ARRIS International's (ARRS) CEO Bruce McClelland on Q4 2017 Results - Earnings Call Transcript

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About: ARRIS International plc (ARRS)
by: SA Transcripts

ARRIS International Plc. (NASDAQ:ARRS) Q4 2017 Earnings Conference Call February 14, 2018 5:00 PM ET

Executives

Robert Puccini - IR

Bruce McClelland - CEO

David Potts - EVP & CFO

Analysts

Meta Marshall - Morgan Stanley & Co.

Walter Piecyk - BTIG LLC

Doug Clark - Goldman Sachs & Co.

James Kisner - Loop Capital Markets

Richard Valera - Needham & Co.

Simon Leopold - Raymond James & Associates, Inc.

Woo Jin Ho - Bloomberg Intelligence

Kyle McNealy - Jefferies

Operator

Good day, ladies and gentlemen, and welcome to the Q4 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 call is being recorded.

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

Robert Puccini

Thank you, Sandra, and welcome, everyone, to the ARRIS conference call with management. This afternoon, we will be discussing our fourth quarter and full year 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 and products, estimated revenue and earnings and certain financial operating metrics. It is important to note that actual results may differ materially from those suggested by any forward-looking statements which we may make 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 these forward-looking statements, please see our recent filings with the SEC.

Joining us on the call today are Bruce McClelland, ARRIS CEO and David Potts, Executive Vice President and CFO. Now, if we can move on to page 3, I'd like to turn over to Bruce McClelland. Bruce?

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

Bruce McClelland

Great. Thanks, Bob. Good evening, everyone and thanks for joining us. Let's get started and turn to slide 4.

As you've seen in our results, we had an outstanding fourth quarter with earnings once again well above the high-end of our guidance. All aspects of our business contributed to this achievement with a strong mix benefitting each of the product segments. Revenue including one month of enterprise sales came in at $1.74 billion and non-GAAP EPS was $0.88 per share, a record quarter for the company which was a great achievement.

And even with only one month of enterprise sales, we saw a meaningful improvement in gross margin increasing to 28.8% percent on an adjusted basis. After the closing of the Ruckus acquisition, our gross cash position at the end of the year was $511 million which also included the use of $50 million in the quarter to repurchase shares which we continue to believe a good use of cash at the current stock price levels.

In Network and Cloud, continued strong sales of E6000 capacity licenses was complemented by growing sales of our Gen2 platform and an increasing mix of professional services and software sales. In the CPE segment results benefited from a good mix of higher margin products and continued focus on product cost. It was very pleasing to see the new Ruckus enterprise business perform well with a great team effort to hit the ground running and execute on key customer shipments in December.

Other financial metrics including sales outside the US, backlog and book to bill were all very solid in the quarter. All in all, a very strong close to 2017.

Please turn to slide 5. The breadth of the new ARRIS portfolio positions us to be able to provide solutions and practically all aspects of the network connecting people and devices to services in a simple and secure way wherever they are. As we continue to execute on our strategy to redefine connectivity, there are several important achievements in 2017 that we will continue to build on in 2018.

Every aspect of our business is focused on creating great connections and we play a vital role in how experiences are defined and redefined every day. Our solutions bring to life many of the exciting new technologies that are driving broadband and video innovation. The Ruckus acquisition is central to this strategy, in addition to expanding our wireless technology talent we are very excited about the opportunities we are seeing to grow sales of both wireless LAN and gigabit switching to both enterprise and service provider customers.

Our announcement this morning with DELL EMC validates the strength of the Ruckus portfolio and significantly expands our channel to market. And the interest in our open G LTE small cell technology is very strong and really embodies our vision behind redefining connectivity. We expect this will become a major new cornerstone for the company and are projecting greater than 20% sales growth year-over-year on a proforma basis for the overall Ruckus business.

The launch and deployment of our Gen2 E6000 platform has been very successful and positions ARRIS as the clear leader in the deployment of the gigabit internet. Broadband service providers continue to expand their fiber network to keep pace with the exponential growth in internet traffic and we remain well positioned with the strongest CCAP, Edge Routing and HSC portfolio in the industry. Combined with the early success we are having with our Remote PHY in distributed access portfolio additions, we are very focused on growing this profitable business and gaining market share in 2018.

As I mentioned last quarter, we're very well positioned to benefit from the growth in over the top traffic and the increasing dependency on the broadband network placed our strength and improves our profitability. In our CPE business, we have two clear goals in 2018; expanding our broadband portfolio and improving overall profitability. The upgrade cycle supporting the deployment of 4K video gained momentum in 2017 and we announced new products and supported launches with many of our customers.

DOCSIS 3.1 progressed from trials to full scale commercial deployment. And service providers have embraced the need for advanced in-home wireless networking to improve customer experience and support the increasing demands of consumer electronics devices.

In 2018, we're very focused on expanding our broadband CPE portfolio with a full range of DOCSIS fiber, copper, and broadband wireless devices. And we will be at the forefront of new in-home wireless and networking technologies. And the increased focus on growing our international presence paid off in 2017 with sales increasing by more than 15%, we expect to build on this in 2018 with improved visibility in Latin America and strong momentum in Europe and the enterprise business has good moment in all regions.

Please turn to slide 6. In our CPE segment, sales of broadband devices increased 7% year-over-year with growing momentum in advance DOCSIS gateways resulting in another record level of DOCSIS devices in the fourth quarter. Video set up sales declined 13% year-over-year on lower volumes and a shift in mix towards lighter-weight client devices.

As we enter 2018, the team continues to sharpen the focus on enhancing the economics within the CPE business and we are taking a number of steps to improve efficiency. Last week, we announced the sale of our Set-Top manufacturing facility in Taiwan to Pegatron one of our long-time partners.

Once completed, we will be able to more fully leverage their scale and supply chain yielding an annual benefit of $20 million or more in lower product costs. And we are in extensive discussions with customers to adjust pricing to reflect increased memory costs and are being increasingly more selective on the projects that we pursue. Combined with a broader set of actions, we're committed to improving the financial performance of this product segment.

We expect demand for gigabit capable broadband devices to continue to strengthen as service providers increase broadband speeds and further their migration towards Ip delivered video services. We expect continued international growth on the strength of new advanced 4K Set-Top design wins and as the global refresh cycle accelerates, as an example we just announced the new deployment when with DELL Canada for an advanced Set-Top featuring the latest 4K HDR capabilities with integrated Wi-Fi. And we're seeing continued improvements in the Latin American region as investments begin to return to normal.

Please turn to slide 7. Q4 was a great finish to a strong year for the Network and Cloud business where we saw steady sequential growth and improved profitability across the year. Service providers continued to invest in expanding the capacity of their network to meet growing bandwidth demand. Sales of our access technology, optics and RF portfolio remained strong and shipments of our Gen2 E6000 platform accelerated in the second half. Profitability in the quarter benefited significantly from continued sales of E6000 DOCSIS capacity licenses.

We've been very pleased by the growth of our professional services and software portfolio sales, as they become a larger contributor to the business. We have extensive engagement with our traditional cable and telco customers as well as with a growing list of name brand top tier ISPs. And the team has done a very good job of focusing our investment and rationalizing the portfolio such that we're getting a great return on our R&D dollars.

All of this translated into strong results in the fourth quarter for both sales and earnings and 18% improvement in profitability for this segment year-over-year just a great effort by the team. Many of these things are expected to continue in 2018. Our E6000 platform once again leads the industry in density and capacity and gracefully evolves to support distributed access architectures.

We're focused on working with customers to migrate the installed base of chassis to our full Gen2 baseline enabling another cycle of software capacity expansion over time. We expect to see continued sales of DOCSIS 3.1 licenses as modem deployments expand and the upgrade cycle gains momentum. And we expect our customers to continue their multi-year network capacity expansion investment driving fiber deeper, splitting nodes, deploying remote PHY platforms and a growing mix of full fiber to the home PON deployments.

As discussed last quarter, we've made great progress enabling a highly distributed automated cable access infrastructure and are in early trials with customers. We expect full commercial deployments later this year. And I am excited about the strength in our professional services business, as we augment our traditional competency in network planning and engineering with the growing managed service business. And we really hit our stride with our portfolio device management and network surveillance products and expect further advancements in advanced analytics and IoT integration.

We'll turn to slide 8. Turning to our new enterprise business, I know I speak for the entire organization when I say how excited we are by the outlook for the Ruckus networks business and the engagement with our new customers. In the first 30 days in December, sales and earnings were right on target and we have already benefitted from the increased mix of higher margin product.

For 2018, we are initially very focused on executing well operationally. Fully transitioning systems over to ARRIS and integrating supply chains. And of-course we're very focused on our channel partners and customers to ensure their experience with ARRIS is outstanding in every way. We believe the industrial logic of a combined wireless LAN and campus [ph] switching portfolio is very strong and the sales team is keenly focused on cross selling the entire portfolio both to enterprise customers and service providers.

As an example, we've already seen early success selling the campus switching products to existing ARRIS service provider customers and securing new wireless access point wins. Our new DELL EMC engagement will certainly be a big focus in 2018. This is a global OEM partnership whereby the Ruckus Wireless portfolio will be sold through DELL's extensive sales channel. It is a very exciting development that should lead to substantial opportunity in the second half of the year.

The sweet spot of the market for Ruckus has traditionally been hospitality, education, service provider, lead managed services, large public venues and smart cities and this continues to be of primary importance. And large institutions and agencies such as the federal government look a lot like large service providers and present excellent growth opportunities. We have an aggressive R&D investment plan for 2018 aimed at being at the forefront of commercial revenue generating deployment of 802.11ax wireless devices.

And in support of this, we are enhancing our Ethernet switching portfolio to support the upgrade of the enterprise to multi gig switching and dense high power, power over Ethernet applications. And we have a big focus on expanding our cloud managed capabilities and geographical coverage. One of the areas, I am most excited about is our future growth with the potential for CBRS-LTE portfolio. We have a very active engagement pipeline with a range of customers including traditional wireless providers, traditional wireline providers expanding in the wireless, enterprise customers build private secure LTE networks and wireless ISPs.

In the US, we expect the FCC will solidify rules around use of the 3.5 gigahertz CBRS spectrum and early commercial trials to begin later this year. We're developing a full range of client and access points to address this exciting new area. And finally, we're making focused investments around IoT and advanced analytics that levers the scale and extensibility of the Ruckus platform. I expect these targeted investments to lead to an expanded portfolio of products and services in 2019.

Dave, let me turn it over you to go through the financials in a little more detail.

David Potts

Great. Thanks, Bruce, and thanks everyone for joining us this afternoon and I am pleased to report on a very good quarter. Let's turn to financial highlights on chart 10 please. So please note the comparisons to prior periods will be impacted by the acquisition of Ruckus in Q4. So, sales in the fourth quarter were $1.739 billion up from $1.729 billion in the third quarter of 17 and compares to $1.759 billion in Q4 16. Sales in Q4 were increased by about $8 million as a result of the non-cash fair value adjustment related our warrant program. Non-GAAP sales were $1.732 billion in Q4.

GAAP gross margin was 28.4% in fourth quarter up meaningfully from both 24.9% in the third quarter of 17 and 24.8% in the fourth quarter of last year. Non-GAAP gross margin was approximately 28.8% in the fourth quarter of 17 and up from 25.3% in the third quarter of 17 and 25.6% in the fourth quarter of last year. The acquisition of enterprise networks and higher N&C sales are helping offset continued memory pricing pressures.

Also, as required by accounting guidance, we wrote acquired enterprise inventory up from historical costs to fair value this increased cost to sales in Q4 by about $8 million or 30 basis points and we of course adjusted this in our non-GAAP EPS as we've done with prior acquisitions. Operating expenses were $282 million in the fourth quarter and were up compared to both the third quarter of 17 and the fourth quarter of last year and the increase in OpEx is primarily due to the inclusion of the enterprise networks acquisition.

Into the quarter, we've recorded a non-cash goodwill impairment related to our active video investment and our fourth quarter 2017 GAAP EPS was $0.07 which compares to $0.47 in the third quarter of 17 and $0.46 cents in the fourth quarter 2016. Non-GAAP EPS was $0.88 which was a record for us and up from $0.80 in the third quarter and $0.79 in the fourth quarter of 16.

A couple of items to note, first as Bruce mentioned we have strong N&C sales which help the profitability and we have been projecting the non-GAAP tax rate of 23% for the year. However, it ended up at 22%. So, the full year effect was about $0.03 cents per share of which $0.02 is related to the cumulative catch up from prior quarter and as always, a reconciliation of GAAP to non-GAAP is attached to the press release and you can find it on our website.

We ended Q4 with $511 million of cash resources and of course we use $822 million to fund the enterprise acquisition in the quarter. Our bank debt at face value is $2.2 billion. Cash used for operating activities was $78 million in Q4, this includes $62 million paid at close for unvested employee equity as required by the purchase agreement. Under GAAP, we require to expense this versus treating it as purchase price.

For the year, we generated $534 million of cash from operating activities and just under $600 million adjusting for the equity payment. This is below the targets we established. Our working capital is higher than we like at the moments in particular inventory and we're going to work hard in 2018 to reduce it. In the fourth quarter, we repurchased 1.9 million shares for a total of $50 million. Year-to-date we've repurchased 7.5 million shares for $197 million.

And again, attached to the press release there is more details related to results and of course we're happy to any questions that you might have.

On to chart 11 please. As I said I would on the call in December, I've included this chart to provide the estimated split of results between historic ARRIS and enterprise. So, we anticipated enterprise would have between $40 million and $50 million of sales and a neutral impact to non-GAAP earnings and in fact that's exactly what happened.

On slide 12 please. So, cash from operating activities. So, I begin with net income then I added back the non-cash items including depreciation, amortization, equity compensation, and other cash items - non-cash items to come to net income. Net income including adjustments for Q4 was $160 million and $644 million for the year and this of course underpins the cash generation of the company. Next, I subtracted the change in working capital in order to calculate the reported cash from operating activities then in the fourth quarter included in that income is the $62 million acquisition equity payment this affects cash from operating activities we view this more as purchase price.

Therefore, I adjusted in order to normalize cash from operating activities for you. Two items on working capital, accounts receivable increased by approximately $129 million quarter-over-quarter and this relates to the timing of shipments to some major customers, it decreased year-over-year. Inventory excluding the Ruckus acquisition was flat quarter-over-quarter but up for the year, again we will work this down to 2018.

Let's go on to chart 13 please. A few words on our capital structure. As we announced in December, we recently completed another amendment to our credit agreement which allowed us to successfully reprise our term loan B, this repricing allowed us to reduce the interest rate by another 25 basis points.

For the full year, we were very effective in refinancing all of our debt facilities. We extended the debt maturities of our revolver and term loans A and A-1 by over two years and we extended the debt maturity of our term loan B by over four years. In addition to extending all of our debt maturities in 2017, we also reduced the interest rate for our term loan B by a total of 50 basis points and finally, we're able to add further enhancements to our borrowing terms and conditions that provide more flexibility for our capital structure.

Once again, I'm very pleased with the outcome and I think our bank group for their continued support. On to slide 14 please. So, use of cash. In both 2016 and 2017, we executed on significant M&A and provided meaningful return of capital through share repurchases. In the fourth quarter, we repurchased 1.9 million shares for a total of $50 million and year-to-date we repurchased 7.5 million shares for $197 million. In 2017, we used 33% of our cash from operating activities to buy back shares and 49% in 2016. And at the end of 2017 we had $225 million remaining on our share repurchase authorization.

On to slide 15 please. Just a few other items for you, so tax reform. We anticipate our non-GAAP tax rate will decrease to about 20% in 2018 this reflects the new US tax rate and our anticipated mix of income by jurisdiction. In the fourth quarter 17, we recorded a non-cash $25 million benefit resulting from revaluing our net deferred tax, assets and liabilities and we've treated that as non-GAAP.

We will be adopting the new revenue recognition standard in the first quarter and we don't believe it'll have a material impact on us. Finally, we've been reviewing the level of information we provide by segment. With the addition of the enterprise and its independent sales force, it makes comparisons to our N&C and CPE segments more difficult. So as a result, from 2018 we'll start to provide supplemental information and we'll [ph] from our corporate category to the segments in particular bonus and equity compensation and allocate service provider sales and marketing costs. We will create a first pass for this for upcoming investor day and we hope this will help you.

On to chart 16 please. So, let's turn to guidance. At this point, we estimate that we'll have sales of $1.575 billion to $1.625 billion for the first quarter. We anticipate we'll have a GAAP loss of $0.43 to $0.38 and non-GAAP earnings of $0.50 to $0.55 in the first quarter. With respect to the first quarter GAAP loss, its effected by several things. First, there are purchase accounting the facts in particular the cost of sales increase related to the fair value step up of inventory. This will decrease in the other quarter as we burn off that inventory.

We also anticipate severance associated with the fact we're still being booked in the first quarter and a small write-down of some good will. For the full-year 2018, we estimate that we'll have sales of $7.1 billion to $7.35 billion and for the full year 2018, we anticipate we will have GAAP earnings of $0.48 to $0.73 and non-GAAP earnings of $2.80 and $3.05. And of-course we've attached the reconciliation of GAAP to non-GAAP guidance to the press release and to the presentation. With that, let me turn it over to Bruce to provide a bit more colorful for it.

Bruce McClelland

Thanks, Dave. We're projecting approximately 9% growth in sales year-over-year with our new enterprise business obviously being the largest increase. We continue to feel very good about the opportunities for that business and remain confident in the $650 million to $700 million range we projected early last year. Our Network and Cloud business, certainly has opportunities for growth this year and we'll be dependent on the velocity of network construction and the pace of rollout of DOCSIS 3.1.

We do expect a stronger mix of hardware sales as Gen2 deployments increase, so margins will vary somewhat quarter-to-quarter. And as part of the integration with Ruckus, the revenue we generated from the resale of Ruckus wireless is now directly in the enterprise segment which was approximately $44 million in 2017.

As I mentioned earlier, we expect sales in the CPE segment to continue to shift towards the higher mix of broadband and less video. And while overall demand remains pretty strong for Set-Tops, we're being more selective and focused more on profitability than on sales growth. Overall, I think CPE sales will be flat to down 4% year-over-year. We have a real focus on improving profitability with a combination of price adjustments and operational efficiencies such as the sale of our Taiwan factory.

We expect that cost of memory will continue to be an issue in our CPE segment and are currently projecting another 10% increase in costs in 2018 relative to the fourth quarter of 2017. And finally, as Dave mentioned earlier, our current view on taxes and our non-GAAP tax rate should be a little lower this year which will also help improve EPS.

I hope the additional color on our assumptions was helpful. Obviously, there are a lot of variables that influence our projections, but I think this is right down the fairway. As I've already commented, there were many opportunities for us to do better this year but we're balancing this with the continued challenges on product cost. We'll update you as the year progresses and any changes in our assumptions.

Now, let me just wrap with a few comments on the macro environment first and foremost the new tax legislation here in the US is absolutely a net positive for investment in technology and infrastructure. I'm hopeful that some of these benefits from lower taxes will flow through the industry and increase the investment in the broadband ecosystem. At the same time, the recent changes by the FCC on net neutrality regulation are clearly a positive for the industry, increasing confidence in the rules of the road and reducing risk in major capital investments.

Internationally, the modestly weak weaker US dollar trend has been positive and in regions like South America, we've seen a definite change in attitude the last several months. Obviously, the competition for consumer dollars continues to increase for video services for internet services and for mobile services. This will continue to be a major catalyst for investment and the shift towards everything IP and everything wireless is definitely a positive direction for us.

And of-course the number of connected devices and the exponential growth in traffic from consumers and devices grows unabated. Ultimately these trends combined and are what drives investment in our products. We remain very well positioned to capture a growing portion of our customers spend and have the potential for strong earnings generation as we've seen in the fourth quarter.

Okay Bob, with that let's go ahead and open up for some questions.

Robert Puccini

Thank you, Bruce. Sandra, would you come back on the line please and remind everyone how they could ask their questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Meta Marshall with Morgan Stanley. Your line is now open.

Meta Marchall

Great. Thanks. I just wanted to kind of get a sense of what you're seeing as far as the pace of DOCSIS 3.1 rollout and whether they have been pacing to expectation or areas where it might have been faster or slower?

And then kind of corollary to that in the CPE segment just as far as what you're seeing as far as upgrades to the DOCSIS modem, 3.1 modems and when you would - just kind of product mix within the CPE segment throughout the year would we expect it to be more broadband weighted in the second half versus the first half?

Bruce McClelland

Yes, hi Meta. So, on DOCSIS 3.1 I think I probably didn't mention I think we ended up shipping about 1.6 million units in total in 2017 which was a little less than 10% or right about 10% of our volume. So, we definitely think that ships to a much more significant level here in 2018. There's a kind of an expansion of the number and types of different products from low and kind of simpler modems all the way through to these advanced gateways. We have new 802.11ax versions of the product coming out later this year.

So, we definitely think the velocity on that picks up and it's really across the board, I think pretty well every customer we work with is headed that direction.

And I think your question on the mix, certainly we see a stronger mix around broadband as the year progresses and DOCSIS 3.1 is a large part of that for sure.

Meta Marchall

Got it. And if I could just follow-up on the Ruckus with the enterprise business, just a sense of some of the strength is it coming from the Wi-Fi piece of the portfolio of the campus switching piece of the portfolio just any context on the performance of the different business segment?

Bruce McClelland

Yes. Good question and it's actually been really balanced. We've been pleased on both fronts. It's not like one dramatically stronger than the other. We've been doing well on both product lines and the strategy around putting those two businesses together and cross-selling and selling them together as a combined asset is just going to strengthen over time, so we're really bullish on that.

Meta Marchall

Got it. Thank you.

Bruce McClelland

Thanks Meta.

Operator

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

Walter Piecyk

Thanks. Your share repurchase was up this quarter. Just curious given the free cash flow outlook for next year that was slightly improved I guess by the tax rate but just generally looks pretty strong for 2018 what we should be thinking about in terms of use of that cash and should we see some more sequential increases in share repurchase going forward?

Bruce McClelland

Well, I know Dave covered this pretty well and he can comment. So, we've got $225 million still remaining on our authorization and certainly at the current share price, we think it's undervalued and a good use of cash. So, I think you will see us continue to have a pretty balanced approach on how we use cash this year. And I guess Dave maybe just comment on working capital.

David Potts

Yes, sure, and again we did use 33% of our cash from operating activities in 17 and real nearly 50% in 16. So, it is part of what we do. The working capital side, which Bruce is sort of asking a little bit about, we were a bit disappointed with where we actually ended up with cash from operating activities at the end of 2017 where we thought we probably get closer to the 700-mark. In fact, we were at 6, I think the 613 at the end of the third quarter.

So, we did have some use of working capital in the fourth which I think we actually should be able to turn around through 2018 particularly in inventory so that that should I think help us again on the free cash flow side. And on the capital allocation, I think Bruce said it, we always have a bit of a balanced view that investing in our business through M&A is something that is on our mind and always will be at the same time we are very cognizant of return of capital through the appropriate means.

Bruce McClelland

And we continue to think the $500 million in cash for uses in the business is the right level.

David Potts

It was interesting as we closed the Ruckus transaction and completely used cash and that number turned out to be about the right number that's what we needed through all the jurisdictions around the globe.

Walter Piecyk

So, when we look at the receivables and the payables in the quarter is some of that impacted by the consolidation of Ruckus or is it just any [ph] of bill collecting in January and February.

David Potts

And again, if you look receivables are actually down year-over-year but they went up in the quarter. And if you go back to what I was talking about at Analyst Day, I actually thought we probably come down even a bit more in accounts receivable by the end of the year. But as I warn people, it just all depends upon what happens at the end of the quarter. So, we had a little bit more of the sales activity which was hung up in receivables at the end of the year which should turn over.

But inventory, again, we do need to, and we will take that down through 2018.

Bruce McClelland

We did pick up AR.

David Potts

We did pick up some AR and if memory serves correct it's about $40 million that's in the absolute balance that would-be part of the purchase accounting side.

Walter Piecyk

Got it. And then just one last one. On Ruckus, now that you've had it a couple of months. What's been some of the early positive feedback in terms of industry sets or product sets that are going well so far or you know even the mix between maybe switching versus Wi-Fi maybe? I guess obviously too early for CBRS, but can you give us a sense on how that businesses look so far?

Bruce McClelland

Well, I can certainly tell you the channel partners that I've talked to are just so delighted to have some certainty and focus going forward. So, no lack of enthusiasm. Obviously, we're a large part of their success and they are a large part of ours. So, it's very symbiotic in the nature of selling that part of the portfolio.

I mentioned a couple of early wins of selling, in particular the switching platform into existing service provider customers that we had and that wasn't a product line that we were distributing before so that's been great to see and again the strength in both those portfolios has been really, really solid. We expected it would be, but we're obviously really pleased to have a couple of months under our belt now.

Walter Piecyk

Great. Thank you so much.

Operator

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

Doug Clark

Great thanks. My first question is on the video CPE side. You talked about taking a more kind of disciplined approach and having price conversations with customers. Can you give a little bit more detail, that seems like a bit of a change of tone for you guys so how are those conversations going what would it take to walk away from business and anything else you'd like to add?

Bruce McClelland

Well, I guess I would say as it's become clear what we think happens in 2018 with memory it's a situation where we have to have these discussions with customers and find a path forward and I'll kind of leave it at that. It's extremely active dialogue across the board and I think we'll be successful in finding a middle ground that works for everyone and if we can't on some pieces of business that just don't look like they're long term the right place for us to be, I think you'll find us trim those out.

Doug Clark

And then my other question was you started breaking out the software and services component of Network and Cloud and the fourth quarter detail as you gave this kind of an up and to the right trajectory. Can you talk about what's driving that specifically and how you expect that the trend overall?

Bruce McClelland

Yes. And we actually do break that in our Annual and the MD&A and so I thought it might be useful to break that going forward as it is becoming larger. I've mentioned in the past we have probably thousand professionals around the world working on different pro service engagements ranging from network planning and design through to data center activities and just a whole variety of things including a new managed Wi-Fi service offering that we're operating for several of our customers.

So that's the professional services side, and we think that can really continue to grow on a profitable way for us. The software product lines that we look into that are mainly focused around device management large scale, millions of device broadband gateway and video devices that we surveil and manage and network management tools that again surveil the network and using advanced analytics help our customers fault isolate issues and quickly resolve problems, so there's a variety of different solutions there and some big programs we've had in North America associated with enhancements to those products to include things like monitoring the Wi-Fi network in the home and things like that.

So those were the main areas.

Doug Clark

Great. Thanks a lot.

Bruce McClelland

Thanks Doug.

Operator

Thank you. And our next question comes from the line of James Kisner with Loop Capital Markets. Your line is now open.

James Kisner

Thank you. So, just regarding sort of clarification on Ruckus for kind of real question here. So, you guys said reclassify revenue for Network and Cloud into the enterprise networks if the [ph] Ruckus product did that happen, and I assume that's in the number for the 650 to 700 and I guess sort of lately if that is the case is it fair to say that this growth rate for networking cloud up 5% is understated by my calculations a couple hundred basis points is that the right way to think about it?

Bruce McClelland

Yes. I guess that's the reason I flagged. It was if you picture in 2017, we were a distributor, a reseller, a borrower for Ruckus and so the $44 million that we sold in 2017 Ruckus also recognize that revenue.

And so, as we put the companies together, you can think of that as a revenue synergy if you will. Going forward those revenues are all in the enterprise segment. And so, we didn't we reclassify or move anything, I would just flag that in 17, we had those revenues in networking cloud and you won't see those in 2018. So, I think your math is right, you can kind of think of the range that I provided is actually a little understated if you took the 2017 revenue out of 17.

James Kisner

Okay. That's really helpful. So, as I kind of do the math on your annual guidance I guess - I mean you said you thought you grew modestly in this year. I'm kind of wondering, if I back out ruckus you're not really growing on the business I'm wondering on the core business, I'm wondering if part of that is maybe there were some revenues pulled into Q4 through your customers that are adjusting a little bit. I'm wondering also is that I think Q1 guide obviously when your customers, said they should have stocked up before 2018 or maybe it's the video is perhaps even worst thing your might have expect when you made that comment the 14 but, kind of modest revenue growth.

Could you just kind of elaborate a little bit on the revenue of the company ex-Ruckus and your expectations now they may have changed?

Bruce McClelland

Well, I would say we think there was some pull in into Q4. It wasn't at the level of magnitude of a year ago. So, I didn't comment on it in a big way. But given the profitability we reported, we think there's certainly $10 million or $20 million of profit or licenses that maybe naturally would have been in Q1 that ended up in Q4, so that's probably part of the slightly softer guidance for Q1 than you might have might have anticipated.

James Kisner

It's less when you're guiding Ruckus I mean I assume you didn't have this DELL EMC deal kind of in the wings and even you've been keeping this guidance for the enterprise networks for a while now and you're saying in the second half you might know how to get an impact and just wondering is that just assume that's just not in the number and maybe that's upside and also wondering if you had to give up anything from a probability stand point to get that deal done could that be -- what I mean were dilutive to networking or signifies network margins that OEM arrangements that you can comment at all? Thanks.

Bruce McClelland

Yes. And we certainly, as we go back a year ago that deal didn't exist. So, I do think there's potential for that to be upside for us as the year progresses it's early yet. So, just part of the reason I provided the additional color on the guidance was to be able to have this type of dialogue as the year progresses and we can give you a better indication of where things are going well.

James Kisner

All right. Thanks very much.

Operator

Thank you. And our next question comes from the line of Rich Valera with Needham & Co. Your line is now open.

Richard Valera

Bruce, encouraging forecast for the Ruckus business for this year. Can you say, give us any kind of metric on what that grew in the fourth quarter understanding? It was kind of a messy quarter, but just what are some of the data points assigned post you're seeing that give you some confidence that business can grow at that sort of strong double-digit growth rate this year?

Bruce McClelland

Yes. So obviously, we only owned it for a month and Dave talked about what those numbers were. So, we were pleased to be able to execute exactly the way we thought we would be able to and as we entered the year and we look at backlog for the quarter obviously all of that goes into our thinking here for Q1.

And again, it's obviously a bottoms-up across a whole set of channel partners in regions of the world and you know as we look at the final field, continue to feel really, really good about the range that we talked about a year ago. So, I think that's a real credit to Dan Rabinovitsj and his team and the visibility they have in the business.

Richard Valera

That's great and then with the DELL OEM agreement just at the end of 17 DELL had signed what looked like a pretty similar OEM agreement where they will be selling this competitor of yours' products with their own name on it. I'm just curious, I don't know if you can say anything on this if your agreement in any way supplements [ph] that or it'll be sort of in addition to that where they'll have effectively multiple Wi-Fi solutions to sell from you and I guess a competitor of yours.

Bruce McClelland

Yes. I can't comment too much on that Rich. We'll see how the next few months play out here and we'll go earn our unfair share is I would like to say.

Richard Valera

Okay. That's fair. And just one more for Dave. Dave, lot of talk around sort of cash flow for this year. But I don't think you've actually put out sort of a range for CFO for this year. Are you willing to do that at this point?

David Potts

Well, I would say that if you go out and build your models, so it's got to be a 100 or 150 that we hope we get our working capital, so that would be I think the missing link that you have Rich.

Richard Valera

Fair enough. That's great thank you Dave. Thanks gentlemen.

Operator

Thank you. And our next question comes from the line of Simon Leopold with Raymond James. Your line is now open.

Simon Leopold

Great. Thanks for taking my question. Just hopefully a quick housekeeping, first is I see in the back-up material you do give us a little bit of information on the 10% customers in the fourth quarter could you give us the full detail for 2017, identities and mix of your 10% customers, I'm assuming that would be in the K?

Bruce McClelland

It will be in the K. So, we'll wait until we put it out in the K if you don't mind.

Simon Leopold

Okay. And then in terms of the trends in the first quarter, it looks like your given the lower revenue than we were expecting but the earnings look like they're more or less in line it to me implies the gross margin is going to be pretty good or I think relative to expectations. How much of this should we attribute to mix and how much to factors like cost reduction or for better purchasing agreements could you help us understand maybe the levers in your Q1 gross margin?

Bruce McClelland

Yes, Simon. Maybe Dave can comment as well. Of-course we always say it's all mix at the end of the day the mix of not just different pieces of the portfolio but the customers we sell to et cetera that go into that whole number. From a gross margin percentage perspective clearly, the incremental sales of enterprise start to really move the needle on our gross margin percentage and we're looking at what mix of licenses and hardware we ship as you mentioned the top-line perhaps is a little softer than expected and again we're focused more on how do we make sure we get at the profitability than top-line sales growth and so that maybe it's a part reflection on just how we're trying to approach the market.

David Potts

And ultimately once you built it down Simon you'll find you're taking our tax rate down from 22 down to 20. It's got to help.

Bruce McClelland

It helps a little bit as well.

Simon Leopold

In the past you've talked about the mix within the CPE segment evolving maybe from sort of a 60% video to 40% broadband to flipping that around over a period of several years. Can you update us on how you see that playing out is 2019 a timeframe where we should think of that mix being 50-50 or does broadband get to be 60%?

I guess I'm not looking for something super specific, but just some idea of the rate of change in that trend?

Bruce McClelland

Yes, so maybe I might ask to hold that question till our investor conference. I think we can provide a little more perspective on it at that point and the different new products coming out and how that mixes over time that does continue to shift in that direction but trying to get more specific maybe we'll wait till the investor conference on that one Simon.

Simon Leopold

Okay and maybe one last one then if I might though. One of your larger customers had talked about a meaningful decline in their CapEx in 2019, sort of the old cable strategy. This is the last year we're ever going to spend money again and then we don't need to, it never was true in the past but what's your thought about the longer-term spending trends among the cable TV operators?

Bruce McClelland

Well, right and it never has been true before maybe this is the time. But I'd be surprised you know just as a data point the penetration of 4K capable video devices in the US is extremely small and yet many of the OTT client devices you can purchase support 4K. So, you know I think as those types of technologies better Wi-Fi in the home et cetera become more and more important.

I don't know, that's hard to imagine that it materially just drops off because it's done. The upgrade is done and never has to happen again, so we'll see.

Simon Leopold

Great. Thanks for taking my questions.

Bruce McClelland

Thanks Simon.

Operator

Thank you. And our next question comes from the line of Woo Jin Ho with Bloomberg Intelligence. Your line is now open.

Woo Jin Ho

Great. Thank you for taking my questions. Just a couple on the market environment. So where are your customers today Bruce in terms of the DOCSIS 3.1 network rollout and then as it applies to your Network and Cloud guidance of 2% to 5% are you anticipating any revenue from the remote PHY side of the business?

Bruce McClelland

Yes. So, on DOCSIS 3.1, I think a number of our customers have certainly activated 3.1 capacity kind of the initial capacity to be able to range and register a modem in 3.1 mode. I don't have a feel for percentage maybe that's another question I can take offline and talk about work the Investor Conference, but you know we've talked now for probably three quarters that we've been selling DOCSIS 3.1 licenses for E6000, so they're definitely starting to get some level of penetration.

Obviously the DOCSIS 31, number of DOCSIS 3.1 devices is still very very small relative to the installed base and so as that penetration increases more traffic moves to the DOCSIS 3.1 tier and more capacity has to be added to the network. So, that's how we see things evolving this year. As far as your question on remote PHY definitely a portion of the revenue were projecting for 2018 includes remote PHY. We haven't tried to put a specific number obviously on that yet, but in a lot of ways we think of it as an evolution of the portfolio today we'll sell or call it an analog fiber node it will be analog down and digital up fiber node will now be a fully digital node with a remote PHY module and digital in both directions.

So, in some ways it's a replacement for an analog node as a digital node as opposed to its fully incremental, it'll be really just an evolution of the portfolio.

Woo Jin Ho

And in terms of your CPE guidance, I'm just trying to get a better understanding of your comments around the broadband CPE having a much better uptake going into 2018 as DOCSIS 3.1 starts rolling out. But how should we start thinking about the competitive environment as we start getting deeper into these DOCSIS 3.1 rollout and as they start engaging customers.

Bruce McClelland

Well, no there's not a lot of dramatic shifts in the competitive landscape the people we've been competing with on broadband devices continue to be the ones we see show up every day -- everyone, there's no secret DOCSIS 3.1 is going to be a significant technology upgrade cycle across the network over several years and everybody would like to have a meaningful piece of that. So, we've got to keep running hard and be the best product at a good price point and win our share.

Woo Jin Ho

Great. And then one last one financial one for me in terms of gross margin. Very nice job on the fourth quarter gross margin. As we think about 2018 and how we start progressing in the quarters based on your commentary around memory pricing plus mix, I mean should we think about gross margins trending down just a little bit but still above what we saw as the annual gross margin for 2017?

Bruce McClelland

Yes, and obviously the lot of variables and dependencies that go into that, but you know clearly from a full year 17 to a full year 18 you know we expect a meaningful improvement in gross margin as we add size into the mix. I wouldn't necessarily just take the fourth quarter exit run rate gross margin and profile that going forward in fact I think as you do your models you probably see it's a little less than that and maybe we'll talk more about that at the Investor Conference as well.

Woo Jin Ho

Thank you.

Bruce McClelland

Yes, thank you.

Operator

Thank you. Our next question comes from the line of Kyle McNealy with Jefferies. Your line is now open.

Kyle McNealy

Hi, great. Thanks a lot for taking the questions. So, you mentioned that you saw a shift to lighter-weight video CPE devises in the quarter. Just wanted to get a sense for do you see that persisting over the next year or so or is that a shorter-term trend for now and then also can you give any more detail on what types of customers or reasons or I guess areas they're driving the shift to lighter-weight devices? Thanks.

Bruce McClelland

Yes, thanks Kyle. So, I don't have the numbers in front of me it was more of a kind of a general trend comment and just specific on the quarter. I guess certainly what we've seen is things like network-based DDR becomes a more significant capability device that include embedded DVRs will shift over time and the ability now for a gateway to be able to serve content to a whole variety of lighter-weight client devices in the home is an ongoing trend.

So, I think it will continue in 18 it kind of reflects on the overall outlook I talked about for the video CP portion that bound not necessarily from a number of devices perspective but maybe from an overall revenue perspective is lower in 18.

Kyle McNealy

Sure. Great. Thanks a lot. And would you say that you also see the same trend driving more investment in broadband infrastructure like your Network and Cloud E6000 now that the video would be delivered over the IP side versus traditional methods of delivering video?

Bruce McClelland

Yes, no question. Absolutely no question. What's driving the need for more bread broadband is video a lot of that video is over the top traffic today whether it's streaming Netflix or Amazon etcetera as the cable operators move more of their content on to IP that just drives the need for a better broadband network, a more reliable network, and more capacity no question.

Kyle McNealy

Okay. Great and one last one for me on Ruckus. You referenced in December that you see the industry growing about 11% to 15% and you expected to grow faster than the industry for Ruckus, just wanted to see if you could add any color to what's driving your confidence in the faster than industry growth in 2018 is this specific customer deployments, share gain, new products anymore color you can provide would be great? Thanks.

Bruce McClelland

Yes, one of the references I probably should have mentioned if you go back prior to the Broadcom Brocade announcement early last year after Brocade and Ruckus had come together as a company, they had a couple of great quarters with that combined business and in some ways if you look at the numbers we're talking about for 18 they're not a lot different than what they were doing 18 months ago.

So, to me there's just no question the opportunities there if we execute well for that business to look like this or better this year.

Kyle McNealy

Okay, great. Thanks a lot that's it for me.

Operator

Thank you. And I'm showing no further questions in the queue. So, I'd like to return the call to Mr. Bob Puccini for any closing remarks.

Robert Puccini

Thank you, Sandra. Actually, thanks everyone for joining us this evening. And that concludes our call.

Operator

Ladies and gentlemen thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.