Yesterday, after the closing bell, Arris Group Inc. (ARRS) declared its third quarter 2010 financial results that barely meet our expectations. However, an extremely week fourth quarter financial guidance resulted in the stock price reduction of 50 cents (5.32%) to $8.89 in the aftermarket trade on NASDAQ.
GAAP net income in the third quarter was $14.1 million or 11 cents per share compared with a net income of $21.7 million or 17 cents per share in the prior-year quarter. Adjusted (excluding special items) EPS, in the reported quarter was 16 cents, exactly in line with the Zacks Consensus Estimate.
Revenue
Total revenue of $274.3 million was down 0.5% year over year and also below the Zacks Consensus Estimate of $280 million. This was primarily due to poor performance of the Broadband Communications Systems division. Quarterly Domestic revenue was 64.6% and International revenue was 35.4%. Comcast Corp. (CMCSA) and Time Warner Cable Inc. (TWC) together constituted 40% of total quarterly revenue.
Quarterly gross margin was 37.2% compared with 41.9% in the year ago quarter. This indicates unfavorable product mix. Operating expenses, in the third quarter, were $78 million compared with $76.6 million in the prior-year quarter.
Arris generated $12.5 million cash from operations during the reported quarter compared to a massive $63.1 million in the prior-year quarter. Quarterly free cash flow (cash flow from operation less capital expenditure) was $5.7 million compared to $59.6 million in the year-ago quarter.
Balance Sheet
At the end of the quarter, Arris had $640.4 million of cash & marketable securities on its balance sheet compared to $561.7 million at the end of third quarter of 2009. Total debt was $204.1 million at the end of the third quarter 2010 compared to $208.6 million at the end of third quarter of 2009. At the end of the reported quarter, debt-to-capitalization ratio was 0.17 compared to 0.18 at the end of the prior-year quarter.
Order Backlog and Book-to-Bill Ratio
Total order backlog of Arris, at the end of the quarter was $119.6 million compared to $169.5 million at the end of the prior-year quarter. Book-to-bill ratio was 0.80 in the same quarter compared with 1.01 in the prior-year quarter.
During the third quarter of 2010, Arris repurchased approximately 1.7 million shares of common stock for $15.6 million and repurchased $14.0 million (face value) of Convertible Notes for $13.5 million.
Segment Performance
Broadband Communications Systems Segment: Quarterly revenue was $203.8 million, down 3.5% year-over-year. Quarterly gross margin was 37.2% in the reported quarter, significantly below 44.6% in the year-ago quarter. During the third quarter 2010, Arris shipped 24,714 downstream CMTS and 13,464 upstream CMTS. Arris shipped total 1.765 million CPE, its strongest quarterly performance since 2007. Out of this, DOCSIS 3.0 CPE constituted 33.5%.
Access, Transport, & Supplies Segment: Quarterly revenue was $47.6 million, up 14.6% year-over-year. Quarterly gross margin was 26.3% compared to 23.4% in the year-ago quarter.
Media & Communication System Segment: Quarterly revenue was $22.9 million, up 20.5% year-over-year. Quarterly gross margin was 59.6% compared to the gross margin of 55.3% in the year-ago quarter.
Financial Outlook by Management
Management has given a guidance that net sales in the fourth quarter of 2010 will be within the range of $250 million – $275 million. Its mid point of $262.5 million is far below the current Zacks Consensus Estimate of $282 million.
EPS on a GAAP basis is expected within the range of 5 cents to 9 cents. EPS on a non-GAAP basis is expected within the range of 14 cents to 18 cents. This includes stock-based compensation expenses of 3 cents per share. Excluding the stock-based compensation expense, the non-GAAP EPS range is 11 cents to 15 cents. Its mid point of 13 cents is well below the current Zacks Consensus Estimate of 17 cents.
Our Recommendation
Arris is solely dependent on cable operators for its revenue. The lack of industry diversification may result in limited business prospects since potential shifts in industry dynamics may adversely impact cable TV service providers. This is evident from the fact that large telecom carriers in the U.S. are increasingly expanding their high-speed fiber based network and the satellite TV providers are also upgrading their networks. Cable MSOs are gradually losing their basic video customers to low-cost satellite TV service providers.
We maintain our Underperform recommendation on Arris for the long term. For the short term, it is currently a Zacks #4 Rank (Sell) stock.
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