ARRIS International Plc (ARRS) Q3 2017 Results - Earnings Call Transcript

ARRIS International Plc (NASDAQ:ARRS) Q3 2017 Earnings Call November 1, 2017 5:00 PM ET

Executives

Robert Puccini - ARRIS International Plc

Bruce William McClelland - ARRIS International Plc

David B. Potts - ARRIS International Plc

Larry Robinson - ARRIS International Plc

Dan Whalen - ARRIS International Plc

Analysts

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

Doug Clark - Goldman Sachs & Co. LLC

Richard Valera - Needham & Co. LLC

Walter Piecyk - BTIG LLC

George C. Notter - Jefferies LLC

Mitch Steves - RBC Capital Markets LLC

Meta A. Marshall - Morgan Stanley & Co. LLC

Greg Mesniaeff - Drexel Hamilton LLC

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2017 ARRIS International Plc Earnings Conference Call. At this time, all participants are in a listen-only mode. And later, we will conduct a question-and-answer session and instructions will follow at that time. And as a reminder, this conference is being recorded.

I'd now like to introduce your host for today's conference Mr. Bob Puccini, ARRIS Investor Relations. Sir, you may begin.

Robert Puccini - ARRIS International Plc

Thank you, Amanda, and welcome, everyone, to the ARRIS conference call with management. This afternoon, we will be discussing our third quarter 2017 results. We will be using a series of slides during our webcast, which are posted on the ARRIS website in the Investor Relations section. There will be a replay of this entire call available, including our slides, on our corporate website for the next 12 months.

Before we begin, please go to chart 2. 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 for various product categories.

It 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 information in this regard and for specific examples of risks that could cause actual results to differ materially from those in these forward-looking statements, please see our recent filings with the SEC.

Now, if we could go on the chart 3. Joining us on the call today are Bruce McClelland, ARRIS CEO; David Potts, Executive Vice President and CFO; Larry Robinson, President-Customer Premises Equipment; and Dan Whalen, President, Network & Cloud.

If we could move on to page 4, I'd like to turn it over to Bruce McClelland. Bruce?

Bruce William McClelland - ARRIS International Plc

Great. Thanks, Bob, and good evening, everyone, thank you for joining us. Let's go ahead and get started, and turn to Slide 5 please. I'm very pleased to report that our business performed well in the third quarter, resulting in earnings well above the high end of our guidance. In particular, we had a great quarter from our Network & Cloud segment.

Sales of our E6000 CCAP Edge Router platform were very strong, as we ramp production of our (2:25-2:56) of lower-margin CPE combined with the higher-margin Network & Cloud hardware and software, resulted in improved overall gross margins for the business.

A few words on our set-top business. Clearly, our customers are competing in a changing competitive landscape with increasing fragmentation. And in Q3, the traditional pay-TV subscriber addition metrics in the U.S. were mostly negative. Of course, there are a variety of drivers behind this. Cord cutting or shaving is part of it as well as the storm-related disruptions. But other changes in business strategies such as changing consumer credit policies and focus on higher ARPU bundles were a part of it as well.

Internationally, we continue to see growth in the traditional pay-TV landscape. Our customers have certainly anticipated the change in consumer habits and the increased competition from new entrants. Many have launched complementary over-the-top services. In some cases, this leads to increased churn of the traditional pay-TV subscription. But in other cases, it leads to an even a richer, more comprehensive bundle of services. Of course, all of this requires even more broadband bandwidth and a highly reliable network. And while we strongly believe in the power of the multifaceted bundle offered by our service provider customers, it's really important for me to emphasize that we are very well positioned to benefit from the growth in over-the-top traffic.

In particular, the increasing dependency on the broadband network plays to our strength and can improve profitability as we've seen this quarter. The shift of CapEx dollars from traditional pay-TV technologies to broadband increasing capacity, increasing speeds, driving fiber deeper and improving wireless coverage creates opportunities for us to grow profitably. These technology upgrade cycles are the key drivers behind our business.

Now, on to the Q3 results. Please turn to slide 6. Dave will go through the details more in a minute, but sales and earnings were up nicely quarter-over-quarter. The initial ramp of our E6000 Gen 2 platform has gone well. And the mix of E6000 software capacity licenses were stronger than we expected. CPE sales were up modestly from the previous quarter with increased sales to many of our cable accounts, offset by lower sales to some of our U.S. telco and satellite customers.

Memory cost continued to be a headwind and impacted profitability of the CPE segment. International accounted for 34.5% of sales in the quarter and continue to be a source of strength, up 23% year-over-year and 9% quarter-over-quarter. Europe, Canada and Australia were all strong this quarter.

Continuing with the trend from the first half, cash from operations were solid this quarter with some increase in inventory, as we position to take advantage of potential extra CapEx in Q4. And we used a portion of free cash flow to repurchase $20 million in shares in the quarter.

So Dave, why don't you go through the financials in a little more detail, and then Larry and Dan will comment on their businesses. And then I'll wrap up with a few comments on outlook going forward.

David B. Potts - ARRIS International Plc

Great. Thanks, Bruce, and thanks, again, everyone for joining us this afternoon. And I'm pleased to report on a very good quarter. So, let's turn to the financial highlights on chart 8, please. So sales in the third quarter were $1.729 billion, up from $1.664 billion in the second quarter of 2017 and compared to $1.725 billion in the third quarter of last year. Sales in Q3 were reduced by about $3 million, as a result of recording a non-cash fair value adjustment related to our warrant program.

Gross margin was approximately 24.9% in the third quarter, up from 24.2% in the second quarter of 2017 and down from 25.7% in the third quarter of last year. Non-GAAP gross margin was approximately 25.3% in the third quarter, up from 24.6% in the second quarter of 2017 and down from the third quarter of 2016. Our higher N&C sales are helping offset continued memory pricing issues.

Operating expenses were $246 million in the third quarter and down slightly compared to the second quarter, but OpEx decreased $6 million compared to the third quarter 2016. I continue to be very pleased with our OpEx results. Our third quarter 2017 GAAP EPS is $0.47, which compares to $0.16 in the second quarter of 2017 and $0.25 in the third quarter of 2016.

Non-GAAP EPS was above our guidance at $0.80 and up from $0.63 in the second quarter and $0.77 in the third quarter of 2016. A couple of items to note. First, as Bruce mentioned, we did have a very strong N&C sales quarter, which helped our profitability. And I do want to highlight FX. In Q3, we recorded a gain of about $0.05 per share compared to a loss of about $0.03 per share in the second quarter, resulting in the movement of the dollar versus various currencies. And as always, you can find a reconciliation of our GAAP to non-GAAP results and it's attached to the press release and it's also on our website.

We ended the third quarter with $1.413 billion of cash resources. And of course, we'll be using a portion of this cash to fund the Ruckus acquisition. Our bank debt ended Q3 at $2.1 billion. And cash from operating activities was $116 million. We did use some cash for working capital this quarter, and particularly inventory, which we will consume over the next few quarters.

Year-to-date, cash from operating activities is $612 million. And as we discussed at our Analyst Day, we anticipate strong cash generation in 2017. And as expected, some of our cash performance has benefited from movement in working capital, which of course can vary.

In the third quarter, we repurchased 700,000 shares for about $20 million. And year-to-date, we have repurchased 5.7 million shares for $147 million. One last item. In mid-October, we completed an amend and extend of our revolver and A/A-1 debt. We have a new five-year maturity, and we're able to negotiate several enhancements. I've included an overview in the backup slides for you.

So we've now refinanced all our debt in 2017. As you may recall, we completed our Term Loan B in April. I'm very pleased with our capital structure with an overall cost of debt of less than 3.75%, including the cost of hedges we have in place. And attached to the presentation are some more detailed slides. And of course, we're happy to answer any questions that you may have.

On to slide 9, please. So with respect to guidance. As we said before, Q4 can sometimes be very difficult to forecast. At this point, we estimate that we'll have GAAP sales of $1.670 billion to $1.745 billion and non-GAAP sales of $1.675 billion to $1.750 billion in the fourth quarter. And we anticipate we'll have GAAP earnings of $0.31 to $0.37 and non-GAAP earnings of $0.74 to $0.80 in the fourth quarter. These numbers, of course, exclude our pending Ruckus acquisition. And then again, you'll find the reconciliations to GAAP at back of this release and, indeed, on our website.

So with that, thanks, and over to you Larry.

Larry Robinson - ARRIS International Plc

Thanks, Dave. Now, let's turn to chart 11 and look at the Customer Premises Equipment highlights. Segment sales were up 2% as compared to Q2 2017 with solid contributions from both the broadband and video portfolios. Strength in our U.S. cable-related products and growth in international CPE were offset by modestly lower sales with our U.S. telco and satellite customers.

Sales were down 5% year-on-year due to lower set-top volumes. Broadband devices comprised approximately 40% of the portfolio during the quarter. Additionally, through the first three quarters of 2017, we've seen a 7% increase in broadband revenues as compared to the first three quarters of 2016, while video CPE sales were 9% lower for the same time periods.

As we have discussed throughout the year, memory costs have continued to impact product margins. This pressure remained through the course of the third quarter. Our team remains very focused on margin improvement initiatives. Direct operating income was up sequentially, but remained down as compared to this time last year in light of the product mix and the product cost challenges with memory I mentioned earlier (11:34).

Now, let's turn to chart 12. Looking at the product areas, broadband portfolio sales decreased 5% sequentially due to lower DSL shipments, while DOCSIS sales continued to grow. In general, we continue to be really pleased with momentum tied to our DOCSIS solutions, as operators further ramp their investments associated with the 3.1 upgrade cycle, ultimately enabling sustained gigabit speeds and providing the infrastructure necessary for full IP video delivery.

I previously mentioned the 2 million unit shipment target for DOCSIS 3.1 devices this year. And while our current year-end projections are a little shy of that number, we see tremendous opportunities solidifying in the coming months. Overall, broadband sales were 10% higher as compared to Q3 2016, once again driven by the healthy demand for our DOCSIS products.

During the quarter, the ARRIS team achieved a significant milestone, shipping out 200 million DOCSIS device, representing a terrific track record of innovation. As we look forward, we continue to see great opportunities with the transition towards DOCSIS 3.1 capable devices and, ultimately, technologies such as Full Duplex DOCSIS.

We also initiated deployments of a new DOCSIS 3.1 Voice Modem with a key U.S. cable operator, and in addition started shipments of an outdoor Wi-Fi gateway that will be used by service providers to continue to evolve their broadband and mobility offerings. Finally, we launched our first gateway in retail integrating ARRIS Secure Home Internet by McAfee. The SURFboard SBG7580 with McAfee is available exclusively at BestBuy.

Now, let's turn to chart 13 and transition to video CPE highlights. Revenues were up 7% as compared to Q2 2017 due to solid demand across all access technologies and lower by 12% versus Q3 2016. During the quarter, we formally announced our expanded partnership with Altice. And as I previously discussed, this agreement provides us with the deployment path for our next generation set-tops across Altice's global footprint.

The team is also focused on expanding our X1 syndication position in Canada, further building upon the investments we have made in a portfolio of products related to the X1 service platform. Cablevision Argentina deployed the ARRIS DCX4220 set-top as part of their Flow TV experience, leveraging our systems integration and services support capabilities. The DCX4220's hybrid IP design enabled Cablevision to integrate all of their traditional TV channels and on-demand content with a new user interface.

And finally, we launched a new line of Ultra HD set-top solutions, incorporating Android TV and secured a Tier 1 operator award. The international market response and interest at IBC was very high as service providers' enthusiasm over this new TV ecosystem is clearly increasing.

With that, I will now turn it over to Dan.

Dan Whalen - ARRIS International Plc

Thanks, Larry. Let's go to slide 15, and I'll talk about the Network & Cloud business. Q3 was just a tremendous quarter for our Network & Cloud business, and I couldn't be prouder of the team. Our revenues were up 9% sequentially and 10% year-over-year. Direct operating income was up 13% sequentially and 34% year-over-year, as we had a strong mix of license and hardware sales and also benefited from portfolio adjustments that increased efficiency and focus on growth areas. The results are a clear indication that our strategy and execution are working.

Our E6000 Converged Edge Router business had double-digit year-over-year growth, as operators continue to add more hardware and license capacity. Our Access Technology business had solid results as fiber expansion continued. Our customers' continued investment in bandwidth also drove more global services business, resulting in another record quarter for that business. We also saw strong contributions from our Video Systems business as our customers prepare for Ultra High Definition, 4K and IP video content.

We expect strong results in Q4 as we reach optimum production and shipment levels of our Gen 2 E6000 line cards and more license capacity sales. We're encouraged by signs that DOCSIS 3.1 upgrade cycle is gaining momentum, as many of our customers deploy new services based on the higher throughput possible with DOCSIS 3. 1.

Demand for our HFC products will continue to support HFC capacity needs and as fiber expansion program gain velocity. Q4 has historically been strong for our Services business and Video Systems businesses and we have line of sight to competing some key IP video and subscriber management programs before year end, which will cap off a very strong year in these businesses.

If you would, let's turn to slide 16. We declared a general availability on our second-generation E6000 line cards and production ramped up in Q3 and we expect that to continue in Q4 and beyond. With Gen 2 hardware, service group density has increased by 70% or more to support the growing demand for broadband services.

The E6000 is the most widely deployed CCAP platform in the world with a flexibility to support our customers' bandwidth delivery needs for many years to come. The platform is extensible to serve a variety of customer architectures, including traditional integrated CCAP, Distributed Access Architectures, like Remote PHY, and 10-gig PON expansion cards.

The ongoing interest from customers was very apparent at our recent cable industry tradeshow, where we demonstrated DOCSIS 3.1 Remote PHY, Full Duplex DOCSIS and 10-gig PON on E6000 to a standing room-only crowd over three days. While most customers remained focused on an evolutionary approach to bandwidth expansion, we also demonstrated our virtualized platform. By supporting all of these technologies, our customers have more network evolution flexibility and can rest assured their investments today will continue to provide returns in the future.

We are shipping our Remote PHY solution today and expect to have several commercial deployments in Q4. Our Access Technology business is evolving to support various directions and traditional HFC expansion, hub densification programs and multiple variants of Distributed Access Architectures. We continue to develop our 1.2 gigahertz portfolio and had a success with our next generation Headend Optics Platform supporting gigabit services over HFC with industry-leading density and power consumption.

We've several node platforms being used in Distributed Access field trials that will lead to Q4 commercial deployments and several others that will be upgradable to support Distributed Access Architectures in the future. Our extensive installed base of nodes will continue to provide benefits for the MSOs as their networks evolve over time.

Customer commitment to our Network & Cloud business continues to grow right along with our own network expansions and evolution. ARRIS has the broadest set of broadband network options to help our customers address the growing demand of consumers and businesses to have constant connectivity.

Now I'll turn it back to Bruce.

Bruce William McClelland - ARRIS International Plc

Okay. Great. Thanks, Dan. Let's turn to slide 18, please. So as we close in on the end of the year, we're on a path to achieve the profitability targets we established for the full year. In fact, despite CPE sales being a little lower than we expected, we're really on track to achieve all of the remaining targets we set at our investor conference back in March.

I expect overall demand for our products to continue in 2018 and believe that consensus profitability targets for next year are achievable. You need to look no further than the recent Cable SCTE Show in Denver to see the renewed focus on network expansion and reconstruction of the Broadband Access Network. I had the pleasure of joining Dave Watson, the Comcast Cable CEO on the Awards Luncheon panel to discuss technology trends and opportunities ahead for our industry.

We discussed topics such as machine learning, next generation optics, wireless and mobile strategies and, of course, the evolution of the DOCSIS network itself. So while the pay TV business model evolves and direct-to-consumer distribution becomes a larger part of ecosystem, I expect the investment cycle related to the broadband network will accelerate and continue for years to come.

And we're not standing still. We remain optimistic that our deal with Broadcom and Brocade to acquire the Ruckus Networks business will be approved. The Ruckus portfolio provides us immediate diversification into the enterprise market and strengthens our portfolio of wireline and wireless products. This will be immediately accretive to our business, both top line and bottom line, and deliver on the multi-year growth plan we outlined at our investor conference earlier this year.

And with work Dave and his team have done to refresh our capital structure this year, we're really well positioned to continue to diversify and grow the company, while also balancing return of cash to shareholders.

So with that, Bob, why don't we open up for a few questions?

Robert Puccini - ARRIS International Plc

Thanks, Bruce. Amanda, would you come back on the line please, and let folks know how they can ask questions?

Question-and-Answer Session

Operator

Absolutely. And our first question comes from the line of Simon Leopold of Raymond James. And your line is open.

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

Great. Thanks for taking my question. I wanted to see if you had some thoughts on the seasonal pattern that we saw last year, which was the, I guess, Comcast Charter being incented – to have an incentive to spend more in the fourth quarter in order to get the warrants exercised. The guidance doesn't imply that you are anticipating that. And I think the part of reason I want to ask is that what we saw in the prior year was a weaker Q1, because they pulled in orders. I just want to see if you could shed a little bit of light on what you're thinking in terms of that factor playing into your guidance in your Q1? And then I've got a follow-up.

Bruce William McClelland - ARRIS International Plc

Yeah. Hi, Simon. So, I think Q4, as Dave mentioned, is always the tougher one to predict. What we've tried to do is kind of be as kind of down in the middle as we can see the business at this point. And it obviously could have some variability like we saw last year, but we're not able to really estimate that at this stage. So (22:36).

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

So you're not baking in some assumption for them pulling in orders is, I think, what you're saying?

Bruce William McClelland - ARRIS International Plc

We are not anticipating the same sort of dramatic shift that we saw last year at this stage, right.

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

Okay. Thank you. And then in terms of the upside to gross margin this quarter, it seems to imply to me that maybe it's a mix within a mix variable that I'd like to get a better understanding. And what I'm imagining occurred in the quarter is the mix within your Network & Cloud business turned more favorable, whether it was through licensing or more blades, I'm not quite sure. But if we could get a better understanding of what were the mix factors maybe that helped your gross margin in September.

Bruce William McClelland - ARRIS International Plc

Yeah, I like your mix within mix. I think, I'll use that. Definitely, obviously, just a stronger quarter in general for Network & Cloud. And then I think a stronger mix of licenses. And of course, we saw that last quarter as well in the second quarter, and continue to see good velocity on that here in the third quarter. And I think as Dan mentioned, as we ship more of the platforms and go through Gen 1 to Gen 2 upgrades, there is more and more capacity that we can then ship as software licenses in the future as well. So hopefully that bodes well for future growth.

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

Great. Just one last one, if you could see if you would reiterate the commentary you've given us on Ruckus previously, I think you did indicate your optimism about the deal closing. Just want to verify your views on the contribution. I think you've talked about $650 million to $700 million of sales contribution in the first year. I want to make sure that's still the case.

Bruce William McClelland - ARRIS International Plc

Yeah. So, I think the team is continuing to do a great job over there, keeping everybody focused. Of course, as time slips by, we'll have to assess whether we're still on track for that as we close. And obviously, we think the trajectory is very, very similar there, Simon. But getting more accurate at this stage, I think, I'll hold off till we know exactly what the date is.

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

Great. Thank you for taking my questions.

Operator

Thank you. And our next question comes from the line of Doug Clark of Goldman Sachs. And your line is open.

Doug Clark - Goldman Sachs & Co. LLC

Thanks for taking my questions. My first ones actually dovetail off that last one on Ruckus. I think, at the end, Bruce, you may have mentioned that you actually expect Ruckus, assuming that it closes, to be immediately accretive to the top and bottom line. I just want to make sure that that was the statement that you had made?

Bruce William McClelland - ARRIS International Plc

It was. And I'm thinking – I guess, I'm thinking in a full-year perspective. So, obviously, there's purchase accounting and inventory write-ups that you have to do in the first three to six months. But certainly, from a full-year perspective, that's what I was thinking.

Doug Clark - Goldman Sachs & Co. LLC

Okay. Thanks for clarifying that. And then my other question, as we look into the fourth quarter, it sounds like a lot of the strength that you saw in the third quarter is expected to persist, especially with a first full quarter of higher production volumes on Gen 2 baked into the guidance, is there the assumption that Network & Cloud grows sequentially, while CPE comes down sequentially?

Bruce William McClelland - ARRIS International Plc

Well, I guess the way I'll answer that is if you look at the earnings power – the earnings generation in third and fourth quarter combined as a second half of the year, the results we just saw in the third quarter plus what we're guiding to in the fourth quarter, I think, is incrementally stronger than what the consensus numbers were that were out there. And a lot of that is mix related. So, we do continue to see strong mix for Q4.

Doug Clark - Goldman Sachs & Co. LLC

Okay. Got it. And then final question for me, just on the memory costs. I recognize you cited that as a continued headwind. Was it more of a drag in the quarter than you had anticipated? And at this point, I think last quarter, you talked about having some kind of hedges in place or at least some supply source toward the end of the third quarter. Can you update us on where you're at from kind of a supply acquisition standpoint?

Bruce William McClelland - ARRIS International Plc

Yeah. Really, not a lot of change there. I mean we grind it out every day. It's still very tight in the market right now. So securing supply, keeping the factory running, et cetera, it's the daily effort. No significant changes and no real great clarity yet on when things might shift differently as we look over the next few months, so...

Doug Clark - Goldman Sachs & Co. LLC

Okay. Thanks a lot.

Bruce William McClelland - ARRIS International Plc

Yeah. Thanks, Doug.

Operator

Thank you. And our next question is from the line of Rich Valera of Needham & Company. Your line is open.

Richard Valera - Needham & Co. LLC

Thank you. Bruce, wanted to go back to your statement that, I think, you said you thought the consensus profitability level for next year look achievable. Want to try and understand what was baked into that. One, does that anticipate you closing Ruckus at the end of this year so that, in essence, that accretion contributing to that outlook? And then two, what are you kind of assuming about memory prices and maybe your ability to pass some of that on to your customers? Thank you.

Bruce William McClelland - ARRIS International Plc

Yeah. So, it's a good question and I'll caveat by saying, we're not trying to provide guidance, per se. I think, we'll talk about that as we get into investor conference next year. Having said that, as we look at those numbers, we think there are targets that we could be striving for next year with the core business, not including adding Ruckus into the equation and all those accounting adjustments we have to make for that, et cetera. But we think that velocity is the right sort of target for us to be shooting for next year in the aggregate.

Richard Valera - Needham & Co. LLC

Any comments on the memory impact there and your ability to offset that?

Bruce William McClelland - ARRIS International Plc

Yeah. So, I think we anticipate as additional capacity comes on that we'll start to see some benefit in the second half next year. It's too early to tell whether that's an accurate prediction at this point. But I think we would like to see some of that benefit to help us get to that goal next year, yeah.

Richard Valera - Needham & Co. LLC

Right. Okay, that's great. And just to clarify on the E6000, the launch of the downstream card, was that a material contributor, the Gen 2 downstream card in Q3? Or is that really going to be kind of an incremental contributor in Q4?

Bruce William McClelland - ARRIS International Plc

Well, material's kind of a big word on a $1.7 billion number. So, in that context, maybe not. But it was...

Richard Valera - Needham & Co. LLC

I meant (29:22) in the context of that business?

Bruce William McClelland - ARRIS International Plc

Yeah. So, I think it was reasonably material, yes.

Richard Valera - Needham & Co. LLC

Got it. Okay. That's it for me. Thank you.

Bruce William McClelland - ARRIS International Plc

Thanks, Rich.

Operator

Thank you. And our next question is from the line of Walter Piecyk of BTIG. Your line is open.

Walter Piecyk - BTIG LLC

Thanks. Your inventories are up, obviously, this quarter and last quarter. So, it's like a $220 million move over six months, seem like the highest level you've been at in a while. Can you give us a sense of the types of products that have been driving that over the past six months?

Bruce William McClelland - ARRIS International Plc

Yeah. So, I think for the most part it's CPE-related. And as I think I mentioned in my start, we were a little softer at the end of Q3. And so, that was part of it. Probably just a little less shipment than we predicted. And then the other part is coming up on Q4 with some of the unpredictability there, we want to be positioned to move quickly if the opportunity presents itself. And for the most part, this is all product that we're shipping in volume today. And if we don't ship it this quarter, we ship next quarter, stuff like that. So...

Walter Piecyk - BTIG LLC

Understood. So, you're obviously optimistic, if you're building the inventory going into fourth quarter, how do the warrants work? I mean, is it a situation where they could kind of go back and forth from year-on-year? Or is there a cap on them. Meaning that like, if you look at last year, they jacked in a bunch in the fourth quarter that impacted the first quarter. So, is it possible that they would keep ordering low in 2017 and then kind of stack all the orders in 2018, thereby benefiting to a greater extent with the warrants or do they not work that way.

Bruce William McClelland - ARRIS International Plc

Yeah, I guess, I would think of it as it really doesn't change their buying habits. I mean whatever they have to invest in is what they'll spend. Of course, the idea behind the warrants is to incent them to spend a little bit more with us and little less with somebody else at the end of the day. But it doesn't – I don't think you should think of it as in any context it's dramatically moving things around for them.

Walter Piecyk - BTIG LLC

Understood. And just last question, you'd mentioned on broadband being down sequentially, the devices on DSL. Can you give us some sense of what the mix is on DSL because I assume that if that gets low enough, then we shouldn't see any type of sequential declines in that regard?

Bruce William McClelland - ARRIS International Plc

Well, that's true. If it gets to zero, then it's – you won't see decline. DSL is still a very meaningful part of the business. And we don't break that detail out at this stage, Larry, right?

Larry Robinson - ARRIS International Plc

No, we don't.

Bruce William McClelland - ARRIS International Plc

Yeah.

Walter Piecyk - BTIG LLC

Can you give us some sense of what the growth rate is on the DOCSIS 3.1 then at least?

Bruce William McClelland - ARRIS International Plc

Well, DOCSIS 3.1's going from zero in the first quarter, essentially, right, beginning of the year to – what we – Larry talked about was trying to exit at that 2 million level for the year. I think we're going to be able to short it out at this point, but that's significant growth, obviously.

Walter Piecyk - BTIG LLC

Got it. Thank you.

Bruce William McClelland - ARRIS International Plc

All right. Thanks, Walter.

Operator

Thank you. And our next question is from the line of George Notter of Jefferies. Your line is open.

George C. Notter - Jefferies LLC

Hi, guys. Thanks very much. I guess a clarification and then a question. Bruce, I think you mentioned consensus profitability target for 2018 being achievable. Can you just clarify, are we referencing margins or earnings there? And then also any sort of thoughts on consensus revenue targets? And then, I guess, the question here also is on the hedging program. I think just to expand on an earlier question. I was wondering were you guys able to extend your hedges or buy forward on memory? I think the last update you guys talked about being out through portion of Q4. Did you go ahead and extend that into next year at all? Thanks.

Bruce William McClelland - ARRIS International Plc

Yeah. So, I think, my comments were definitely focused on basically the non-GAAP EPS targets that are published by you all and it generate the consensus at the end of the day. So, that was the focus as opposed to gross margin percentage. And I think I'll hold off talking about sales and revenue targets for next year at this stage. So, really, focusing on the profitability metrics and, of course, that's what we're focused on here, right, generating dollars of cash at the bottom.

From a hedging perspective, it's not so much hedging, right? It's simply buying – securing memory for production in future months. You'd call it hedging, I suppose, but really it's just simply at what price point can we buy a certain amount of memory, not to exceed a certain volume, et cetera. And just given lead times on components, in general, we're obviously well into first quarter at this stage on memory purchases and planning.

George C. Notter - Jefferies LLC

Thank you.

Bruce William McClelland - ARRIS International Plc

Thanks, George.

Operator

Thank you. And our next question is from the line of Mitch Steves of RBC Capital Markets. Your line is open.

Mitch Steves - RBC Capital Markets LLC

Hey, guys. Thanks for taking my question. Just had two quick ones. So, first, on the comment about profitability metrics seeming okay for 2018. Does that encapsulate the increase in kind of memory costs you're seeing throughout the year? And then, secondly, when we look at the line cards, you're going to have 16 ports in all those now. So, how does the margin profile differ from the new line cards versus old ones, which only had 8 ports? That's it for me. Thank you.

Bruce William McClelland - ARRIS International Plc

Yeah. So, I think we are anticipating some improvement in memory costs next year, as we think about what the right targets are for next year. And I'll kind of leave it at that point until we get closer into 2018. And then on the line cards, Dan, it's an ongoing process, right, as far as pricing and cutting in the new version and whatnot. So, I'm not sure there is a material. Do you want to comment on that?

Dan Whalen - ARRIS International Plc

Yeah. No, people are buying it in very different configurations at this point and, at that point, we start working in different models for them – consistently different models. Some people like to deploy at full capacity out of the gate, and other like to deploy minimum and add as they go along. We think that everything that we have, both the Gen 1 and Gen 2 cards, have a long life span inside of customer networks, depending on how quickly they're going to move from DOCSIS 3.0 to 3.1. So, we'll see continuous different models as our platform will support complete hybrid functionality across the different deployments as they go along.

Bruce William McClelland - ARRIS International Plc

Yeah, we describe this not as a step function, per se, as we cut in Gen 2, it's really as they need to buy capacity, it becomes more optimal certainly to do it on the Gen 2 platform, so...

Operator

Thank you. Our next question comes from the line of Meta Marshall of Morgan Stanley. Your line is open.

Meta A. Marshall - Morgan Stanley & Co. LLC

Great. Thanks so much. A quick question of just – you mentioned kind of CPE being a little bit weaker than expected during the year. And I mean, do you think that there is any sort of correlation of memory prices have gone up and as they look at some of the prices of the boxes, they think maybe we'll wait till memory prices come down and that being any part of their consideration of how they roll out kind of some of their CPE plans or are the two uncorrelated and it's more due to just overall video trends or over-the-top trends?

Bruce William McClelland - ARRIS International Plc

Yeah, I don't think the memory situation weighs in on it at all, Meta, at this stage.

Meta A. Marshall - Morgan Stanley & Co. LLC

Okay. And then, it seems as if you're kind of indicating – and you may have addressed this, but it seems as if all the weakness is more on the video CPE side. Would you say that kind of the modem or the broadband side is meeting expectations for kind of the full year of 2017?

Bruce William McClelland - ARRIS International Plc

Well, Larry did point to some weakness in the DSL – the U.S. telco broadband space, so that was a contributor to it and fairly meaningful, I think this quarter. So, that was an area (37:36) Larry pointed to.

Meta A. Marshall - Morgan Stanley & Co. LLC

But just no kind of pause ahead of DOCSIS 3.1 refreshes or that was already kind of taken into account in your considerations?

Bruce William McClelland - ARRIS International Plc

No, in fact, the DOCSIS business was up again in third quarter. So, that was solid.

Meta A. Marshall - Morgan Stanley & Co. LLC

Okay. Great. Thanks and I'll pass it on.

Bruce William McClelland - ARRIS International Plc

Thanks, Meta.

Robert Puccini - ARRIS International Plc

Thanks, Meta.

Operator

Thank you. And our next question is from the line of Greg Mesniaeff of Drexel Hamilton. Your line is open.

Greg Mesniaeff - Drexel Hamilton LLC

Yes. Thank you. Just a quick clarification on the set-top box business. With all the talk about memory pricing and softening of demand in the domestic market, how much runway do you guys have for R&D product related, product redesign at this point?

Bruce William McClelland - ARRIS International Plc

Well, Larry can comment a bit. But a typical kind of fairly rapid new box is a 12-month cycle, nine to 12 months. And if it's a major development effort with new software and middleware and everything, that's an 18-month-plus cycle or something, Larry, right? Something like that.

Larry Robinson - ARRIS International Plc

Yeah. That's about right. I mean, depending on where the overall product or program is in its life cycle in terms of silicon availability, et cetera. But that being said, we do have a number of programs kind of underway that are built around 4K and HDR and kind of the next generation of video experience, coupled with a number of platforms incorporating things like Android and other software solutions. But in terms of product life cycle, it's pretty similar to what Bruce described.

Greg Mesniaeff - Drexel Hamilton LLC

So, it's fair to say that right now, there's no major set-top box redesign initiative in progress or in late stages or anything like that?

Bruce William McClelland - ARRIS International Plc

I think we're always going through some major programs. Everybody is at a different stage. But there's two that we pointed to this year, which are meaningful; the Telefónica engagement, which is a whole variety of different platforms for all their properties around the world. So, that's a major platform initiative. Larry, you talked about the Altice initiative, which we talked a little bit about on the last call as well, that's another major initiative. So, a whole variety of things there, Greg.

Greg Mesniaeff - Drexel Hamilton LLC

Got you. Okay. And just one quick follow-up on the E6000 product. Besides the current line card introductions you guys have been making, what other milestones do you foresee in terms of a roadmap for CCAP? Is there anything else that needs to be done beyond what you're currently doing as far as line card upgrades?

Bruce William McClelland - ARRIS International Plc

Well, Dan can comment in a minute. We have some big initiatives going on around the Distributed Access efforts. Dan talked a little bit about them. And then kind of right behind that is this Full Duplex capability, which is basically the ability to offer symmetrical data speeds over the existing DOCSIS networks.

Greg Mesniaeff - Drexel Hamilton LLC

And any rough idea for timeline for that at this point?

Dan Whalen - ARRIS International Plc

I think I mentioned earlier in presentation that a Q4 will be – we've a couple of customers deploying with live customers on our Remote PHY product, which is the E6000 through a software upgrade becomes a MAC core (40:57) managing Remote PHY devices that reside out in the field. So, we think that that's very extensible part of our strategy for the E6000 as it supports that variant.

We hear and are working on the timing of Full Duplex DOCSIS and we think sometimes towards end of next year, we're in trials and potentially being deploying by the beginning of 2019 with that. And that enables the service providers, software, symmetrical gigabit services to their customers and compete directly with Fiber-to-the-Home entry. So, really powerful story for them.

The other thing that we're working on later on, years out, more of the virtual platform where we take all that expertise and code that we have and figure out how we build it and put it on to a COT (41:46) based server and that could operate out of a data center or headend. And we're already demonstrating the early versions of that product and people will adapt it as they needed.

The other thing we don't talk about a lot is E6000 as a great hub densification platform. It also supports video – legacy video QAM. So, customers can move some of their old hardware-based QAM business as a software license right on to the E6000 and really saves them lot of rack space, power efficiency in the headend and gets them on to one platform.

Greg Mesniaeff - Drexel Hamilton LLC

Great. Thank you.

Bruce William McClelland - ARRIS International Plc

Thanks, Greg.

Operator

Thank you. And our last question for today comes from the line of Rich Valera from Needham & Company. Your line is open.

Richard Valera - Needham & Co. LLC

Thank you. With respect to the closing of the Ruckus deal, as it's structured now, I guess, your deal is contingent on the Brocade-Broadcom deal closing, which seems like, at least the way the market's looking at it, that there is a decent probability it might not close, at least from the arb spread there. Is there a way to potentially restructure your deals that you could do an asset purchase, like Extreme Networks did, and just buy this independent on whether the deal closes with Broadcom?

Bruce William McClelland - ARRIS International Plc

Yeah, I guess, we'll just have to see how that plays out, Rich. I think the context of that deal was certainly different and the magnitude much different as well. So, it's a little hard to comment. We're really focused on seeing it through as the way it's structured right now.

Richard Valera - Needham & Co. LLC

Okay. Thank you.

Bruce William McClelland - ARRIS International Plc

Thanks, Rich.

Operator

Thank you. And that does conclude our Q&A session for today.

Robert Puccini - ARRIS International Plc

Thank you, Amanda. Bruce, any final words?

Bruce William McClelland - ARRIS International Plc

Well, let me just thank everyone again for joining the call today. In closing, we had a really good third quarter. I'm really pleased with the continued improvement in our profitability. We expect to continue that momentum here in the fourth quarter and are on track to achieve the full year targets that we set earlier this year.

The efforts by the entire ARRIS team to expand the portfolio over the last several years really puts us in a good position to capitalize on the investment in both the traditional pay-TV industry as well as in the growing direct-to-consumer business model. That exponential increase in broadband traffic will continue to be the catalyst for our customers to invest in our products for years to come. And as we just talked about, we wait impatiently to complete our acquisition, and welcome the Ruckus team into the ARRIS fold.

So, with that, thanks everyone for your time and look forward to talking again soon. Thanks, Amanda.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everybody, have a great day.