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ARRIS Group (NASDAQ:ARRS)

Q4 2013 Earnings Conference Call

February 19, 2014 17:00 ET

Executives

Bob Puccini - IR

Bob Stanzione - Chairman & CEO

David Potts - VP & CFO

Bruce McClelland - President Network & Cloud

Larry Robinson - President & Customer Premises Equipment

Analysts

James Kisner - Jefferies LLC

Simon Leopold - Raymond James

Tim Quillin - Stephens Inc.

Brian Cowen - National Alliance

Todd Mitchell - Brean Capital

Joe Stein - Wells Fargo

Joseph Wolf - Barclays

Kishore Vykuntapu - Wells Fargo

Operator

Good day ladies and gentlemen. Welcome to the Fourth Quarter 2013 ARRIS Earnings Conference Call. My name is Celia and I will be our operator for today. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Bob Puccini, Vice President of Investor Relations. Please proceed, sir.

Bob Puccini

Thank you Celia. Welcome everyone to the ARRIS Conference with management. This afternoon we will be discussing our fourth quarter 2013 results which will release after close of market today. We will be using a series of slides during our webcast which are also posted on the ARRIS website in the Investor Relation section.

With us here at the ARRIS headquarters are Bob Stanzione, ARRIS 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, introduction of new products and technologies, anticipated spending patterns by some of our customers and expected sales levels for various product categories.

It is important to note that actual results may differ materially from those suggested by any forward-looking statements, which we may make during today's call. For further 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 can 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?

Bob Stanzione

Thank you Bob. I’m extremely pleased this evening to report on our Q4 results, the progress that we made in 2013 as well as our outlook for 2014. So let’s turn to chart 4 and we will look at some full year accomplishments. 2013 certainly turned out to be a transformative year as we anticipated. With our successful acquisition and integration of Motorola home we’re now a larger, stronger, more relevant and a more profitable enterprise. By almost any metric I can say that the year 2013 was a big success. We delivered on each of the goals we outlined a year ago. We deployed several next generation network and CPE solutions such as our E6000 CCAP platform and array of new in-home gateway devices which would position us for further growth in 2014. We significantly diversified our customer base and we increased our international presence. We achieved our synergy goals ahead of schedule and in December we accelerated the pay down of our debt and we delivered significantly better earnings and turned in some very nice top line growth as it's reflected in the Q4 numbers.

And most importantly for the future we significantly advanced our strategic objectives by diversifying our customer base and increasing our global presence. We have truly become a world leader in the delivery of video solutions. Please turn to chart 5 and take a look at the Q4 highlights; our Q4 results were quite strong with both sales and non-GAAP EPS well above the range of our guidance driven by across the Board strength but especially by the new product launches that we talked about earlier in the year. Revenues were over 12% ahead of Q3, almost 2.5 times what they were in the fourth quarter when we were ARRIS alone.

Our adjusted non-GAAP net income of $0.54 per share in the fourth quarter was over 38% better than the third quarter. And 93% better than the same period last year. Our cash position was and is strong and as I’ve said we choose to make an advanced debt repayment of a 125 million in addition to redeeming 232 million of convertible debt that came due in the quarter and making required debt repayments of 15.8 million. Book to Bill was 1.01 and we entered Q1 with a healthy backlog of 539 million. Overall we feel great about what we have achieved and our prospects going forward. Most if not all the integration risk that we faced earlier in the year is now behind us and the scale and diversification that we created in 2013 are clearly are paying off.

So please turn to chart 6 and we will look at some highlights of the CPE segment. Segment sales and direct contribution were up 15% and 25% respectively versus the prior quarter due to strong demand for both our Cable and Telco product lines. We’re continuing to see industry wide interest around new in-home architectures and technologies for delivering advanced services to both primary and secondary screens and the momentum around the advance gateway devices is continuing to grow.

Our cable set top unit shipments were up around 43% as compared to Q3. During the quarter we made great progress in the areas of product development and launch. We experienced higher demand for our traditional set tops and the Comcast XG1 came on very strong at the end of the year following the successful completion of product qualification.

We also saw a first DVD set top boxes deployed in Latin America and which is a region that continues to be a strong opportunity for us showing significant promise. Continuing on chart 7, we experienced continuing strong demand from our Telco customers for IP set tops and advanced DSL devices.

DOCSIS CPE [ph] sales were off somewhat from the record levels earlier in the year. However we’re seeing demand rebounding in Q1. During the quarter we announced the release of IPv6 support for ARRIS wireless gateways and deployed the software across 4 million devices in the install base and during the quarter 87% of our shipments were DOCSIS 3 and 58% were WiFi enabled.

I will also go to chart 8 and we will look at the networking cloud segment, the networking cloud segment sales and direct contribution were up 5% and 27% respectively compared to the third quarter with mix trending favorably on strong video infrastructure, CMTS and cloud sales. At year-end our E6000 was supporting over 2 million subscribers doubling the number of subscribers on that platform since Q3. The customer base is expanding and it's truly global with the CCAP refresh cycle gaining momentum and showing strong demand for the first half of this year and we continue to make progress in optimizing our supply chain and achieved a major milestone by completing the manufacturing consolidation of our access and transport product lines in our factory in Tijuana.

Continuing on to chart 9, our video infrastructure business saw strong quarter-over-quarter growth with both service provider and programmer customers. This business supports the ongoing increases in high definition and video content as well as the network upgrades underway to reduce analog content and implement all digital networks. We have also seen increasing demand for on-demand storage and streaming equipment for traditional video on-demand and network DVR services. We also continue to expand our Edge QAM footprint with the Apex3000; our service providers increasingly look to deploy CCAP capable platforms. Our cloud business, our growth and consumer customer wins for our video on-demand back office platform as well as more subscribers are now enjoying our Moxi and Dream Gallery experiences and our global services group finished the year strong reaching key milestones on several projects.

Finally on to chart 10, as you’ve seen on the press release our Q1, 2014 reflects continued strong demand across our product lines and it represents a significant year-over-year increase compared with the pro forma of Q1, 2013 results. However, we anticipate demand shifting among the products resulting in a slightly less favorable mix than we had in Q4 and non-GAAP earnings are going to be impacted by the failure of Congress to renew the R&D tax credit and the increase in our share count which together have a $0.03 to $0.04 per share impact on Q1 guidance. Dave will go over this again in a minute.

Looking further ahead our visibility into the second quarter shows good opportunity for revenue expansion. We have already seen solid order flow as well as positive messaging from our customers and we expect service provider capital budgets will modesty increase in 2013 and growing portion of that increase is being invested in our core products. Therefore we’re now investing in a supply chain to add more capacity and more flexibility to address these growing opportunities.

With what I can see right now I believe 2014 is shaping up to be a very good year and now over to Dave.

David Potts

Thanks Bob and thanks everyone for joining us this afternoon. I’m very pleased to announce strong results for the fourth quarter. So let’s turn to financial highlights in chart 12 please. As a reminder given that we closed the acquisition of Motorola Home in April, 2013 comparisons to prior periods may not be as comparable. Sales in the fourth quarter were 1.199 billion and above our guidance, this compares to 1.068 billion in the third quarter of ’13 and 344 million in the fourth quarter of 2012 which of course excludes Motorola Home. Gross margin was approximately 30.6% in the fourth quarter up from 29.7% in the third quarter of 2013 reflecting a positive mix.

Non-GAAP EPS was $0.54 in the quarter and compares to $0.39 in the third quarter of 2013 and $0.28 in the fourth quarter of 2012. Our fourth quarter 2013 GAAP EPS was a loss of $0.02 which compares to a profit of $0.12 in the third quarter of ’13 and $0.13 in the fourth quarter of 2012. GAAP EPS came in a bit below our expectations. Our GAAP taxes for higher than estimated and we also incurred higher integration cost than anticipated. With respect to cash taxes as expected we had no U.S. taxes payable in 2013 and had modest state and foreign taxes.

And as always a reconciliation of our GAAP to non-GAAP results is attached to the press release and can also be found in our website. We ended the quarter with $513 million of cash resources and we generated $191 million of cash from operating activities in the quarter. It is also important to note that we repaid $373 million of debt in the quarter. We retired our $232 million of convertible notes as planned, we also repaid a $141 million of our term debt including a $125 million optional prepayments and we had weighted average share count of a 144 million in Q4 which reflects a partial quarter of the 3.1 million shares we issued to recover the premium on retirement of the convertible notes. Our backlog at the end of the quarter was $539 million and our Book to Bill ratio was 1.01.

All right, let’s turn to slide 13 please. So a little bit look at the sales, sales from the quarter are again were 1.199 billion, sales of our CPE segment was 865 million, sales of our network and cloud were 337 million. Our sales were up a 131 million or 12% from the third quarter of 2013 on the strengthen of our new product introductions. Sales to Comcast were $223 million or about 19% of our sales. Sales to Time Warner were $83 million or about 7% of our sales and sales to Verizon were $150 million or about 13% of our sales. And our international sales were about 31% of in the quarter.

On to slide 14 please, on this chart, we break out sales and direct contribution in our new segment format. As a reminder, we have 2 segments, CPE and Network & Cloud. And certain costs that are not allocated to the segments are captured in Corporate Other and include the sales organization and Central G&A. We also showed the purchase accounting impacts and the Corporate Other category. So sales of our Network & Cloud were $337 million in Q4, with a direct contribution of $75 million and sales of CPE were $865 million in Q4 with a direct contribution of $188 million.

Okay on to chart 15 please, I'm very pleased with the progress we've made on OpEx post the acquisition. As expected OpEx was up a bit in the fourth quarter, R&D was $129.5 million in the fourth quarter up slightly from a $128.7 in the third quarter and SG&A was $110.6 million in Q4, up from $99.7 million in Q3. We incurred higher legal cost in the quarter as most higher variable compensation and some other costs. Included in R&D and SG&A was $10 million of equity compensation expense in the fourth quarter and in the fourth quarter we incurred integration cost of about $12.7 million, integration of our IP and accounting infrastructures will continue into 2014 and we still have other few facilities consolidations to go.

Let’s turn to chart 16 please, so let me touch on some of the cash and key cash items. We ended the quarter with cash and investments of approximately $513 million, down $182 million from the end of the third quarter. Cash from operating activities was $191 million in the quarter, and on this chart, I've highlighted some of the key items related to it. Very importantly the elements of earnings which are cash based were approximately $103 million. We also had other net positive movement in working capital of $88 million. We have higher accounts payable which was a function of timing and we also had lower inventory. Looking forward we expect that our EAP will decline somewhat in the first quarter. Also in the first quarter we will pay annual bonuses which of course build-up through the year. In the quarter we have CapEx of approximately $18 million and I’m very pleased to report that retired $232 million of convertible debt in the fourth quarter also again we repaid a $141 million of our term loans including a $125 million optional prepayment. All in I must say I’m very pleased with our cash generation and our balance sheet position.

On the slide 17 please, so let’s touch on guidance. At this point we estimate that we will have sales in the range of 1.170 billion to 1.21 billion and we anticipate the non-GAAP earnings will be in the $0.42 to $0.47 range and GAAP earnings approximately $0.10 and of course the reconciliation of our GAAP to non-GAAP is attached to the presentation and can also be found in our website. We estimate that our diluted share count will be about a 147 million shares and we estimate that our non-GAAP tax rate will be about 36%.

This rate is impacted by Congress not yet extending the R&D tax legislation. This is expected to have about a $0.12 per share negative impact for the year and less tax. So with that thanks and over to you Bob.

Bob Stanzione

With that we would like to open the lines up for questions. Celia, would you mind coming back on please in letting our participants know how to queue their questions.

Question-and-Answer Session

Operator

(Operator Instructions). The first question comes from the line of Mark Sue. Please proceed.

Unidentified Analyst

(Indiscernible) calling on behalf of Mark Sue. I just had a couple of quick ones, could you may be discuss what you’re seeing in terms of an impact on some of the end market consolidations, has there been any impact in terms of demand trends that you’re seeing in terms of orders either being pushed out or anything on those lines?

Bob Stanzione

We see no impact so far and obviously we talk to our customers a lot and don’t anticipate anything untoward happening to the business this year. It seems like it's fully speed ahead.

Unidentified Analyst

And quickly highlight the expectations of modest CapEx in calendar ’14. Could you maybe share your thoughts and sort of spending by region and in terms of the way you were expecting to see this and then so your markets CPE and network and cloud?

Bob Stanzione

I think what we’re saying is that we have seen announcements from major service providers in the U.S. in particular indicating that they are going to spend more CapEx this year. That’s confirmed by private discussions we have had with our customers in terms of not only what their overall CapEx plans are but, their plans are on particular product lines. In terms of how it might be spread between the two segments we see strengthening demand in both segments on Bruce’s side of the business in Network & Cloud, he is seeing increased demand as well as with Larry. So I will let them comment a little bit on what we’re seeing in terms of the outlook for the year.

Bruce McClelland

I guess of course the trick is making sure we’ve got the right products where they are spending the CapEx and if the CapEx bubble is growing up single-digit percentage we still think we can gain additional share because of the product positioning. And so in networking cloud the investments are in broadband capacity upgrades not only for the ongoing consumption of things like over the top video but launches of their own service providers managed IP streaming services, so a lot of effort going into that today. At the same time in order to do that they have to change the way they are partitioning the bandwidth within the network. So for the cable operators they are reclaiming analog spectrum, freeing up more room for digital video, high definition video and IP video. So there as Bob mentioned investments in CapEx increases we saw in Q4 in those areas. So those are probably the big ones in Network & Cloud.

Larry Robinson

Yeah on the CPE side we continue to see good demand on broadband area both in the DOCSIS and DSL space as operators continue to rule out the latest in terms of networking speeds as well as taking advantage of networking capabilities that exist within the home whether it be wireless or other wired network technologies. We’re also seeing good demand for as Bob mentioned our traditional set tops but also as operators begin to continue their migration towards more of a gateway architecture, video gateways in this case. We expect demand in that category to continue to be quite solid through this year and going forward.

Operator

The next question comes from the line of James Kisner, Jefferies LLC. Please proceed.

James Kisner - Jefferies LLC

So I guess I want to give you an opportunity, do you see incremental opportunities as a result of the large consolidation that we’re now expecting?

David Potts

Maybe. Both Time Warner and Comcast are following similar technology paths of offering higher bandwidth to their customers. They are announcing doubling of their download speeds; they have similar strategies in terms of the March toward internet protocol in their businesses. They are both working on similar paths towards better user experiences, they formed the RDK Alliance and they're moving forward in that direction. And also the fact that competition is not lessening but it increasing, it's escalating in the business. We also are what Google announced this afternoon about expanding Google Fiber into other areas in the country. So we don’t see that any of these companies in the U.S. that are perhaps consolidating and of course we have to see what the regulatory agencies do in this process. But with the competition and the similarities that Time Warner and Comcast have in their game plans I see it as a pretty good year coming up and it could result even in more business for us.

James Kisner - Jefferies LLC

I really want to drill down a little bit on CPE quickly. You said 43% quarter-over-quarter increasing set tops, is it fair to say the lion share of the increase is the XG1 or did you see kind of a more meaningful bounce back in that set top box? The legacy set top box side and is there underlying reason that’s obvious why that bounce back?

Larry Robinson

So from a set top box perspective I mean we absolutely did have a nice quarter with respect to completing the XG1 product qualification and beginning shipments for that product. But we also did see ongoing demand or improvements quarter-over-quarter for some of our what I would call more traditional non-video gateway set tops to some of our key customers but certainly the XG1 played a nice factor in the quarter.

James Kisner - Jefferies LLC

And I just wonder about profitability and obviously you talked about, this is increasingly commoditized is a harsh word but the set top business is very competitive as you know and they are pulling some software out and you would now like some margin pressure here. I’m just wondering are you are seeing a better-than expected gross margin on set top boxes this last quarter? It seems like your operating contribution is pretty solid on that division and you sort of relatedly I just love to get you to parse out in your Q1 guidance your thoughts of gross margin in Q1 something that you think is going to be down in OpEx, can you give us some more texture on the direction of those as we go into Q1? Thanks.

Bob Stanzione

Yes from a CPE perspective overall I would say that the gross margins continue to look pretty good from a product standpoint, I think what you’re seeing or what you saw in the Q4 results was really the effects of product mix. Obviously we’re introducing new products as well as transitioning with our customers to new platforms. We expect that to continue to some degree obviously as we go through the first part of 2014 and you know certainly recognizing the competitive dynamics in this space. That being said I think from a contribution perspective we expect things in CPE space to continue to be pretty solid.

David Potts

W overall we will guide the gross margins per se James but we will see how the mix turns out but we do believe that we have a modest mix change in the first quarter.

Bob Stanzione

I think one of the items on mix is the increased shipments of E6000 hardware assumed in Q1 and as you’re shipping more hardware in gaining that important foot print the cost base is higher that if you’re selling a capacity software license and so you can think of that ceding the markets and bearing fruit longer term as we sell more capacity into that install base.

James Kisner - Jefferies LLC

Okay one last follow-up just on OpEx, I mean maybe just try to figure out did you say if it was going to be up or down sequentially in Q1? I know (indiscernible) is not coming off until the QSAR is coming off till Q3 and you’re sort of building infrastructure behind this that we’re trying to model OpEx here just trying to understand given these were up as you expected this quarter, should they start to come down in Q2 and sort of stay here in Q1? Just any kind of picture on OpEx and I will happy pass on that. Thanks.

David Potts

There is always being some jitter in this but I would think that if in the zone or maybe it's a little bit higher in Q1. So we will see what happens to some of those one timers, Bruce could have any type of sort of samples to go we will see a legal cost come in but I think Q4 was in the zone in what you said but might be a little higher.

Operator

The next question comes from the line of (indiscernible), UBS. Please proceed.

Unidentified Analyst

I guess my first question was I just wanted to go back to the comments around mix and I’m just trying to understand you make references to mixes, is it just predominantly across the two major segments or are you also making references to mix effects whether these product category because again I’m just strongly to think about sort of the baseline gross margin and how we should be thinking about that?

David Potts

Well it's both, the mix shifts from quarter-to-quarter. Obviously the dollars are coming in the door and I will try to make it easier to understand by giving a couple of examples. In Larry’s area in CPE there are a variety of products that have a variety of margins associated with them. What we’re seeing in the first quarter are increased demand for certain of the lower margin product such as DTAs. Those are kind of low end products that we supply that have lower margins and so we’re seeing a little more of that in his mix in the quarter and then on Bruce’s side of the business as he stated we expect to have more network hardware going out the door in the first quarter and software so there is more of a hardware mix in the cloud side than there was in the fourth quarter. Now remember we said, he said that hardware that he puts out there is sort of the pre-cursor, it's planting the seeds for later sales of software upgrades to that hardware which will in some future quarter cause the margins to go back together. I hope that’s helpful.

Unidentified Analyst

Yes it was. And I just have a couple more, but just on the strength on Verizon if I’m not mistaken I think the first time we are seeing Verizon pop back to 10% plus customer. Just wanted to understand the dynamics in the account. Is this something a sustainable, what kind of drove this strength there?

Larry Robinson

So the growth that you saw there quarter-on-quarter was really driven around I would say they are ongoing demand associated with their continued roll out of the FiOS service. So we call our QIP set tops we had a good quarter with Verizon as they continued to drive that video service deeper into their system footprint.

Unidentified Analyst

Do you continue to expect going forward or was it sort of a catch up or one time disintegrated?

Larry Robinson

We expect Verizon to continue to grow their subscriber base, not in consistent with their pass performance. So once again it shifts a little bit from quarter-to-quarter but we expect Verizon to continue as we go through the course of this year.

Unidentified Analyst

And just on the overall competitive environment how would you sort of characterize it? There is a lot of larger competitors talking about the notion of set top but my understanding is they are still very much engaged in the business. Just wanted to get your update and thoughts of the competitive landscape and what you might be seeing out there?

Bob Stanzione

Don’t see a lot of change in the competitive environment; it continues to be a fairly intensive competitive environment quite frankly. The large competitor is still there and still meeting us in the market place as well as number of others. So I don’t see anyone throwing the towel by any means and therefore we’re investing very aggressively in cost reduction, we’re investing very aggressively in new technology and in fact I believe we’re probably investing more in new technology than any of our competitors which I think gives us a leg up.

Operator

The next question comes from the line of Simon Leopold, Raymond James. Please proceed.

Simon Leopold - Raymond James

A couple of quick ones and then maybe a little bit trickier question. On the quick ones just Dave if you could clarify your answer to James earlier regarding the operating expenses in Q1, I wasn’t clear whether you were saying they would be up sequentially or down sequentially because I just wanted to…

David Potts

We did 240 including stock comp. I always just remind everybody that our numbers include equity comp right, I think it's probably at the high end where we would be my guess and we might be down a little bit in Q1.

Simon Leopold - Raymond James

And then when we look at the December quarter you just reported your gross margin was nicely higher than what I think I was modeling as well as above consensus expectations. So want to get an understanding of first of all was the gross margin better than your original assumptions and if so if you could help us understand what were the surprises in terms of what helped the gross margin, was it greater software or greater volumes? Help us understand the levers on the gross margin.

Bob Stanzione

I think one of the things that comes to mind that in Bruce’s area there were a lot of orders late in the year for video infrastructure products, Bruce right?

Bruce McClelland

so this is products that groom the digital video traffic and allow the operator to steer the traffic in the right direction and the right bitrate all those sorts of things and the network as well as support this analog to digital upgrade transition I talked about, so this equipment and headend that facilitates that and so close to the end of the year we ended up with a little more business in that area than we expected in the long part of the margins that are better than the average so that helped. We had a couple of services projects come to completion which we recognized the cost typically in period and then recognized the revenue of high margin. So when those programs complete they help the margin profile. So we had few of those completed in the fourth quarter. There are two or three other smaller ones like that but at the end of the quarter I think that’s one of the big areas that are contributing, being little better than we expected.

Bob Stanzione

Back to the former question. It can be products within the segment and it can be the segments, it really just depends.

Simon Leopold - Raymond James

Great and then when we look at the Network & Cloud segment it's been down on a year-over-year basis past couple of quarters, just wondering when you see a situation where you think you will be delivering year-over-year growth on the Network & Cloud business. Is that something we should envision happening in the second half of the year or later this year, how do you see that trending?

Bob Stanzione

Yeah so I think certainly in the second half of ’13 we were in the transition period from a classic CMTS platform to CCAP platform. I think even in Q4 we saw that momentum shift and I think over half of our shipments in Q4 were in platform and we see that accelerating in the first half of this year. So we think we’re really on a growth trajectory from where we were in Q4 going forward. We will depend on a whole bunch of factors not only to which it's pricing and things like that but as Bob mentioned we’re actively adding more capacity into several product lines, we will now be able to build more products so that’s a pretty good sign I think.

Simon Leopold - Raymond James

Okay and then I’m going to ask a question that’s probably more blunt than you’re going to answer but maybe you can help us understand how to think about it. With all this talk about operators consolidating even though the operators all were heading towards I think the same general target of IP network. They have taken different strategies, Comcast looking at an X1, Charter putting I think more digital boxes and maybe Time Warner is thinking about using more DTAs than some of the other operators. I guess what I’m trying to get a sense of is how you sort of see the industry playing out in the shorter term. So I think we all agree that the long term strategy is a good path but maybe over the shorter term help us understand what are the puts and takes based on different upgrade strategies, see if you can work with that and just help me understand how to think about the next year?

Bob Stanzione

So I guess I will say a couple of things and ask Larry and Bruce to join in. Clearly Time Warner’s approach and Comcast approach at least to me look to be more similar than Charter’s. Charter has this very aggressive plan to essentially digitize their network with digital set top boxes. Comcast has already digitized their network, they did couple of years ago with DTAs and Time Warner is kind of somewhere in between those two but I guess from my point of view they are more similar than they are different. They are both racing to meet increasing demands for bandwidth and increasing demands for speed in their networks which require them to buy more CMTS capacity, more Larry’s advanced DOCSIS products and the they are all trying to improve the user experience with better user interfaces, more powerful in-home devices. Larry you might want to talk about the difference between today’s in-home device and those of say 3 to 5 years ago in terms of processor and memory.

Larry Robinson

Just to build on Bob’s comments. When I look at the shift to IP while you know the devil is certainly in the details in terms of the tactics to get there. I think at an aggregate level there are a lot of common themes that are developing right it's the utilization of bandwidth and the efficiency by which they use the spectrum that’s available to them and then we will think about the migration IP. From my perspective the whole will shift to IP probably more quickly than the network will which will take several years but while that shift is happening there will obviously be a drive towards new and innovative user experiences right in starting that shift towards the cloud. So I foresee as migration happening in phases and it will be in evolution and each operator may follow us slightly different path but I see gateways becoming more and more present in the marketplace as operators continue to roll out really an entertainment hub within the home that’s capable of serving not only you know more traditional set top devices but also we would call customer owned and maintained equipment tablets, Smart TVs, things of that nature. When I look at kind of our position to go capitalize on that migration and opportunity I look at the portfolio that’s available to us from an ARRIS perspective and I think we’re well positioned to help each of the operators depending where they are at in that transition to make that migration moving forward whether that be purely a video gateway that’s a device that’s focused just on delivery of video services through gateway architecture or one that begins to incorporate more of the triple play capabilities into one device. So once again leveraging the portfolio that we have I think positions us well to help operators through that multi-year migration that we’re just beginning to embark on. Bruce?

Bruce McClelland

I think we’re trying to think outside in the U.S. market as well because we get so fixated on U.S. market but there is two big imperatives I think service providers have around the world, one is enhancing the main TV experience that’s more advanced user interfaces, more interactivity, more content and making sure that they are the compelling portal of content for consumers and the second is simply getting that content on to a variety of additional devices so that’s an imperative theme for every service provider, they are all coming out a little bit differently but I think those are, if you would talk to them those two big compelling things they are focused on.

Operator

The next question comes from the line of Tim Quillin, Stephens Inc. Please proceed.

Tim Quillin - Stephens Inc.

Dave just to follow-up on that question on operating expenses I understand what you’re saying on first quarter but how should we think about second quarter and beyond as you wean off of the Google back office support and what precisely is the timing around that as well?

David Potts

So it's going to take us into May – June to completely finish I think some of that back office piece. There will always be jitters at the end of the day, so again the kind of the model which we put out to you before is reasonable. So, low point was to 229 last quarter, perhaps. We are 240 in this, so again the zone that we painted for you in our model is probably is out [ph].

Tim Quillin - Stephens Inc.

Okay so they will stay in that zone after you get off of the Google back office?

David Potts

Unless I’m missing something it will always be you know puts and takes with things again like as if we have prototypes or if there is spikes in legal and things like that but yes…

Tim Quillin - Stephens Inc.

And then question for Bob or Larry, I think over the past couple of conference calls maybe you’ve alluded to new gateway roll outs for some of your largest service provider customers. I’m wondering what the timing of those might look like right now or what exactly is in the house [ph] right now? And then maybe even more blunt, would a Time Warner upgrade cycle be slowed down if they are in the process of being acquired?

Bob Stanzione

Well to the broader kind of product pipeline activities, so obviously the one we announced and kind of took place in Q4 was really around the Comcast XG1. We have also had other devices and when we speak gateways once again those could be broadband data gateways as well as video gateways, so really covering the portfolio of products you know while we announced the specific customer activities we did complete some product qualification activities efforts in Q4 and expect to see those products roll out on the first half of this year. Also on back to the video gateway side I would anticipate you know another one of the products that we discussed in the pipeline over the last few calls rolling out kind of middle of this year and then one or two second half of 2014.

Tim Quillin - Stephens Inc.

So I guess you’re not going to answer the question regarding the potential impact on the Time Warner upgrade cycle?

Bob Stanzione

Frankly we have been talking with Time Warner they have not changed their forecast, they have, we have got orders in house and we’re going full speed ahead with no change as a result of last week’s announcement, Tim. So far we don’t see any change and frankly we don’t anticipate much of any change.

Tim Quillin - Stephens Inc.

And just last question on cash flow when you first announced the acquisition you talked about a free cash flow target of 303 million to 338 million. I think you had a run-rate right now of $400 million plus were in the fourth quarter, do you’ve an updated target and how would you expect to use your free cash flow is it continued debt reduction or would you think about buybacks or acquisitions at this point? Thank you.

Bob Stanzione

I have not updated that target but I will say I continue to think of cash taxes particularly if we can ultimately get the R&D tax credit solved, it's not the same as I thought about it previously. So I think we’re in a good place there. But our balance sheet allocations strategy is unchanged, you know the two things we talked at the Analyst Day in New York where that ultimately debt pay down is something that’s high in our list as you know looking continuing to think about acquisition. So just depend on what comes our way in that fashion. I would say probably share repurchase is not in the horizon at this stage. Getting to delevering and really trying to dig up those seconds [ph] is what’s in our mind.

Operator

The next question comes from the line of Brian Cowen, National Alliance [ph]. Please proceed.

Unidentified Analyst

Couple of questions, first of all I was wondering if you could talk a little bit about, I’m going to be the be the OpEx horse a little bit more. Dave you have talked about sort of the 240 level today or the past quarter being perhaps a little bit higher but generally not really out of line and that’s really kind of right in line with what your target run-rate looks like. At the same times you look at the that OpEx as a percentage of sales is probably low, maybe six quarters preimposed Moto Home. So I’m kind of wondering if, how much leverage you really see in that numbers you look toward the other quarters in 2014 and if you’re really, when you’re talking about that guidance is it really sort of that $930 to $980 figure that your target run-rate guidance for OpEx or is it more sort of managing it, and managing expectations more sort of on a percentage basis.

David Potts

So in percentage basis I would argue it's not a good way to look at this, so we have R&D budgets, we have also marketing budgets, sure ambitions can go up and down a little bit but really there isn't much very variability as a percentage of sales. We should be able to create leverage and I won't call it step function differences that we would take but right now I think we’re in the place again we will have jitter but I don’t think it's significant of declines in numbers that we were talking about. So we did 229 last quarter, we did 240 this quarter; we will see where it comes in. I’m not sure how to be any more crystal clear in that kind of the zone that you think we’re in.

Unidentified Analyst

So I will move off the OpEx question. I think you replied the timing on the question regarding the transition from the Classic CMTS to E6000 platform and if I heard you right I think you said it was more than half of shipments in 4Q of E6000. Just want to make sure that I heard that right and I guess do you sort of as you look at the next quarter do you think that trend will continue to, does it accelerate? Does it sort of moderate as you look ahead at least over the next quarter that we’re in and then maybe perhaps a longer term view and then just to put the cherry on top what if you can give me, help us out even just qualitatively a little bit on what you’re seeing today on a margin differential between the old C4 Classic CMTS and the E6000?

David Potts

To answer the first couple of questions and not answer the last ones but on the couple questions, I guess not surprisingly we have seen strong interest around the world and moving to a next gen CCAP platform a lot of the emphasis today is simply on capacity expansion for high speed data adding more channels into a service group those sorts of things and it's a pretty compelling solution when you can reduce the number of chassis and headend, reduce the power consumption and then kind of future proof [ph] you will be add more capacity overtime through these software licenses. So it's a bit of a no brainer pretty compelling and now that we’re in volume and as Bon mentioned over 2 million subs that will be the majority of shipments going forward, doesn’t mean there isn't some on the Classic platform, it still makes a lot of sense in certain areas but I expect percentage you need to grow with as years goes on and yeah somewhere around half of what we shipped in Q4 was of the new platform. So really good momentum there.

And I just won't talk about individual margins on the products. Certainly as we have mentioned once already that we’re shipping clearly a lot of hardware now you know we’re putting these new platforms out seeking the market et cetera and that’s high mix of hardware so the initial margins on the product are lower than if you’re selling software licenses clearly but I won't comment too much more on it than that.

Unidentified Analyst

I will maybe try to tweak it one more way; I mean do you view the differences in the margins as primarily being a function of sort of the hardware/software mix or sort of the chassis blade mix, if you will? Or, are there some sort of kind of fundamentally they are sort of market driven or product driven differences fundamentally in the product that we should think about the margins maybe being a little bit different.

David Potts

Yeah I guess it's more of the former but I won't let you take me much further.

Operator

The next question comes from the line of Todd Mitchell, Brean Capital. Please proceed.

Todd Mitchell - Brean Capital

Two questions first in terms of the CPE business can you give us a little bit of sort of qualitative information in terms of rolling out sort of these newer higher ARPU home gateway businesses, I mean do you get longer lead times on this business? Do you have better visibility sort of versus the lower in DTA products and if so could you give us some sort of qualitative measurement of that and can you also talk about how you could image these things year-over-year?

Bob Stanzione

I’m sorry Todd I didn’t catch that last year on the year-over-year.

Todd Mitchell - Brean Capital

Well just basically, at the higher end is there a difference in kind of the way the pacing’s and the spending for the roll out of these boxes go versus the lower end products?

Bob Stanzione

I think it varies by customer, some get really good visibility and others not so much.

Larry Robinson

I don’t see my perspective I don’t see a big difference once the product is kind of through qualification and operators are rolling out kind of the new platform whether that be a lower end device driving for instance in all-digital migration or a higher end device driving and new user experience leveraging and potentially a gateway architecture from a supply chain perspective you know we’re fairly well connected with our customers and I would say manage the supply chain in many respects in a very similar fashion depending on you know given the particular product and to Bruce’s point it does vary a little bit by customer by customer but generally when they are rolling forward with an initiative I would say the lead times are pretty similar across their respective products.

Todd Mitchell - Brean Capital

And second question has to do with it's kind of two part in regards to the International business, can you give us an update on efforts to qualify CPE at the high end in the European market and can you also talk about exposure to Latin American markets with currency issues.

Bob Stanzione

So with respect to CPE activities in Europe I mean we’re still on the process of working with customers to get as you kind of classify at the higher end platforms qualified and accepted in shipping, particularly I would comment more out I will say reference to the cable space so that’s a market we’re continuing to very much target and aggressively pursue but that is a kind of an ongoing activity and with respect to the general in currency, right, I think Argentina is probably the most problematic these days. It's sort of a fluid situation but we work daily with our customers to try to work through how we structure it.

Larry Robinson

The good news, the customers we sell through in that market are very well capitalized the large corporation so it's I think more of a temporary issue to work through than a risk exposure issue.

Todd Mitchell - Brean Capital

Okay so then to sort of follow-up on both of those, do you expect to get qualifications in Europe this year and do you see an significant impact from currency issues in Latin America going forward?

Bob Stanzione

So with respect to the qualifications we’re still working to finalize kind of the plan of record to make sure we obviously qualified in rolling out. So at this point given where we’re at in the year we’re not quite there yet and I don’t know that at this point we anticipate any, I mean a lot of the equipment sales that we make in these markets are revenue generating sales and so if they stop purchasing and stop adding customers they stop generating revenue so while they will I think be as careful as they can and they have to continue to operate the business.

Operator

The next question comes from the line of Joe Stein, Wells Fargo. Please proceed.

Joe Stein - Wells Fargo

Just a question about the term loan pay down during the quarter, I’m wondering if you guys have set your sights on the coupon step down that you’ve in your Term Loan B and if that’s something you think might seek to obtain in the near future. Thanks.

Bob Stanzione

Yes I think so. So we’re focused on the term loan being and continuing to take it down first as you might know we have said before we actually have some derivative instruments in place to help, to protect us on the A, so yes I think the step down is possible and I think you probably did also know that we have had some sort of I guess traffic from both Moody’s and Standard & Poor one of whom basically said that we’re stable and the other sort of on a positive outlook which is good news for us.

Operator

The next question comes from the line of Joseph Wolf, Barclays. Please proceed.

Joseph Wolf - Barclays

I just had a question on the bookings and the backlog given the mix of the new products. Is there a longer lead time in terms of how long product stay in the backlog or is there a new way we should be thinking about that and I guess how do we tie that into expected cash flow in terms of a number for the year based on a full year of consolidated numbers of the acquisition?

Bob Stanzione

I don’t see any major change on how long products stay in, how long in order might stay in a backlog. The second part of the question, how it might play out in terms of cash flow during the year. There is the ebb and flow of working capital in the business is I don’t see it changing.

David Potts

So as we get perhaps higher so perhaps permanently more in accounts receivable but we have high velocity of receivables in any event and I don’t see it dramatically changing.

Operator

Final question from the line of Kishore Vykuntapu, Wells Fargo. Please proceed.

Kishore Vykuntapu - Wells Fargo

Was there any onetime items in 4Q cash flow that actually kind of you had a pretty significant free cash flow in 4Q? I mean where there any onetime items that impacted it or do you think that’s pretty clean?

David Potts

I will break it into two, so we have what I call the earnings element which is the 103 million and then we have stuff from working capital (indiscernible). I do believe that the accounts payable was a little bit higher than normal I think that does come down. Again remember that we do build annually our bonuses through four quarters so we’re at the high point there and then there are some International ebbs and flows, there is nothing I can really point to but except we do that that I would say our niche [ph] will.

Kishore Vykuntapu - Wells Fargo

Okay and then if you can share it can you share what the bank EBITDA is for 2013?

David Potts

Well we’re finding the compliance we have not disclosed the leverage ratios but we’re finding within our compliances.

Operator

With no further questions we will turn the call back over to Mr. Bob Puccini for closing remarks.

Bob Puccini

Thank you Celia. Bob any final words?

Bob Stanzione

Yeah. I think we’re in a great place at a great time. I think that a lot of the concern over or the integration risks with this big transaction that we did is behind us. One of the thing that I saw recently that I think is worth mentioning is that I was watching the Super Bowl, in the commercials two of our major customers featured in their Super Bowl advertisements the in-home devices that they were offering indicating to me that the in-home device is an important part that they offer to their customers and the performance of those in-home devices is dependent upon the network equipment that we have. So I think that’s just one more signal that supports our contention that we’re in a great business with great growth opportunities at a great time. The economy continues to improve and our business continues to improve and I think we’re looking to a pretty good 2014. So with that I think we will sign off and thank you and we will be on the call again after three months.

Bob Puccini

Thank you Celia. Thanks everyone. That concludes our call.

Operator

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.

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