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Executives

Bob Stanzione – Chairman, CEO

David Potts – CFO

Bruce McLelland – President, Broadband Comm Group

John Caezza – President, Access Transport and Supplies

Analysts

Brian Coyne – Friedman, Billings, Ramsey & Co.

Ehud Gelblum - JP Morgan

Todd Koffman – Raymond James

Jason Ader – Thomas Weisel Partners

Ray Archibold - Kaufman Bros.

Greg Mesniaeff – Needham & Company

Amitaf Pasi  – UBS

David Wright - Henry Investment Trust

Arris Group Inc. (ARRS) Q4 2007 Earnings Call February 14, 1969 9:00 AM ET

Operator

Welcome to the Fourth Quarter and Full Year 2007 Arris Group Incorporated Earnings Conference Call.

(Operator Instructions)

I would now turn the presentation over to your host for today, Mr. Jim Bauer, Vice President Investor Relations.  Please proceed sir.

Jim Bauer

Welcome to all in the Arris Conference Call with management.  This afternoon we are going to discuss our Fourth Quarter and Full Year 2007 and financial results which were released after the close of markets today.

We will be using a series of slides during our webcast today which were also posted on the Arris website in the Investor Relations Section.  With us here at the Arris headquarters are Bob Stanzione, Arris Chairman and CEO, and Dave Potts, our Executive Vice President and Chief Financial Officer, as well as the presidents of our three business units.  As noted in the press release, there will be a replay of the entire call available approximately two hours after the conclusion of this call, and the replay and the slides will be available on our corporate website for the next 12 months.

Before we begin, I would like to mention that during the call we will be making certain forward-looking statements including statements regarding our outlook and expectations for the industry in general, estimated revenue, earnings for the fourth quarter of 2007, our outlook for 2008, certain financial operating metrics, the timing and introduction of new products and technologies, as well as spending patterns by some of our customers, and expected sales levels for certain product categories.

It is important to note that the actual results made differ materially from those suggested by any forward-looking statements which maybe made during the call.

For further information in this regard and for specific examples of risks that could cause actual result to differ materially from what we make in the call today, please see our recent filings with the SEC.

Bob and Dave will now provide comments on our results and other topics as well, after which we will open up for your questions and answers.  Now, I would like to turn it over to Bob Stanzione.

Bob Stanzione

By now you have seen our press release and know our fourth quarter results fell short of expectations.  Nevertheless, 2007 was a year of solid growth and excellent execution for Arris, and we enter 2008 with a solid profitable and highly capable company.

In just a moment, I am going to address the first quarter guidance and the outlook for 2008 and then you will hear more from Dave about the full year and fourth quarter results in 2007.  But first I want to comment for a moment on the significant and notable progress at Arris both on our short term in-year operational objectives, as well as toward our longer term strategic objectives.

Year-over-year we grew our top line by 11%, and we diversified our customer base significantly.  Early in 2007, we gracefully exited from our old circuits switch telephony product line and established ourselves as the world’s leading vendor of cable Voice over IP customer premise equipment.

We shipped 7.6 million CPE units in the year that is up 46% from the 5.2 million that we shifted in 2006.  In the fourth quarter, we shipped 1.79 million units compared to 1.4 million in the prior year.  We also grew our CMTS business significantly, and added numerous new customers.  I am pleased to report that our C4 CMTS business reached a record revenue level in the fourth quarter.

For the year, shipments of downstream ports grew by 30% and reached a record level of 7,810 in the fourth quarter alone.  More importantly, we shipped almost 1,100 chassis in 2007 that is up over a 100% from the prior year, and many of these chassis are partially filled which leaves room for more growth when we introduce next generation blades in the middle of this year.

Our strategy of aggressively marketing are DOCSIS 3.0 Evolution plan clearly hit the mark, as we increased our market share from approximately 25% at the end of 2006 to 35% by the third quarter of 2007.  Incidentally, if you want to learn a little more about the CMTS business, there is a great article on the importance of DOCSIS 3.0 on page B3 of this morning’s Wall Street Journal.

“We continue to diversify our customer base by growing our international presence most significantly in Canada and in Latin America.  We also made major gains in Europe, particularly in Germany and the Eastern Countries, and in Asia, as well as with smaller MSO’s in Japan.”

“The fourth quarter of 2007 was by far our best-ever for international sales, both in terms of dollars and percent.  International sales were almost 32% of the total in the quarter.  I cannot over state the importance of this achievement as these new customers substantially diversify our customer base and represent one of our best growth opportunities.  On the domestic front, our CMTS sales to Time Warner, Bright House, and Cable Vision begun to take off.  It is also notable that Time Warner recently announced that they had passed 3 million voice-over-IP subscribers and are still growing.”

On the strategic front, we began 2007 with an objective of gaining scale and diversifying the company both by expanding our product lines and by reaching new customers while remaining primarily focused on the cable MSO market that we know so well.  We achieved outstanding progress toward this objective through the acquisition of C-COR which closed in December.  Specifically, with this acquisition, we added a critical video component to our already strong positions in voice and data.  We picked up two software intensive high margin businesses, on-demand and OSS that have significant growth potential, and we gained enhanced presence in key accounts such as Time Warner and Cable Vision in the US, and with international operators such as Telefonica and ONO in Spain, and many others around the world.

Although our business slowed a bit as the year ended taking in everything into account, 2007 was a solid year.

Now turning to guidance and outlook, I will not mince words.  First quarter forecast is indeed very disappointing especially when it is compared to the steady growth that we have experienced over the past several years.  Nevertheless, even with lower sales we expect to remain profitable and bounce back sharply as the year goes on.  The slow down which we have learned about quite recently is centered with Comcast, our largest customer.

The good news is that the business in our other customer segments looks quite healthy as we start 2008, and we expect that our sales to Comcast will rebound sharply as the year goes on.

The largest impact is in our EMTA product line.  As we have told you and as we all know, after over a year during which we enjoy virtually 100% market share at Comcast, a second vendor entered into the mix in the fourth quarter, at the same time an apparent leveling out of their net subscriber growth over the past two quarters as well as a resultant adjustment of inventories causing Comcast orders in Q1 to fall to a very low level.  However, we expect EMTA unit orders to bounce back significantly in Q2 and beyond although not to the peak levels that we saw when we were their sole EMTA source.

We are seeing a similar though smaller effect on the top line of our business for CMTS revenues for a different reason.  Comcast appears to be reserving much of their CMTS budget for an aggressive DOCSIS 3.0 roll out in the second half of the year to meet their objective of wide band deployment over 20% of their footprint by yearend.

Let me stress the point here that in both cases Voice-over-IP EMTAs and CMTS, we remain a preferred primary supplier to Comcast.  The bottom line is that although we expected a slow start in 2008, these reductions are far beyond what we expected and have come to light only recently.

As I said, our business sales were solid.  In fact at this time our outlook for the second half of 2008 is quite good.  It is too early especially with the current turbulent market conditions to give specific guidance beyond our usual one quarter.  However, I will say that in the second half of the year we expect to be reporting respectable year-over-year gains in both revenues and earnings.  We also expect good margin expansion this year with margins well above the 30% level.

We do intend to increase our R&D spending somewhat, but will continue to drive for the expense synergies associated with the C-COR acquisition and will as usual keep tight reins on our spending in general.  MSO spending will surely be very focused this year especially if the economy continues to slow down and household formation remains at a low level, even so the forces of competition and the growing demand for bandwidth, driven by rapidly growing video traffic will require more of the market leading products that we provide.

We will see significant benefit coming from DOCSIS 3.0 from switch digital video, from commercial services roll outs.  In addition, we see growing demand for our on demand products as subscribers seek more control over content and MSO’s increase their focus on advanced advertising.  We also seek growing demand for our OSS solutions as system operators seek ways to reduce rapidly escalating operating expenses.

The continued expansion of HDTV in conjunction with the push to expand voice penetration and high speed data capacity bodes well for our access business as operators continue to segment their nodes.  Netting it all out although the first quarter outlook is certainly a disappointment, we see substantial improvements coming especially over the second half of the year.  And now Dave will give you the financial results.

David Potts

Let us go to chart six if we could for the moderator please.  Thanks everybody for joining us today.

Before I provide an overview of the results, I think it is important to note two things.  First, we closed our acquisition of C-COR in December 14, 2007.  As a result the year-end balance sheets include the impacts recording the assets and liabilities of fair value at close.  The balance sheet also includes the impact of pay no cash in our shares to C-COR shareholders, and the result for the quarter include approximately two weeks of operating results for C-COR.  I will also add that these two weeks are seasonally low as a result of the normal slower activity during the holiday period.

Secondly, as we announced in December, in conjunction with the C-COR acquisition, we implemented a new organizational structure.  As a result, beginning in the fourth quarter of 2007 we began to report our current and historical results in three reporting segments that align to this new structure.  During this quarter of transition there are many moving parts to consider which might be a bit confusing.  As we moved through this in the ensuing quarter some content will become very clear.

On chart 7, I have outlined the former product categories and the new reporting segments to help you with the comparisons.  As you can see, there are now three new reporting segments, Broadband Communication System or BCS, Access Transport and Supplies or ATS, and Media Communications Systems or MCS.

Our customer premises equipments specifically EMTA’s and cable modems are no longer grouped with supplies and are now part of Broadband Communications System segment.  With the addition of the C-COR products we have expanded our supplies category to include access and transport products.

Lastly, our new Media and Communications segment focuses on delivery and management of content and services.  As I am sure you know, our financial reporting will compare current results to historic results by these segments.  The history will only include Arris’s results and will not pick up C-COR’s historical results.  In order to help you with some comparisons, we will post to our website a quarterly summary of sales and gross margin for 2007 by reporting segment for Arris results and our estimates of C-COR’s sales and gross margins for the same period.  I hope that helps you.

Let us move to the financial highlights in chart 8.

Sales for the quarter are $249.6 million up 6% year-over-year and down 2% from the prior quarter.  The fourth quarter sales include approximately $6.6 million of sales of C-COR products for the last two weeks of the year.  Year-over-year, our sales ramped 11% as a result of the continued robust demand for EMTAs and CMTS’s.  Gross margin percentage for the quarter was 25.6% down from Q4 2006 and sequentially. I will elaborate on margin in a moment.

We recorded expenses totaling $8.2 million resulting from a write off event process R&D and amortization of intangibles both as a result of the C-COR acquisition.  Our non-GAAP EPS was $0.16 in the quarter while our GAAP EPS was $0.08.  Significant reconciling items include; write off of in-process R&D of $0.05, equity compensation of $0.02, amortization of intangibles of $0.02 cents, and other tax acquisition cost restructuring items which net to a penny.  Our reconciliation of our GAAP to non-GAAP EPS’s included with this presentation on slide 19 and is also attached to our press release and of course it will be on our website.

Let me comment on the results relative to the guidance we provided in October.  As we stated at the time, our guidance assume no impacts from the then pending acquisition of C-COR.  Given that the deal closed in December, there is not a direct comparison between our actual results and the guidance.  Had the deal not closed, our best estimates are that the sales would have been $243 million and that non-GAAP earnings per share would have been approximately $0.18 to $0.19 per share.  For the full year of 2007, our non-GAAP EPS and GAAP EPS were $0.79 and $0.87 respectively and compared to $1.04 and $1.30 respectively for 2006.

It is important to note that income tax expense is significantly different year-over-year.  First, in 2007 we began accruing taxes at four rates which was not the case in 2006.  In 2007, we recorded income tax expense of $41 million as compared to a benefit of $35 million in 2006.  As you may remember in the fourth quarter of 2006, we reversed valuation allowances we had in place with respect to our deferred tax assets which resulted in a gain of nearly $39 million, or $0.35 per share in the fourth quarter, this of course did not repeat in 2007.

We generated $52.8 million of cash from operating activities in the fourth quarter and ended the year with just under $392 million of cash in short-term investments, after the cash of $365.7 million we used to acquire C-COR.

Let us turn to chart nine.  Here you can the sales break up based on the old product categories and our new reporting segments.  Going forward, we will be presenting our sales based on our new reporting segments.  We have also provided an estimate of what C-COR recorded as sales prior to the December 14 acquisition date in the fourth quarter, which was about $62 million.

The Broadband sales are up $14 million in the third quarter of 2007.  Continued robust demand for our CMTS products coupled with higher sales of the Universal Edge QAM D5 account for the increase.  Supplies and CPE sales of $156.4 million were down $26 million from the third quarter.  Lower sales of the EMTAs to several customers in particular Comcast coupled with the seasonally lower supply sales led to the decrease.

Let us look at some of the sales details in chart 10.

Looking at sales of our new reporting segments, first, Broadband Communication System sales were $216.9 million down $8 million from the third quarter of 2007 and up $13.6 million from the fourth quarter of 2006.  The sequential decrease is a result of lower sales of EMTAs which I mentioned a moment ago partially offset by the increase in CMTS and D5 sales, access transport in supply sales of $30.9 million or $1.4 million from the third quarter of 2007 and just slightly above 2006.

Sales as the result of our C-COR acquisition more than offset a slight decline in our supplies products.  Turning to sales of our 10% customers in the fourth quarter; the sales to Comcast were $95.3 million and sales to Time Warner with $30.9 million.  One other statistic, given the acquisition and in particular the timing of it, normal book to bill ratios are not as meaningful, what I can tell you is we ended the year with a combined backlog of $137 million and that we estimate the book to bill for the pre-acquisition Arris in Q4 was approximately 1.00.

Let us turn to chart 11 and review gross margins.

Consolidated gross margins were 25.6% down from 27% in Q3 of 2007, this despite the fact we had less EMTA’s and more C4’s in the mix.  Several factors led to this, first; lower margins and higher start up costs associated with the D5 contributed significantly to the decrease.

Second, we incurred a one-time warranty charge of about a million dollars related to a small amount of unique power supplies in the quarter.  Lastly, we had an inventory charge of approximately $1million associated with the discontinuance of the CXM product line.  Excluding these factors, our consolidated gross margins would have been approximately 27.7%.

Let us turn to chart 12 and review gross profit by the previous product categories.  Please note that this is the last quarter in which we will provide details on our margins by previous product categories.  Beginning next quarter, we will move to providing gross margins in our new reporting segments.  Broadband margins were 38.7% in the fourth quarter and compared to 44.3% in the third quarter of 2007.

The decline is predominantly the result of the lower margins and start-up costs associated with the D5.  Gross margin percent for our supplies and CPE product was 18.3% as compared to 20.1% in Q3.  Several factors led to the majority of the decline, first, as I had just mentioned we chose to exit one of our CXM product lines and recorded an inventory charge of approximately a million dollars.  Next, the warranty charge I mentioned a moment ago also impacted this category.

Now, let us turn to operating expenses on chart 13.

Once again, it is important to note that we closed the C-COR acquisition in mid–December.  Operating expenses were $51.3 million in Q4 which included a write off of in-process R&D and amortization of intangibles related to the C-COR acquisition of $8.2 million dollars.  About $2.9 million dollars of R&D and SG&A from the former C-COR and about a million and a half dollars of acquisition integration and severance cost resulting from the C-COR transaction.  If you bat these factors out, spending was about $39 million dollars as compared to $41.6 million dollars in the third quarter of 2007.  The decline is mainly the result of lower variable people related costs.  With respect to synergies, we continue to believe we are on track to meeting our yearend target of a reduction of about $15 million to $16 million.

Let me touch on the balance sheet briefly on chart 14.

We ended the quarter with $392 million of cash in short-term investment which was net of the cash we paid for C-COR and the cash they had on hand at close.  We generated approximately $53 million of cash from operating activities in Q4.  This is a result of the underlying earnings and a reduction in working capital particularly the Arris inventory.  Inventory ended December at $131.8 million including about $28 million we acquired from C-COR at close; and accounts receivable ended at $167 million including about $34 million of accounts receivable we acquired from C-COR.

Turning to chart 15.

When we announced the acquisition of C-COR last September, I explained that certain impacts resulting from purchasing and accounting will affect us; I also said we would give you an estimate of those impacts.  As promised, I highlight five key items on this chart, first inventory valuation.  The accounting rules require that inventory be recorded a fair value on the opening balance sheet, this is different from the historical cost, essentially, we were required to write their usable inventory up to end-customer price less a reasonable margin as a distributor.  This resulted in an increase in the value of inventory of about $3 million which will result in higher cost to goods as it is sold.

Deferred revenue and deferred cost, at close C-COR had $27.5 million of deferred revenue, the fair value of which is $4 million applying the purchase accounting rules.  Similarly, they have $7 million of deferred cost, the fair value of which is zero, applying purchase in accounting.  In essence, even though the cash has been received this revenue and cost goes into the tether as neither C-COR nor Arris will ever score them.  Intangibles have been valued at about $272 million, this will result in higher amortization expense for multiple years, and finally in-process R&D has been valued at $6.21 million which was expensed in the fourth quarter.

Turning to slide 16, I had provided the estimated impact in various time periods of key purchasing account items, please note that two of the items; in-process R&D and amortization of intangibles have and will be adjusted in our GAAP to non-GAAP reconciliation that is why our actual expense is captured in our income statements in the future.  The others are not captured in the reconciliation, so as an aid for you to compare historic C-COR results we have quantified these items for you, in particular deferred revenue, deferred cost, and inventory valuation.  As you can see, we estimate that the impact was about $0.03 per share in the first quarter of 2008 of these items.  I hope this helps you.

Next on chart 17, let us review guidance for the first quarter.

At this point, we estimate that sales will be in the range of $270 million to $285 million and that non-GAAP EPS will be I the range on $0.08 to $0.12 per diluted share; and GAAP EPS will be in the range of break even to $0.04 per diluted share.  The reconciliation of GAAPs to non-GAAP EPS guidance can be found in chart 18, and is also attached to the press release.  Reconciling items include amortization of intangibles, equity compensation expense, and some integration costs.  We are assuming $138 million fully diluted shares; we are assuming a tax rate of 37% on the first quarter.  As you may know, Congress is yet to approve the continuation of the QRE credit, once they do and assuming it will be applied retroactively, which it usually is, our rate should reduce to about 35% for the year.

And finally, for completeness in chart 19, we have included the reconciliation of our GAAP to non-GAAP earnings per share for each quarter and for full year 2006 and 2007.  That concludes my remarks and let me turn it over to Jim Bauer.

Jim Bauer

Thank you Dave, Stacey if you could come out back on line and then just instruct the participants on how to ask their questions and we will get on with our answers.

Question and Answer Session

Operator

(Operator Instructions)

Your first question comes from the line of Brian Coyne with Friedman, Billings; please proceed.

Brian Coyne – Friedman, Billings, Ramsey & Co.

Few questions, first of all on the voice modem side, I was wondering if you can sort of give us a sense as to where you think shares stands at your largest customer given the addition of the new EMTA vendor and where do you see that going for the year?  And, then sort of secondly, Dave I was wondering in terms of the future P&L impacts, I know you walked through a lot of stuff and I am going to have to take some time to go through it but maybe I missed it, could you talk a little bit about the net revenue impact that you thought would be the case in 1Q and maybe just refresh us on how you view this at the time of the acquisition?

David Potts

So indeed on the chart, it gives you the actual numbers on that piece, it is a bit lower; I believe at the time of acquisition, we thought there was $36 million of deferred revenue and it turned out to be $27 million.  I would have to go back and really compare, but I believe that is the case.  The timing which we have laid out on the chart for you, I think will help you see how it would have cycled out on the historic C-COR; and I would be happy to talk to you about it if you need it.

Jim Bauer

On the voice modem part of business, with our largest customer, we expect that as the year settles out, we will have at least 50% market share.  I think that addresses your question, right?

Brian Coyne – Friedman, Billings, Ramsey & Co.

Yes and I mean obviously, I guess, with about 1.7 million shipped in the quarter, do you think you are sort of halfway there at this stage?

Bob Stanzione

Well what we are seeing is a big dip in the first quarter, so it is a very significant adjustment.  Because what I believe happened is that we both shipped significant quantities in, in late December, and we scored pretty good revenues with voice modems in the fourth quarter although it was down from the third quarter.  But so did our competitor in the quarter, I believe what our customer was doing was ensuring supply given that they were starting up with a new vendor, they ordered a large quantity from us and they ordered a large quantity from the alternative source.

Now they will spend I think most of this quarter digesting that; we will be making shipments in there this quarter towards the end of the quarter and we expect that second quarter numbers will bounce back considerably, but again we are not going to be the 100% supplier and therefore the second quarter numbers will not be at the peak numbers that we saw last year.

Brian Coyne – Friedman, Billings, Ramsey & Co.

Alright, and then maybe just one more quick comment on how you see sort of the rest of your customer-base going on the voice modem side over the next couple of years?

Bob Stanzione

We see it going very well, in fact if we were to, and we are not going to because we do not have the permission from customers to reveal their specific data, but I can say that if you exclude Comcast, our largest customer in this adjustment that is taking place in the first quarter that the shipments of voice modems to all other customers would be up.

Brian Coyne – Friedman, Billings, Ramsey & Co.

Got it and then finally I guess, I am trying to think of one more, on the D5, can you say whether or not that was profitable at all on the gross margin side?

Bob Stanzione

No, it was not.

Brian Coyne – Friedman, Billings, Ramsey & Co.

Do you have a timeline or something like that, I guess is it mainly just volume related, is that sort of the only thing or do you have to do a kind of incremental engineering and grinding costs out on that basis before you start to see that sort of pick up and when do you sort of see that getting back towards or getting closer at least toward corporate average?

Bob Stanzione

First of all, the D5 sales are off to bit of a slow start, I think the STV deployments are off to a bit of a slow start, to answer your question, your specific question about the profitability, it is both volume and design-spin oriented.  As the volumes increase this year, of course our cost go down from our OEM partners.  And secondly, we have a very significant design spin that is in process and that is going to yield a marked major reduction in cost towards the latter part of the year.

Operator

Your next question comes from the line of Ehud Gelblum with JP Morgan, please proceed.

Ehud Gelblum - JP Morgan

Did you mention the size of the D5 revenues this quarter?

David Potts

No, we did not.  Well, we do not report on specific products, but it is a small number, as a percent of our sales, it is a very small percentage.

Ehud Gelblum - JP Morgan

Okay, as you mentioned, Bob that you think that is it starting off a little bit slow that you may have anticipated, as you look at the rest of this year and into’09.  How do you think that ramps, do you think you could get ahead maybe 5% of revenue at some point by the end of this year or the next?  How are you looking at it now that you have probably a little bit better handle on what the deployment schedule may look like?

Bob Stanzione

It is possible to reach that level, what I think what I will stand by is what we said before is that we think that by the end of this year like fourth quarter, will be shipping $10 million to $15 million per quarter of the D5 EdgeQAM product.  Because, we are seeing a lot of interest in that product, not just in the one announced win that we have, but an enormous amount of interest from other customers, not only for Switch Digital Video deployments, maybe I should let Bruce McClelland, who is here, the President of the division that runs that comment on that.

Bruce McClelland

The Universal EdgeQam is really for intended applications, broadcast video, VOD, switch digital, as well as, part of the module or CMTS architecture, so there is really four targeted applications and as I Bob said, there is a significant interest and we are pretty optimistic as the year progresses.

Ehud Gelblum - JP Morgan

So, we are can have roughly 5% by Q4 is that changed from what you thought was prior?

Bob Stanzione

The number of 10 to 15 has not changed, the percentage depends on what our total revenue is in for Q4.

Ehud Gelblum - JP Morgan

Right, what happened in terms of the start has not changed your thought processes and how far it gets?  When you get that 10 to 15 level assuming you get that by Q4 of ’08, roughly what gross margin is associated with that?

Bob Stanzione

I think it will be at or above the average of the company’s gross margin.

Ehud Gelblum - JP Morgan

Now, if we can get back on EMTAs for a moment, you mentioned that with the slide of Comcast now with the larger spending that they did earlier that would fall off now.  The strength from me, out of everyone else, do you anticipate ASPs to remain relatively stable as you go through that this year, as Comcast comes back up or do you think by the time Comcast comes up you may see ASP’s drop and therefore, kind of off-setting the growth that we might see in volume?

Bob Stanzione

I do not think we will see any change in the rate of change of ASPs, as you know they go down 5% to 10% a year.  The volumes go up considerably, so I do not see any dislocation occurring in the pricing trends on EMTAs, do you have one more?

Ehud Gelblum - JP Morgan

Yes, I have one more, Dave, you have mentioned for revenue, in that original presentation when you bought C-COR that running $36 million or you kind of showed that quarter by quarter, how that was going to kind of fade off throughout the year.  Why do you think that there was a difference between the $36 and the $26 that you actually have now?

David Potts

It is just purely timing, so that was their actual deferred revenue, I forget what quarter it was, but it is purely timing of the ins and outs.

Ehud Gelblum - JP Morgan

Did that impact at all what you anticipate that C-COR produces for you in revenue for Q1, and what their revenue contribution will be for all of 2008.

David Potts

Well, as you try to compare back to the history, of course, we would suggest that you take the amount I showed you for the deferred revenue and cost and you would have to build that into the comparables back to the C-COR history, because we will lose that trail and then it is just a matter for us to rebuild our deferred revenue and deferred cost as we go forward.  I would comment that I believe that we are off to a pretty good start on that portion of the business.

Ehud Gelblum - JP Morgan

Right, so it has nothing to do with deferred revenue, just the entire revenue contribution from C-COR aside from the stuff that you can actually recognize.  Has there been any change to your observation of that?  I thought you only did $6.6 million?

David Potts

That is the material, at all no.

Ehud Gelblum - JP Morgan

Okay, so having $6.6 million in those two weeks, of course, we were looking for a little larger than that.  That was kind of roughly in line in your thoughts for complete revenue contributions.

David Potts

Not many docks are open around Christmas; I will say that, that was a challenge.

Operator

Your next question comes from the line of Todd Koffman with Raymond James, please proceed.

Todd Koffman – Raymond James

Can I just get a clarification on that follow-up, we are going to lose the C-COR trail the September quarter C-COR, I guess the December quarter was $69 million and you did not make any commentary in your outlook guidance for March regarding C-COR being a factor in the weakness.  Can you make any comment there?  Thank you.

David Potts

We do not see this as a major impact.

Bob Stanzione

As I said, the major impact of the first quarter is in one customer with those items that I mentioned.  Otherwise, the business looks quite good.

Todd Koffman – Raymond James

I do not have C-COR trail I&D, it was $69 million in total revenue; C-COR in the December quarter, do you have the September quarter?

David Potts

We do, we pull it up while we continue on, how is that?

Todd Koffman – Raymond James

Okay, and just one follow-up question, which is kind of interrelated, when I am looking at the new segments, which are somewhat named, somewhat generically.  How will the C-COR business be split-up in your new three reporting segments?

David Potts

The access and transport business, which John Caezza heads would be combined with the supplies business which we previously had and the OSS and On-Demand businesses would be part of Bryant Isaac’s new piece in the media and communications segment.

Todd Koffman – Raymond James

Since I do not approximately how big in the December quarter was the full quarter, say, C-COR Arris of media and communications?

Bob Stanzione

Todd, there is a great chart on our website, from a presentation that I gave at the beginning of the year that shows a pie chart with how these things map into one another.  And, I think it just exactly answers your question, so if you can just go on our website, it was the presentation I gave at the Needham conference on January 9.

David Potts

And, Todd your answer to the trail was about $72 million is what C-COR recorded in the third quarter.

Operator

Your next question comes from the line of Jason Ader with Thomas Weisel, please proceed.

Jason Ader – Thomas Weisel Partners

Bob, could you rank order the three drivers for the low EMTA sales in Q1.  I think you have mentioned three different things.  Did you order those correctly?

Bob Stanzione

Well, I think I said three things, one was the introduction of a second vendor and of course, that is the big item.  That is, by far, the biggest effect and as I was trying to explain earlier, I believe that what happened was we had fairly significant shipments into Comcast in the fourth quarter as did our competitor.

Just kind of thinking through it logically, if you were the customer; if the introduction of a new vendor is somewhat risky and therefore, you would hedge your risk by making more purchases than you might have normally, so, I think they ended up the year with a lot of product-on-hand.

The second effect I said was that the Comcast voice Net-ads have been tampered somewhat.  I listened to their call this morning and they were down slightly from the previous quarter.

In my discussions with Comcast, they believe that in 2008, that number is going to pick back up again and they are going to have quite a good year in Voice Ads.  And, with the introduction, by the way, I will embellish the answer a little bit, by saying with the introduction of DOCSIS 3.0, I think we will get another boost towards the end of the year as those products get introduced.

Those are the two main effects and of course, there is the inventory adjustment related to those two things.

Jason Ader – Thomas Weisel Partners

Now, they bought a lot of boxes from you, a lot of EMTA’s in Q4, why was the revenue down $10 million?  How would you explain that sequentially?

Bob Stanzione

They did not buy as many as they did in the peak quarter.  The peak quarter was I think the third quarter.  Bruce is signaling me yes, it is the third quarter, so they were down some from that and if you recall, so were their subscriber ads.

Jason Ader – Thomas Weisel Partners

And could you give us a sense of the impact in Q1 from both the EMTA and CMTS commentary or guidance that you have given related to Comcast, I mean, are we talking about, you would have been able to do $40 million or $50 million more in Q1?  Can you give us just some sense more or less quantify a little bit how big this was and how far off it was what you would have guided if you did not get that call this week?

Bob Stanzione

I think, well it was not a call this week.  It was over the past week or a couple of weeks that it began to ooze out and we nailed it down just in the past few days, but let me put it this way, if Comcast were flat quarter to quarter, our revenues would be up in this quarter.  In other words, I think that the reduction you are seeing from the fourth quarter to the first quarter is all due to Comcast because of this adjustment.

Jason Ader – Thomas Weisel Partners

So you have got to give us what C-COR was in order to make that math work?

Bob Stanzione

Well, we were just talking about C-COR, it is about 70 a quarter.

Jason Ader – Thomas Weisel Partners

So if you add 70 to your 243, is what you are saying, assume that Comcast was flat in Q4 to Q1, if you take the delta from that with the 270 to 285, then you get your impact, is that about right?

Bob Stanzione

That is roughly right.

Jason Ader – Thomas Weisel Partners

Last question, you were at our conference last week Bob and you said that you still see growth in residential EMTA units this year an  I am just wondering, in light of the Q1 guidance, do you stand by that statement?

Bob Stanzione

I think I have to back-off from that statement, quite honestly, I think that the next three quarters are going to be good quarters beyond first quarter, but it will be hard to make up for the difference in the first quarter, the difference that we are experiencing in the first quarter.

Jason Ader – Thomas Weisel Partners

Did you considered pre-announcing for Q4, given that you have the shortfall?

Bob Stanzione

No, well, of course, we considered it, but we decided not to because the miss, first of all, the guidance was given assuming that the C-COR acquisition is going to be completed in January and then we closed it early and that distorted the results.  So, the miss compared to the low end of our guidance was not that much, it was a penny or two and the advice we had was that we should not pre-announce.

Operator

Your next question comes from the line of Simon Leopold with Morgan, Keegan, please proceed.

Simon Leopold – Morgan, Keegan & Company, Inc.

I have got a couple of things that I would like to try to drill down on.  One is on the broadband gross margin; you gave us a pro forma number and I think it seemed like it was very weak I am assuming that the D5 contribution was so small, but that is not all.  Maybe if you could help us understand the core gross margin on broadband?

David Potts

Actually, the D5 is by far the biggest impact in the reduction, in the whole product category.

Simon Leopold – Morgan, Keegan & Company, Inc.

So, should we assume that the CMTS business gross margins are trending similar to the way they have been?

Bob Stanzione

Yes.

Simon Leopold – Morgan, Keegan & Company, Inc.

Okay great, if you could give a little bit more color on some of your other customers, as you have in the past, Cox and Liberty?

Bob Stanzione

I think sales to Cox and Liberty were roughly flat in the quarter, I do not know Simon.  They have not been 10% customers for quite some time and therefore, we took them off the chart, but we are looking it up right now.

Simon Leopold – Morgan, Keegan & Company, Inc.

Okay, while you are looking that up, let me throw in another question.  The cash balance, I think was a little bit better than what you had guided to on the deal and I just want to see whether, and I have not gotten the chance to digest all the details, but maybe you can highlight what is helping out here in terms of the better cash and whether there is something whether this is one-time or whether that is sustainable.

David Potts

Remember that we had a piece of paper, the $35 million convert, which we actually paid out in January, about January 12th or 13th I believe, which was $35 million.  That was actually next question I believe so.

Simon Leopold – Morgan, Keegan & Company, Inc.

Yes, I think so, I have got to sort of go through the numbers a little bit in more detail to maybe formulate it, but optically the number was bigger than what I thought you were going to put up.  I think you had guided $275 million to $300 million in cash and equivalents.

Bob Stanzione

By the end of the year and we did better than that.

David Potts

I am sorry, I answered the different question than what you are asking. I am sorry.

Simon Leopold – Morgan, Keegan & Company, Inc.

It is quite a bit better than that and I am trying to figure out where the extra money came from.

David Potts

An inventory was down substantially and we also adjusted the basic earnings with the firm and some higher payables, but yes, we are $52 million in the quarter.  It is probably a bit better than I had expected.

Simon Leopold – Morgan, Keegan & Company, Inc.

Okay and then, if we think about sort of the trending throughout the year, particularly on the CMTS business and looking out to where we get a step function.  Bob, I got a little bit confused, because some of your commentary suggest it was second half ’08, some of it seem to imply it would be as early as the second quarter.  And, I am assuming if DOCSIS 3.0 is being launched in the second half of the year by your customers, you would see revenue in the second quarter, if you could just clarify what you are talking about on that?

Bruce McClelland

The DOCSIS 3.0 technology is going through testing today in our labs, as well as customers and we anticipate just the start of revenue really in the second quarter.  So, the majority is really in third and fourth quarter where we think it really starts to hit the stride and there are really two sources there.  One is obviously new chassis sales with DOCSIS 3.0 technology and the second is upgrading the existing footprint I think as Bob mentioned earlier that the strategy in ’07 of exceeding that market and establishing footprint was pretty successful in increasing market share.  So, we started to sort of adding in the second half as we go back and enable those chassis with DOCSIS 3.0.

Simon Leopold – Morgan, Keegan & Company, Inc.

Okay, and I have just one last question it is around trying to model the gross margin particularly, thinking about what your mix looks like, whether it is in the first quarter through 2008.  I think Bob mentioned it would be over 30%, were you suggesting you would get back over the 30% in the first quarter or that was more of a target.

Bob Stanzione

What I meant was that for the year, I think we will average out over 30% by the second half of the year; we will be well into the 30s.

Simon Leopold – Morgan, Keegan & Company, Inc.

And, what do you expect for the first quarter?

Bob Stanzione

We are not giving specific guidance on margins.

Simon Leopold – Morgan, Keegan & Company, Inc.

How about for the mix, what kind of mix do you expect?  Similar product mix in Q1?

Bob Stanzione

No, I think the mix will be more in favor of the higher margin products, given the big reduction we are seeing in the EMTA to Comcast.

Operator

Your next question comes from the line of Glenn Anderson with Oppenheimer, please proceed.

Glenn Anderson – Oppenheimer

Can you guys typically provide a little more granularity in terms of ports shipped?  I did not hear any international sales number.  Some of these data that is provided, did I just miss it or is it provided somewhere else?

Bob Stanzione

I did mention in my comments, we shipped 7,810 ports.

Glenn Anderson – Oppenheimer

In EMTA volumes, did you?

Bob Stanzione

I said $1.79 million CPE devices, which is mostly EMTA, so it is about a 130,000 cable nodes in that.  And, I also said international sales were 31.7% or approximately 32%.

Glenn Anderson – Oppenheimer

The real question here, with respect to CMTS’s, it  has been suggested that ASPs are falling pretty rapidly, I want to get a sense for how the CMTS pricing environment looks and has the erosion of pricing there accelerated, decelerated what is the pricing environment right now?

Bruce McClelland

So, one of the benefits of the DOCSIS 3.0 technology as we get further in the year is not only increased speeds and wide band capability, but the technology is, as what a lot of technology actually allows, a lower cost base from a cost per megabyte or cost per bandwidth perspective.  So, I think there is an anticipation that ASP’s in general, if compared them on the down stream basis will fall throughout the year.  Keep in mind that part of what we are doing on the CMTS is actually separating the upstream and downstream technology so that customers can purchase the bandwidth they really need to have as opposed to buying in fixed quantities and so as you think about prices per down stream and everything, you need to take that into account as a lot of the cost inside the technology associated with the upstream bandwidth, not just the downstream and the new blades, there are interviews later in the year with DOCSIS 3.O that allow us to have 16 down streams on a blade, change those ratios.

Glenn Anderson – Oppenheimer

Got it, and a follow up question; with respect to C-COR, the way you see C-COR business as the access and transport business, any of the weakness in the quarter and the guidance associated with the weakness in that business or do the fundamentals remain pretty strong there?  I think we are expecting the Adelphia plant to sort of taper off, is that going to produce weakness over the next quarters?

Bob Stanzione

Let me introduce John Caezza who is the President of the Access Transport and supplies segment to answer that question, John.

John Caezza

I think as we had taken a look at the trends for the access business, we anticipate a steady progress kind of consistent low for that part of the business as the operators work to expand their capacity, their networks without really having to make significant investments and infrastructure in the traditional sense, so where in the past there has been a lot of investment from the stand point of labor to rebuild the networks, they were a able to do that pretty simply today by just adding the types of components that we provide to give them that capacity, so it is an expansion of the optics and I think things look pretty good today so it is really more capacity from the network they already have.

Bob Stanzione

Are you expecting growth in that business throughout the year?

John Caezza

I think that at this point we would probably look at it to be flat, maybe a little bit up, but I think given what is going on with other segments in the market today we would anticipate it to be kind of steady to where we are.

Operator

Your next question comes from the line of Ray Archibold with Kaufman Bros., please proceed.

Ray Archibold - Kaufman Bros.

Just a housekeeping item, in terms of the new segment reporting, are you going to provide some of the pro-forma historical data?

David Potts

We will be doing sales and gross margin and we will be putting them on the website hopefully tomorrow for you.

Ray Archibold - Kaufman Bros.

Okay very good, and then just a couple of things, one in terms of the gross margin on supplies and CPE, from quarter to quarter is that all related to volume or was there pricing concessions that kicked in the fourth quarter?

David Potts

There are two things I mentioned; one is that we had a write off of some inventory from a product line from CXM which actually is not the EMTA’s that was just over a million dollars.  We also had a warranty cost which is very rare actually in this stuff for some isolated power supplies that we have on one of the modems which us another million bucks.  If you back those up we are still a little bit below, but it is much closer to what the historical margins were.

Ray Archibold - Kaufman Bros.

And then if I understand correctly as far as Comcast reporting in terms of the EMTA business, you shipped a substantial amount though lower than the 3Q, you had a second vendor which also shipped quite a bit, so it sounds like your read is Comcast is carrying a lot of inventory going in to the first quarter, is that correct?  And secondly sort of, your expectations that that gets burned off largely in the first quarter and we return in kind of a normal seasonal pattern?

Bob Stanzione

Yes that is correct, as I mentioned we expect to ship products to Comcast this quarter, it is just at a much lower level, so they will burn through that inventory during the first part of the quarter and they will begin replenishing towards the end of the quarter.  I would expect that we will return to a more normal level although not as a peak, remember we expected that the second vendor was going to come in a year before it did, and so we were—

Ray Archibold - Kaufman Bros.

I guess I am trying to establish what is the base that we should be looking in terms of modeling if you will, normal progression is the first quarter expectation, the base or is it something between the first quarter and the fourth quarter, how should we think about that in terms of what a normalized level should be going forward?

Bob Stanzione

Probably closer to the fourth quarter than the first quarter but I cannot—

Ray Archibold - Kaufman Bros.

But not quite that level?

Bob Stanzione

We cannot predict that well, not that far.

Ray Archibold - Kaufman Bros.

And then on the CMTS, or I guess on the broadband and infrastructure side, sounds like you are indicating again that Comcast is back and loading their adoption of DOCSIS 3.0, you did talk to strong volumes I guess coming out of Cable Vision and Time Warner but probably not as sufficient to offset the delays if you will coming out of Comcast, but I guess my question is related to the rest of your customers, shall we expect, I guess if you will, more normal seasonality going forward or is that business sort of ramping through or can you give us a sense in terms of the non-Comcast business if you will, what that trend looks like for the remainder of the year, so we get a sense of what the trajectory could look like as we get into the second half of 2008.

Bruce McClelland

This is Bruce, I think one of the indications Bob talked about earlier was the increase in the international business and that certainly applies to the CMTS and broadband segment that we have seen.  Pretty healthy growth particularly in South America and even in Europe, so I think if it is not enough to make up for what is a slower rate in the first two quarters with Comcast, it certainly makes up as a piece of it, so we are pretty bullish on the growth outside of that Comcast only.

Ray Archibold - Kaufman Bros.

Okay and in terms of the guidance, so you have given and the risk that could stay, so I am assuming that takes into account the lack of the deferred revenue recognition from C-COR?

Bruce McClelland

Yes.

Ray Archibold - Kaufman Bros.

In the first quarter?

Bruce McClelland

Right.

Ray Archibold - Kaufman Bros.

So this is a GAAP number as opposed to anything else?

Bruce McClelland

Yes.

Operator

Your next question comes from the line of Greg Mesniaeff from Needham & Company; please proceed.

Greg Mesniaeff – Needham & Company

I have a question regarding Comcast and EMTA’s, can you quantify to the extent possible how much leverage or wiggle room you have with Comcast to potentially alter or shift the current market share dynamic based on price and on future set particularly as future sets get enhanced throughout the year.

Bob Stanzione

That is a great question, certainly the environment at Comcast with additional vendors is more of a competitive environment and we do not take our market share for granted at all, it is a business where you have to win the business everywhere, every month, every week, and it is about additional features in the product to produce operational cost and  I think we have talked about in the past that there are number of things that we have designed into the product to make the installation and the quality of the service differentiated and better than the competition and we continue to focus on that and the customer service and the flexibility of the product is a huge focus, so I think you are right that our challenge is to make sure we win our unfair share of the market going forward.  The other growth area in 2008 we have not talked about is the commercial services arena in the small business environment, I think if you listen to the Comcast call today that is certainly a very major focus for them as well as several of the other operators here in the US.  I think we are very well positioned with the portfolio products to address that market as well.

Greg Mesniaeff – Needham & Company

Could you comment on your multi-lining MTA vis a vis the other vendor?

Bob Stanzione

So I think we are pretty much the only vendor with a suite of multi-line products today that are shipping, so I think that is a differentiated area and something we focus on a lot.

Greg Mesniaeff – Needham & Company

And just to kind of close the loop on my first question; in hind sight, is it fair to say that Comcast has been planning this for quite sometime to namely to introduce a second vendor, and this is sort of them putting a stake in the ground and at this point going forward it will be more of who gets to win the business based on the credentials and on the specifications of the products?

Bob Stanzione

They have a policy; a multi vendor policy that we have commented on and I am sure you recall, we expected quite honestly that this was going to occur a year before and evidently our competitors had more difficulty in getting their product qualified than we anticipated, we enjoyed a tremendous progress in that, so I think that the business throughout 2007 and of course now another vendor has come in and performed.

So I think that this is the abruptness of the adjustment is coming unexpectedly or the size of the adjustment I should say is unexpected, but the fact that it happened is not.  Now Bruce has been up there recently the past few days, and we are trying to work out a forecast arrangement so that these unexpected changes in the business do not occur and I think he has made tremendous progress in that; so I think that the business will be more predictable as we go forward.

Greg Mesniaeff – Needham & Company

I guess the concern some people have is that price could become a far more gating factor here than it has been and I am kind of wondering whether this is going to be really a price driven equation or a feature richness driven equation.

David Potts

I think price is number one, two and three and in a lot of minds, and it always has been with all the operators, I mean if you are not competitive on price you are not going to get the business.  However, what decides is the market share split and the volume is all about differentiating the product and providing more value at a similar price range, so I do not think we believe that dynamic has changed substantially, it is the life we live everyday on this product line and you have got to be grinding the cost out of the product and constantly with your partner and your supply chain and that does not change.

Bob Stanzione

And I think we have an advantage on cost, given our volume is so much higher than anyone else’s.  So I think Bruce and Jim before hand have done a great job in establishing a culture where we are keeping the margins up by reducing the cost at about the same rate the prices have changed.

Greg Mesniaeff – Needham & Company

Great, one more quick housekeeping question; what were DSO’s in the quarter?

Bob Stanzione

So DSO’s are sort of meaningless because we have brought in the receivables from C-COR so we did not give the statistics.

Greg Mesniaeff – Needham & Company

Sure, okay, got you.

Operator

Your next question comes from the line of Amitaf Pasi (ph) with UBS; please proceed.

Amitaf Pasi – UBS

Bob just have time for you regarding Comcast, I mean Comcast today guided to CAPEX being roughly flat just like we up in the year, call it maybe up 1%; do you think you can actually at least have your business at Comcast remain flat in 2008 over 2007 including C-COR contribution?

Bob Stanzione

The first quarter puts us in a hole of course and so we would have to make up for that and more in the next three quarters in order to have the same amount of revenue or more than we had in 2007, so I would say that is going to be a hard thing to do, although I do think that as the year goes on you are going to see the revenue dollars coming out of Comcast to Arris bounce back nicely.  We have got other products besides the two that we have talked about predominantly on this call, John Caezza is Access and Transport products, I think we have great upside opportunities in Comcast for that, Bryan Isaacs here with his software products, the OSS as well as the On-Demand products particularly the ad insertion, a lot of people do not realize that Arris is the number one vendor of ad insertion equipment as a result of our acquisition of C-COR.

Bryan and his team are very much involved in winning more of that targeted or advanced advertising piece of the pie, so I think there are opportunities that are going to emerge as the year goes on outside of just the EMTA’s and CMTS, and I think even in those two categories the introduction of DOCSIS 3.0 is going to open some gates to more spending in the second half of the year.

Amitaf Pasi – UBS

Okay and then just a couple of questions around your first quarter guidance, the gross margin that you reported for the broadband segment, I mean is it fair to assume that that is the level we should expect over the next couple of quarters or even potentially have them trend down driving cost out of D5 or should we consider 4Q 07 as a low point; just trying to get a sense of how to think about margins over the next couple of quarters.

David Potts

I would think it is a low point.

Bob Stanzione

Bruce, elaborate on that.

Bruce McClelland

Alright again, we will just extend this a little bit more.  There seems to be a lot of questions in queue, so we will take another one.

Amitaf Pasi – UBS

Okay just one final question from my end, could you give a number for the multi line units for the quarter.

Bob Stanzione

We did it but, Bruce what was it roughly what we had?

Bruce McClelland

It was roughly what we did in the first quarter.

Amitaf Pasi – UBS

About 21K?

Bruce McClelland

Yes, very close.

Operator

Your next question comes from the line of Ray Archibold with Kaufman Brothers, please proceed.

Ray Archibold - Kaufman Bros.

I think we have already gotten Ray’s question, is there another one in line?

Operator

There are no further questions in the queue.

Bob Stanzione

Okay, Ray go ahead, Ray did we answer your question or you have another one?  I think we answered Ray’s question.

Operator

An interruption, there is one more question in the queue from David Wright with Henry Investment Trust

David Wright - Henry Investment Trust

Can I ask a question, on the slide, is the $138 million shares, is that an actual or is that an average?

Bob Stanzione

That is what we anticipate to be the fully diluted share count for the first quarter into the next year.

David Wright - Henry Investment Trust

But is that also the actual?

Bob Stanzione

No, it would not be because we would have options in it.

David Wright - Henry Investment Trust

Right so what is the actual?

Bob Stanzione

We have to—

David Wright - Henry Investment Trus

How many shares did you issue for C-COR?

David Potts

$25.1 million.

David Wright - Henry Investment Trust

Using the $138 and the billion and the quarter dollar of equity that is on the balance sheet in the press release, I get a book value around $743, and obviously there is a lot of goodwill in that book value but a lot of it from the acquisition that is very recently closed, my question is with the stock fleeting pretty freely at around $6.10, does it makes sense to buy some stocks back and if it does are you at all prohibited from buying any stock back having just closed this large acquisition with stock?

Bob Stanzione

We will not be prohibited after Monday I believe, we have an open window, we have established or in fact re-established the Committee of the Board of Directors that we will be examining that essentially day by day, and we may, I am not sure whether we will, but we do have the facility to do that if we see the need to.

David Wright - Henry Investment Trus

Do you have a presently authorized buyback open?

Bob Stanzione

No but we do have this committee so that we can act very quickly should we decide to do that.

David Wright - Henry Investment Trus

Thank you very much.

Bob Stanzione

Alright, thank you and with that I would like to just summarize this for those of you who have stuck around until the end.  We are very confident that we have the right products and the right technologies and that the industry that we are in is going to continue to invest aggressively against their competition.

So to balance things out, I would say that our disappointment in the first quarter is offset by our enthusiasm for the rest of the year.  I also want to mention that we are holding an Investor Conference on March 4 and 5 here in Atlanta and you are all certainly invited to come, we are certainly be doing a deeper dive both on the financial side of the business as well as on some of the technologies.  With that I would like to thank you for attending today and we will adjourn.

Operator

Thank you for your participation in today’s conference that concludes your presentation, you may now disconnect and have a good day.

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Source: Arris Group Inc. Q4 2007 Earnings Call Transcript
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