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ARRIS GROUP INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) 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, 2011. 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 2013 debt maturity, 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 delivery, multi-screen video, operations management, network integration, and business services opportunities. Below are some key highlights relative to the three months ended March 31, 2012: Financial Highlights • Sales in the first quarter of 2012 were $302.9 million as compared to $267.4 million in the same period in 2011. The increase is the result of higher sales of our DOCSIS CPE and Video Gateway products as well as the effect of a full quarter of sales of our EMP product resulting from our late 2011 acquisition of BigBand Networks. • Gross margin percentage was 36.0% in the first quarter of 2012, which compares to 36.3% in the first quarter of 2011. • Total operating expenses (excluding amortization of intangible assets) in the first quarter of 2012 were $89.8 million, as compared to $72.9 million in the same period last year. The increase is the result of the inclusion of expenses associated with the late 2011 BigBand acquisition and restructuring costs we incurred as we took steps to reduce our overall cost structure post the acquisition of BigBand. • We ended the first quarter 2012 with an order backlog of approximately $277.7 million and a book-to-bill ratio of 1.43. This compares to $177.5 million and 1.14 in the first quarter 2011, respectively. • We ended the first quarter of 2012 with $567.2 million of cash, cash equivalents, short-term and long-term marketable security investments. We generated approximately $35.3 million of cash from operating activities in the first quarter of 2012. • In the first quarter of 2012, we used $26.3 million of cash to repurchase 2.3 million shares of our common stock. Year over year, our diluted share count was lower by 8.1 million shares as a result of our share repurchase activities. 18 -------------------------------------------------------------------------------- Table of Contents Product Line Highlights • Broadband Communications Systems o CMTS ¡ Continued strong demand for increased network capacity, shipping a record number of downstream ports, up 10% from the previous high in fourth quarter 2011 to almost 110 thousand ports in the first quarter of 2012. ¡ Full production of new cost-reduced 24U line card enabling lower overall cost/downstream for new Greenfield hardware shipments. ¡ Continued strength in sales of downstream software licenses enabling increased capacity of existing deployed hardware platforms. ¡ Continued progress on development and early customer testing of next generation Converged Edge Router CMTS product that will enable smooth transition of legacy video networks to IP. ¡ Strong upstream port shipments again this quarter driven by a mix of 12U and 24U CAMs. o Video Processing ¡ New MPEG4 Adaptive Bitrate VIPr platform under test with lead customers to support multi-screen video delivery. o Whole House Solution ¡ Successful service launch with Wide Open West; early deployments also underway with Buckeye Cable. ¡ New projects launched that include integration of third party middleware software providers in close collaboration with lead customers. o CPE ¡ Strong quarter with approximately 1.6 million CPE units shipped. ¡ Mix of DOCSIS 3.0 CPE increased to 61% of the total unit shipments as compared to 46 % in the fourth quarter of last year. ¡ Maintained number one EMTA market share for 29 consecutive quarters. (source: Infonetics) ¡ Strong demand for DOCSIS 3.0 WiFi Voice and Data Gateway variants. o Edge Media Processing ¡ Good progress in completing development of QAM and Video Processing features on the Multi-Service Platform (MSP). Deployment of MSP-QAM platform underway with Tier 1 U.S. MSO. ¡ Expansion of SDV platform with several Tier 1 U.S. MSOs. • Access, Transport & Supplies o Sales in first quarter 2012 reflect seasonal softness. o Sale of Electronic Connector Corp (ECCO) product line to Eclipse Embedded Technologies during the first quarter 2012. • Media & Communications Systems o Support for Android-based mobile devices introduced on WorkAssureTM product. o Continued competitive replacements with SkyVision TM Linear Ad Insertion product. 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 months ended March 31, 2012 and 2011 which detail and reconcile GAAP and non-GAAP earnings per share: 19 -------------------------------------------------------------------------------- Table of Contents (in thousands, except per share data) For the Three Months Ended March 31, 2012 Other Operating Operating (Income) Tax Expense Net Income Gross Margin Expense Income Expense (Benefit) (Loss) Net income in accordance with GAAP $ 108,908 $ 97,217 $ 11,691 $ 3,006 $ 2,886 $ 5,799 Purchase accounting impacts of deferred revenue 1,258 - 1,258 - - 1,258 Stock compensation expense 750 (5,899 ) 6,649 - - 6,649 Amortization of intangible assets - (7,379 ) 7,379 - - 7,379 Acquisition costs - (607 ) 607 - - 607 Restructuring - (5,203 ) 5,203 - - 5,203 Loss of sale of product line - (337 ) 337 - - 337 Non-cash interest expense - - - (2,999 ) - 2,999 Tax related to items above - - - - 8,121 (8,121 ) Non-GAAP net income $ 110,916 $ 77,792 $ 33,124 $ 7 $ 11,007 $ 22,110 GAAP net income per share - diluted $ 0.05 Non-GAAP net income per share - diluted $ 0.19 Weighted average common shares - diluted 117,597 (in thousands, except per share data) For the Three Months Ended March 31, 2011 Other Operating Operating (Income) Tax Expense Net Income Gross Margin Expense Income Expense (Benefit) (Loss) Net income in accordance with GAAP $ 96,946 $ 81,822 $ 15,124 $ 3,799 $ (239 ) $ 11,564 Stock compensation expense 437 (4,847 ) 5,284 - - 5,284 Amortization of intangible assets - (8,944 ) 8,944 - - 8,944 Non-cash interest expense - - - (2,832 ) - 2,832 Tax related to items above - - - - 5,024 (5,024 ) Adjustments of income tax valuation allowances, R&D credits, and other discrete tax items - - - - 3,583 (3,583 ) Non-GAAP net income $ 97,383 $ 68,031 $ 29,352 $ 967 $ 8,368 $ 20,017 GAAP net income per share - diluted $ 0.09 Non-GAAP net income per share - diluted $ 0.16 Weighted average common shares - diluted 125,732 In managing and reviewing our business performance, we exclude a number of items required by GAAP. Management believes that excluding these items is useful in understanding the trends and managing our operations. We provide these supplemental non-GAAP measures in order to assist the investment community to see ARRIS through the "eyes of management," and therefore enhance understanding of ARRIS' operating performance. Non-GAAP financial measures should be viewed in addition to, and not as an alternative to, the Company's reported results prepared in accordance with GAAP. Our non-GAAP financial measures reflect adjustments based on the following items, as well as the related income tax effects: Purchase Accounting Impacts Related to Deferred Revenue: In connection with our acquisition of BigBand, business combination rules require us to account for the fair values of deferred revenue arrangements for which acceptance has not been obtained, and post contract support in our purchase accounting. The non-GAAP adjustment to our sales and cost of sales is intended to include the full amounts of such revenues as if these purchase accounting adjustments had not been applied. We believe the adjustment to these revenues is useful as a measure of the ongoing performance of our business. We have historically experienced high renewal rates related to our support agreements and our objective is to increase the renewal rates on acquired post contract support agreements; however, we cannot be certain that our customers will renew our contracts. 20-------------------------------------------------------------------------------- Table of Contents Stock-Based Compensation Expense: We have excluded the effect of stock-based compensation expenses in calculating our non-GAAP operating expenses and net income (loss) measures. Although stock-based compensation is a key incentive offered to our employees, we continue to evaluate our business performance excluding stock-based compensation expenses. We record non-cash compensation expense related to grants of options and restricted stock. Depending upon the size, timing and the terms of the grants, the non-cash compensation expense may vary significantly but will recur in future periods. Amortization of Intangible Assets: We have excluded the effect of amortization of intangible assets in calculating our non-GAAP operating expenses and net income (loss) measures. Amortization of intangible assets is non-cash, and is inconsistent in amount and frequency and is significantly affected by the timing and size of our acquisitions. Investors should note that the use of intangible assets contributed to our revenues earned during the periods presented and will contribute to our future period revenues as well. Amortization of intangible assets will recur in future periods. Acquisition Costs: We have excluded the effect of acquisition related expenses in calculating our non-GAAP operating expenses and net income (loss) measures. We incurred significant expenses in connection with our recent acquisition of BigBand, which we generally would not have otherwise incurred in the periods presented as part of our continuing operations. Acquisition related expenses consist of transaction costs, costs for transitional employees, other acquired employee related costs, and integration related outside services. We believe it is useful to understand the effects of these items on our total operating expenses. Restructuring Costs: We have excluded the effect of restructuring charges in calculating our non-GAAP operating expenses and net income (loss) measures. Restructuring expenses consist of employee severance, abandoned facilities, and other exit costs. We believe it is useful to understand the effects of these items on our total operating expenses. Loss on Sale of Product Line: We have excluded the effect of a loss on the sale of a product line in calculating our non-GAAP operating expenses and net income measures. We believe it is useful to understand the effects of these items on our total operating expenses. Non-Cash Interest on Convertible Debt: We have excluded the effect of non-cash interest in calculating our non-GAAP operating expenses and net income (loss) measures. We record the accretion of the debt discount related to the equity component non-cash interest expense. We believe it is useful to understand the component of interest expense that will not be paid out in cash. Income Tax Expense (Benefit): We have excluded the tax effect of the non-GAAP items mentioned above. Additionally, we have excluded the effects of certain tax adjustments related to state valuation allowances, research and development tax credits and provision to return differences. Significant Customers 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 under common control. A summary of sales to these customers for the three months ended March 31, 2012 and 2011 are set forth below (in thousands): Three Months Ended March 31, 2012 2011 Comcast and affiliates $ 81,802 $ 72,933 % of sales 27.0% 27.3% Time Warner Cable and affiliates $ 44,635 $ 42,735 % of sales 14.7% 16.0% 21 -------------------------------------------------------------------------------- Table of Contents Comparison of Operations for the Three Months Ended March 31, 2012 and 2011 Net Sales The table below sets forth our net sales for the three months ended March 31, 2012 and 2011, for each of our segments (in thousands): Net Sales Three Months Ended Increase (Decrease) - March 31, 2012 vs. 2011 2012 2011 $ % Business Segment: Broadband Communications Systems $ 244,515 $ 206,630 $ 37,885 18.3 % Access, Transport & Supplies 44,057 45,622 (1,565 ) (3.4 )% Media & Communications Systems 14,329 15,184 (855 ) (5.6 )% Total sales $ 302,901 $ 267,436 $ 35,465 13.3 % The table below sets forth our domestic and international sales for the three months ended March 31, 2012 and 2011 (in thousands): Net Sales Three Months Ended Increase (Decrease) - March 31, 2012 vs. 2011 2012 2011 $ % Domestic sales $ 227,525 $ 189,864 $ 37,661 19.8 % International sales 75,376 77,572 (2,196 ) (2.8 )% Total sales $ 302,901 $ 267,436 $ 35,465 13.3 % Broadband Communication Systems Net Sales 2012 vs. 2011 During the three months ended March 31, 2012, sales in our BCS segment increased by approximately 18.3% as compared to the same period in 2011. We had higher sales of CPE products, in particular wireless EMTAs and cable modems in the quarter. In addition, we had a full quarter of BigBand product sales in Q1 2012. Access, Transport & Supplies Net Sales 2012 vs. 2011 During the three months ended March 31, 2012, sales in our Access, Transport and Supplies segment decreased by approximately 3.4% as compared to the same period in 2011. The decline in sales is primarily the result of lower sales of Supplies products and professional and commercial services. Partially offsetting these declines in Supplies and Services were higher sales of access and transport products, primarily for headend optics. Media & Communication Systems Net Sales 2012 vs. 2011 During the three months ended March 31, 2012, sales in our Media & Communications Systems segment decreased by approximately 5.6% as compared to the same period in 2011. Revenue in this segment varies as it is tied to customer acceptances and non linear orders. 22-------------------------------------------------------------------------------- Table of Contents Gross Margin The table below sets forth our gross margin for the three months ended March 31, 2012 and 2011, for each of our reporting segments (in thousands): Gross Margin $ Three Months Ended Increase (Decrease) March 31, 2012 vs. 2011 2012 2011 $ % Business Segment: Broadband Communications Systems $ 89,565 $ 77,057 $ 12,508 16.2 % Access, Transport & Supplies 10,635 10,985 (350 ) (3.2 )% Media & Communications Systems 8,708 8,904 (196 ) (2.2 )% Total $ 108,908 $ 96,946 $ 11,962 12.3 % The table below sets forth our gross margin percentages for the three months ended March 31, 2012 and 2011, for each of our business segments: Gross Margin % Three Months Ended Percentage Point March 31, Increase (Decrease) 2012 2011 2012 vs. 2011 Business Segment: Broadband Communications Systems 36.6 % 37.3 % (0.7 ) Access, Transport & Supplies 24.1 % 24.1 % - Media & Communications Systems 60.8 % 58.6 % 2.2 Total 36.0 % 36.3 % (0.3 ) Broadband Communications Systems Gross Margin 2012 vs. 2011 Broadband Communications Systems segment gross margin percentage decreased but gross margin dollars increased during the three months ended March 31, 2012 as compared to the same period in 2011. The decrease in gross margin percentage reflects a product mix change as we had higher CPE sales and lower CMTS revenue (CMTS products have a higher gross margin than CPE products). The increase in gross margin dollar was primarily the result of higher sales. Access, Transport & Supplies Gross Margin 2012 vs. 2011 The Access, Transport & Supplies segment gross margin dollars decreased and gross margin percentage remained flat during the three months ended March 31, 2012 as compared to the same period in 2011. The decrease was driven by lower sales and product mix. Media & Communications Systems Gross Margin 2012 vs. 2011 Media & Communications Systems segment gross margin dollars decreased but gross margin percentage increased during the three months ended March 31, 2012. The decrease in gross margin dollar was due to lower sales. The increase gross margin percentage was primarily a result of product mix. 23-------------------------------------------------------------------------------- Table of Contents Operating Expenses The table below provides detail regarding our operating expenses (in thousands): Operating Expenses Three Months Ended Increase (Decrease) March 31, 2012 vs. 2011 2012 2011 $ % Selling, general, and administrative $ 39,544 $ 36,838 $ 2,706 7.3% Research and development 44,147 36,040 8,107 22.5% Restructuring 5,203 - 5,203 100.0% Acquisition costs 607 - 607 100.0% Loss on sale of product line 337 - 337 100.0% Amortization of intangible assets 7,379 8,944 (1,565) (17.5)% Total $ 97,217 $ 81,822 $ 15,395 18.8% Selling, General, and Administrative, or SG&A, Expenses The year over year increase in SG&A expenses reflects the addition of BigBand. Research & Development, or R&D, Expenses The year over year increase in R&D expenses reflects the addition of Bigband and increased headcount, as we continued to aggressively invest in R&D. Restructuring Charges During the first quarter of 2012, ARRIS continued its implementation of the restructuring initiative following the acquisition of BigBand to align our workforce and operating costs with current business opportunities. This resulted in restructuring charge of $5.2 million related to severance, termination benefits and facilities during the three month period ending March 31, 2012. On a quarterly basis, we review our existing restructuring accruals and make adjustments if necessary. No accrual adjustments were necessary for previously recorded restructuring accruals. Acquisition Costs During the first quarter of 2012, we recorded acquisition related expenses of $0.6 million. These expenses were related to the acquisition of BigBand and consisted of transaction costs and integration related outside services. Loss on Sale of Product Line In March of 2012, the Company completed the sale of certain assets of its ECCO electronic connector product line to Eclipse Embedded Technologies, Inc. for approximately $3.9 million. The Company recorded a net loss of $(0.3) million on the sale, which included approximately $0.3 million of transaction related costs. The results of the ECCO product line were deemed immaterial to the overall financial results of the Company, and as such the Company has not reported the results in discontinued operations (see Note 7 of the Notes to the Condensed Consolidated Financial Statements). Amortization of Intangibles Intangibles amortization expense for the three months ended March 31, 2012 and 2011 was $7.4 million and $8.9 million, respectively. Our intangible expense is related to the acquisitions of BigBand Networks in November 2011, Digeo, Inc. in October 2009, EG Technologies in September 2009, Auspice Corporation in August 2008 and C-COR Incorporated in December 2007. 24-------------------------------------------------------------------------------- Table of Contents Other Expense (Income) Interest Expense Interest expense for the three months ended March 31, 2012 and 2011 was $4.4 million and $4.2 million respectively. Interest expense reflects the amortization of deferred finance fees, the non-cash interest component of our convertible subordinated notes, interest paid on the notes, capital leases and other debt obligations. Interest Income Interest income during the three months ended March 31, 2012 and 2011 was $0.8 million. The income reflects interest earned on cash, cash equivalents, short-term and long-term investments. Loss (Gain) on Foreign Currency During the three months ended March 31, 2012 and 2011, we recorded a foreign currency loss of approximately $0.8 million and $0.9 million, respectively. We have certain international customers who are billed in their local currency, primarily the euro. To mitigate the volatility related to fluctuations in the foreign exchange rates, we may enter into various foreign currency contracts. The loss (gain) on foreign currency is driven by the fluctuations in the foreign currency exchanges rates, primarily the euro. Loss (Gain) on Investments From time to time, we hold certain investments in the common stock of private and publicly-traded companies, a number of non-marketable equity securities, and investments in rabbi trusts associated with our deferred compensation plans. During the three months ended March 31, 2012 and 2011, we recorded net gains related to these investments of $1.0 million, and $0.4 million, respectively. Other Expense (Income) Other income for the three months ended March 31, 2012 and 2011 was $0.4 million and $0.1 million, respectively. Income Tax Expense (Benefit) In the three months ended March 31, 2012 and 2011, we recorded income tax expense (benefit) of $2.9 million and $(0.2) million, respectively. There were no discrete tax events during the first quarter of 2012. In the first quarter of 2011, the Company implemented certain legal entity changes to reduce complexity and simplify our corporate organizational structure and tax accounting provision process. As a result, approximately $3.6 million of valuation allowances related to state deferred tax assets, primarily net operating losses, were reversed as we concluded it was more likely than not that we will now be able to utilize the deferred tax assets in future periods The Company anticipates that the effective income tax rate for full year 2012, excluding discrete items and the potential for an extension of legislation that provides for the research and development tax credit, will be approximately 33.5%. 25 -------------------------------------------------------------------------------- Table of Contents Financial Liquidity and Capital Resources Overview One of our key strategies is to maintain and improve our capital structure. The key metrics we focus on are summarized in the table below: Liquidity & Capital Resources Data Three Months Ended March 31, 2012 2011 (in thousands, except DSO and turns) Key Working Capital Items Cash provided by (used in) operating activities $ 35,273 $ (3,571 ) Cash, cash equivalents, and short-term investments $ 514,347 $ 619,609 Long-term U.S. corporate & government agency bonds $ 52,865 $ - Accounts receivable, net $ 183,427 $ 149,976 Days Sales Outstanding ("DSOs") 51 47 Inventory $ 105,114 $ 105,787 Inventory turns 7.0 6.6 Key Financing Items Convertible notes at face value $ 232,050 $ 237,050 Convertible notes at book value $ 212,765 $ 205,447 Key Shareholder Equity Items Cash used for share repurchases $ 26,315 $ - Capital Expenditures $ 3,762 $ 6,251 In managing our liquidity and capital structure, we have been and are focused on key goals, and we have and will continue in the future to implement actions to achieve them. They include: • Liquidity - ensure that we have sufficient cash resources or other short term liquidity to manage day to day operations • Growth - implement a plan to ensure that we have adequate capital resources, or access thereto, fund internal growth and execute acquisitions while retiring our convertible notes in a timely fashion. • Share repurchases - opportunistically repurchase our common stock. Below is a description of key actions taken and an explanation as to their potential impact: Accounts Receivable & Inventory We use the number of times per year that inventory turns over (based upon sales for the most recent period, or turns) to evaluate inventory management, and days sales outstanding, or DSOs, to evaluate accounts receivable management. Accounts receivable increased and DSOs increased during the three months of 2012 as compared to 2011 primarily as a result of higher sales in the first quarter of 2012. DSOs increased primarily the result of payment patterns of our customers and timing of shipments to customers. Looking forward, it is possible that DSOs may increase dependent upon our customer mix and payment patterns, particularly if international sales increase. Inventory at the end of the first quarter of 2012 was $0.7 million lower than the end of the first quarter of 2011. Inventory turns during the first three months of 2012 were 7.0 as compared to 6.6 in the same period of 2011. The decrease in inventory reflects the sale of $3.6 million of net inventory of the ECCO product line. 26 -------------------------------------------------------------------------------- Table of Contents Common Share Repurchases During the first quarter of 2012, we repurchased 2.3 million shares of our common stock for $26.3 million at an average stock price of $11.32. During the first three months of 2011, ARRIS did not repurchase any shares under the plan. Summary of Current Liquidity Position and Potential for Future Capital Raising We believe our current liquidity position, where we have approximately $514.3 million of cash, cash equivalents, and short-term investments and $52.9 million of long-term marketable securities on hand as of March 31, 2012, together with the prospects for continued generation of cash from operations are adequate for our short- and medium-term business needs. We may in the future elect to repurchase additional shares of our common stock or convertible notes. In addition, a key part of our overall long-term strategy may be implemented through additional acquisitions, and a portion of these funds may be used for that purpose. Should our available funds be insufficient for those purposes, it is possible that we will raise capital through private or public, share or debt offerings. During the first quarter of 2009, ARRIS' Board of Directors authorized a plan for the Company to repurchase up to $100 million of the Company's common stock. The Company did not repurchase any shares under the plan during 2009. In 2010, ARRIS repurchased 6.8 million shares of the Company's common stock at an average price of $10.24 per share for an aggregate consideration of approximately $69.3 million. In May 2011, the share repurchase authorization amount under the 2009 plan was exhausted. In the second quarter of 2011, the Board authorized a new plan for the Company to purchase up to $150 million of the Company's common stock. During 2011, ARRIS repurchased 10.0 million shares of our common stock at an average price of $10.95 per share for an aggregate consideration of approximately $109.1 million. During the first three month of 2012, ARRIS repurchased 2.3 million shares of the Company's common stock at an average price of $11.32 per share, for an aggregate consideration of approximately $26.3 million. As of March 31, 2012, the remaining authorized amount for future repurchases was $45.2 million. Commitments Our contractual obligations are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011. There has been no material change to our contractual obligations during the first three months of 2012. Off-Balance Sheet Arrangements We do not have any material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K. Cash Flow Below is a table setting forth the key line items of our Consolidated Statements of Cash Flows (in thousands): For the Three Months Ended March 31, 2012 2011 Cash provided by (used in) operating activities $ 35,273 $ (3,571 ) Cash provided by (used in) investing activities (26,371 ) 379 Cash provided by (used in) financing activities (28,969 ) 8,818 Net increase (decrease) in cash $ (20,067 ) $ 5,626 27 -------------------------------------------------------------------------------- Table of Contents Operating Activities: Below are the key line items affecting cash provided by operating activities (in thousands): For the Three Months Ended March 31, 2012 2011 Net income $ 5,799 $ 11,564 Adjustments to reconcile net income to cash provided by operating activities 17,526 11,145 Net income including adjustments 23,325 22,709 (Increase) decrease in accounts receivable (31,799 ) (24,043 ) (Increase) decrease in inventory 7,243 (4,024 ) Increase (decrease) in accounts payable and accrued liabilities 22,398 (7,048 ) All other - net 14,106 8,835 Cash provided by (used in) operating activities $ 35,273 $ (3,571 ) Net income, including adjustments, increased $0.6 million during the first three months of 2012 as compared to 2011. Accounts receivable increased by $31.8 million during the first three months of 2012. This increase was primarily as a result of higher sales in the first quarter of 2012 as compared to first quarter of 2011 and payment patterns of our customers. Inventory decreased by $7.2 million during the first three months of 2012. The decrease was due to higher sales and the sale of the ECCO product line. Accounts payable and accrued liabilities increased by $22.4 million. Accounts payable increased due to increased purchases resulting from higher sales. Deferred revenue increased by $16.4 million, which was the result of the build-up of the deferred revenue due to annual maintenance renewals which typically occur in the first quarter. All other accounts, net, includes the changes in other receivables, income taxes payable (recoverable), and prepaids. The other receivables represent amounts due from our contract manufacturers for material used in the assembly of our finished goods. The change in our income taxes recoverable account is a result of the timing of the actual estimated tax payments during the year as compared to the actual tax liability for the year. The net change during the first three months of 2012 was approximately $14.1 million. Investing Activities: Below are the key line items affecting investing activities (in thousands): For the Three Months Ended March 31, 2012 2011 Purchases of property, plant and equipment $ (3,762 ) $ (6,251 ) Cash proceeds from sale of property, plant and equipment - 42 Purchases of investments (77,766 ) (99,361 ) Sales of investments 51,908 105,949 Cash proceeds from sale of product line 3,249 - Cash provided by (used in) investing activities $ (26,371 ) $ 379 Purchases of Property, Plant and Equipment - This represents capital expenditures which are mainly for test equipment, laboratory equipment, and computing equipment. We anticipate investing approximately $25 million in fiscal year 2012. 28 -------------------------------------------------------------------------------- Table of Contents Cash Proceeds from Sale of Property, Plant and Equipment - This represents the cash proceeds we received from the sale of property, plant and equipment. Purchases and Sales of Investments - These represent purchases and sales of securities Cash Proceeds from Sale of Product Line - This represents the cash proceeds we received from the sale of our ECCO product line. Financing Activities: Below are the key line items affecting our financing activities (in thousands): For the Three Months Ended March 31, 2012 2011 Repurchase of common stock $ (26,315 ) $ - Excess income tax benefits from stock-based compensation plans 1,654 3,700 Repurchase of shares to satisfy employee tax withholdings (8,033 ) (8,245 ) Proceeds from issuance of common stock 3,725 13,363 Cash provided by (used in) financing activities $ (28,969 ) $ 8,818 Repurchase of Common Stock - During the first three months of 2012, ARRIS repurchased approximately 2.3 million shares of the Company's common stock at an average price of $11.32 per share for an aggregate consideration of approximately $26.3 million. During the first three months of 2011, ARRIS did not repurchase any shares. Excess Income Tax Benefits from Stock-Based Compensation Plans - This represents the cash that otherwise would have been paid for income taxes if increases in the value of equity instruments also had not been deductible in determining taxable income. Repurchase of Shares to Satisfy Tax Withholdings - This represents the minimum shares withheld to satisfy the tax withholding when restricted stock vests. Proceeds from Issuance of Common Stock, Net - Represents cash proceeds related to the exercise of employee stock options, offset by expenses paid related to issuance of common stock. Interest Rates As of March 31, 2012, we did not have any floating rate indebtedness or outstanding interest rate swap agreements. Foreign Currency A significant portion of our products are manufactured or assembled in Mexico and Taiwan, and we have research and development centers in China, Israel, and Ireland. 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. We use a hedging strategy and enter into forward or currency option contracts based on a percentage of expected foreign currency revenues. The percentage can vary, based on the predictability of the revenues denominated in the foreign currency. 29 -------------------------------------------------------------------------------- Table of Contents Financial Instruments In the ordinary course of business, we, from time to time, will enter into financing arrangements with customers. These financial arrangements 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. ARRIS executes letters of credit in favor of certain landlords and vendors to guarantee performance on lease and insurance contracts. Additionally, we have cash collateral account agreements with our financial institutions as security against potential losses with respect to our foreign currency hedging activities. The letters of credit and cash collateral accounts are reported as restricted cash. As of March 31, 2012 and December 31, 2011, we had approximately $3.9 million and $4.1 million outstanding, respectively, of cash collateral. Cash, Cash Equivalents, and Short-Term Investments Our cash and cash equivalents (which are highly-liquid investments with an original maturity of three months or less) are primarily held in money market funds that pay either taxable or non-taxable interest. We hold short-term investments consisting of debt securities classified as available-for-sale, which are stated at estimated fair value. These debt securities consist primarily of commercial paper, certificates of deposits, and U.S. government agency financial instruments. From time to time, we hold certain investments in the common stock of publicly-traded companies, which are classified as available-for-sale. As of March 31, 2012 and December 31, 2011 our holdings in these investments were $5.3 million and $4.8 million, respectively. Changes in the market value of these securities are recorded in other comprehensive income and gains or losses on related sales of these securities are recognized in income (loss). ARRIS holds a cost method investment in a private company. This investment is recorded at $1.0 million as of March 31, 2012 and December 31, 2011. Due to the fact the investment is in a private company, we are exempt from estimating the fair value on an interim basis. 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. Each quarter, we evaluate our investment for any other-than-temporary impairment, by reviewing any capital transactions, the current revenues, bookings and long-term plan of the private company. During the evaluation performed as of December 31, 2011, ARRIS concluded that the private company would be depleting cash balances in early 2012. Further, ARRIS was notified that the private company intends to raise capital by offering a new round of financing to its existing and new investors. ARRIS concluded that the investee's need to raise further capital was an indicator of impairment and therefore, performed steps to determine the fair value of its investment in the private company. ARRIS was unable to apply traditional valuation techniques as the required inputs to these techniques are unavailable. ARRIS determined that the best estimate of the fair value of its investment was to calculate it based upon the preliminary indication of value related to the new round of financing. As a result of these considerations, ARRIS recorded an other-than-temporary impairment on its investment of $3.0 million in the fourth quarter of 2011. See Note 4 of Notes to the Consolidated Financial Statements for disclosures related to the fair value of our investments. We have a deferred compensation plan that was available to certain current and former officers and key executives of C-COR. During 2008, this plan was merged into a new non-qualified deferred compensation plan which is also available to our key executives. Employee compensation deferrals and matching contributions are held in a rabbi trust, which is a funding vehicle used to protect the deferred compensation from various events (but not from bankruptcy or insolvency). Additionally, we previously offered a deferred compensation arrangement to certain senior employees. As of December 31, 2004, the plan was frozen and no further contributions are allowed. The deferred earnings are invested in a rabbi trust. We also have deferred retirement salary plans, which were limited to certain current or former officers of C-COR. We hold investments to cover the liability. ARRIS also funds its nonqualified defined benefit plan for certain executives in a rabbi trust. 30 -------------------------------------------------------------------------------- Table of Contents Capital Expenditures Capital expenditures are made at a level designed to support the strategic and operating needs of the business. ARRIS' capital expenditures were $3.8 million in the first three months of 2012 as compared to $6.3 million in the first three months of 2011. Management expects to invest approximately $25 million in capital expenditures for the fiscal year 2012. Critical Accounting Policies and Estimates The accounting and financial reporting policies of ARRIS are in conformity with U.S. generally accepted accounting principles, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Management has discussed the development and selection of the Company's critical accounting estimates with the audit committee of the Company's Board of Directors and the audit committee has reviewed the Company's related disclosures. Our critical accounting policies and estimates are disclosed in our Form 10-K for the year ended December 31, 2011, as filed with the SEC. Our critical accounting estimates have not changed in any material respect during the three months ended March 31, 2012. 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 regarding the acquisition of BigBand and other 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 set forth in Item 1A, Part II, "Risk Factors." 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. |