UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

of

ARRIS GROUP, INC.

A Delaware Corporation
IRS Employer Identification No. 58-2588724
SEC File Number 000-31254

ARRIS Group, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

ARRIS Group, Inc. is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

As of July 31, 2005, 103,897,410 shares of the registrant’s Common Stock, $0.01 par value, were outstanding.

 

 

ARRIS GROUP, INC.

FORM 10-Q
For the Three and Six Months Ended June 30, 2005

INDEX

		Page
Part I. Financial Information
Item 1. Financial Statements
a) Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004			2
b) Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2005 and 2004			3
c) Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2004			4
d) Notes to the Consolidated Financial Statements			6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			17
Item 3. Quantitative and Qualitative Disclosures on Market Risk			33
Item 4. Controls and Procedures			33
Part II. Other Information
Item 2. Recent Sales of Unregistered Securities			33
Item 4. Submission of Matters to a Vote of Security Holders			34
Item 6. Exhibits			34
Signatures			35
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32.1 SECTION 906 CERTIFICATION OF THE CEO
EX-32.2 SECTION 906 CERTIFICATION OF THE CFO

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

ARRIS GROUP, INC.

CONSOLIDATED BALANCE SHEETS

		June 30,				December 31,
		2005				2004
		(unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	97,194			$	25,072
Short-term investments, at fair value			—				78,000
Total cash, cash equivalents and short-term investments			97,194				103,072
Restricted cash			4,037				4,017
Accounts receivable (net of allowances for doubtful accounts of $3,063 in 2005 and $3,829 in 2004)			87,900				55,661
Other receivables			288				420
Inventories, net			80,869				92,636
Other current assets			6,700				9,416
Total current assets			276,988				265,222
Property, plant and equipment (net of accumulated depreciation of $64,604 in 2005 and $61,146 in 2004)			26,351				27,125
Goodwill			150,569				150,569
Intangibles (net of accumulated amortization of $106,222 in 2005 and $105,446 in 2004)			1,356				1,672
Investments			3,223				3,620
Other assets			399				2,470
		$	458,886			$	450,678
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	30,863			$	30,640
Accrued compensation, benefits and related taxes			9,927				14,845
Other accrued liabilities			29,879				32,111
Total current liabilities			70,669				77,596
Long-term debt, net of current portion			—				75,000
Other long-term liabilities			17,211				16,781
Total liabilities			87,880				169,377
Stockholders’ equity:
Preferred stock, par value $1.00 per share, 5.0 million shares authorized; none issued and outstanding			—				—
Common stock, par value $0.01 per share, 320.0 million shares authorized; 103.5 million and 87.7 million shares issued and outstanding in 2005 and 2004, respectively			1,053				889
Capital in excess of par value			727,096				644,838
Accumulated deficit			(346,340	)			(357,038	)
Unrealized gain on marketable securities			838				706
Unearned compensation			(8,112	)			(4,566	)
Unfunded pension losses			(3,345	)			(3,345	)
Cumulative translation adjustments			(184	)			(183	)
Total stockholders’ equity			371,006				281,301
		$	458,886			$	450,678

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)
(in thousands, except per share data)

		Three Months Ended June 30,								Six Months Ended June 30,
		2005				2004				2005				2004
Net sales		$	162,201			$	120,537			$	298,125			$	232,165
Cost of sales			121,118				80,185				220,251				155,519
Gross margin			41,083				40,352				77,874				76,646
Gross margin %			25.3	%			33.5	%			26.1	%			33.0	%
Operating expenses:
Selling, general and administrative expenses			17,572				18,495				34,243				36,039
Provision for doubtful accounts			(358	)			252				(510	)			296
Research and development expenses			14,336				16,323				29,137				32,500
Restructuring and impairment charges			198				876				396				7,051
Amortization of intangibles			218				8,927				775				17,849
Total operating expenses			31,966				44,873				64,041				93,735
Operating income (loss)			9,117				(4,521	)			13,833				(17,089	)
Other expense (income):
Interest expense			1,004				1,081				2,022				2,645
Loss on debt retirement			2,372				—				2,372				4,406
Loss on investments			—				580				—				1,439
Equity loss on unconsolidated affiliate			—				—				75				—
Loss (gain) in foreign currency			(1,078	)			136				(143	)			139
Other expense (income), net			(481	)			(95	)			(1,039	)			(509	)
Income (loss) from continuing operations before income taxes			7,300				(6,223	)			10,546				(25,209	)
Income tax expense (benefit)			87				37				(65	)			46
Net income (loss) from continuing operations			7,213				(6,260	)			10,611				(25,255	)
Income from discontinued operations			76				832				86				1,171
Net income (loss)		$	7,289			$	(5,428	)		$	10,697			$	(24,084	)
Net income (loss) per common share -
Basic:
Income (loss) from continuing operations		$	0.08			$	(0.07	)		$	0.12			$	(0.30	)
Income from discontinued operations			0.00				0.01				0.00				0.01
Net income (loss)		$	0.08			$	(0.06	)		$	0.12			$	(0.29	)
Diluted:
Income (loss) from continuing operations		$	0.08			$	(0.07	)		$	0.12			$	(0.30	)
Income from discontinued operations			0.00				0.01				0.00				0.01
Net income (loss)		$	0.08			$	(0.06	)		$	0.12			$	(0.29	)
Weighted average common shares:
Basic			88,837				87,113				88,347				82,971
Diluted			91,356				87,113				90,505				82,971

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)
(in thousands)

		Six Months Ended
		June 30,
		2005				2004
Operating activities:
Net income (loss)		$	10,697			$	(24,084	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation			5,098				5,326
Amortization of intangibles			775				17,849
Amortization of unearned compensation			1,730				1,624
Amortization of deferred finance fees			305				384
Provision for doubtful accounts			(510	)			296
Loss on disposal of fixed assets			131				95
Loss on investments			—				1,439
Equity loss on unconsolidated affiliate			75				—
Loss on debt retirement			2,372				4,406
Impairment of long-lived assets			291				—
Gain on discontinued product lines			(86	)			(1,171	)
Gain on derivative instrument			(1,230	)			—
Changes in operating assets and liabilities, net of effect of acquisitions and dispositions:
Accounts receivable			(31,479	)			(7,344	)
Other receivables			132				(537	)
Inventory			12,077				4,029
Accounts payable and accrued liabilities			(6,192	)			16,466
Other, net			3,694				(4,888	)
Net cash provided by (used in) operating activities			(2,120	)			13,890
Investing activities:
Purchases of property, plant and equipment			(4,883	)			(4,239	)
Cash proceeds from sale of property, plant and equipment			40				—
Cash paid for acquisition, net of cash acquired			(89	)			(50	)
Purchases of short-term investments			(5,000	)			(79,750	)
Disposals of short-term investments			83,000				30,000
Purchases of equity investment			(259	)			—
Net cash provided by (used in) investing activities			72,809				(54,039	)
Financing activities:
Payments on capital lease obligations			—				(14	)
Payments on debt obligations			—				(1,163	)
Proceeds from issuance of stock			1,433				7,041
Net cash provided by (used in) financing activities			1,433				5,864
Net increase (decrease) in cash and cash equivalents			72,122				(34,285	)
Cash and cash equivalents at beginning of period			25,072				74,882
Cash and cash equivalents at end of period		$	97,194			$	40,597

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)

		Six Months Ended June 30,
		2005				2004
Noncash investing and financing activities:
Net tangible assets acquired, excluding cash		$	799			$	—
Investment in acquired company			(1,325	)			—
Net liabilities assumed			(76	)			50
Intangible assets acquired			691				—
Cash paid for acquisition, net of cash acquired		$	89			$	50
Landlord funded leasehold improvements		$	—			$	785
Equity issued in exchange for 4 1/2% convertible subordinated notes due 2008		$	75,000			$	50,000
Equity issued for make-whole interest payment - 4 1/2% convertible subordinated notes due 2008		$	2,372			$	4,406

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

Note 1. Organization and Basis of Presentation

ARRIS Group, Inc. (together with its consolidated subsidiaries, except as the context otherwise indicates, “ARRIS” or the “Company”), headquartered in Suwanee, Georgia, is a leading developer, manufacturer and supplier of telephony, data, video, construction, rebuild and maintenance equipment for the broadband communications industry. The Company provides its customers with products and services that enable reliable, high-speed, two-way broadband transmission of video, telephony, and data. ARRIS operates in one segment, Communications.

The consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) that are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements for the periods shown. Additionally, certain prior period amounts have been reclassified to conform to the 2005 financial statement presentation. Interim results of operations are not necessarily indicative of results to be expected from a twelve-month period. These financial statements should be read in conjunction with the Company’s most recently audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, as filed with the United States Securities and Exchange Commission (“SEC”).

Note 2. Impact of Recently Issued Accounting Standards

In June 2005, the Financial Accounting Standards Board (“FASB”) issued Statement of financial Accounting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3. Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of SFAS No. 154 to have an impact on the consolidated financial statements.

In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment. SFAS No. 123R requires all companies to measure compensation cost for all share-based payments (including employee stock options and the Employee Stock Purchase Plan) at fair value. ARRIS currently accounts for share-based payments to employees using the intrinsic value method (with the exception of those stock options subject to variable accounting as discussed in Note 3 of Notes to the Financial Statements) and, therefore, generally does not recognize compensation expense for employee stock options as long as the exercise price is equal to the fair value on the grant date. In April 2005, the SEC adopted a new rule that amends the compliance dates for SFAS No. 123R. Under the SEC’s new rule, the Company is required to adopt SFAS No. 123R beginning January 1, 2006. The Company is currently evaluating whether it will early adopt SFAS No. 123R and the expected impact that the transition will have on future results of operations. See Note 3 of Notes to the Consolidated Financial Statements for further discussion.

In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets — An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions. The standard requires that nonmonetary asset exchanges should be recorded and measured at the fair value of the assets exchanged, with certain exceptions. Productive assets must be accounted for at fair value, rather than at carryover basis, unless neither the asset received nor the asset surrendered has a fair value that is determinable within reasonable limits or the transactions lack commercial substance. SFAS No. 153 states that a nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 becomes effective as of January 1, 2006. ARRIS does not expect the adoption of SFAS No. 153 to have a material impact on its results of operations.

In November 2004, the FASB issued SFAS No. 151, Inventory Costs — An Amendment of ARB No. 43, Chapter 4. SFAS No. 151 requires that abnormal amounts of idle facility expense, freight, handling costs, and waste material be recognized as current period expense. Further, the standard requires that the allocation of fixed production overhead to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151

becomes effective as of January 1, 2006. ARRIS does not expect the adoption of SFAS No. 151 to have a material impact on its results of operations.

Note 3. Stock-Based Compensation

The Company uses the intrinsic value method for valuing its awards of stock options and restricted stock and records the related compensation expense, if any, in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. With the exception of the variable stock option expense discussed below, no other stock-based employee or director compensation cost for stock options is reflected in net income (loss), as all options granted have exercise prices equal to the market value of the underlying common stock on the date of grant. The Company records compensation expense related to its restricted stock awards and director stock units. The following table illustrates the effect on net income (loss) and earnings (loss) per share as if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-based Compensation — Transition and Disclosure, to all stock-based employee compensation.

		Three Months Ended June 30,								Six Months Ended June 30,
		(in thousands, except per share data)
		(unaudited)
		2005				2004				2005				200
Net income (loss), as reported		$	7,289			$	(5,428	)		$	10,697			$	(24,084	)
Add: Stock-based employee compensation included in reported net income (loss), net of taxes			1,188				575				1,730				1,624
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards, net of taxes			(8,945	)			(3,972	)			(11,627	)			(7,205	)
Net income (loss), pro forma		$	(468	)		$	(8,825	)		$	800			$	(29,665	)
Net income (loss) per common share:
Basic — as reported		$	0.08			$	(0.06	)		$	0.12			$	(0.29	)
Basic — pro forma		$	(0.01	)		$	(0.10	)		$	0.01			$	(0.36	)
Diluted — as reported		$	0.08			$	(0.06	)		$	0.12			$	(0.29	)
Diluted — pro forma		$	(0.01	)		$	(0.10	)		$	0.01			$	(0.36	)

Effective as of May 5, 2005, the ARRIS Board of Directors approved the acceleration of outstanding options with exercise prices equal to $9.06 and above. All of these options were “out-of-the-money” at the time of acceleration, as the closing stock price on May 5, 2005 was $7.67. The acceleration covered options to purchase approximately 1.4 million shares of common stock, but did not involve any options held by directors or executive officers. The purpose of the acceleration was to reduce the expense that would be associated with these options in accordance with the provisions of SFAS No. 123R, Share-Based Payment, once adopted. The total stock-based employee compensation, presented in the table above, of $8.9 million and $11.6 million for the three and six month periods ended June 30, 2005, respectively, includes expense of approximately $5.7 million related to the acceleration of these options.

In 2003, the Company offered to all eligible employees the opportunity to exchange certain outstanding stock options for restricted shares of ARRIS common stock. The Company’s Board of Directors and its eight most highly compensated executive officers during 2002 were not eligible to participate in the offer. Employees tendered approximately 76% of the options eligible to be exchanged under the program and ARRIS cancelled options to purchase approximately 4.7 million shares of common stock and granted approximately 1.5 million restricted shares in exchange. In accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, the Company recorded a fixed compensation expense equal to the fair market value of the shares of restricted stock granted through the offer; this cost is being amortized over the four-year vesting period for the restricted shares. All eligible options that were not tendered for exchange are subject to variable accounting. The variable accounting charge will fluctuate in accordance with the market price of the ARRIS common stock at the end of each accounting period until such stock options are exercised, forfeited, or expire unexercised. Compensation expense (income) for those options subject to variable accounting was $0.2 million and $(0.2)

million for the three months ending June 30, 2005 and June 30, 2004, respectively, and $0.2 million and $0 million for the six months ending June 30, 2005 and June 30, 2004, respectively.

The table below summarizes the number of options, exercise price and cumulative expense through June 30, 2005 related to substantially all of those options subject to variable accounting (unaudited).

		(b)				(c)								(e)								(g)
		Market				Net								Total								Variable
(a)		Value at				Market				(d)				Incremental				(f)				Accounting
Exercise		June 30,				Value				Options				Market Value				Percentage				Expense				Expiration
Price		2005				(b-a)				Outstanding				(c*d)				Vested				(e*f)				Date
										(in 000s)				(in 000s)								(in 000s)
$8.00		$	8.71			$	0.71				50.7			$	36.0				100.00	%		$	36.0			December 2010
$8.12		$	8.71			$	0.59				325.8				192.2				93.75	%			180.2			January 2012
$10.20		$	8.71			$	0.00				549.8				0.0				100.00	%			0.0			August 2011
$10.32		$	8.71			$	0.00				106.6				0.0				100.00	%			0.0			January 2012
$38.94		$	8.71			$	0.00				34.9				0.0				100.00	%			0.0			January 2010
																						$	216.2

Note 4. Pension Benefits

Components of Net Periodic Pension Benefit Cost

		Three Months Ended June 30,								Six Months Ended June 30,
		2005				2004				2005				2004
		(in thousands)
		(unaudited)
Service cost		$	105			$	142			$	248			$	283
Interest cost			360				316				715				631
Expected return (loss) on plan assets			(266	)			(224	)			(518	)			(447	)
Amortization of prior service cost			110				139				229				279
Amortization of net (gain) loss			(27	)			(23	)			(40	)			(46	)
Net periodic pension cost		$	282			$	350			$	634			$	700

Employer Contributions

No minimum funding contributions are required in 2005; however, the Company may make voluntary contributions. During the three and six months ended June 30, 2005, the Company contributed $16,000 and $32,000, respectively, to the plan.

Note 5. Guarantees

Warranty

ARRIS provides warranties of various lengths to customers based on the specific product and the terms of individual agreements. The Company provides for the estimated cost of product warranties based on historical trends, the embedded base of product in the field, failure rates, and repair costs at the time revenue is recognized. Expenses related to product defects and unusual product warranty problems are recorded in the period that the problem is identified. While the Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its suppliers, the estimated warranty obligation could be affected by changes in ongoing product failure rates, material usage and service delivery costs incurred in correcting a product failure, as well as specific product failures outside of ARRIS’ baseline experience. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions (which could be material) would be recorded as increases to the warranty liability. ARRIS evaluates its warranty obligations on an individual product basis.

The Company offers extended warranties and support service agreements on certain products. Revenue from these agreements is deferred at the time of the sale and recognized on a straight-line basis over the contract period. Costs of services performed under these types of contracts are charged to expense as incurred, which approximates the timing of the revenue stream.

Information regarding the changes in ARRIS’ aggregate product warranty liabilities was as follows for the six month period ended June 30, 2005 (in thousands):

Balance at December 31, 2004		$	5,453
Accruals related to warranties (including changes in estimates)			2,754
Settlements made (in cash or in kind)			(1,674	)
Balance at June 30, 2005		$	6,533

Note 6. Discontinued Operations

In 2002, the Company sold its Keptel telecommunications and Actives product lines for net proceeds of $30.0 million and $31.8 million, respectively. As of June 30, 2005, approximately $32,000 related to outside fees remained in an accrual to be paid. The remaining payments are expected to be made in 2005.

During the first quarter 2004, the Company recognized a partial recovery with respect to inventory previously written off associated with an Argentinean customer. Of the total gain of $0.9 million, approximately $0.3 million related to the discontinued operations of the Actives and Keptel product lines. During the second quarter 2004, the Company recorded income from discontinued operations of $0.8 million with respect to the Actives and Keptel product lines as a result of changes in estimates related to real estate, vendor liabilities, and other accruals. During the first and second quarters 2005, the Company adjusted its reserves for discontinued operations by reducing the accrual by $10,000 and $76,000, respectively, for various vendor liabilities and certain other costs as a result of the favorable resolution of such liabilities, resulting in income from discontinued operations. As of June 30, 2005, approximately $18,000 related to severance remained in an accrual to be paid. The remaining payments are expected to be made in 2005.

Note 7. Business Acquisition

Acquisition of cXm Broadband

On April 1, 2005, the Company acquired the remaining 75% of the membership interest of cXm Broadband L.L.C., an entity that was previously accounted for under the equity method of accounting. From January 31, 2005 through March 31, 2005, ARRIS held a 25% ownership stake in the company. ARRIS decided to acquire the remaining membership interest in order to expand its existing Broadband product portfolio and to penetrate the Korean market for high speed data access into multi-dwelling units. ARRIS acquired the remaining ownership percentage from the other shareholder for cash of $0.2 million and the assumption of certain liabilities. The preliminary purchase price also includes the Company’s existing $1.3 million equity investment in the L.L.C.

The following is a summary of the preliminary purchase price allocation to record our purchase of the net assets of cXm Broadband and is based upon an independent valuation of the assets. The preliminary purchase price was equal to the net tangible and intangible assets acquired (in thousands):

Cash paid to other shareholder		$	67
Acquisition costs (legal fees, valuation fees)			22
Equity investment balance			1,325
Assumption of certain liabilities of cXm Broadband			76
Adjusted preliminary purchase price		$	1,490
Allocation of preliminary purchase price:
Net tangible assets acquired		$	799
Existing technology and customer value (to be amortized over 3 years)			691
Total allocated preliminary purchase price		$	1,490

Note 8. Restructuring and Impairment Charges

The Company’s restructuring activities occurring after December 31, 2002 are accounted for in accordance with Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities. Prior to December 31, 2002, all restructuring activities were accounted for in accordance with Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).

On December 31, 2004, the Company announced that it would close its office in Fremont, California, which previously housed the Atoga Systems product line. The marketing and support for certain products acquired as part of the Atoga Systems acquisition were transferred to other locations. The Company decided to close the office in order to reduce operating costs through consolidation of its facilities. The closure affected seven employees. In connection with these actions, the Company recorded a net charge of approximately $0.3 million in the fourth quarter of 2004, which included approximately $0.1 million related to remaining lease payments and $0.2 million of severance charges. As of June 30, 2005, less than $13,000 remained in the restructuring accrual to be paid. ARRIS expects the remaining payments to be made in 2005. Below is a table that summarizes the activity in the restructuring reserve (in millions):

		Lease
		Commitments				Severance				Total
Balance as of December 31, 2003		$	—			$	—			$	—
2004 Provision			0.1				0.2				0.3
Balance as of December 31, 2004			0.1				0.2				0.3
First quarter 2005 payments			—				(0.2	)			(0.2	)
Balance as of March 31, 2005			0.1				—				0.1
Second quarter 2005 payments			(0.1	)			—				(0.1	)
Balance as of June 30, 2005		$	—			$	—			$	—

During the first quarter of 2004, ARRIS consolidated two facilities in Georgia, giving the Company the ability to house many of its core technology, marketing, and corporate headquarters functions in a single building. This consolidation resulted in a restructuring charge of $6.2 million in the first quarter of 2004 related to lease commitments and the write-off of leasehold improvements and other fixed assets. As of June 30, 2005, approximately $3.1 million related to the lease commitments remained in the restructuring accrual to be paid. ARRIS expects the remaining payments to be made by the second quarter of 2009 (end of lease). Below is a table that summarizes the activity in the restructuring reserve (in millions):

		Writedown of
		Leasehold				Lease
		Improvements				Commitments				Total
Balance as of December 31, 2003		$	—			$	—			$	—
2004 Provision			1.1				5.1				6.2
Non-cash expense (disposal of assets)			(1.1	)			—				(1.1	)
2004 payments			—				(1.2	)			(1.2	)
Adjustments to accrual			—				0.2				0.2
Balance as of December 31, 2004			—				4.1				4.1
First quarter 2005 payments			—				(0.4	)			(0.4	)
First quarter 2005 adjustments to accrual			—				(0.2	)			(0.2	)
Balance as of March 31, 2005			—				3.5				3.5
Second quarter 2005 payments			—				(0.4	)			(0.4	)
Balance as of June 30, 2005		$	—			$	3.1			$	3.1

On October 30, 2002, the Company announced that it would close its office in Andover, Massachusetts, which was primarily a product development and repair facility. The Company decided to close the office in order to reduce operating costs through consolidation of its facilities. The closure affected approximately 75 employees. In connection with these actions, the Company recorded a net charge of approximately $7.1 million in the fourth quarter of 2002. Included in this restructuring charge was approximately $2.2 million related to remaining lease payments, $2.7 million of fixed asset write-offs, $2.2 million of severance, and $0.5 million of other costs, net of a reduction of a bonus accrual related to the severed employees of $0.5 million. During the second quarter 2005, the Company satisfied the lease payment and the restructuring accrual was fully settled as of June 30, 2005. Below is a table that summarizes the activity in the restructuring reserve (in millions):

		Lease				Employee
		Commitments				Severance				Other Costs				Total
Balance as of December 31, 2002		$	2.2			$	2.1			$	0.5			$	4.8
2003 payments			(1.2	)			(1.9	)			—				(3.1	)
Adjustments to accrual			—				(0.2	)			(0.5	)			(0.7	)
Balance as of December 31, 2003			1.0				—				—				1.0
2004 payments			(0.7	)			—				—				(0.7	)
Balance as of December 31, 2004			0.3				—				—				0.3
First quarter 2005 payments			—				—				—				—
Balance as of March 31, 2005			0.3				—				—				0.3
Second quarter 2005 payments			(0.4	)			—				—				(0.4	)
Second quarter 2005 adjustments to accrual			0.1				—				—				0.1
Balance as of June 20, 2005		$	—			$	—			$	—			$	—

In the third quarter of 2001, the Company announced a restructuring plan to outsource the functions of most of its manufacturing facilities. This decision to reorganize was due in part to the ongoing weakness in industry spending patterns. Also during the third quarter of 2001, the Company reserved for lease commitments related to an excess facility in Atlanta. As a result of market conditions at that time, ARRIS had downsized and the facility was vacant. As of June 30, 2005, the remaining $1.0 million balance in the restructuring reserve related to lease terminations and other shutdown costs. The remaining costs are expected to be expended by the end of 2006 (end of lease). Below is a table that summarizes the activity in the accrual account (in millions):

		Lease
		Commitments				Employee
		& Other Costs				Severance				Total
Balance as of December 31, 2002		$	2.0			$	0.8			$	2.8
2003 payments			(2.5	)			(0.5	)			(3.0	)
2003 adjustments to accrual			5.0				(0.2	)			4.8
Balance as of December 31, 2003			4.5				0.1				4.6
2004 payments			(3.1	)			—				(3.1	)
2004 adjustments to accrual			0.1				(0.1	)			—
Balance as of December 31, 2004			1.5				—				1.5
First quarter 2005 payments			(0.4	)			—				(0.4	)
First quarter 2005 adjustments to accrual			0.1				—				0.1
Balance as of March 31, 2005			1.2				—				1.2
Second quarter 2005 payments			(0.1	)			—				(0.1	)
Second quarter 2005 adjustments to accrual			(0.1	)			—				(0.1	)
Balance as of June 30, 2005		$	1.0			$	—			$	1.0

Note 9. Inventories

 

Inventories are stated at the lower of average, approximating first-in, first-out, cost or market. The components of inventory are as follows, net of reserves (in thousands):

		June 30,				December 31,
		2005				2004
		(Unaudited)
Raw material		$	2,245			$	1,456
Finished goods			78,624				91,180
Total net inventories		$	80,869			$	92,636

Note 10. Property, Plant and Equipment

Property, plant and equipment, at cost, consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
		(Unaudited)
Land		$	1,822			$	1,822
Building and leasehold improvements			11,142				11,828
Machinery and equipment			77,991				74,621
			90,955				88,271
Less: Accumulated depreciation			(64,604	)			(61,146	)
Total property, plant and equipment, net		$	26,351			$	27,125

Note 11. Goodwill and Intangible Assets

The Company’s goodwill and indefinite lived intangible assets are reviewed annually for impairment or more frequently if impairment indicators arise. The annual valuation is performed during the fourth quarter of each year and is based upon management’s analysis including an independent valuation. Separable intangible assets that are not deemed to have an indefinite life are amortized over their useful lives. Each of the Company’s intangible assets has an amortization period of three years.

The carrying amount of goodwill for both the year ended December 31, 2004 and for the six months ended June 30, 2005 was $150.6 million.

During the first quarter 2005, a decrease in expected future cash flows related to the Atoga product line indicated that the long-lived assets associated with these products may be impaired. As a result, the Company analyzed the fair value of those assets, using the expected cash flow approach, in accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. The resulting analysis indicated that the remaining intangibles of $0.2 million were fully impaired and were written off in the first quarter 2005. There were no additional assets deemed to be impaired in the second quarter 2005.

The gross carrying amount and accumulated amortization of the Company’s intangible assets, other than goodwill, as of June 30, 2005 and December 31, 2004 are as follows (in thousands ) :

		June 30, 2005																December 31, 2004
														Net												Net
		Gross								Accumulated				Book				Gross				Accumulated				Book
		Amount				Impairment				Amortization				Value				Amount				Amortization				Value
Existing technology acquired:
Arris Interactive L.L.C		$	51,500			$	—			$	(51,500	)		$	—			$	51,500			$	(51,500	)		$	—
Cadant, Inc.			53,000				—				(53,000	)			—				53,000				(52,661	)			339
Atoga Systems			689				(231	)			(458	)			—				689				(401	)			288
Com21			1,929				—				(1,206	)			723				1,929				(884	)			1,045
cXm Broadband			691				—				(58	)			633				—				—				—
Total		$	107,809			$	(231	)		$	(106,222	)		$	1,356			$	107,118			$	(105,446	)		$	1,672

Amortization expense recorded on the intangible assets listed in the above table for the three and six months ended June 30, 2005 was $0.2 million and $0.8 million, respectively, and compares to expense of $8.9 million and $17.8 million, respectively, for the same periods in 2004. The estimated remaining amortization expense for the next five fiscal years is as follows (in thousands):

2005		$	436
2006		$	632
2007		$	230
2008		$	58
2009		$	—

Note 12. Long-Term Obligations

Long-term debt, capital lease obligations and other long-term obligations consist of the following (in thousands):

		June 30,				December 31,
		2005				2004
		(unaudited)
4 1/2% convertible subordinated notes due 2008		$	—			$	75,000
Other liabilities			17,211				16,781
Total long term debt and other long-term liabilities		$	17,211			$	91,781

On March 18, 2003, the Company issued $125.0 million of 4 1/2% convertible subordinated notes due 2008 (“Notes”). The Notes were convertible, at the option of the holder, at any time prior to maturity, into the Company’s common stock at a conversion price of $5.00 per share, subject to adjustment. In February 2004, the Company called $50.0 million of the Notes for redemption, and the holders of the called Notes elected to convert those Notes into an aggregate of 10.0 million shares of common stock rather than have the Notes redeemed. The Company also made a make-whole interest payment of approximately 0.5 million common shares, resulting in a charge of $4.4 million during the first quarter of 2004. In May 2005, the Company called the remaining $75.0 million of the Notes for redemption, and the holders of the Notes elected to convert the notes into 15.0 million shares of common stock rather than have the Notes redeemed. The Company made a make-whole interest

payment of approximately 0.3 million shares, resulting in a charge of $2.3 million during the second quarter 2005. As of June 30, 2005, the Notes have been fully converted and the Company has no long term debt.

As of June 30, 2005 and December 31, 2004, the Company had approximately $4.0 million outstanding under letters of credit, which are cash collateralized and classified as restricted cash on the Consolidated Balance Sheets.

As of June 30, 2005, the Company had approximately $17.2 million of other long-term liabilities, which included $11.6 million related to its accrued pension, $3.0 million related to its deferred compensation obligations, deferred rental expense of $2.5 million related to landlord funded leasehold improvements, and $0.1 million related to security deposits received. As of December 31, 2004, the Company had approximately $16.8 million of other long-term liabilities, which included $10.9 million related to its accrued pension, $3.0 million related to its deferred compensation obligations, $2.8 million related to landlord funded leasehold improvements, and $0.1 million related to security deposits received.

The Company has not paid cash dividends on its common stock since its inception. In 2002, to implement its shareholder rights plan, the Company’s Board of Directors declared a dividend consisting of one right for each share of its common stock outstanding. Each right represents the right to purchase one one-thousandth of a share of its Series A Participating Preferred Stock and becomes exercisable only if a person or group acquires beneficial ownership of 15% or more of its common stock or announces a tender or exchange offer for 15% or more of its common stock or under other similar circumstances.

Note 13. Comprehensive Income (Loss)

Total comprehensive income (loss) represents the net change in stockholders’ equity during a period from sources other than transactions with stockholders. For ARRIS, the components of total comprehensive income (loss) include the unrealized gain (loss) on marketable securities and foreign currency translation adjustments. The components of comprehensive income (loss) for the three and six months ended June 30, 2005 and 2004 are as follows (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		(unaudited)
		2005				2004				2005				2004
Net income (loss)		$	7,289			$	(5,428	)		$	10,697			$	(24,084	)
Other comprehensive income (loss):			—
Change in translation adjustments.			—				231				(1	)			241
Change in unfunded pension losses			—				—				—				—
Change in unrealized gain (loss) on marketable securities			96				2				132				(37	)
Comprehensive income (loss)		$	7,385			$	(5,195	)		$	10,828			$	(23,880	)

Note 14. Sales Information

A significant portion of the Company’s revenue is derived from sales to its top five customers: Comcast, Liberty Media International (including its affiliates), Cox Communications, Charter Communications and Time Warner. Sales to these customers for the three and six month periods ended June 30, 2005 and 2004 are set forth below (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		(unaudited)
		2005				2004				2005				2004
Comcast		$	27,527			$	36,334			$	47,325			$	64,001
% of sales			17.0	%			30.1	%			15.9	%			27.6	%
Liberty Media (including affiliates)		$	25,846			$	18,681			$	51,011			$	35,926
% of sales			15.9	%			15.5	%			17.1	%			15.5	%
Cox Communications		$	25,589			$	23,949			$	54,375			$	51,799
% of sales			15.8	%			19.9	%			18.2	%			22.3	%
Charter Communications		$	18,947			$	3,704			$	26,005			$	8,327
% of sales			11.7	%			3.1	%			8.7	%			3.6	%
Time Warner		$	17,191			$	6,213			$	33,692			$	10,531
% of sales			10.6	%			5.2	%			11.3	%			4.5	%

No other customer provided more than 10% of total sales for the three or six months ended June 30, 2005 or 2004.

The Company operates globally and offers products and services that are sold to cable system operators and telecommunications providers. The Company’s products and services are focused in two product categories: Broadband and Supplies & Customer Premises Equipment (“CPE”). Consolidated revenue by principal product and service for the three and six months ended June 30, 2005 and 2004 were as follows (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		(unaudited)
		2005				2004				2005				2004
Broadband		$	71,233			$	78,814			$	140,885			$	150,932
Supplies and CPE			90,968				41,723				157,240				81,233
Total sales		$	162,201			$	120,537			$	298,125			$	232,165

ARRIS sells its products primarily in North America. The Company’s international revenue is generated from Asia Pacific, Europe, Latin America and Canada. The Asia Pacific market primarily includes China, Hong Kong, Japan, Korea, Singapore, and Taiwan. The European market primarily includes Austria, Belgium, France, Germany, the Netherlands, Poland, Portugal, Spain, and Switzerland. The Latin American market primarily includes Argentina, Chile, Brazil, and Puerto Rico. Sales to international customers were approximately $44.1 million, or 27.2% of total sales and $80.0 million, or 26.8% of total sales for the three and six months ended June 30, 2005. International sales during the same periods in 2004 were $27.1 million, or 22.5% of total sales and $51.9 million, or 22.3% of total sales.

As of June 30, 2005, ARRIS held approximately $1.5 million of assets in Ireland, comprised of $0.5 million of cash, $0.1 million of miscellaneous receivables, and $0.9 million of fixed assets. As of December 31, 2004, ARRIS held approximately $2.1 million of assets in Ireland, comprised of $1.3 million of cash and $0.8 million of fixed assets.

Note 15. Earnings Per Share

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share (“EPS”) computations for the periods indicated (in thousands except per share data):

		Three Months Ended June 30,								Six Months Ended June 30,
						(unaudited)
		2005				2004				2005				2004
Basic:
Income (loss) from continuing operations		$	7,213			$	(6,260	)		$	10,611			$	(25,255	)
Income (loss) from discontinued operations			76				832				86				1,171
Net income (loss)		$	7,289			$	(5,428	)		$	10,697			$	(24,084	)
Weighted average shares outstanding			88,837				87,113				88,347				82,971
Basic earnings (loss) per share		$	0.08			$	(0.06	)		$	0.12			$	(0.29	)
Diluted:
Income (loss) from continuing operations		$	7,213			$	(6,260	)		$	10,611			$	(25,255	)
Income (loss) from discontinued operations			76				832				86				1,171
Net income (loss)		$	7,289			$	(5,428	)		$	10,697			$	(24,084	)
Weighted average shares outstanding			88,837				87,113				88,347				82,971
Net effect of dilutive equity awards			2,519				—				2,158				—
Total			91,356				87,113				90,505				82,971
Diluted earnings (loss) per share		$	0.08			$	(0.06	)		$	0.12			$	(0.29	)

The Notes were antidilutive for all periods presented. The effects of the options and warrants were not presented for the three and six month periods ended June 30, 2004 as the Company incurred a net loss during that period and inclusion of these securities would have been antidilutive.

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Our long-term goal is to continue to increase our leading position as a worldwide provider of broadband access products and services. Our primary market and focus is cable providers or MSOs. To achieve this goal, we have implemented a long-term business strategy that includes the following key elements:

	•		Transition to VoIP with an “Everything IP, Everywhere” philosophy and build on current market successes;
	•		Leverage our current voice and data business;
	•		Strengthen and grow our supplies infrastructure distribution channel;
	•		Expand our existing product/services portfolio through internal developments, partnerships and acquisitions;
	•		Continually rationalize our product portfolio; and
	•		Maintain and improve an already strong capital structure and expense structure.

Below is a summary of key year to date events, accomplishments and actions relative to these strategies:

Transition to VoIP with an “Everything IP, Everywhere” philosophy and build on current market successes

	•		MSOs continued to aggressively deploy VoIP and, as a result, sales of embedded multimedia terminal adapters (“E-MTA”) increased significantly quarter over quarter. In the second quarter 2005, we sold over 567,000 E-MTAs as compared to 334,000 in the first quarter 2005 and 30,000 in the second quarter 2004. We anticipate that demand for this product will continue to increase in 2005, and we are working with our contract manufacturers to achieve projected demand.
	•		CableLabs selected the “packet bonding” approach to high speed wideband data service envisioned in DOCSIS 3.0. ARRIS has been a proponent of this approach over other alternatives. We believe this positions us well for the evolution of our products.
	•		We further diversified our customer base through the first six months of 2005, adding new customers for our products and, in the second quarter, expanding our 10 percent customer list to five, with the addition of Charter to the list.

Leverage our current voice and data business

•

In the first quarter 2005, we granted price reductions to our customers of constant bit rate (“CBR”) telephony products in order to extend the life of this product. Although sales of this product have been robust, we anticipate that they will continually decline in 2005 as customers move to VoIP for telephony services.

•

In the second quarter we spent $14.3 million on research and development. Included in the quarterly expenses was a benefit of approximately $1.2 million representing funding received from a customer related to development work that ARRIS performed for it. Excluding this reimbursement, our research and development expenses in the second quarter 2005 were approximately $15.5 million. Through the first six months of 2005, we spent approximately $29.1 million on research and development. Key accomplishments included:

	o		The introduction of next generation E-MTAs, including cost reduced versions.
	o		The introduction of cost reductions within the CMTS product family.
	o		Continued work on our Keystone D5 Digital Multimedia Termination System product which is expected to be commercially available in the second half of 2005. This new product is currently in trial with a customer.
	o		The Cadant C4 achieved Euro-DOCSIS 2.0 certification.

	o		Continued work on a multi-line E-MTA for use by our customers in multi-dwelling units (“MDU”) and businesses. We expect to launch this product in the fourth quarter of 2005.
	o		Continued work on a session initiated protocol (“SIP”) based version of our E-MTA for Eastern European and Asian customers. We expect to launch this product in the fourth quarter of 2005.

•

We acquired the assets of cXm Broadband, formerly known as coaXmedia. The product line included in these assets is expected to provide us with extended reach into the MDU and hospitality markets.

Maintain and improve an already strong capital structure and expense structure

	•		We called for redemption the balance of our 2008 Notes in the second quarter 2005. All holders of the Notes chose to convert their holdings into shares resulting in the issuance of 15.3 million shares. We now have no long-term debt.
	•		Through the first six months of 2005, we consumed $2.1 million of cash for operating activities, and we used approximately $31.5 million to fund higher accounts receivable levels resulting from our increased sales. In the same period, we generated approximately $19.6 million from our net income, after adjusting for non-cash items.
	•		Our inventory and accounts receivable performance continues to be strong, with DSOs of 43 days and inventory turns of 6.2 in the second quarter 2005.

Significant Customers

A significant portion of the Company’s revenue is derived from sales to its top five customers: Comcast, Liberty Media International (including its affiliates), Cox Communications, Charter Communications and Time Warner. Sales to these customers for the three and six month periods ended June 30, 2005 and 2004 are set forth below (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		(unaudited)
		2005				2004				2005				2004
Comcast		$	27,527			$	36,334			$	47,325			$	64,001
% of sales			17.0	%			30.1	%			15.9	%			27.6	%
Liberty Media (including affiliates)		$	25,846			$	18,681			$	51,011			$	35,926
% of sales			15.9	%			15.5	%			17.1	%			15.5	%
Cox Communications		$	25,589			$	23,949			$	54,375			$	51,799
% of sales			15.8	%			19.9	%			18.2	%			22.3	%
Charter Communications		$	18,947			$	3,704			$	26,005			$	8,327
% of sales			11.7	%			3.1	%			8.7	%			3.6	%
Time Warner		$	17,191			$	6,213			$	33,692			$	10,531
% of sales			10.6	%			5.2	%			11.3	%			4.5	%

No other customer provided more than 10% of total sales for the three or six months ended June 30, 2005 or 2004.

Comparison of Operations for the Three and Six Months Ended June 30, 2005 and 2004

Net Sales

The table below sets forth our net sales for the three and six months ended June 30, 2005 and 2004, for each of our product categories (in millions):

		Net Sales																Increase (Decrease) Between 2005 and 2004
		For the Three Months								For the Six Months								For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,								Ended June 30								Ended June 30
		2005				2004				2005				2004				$				%				$				%
Product Category:
Broadband		$	71.2			$	78.8			$	140.9			$	150.9			$	(7.6	)			(10	%)		$	(10.0	)			(7	%)
Supplies & CPE			91.0				41.7				157.2				81.3				49.3				118	%			75.9				93	%
Total sales		$	162.2			$	120.5			$	298.1			$	232.2			$	41.7				35	%		$	65.9				28	%

The table below sets forth our domestic and international sales for the three and six months ended June 30, 2005 and 2004 (in millions):

		Net Sales																Increase (Decrease) Between 2005 and 2004
		For the Three Months								For the Six Months								For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,								Ended June 30								Ended June 30
		2005				2004				2005				2004				$				%				$				%
Domestic		$	118.1			$	93.4			$	218.1			$	180.3			$	24.7				26	%		$	37.8				21	%
International			44.1				27.1				80.0				51.9				17.0				63	%			28.1				54	%
Total sales		$	162.2			$	120.5			$	298.1			$	232.2			$	41.7				35	%		$	65.9				28	%