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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
of
ARRIS GROUP, INC.
A Delaware Corporation
IRS Employer Identification No. 58-2588724
SEC File Number 001-16631
11450 TECHNOLOGY CIRCLE
DULUTH, GA 30097
(678) 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 an accelerated filer (as defined in Rule 21b-2 of the
Exchange Act).
As of May 9, 2003, 74,850,714 shares of the registrant's Common Stock, $0.01 par
value, were outstanding.
ARRIS GROUP, INC.
FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 2003
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements
a) Consolidated Balance Sheets as of March 31, 2003 and
December 31, 2002 1
b) Consolidated Statements of Operations for the Three
Months Ended March 31, 2003 and 2002 2
c) Consolidated Statements of Cash Flows for the Three
Months Ended March 31, 2003 and 2002 3
d) Notes to the Consolidated Financial Statements 4
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 15
Item 3. Quantitative and Qualitative Disclosures on Market Risk 30
Item 4. Control and Procedures 30
Part II. Other Information
Item 2. Changes in Securities and Use of Proceeds 31
Item 6. Exhibits and Reports on Form 8-K 31
Signatures 33
Certifications 34
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ARRIS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
MARCH 31, DECEMBER 31,
2003 2002
--------- ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ........................................... $ 76,543 $ 98,409
Accounts receivable (net of allowances for doubtful accounts of
$10,614 in 2003 and $10,698 in 2002) .............................. 69,264 78,743
Accounts receivable from Nortel Networks ............................ 289 2,212
Other receivables ................................................... 1,919 3,154
Inventories ......................................................... 104,331 104,203
Investments held for resale ......................................... 160 137
Other current assets ................................................ 14,647 14,834
--------- ---------
Total current assets ......................................... 267,153 301,692
Property, plant and equipment (net of accumulated depreciation of
$46,017 in 2003 and $44,810 in 2002) .............................. 30,210 34,540
Goodwill .............................................................. 151,253 151,265
Intangibles (net of accumulated amortization of $50,214 in 2003 and
$41,506 in 2002) .................................................. 56,794 64,843
Investments ........................................................... 4,885 4,594
Other assets .......................................................... 11,701 6,478
--------- ---------
$ 521,996 $ 563,412
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .................................................... $ 29,343 $ 24,253
Accrued compensation, benefits and related taxes .................... 16,914 23,423
Accounts payable and accrued expenses - Nortel Networks ............. 540 11,303
Current portion of long-term debt ................................... 11,755 23,887
Current portion of capital lease obligations ........................ 1,415 1,120
Other accrued liabilities ........................................... 39,513 44,360
--------- ---------
Total current liabilities .................................... 99,480 128,346
Capital lease obligations, net of current portion ..................... 337 158
Long-term debt ........................................................ 125,028 --
--------- ---------
Total liabilities ............................................ 224,845 128,504
Membership interest - Nortel Networks ................................. -- 114,518
--------- ---------
Total liabilities & membership interest ...................... 224,845 243,022
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; 74.8 million and 82.5 million shares issued and
outstanding in 2003 and 2002, respectively ........................ 758 831
Capital in excess of par value ...................................... 578,397 603,563
Accumulated deficit ................................................. (277,883) (281,329)
Unrealized holding gain on marketable securities .................... 445 227
Unearned compensation ............................................... (3,328) (1,649)
Unfunded pension losses ............................................. (1,219) (1,219)
Cumulative translation adjustments .................................. (19) (34)
--------- ---------
Total stockholders' equity ................................... 297,151 320,390
--------- ---------
$ 521,996 $ 563,412
========= =========
See accompanying notes to the consolidated financial statements.
1
ARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
-------- ---------
Net sales (includes sales to Nortel Networks of $1 and $1,466 for the
periods ended March 31, 2003 and 2002, respectively).................. $ 91,343 $ 172,397
Cost of sales ........................................................... 66,599 114,166
-------- ---------
Gross profit ................................................... 24,744 58,231
Operating expenses:
Selling, general, administrative and development ............... 37,240 47,183
Restructuring and impairment charges ........................... 336 --
Amortization of intangibles .................................... 8,708 8,370
-------- ---------
Total operating expenses ................................... 46,284 55,553
-------- ---------
Operating income (loss) ................................................. (21,540) 2,678
Other expense (income):
Interest expense .................................................. 1,664 2,298
Membership interest ............................................... 2,418 2,500
(Gain) on retirement of membership interest ....................... (28,506) --
(Gain) loss on investments ........................................ (23) 214
(Gain) loss on foreign currency ................................... (482) 826
Other expense (income), net ....................................... (57) 197
-------- ---------
Income (loss) from continuing operations before income taxes ............ 3,446 (3,357)
Income tax expense (benefit) ............................................ -- (6,800)
-------- ---------
Net income (loss) from continuing operations ............................ 3,446
3,443
Income (loss) from discontinued operations .............................. -- (5,377)
-------- ---------
Net income (loss) before cumulative effect of an accounting change ...... 3,446 (1,934)
Cumulative effect of an accounting change - goodwill .................... -- 57,960
-------- ---------
Net income (loss) ................................................. $ 3,446 $ (59,894)
======== =========
Net income (loss) per common share:
Basic:
Income (loss) from continuing operations ........................ $ 0.04 $ 0.04
Income (loss) from discontinued operations ...................... -- (0.07)
Cumulative effect of an accounting change ....................... -- (0.72)
-------- ---------
Net income (loss) ............................................ $ 0.04 $ (0.75)
======== =========
Diluted:
Income (loss) from continuing operations ........................ $ 0.04 $ 0.04
Income (loss) from discontinued operations ...................... -- (0.07)
Cumulative effect of an accounting change ....................... -- (0.72)
-------- ---------
Net income (loss) ............................................ $ 0.04 $ (0.75)
======== =========
Weighted average common shares:
Basic .......................................................... 82,068 80,258
======== =========
Diluted ........................................................ 83,602 80,258
======== =========
See accompanying notes to the consolidated financial statements.
2
ARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
--------- --------
Operating activities:
Net income (loss) ...................................................... $ 3,446 $(59,894)
Adjustments to reconcile net income (loss) to net cash provided by
(used in) operating activities:
Depreciation ......................................................... 6,165 5,564
Amortization of intangibles .......................................... 8,708 8,370
Amortization of deferred financing fees .............................. 943 635
Amortization of unearned compensation ................................ 476 491
Provision for doubtful accounts ...................................... 843 2,115
Loss (gain) on investments ........................................... (23) 214
Gain on retirement of membership interest ............................ (28,506) --
Cumulative effect of an accounting change - goodwill ................. -- 57,960
Changes in operating assets and liabilities, net of effect of
acquisitions and dispositions:
Accounts receivable ................................................ 10,559 1,774
Other receivables .................................................. 1,235 (2,476)
Inventory .......................................................... 203 21,797
Accounts payable and accrued liabilities ........................... (17,153) 2,375
Income taxes recoverable ........................................... -- (7,787)
Accrued membership interest ........................................ 2,418 2,500
Other, net ......................................................... (1,294) (9,676)
--------- --------
Net cash provided by (used in) operating activities ........................ (11,980) 23,962
Investing activities:
Purchases of property, plant and equipment ........................... (1,099) (1,105)
Cash paid for acquisition ............................................ (458) (676)
--------- --------
Net cash provided by (used in) investing activities ........................ (1,557) (1,781)
Financing activities:
Proceeds from issuance of bonds ...................................... 125,000 --
Redemption of membership interest .................................... (88,430) --
Repurchase and retirement of common stock ............................ (28,000) --
Payments on capital lease obligations ................................ (392) (238)
Payments on debt obligations ......................................... (12,370) --
Deferred financing costs paid ........................................ (4,744) --
Proceeds from issuance of stock ...................................... 607 77
--------- --------
Net cash provided by (used in) financing activities ........................ (8,329) (161)
--------- --------
Net increase (decrease) in cash and cash equivalents ....................... (21,866) 22,020
Cash and cash equivalents at beginning of period ........................... 98,409 5,337
--------- --------
Cash and cash equivalents at end of period ................................. $ 76,543 $ 27,357
========= ========
Noncash investing and financing activities:
Net tangible assets acquired, excluding cash ......................... $ 990 $ 4,578
Net liabilities assumed .............................................. (1,215) (16,528)
Intangible assets acquired, including goodwill ....................... 683 81,199
Noncash purchase price, including 5,250,000 shares of common stock
and fair market value of stock options issued ...................... -- (68,573)
--------- --------
Cash paid for acquisition, net of cash acquired ...................... $ 458 $ 676
========= ========
Supplemental cash flow information:
Interest paid during the period ...................................... $ 418 $ 337
========= ========
Income taxes paid during the period .................................. $ -- $ 100
========= ========
See accompanying notes to the consolidated financial statements.
3
ARRIS GROUP, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
ARRIS Group, Inc., the successor to ANTEC Corporation (together with its
consolidated subsidiaries, except as the context otherwise indicates, "ARRIS" or
the "Company"), is a global communications technology company, headquartered in
Duluth, Georgia. ARRIS specializes in the design and engineering of hybrid
fiber-coax architectures and the development and distribution of products for
these broadband networks. The Company provides its customers with products and
services that enable reliable, high-speed, two-way broadband transmission of
video, telephony, and data.
ARRIS operates in one business segment, Communications, providing a range of
customers with network and system products and services, primarily hybrid
fiber-coax networks and systems for the communications industry. This segment
accounts for 100% of consolidated sales, operating profit and identifiable
assets of the Company. ARRIS provides a broad range of products and services to
cable system operators and telecommunication providers. ARRIS is a leading
developer, manufacturer and supplier of telephony, data, construction, rebuild
and maintenance equipment for the broadband communications industry. ARRIS
supplies most of the products required in a broadband communication system,
including headend, distribution, drop and in-home subscriber products.
In 2002, ARRIS sold the Keptel and Actives product lines, which have been
accounted for as discontinued operations in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets. As a result, these two product lines and
historical results have been reclassified accordingly for all periods presented.
See further discussion in Note 4 of Notes to the Consolidated Financial
Statements.
The consolidated financial statements furnished herein 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 2003 financial statement presentation.
Interim results of operations are not necessarily indicative of results to be
expected from a twelve-month period. These interim financial statements should
be read in conjunction with the Company's most recently audited consolidated
financial statements and notes thereto included in the Company's Annual Report
on Form 10-K for the Company's year ended December 31, 2002, as filed with the
United States Securities and Exchange Commission.
NOTE 2. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
No. 51. This Interpretation provides clarification on the consolidation of
certain entities in which equity investors do not have sufficient equity at risk
for the entity to finance its activities without additional subordinated
financial support from other parties. Such entities are defined as variable
interest entities ("VIEs"). This Interpretation requires that VIEs be
consolidated by the entity considered to be the primary beneficiary of the VIE.
The Interpretation is effective immediately for newly created VIEs after January
31, 2003 and effective July 1, 2003 for any VIEs created prior to February 1,
2003. We have evaluated our relationships with potential unconsolidated entities
that may meet the consolidation requirements of this Interpretation and we do
not believe the adoption will have a material impact on our consolidated
financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure. The Company adopted SFAS No. 148 on
January 1, 2003. See Note 2 of Notes to the Consolidated Financial Statements.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness to Others, an interpretation of FASB Statements No.
4
5, 57, and 107 and a rescission of FASB Interpretation No. 34 ("FIN 45"). FIN 45
elaborates on the disclosures to be made by a guarantor in its interim and
annual financial statements about its obligations under guarantees issued. FIN
45 also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligation undertaken. The
initial recognition and measurement provisions of FIN 45 is applicable to
guarantees issued or modified after December 31, 2002 and have not had a
material effect on the Company's financial statements. The disclosure
requirements are effective for financial statements of interim and annual
periods ending after December 31, 2002, and are discussed in Note 4 of Notes to
the Consolidated Financial Statements.
NOTE 3. STOCK-BASED COMPENSATION
In December 2002, the Financial Accounting Standards Board, ("FASB") issued SFAS
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.
This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this Statement amends the disclosure requirements of SFAS No. 123 to
require prominent disclosures in both annual and interim financial statements
about the method of accounting for stock-based employee compensation and the
effect of the method used on reported results.
The Company uses the intrinsic value method for valuing its awards of stock
options and restricted stock and recording the related compensation expense, if
any, in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees and related interpretations. No stock-based employee or director
compensation cost for stock options is reflected in net income, as all options
granted have exercise prices equal to the market value of the underlying common
stock on the date of grant. The Company records compensation expense related to
its restricted stock awards and director stock units. The following table
illustrates the effect on net income and earnings per share as if the Company
had applied the fair value recognition provisions of SFAS No. 123 to all
stock-based employee compensation.
THREE MONTHS ENDED MARCH 31,
2003 2002
-------- ----------
Net income (loss), as reported ..................................... $ 3,446 $ (59,894)
Add: Stock-based employee compensation included in reported
net income, net of taxes ......................................... 476 491
Deduct: Total stock-based employee compensation expense
determined under fair value based methods for all awards,
net of taxes ...................................................... (6,915) (7,434)
-------- ----------
Net income (loss), pro forma ....................................... $ (2,993) $ (66,837)
======== ==========
Net income (loss) per common share:
Basic - as reported .............................................. $ 0.04 $ (0.75)
======== ==========
Basic - pro forma ................................................ $ (0.04) $ (0.83)
======== ==========
Diluted - as reported ............................................ $ 0.04 $ (0.75)
======== ==========
Diluted - pro forma .............................................. $ (0.04) $ (0.83)
======== ==========
NOTE 4. GUARANTEES
As discussed in Note 2 of Notes to the Consolidated Financial Statements, in
November 2002, the FASB issued FIN 45. FIN 45 elaborates on the existing
disclosure requirements for most guarantees, including loan guarantees such as
standby letters of credit. It also clarifies that at the time a company issues a
guarantee, the company must recognize an initial liability for the fair value,
or market value, of the obligations it assumes under the guarantee and must
disclose that information in its interim and annual financial statements. The
provisions related to recognizing a liability at inception of the guarantee for
the fair value of the guarantor's obligations do not apply to product warranties
or to guarantees accounted for as derivatives. The initial recognition and
initial measurement provisions apply on a prospective basis to guarantees issued
or modified after December 31, 2002. As discussed in Note 2 of
5
Notes to the Consolidated Financial Statements, the adoption of FIN 45 did not
have a material impact on the Company's results of operations or financial
condition and did not result in any additional liabilities as of March 31, 2003
associated with guarantees covered by this interpretation.
Warranty
ARRIS provides for the estimated cost of product warranties at the time revenue
is recognized. 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 is affected by ongoing product
failure rates, material usage and service delivery costs incurred in correcting
a product failure as well as specific product class failures outside of ARRIS'
baseline experience. If actual product failure rates, material usage or service
delivery costs differ from estimates, revisions to the estimated warranty
liability would be required. ARRIS evaluates its warranty obligations on a
product line basis.
Information regarding the changes in ARRIS' aggregate product warranty
liabilities was as follows for the three month period ended March 31, 2003 (in
thousands):
Balance, December 31, 2002 ...................................... $ 6,031
Accruals for warranties issued during the period ................ --
Accruals related to pre-existing warranties (including
changes in estimates) ....................................... 114
Settlements made (in cash or in kind) during the period.......... (267)
-------
Balance, March 31, 2003 ......................................... $ 5,878
=======
NOTE 5. DISCONTINUED OPERATIONS
Upon evaluation and review of the ARRIS product portfolio, the Company concluded
that the Keptel product line was not core to its long-term strategy and thus
sold the product line on April 24, 2002. Keptel designed and marketed network
interface systems and fiber optic cable management products primarily for
traditional residential and commercial telecommunications applications. The
transaction generated cash proceeds of $30.0 million. Additionally, ARRIS
retained a potential earn-out over a twenty-four month period based on the
achievement of sales targets. The transaction also included a distribution
agreement whereby the Company will continue to distribute Keptel products until
April 2005. The Keptel product line generated approximately $7.9 million of
revenue for the three months ended March 31, 2002. Total assets of approximately
$31.1 million were disposed of, which included inventory, fixed assets,
intangibles (formerly classified as goodwill), and other assets. ARRIS incurred
approximately $5.0 million of related closure costs, including severance, vendor
liabilities, outside consulting fees, and other shutdown expenses. During 2002,
a net loss of $6.2 million was recorded in connection with the sale of the
Keptel product line. As of March 31, 2003, approximately $1.0 million related to
outside consulting fees and $0.1 million related to other shutdown expenses
remained in an accrual to be paid. ARRIS expects to complete the remaining
payments by the end of 2003.
Upon continued review of ARRIS' product portfolio, the Company sold its Actives
product line on November 21, 2002, for net proceeds of $31.8 million. The
Actives product line generated approximately $11.3 million of revenue for the
three months ended March 31, 2002. Total assets of approximately $20.3 million
were disposed of, which included inventory, fixed assets, and other assets
attributable to the product line. Additionally, ARRIS incurred approximately
$9.3 million of related closure costs, including severance, vendor liabilities,
professional fees, and other shutdown expenses. In connection with the sale, the
Company recognized a gain of approximately $2.2 million in 2002. As of March 31,
2003, approximately $1.8 million of the proceeds are receivable. As of March 31,
2003, approximately $0.2 million related to severance, $6.5 million related to
vendor liabilities, $0.2 million related to professional fees, and $0.5 million
related to other shutdown expenses remained in an accrual to be paid. ARRIS
expects to complete the remaining payments by the end of 2003.
The Company's Keptel and Actives product lines, as a whole, constituted the
majority of its transmission, optical and outside plant product category and
qualified as discontinued operations in accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. Accordingly, the results of
these product lines
6
have been reclassified to discontinued operations for all periods presented. The
remaining product lines within the transmission, optical and outside plant
product category have been reclassified to the supplies and services product
category.
Revenues from discontinued operations were $19.2 million for the three months
ended March 31, 2002. The net loss from discontinued operations, net of taxes,
for the three months ending March 31, 2002 was $(5.4) million. During 2002, the
Company recorded a net loss on these disposals of $(4.0) million.
NOTE 6. RESTRUCTURING AND OTHER CHARGES
On October 30, 2002, the Company announced that it would close its office in
Andover, Massachusetts, which is primarily a product development and repair
facility. The Company decided to close the office in order to reduce operating
costs through consolidations of its facilities. The closure affected
approximately 75 employees and is expected to be completed during the second
quarter of 2003. In connection with these actions, the Company recorded a charge
of approximately $7.1 million in the fourth quarter of 2002. Included in this
restructuring charge was approximately $2.1 million related to remaining lease
payments, $2.7 million of fixed asset write-offs, $2.1 million of severance, and
$0.2 million of other costs associated with these actions. As of March 31, 2003,
approximately $1.9 million related to lease commitments, $0.5 million related to
severance, and $0.2 million related to other costs remained in the restructuring
accrual to be paid. ARRIS expects to complete the remaining payments by the
second quarter of 2006 (end of lease).
In the fourth quarter of 2001, ARRIS closed a research and development facility
in Raleigh, North Carolina and recorded a $4.0 million charge related to
severance and other costs associated with closing that facility. This charge
included termination expenses of $2.2 million related to the involuntary
dismissal of 48 employees, primarily engaged in engineering functions at that
facility. Also included in the $4.0 million charge was $0.7 million related to
lease commitments, $0.2 million related to the impairment of fixed assets, and
$0.9 million related to other shutdown expenses. As of March 31, 2003,
approximately $0.6 million related to lease commitments remained in an accrual
to be paid. ARRIS expects to complete the remaining payments by the third
quarter of 2004 (end of lease).
In the third quarter of 2001, the Company announced a restructuring plan to
outsource the functions of most of its manufacturing facilities. This decision
to reorganize was due in part to the ongoing weakness in industry spending
patterns. The plan entailed the implementation of an expanded manufacturing
outsourcing strategy and the related closure of the four factories located in El
Paso, Texas and Juarez, Mexico. As a result, the Company recorded restructuring
and impairment charges of $66.2 million, of which approximately $50.1 million
relates to and is classified in discontinued operations. Included in these
charges was approximately $33.7 million related to the write-down of
inventories, and remaining warranty and purchase order commitments of which
approximately $8.6 million was reflected in cost of goods sold and $25.1 million
was reflected in discontinued operations. Additional charges incurred were
approximately $5.7 million related to severance and associated personnel costs,
$5.9 million related to the impairment of goodwill due to the sale of the power
product lines, $14.8 million related to the impairment of fixed assets, and
approximately $6.1 million related to lease terminations of factories and office
space and other shutdown expenses. Of these charges, approximately $7.5 million
is reflected in restructuring expense and $25.0 million is reflected in
discontinued operations. The personnel-related costs included termination
expenses for the involuntary dismissal of 807 employees, primarily engaged in
production and assembly functions performed at the facilities. ARRIS offered
terminated employees separation amounts in accordance with the Company's
severance policy and provided the employees with specific separation dates. Due
to unforeseen delays in exiting the facility after the shutdown, during the
fourth quarter of 2002 the Company recorded an additional charge of $2.4 million
to discontinued operations. As of March 31, 2003, approximately $0.4 million
related to severance and associated personnel costs, and $1.2 million related to
lease terminations of factories and office space and other shutdown costs
remained in an accrual to be paid. ARRIS expects to complete the remaining
payments by the end of 2003.
7
NOTE 7. INVENTORIES
Inventories are stated at the lower of average, approximating first-in,
first-out, cost or market. The components of inventory are as follows (in
thousands):
MARCH 31, DECEMBER 31,
2003 2002
--------- ------------
(UNAUDITED)
Raw material ........................... $ 6,849 $ 3,941
Finished goods ......................... 97,482
100,262
-------- --------
Total inventories ................. $104,331 $104,203
======== ========
NOTE 8. PROPERTY, PLANT AND EQUIPMENT NET
Property, plant and equipment, at cost, consists of the following (in
thousands):
MARCH 31, DECEMBER 31,
2003 2002
--------- ------------
(UNAUDITED)
Land ..................................... $ 1,822 $ 1,822
Building and leasehold improvements ...... 7,406 7,295
Machinery and equipment .................. 66,999 70,233
-------- --------
76,227 79,350
Less: Accumulated depreciation............ (46,017) (44,810)
-------- --------
Total property, plant and equipment,
net .................................... $ 30,210 $ 34,540
======== ========
NOTE 9. GOODWILL AND INTANGIBLE ASSETS
ARRIS adopted SFAS No. 142, Goodwill and Other Intangible Assets, on January 1,
2002. Under the new rules, goodwill and indefinite lived intangible assets are
no longer amortized but are reviewed annually for impairment, or more frequently
if impairment indicators arise. Separable intangible assets that are not deemed
to have an indefinite life will continue to be amortized over their useful
lives. Upon adoption of SFAS No. 142, the Company recorded a goodwill impairment
loss of approximately $58.0 million, primarily related to the Keptel product
line, based upon management's analysis including an independent valuation. The
resulting impairment loss has been recorded as a cumulative effect of a change
in accounting principle on the accompanying Consolidated Statements of
Operations for the quarter ended March 31, 2002. The valuation was determined
using a combination of the income and market approaches on an invested capital
basis, which is the market value of equity plus interest-bearing debt. The
Company's remaining goodwill was reviewed in the fourth quarter of 2002, and
based upon management's analysis including an independent valuation, an
impairment charge of $70.2 million was recorded with respect to its supplies and
services product category.
The changes in the carrying amount of goodwill for the year ended December 31,
2002 and for the three months ended March 31, 2003 are as follows (in
thousands):
Balance as of December 31, 2001 .................................. $ 259,062
Transitional impairment charge ................................... (57,960)
Purchase price allocation adjustment - Arris Interactive L.L.C ... 33
Goodwill acquired from Cadant, Inc. acquisition .................. 26,339
Transferred to intangible asset upon adoption of SFAS No. 142 .... (6,000)
Goodwill impairment charge, October 1, 2002 ...................... (70,209)
---------
Balance as of December 31, 2002 .................................. $ 151,265
Purchase price allocation adjustment - Cadant, Inc. .............. (12)
---------
Balance as of March 31, 2003 ..................................... $ 151,253
=========
8
The gross carrying amount and accumulated amortization of the Company's
intangible assets, other than goodwill, as of March 31, 2003 and December 31,
2002 are as follows (in thousands):
MARCH 31, 2003 DECEMBER 31, 2002
---------------------------------------- ----------------------------------------
GROSS ACCUMULATED NET BOOK GROSS ACCUMULATED NET BOOK
AMOUNT AMORTIZATION VALUE AMOUNT AMORTIZATION VALUE
-------- ------------ -------- -------- ------------ --------
Existing technology acquired:
Arris Interactive L.L.C .... $ 51,500 $(28,470) $23,030 $ 51,500 $(24,178) $27,322
Cadant, Inc. ............... 53,000 (21,744) 31,256 53,000 (17,328) 35,672
Atoga Systems .............. 659 -- 659 -- -- --
Pension asset ................... 1,849 -- 1,849 1,849 -- 1,849
-------- -------- ------- -------- -------- -------
Total ...................... $107,008 $(50,214) $56,794 $106,349 $(41,506) $64,843
======== ======== ======= ======== ======== =======
Amortization expense recorded on the intangible assets listed in the above table
for the three months ended March 31, 2003 and 2002 was $8.7 million and $8.4
million, respectively. The estimated total amortization expense for each of the
next five fiscal years is as follows (in thousands):
2003 ... $34,998
2004 ... $28,041
2005 ... $ 559
2006 ... $ 55
2007 ... $ --
NOTE 10. LONG TERM DEBT, CAPITAL LEASE OBLIGATIONS AND MEMBERSHIP INTEREST
Long term debt, capital lease obligations and membership interest consist of the
following (in thousands):
MARCH 31, DECEMBER 31,
2003 2002
--------- ------------
(UNAUDITED)
Capital lease obligations $ 1,752 $ 1,278
Equipment loan 246 --
Membership interest -Nortel Networks -- 114,518
4.5% Convertible Subordinated Notes due 2003 11,537 23,887
4.5% Convertible Subordinated Notes due 2008 125,000 --
--------- ---------
Total debt, capital lease obligations and membership interest 138,535 139,683
Less current portion (13,170) (25,007)
--------- ---------
Total long term debt, capital lease obligations and membership interest $ 125,365 $ 114,676
========= =========
On March 18, 2003, the Company issued $125.0 million of 4-1/2% Convertible
Subordinated Notes due 2008 ("Notes due 2008"). The Notes due 2008 are
convertible, at the option of the holder, at any time prior to maturity, into
the Company's common stock at a conversion price of $5.00 per share, subject to
adjustment. The Notes due 2008 will pay interest semi-annually, based on an
annual rate of 4-1/2%, on March 15 and September 15 of each year, commencing
September 15, 2003. The Company used approximately $88.4 million of the proceeds
from the issuance, including the reduction in the forgiveness of the Class B
membership interest, to redeem the Class B membership interest in Arris
Interactive held by Nortel Networks resulting in a gain of approximately $28.5
million, recorded in operations in accordance with SFAS No. 145, Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections. On March 24, 2003, the Company used approximately $28.0
million of the proceeds of the issuance to repurchase and retire 8 million
shares of its common stock held by Nortel Networks at a discount. The Company
expects to use the remaining proceeds for general corporate purposes. As of
March 31, 2003, there were $125.0 million of the Notes due 2008 outstanding.
In 1998, the Company issued $115.0 million of 4-1/2% Convertible Subordinated
Notes due May 15, 2003 ("Notes due 2003"). The Notes due 2003 are convertible,
at the option of the holder, at any time prior to maturity, into the Company's
common stock at a conversion price of $24.00 per share. In 2002, ARRIS exchanged
1,593,789 shares
9
of its common stock for approximately $15.4 million of the Notes due 2003.
Additionally, the Company redeemed $12.4 million and $75.7 million of the Notes
due 2003 in 2003 and 2002, respectively, using cash. As of March 31, 2003, there
were approximately $11.5 million of the Notes due 2003 outstanding and will be
redeemed on or prior to the due date of May 15, 2003.
The Company's existing bank indebtedness, as subsequently amended, is an
asset-based revolving credit facility (the "Credit Facility") permitting the
Company to borrow up to $115.0 million (which can be increased under certain
conditions by up to $25.0 million), based upon availability under a borrowing
base calculation. In general, the borrowing base is limited to 85% of net
eligible receivables (with a cap of $5.0 million in relation to foreign
receivables), subject to a reserve of $10.0 million. In addition, upon obtaining
appropriate asset appraisals the Company may include in the borrowing base
calculation 80% of the orderly liquidation value of net eligible inventory (not
to exceed $60.0 million). The Credit Facility contains traditional financial
covenants, including fixed charge coverage, senior debt leverage, minimum net
worth, and minimum inventory turns ratios. The Credit Facility was amended in
January 2003 to provide that the minimum net worth covenant applied only to the
period prior to December 31, 2002.
On March 11, 2003, ARRIS amended its credit facility to permit the Company to
issue up to $125.0 million of the Notes due 2008, to use the proceeds of such
notes to redeem the Class B membership interest in Arris Interactive held by
Nortel Networks and to purchase shares of the ARRIS common stock held by Nortel
Networks, subject to certain limitations. The amendment also reduced the
revolving loan commitments by $10.0 million to $115.0 million. The facility is
secured by substantially all of the Company's assets. The Credit Facility has a
maturity date of August 3, 2004. The commitment fee on unused borrowings is
0.75%. The availability under the Credit Facility at March 31, 2003 was
approximately $17.1 million, and the Company had no borrowings under the
facility.
In connection with the acquisition of Arris Interactive in August 2001, Nortel
Networks exchanged its remaining ownership interest in Arris Interactive for 37
million shares of ARRIS common stock and a subordinated redeemable Class B
membership interest in Arris Interactive with a face amount of $100.0 million.
The Class B membership interest earned an accreting non-cash return of 10% per
annum, compounded annually, and was redeemable in approximately four quarterly
installments commencing February 3, 2002, provided that certain availability and
other tests are met under the Company's Credit Facility. Those tests were not
met. In June 2002, ARRIS entered into an option agreement with Nortel Networks
that permitted ARRIS to redeem the Class B membership interest in Arris
Interactive at a discount of 21% prior to June 30, 2003. To further induce the
Company to redeem the Class B membership interest, Nortel Networks offered to
forgive approximately $5.9 million of the amount owed Nortel Networks if ARRIS
redeemed it prior to March 31, 2003. The Company used approximately $88.4
million of the proceeds, including the reduction in the forgiveness of the Class
B membership interest, of the March 2003 offering of its 4-1/2% the Notes due
2008 to redeem the Class B membership interest at a discount resulting in a gain
of approximately $28.5 million, recorded in operations in accordance with SFAS
No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections.
In conjunction with the acquisition of Cadant, Inc. and Atoga Systems, the
Company assumed capital lease obligations and an equipment loan related to
machinery and equipment. The leases require future rental payments until 2005.
The balance of the capital lease obligations and equipment loan at March 31,
2003 was approximately $1.8 million and $0.2 million, respectively.
ARRIS has not paid cash dividends on its common stock since its inception. The
Company's credit agreement contains covenants that prohibit them from paying
such dividends. In 2002, to implement its shareholder rights plan, the Company's
board of directors declared a dividend consisting of one right for each share of
its common stock outstanding. Each right represents the right to purchase one
one-thousandth of a share of its Series A Participating Preferred Stock and
becomes exercisable only if a person or group acquires beneficial ownership of
15% or more of its common stock or announces a tender or exchange offer for 15%
or more of its common stock or under other similar circumstances.
NOTE 11. COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) for the three-month periods ended March 31,
2003 and 2002 was $3.7 million and $(60.2) million, respectively. Such
comprehensive loss, which is recorded as a separate component of
10
stockholders' equity, is related to cumulative translation adjustments and
unrealized holding losses on marketable securities.
NOTE 12. SALES INFORMATION
A significant portion of ARRIS' revenue is derived from sales to Cox
Communications and Comcast (including AT&T Broadband). Sales to these two
customers for the three-month periods ended March 31, 2003 and 2002 are set
forth below (in thousands):
THREE MONTHS ENDED MARCH 31,
-------------------------------
2003 2002
--------- ---------
Cox Communications ................... $ 25,122 $ 32,667
% of sales ........................... 27.5% 18.9%
Comcast (including AT&T Broadband) ... $ 23,804 $ 48,024
% of sales ........................... 26.1% 27.9%
In the fourth quarter of 2002, Comcast completed its purchase of AT&T Broadband.
AT&T Broadband was the Company's largest customer in terms of revenues in the
first three quarters of 2002. AT&T Broadband, with the deployment of telephony
as part of its core strategy, had been using ARRIS' constant bit rate products
in many of its major markets. Comcast has announced that its initial priority
after its acquisition of AT&T Broadband will be to emphasize video and
high-speed data operations and focus on improving the profitability of its
telephony operations at the expense of subscriber growth. As a result, the
Company's sales of CBR products to Comcast decreased significantly in the first
quarter of 2003.
ARRIS operates globally and offers products and services that are sold to cable
system operators and telecommunications providers. ARRIS' products and services
are focused in two product categories instead of the previous three categories:
Broadband, and Supplies and Services. As a result of the sale of the Company's
Keptel and Actives product lines in 2002, revenues from the remaining product
lines within the former Transmission, Optical, and Outside Plant product
category are now reported with the Supplies and Services product category. All
prior period revenues have been aggregated to conform to the new product
categories. Consolidated revenues by principal products and services for the
three-month periods ended March 31, 2003 and 2002 were as follows (in
thousands):
SUPPLIES &
BROADBAND SERVICES TOTAL
--------- ---------- --------
Quarterly sales
March 31, 2003 ... $ 61,656 $29,687 $ 91,343
March 31, 2002 ... $114,182 $58,215 $172,397
11
The Company sells its products primarily in the United States with its
international revenue being generated from Asia Pacific, Europe, Latin America
and Canada. The Asia Pacific market primarily includes China, Hong Kong, Japan,
Korea, and Singapore. The European market primarily includes Austria, Germany,
France, Netherlands, Poland, Portugal, Romania, Spain, and Switzerland. The
Latin American market primarily includes Argentina, the Bahamas, Chile,
Colombia, Mexico, and Puerto Rico. Sales to international customers were
approximately 20.5%, and 25.7% of total sales for the periods ended March 31,
2003 and 2002, respectively. Sales for the periods ended March 31, 2003 and 2002
are as follows (in thousands):
THREE MONTHS ENDED MARCH 31,
---------------------------
2003 2002
------- --------
International region
Asia Pacific ............................... $ 5,368 $ 11,141
Europe ..................................... 9,068 28,312
Latin America .............................. 1,332 2,899
Canada ..................................... 2,948 1,909
------- --------
Total international sales ... 18,716 44,261
Total domestic sales ........ 72,627 128,136
------- --------
Total sales ................. $91,343 $172,397
======= ========
Total identifiable international assets were immaterial.
NOTE 13. 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,
---------------------------
2003 2002
------- --------
Basic:
Income (loss) from continuing operations ..... $ 3,446 $ 3,443
Income (loss) from discontinued operations ... -- (5,377)
Cumulative effect of an accounting change .... -- (57,960)
------- --------
Net income (loss) .......................... $ 3,446 $(59,894)
======= ========
Weighted average shares outstanding ........ 82,068 80,258
======= ========
Basic earnings (loss) per share ............ $ 0.04 $ (0.75)
======= ========
Diluted:
Income (loss) from continuing operations ..... $ 3,446 $ 3,443
Income (loss) from discontinued operations ... -- (5,377)
Cumulative effect of an accounting change .... -- (57,960)
------- --------
Net income (loss) .......................... $ 3,446 $(59,894)
======= ========
Weighted average shares outstanding ........ 82,068 80,258
Net effect of dilutive stock options ....... 1,534 --
------- --------
Total ................................. 83,602 80,258
======= ========
Diluted earnings (loss) per share ..... $ 0.04 $ (0.75)
======= ========
The 4-1/2% convertible subordinated notes were antidilutive for both periods
presented. The effects of the options and warrants were not presented for the
three-month period ended March 31, 2002 as the Company incurred a net loss
during that period and inclusion of these securities would be antidilutive.
NOTE 14. BUSINESS ACQUISITIONS
ACQUISITION OF ATOGA SYSTEMS
On March 21, 2003, ARRIS purchased certain assets of Atoga Systems, a Fremont,
California-based developer of optical transport systems for metropolitan area
networks. The Company decided to undertake this transaction
12
because it expands its existing broadband product portfolio and is anticipated
to have a positive impact on future results of the Company over the long-term.
Under the terms of the agreement, ARRIS obtained certain inventory, fixed
assets, and existing technology in exchange for approximately $0.4 million of
cash and the assumption of certain lease obligations. Further, the Company
retained 28 employees and issued a total of 500,000 shares of restricted stock
to those employees.
The following is a summary of the preliminary purchase price allocation to
record ARRIS' purchase price of the assets and certain liabilities of Atoga
Systems. The purchase price was equal to the net tangible and intangible assets
acquired. The final allocation of the purchase price will be determined after
completion of thorough analyses to identify and determine the fair values of
Atoga Systems' tangible and identifiable intangible assets and liabilities as of
the date the transaction was completed.
(IN THOUSANDS)
Cash paid to Atoga Systems ............................. $ 434
Acquisition costs (legal fees) ......................... --
Assumption of certain liabilities of Atoga Systems ..... 1,215
------
Adjusted preliminary purchase price .................. $1,649
======
Allocation of purchase price:
Net tangible assets acquired ......................... $ 990
Existing technology (to be amortized over 3 years) ... 659
------
Total allocated preliminary purchase price ........... $1,649
======
ACQUISITION OF CADANT, INC.
On January 8, 2002, ARRIS completed the acquisition of all of the assets of
Cadant, Inc., a privately held designer and manufacturer of next generation
Cable Modem Termination Systems ("CMTS"). The Company decided to complete this
transaction because it provides significant product and technology extensions in
Broadband and would have a positive impact on future results of the Company. As
a part of this transaction:
- ARRIS issued 5.25 million shares of ARRIS common stock for the
purchase of substantially all of Cadant's assets and certain
liabilities.
- ARRIS agreed to pay up to 2.0 million shares based upon future
sales of the CMTS product through January 8, 2003. These
targets were not met as of January 8, 2003, and therefore, no
further shares were issued.
The following is a summary of the purchase price allocation to record ARRIS'
purchase price of the assets and certain liabilities of Cadant, Inc. for
5,250,000 shares of ARRIS Group, Inc. common stock based on the average closing
price of ARRIS' common stock for 5 days prior and 5 days after the date of the
transaction as quoted on the Nasdaq National Market System. The excess of the
purchase price over the fair value of the net tangible and intangible assets
acquired has been allocated to goodwill.
(IN THOUSANDS)
5,250,000 shares of ARRIS Group, Inc.'s $0.01 par value
common stock at $10.631 per common share .................... $55,813
Acquisition costs (banking fees, legal and accounting fees,
printing costs) ............................................. 898
Fair value of stock options to Cadant, Inc. employees ......... 12,760
Assumption of certain liabilities of Cadant, Inc. ............. 14,919
-------
Adjusted purchase price ..................................... $84,390
=======
Allocation of Purchase Price:
Net tangible assets acquired ................................ $ 5,063
Existing technology (to be amortized over 3 years) .......... 53,000
Goodwill (not deductible for income tax purposes) ........... 26,327
-------
Total allocated purchase price .............................. $84,390
=======
13
SUPPLEMENTAL PRO FORMA INFORMATION
Presented below is summary unaudited pro forma combined financial information
for the Company, Atoga Systems, and Cadant, Inc. to give effect to the
transactions. This summary unaudited pro forma combined financial information is
derived from the historical financial statements of the Company, Atoga Systems,
and Cadant, Inc. This information assumes the transaction was consummated at the
beginning of the applicable period. This information is presented for
illustrative purposes only and does not purport to represent what the financial
position or results of operations of the Company, Atoga Systems, and Cadant,
Inc., or the combined entity would actually have been had the transaction
occurred at the applicable dates, or to project the Company's, Atoga Systems',
and Cadant, Inc.'s, or the combined entity's results of operations for any
future period or date. The actual results of Atoga Systems are included in the
Company's operations from March 21, 2003 to March 31, 2003. The actual results
of Cadant, Inc. are included in the Company's operations from January 8, 2002 to
March 31, 2003.
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
------------------------------
2003 2002
-------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales ......................................................... $ 91,343 $ 172,397
Gross profit ...................................................... 24,744 58,231
Operating income (loss) ........................................... (23,053) (2,590)
Income (loss) before income taxes ................................. 1,839 (8,710)
Income (loss) from continuing operations .......................... 1,839 (1,910)
Income (loss) from discontinued operations ........................ -- (5,377)
Net income (loss) before cumulative effect of accounting change ... 1,839 (7,287)
Net income (loss) ................................................. $ 1,839 $ (65,247)
======== =========
Net income (loss) per common share:
Basic and diluted ............................................... $ 0.02 $ (0.81)
======== =========
Weighted average common shares:
Basic and diluted ............................................... 83,602 80,373
======== ==========
The following table represents the amount assigned to each major asset and
liability caption of Atoga Systems as of March 21, 2003 and Cadant, Inc. as of
January 8, 2002, as adjusted:
AS OF ACQUISITION DATE
(IN THOUSANDS)
---------------------------------
ATOGA SYSTEMS CADANT, INC.
------------- ------------
Total current assets .......................... $ 330 $ 782
Property, plant and equipment, net ............ $ 660 $ 4,281
Goodwill ...................................... $ -- $26,327
Intangible assets ............................. $ 659 $53,000
Total assets .................................. $1,649 $84,390
Total current and long-term liabilities ....... $1,649 $14,919
Total liabilities and membership interest ..... $1,649 $14,919
Total stockholders' equity .................... $ -- $ --
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
Set forth below is a more detailed description of how our business performed
during the three-month period ending March 31, 2003 as compared to the same
period in 2002. During the past two years, we have significantly changed our
business through acquisitions, product line rationalizations and cost reduction
actions, allowing us to focus on our long-term business strategy. As a result of
our acquisitions and dispositions, our business has changed significantly and
our historical results of operations will not be as indicative of future results
of operations as they otherwise might suggest. Some of these differences are
discussed below.
CAPITAL STRUCTURE ACTIONS
Notes due 2008. On March 18, 2003, we issued $125.0 million of 4-1/2%
convertible subordinated notes due March 15, 2008 under Rule 144A. These notes
are convertible at the option of the holder into our common stock at $5.00 per
share, subject to adjustment. We are entitled to call the notes for redemption
at any time, subject to our making a "make whole" payment if we call them for
redemption prior to March 15, 2006. In addition, we are required to repurchase
the notes in the event of a "change in control."
We used approximately $88.4 million of the proceeds, including the reduction in
the forgiveness of the Class B membership interest, of the notes issuance to
redeem the entire Class B membership interest in Arris Interactive held by
Nortel Networks. We used approximately $28.0 million of the proceeds of the
issuance to repurchase and retire 8 million shares of our common stock held by
Nortel Networks at a discount. We will use the remaining proceeds for general
corporate purposes.
Credit Facility. On several occasions during 2002 we modified our credit
facility in order to allow us to use existing cash reserves and proceeds of
asset sales to purchase or redeem our outstanding 4-1/2% convertible
subordinated notes due 2003. These modifications imposed certain conditions on
the use of such cash to purchase or redeem additional notes. On March 11, 2003,
we amended the credit facility to permit us to issue up to $125.0 million of new
convertible subordinated notes due 2008 and to use the proceeds of the new notes
to redeem the Class B membership interest in Arris Interactive held by Nortel
Networks and to purchase shares of the our common stock held by Nortel Networks,
subject to certain limitations. The amendment also reduced the revolving loan
commitments to $115.0 million.
Membership Interest. In connection with the acquisition of Arris Interactive in
August 2001, Nortel Networks exchanged its remaining ownership interest in Arris
Interactive for 37 million shares of our common stock and a subordinated
redeemable Class B membership interest in Arris Interactive with a face amount
of $100.0 million. The Class B membership interest earned an accreting non-cash
return of 10% per annum, compounded annually, and was redeemable in
approximately four quarterly installments commencing February 3, 2002, provided
that certain availability and other tests are met under our revolving credit
facility. Those tests were not met. The balance of the Class B membership
interest as of December 31, 2002 was approximately $114.5 million. In June 2002,
we entered into an option agreement with Nortel Networks that permitted us to
redeem the Class B membership interest in Arris Interactive at a discount of 21%
prior to June 30, 2003. To further induce us to redeem the Class B membership
interest, Nortel Networks offered to forgive an additional $5.9 million of the
amount owed Nortel Networks if we redeemed it prior to March 31, 2003. We used
approximately $88.4 million of the proceeds of the March 2003 convertible note
offering to redeem the entire Class B membership interest.
Notes due 2003. In May 1998, we issued $115.0 million of 4-1/2% convertible
subordinated notes due May 15, 2003. In 2002, we retired $91.1 million of these
notes through cash repurchases and exchanges for our common stock. During the
first quarter 2003, we repurchased an additional $12.4 million of the notes,
leaving $11.5 million to retire at maturity on May 15, 2003.
Common Stock. Of the 37 million shares of our common stock that Nortel Networks
received in 2001, it sold 15 million in a registered public offering in June
2002. In order to reduce its holdings further, in March 2003 Nortel Networks
granted us an option to purchase up to 16 million shares at a 10% discount to
market, subject to a
15
minimum purchase price of $3.50 per share for 8 million shares and $4.00 per
share for the remainder. In addition, to the extent that we purchased shares at
a price of less than $4.00 per share, we were obligated to return to Nortel
Networks a portion of the return that was forgiven with respect to the Class B
membership interest, up to a maximum of $2.0 million. Pursuant to this option,
on March 24, 2003, we purchased 8 million shares for an aggregate purchase price
of $28.0 million. Contemporaneously with this transaction, we paid Nortel
Networks $2.0 million, which represented the reduction in the forgiveness of the
Class B membership interest. We have not decided when or whether we will
exercise the option to repurchase the remaining 8 million shares offered by
Nortel Networks under the option, which will expire June 30, 2003.
Amendment to Investor Rights Agreement. In connection with the sale of shares of
our common stock by Nortel Networks in June 2002, effective September 30, 2002,
we agreed to relax certain restrictions in the Investor Rights Agreement
governing Nortel Networks' ownership and disposition of our stock that will make
it easier for Nortel Networks to sell its remaining shares of our stock.
Additionally, Nortel Networks and Liberty Media (our other large shareholder),
entered into a "standstill" agreement under which each of them has agreed that
it will not exercise its registration rights or, except under certain
circumstances, sell any shares of our common stock until July 31, 2003, unless
prior to then we both redeem 66% of the original principal amount of our
outstanding 4-1/2% convertible subordinated notes due 2003 and repurchase at
least 66% of Nortel Networks' Class B membership interest, in which case the
restrictions expire 30 days after the later of those two events. As a result of
the repurchase of the Class B membership interest, those restrictions expired on
April 17, 2003.
In connection with the issuance of 4-1/2% convertible subordinated notes due
2008, each of Nortel Networks and Liberty Media entered into a standstill
agreement with CIBC World Markets Corp., the initial purchaser of the notes.
Under these agreements, Nortel Networks and Liberty Media may not, without the
prior written consent of CIBC World Markets Corp., sell any shares of our common
stock or exercise any registration rights until on or after June 10, 2003,
except that Nortel Networks may require us to register up to 6,000,000 shares of
common stock.
PRODUCT PORTFOLIO ACTIONS
Acquisition of Atoga Systems
On March 21, 2003, we purchased certain assets of Atoga Systems, a Fremont,
California-based developer of optical transport systems for metropolitan area
networks. Under the terms of the agreement, we obtained certain inventory, fixed
assets, and intellectual property in consideration for approximately $0.4
million of cash and the assumption of certain obligations. Further, we retained
28 employees and issued a total of 500,000 shares of restricted stock to those
employees. We anticipate the transaction to be slightly dilutive to our earnings
per share in 2003.
Acquisition of Cadant, Inc.
On January 8, 2002, we acquired substantially all of the assets of Cadant, Inc.,
a privately held designer and manufacturer of next generation CMTS. Under the
terms of the transaction, we issued 5.25 million shares of our common stock and
assumed approximately $16.5 million in liabilities in exchange for the assets.
We issued 2.0 million options to purchase our common stock and 250,000 shares of
restricted stock to Cadant employees. We also agreed to issue up to 2.0 million
additional shares of our common stock based upon the achievement of future sales
targets through 2003 for the CMTS product. These sales targets were not achieved
and no additional shares of our common stock will be issued.
16
Sale of Actives Product Line
On November 21, 2002, we sold our Actives product line, excluding receivables
and payables, for $31.8 million in net proceeds. The agreement provided for the
transfer of inventory and equipment attributable to the product lines, plus the
transfer of approximately 34 employees. The Actives product line had
approximately $11.3 million of revenue for the three months ended March 31,
2002. Total assets of approximately $20.3 million were disposed of, which
included inventory, fixed assets, and other assets attributable to the product
line. Additionally, we incurred approximately $9.3 million of related closure
costs, including severance, vendor liabilities, professional fees, and other
shutdown expenses. In connection with the sale, we recognized a gain of
approximately $2.2 million.
Sale of Keptel Product Line
On April 24, 2002, we sold our Keptel product line. Keptel designed and marketed
network interface systems and fiber optic cable management products primarily
for traditional telecommunications residential and commercial applications. The
transaction generated cash proceeds of $30.0 million. Additionally, we retained
a potential earnout over a twenty-four month period based on sales achievements.
The transaction also includes a distribution agreement whereby we will continue
to distribute Keptel products. The Keptel product line had approximately $6.3
million of revenue for the three months ended March 31, 2002. Total assets of
approximately $31.1 million were disposed of, which included inventory, fixed
assets, intangibles (formerly classified as goodwill), and other assets. We
incurred approximately $5.0 million of related closure costs, including
severance, vendor liabilities, outside consulting fees, and other shutdown
expenses. The net result of the transaction was a loss on the sale of the
product line of approximately $6.2 million.
COST REDUCTION ACTIONS
During 2001 and 2002, we implemented significant cost reduction actions. In the
third quarter of 2001, we concluded that it would be more cost effective to
outsource manufacturing of our Actives and Keptel product lines. This resulted
in the closure of four factories in Juarez, Mexico and El Paso, Texas. In
conjunction with the purchase of Cadant, we closed our facility in Raleigh,
North Carolina. The Raleigh location was a development facility where
duplicative work to that being done by the Cadant organization was being
performed. In 2001 and 2002, we continuously reviewed our cost structure with
the goal of improving both our effectiveness and efficiency of operations. As a
result, in October 2002, we announced the closure of our development and repair
facility in Andover, Massachusetts and implemented other expense reduction
actions including general reductions in force. These actions were, in part,
facilitated by the simplification of our business model as a result of the
closure of factories and product line rationalizations.
INDUSTRY CONDITIONS
Our performance is largely dependent on capital spending for constructing,
rebuilding, maintaining and upgrading broadband communications systems. After a
period of intense consolidation and rapid capital expenditures within the
industry through the fourth quarter of 2000, there was a tightening of credit
availability throughout the telecommunications industry and a broad-based and
severe drop in market capitalization for the sector. This caused broadband
system operators to become more cautious in their capital spending, adversely
affecting us and other equipment providers.
Developments in the industry and in the capital markets over the past two years
have reduced access to funding for new and existing customers, causing delays in
the timing and scale of deployments of our equipment, as well as the
postponement or cancellation of certain projects by our customers. In addition,
during the same period, we and other vendors received notification that several
customers were canceling new projects or scaling back existing projects or
delaying new orders to allow them to reduce inventory levels which were in
excess of their current deployment requirements.
This industry downturn and other factors have adversely affected several of our
largest customers. In June 2002, Adelphia filed bankruptcy at a time when it
owed us approximately $20.2 million in accounts receivable. As a result, we
incurred a $20.2 million charge during the second quarter 2002. However, we sold
a portion of the Adelphia receivables during the third quarter 2002 to an
unrelated third party, resulting in net gain of approximately
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$4.3 million. For the year ended December 31, 2002, the net result was a loss of
$15.9 million related to the Adelphia situation.
In addition, as of May 12, 2003, Cabovisao, a Portugal-based customer owed us
approximately 18.6 million euros in accounts receivable, a substantial portion
of which was past due. This customer accounted for approximately 6% of our sales
in 2002. On October 17, 2002, the parent company of Cabovisao, CSii, issued an
announcement that suggested it may have difficulty in accessing or refinancing
its senior credit facility in the future. On March 1, 2003, CSii announced that
it had formed a special committee of its board of directors to review and
evaluate alternatives to meet the financial needs of CSii and Cabovisao,
including: debt restructuring, recapitalization, capital infusion and court
supervised restructuring. On May 7, 2003, CSii announced that it had obtained an
extension of the maturity date of its credit facility to May 28, 2003, and that
it was continuing negotiations with respect to a long term financing solution.
We are uncertain what effect, if any, these developments will have on our
existing accounts receivable or future relationship with Cabovisao.
Further, in the fourth quarter of 2002 Comcast completed its purchase of AT&T
Broadband. Historically, AT&T Broadband has been our largest customer. AT&T
Broadband, with the deployment of telephony as part of its core strategy, had
been using our CBR products in many of its major markets. Comcast has announced
that its initial priority after its acquisition of AT&T Broadband will be to
emphasize video and high-speed data operations and focus on improving the
profitability of its telephony operations at the expense of subscriber growth.
As a result, we experienced a significant decline in sales of our CBR telephony
product to Comcast in the fourth quarter of 2002, which has continued into 2003.
On June 27, 2002, Comcast announced that it had chosen us to provide an initial
DOCSIS 1.1 C4 CMTS to be installed at the headend of a Comcast cable system in
the Philadelphia area. On January 13, 2003, we announced that Comcast had
ordered an additional fifty C4 CMTS chassis for immediate data service
deployment.
SIGNIFICANT CUSTOMERS
A significant portion of ARRIS' revenue is derived from sales to Cox
Communications and Comcast (including AT&T Broadband). Sales to these two
customers for the three-month periods ended March 31, 2003 and 2002 were as
follows (in thousands):
THREE MONTHS ENDED MARCH 31
---------------------------
2003 2002
------- --------
Cox Communications ................... $25,122 $32,667
% of sales ........................... 27.5% 18.9%
Comcast (including AT&T Broadband) ... $23,804 $48,024
% of sales ........................... 26.1% 27.9%
As described above, we have uncertainties surrounding our future transactions
with Adelphia and Cabovisao. Sales to these two customers for the three-month
periods ended March 31, 2003 and 2002 were as follows (in thousands):
THREE MONTHS ENDED MARCH 31
---------------------------
2003 2002
------ --------
Adelphia Communications .............. $2,821 $16,039
% of sales ........................... 3.1% 9.3%
Cabovisao ............................ $ 510 $17,562
% of sales ........................... 0.6% 10.2%
COMPARISON OF OPERATIONS FOR THE THREE MONTHS ENDED MARCH 31, 2003 AND 2002
As the sale of our Actives and Keptel product lines in 2002 represented a
majority of the transmission, optical and outside plant product category, we
have reclassified the results of these product lines to discontinued operations
for all periods presented in accordance with Statement of Financial Accounting
Standards No. 144, Accounting for the
18
Impairment or Disposal of Long-Lived Assets. Our products and services are
summarized in the following two product categories, broadband, and supplies and
services, instead of the previous three categories. The balance of the product
lines previously reported in the former transmission, optical and outside plant
product category have been combined with our supplies and services product
category. All prior period amounts have been aggregated to conform to the new
product categories.
Net Sales. ARRIS' sales for the first quarter 2003 decreased by $81.1 million or
47.0% to $91.3 million, as compared to the first quarter 2002 sales of $172.4
million.
- - Broadband product revenues decreased by approximately $52.5 million or
46.0% to $61.7 million in the first quarter 2003, as compared to
revenues of $114.2 million during the same quarter in 2002. Broadband
product revenue accounted for approximately 67.5% of the first quarter
2003 sales, as compared to 66.2% during the same period in 2002. The
significant decrease in broadband product revenue is the result of
several factors:
o Sales to Comcast (including AT&T Broadband) for constant bit
rate telephony products declined by approximately $29.6
million. AT&T Broadband had been our largest customer of
constant bit rate telephony products. In the fourth quarter
2002, Comcast completed its purchase of AT&T Broadband.
Comcast has announced that its initial priority after its
acquisition of AT&T Broadband will be to emphasize video and
high-speed data operations and focus on improving the
profitability of its telephony operations at the expense of
subscriber growth. As a result, our sales of CBR products to
Comcast have decreased significantly in the first quarter of
2003.
o Sales internationally declined by $24.8 million. A significant
portion of this decline is attributable to the reduced
purchases by Cabovisao. Sales to this customer decreased by
approximately $17.1 million quarter over quarter.
o Offsetting the above decreases were increases in sales of our
Cadant C4 CMTS product line. Sales of this product line during
the first quarter 2003, while higher than the first quarter
2002, were hindered by manufacturing and component
availability issues.
- - Supplies and services product revenue decreased by approximately $28.5
million or 49.0% to $29.7 million in the first quarter 2003 as compared
to sales of $58.2 million in the first quarter 2002. Supplies and
services product revenue accounted for approximately 32.5% of the first
quarter 2003 sales, as compared to 33.8% during the same period in
2002. The bankruptcy filing by Adelphia and the resulting reduced sales
to Adelphia accounted for approximately $8.6 million or 30.1% of the
overall decrease in supplies and services product revenue quarter over
quarter. Furthermore, revenues during 2003 were reduced due to
weather-related issues regionally during the first quarter, causing
disruptions of shipments.
International sales decreased by approximately $25.5 million or 57.7% to $18.7
million for the three months ended March 31, 2003, as compared to sales of $44.3
million during the same quarter in 2002. International revenue for the first
quarter 2003 represented approximately 20.5% of our total revenue for the
quarter. This compares to international revenue of 25.7% of our total revenue
for the first quarter 2002. The reduced level of international business is
reflective of the tight capital spending market, coupled with the specific
situation with Cabovisao, primarily its financing difficulties, as previously
discussed. Cabovisao accounted for approximately $17.1 million or 66.8% of the
decrease in international revenues. We have halted shipments to Cabovisao until
its refinancing status is clarified.
Gross Profit. Gross profit decreased by $33.5 million or 57.5% to $24.7 million
in the first quarter 2003, as compared to $58.2 million in the first quarter
2002. Gross profit margins for the quarter ended March 31, 2003 decreased
approximately 6.7 percentage points to 27.1% as compared to 33.8% for the first
three months of 2002. This reduction in gross margin reflects two primary
factors:
- - The reduced sales volume in the first quarter 2003, as compared to the
first quarter 2002, provided a lower base to cover our fixed
manufacturing costs leading to a reduction in our gross margin
percentage.
- - Our gross margin within the broadband product category declined as a
result of a shift in product mix. Specifically, we sold less constant
bit rate headend equipment in the first quarter 2003 as compared to the
first quarter 2002.
19
Selling, General, Administrative and Development ("SGA&D") Expenses. SGA&D
expenses decreased by approximately $10.0 million or 21.1% to $37.2 million
during the first quarter 2003 from $47.2 million during the first quarter 2002.
SGA&D expenses for 2003 included a charge of approximately $2.2 million related
to the write-off of customer-relations software. SGA&D expenses for 2002
included approximately $2.3 million of severance costs related to workforce
reductions. The elimination of the Nortel Networks' agency fee in 2003 accounted
for approximately $4.2 million of the quarter-over-quarter decrease. The
agreement with Nortel Networks for international agency fees terminated in
December 2002. The remaining decrease was a result of the reduced headcount
levels and aggressive operating expense management, resulting in significant
reductions in expenses. However, although overall operating expenses remained
well controlled, we continued to invest in research and development. R&D
expenditures for the first quarter 2003 were approximately $13.2 million, as
compared to $16.4 million for the first quarter 2002.
Restructuring and Impairment Charges. In the first quarter of 2003, ARRIS
evaluated the restructuring accruals related to previously closed facilities
within our broadband product category. Upon final review, we recorded an
additional restructuring charge of $0.3 million during the quarter as a result
of a change to the initial estimates used. During the first quarter 2002, no
restructuring charges were recorded.
Amortization of Intangibles. Intangibles amortization expense for the
three-month periods ended March 31, 2003 and 2002 was $8.7 million and $8.4
million, respectively. The majority of our intangibles represent existing
technology acquired as a result of the Arris Interactive L.L.C. acquisition in
the third quarter 2001, the Cadant, Inc. acquisition in the first quarter 2002,
and the Atoga Systems' acquisition in the first quarter 2003.
Interest Expense. Interest expense for the quarters ended March 31, 2003 and
2002 was $1.7 million and $2.3 million, respectively. Interest expense for both
periods reflects the cost of borrowings on our revolving line of credit,
amortization of deferred finance fees, and the interest paid on the 4-1/2%
convertible subordinated notes due 2003. As of March 31, 2003 and 2002, we did
not have a balance outstanding under our credit facility. The balance of our
outstanding convertible subordinated notes was approximately $11.5 million at
March 31, 2003, as compared to $115.0 million outstanding as of March 31, 2002.
Membership Interest Expense. In conjunction with the acquisition of Arris
Interactive L.L.C., we issued to Nortel Networks a subordinated redeemable Class
B membership interest in Arris Interactive with a face amount of $100.0 million.
This membership interest earned a return of 10% per annum, compounded annually.
For the three-month periods ended March 31, 2003 and 2002, we recorded
membership interest expense of $2.4 million and $2.5 million, respectively.
During the first quarter 2003, we redeemed the entire Class B membership
interest in Arris Interactive held by Nortel Networks, at a discount, and,
therefore, the membership interest will cease.
Gain on Membership Interest Retirement. During the first quarter 2003, ARRIS
redeemed the entire Class B membership interest in Arris Interactive held by
Nortel Networks for approximately $88.4 million. This discounted redemption
resulted in a gain of approximately $28.5 million.
Loss (Gain) on Investments. We hold certain investments in the common stock of
publicly traded companies totaling approximately $0.2 million and $0.6 million
at March 31, 2003 and 2002, respectively, which are classified as trading
securities. Changes in the market value of these securities and gains or losses
on related sales of these securities are recognized in income and resulted in a
pre-tax gain of approximately $(23,000) during the first quarter 2003 and a
pre-tax loss of $0.2 million during the first quarter 2002.
Loss (Gain) in Foreign Currency. During the first quarter 2003, we recorded a
foreign currency gain of approximately $(0.5) million, as compared to a foreign
currency loss of $0.8 million for the first quarter 2002. The foreign currency
loss (gain) is primarily driven by the fluctuation of the value of the euro, as
compared to the U.S. dollar, as we have several European customers whose
receivables and collections are denominated in euros.
20
Other Expense (Income). Other expense (income) for the three-month periods ended
March 31, 2003 and 2002 was $(0.1) million and $0.2 million, respectively. The
other income recorded during the first quarter 2003 was primarily interest
income. The other expense for the three months ended March 31, 2002 was related
to bank charges during the quarter.
Income Tax (Benefit) Expense. During the quarter ended March 31, 2002, we
recorded an income tax benefit of $6.8 million as a result of a change in tax
legislation, allowing us to carry back losses for five years versus the previous
limit of two years. As we are in a cumulative loss position for tax purposes, we
did not incur income tax expense (benefit) during the quarter ended March 31,
2003.
Discontinued Operations. In 2002, ARRIS sold the Keptel and Actives product
lines, which have been accounted for as discontinued operations in accordance
with Statement of Financial Accounting Standards ("SFAS") No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. As a result, these two
product lines and historical results have been reclassified accordingly for all
periods presented. Revenues from the discontinued operations were $19.2 million
for the three months ended March 31, 2002. The net loss from discontinued
operations, net of taxes, for the three months ended March 31, 2002 was $(5.4)
million.
Cumulative Effect of an Accounting Change - Goodwill. We adopted SFAS No. 142,
Goodwill and Other Intangible Assets, on January 1, 2002. Under the transitional
provisions of SFAS No. 142, we recorded a goodwill impairment loss of
approximately $(58.0) million. The impairment loss has been recorded as a
cumulative effect of a change in accounting principle on the accompanying
Consolidated Statement of Operations for the quarter ended March 31, 2002.
Net Income (Loss). Net income of $3.4 million or $0.04 per diluted share was
recorded for the quarter ended March 31, 2003, all of which was related to
continuing operations. A net loss of $(59.9) million or $(0.75) per diluted
share was recorded for the quarter ended March 31, 2002. Continuing operations
generated net income of $3.4 million or $0.04 per diluted share, which was
offset with a net loss from discontinued operations of $(5.4) million or $(0.07)
per diluted share, and a loss related to a cumulative effect of an accounting
change of approximately $58.0 million or $(0.72) per diluted share.
MATERIAL COMMITMENTS
In the ordinary course of our business we enter into contracts with landlords,
suppliers and others that involve multi-year commitments on our part. Of those,
the most significant (financially) is the lease for our headquarters in Duluth,
Georgia. That lease requires annual payments of $1.5 million, subject to
adjustment, through 2009.
We also are party to various multi-year contracts with vendors. These contracts
generally do not require minimum purchases by us. The two most significant of
these are with Solectron and Mitsumi for contract manufacturing and are filed as
exhibits to previous reports filed with the Securities and Exchange Commission.
Lastly, we have several multi-year commitments that are not related to the
ordinary operation of our business. These include registration rights agreements
with Nortel Networks and Liberty Media as well as registration rights
obligations with Cadant, Inc. Although our monetary commitments under these
agreements may not be significant, they could impact our business in other ways
that investors might consider significant.
FINANCIAL LIQUIDITY AND CAPITAL RESOURCES
Financing
Our existing bank indebtedness, as subsequently amended, is an asset-based
revolving credit facility permitting us to borrow up to $115.0 million (which
can be increased under certain conditions by up to $25.0 million), based upon
availability under a borrowing base calculation. In general, the borrowing base
is limited to 85% of net eligible receivables (with a cap of $5.0 million in
relation to foreign receivables), subject to a reserve of $10.0 million. In
addition, upon obtaining appropriate asset appraisals, we may include in the
borrowing base calculation 80% of the orderly liquidation value of net eligible
inventory (not to exceed $60.0 million). The facility contains traditional
21
financial covenants, including fixed charge coverage, senior debt leverage,
minimum net worth, and minimum inventory turns ratios. The credit facility was
amended in January 2003 to provide that the minimum net worth covenant applied
only to the period prior to December 31, 2002. The facility is secured by
substantially all of our assets. The credit facility has a maturity date of
August 3, 2004. The commitment fee on unused borrowings is 0.75%.
On March 11, 2003, ARRIS amended its credit facility to permit the Company to
issue up to $125.0 million of subordinated convertible notes due 2008, to use
the proceeds of such notes to redeem the Class B membership interest in Arris
Interactive held by Nortel Networks and to purchase shares of the ARRIS common
stock held by Nortel Networks, subject to certain limitations. The amendment
also reduced the revolving loan commitments to $115.0 million.
As of March 31, 2003, we had no borrowings outstanding under our credit facility
and $17.1 million of available capacity. As of March 31, 2003, we had
approximately $5.1 million outstanding under letters of credit with our banks.
We were in compliance with all covenants mandated by the credit facility.
Contractual Obligations and Commercial Commitments
Following is a summary of our contractual obligations and commercial
commitments, excluding routine items such as purchase orders, as of March 31,
2003:
PAYMENTS DUE
-----------------------------------------------------------
3/31/03 - 1/1/06 -
CONTRACTUAL OBLIGATIONS 12/31/05 12/31/07 AFTER 1/1/08 TOTAL
--------- -------- ------------ ------
(IN MILLIONS)
Current portion of long-term debt .... $ 11.8 $ -- $ -- $ 11.8
Long term debt ....................... -- 125.0 -- 125.0
Operating leases ..................... 20.9 6.6 2.3 29.8
Sublease income ...................... (2.0) -- -- (2.0)
Capital leases ....................... 1.8 -- -- 1.8
------ ------ ------ ------
Total contractual cash obligations ... $ 32.5 $131.6 $ 2.3 $166.4
------ ------ ------ ------
Cash Flow
Cash levels decreased by approximately $21.9 million during the first quarter of
2003 as compared to an increase of approximately $22.0 million during the same
period in 2002. Operating activities in the first quarter 2003 used
approximately $12.0 million in cash, and investing activities and financing
activities used approximately $1.6 million and $8.3 million, respectively, in
cash flow.
Operating activities used cash of $12.0 million during the first quarter of
2003. Net income provided $3.4 million in cash flow during this period. Other
non-cash items such as depreciation, amortization, and provisions for doubtful
accounts accounted for positive adjustments of approximately $17.1 million
during the first quarter 2003. A gain on the retirement of debt accounted for an
adjustment to net income of $(28.5) million. Decreases in accounts receivable,
other receivables, inventory, and accrued membership interest provided positive
cash flows of $14.4 million. These net cash inflows were offset by a decrease in
accounts payable and accrued liabilities of approximately $17.1 million, and an
aggregate change in various other assets and liabilities of $1.3 million during
the quarter ended March 31, 2003.
Operating activities provided cash of approximately $24.0 million during the
first quarter of 2002. A net loss used $59.9 million in cash flow during this
period. Other non-cash items such as depreciation, amortization, provisions for
doubtful accounts, losses on investments, and cumulative effect of an accounting
changes accounted for positive adjustments of approximately $75.4 million during
the first quarter 2002. Decreases in accounts receivable and inventory provided
positive cash flow of $1.8 million and $21.8 million, respectively. Increases in
accounts payable, accrued liabilities, and accrued membership interest also
provided positive cash flows of $4.9 million. These net cash inflows were offset
by an increase in other receivables of $2.5 million, an increase in income taxes
22
recoverable of $7.8 million, and an aggregate change in various other assets and
liabilities of approximately $9.7 million.
Days sales outstanding ("DSO") were approximately 75 days at March 31, 2003 as
compared to 65 days outstanding at the close of the first quarter 2002. Trade
accounts receivables at the end of the first quarter 2003 were approximately
$69.6 million. Included in this balance was approximately 18.6 million euros
($19.5 million as of March 31, 2003) due from Cabovisao, of which a substantial
portion is past due. Cabovisao and its parent company are currently in the
process of restructuring their financing. See Risk Factors for further
discussion. The increase in DSOs from the first quarter 2002 as compared to the
first quarter 2003 is predominantly due to the outstanding balance from
Cabovisao.
Inventory at March 31, 2003 was $104.3 million, as compared to $104.2 million at
December 31, 2002. Inventory increased approximately $0.3 million as a result of
acquired Atoga inventory in March 2003. Inventory levels related to ongoing
operations decreased by approximately $0.2 million, net of the effects of the
Atoga acquisition. Inventory turns were approximately 2.6 times at March 31,
2003, as compared to 3.0 times at the close of the first quarter 2002.
Cash flows used by investing activities were approximately $1.6 million for the
three months ended March 31, 2003 as compared to $1.8 million during the same
period in 2002. The investments made during 2003 included $1.1 million related
to capital expenditures and approximately $0.5 million for fees primarily
related to the Atoga Systems' acquisition in March 2003. The investments during
the first quarter of 2002 included $1.1 million spent on capital assets and
approximately $0.7 million for fees related to the Cadant acquisition in January
2002.
Cash flows used in financing activities were $8.3 million for the quarter ended
March 31, 2003. Proceeds from the issuance of convertible subordinated notes due
2008 provided $125.0 million in cash, and proceeds from the issuance of common
stock provided $0.6 million. These cash inflows were offset with a cash use of
approximately $88.4 million to redeem the Nortel Networks membership interest,
$28.0 million used to repurchase and retire 8 million shares of common stock
held by Nortel Networks, and $12.4 million to repurchase a portion of the
convertible subordinated notes due 2003. Other uses of cash included payments on
capital lease obligations and deferred financing costs paid of $0.4 million and
$4.7 million, respectively. Cash flows used in financing activities were $0.2
million for the first quarter 2002, resulting from the proceeds from issuance of
common stock offset by capital lease payments.
Based upon current levels of operations, we expect that sufficient cash flow
will be generated from operations so that, combined with cash on hand and other
financing alternatives available, including bank credit facilities, we will be
able to meet all of our current debt service, capital expenditure and working
capital requirements.
Foreign Currency
A significant portion of our products are manufactured or assembled in Mexico,
the Philippines, 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.
Beginning in 2002, we implemented a hedging strategy to mitigate the monetary
exchange fluctuations from the time of invoice to the time of payment, and have
entered into forward contracts based on a percentage of expected foreign
currency receipts. The percentage can vary, based on the predictability of cash
receipts. We regularly review our accounts receivable in foreign currency and
purchase additional forward contracts when appropriate. As of March 31, 2003, we
had one foreign currency forward purchase contract outstanding.
Financial Instruments
In the ordinary course of business, we, from time to time, will enter into
financing arrangements with customers. These
23
financial instruments include letters of credit, commitments to extend credit
and guarantees of debt. 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, 2003, we had approximately $5.1 million outstanding
under letters of credit with our banks.
Investments
In the ordinary course of business, we may make strategic investments in the
equity securities of various companies, both public and private. We hold certain
investments in the common stock of publicly traded companies totaling
approximately $0.2 million at March 31, 2003, which are classified as trading
securities. Changes in the market value of these securities and gains or losses
on related sales of these securities are recognized in income. We recorded a
pre-tax gain of approximately $(23,000) during the first quarter 2003 and a
pre-tax loss of $0.2 million during the first quarter 2002 related to these
investments.
We hold certain additional investments in the common stock of publicly traded
companies totaling approximately $2.0 million at March 31, 2003, which are
classified as available for sale. In addition, we hold a number of
non-marketable equity securities totaling approximately $2.8 million, which are
classified as available for sale. At March 31, 2003, we had unrealized gains
related to these available for sale securities of approximately $0.3 million
included in comprehensive income.
We offer a deferred compensation arrangement, which allows certain employees to
defer a portion of their earnings and defer the related income taxes. These
deferred earnings are invested in a "rabbi trust", and are accounted for in
accordance with Emerging Issues Task Force 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 events (other than bankruptcy). The investment in the
rabbi trust is classified as a current asset on our balance sheet. At March 31,
2003, we had an unrealized gain related to the rabbi trust of approximately $0.2
million included in 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 $1.1 million
for both the first quarter 2003 and the first quarter 2002. We had no
significant commitments for capital expenditures at March 31, 2003. Management
expects to invest approximately $8.0 million in capital expenditures for the
year 2003.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses ARRIS' Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and 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. On an on-going basis, management evaluates its
estimates and judgments, including those related to customer incentives, product
returns, bad debts, inventories, investments, intangible assets, income taxes,
financing operations, warranty obligations, restructuring costs, retirement
benefits, and contingencies and litigation. Management bases its estimates and
judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
Our critical accounting policies are disclosed extensively in our Form 10-K for
the year ended December 31, 2002, as filed with the United States Securities and
Exchange Commission. That discussion is incorporated herein by reference.
24
FORWARD-LOOKING STATEMENTS
Certain information and statements contained in this Management's Discussion and
Analysis of Financial Condition and Results of Operations and other sections of
this report, including statements using terms such as "may," "expect,"
"anticipate," "intend," "estimate," "believe," "plan," "continue," "could be,"
or similar variations or the negative thereof, constitute forward-looking
statements with respect to the financial condition, results of operations, and
business of ARRIS, including statements that are based on current expectations,
estimates, forecasts, and projections about the markets in which we operate and
management's beliefs and assumptions regarding these markets. These and any
other statements in this document that are not statements about historical facts
are "forward-looking statements." We caution investors that forward-looking
statements made by us are not guarantees of future performance and that a
variety of factors could cause our actual results to differ materially from the
anticipated results or other expectations expressed in our forward-looking
statements. Important factors that could cause results or events to differ from
current expectations are described in the risk factors below. These factors are
not intended to be an all-encompassing list of risks and uncertainties that may
affect the operations, performance, development and results of our business. In
providing forward-looking statements, ARRIS expressly disclaims any obligation
to update publicly or otherwise these statements, whether as a result of new
information, future events or otherwise except to the extent required by law.
RISK FACTORS
OUR BUSINESS IS DEPENDENT ON CUSTOMERS' CAPITAL SPENDING ON BROADBAND
COMMUNICATION SYSTEMS, AND REDUCTIONS BY CUSTOMERS IN CAPITAL SPENDING COULD
ADVERSELY AFFECT OUR BUSINESS.
Our performance has been largely 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 will affect the amount of capital spending, and therefore,
our sales and profits, including:
- - general economic conditions;
- - availability and cost of capital;
- - other demands and opportunities for capital;
- - regulations;
- - demands for network services;
- - competition and technology; and
- - real or perceived trends or uncertainties in these factors.
Developments in the industry and in the capital markets over the past two years
have reduced access to funding for new and existing customers, causing delays in
the timing and scale of deployments of our equipment, as well as the
postponement or cancellation of certain projects by our customers. In addition,
during the same period, we and other vendors received notification from several
customers that they were canceling new projects or scaling back existing
projects or delaying new orders to allow them to reduce inventory levels which
were in excess of their current deployment requirements.
Further, several of our customers have accumulated significant levels of debt
and have recently announced, or are expected to announce, financial
restructurings, including bankruptcy filings. For example, Adelphia has been
operating under bankruptcy since the first half of 2002. Even if the financial
health of that company and other customers improve, we cannot assure you that
these customers will be in a position to purchase new equipment at levels we
have seen in the past. In addition, the bankruptcy filing of Adelphia in June
2002 further heightened concerns in the financial markets about the domestic
cable industry. This concern, coupled with the current uncertainty and volatile
capital markets, has affected the market values of domestic cable operators and
may further restrict their access to capital.
25
DEVELOPMENTS RELATING TO CABOVISAO MAY ADVERSELY AFFECT OUR BUSINESS AND RESULTS
OF OPERATIONS.
Cabovisao, a Portugal-based MSO, accounted for approximately 6% of our total
sales in 2002. As of May 12, 2003, Cabovisao owed us 18.6 million euros in
accounts receivable. Cabovisao committed to a schedule of 2003 payments to us
for our products and services. Cabovisao made its January 2003 payment of 2.0
million euros to us according to the schedule. However, Cabovisao failed to make
the subsequent scheduled payments to us by the due date, which was 2.5 million
euros each in February, March, and April. Cabovisao and its parent company,
Csii, are currently considering alternatives to meet its financial needs,
including debt restructuring or a possible court-supervised restructuring, among
other alternatives. We will not deliver further products to Cabovisao until we
have a satisfactory payment plan with Cabovisao and are considering what actions
should be taken regarding the situation. We cannot assure you that Cabovisao
will pay us according to a schedule, if at all, or that we will make any sales
to Cabovisao in the future.
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 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 us. Our major competitors include:
- - ADC Telecommunications, Inc.;
- - Broadband Services, Inc.;
- - Cisco Systems, Inc.;
- - Juniper Networks, Inc.;
- - Motorola, Inc.;
- - Riverstone Networks, Inc.;
- - Scientific-Atlanta, Inc.;
- - Tellabs, Inc.;
- - Terayon Communications Systems, Inc.; and
- - 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 ours. 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 long-standing and established relationships with domestic and foreign
broadband service providers. We may not be able to compete successfully in the
future, and competition may harm our business.
OUR BUSINESS HAS PRIMARILY COME FROM SEVERAL KEY CUSTOMERS. THE LOSS OF ONE OF
THESE CUSTOMERS OR A SIGNIFICANT REDUCTION IN SERVICES TO ONE OF THESE CUSTOMERS
WOULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our two largest customers are Cox Communications and Comcast (primarily through
the recently acquired AT&T Broadband business). For the quarter ended March 31,
2003, sales to Cox Communications accounted for approximately 27.5% of our total
revenues, while sales to Comcast (including AT&T Broadband) accounted for
approximately 26.1%. We currently are the exclusive provider of telephony
products for both Cox Communications
26
and, in eight metro areas, Comcast, as successor to AT&T Broadband. In addition,
we have two other customers who accounted for more than 5% each of our total
revenues for the quarter ended March 31, 2003. The loss of Cox Communications,
Comcast, or one of our other large customers, or a significant reduction in the
services provided to any of them would have a material adverse impact on our
business. In addition, as a result of the merger of Comcast with AT&T Broadband
in late 2002, we have experienced interruptions in purchasing by the resulting
Comcast entity in 2003. Comcast has announced that its initial priority after
its acquisition of AT&T Broadband will be to emphasize video and high-speed data
operations and focus on improving the profitability of its telephony operations
at the expense of subscriber growth. As a result, we experienced a significant
decline in sales of our CBR telephony product to Comcast in the fourth quarter
of 2002, which has continued into 2003.
OUR CREDIT FACILITY IMPOSES FINANCIAL COVENANTS THAT MAY ADVERSELY AFFECT THE
REALIZATION OF OUR STRATEGIC OBJECTIVES.
We and certain of our subsidiaries have entered into a revolving credit facility
providing for borrowing up to a committed amount of $115.0 million, with
borrowing also limited by a borrowing base determined by reference to eligible
accounts receivable and, subject to certain conditions, eligible inventory. As
of March 31, 2003, the borrowing base was $17.1 million. The credit facility
imposes, among other things, covenants limiting the incurrence of additional
debt and liens and requires us to meet certain financial objectives. The credit
facility has a maturity date of August 3, 2004. As of May 4, 2003, we had no
borrowings outstanding under the credit facility, and our borrowing base was
$43.9 million. Any acceleration of the maturity date of the credit facility
could have a material adverse effect on our business.
WE HAVE SIGNIFICANT STOCKHOLDERS THAT MAY NOT ACT CONSISTENTLY WITH THE
INTERESTS OF OUR OTHER STOCKHOLDERS.
As of May 12, 2003, Nortel Networks owned approximately 18.7% of our common
stock and Liberty Media Group beneficially owned approximately 10.3% of our
common stock. These respective ownership interests result in both Nortel
Networks and Liberty Media having a significant influence over us. Nortel
Networks and Liberty Media may exert their respective influences or sell their
respective shares at a time or in a manner that is inconsistent with the
interests of our other stockholders.
Any sales of substantial amounts of our common stock in the public market, or
the perception that such sales might occur, could have a depressive effect on
the market price of our common stock.
WE HAVE ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION OF OUR
COMPANY.
On October 3, 2002, our board of directors approved the adoption of 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 shareholders' interests. This poison pill could make it more difficult
for a third party to acquire us or may delay that process.
WE MAY DISPOSE OF EXISTING PRODUCT LINES OR ACQUIRE NEW PRODUCT LINES IN
TRANSACTIONS THAT MAY ADVERSELY IMPACT US AND OUR FUTURE RESULTS.
On an ongoing basis, we evaluate our various product offerings in order to
determine whether any should be sold or closed and whether there are businesses
that we should pursue acquiring. Future acquisitions and divestitures entail
various risks, including:
- - the risk that acquisitions will not be integrated or otherwise perform
as expected;
- - the risk that we will not be able to find a buyer for a product line
while product line sales and employee morale will have been damaged
because of general awareness that the product line is for sale; and
- - the risk that the purchase price obtained will not be equal to the book
value of the assets for the product line that we sell.
27
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 currently under development by us
may not be successfully developed. Even if products under development are
successfully completed, they may not be widely used or we may not be able to
successfully exploit these technology applications. 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:
- - are not cost-effective;
- - are not brought to market in a timely manner;
- - fail to achieve market acceptance; or
- - fail to meet industry certification standards.
Furthermore, our competitors may develop similar or alternative new technology
applications 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 partner could
have a material adverse effect on the progress of new products under development
with that partner.
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 is expected to continue. We and one or
more of our competitors may each supply products to businesses that have merged,
such as AT&T Broadband and Comcast, or will merge in the future. Consolidations
could result in delays in purchasing decisions by the merged businesses, and we
could play either a greater or lesser role in supplying the communications
products to the merged entity. These purchasing decisions of the merged
companies could have a material adverse effect on our business. For example, we
experienced delays while the Comcast and AT&T Broadband deal was pending, and
have experienced slowdowns since the transaction was completed. Mergers among
the supplier base also have increased, and this trend may continue. The 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.
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 executives, marketing, engineering, and sales
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.
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
28
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 PRODUCTS ARE MANUFACTURED.
A significant portion of our products are manufactured or assembled in Mexico
and the Philippines and other countries outside of the United States. The
governments of the foreign countries in which we have plants 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 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 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 past, 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 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 proprietary rights. 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 adversely affected.
29
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.
In the past, we have used interest rate swap agreements, with large creditworthy
financial institutions, to manage our exposure to interest rate changes. These
swaps would involve the exchange of fixed and variable interest rate payments
without exchanging the notional principal amount. During the quarter ended March
31, 2003, we did not have any outstanding interest rate swap agreements.
A significant portion of our products are manufactured or assembled in Mexico,
the Philippines, 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 is the predominant currency of those
customers who are billed in their local currency. Taking into account the
effects of foreign currency fluctuations of the euro versus the dollar, a
hypothetical 10% weakening of the U.S. dollar (as of March 31, 2003) would
provide a gain on foreign currency of approximately $2.6 million. Conversely, a
hypothetical 10% strengthening of the U.S. dollar would provide a loss on
foreign currency of approximately $2.6 million. As of March 31, 2003, we had no
material contracts, other than accounts receivable, denominated in foreign
currencies.
We regularly review our accounts receivable in foreign currency and purchase
forward contracts when appropriate. As of March 31, 2003, we had one foreign
currency forward purchase contract outstanding. The contract was entered into on
January 31, 2003 for 2.0 million euros and was due April 30, 2003. The contract
was taken out in anticipation of receiving a substantial euro payment from one
of our customers, which we received on a timely basis. The fair value adjustment
at March 31, 2003 was not significant.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-14(c)
and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act") as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"). Based on such evaluation, such
officers have concluded that, as of the Evaluation Date, our disclosure controls
and procedures are effective in alerting them on a timely basis to material
information relating to our company (including our consolidated subsidiaries)
required to be included in our reports filed or submitted under the Exchange
Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have not
been any significant changes in our internal controls or in other factors that
could significantly affect such controls.
30
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(a) Not applicable
(b) Not applicable
(c) In March 2003, the Company sold $125,000,000 principal amount
of 4-1/2% convertible subordinated notes due March 15, 2008
(the "Notes") in a private placement to CIBC World Markets
Corp. (the "Initial Purchaser") at 100% of their principal
amount, less a selling discount to the Initial Purchaser of
3.5% of the principal amount.
Exemption from registration requirements is claimed under the
Securities Act of 1933 (the "Securities Act") in reliance on
Section 4(2) of the Securities Act or Rule 506 of Regulation D
promulgated thereunder. The Initial Purchaser had adequate
access to information about the Company and represented to the
Company that it was a qualified institutional investors within
the meaning of Rule 144A under the Securities Act and that it
offered the Notes, and will offer and sell the Notes, inside
the United States only to persons whom it reasonably believes
are "qualified institutional buyers" in accordance with Rule
144A. Appropriate legends were affixed to the certificates
evidencing the Notes in such transaction.
At any time prior to maturity or redemption, the Notes are
convertible into shares of common stock of the Company at a
conversion price of $5.00 per share, subject to adjustment
(equivalent to a conversion rate of 200 shares per $1,000
principal amount of Notes), representing an initial conversion
premium of 42%, for a total of 25,000,000 shares of common
stock of the Company.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibit No. Description of Exhibit
- ----------- ----------------------
4.1 Indenture dated March 18, 2003 (incorporated by reference to
Exhibit 4.3 to ARRIS' Annual Report on Form 10-K for the year
ended December 31, 2002).
10.1 Eighth Amendment to Credit Agreement, dated March 11, 2003
(incorporated by reference to Exhibit 10.1 to ARRIS' Current
Report on Form 8-K filed on March 11, 2003).
10.2 Letter Agreement with Nortel Networks, dated March 11, 2003
(incorporated by reference to Exhibit 10.2 to ARRIS' Current
Report on Form 8-K filed on March 11, 2003).
10.3 Settlement and Release Agreement between Arris Interactive
L.L.C. and Nortel Networks, Inc., dated March 11, 2003
(incorporated by reference to Exhibit 10.3 to ARRIS' Current
Report on Form 8-K filed on March 11, 2003).
10.4 Letter Agreement with Nortel Networks, dated March 11, 2003
(incorporated by reference to Exhibit 10.4 to ARRIS' Current
Report on Form 8-K filed on March 11, 2003).
10.5 Registration Rights Agreement dated March 18, 2003, between
ARRIS and CIBC World Markets Corp. (filed herewith).
31
Reports on Form 8-K
FILING DATE ITEMS REPORTED
----------- --------------
01/08/03 Item 7 and Item 9
01/09/03 Item 5 and Item 7
02/12/03 Item 5 and Item 7
03/10/03 Item 5
03/11/03 Item 5 and Item 7
03/13/03 Item 5 and Item 7
03/18/03 Item 5 and Item 7
32
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.
ARRIS GROUP, INC.
/s/ LAWRENCE A. MARGOLIS
-----------------------------------------
Lawrence A. Margolis
Executive Vice President,
Chief Financial Officer
Dated: May 14, 2003
33
CERTIFICATION PURSUANT TO SS. 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Robert J. Stanzione, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ARRIS
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 14, 2003 /s/ Robert J. Stanzione
-----------------------------------------
Robert J. Stanzione
President and Chief Executive Officer
34
CERTIFICATION PURSUANT TO SS. 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Lawrence A. Margolis, certify that:
1. I have reviewed this quarterly report on Form 10-Q of ARRIS
Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain
any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light
of the circumstances under which such statements were made,
not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report,
fairly present in all material respects the financial
condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions
about the effectiveness of the disclosure controls
and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and the audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 14, 2003 /s/ Lawrence A. Margolis
-----------------------------------------
Lawrence A. Margolis
Executive Vice President, Chief Financial
Officer and Secretary
35