ARRIS GROUP, INC.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarter ended March 31, 2007
of
ARRIS GROUP, INC.
A Delaware Corporation
IRS Employer Identification No. 58-2588724
SEC File Number 000-31254
3871 Lakefield Drive
Suwanee, GA 30024
(770) 473-2000
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 a large accelerated filer and is not a shell company.
As of April 30, 2007, 109,018,580 shares of the registrants Common Stock, $0.01 par value, were
outstanding.
ARRIS GROUP, INC.
FORM 10-Q
For the Three Months Ended March 31, 2007
INDEX
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
ARRIS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(unaudited) |
|
|
|
|
|
ASSETS |
|
|
|
|
|
|
|
|
Current assets: |
|
|
|
|
|
|
|
|
Cash and cash equivalents |
|
$ |
441,317 |
|
|
$ |
461,618 |
|
Short-term investments, at fair value |
|
|
134,610 |
|
|
|
87,575 |
|
|
|
|
|
|
|
|
Total cash, cash equivalents and short-term investments |
|
|
575,927 |
|
|
|
549,193 |
|
Restricted cash |
|
|
3,128 |
|
|
|
3,124 |
|
Accounts receivable (net of allowances for doubtful
accounts of $2,814 in 2007 and $3,576 in 2006) |
|
|
125,756 |
|
|
|
115,304 |
|
Other receivables |
|
|
9,888 |
|
|
|
2,556 |
|
Inventories |
|
|
78,186 |
|
|
|
94,226 |
|
Prepaids |
|
|
3,500 |
|
|
|
3,547 |
|
Current deferred income tax assets |
|
|
26,818 |
|
|
|
29,285 |
|
Other current assets |
|
|
4,001 |
|
|
|
3,717 |
|
|
|
|
|
|
|
|
Total current assets |
|
|
827,204 |
|
|
|
800,952 |
|
Property, plant and equipment (net of accumulated
depreciation of $79,810 in 2007 and $77,311 in 2006) |
|
|
28,076 |
|
|
|
28,287 |
|
Goodwill |
|
|
150,569 |
|
|
|
150,569 |
|
Intangibles (net of accumulated amortization of $106,890 in
2007 and $106,832 in 2006) |
|
|
230 |
|
|
|
288 |
|
Investments |
|
|
3,569 |
|
|
|
3,520 |
|
Noncurrent deferred income tax assets |
|
|
18,639 |
|
|
|
20,874 |
|
Other assets |
|
|
7,790 |
|
|
|
9,067 |
|
|
|
|
|
|
|
|
|
|
$ |
1,036,077 |
|
|
$ |
1,013,557 |
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY |
|
|
|
|
|
|
|
|
Current liabilities: |
|
|
|
|
|
|
|
|
Accounts payable |
|
$ |
41,337 |
|
|
$ |
60,853 |
|
Accrued compensation, benefits and related taxes |
|
|
9,991 |
|
|
|
23,269 |
|
Accrued warranty |
|
|
7,968 |
|
|
|
8,234 |
|
Other accrued liabilities |
|
|
32,411 |
|
|
|
29,057 |
|
|
|
|
|
|
|
|
Total current liabilities |
|
|
91,707 |
|
|
|
121,413 |
|
Long-term debt, net of current portion |
|
|
276,000 |
|
|
|
276,000 |
|
Accrued pension |
|
|
12,420 |
|
|
|
12,061 |
|
Noncurrent income tax payable |
|
|
4,334 |
|
|
|
3,041 |
|
Other long-term liabilities |
|
|
5,606 |
|
|
|
5,621 |
|
|
|
|
|
|
|
|
Total liabilities |
|
|
390,067 |
|
|
|
418,136 |
|
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; 108.6 million and 107.9 million
shares issued and outstanding in 2007 and 2006,
respectively |
|
|
1,096 |
|
|
|
1,089 |
|
Capital in excess of par value |
|
|
773,839 |
|
|
|
761,500 |
|
Accumulated deficit |
|
|
(125,624 |
) |
|
|
(163,268 |
) |
Unrealized gain on marketable securities |
|
|
1,345 |
|
|
|
1,297 |
|
Unfunded pension losses |
|
|
(4,462 |
) |
|
|
(4,462 |
) |
Unrealized loss on derivatives |
|
|
|
|
|
|
(551 |
) |
Cumulative translation adjustments |
|
|
(184 |
) |
|
|
(184 |
) |
|
|
|
|
|
|
|
Total stockholders equity |
|
|
646,010 |
|
|
|
595,421 |
|
|
|
|
|
|
|
|
|
|
$ |
1,036,077 |
|
|
$ |
1,013,557 |
|
|
|
|
|
|
|
|
See accompanying notes to the consolidated financial statements.
2
ARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
(in thousands, except per share data and percentages)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2007 |
|
|
2006 |
|
Net sales |
|
$ |
235,253 |
|
|
$ |
208,344 |
|
Cost of sales |
|
|
166,506 |
|
|
|
151,837 |
|
|
|
|
|
|
|
|
Gross margin |
|
|
68,747 |
|
|
|
56,507 |
|
Gross margin % |
|
|
29.2 |
% |
|
|
27.1 |
% |
Operating expenses: |
|
|
|
|
|
|
|
|
Selling, general, and administrative expenses |
|
|
24,175 |
|
|
|
21,278 |
|
Research and development expenses |
|
|
18,096 |
|
|
|
15,074 |
|
Restructuring and impairment charges |
|
|
421 |
|
|
|
328 |
|
Amortization of intangibles |
|
|
58 |
|
|
|
218 |
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
42,750 |
|
|
|
36,898 |
|
|
|
|
|
|
|
|
Operating income |
|
|
25,997 |
|
|
|
19,609 |
|
Other expense (income): |
|
|
|
|
|
|
|
|
Interest expense |
|
|
1,668 |
|
|
|
10 |
|
Loss on investments |
|
|
19 |
|
|
|
|
|
Loss (gain) on foreign currency |
|
|
322 |
|
|
|
(317 |
) |
Interest income |
|
|
(6,483 |
) |
|
|
(1,520 |
) |
Gain related to terminated acquisition, net of expenses |
|
|
(22,835 |
) |
|
|
|
|
Other expense (income), net |
|
|
65 |
|
|
|
106 |
|
|
|
|
|
|
|
|
Income from continuing operations before income taxes |
|
|
53,241 |
|
|
|
21,330 |
|
Income tax expense |
|
|
15,597 |
|
|
|
628 |
|
|
|
|
|
|
|
|
Net income from continuing operations |
|
|
37,644 |
|
|
|
20,702 |
|
Income from discontinued operations |
|
|
|
|
|
|
21 |
|
|
|
|
|
|
|
|
Net income |
|
$ |
37,644 |
|
|
$ |
20,723 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per common share: |
|
|
|
|
|
|
|
|
Basic: |
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
0.35 |
|
|
$ |
0.20 |
|
Income from discontinued operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
0.35 |
|
|
$ |
0.20 |
|
|
|
|
|
|
|
|
Diluted: |
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
0.34 |
|
|
$ |
0.19 |
|
Income from discontinued operations |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
0.34 |
|
|
$ |
0.19 |
|
|
|
|
|
|
|
|
Weighted average common shares: |
|
|
|
|
|
|
|
|
Basic |
|
|
108,467 |
|
|
|
106,227 |
|
|
|
|
|
|
|
|
Diluted |
|
|
110,988 |
|
|
|
109,345 |
|
|
|
|
|
|
|
|
See accompanying notes to the consolidated financial statements.
3
ARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(in thousands)
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
2007 |
|
|
2006 |
|
Operating activities: |
|
|
|
|
|
|
|
|
Net income |
|
$ |
37,644 |
|
|
$ |
20,723 |
|
Adjustments to reconcile net income to net cash provided by (used in) operating
activities: |
|
|
|
|
|
|
|
|
Depreciation |
|
|
2,497 |
|
|
|
2,618 |
|
Amortization of intangibles |
|
|
58 |
|
|
|
218 |
|
Stock compensation expense |
|
|
2,656 |
|
|
|
2,248 |
|
Deferred income tax provision |
|
|
4,702 |
|
|
|
|
|
Amortization of deferred finance fees |
|
|
279 |
|
|
|
|
|
Provision for doubtful accounts |
|
|
371 |
|
|
|
(265 |
) |
Gain related to previously written off receivables |
|
|
(377 |
) |
|
|
(475 |
) |
Loss on disposal of fixed assets |
|
|
|
|
|
|
2 |
|
Loss on investments |
|
|
19 |
|
|
|
|
|
Gain on discontinued product lines |
|
|
|
|
|
|
(21 |
) |
Gain related to terminated acquisition, net of expenses |
|
|
(22,835 |
) |
|
|
|
|
Changes in operating assets and liabilities, net of effect of acquisitions and
dispositions: |
|
|
|
|
|
|
|
|
Accounts receivable |
|
|
(10,823 |
) |
|
|
(7,555 |
) |
Other receivables |
|
|
(7,332 |
) |
|
|
(3,852 |
) |
Inventory |
|
|
16,040 |
|
|
|
14,236 |
|
Accounts payable and accrued liabilities |
|
|
(24,842 |
) |
|
|
(3,639 |
) |
Excess tax benefits from stock-based compensation plans |
|
|
(4,855 |
) |
|
|
(169 |
) |
Prepaids and other, net |
|
|
2,763 |
|
|
|
7,280 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) operating activities |
|
|
(4,035 |
) |
|
|
31,349 |
|
|
|
|
|
|
|
|
|
|
Investing activities: |
|
|
|
|
|
|
|
|
Purchases of property, plant and equipment |
|
|
(2,287 |
) |
|
|
(1,389 |
) |
Cash received related to terminated acquisition, net of expenses paid |
|
|
10,881 |
|
|
|
|
|
Cash paid for hedge related to terminated acquisition |
|
|
(26,469 |
) |
|
|
|
|
Cash proceeds from hedge related to terminated acquisition |
|
|
38,750 |
|
|
|
|
|
Purchases of short-term investments |
|
|
(128,135 |
) |
|
|
|
|
Disposals of short-term investments |
|
|
81,100 |
|
|
|
18,000 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities |
|
|
(26,160 |
) |
|
|
16,611 |
|
|
|
|
|
|
|
|
|
|
Financing activities: |
|
|
|
|
|
|
|
|
Excess tax benefits from stock-based compensation plans |
|
|
4,855 |
|
|
|
169 |
|
Employer repurchase of shares to satisfy minimum tax withholdings |
|
|
|
|
|
|
(27 |
) |
Proceeds from issuance of stock |
|
|
5,039 |
|
|
|
6,171 |
|
|
|
|
|
|
|
|
Net cash provided by (used in) financing activities |
|
|
9,894 |
|
|
|
6,313 |
|
Net increase (decrease) in cash and cash equivalents |
|
|
(20,301 |
) |
|
|
54,273 |
|
Cash and cash equivalents at beginning of period |
|
|
461,618 |
|
|
|
75,286 |
|
|
|
|
|
|
|
|
Cash and cash equivalents at end of period |
|
$ |
441,317 |
|
|
$ |
129,559 |
|
|
|
|
|
|
|
|
See accompanying notes to the consolidated financial statements.
4
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), is an international communications technology company,
headquartered in Suwanee, Georgia. ARRIS operates in one business segment, Communications,
providing a range of customers, primarily cable MSOs, with network and system products and
services, primarily hybrid fiber-coax networks and systems, for the communications industry. ARRIS
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.
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 2007 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 Companys most recently
audited consolidated financial statements and notes thereto included in the Companys Annual Report
on Form 10-K for the year ended December 31, 2006, as filed with the United States Securities and
Exchange Commission (SEC).
Note 2. Impact of Recently Issued Accounting Standards
In July 2006, the FASB issued FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in
Income Taxesan interpretation of FASB Statement No. 109, Accounting for Income Taxes, which
clarifies the accounting for uncertainty in income taxes. FIN 48 prescribes a recognition threshold
and measurement attribute for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. The Interpretation requires that the Company
recognize in the financial statements the impact of certain tax positions, based on the technical
merits of the position. FIN 48 also provides guidance on de-recognition, classification, interest
and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective
for fiscal years beginning after December 15, 2006 with the cumulative effect of the change in
accounting principle recorded as an adjustment to opening retained earnings. ARRIS adopted FIN 48
on January 1, 2007. Based on the Companys initial analysis, FIN 48 did not have a material effect
on ARRIS consolidated results of operations, cash flows or financial position. See Note 12 of
Notes to the Consolidated Financial Statements.
Note 3. Pension Benefits
Components of Net Periodic Pension Benefit Cost
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(in thousands) |
|
|
|
(unaudited) |
|
Service cost |
|
$ |
140 |
|
|
$ |
130 |
|
Interest cost |
|
|
412 |
|
|
|
369 |
|
Expected return on plan assets |
|
|
(319 |
) |
|
|
(281 |
) |
Amortization of prior service cost |
|
|
119 |
|
|
|
119 |
|
Amortization of net (gain) loss |
|
|
25 |
|
|
|
2 |
|
|
|
|
|
|
|
|
Net periodic pension cost |
|
$ |
377 |
|
|
$ |
339 |
|
|
|
|
|
|
|
|
5
Employer Contributions
No minimum funding contributions are required in 2007 under the Companys defined benefit plan.
However, the Company made voluntary contributions to the plan of approximately $19 thousand and $16
thousand for the three month periods ended March 31, 2007 and 2006, respectively.
Note 4. 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 against 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 for the three
months ending March 31, 2007 was as follows (in thousands):
|
|
|
|
|
Balance at December 31, 2006 |
|
$ |
8,234 |
|
Accruals related to warranties (including changes in estimates) |
|
|
872 |
|
Settlements made (in cash or in kind) |
|
|
(1,138 |
) |
|
|
|
|
|
Balance at March 31, 2007 (unaudited) |
|
$ |
7,968 |
|
|
|
|
|
|
Note 5. Restructuring and Impairment Charges
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 March 31, 2007, approximately $3.5 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).
|
|
|
|
|
|
|
(in millions) |
|
Balance as of December 31, 2006 |
|
$ |
3.6 |
|
First quarter payments |
|
|
(0.5 |
) |
Adjustments to accrual |
|
|
0.4 |
|
|
|
|
|
Balance as of March 31, 2007 (unaudited) |
|
$ |
3.5 |
|
|
|
|
|
6
Note 6. Inventories
The components of inventory are as follows, net of reserves (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(unaudited) |
|
|
|
|
|
Raw material |
|
$ |
2,601 |
|
|
$ |
341 |
|
Finished goods |
|
|
75,585 |
|
|
|
93,885 |
|
|
|
|
|
|
|
|
Total net inventories |
|
$ |
78,186 |
|
|
$ |
94,226 |
|
|
|
|
|
|
|
|
Note 7. Property, Plant and Equipment
Property, plant and equipment, at cost, consisted of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
(unaudited) |
|
|
|
|
|
Land |
|
$ |
1,822 |
|
|
$ |
1,822 |
|
Building and leasehold improvements |
|
|
12,846 |
|
|
|
11,470 |
|
Machinery and equipment |
|
|
93,218 |
|
|
|
92,306 |
|
|
|
|
|
|
|
|
|
|
|
107,886 |
|
|
|
105,598 |
|
Less: Accumulated depreciation |
|
|
(79,810 |
) |
|
|
(77,311 |
) |
|
|
|
|
|
|
|
Total property, plant and equipment, net |
|
$ |
28,076 |
|
|
$ |
28,287 |
|
|
|
|
|
|
|
|
Note 8. Long-Term Obligations
Debt and other long-term liabilities consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
March 31, |
|
|
December 31, |
|
|
|
2007 |
|
|
2006 |
|
Other long-term liabilities |
|
$ |
22,360 |
|
|
$ |
20,723 |
|
2.00 % convertible senior notes due 2026 |
|
|
276,000 |
|
|
|
276,000 |
|
|
|
|
|
|
|
|
Total long term debt and other long-term liabilities |
|
$ |
298,360 |
|
|
$ |
296,723 |
|
|
|
|
|
|
|
|
On November 6, 2006, the Company issued $276.0 million of 2% convertible senior notes due
2026. The notes are convertible, at the option of the holder, based on an initial conversion rate,
subject to adjustment, of 62.1504 shares per $1,000 base amount (which represents an initial
conversion price of approximately $16.09 per share of our common stock), into cash up to the
principal amount and, if applicable, shares of the Companys common stock, cash or a combination
thereof. The notes may be converted during any calendar quarter in which the closing price of
ARRIS common stock for 20 or more trading days in a period of 30 consecutive trading days ending
on the last trading day of the immediately preceding calendar quarter exceeds 120% of the
conversion price in effect at that time (which, based on the current conversion price would be
$19.31) and upon the occurrence of certain other events. Upon conversion, the holder will receive
the principal amount in cash and an additional payment, in either cash or stock at the option of
the Company. The additional payment will be based on a formula which calculates the difference
between the initial conversion rate ($16.09) and the market price at the date of the conversion.
As of May 8, 2007, the notes could not be converted by the holders thereof. Interest is payable on
May 15 and November 15 of each year. The Company may redeem the notes at any time on or after
November 15, 2013, subject to certain conditions. As of March 31, 2007 and December 31, 2006,
there were $276.0 million of the notes outstanding.
As of both March 31, 2007 and December 31, 2006, the Company had approximately $3.1 million
outstanding under letters of credit, which are cash collateralized and classified as restricted
cash on the Consolidated Balance Sheets.
As of March 31, 2007, the Company had approximately $22.4 million of other long-term liabilities,
which included $12.4 million related to its accrued pension, $3.6 million related to its deferred
compensation
7
obligations, deferred rental expense of $2.0 million related to landlord funded leasehold
improvements and $4.4 million related to its noncurrent income tax payable. As of December 31,
2006, the Company had approximately $20.7 million of other long-term liabilities, which included
$12.1 million related to its accrued pension, $3.5 million related to its deferred compensation
obligations, $2.1 million related to landlord funded leasehold improvements and $3.0 million
related to its noncurrent income tax payable.
The Company has not paid cash dividends on its common stock since its inception. In 2002, to
implement its shareholder rights plan, the Companys 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 9. Comprehensive Income
Total comprehensive income 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 include the unrealized gain (loss) on marketable securities, unrealized gain
(loss) on derivative instruments qualifying for hedge accounting, and foreign currency translation
adjustments. The components of comprehensive income for the three months ended March 31, 2007 and
2006 are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(unaudited) |
|
|
2007 |
|
2006 |
Net income |
|
$ |
37,644 |
|
|
$ |
20,723 |
|
Changes in the following equity accounts |
|
|
|
|
|
|
|
|
Unrealized gain (loss) on marketable securities |
|
|
48 |
|
|
|
37 |
|
Unrealized gain (loss) on derivative
instruments |
|
|
551 |
|
|
|
(991 |
) |
Translation adjustment |
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income |
|
$ |
38,243 |
|
|
$ |
19,769 |
|
|
|
|
In March 2007, ARRIS concluded that the foreign exchange contract hedges were no longer effective
and discontinued hedge accounting resulting in a reclassification of $551 thousand remaining in
other comprehensive income to the applicable income statement lines.
8
Note 10. Sales Information
The Companys four largest customers (including their affiliates, as applicable) are Comcast, Cox
Communications, Liberty Media International and Time-Warner Cable. Over the past year, certain
customers beneficial ownership may have changed as a result of mergers and acquisitions.
Therefore, the revenue for ARRIS customers for prior periods has been adjusted to include the
affiliates under common control. A summary of sales to these customers for the three month periods
ended March 31, 2007 and 2006 are set forth below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
(unaudited) |
|
|
2007 |
|
2006 |
Comcast |
|
$ |
91,568 |
|
|
$ |
72,541 |
|
% of sales |
|
|
38.9 |
% |
|
|
34.8 |
% |
|
|
|
|
|
|
|
|
|
Cox Communications |
|
$ |
14,846 |
|
|
$ |
25,718 |
|
% of sales |
|
|
6.3 |
% |
|
|
12.3 |
% |
|
|
|
|
|
|
|
|
|
Liberty Media International |
|
$ |
19,307 |
|
|
$ |
21,346 |
|
% of sales |
|
|
8.2 |
% |
|
|
10.2 |
% |
|
|
|
|
|
|
|
|
|
TimeWarner Cable |
|
$ |
22,380 |
|
|
$ |
22,486 |
|
% of sales |
|
|
9.5 |
% |
|
|
10.8 |
% |
No other customer provided more than 10% of total sales for the three months ended March 31, 2007
or 2006.
The Company operates globally and offers products and services that are sold to cable system
operators and telecommunications providers. The Companys 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 months ended March 31, 2007 and 2006 were as
follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
|
March 31, |
|
|
|
(unaudited) |
|
|
|
2007 |
|
|
2006 |
|
Broadband |
|
$ |
80,149 |
|
|
$ |
85,390 |
|
Supplies and CPE |
|
|
155,104 |
|
|
|
122,954 |
|
|
|
|
|
|
|
|
Total sales |
|
$ |
235,253 |
|
|
$ |
208,344 |
|
|
|
|
|
|
|
|
ARRIS sells its products primarily in North America. The Companys international revenue is
generated from Asia Pacific, Europe, Latin America and Canada. The Asia Pacific market primarily
includes China, Japan, Korea, and Taiwan. The European market primarily includes Austria, Belgium,
Germany, Hungary, the Netherlands, Poland, Portugal, Romania, and Switzerland. The Latin American
market primarily includes Argentina, Chile, Colombia, and Mexico. Sales to international customers
were approximately $60.5 million, or 25.7% of total sales, for the three months ended March 31,
2007. International sales during the same period in 2006 were $50.9 million, or 24.4% of total
sales.
As of March 31, 2007, ARRIS held approximately $3.2 million of assets in Ireland (related to its
Com21 facility), comprised of $2.2 million of cash, $0.1 million of prepaid assets and $0.9 million
of fixed assets. As of December 31, 2006, ARRIS held approximately $2.3 million of assets in
Ireland, comprised of $1.5 million of cash and $0.8 million of fixed assets.
9
Note 11. 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 |
|
|
|
March 31, |
|
|
|
(unaudited) |
|
|
|
2007 |
|
|
2006 |
|
Basic: |
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
37,644 |
|
|
$ |
20,702 |
|
Income from discontinued operations |
|
|
|
|
|
|
21 |
|
|
|
|
|
|
|
|
Net income |
|
$ |
37,644 |
|
|
$ |
20,723 |
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
108,467 |
|
|
|
106,227 |
|
|
|
|
|
|
|
|
Basic earnings per share |
|
$ |
0.35 |
|
|
$ |
0.20 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted: |
|
|
|
|
|
|
|
|
Income from continuing operations |
|
$ |
37,644 |
|
|
$ |
20,702 |
|
Income from discontinued operations |
|
|
|
|
|
|
21 |
|
|
|
|
|
|
|
|
Net income |
|
$ |
37,644 |
|
|
$ |
20,723 |
|
|
|
|
|
|
|
|
Weighted average shares outstanding |
|
|
108,467 |
|
|
|
106,227 |
|
Net effect of dilutive equity awards |
|
|
2,521 |
|
|
|
3,118 |
|
|
|
|
|
|
|
|
Total |
|
|
110,988 |
|
|
|
109,345 |
|
|
|
|
|
|
|
|
Diluted earnings per share |
|
$ |
0.34 |
|
|
$ |
0.19 |
|
|
|
|
|
|
|
|
Excluded from the dilutive securities described above are employee stock options to acquire
approximately 2.1 million shares and 0.9 million shares for the three months ended March 31, 2007
and 2006, respectively. These exclusions were made because they were antidilutive.
Note 12. Income Taxes
Adoption of FASB Interpretation No. (FIN) 48, Accounting for Uncertainty in Income Taxesan
interpretation of FASB Statement No. 109, Accounting for Income Taxes.
On January 1, 2007, the Company adopted the provisions of FIN 48, Accounting for Uncertainty in
Income Taxesan Interpretation of FASB Statement No. 109, Accounting for Income Taxes. FIN 48
seeks to clarify the accounting or uncertainty in income taxes recognized in an enterprises
financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes, by
prescribing a recognition threshold and measurement attribute for the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax return. Under
FIN 48, the financial statement effects of a tax position should initially be recognized when it is
more likely than not, based on the technical merits, that the position will be sustained upon
examination. A tax position that meets the more-likely-than-not recognition threshold should
initially and subsequently be measured as the largest amount of tax benefit that has a greater than
50% likelihood of being realized upon ultimate settlement with a taxing authority.
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction, and
various states and foreign jurisdictions. With few exceptions, the Company is no longer subject to
U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years
before 2001. Neither the Company nor any of its subsidiaries are currently under income tax audit,
nor have they received notices of any planned or proposed income tax audits. Additionally, the
Company has no outstanding unpaid income tax assessments for prior income tax audits.
Due to the immaterial amount of the calculated adjustment to the liability for unrecognized tax
benefits arising from the adoption of FIN 48, the Company recorded no adjustment to the January 1,
2007 balance in retained earnings.
At the beginning of 2007, the Companys unrecognized tax benefits totaled approximately $3.1
million, all of which would cause the effective income tax rate to change upon the recognition.
ARRIS does not currently anticipate that the total amount of
unrecognized tax benefits will significantly increase or decrease
within the next twelve months. The Company has recorded no interest or penalty accrual related to payment of these potential tax
liabilities, since it does not anticipate that interest and penalties will be assessed on these
liabilities in the future. The Company intends to classify interest
10
and penalties recognized on the liability for uncertain tax benefits, when it is appropriate to
accrue them, as income tax expense.
Income Tax Expense
In the first quarters of 2007 and 2006, the Company recorded income tax expense of $15.6 million
and $0.6 million, respectively. Below is a summary of the components of the tax expense in each
period (in millions, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2007 |
|
|
2006 |
|
|
|
Income Before Tax |
|
|
Income Tax Expense |
|
|
Effective Tax Rate |
|
|
Income Before Tax |
|
|
Income Tax Expense |
|
|
Effective Tax Rate |
|
Non-Discrete Items |
|
$ |
30.4 |
|
|
$ |
10.1 |
|
|
|
33.3 |
% |
|
$ |
21.3 |
|
|
$ |
0.6 |
|
|
|
2.8 |
% |
Discrete Accounting
Events |
|
|
22.8 |
|
|
|
8.7 |
|
|
|
38.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
Discrete Tax Events Valuation Allowances / FIN 48 Reserves |
|
|
|
|
|
|
(3.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
53.2 |
|
|
$ |
15.6 |
|
|
|
29.3 |
% |
|
$ |
21.3 |
|
|
$ |
0.6 |
|
|
|
2.8 |
% |
|
|
|
In the first quarter of 2007, the Company considered the net gain related to the
termination of the TANDBERG Television acquisition to be discrete in nature in accordance
with the guidance of APB Opinion 28, Interim Financial Reporting and FIN 18, Accounting for
Income Taxes in Interim Periods. As a result, income tax expense was recorded at a
discrete rate of 38.0%. |
|
|
|
|
The termination fee, less expenses, associated with the terminated TANDBERG Television
acquisition is considered capital in nature. As a result, the Company reversed a net of
$4.0 million of valuation allowances associated with deferred tax assets related to net
capital loss carryforwards. Prior to the capital gain created by the terminated
acquisition, the Company considered it more-likely-than-not that capital loss carryforwards
would not be realizable. Additionally, we recorded an additional $0.8 million of discrete
income tax expense related to the TANDBERG transaction. |
|
|
|
|
In the first quarter of 2006, income tax expense was recorded at the federal AMT rate
and state rates, as applicable. Prior to the end of 2006, the Company was in a cumulative
loss position for the prior three fiscal years. As a result, it had recorded a valuation
allowance equivalent to its net deferred tax assets. At the end of 2006, the Company
reversed the majority of the valuation allowance. See the Companys Annual Report on Form
10-K for the year ended December 31, 2006, as filed with the SEC for further discussion. |
The Company anticipates that the effective tax rate for the remainder of 2007 will be approximately
34%.
Note 13. Termination of Proposed Acquisition
In January 2007, ARRIS announced its intention to purchase the shares of TANDBERG Television for
approximately $1.2 billion. In February 2007, another party announced its intent to make a
competing all cash offer for all of TANDBERG Televisions outstanding shares at a higher price than
ARRIS offer. Ultimately, the board of directors of TANDBERG Television recommended to their
shareholders that they accept the other partys bid and our bid lapsed without being accepted.
As part of the agreement with TANDBERG, ARRIS received a break-up fee of $18.0 million. In
conjunction with the proposed transaction, the Company incurred expenses of approximately $7.5
million. ARRIS also realized a gain of approximately $12.3 million on the sale of foreign exchange
contracts the Company purchased to hedge the transaction purchase price.
11
Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
Our long-term goal is to continue to strengthen our position as a leading provider of broadband
access products and services worldwide. Our primary market and focus is cable service providers,
or major system operators (MSOs). Our customers, the MSOs, seek new cost effective revenue
generating services that they can market and sell to their subscribers. The key new services at
this time are digital video, high speed data and IP telephony. Through internal development and
various acquisitions that we have made and may make in the future, we market and sell broadband
access products that enable the delivery of these services by the MSOs, and to potentially other
operators such as satellite service providers and telephone companies.
Our Strategy and Key Highlights
Taking into consideration the industry conditions, to achieve our goal of increasing our position
as a leading worldwide provider of broadband access products and services, 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; and |
|
|
|
|
Maintain and improve an already strong capital and expense structure. |
Below is a summary of some of our key trends, actions and highlights relative to these strategies:
Everything IP, Everywhere is taking hold as MSOs globally have embraced VoIP and are now rapidly
deploying this key new service.
|
|
|
Our sales and operating income, improved year over year as a result of the growth in the
VoIP market and customer acceptance of our products. |
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(in thousands) |
|
|
2007 |
|
2006 |
Sales |
|
$ |
235,253 |
|
|
$ |
208,344 |
|
Operating income |
|
$ |
25,997 |
|
|
$ |
19,609 |
|
Cash, cash equivalents, and short-term
investments |
|
$ |
575,927 |
|
|
$ |
165,809 |
|
|
|
|
We have successfully leveraged our existing market position and industry experience to
increase sales of both EMTA and CMTS products. |
|
|
|
|
We expect demand for CMTS products will continue to increase in future periods as new
services and competition between our customers and their competitors intensifies the need
to provide ever faster download speeds which require additional CMTS capacity and features. |
|
|
|
|
We expect demand for EMTAs to moderate as many of our customers have now passed through
the initial launch stage and have reached a sustainable level of deployments. |
|
|
|
|
Sales of our CBR products, consistent with the expectation that we previously disclosed,
decreased significantly year over year as this product line nears the end of its life. We
anticipate sales of CBR products to continue to decline in 2007. |
We continue to invest significantly in research and development.
|
|
|
We have made significant investments through our research and development efforts in new
products and expansion of our existing products. Our primary focus has been on products
and services that will enable |
12
|
|
|
MSOs to build and operate high-availability, fault-tolerant networks, which allow them to
generate greater revenue by offering high-speed data, IP telephony and digital video. This
success-based capital expenditure is becoming an increasing portion of the cable
operators total capital spending. In addition, some MSOs have expressed interest in
offering bundled wireless telephony as part of their product offering. This product known
as Fixed Mobile Convergence (FMC) will allow cable subscribers to use mobile phones in their
homes, which connects the MSOs VoIP network in the home to the cellular network outside of
the home and roams back and forth seamlessly. We are developing products to support this
new offering. In the first quarter of 2007, we spent approximately $18.1 million on research
and development, or 7.7% of revenue, which compares to $15.1 million or 7.2% of revenue in
the same period last year. We expect to continue to spend similar levels on research and
development in the future. |
|
|
|
Key research and development accomplishments in the first quarter 2007 included: |
|
|
|
Introduction of the TTM502C, a Japanese version of our industry leading
two line battery powered EMTA. |
|
|
|
|
Introduction of the TM552-series EMTA with an integrated 802.11G
wireless base station with wireless mesh networks and VLAN features to support
commercial services. |
|
|
|
|
C4 CMTS Release 5.0 with support for Flexpath wideband data services,
Layer-3 VLAN, lawful intercept, and dynamic load balancing in both the upstream and
downstream. During the first quarter, JComm, a major Japanese MSO, announced the
commercial launch of a 160 megabit data service in several cities using the C4 CMTS
with Flexpath. Layer-3 VLAN support is a major feature supporting business
services over cable. Dynamic load balancing enables the operators to efficiently
manage wide variations in data and VoIP traffic patterns across the day and the
week. |
In January 2007, we announced a bid to purchase TANDBERG Television that ultimately was not
accepted.
|
|
|
In January 2007, we announced our intention to purchase the shares of TANDBERG
Television for approximately $1.2 billion. |
|
|
|
|
On February 26, 2007, a third party, Ericsson, announced its intent to make a competing
all cash offer for all of TANDBERG Televisions outstanding shares at a higher price than
our offer of NOK 96 per share of TANDBERGs common stock. We examined the cost/benefit of
increasing our bid and concluded it was not in the best interest of our shareholders to do
so. Ultimately, the board of directors of TANDBERG Television recommended to their
shareholders that they accept the Ericsson bid and our bid lapsed without being accepted.
As part of our agreement with TANDBERG we received a break-up fee of $18.0 million. We
incurred expenses of approximately $7.5 million related to the deal. We also realized a
gain of approximately $12.3 million on the sale of foreign exchange contracts we purchased
to hedge the transaction purchase price. |
|
|
|
|
We continue to consider other acquisition opportunities in support of our long term
goals. |
At the end of the first quarter we had cash, cash equivalents and short term investments of
approximately $576 million.
|
|
|
Through a combination of our cash resources, anticipated cash generation from operating
activities and our ability to access capital markets we continue to be well positioned to
execute on strategic opportunities. |
Our income statement reflects significantly higher income tax expense year over year and we have
essentially utilized the vast majority of our Net Operating Losses (NOLs).
|
|
|
In the fourth quarter of 2006, given our recent history of cumulative profitability, we
concluded that it was more likely than not that we will generate sufficient income in the
future to utilize deferred tax assets, including NOLs. As a result we reversed a portion
of the valuation allowances that had been recorded related to those deferred tax assets.
Further, through the fourth quarter of 2006 we had sufficient NOLs to limit our actual cash
tax liabilities. Given these facts, we had minimal tax expense of $0.6 million in the
first quarter of 2006 which equated to an effective tax rate of 2.9%. |
|
|
|
|
In the first quarter of 2007 we recorded a tax expense of $15.6 million, which equates
to an effective tax rate of 29.3%. Included in the tax expense are discrete items, per the
guidance of Accounting Principles |
13
|
|
|
Board (APB) Opinion 28, Interim Financial Reporting, related to the terminated TANDBERG
transaction. The foreign exchange gain, break-up fee and deal expenses were considered
discrete items and were recorded at a marginal tax rate of 38.0%. The break-up fee and
expenses are considered to be capital in nature versus ordinary income. As a result, we
reversed a net $3.2 million of deferred tax valuation allowances as we now view it as more
likely than not that we will be able to utilize the capital gain NOLs to offset the capital
gain recorded as a result of the TANDBERG break-up fee net of expenses. |
Significant Customers
The Companys four largest customers (including their affiliates, as applicable) are Comcast, Cox
Communications, Liberty Media International and Time-Warner Cable. Over the past year, certain
customers beneficial ownership may have changed as a result of mergers and acquisitions. Therefore
the revenue for ARRIS customers for prior periods has been adjusted to include the affiliates
under common control. A summary of sales to these customers for the three month periods ended
March 31, 2007 and 2006 are set forth below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
(unaudited) |
|
|
2007 |
|
2006 |
Comcast |
|
$ |
91,568 |
|
|
$ |
72,541 |
|
% of sales |
|
|
38.9 |
% |
|
|
34.8 |
% |
|
|
|
|
|
|
|
|
|
Cox Communications |
|
$ |
14,846 |
|
|
$ |
25,718 |
|
% of sales |
|
|
6.3 |
% |
|
|
12.3 |
% |
|
|
|
|
|
|
|
|
|
Liberty Media International |
|
$ |
19,307 |
|
|
$ |
21,346 |
|
% of sales |
|
|
8.2 |
% |
|
|
10.2 |
% |
|
|
|
|
|
|
|
|
|
TimeWarner Cable |
|
$ |
22,380 |
|
|
$ |
22,486 |
|
% of sales |
|
|
9.5 |
% |
|
|
10.8 |
% |
No other customer provided more than 10% of total sales for the three months ended March 31, 2007
or 2006.
Comparison of Operations for the Three Months Ended March 31, 2007 and 2006
Net Sales
The table below sets forth our net sales for the three months ended March 31, 2007 and 2006, for
each of our product categories (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales |
|
|
|
Three Months Ended |
|
|
Increase (decrease) |
|
|
|
March 31, |
|
|
2007 vs. 2006 |
|
|
|
2007 |
|
|
2006 |
|
|
$ |
|
|
% |
|
Product Category: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Broadband |
|
$ |
80.2 |
|
|
$ |
85.4 |
|
|
$ |
(5.2 |
) |
|
|
(6.1 |
)% |
Supplies & CPE |
|
|
155.1 |
|
|
|
122.9 |
|
|
|
32.2 |
|
|
|
26.2 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total sales |
|
$ |
235.3 |
|
|
$ |
208.3 |
|
|
$ |
27.0 |
|
|
|
13.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14
The table below sets forth our domestic and international sales for the three months ended
March 31, 2007 and 2006 (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net Sales |
|
|
|
Three Months Ended |
|
|
|
|
|
|
March 31, |
|
|
Increase 2007 vs. 2006 |
|
|
|
2007 |
|
|
2006 |
|
|
$ |
|
|
% |
|
Domestic sales |
|
$ |
174.8 |
|
|
$ |
157.4 |
|
|
$ |
17.4 |
|
|
|
11.1 |
% |
International sales |
|
|
60.5 |
|
|
|
50.9 |
|
|
|
9.6 |
|
|
|
18.9 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total sales |
|
$ |
235.3 |
|
|
$ |
208.3 |
|
|
$ |
27.0 |
|
|
|
13.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Broadband Net Sales 2007 vs. 2006
During the first quarter of 2007, sales of our Broadband products decreased by approximately 6.1%
as compared to the first quarter of 2006. This decrease in Broadband revenue resulted from:
|
|
|
As previously disclosed, sales of our CBR product decreased significantly year over year
as this product line nears the end of its life. In the first quarter 2007 we shipped 24
thousand voiceports as compared to 129 thousand in the same period last year. We
anticipate sales of CBR products to continue to decline in 2007. |
|
|
|
|
Sales of our CMTS product increased in the first quarter 2007 as compared to the same
quarter in 2006, partially offsetting the decline in CBR sales. In the first quarter 2007,
we shipped 6,048 downstreams as compared to 4,359 in the first quarter 2006. |
Supplies & CPE Net Sales 2007 vs. 2006
Supplies & CPE product revenue increased by approximately 26.2% in the first quarter of 2007, as
compared to the first quarter of 2006:
|
|
|
Increased sales of our EMTA product provided the majority of the increase as operators
ramped up deployment of VoIP. In the first quarter of 2007, we sold approximately 1.6
million EMTAs in comparison to approximately 1.1 million in the first quarter of 2006. |
Gross Margin
The table below sets forth our gross margin for the three months ended March 31, 2007 and 2006, for
each of our product categories (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Margin $ |
|
|
|
Three Months Ended |
|
|
Increase (decrease) |
|
|
|
March 31, |
|
|
2007 vs. 2006 |
|
|
|
2007 |
|
|
2006 |
|
|
$ |
|
|
% |
|
Product Category: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Broadband |
|
$ |
38.7 |
|
|
$ |
38.9 |
|
|
$ |
(0.2 |
) |
|
|
(0.5 |
)% |
Supplies & CPE |
|
|
30.1 |
|
|
|
17.6 |
|
|
|
12.5 |
|
|
|
71.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
68.8 |
|
|
$ |
56.5 |
|
|
$ |
12.3 |
|
|
|
21.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15
The table below sets forth our gross margin percentages for the three months ended March 31, 2007
and 2006, for each of our product categories:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross Margin % |
|
|
Three Months Ended |
|
Percentage Point |
|
|
March 31, |
|
Increase (Decrease) |
|
|
2007 |
|
2006 |
|
2007 vs. 2006 |
Product Category: |
|
|
|
|
|
|
|
|
|
|
|
|
Broadband |
|
|
48.3 |
% |
|
|
45.6 |
% |
|
|
2.7 |
|
Supplies & CPE |
|
|
19.4 |
% |
|
|
14.3 |
% |
|
|
5.1 |
|
Total |
|
|
29.2 |
% |
|
|
27.1 |
% |
|
|
2.1 |
|
Broadband Gross Margin 2007 vs. 2006
Broadband gross margin dollars were essentially flat year over year while gross margin percentage
improved by 2.7 percentage points:
|
|
|
Despite the decline in Broadband sales year over year, gross margin dollars were
essentially flat as a result of the improvement in gross margin percentage. This margin
percentage improvement was driven by cost reduction programs related to our CMTS product
line coupled with a change in product mix. |
|
|
|
|
In the second quarter of 2007, we anticipate a modest reduction in Broadband gross
margin dollars and percentage. Gross margins dollars are expected to decline as a result
of lower CBR sales. Gross margin percentage is expected to decline as a result of lower
price points for our CMTS product. |
Supplies & CPE Gross Margin 2007 vs. 2006
The Supplies & CPE category gross margin dollars and percentage increased year over year:
|
|
|
The increase in revenues year-over-year significantly impacted gross margin dollars.
This was predominantly related to our increase in sales of EMTAs. |
|
|
|
|
Gross margin percentage improved 5.1 percentage points year over year to 19.4%. In
early 2006 we implemented price reductions related to our EMTA products in conjunction with
agreements entered into with customers that provided us with better market share and
visibility. The reductions were implemented as we were in the process of introducing a
cost reduced version of the product. Until the product was fully introduced in the first
quarter 2007, we recorded lower gross margins. We believe that our Supplies & CPE margins
will continue to improve in 2007, but the improvement is dependent upon the impact of,
among other factors, achievement of planned cost reductions, product mix, and price
pressures. |
Operating Expenses
The table below provides detail regarding our operating expenses (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Expenses |
|
|
|
Three Months Ended |
|
|
|
|
|
|
March 31, |
|
|
Increase (Decrease) 2007 vs. 2006 |
|
|
|
2007 |
|
|
2006 |
|
|
$ |
|
|
% |
|
SG&A |
|
$ |
24.2 |
|
|
$ |
21.3 |
|
|
$ |
2.9 |
|
|
|
13.6 |
% |
R&D |
|
|
18.1 |
|
|
|
15.1 |
|
|
|
3.0 |
|
|
|
19.9 |
% |
Restructuring & impairment |
|
|
0.4 |
|
|
|
0.3 |
|
|
|
0.1 |
|
|
|
33.3 |
% |
Amortization of intangibles |
|
|
0.1 |
|
|
|
0.2 |
|
|
|
(0.1 |
) |
|
|
(50.0 |
)% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
42.8 |
|
|
$ |
36.9 |
|
|
$ |
5.9 |
|
|
|
16.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
16
Selling, General, and Administrative, or SG&A, Expenses
The year over year increase in SG&A expense includes:
|
|
|
Higher employee costs totaling $1.6 million related to higher staffing levels, salary
increases, taxes, other fringe benefits and travel. Over the past twelve months we made
the decision to supplement our staffing particularly in sales and marketing. |
|
|
|
|
We incurred higher bad debt expense and higher legal costs in the first quarter 2007 as
compared to the same period in 2006. The higher legal expenses relate primarily to ongoing
activities related to potential patent claims. See Legal Proceedings in Part II, Item 1
for further discussion. |
Research & Development Expenses
We continue to aggressively invest in research and development. Our primary focus is on products
that allow MSOs to capture new revenues, in particular, high-speed data, VoIP, and Video over IP;
however, we also continue to place emphasis on reducing product costs and test equipment costs.
R&D expense for the three months ended March 31, 2007, increased $3.0 million compared to the same
period in 2006:
|
|
|
In the first quarter of 2007, we incurred a $1.5 million expense for licensing fees
related to our Fixed Mobile Convergence development that did not occur in the first
quarter of 2006. |
|
|
|
|
We incurred higher employee costs totaling $1.5 million related to higher staffing
levels, salary increases, bonus accruals, taxes, other fringe benefits and travel and
living. |
Restructuring and Impairment Charges
On a quarterly basis, we review our existing restructuring accruals and make adjustments if
necessary. For the first three months of 2007 and 2006, we recorded $0.4 million and $0.3 million
related to changes in estimates associated with real estate leases. These adjustments were
required due to changes to the initial estimates used.
Amortization of Intangibles
Intangibles amortization expense for the three months ended March 31, 2007 and 2006 was $0.1
million and $0.2 million, respectively. Our intangible expense represents the amortization of
existing technology acquired as a result of the Com21 acquisition in the third quarter of 2003 and
the cXm Broadband acquisition in the second quarter of 2005.
Other Expense (Income)
Interest Expense
Interest expense for the first quarter 2007 and 2006 was $1.7 million and $0.0 million,
respectively. Interest expense reflects interest and the amortization of deferred finance fees
associated with our $276.0 million 2% convertible subordinated notes.
Loss (Gain) in Foreign Currency
During the
first quarter 2007, we recorded a foreign currency loss of approximately $0.3 million.
During the first quarter 2006, we recorded a foreign currency gain of approximately $0.3 million.
The gains and losses are primarily driven by the fluctuation of the value of the euro, as compared
to the U.S. dollar, as we had several European customers whose receivables and collections are
denominated in euros. We have implemented a hedging strategy to mitigate the monetary exchange
fluctuations from the time of invoice to the time of payment, and have occasionally entered into
forward contracts based on a percentage of expected foreign currency receipts.
Interest Income
Interest income during the first quarter of 2007 and 2006 was $6.5 million and $1.5 million,
respectively. The income reflects interest earned on cash, cash equivalents and short term
investments, which increased year over year by approximately $410.0 million, thus resulting in
higher interest income.
17
Gains Related to Terminated Acquisition, Net of Expenses
In the first quarter of 2007 we recorded a net gain of $22.8 million related to the proposed
TANDBERG Television acquisition which was terminated in March 2007. The gain consisted of a
termination fee of $18.0 million, gains of $12.3 million on foreign exchange contracts we entered
into to hedge the purchase, offset by expenses incurred of approximately $7.5 million.
Other Expense (Income)
Other
expense (income) for the three months ended March 31, 2007 and 2006 was $0.1 million in each period and relates primarily to bank fees.
Income Taxes
In the first quarters of 2007 and 2006, we recorded income tax expense of $15.6 million and $0.6
million, respectively. Below is a summary of the components of the tax expense in each period (in
thousands, except for percentages):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
|
|
|
|
2007 |
|
|
|
|
|
|
|
|
|
|
2006 |
|
|
|
|
|
|
Income |
|
|
Income |
|
|
Effective |
|
|
Income |
|
|
Income |
|
|
Effective |
|
|
|
Before Tax |
|
|
Tax Expense |
|
|
Tax Rate |
|
|
Before Tax |
|
|
Tax Expense |
|
|
Tax Rate |
|
Non-Discrete Items |
|
$ |
30.4 |
|
|
$ |
10.1 |
|
|
|
33.3 |
% |
|
$ |
21.3 |
|
|
$ |
0.6 |
|
|
|
2.8 |
% |
Discrete Accounting
Events |
|
|
22.8 |
|
|
|
8.7 |
|
|
|
38.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
Discrete Tax Events Valuation
Allowances / FIN 48 Reserves |
|
|
|
|
|
|
(3.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
53.2 |
|
|
$ |
15.6 |
|
|
|
29.3 |
% |
|
$ |
21.3 |
|
|
$ |
0.6 |
|
|
|
2.8 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In the first quarter of 2007, we considered the net gain related to the termination of
the proposed TANDBERG Television acquisition to be discrete in nature in accordance with
the guidance of APB Opinion 28 and FIN 18 Accounting for Income Taxes in Interim Periods.
As a result, income tax expense was recorded at a discrete rate of 38.0%. |
|
|
|
|
The termination fee, less expenses, associated with the terminated TANDBERG Television
acquisition is considered capital in nature. As a result, we reversed a net of $4.0
million of valuation allowances associated with deferred tax assets related to net capital
loss carryforwards. Prior to the capital gain created by the terminated acquisition, we
considered it more-likely-than-not that capital loss carryforwards would not be realizable.
Additionally, we recorded an additional $0.8 million of discrete income tax expense
related to the TANDBERG transaction. |
|
|
|
|
In the first quarter of 2006, income tax expense was recorded at the federal AMT rate
and state rates, as applicable. Prior to the end of 2006, we were in a cumulative loss
position for the prior three fiscal years. As a result, we had recorded a valuation
allowance equivalent to our net deferred tax assets. At the end of 2006, we reversed the
majority of the valuation allowance. See our Annual Report on Form 10-K for the year ended
December 31, 2006, as filed with the SEC for further discussion. |
We anticipate that the effective tax rate for the remainder of 2007 will be approximately 34%.
18
Financial Liquidity and Capital Resources
Overview
One of our key strategies is to maintain and improve our capital structure. The key metrics we
focus on are summarized in the table below:
Liquidity & Capital Resources Data
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
2007 |
|
2006 |
|
|
(in millions, except DSO and turns) |
Key Working Capital Items |
|
|
|
|
|
|
|
|
Cash provided by (used in)
operating activities |
|
$ |
(4.0 |
) |
|
$ |
31.3 |
|
Cash, cash equivalents, and
short-term investments |
|
$ |
575.9 |
|
|
$ |
165.8 |
|
Accounts receivable, net |
|
$ |
125.8 |
|
|
$ |
91.4 |
|
Days Sales Outstanding (DSOs) |
|
|
47 |
|
|
|
38 |
|
Inventory |
|
$ |
78.2 |
|
|
$ |
99.7 |
|
Inventory turns |
|
|
7.7 |
|
|
|
5.7 |
|
Inventory & Accounts Receivable
We place a strong emphasis on working capital management, particularly with respect to accounts
receivable and inventory. We use turns to evaluate inventory management and days sales
outstanding, or DSOs, to evaluate accounts receivable management.
Summary of Current Liquidity Position and Potential for Future Capital Raising
We believe our current liquidity position, including approximately $575.9 million of cash, cash
equivalents, and short-term investments on hand as of March 31, 2007, together with the prospects
for continued generation of cash from operations, are adequate for our short- and medium-term
business needs. However, a key part of our overall long-term strategy may be implemented through
acquisitions. Either in order to be prepared to make acquisitions generally or in connection with
particular acquisitions, it is possible that we will raise capital through private, or public,
share or debt offerings. We believe we have the ability to access the capital markets upon
commercially reasonable terms.
Commitments
Our contractual obligations are disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2006. There has been no material change to our contractual obligations during the
first quarter of 2007.
Cash Flow
Below is a table setting forth the key line items of our Consolidated Statements of Cash Flows (in
millions):
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
March 31, |
|
|
2007 |
|
2006 |
Cash provided (used) by operating activities |
|
$ |
(4.0 |
) |
|
$ |
31.3 |
|
Cash provided (used) by investing activities |
|
$ |
(26.2 |
) |
|
$ |
16.6 |
|
Cash provided by financing activities |
|
$ |
9.9 |
|
|
$ |
6.4 |
|
Net increase (decrease) in cash |
|
$ |
(20.3 |
) |
|
$ |
54.3 |
|
19
Operating Activities:
Below are the key line items affecting cash from operating activities (in millions):
|
|
|
|
|
|
|
|
|
|
|
For the Three Months Ended |
|
|
March 31, |
|
|
2007 |
|
2006 |
Net income after non-cash adjustments |
|
$ |
25.0 |
|
|
$ |
25.0 |
|
(Increase)/Decrease in accounts receivable |
|
|
(10.8 |
) |
|
|
(7.6 |
) |
(Increase)/Decrease in inventory |
|
|
16.0 |
|
|
|
14.2 |
|
(Increase)/Decrease in accounts payable
and accrued liabilities |
|
|
(24.8 |
) |
|
|
(3.6 |
) |
All other net |
|
|
(9.4 |
) |
|
|
3.3 |
|
|
|
|
Cash provided by (used in) operating
activities |
|
$ |
(4.0 |
) |
|
$ |
31.3 |
|
|
|
|
|
|
|
Our inventory levels decreased in the first quarter of 2007 as compared to the same
period in 2006. We had less CBR inventory as this product nears end of life. We also had
less EMTA inventory due to timing. Our first quarter 2007 inventory turns were 7.7, as
compared to our first quarter 2006 turns of 5.7. We expect our inventory level to modestly
increase in 2007. |
|
|
|
|
Our accounts receivable level increased year over year reflecting higher sales. Our
first quarter 2007 DSO was 47 days as compared to our first quarter 2006 DSO of 38 days. |
Investing Activities:
Below are the key line items affecting investing activities (in millions):
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
|
March 31, |
|
|
2007 |
|
2006 |
Capital expenditures |
|
$ |
(2.3 |
) |
|
$ |
(1.4 |
) |
TANDBERG break-up fee, net of expenses paid |
|
|
10.9 |
|
|
|
|
|
Cash paid for hedge related to terminated
TANDBERG acquisition |
|
|
(26.5 |
) |
|
|
|
|
Cash proceeds from hedge related to terminated
TANDBERG acquisition |
|
|
38.7 |
|
|
|
|
|
Purchases of short-term investments |
|
|
(128.1 |
) |
|
|
|
|
Disposals of short-term investments |
|
|
81.1 |
|
|
|
18.0 |
|
|
|
|
Cash provided by (used in) investing activities |
|
$ |
(26.2 |
) |
|
$ |
16.6 |
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|
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|
Capital Expenditures
Capital expenditures are mainly for test equipment, and computing equipment. We anticipate
investing approximately $10 to $12 million in fiscal year 2007.
Gains Related to Terminated TANDBERG Acquisition, Net of Expenses -
Net proceeds of $22.8 million were raised as a result of the terminated TANDBERG acquisition. The
components include a termination fee of $18.0 million, gains on foreign exchange contracts we
entered into to hedge the purchase of $12.3 million, offset by expenses incurred of approximately
$7.5 million. Of the $7.5 million of expenses, approximately $7.2 million had been paid as of
March 31, 2007 and the remaining $0.3 million was in an accrual to be paid.
Purchases/Disposals of Short-Term Investments
This represents purchases and disposals of auction rate securities held as short-term investments.
20
Financing Activities:
Below are the key line items affecting our financing activities (in millions):
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For the Three Months Ended |
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|
March 31, |
|
|
|
2007 |
|
|
2006 |
|
Excess tax benefits from stock-based
compensation plans |
|
$ |
4.9 |
|
|
$ |
0.2 |
|
Proceeds from issuance of stock |
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|
5.0 |
|
|
|
6.2 |
|
|
|
|
|
|
|
|
Cash provided by financing activities |
|
$ |
9.9 |
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|
$ |
6.4 |
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|
Cash provided from issuance of stock for both quarters presented is primarily related to the
exercise of stock options by employees.
Interest Rates
As of March 31, 2007, we did not have any floating rate indebtedness or outstanding interest rate
swap agreements.
Foreign Currency
A significant portion of our products are manufactured or assembled in Mexico, Taiwan, China, the
Philippines, and other foreign countries. Our sales into international markets have been and are
expected in the future to be an important part of our business. These foreign operations are
subject to the usual risks inherent in conducting business abroad, including risks with respect to
currency exchange rates, economic and political destabilization, restrictive actions and taxation
by foreign governments, nationalization, the laws and policies of the United States affecting
trade, foreign investment and loans, and foreign tax laws.
We have certain international customers who are billed in their local currency. We use a hedging
strategy and enter into forward or currency option contracts based on a percentage of expected
foreign currency revenues. The percentage can vary, based on the predictability of the revenues
denominated in euros.
As of March 31, 2007, we had 14.8 million euros of option contracts outstanding that expire in 2007
as compared to the same period in 2006 when we had 20.5 million euros of options contracts
outstanding. During the first quarter of 2007, we recognized a net
loss of $0.6 million related to
option contracts compared to a net gain of $0.4 million for the same period in 2006.
Financial Instruments
In the ordinary course of business, we, from time to time, will enter into financing arrangements,
such as letters of credit, with customers. These agreements could include the granting of extended
payment terms that result in longer collection periods for accounts receivable and slower cash
inflows from operations and/or could result in the deferral of revenue. As of March 31, 2007 and
December 31, 2006, we had approximately $3.1 million outstanding at the end of each period under
letters of credit that were cash collateralized. The cash collateral is reported as restricted
cash.
Cash and Short-Term Investments
Our cash and cash equivalents (which are highly-liquid investments with an original maturity of
three months or less) are primarily held in money market funds that pay either taxable or
non-taxable interest. We hold short-term investments consisting of debt securities classified as
available-for-sale, which are stated at estimated fair value. These debt securities consist of
auction rate securities paying either taxable or non-taxable interest. These investments are on
deposit with three major financial institutions.
Investments
We hold certain investments in the common stock of publicly traded companies totaling approximately
$0.2 million at the end of March 31, 2007. We did not hold any of these investments at the end of
December 31, 2006.
21
Changes in the market value of these securities and gain or losses on related sales of these
securities are recognized income. We recorded pre-tax losses of approximately $19 thousand during
the three months ended March 31, 2007.
We offered a deferred compensation arrangement, which allowed certain employees to defer a portion
of their earnings and defer the related income taxes. As of December 31, 2004, the plan was frozen
and no further contributions are allowed. The deferred earnings are invested in a rabbi trust,
and are accounted for in accordance with Emerging Issues Task Force Issue No. 97-14, Accounting for
Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested. A
rabbi trust is a funding vehicle used to protect deferred compensation benefits from various events
(but not from bankruptcy or insolvency). At both March 31, 2007 and December 31, 2006, ARRIS had
an accumulated unrealized gain related to the rabbi trust of approximately $1.3 million included in
other comprehensive income.
Capital Expenditures
Capital expenditures are made at a level designed to support the strategic and operating needs of
the business. ARRIS capital expenditures were $2.3 million in the first quarter 2007 as compared
to $1.4 million in the first quarter 2006. ARRIS had no significant commitments for capital
expenditures at March 31, 2007. Management expects to invest approximately $10 to $12 million in
capital expenditures for the fiscal year 2007.
Critical Accounting Estimates
The accounting and financial reporting policies of the ARRIS are in conformity with U.S. generally
accepted accounting principles. The preparation of financial statements in conformity with U.S.
generally accepted accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of contingent assets and
liabilities at the date of the financial statements, and the reported amounts of revenues and
expenses during the reporting period. Management has discussed the development and selection of
the Companys critical accounting estimates with the audit committee of the Companys Board of
Directors and the audit committee has reviewed the Companys related disclosures. Our critical
accounting policies and estimates are disclosed extensively in our Form 10-K for the year ended
December 31, 2006, as filed with the SEC. Our critical accounting estimates have not changed in
any material respect during the three months ended March 31, 2007. However, upon the adoption of
FIN 48 on January 1, 2007, ARRIS has adopted the following critical policy with regards to income
taxes.
Income Taxes
Our annual provision for income taxes and determination of the deferred tax assets and liabilities
require management to assess uncertainties, make judgments regarding outcomes, and utilize
estimates. To the extent the final outcome differs from initial assessments and estimates, future
adjustments to our tax assets and liabilities will be necessary. There are two primary areas
within accounting for income taxes where the Company must utilize its judgment in identifying and
measuring income tax liabilities. First, the Company is required to record a valuation allowance
when it is more likely than not that all or a portion of its deferred tax assets will not be
realized. Second, since the Company adopted the provisions of FASB Interpretation No. (FIN) 48,
Accounting for Uncertainty in Income Taxes an interpretation of FASB Statement No. 109,
Accounting for Income Taxes as of January 1, 2007, the Company must regularly assess the
applicability of FIN 48. FIN 48 seeks to clarify the accounting for uncertainty in income taxes
recognized in an enterprises financial statements by prescribing a recognition threshold and
measurement criteria for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. See Notes 2 and 12 of Notes to the Consolidated
Financial Statements for further details regarding the adoption of this interpretation. The
Company continually reviews both the adequacy of the valuation allowance related to its deferred
tax assets and the sufficiency of its accrual related to uncertain tax positions to re-evaluate the
many judgments and estimates utilized in establishing these two types of accounting accruals.
22
Forward-Looking Statements
We make numerous forward-looking statements throughout this report, including statements with
respect to strategy, expected changes in sales levels of different products, product development
plans, gross margin levels, expense levels, income taxes, acquisitions and liquidity. Frequently
these statements are introduced with words such as may, expect, likely, will, believe,
estimate, project, anticipate, intend, plan, continue, could be, or predict.
Actual results may differ materially from those suggest by the forward-looking statements that we
make for a number of reasons including those described in Part II, Item 1A, Risk Factors of this
Report.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including interest rates and foreign currency rates. The
following discussion of our risk-management activities includes forward-looking statements that
involve risks and uncertainties. Actual results could differ materially from those projected in the
forward-looking statements.
We have an investment portfolio of auction rate securities, both taxable and non-taxable, that are
classified as available-for-sale securities. Although these securities have maturity dates of 15
to 30 years, they have characteristics of short-term investments as the interest rates reset every
7, 28, or 35 days and we have the potential to liquidate them in an auction process. Due to the
short duration of these investments, a movement in market interest rates would not have a material
impact on our operating results.
A significant portion of our products are manufactured or assembled in China, Mexico, the
Philippines, Taiwan, and other countries outside the United States. Our sales into international
markets have been and are expected in the future to be an important part of our business. These
foreign operations are subject to the usual risks inherent in conducting business abroad, including
risks with respect to currency exchange rates, economic and political destabilization, restrictive
actions and taxation by foreign governments, nationalization, the laws and policies of the United
States affecting trade, foreign investment and loans, and foreign tax laws.
We have certain international customers who are billed in their local currency. Changes in the
monetary exchange rates may adversely affect our results of operations and financial condition. To
manage the volatility relating to these typical business exposures, we may enter into various
derivative transactions, when appropriate. We do not hold or issue derivative instruments for
trading or other speculative purposes. The euro and the yen are the predominant currencies of
those customers who are billed in their local currency. Taking into account the effects of foreign
currency fluctuations of the euro and the yen versus the dollar, a hypothetical 10% weakening of
the U.S. dollar (as of March 31, 2007) would provide a gain on foreign currency of approximately
$1.2 million. Conversely, a hypothetical 10% strengthening of the U.S. dollar would provide a loss
on foreign currency of approximately $1.2 million. As of March 31, 2007, we had no material
contracts, other than accounts receivable, denominated in foreign currencies.
We regularly review our forecasted sources and uses of foreign currencies and enter into option
contracts when appropriate. These contracts are marked-to-market at the close of every reporting
period and the resultant gain or loss is included in net income. As of March 31, 2007, we had
option collars outstanding with notional amounts totaling 14.8 million euros, which mature through
September 2007.
Item 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our principal executive officer and
principal financial officer evaluated the effectiveness of our disclosure controls and procedures
(as such term is defined in Rules 13a-15(e) under the Securities Exchange Act of 1934) as of the
end of the period covered by this report (the Evaluation Date). Based on that evaluation, such
officers concluded that, as of the Evaluation Date, our disclosure controls and procedures were
effective as contemplated by the Act.
(b) Changes in Internal Control over Financial Reporting. Our principal executive officer and
principal financial officer evaluated the changes in our internal control over financial reporting
that occurred during the most recent fiscal quarter. Based on that evaluation, our principal
executive officer and principal financial officer concluded that there had been no change in our
internal control over financial reporting during the most recent fiscal quarter
23
that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
From time to time, ARRIS is involved in claims, disputes, litigation or legal proceedings incident
to the ordinary course of its business, such as employment matters, environmental proceedings,
contractual disputes and intellectual property disputes. Except as described below, ARRIS is not a
party to, nor has not been party to, during the period covering the previous 3 months, any
governmental, legal or arbitration proceedings, including such proceedings which are pending or
threatened of which ARRIS is aware, which may have, or have had in the recent past, significant
effects on ARRIS financial position or profitability.
Currently, ARRIS is a party in two related proceedings pending in federal court in Texas and
California. ARRIS has sought to clarify its intellectual property rights to the following four
United States Patents: No. Re 35,774 (revised no. 5,347,304); No. 5,586,121; No. 5,818, 845; and
No. 5,828,655 (the Patents). In both suits, ARRIS is seeking a declaratory judgment that it has a
nonexclusive license to, and has the right to gain ownership rights in, the Patents. ARRIS
allegations are based on the provisions of a January 11, 1999, license agreement (License
Agreement) between the Patents former owner, Hybrid Networks, Inc. (HNI), and ARRIS
predecessor in interest, Com21, Inc. (Com21). The License Agreement, which bound both parties
successors, provided Com21 with a nonexclusive license to use, and a right-of-first-refusal to
purchase, the Patents. Subsequently, ARRIS purchased substantially all of the assets of
Com21, including all of Com21s IP assets for the cable modem termination systems business, which,
ARRIS believes, includes the rights under the License Agreement. Thus, ARRIS has argued in both
cases that it has succeeded to Com21s licensing and ownership rights to the Patents under the
terms of the License Agreement. Hybrid Patents, Inc. (the party claiming current ownership of the
patents) has sued or has made other claims against other customers of ours, and these customers
either have or are expected to request indemnification from us.
The cases are summarized as follows:
Hybrid Patents, Inc. v. Charter Communications, Inc., Case No. 2:05-CV-436 (E.D. Tex). Charter
Communications, Inc. (Charter) is one of ARRIS customers, in ARRIS business of selling cable
modem termination systems. Hybrid Patents, Inc. (Hybrid Patents) claims that it succeeded in
interest as owner of the Patents from HNI. On September 13, 2005, Hybrid Patents sued Charter in
this case for infringement of the Patents. Charter responded by bringing a third-party claim for
indemnification against ARRIS and nine of Charters other suppliers, alleging that ARRIS and/or the
other suppliers were responsible for any infringement due to products which infringed the Patents
that any or all of them sold to Charter. After ARRIS answered, and filed a third-party claim
against Hybrid Patents in which ARRIS asserted its rights to the Patents, Hybrid Patents brought a
third-party claim for direct and contributory patent infringement against ARRIS. ARRIS has denied
that it is liable for any patent infringement claims. The Texas court held a Markman hearing during
which the judge requested summary judgment briefs from the parties addressing the Patents ownership
issue.
ARRIS International, Inc. v. Hybrid Patents, Inc., Hybrid Networks, Inc., HYBR Wireless Industries,
Inc., London Pacific Life & Annuity Company, and Carol Wu, Trustee of the Estate of Com21, Inc. ,
Case No. 03-54533MM, Chapter 7, Adversary Proceeding in Bankruptcy, Adv. No. 06-5098MM (Bankr. N.D.
Cal.). ARRIS brought this claim after learning that its customer, Charter, was being sued for
infringement of the Patents in Texas, but before being joined as a party in the Texas litigation.
In this suit, ARRIS seeks to have the bankruptcy court declare that Com21 passed all of its rights
under the License Agreement to its successor in interest, ARRIS, and that ARRIS thus has a
nonexclusive license to, and ownership rights in, the Patents. The court has denied a motion to
dismiss the case, and a motion to transfer the case to the Texas jurisdiction, brought by Hybrid
Patents, HYBR Wireless Industries, Inc., and London Pacific Life & Annuity Company.
In the above-mentioned cases it is premature to assess the likelihood of a favorable or unfavorable
outcome. In the event of an adverse outcome, ARRIS and other similarly situated suppliers of DOCSIS
compliant products could be required to indemnify its customers, pay royalties, and/or cease using
certain technology. Also, an adverse outcome may require a change in the DOCSIS standards to avoid
using the patented technology.
24
In the following cases, ARRIS is not a party, but the cases may have an effect on ARRIS operations
or financial position:
Commencing in 2005, Rembrandt Technologies, LP filed a series of at least seven lawsuits in the
Federal Court for the Eastern District of Texas against Charter Communications, Inc, Time Warner
Cable, Inc., Comcast Corporation and others alleging patent infringement related to the cable
systems operators use of data transmission, video, cable modem, voice-over-internet, and other
technologies and applications. Although ARRIS is not a defendant in any of these lawsuits, its
customers are, and its customers either have requested indemnification from, or are expected to
request indemnification from, ARRIS and the other manufacturers of the equipment that is alleged to
infringe. ARRIS is party to a joint defense agreement with respect to one of the lawsuits and has
various understandings with the defendants in the remaining lawsuits with respect to cost sharing.
The first of the lawsuits is scheduled to be tried in July 2007. The defendants are vigorously
contesting the lawsuits; however, it is premature to assess the likelihood of a favorable outcome.
In the event of an adverse outcome, ARRIS and other similarly situated suppliers of DOCSIS
compliant products could be required to indemnify its customers, pay royalties, and/or cease using
certain technology. Also, an adverse outcome may require a change in the DOCSIS standards to avoid
using the patented technology.
On February 2, 2007, GPNE Corp. (GPNE) filed a patent infringement lawsuit against Time Warner Inc.
(TWI), Comcast and Charter, in the United States District Court for the Eastern District of Texas.
In its suit, GPNE alleges that certain DOCSIS standard products and services sold or used by the
defendants infringe a GPNE patent. To date ARRIS has not been named a defendant, nor has ARRIS
received a formal request for indemnification. However, we believe it is likely the defendants will
make indemnification requests, as well as a request to contribute to the legal costs and expenses
of the litigation. It is premature to assess the likelihood of a favorable outcome. In the event of
an adverse outcome, ARRIS and other similarly situated suppliers of DOCSIS compliant products could
be required to indemnify its customers, pay royalties, and/or cease using certain technology. Also,
an adverse outcome may require a change in the DOCSIS standards to avoid using the patented
technology.
ARRIS intends to vigorously defend all claims that may arise against it in connection with the
above described matters.
Item 1A. RISK FACTORS
Our business is dependent on customers capital spending on broadband communication systems, and
reductions by customers in capital spending would adversely affect our business.
Our performance is dependent on customers capital spending for constructing, rebuilding,
maintaining or upgrading broadband communications systems. Capital spending in the
telecommunications industry is cyclical. A variety of factors affect the amount of capital
spending, and, therefore, our sales and profits, including:
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General economic conditions; |
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Availability and cost of capital; |
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Governmental regulation; |
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Demands for network services; |
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Competition from other providers of broadband and high speed services; |
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Acceptance of new services offered by our customers; and |
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Real or perceived trends or uncertainties in these factors. |
Several of our customers have accumulated significant levels of debt. In addition, the bankruptcy
filing of Adelphia in June 2002 heightened concerns in the financial markets about the viability of
the domestic cable industry. These historic events, coupled with the current uncertainty and
volatility in the capital markets, has affected the market values of domestic cable operators and
may restrict their access to capital in the future. Even if the financial health of our customers
remains intact, we cannot assure you that these customers will be in a position to purchase new
equipment at levels we have seen in the past.
25
The markets in which we operate are intensely competitive, and competitive pressures may adversely
affect our results of operations.
The markets for broadband communication systems are extremely competitive and dynamic, requiring
the companies that compete in these markets to react quickly and capitalize on change. This will
require us to retain skilled and experienced personnel as well as to deploy substantial resources
toward meeting the ever-changing demands of the industry. We compete with national and
international manufacturers, distributors and wholesalers including many companies larger than
ARRIS. Our major competitors include:
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Big Band Networks; |
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Cisco Systems, Inc.; |
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Motorola, Inc.; and |
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TVC Communications, Inc. |
The rapid technological changes occurring in the broadband markets may lead to the entry of new
competitors, including those with substantially greater resources than our own. Because the
markets in which we compete are characterized by rapid growth and, in some cases, low barriers to
entry, smaller niche market companies and start-up ventures also may become principal competitors
in the future. Actions by existing competitors and the entry of new competitors may have an
adverse effect on our sales and profitability. The broadband communications industry is further
characterized by rapid technological change. In the future, technological advances could lead to
the obsolescence of some of our current products, which could have a material adverse effect on our
business.
Further, many of our larger competitors are in a better position to withstand any significant
reduction in capital spending by customers in these markets. They often have broader product lines
and market focus and therefore will not be as susceptible to downturns in a particular market. In
addition, several of our competitors have been in operation longer than we have been, and therefore
they have more established relationships with domestic and foreign broadband service users. We may
not be able to compete successfully in the future, and competition may negatively impact our
business.
Consolidations in the telecommunications industry could result in delays or reductions in purchases
of products, which would have a material adverse effect on our business.
The telecommunications industry has experienced the consolidation of many industry participants,
and this trend may continue. For instance, in November 2005, Cox Communications announced a
definitive agreement to sell some of its cable television systems to Cebridge Connections; this
transaction was completed in May 2006. Also, in April 2005, Adelphia announced that its assets
were going to be acquired by Comcast and Time Warner; this transaction was completed in July 2006.
When consolidations occur, it is possible that the acquirer will not continue using the same
suppliers, thereby possibly resulting in an immediate or future elimination of sales opportunities
for us or our competitors, depending upon who had the business initially. Consolidations also
could result in delays in purchasing decisions by the merged businesses. The purchasing decisions
of the merged companies could have a material adverse effect on our business.
Mergers among the supplier base also have increased, and this trend may continue. For example, in
February 2006, Cisco Systems, Inc. completed its acquisition of Scientific-Atlanta, Inc. In April
2007, Ericsson completed its acquisition of TANDBERG Television ASA. In April 2007, Motorola, Inc.
announced its intention to acquire Terayon, Inc. Larger combined companies with pooled capital
resources may be able to provide solution alternatives with which we would be put at a disadvantage
to compete. The larger breadth of product offerings by these consolidated suppliers could result
in customers electing to trim their supplier base for the advantages of one-stop shopping solutions
for all of their product needs. Consolidation of the supplier base could have a material adverse
effect on our business.
Acquisitions can involve significant risks.
We routinely consider acquisitions of, or investments in, other businesses, including acquisitions
that could be significant relative to the size of our business. There are a number of risks
attendant to any acquisition, including the possibility that we will overvalue the assets to be
purchased, that any acquired business may have liabilities of which we are unaware or which we are
not able to assess at the time of the acquisition, that we will not be able to successfully
integrate and retain a significant number of new employees at a single time, our ability to combine
and integrate accounting and other systems, and our ability to capitalize on the expected
technological and customer opportunities. In addition, we might incur substantial additional
indebtedness in order to finance an acquisition, which could require additional payments in the
future, and we might issue common stock or other
26
securities to pay for an acquisition, in which event the acquisition may ultimately prove to be
dilutive to our current stockholders. As a result, the impact of any acquisition on our future
performance may not be as favorable as expected and actually may be adverse. Further, no
assurances can be provided that we will complete any such acquisition.
Our business has primarily come from several key customers. The loss of one of these customers or
a significant reduction in sales to one of these customers would have a material adverse effect on
our business.
Our four largest customers (including their affiliates, as applicable) are Comcast, Cox
Communications, Liberty Media International, and Time Warner Cable. For the three months ended
March 31, 2007, sales to Comcast accounted for approximately 38.9%, sales to Cox Communications
accounted for approximately 6.3%, sales to Liberty Media International accounted for approximately
8.2%, and sales to Time Warner Cable accounted for approximately 9.5% of our total revenue. The
loss of any of these customers, or one of our other large customers, or a significant reduction in
the products or services provided to any of them would have a material adverse impact on our
business.
The broadband products that we develop and sell are subject to technological change and a trend
towards open standards, which may impact our future sales and margins.
The broadband products we sell are subject to continuous technological evolution. Further, the
cable industry has and will continue to demand a move towards open standards. The move towards
open standards is expected to increase the number of MSOs that will offer new services, in
particular, telephony. This trend also is expected to increase the number of competitors and
drive capital costs per subscriber deployed down. These factors may adversely impact both our
future revenues and margins.
Products currently under development may fail to realize anticipated benefits.
Rapidly changing technologies, evolving industry standards, frequent new product introductions and
relatively short product life cycles characterize the markets for our products. The technology
applications that we currently are developing may not ultimately be successful. Even if the
products in development are successfully brought to market, they may not be widely used or we may
not be able to successfully capitalize on their technology. To compete successfully, we must
quickly design, develop, manufacture and sell new or enhanced products that provide increasingly
higher levels of performance and reliability. However, we may not be able to successfully develop
or introduce these products if our products:
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Are not cost-effective; |
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Are not brought to market in a timely manner; |
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Fail to achieve market acceptance; or |
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Fail to meet industry certification standards. |
Furthermore, our competitors may develop similar or alternative technologies that, if successful,
could have a material adverse effect on us. Our strategic alliances are based on business
relationships that have not been the subject of written agreements expressly providing for the
alliance to continue for a significant period of time. The loss of a strategic relationship could
have a material adverse effect on the progress of new products under development with that third
party.
Our success depends in large part on our ability to attract and retain qualified personnel in all
facets of our operations.
Competition for qualified personnel is intense, and we may not be successful in attracting and
retaining key personnel, which could impact our ability to maintain and grow our operations. Our
future success will depend, to a significant extent, on the ability of our management to operate
effectively. In the past, competitors and others have attempted to recruit our employees and in
the future, their attempts may continue. The loss of services of any key personnel, the inability
to attract and retain qualified personnel in the future or delays in hiring required personnel,
particularly engineers and other technical professionals, could negatively affect our business.
27
We are substantially dependent on contract manufacturers, and an inability to obtain adequate and
timely delivery of supplies could adversely affect our business.
Many components, subassemblies and modules necessary for the manufacture or integration of our
products are obtained from a sole supplier or a limited group of suppliers. Our reliance on sole
or limited suppliers, particularly foreign suppliers, and our reliance on subcontractors involves
several risks including a potential inability to obtain an adequate supply of required components,
subassemblies or modules and reduced control over pricing, quality and timely delivery of
components, subassemblies or modules. Historically, we have not generally maintained long-term
agreements with any of our suppliers or subcontractors. An inability to obtain adequate deliveries
or any other circumstance that would require us to seek alternative sources of supply could affect
our ability to ship products on a timely basis. Any inability to reliably ship our products on
time could damage relationships with current and prospective customers and harm our business.
Our international operations may be adversely affected by any decline in the demand for broadband
systems designs and equipment in international markets.
Sales of broadband communications equipment into international markets are an important part of our
business. The entire line of our products is marketed and made available to existing and potential
international customers. In addition, United States broadband system designs and equipment are
increasingly being employed in international markets, where market penetration is relatively lower
than in the United States. While international operations are expected to comprise an integral
part of our future business, international markets may no longer continue to develop at the current
rate, or at all. We may fail to receive additional contracts to supply equipment in these markets.
Our international operations may be adversely affected by changes in the foreign laws in the
countries in which our manufacturers and assemblers have plants.
A significant portion of our products are manufactured or assembled in China, Ireland, Mexico, the
Philippines, and other countries outside of the United States. The governments of the foreign
countries in which our products are manufactured may pass laws that impair our operations, such as
laws that impose exorbitant tax obligations or nationalize these manufacturing facilities.
We face risks relating to currency fluctuations and currency exchange.
We may encounter difficulties in converting our earnings from international operations to U.S.
dollars for use in the United States. These obstacles may include problems moving funds out of the
countries in which the funds were earned and difficulties in collecting accounts receivable in
foreign countries where the usual accounts receivable payment cycle is longer.
We are exposed to various market risk factors such as fluctuating interest rates and changes in
foreign currency rates. These risk factors can impact our results of operations, cash flows and
financial position. We manage these risks through regular operating and financing activities and
periodically use derivative financial instruments such as foreign exchange forward and option
contracts. There can be no assurance that our risk management strategies will be effective.
Our profitability has been, and may continue to be, volatile, which could adversely affect the
price of our stock.
We have experienced several years with significant operating losses. Although we have been
profitable in the last two fiscal years, we may not be profitable or meet the level of expectations
of the investment community in the future, which could have a material adverse impact on our stock
price. In addition, our operating results may be adversely affected by the timing of sales or a
shift in our product mix.
We may face higher costs associated with protecting our intellectual property.
Our future success depends in part upon our proprietary technology, product development,
technological expertise and distribution channels. We cannot predict whether we can protect our
technology or whether competitors can develop similar technology independently. We have received
and may continue to receive from third parties, including some of our competitors, notices claiming
that we have infringed upon third-party patents or other
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proprietary rights. We are currently a party in proceedings in federal court in California and in
Texas, in which one of our customers has been sued for patent infringement and has sued us and
several other suppliers for indemnification, and we may become involved in similar litigation
involving other customers. Any of these claims, whether with or without merit, could result in
costly litigation, divert the time, attention and resources of our management, delay our product
shipments, or require us to enter into royalty or licensing agreements. If a claim of product
infringement against us is successful and we fail to obtain a license or develop non-infringing
technology, our business and operating results could be materially and adversely affected. In
addition, the payment of any necessary licensing fees or indemnification costs associated with a
patent infringement claim could also materially adversely affect our operating results.
We do not intend to pay cash dividends on our common stock in the foreseeable future.
We currently intend to continue our policy of retaining earnings to finance the growth of our
business. In addition, the payment of dividends in certain circumstances may be prohibited by the
terms of our current and future indebtedness. As a result, we do not anticipate paying cash
dividends on our common stock in the foreseeable future.
We have anti-takeover defenses that could delay or prevent an acquisition of our company.
We have a shareholder rights plan (commonly known as a poison pill). This plan is not intended
to prevent a takeover, but is intended to protect and maximize the value of stockholders
interests. This plan could make it more difficult for a third party to acquire us or may delay
that process.
We have the ability to issue preferred shares without stockholder approval.
Our common shares may be subordinate to classes of preferred shares issued in the future in the
payment of dividends and other distributions made with respect to common shares, including
distributions upon liquidation or dissolution. Our Amended and Restated Certificate of
Incorporation permits our board of directors to issue preferred shares without first obtaining
stockholder approval. If we issued preferred shares, these additional securities may have dividend
or liquidation preferences senior to the common shares. If we issue convertible preferred shares, a
subsequent conversion may dilute the current common stockholders interest.
Item 6. EXHIBITS
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Exhibit No. |
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Description of Exhibit |
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31.1
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Section 302 Certification of Chief Executive Officer, filed herewith |
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31.2
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Section 302 Certification of Chief Financial Officer, filed herewith |
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32.1
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Section 906 Certification of Chief Executive Officer, filed herewith |
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32.2
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Section 906 Certification of Chief Financial Officer, filed herewith |
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SIGNATURES
Pursuant to the requirements the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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ARRIS GROUP, INC.
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/s/
David B. Potts
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David B. Potts |
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Executive Vice President, Chief
Financial Officer, Chief Accounting
Officer, and Chief Information
Officer |
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Dated: May 9, 2007
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