UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the quarter ended September 30, 2004

of

ARRIS GROUP, INC.

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

3871 Lakefield Drive
Suwanee, GA 30024
(770) 622-8400

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 of October 31, 2004, 87,667,409 shares of the registrant’s Common Stock, $0.01 par value, were outstanding.

ARRIS GROUP, INC.
FORM 10-Q
For the Quarter Ended September 30, 2004

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

ARRIS GROUP, INC.

See accompanying notes to the consolidated financial statements.

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ARRIS GROUP, INC.

See accompanying notes to the consolidated financial statements.

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ARRIS GROUP, INC.

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See accompanying notes to the consolidated financial statements.

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ARRIS GROUP, INC.

Note 1. Organization and Basis of Presentation

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

The consolidated financial statements 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 2004 financial statement presentation. Interim results of operations are not necessarily indicative of results to be expected from a twelve-month period. These financial statements should be read in conjunction with the Company’s most recently audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the United States Securities and Exchange Commission.

Note 2. Impact of Recently Issued Accounting Standards

On October 13, 2004, the Financial Accounting Standards Board (“FASB”) concluded that Statement of Financial Accounting Standards (“SFAS”) No. 123R, Share-Based Payment, would be effective for public companies for interim or annual periods beginning after June 15, 2005. As revised, this statement will require all companies to measure compensation cost for all share-based payments (including employee stock options) at fair value. ARRIS will be required to apply the revised standard beginning July 1, 2005, or for the quarter ending September 30, 2005. The Company may choose to apply the provisions retroactively from January 1, 2005 to June 30, 2005, and restate the year-to-date period in its third quarter 2005 Form 10-Q. Alternatively, the Company can early adopt the proposed SFAS in its first quarter 2005 Form 10-Q. ARRIS is currently evaluating the date it plans to adopt the SFAS123R and the impact it will have on the Company’s future results of operations.

Note 3. Stock-Based Compensation

The Company uses the intrinsic value method for valuing its awards of stock options and restricted stock and records the related compensation expense, if any, in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations. Except as described below, 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, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-based Compensation — Transition and Disclosure, to all stock-based employee compensation.

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In 2003, the Company offered to all eligible employees the opportunity to exchange certain outstanding stock options for restricted shares of ARRIS common stock. As a result, ARRIS cancelled options to purchase approximately 4.7 million shares of common stock and granted approximately 1.5 million restricted shares in exchange. Employees tendered approximately 76% of the options eligible to be exchanged under the program. In accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees, the Company recorded a fixed compensation expense equal to the fair market value of the shares of restricted stock granted through the offer; this cost is being amortized over the four-year vesting period for the restricted shares. All eligible options that were not surrendered for exchange are subject to variable accounting. This variable accounting charge will fluctuate in accordance with the market price of ARRIS common stock until such stock options are exercised, forfeited, or expire unexercised. During the three months ended March 31, 2004, ARRIS recognized compensation expense of approximately $0.2 million related to the vested portion of these options. However, the market price of ARRIS common stock declined during the second quarter and the Company marked-to-market the vested portion of the options subject to variable accounting, resulting in a reversal of previously recognized compensation expense of approximately $0.2 million. For the quarter and year-to-date period ended September 30, 2004, the variable accounting has had no impact on the Company’s results of operations. As of September 30, 2004, there were approximately 1.1 million options outstanding subject to variable accounting, of which approximately 0.8 million were vested. Approximately 95% of the eligible options have an exercise price of $11.00 or less, and are either fully vested or will become fully vested over the next two years.

Note 4. Pension Benefits

Components of Net Periodic Pension Benefit Cost

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Employer Contributions

No minimum funding contributions are required in 2004; however, the Company made voluntary contributions of $0.8 million during the three months ended September 30, 2004. During the nine months ended September 30, 2004, the Company contributed a total of $0.8 million to the plan.

Note 5. Guarantees

Warranty

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

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

The changes in ARRIS’ aggregate product warranty liabilities were as follows for the nine months ended September 30, 2004 (in thousands):

The accruals related to warranties included:

	1)		a decrease in the estimate of the future costs of repairs as a result of ARRIS’ decision to return a greater number of products to the manufacturer for repair rather than arranging for the repair domestically at a higher expense,
	2)		an increase reflecting that historically ARRIS calculated the warranty reserve using warranty lengths and rates of repair experience that were, on average, less than those actually experienced by the Company, and
	3)		routine adjustments reflecting sales volume, warranty terms, changes in return experience, and the other factors that the Company uses to determine the warranty reserve.

Note 6. Disposal of Keptel and Actives Product Lines

The Company sold its Keptel telecommunications product line on April 24, 2002. The transaction included a distribution agreement whereby the Company will continue to distribute certain Keptel products to cable operators. Prior to the sale of the Keptel product line, the related products were manufactured by Keptel and were subsequently sold either directly by Keptel’s sales force to non-cable operators or through Telewire, ARRIS’ distribution arm. Although a few Keptel products are still distributed by Telewire in accordance with the distribution agreement from the new owner, they are no longer manufactured by the Company. The Keptel products distributed represented approximately $1.0 million and $1.6 million of sales for the three months ended September 30, 2004 and 2003, respectively, and $3.1 million and $5.1 million of sales for the nine months ended

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September 30, 2004 and 2003, respectively. As of September 30, 2004, approximately $0.4 million related to outside fees associated with the disposal remained in an accrual to be paid. The remaining payments are expected to be made in the first half of 2005.

The Company sold its Actives product line to Scientific-Atlanta on November 21, 2002, for net proceeds of $31.8 million. As of September 30, 2004, approximately $0.1 million related to severance and approximately $0.3 million related to other shutdown expenses remained in an accrual to be paid. The remaining payments are expected to be made in the first half of 2005.

During the second and third quarters of 2004, the Company recorded income from discontinued operations of $0.8 million and $0.1 million, respectively, related to the Actives and Keptel product lines as a result of changes in estimates related to real estate, vendor liabilities, and other accruals. During the first quarter of 2004, the Company recognized a partial recovery with respect to inventory previously written off associated with an Argentinean customer. Of the total gain of $0.9 million, approximately $0.3 million related to the discontinued operations of Actives and Keptel. These adjustments resulted in income from discontinued operations of $1.2 million for the nine months ended September 30, 2004.

The Company’s Actives and Keptel telecommunications product lines 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 have been classified as discontinued operations for all periods presented. Keptel products for cable companies, which have been and continue to be sold by Telewire, are included in continuing operations for all periods presented.

Note 7. Business Acquisitions

Acquisition of Certain Assets of Com21

On August 13, 2003, the Company acquired certain cable modem termination system (“CMTS”) related assets of Com21, including the stock of its Irish subsidiary. Under the terms of the agreement, ARRIS obtained accounts receivable, inventory, fixed assets, other current prepaid assets, and existing technology in exchange for approximately $2.4 million of cash, of which $2.2 million has been paid, and the assumption of approximately $0.7 million in liabilities. The Company retained $0.2 million of the cash consideration to protect against any liabilities ARRIS may be required to pay resulting from Com21 activity prior to the acquisition date, of which approximately $0.1 million has been paid for such liabilities since the acquisition date. The Company also incurred approximately $0.2 million of legal and professional fees associated with the transaction. ARRIS retained approximately 50 Com21 employees. The Company completed this acquisition because it believed that the acquired product line, along with the existing product offerings of ARRIS, would allow the Company to reach smaller scale cable systems domestically and internationally.

The following is a summary of the purchase price allocation to record ARRIS’ purchase of certain assets of Com21, including the stock of its Irish subsidiary. The purchase price was equal to the net tangible and intangible assets acquired.

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Acquisition of Atoga Systems

On March 21, 2003, ARRIS purchased the business and 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 because it would expand the Company’s existing Broadband product portfolio. 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 value of the restricted stock is being recognized as compensation expense over the related vesting period.

The following is a summary of the purchase price allocation to record ARRIS’ purchase price of the assets and certain liabilities of Atoga Systems.

Supplemental Pro Forma Information

Presented below is a summary of unaudited pro forma combined financial information for the Company, the Com21 CMTS business, and Atoga Systems to give effect to the transactions. This summary unaudited pro forma combined financial information for 2003 is derived from the historical financial statements of the Company, the Com21 CMTS business, and Atoga Systems. This information assumes the transactions were consummated as of January 1, 2003. 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, Com21, and Atoga Systems, 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 the Com21 CMTS business’, or the combined entity’s results of operations for any future period or date. The actual results of the Com21 CMTS business are included in the Company’s operations commencing August 13, 2003. The actual results of Atoga Systems are included in the Company’s operations commencing March 21, 2003.

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The following table represents the amount assigned to each major asset and liability caption of Com21 as of August 13, 2003 and Atoga Systems as of March 21, 2003, as adjusted: