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ARRS > SEC Filings for ARRS > Form 10-Q on 8-Nov-2013All Recent SEC Filings

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Form 10-Q for ARRIS GROUP INC


8-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a premier video and broadband technology company that transforms how service providers worldwide deliver entertainment and communications without boundaries. Our powerful end-to-end platforms enable service and content providers to improve the way people connect with each other and with their favorite content. Headquartered north of Atlanta, in Suwanee, Georgia, we have R&D, sales and support centers throughout the world.

Acquisition of Motorola Home

On April 17, 2013 we acquired the Motorola Home business from General Instrument Holdings, Inc., a subsidiary of Google, Inc. for $2.4 billion in cash and equity, subject to certain adjustments as provided for in the acquisition agreement (the "Acquisition"). We believe the Acquisition enhances our ability to provide next-generation consumer video products and services, supporting a more comprehensive product offering while also accelerating our ability to deliver a comprehensive set of industry-leading new products to a wide spectrum of customers. We more than doubled in size as a result of the Acquisition, which had significant effects on virtually every aspect of our business and operations and which make comparisons in this discussion to our historical results difficult. These impacts include:

Significant Increase in Scale and Geographic Footprint. Our sales increased from $353.7 million for the first quarter 2013 to $1,067.8 million for the third quarter of 2013, compared to $302.9 million and $357.4 million, respectively for the same periods in 2012. We almost tripled our number of employees from approximately 2,200 employees to approximately 6,500 employees. In addition, we now have a direct presence in over 25 countries and channel presence in over 85 countries compared to 21 and 30, respectively, prior to the Acquisition.

Expansion of the Industry that we Serve. Historically almost all of our revenues were derived from sales to cable television multiple system operators ("MSOs"). While MSOs remain a large and important component of our business, our operations have broadened through the Acquisition to include more sales to telephone companies and programmers, as well as the addition of retail distribution channels. As a result, we have a significantly more diverse customer base. Our top five customers following the Acquisition would have accounted for approximately 50% of our 2012 sales on a pro forma basis, compared with over 50% from only our two largest customers, Comcast and Time Warner, prior to the Acquisition.

Additional Product Offerings. Our portfolio of products expanded as a result of the Acquisition to include products for passive optical networks, optical Ethernet components, multiscreen software solutions and DSL modems and gateways. In addition, our traditional product lines, such as set-top boxes and gateways, routers, DOCSIS cable modems, encoders and transcoders, have expanded, in many cases, increasing our relevance with our customers.

Increased IP Portfolio and R&D. We now have over 2,000 granted and in-process patents, which is more than double our portfolio prior to the Acquisition. In addition, as part of the transaction we also received a limited license to approximately 20,000 additional patents. With the additional resources and employees gained from the Acquisition, we expect to significantly increase our investment in fundamental research, expanding our intellectual property rights and developing new product offerings.

Debt. As described below under "Financial Liquidity and Capital Resources," we entered into senior secured credit facilities to fund a portion of the acquisition costs and to support our on-going working capital needs. As a result, the face value our debt increased from $232.1 million at March 31, 2013 to $2,125.3 million at September 30, 2013. We are subject to a number of financial covenants under the senior secured credit facilities that could impact our operational flexibility.

In addition, as described below, we have reduced our reportable operating segments from three to two. Readers should consider the size and transformative nature of the Acquisition when reviewing this "Management's Discussion and Analysis of Financial Condition and Results of Operations."


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New Operating Segments

The completion of the Motorola Home acquisition changed the way that we manage and review our business. As a result, beginning with the periods ended June 30, 2013, we now report two operating segments, (1) Network & Cloud and (2) Customer Premises Equipment. Corporate and other expenses not included in the measure of segment contribution will be reported in an "All Other" category. A comparison of our products and the acquired Motorola Home products included in our new reporting segments is set forth in the table below. See Note 16 for additional information regarding this resegmentation.

                           Prior Segments                                New Segments
ARRIS                                        Motorola Home
Broadband Communications Systems:   Network Infrastructure:            Network and Cloud
   CMTS, CCAP, Edge QAMs,             CMTS, Edge QAMs, HE Optics,         ("N&C")
Encoder/Decoder/Transcoder          Fiber Nodes, RF Amplifiers,
Access, Transport & Supplies:       Encoders/Decoders/Transcoders


HE Optics, Fiber Nodes & RF Convergence Experiences:
Amplifiers Service Assurance, Content Media & Communication Systems: Management & Security, Ad
Service Assurance, Analytics, Insertion, Video on Demand, User Workforce Management, Video on Experience Demand, Ad Insertion & Management

Broadband Communications Systems: Home Devices: Customer Premises
Modems, EMTAs, Gateways Modems, EMTAs, Gateways, Equipment ("CPE") Set-top Boxes

Key Highlights

Set forth below are some key highlights that we achieved in the three and nine months ended September 30, 2013:

Financial Highlights

Sales in the third quarter and nine months ended September 30, 2013 were $1,067.8 million and $2,421.8 million, respectively, as compared to $357.5 million and $1,009.7 million in the same periods in 2012. The increase is primarily attributed to the inclusion of sales from the acquired Motorola Home business.

Gross margin percentage was 29.7% in the third quarter of 2013, which compares to 31.3% in the third quarter of 2012. The year over year decline reflects the inclusion of the Motorola Home products, which in the aggregate have lower overall margins than the historic ARRIS products.

Total operating expenses (excluding amortization of intangible assets, restructuring charges and acquisition and other costs) in the third quarter of 2013 were $228.1 million, as compared to $80.9 million in the same period last year. The increase is the result of the inclusion of expenses associated with the Acquisition.

We incurred $6.1 million of restructuring charges and $6.2 million of acquisition and integration related costs in the third quarter 2013 related to the Acquisition.

Intangible amortization increased from $7.7 million in the third quarter 2012 to $64.6 million in the third quarter 2013 as a result of the Acquisition.

We ended the third quarter of 2013 with $695.0 million of cash, cash equivalents, short-term and long-term marketable security investments. The Company generated $380.0 million of cash from operating activities through the first nine months of 2013, which compares to $72.6 million generated during the same period


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in 2012. The portion of earnings that are cash-based were approximately $135.8 million during the same period. Changes in working capital, primarily accounts payable, accrued liabilities and inventory, accounted for $244.3 million of the change in cash from operating activities through the first nine months of 2013.

We ended the third quarter 2013 with outstanding debt of $2,116.3 million, the current portion of which is $293.4 million. We anticipate retiring the short-term debt with cash resources. We issued $1,925 million of new debt in the second quarter 2013 in conjunction with our acquisition of Motorola Home.

Product Line Highlights

Customer Premises Equipment

o Set-top Solutions

Continue to experience strong customer interest around new in-home architectures and technologies for delivering the latest in video and broadband-based services.

Achieved product acceptance and began deployment of a new set top box platform for Charter Communications.

Commenced XG1 video gateway field trials with Comcast as part of the ongoing ARRIS product qualification activity.

Announced a new portfolio of devices, including wireless set-tops, at the IBC2013 (International Broadcasting Convention) trade show.

Selected by Telenor Sweden to provide IPTV set top box solutions.

o Broadband Devices

DOCSIS device shipments remained solid in the third quarter as consumer demand for broadband services continued. Approximately 89 percent of the third quarter 2013 DOCSIS devices shipments were DOCSIS 3.0 capable units and 60 percent of the shipments included WiFi enabled product.

Introduced a next generation wireless data gateway into the retail channel that included support for IEEE 802.11AC.

Network and Cloud

o CMTS

Continued deployment of E6000 Converged Edge Router, approaching 1 million in service subscribers connected to the platform.

Continued deployment of both C4 and BSR CMTS platforms as operators continue to cost effectively extend their current installed base, although operator capital expenditure, are shifting to new E6000 Converged Cable Access Platform.

o Access and Transport

Momentum building around deep fiber and all-digital optics network architectures.

o Video Infrastructure

Strong shipments of Video Processing products such as the Cherry Picker Application Platform CAP-1000 as operators continue to invest in improving the reliability and flexibility of their video distribution network.

Several new APEX3000 EdgeQAM customer wins.

Announced new High Efficiency Video Codec (HEVC) encoder platform.

Continuing field trial of Network DVR storage and control plane with Tier 1 cable operator.

Continued shipments of MPEG4 encoder/Transcoder products to programmer and IPTV operators

o Cloud

Good growth in both Dream Gallery and Moxi subscriber base

Announced partnership with Echostar and their Sling product team to integrate their place-shifting technology with the ARRIS Mobile TV products


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Non-GAAP Measures

As part of our ongoing review of financial information related to our business, we regularly use non-GAAP measures, in particular non-GAAP net income per share, as we believe they provide a meaningful insight into our business and trends. We also believe that these non-GAAP measures provide readers of our financial statements with useful information and insight with respect to the results of our business. However, the presentation of non-GAAP information is not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. Below are tables for the three and nine months ended September 30, 2013 and 2012 which detail and reconcile GAAP and non-GAAP net income per share:

(in thousands, except per share data)                                                  For the Three Months Ended September 30, 2013

                                                                                                                            Other            Income
                                                                                        Operating        Operating        (Income)         Tax Expense        Net Income
                                                      Sales          Gross Margin        Expense           Income          Expense          (Benefit)           (Loss)

Amounts in accordance with GAAP                    $ 1,067,823      $      316,992      $  305,020       $   11,972       $  22,029       $     (28,016 )     $    17,959
Acquisition accounting impacts related to
deferred revenue                                         1,556               1,006             -              1,006             -                   -               1,006
Stock compensation expense                                 -                 1,248          (9,481 )         10,729             -                   -              10,729
Amortization of intangible assets                          -                   -           (64,606 )         64,606             -                   -              64,606
Acquisition costs, restructuring, and
integration costs                                          -                   -           (12,278 )         12,278             -                   -              12,278
Non-cash interest expense                                  -                   -               -                -            (3,374 )               -               3,374
Net tax items                                              -                   -               -                -               -                54,998           (54,998 )

Non-GAAP amounts                                   $ 1,069,379      $      319,246      $  218,655       $  100,591       $  18,655       $      26,982       $    54,954


GAAP net income per share - diluted                                                                                                                           $      0.13

Non-GAAP net income per share - diluted                                                                                                                       $      0.39


Weighted average common shares - basic                                                                                                                            138,478

Weighted average common shares - diluted                                                                                                                          140,605


(in thousands, except per share data)                                                   For the Nine Months Ended September 30, 2013

                                                                                                                            Other            Income
                                                                                        Operating        Operating        (Income)         Tax Expense        Net Income
                                                      Sales          Gross Margin        Expense           Income          Expense          (Benefit)           (Loss)

Amounts in accordance with GAAP                    $ 2,421,835      $      656,595      $  722,396       $  (65,801 )     $  55,208       $     (76,629 )     $   (44,380 )
Reduction in revenue related to Comcast's
investment in ARRIS                                     13,182              13,182             -             13,182             -                   -              13,182
Acquisition accounting impacts related to fair
value of inventory                                         -                57,600             -             57,600             -                   -              57,600
Acquisition accounting impacts related to
deferred revenue                                         3,973               2,478             -              2,478             -                   -               2,478
Product Rationalization                                    -                13,582             -             13,582             -                   -              13,582
Stock compensation expense                                 -                 2,945         (21,708 )         24,653             -                   -              24,653
Amortization of intangible assets                          -                   -          (127,751 )        127,751             -                   -             127,751
Acquisition costs, restructuring, and
integration costs                                          -                   -           (71,127 )         71,127             -                   -              71,127
Credit facility - ticking fees                             -                   -                                -              (865 )               -                 865
Mark-to-market FV adjustment related to
Comcast's investment in ARRIS                              -                   -               -                -           (13,189 )               -              13,189
Non-cash interest expense                                  -                   -                                -            (9,926 )               -               9,926
Net tax items                                              -                   -               -                -               -               143,034          (143,034 )

Non-GAAP amounts                                   $ 2,438,990      $      746,382      $  501,810       $  244,572       $  31,228       $      66,405       $   146,939


GAAP net loss per share - diluted                                                                                                                             $     (0.34 )

Non-GAAP net income per share - diluted                                                                                                                       $      1.11


Weighted average common shares - basic                                                                                                                            129,502

Weighted average common shares - diluted                                                                                                                          132,169

(1) Basic shares used as losses were reported for those periods and the inclusion of dilutive shares would be anti-dilutive


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(in thousands, except per share data)                                                  For the Three Months Ended September 30, 2012

                                                                                                                         Other            Income
                                                                         Gross        Operating        Operating       (Income)         Tax Expense        Net Income
                                                         Sales          Margin         Expense           Income         Expense          (Benefit)           (Loss)

Amounts in accordance with GAAP                       $   357,432      $ 111,952      $   88,829       $   23,123      $   2,277       $       2,982      $     17,864
Acquisition accounting impacts of deferred revenue            546            546             -                546            -                   -                 546
Stock compensation expense                                    -              808          (5,870 )          6,678            -                   -               6,678
Amortization of intangible assets                             -              -            (7,742 )          7,742            -                   -               7,742
Acquisition costs                                             -              -               (30 )             30            -                   -                  30
Restructuring                                                 -              -              (213 )            213            -                   -                 213
Non-cash interest expense                                     -              -                                -           (3,120 )               -               3,120
Net tax items                                                 -              -               -                -              -                10,545           (10,545 )

Non-GAAP amounts                                      $   357,978      $ 113,306      $   74,974       $   38,332      $    (843 )     $      13,527      $     25,648


GAAP net income per share - diluted                                                                                                                       $       0.15

Non-GAAP net income per share - diluted                                                                                                                   $       0.22


Weighted average common shares - basic                                                                                                                         113,709

Weighted average common shares - diluted                                                                                                                       116,346


(in thousands, except per share data)                                                   For the Nine Months Ended September 30, 2012

                                                                                                                         Other            Income
                                                                         Gross        Operating        Operating       (Income)         Tax Expense        Net Income
                                                         Sales          Margin         Expense           Income         Expense          (Benefit)           (Loss)

Amounts in accordance with GAAP                       $ 1,009,660      $ 339,386      $  277,646       $   61,740      $   9,646       $      13,430      $     38,664
Acquisition accounting impacts of deferred revenue          2,980          2,467             -              2,467            -                   -               2,467
Stock compensation expense                                    -            2,367         (18,827 )         21,194            -                   -              21,194
Amortization of intangible assets                             -              -           (22,565 )         22,565            -                   -              22,565
Acquisition costs                                             -              -              (739 )            739            -                   -                 739
Restructuring                                                 -              -            (6,455 )          6,455            -                   -               6,455
Loss of sale of product line                                  -              -              (337 )            337            -                   -                 337
Impairment of investment                                      -              -              (466 )            466            -                   -                 466
Non-cash interest expense                                     -              -               -                -           (9,177 )               -               9,177
Net tax items                                                 -              -               -                -              -                25,415           (25,415 )

Non-GAAP amounts                                      $ 1,012,640      $ 344,220      $  228,257       $  115,963      $     469       $      38,845      $     76,649


GAAP net income per share - diluted                                                                                                                       $       0.33

Non-GAAP net income per share - diluted                                                                                                                   $       0.66


Weighted average common shares - basic                                                                                                                         113,709

Weighted average common shares - diluted                                                                                                                       116,348

In managing and reviewing our business performance, we exclude a number of items required by GAAP. Management believes that excluding these items is useful in understanding the trends and managing our operations. We provide these supplemental non-GAAP measures in order to assist the investment community to see ARRIS through the "eyes of management," and therefore enhance understanding of ARRIS' operating performance. Non-GAAP financial measures should be viewed in addition to, and not as an alternative to, the Company's reported results prepared in accordance with GAAP. Our non-GAAP financial measures reflect adjustments based on the following items, as well as the related income tax effects:

Reduction in Revenue Related to Comcast's Investment in ARRIS: In connection with the Acquisition in January 2013 Comcast agreed to invest in ARRIS. The per share purchase price, which was based on the value used to determine the number of shares issued in the Acquisition, for the investment was less than the market price on the date the agreement was executed. As a result, the accounting guidance requires that we record the implied fair value of benefit received by Comcast as a reduction in revenue. We have excluded the effect of the implied fair value in calculating our non-GAAP financial measures. We believe it is useful to understand the effects of these items on our total revenues and gross margin.

Acquisition Accounting Impacts Related to Deferred Revenue: In connection with our acquisitions, business combination rules require us to account for the fair values of deferred revenue arrangements for which acceptance has not been obtained, and post contract support in our purchase accounting. The non-GAAP adjustment to our sales and cost of sales is intended to include the full amounts of such revenues as if these purchase accounting adjustments had not been applied. We believe the adjustment to these revenues is useful as a measure of the ongoing performance of our business. We historically have experienced high renewal rates related to our support agreements and our objective is to increase the renewal rates on acquired post contract support agreements. However, we cannot be certain that our customers will renew our contracts.


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Acquisition Accounting Impacts Related to Inventory Valuation: In connection with our acquisition of Motorola Home, business combinations rules require the inventory be recorded at fair value on the opening balance sheet. This is different from historical cost. Essentially we were required to write the inventory up to end customer price less a reasonable margin as a distributor. This resulted in an increase in the value of inventory and will result in higher cost of goods sold as it is sold.

Product Rationalization: In conjunction with the integration of Motorola Home, we have identified certain product lines which overlap. In the second quarter of 2013, we made the decision to eliminate certain products. As a result, we recorded expenses related to the elimination of inventory and certain vendor liabilities. We believe it is useful to understand the effects of this item on our total cost of goods sold.

Stock-Based Compensation Expense: We have excluded the effect of stock-based compensation expenses in calculating our non-GAAP operating expenses and net income (loss) measures. Although stock-based compensation is a key incentive offered to our employees, we continue to evaluate our business performance excluding stock-based compensation expenses. We record non-cash compensation expense related to grants of options and restricted stock. Depending upon the size, timing and the terms of the grants, the non-cash compensation expense may . . .

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