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ARRIS Group, Inc. (NASDAQ:ARRS)

Q1 2014 Results Earnings Conference Call

May 6, 2014 5:00 PM ET

Executives

Bob Puccini - Investor Relations

Bob Stanzione - Chairman and CEO

David Potts - Executive Vice President and CFO

Bruce McClelland - President Network & Cloud

Larry Robinson - President, Customer Premises Equipment

Analysts

James Kisner - Jefferies

Mark Sue - RBC Capital Markets

Amitabh Passi - UBS

Simon Leopold - Raymond James

Joseph Wolf - Barclays

Brian Cowen - National Alliance

Todd Mitchell - Brean Capital

Operator

Ladies and gentlemen, good afternoon. And welcome to the First Quarter 2014 ARRIS Earnings Call. My name is Ryan, and I’ll be the operator on today’s event. At this time all participants are in listen-only mode. Later, we will be opening a line to facilitate questions-and-answers. (Operator Instructions)

And as a reminder, we are recording call for replay. Now, it’s my pleasure to turn the call over to Mr. Bob Puccini, ARRIS Investor Relations.

Bob Puccini

Thank you, Ryan. And welcome everyone to the ARRIS conference call with management. This afternoon we will be discussing our first quarter 2014 results which were release after close of markets today. We will be using a series of slides during our webcast which are also posted on the ARRIS website in the Investor Relations section.

With us here at the ARRIS facility 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 two. During this call, we will be making forward-looking statements, including our outlook and expectations for our industry in general, estimated revenue and earnings, certain financial operating metrics, the timing and introduction of new products and technologies, anticipated spending patterns by some of our customers and expected sales levels 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 those forward-looking statements, please see our recent filings with the SEC.

Now, if you go on to chart three. Bob and Dave will provide their comments on quarter results after which we’ll open up for questions. Bob?

Bob Stanzione

Thanks a lot, Bob. I’m extremely pleased this evening to report on our Q1 results, the progress we’ve made to date, as well as our outlook for Q2 and beyond. We are clearly off to a great start this year. Q1 results were strong and as you can see from our guidance, Q2 is shaping up to be an outstanding quarter.

So let’s turn to chart four, please. The Q1 numbers certainly reflect continued progress toward achieving the vision that we described just over a year ago. Service providers worldwide are investing aggressively to expand their broadband platforms and improve the video experience and we are right there, deeply involved in helping them achieve their objectives.

We saw strong demand across the Board, with particularly high order input for broadband speed and capacity expansions using our in-home solutions and our E6000 CCAP platform.

Specifically, revenues of $1,225 million were up 2% sequentially and above the high-end of our guidance. Non-GAAP earnings were $0.47 per share and at the top of our guidance.

Book-to-bill was a healthy 1.37 and we entered Q2 with a record backlog of just under $1 billion. Overall, we feel very good about what we’ve achieved and our prospects going forward.

Let’s turn to chart five and take a look at the CPE segment highlights. Segment sales were up 4% over Q4 of 2013. Direct contribution was down slightly by 1% from the previous quarter due to a product mix change. We continued to see industry-wide increases in investments in new in-home solutions and we believe that we’ve gain share in this important segment of the business.

Set-top unit shipments were up 11% as compared to Q4. Although, mix turned somewhat unfavorable due to the heavy shipments of lower margin and lower ASP digital terminal adapters. We announced a high definition DVD set-top win with China Network Systems in Taiwan and momentum for a variety of our advanced video solutions remains strong.

We secured our first Ultra HD 4K set-top award with a major Telco and we’ve been generating lots of interest in our portfolio at tradeshows around the globe. Momentum is continuing to grow across multiple customers for our video gateway solutions and high-speed data products.

Let’s go to chart six. Here on chart six are three high profile recent examples of significant investments our customers are making in evolving their video and broadband service offerings, all of which we are actively supporting.

On Chart 7, demand for our broadband high-speed data devices has been outstanding. Unit volumes were up 20%, rebounding strongly from Q4. ARRIS DOCSIS 3.0 wireless gateways are supporting Time Warner Cable’s Maxx market initiatives in Los Angeles and in New York. And 93% of the quarter’s shipments of these devices were DOCSIS 3.0 and 58% of them were Wi-Fi enabled devices.

Now turn to Chart 8. And we’ll take a look at the network and cloud segment. As expected following the robust end-of-year sales of video systems equipment, segment sales were down 3.5% compared to Q4.

Mix in the segment has now shifted heavily toward our new E6000 CCAP platform. There are now over 5 million subscribers on the E6000 platform, more than doubling the Q4 subscriber count. Demand for this product has been outstanding. And we would have shipped more were it not for supply constraints that have now been addressed.

Let’s go to Chart 9. Our ATS business grew modestly in the fourth quarter supported by stronger demand for optical transmitters and Wi-Fi growth. And as I mentioned, the video systems business saw a pullback in the first quarter; however, we did have solid sales of video infrastructure products to North American Telcos. And we are continuing investments in HEVC encoding products and 4K video processing.

It was a good quarter too for our assurance business with customer wins for our WorkAssure Field Service Management software suite. And we introduced new management software to improve service provider Wi-Fi efficiency and quality. And it was another solid quarter for the global services team, who were involved in numerous DOCSIS migration, wireless access and HFC design programs.

And finally onto Chart 10. As you have seen in our press release, Q2 2014 represents and reflects outstanding demand across all of our product lines. We are entering the quarter with record backlog. We see growth in both domestic and international markets, growing demand for network expansions and video experience enhancements, coupled with broad acceptance of ARRIS CPE and network and cloud solutions.

With what I can see right now, I believe 2014 is shaping up to be a very impressive year. Everywhere I look, service and content providers are announcing new faster, higher value services. For example, service providers worldwide are announcing higher and higher high-speed data services, GigaPower from AT&T, Gigasphere is the new term in cable.

Liberty Global has announced that they are substantially increasing broadband speeds across their global footprint. And Charter and Time Warner have also announced and are deploying higher speeds to their subscribers. And ARRIS is right in the middle of all of these endeavors.

At the same time, we continue to invest heavily in tomorrow’s technologies such as DOCSIS 3.1, multiscreen, HEVC encoding, ultra high definition, advanced Wi-Fi and

targeted and dynamic advertising.

And with that, let me turn this over to Dave.

Dave Potts

Great. Thanks, Bob and thanks, everyone, for joining us this afternoon. And I’m pleased to announce strong results in the first quarter. So let’s turn to financial highlights on Chart 12 please.

As a reminder, given that we closed the Motorola acquisition in April of 2013, comparisons to the first quarter 2013 may not be as meaningful. So sales in the first quarter were $1.225 billion and above our guidance. And this compares to $1.199 billion in the fourth quarter of 2013 and $354 million in the first quarter of 2013, which, of course excludes Motorola Home.

Gross margin was approximately 28.3% in the first quarter. And as expected, down from 30.6% in the fourth quarter of 2013, reflecting the change in product mix. Gross margin was 30.7% in the first quarter of 2013. Non-GAAP EPS was $0.47 in the quarter and that compares to $0.54 in the fourth quarter of 2013 and $0.25 in the first quarter a year ago.

Our first quarter 2014 GAAP EPS was a profit of $0.28, which compares to a loss of $0.02 in the fourth quarter of last year and a loss of $0.13 in the first quarter of 2013. In the first quarter of 2014, we recorded some GAAP tax benefits, which I will touch upon in a moment. And as always, a reconciliation of our GAAP to non-GAAP results was attached to the press release and can also be found on our website.

We ended the quarter with $522 million of cash resources and we generated $35 million of cash from operating activities in the quarter. And we had a weighted average share count of 147 million shares in the quarter. Our backlog at the end of the quarter was very strong at $996 million and our book-to-bill was 1.37.

Okay. Let’s turn to slide 13, please. So again, sales in the quarter were $1.225 billion. Sales of our CPE segment were $894 million, while sales of Network & Cloud were $332 million. Our sales were up $26 million or 2.2% from the fourth quarter of last year. Sales to Comcast were $203 million. Sales to Time Warner were $159 million. Sales to Charter were $137 million and sales to AT&T were $134 million. And our international sales were about 26% in the quarter.

So on to slide 14, please. On this chart we break out sales and direct contribution. As a reminder, we have two segments, CPE and Network & Cloud. Certain costs that are not allocated to the segments are captured in corporate/other include things like sales organization and central G&A. We also show purchase accounting impacts in the corporate/other category. Sales of Network & Cloud were $332 million in the first quarter of 2014, with a direct contribution of $65 million and sales of CPE were $894 million, with a direct contribution of $192 million.

On to chart 15, please. Operating expenses were $233 million in the quarter. R&D was $134.2 million, up from $129.4 million in the fourth quarter of last year. SG&A was $99.1 million in Q1, down from $110.6 million in the fourth quarter of last year. We incurred higher legal cost in the fourth quarter of last year and in the first quarter of 2014 we had lower transition services costs relative to the fourth quarter. Included in R&D and SG&A was $10 million of equity compensation expense in the quarter. And in the first quarter of 2014, we incurred integration costs of over $11.5 million. Integration of our IT and accounting infrastructures continue and will continue in 2014.

On to chart 16, please. Let me touch on some of the balance sheet pieces. We ended the quarter with cash and investments of approximately $522 million, up $8 million from the end of last year. Cash from operating activities was $35 million in the quarter. And on this chart I’ve highlighted some of the key items. Very importantly, the elements of earnings which were cash-based were approximately $121 million and we used about $87 million of working capital in the quarter. AR increased reflecting the timing of sales and the payment patterns of our customers. And we paid out our 2013 annual bonuses in the first quarter. Inventory was down from the fourth quarter, reflecting our strong demand. In the quarter, we had CapEx of approximately $13 million. All-in, I’m very pleased with our balance sheet position.

Let’s turn to slide 17, please. With respect to taxes, there are several items to note. First, our normal rate, which excludes certain discrete tax items, was about 35% in the quarter. Congress has still not passed the extension of the R&D tax credit. As a result, our rate is higher. We estimate the impact to be about $0.12 for the year if not passed. And we recorded two key discrete tax benefits in the first quarter of 2014, which are in our GAAP results but not in our non-GAAP results. First, we continued work with Google on certain tax items. As a result of this work, we now estimate that we will be able to utilize certain NOLs resulting from the Home acquisition in the future. We estimate that benefit to be approximately $18 million. Secondly, we concluded an IRS audit. As a result of that audit, we reduced reserves for uncertain tax positions by approximately $3 million.

Okay. Let’s turn to chart 18, please. So with respect to guidance, at this point we estimate that we will have sales in the range of $1.41 billion to $1.45 billion and we anticipate that non-GAAP earnings will be $0.64 to $0.70 and GAAP earnings of $0.27 to $0.33 in the second quarter. We entered the second quarter with a very strong backlog and are catching up on demand for certain products.

As a result, we anticipate a strong quarter. With respect to OpEx, we do expect it to increase quarter-over-quarter. Annual raises began on April 1st. We will have an increase in equity compensation, as former Home employees will have two years of grants in play versus one. With the higher sales in direct operating income, we will also have higher variable compensation.

Finally, we expect higher tradeshow and some other costs in the quarter. A reconciliation of our GAAP to non-GAAP guidance is attached to this presentation and can be found on our website. We estimate that our diluted share count will be about 148 million shares in the quarter and we estimate our non-GAAP tax rate to be 35%.

One other item I would like to highlight is that there is the potential for a labor disruption in certain ports on the West Coast in the second quarter. While we’re working on contingency plans, if this comes to pass, it’s possible this could have an impact on us.

And so with that, thank you very much. And back to you, Bob.

Bob Stanzione

Thank you, Dave. With that, we would like to open up the lines up for questions. Ryan, would you come back on the line, please and let our participants know how they can ask questions?

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) And our first question comes from James Kisner with Jefferies.

James Kisner - Jefferies

Hi, guys. Nice quarter and guidance, gentlemen.

Bob Stanzione

Thanks.

James Kisner - Jefferies

So turning to questions, I mean, I think the most obvious question is around sustainability, especially given the supply constraints you guys have talked about. I was wondering if you perhaps can quantify in anyway how much of business you might have left on the table as a result of supply constraints and also, might we assume any kind of headwinds into Q3 as supply catches up with demand?

Bob Stanzione

So to be as clear as we can, there were some supply constraints in the first quarter, particularly around the E6000, which is doing extremely well in the marketplace probably in the order of $20 million to $30 million that we might have shipped in the first quarter that slipped into the second quarter. We do expect -- although we are not giving guidance for the third quarter at this time, we are far enough into the second quarter that we have fairly decent visibility into the third. And it looks like the third quarter is shaping up very nicely.

So beyond that, of course, fourth quarter is always a little bit dicey. Sometimes they are up, sometimes they are down. But right now, with the share that we are gaining we are gaining share, I believe in both CPE as well as in network and cloud, as well as the fairly vibrant market that we are selling into, with all the excitement about increasing broadband speeds, with over-the-top streaming video growth and the like. We see this business doing very well right into the future.

James Kisner - Jefferies

That’s great. And I guess, clearly, your guidance totally blows away your old operating model here. I mean, do you have any updated thoughts here on kind of like your long-term operating model at this point?

Bob Stanzione

No. I wouldn’t want to answer that right now, James. I think we need to digest what we’ve got here. We’ve been so focused on integration over the past year. I think we’ve got that substantially behind us. And we are certainly future focused right now, but to announce a new operating model I think now would be a little bit premature. Hopefully, we can do that in the very near future.

James Kisner - Jefferies

Great. And then just one final one, sort of housekeeping, the video infrastructure stuff that you talked about, I’m kind of wondering if that’s the BMR or the Telco, or perhaps that’s encoding. Could you give us any more texture at all on the video infrastructure strength and how fast thing improves?

Bob Stanzione

Yes. Bruce McClelland can do that.

Bruce McClelland

Hi James. So it includes -- excuse me all of the products you just mentioned, the conditional access business, the security encryption, advertising, splicing those sorts of product lines and we sell all of those into both Telcos and cable operators. And so we had some solid business with the Telco operators in those products in Q1.

James Kisner - Jefferies

Is that why the deferred revenue popped so much sequentially? Two, is all that stuff, is that all picked up?

David Potts

Yes. Deferred revenues in the first quarter, it was -- this is Dave speaking, James, is always the heaviest because of course, we have all of the service and the maintenance contracts renewals which come in, which is also embedded into the backlog as well. But deferred revenue was -- we did have some programs that are deferred. It’s always highest in the first single down from there.

James Kisner - Jefferies

Great. Thanks very much.

David Potts

Yeah, James.

Operator

We’ve got another question coming through from Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets

Thank you. Gentlemen, the set-top boxes, I guess, the drop was that some people had modeled the decline over time, instead that’s growing at 11%. Maybe some comments on the breadth of the growth in set-top boxes, both cable and Telco, where you are seeing the spurt and are we at a point where many competitors have -- many service providers now need to refresh their set-top boxes?

Bob Stanzione

I think refresh is the right term as well as share gains. But I’d like, Larry Robinson to elaborate.

Larry Robinson

Hey, Mark. I think it’s a combination of all the things you mentioned. Where we are seeing some of the near-term improvements is certainly driven around the introduction of video gateways. We also highlighted some shipments around digital terminals adapters to some specific customers.

I think, longer-term, we are anticipating that there will be a refresh cycle and potentially an acceleration of that refresh cycle. So typically boxes will remain in the field for quite sometime. Historically, we think with the application and service, innovation that’s taking place, it’s setting the stage nicely for boxes to be refreshed on a much bigger rate than historically has been done.

Mark Sue - RBC Capital Markets

Any thoughts on just kind of the tail of that, how long this can match or refresh? It is a cyclical business, so we are just trying to get a sense on how -- are the cable operators following the Telcos and then we will see a subsequent refresh in other regions?

Bob Stanzione

I think we are in the early stages of a refresh cycle. The devices in the home -- although cloud is really the cool thing right now and core element in what’s going on. The devices in the home are selling. If you look at the advertising that’s being done by the operators, right in their home that they are advertising. And I think one other aspect of the CPE refresh cycle that has been overlooked and we will begin to -- we’ll certainly extend that tail to DOCSIS 3.1 cycle, that won’t even start until late next year. Excuse me?

Mark Sue - RBC Capital Markets

That’s helpful. And then maybe, Dave, a follow -- a question for you, as we look at the financial models, just your thoughts on reducing interest expense if you are inclined to do so and kind of a ballpark of how we should think about annual free cash flow?

David Potts

Yeah. So, I sort of follow the implied EBITDA that comes out of the models that you are creating, I think that will be fine. CapEx, again, about $60 million, $70 million is probably the right number to go with that. And on the OpEx side, as I mentioned, I do believe OpEx will go up in the second quarter and there is a number of reasons. Some will perform its space. Obviously, our numbers are better than what we’ve anticipated. So there is some variable compensation in there.

Equity compensation which I’ve been suggesting every quarter, we’ve got together as each year is a new trench for the Motorola Home people come in. There will be a natural increase that’s embedded into it. We do have a couple of one-offs I think in the second quarter for trade shows and leaving it out for some computer refreshes, things like that which I think are built into the annual raises. But we will go up and I would say it’s probably $10 million plus from today’s into the next quarter. It’s a variable piece that’s come down and we’ll probably get more into that operating model. I have been talking at $230 million to $240 million has been the number. But we will see how that plays out.

Mark Sue - RBC Capital Markets

Okay. That’s helpful. Lastly, I guess this is the -- just a thought on how we should calibrate the impact of any potential work shortages?

Bob Stanzione

Well, it’s hard for us to really tell, so there -- I’m not sure if we can really put a number on that. There certainly are devices that would come in through the -- both Seattle and through Los Angeles, which could impact. We would have to make decisions with share ship so if it finds its way into margin if you like or maybe possible if some could be left on the table but it’s not hundreds of millions of dollars. If less, it’s like hundred or less, but it is something that could actually impact us.

Mark Sue - RBC Capital Markets

Okay, got it. Thank you gentlemen and good luck.

Bob Stanzione

Thank you.

Operator

Next question comes through from Amitabh Passi, UBS.

Amitabh Passi - UBS

Hi, guys. Thank you. I guess, Bob, first question for you is the stress that you see and better than your guidance from March to June. Can you help us maybe get a better sense of how much of that is coming from Network & Cloud versus CPE segment? And then maybe within CPE, set-top versus modem. So I’m just trying to get sort of sense of the -- your source of strength?

Bob Stanzione

Well, in Network & Cloud, it’s clearly the E6000, which has taken in the, gosh, all over the world, as I said more than 5 million and that was at the end of the fourth quarter right. So that product has just been an outstanding performer for us and remember every intra footprint that we achieve with that product virtually guarantees future sales of software upgrades. So we are ceding the market way it’s going to benefit us for years to come.

On the CPE side of the business, it’s the high-speed data products that I think are going to be the strong performer in Q2. Larry, Bruce do you want to add anything to that?

Bruce McClelland

I think that the strength is coming evenly spilt between the two business segments. So, a strong growth expected on both of those.

Larry Robinson

Yes. From a CPE perspective, we are absolutely seeing a very strong demand around our DOCSIS 3.0 gateway products, but also complemented pretty nicely by continued strong demand around video gateway platforms across the variety of customers.

Amitabh Passi - UBS

And is that DOCSIS 3.0 mainly a North American statement or is that more international or is it again evenly split across the geographies?

Larry Robinson

It is pretty well split. I mean this demand for more bandwidth we’re seeing geographically around the world and when we sell E6000 to double the bandwidth in an operators network. On the other hand, they are putting DOCSIS 3.0 modem and typically the modem has been shift today or capable of maximum speed approaching 300 megabits. The next version of product towards the end of the year will that. It will got by 500, 600 megabits and then Bob mentioned DOCSIS 3.0 the next technology innovation beyond that is targeted at gigabit speed. So we see not only strength in the short term if you will, but yet another refresh cycle planned starting towards the end of next year to continue literally push the envelope on more speed and more bandwidth.

Amitabh Passi - UBS

Got it. And just a couple other quick ones. Charter and AT&T, I apologize, I don’t believe they were disclosed last quarter, so curios where the strength came from in calendar 1Q?

Larry Robinson

Again across the board the product, it’s kind of new products that we’re just talking about.

Amitabh Passi - UBS

Okay.

Larry Robinson

Those are going into for E6000, it’s not going into AT&T, but I think for the advertising and set-top and things.

Amitabh Passi - UBS

And then just a final one for me. You mentioned the momentum you are seeing in the broadband side of the business. I was curious, Bob, where does fiber potentially fiber-based access fit into your portfolio? Do you see a need for deeper fiber builds or fiber-all-the-way to -- within cable footprints?

Bob Stanzione

I think we’ve got a lot of interest in that. Bruce’s got that covered.

Bruce McClelland

Yes, so two thoughts on that. One is the existing PON product line that we have that we continue to sell into the Telco space, but more interestingly, I guess order terms, certainly the service providers are looking to augment current say either twisted pair or HFC builds with additional deeper fiber potentially PON and the higher speed PON technology.

And as we look at our roadmaps, that’s certainly something we build into as an example of CCAP platform being able to have either take a deep end at PON Interfaces directly subtended off of those products is in the strategy in the plan.

Amitabh Passi - UBS

Got it. Okay. Thank you.

Operator

Okay. Next question comes from Simon Leopold with Raymond James.

Simon Leopold - Raymond James

Great. Thank you very much. Couple of things, certainly impressive forecast here. And I guess, one of the things we’re struggling with, just had to think about the gross margin trends. In that, you’ve got some newer products and maybe some mix issues that might restrain gross margin but the volume increase is obviously very, very significant on a sequential basis. How should we think about the moving parts affecting gross margin in the June quarter.

Bob Stanzione

Couple of reason to kick in. So obviously the whole segments we believe we’ve got strength that is dollars that are in CP side are large dollars, right. So with lower margin that has to impact the percentages at the end of the day. And within that, there is even product mixes within the CP segment which can have an impact on it. So it’s not a simple answer that I think we’re probably at a good place in gross margins but maybe some upside from what we had in the first quarter.

Simon Leopold - Raymond James

So sequentially it could rise?

Bob Stanzione

It could. But it’s not -- we are not talking material amounts here.

Simon Leopold - Raymond James

Sure. Sure. And then, the other thing that kind of jumped out here in this was relative weakness of international and we don’t really have enough history with the Motorola business to know what seasonal versus what’s not. Could you talk a little bit about what went on international in terms of either seasonality or non-seasonal behavior in terms of its sequential pattern from March compared to December?

Bob Stanzione

I don’t remember exactly numbers in December. The percentage was higher in the December quarter than it is in this quarter. So there was some more of shift, nevertheless, we see international bouncing back nicely in Q2 and going on from there. I think the forecast that we see right know is pretty good for international in second and third quarter, right.

Simon Leopold - Raymond James

Yeah. So nothing jump out?

David Potts

There are a number of customers in these fiscal cycles ended at the end of the April internationally. So whether that impact a little bit of their CapEx spend in the first quarter fiscal quarter is certainly a potential, but as Bob mentioned, we certainly see strength in the second quarter, yeah.

Simon Leopold - Raymond James

Okay. Yeah. I guess, this December I have $373 million going to March $314 million, so obviously if that’s rebounding, that is a nice tailwind helping out in terms supporting that June forecast?

Bob Stanzione

Yeah. You are exactly right, Bob Puccini just shoved them in front of me and those are the right numbers.

Simon Leopold - Raymond James

Okay. And then, the last one I had was, in the past you’ve talked about some of the, I guess, traditional expenses with Google, I guess, back office systems and things like that? If we could get an update on where you are in terms of those expenses and whether there is a transitional aspect that will change your operating expenses profile as you get off the Google systems or are you completely off?

Bob Stanzione

We are not completely off, but we certainly did have a reduction from in Q1 from Q4 as got up with some of the major IT systems in particular, even through the month of May we are continuing with some services from Google, but we should be more of us done in the second quarter.

And so there will be perhaps some other small step down that we would have in the second quarter, really I guess even see some in third because we have some more still to go in the second.

On the integration cost front, we continue to spend money on that and it’s being a long-haul to able to get off this and we will continue to spend dollars to get those finance systems, ERP systems and what not transition through the year.

Simon Leopold - Raymond James

Great. Appreciate it. Thank you very much.

Bob Stanzione

Yeah.

Operator

Yeah. We have a few more questions coming through, next comes from Joseph Wolf of Barclays.

Joseph Wolf - Barclays

Hi, guys. Good afternoon. Can you me hear okay?

Bob Stanzione

We can.

Joseph Wolf - Barclays

Thank you. Just a couple of question, I guess, just the review on the expense side, look at the 2Q guidance and back into like operating expense number? Should we come -- should we coming back that 230 to 240 number or should it would be going up a little bit…

David Potts

Let me talk about, as I said a few minutes ago, I think, it will go up more than that. So, again, there is multiple components, there is, indeed April is when the rate has just kicked in, April is when the next tranche of equity kicks in for which the Motorola home people will now have two plays -- two cycles in play versus one.

We also have higher variable compensation which will be for sales compensation and just performance-based plans, if the numbers are higher, I mean, that good news thing, but that’s, where we will higher expenses from that.

And also in the quarter, we do have higher cost related to shows and particularly the NCTA and we have something going on due to refreshments which are -- which we will have. So, as I said, I think, its $10 million plus that will provide in the second quarter.

Joseph Wolf - Barclays

Yeah. Well, thinking, looking forward, if this revenue level is sustained, some of those, sound like the seasonal spend, would be come back down to that $230, $240 level or stay up a little bit commensurate with the revenue?

David Potts

If one-offs come up, but then, depends upon the timing, but if we continue to outperform, I think, the performance base continue at that rate and obviously, next year we’ll reach that and go from there.

Joseph Wolf - Barclays

Question looking forward and I think, Bob, you mentioned this, when you talk about the selling the E6000, what that leads to. In one of your recent presentations you had tiered deployment, I guess, slide that depicted how you garner more revenues as you go through the cycles in the software and next-generation? I’m assuming everything right now, it’s just the first level of grow out and you are nicely selling up the chassis yet? So we have got -- how should we be thinking about, how much more revenue you can get per bucks as we look at next 12 to 18 months?

Bob Stanzione

Yeah. I think you have got the right picture, most of the equipment we are selling today is new hardware and software and what we expect to see over the coming quarters is a growing mix of software license sales into the installed base that we seeing now. So as an example, we may ship a chassis today with a third of the capacity activated and then the operators are able to come back and turn on incremental capacity through a software license mechanism in the future.

And the revenue per megabit if you will, it will be lower as we sell those software license, but obviously, the margin is much higher and so we do expect to see a blend going forward which helps increase the margin percentage obviously going forward.

Joseph Wolf - Barclays

Perfect. And then just last -- one last question for me, but if you look at the amount that you had on the acquisition of SeaWell? Could you give us a sense of where the market is and sense of the integration that provides you with?

Bob Stanzione

Right. I think the right way to think of SeaWell is a technology tuck-in or an enabler, their technology is focusing multiscreen IP video delivery and the preparation of the packaging of that video into different formats for different types of end devices.

So it blends in nicely to our broader strategy around multiscreen and IP video, as well as in the advertising, again where their technology application is in the filtration of video streams to do ad insertion and targeted advertising. So those are some of the two strategies behind the acquisition.

Joseph Wolf - Barclays

You didn’t buy too early, that is just what your customers are in terms of the development plan when it leads to revenue?

Bob Stanzione

A little bit this year and again, really, part of our broader strategy around like Network DVR and TV Everywhere, delivery of video to a variety of different devices. So I think it is really part of larger solution sell as opposed to revenue, specifically around just that piece of the product.

Joseph Wolf - Barclays

Great. Thank you, guys.

Bob Stanzione

Sure.

Operator

Next we have Brian Cowen with National Alliance.

Brian Cowen - National Alliance

Hey, guys. Good afternoon. Great numbers, great guidance.

Bob Stanzione

Thanks, Brian.

Brian Cowen - National Alliance

Hi. Similar question for Larry and for Bruce, really on the competitive and market landscapes, if you will, looking at the CPE front, I’m wondering if some of the momentum you saw in the quarter and then your guidance? How much do you attribute that to perhaps a little bit of a speed up or catch-up at some of your bigger cable customers, just as market shares tend to move?

And then, I guess, also with regard to the next-generation headend and the E6000, looking at your sort of your two bigger competitors there? I wonder if you could give us an update on how you are winning against those guys sort of what the criteria are and kind of, I guess, just how much the share gains relative to sort of the overall rising tide of demand is impacting your outlook?

Larry Robinson

So, Brian, it’s Larry, I would characterize it as the improvement in the business of the momentum is really kind of build around both of those. As Bob mentioned in the opening remarks, certainly, there has been some share gain that we’ve experienced based on new introductions that we made at the end of last year and that momentum continued into Q1.

I would say, we’re also seeing overall strength in the market in terms of CapEx investment around some of the CPE categories, specifically once again, gateways, whether they be video gateways or advanced broadband gateways tie to DOCSIS 3.0. So it’s really been a combination of the two in the CPE area.

Bruce McClelland

Yeah. And I guess, from our CMTS or CCAP perspective, I think we are benefiting certainly from a bit of pent-up or wait for around CCAP and as Bob mentioned, we would have easily ship more in Q1, if we could have supplied all of it. So, certainly, we’re benefiting from that in Q2.

We are obviously benefiting from being first to market, I think on this next-generation converge platform and that’s what allows the market share gains to ship around clearly. I don’t know if we predicted that CCAP would be adopted quite as strongly as it is, but clearly around the world that cable service providers are really focused on investing their bandwidth dollars on that more future proof platform and we’re benefiting from it at this stage.

Brian Cowen - National Alliance

That’s great. Along the same lines, I remember, I think, already mentioned it was a Morgan Stanley conference a couple of months ago and was basically saying that part of their Comcast agreement is that they can potentially accelerate some CapEx if they see some contraction even though their overall CapEx number sustain that kind of guided range, high 3 billions. Do you think any of that has been kind of accelerated in anticipation of the deal getting done later this year, I mean, among your just sort of larger two, three customers? Is that having any impact on the strong outlook?

Bob Stanzione

It’s hard for me to say. I don’t believe that the anticipation of the deal has caused any acceleration of CapEx. I thought it’s just market conditions that are causing the operators after quite a long spell quite honestly of this past five years of kind of the rents being felt tight on network expansions and how we see this almost explosion of newer over the top services coming out. This competition is who has that speed and who has the best service and who has the highest quality. Customer experience is driving these investments. Clearly competition has not abated at all. It’s as intense and fierce as it ever has been.

Brian Cowen - National Alliance

That’s great, Bob. Thanks. And then just to wrap up, turning to inventory, I think this might have been touched on a little bit. Obviously, it’s down sequentially. Yet obviously you’ve got pretty strong growth guided for the second quarter. I mean, that’s just simply due to the overall mix shift and just kind of the different natures of those businesses, perhaps if there’s a little bit more emphasis on the CPE side. And if so, how are you managing that relative to the strong order book and do you think that builds back up or it’s going to stay in sort of that range of return?

Bob Stanzione

I think that’s to build back up some. We’re playing catch up mode for some of the quarter, so I think it comes up some.

Brian Cowen - National Alliance

Got it. Okay, great. Thanks guys.

Operator

(Operator Instructions) And our next question comes from Todd Mitchell with Brean Capital.

Todd Mitchell - Brean Capital

Thank you very much. Most of my questions have been asked. I do have a question sort of on the software side. So you’re benefiting from this product cycle in their home gateways, which seems to be a much more sophisticated piece of hardware. At what point, do you -- does the volume versus pricing and the pricing pressure against you start to kick in, in terms of how long you see the cycle is? And what do you do to sort of offset that? And I guess that brings to my real question. We saw the SeaWell acquisition. Are you looking at generally now that you have got certain amount of scale moving up in terms of the IT account at the company basically? Thank you.

Bruce McClelland

Let me say a couple of things first. I mean, I think the competition has always been there and as fierce today as Bob mentioned, as it never has been, so I don’t think we see, it’s all of a sudden drastically growing, I mean, it’s fierce everyday. We have a number of strategies around software and hardware, how do we differentiate. Obviously, there is a strategy around being best-in-class platform provider with a variety of different software, middleware and application layers and where we’ve done a great job diversifying that piece of the business and really being able to sell into all of those different types of software environments.

At the same time, we’re investing significantly in software ourselves to have a complete, tightly integrated and then solution, both from our UI user experience perspective, all the way back into the network, supporting things like cloud-based network DVR capabilities, which is where the SeaWell acquisition kind of fits in. So, we’re trying to attack all different angles and have our solution into each of those different pockets to make sure, as the market shifts we’re able to react and grow the business in different directions.

Todd Mitchell - Brean Capital

Do you ever see yourself as this infrastructure gets deployed greater and all of these operators say, this is the last set-top box I want to buy and then I want to able to upgrade it? As with the E6000 now becomes more of a software game leader in the cycle, do you ever see yourself being -- I know you are a UI provider now, but do you ever see yourself being in that business in much greater scale? And with it, sort of being an application provider on top of it, so that every time I need to update my service profile, I come to you and I say, making it like the icon for my box or something to that order?

Bob Stanzione

Yeah, I guess it’s hard to tell how the business evolves exactly. I do believe that software becomes a bigger component of our business and our customers want to increase the virtualization of their network, the software layer to be able to move more nimbly, add features and capabilities more rapidly. That doesn’t mean there are appliances both in the networks and then in the home to enable this types of capabilities. So, I think it’s going to be a mixture of software and hardware for many years to come. But I think inevitably there is more investment, more capabilities, they are more virtualized, more software based.

David Potts

Yeah, I agree. So, I think -- so the comment around kind of the platform evolution, I think there is still continued investment requires, kind of, what I would call a hardware as new decode functionality comes out, more memories required in the box, greater processing capability or functionalities needed. I think that over time does drive a need for new platform. That being said to Bruce’s point, the emphases on software is going up dramatically. And you pointed out the complexity of the gateways and home.

And while everything is kind of shifting towards IP, I think which brings in a number of efficiencies. It is introducing a tremendous amount of complexity to the home ecosystem that kind of feeds its way back into the network. So, I think that is an area you will continue to see us investing and emphasize going forward. And I think it does provide us a tremendous opportunity for differentiation in the portfolio.

Todd Mitchell - Brean Capital

Okay. Thank you. And one last quick question. Otherwise customers are sensitive but you disclosed the Comcast number. Can you give us some sort of qualitative information as to -- I guess, looking at the XG1, where, what that was in the mix? Are you fully on board? Is that still ramping in terms of the volume? I mean, can you give us some kind of, just qualitative as to where you are in the rollout there and the scaling of that product with that customer?

Bob Stanzione

Well, the fourth quarter -- Q4 was up, first quarter up, significant shipments of XG1s and it was a big quarter. And I think we’re more towards a normal run rate. There was obviously a little bit of pipeline ceiling that went on in the fourth quarter. And in the first quarter, I think, things are beginning to normalize, expect them to normalize at a healthy pace in the second quarter and beyond.

Todd Mitchell - Brean Capital

Great. Thank you very much.

Operator

Okay. And we have no other questions in the queue. So, I’ll turn it back to you Bob for any closing remarks.

David Potts

Thank you, Ryan. Bob, any final words.

Bob Stanzione

Just that, I appreciate your following us in this call, this evening. Things are going well as I said. I think ARRIS is in the right place at the right time, right now and we will continue to work hard to grow the business. In that regard, I think we’ll just sign-off.

Bob Puccini

Thanks everyone. That concludes our call.

Operator

Great. Thanks everyone for your time, your participation. Now you may disconnect and enjoy the rest of your week.

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Source: ARRIS' (ARRS) CEO Bob Stanzione on Q1 2014 Results - Earnings Call Transcript

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