and our book-to-bill ratio was 0.95. Okay, let's turn to Chart 15, please.

I thought it was important to highlight some IT items that impacted the second quarter results. First, there are 2 items impacting gross margin in the quarter, which we have adjusted for in our non-GAAP results. The first is the impact of writing up the acquired inventory for Motorola Home to fair value as part of purchase accounting. This was $57 million, which inflates our cost of goods sold relative to both history and future periods. The second is $14 million of cost of goods we incurred as a result of rationalizing certain products post close. These are essentially restructuring type costs.

The other thing to note is that our Q2 results exclude Motorola Home for the 16 days of the quarter. We estimate that Home had $66 million of sales and an operating loss of approximately $30 million for that time period. As you compare the future periods to Q2, we thought this information may be helpful.

Let's turn to Chart 16, please.

Here, we have some sales details. So sales in the quarter were $1 billion, and sales to our CPE segment were about $660 million, while sales in Network & Cloud were $340 million. The pie chart excludes some adjustments that remain on the corporate level. Sales to Comcast were $190 million, or about 19% of sales, and sales to Time Warner were $99 million or about 10% of sales. And our international sales were about 34% in the quarter.

Let's turn to Slide 17, please.

On this chart, we break out sales and direct contribution in our new segment format. And as Bob mentioned and as a reminder, we have 2 segments, CPE and Network & Cloud. Certain clouds that are not allocated to the segments are captured in Corporate/Other and include things like the sales organization and central G&A..We also showed the purchase accounting impacts, non-GAAP, in the Corporate/Other category. So combined sales of Network & Cloud were $340 million in Q2 2013, which excludes the legacy Home sales for the first 16 days of the quarter with a direct contribution of $66 million, and sales of CPE were about $660 million in Q2, again, excluding legacy Home for the first 16 days with a direct contribution of $124 million.

Let's turn to Slide 18, please.

Now SG&A and R&D totaled $211 million in the quarter. Please note that this excludes Motorola Home for first 16 days. We estimate that Motorola Home had about $34 million of SG&A and R&D for that period, so you may want to consider that when comparing to future periods, including an R&D and SG&A of $7.2 million of equity compensation in the second quarter.

In the second quarter, we incurred acquisition cost of about $19 million for bankers fees, legal and accounting costs, and we also incurred $32 million of restructuring costs related to our synergies in the quarter. On the right, I show the estimated R&D and SG&A costs for multiple periods, and these are combined, if you like, for both companies.

Note that average sum where we thought was more meaningful to do so. So in discussing our goals, we have stated that we are aiming for an annual operating expense, which is R&D and SG&A, of about $930 million to $980 million. So on a quarterly basis, that is a midpoint average of about $239 million.

On an estimated combined basis, we were at about $246 million in Q2. And with the actions that we've implemented, I predict we will be in between $235 million and $245 million in the third and fourth quarters of this year. So I think we're well on our way to achieve our synergy goals. And we're still investigating other savings. We anticipate savings associated with the TSAs we have with Google as we phase them out. We're exiting certain facilities, and we're looking at other things as well. So we anticipate we will continue to drive the run rate down with these and other actions.

It is also important to note that we're achieving synergies on our cost of goods line, and we expect to achieve more. As an example, we're in the midst of consolidating the production of certain products into our factory in Mexico, leveraging the capacity and cost structure we enjoy there. Let's turn to Slide 19, please.

Let me touch on cash from operating activities. So cash from operating activities in the quarter was $294 million. Changes in working capital is a primary driver, some of which will reverse in subsequent quarters. On this chart, I've highlighted some of the key items. Accounts payable and accrued liabilities is up about $223 million. Now shortly after the close, under our TSA agreement, Google paid approximately $150 million of accounts payable on our behalf, which we agreed we would settle up, at the same time we true up our working capital adjustment contemplated in the acquisition agreement. And this is scheduled for Q3.

So the $150 million will show the use of cash in Q3. Accounts payables is up from the April 17 acquisition date for Home as well. We acquired Home basically at the low point in the quarter with relation to accounts payable. It grew from the April 17 date to the end of the quarter, and we really believe it's sort of a normalized level at the end of the quarter. So I don't anticipate any use of cash in the third quarter from that. Also included in accrued liabilities is unpaid restructuring and acquisition integration costs, and I anticipate about $15 million to be paid in Q3 and Q4.

Inventory was down $85 million. Of these, $57 million relates to the adjustments we made to the fair value of inventory of close, which has now flowed through cost of sales. Another way to look at this, as we do on our non-GAAP earnings, is that earnings would have been higher without it. This is a permanent reduction in inventory because we have sold the inventory and, hence, will not reverse in the following quarters. And of course, we expect to generate cash from earnings in the second half, and we'll file our 10-Q in the next couple of days and details about cash from operating activities and, indeed, uses of cash in the 4 periods is included in that, as well.

So let's turn to Slide 20, please.

A few comments on taxes, which I think are important. In 2013, I estimate that we'll have little or no cash taxes payable federally, particularly in light of the deal and restructuring charges we have incurred this year. Next up, when we're evaluating the acquisition, we really couldn't determine the value of the tax assets. As a result, we ascribed just nominal value to them. At this point, it would appear we're seeing some potentially significant upside. We've preliminarily have recorded a tax asset of over $300 million as a result of the Home acquisition, and we'll use this over the next 10 years, and we will reduce our cash taxes payable to the government. This asset does not impact our rate because it's recorded as an asset upfront in our balance sheet.

In our non-GAAP, it's estimated to be about 30% for the year. This includes the impact of R&D credits and other tax-planning items and is applied to our estimated pre-tax non-GAAP profit. The rate is improved from our target model. I will say that as we create more non-GAAP earnings, the rate will increase as those extra earnings are essentially taxed at the incremental rate and our R&D tax credits are a fixed amount.

Finally, we estimate that our annual GAAP tax rate will be about 45%. Given the purchasing accounting impacts in our restructuring and acquisition cost, we predict the full year GAAP loss before tax. So the 45% is a benefit to our GAAP P&L. The rate also includes the benefits of our R&D tax credits and other tax planning items.

All right, let's move on to Slide 21, please. With respect to guidance, at this point, we estimate that we'll have sales between $1050 million and $1080 million, and this compares to $1 billion in Q2, which excludes about $66 million of Home sales from April 1 to April 16. And we anticipate that non-GAAP earnings will be between $0.32 and $0.37 and a GAAP loss of between $0.07 and $0.12. And a reconciliation of our GAAP to non-GAAP guidance is attached in the presentation and can also be found on our website.

And as part of this, we estimate that our diluted share count will be about 141 million shares, and we estimate again that our non-GAAP tax rate will be about 30%. So with that, back to you, Bob.

Robert J. Stanzione

Thanks, Dave. With that, we'd like to open the lines up for questions. Ayesha, would you come back on the line, please, and let our participants know how they can ask their questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets, LLC, Research Division

If I could start up the -- if I look at your book-to-bill, if I look at your guidance, I think the guidance is a tad below most expectations for the upcoming quarter. And it did sound as if it's related to getting some products out or maybe some rationalization of some products there. So overall, maybe if you could give us just a sense of what's moving faster, what's moving slower as we walk to our $4.8 billion, $5.1 billion revenue portfolio, revenue target, just the moving dynamics there, because it does seems as if the carriers are moving a little bit faster?

Robert J. Stanzione

Right. The things that are moving slower are the traditional set-top business. And what we expect to happen over the next 5 months is that these programs that I referred to in my narrative will begin to gain traction. We announced the Comcast program a month or so ago, and there are 3 or 4 other significant programs in Larry's segment of the business that we can't announce the specifics of at this point, but I can tell you that those programs are well along in the planning process and will begin to have impact late in the fourth quarter and then early in the new year. Larry, you want to expound on what's going well and what's not going so well?

Larry Robinson

Sure, Bob.

Mark Sue - RBC Capital Markets, LLC, Research Division

And, Larry, also, it does sound like there's a lot of commitment for this. Is it more a timing issue?

Larry Robinson

Yes. So let me first start out but kind of reinforcing the point, Mark, that Bob made around -- we do have a number of new products that are currently under development, about half a dozen across the portfolio, several of which are Video Gateway platforms, as well as some broadband gateway devices that are in various states of product qualification, as well as field trial. Many of them are progressing well, although we expect it will still take some time to get through all of the various service provider qualification gates to ultimately get to full-scale production and shipment of those products into the various markets. So yes, I would describe it more as a matter of timing as we begin to realize the benefits and results of many of the products that we currently have in the pipeline.

Mark Sue - RBC Capital Markets, LLC, Research Division

And, Dave, maybe a question for you. I understand the fair value of the inventory adjustment for the Motorola assets. The product rationalization of $14 million, can you help -- can you just explain that one more time? How should we think of...

David B. Potts

So the $14 million is split between some inventory and some vendor liabilities with products that we saw as overlap. So once we got hold of the business that Bruce and Larry went to process just to say which product should we pick to the extent that we have some overlaps that we looked at inventory positions and obligations to vendors, and we reserved for those in the quarter. So that's really kind of like the restructuring process, if you like. Similarly, where we had folks that may have been working on those products, they probably were affected as well, Mark. That makes sense?

Mark Sue - RBC Capital Markets, LLC, Research Division

Yes, makes sense. And then on the working capital accounts payable and inventories giving a big boost for cash, some of that will revert. How should we think about it from an annual free cash flow point of view now that you have almost a quarter underneath you? Kind of how do you feel about steady state cash generation for the year?

David B. Potts

So we'll have ebbs and flows. I think you have to go through in sort of calculating your models as to what you believe the EBITDA is. Remember, I do not believe we're going to have any federal tax cash -- federal tax payable, if you like, from a cash perspective, although it's in the rate. So that helps us in terms of that cash generation. But I would suggest you just follow through your model and time it to EBITDA and recognize that we will have interest to pay but not necessarily taxes. This quarter was, of course, impacted as well by the fact we took restructuring charges, and we had significant deal costs associated with it as well. I think if you sort of added all those things back in the fair value of inventory, it'd be close to about $100 million or something like that, Mark. I'm just thinking off the top of my head.

Mark Sue - RBC Capital Markets, LLC, Research Division

Okay. And I think, if I refer to your original thoughts, it was about $303 million, $338 million. If I would do some of the rough math on EBITDA and think about the charges and expenses that are not recurring, I would imagine that it's still kind of comfortably within that range, although you almost did it in 1 quarter?

David B. Potts

Yes. So again, we got on the synergy pieces pretty darn quickly. Part of it, you have to certainly when you get to sales force rationalizations and things like that. You can't have 2 folks calling. But we got into the product pieces pretty quickly and took actions relatively swiftly. But I am encouraged that on a go-forward piece, I think we can do more. In my world, if you like, once I'm off to Google TSAs, which both of us would like to do, we'll save cash there. We really haven't got to whether we have duplicate facilities where we know we're [indiscernible] we'll ultimately exit. Until we're out of them, we really can't get to those savings. And there'll be just more and more. It's actually been quite good just from looking at purchasing power and looking at how we can combine things like travel, things like that if the blocking and tackling things aren't paying off, Mark.

Operator

Your next question comes from the line of James Kisner with Jefferies.

James M. Kisner - Jefferies LLC, Research Division

So 2 quick housekeeping -- double-quick housekeeping questions. Just sort of understanding expenses. What kind of stock comp should we expect next quarter?

David B. Potts

So I have to think of [indiscernible]. So that's a very good question, and you've noticed, I've been putting stock comp on the bottom of the charts to help you, so you can back it out. We did not do any meaningful grants in the second quarter, but we did have grants that went out to the former Home people. And unless we see my folks can pull it up, there'll probably be another few million dollars that we have in the quarter from that grant. And this is a word of caution as you think about the modeling on a go-forward year -- on a go-forward basis. Remember that these are all in grants invest over 4 years. So year 1, you have 25% of an expense. Year 2, you get the 50%. Year 3, you get to 75%. And then year 4 when you get to steady-state for all the new employees at 100%, you'll have 1 year drop off and another year come on. So you'll see stock comp grow, if you like, over the next 4 years because we have to take that into account. Now I'll come back to you with that number, just a second.

James M. Kisner - Jefferies LLC, Research Division

Perfect, okay. And just to move along. So on these direct contributions by segment, Networking & Cloud and CPE, there's a pretty big corporate allocation. It seems to me like there must be some R&D in there. Is that right? Is there a fair amount of corporate R&D? Perhaps you could give us a peek into this sort of negative corporate operating margin contribution, a rough mix of R&D and SG&A for those of us who would love to try and build little divisional P&Ls?

David B. Potts

So we do carry in that stock comp and we do carry in that bonus for the whole company. We carry the corporate G&A group, and we carry all of the sales organization. There is a small portion, which could be for R&D, but it really is small relatively speaking. Albeit all of the R&D, if you like, it's blended -- all of the bonus and equity comp is blended across, but we do carry that in court [ph].

James M. Kisner - Jefferies LLC, Research Division

Okay, that's interesting. So I guess I was -- just one thing, I'll follow-up on that with Mr. Puccini. But just one final check, if I might. I just want to understand gross margins. They looked like they were relatively strong this quarter at 30.4%. I mean if you look at Google like we saw pretty big decline in gross margins and some that you're implying a decline in gross margins. Wondering was it a lot better than you expected in this quarter, and whether -- what kind of elements of mix made it -- performed better this quarter into the gross margin?

David B. Potts

So when you're talking to Mr. Puccini, I suggest that you also just talk through some of the statistics we put on the page, which relate to the first 16 days related to Motorola Home. I think when you go off and do some math, I think you'll find that, that number might be just a bit less than what you're suggesting.

James M. Kisner - Jefferies LLC, Research Division

I'm sorry the gross margin number is less?

David B. Potts

Yes, yes. Because if we had -- if we have about a $30 million operating loss for those 17 days and there was about $34 million of OpEx, that would imply the gross margin on that $66 million would be about $4 million. So again, if you start to add those things together, I think, you'll find the number will be a bit less than what you're thinking. And if you're trying to compare it apples-to-apples on a go-forward, which is why we did this, I think you might want to -- the math probably is relevant. And I was close, it was about $2.5 million, $3 million is what we'll add for equity comp per quarter.

James M. Kisner - Jefferies LLC, Research Division

Okay. I'll follow up. And just one final one, I'm sorry. GPON. Can you just quickly tell us, is there a revenue impact from this GPON? Is it a discontinuation? You're not going to invest in it. How do we think about this GPON? Is it ONTs and OLTs or just ONTs? We need detail on that.

Bruce W. McClelland

Jim, this is Bruce. So we essentially have one large customer for that product line and has had a significant reduction in the sales year-over-year. And we do expect that to continue in that direction over the next 12 to 24 months. We do work really closely and support the product line, but we don't expect the sales to grow. We expect them to diminish over time.

David B. Potts

Just one other thing. When you do that margin, remember: stock comp is in there as well, so just be careful of that.

Operator

Your next question comes from the line of Amitabh Passi with UBS.

Amitabh Passi - UBS Investment Bank, Research Division

It's Amitabh Passi. Dave, just first question. I was hoping you'd help me understand. If I include Motorola in the second calendar quarter, it looks like your guidance is essentially flattish in the top line for 3Q, but yet you're going from about $0.31 to roughly $0.34, $0.35. I was curious where most of that improvement is coming. Is it synergies in the OpEx line? Are you expecting further improvements in gross margin? Any incremental insight would be helpful.

David B. Potts

So I would suggest that OpEx we'll continue to see will improve. And I would also point to taxes as being another element of that as well. If you remember when we did the target model in December, I'd started at about 38%. As I get into this a bit more, I'm guiding on a non-GAAP, if you like, earnings basis closer to 30%. But I think margins are probably similar. OpEx is probably lower. We, of course, are going to have more interest expense because we have more debt and more days. But I do, I point to taxes.

Robert J. Stanzione

Taxes are from Q2 to Q3, he's asking ...

David B. Potts

Oh, Q2 to Q3. Taxes is actually probably similar, Q2 to Q3.

Robert J. Stanzione

So it's more of the OpEx difference, right?

David B. Potts

Right, true.

Amitabh Passi - UBS Investment Bank, Research Division

And are you expecting gross margins to stay relatively flat? You said you saw some benefits from product mix in the second calendar quarter. Would it stay flattish into the third or are there puts and takes? I'm just trying to get a sense of how gross margin would trend?

David B. Potts

I'm not seeing materially differently that I see at this stage.

Robert J. Stanzione

Right. As Brennan gets a little more athletic with his supply chain synergies that we're looking for, we should see some improvement there. But I think Dave is right on as far as the third quarter is concerned.

Amitabh Passi - UBS Investment Bank, Research Division

So Bob, and just if I take the third calendar quarter guidance, looks like you're maybe $200 million, $250 million away from sort of the target model. How do you anticipate getting to that? Would it be sort of a linear march up over the next 3, 4 quarters. I'm just trying to get a sense of linearity in how we get to that target over the next 3 or 4 quarters. Is it straight and up to the right or would you expect some volatility quarter-to-quarter?

Robert J. Stanzione

No. Clearly, we're guiding to a flattish third quarter. And a number of the programs that Larry just referred to don't really start hitting until late in the fourth quarter. So we think that early next year, we'll begin to see a rebuild of the top line.

Amitabh Passi - UBS Investment Bank, Research Division

Okay. And just one final one for me. Bob. As these programs come online, obviously they'll help the revenue line. Any help you can give me in terms of how we think on the gross margin line? Will it be slightly dilutive to the 2Q level?

Robert J. Stanzione

No. I wouldn't say so. I'd say they'd be pretty much in line with the Q2, Q3 level.

Operator

[Operator Instructions] Your next question comes from the line of Rich Valera with Needham & Company.

Richard Valera - Needham & Company, LLC, Research Division

I think you attributed the kind of flattish and somewhat disappointing third quarter outlook to the CPE business. And I was just wondering, is it more to do with the existing set-top business being down more than you expected, or delays relative to your former timelines for this half a dozen programs that you expect to ramp?

Larry Robinson

So Rich, this is Larry. I think it's really a combination of the 2. Obviously, there's several factors that influence sales. But we find ourselves kind of in the midst with many operators going through and changing their in-home ecosystem, which puts us into a situation where we're developing new platforms that obviously take time to get introduced into the market. And while we're doing that, we are seeing some of the, I'll say, more traditional set-top box sales soften or decline over a period, leading up to the introduction of these new platforms. So as we mentioned earlier, I have about 4 to 6 new products that are in the pipeline that we'd like to see launched. As Bob indicated, throughout the course of the fourth quarter kind of ramping over that period into the first half of next year. And as Bob also mentioned in his opening remarks, we have seen overall set-top box unit shipments or traditional set-top box unit shipments down first half of this year as compared to first half of 2012 by about 8% to 10%. So a combination of those factors, both a little bit of softness in the existing set-top box business, coupled with the timing of the new products and the qualification activities with those customers is driving kind of the revenue profile that we're projecting for CPE.

Richard Valera - Needham & Company, LLC, Research Division

Great. I gather from your comments that the 4 to 6, these are actual wins. I just wonder if you can give any color on the mechanics of getting them from win to production shipments. Now I'm guessing each one may be a little different, but any color in terms of some of the potential stumbling blocks or the puts and takes you typically see as these products go from win to sort of mass deployment?

Larry Robinson

Sure. I would describe them as, lack of a better term, a design win in terms of these products. Now these are products that we're working very closely with our service provider customers to bring to market. And many of them, at this point, are well down the path in terms of development and integration. But just to address your question around some of the, I'll say, inherent challenges of bringing new product to market. When you look at the complexity of the devices that we're talking about, really a new in-home architecture with a Video Gateway platform supporting multiple video streams concurrently with a much more complex in-home network. You can imagine there's a fair amount of technical challenge in terms of bringing that to market, one that I think we're well positioned to handle. The other piece is obviously, there's integration with the broader ecosystem of components, right. So application integration, as well as integration into customers' network. Once again, we have experience in many of those areas and are working closely with our customers to ensure we don't hit many stumbling blocks. But obviously, it is a complex process, but one that we've been through before.

Richard Valera - Needham & Company, LLC, Research Division

Is this an unprecedented level of roll out of these types of products? And do you think you have the resources to get all these to market in a timely manner?

Larry Robinson

I would say that when I look at the CPE market in general, we are going through a period inflection as many, particularly, cable operators shift to IP to support multiscreen experiences, and that obviously applies to the telco's side as well. So I would say that the industry is going through a significant inflection point. I think we're well positioned to support that migration. We have several core platforms that we're able to leverage. And as I indicated, I think we're pretty far down the path in terms of developing those core platforms. And now it's a matter of working through all the integrations, both from an application ecosystem as well as the customers' network. But I think we're in fairly good shape to deal with that, not only from a development standpoint but also from a services perspective.

Richard Valera - Needham & Company, LLC, Research Division

Great. I appreciate that color. And one final one for me. Bob, are you willing to comment on what you expect your non-GAAP tax rate to be into 2014?

Robert J. Stanzione

I think it should probably be similar to that 30%.

Operator

Your next question comes from the line of Simon Leopold with Raymond James.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Looking at Slide 18 real quick, just a clarification on the operating expense guidance in terms of the target run rate, does that value, the $233 million to $245 million, include stock-based compensation? If so, how much stock-based compensation?

David B. Potts

Yes, it does. And again, for the -- if you look at the third quarter, we're anticipating about $9 million, maybe $10 million of stock comp.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Great. Then if we think about this quarter you just reported, you up-sided your own earnings expectation significantly. Could you give us a sense of really the rank order of what surprised you to yield that upside versus your original expectation?

Robert J. Stanzione

The rank order of it? I'd say the OpEx. We really overachieved on the OpEx savings by getting synergies early and by holding very tight rein on OpEx in general, Simon. That would be #1. #2 would be the margins came in better. I think the mix of the products that we sold, as well as cost reductions, that had been in the process for a while kicked then, so we did well there.

David B. Potts

And taxes did -- was an impact as well, Simon. And to be honest with you, our visibility into some of the taxes until we really get under the covers just wasn't huge. So as we got into it, it turned out to be better, which we sort of thought it would be, but that was all good news to us.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Great. I appreciate that. Always helpful. And when we think about your fourth quarter, historically, fourth quarter has been kind of a wildcard with ARRIS on a standalone basis. I think you've given us enough indications, particularly around the ramp of the XG1 product to suggest that it's going to be a good sequential up. Is there anything you can give us in terms of helping us understand how to extrapolate our models beyond the September quarter?

Robert J. Stanzione

Not really much beyond what we've already said and what you said in your question that we believe that some of this new product that is in the pipeline will begin to be shipped out in the fourth quarter. I don't know whether that'll be in November or December. But clearly, our customers are planning to begin to stock up for the deployment of these new projects that Larry described. And so -- okay, go ahead.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

And then I guess I think one of the more important questions that you haven't explicitly addressed is the post-deal synergies update. When the deal was announced, you talked about post-deal target of non-GAAP EBITDA of $608 million to $643 million. Just like to see if you can reaffirm that guidance?

David B. Potts

You're talking about synergies. So again on the OpEx piece, we're certainly there. And as Bob said, we'll go ahead with what you said. Well, the bottom line is post the deal synergy completion, you expect to be at the level to deliver the $608 million to $643 million of EBITDA.

Robert J. Stanzione

I don't remember exact EBITDA numbers. We're looking at it right now, but I do remember what I said. I said $4.8 billion to $5.1 billion of revenues and $2 to $2.15 of non-GAAP earnings per share. Four quarters out, which is the 4 quarters it was going to take us to achieve the synergies, and I believe, Simon, we are capable of getting to that model in that timeframe.

Simon M. Leopold - Raymond James & Associates, Inc., Research Division

Great. For me I think that the key takeaway of everything coming off this call is are we still getting there? So that's what I was looking for.

Robert J. Stanzione

Right now, I believe that we have a very good shot at doing that.

Operator

You have a follow-up question coming from the line of Amitabh Passi with UBS.

Amitabh Passi - UBS Investment Bank, Research Division

Bob, you talked about significant momentum and strength with the E6k, particularly with Comcast. I wonder if you could help us get some sense of what significant means here. And also just how your conversation is going with operators other than Comcast with respect to the E6k.

Robert J. Stanzione

Bruce will handle that 1.

Bruce W. McClelland

Amitabh, so the second quarter, we were really selling 3 platforms: The C4 and the DSR, the classic CMTS, if you will, and then the E6000 significant volume, significant being a fairly significant portion of the sales in second quarter or so. We're not giving exact numbers, but it was materially large chunk of what we did so -- I think Bob may have mentioned it, but second quarter was a record level of shipments for downstream for the business as well without the Motorola CMTS added in, clearly even more with those shipments.

Amitabh Passi - UBS Investment Bank, Research Division

And then just in terms of this broader market adoption both either domestically or overseas?

Bruce W. McClelland

Yes, we have trials or deployments now with the E6000 in all the regions of the world. What we expect to see happen is transition off of the classic products onto the next gen E6000 over the next, say, 6 to 9 months. So it will be fairly solid tail of upgrades and extensions on the current platforms that are deployed. But as the operators kind of look to new greenfield or enhanced capacity or significant capacity additions, we think more and more of that will be on the E6000. But it's a fairly broad-based customers at this stage.

Amitabh Passi - UBS Investment Bank, Research Division

And just a final one. I guess, Bob, you talked about consolidation in the industry. Any concerns about a maybe a slight pause in spending as a lot of these marriages occur or -- I'm just curious how you're thinking about any potential impact to spending?

Robert J. Stanzione

Yes. That's a wildcard. I don't know what to expect there, and I don't think anybody or anyone else does. Oftentimes, when there is a consolidation, it is followed by or associated with a pause and then a heavy spending pattern right after that. That's what we've seen in the past. Oftentimes, when a company's leading up to being acquired, they just hold off on CapEx and they starve the network, and then they have to catch up after the deal is done. We've seen that internationally, as well as here in the U.S.

Operator

You have a follow-up question coming from the line of James Kisner with Jefferies.

James M. Kisner - Jefferies LLC, Research Division

Cash restructuring costs. I was wondering what we've spent so far, and like what may be in front of this. Can you also just remind us what the near terms of debt repayment schedule looks like other than your convert that's coming to you?

David B. Potts

So we've had about $15 million a quarter of mandatory repayments on the debt, and we'll assess into the fourth quarter whether we make some optional repayments on that. So on the cash restructuring cost, while we know we put the $32 million up on the balance sheet, of which there's probably -- most of that actually would be a cash out in the third quarter. We're spending dollars on the restructuring and integration costs. And again, if you look at the income statement for this quarter, it was probably, what was it, $16 million if my memory serves me correct. That's all cash. I see that continuing not at that rate, but I see that continuing for several million dollars a quarter through to the end of the year. Particularly on the finance and the IT front, where we still have some heavy lifting to do to get through some of the systems changes. But things like the bankers fees are behind us, so I think really more into the paying out the restructurings that we did and then ultimately continuing on, on the integration classes of -- it's not $10 million a quarter, it's less than that. Single digits.

Operator

There are no further questions in the queue at this time. I would now like to turn the call over to Bob Puccini for closing remarks.

Robert Puccini

Thank you, Ayesha. Bob, any final words?

Robert J. Stanzione

I would just say that things are coming together very well. We're ahead of schedule in some of the plans that we had for generating synergies in the business. There are tailwinds in the market that I think we can benefit from, and we've got a number of good things in the pipeline that are ready to emerge. So we're looking forward to improving results as the year goes on and certainly into next year. And with that, I think we'll sign off. Thank you very much.

Robert Puccini

Thanks, everyone. That concludes our call.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Arris Enterprises Management Discusses Q2 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts