ARRIS International Plc (ARRS) Robert J. Stanzione on Q4 2015 Results - Earnings Call Transcript

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ARRIS International Plc (NASDAQ:ARRS)

Q4 2015 Earnings Call

February 17, 2016 5:00 pm ET

Executives

Robert Puccini - VP Investor Relations, ARRIS Group, Inc.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

David B. Potts - Chief Financial Officer & Executive Vice President

Larry Robinson - President-Customer Premises Equipment, ARRIS Group, Inc.

Bruce William McClelland - President-Network & Cloud, ARRIS Group, Inc.

Analysts

George C. Notter - Jefferies LLC

Joseph Wolf - Barclays Capital, Inc.

Simon M. Leopold - Raymond James & Associates, Inc.

Doug Clark - Goldman Sachs & Co.

Rich F. Valera - Needham & Co. LLC

Joseph Stein - Wells Fargo Securities LLC

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2015 ARRIS Earnings Conference Call. My name is Jasmine, and I'll be your operator for you today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session.

As a reminder, this conference is being recorded for replay purposes. And now I'd now like to hand the conference over to your host for today, Mr. Bob Puccini, please proceed.

Robert Puccini - VP Investor Relations, ARRIS Group, Inc.

Thank you, Jasmine, and welcome everyone to the ARRIS conference call with management. This afternoon, we will be discussing our fourth quarter and full-year 2015 results, which were released after close of market today. We will be using a series of slides during our webcast which are posted on the ARRIS website, www.arris.com, in the Investor Relations section. There will be a replay of this entire call available including our slides on our corporate website the next 12 months. Before we begin, can we please go to chart two?

During this call, we may 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 of various product categories and the completion of pending transactions. This is important to note that actual results may differ materially from those suggested by any forward-looking statements, which may be made during today's call. For further our 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 we go on to chart three to review today's agenda. Bob Stanzione, ARRIS Chairman and CEO will provide a brief overview of the results. David Potts, Executive Vice President and CFO, will review the financials. Larry Robinson, President, Customer Premises Equipment, and Bruce McClelland, President, Network & Cloud, will review the business segments. Bob will give us an update on the Pace transaction and the business outlook.

Now, if we can move on to page four, I'd like to turn it over to Bob Stanzione. Bob?

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Thanks, Bob. Good evening and welcome to our earnings call as we look back on the ARRIS group business and look forward as the newly formed ARRIS International. Let's move to chart five.

As we preannounced, our Q4 revenue results were at the low end of our guidance but with margins and non-GAAP earnings up quarter-over-quarter and above the top of our original guidance due to the effects of increased year-end software license sales and R&D tax credits. CPE sales were down the quarter while Network & Cloud segment had its best quarter of the year led by strong CCAP, Edge Router hardware, and software license demand and pro-services growth. This shift towards infrastructure spending resulted in an overall favorable mix and accounts for the quarter-over-quarter margin improvement.

Sales to U.S. cable were off in Q4 although for the full year, we're generally positive. Sales to U.S telcos continued down due to the very weak video subscriber additions and AT&T's move away from U-verse video delivery. And in spite of continuing pressure from the strong dollar, international sales were actually up in Q3 at $357 million and represented 32% of our total sales.

Certainly, the financial highlights of the quarter was the software license sales to augment E6000 capacity that Bruce is about to talk about. Book-to-bill, backlog, and cash generation are all in good shape.

And now, you'll hear from Dave, Bruce, and Larry, and then I'll come back and update you on the Pace integration and offer some comments on the year ahead. Dave?

David B. Potts - Chief Financial Officer & Executive Vice President

Great. Thanks, Bob, and thanks everyone for joining us this afternoon. So let's take a look at some of the financial highlights in chart seven, please.

So sales in the fourth quarter were $1.102 billion, and this compares to $1.221 billion in the third quarter 2015 and $1.263 billion in the fourth quarter of last year. Gross margin was approximately 32.6% in the fourth quarter up from 29.4% in the third quarter of 2015, reflecting a change in product mix in the quarter. Specifically, we had strong sales of E6000 and, as Bob mentioned, the software sales associated with that. And gross margin was 30.1% in the fourth quarter of 2014.

Non-GAAP EPS was $0.62 in the quarter and compares to $0.56 in the third quarter of 2015 and $0.78 in the fourth quarter of last year. In Q4, both our GAAP and non-GAAP results, we recorded the full-year impact of R&D tax credit. This was about $0.14 a share that I think as most of you know is part of what went on in Washington, and late in the year, Congress passed the legislation which permanently extends the R&D tax credit so which is very good news that we are permanently extended at this stage.

Our fourth quarter GAAP EPS was a profit of $0.20, which compares to $0.18 in the third quarter of 2015 and $1.29 in the fourth quarter of last year. And as always, a reconciliation of our GAAP to non-GAAP results is attached to the back of the press release, and you can also find it on our website. We ended the year with $879 million of cash resources, and we generated $127 million of cash from operating activities in the quarter. And our backlog at the end of the quarter was $716 million, and our book-to-bill ratio was 1.14.

Let's turn to slide eight, please? So a look at some of the sales detail, sales in the quarter again were $1.1 billion, sales of our CPE segment were $665 million, down $147 million or 18% from the third quarter and down $164 million or 20% from the fourth quarter of last year. A particular note and as we expected, year-over-year, we have lower sales of CPE products to both Verizon and AT&T.

Sales in Network & Cloud were $436 million, up $26 million or 6% from the third quarter, and up $1 million from the fourth quarter of last year. I will note that in the fourth quarter of last year, we had about $6 million of sales of our supplies product line, which we disposed out in the third quarter of 2015.

We had two 10% customers in the fourth quarter, which accounted for 34% of our overall sales. And our international sales were $357 million in Q4 or about 32% of our total revenue and is up from $332 million or 27% in Q3 of this year – of 2015.

On to slide nine, please? So on this chart, we break out sales and direct contribution. Sales in Network & Cloud again were $436 million in the fourth quarter with the direct contribution of $154 million and sales of CPE were $665 million in the fourth quarter with a direct contribution of $106 million.

To chart 10, please? So operating expenses, OpEx was $241 million in the quarter, and we were up from both the third quarter of 2015 and the fourth quarter of last year. I will highlight that we are consolidating the financial results of our recent ActiveVideo acquisition. In Q4, we included about $7 million of expense, which of course did not exist last year. R&D was $133 million in the fourth quarter, up from $132 million in the third quarter, and down from $136 million in the fourth quarter of last year. As I mentioned on the call last quarter, we received some state R&D credits in Q3, which did not repeat in Q4. So that contributed to the sequential increase. Year-over-year, the decrease is primarily related to variable compensation expenses, lower project-related expenses, and was partially offset, by of course, the increase we had related to ActiveVideo.

SG&A was a $108 million in Q4, up from a $102 million in Q3, and up from Q4 of last year of $96 million. The increase quarter-over-quarter is primarily due to higher equity compensation expense, some increased legal expenses, and some increased expenses related to ActiveVideo. And this is partially offset by lower sales and marketing costs. Year-over-year, their increase is primarily related to higher sales and marketing costs; of course, the ActiveVideo expenses; and was offset by lower variable compensation expense. Included in R&D and SG&A was $15 million of equity compensation expense in the fourth quarter, which compares to $14 million in Q3. And in the fourth quarter, we incurred integration and acquisition cost related to the Pace deal of about $8.3 million.

Let's turn to chart 11, please? So touch on tax briefly, again, our full year non-tax GAAP rate was about 32%. And as I mentioned since Congress permanently extended the R&D tax credit late in 2015, it didn't lower our Q4 and our full-year non-GAAP rate. As a result, we recorded a benefit of about $20 million in Q4. And this, again, is the full-year benefit not just the end-quarter benefit, taking our non-GAAP rate down to 32%.

Let's go to chart 12, please? So let me touch on cash and some key cash items. I must say I am pleased with our cash generation in the quarter. We ended the quarter with cash and investments of approximately $879 million, up $98 million from the end of last quarter. Cash generated from operating activities was a $127 million in the fourth quarter. And on this chart, I've highlighted some of the key items. So very importantly, the elements of earnings, which are cash-based, were approximately $110 million, and we generated about $18 million from working capital in the quarter. And to help you with some of your modeling, we did indeed have CapEx of $12 million in the quarter, and we did have mandatory debt payments of $12 million in the quarter as well.

On to slide 13, please? So with respect to guidance for the first quarter, at this point, we estimate that we'll have sales of about $1.560 billion to $1.610 billion. We anticipate non-GAAP earnings will be in the range of $0.37 to $0.42 and GAAP earnings of $0.01 to $0.06. Again, a reconciliation is attached in the presentation. Now, please note that our earnings guidance does not include the impact of purchase accounting adjustments and restructuring costs, which we're still working through at this time. We are making progress on our cost synergy planning. The combined ARRIS OpEx, excluding amortization, integration, and acquisition costs, we estimate to be about $305 million in the fourth quarter of 2015. And we're targeting the range of about $295 million to $305 million in Q1. And we do indeed expect improvement through the year as we get deeper into our synergy planning.

We estimate our non-GAAP tax rate to be about 25%. Our tax planning is indeed again coming together and, at this time, will be (11:07) targets, which we previously set at the 26% to 28%. We estimated our diluted share account will be about 200 million.

So beyond 2000 – the first quarter 2016, we expect sequential improvement in revenue throughout the year. And that the – that combined with the impact of our synergy actions, we anticipate sequential improvements in non-GAAP EPS at this stage.

So with that, thank you very much, and let me turn it over to Larry.

Larry Robinson - President-Customer Premises Equipment, ARRIS Group, Inc.

Thanks, Dave. Now let's turn to chart 15 and look at the Customer Premises Equipment highlights.

As we noted throughout last year, segment sales and direct contribution were down from 2014, primarily due to the market challenges our telco customers encountered as they've repositioned their respective businesses. Cable CPE activities were more robust as we saw continued investments in advancing the video experience to more consumers. Additionally, our DOCSIS results were strong as operators furthered their push towards more capable platforms, both in terms of access speeds as well as in-home networking capabilities. We expect both of these market trends to continue throughout the course of the coming year.

As expected, sequential and year-over-year quarter sales were lower in Q4 due to video and broadband volume decreases. Now, looking at the respective product areas, the aggregate broadband CPE portfolio unit volumes were lower. DSL shipment performance was down as compared to Q4 2014, as well as relative to the prior quarter due to continued weakness in AT&T's subscriber results.

In case of DOCSIS, following a record level of shipments in Q3, volumes were lower as operators managed year-end expenditures, but shipments increased year-over-year, continuing to reflect the momentum in this part of the portfolio. During the quarter, we secured a key product win with a North American operator to deploy a network bridge as part of their in-home architecture. This is indicative of the evolving residential ecosystem whereby networking technologies play a more significant role in further enabling the consumer experience, both in terms of connectivity to different device types as well shift in product functionality.

With respect on our Liberty Global engagement, we started deployments of an advanced EuroDOCSIS gateway, marking a significant milestone, and the feedback regarding product performance has been quite positive. Consistent with the theme that we have seen for several quarters, the interest and demand for higher capacity DOCSIS solutions remain strong. We're continuing to expand our retail portfolio with gigabit devices including standalone Wi-Fi routers. And DOCSIS 3.1 remains a significant initiative for our teams with active development programs underway in support of key customer design wins.

Now, let's turn to chart 16. Our video CPE portfolio also saw unit volumes decrease on a comparative basis. The year-over-year performance was attributable to reduced telco shipments. Our sequential results were driven by a combination of lower telco and cable volumes despite us maintaining our market share positions. From a technology standpoint, during the quarter, we launched the new set of media server features in collaboration with Verizon as part of their FiOS TV to-go initiative. These mobility features leverage the advanced capabilities within the platform, extending the video experience to other consumer electronics.

Additionally, through a collaborative engagement with Bell Canada, the teams provided set-tops to support their launch of a 4K service, demonstrating a strong commitment to video innovation. Now combined with Pace, we have launched two of the world's first 4K solutions. Ultra HD is an area that we expect to see ongoing investment by operators as they look to bring consumers the latest in video technology. We also commercially launched and transitioned several customers to our latest DCX video gateway and IP client set-top platforms. And finally, we saw continued traction in our international business with shipments of a new gateway supporting video mobility applications for CNS in Taiwan.

I will now turn it over to Bruce.

Bruce William McClelland - President-Network & Cloud, ARRIS Group, Inc.

Thanks, Larry. Let's turn to chart 18. In the Network & Cloud segment, we had our strongest results of the year with sales up 7% and direct operating profit up 27% compared to the third quarter. Year-over-year, sales were up slightly from the fourth quarter of 2014 while operating profit improved by 22%. The improved performance was the result of our best ever CMTS quarter with a strong mix of both hardware and software, as well as a very good quarter in our Professional Services business.

From a full-year perspective, the Network & Cloud business grew 1.5%, while profitability improved 13%. Highlights for the year included very good growth from our strategic investment in Professional Services as well as the growth in the Access Technologies product group. The increased mix of software license sales on our E6000 platform contributed to the improved profitability yield. Please turn to chart 19.

We achieved a new record level in several key metrics with our E6000 CCAP platform in fourth quarter, including chassis shipments, total downstream channel shift, and downstream channel software licenses. As we've discussed many times in the past, the strategy to establish footprint in order to sell future upgrades on the platform is very important and pays dividends for years to come. Demand for new hardware continues to be strong this quarter, and we expect to be somewhat supply-bound.

I mentioned last quarter that we expected to start live field trials with our DOCSIS 3.1 features in fourth quarter, and that happened as expected. You've probably seen the recent announcements by Comcast on their plans to start commercial deployments for this capability in the first half of 2016. It's becoming very clear that DOCSIS 3.1 will be a major priority for the majority of our customers in 2016 and beyond. This will translate into more software sales, as well as a new round of hardware upgrades starting later this year.

As operators continue to drive efficiency in their own operations, we are now seeing more significant deployment of legacy video MPEG channels on the E6000 Converged CCAP platform, contributing to the software license sales in the fourth quarter. I just returned from a trip to Australia last week to meet with several of our customers including NBN, Telstra, and Foxtel. At the end of the year, we announced our new E6000 win with Telstra as they modernize the network in Australia, working closely with NBN to prepare for the deployment of DOCSIS 3.1 later this year.

In our HSE Access Technologies business, we had a very solid quarter but down from the peak shipments in the summer construction months. In 2015, this business grew by greater than 20%. And now combined with the Pace Aurora portfolio, we expect 2016 to be a very good year as operators race to drive fiber deeper, expand capacity, and refresh their outside plan. And we expect this momentum to continue over the next several years. Near term, the team is very focused on keeping up with demand and adding production capacity.

Please turn to chart 20. Within our video systems product category, we've launched our new video processing platform called the ME-7000 and had several early wins across all regions. And we had another solid quarter of Network DVR sales to add capacity to current deployments and had several new pipeline opportunities.

I've spoken several times about the work we are doing in our cloud business, introduced a new staff-based platform called WorkAssure Online. We've reached the very important milestone in the fourth quarter, activating the service with a leading North American service provider. This is a crucial technology used by service providers to remake their relationship with consumers and build confidence in their ability to deliver services on time, when and where the consumer wants.

Finally, we had an excellent quarter in our growing Professional Services business, reaching important milestones on the several large projects, spurring growth this quarter. In particular, we're excited about the momentum building in our Service Provider Wi-Fi initiative with deployments underway with Suddenlink as well as our recently announced deployment at the Daytona International Speedway. We look forward to have racing fans having a great Wi-Fi experience there this weekend.

With that, Bob back to you.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

All right, thanks. Thanks, so let's go on to chart 22. Okay, as you all know, we closed the deal to acquire Pace back on January 4. So we started 2016 with a boarder portfolio of equipment, software, and services and allowing us to invest aggressively in new innovative solutions for customers worldwide. We enhanced our global presence, anticipating annual international sales of approaching $2 billion. We entered the important satellite market segment. Mostly importantly, we expect the deal to be accretive over to our earnings.

We'll continue to report the same two segments with Pace CPE aligning with ARRIS CPE led by Larry Robinson and Pace networks and software and services aligned with ARRIS Network & Cloud led by Bruce. Integration work is well underway and we've made great progress first with tax planning, as Dave pointed out, and with the customer-facing organizations that were restructured in early January. In order to reinforce our goal of further growing our international sales, we have split the sales responsibilities with Ron Coppock heading international sales and Tim O'Loughlin, who is formerly of Pace, leading North American sales. And we're now in the process of addressing overlaps and product roadmaps and corporate functions.

Our goal is to have OpEx reduction substantially completed in the first half of the year. And at the same time, our supply-chain team is busy working on cost of sales synergies. However, I expect these may phase in more slowly as Jim Brennan and his team implement purchasing and manufacturing efficiencies.

And as many of you have asked, we do acknowledge that there may be some revenue dis-synergies. However at this time, we have no specific visibility of such to report. We remain enthusiastic about the benefits of the combination, and we're committed to getting this integration done quickly. We'll provide you with a lot more detail on the integration work and the 2016 outlook at our Investor Day in New York on March 16.

Let's go to chart 23. Regarding Q1 guidance, given our status as a new company, we're dealing with more than the usual complexity and challenge. And as Bruce mentioned, we're also dealing with some supply constraints in the first quarter in the Network & Cloud segment. There continues to be near-term uncertainty surrounding industry restructuring, such as the Charter, Time Warner Cable, and Bright House integration plans; the Altice acquisition of Cablevision; and Verizon sale of a portion of their FiOS footprint to Frontier.

We expect North American telco business to pick up this year, but we're unsure as to the pace of the ramp. Latin America exchange ratios have actually gotten worse. For example, the pesos devalued another 10% just since the first of the year. We see this as continued downward pressure on our business, particularly in Brazil and Mexico. And these market conditions may cause us to take longer to reach our financial goals.

Nevertheless, we expect both sales and earnings to improve as the year goes on. Our largest customers in the United States market have recently announced healthy CapEx plans. We have great relationships and significant installed basis with these service providers and will certainly play a substantial role in their plans going forward.

For example, 2016 will mark the launch of the highly anticipated DOCSIS 3.1 technology in an acceleration toward all IP networks. We expect that AT&T spending in both the DSL and the video businesses will accelerate through the year. And that Frontier will invest more aggressively in the FiOS footprint that they're buying from Verizon. And with the marketplace wins that we've mentioned before, such as the NBN program in Australia and projects in the Liberty Global, as well as recently announced projects in Shaw, Suddenlink, Charter, Telstra, and others, the fundamentals of the business are strong. And we're poised for growth in 2016.

Last, I want to mention that our board has recently authorized a $300 million share repurchase program replacing a prior program at the ARRIS level – at the ARRIS Group level.

So thank you, and back to Bob for the Q&A.

Robert Puccini - VP Investor Relations, ARRIS Group, Inc.

Thank you, Bob. With that, we'd like to open the lines up for questions. Jasmine, would you come back on, please and let our participants know how they would ask their questions?

Question-and-Answer Session

Operator

And our first question comes from the line of George Notter of Jefferies. Please proceed.

George C. Notter - Jefferies LLC

Hi, there. Thanks very much guys. I wanted to ask about the guidance for Q1. I guess it is a little bit lower than – I guess we've been given the size of the Pace coming into this. Can you talk a little bit about kind of the bigger moving part in your guidance? Sounds like some of this certainly is conservatism per your comments earlier, Bob, but obviously lack LATAM. Any way to kind of put the different factors in terms of rank order or size in terms of how they kind of funneled into that guidance for Q1? Thanks.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Sure, I think that – the key elements that are putting downward pressure on the business are the strong dollar as it affects our business in Latin America particularly, but also somewhat in other parts of the world, Europe. But Latin America, Brazil in particular, and Mexico are suffering as a result – our sales in there are suffering as a result of the strong dollar. We believe the demand is there. We believe that the customers that – our service provider customers have in Latin America continue to want higher speed broadband services and more video services. And so, we believe there's pent-up demand there and are hopeful that the business picks-up as the year goes on.

And then on the domestic front, we see continued weakness in our telco business. As AT&T has reported, they're moving away from U-verse. And so, our sales of U-verse video equipment have bottomed out. And their ramp-up of their new video business, as Randall Stephenson mentioned on a recent call, has gone a little bit slower than they expected. However, we predict success there, and we think that business will pick up as the year goes on.

On the cable side of the U.S. business, things look fairly good. Our big customers in that sector announced fairly strong fourth quarter results. And they announced good forecasts for capital expenditures in 2016. So I think we'll be in good shape there. So I see it as – a number of signs out there that the business will pick up as the year goes on.

George C. Notter - Jefferies LLC

Got it. And then the other question I wanted to kind of put out there was just around DOCSIS 3.1. I guess I'm trying to better understand how the operators plan to roll it out. Is it a service that you see is getting deployed to kind of heavy users, the broadband services selectively, or is it the operator is now kind of biting the bullet and rolling it out in a more broad-based way? How do you kind of see those rolling out? And then, how do you start to see that kind of flow through your model, timing? And then, I would imagine also the certification process kind of feeds into that timing. Walk us through kind of what you see on 3.1. Thanks.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Okay. First of all, I'll just say, I think, we're very fortunate that it is highly anticipated, and we believe demand is there. And we're fortunate to have both ends of DOCSIS 3.1, the network and the CPE end. So we'll start by asking Bruce to answer the question from the network side, and then have Larry talk about the CPE part.

Bruce William McClelland - President-Network & Cloud, ARRIS Group, Inc.

Yeah. So I think it will follow a pretty similar trend of what we've seen in the past where these new technologies kind of start out addressing the heavier users, the faster speed requirements. But then, fairly quickly after that, the operators will continue to ratchet up their speeds, their default speeds across the board. And say a two-year or three-year period, it becomes a much more ubiquitous technology. So I think, as we think of this year, it's really the former, right? It's kind of getting the infrastructure put in place and addressing the heavy users, the biggest needs, and then you'll see that kind of work its way through I think the rest of the ecosystem. Larry?

Larry Robinson - President-Customer Premises Equipment, ARRIS Group, Inc.

Yeah, from a CPE perspective, obviously, as I mentioned in my comments, we have some very active development programs that are underway, targeting typically pretty advanced gateways. And from a timeline perspective, we would expect the trial activity to pick-up through the course of the year, commercial deployments to begin the latter part of this year and then candidly over the next few years that transition to take place. Similar to what occurred on the DOCSIS 2.0 to DOCSIS 3.0 transition, we would expect kind of a similar type model to occur. And obviously to Bruce's comments, it varies a little bit customer-by-customer based on their particular strategies but, certainly, what I would describe is the beginning phases of what should be a very positive upgrade cycle from a DOCSIS technology standpoint.

George C. Notter - Jefferies LLC

Got it, thank you.

Operator

And our next question comes from the line of Joseph Wolf with Barclays. Please proceed.

Joseph Wolf - Barclays Capital, Inc.

Thanks. I was wondering if you could – you mentioned the ActiveVideo expense in the quarter, but I was wondering if you could tie that business into a comment about revenues and opportunities for 2016 and connect that to the current FCC proposal to open up the set-top box market potentially.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Bruce?

Bruce William McClelland - President-Network & Cloud, ARRIS Group, Inc.

Yeah. So I'm not sure how to tie them together exactly. I would say we're in the early stages certainly on the ActiveVideo deployment. And obviously, we have this joint venture with Charter and that's kind of a key tenet to their refreshing of the entire user experience. And so far so good there, right? We'll see that continue and plenty of opportunities both in Europe and in South America for that technology. But it will be – I think it will remain a small part of our business throughout 2016 and hopefully a growth engine beyond that.

As we kind of talk about the FCC activities for a minute and maybe I'll give you a little longer answer on that one, the last 24 months have seen a lot of innovation in the video delivery space, particularly as service providers have embraced TV everywhere and delivered a lot of new major capabilities. Last year, Congress directed the FCC to create a committee to study this with an altruistic type goal of promoting more competition and more consumer choice with MVPD video services. And that was a committee I participated on throughout 2015 very actively. We expect the FCC Chairman to publish his recommendations through what they call an NPRM tomorrow. And this will kick off somewhat indeterminate process around his recommendations on a common period and it's really hard to tell where that goes over time, but it's likely to be a lengthy process. As we think about it...

Joseph Wolf - Barclays Capital, Inc.

Yeah, I'm sorry. Go ahead.

Bruce William McClelland - President-Network & Cloud, ARRIS Group, Inc.

Yeah, let me just run through a couple other thoughts here. As we think about it, it's hard for us to imagine how consumers really benefit from this type of government regulation on – in particular around this technology decisions. And certainly, that was part of the recommendation from this committee I participated in. So there's a very vibrant investment already underway around an application or an app model to enable consumer third-party devices to be able to receive MVPD services, and there are tens of millions of apps that deploy throughout the U.S. with this capability. And you look at the broadband space where consumers already have an option to purchase modems rather than lease them, and that's really only the fraction of the number of broadband devices. Consumers have fully chosen for the most part continue with the lease model.

However, if the FCC does press forward with some sort of rulemaking that requires the MVPDs to change the way they deliver service, I think we're pretty well positioned. I think ultimately IP delivery will likely be the unifying architecture. And clearly, that would benefit our broadband business. The transition from today's video network to a common delivery architecture is bound to be complex. And certainly given the footprint of technology know-how that we have, I think that expertise will be invaluable to our customers.

We have a strong retail business today that we think we could leverage if that's the direction that the FCC pushes the industry and certainly something that can be leveraged and a lot of good experience from our previous MOXI product line that we had which is a video set-top that we sold directly to consumers. So in the meantime, we're very focused on working directly with our customers and a lot innovation in the pipeline and we're going to keep our heads down pretty focused on working closely with them and obviously providing our thoughts to both the FCC and the industry around this.

Joseph Wolf - Barclays Capital, Inc.

Great. And can I just jump to the networking side, cloud side of the business. Beyond DOCSIS 3.1, which I think, we all see as the driver right now, there was a slide – there was a mention of this – the 20% growth and the expanded capacity and I guess some node opportunities. How quickly is that taking place? And what size – can you size that business for us, I guess in maybe just relative to the DOCSIS 3.1 opportunity? How quickly that can develop? And then the other kind of products you may have out there for these deeper fiber and smaller nodes that are being designed right now?

Bruce William McClelland - President-Network & Cloud, ARRIS Group, Inc.

Yeah, good question. I guess the combined ARRIS and Pace network infrastructure business is a major business for us and really one of the important tenets of the Pace acquisition though it is a major product portfolio of the magnitude of the CMTS business, and that – this is what I call outside plan equipment, it's hand off to transmit the signal into the network, or to your neighborhood, and then devices that live in the network to covert signals back to HFC back to coax to deliver to your house. And what's going on with our customers, as they are having to move that fiber connection deeper and deeper into the network to get more capacity to the home, to be able to do things like DOCSIS 3.1, and add more capacity, it's investment not just in the CMTS and not just in the modem but in the connectivity fabric that connects those two things together. So that 20% growth, I talked about in that business and what we think will be continued growth is all related to adding more capacity, more broadband capacity to the network.

Joseph Wolf - Barclays Capital, Inc.

Okay. Thanks, guys.

Unknown Speaker

Thanks, Joseph.

Operator

And our next question comes from the line of Simon Leopold with Raymond James. Please proceed.

Simon M. Leopold - Raymond James & Associates, Inc.

Great, thank you very much for taking my question. A handful of things I'd like to see if we could get some help with. First one is regarding the Pace business. So that we can kind of get a baseline for 2016, can you provide us with some insight as to Pace's sales for calendar 2015 in the fourth quarter for Pace?

David B. Potts - Chief Financial Officer & Executive Vice President

So we'll do that as part of the Analyst Day I think Joseph, but the...

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Simon.

David B. Potts - Chief Financial Officer & Executive Vice President

Pardon me, Simon. The sales were close to what the guidance was that they have exceeding the second half guidance, but it's a bit below that.

Simon M. Leopold - Raymond James & Associates, Inc.

Can you remind us what that guidance was?

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Pull it off, Dave. It's the...

David B. Potts - Chief Financial Officer & Executive Vice President

The full year was just under $2 billion.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

The $2.2 billion?

David B. Potts - Chief Financial Officer & Executive Vice President

Yeah.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Something like that?

David B. Potts - Chief Financial Officer & Executive Vice President

Something like that, yeah.

Simon M. Leopold - Raymond James & Associates, Inc.

Okay, that's helpful. And the other – the other item for those that are modeling that might be helpful, given that this is the first full quarter – March will be your first full quarter essentially full with the Pace expenses, could you help us level set in terms of what we should assume for pro forma operating expenses in the March quarter?

David B. Potts - Chief Financial Officer & Executive Vice President

So as I said, I think the combination of the two in the fourth quarter were about $305 million between Pace and ARRIS and I said if we sort of look at $295 million to $300 million is being the first quarter, which would include some equity compensation. And as Bob mentioned in his chart, if you think about the things that we were able to get that quickly, where some of the public company costs that they had as a company, we did immediately get into how we went to the go-to-market cost and some of that. And now, we're into some of the more heavy lifting if you like. So we'll find those go down over the year, Simon.

Simon M. Leopold - Raymond James & Associates, Inc.

Okay, that's helpful. So the guidance, at least in my imagination, implies a bit of a decline in gross margin versus the December quarter, which was obviously very strong. So is it safe to assume that you're not expecting the same kind of software mix in your March quarter or anything similar? And that's the driver for the gross margin decline or help us understand...

Robert J. Stanzione - Chairman, President & Chief Executive Officer

It certainly is a driver. We certainly don't have the same level of software sales in the first quarter. And of course, we're bringing in more CPE product into the mix. So when you go backwards and do the math, you'll get to the lower gross margin.

Simon M. Leopold - Raymond James & Associates, Inc.

Yeah. Okay, that's helpful and then just one last one if I might.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Sure.

Simon M. Leopold - Raymond James & Associates, Inc.

I believe on our prior conference call, when you offered the guidance for December, there was some discussion as to forex affecting international customers, who had basically run out of their budgets. And so, I think I had imagined that we'd get into calendar 2016, we'd see some reset of budgets, and we'd see international customers improving even with the forex challenges simply because they had new budgets to work from. I'm wondering if you could talk to that aspect or that thought.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Well, yes, we're doing worse than expected in the first quarter. In fact, we expect our international sales in the first quarter, of the combined company, to be down. And it's just hit a lot harder than we expected, Simon.

Simon M. Leopold - Raymond James & Associates, Inc.

Okay, thank you very much for taking my questions.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Okay.

Operator

And our next question comes from the line of Doug Clark with Goldman Sachs. Please proceed.

Doug Clark - Goldman Sachs & Co.

Hi, thanks for taking my question. I want to follow-up on the Pace point first and in terms of what's baked in for the first quarter guidance. I just want to reconcile a little bit revenue growth of 40% sequential. I understand the gross margin impact, but if kind of look at the OpEx number, I'm wondering just want to see if there is anything else in there perhaps one-time or additional costs that may not have been in the organic business.

David B. Potts - Chief Financial Officer & Executive Vice President

Sorry, I'm not quite understanding your question. Is it related to revenue?

Doug Clark - Goldman Sachs & Co.

Well, I was making the point that revenues are up 40% sequentially and EPS coming down sequentially. I understand the gross margin impact. I'm wondering if there are any other additional costs in there.

David B. Potts - Chief Financial Officer & Executive Vice President

Sure. We have more interest expense because we did and did borrow $800 million more and we had an increase of shares to 200 million shares that would be a good part of it.

Doug Clark - Goldman Sachs & Co.

And what is the expected interest expense for the first quarter?

David B. Potts - Chief Financial Officer & Executive Vice President

It's probably, call it, $18 million something like that.

Doug Clark - Goldman Sachs & Co.

Okay, that's helpful. And then the other question, during the prepared remarks, you mentioned that the cable industry in particular on the CPE side kind of pulled back in the fourth quarter. Wondering if that was just seasonal digestion of set-top boxes and how you expect the cable industry to perform in the first quarter.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Well, I think, yes, it was a digestion of the large CPE shipments that occurred in the third quarter as well as a shift in their investment from CPE to network equipment. So as you know, CPE went down in the fourth quarter. And U.S. cable, As Larry pointed out and as Bruce pointed out, he had his best quarter ever in CMTS, which is kind of the flagship cable product that we have. So it was a shift in investment.

Doug Clark - Goldman Sachs & Co.

Okay.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

And in terms of the second part of your question, we expect fairly healthy cable sales this year again based on the major announcement – the announcements of our major service providers in the U.S. Of course, we don't know what effect the mergers that I talked about in my prepared remarks may have, but there may be a temporary interruption as a result of that. But we anticipate spending may pick up after Charter, Time Warner closes.

Doug Clark - Goldman Sachs & Co.

Got it. Thank you.

Operator

And our next question comes from the line of Rich Valera with Needham & Company. Please proceed.

Rich F. Valera - Needham & Co. LLC

Thank you. Dave, I was wondering if you could give us a sense of where you expect that quarterly expense level of $295 million to $300 million to be when you have achieved your full run rate operating expense synergies and when you think you might achieve that.

David B. Potts - Chief Financial Officer & Executive Vice President

We hold off from that one until the Analyst Day. But I think we'll see sequential improvement through the years. But we do expect to get pretty substantial reductions in OpEx through the fourth quarter. But come to New York and we'll have a little bit more on that.

Rich F. Valera - Needham & Co. LLC

Would you be willing to give any qualitative on what is substantial? Is it 5% something? I don't know, just fishing here I guess.

David B. Potts - Chief Financial Officer & Executive Vice President

Yes, we'll wait until we get out that. But I do believe we'll be able to make good progress in the OpEx through the year.

Rich F. Valera - Needham & Co. LLC

Great. And it sounds like in the prior question, you answered this affirmatively, but that does include the stock comp expense. Is that correct?

David B. Potts - Chief Financial Officer & Executive Vice President

Yes, so there's still some stock comps that's embedded within the numbers themselves. So if you go back into our GAAP to non-GAAP reconciliation, you'll see that there was, I think, the equivalent of about $15 million is what we probably built into the guidance.

Rich F. Valera - Needham & Co. LLC

Right.

David B. Potts - Chief Financial Officer & Executive Vice President

There is no stock comp in there at the moment for what would be the Pace folks because essentially they were cashed out at the time of the deal. So that would be the indigenous value that we have. As we get later into the year, and we begin to build in stock comp expense, it's the same idea that we would have for – when we bought Motorola that you'd begin building up four tranches over four years. So you'll see that build over time. And in fact, we'll add more for the Motorola folks coming in, I guess, it's in the second quarter that would be baked back in over the non-GAAP numbers.

Rich F. Valera - Needham & Co. LLC

Got it. That's helpful. And I guess, it's never actually come up on the call, but is your prior accretion target, I believe $65 million to $75 million, is that still seen as achievable and what the target is?

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Rich, we think it's still achievable. However, as I said in my prepared remarks, I think it's going to take us longer to get there than we originally thought. As you may recall, we thought we could get that amount of accretion in the first year. And because the year is starting out more weakly than we thought it was, I think it's going to take a little bit longer.

Rich F. Valera - Needham & Co. LLC

I see. Okay, that's it for me. Thank you, gentlemen.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Sure.

Operator

And our next question comes from the line of Joe Stein with Wells Fargo. Please proceed.

Joseph Stein - Wells Fargo Securities LLC

Hi. Thanks for taking the question. I was wondering if you could talk a little bit more about the retail business that you referenced in your comments previously as in how you actually approach and market to the retail consumer and how that might work in a world where set-top box competition has been opened up by the FCC. And I was also wondering, I'm not as familiar with payTV markets internationally, if you know of any international markets where the set-top box is a purchase decision that's made by the consumer? Thanks.

Larry Robinson - President-Customer Premises Equipment, ARRIS Group, Inc.

Sure, Joe. So this is Larry. With respect to the DOCSIS retail business that we have, so we've been shipping for several years now a combination of DOCSIS modems as well as advanced gateways through a very wide variety of retail distribution points, everything from brick and mortar to online e-commerce outlets. And so it's very much a retail-oriented business in terms of you have a product lineup that you're going to market with, kind of a good, better, best approach with addressing a variety of the consumer price points based on what we believe the needs are of the consumer. And we've been very successful at one, getting products approved to be positioned within retail but also driving retail and consumer demand for those products through a variety of the channels that I just mentioned.

So it's certainly complemented by very strong marketing program, set of programs that we have, to drive that demand. And we're in the process, I mentioned in my remarks, of expanding that portfolio of products to include things like Wi-Fi routers and other devices that are really adjacent opportunities to the broadband space that we participate in.

So it's kind of – I'll say the quick synopsis of how the retail business works. And once again, Q3 and Q4 were very good quarters for us. And in the last couple of years, I'd say, we've been able to grow that business nicely as really, quite honestly, a complement to what we do obviously with service providers.

Joseph Stein - Wells Fargo Securities LLC

Got it.

Larry Robinson - President-Customer Premises Equipment, ARRIS Group, Inc.

Your question on should the FCC go drive something towards retail, I'm not sure I want to go too far into speculating what that might be. But certainly, continuing to expand the portfolio of products that we bring through the retail channel is something in our minds is a very easy step for us to go make happen. And as Bruce indicated, we've had products around the video environment that have been distributed through retail previously, so certainly something we're very comfortable with. And I think your final question was outside of the U.S. Certainly in Canada, I'm aware of a couple of operators that make their set-tops available to consumers for purchase and it's a model that has been in place for many years and I think has worked just fine.

Joseph Stein - Wells Fargo Securities LLC

Great. Thank you.

Operator

And we do have a follow-up question from Simon Leopold with the Raymond James. Please proceed.

Simon M. Leopold - Raymond James & Associates, Inc.

Great. Thank you. I'm glad you're able to get me back in here. You did mention that you do expect the telco to improve later this year. Just want to clarify how this manifests itself? I'm under the assumption that we should expect most of the improvement really in the second half of the year and more oriented towards the satellite products than anything else. Is that what you're suggesting?

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Well, there are a couple of things. One is, what you mentioned, the satellite business. At AT&T, we think it's going to pick up and we believe we have a lot to offer AT&T and that we'll be a player in that business with them as that business grows. And then, there's also the transfer of properties from Verizon to Frontier. And we think that Frontier will invest more aggressively in those properties once they get hold of them closer to...

Simon M. Leopold - Raymond James & Associates, Inc.

And you...

Robert J. Stanzione - Chairman, President & Chief Executive Officer

...largest factors, right?

Simon M. Leopold - Raymond James & Associates, Inc.

And is Pace the primary supplier of the Genie boxes or how is that business has been split? Do we know that yet?

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Well, direct – the business is split, and we're not at liberty to say what our share is.

Simon M. Leopold - Raymond James & Associates, Inc.

Okay. And one last one, I presume, it we will be in the K, but you did mention your 10% customer in the quarter. But can you identify the full-year 10% customers by name and percent?

Robert J. Stanzione - Chairman, President & Chief Executive Officer

Sure, Dave?

David B. Potts - Chief Financial Officer & Executive Vice President

Comcast and Time Warner right? I don't have the split actually in front of me, but those were the two.

Simon M. Leopold - Raymond James & Associates, Inc.

Would have guessed that but good to know. Thank you.

Robert J. Stanzione - Chairman, President & Chief Executive Officer

You're welcome.

Operator

And that concludes, today's question-and-answer session. I would now like to turn the conference back over to Mr. Bob Puccini for closing remarks.

Robert Puccini - VP Investor Relations, ARRIS Group, Inc.

Thank you, Jasmine. Bob, any final words?

Robert J. Stanzione - Chairman, President & Chief Executive Officer

No, just the fundamental driver of our business is Internet traffic, and Internet traffic continues to grow at an amazing rate. And that's primarily driven by increasing video over the top traffic. I think we are very well positioned to participate in that growth. And I think we've got a good year ahead of us. Thank you.

Robert Puccini - VP Investor Relations, ARRIS Group, Inc.

Thank you everyone. That concludes our call for this evening.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. So you all have a great day.

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