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3 Key Takeaways From Arris Group Inc's Earnings Report

By Adam Levy – Feb 21, 2014 at 11:41AM

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Arris surprised on both the top and bottom line, but here's what you'll find by digging deeper.

Arris Group (ARRS) reported its fourth-quarter earnings on Wednesday. The company beat the consensus estimates on both the top and bottom lines with $0.54 in non-GAAP EPS and $1.2 billion in revenue. Analysts expected $0.45 per share on revenue of $1.16 billion.

The company benefited from the rollout of Comcast's (CMCSA 0.34%) XG1 set-top box as well as Verizon's (VZ 0.26%) strength in the market. Arris is also benefiting from increased competition from telecoms in the pay-TV market, as cable providers look to use the set-top box to differentiate their products. Here are three takeaways from Arris' fourth-quarter release.

Gross margin improves
Gross margin expanded 90 basis points sequentially in the fourth quarter to 30.5%. That number is still far from the 35.8% margin the company posted in its fourth quarter of 2012. Nonetheless, as Arris shifts its product mix more heavily toward its CPE segment, with the acquisition of Motorola Home, improving margins is a good sign.

The likeliest driver of gross-margin improvement is Comcast's XG1 set-top box. Comcast's X1 platform helped propel the company to its first quarter of video subscriber growth in six-and-a-half years. These higher-margin boxes, which include IPTV capabilities and six television tuners, helped drive both companies' earnings.

Arris expects to further capitalize on product rollouts in 2014. Its E6000 platform and in-home gateway devices ought to gain traction and further boost profits. While the company doesn't forecast gross margin, the industry is shifting toward more expensive set-top boxes and gateways in order to differentiate their offerings.

Verizon is shifting more toward IPTV services with its acquisition of Intel's OnCue. Its FiOS video service added 92,000 net new subscribers in the fourth quarter, and the company now serves 5.3 million homes. As providers start integrating more advanced technology into their set-top boxes, Arris stands to benefit, but it will have to stay ahead of the competition in order to win business from cable companies outside of Comcast.

Accelerated debt retirement
During the quarter, Arris paid down $141 million in term loan debt, including $125 million in optional prepayment. The company took on significant debt to fund its acquisition of Motorola Home, and this is a strong signal that it's using the added cash flow to quickly pay down its debt. Retiring this debt is high on the company's priority list, and that came through in the fourth quarter.

The company's ability to get debt off its balance sheet will allow it to reduce its coupon rate as there's a step down in Term Loan A from Term Loan B. It could also open the door to take on additional debt to make another acquisition.

Maintaining R&D spending
Despite the increasing debt payments, Arris is still generating enough cash to reinvest in R&D, as it edged up slightly in the fourth quarter sequentially. Maintaining a strong pipeline of products is crucial to the company's success.

On the conference call, CEO Bob Stanzione said, "I believe we're probably investing more in new technology than any of our competitors, which I think gives us a leg up." Still, there may be leverage in the business, as Arris improved sales 12% while R&D remained nearly flat. On the conference call, management said that it doesn't look at its operating expenses in terms of sales, and instead budgets a certain amount for R&D and marketing expenses.

The market loves its TV
Arris shares popped when the market opened on Thursday, climbing as much as 11.7% in early trading. The market is clearly pleased with its earnings results and excited for what's ahead in 2014. Still only trading at just 12.3 times its forward earnings, and with strong growth potential ahead, Arris might make for a good growth investment.

Adam Levy owns shares of Arris Group. The Motley Fool has no position in any of the stocks mentioned. 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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