Is Arris Group, Inc. Just a Flash in the Pan?

Arris posted a strong Q2 outlook, but Foolish investors should be looking for more.

May 13, 2014 at 10:00AM

Arris Group (NASDAQ:ARRS) announced its first quarter earnings on Tuesday, beating estimates on both the top and bottom lines. The big news from the AT&T (NYSE:T) and Comcast (NASDAQ:CMCSA) set-top box maker, however, came in the form of the monster guidance management provided. This quarter is the first comparable quarter since the acquisition of Motorola Home from Google (NASDAQ:GOOGL) last year.

For the second quarter, management expects earnings per share of $0.64 to $0.70 on revenue of $1.41 billion to $1.45 billion. Analysts had been modelling EPS of $0.50 on revenue of $1.22 billion.

The news sent shares higher after hours, opening for trading Wednesday nearly 16% above Tuesday's closing price. While a lot of big money is moving into the stock based on its short-term strength, Foolish investors want to see long-term strength in its business model.

Based on the latest numbers from Arris, the company looks to possess enough strength to maintain elevated revenue for the long-haul.

Short-term numbers

  • Book-to-bill ratio of 1.37. A book-to-bill ratio above one is a strong short-term indicator of demand. All said, the company booked about $450 million more in sales than it could ship last quarter, resulting in a boost to its backlog. How quickly the company is able to get through those extra orders will be key to its long-term growth trajectory. In the short-term, it's easy money.

  • Order backlog of $996.1 million. Arris' backlog increased 85% from the end of last quarter, when it stood at $538.6 million. A small portion of the backlog was likely due to supply constraints on the E6000, but the vast majority is due to strong demand for its products across the board. Unit shipments for its broadband high-speed data devices grew 20% sequentially.

  • Inventory declined $44 million. Usually seeing an inventory decline is a sign that a company expects weaker sales going forward. In the case of Arris, however, it may just be a sign that it's having trouble keeping up with demand -- a much better problem to have. Nonetheless, investors should watch to see this number build back up to previous levels if not higher in the coming quarters.

Long-term story
Arris operates in a market that's currently in flux: cable operators are looking to differentiate their products, Internet speeds are getting faster, and video delivery is being rethought.

Arris is positioned to take advantage of all of these changes within the industry.

  • Differentiated products. A lot has been made of Comcast's XG1 set-top box. Although Comcast did a lot of work and spent a lot of money developing the box, Arris technology is behind it all. Arris saw a strong lift in sales due to the XG1 in the fourth quarter, and sales leveled off (as expected) in the first quarter.

    Comcast, likewise, is seeing improvements in video subscribers, adding 43,000 and 24,000 net new video subscribers in the fourth quarter and first quarter, respectively.

    AT&T, another large customer of Arris, advertises its WiFi-enabled, put-the-TV-anywhere set-top boxes, in an attempt to differentiate its product. The telco added 194,000 and 201,000 net new subscribers to its television service in the fourth quarter and first quarter, respectively.

  • Faster Internet speeds. AT&T also recently announced that it would begin a roll-out of gigabit Internet service. This is just one response, among many, to Google's expansion of Fiber. As Google becomes more serious with the project, with plans of rolling it out to nine new cities, it appears to have achieved its initial goal -- getting Internet providers to boost speeds.

    There's already strong demand for Arris' high-speed data products as exemplified by its 20% unit growth, but further speed improvements by telcos and cable operators will lead to long-term success at Arris.

  • New forms of video delivery. The future of video delivery is through Internet protocol. While most cable and telcos have begun the transition to IPTV, it's a long and ongoing process. Arris is positioned well with its video gateway products, as well as its multiscreen delivery software, which is bolstered by its recent acquisition of SeaWell, which specializes in video encoding. IPTV also allows for dynamic ad insertion, for which Arris has a solution as well. The transition may lead to an accelerated upgrade cycle for Arris, in addition to further revenue opportunities in the long-run.

Good numbers, good story
ARRIS positive momentum is not just about short-term improvements in demand. This is a long-term trend, and Arris appears to be gaining market share against its competitors. As a result, I believe Arris will continue to see strength in its revenue growth, and despite margin pressure due to increased mix of its CPE division, it should see excellent earnings growth as well. Trading at a non-GAAP earnings multiple in the low-teens, I think it still represents a great stock to buy.

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Adam Levy owns shares of Arris Group. The Motley Fool recommends Google (A shares). The Motley Fool owns shares of Google (A shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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