ARRIS International Plc (ARRS) Q2 2018 Results - Earnings Call Transcript

ARRIS International Plc (NASDAQ:ARRS) Q2 2018 Earnings Call August 1, 2018 5:00 PM ET

Executives

Robert Puccini - ARRIS International Plc

Bruce William McClelland - ARRIS International Plc

David B. Potts - ARRIS International Plc

Analysts

Rod Hall - Goldman Sachs & Co. LLC

Aaron Rakers - Wells Fargo Securities LLC

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

Richard Valera - Needham & Co. LLC

Mitch Steves - RBC Capital Markets LLC

Meta A. Marshall - Morgan Stanley & Co. LLC

James Kisner - Loop Capital Markets LLC

George C. Notter - Jefferies LLC

Walter Piecyk - BTIG LLC

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 ARRIS International Earnings Conference Call. At this time, all participants are in a listen-only mode. 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 will 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 second quarter 2018 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 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 forward-looking statements, please see our recent filings with the SEC.

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

Bruce William McClelland - ARRIS International Plc

Okay, great. Thanks, Bob, and welcome to our call and thanks for joining us this evening. Let's go ahead and turn to slide 4 and get started. We reported solid results for the second quarter with revenue up 10% quarter-over-quarter to $1.73 billion. Sales were up across all segments and CPE returned to over $1 billion in sales as we projected.

In particular, shipments of HFC networking equipment and E6000 CCAP Gen2 hardware were strong in the quarter. Sales were just below our guidance with component availability shifting production of some CPE and access equipment to Q3. Non-GAAP earnings came in at $0.72 per share, similar to the strong Q1 results that we posted, and up from $0.63 per share a year ago.

As expected, gross margin was down quarter-over-quarter to 29.2% due to higher CPE sales and a higher mix of Network & Cloud hardware shipments. Business with our international customers continue to be very strong, once again reaching a new record level and accounting for 42.4% of shipments in the quarter, up 35% year-over-year and 7% quarter-over-quarter. Backlog was strong at $1.3 billion and we entered the third quarter and book-to-bill was just under 1.

We generated just over $100 million of cash from operating activities and ended the quarter with $548 million in cash, with inventory levels coming down offset by higher AR. We used most of our free cash to repurchase shares with over $150 million of purchases since the beginning of the second quarter. More on this topic from Dave in a moment.

Let's turn to slide 5. At the midpoint of the year, I wanted to take a moment to reflect on the performance of the company over the last two-and-a-half years. Despite the historic challenges on component costs and the evolving industry landscape, the company has executed incredibly well. With the addition of Pace two-plus years ago and now more recently with Ruckus, the company has never been more profitable in its history on a trailing 12-month non-GAAP EBITDA basis.

Our strategy of combining organic investment with strategic acquisitions has resulted in an industry-leading portfolio of connectivity solutions with leading market share positions. As our industry transforms, we will continue to reposition the company to continue this great track record.

Let's turn to slide 6 and I'll comment on each of our segments. Sales in our Network & Cloud business increased 2% quarter-over-quarter and 7.5% year-over-year with strong demand for HFC Access equipment – E6000 Gen2 hardware, and our Video Systems products. As expected, DOI contribution for the segment was down from the record levels in Q1 as mix shifted towards more hardware. Sales of our E6000 Edge Router were strong with an increasing mix of Gen2 line cards and new chassis, as we gained share and increased our footprint with Tier 1 customers. This increase in new hardware becomes an incredibly valuable foundation for future sales, higher margin capacity licenses.

Sales of our HFC Access equipment increased again this quarter with construction season accelerating demand for optical nodes and associated RF equipment as operators invest in their network to add capacity to keep pace with the increasing broadband demand.

We also had a very strong quarter in our Video Systems business unit, as our customers evolved their video distribution network to allocate more spectrum to high-speed data capacity and make more efficient use of their valuable head-end real estate and power. I'm pleased with the progress we're making with our Distributed Access solutions and deployment of Remote PHY products. We now have both small and large node form factors, as well as a dense Remote PHY shelf version that gives operators the flexibility they need to deploy Remote PHY to fit any network topology.

As part of our DAA solution, we're now also providing a software-based video core that manages the complexity of broadcast and narrowcast video in a remote PHY architecture, which I think is really the hard part of transforming an existing multi-service network to DAA. And we've introduced a virtual management toolset for simplifying the deployment and management of wide-scale DAA networks.

Our focus for the remainder of the year continues to be on expanding our E6000 footprint; with its market-leading density and throughput, coupled with its flexibility to support DOCSIS3.0, DOCSIS3.1, video, and Remote PHY, it continues to provide the best value for cable operators. And you can watch for a new DOCSIS3.1 launch announcement from a major international customer over the next few weeks that leverages our full Network & Cloud portfolio, as well as CPE products.

In our global services organization, we're working closely with Tier 1 service providers to deploy SD-WAN based managed services for small- and medium-sized businesses that will start to generate revenue in the second half of the year, and open new revenue streams for us. So we clearly have lots of good things going on in Network & Cloud this year.

Let's turn to slide 7 and discuss the Customer Premises Equipment segment. As expected, our sales came in above $1 billion in the quarter but were slightly lower than our expectation as we managed the timing of supply and component availability. The results reflect growth in both broadband devices and video set-tops.

International revenues continue to be particularly strong with a record quarter as volumes further increased in Canada and South America, driven by demand for our DOCSIS products and video set-tops. In the U.S., sales improved as compared to the first quarter with both DOCSIS and DSL shipments increasing, as well as higher volumes for our Telco set-tops.

Also as expected, adjusted direct contribution was higher this quarter due to the increased sales volume and product mix favorability.

For the remainder of 2018, we're obviously very focused on profitability, which I'll talk more about in a moment. In terms of product innovation, we're increasing our investment in DOCSIS3.1 in order to fully capitalize on this upgrade cycle.

We're seeing volumes increase building on the shipments we made last year. We're also driving programs with several key operators globally in order to introduce new products, thereby extending our international sales momentum and further diversifying our revenue base.

Now turning to slide 8, at our Investor Day back in March, we outlined our objectives for the CPE business. In light of the dynamics that we're experiencing, I thought it was beneficial to outline some of the more specific targets that we've set. We're targeting sales at or above $1 billion a quarter. And while I expect revenues will fluctuate quarter to quarter over the long term, this level of business is achievable, and so will be (00:08:43) driven by strong investments in broadband, as well as the ongoing need for video devices in the home. Our international momentum will also enable us to maintain a strong base of revenue.

That said, we'll continue to optimize the business in favor of profitability as opposed to top-line sales. We've had extensive interactions with our customers to adjust prices in the second half of the year and 2019 to reflect the increased component cost, primarily memory and MLCC capacitor components, and plan to further rationalize lower contribution customer engagements.

We also completed actions in July to reduce operational expenses in the CPE segment. This will result in 10% lower annualized expense run rate. So our overall target for the CPE business is to generate high-single-digit adjusted DOI contribution. Execution against these goals over the coming quarters will enable us to improve the cash generation profitability from this part of the business. Although we expect modestly lower margin in Q3, this price increases take effect to offset higher component costs.

Now turning to slide 9. We have another good quarter in our Enterprise segment with sales of wireless LAN equipment once again reaching a new record level as our channel and service provider businesses continue to strengthen. Contribution margin was down versus the first quarter as we invest in both R&D and the sales team and marketing efforts. This will pay dividends for us longer term, as we expect this business to generate 15% plus adjusted direct contribution as sales continue to grow.

We have a lot of focus on leveraging the new Dell EMC sales channel and have increased investment to ensure a friction-free engagement. We had initial sales in the second quarter and expect this channel will become a significant growth driver in the second half of the year. We're getting a lot of interest in our recently announced IoT suite, which leverages our installed base of Wi-Fi access points to easily support a variety of secure IoT technologies; and more importantly, simplify onboarding of IoT devices through our open API architecture. We're partnered with leading IoT suppliers working together to enable a smarter network edge. We believe these capabilities significantly differentiate the Ruckus Wi-Fi solutions and will help drive incremental sales.

For the remainder of 2018, we're very focused on growing our position in the market, cross-selling both wired and wireless solutions with our Enterprise and service provider customers, and driving the 802.11ax and multi-gigabit switching upgrade cycle.

And we expect our CBRS LTE small-cell trials to accelerate and reach early commercial deployments by the end of the year. I continue to be very confident in our plans to achieve the $700 million-plus level of sales this year with continued growth in 2019.

Now let's turn to slide 10 and I'll comment on the broader market and industry trends influencing our business. Momentum in broadband continues to be strong with most of our customers reporting excellent results in the second quarter for net subscriber additions and profitability. I anticipate investments to add capacity and improve network efficiency to continue for the foreseeable future. The emergence of 5G technology creates a more competitive dynamic, increasing the value of fiber-rich networks and creates a new catalyst for further investment.

With our cable customers, the increased flexibility and capacity of distributed networks is slowly gaining momentum and has a natural long-term evolution of the network. I think we're well-positioned to support this technology upgrade cycle.

Over-the-top video consumption continues to gain momentum, spurring investment in the broadband network, while reducing demand for traditional pay-TV connections. This evolution is more pronounced in the U.S. market, while demand internationally for next-generation set-tops remains robust.

Importantly, there continues to be huge value in aggregation of content and our service provider customers that provide a complete solution of linear, on-demand, and over-the-top content have a powerful value proposition for consumers and a strong video franchise. And as enterprises of all kinds embrace cloud-based computing to enhance their business, networking and connectivity has never been more important.

High performance, highly reliable edge networking, leveraging cloud-based deployment and analytics define the next generation of enterprise connectivity. And many businesses are looking for a turnkey managed service support model that allows them to focus on their business rather than the complexities of running a network. All of these trends play to the strength of the ARRIS portfolio and underpin our confidence in the future.

So with that, Dave, why don't you review our second quarter results, third quarter guidance, and share our plans on capital allocation for the second half of the year.

David B. Potts - ARRIS International Plc

Great. So, thanks, Bruce, and thanks, everyone, for joining us this afternoon. So let's turn to the financial highlights on chart 12, please. And please note the comparisons to prior periods will reflect our acquisition of the – in Ruckus in the fourth quarter of last year. So, sales in the second quarter $1.727 billion and up from $1.578 billion in the first quarter of 2018 and up compared to $1.664 billion in the second quarter of last year. And while CPE hit the $1 billion mark, it did come in a little bit below our original expectations.

GAAP gross margin was 28.9% in the second quarter, down from the first quarter of 30.2% and up meaningfully from the second quarter of last year of 24.2%. Non-GAAP margin was 29.2% in the second quarter, down from 31.7% in the first quarter and again up significantly from 24.6% in the second quarter of last year. And as expected, gross margin percentage improved in CPE quarter-over-quarter as a result of mix and the increased scale.

N&C gross margin percent declined sequentially reflecting mix in particular the level of license sales we experienced in the first quarter. In year-over-year, the inclusion of Enterprise Networks, coupled with the higher E6000 capacity sales, are helping offset lower CPE margins resulting from continued component pricing pressures the volume and mix, and purchase price accounting adjustments are what account for the differences between the GAAP and non-GAAP and they should diminish through the year.

Operating expenses were $341 million in the second quarter and were up compared to both the first quarter of this year and the second quarter of last year. The increase quarter-over-quarter reflects incremental investment in Enterprise Networks to drive higher sales and market share, as well as some timing differences that we have with some other expenses.

We've implemented cost reduction programs in early Q3, which we expect to drive our OpEx levels lower in the second half. Our second quarter 2008 GAAP EPS is $0.19, which compares to a loss of $0.07 in the first quarter of 2018 and a profit of $0.16 in the second quarter of last year. Non-GAAP EPS was $0.72 and compares to $0.73 in the first quarter, and it's up from $0.63 in the first quarter of last year.

And as always, you can find a reconciliation of our GAAP to non-GAAP results attached to the press release and it's also on our website. We ended Q2 with $548 million of cash resources. Cash from operating activities was $103 million in Q2. And year-to-date cash from operating activities was about $200 million. Inventory did decline this quarter – quarter-over-quarter by about $45 million.

We continue to work on overall reductions in working capital by the end of the year. And timing of year-end sales will be a key element of our year-end working capital and full-year cash from operating activities.

And in the second quarter, we repurchased about 4 million shares for a total of $100 million. So far, in the third quarter, we've repurchased another $50 million. So year-to-date, through August 1, we've repurchased 6.9 million shares for $175 million. More on this in a moment. And attached to the press release are some more details, and of course, we're happy to answer any questions which you may have.

Let's move on to the next slide, please. So let's turn to guidance. We do recognize that there are several moving parts. We tried to give you a bit more detail this time. At this point for the third quarter, we estimate that we will have sales of $1.68 billion to $1.73 billion and non-GAAP EPS of $0.65 to $0.70. And for the full year, we estimate that we'll have sales between $6.85 billion and $7 billion with non-GAAP earnings of $2.85 to $3 per share.

Let me provide you with some color. So, starting with CPE, we anticipate modestly lower sales in Q3 but increasing in Q4 with DOCSIS3.1 growth. We expect lower adjusted DOI in the third quarter, an improvement in Q4, as price adjustments take effect. We also expect lower OpEx resulting from the actions we have implemented, which will also find its way into the adjusted DOI in the fourth quarter.

Next up is Network & Cloud. We're forecasting top-line growth in Q3 with variability in Q4 depending upon our year-end customer demand. And at this point, we expect lower adjusted DOI in the second half reflecting higher hardware mix.

With respect to Enterprise, we expect sales growth in both the third and the fourth quarter, and adjusted DOI percent to be at 15%-plus by the end of the year. I will also add that our guidance does not include the cost of proposed tariffs. Our plans are to have our suppliers adjust where goods are manufactured and/or past tariffs along to our customers as applicable.

And a comment on cash from operating activities. At this point, we're projecting cash from operating activities to be in the $650 million to $750 million range, reflecting the lower sales and operating income projected for the year. And our projections continue to include reductions in working capital expected in the second half, and you can find a reconciliation of our GAAP to non-GAAP guidance at the back of the press release on our website.

Let's move on to slide 14, please. So let me finish up with share repurchases. So at the moment, we view our stock as undervalued and have been using most of our free cash flow to buy back shares – $175 million so far. Given the stock price, our plans are to continue to repurchase. We're targeting a minimum of $400 million for 2018, and of course, we'll speed up or slow down as market conditions change. But at the moment, we intend to accelerate.

A note on share count, on the guidance slide, we're using weighted average diluted shares in period. We're estimating we should exit the year with around 177 million diluted shares, which will provide a good entry point into 2019.

So with that let me turn it back to Bruce.

Bruce William McClelland - ARRIS International Plc

Okay, great. Let's go to the next slide and let me wrap just with a couple of comments, that's tied back to the value creation drivers I presented at our investor conference back in March. We're making good progress against most of these metrics and I've added a few specific proof points at the bottom. But we recognize we have lots of work to do, and the ultimate measure of success will be seeing the stock price appreciate and shareholders rewarded for their investment.

Please turn to slide 16. As we discussed back in March, we believe we'll be able to grow earnings and EPS through a combination of organic growth and specific improvement in CPE profitability. But on top of this, our strategy is to use the free cash flow from a business to improve shareholder return through both repurchase of shares and additional M&A. So I think it's important that – this is an important way to look at it and value a company like ARRIS with a proven track record of cash generation, transforming and growing the company.

So, Bob, let's open up for a few questions.

Robert Puccini - ARRIS International Plc

Thank you, Bruce. With that we'd like to open the lines up for questions. Amanda, would you mind coming back on, please, letting our participants know how they may ask their question?

Question-and-Answer Session

Operator

Absolutely. And our first question is coming from the line of James Kisner of Loop Capital Markets. Your line is open.

Robert Puccini - ARRIS International Plc

James, are you on mute?

Operator

Your line is open.

Robert Puccini - ARRIS International Plc

James, are you there?

Operator

And our next question comes from the line of Rod Hall of Goldman Sachs. Your line is open.

Rod Hall - Goldman Sachs & Co. LLC

Yeah. Hi, guys. Appreciate the question. I wanted to start off and maybe just ask about the CPE business, just a couple of things. One of your competitors was talking about MLCC shortages that were affecting their ability to produce. So, I wanted to ask about that, how you guys see that?

And also, you talk about passing price increases through. How much of your CPE business do you think is protected in that way that you could pass prices through and not really see very much impact from a margin point of view? And then how much do you think is exposed to the price fluctuations, margin fluctuations? Thanks. And then I have a follow-up.

Bruce William McClelland - ARRIS International Plc

All right. Yeah, I spent a week in Asia just a week or two ago and met with all of our key suppliers as well as all of their key suppliers, including MLCC manufacturers. And it's an interesting environment. It's the typical kind of supply-demand equation. But there's a couple of nuances with the approach to business and pushing more component supply through distribution, which has kind of created an odd environment around MLCC. So, it's not just kind of the normal supply-demand price has gone up a bit; it's really the business distribution model that changed.

And so, most companies like us are in an environment where trying to secure supply is on a week-to-week basis and prices fluctuate pretty significantly. And so, what we've done is worked pretty closely with customers around their supply needs, try and minimize the amount of premiums you're paying as much as possible, and ultimately on top of what we've gone through with memory, we're not in a position we can absorb those costs. And so, we've been pretty upfront and open with customers on what the price increases are, and obviously, seeing a lot of that implemented here in the third quarter and kind of fully implemented by the fourth quarter at this point. So it's been a bit of a journey on that. And a difficult discussion with many customers, but it's a reality of the entire market at this stage and we'll stay close both on the supply side and on the customer side to be as optimized as we can around the cost of production.

Rod Hall - Goldman Sachs & Co. LLC

Okay. And then, I wanted to also just come back to Network & Cloud and see if you could talk a little bit about the puts and takes around, particularly Q4. You said maybe it grows, maybe it doesn't. I know that you guys had originally said 2% to 5% growth there. Is that still where you see things coming out there? Do you think it's possible that you come in above that range? Just curious what you're thinking about seasonality in Q4 and maybe more color around that.

Bruce William McClelland - ARRIS International Plc

Well, that tends to be the most challenging quarter for us to predict, and what we've seen is some pretty solid results Q1, pretty solid Q2. We're expecting Q3 to be up. And we'll just have to see how Q4 plays out. I think as Dave mentioned, there's a chance it could be up, there's a chance it could be down; it just depends on kind of what the end-of-the-year spurt ends up looking like. So we wish we could give you 100% accuracy, but that's the visibility we have at this stage.

Rod Hall - Goldman Sachs & Co. LLC

Okay, great. Appreciate it.

Bruce William McClelland - ARRIS International Plc

Okay. Thanks, Rod.

Operator

Thank you. Our next question comes from the line of Aaron Rakers of Wells Fargo. Your line is open.

Aaron Rakers - Wells Fargo Securities LLC

Yeah. Thanks for taking the questions as well. I just want to go to the guidance. I mean, you've taken the guidance down at the midpoint relative to prior quarter by about $300 million. It looks like just the math at the midpoint is also assuming about 12% sequential growth going in to 4Q. When I look back, that's clearly much stronger than a 4Q sequential that we've seen in the past couple of years, at least. So I'm kind of curious of: one, what drove the $300 million reduction in the full-year revenue forecast? And number two, what are the drivers that gives you confidence to see that potentially meaningful of a sequential growth going into the December quarter?

Bruce William McClelland - ARRIS International Plc

So, a couple questions there. The majority of kind of the rebase on the forecast is around CPE, and we've talked about kind of at the $1 billion a quarter range and focused again less on chasing top line and trying to improve profitability and return on that business.

So that accounts for a lot of it. We are obviously having some benefit every quarter from the incremental share buybacks. And so, you need to kind of take that into account as you're comparing the previous guidance back from March to where we're at today, as well as some of the tax benefit that flows through here as well.

Aaron Rakers - Wells Fargo Securities LLC

Okay. And then as a quick follow-up, as I look at the Network & Cloud business, one of the – it looks like the software piece of the business has declined over the last couple of quarters. I'm just curious of how we should think about that going into the back half the year, maybe why that's declined over the past few quarters. And how maybe we should think about that software and services growth returning as we look out over the next few quarters?

Bruce William McClelland - ARRIS International Plc

Right. So, kind of two things just to make sure I'm clear on how I'm communicating. The software capacity that we sell as a license on top of the CCAP platform all flows into our E6000 revenue and as part of, if you're looking at the chart, the orange piece on the bottom. The software and services gray (00:27:15) variety of other software products that we sell, things like device management, products and workforce management, et cetera, along with our global services.

In particular, the global services piece can be lumpy depending on project completion. And so, Q2 was indeed down relative to where Q1 was, but it's really just the timing of completion on construction programs and things like that. And we expect that to continue to be a growth area (00:27:43).

Aaron Rakers - Wells Fargo Securities LLC

Okay. Thank you.

Bruce William McClelland - ARRIS International Plc

Thanks.

Robert Puccini - ARRIS International Plc

Thanks, Aaron.

Operator

Thank you. Our next question comes from the line of Simon Leopold of Raymond James. Your line is open.

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

Thanks for taking my question. Just a couple of things. One, just wanted to verify some quick math. You've given us some guidance commentary on expenses for the third quarter and the full year. And it looks like excluding stock comp, you're guiding for operating expenses to decline in the fourth quarter to about $303 million. Am I doing that correctly? And should I interpret that as an indication on how you think revenue is trending in the fourth quarter?

David B. Potts - ARRIS International Plc

So again, on the guidance slide, Simon, I think I tried to give you the breadcrumbs for that. So I'd said you'd have operating expenses of about $335 million for the third quarter. And I wouldn't think it would be maybe a little bit down into the fourth but – and then we would be able to take out the equity comp, call it at the $24 million, so you're probably closer to $310 million, 3 – something like that, in the way that you're doing it.

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

Okay. Okay. And with the pivot towards the more aggressive share buybacks as the use of cash, could you provide an update on your philosophy and strategy regarding potential acquisitions?

Bruce William McClelland - ARRIS International Plc

Yeah. Good question, Simon. So at this stage, we're obviously very focused on the integration of the Ruckus business and expanding – growing that channel, et cetera. And we feel like given we're a – that we're valued today that a better use of cash for the rest of this year is going to be really clearly on stock buyback, and not anticipating M&A activity that would use the cash for this year.

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

Great. And then, just one last one if I might. I guess, this is a common theme, but maybe there's a way you can bridge how much of the CPE weakness in the back half of the year is you being disciplined and walking away from business that's unprofitable versus a change in demand. Thank you.

Bruce William McClelland - ARRIS International Plc

Yeah, good question, another good question. So certainly in the U.S. market on pay TV, demand is down. And you can kind of see the reports from our customers, so that's clearly a part of it. On the other hand, we could ship more products if we lowered our prices further, and we're less profitable, so it really is a combination of both. And we are pretty committed to the discipline that I documented on the one slide I presented, so it's a combination of both.

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

Great. Thanks for taking my questions.

David B. Potts - ARRIS International Plc

Hey, Simon, just one clarification, so that $24 million of equity comp includes some in COGS, so it's probably $20 million as OpEx, so that would be the better way to do the math.

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

That's very helpful. Thank you.

David B. Potts - ARRIS International Plc

Sure.

Operator

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

Richard Valera - Needham & Co. LLC

Thank you. Bruce, follow-up on the lower CPE expectations, and you've given some color around essentially discipline you're enacting in the business. Was there also any impact from the DOCSIS3.1 certification? I think there'd been some chatter that maybe you guys were a little later than expected as far as certifying some of your 3.1 modems. Just wondering if that had an impact on the guide.

Bruce William McClelland - ARRIS International Plc

Well, certainly, as we were in Q1, I talked about I'll call a bit of a wait for (00:31:32) on some of the newer DOCSIS3.1 gateways. At this point, there are – developments completed. They've gone through certification. We're ramping those in volume. So I would say we're a little lower for sure than where I'd like to be, but we're kind of past that, it's starting to ramp back up and part of the increase in Q4 is shipping more DOCSIS3.1. I will say we've shipped quite a bit of DOCSIS3.1, so the idea that we're not shipping is kind of silly, but it will ramp from here for sure.

Richard Valera - Needham & Co. LLC

Got it. And then international as you noted has been exceptionally strong and just wondering how we should think about that business going forward. I mean, obviously, I don't think it can continue to grow at the rates it's been growing as it starts comping against those – that growth. But how should we think about that, very robust growth and just wanted to think about how you're thinking about that longer term?

Bruce William McClelland - ARRIS International Plc

Yeah. So I think the opportunity is there to grow further for sure, and part of that is gaining share and part of it I think is the natural growth in the market. And I think in the areas that we're focused, the markets growing pretty healthily in some of these markets. So now, does it grow at 25% or 30% year-over-year? I'm not sure that is the way I'd project it, but we're optimistic, we'll do well internationally.

Richard Valera - Needham & Co. LLC

Okay. Thanks for taking my questions.

Bruce William McClelland - ARRIS International Plc

Thanks, Rich.

Operator

Thank you. Our next question comes from the line of James Kisner of Loop Capital Markets. Your line is open.

Robert Puccini - ARRIS International Plc

And you're still on mute, James? Can't hear you, James.

Operator

Mr. Kisner, your line is open.

Robert Puccini - ARRIS International Plc

Amanda, let's move on and we'll get hold of James somehow.

Operator

Okay. Our next question comes 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. So mine is actually on the margin front, so I'm trying to combine two comments. You're basically taking the gross margin guidance down. It sounds like the – Q4 should come around in the 26% range. And so if that's the case, then when will we see kind of the pricing increases or memory costs pushed down to the customers? Is that more of a 2019 comment?

Bruce William McClelland - ARRIS International Plc

Well I'm not sure what we said to get you to 26% in Q4. That sounds awfully low at this point, so.

Mitch Steves - RBC Capital Markets LLC

Okay. Well, I mean, I'm just backing into it based on the full-year guidance, but then, so, what quarter would we see the impact of the kind of pass through of the memory cost and the component cost with customers?

Bruce William McClelland - ARRIS International Plc

Well, right, so I think, as Dave tried to provide color, we do think Q3 is a little lower on CPE, but we think Q4 is better. So as kind of the full gamut of price increases are implemented, we think we're back up again in Q4.

Mitch Steves - RBC Capital Markets LLC

Okay. And then for the last one just on the OpEx side, so you're doing some kind of cost cutting, so is that going to flow through additional cost cuts in Q4, is that just going to be a Q3 phenomenon?

Bruce William McClelland - ARRIS International Plc

No. So, that is Q4.

David B. Potts - ARRIS International Plc

Yeah. There's a bit in Q3, but most of it probably hits (00:35:00) in Q4.

Mitch Steves - RBC Capital Markets LLC

Okay, got it. Thank you.

Bruce William McClelland - ARRIS International Plc

All right, thanks.

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. And maybe just kind of digging in on what you mentioned to Rich a little bit earlier. Just I think we had been under the impression that kind of the broadband devices or DOCSIS3.1 broadband CPE should follow kind of six months after you were starting to see some of the hardware implementation, and so – but we're still seeing kind of broadband CPE down a fair amount. And so, just trying to get a sense of you did mention that you are shipping DOCSIS3.1, but are you expecting a catch-up as those just walking away from unattractive business? Just helping us understand the dynamics of broadband CPE and kind of how – where we are in the DOCSIS3.1 kind of uplift that we should see from that rollout? That's kind of the first question.

Bruce William McClelland - ARRIS International Plc

Okay. Well, obviously, in Q1, we were at, what, $320 million in broadband shipments, and of course, that's a combination of DSL and DOCSIS. And so, that was pretty weak. We were up over $400 million again in Q2. And I think we continue to grow from there for the rest of the year.

Meta A. Marshall - Morgan Stanley & Co. LLC

And that growth would be driven by DOCSIS3.1 deployments primarily? Okay.

Bruce William McClelland - ARRIS International Plc

It is. Although, I'll say we still ship a lot of DOCSIS3.0. There's, I mean, clearly a lot of volume in DOCSIS3.0, but yes, we think DOCSIS3.1 as a percentage of total shipments continues to increase as the year progresses.

Meta A. Marshall - Morgan Stanley & Co. LLC

Got it. And then maybe taking that to the Network & Cloud level of – when do we start seeing maybe some of the more attractive margins on line cards coming after a lot of the hardware deployment? Was that something you think is primarily 2019, 2020? Could we start to see some of that in Q4 just kind of some of the timing that you've traditionally seen on line cards following chassis deployment.

Bruce William McClelland - ARRIS International Plc

Well, it's always a blend, right? And so you're, at one point, in time shipping new chassis and gaining new footprint with one customer while another one is doing license upgrades, so it's a blend over time. Obviously, what we've seen in the last four quarters prior to second quarter was every quarter it got a little bit better, right, and we shipped more and more licenses. And what we've been trying to signal for the second half of the year is that we think that shifts to more hardware and more line card upgrades, and obviously that's a good thing longer term.

To be a little more specific, I guess, as an example if you ship a new chassis or a new piece of hardware and a certain amount of capacity is activated, it's probably a year or so until they come back and need to add more capacity on to the line card. So maybe that's kind of partially the answer you're looking for.

Meta A. Marshall - Morgan Stanley & Co. LLC

Yeah, that's very helpful. And then if I could just kind of get one more in, on the Enterprise business, just any trends between kind of Wi-Fi and the campus business and just with one more – just want a (00:38:24) better source of strength during the quarter?

Bruce William McClelland - ARRIS International Plc

Right. So they were both up quarter-over-quarter, but obviously not a lot because the total number didn't go up significantly quarter-over-quarter. We do think we have more growth, definitely a higher growth rate in the second half of the year based on what we're seeing in the pipeline and all the good things going on there. So both were strong. It wasn't like one shifted dramatically to the other. Both were really good and was another kind of record on the wireless LAN side for the Ruckus team.

Meta A. Marshall - Morgan Stanley & Co. LLC

Okay. Great. Thank you.

Bruce William McClelland - ARRIS International Plc

All right. Thank you.

Operator

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

James Kisner - Loop Capital Markets LLC

Can you hear me now?

Robert Puccini - ARRIS International Plc

There you go.

James Kisner - Loop Capital Markets LLC

Third time's a charm. Thank you. I'm going to blame one of your customers, your – landline. So...

Robert Puccini - ARRIS International Plc

(00:39:16)

James Kisner - Loop Capital Markets LLC

(00:39:17) nameless.

But I guess, I think we danced (00:39:21) around this, as we get more explicit about the guide down for the revenue for the year, (00:39:25) that you're taking the revenue down by $300 million. Sounds like it's mostly CPE, but I mean, you're just seeing Enterprise, you're still sticking to the $700 million, but can you get a parse that (00:39:34) $300 million like what is – what are the different pieces of that, if you can?

Bruce William McClelland - ARRIS International Plc

No, I think if you went back to when we put the guidance in place in March and where we're at today, most of the reduction in the top-line number is around CPE and we'd expected a more robust environment in the U.S. and the lower shipments on DOCSIS3.1, which we talked about kind in the first half were not what we were anticipating. So we felt like it was time to adjust the view for the year. That's always the risk in providing guidance for the year. But we felt this was the right range to look at for the rest of the year.

James Kisner - Loop Capital Markets LLC

(00:40:18) dive into that. Why do you think that happened? I mean, is it just product wasn't available when they thought or are you saying that you weren't late that you got certified that you've been shipping? So that doesn't seem like that's the issue. But do you think the (00:40:31) operators has lower uptake or didn't marketers (00:40:33) you thought or had lower inventories? Just any thoughts on why – looking back why you think that is.

Bruce William McClelland - ARRIS International Plc

On our part it was getting the new products certified. So clearly that was a showstopper getting through certifications. How much of that we lost share versus was just buying more DOCSIS3.0, clearly we shipped more DOCSIS3.0 than we planned as well. So I know it's hard to give you a lot more definition than that at this point, James.

James Kisner - Loop Capital Markets LLC

Okay, that helps. Maybe just go back to Ruckus, it's interesting you're seeing that the Dell OEM agreement has started for revenue. Maybe you talk more about how that launch is being handled and kind of how you expect that to evolve? Is it a stage introduction somehow? Any updated thoughts on your competitor that I think is also being OEM by them still, how they kind of plan to market the two products? And I guess sort of one thing I would tack on there, as I think your original guidance didn't – for Enterprise, did not include any Dell OEM, so I'm wondering if there might not be (00:41:36) an upside to that $700 million as a result of you now shipping into that. Thanks.

Bruce William McClelland - ARRIS International Plc

Yeah. So, I think our original kind of guidance on Enterprise was $650 million to $700 million. And the combination of the Dell relationship and other things gives us pretty good confidence. We're at the top end of that or higher. So it definitely is helping. As far as how Dell implements that, that really kind of is up to them. It's a global relationship. And so, we've got people working side by side with them really in all regions of the world. And as I mentioned, kind of from a – we're just trying to make it as simple and easy as possible for us to step in and help them grow their business. So we're really excited about how things are off to a good start there.

James Kisner - Loop Capital Markets LLC

Okay. Thank you very much.

Bruce William McClelland - ARRIS International Plc

Thanks.

Operator

Thank you. 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 I was curious to learn more about your conversations with customers on the set-top box business and what kind of success you're having in getting price improvement because of DRAM costs, and I guess now also MLCC costs. Anything you can tell us that's sort of numeric here or number of customers you've been able to reprice with or maybe percentage of your set-top revenue that you've been able to reprice, or the size of the increases you're getting? I mean, anything you could tell us there would be very interesting.

Bruce William McClelland - ARRIS International Plc

Well, I hesitate to give a lot more color, George, but I will tell you this is across the board, right? I mean, this is across the landscape of our customers, and it's something we're in a position we have to go implement and we have. And the exact date and time and everything is something we go through with customers depending on their demand.

And frankly, again, given the fluctuation in product cost with some of these components, if we can kind of balance out and smooth out the demand, that's a good thing. And so, we're doing everything we can to minimize the impact to their business as well. But no, this is really across the board. And if we are in a position where we can't do that, we'll find other business, right? I mean, we just – we're not going to let the business deteriorate to the point where it's not worth being in it, so.

George C. Notter - Jefferies LLC

Got it. So, just going back to, for example, the Analyst Day, you guys sounded a little hesitant in terms of your opportunity for success and repricing that business. And here, I don't want to put words in your mouth, but it sounds like you've had more success, and I mean is that fair to say? And I guess, I mean, just any kind of ballpark? Are we talking about 10%, 20%? I would imagine certainly, we're not even approaching the size of DRAM prices, the increase we've seen over the last year, but I mean, again, anything you can tell us in terms of the magnitude?

Bruce William McClelland - ARRIS International Plc

No. It's very fair to say that. It's fair to say that we're much more aggressive on it because we have to be. What we've seen in memory now is somewhat of a stabilization, I think, in the second half of the year. And I'm hopeful that things start to actually improve towards the end of the year and get into 2019. But on these capacitors, which historically have been a low part of the bill of material, the price fluctuations have been really significant, the cost fluctuations, and we've had to definitely take a different tact and move forward with price increases; and as I mentioned, really across the board at this stage.

George C. Notter - Jefferies LLC

Got it. Okay. And then, I'm sorry, just going back to a statement you made earlier. I guess at one point it sounded like a fair amount of the reduction in full year expectations came from you guys walking away from set-top box business. And then, I think earlier you also kind of referenced just general softness in set-tops, as well as even broadband CPE. I guess, I just – again, I want to put a little finer point on the $300 million reduction, is it you guys walking away from business, or is it again the business kind of drying up organically?

Bruce William McClelland - ARRIS International Plc

Yeah. I don't know if I want to characterize it as walking away. What I did say was we could ship more if we were willing to lower our prices further. And maybe those are one and the same. But most of it's just (00:46:07) less demand around video set-tops in the U.S. environment.

George C. Notter - Jefferies LLC

Yeah. Okay. Thanks very much.

Bruce William McClelland - ARRIS International Plc

Yeah. Thanks, George.

Operator

Thank you. Our next question comes from the line of Rose Vasquez of State Street (00:46:21). Your line is open.

Unknown Speaker

Hi. Can you hear me?

Robert Puccini - ARRIS International Plc

Yeah.

Bruce William McClelland - ARRIS International Plc

Yeah, we can hear you.

Unknown Speaker

Yeah. You could hear me. Okay, good. So I'm not on mute. I have three questions. So the first – I think they're all sort of related to the CPE segment. So the first one would be, I think right now your breakdown between video CPE and broadband CPE is about 60/40. So I'm wondering if you have any sort of target for that breakdown. So that's the first question.

The second question is in the – I think 50% or about 50% of your international sales are in the Americas. So are those video CPE sales, or is that the broadband CPE? And then the third question is direct contribution. So, I have direct contribution for CPE to be around 5%. I don't know if you are able to provide color in terms of the sort of – I'm looking for a proxy for margins between the video CPE and the broadband CPE?

Bruce William McClelland - ARRIS International Plc

Well, let me start with the last one first. So, if you look at slide 7 in the deck, we reported in the second quarter direct contribution for the CPE segment at 7.8%.

Unknown Speaker

Okay.

Bruce William McClelland - ARRIS International Plc

And we do not break out the profitability for each of the different portions.

Unknown Speaker

Okay. But I guess in general, is the broadband direct contribution higher than the video CPE?

Bruce William McClelland - ARRIS International Plc

Well. So, I'd characterize them as similar and that's probably as far as you can get me at this point, so.

Unknown Speaker

Similar. Okay, fine.

Bruce William McClelland - ARRIS International Plc

Yeah, yeah. Your second question was on our international business in the Americas, I think, and whether it was video or broadband. And in fact, I think in my comments I said it was really both. I mean, we had both video and broadband increase quarter-over-quarter for sure. So, it's a good mix. It's a mix of both products and in fact just about every region we're in, that's a really good mix of both broadband and video.

Unknown Speaker

Okay.

Bruce William McClelland - ARRIS International Plc

And then your first question was on the target of the mix between video and broadband. We've talked about – we do expect them to become more similar, 50% – 50/50, over the next couple of years, we haven't – it's a little hard to put a fine point on it. If you went back a little bit, we thought it was going to happen sooner but then video grew. So, it all depends on how the business has evolved, and we'll keep you posted on it as we get more solid on when that happens.

Unknown Speaker

Okay. Thank you.

Bruce William McClelland - ARRIS International Plc

Thank you, Rosa (00:49:24).

Robert Puccini - ARRIS International Plc

Thanks, Rosa (00:49:25).

Operator

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

Walter Piecyk - BTIG LLC

Thanks. Hopefully, this question wasn't asked. I've been on a bunch of different calls (00:49:37). Charter has talked about or talked openly about CBRS trials that they're planning in a couple of markets. I think Comcast has not as been vocal about it, but it sounds like they're looking at similar things. Can you expect any revenue in terms of CBRS products in your wireless division in 2018? Thanks.

Bruce William McClelland - ARRIS International Plc

Yeah. Hi, Walter. So I do think we will have revenue, CBRS revenue before the end of the year. I really do. In fact, I know one of the trials that was announced here recently was with Boingo in the Dallas Love Field Airport. So not to comment directly on Charter or Comcast, but I know that one was public and – so we're doing an awful lot of work around CBRS for sure.

Walter Piecyk - BTIG LLC

And is your product focused on outdoor units or do you have under-development modems or even set-top boxes that would integrate that technology for CPE?

Bruce William McClelland - ARRIS International Plc

Well, so I think most of our focus is actually on kind of an indoor out type approach, so adding the CBRS capability to indoor access points. And the logic behind that is that's where the biggest coverage issue is, typically inside buildings. And I think that we can leverage the channel that we have, the distribution channel to really accelerate CBRS deployments. Now outdoor is also a viable deployment model and makes a lot of sense, but I think in particular indoor is an area we're focused on.

Walter Piecyk - BTIG LLC

And is there an opportunity to or has there been an ask yet to look at maybe putting that in the set-top box on the video or would it only occur in the modem?

Bruce William McClelland - ARRIS International Plc

It makes a lot more sense from a gateway perspective because of the power levels from the radio and everything, that's a good spot to be. You don't really have to be in the set-top further or deeper in the home. So, that hasn't been a real focus, not that it couldn't be done technically, you just – I haven't heard of a strong interest in that deployment model.

Walter Piecyk - BTIG LLC

And then just the last question on this, are there related network investments that you might see in 2019 related to CBRS in any way?

Bruce William McClelland - ARRIS International Plc

Well, there's opportunity for different things there. I'm not sure how big a priority they are. One of the areas we're investing quite a bit is around the cloud management system that goes with it, to simplify onboarding, simplify the provisioning, surveillance, all those things. So, if you think of it from that perspective, definitely. But in many cases we're going to have – work back into an existing wireless infrastructure that's already in place. We did do an investment in a company called Federated Wireless that does the SAS back-office that monitors the spectrum utilization. And so, we've definitely invested around that.

Walter Piecyk - BTIG LLC

And just one – actually if I can sneak one more in on this, is your anticipation or do you already have orders for customers that aren't cable operators for these products?

Bruce William McClelland - ARRIS International Plc

Oh, definitely. Definitely.

Walter Piecyk - BTIG LLC

Great. Thank you.

Bruce William McClelland - ARRIS International Plc

Okay. Thank you.

Operator

Thank you. And we do have a follow-up question from the line of Aaron Rakers of Wells Fargo. Your line is open.

Aaron Rakers - Wells Fargo Securities LLC

Yeah, thanks for the real quick follow-up. I just wanted to go back to the DOCSIS3.1 upgrade. I think at the Analyst Day, you gave some interesting metrics around the fact that you only expected about, I think, it was 15% of your installed base upgraded with the new line cards. Any update to that of where we stand today and whether or not that upgrade rate is accelerating at all?

And then as a quick follow-up to that, I'm just curious, how should we think about DAA deployments and when that or what that means from a revenue perspective? Is that more of a 2019, and we should expect revenue from those at that point? And how should we think about that relative to the traditional business?

Bruce William McClelland - ARRIS International Plc

Yes, I don't have a new metric for you on the Gen2 upgrade. We know we are still ramping production to kind of keep up with demand there. So we're – I think we're kind of on track to what we said at the Investor Day at this point for our Gen2 upgrade and just to make sure, I've got it clear with everyone, we can do DOCSIS3.1 on the current installed base, obviously, without Gen2. So Gen2 is really around capacity expansion and doubling the capacity of the current footprints, so.

And on DAA, there's definitely revenue this year. In fact, this quarter, we'll start to recognize revenue, I think, on DAA and that will start to accelerate in future quarters as the production of the Remote PHY module and the new node form factors and everything go into full deployment, but definitely revenue, even this quarter.

Aaron Rakers - Wells Fargo Securities LLC

Great, thank you.

Bruce William McClelland - ARRIS International Plc

All right. Thanks, Aaron.

Operator

Thank you. And at this time, there are no further questions. I'd like to turn the conference back over to Mr. Bob Puccini for the closing remarks.

Robert Puccini - ARRIS International Plc

Great. Thank you, Amanda. Bruce, any final comments?

Bruce William McClelland - ARRIS International Plc

Well, thanks, Bob. Thanks, everyone, for joining us this evening. I look forward to keeping in touch with you and updating you on our progress later in the year. So have a good evening.

Robert Puccini - ARRIS International Plc

Great. Thanks, everyone. That concludes our call.

Operator

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