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ARRS > SEC Filings for ARRS > Form 10-Q on 8-Aug-2014All Recent SEC Filings

Show all filings for ARRIS GROUP INC

Form 10-Q for ARRIS GROUP INC


8-Aug-2014

Quarterly Report


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

Overview

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"). For more detail, see Note 3 Business Acquisitions to Notes to our Consolidated Financial Statements. 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.

In addition, we have revised our segment disclosures to reflect changes in operating responsibilities that occurred during the first quarter of 2014. For more detail, see Note 14 Segment Information to Notes to our Consolidated Financial Statements. 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."

Business and Financial Highlights

Business Highlights

Year-over-year revenue growth as a result of the Motorola Home acquisition

Sequential revenue growth (approximately 17% from the first quarter of 2014)

- Continued industry momentum for advanced CPE solutions and strong telco video CPE and broadband CPE shipments

- Demand for CCAP and Video Systems products

Strong earnings and cash generation

CPE Segment

Sales up 14% as compared to first quarter of 2014; direct contribution dollars up 17%

- Set top unit volumes increased 8% from the first quarter of 2014 excluding Digital Terminal Adapters

- Announced availability of new high-definition set-top targeting Latin American service providers

- Broadband device and accessory unit volumes up 11% from the first quarter of 2014; strong DOCSIS & DSL unit sales

- Announced new EuroDOCSIS 3.0 wireless data and EMTA gateway products offering superior wireless performance

- Approximately 65% of DOCSIS units were Wi-Fi enabled gateway devices in the second quarter of 2014

N&C Segment

Sales up 23% as compared to first quarter of 2014; direct contribution dollars up 60%

- Strong E6000 momentum, as operators expand broadband capacity and re-fresh their infrastructure with new converged platform

- Increased Access and Transport business (Headend Optics and Fiber Nodes)

- Expanded Network DVR deployments and Programmer MPEG4 upgrades

- Launched new SaaS-based WorkForce Management solution

- Launched new Sling-powered TV Everywhere solution and new ARRIS Market OTT Video solution


Table of Contents

Financial Highlights

Sales in the second quarter and first half of 2014 were $1,429.1 million and $2,654.1 million, respectively, as compared to $1,000.4 million and $1,354.0 million in the same periods in 2013, reflecting the acquisition of Motorola Home and strong demand.

Gross margin percentage was 29.3% in the second quarter of 2014, which compares to 23.1% in the second quarter of 2013. The second quarter 2013 gross margin includes a $57.6 million impact associated with writing up the historic cost of the Motorola Home inventory to fair value at the date of acquisition (subsequently increasing cost of goods sold) as well as $13.6 million of costs associated with the rationalization of certain products after the acquisition date.

Total operating expenses (excluding amortization of intangible assets, integration, acquisition, restructuring and other costs) in the second quarter of 2014 were $256.5 million, as compared to $211.5 million in the same period last year.

We ended the second quarter of 2014 with $551.9 million of cash, cash equivalents, and short-term marketable security investments. The Company generated $255.2 million of cash from operating activities through the first six months of 2014, which compares to $344.0 million generated during the same period in 2013.

We ended the second quarter 2014 with long-term debt of $1,575.1 million, at face value, the current portion of which is $61.9 million. We repaid $177.5 million of our Term Loans in the first six months of 2014, including a $150 million optional prepayment.

We ended the second quarter 2014 with an order backlog of $787.6 million and had a book-to-bill ratio of 0.85 in the quarter.

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 earnings 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 six months ended June 30, 2014 and 2013 which detail and reconcile GAAP and non-GAAP earnings per share:

(in thousands, except per share data)                                                 For the Three Months Ended June 30, 2014

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

Amounts in accordance with GAAP                     $ 1,429,071      $ 419,412      $  327,736           91,676      $  26,514       $      26,138      $  39,024
Acquisition accounting impacts related to
deferred revenue                                          3,489          2,802             -              2,802            -                   -            2,802
Stock compensation expense                                  -            1,835         (13,449 )         15,284            -                   -           15,284
Amortization of intangible assets                           -              -           (58,735 )         58,735            -                   -           58,735
Integration, acquisition, restructuring and
other costs                                                 -              -           (12,518 )         12,518            -                   -           12,518
Impairment of investments                                   -              -               -                -           (3,000 )               -            3,000
Asset held for sale impairment                              -              -               -                -           (2,125 )               -            2,125
Net tax items                                               -              -               -                -              -                29,204        (29,204 )

Non-GAAP amounts                                    $ 1,432,560      $ 424,049      $  243,034       $  181,015      $  21,389       $      55,342      $ 104,284


GAAP net income per share - diluted                                                                                                                     $    0.26

Non-GAAP net income per share - diluted                                                                                                                 $    0.70


Weighted average common shares - basic                                                                                                                    144,415

Weighted average common shares - diluted                                                                                                                  148,063


Table of Contents
(in thousands, except per share data)                                                         For the Six Months Ended June 30, 2014

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

Amounts in accordance with GAAP                       $ 2,654,088      $      766,187      $  636,524          129,663       $  45,697       $       4,142       $     79,824
Acquisition accounting impacts related to deferred
revenue                                                     3,695               3,001             -              3,001             -                   -                3,001
Stock compensation expense                                    -                 3,110         (23,207 )         26,317             -                   -               26,317
Amortization of intangible assets                             -                   -          (122,736 )        122,736             -                   -              122,736
Integration, acquisition, restructuring and other
costs                                                         -                   -           (24,020 )         24,020             -                   -               24,020
Impairment of investments                                     -                   -               -                -            (3,000 )               -                3,000
Asset held for sale impairment                                -                   -               -                -            (2,125 )               -                2,125
Net tax items                                                 -                   -               -                -               -                88,054            (88,054 )

Non-GAAP amounts                                      $ 2,657,783      $      772,298      $  466,561       $  305,737       $  40,572       $      92,196       $    172,969


GAAP net income per share - diluted                                                                                                                              $       0.54

Non-GAAP net income per share - diluted                                                                                                                          $       1.17


Weighted average common shares - basic                                                                                                                                143,637

Weighted average common shares - diluted                                                                                                                              147,610


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

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

Amounts in accordance with GAAP                       $ 1,000,362      $      230,957      $  319,019       $  (88,062 )     $   9,715       $     (49,314 )     $    (48,463 )
Reduction in revenue related to Comcast's
investment in ARRIS                                           -                   -               -                -               -                   -                  -
Acquisition accounting impacts related to fair
value of inventory                                            -                57,600             -             57,600             -                   -               57,600
Acquisition accounting impacts related to deferred
revenue                                                     2,417               1,472             -              1,472             -                   -                1,472
Product Rationalization                                       -                13,582             -             13,582             -                   -               13,582
Stock compensation expense                                    -                   866          (6,314 )          7,180             -                   -                7,180
Amortization of intangible assets                             -                   -           (55,915 )         55,915             -                   -               55,915
Integration, acquisition, restructuring and other
costs                                                         -                   -           (51,649 )         51,649             -                   -               51,649
Credit facility - ticking fees                                -                   -               -                -              (477 )               -                  477
Mark-to-market FV adjustment related to Comcast's
investment in ARRIS                                           -                   -               -                -             6,159                 -               (6,159 )
Non-cash interest expense                                     -                   -               -                -            (3,308 )               -                3,308
Tax related to items above                                    -                   -               -                -               -                74,784            (74,784 )

Non-GAAP amounts                                      $ 1,002,779      $      304,477      $  205,141       $   99,336       $  12,089       $      25,470       $     61,777


GAAP net income per share - diluted                                                                                                                              $      (0.36 ) (1)

Non-GAAP net income per share - diluted                                                                                                                          $       0.45


Weighted average common shares - basic                                                                                                                                134,626

Weighted average common shares - diluted                                                                                                                              136,626

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

(in thousands, except per share data)                                                         For the Six Months Ended June 30, 2013

                                                                                                                               Other            Income
                                                                                           Operating        Operating        (Income)         Tax Expense         Net Income
                                                         Sales          Gross Margin        Expense           Income          Expense          (Benefit)            (Loss)
Amounts in accordance with GAAP                       $ 1,354,012      $      339,483      $  418,029       $  (78,546 )     $  33,180       $     (48,613 )     $    (63,113 )
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                                                     2,417               1,472             -              1,472             -                   -                1,472
Product Rationalization                                       -                13,582             -             13,582             -                   -               13,582
Stock compensation expense                                    -                 1,697         (12,227 )         13,924             -                   -               13,924
Amortization of intangible assets                             -                   -           (63,518 )         63,518             -                   -               63,518
Integration, acquisition, restructuring and other
costs                                                         -                   -           (58,848 )         58,848             -                   -               58,848
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                                     -                   -                                -            (6,552 )               -                6,552
Tax related to items above                                    -                   -               -                -               -                88,035            (88,035 )

Non-GAAP amounts                                      $ 1,369,611      $      427,016      $  283,436       $  143,580       $  12,574       $      39,422       $     91,584


GAAP net income per share - diluted                                                                                                                              $      (0.51 ) (1)

Non-GAAP net income per share - diluted                                                                                                                          $       0.72


Weighted average common shares - basic                                                                                                                                124,940

Weighted average common shares - diluted                                                                                                                              127,876

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


Table of Contents

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 Investment in ARRIS: In connection with our acquisition of Motorola Home, Comcast was given an opportunity to invest in ARRIS. The accounting guidance requires that we record the implied fair value of benefit received by Comcast as a reduction in revenue. Until the closing of the deal, changes in the value of the investment were marked to market and flowed through other expense (income). 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 other expense (income).

Acquisition Accounting Impacts Related to Deferred Revenue: In connection with the accounting related to 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 their contracts.

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 resulted in higher cost of goods sold as it was sold.

Product Rationalization: In conjunction with the integration of Motorola Home, we 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 vary significantly but will recur in future periods.

Amortization of Intangible Assets: We have excluded the effect of amortization of intangible assets in calculating our non-GAAP operating expenses and net income (loss) measures. Amortization of intangible assets is non-cash, and is inconsistent in amount and frequency and is significantly affected by the timing and size of our acquisitions. Investors should note that the use of intangible assets contributed to our revenues earned during the periods presented and will contribute to our future period revenues as well. Amortization of intangible assets will recur in future periods.

Integration, Acquisition, Restructuring and Other Costs: We have excluded the effect of integration, acquisition, restructuring and other costs and the effect of restructuring expenses in calculating our non-GAAP operating expenses and net income measures. We will incur significant expenses in connection with our recent acquisition of Motorola Home, which we generally would not otherwise incur in the periods presented as part of our continuing operations. Acquisition related expenses consist of transaction costs, costs for transitional employees, other acquired employee related costs, and integration related outside services. Restructuring expenses consist of employee severance, abandoned facilities, and other exit costs. We believe it is useful to understand the effects of these items on our total operating expenses.


Table of Contents

Credit Facility-Ticking Fees: In connection with our acquisition of Motorola Home, the cash portion of the consideration was funded through debt financing commitments. A ticking fee is a fee paid to our banks to compensate for the time lag between the commitment to make the loan and the actual funding. We have excluded the effect of the ticking fee in calculating our non-GAAP financial measures. We believe it is useful to understand the effect of these items in our other (income) expense.

Mark To Market Fair Value Adjustment Related To Comcast Investment in ARRIS: In connection with our acquisition of Motorola Home, Comcast was given an opportunity to invest in ARRIS. The accounting guidance requires we mark to market the changes in the value of the investment and flow through other expense (income). 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 other expense (income).

Non-Cash Interest on Convertible Debt: We have excluded the effect of non-cash interest in calculating our non-GAAP operating expenses and net income (loss) measures. We record the accretion of the debt discount related to the equity component non-cash interest expense. We believe it is useful to understand the component of interest expense that will not be paid out in cash.

Impairment of Investment: We have excluded the effect of an other-than-temporary impairment of a cost method investment in calculating our non-GAAP financial measures. We believe it is useful to understand the effect of this non-cash item in our other expense (income).

Asset Held for Sale Impairment: In the second quarter of 2014, we entered into a contract to facilitate the sale of a building at less than its carrying value. The asset has been reclassified as held for sale and was measured at the lower of its carrying amount or fair value less cost to sell. We have recorded an impairment charge to reduce the assets carrying amount to its estimated fair value less costs to sell in the period the held for sale criteria were met. We have excluded the effect of the asset held for sale impairment in calculating our non-GAAP financial measures. We believe it is useful to understand the effect of this non-cash item in our other expense (income).

Net Tax Items: We have excluded the tax effect of the non-GAAP items mentioned above. Additionally, we have excluded the effects of certain tax adjustments related to state valuation allowances, research and development tax credits and provision to return differences.

Comparison of Operations for the Three and Six Months Ended June 30, 2014 and 2013

Net Sales

The table below sets forth our net sales for the three and six months ended
June 30, 2014 and 2013, for each of our segments (in thousands):



                                                                     Net Sales                                                Increase (Decrease) Between 2014 and 2013
                                           For the Three Months Ended           For the Six Months Ended           For the Three Months Ended            For the Six Months Ended
                                                    June 30,                            June 30,                             June 30                              June 30
                                              2014              2013              2014             2013                 $                  %                  $                 %

Business Segment:
CPE                                      $    1,022,925      $   659,331      $  1,916,526      $   845,895      $       363,594            55.1 %     $     1,070,631         126.6 %
. . .
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