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ARRIS Group Inc (NASDAQ:ARRS)

Q4 2009 Earnings Call

February 10, 2010 05:00 pm ET

Executives

James Bauer - VP, IR

Bob Stanzione - Chairman & CEO

Dave Potts - EVP & CFO

Bruce McClellend - President of Broadband Communications

Jim Lakin - President of Advanced Technologies

Bryant Isaacs - President of Media and Communications Systems

Analysts

John Vinh - Collins Stewart

Mark Sue - RBC Capital Markets

Nikos Theodosopoulos - UBS

James Kisner - Jefferies

Greg Mesniaeff - Needham & Company

Blair King - Avondale Partners

Todd Koffman - Raymond James

Simon Leopold - Morgan Keegan

Larry Harris - C.L. King

Shubho Ghosh - Thomas Weisel

Jim Suva - Citi

Operator

Good day, ladies and gentlemen and welcome to the Q4 2009 and full year ARRIS Group Inc. earnings conference call. My name is Diana and I will be your operator for today. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session. (Operator Instructions). I would now like to turn the conference over to your host for today, Mr. James Bauer, Vice President, Investor Relations. Please proceed.

James Bauer

Thank you, Vienna and welcome all to the ARRIS conference call with management. This afternoon we're going to be discussing our fourth quarter and full year 2009 financial results, which we released this afternoon after close of markets today. We'll be using a series of slides during our webcast, which were also posted on the front of the ARRIS website.

With us here at the ARRIS headquarters are Bob Stanzione, ARRIS Chairman and CEO; Dave Potts, our EVP and Chief Financial Officer; Bruce McClellend, President of Broadband Communications; and Jim Lakin, President of Advanced Technologies. There will be a replay of the call available several hours after the conclusion of this call and a replay of the full call and the slides will be available on our corporate website for the next 12 months.

Before we began, please go onto chart number two. During this call, we will be making or we maybe called to make forward-looking statements, including our outlook and expectations for our industry in general, estimated revenue and earnings for the first quarter of 2010, certain financial operating metrics, the timing and introduction of certain new products and technologies as well as anticipated spending patterns by some of our customers and expected sales levels for various product groups. It's important to note that actual results may differ materially from those suggested by any forward-looking statements, which maybe made. For further information in this regard and specific examples of risks that could cause these actual results to differ materially from these forward statements, please see our recent filings with the SEC.

Now if you go onto chart number three, Bob, Dave will provide their comments on the quarter, after which time we'll open up for your questions and our answers.

With that, now over to you, Bob.

Bob Stanzione

Thanks, Jim and good afternoon everyone. I'm extremely pleased to report outstanding results for the fourth quarter. In many ways the fourth quarter of 2009 was the best one we have ever had. Our sales reached to new high of $300 million on our gross margins and operating margins also hit new highs. Adjusted non-GAAP earnings per share of $0.32 was as high as it's ever been. Cash from operations was almost $70 million in the quarter and operating metrics such as inventory turns and DSOs were just great.

For the full year, total revenues were down about 3% due to the effects of the recession. However, primarily because of the strong performance of our DOCSIS 3.0 wideband rollout. We have increased adjusted earnings per share and operating income by 31% and 39% respectively. For the year, the company generated a healthy $241 million in cash and we ended the year with our highest cash balance ever. Most importantly though I believe our position in the market is stronger than ever. This is evident in the high market share positions that we hold in key products such as CMTS Edge Routers and Voice over IP Terminals.

We also exited 2009 with a higher backlog than we did the year before. Now let's go to chart five please. We scored some great market wins at the latter part of the year although international revenues were down a bit in the quarter, we did get sizeable orders from key customers in Latin America and in Europe that are going to ship early in the year. Our business with Time Warner continued to grow. As you will hear from Dave, Time Warner was again our second largest customer and we had the best quarter in our history with that account as they began rolling out DOCSIS 3.0 platforms as well as our Workassure workforce management OSS system.

Time Warner has become a great ARRIS customer using almost all of our products in their network. One of the goals that we had established for 2009 was to increase our investments and R&D by about 10%, so that we could accelerate important next generation programs. We accomplished this by adding key hardware and software talent throughout the year and through the acquisition of EG Technologies and Digeo which we did in late September. Our services revenues have also grown to record levels. We booked a major proservice order at the end of the quarter with a new global customer for work that will go on for at least another year. Now please go to chart six and look at some of the segment highlights.

The BCS, our broadband communications systems group had a banner year and a banner quarter setting all time highs in both revenues and margins. Our C4 CMTS Cable Edge Router gained a distinction of having number one market share over the course of the year. In the fourth quarter, we shipped a record 44,000 downstreams as the rapid growth of video traffic continues. We also saw increasing sales of our recently introduced C4c and our D5 Edge QAMs.

CPE shipments were 1.6 million devices in the quarter as the weak economy continued to take a toll. We continue to hold the number one market share position in the EMTA category and we expect this product line to recover as the economy picks up and also as we introduce new DOCSIS 3.0 products into the market.

Now onto chart seven, the MCF segment also did well in the quarter. Sales were up about 5% sequentially and about 19% year-over-year. We continue deployment of our recently introduced Converged Media Management back office software system and our XMS server platform in North America and we also just completed a 25,000 stream BOD system installation in China. We won and booked a sizeable new enterprise wide service installation at a tier 1 account in North America and as I mentioned earlier, we are deploying Workassure in Time Warner systems around the country.

And we continue our production field trial of our fixed mobile convergence platform in a major North American MSO. Now onto chart 8. The ATS segment had a solid finish to the year. Although the fourth quarter was down slightly, we feel this business has stabilized and is starting to improve. Sales in the second half of the year were up about 4% over the first half and profitability improved due to the strengthening sales of our optics line as well as the cost and expense reduction initiatives that were implemented later in the year. We experienced strong year end orders from Time Warner. We had nice wins at Cox and Suddenlink and expanded our RF over Glass and Ethernet PON trials in both North America and in Europe. It is also notable that we will be shipping our first RF over Glass and Ethernet PON deployments early this year.

Onto chart nine, as we look forward I believe the outlook for the business is very bright. Web to TV is indeed coming and sales of web enabled TVs and 3D TVs are accelerating. IP Video is emerging rapidly and it is a huge opportunity for us and one of the things we are investing most aggressively in. Broadband traffic is doubling every 18 to 24 months and speeds are also increasing. All this is driving the demand for our DOCSIS 3.0 CMTS Edge Routers as well as for our other products.

We are still in the early stages of a worldwide deployment of this generation of technology and I don't expect these trends to let up neither do I expect cable operators to stop improving their networks as they aggressively compete with telcos and satellite service providers.

Chart 10. Chart 10 is really a gee whiz chart that you have seen before, but we have updated it with December comp score data. As you can see from the chart on the left, online video viewing really took off around March of last year. The growth has just been phenomenal. And we know that the length as well as the quality of the videos that are being transmitted is increasing at the same time.

Now let's go to chart 11 please. Okay I am including this chart for a number of reasons. First to show you the growth that ARRIS has achieved over the post-internet bubble period, but more appropriate to today's call is to show you the seasonality of our business. There are two important points to make here. First as we just experienced, the fourth quarters are the least predictable quarters of the year. Last year in 2009, our business took a very positive swing, but in the years gone by we have seen it go both ways. The second important point to draw is that the first quarter of each of the past seven years has been the lowest quarter of that calendar year. It's been true a 100% of the time. I believe that 2010 is going to show a similar trend. We are off to a seasonally slow, but normal start, but we have strong indications that the business will gain momentum as the year goes on.

So turning to chart 12. I see 2010 as another strong year for ARRIS. As I said we entered the year with more backlog than we did in 2009 and we have good visibility to a strong comeback in international business. I expect the quarterly profile be similar to last year, at least for the first three quarters. Clearly our first quarter is affected by the very significant order pull-ins that occurred in the last quarter. Another notable shift in the business that I want to mention today is that we expect Comcast sales to be down this year while the large capacity augmentation is done over the past 18 months are being consumed by growing volumes of traffic.

However we also expect to see sales to other customers more than make up for the difference as DOCSIS 3.0 waves spreads across the length of the globe. Fourth quarter results are a clear indicator of this trend. The sales of Comcast in the fourth quarter down about $12 million and sales to other customers up by $37 million. Now let's go to chart 13. I will end my comments this afternoon by just saying that this company has never been stronger than it is right now. We have a great financial profile and a solid foundation for growth. And last I want to encourage all of you to attend our Investor Conference on March 17 and 18 here in Suwanee. We will be articulating our plans for future growth and you will be hearing from key leaders in the business about the major initiatives that we have underway the path to our continued profitable growth. Thank you, Jim and now Dave.

Dave Potts

Thanks Bob and thanks everyone for joining us this afternoon. As Bob has said, we're very, very pleased with our outstanding fourth quarter results with both sales and earnings coming in above our guidance. So let's get into some of the details starting with the financial highlights on chart 15, please.

Sales were $300 million in the fourth quarter, the first time in our history that we have touched the $300 million mark, this compares to $292.4 million in the fourth quarter last year and $275.8 million in the third quarter of 2009. Full year 2009 sales were $1.108 billion versus $1.145 billion in 2008. I'll provide a breakdown by segment in just a moment. Gross margin was 44.8% in the fourth quarter, also our highest level ever, up from 37.2% in the fourth quarter last year and 41.9% in the third quarter of 2009.

SG&A and R&D totaled $72.7 million in the fourth quarter and was up approximately $6.5 million year-over-year primarily as a result of the acquisitions of EGT and Digeo.

Our adjusted non-GAAP EPS was $0.32 in the fourth quarter, which compares to $0.25 in both, the fourth quarter of 2008 and the third quarter of 2009. Our fourth quarter 2009 GAAP EPS was a profit of $0.26 per share and compares to a loss of $1.33 per share in the fourth quarter of 2008. Some significant items to note. First in the fourth quarter of 2008, we recorded a goodwill impairment of $209 million or $1.68 per share. This did not repeat in 2008. Partially offsetting the goodwill impairment in Q4 2008 was a benefit of about $25 million or $0.20 per share related to deferred taxes associated with the impairment. This too did not repeat in 2009. Next is amortization of intangibles, which was a before tax expense of approximately $9 million in both periods, also included in our GAAP earnings is non-cash interest related to our convertible debt. This was approximately $2.8 million in both the fourth quarter of 2009 and 2008.

Included in our GAAP operating expenses was $2.9 million of restructuring charges and I will touch on these in just a moment. Finally, there were certain discrete tax items included in our GAAP tax expense. Notably in the fourth quarter of 2009, we had approximately 4.4 million of favorable adjustments to valuation allowances associated with some foreign NOLs that arose out of settlements in the quarter.

And as always a reconciliation of our GAAP to non-GAAP earnings is attached to the press release and can also be found on our website. Cash and short term and long-term marketable securities were $626 million at the end of the fourth quarter and we generated about $70 million from operating activities in the quarter. And again I will touch more on the balance sheet and cash in just a few minutes, but obviously a terrific result. With respect to orders, our order backlog was $144 million at the end of the quarter, and our book-to-bill ratio was 1.92, also which were improved to the comparable period last year.

All right. Well let's turn to chart 16 and look at some of the fourth quarter sales details please. First, let's focus on the sales by segment bar chart for the fourth quarter, comparing our reported sales by segment. BCS sales were $235.7 million in the fourth quarter and compared to $225 million in fourth quarter of 2008 and $211.3 million last quarter. It is also important to note that the sales mix is quite germane, particularly year-over-year, where we have a larger percentage of DOCSIS 3.0 CMTS sales and you'll see that in our margins in just a moment.

ATS sales were $44.3 million in the fourth quarter and compared to $50.5 million in the fourth quarter of 2008, and $45.5 million last quarter. MCS sales were $20 million in the fourth quarter, as compared to $16.9 million in the same period last year and $19 million in the third quarter of 2009.

Let's turn to our geographic split. Our international sales was $73 million in the fourth quarter, down from both the third quarter of 2009, and the fourth quarter of 2008. We have two 10% customers in the quarter, sales to Time Warner were up quarter-over-quarter to $82 million and sale to Comcast were down quarter-over-quarter to $90 million.

Some final comments on sales. Our fourth quarter results came in above what we had originally expected. As the quarter progressed it was our belief that some customers accelerated CapEx from 2010 into 2009 and this is expected to have an impact on our first quarter of 2010. Lastly of notice the $12 million increase in current deferred revenue quarter-over-quarter. Most of the increase relates to two specific BCS opportunities where we expect to score the majority of this revenue in the second quarter of 2010. Let's turn to chart 17 and look at some of the year-to-date sales highlights. On the slide we provide the same sales data for the full year.

Despite the economic environment our sales in 2009 were $1.08 billion, only down approximately $37 million or 3% from 2008. Within that there is some key things to note. First BCS sales were up $30 million as we saw higher sales to multiple customers of our CMTS products. ATS sales were down $86 million year-over-year and we continue to cautious infrastructure spread by our customers and limited upgrade projects and finally MCS sales are up $19 million.

All right let's move on to slide 18 and look at gross margins. Our fourth quarter overall gross margin was 44.8% which compares to 37.2% in the fourth quarter of 2008 and 41.9% in the third quarter of 2009. The year-over-year increase is primarily related to the highly successful introduction of our DOCSIS 3.0 CMTS, the improvement in the level of MCS sales and the mix effects of lower EMTA and ATS sales. Our gross margin percent for BCS was 48.1% in the fourth quarter of 2009 this compared to 38.4% in the fourth quarter last year and 44.6% in the third quarter of 2009. The gross percent of our ATS segment was 23.3% down slightly from the third quarter of 2009 and down from 27.7% in the fourth quarter of 2008.

The decline year-over-year reflects a number of fact this including lower sales and product mix in particular a high percentage of supply sales. The gross margin percent for MCS was 54.5% in the quarter up from 50.3% in the fourth quarter 2008 and down slightly from 55.3% in the third quarter of 2009. As we mentioned before performance in the segment can be a bit lumpy as revenue recognition is significantly tied to customer acceptances and relatively large non-linear appeals for licenses.

Let's turn to slide 19 and look at operating expenses. Total R&D and SG&A was $72.7 million in the fourth quarter up approximately $5.5 million from the third quarter 2009 and up $6.4 million from the same period last year. On the year-to-date basis total R&D and SG&A was $272.9 million for the full year 2009 up $16.4 million from the same period in 2008.

And as we've discussed previously, we expected an increase in spending particularly as a result of the Digeo and EGT acquisitions. It is also worthy to note that Q4 included higher commissions and incentive accruals due to the strong quarter and full year results. With respect to SG&A fourth quarter 2009 expenses are up slightly as compared to the fourth quarter of 2008 for the full year 2009 total SG&A expenses were up $4.4 million as compared to the same period in 2008, the increase reflects higher variable compensation and legal costs.

With respect to R&D fourth quarter 2009 expenses are up $5.8 million compared to the fourth quarter 2008. For the full year 2009 total R&D expenses are up $12 million as compared to the same period in 2008. As we stated, we are incrementally investing in R&D, in the fourth quarter of 2009 the R&D increase is result of the Digeo and EGT acquisitions as well as higher variable pay.

In Q4 2009, we incurred approximately $2.9 million of restructuring charges, this relates to two things. First, we did reduce force in the ATS segment incurred some severance. And second, we adjusted our estimates related to when we made [sublet idle] space given the current market conditions. Included in our overall operating expenses is amortization of intangibles which remain flat as compared to Q4 2008. For the full year amortization decreased by $7 million as compared to the same period in 2008. The vast majority of the amortization related to the C-COR acquisition, the decline reflects the completion of the amortization of certain intangibles in 2008 specifically the order backlog. And also included in operating expenses in the fourth quarter of 2008 of course is the non-cash goodwill impairment of $209 million.

So, let's move to slide 20 and look at some of the balance sheet highlights. We ended the quarter with $626 million of cash in short and long-term marketable securities as compared to $577 million at the end of the third quarter 2009 and $427 million at the end of last year. Our cash generation has been very strong. Over the past two years we have generated $430 million of cash from operating activities $241 million in 2009 and $189 million in 2008. Some things to note, we generated about $70 million from operating activities in the fourth quarter let me touch in some of the pieces. The elements of earnings which were cash-based were approximately $48 million.

We generated about $22 million from working capital in the quarter. Our accounts payable on the accrued liabilities were up $37 million from the end of Q3 our [AP] for inventory increased which is essentially a function of timing in our accrued compensation increase reflecting incentive accruals which were schedule to be paid in the first quarter of 2010.

Our accounts receivables were higher by about $19 million reflecting our higher sales and timing and payout patterns of customers. That being said our DSOs improved to 40 days. Our inventory declined by about $8 million again this is partially timing and partially in effort to reduce levels and we'll note that our returns improved to $6.8 million.

Finally, we had a net $4 million change in other items including such things as taxes. In the quarter we raise $1.8 million in cash from the issuance of shares as result of employee stock option exercises and CapEx was approximately $4 million in the quarter and just under $19 million for the year.

We also spent approximately $14.6 million in the quarter on the Digeo acquisition. So our balance sheet position is very strong with a net cash position including to short term investments of approximately $365 million. The net position includes $261 million of 2% convertible notes during 2013. And of course we remain very-very focused on cash generation and prudent balance sheet.

Let's turn to guidance on chart 21please. At this point for the first quarter 2010, we estimate that sales will be in the range of 253 to $273 million and that Non-GAAP EPS will be in the range of 18 to $0.22 per diluted share and GAAP EPS will be in the range of $0.10 to $0.14 per diluted share. Our guidance reflects some notable factors.

First, as Bob mentioned, seasonality is indeed a factor. Also as we previously said, our fourth quarter 2009 sales enhance earnings came in somewhat above what we expected as customers accelerated purchases. This is expected to have some impact on Q1. Our mix in Q1 is not expected to be as rich as C4 sales are expected to be lower quarter-over-quarter. We also expect lower MCS sales of Q1 reflecting the lumpiness I described a moment ago. And at this point, we believe that MCS will more than rebound in the second quarter.

We are projecting a tax rate of about 37% to 38% in Q1. As you may know the R&D tax credit extender bill was not passed before the 2009 recess. The same thing happened in 2008 you might recall.

We expected to ultimately be passed but until it is our rate will be higher. If passed we expect a 35% rate for the year and the impact of this is about $0.01 per share in the first quarter. And as always a reconciliation of our GAAP to non-GAAP EPS guidance can be found in chart 22 and is also one attached to the press release and is on our website. Reconciling items include amortization of intangibles equity compensation expense and non-cash interest on the convertible debt and finally we have included reconciliations of our GAAP to non-GAAP earnings per share and operating income on charts 23 and 24.

So with that back over to you Jim.

James Bauer

Okay, now its time for some of your questions and our answers. So, [Diana] would you come back online and just tell the participants how to go about that.

Question-and-Answer Session

Operator

(Operator Instructions). And we have a question from the line John Vinh, Collins Stewart. Please proceed.

John Vinh - Collins Stewart

Hi good afternoon, first question for Bob you have talked about that in 2010 you expect that Comcast revenues to be down but that your other customers and revenues to more than make-up for that. Can you help us understand what sort of visibility do you have and what gives you that level of confidence that that will play out in 2010?

Bob Stanzione

Well first of all I can look back to the fourth quarter and I made the comment about Time Warner but if you don't mind John I'd like Bruce to talk about some of the things that he's seen happening in the market that give us a lot of confidence that the wave of DOCSIS 3 spending is spreading.

Bruce McClellend

Yeah hi John this is Bruce, I think the pattern that we saw at Comcast we have a lot of confidence its going to repeat with other customers and you can see that already starting with Time Warner as an example but the similar pattern where they are upgrading the technology-based DOCSIS 3.0 capability6 and Bob just said kind of a wave approach where there is 12, 18, 24 month upgrade cycle that then gives way to the natural progression of capacity additions and with increase of demand for bandwidth every year of say 50% through into an upgrade in that capacity 18 to 24 months later you come back and have that more capacity is that additional bandwidth gets exhausted. So just from, you can put it into a spreadsheet and do the math on it which gives us a lot of confidence that the demand for the capacity and the equipments continues and each operators that difference phase of that upgrade cycle and then the continued bandwidth adoption and we just reasonably good visibility into what's happening there.

John Vinh - Collins Stewart

Okay just follow up to that on the Comcast side obviously you are forecasting Comcast revenues to come down near about as they talked about it there going to complete the initial roll out of DOCSIS 3 earlier this year. Do you think that they have purchased enough equipment for you guys in Q4 to complete the roll out and the way we should be thinking about Comcast spend in 2010 is really going to be bandwidth capacity additions.

Bruce McClellend

Well, what we know is we started deploying the DOCSIS 3.0 equipment about 20 months ago and they have been pretty public Comcast and particular about their penetration of the 3.0 capability across the network. If you do the math on the capacity demand increase is over a 24-month period you basically have a doubling in capacity requirement, so you can imagine having to comeback and start adding capacity to the equipment that we deployed 20 months ago sometime this summer. So we expect to see that across the customers' base over the next several years that they go back and add more capacity into that footprint.

John Vinh - Collins Stewart

Okay. And then just like Time Warner, obviously the Time Warner revenues were up meaningfully in the quarter Dave continued to indicate that they are going to be surgical and continue to show some level restrain in terms of their commentary about rolling out DOCSIS 3.0, can you just give us a color in terms of what you are seeing at Time Warner, what they are doing there?

Bruce McClellend

Well I can't comment directly on Time Warner but as you know the value proposition around the 3.0 technology is pretty compelling, most of the capacity that's going in today's go for DOCSIS 2.0, so whether an operator is being surgical about the marketing in the deployment of 3.0 in particular is somewhat independent of the fact that they have to add capacity anyway and most operators now are doing it with DOCSIS 3.0 technology not DOCSIS 2.0 technology. So I know it's easy to kind of, it's hard to interpret the words that we are hearting from some of the offerings about their strategies around 3.0 but it's mainly focused on where they are going to really launch the service as opposed to the technology itself is getting adopted as there.

John Vinh - Collins Stewart

Okay and then last question.

Bob Stanzione

Last question I'd really like to limit it to so we get a lot of people in queue here who can get ask any question as we go.

John Vinh - Collins Stewart

Finished up John.

John Vinh - Collins Stewart

Yeah last question for Dave just real quickly on the OpEx those are variable comps increasing in Q4. In Q1 we expect OpEx to come down as some of that goes away.

Dave Potts

Yeah I think so I mean if I were to look at it I think its more in the 68 to 70 excluding amortization in that stuff John.

Operator

We have question from the line Mark Sue, RBC Capital Markets. Please proceed.

Mark Sue - RBC Capital Markets

Thank you I have 10 part question. I am just trying to figure out why would a carrier accelerate March quarter revenues in to the prior December quarter. Isn't it usually a flush that we get in the December quarter and then the question is just kind how you feel that you might be able to grow you feel you can grow revenues year-on-year and with that being said how we should kind of look at the operating expenses in absolute dollars 2009 versus 2010? Thank you.

Bob Stanzione

Okay, Dave why don't you take the…

Dave Potts

I think the operating expenses I think you can see to be relatively flat year-on-year that ones pretty simple.

Bob Stanzione

And why would an operator do a pull in the first part of the question, Mark the people are people. They had budget left to spend at the end of the year and went ahead and exhausted that budget at the end of the year. Quite honestly we weren't expecting that, if you recall our original guidance for the quarter was quite a bit lower than what happened and about I guess around November, mid November we started to get phone calls from customers asking if we could supply additional equipment and of course we acted opportunistically and took those orders and made those shipments. Why I think we can grow year-over-year is that some of the things that Bruce said as well as some of the things we are seeing in the other business units, we are seeing increased activity and planning for network augmentations and upgrades all over the world and as you know the U.S. has been kind of at the beginning of this wave as well as some of the Asian countries. We have got Latin America coming on strong, we are pretty confident that the Latin America business is going to rise rapidly here early this year. So, we just see a number of things happening. Dave mentioned the lumpiness in the MCS business that would indicate that by the second quarter that business will be up considerably from its level in the first quarter. So, it's just a lot of evidence out there plus the seasonality that I was trying to convey with chart 11 this afternoon.

Dave Potts

Just back to the OpEx I probably should have said sort of flat through the year, it's not flat obviously to 2009 because we of course would have had only one quarter Digeo and EGT in there. Sorry, heart palpitation is going in out there.

Operator

We have a question from Nikos Theodosopoulos from UBS. Please proceed.

Nikos Theodosopoulos - UBS

Yes, can you hear me?

Bob Stanzione

Yes.

Nikos Theodosopoulos - UBS

Great. What kind of decline do you expect from Comcast in 2010? And then when you think about the comments you made about the overall business, other customers will make up for Comcast, do you see the same situation for the CMTS business in 2010? In other words, the decline at Comcast should be offset by other customers? Thank you.

Bob Stanzione

So its hard to give visibility through the entire year what we know here in first quarters as Dave mentioned is some of the year end purchases, is capacity that they are adding, that they are going to add in the first quarter and the timing would just, whether it's the end of the year or the first of the quarter the good thing is that its obviously equipment that they need and we are in a position where they liked the products, they like the technology, they like their support and the business came out of way I think that's pretty hardening as we look throughout the rest of the year that we are doing the right things to be well positioned for the purchases that are going to happen you combine that with the growth that we know is going to happen and we optimistically can grow the business as the year progresses.

Nikos Theodosopoulos - UBS

Okay. And on the question on mix, you mentioned gross margin will be impacted by mix in the first quarter. Do you still think that the gross margin will be above 40% or and maybe you can just comment on that.

Dave Potts

I think so we all can see the mix will give the final result Nikos what I think so.

James Bauer

Next question

Operator

Question from the line of George Notter from Jefferies. Please proceed.

James Kisner - Jefferies

Hi guys this is actually James Kisner calling in for George. I guess just the first question was Comcast was obviously down and Time Warner was up large quarter-over-quarter. Is the CMTS business at those two accounts? Is it similarly trending that way? Is the CMTS business down at Comcast and up at Time Warner, quarter-over-quarter?

Dave Potts

Well, obviously the numbers that we are showing on both those accounts is a combination of a bunch of products, not just to CMTS but there is a lot of business we do in both accounts on the EMTAs and the OSS products and the access product. So, it's a blend of everything and every quarter one segment might be up and another one down. So, I wouldn't read too much into that. It's a combination of a bunch of products.

James Kisner - Jefferies

Okay. And just could you give an update on sort of DOCSIS 3.0 CPE sales; can you give us the unit number for DOCSIS 3.0 CPE?

Dave Potts

So the blend for Q4 was less than 10% of shipments for DOCSIS 3.0 which was down a few percentage points from Q3. so, obviously you can tell we are in the early innings still of DOCSIS 3.0 you haven't seen a lot of dramatic changes in marketing strategies yet from the operators particularly in the U.S. around the higher speeds and so there isn't a massive adoption. Having said there is a great deal of interest in a variety of new DOCSIS 3.0 devices kind of higher ends gateway oriented products from a lot of the operators. And I think that will be an integral part of how they market and sell the service later in the year.

Internationally in Europe I think 3.0 is accelerating a little faster, the pricing models are different and the adoption rate is a little faster in Europe and you could say the same thing in Japan.

Operator

So we have a question from the line of Greg Mesniaeff, Needham & Company. Please proceed.

Greg Mesniaeff - Needham & Company

Yes thank you I have a question on Comcast I mean clearly Comcast is becoming less of a pivotal customer for you but at the same time they are still very much in the midst of their 3.0 upgrade to CMTS level I am wondering as the year rolls through has Comcast given you guys any visibility or any requests for any kind of product development to target the SMB market particularly in the access area and if so what kind of impact may that have on R&D as you develop this products thanks.

Bob Stanzione

The Comcast is still a reasonably good customer so I wouldn't say they are small yet for any stretch. SMB is a real focus for a number of the operators in the US I think we will grow this year we have been marketing a line of multi line products for SMB that has been very successful. And there is like a growing focus on things like cellular backhaul and those types of capabilities as well. So I think you are right Greg that's a growth area we will see how it goes this year obviously how well positioned we are but there is a real focus in most of the operators a lot of them have separate businesses is now structured around SMB and larger business opportunities.

Greg Mesniaeff - Needham & Company

And I guess in terms of product road map have they given you any indication of what they are looking to get from vendors including yourselves?

Bob Stanzione

Absolutely yes absolutely there is a variety of new initiatives that they are talking about beyond a voice and data backhaul that they are thinking about.

Greg Mesniaeff - Needham & Company

And just a follow up on DSOs as international customers adopt 3.0 more aggressively do you see any impact on DSOs I mean DSOs were a day better in the quarter.

Dave Potts

I think we could see some increase for that reason Greg but again I think we've had a pretty good track record on the working capital side. So, we'll do our best.

Operator

We have a question from Blair King, Avondale Partners please proceed.

Blair King - Avondale Partners

I have just one question, Bob you talked a lot in the past about Workassure and the success you have had there. I listened to some of the Comcast comments around what they have challenged 2010 and heard similar comments from other operators, that certainly appears to becoming more than opportunity I'm wondering what is the potential for that product side and ultimately how big can that grow to as a percent of that currency as business or actually business in general?

Bob Stanzione

Blair you are right, I have talked a lot about Workassure in the past and we have had some great success with it and Bryant Isaacs is here in the room so, let me ask him to address that question.

Bryant Isaacs

Hi, Blair, Bryant here. On Workassure is one of our assurance tools, the overall purpose of those tools and what customers are tending to want them for is to optimize and decrease there OpEx, in the case of Workassure it's a workforce automation tool and that's also driven by the need to improve the customers experience. So, reducing top rolls for example better understanding where the issues on your networking getting to right field tech there with the right equipment in the time that they say they are going to get there. So, its just overall improves their operational capabilities reducing their costs and improving the customer experience which really all customers are striving to do today so we find that, that product along with the other assurance products has quite a bit of interest and we expect to see with the continued growth of that product in the market place.

Blair King - Avondale Partners

Yeah thanks, I guess I was trying to get more at the pipeline actually what is the trend there for a pretty sizeable increase in that product category or is the trend pretty linear sort of historically I guess the way its been trending?

Bryant Isaacs

Well its increasing and relative to the size of that business which it's a from a revenue perspective it is a smaller business within Arris and relative to the size of that business it is increasing and it is increasing at a relatively large and from my perspective rapid rate one of the things though with selling these product sets I think they even bought both mentioned lumpiness related to thinks like purchases of licenses that happened at discrete intervals sometime that very predictable the sale cycle tends to be long because we really have to get in and fully understand the operations of a customer and then really figure out how that tool fix with every thing else they have in some cases it's a replacement in some cases it has to integrate with stuff they have in some cases there some evolution that needs to happen so despite a bit of work involved in actually getting the tool going in the customer operation but when it gets there the results are rather rapid it and we have mentioned before in Workassure particularly in the case of one of our customers in Brazil there has been very rapid return on investment after we were installed and integrated but the actual architecture of getting for the installed the integration etcetera it took quite a bit and that's sale cycle sometimes is a bit long. Did that help you?

Blair King - Avondale Partners

Yes it does. I appreciate it, thanks Bryant.

Operator

So we have a question from Todd Koffman, Raymond James. Please proceed.

Todd Koffman - Raymond James

Thanks very much. Comcast started their DOCSIS 3.0 deployment a couple of years ago and basically they are finishing up and yet your DOCSIS 3.0 EMTA number is very, very small. Have you lost position in market share to another vendor or is Comcast just not make that bandwidth available and give them piece of CPU equipment that doesn't capitalize on the infrastructure they have deployed or I'm confused.

Bryant Isaacs

No, I think you have understand it Todd, the roll lot of 3.0 CPE and 3.0 service is pretty muted so far, you look at the pricing model by the edge routers in the U.S. and you are paying a significant premium for a DICSIS 3.0 service, its not marketed it as DOCSIS 3.0, its marketed as a 50 meg tier or 100 meg tier those sorts of things and the majority, the capacity that's being put into the network today is getting consumed for DOCSIS 2.0 standard 10 megabit, 20 megabit tier services and that's why its deceiving when somebody talks about 50% penetration of DOCSIS 3.0 or 80% penetration 3.0, that's being all chewed up for standard DOCSIS 2.0 service and we hadn't scratched the surface really on penetration of higher speed services which does nothing but increase the demand for more bandwidth and so I think as operators tweak their marketing model around the higher speed services you are going to see more and more bandwidth consumption clearly. And as far as loosing share I don't think we lost share at all there Todd.

Operator

And we have a question from the line of Simon Leopold, Morgan Keegan please proceed.

Simon Leopold - Morgan Keegan

Great thank you very much one of your peers competitors talked about improved visibility and extended their forecast out two quarters and Bob in your comments it sounds like you have got a little bit more visibility as well you highlight a number of factors looking in to Q2 can you address this topic?

Bob Stanzione

Sure. If you remember last year about this time I don't know whether it was this time or the next quarter I said that the second half of the year was going to be better than the first half of the year I think we are going to see that again this year I think as the year goes on we are going to pickup speed and do better and I feel even more confident of that this year then I did last year quite honestly because last year we were all stunned by the banking prices and what have you in this year things are settling down a bit we do have more visibility I think in some of the things that are coming in second quarter Dave mentioned a differed revenue item that's a fairly significant item that's going to make the floor in the second quarter in the BCS category which is a bit unusual usually most of the deferred revenue is over in the MCS side of the business so we feel pretty good about it and now we debated what type of guidance we should give whether we should give yearly quarterly half yearly or not at all and we kind of settled on this quarter by quarter guidance but I will stick my neck out at this point so I think second quarters going to show an improvement, a nice improvement.

Simon Leopold - Morgan Keegan

Great, I appreciate that. The other question I want to follow up with is the use of cash, you have got a nice cash generation on this quarter, you have made a series of acquisitions recently in the recent past. How are you thinking about an acquisition strategy or share buyback what do you want to do next?

Bob Stanzione

Well, it kind of all depends. The answer that we have been giving is that our primary intent for the use of our cash is acquisition and we want to expand the company in an accretive fashion by expanding primarily the portfolio products that we have and perhaps move into some other categories.

The second option of course is a stock buy back, the stock right now we believe is very undervalued and fact continues, we might consider a stock buyback but we don't announce them ahead of time, we have a committee, we have the ability to trigger buybacks essentially at a moments notice but we don't announce them ahead of time.

Simon Leopold - Morgan Keegan

Okay and can you give us some insight into what kind of revenue you got from either DGO or EDT acquisitions in the quarter?

Bob Stanzione

No, but its fairly, very small, fairly small.

Simon Leopold - Morgan Keegan

Like single digit million kind of small?

Bob Stanzione

Right.

Operator

We have a question from Larry Harris, C.L. King. Please proceed.

Larry Harris - C.L. King

Yes, thank you and congratulations on the earnings and cash flow generation in the quarter. I was wondering if I could ask about the competitive landscape in the CMTS market as you indicated, you captured a leading share this past year according to one trade press publication. CISCO has now decided to follow your lead and come out with integrated products for customers like Time Warner cable. Motorola is changing once again their strategy for the home business. Do you expect to continue the leading role in CMTS? Do you expect to continue to gain share versus your competitors? What you are seeing from them?

Bob Stanzione

We compete against very capable competitors at Motorola and CISCO. We respect them and they have good products and so it's a great fight that we're in and we're very pleased that we have been able to gain market share essentially starting as a new comer into this business a few years back. This business of selling Edge routers to the cable industry is a nice business quite honestly. There are only three companies that the industry can go to. There is an up start cost out there but for the most part 95% to 98% of the market is shared by the three. And there is really no place else for these cable operators to go and with video traffic growing at the rate it is, internet traffic growing at the rate it is, speeds increasing, video coming to the television set, we feel like we're in a great position and therefore we continue to be very aggressive in terms of planting our footprint around the world. So I think we'll continue to be aggressive. Bruce, would you like to add to that?

Bruce McClellend

Yeah, these are complex devices and you don't get here with a short term strategy. It's a long term strategy, long term investment cycle. We're developing and planning products that are going to deliver three years out at this point and working really closely with our customers and making sure we get the right features, the right scalability, cost points, all those sorts of things and as you know, we've established our long term strategy around some unique differentiators in the products with reliability over in these sorts of things that have been the right strategy, upgrade ability to be able to go back to the footprint and cost effectively upgrade the technology with programmable devices and those sorts of things and so it pays dividends in the long run. It takes a lot of upfront planning on this stuff but that's how we get to where we are. It's a fight everyday. We don't take any of it for granted and we've got to win every order to order but we got here with some real long term strategic planning.

Operator

And we have a question from Hasan Imam, Thomas Weisel. Please proceed.

Shubho Ghosh - Thomas Weisel

This is Shubho Ghosh here for Hasan Imam. I was just wondering if you could give us some more color on gross margins, how you kind of see that thing out for the first half, first and the second half of the year and of course if possible if you could tell us about Q1?

Dave Potts

So is really not something that we do but again the first quarter we do see less CMTS sales and lower MCS sales but I do think we have a shot of being in the 40 and above range. It will be all about the product mix but going out past isn't something we do.

Shubho Ghosh - Thomas Weisel

Got it, and about the sizable tier one customer that you were seeing the increased bookings coming from, can you also kind of quantify if possible how should we kind of look at this? Is this high double digit? How would we look at this in terms of the size of the booking?

Bob Stanzione

Are you referring to my comment about bookings coming in? I'm not sure what you're referring to Shubho so I believe its that, go ahead.

Shubho Ghosh - Thomas Weisel

You had mentioned strength in bookings going into the next quarter and some of it coming from win at a Tier-I customer. I believe it was Cox?

Bob Stanzione

I'm not sure which one it is but we do see a lot of business coming in from international customers into the first quarter. I think you will see a big increase in the percentage of our business that's international.

Dave Potts

The other thing that we do see outside our professional services and services business is something that's becoming more relevant and we are seeing some uptick for those services.

Shubho Ghosh - Thomas Weisel

And lastly if I may also ask one question on Comcast. Now you did, I got a good feeling for the trajectory but you did mention that capacity augmentation happens once every 24 months and we are now 18 months into the last capacity augmentation that had begun and I guess has tapered off now in Comcast. When do you see that cycle picking up again? I mean we are six months away from a 24 month cycle here.

Bob Stanzione

So let me just run back through the math real quick on that. What I am referring to is that you go into head end and you're at say 70% capacity utilization and you augment the capacity. So the capacity utilization drops to say 35%. It will take 18 to 24 months in that particular head end or that particular area to get back up to a threshold where you would augment capacity kind of where I was talking about the cycle. Obviously operators are constantly augmenting capacity in different regions of their network and so we've done it. We're going to wait 24 months and do it again. You can think of it that way in a small sample size but across the region its kind of a thing that's happens constantly.

Operator

And we have a question from the line Jim Suva from Citi. Please proceed.

Jim Suva - Citi

I'll make it brief. You made a comment with Comcast and you're maturing some of its ramp yet Time Warner really picking things up here. You had mentioned that the non Comcast customers should more than offset that decline, if I heard that right. And if so, does that basically mean that you're inherently expecting full year 2010 to be up over 2009 and if so I imagine its single digits rather that double digits?

Bob Stanzione

I think that's fair to say I think that there is good sound reason for us to be optimistic that 2010 will be up over 2009, whether its single digit. Double digit would sound pretty aggressive to me at this stage of the game, 1.5 months into the year but we are optimistic about what's happening. There are just so many positive signs out there with what's happening with the consumer, what's happening with our customers as they compete for those consumers. So we're pretty optimistic.

Operator

And we have a follow up question from the line of Nikos Theodosopoulos. Please proceed.

Nikos Theodosopoulos

Just one quick question. On the deferred revenue in the second quarter that's going to be recognized, I'm just curious, is that normal to see that? What is unique about this particular situation? Is it a new product to a customer that hasn't used it before because when I look at your portfolio, the products are not mature but what's causing it?

Dave Potts

Yeah it is a unique situation that we did defer the revenue. You've characterized it correctly Nikos.

Operator

And there are no more questions at this time.

Dave Potts

Well if there are no more questions, I think that will bring our conference call to a close. I do want to just remind you as Bob said that we will be having an Analyst Day and we'll be putting out a press release with details of how to register for that conference and accommodations with schedule and so forth. So look for that in the next several days and with that I thank you for your participation in this conference call and the call is completed. Bob?

Bob Stanzione

Thank you.

Operator

Ladies and Gentlemen thank you for your participation. You may now disconnect and have a great day.

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Source: ARRIS Group Inc Q4 2009 Earnings Call Transcript
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