UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

ARRIS GROUP, INC.

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

ARRIS Group, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.

ARRIS Group, Inc. is a large accelerated filer and is not a shell company.

ARRIS is required to submit electronically and post on its corporate web site Interactive Data Files required to be submitted and posted pursuant to Rule 405 of regulation S-T.

As of July 31, 2011, 119,358,933 shares of the registrant’s Common Stock, $0.01 par value, were outstanding.

 

 

ARRIS GROUP, INC.
FORM 10-Q
For the Three and Six Months Ended June 30, 2011

INDEX

		Page
Part I. Financial Information
Item 1. Condensed Financial Statements (unaudited)
a) Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010			2
b) Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2011 and 2010			3
c) Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2010			4
d) Notes to the Condensed Consolidated Financial Statements			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 4. Controls and Procedures			28
Part II. Other Information			29
Item 1. Legal Proceedings			29
Item 1A. Risk Factors			31
Item 6. Exhibits			37
Signatures			37
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I. FINANCIAL INFORMATION

Item 1. CONDENSED FINANCIAL STATEMENTS (unaudited)

ARRIS GROUP, INC.

		June 30,				December 31,
		2011				2010
ASSETS
Current assets:
Cash and cash equivalents		$	360,281			$	353,121
Short-term investments, at fair value			231,254				266,981
Total cash, cash equivalents and short-term investments			591,535				620,102
Restricted cash			3,646				4,937
Accounts receivable (net of allowances for doubtful accounts of $1,532 in 2011 and $1,649 in 2010)			152,436				125,933
Other receivables			406				6,528
Inventories (net of reserves of $16,369 in 2011 and $16,316 in 2010)			113,020				101,763
Prepaids			10,272				9,237
Current deferred income tax assets			22,681				19,819
Other current assets			25,216				33,054
Total current assets			919,212				921,373
Property, plant and equipment (net of accumulated depreciation of $120,513 in 2011 and $109,267 in 2010)			57,100				56,306
Goodwill			233,440				234,964
Intangible assets (net of accumulated amortization of $244,567 in 2011 and $226,679 in 2010)			150,728				168,616
Investments			34,237				31,015
Noncurrent deferred income tax assets			9,839				6,293
Other assets			5,878				5,520
		$	1,410,434			$	1,424,087
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	27,825			$	50,736
Accrued compensation, benefits and related taxes			20,832				28,778
Accrued warranty			3,300				2,945
Deferred revenue			47,166				31,625
Other accrued liabilities			17,805				18,847
Total current liabilities			116,928				132,931
Long-term debt, net of current portion			208,336				202,615
Accrued pension			17,730				17,213
Noncurrent income tax liability			21,844				17,702
Noncurrent deferred income tax liabilities			24,808				29,151
Other noncurrent liabilities			17,367				15,406
Total liabilities			407,013				415,018
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; 119.2 million and 120.8 million shares issued and outstanding in 2011 and 2010, respectively			1,443				1,409
Capital in excess of par value			1,228,729				1,206,157
Treasury stock at cost, 24.8 million and 19.8 million shares in 2011 and 2010, respectively			(202,933	)			(145,286	)
Accumulated deficit			(19,351	)			(47,606	)
Unrealized gain on marketable securities (net of accumulated tax effect of $878 and $224 in 2011 and 2010, respectively)			1,530				392
Unfunded pension liability (net of accumulated tax effect of $662 in 2011 and 2010)			(5,813	)			(5,813	)
Cumulative translation adjustments			(184	)			(184	)
Total stockholders’ equity			1,003,421				1,009,069
		$	1,410,434			$	1,424,087

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

(in thousands, except per share data and percentages) (unaudited)

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Net sales:
Products		$	228,635			$	248,179			$	463,581			$	488,321
Services			37,164				32,176				69,654				58,731
Total net sales			265,799				280,355				533,235				547,052
Cost of sales:
Products			140,259				151,873				293,014				291,693
Services			18,642				15,204				36,377				29,570
			158,901				167,077				329,391				321,263
Gross margin			106,898				113,278				203,844				225,789
Operating expenses:
Selling, general and administrative expenses			35,868				34,458				72,706				69,576
Research and development expenses			36,629				35,538				72,669				69,903
Restructuring charges			—				21				—				73
Amortization of intangible assets			8,944				9,022				17,888				18,043
Total operating expenses			81,441				79,039				163,263				157,595
Operating income			25,457				34,239				40,581				68,194
Other expense (income):
Interest expense			4,180				4,765				8,405				9,195
Loss (gain) on investments			(334	)			114				(757	)			(31	)
Interest income			(886	)			(696	)			(1,664	)			(1,070	)
Loss on foreign currency			79				457				967				189
Gain on debt retirement			—				(115	)			—				(115	)
Other income, net			(419	)			(131	)			(532	)			(173	)
Income from operations before income taxes			22,837				29,845				34,162				60,199
Income tax expense			6,147				10,071				5,908				21,434
Net income		$	16,690			$	19,774			$	28,254			$	38,765
Net income per common share:
Basic		$	0.14			$	0.16			$	0.23			$	0.31
Diluted		$	0.13			$	0.15			$	0.23			$	0.30
Weighted average common shares:
Basic			121,800				126,584				122,047				126,277
Diluted			123,711				129,717				124,720				129,848

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

		Six Months Ended
		June 30,
		2011				2010
Operating activities:
Net income		$	28,254			$	38,765
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			11,668				11,056
Amortization of intangible assets			17,888				18,043
Stock compensation expense			11,209				10,273
Deferred income tax provision (benefit)			(11,403	)			(2,341	)
Amortization of deferred finance fees			326				357
Provision for doubtful accounts			—				292
Gain on investments			(757	)			(31	)
Loss on disposal of fixed assets			33				32
Excess income tax benefits from stock-based compensation plans			(3,247	)			(2,647	)
Non-cash interest expense			5,721				5,767
Gain on debt retirement			—				(115	)
Changes in operating assets and liabilities, net of effect of acquisitions and dispositions:
Accounts receivable			(26,503	)			3,743
Other receivables			6,117				(1,170	)
Inventories			(11,257	)			17,021
Income taxes payable and recoverable			12,591				(3,008	)
Accounts payable and accrued liabilities			(15,480	)			(19,623	)
Prepaids and other, net			2,649				6,993
Net cash provided by operating activities			27,809				83,407
Investing activities:
Purchases of property, plant and equipment			(12,547	)			(10,265	)
Cash proceeds from sale of property, plant and equipment			43				243
Purchases of short-term investments			(142,841	)			(231,086	)
Sales of short-term investments			179,431				55,154
Net cash provided by (used in) investing activities			24,086				(185,954	)
Financing activities:
Payment of debt obligations			—				(74	)
Early redemption of long-term debt			—				(4,800	)
Repurchase of common stock			(57,647	)			(23,685	)
Excess income tax benefits from stock-based compensation plans			3,247				2,647
Repurchase of shares to satisfy tax withholdings			(8,245	)			(6,425	)
Proceeds from issuance of common stock, net			17,910				5,251
Net cash used in financing activities			(44,735	)			(27,086	)
Net increase (decrease) in cash and cash equivalents			7,160				(129,633	)
Cash and cash equivalents at beginning of period			353,121				500,565
Cash and cash equivalents at end of period		$	360,281			$	370,932

See accompanying notes to the consolidated financial statements.

ARRIS GROUP, INC.

(unaudited)

Note 1. Organization and Basis of Presentation

ARRIS Group, Inc. (together with its consolidated subsidiaries, except as the context otherwise indicates, “ARRIS” or the “Company”) is a global communications technology company headquartered in Suwanee, Georgia. ARRIS operates in three business segments, Broadband Communications Systems, Access, Transport & Supplies, and Media & Communications Systems, specializing in integrated broadband network solutions that include products, systems and software for content and operations management (including video on demand, or VOD), and professional services. ARRIS is a leading developer, manufacturer and supplier of telephony, data, video, construction, rebuild and maintenance equipment for the broadband communications industry. In addition, ARRIS is a leading supplier of infrastructure products used by cable system operators to build-out and maintain hybrid fiber-coaxial (“HFC”) networks. The Company provides its customers with products and services that enable reliable, high speed, two-way broadband transmission of video, telephony, and data.

The condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) that are, in the opinion of management, necessary for a fair presentation of the consolidated financial statements for the periods shown. Interim results of operations are not necessarily indicative of results to be expected for 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, 2010, as filed with the United States Securities and Exchange Commission (“SEC”).

Note 2. Impact of Recently Adopted Accounting Standards

In June 2011, the Financial Accounting Standards Board (“FASB”) issued guidance regarding the presentation of comprehensive income. This guidance requires presentation of total comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance is effective on a retrospective basis for the interim and annual periods ending on or after December 15, 2011. The adoption of this guidance will not have a significant impact on the Company’s consolidated financial statements.

In May 2011, FASB issued amendments to some fair value measurement principles and disclosure requirements for fair value measurements. The provisions of this guidance are effective for the interim and annual periods ending on or after December 15, 2011. The adoption of this guidance will not have a significant impact on the Company’s consolidated financial statements.

Note 3. Investments

ARRIS’ investments as of June 30, 2011 and December 31, 2010 consisted of the following (in thousands):

		As of June 30,				As of December 31,
		2011				2010
Current Assets:
Available-for-sale securities		$	231,254			$	266,981
Noncurrent Assets:
Available-for-sale securities			30,237				27,015
Cost method investments			4,000				4,000
			34,237				31,015
Total		$	265,491			$	297,996

ARRIS’ investments in debt and marketable equity securities are categorized as available-for-sale. The Company currently does not hold any held-to-maturity securities. Realized gains and losses on trading securities and

available-for-sale securities are included in net income. Unrealized gains and losses on available-for-sale securities are included in our consolidated balance sheet as a component of accumulated other comprehensive income (loss). The total gains included in the accumulated other comprehensive income related to available-for-sale securities were $2.4 million and $0.6 million as of June 30, 2011 and December 31, 2010, respectively. The amortized cost basis of the Company’s investments approximates fair value.

As of June 30, 2011 and December 31, 2010, ARRIS’ cost method investment is an investment in a private company, which is recorded at cost of $4.0 million. Each quarter ARRIS evaluates its investment for any other-than-temporary impairment, by reviewing the current revenues, bookings and long-term plan of the private company. In the third quarter of 2010, the private company raised additional financing at the same price and terms on which ARRIS had invested. As of June 30, 2011, ARRIS believes there has been no other-than-temporary impairment but will continue to evaluate the investment for impairment. Due to the fact the investment is in a private company, ARRIS is exempt from estimating the fair value. However, ARRIS is required to estimate the fair value if there has been an identifiable event or change in circumstance that may have a significant adverse effect on the fair value of the investment.

Classification of available-for-sale securities as current or non-current is dependent upon management’s intended holding period, the security’s maturity date and liquidity consideration based on market conditions. If management intends to hold the securities for longer than one year as of the balance sheet date, they are classified as non-current.

Note 4. Fair Value Measurement

Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to increase consistency and comparability in fair value measurements, the FASB has established a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

Level 1: Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

Level 2: Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

The following table presents the Company’s investment assets measured at fair value on a recurring basis as of June 30, 2011 (in thousands):

		Level 1				Level 2				Level 3				Total
Current investments		$	15,000			$	216,254			$	—			$	231,254
Noncurrent investments			7,705				22,532				—				30,237
Foreign currency contracts — asset position			64				—				—				64
Foreign currency contracts — liability position			1,530				—				—				1,530

All of the Company’s short-term investments and long-term investments instruments are classified within Level 1 or Level 2 of the fair value hierarchy as they are valued using quoted market prices, market prices for similar securities, or alternative pricing sources with reasonable levels of price transparency. The types of instruments valued based on quoted market prices in active markets include the Company’s investment in money market funds, mutual funds, U.S. government bonds and investments in public companies. Such instruments are generally classified within Level 1 of the fair value hierarchy. The types of instruments valued based on other observable inputs include the Company’s cash surrender value of company owned life insurance, corporate obligations and bonds, commercial paper and certificates of deposit. Such instruments are classified within Level 2 of the fair value hierarchy. See Note 3 and Note 5 for further information on the Company’s investments and derivative instruments.

All of the Company’s foreign currency contracts are over-the-counter instruments. There is an active market for these instruments, and therefore, they are classified as Level 1 in the fair value hierarchy. ARRIS does not enter into currency contracts for trading purposes. The Company has a master netting agreement with the primary

counterparty to the derivative instruments. This agreement allows for the net settlement of assets and liabilities arising from different transactions with the same counterparty.

Note 5. Derivative Instruments and Hedging Activities

ARRIS has certain international customers that are billed in their local currency. Changes in the monetary exchange rates may affect the Company’s results of operations and financial condition. When deemed appropriate, ARRIS enters into various derivative transactions to enhance its ability to manage the volatility relating to these foreign exchange exposures. The Company does not hold or issue derivative instruments for trading or other speculative purposes. The Company’s derivative instruments are recorded in the Consolidated Balance Sheets at their fair values. The Company’s derivative instruments are not designated as hedges, and, accordingly, all changes in the fair value of the instruments are recognized as a loss (gain) on foreign currency in the Consolidated Statements of Operations. The maximum time frame for ARRIS’ derivatives is currently less than 12 months. Derivative instruments that are subject to master netting arrangements are not offset in the Consolidated Balance Sheets.

The fair values of ARRIS’ derivative instruments recorded in the Consolidated Balance Sheet as of June 30, 2011 and December 31, 2010 were as follows (in thousands):

As of June 30, 2011

As of December 31, 2010

Balance Sheet

Balance Sheet Location

Fair Value

Location

Fair Value

Derivatives Not Designated as Hedging Instruments:

Foreign exchange contracts — asset derivatives

Other current assets

$

64

Other current assets

$

607

Foreign exchange contracts — liability derivatives

Other accrued liabilities

$

1,530

Other accrued liabilities

$

828

The change in the fair values of ARRIS’ derivative instruments recorded in the Consolidated Statements of Operations during the three and six months ended June 30, 2011 and 2010 were as follows (in thousands):

						Three Months Ended								Six Months Ended
		Statement of Operations				June 30,								June 30,
		Location				2011				2010				2011				2010
Derivatives Not Designated as Hedging Instruments:
Foreign exchange contracts		Loss (gain) on				$	881			$	(1,384	)		$	3,014			$	(1,993	)
		foreign currency

Note 6. Pension Benefits

Components of Net Periodic Pension Cost (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Service cost		$	77			$	68			$	156			$	136
Interest cost			536				529				1,071				1,057
Expected gain on plan assets			(406	)			(380	)			(812	)			(760	)
Amortization of prior service cost			—				65				—				130
Amortization of net loss			72				70				144				140
Net periodic pension cost		$	279			$	352			$	559			$	703

Employer Contributions

No minimum funding contributions are required in 2011 under the Company’s defined benefit plan. However, the Company made voluntary contributions to the plan of approximately $21 thousand and $42 thousand for the three and six months ended June 30, 2011, respectively. Additionally, the Company has established two rabbi trusts to fund the Company’s pension obligations under the non-qualified plan of the Chief Executive Officer and certain executive officers. The balance of these rabbi trust assets as of June 30, 2011 was approximately $13.9 million and is included in Investments on the Consolidated Balance Sheets.

Note 7. Guarantees

Warranty

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

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

Information regarding the changes in ARRIS’ aggregate product warranty liabilities for the six months ended June 30, 2011 was as follows (in thousands):

Balance at December 31, 2010		$	5,340
Accruals related to warranties (including changes in estimates)			1,352
Settlements made (in cash or in kind)			(1,015	)
Balance at June 30, 2011		$	5,677

Note 8. Restructuring Charges

ARRIS has restructuring accruals representing contractual obligations that relate to excess leased facilities and equipment. Payments will be made over their remaining lease terms through 2014, unless terminated earlier.

		(in thousands)
Balance as of December 31, 2010		$	1,517
Q1 2011 payments			(93	)
Q2 2011 payments			(94	)
Balance as of June 30, 2011		$	1,330

Note 9. Inventories

Inventories are stated at the lower of average cost, approximating first-in, first-out, or market. The components of inventory were as follows, net of reserves (in thousands):

		June 30,				December 31,
		2011				2010
Raw materials		$	20,841			$	19,053
Work in process			3,437				4,176
Finished goods			88,742				78,534
Total inventories, net		$	113,020			$	101,763

Note 10. Property, Plant and Equipment

Property, plant and equipment, at cost, consisted of the following (in thousands):

		June 30,				December 31,
		2011				2010
Land		$	2,612			$	2,612
Building and leasehold improvements			24,599				23,580
Machinery and equipment			150,402				139,381
			177,613				165,573
Less: Accumulated depreciation			(120,513	)			(109,267	)
Total property, plant and equipment, net		$	57,100			$	56,306

Note 11. Convertible Senior Notes

In 2006, the Company issued $276.0 million of 2% convertible senior notes due 2026. The notes are convertible, at the option of the holder, based on a conversion rate, subject to adjustment, of 62.1504 shares per $1,000 principal amount (which represents a conversion price of approximately $16.09 per share of our common stock), into cash up to the principal amount and, if applicable, shares of the Company’s common stock, cash or a combination thereof for any excess. The notes may be converted during any calendar quarter in which the closing price of ARRIS’ common stock for 20 or more trading days in a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter exceeds 120% of the conversion price in effect at that time (which, based on the current conversion price, would be $19.31) and upon the occurrence of certain other events. Upon conversion, the holder will receive the principal amount in cash and an additional payment, in either cash or stock at the option of the Company. The additional payment will be based on a formula which calculates the difference between the conversion rate ($16.09) and the market price at the date of the conversion. As of August 5, 2011, the notes could not be converted by the holders thereof. Interest is payable on May 15 and November 15 of each year. The Company may redeem the notes at any time on or after November 15, 2013, subject to certain conditions. In addition, the holders may require the Company to purchase all or a portion of their convertible notes on or after November 13, 2013. There are no significant financial covenants related to the notes.

During 2010, ARRIS acquired $24.0 million principal amount of the notes, which had a book value, net of debt discount, of $20.0 million for approximately $23.3 million. The Company allocated $0.1 million to the reacquisition of the equity component of the notes. The Company also wrote off approximately $0.2 million of deferred finance fees associated with the notes acquired. As a result, the Company realized a gain of approximately $0.4 million on the retirement of the notes in 2010.

ARRIS accounts for the liability and equity components of the notes separately. The Company is accreting the debt discount related to the equity component to non-cash interest expense over the estimated seven year life of the convertible notes, which represents the first redemption date of November 13, 2013 when the Company may redeem the notes at its election or the note holders may require their redemption. The equity and liability components related to the notes were as follows (in thousands):

		June 30,				December 31,
		2011				2010
Carrying amount of the equity component		$	48,527			$	48,527
Principal amount of the liability component		$	237,050			$	237,050
Unamortized discount			(28,714	)			(34,435	)
Net carrying amount of the liability component		$	208,336			$	202,615

The following table presents the contractual interest coupon and the amortization of the discount on the equity component related to the notes during the three and six months ended June 30, 2011 and 2010 (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Contractual interest recognized		$	1,185			$	1,296			$	2,371			$	2,601
Amortization of discount			2,888				2,884				5,720				5,768

The effective annual interest rate on the debt component is 7.93%.

The Company paid approximately $7.8 million of finance fees related to the issuance of the notes. Of the $7.8 million, approximately $5.3 million was attributed to the debt component and $2.5 million was attributed to the equity component of the convertible debt instrument. The portion related to the debt component is being amortized over seven years. The remaining balance of unamortized financing costs from these notes as of June 30, 2011 and December 31, 2010 was $1.6 million and $1.9 million, respectively.

The Company has not paid cash dividends on its common stock since its inception.

Note 12. Comprehensive Income

Total comprehensive income represents the net change in stockholders’ equity during a period from sources other than transactions with stockholders. For ARRIS, the components of comprehensive income include the unrealized gain on marketable securities. The components of comprehensive income for the three and six months ended June 30, 2011 and 2010 are as follows (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Net income		$	16,690			$	19,774			$	28,254			$	38,765
Changes in the following equity accounts:
Unrealized gain on marketable securities			286				214				1,138				188
Comprehensive income		$	16,976			$	19,988			$	29,392			$	38,953

Note 13. Segment Information

The “management approach” has been used to present the following segment information. This approach is based upon the way the management of the Company organizes segments within an enterprise for making operating decisions and assessing performance. Financial information is reported on the basis that it is used internally by the chief operating decision maker for evaluating segment performance and deciding how to allocate resources to segments.

The Broadband Communications Systems segment’s product solutions include Headend and Subscriber Premises equipment that enable cable operators to provide Voice over IP, Video over IP and high-speed data services to residential and business subscribers.

The Access, Transport & Supplies segment’s product lines cover all components of a hybrid fiber coax network, including managed and scalable headend and hub equipment, optical nodes, radio frequency products, transport products and supplies.

The Media & Communications Systems segment provides content and operations management systems, including products for Video on Demand, Ad Insertion, Digital Advertising, Service Assurance, Service Fulfillment and Mobile Workforce Management.

The table below presents information about the Company’s reporting segments for the three and six months ended June 30, 2011 and 2010 (in thousands):

		BCS				ATS				MCS				Total
Three Months Ended June 30, 2011:
Net sales		$	201,844			$	46,870			$	17,085			$	265,799
Gross margin			85,812				11,332				9,754				106,898
Three Months Ended June 30, 2010:
Net sales		$	217,090			$	48,336			$	14,929			$	280,355
Gross margin			92,805				13,149				7,324				113,278
Six Months Ended June 30, 2011:
Net sales		$	408,474			$	92,492			$	32,269			$	533,235
Gross margin			162,869				22,316				18,659				203,844
Six Months Ended June 30, 2010:
Net sales		$	425,745			$	90,578			$	30,729			$	547,052
Gross margin			187,479				22,851				15,459				225,789

The Company’s gross intangible assets and goodwill by reportable segment as of June 30, 2011 has not materially changed from December 31, 2010.

Note 14. Sales Information

The Company’s two largest customers (including their affiliates, as applicable) are Comcast and Time Warner Cable. Over the past year, certain customers’ beneficial ownership may have changed as a result of mergers and acquisitions. Therefore the revenue for ARRIS’ customers for prior periods has been adjusted to include the affiliates that are now under common control. A summary of sales to these customers for the three and six month periods ended June 30, 2011 and 2010 are set forth below (in thousands):

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Comcast and affiliates		$	67,314			$	65,679			$	140,247			$	111,286
% of sales			25.3	%			23.4	%			26.3	%			20.3	%
Time Warner Cable and affiliates		$	27,648			$	52,896			$	70,383			$	93,961
% of sales			10.4	%			18.9	%			13.2	%			17.2	%

ARRIS sells its products primarily in the United States. The Company’s international revenue is generated in Asia Pacific, Europe, Latin America and Canada. The Asia Pacific market primarily includes China, Hong Kong, Japan, Korea, Singapore, and Taiwan. The European market primarily includes Austria, Belgium, France, Germany, the Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland, Great Britain, Ireland, Turkey, Russia, Romania, Hungry and Israel. The Latin American market primarily includes Argentina, Brazil, Chile,

Columbia, Mexico, Peru, Puerto Rico, Ecuador, Honduras, Costa Rica, Panama, Jamaica, and Bahamas. Sales to international customers were approximately $84.3 million, or 31.7% of total sales, for the three months ended June 30, 2011. International sales during the same period in 2010 were $92.6 million, or 33.0% of total sales. For the six months ended June 30, 2011 and 2010 sales to international customers were $161.9 million and $201.4 million, or 30.4% and 36.8%, respectively.

Note 15. 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								Six Months Ended
		June 30,								June 30,
		2011(1)				2010(1)				2011(1)				2010(1)
Basic:
Net income		$	16,690			$	19,774			$	28,254			$	38,765
Weighted average shares outstanding			121,800				126,584				122,047				126,277
Basic earnings per share		$	0.14			$	0.16			$	0.23			$	0.31
Diluted:
Net income		$	16,690			$	19,774			$	28,254			$	38,765
Weighted average shares outstanding			121,800				126,584				122,047				126,277
Net effect of dilutive equity awards			1,911				3,133				2,673				3,571
Total			123,711				129,717				124,720				129,848
Diluted earnings per share		$	0.13			$	0.15			$	0.23			$	0.30

The Company has $237.1 million of convertible senior notes outstanding at June 30, 2011. Upon conversion, ARRIS will satisfy at least the principal amount in cash, rather than common stock. This reduced the potential earnings dilution to only include the conversion premium, which is the difference between the conversion price per share of common stock and the average share price. The average share price in 2011 and 2010 was less than the conversion price of $16.09 and, consequently, did not result in dilution.

Excluded from the dilutive securities described above are employee stock options to acquire approximately 5.5 million shares and 3.8 million shares for the three and six months ended June 30, 2011, respectively. During the same periods in 2010, approximately 4.4 million shares and 3.6 million shares, respectively, were excluded from the dilutive securities above. These exclusions are made since the exercise price of these options is greater than the average market price of the common stock for the period, or if the Company has net losses, both of which have an anti-dilutive effect.

During the six months ended June 30, 2011, the Company issued 3.4 million shares of its common stock related to stock option exercises and the vesting of restricted shares, as compared to 2.0 million shares for the twelve months ended December 31, 2010.

Note 16. Income Taxes

In the first half of 2011 and 2010, the Company recorded income tax expense of $5.9 million and $21.4 million, respectively. Below is a summary of the components of the tax expense for the three and six month periods ended June 30, 2011 and 2010 (in thousands, except for percentages):

		For the Three Months Ended June 30																								For the Six Months Ended June 30
		2011												2010												2011												2010
		Income												Income												Income				Income												Income
		Before				Income Tax				Effective Tax				Before				Income Tax				Effective Tax				Before				Tax				Effective				Income Before				Tax				Effective
		Tax				Expense				Rate				Tax				Expense				Rate				Tax				Expense				Tax Rate				Tax				Expense				Tax Rate
Non-discrete Items		$	22,837			$	6,147				26.9	%		$	29,845			$	10,422				34.9	%		$	34,162			$	9,490				27.7	%		$	60,199			$	20,563				34.1	%
Discrete tax events — valuation allowances, uncertain tax positions		—				—								—					(351	)						—					(3,582	)						—					871
Total		$	22,837			$	6,147				26.9	%		$	29,845			$	10,071				33.7	%		$	34,162			$	5,908				17.2	%		$	60,199			$	21,434				35.6	%

•

During the first quarter of 2011, the Company identified $4.0 million of discrete tax benefits relating to the release of valuation allowances against state deferred tax assets, which was partially offset by $0.4 million of additional liabilities related to uncertain tax positions attributable to AMT credits.

•

During the first quarter of 2010, the Company identified $1.2 million of discrete tax adjustments relating to state deferred tax assets. During the second quarter of 2010, the Company recorded a $0.3 million discrete tax benefit attributable to Federal deferred tax assets.

Note 17. Repurchases of ARRIS Common Stock

The table below sets forth the purchases of ARRIS common stock for the quarter ended June 30, 2011 (in thousands, except per share data):

										Total Number of				Approximate
										Shares				Dollar Value of
										Purchased as				Shares That May
						Average				Part of Publicly				Yet Be Purchased
		Total Number of				Price Paid				Announced Plans				Under the Plans
Period		Shares Purchased				Per Share(1)				or Programs(1)(2)				or Programs(1)(2)
April 2011			1,533			$	12.43				1,533			$	11,617
May 2011			1,358			$	11.18				1,358			$	146,426
June 2011			2,178			$	10.75				2,178			$	123,027

Note 18. Contingencies

From time to time, ARRIS is involved in claims, disputes, litigation or legal proceedings incidental to the ordinary course of its business, such as intellectual property disputes, contractual disputes, employment matters and environmental proceedings. It is not possible to reasonably estimate the probability of an adverse outcome or the potential loss associated with any such items. See Part II, Item 1, “Legal Proceedings.”

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

Overview

We are a global communications technology company, headquartered in Suwanee, Georgia. We operate in three business segments, Broadband Communications Systems (“BCS”), Access, Transport & Supplies (“ATS”), and Media & Communications Systems (“MCS”). A detailed description of each segment is contained in “Our Principal Products” in our Form 10-K for the year ended December 31, 2010. We specialize in integrated broadband network solutions that include products, systems and software for content and operations management (including video on demand, or VOD), and professional services. We are a leading developer, manufacturer and supplier of telephony, data, video, construction, rebuild and maintenance equipment for the broadband communications industry. In addition, we are a leading supplier of infrastructure products used by cable system operators to build-out and maintain hybrid fiber-coaxial (“HFC”) networks. We provide our customers with products and services that enable reliable, high speed, two-way broadband transmission of video, telephony, and data.

Our Strategy and Key Highlights

Our long-term business strategy, “Convergence Enabled,” includes the following key elements:

	•		Maintain a strong capital structure, mindful of our debt (which is likely to be required to be repaid in 2013), share repurchase opportunities and other capital needs including mergers and acquisitions.
	•		Grow our current business into a more complete portfolio including a strong video product suite.
	•		Continue to invest in the evolution toward enabling true network convergence onto an all IP platform.
	•		Continue to expand our product/service portfolio through internal developments, partnerships and acquisitions.
	•		Expand our international business and begin to consider opportunities in markets other than cable.
	•		Continue to invest in and evolve the ARRIS talent pool to implement these strategies.

To fulfill our strategy, we develop technology, facilitate its implementation, and enable operators to put their subscribers in control of their entertainment, information, and communication needs. Through a set of business solutions that respond to specific market needs, we are integrating our products, software, and services solutions to work with our customers as they address Internet Protocol telephony deployment, high speed data deployment, high definition television content expansion, on demand video rollout, operations management, network integration, and business services opportunities.

Below are some key highlights relative to our second quarter and first half of 2011:

Financial Highlights

	•		Sales in the second quarter and first half of 2011 were $265.8 million and $533.2 million, respectively, down slightly from $280.4 million and $547.1 million in the same periods in 2010
	•		Gross margin percentage was 40.2% in the second quarter 2011, which compares to 40.4% in the second quarter 2010 and 36.3% in the first quarter 2011. The sequential increase in margin reflects the introduction of our CMTS line card capacity upgrade, which have higher margins.
	•		Total operating expenses (excluding amortization of intangible assets) in the second quarter of 2011 were $72.5 million, up $2.5 million year over year. Research and development expenses increased $1.1 million as a result of prototypes and incremental start up costs related to new product development. Selling, general, and administrative expenses increased $1.4 million as a result of higher variable compensation costs and higher legal costs. We anticipate our operating expenses to modestly increase in the third quarter of 2011 as a result of higher prototype and start up costs related to new product introductions and variable compensation costs.
	•		We ended the second quarter 2011 with $591.5 million of cash, cash equivalents and short-term investments. We generated approximately $31.4 million and $35.2 million of cash from operating activities in the second quarters of 2011 and 2010, respectively. During the first half of 2011, we generated approximately $27.8 million of cash from operating activities as compared to $83.4 million during the first half of 2010.
	•		In the first half of 2011, we repurchased 5.1 million shares of our common stock at an average price of $11.37 per share for an aggregate consideration of approximately $57.6 million.

Product Line Highlights

•

Broadband Communications Systems

o

CMTS

	§		In second quarter 2011 we began to sell new software license that enables operators to purchase incremental downstream capacity on existing deployed line cards.
	§		Downstream port shipments in second quarter 2011 (including both new hardware and software licenses) increased to 79 thousand ports. Year-to-date downstream port shipments were 142 thousand ports.
	§		The introduction of the downstream software license capability enabled lower pricing at improved gross margins, enhancing both competitiveness and profitability.
	§		Good progress on development of new double-density upstream line card.
	§		Good progress on development of next generation Converged Edge Router CMTS product that will enable smooth transition of legacy video networks to IP

o

Video Processing

§

Release of a new video processing platform supporting MPEG4 encoding, transcoding, and adaptive streaming for IP-based video distribution

o

Whole House Solution

§

Commercial launch of new Home Media Gateway solution with lead customers, with first product revenue recognized in the second quarter of 2011.

o

CPE

	§		Approximately 1.3 million and 2.7 million CPE units were shipped in the second quarter of 2011 and in the first six months of 2011, respectively. Shipments of DOCSIS 3.0 CPE increased to 36% of the total unit shipments as compared to 29% in the first quarter of 2011.
	§		Maintained number one EMTA market share for 26 consecutive quarters (source: Infonetics)

•

Access, Transport & Supplies

	o		Increasing demand in the ATS business unit as a result of higher Professional Services and Access product opportunities.
	o		Professional Services growth related to activities in Cell Tower Backhaul, Metro-E and Telco Solutions
	o		MSOs increasing investments in node segmentation as a cost effective vehicle to provide more capacity per subscriber

	§		Multi-wavelength optics continue to gain traction in support of these MSO investments
	§		Investments by ARRIS to take advantage of technology improvements and component cost reductions continue to position us well with the MSO’s

•

Media & Communications Systems

	o		Continued wins in the Ad insertion segment in North America with key trials of Linear Addressable Advertising underway with major MSOs
	o		Storage upgrades to our XMS VOD server platform with key North American customers
	o		Good wins for Assurance products in CALA.
	o		Announcement of ServAssureTM 3.3 which includes support for IPV6.
	o		New trials of FMC with major North American and international operators kicked off.

Non-GAAP Measures

As part of our ongoing review of financial information related to our business, we regularly use Non-GAAP measures, in particular Non-GAAP earnings per share, as we believe they provide a meaningful insight into our business and trends. We also believe that these Non-GAAP measures provide readers of our financial statements with useful information and insight with respect to the results of our business. However, the presentation of Non-GAAP information is not intended to be considered in isolation or as a substitute for results prepared in

accordance with GAAP. Below are tables for the three and six months ended June 30, 2011 and 2010 that detail and reconcile GAAP and Non-GAAP earnings per share:

		For the Three Months Ended June 30, 2011
														Other
						Operating				Operating				(Income)				Income Tax
(in thousands, except per share data)		Gross Margin				Expense				Income				Expense				Expense				Net Income
GAAP		$	106,898			$	81,441			$	25,457			$	2,620			$	6,147			$	16,690
Stock compensation expense			557				(5,368	)			5,925				—								5,925
Amortization of intangible assets			—				(8,944	)			8,944				—								8,944
Non-cash interest expense			—				—				—				(2,889	)							2,889
Tax related to items above			—				—				—				—				4,915				(4,915	)
Non-GAAP		$	107,455			$	67,129			$	40,326			$	(269	)		$	11,062			$	29,533
GAAP net income per share — diluted																						$	0.13
Non-GAAP net income per share — diluted																						$	0.24
GAAP weighted average common shares — diluted																							123,711
Non-GAAP weighted average common shares — diluted																							123,711

		For the Six Months Ended June 30, 2011
														Other
						Operating				Operating				(Income)				Income Tax
(in thousands, except per share data)		Gross Margin				Expense				Income				Expense				Expense				Net Income
GAAP		$	203,844			$	163,263			$	40,581			$	6,419			$	5,908			$	28,254
Stock compensation expense			994				(10,215	)			11,209				—								11,209
Amortization of intangible assets			—				(17,888	)			17,888				—								17,888
Non-cash interest expense			—				—				—				(5,721	)							5,721
Tax related to items above			—				—				—				—				9,939				(9,939	)
Adjustments of income tax valuation allowances, R&D credits, and other discrete tax items			—				—				—				—				3,583				(3,583	)
Non-GAAP		$	204,838			$	135,160			$	69,678			$	698			$	19,430			$	49,550
GAAP net income per share — diluted																						$	0.23
Non-GAAP net income per share — diluted																						$	0.40
GAAP weighted average common shares — diluted																							124,720
Non-GAAP weighted average common shares — diluted																							124,720

		For the Three Months Ended June 30, 2010
														Other
						Operating				Operating				(Income)				Income Tax
(in thousands, except per share data)		Gross Margin				Expense				Income				Expense				Expense				Net Income
GAAP		$	113,278			$	79,039			$	34,239			$	4,394			$	10,071			$	19,774
Stock compensation expense			481				(5,272	)			5,753				—								5,753
Acquisition costs, restructuring, and integration costs			—				(21	)			21				—								21
Amortization of intangible assets			—				(9,022	)			9,022				—								9,022
Non-cash interest expense			—				—				—				(2,884	)							2,884
Gain on repurchase of debt			—				—				—				115								(115	)
Tax related to items above			—				—				—				—				6,170				(6,170	)
Adjustments of income tax valuation allowances, R&D credits, and other discrete tax items			—				—				—				—				351				(351	)
Non-GAAP		$	113,759			$	64,724			$	49,035			$	1,625			$	16,592			$	30,818
GAAP net income per share — diluted																						$	0.15
Non-GAAP net income per share — diluted																						$	0.24
GAAP weighted average common shares — diluted																							129,717
Non-GAAP weighted average common shares — diluted																							129,717

		For the Six Months Ended June 30, 2010
														Other
						Operating				Operating				(Income)				Income Tax
(in thousands, except per share data)		Gross Margin				Expense				Income				Expense				Expense				Net Income
GAAP		$	225,789			$	157,595			$	68,194			$	7,995			$	21,434			$	38,765
Stock compensation expense			914				(9,360	)			10,274				—								10,274
Acquisition costs, restructuring, and integration costs			—				(73	)			73				—								73
Amortization of intangible assets			—				(18,043	)			18,043				—								18,043
Non-cash interest expense			—				—				—				(5,767	)							5,767
Gain on repurchase of debt			—				—				—				115								(115	)
Tax related to items above			—				—				—				—				11,675				(11,675	)
Adjustments of income tax valuation allowances, R&D credits, and other discrete tax items			—				—				—				—				(871	)			871
Non-GAAP		$	226,703			$	130,119			$	96,584			$	2,343			$	32,238			$	62,003
GAAP net income per share — diluted																						$	0.30
Non-GAAP net income per share — diluted																						$	0.48
GAAP weighted average common shares — diluted																							129,848
Non-GAAP weighted average common shares — diluted																							129,848