- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OF
ARRIS GROUP, INC.
A DELAWARE CORPORATION
IRS EMPLOYER IDENTIFICATION NO. 58-2588724
SEC FILE NUMBER 001-16631
11450 TECHNOLOGY CIRCLE
DULUTH, GA 30097
(678) 473-2000
ARRIS Group's Common Stock is registered pursuant to Section 12(g) of the
Securities Exchange Act of 1934. ARRIS Group (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.
Disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is
contained in a definitive proxy statement, portions of which are incorporated by
reference in Part III of this Form 10-K.
The aggregate market value of ARRIS Group's Common Stock held by
non-affiliates as of June 28, 2002 was approximately $270,446,897 (computed on
the basis of the last reported sales price per share $4.48 of such stock on the
Nasdaq National Market System). As of March 24, 2003, 74,641,555 shares of the
registrant's Common Stock were outstanding. For these purposes, directors,
officers and 10% shareholders have been assumed to be affiliates. ARRIS Group,
Inc. is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Portions of ARRIS Group's Proxy Statement for its 2003 Annual Meeting of
Stockholders are incorporated by reference into Part III.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
----
PART I
ITEM 1. Business.................................................... 1
- General................................................. 1
- Industry Overview....................................... 1
- Our Principal Products.................................. 3
- Sales and Marketing..................................... 6
- Customers............................................... 6
- Research and Development................................ 8
- Intellectual Property................................... 9
- Product Sourcing and Distribution....................... 9
- Backlog................................................. 9
- International Opportunities............................. 10
- Competition............................................. 10
- Employees............................................... 11
- Background and History.................................. 11
ITEM 2. Properties.................................................. 12
ITEM 3. Legal Proceedings........................................... 13
ITEM 4. Submission of Matters to a Vote of Security Holders......... 13
PART II
ITEM 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 15
ITEM 6. Selected Consolidated Historical Financial Data............. 16
ITEM 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 20
ITEM 7A. Quantitative and Qualitative Disclosures About Market
Risk........................................................ 47
ITEM 8. Consolidated Financial Statements and Supplementary Data.... 47
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 47
PART III
ITEM 10. Directors and Executive Officers of the Registrant.......... 84
ITEM 11. Executive Compensation...................................... 84
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 84
ITEM 13. Certain Relationships and Related Transactions.............. 84
ITEM 14. Controls and Procedures..................................... 84
PART IV
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 84
ITEM 15(a). Index to Consolidated Financial Statements and Financial
Statement Schedules......................................... 85
Signatures............................................................... 90
</Table>
i
PART I
ITEM 1. BUSINESS
As used in this Annual Report, "we," "our," "us," "the Company," and
"ARRIS" refer to Arris Group, Inc. and our consolidated subsidiaries without
limitation, including Arris International, Inc. (formerly ANTEC Corporation) and
Arris Interactive L.L.C., unless the context otherwise requires.
GENERAL
We develop and supply equipment and technology for cable system operators
and other broadband service providers which allow them to deliver a full range
of integrated voice, video and data services to their subscribers. Further, we
are a leading supplier of infrastructure products used by cable system operators
in the build-out and maintenance of hybrid fiber coaxial, or HFC, networks. We
are the successor to ANTEC Corporation.
Our principal executive offices are located at 11450 Technology Circle,
Duluth, Georgia 30097, and our telephone number is (678) 473-2000. We also have
a worldwide website at http://www.arrisi.com. We are currently developing the
system on our website that will provide copies or hyperlinks to copies of the
annual, quarterly and current reports we file with the Securities and Exchange
Commission and any amendments to those reports. We will provide copies of such
reports in electronic or paper form free of charge upon request to Investor
Relations.
INDUSTRY OVERVIEW
We provide our products and equipment principally to the cable television
market and, more specifically, to operators of multiple cable systems, or MSOs.
In recent years, the technology used in cable systems has evolved significantly.
Historically, cable systems offered only one-way video service. Due to
technological advancements and large investments in infrastructure upgrades,
these systems have evolved to become two-way broadband systems featuring
high-speed, high-volume, interactive services. In the United States alone, MSOs
have aggressively upgraded their networks to cost-effectively support and
deliver enhanced video, voice and data services and have invested over $70
billion in network upgrades. As a result, cable operators have been able to use
broadband systems to increase their revenues by offering enhanced interactive
subscriber services, such as high-speed data, telephony, digital video and video
on demand, and to effectively compete against other broadband communications
technologies, such as digital subscriber line, local multiport distribution
service, direct broadcast satellite, and fixed wireless. Delivery of enhanced
services also has helped MSOs offset slowing basic video subscriber growth and
reduce subscriber churn.
A key factor supporting the growth of broadband systems is the powerful
growth of the internet. Rapid growth in the number of internet users and the
demand for high-speed, high-volume interactive services has strained existing
networks. Increasingly, the high-speed internet access experienced at work is
being demanded at home. The increase in volume and complexity of the signals
transmitted through the network has continually pushed broadband system
operators to deploy new technologies as they evolve. Further, system operators
are looking for products and technology that are flexible, cost effective,
easily deployable and scalable to meet future demand and mix of services.
Because the technologies are evolving and the signals are growing in complexity
and volume, broadband system operators need equipment that provides the
necessary technical capacity at a reasonable cost at the time of initial
deployment and the flexibility to accommodate expansion and technological
advances. We believe that our products position us well to meet these industry
challenges.
A broadband system consists of three principal components:
- Headend. The headend is a central point in the cable system where
signals are received via satellite and other sources and interfaces are
located that connect the Internet and public switched telephony networks.
The headend facility organizes, processes and retransmits those signals
through the distribution network to subscribers.
1
- Distribution Network. The distribution network consists of fiber optic
and coaxial cables and associated optical and electronic equipment that
allocates the combined signals from the headend and transmits them
throughout the cable system to nodes.
- Subscriber Premises. Cable drops extend from nodes to subscribers' homes
and connect to a subscriber's television set, converter box, telephony
network interface device or computer modem.
As cable networks evolved from one-way video only networks to broadband
networks, the underlying network elements have evolved and have been upgraded.
Traditionally, cable systems used coaxial cable and a series of radio frequency,
or RF, amplifiers throughout a distribution network. Today, most of the major
cable systems have been, or will be, upgraded with fiber optic technology. The
use of fiber optic technology enables operators to transmit wider bandwidth
signals greater distances and with less signal degradation than in a traditional
coaxial system. In addition, fiber optic cable's capacity to transmit a wider
bandwidth over greater distances than coaxial cable allows for the transmission
of more video, data and telephony services to a subscriber's premises. The use
of fiber optic technology also reduces the overall maintenance costs associated
with active electronic components. In a fiber optic network, optical signals are
transmitted throughout the distribution system along a fiber optic cable from
the headend to the node, where the signal is received and converted to RF
electronic signals and transferred via coaxial cable to the subscriber premises.
We offer to cable operators many of the hardware elements necessary for these
upgrades and products to maintain their fiber optic networks.
Significant advancements in technology have occurred which allow cable
operators to offer services beyond their traditional video offering. Two key
services are cable telephony and the provision of data. According to
In-Stat/MDR, worldwide revenues from cable telephony services are projected to
increase from $3.1 billion in 2002 to approximately $7.5 billion in 2006,
representing a compound annual growth rate of 25%. Additionally, according to
Gartner Dataquest, cable modem subscribers worldwide are projected to increase
from 28.8 million in 2002 to over 56.1 million in 2006, representing a compound
annual growth rate of 18%.
Data is the method by which cable operators can offer to their customers
high-speed access to the internet. We offer both headend and customer premises
products to cable operators that enable them to offer this service to their
subscribers. Our Cadant C4(TM) CMTS headend product is a high density,
chassis-based product that provides the industry's most flexible built-in
redundancy to ensure carrier-grade performance and allows operators to install
the system for data applications today with a seamless transition to voice
services in the future. We offer a competitive line of cable modems for the
customer premises.
The second key new service, cable telephony, is presently offered to cable
operators using two distinct technologies: constant bit rate, or CBR, technology
and Internet protocol, or IP, technology. CBR technology utilizes the
switched-circuit technology currently used in traditional phone networks. Cable
telephony using CBR technology is an established cable telephony solution
deployed in approximately twenty-six countries. This is a proven carrier-class
telephony solution that enables operators to directly compete with incumbent
telephone carriers with voice services and class-features, which include caller
ID, call-waiting and three-party conferencing. At the end of 2002, our
Cornerstone CBR cable telephone products served over 3.5 million subscriber
lines deployed by 42 operators in 101 cities in 13 countries. IP technology,
also known as voice over IP, or VoIP, permits cable operators to provide
toll-quality cable telephony at costs below those associated with CBR
technology. VoIP technology has been deployed by several system operators
throughout the world and is being tested in trials being conducted by other
system operators. We offer telephony products using both of these technologies.
Data and VoIP services are governed by a set of technical standards
promulgated by CableLabs(R) in North America and TComLabs(R) in Europe, two
industry standard-setting bodies. While the standards set by these two bodies
necessarily differ in a few details to accommodate the differences in HFC
network architectures between North America and Europe, they have a great deal
in common. The primary data standard specification for cable operators in North
America is entitled "Data Over Cable Service Interface Specification", or
DOCSIS. Release 1.1 of this specification has been the governing standard for
data services in North America. The Euro-DOCSIS standard Release 1.1 is the same
for Europe. A new version of the standard, DOCSIS 2.0, was released in 2001, and
suppliers, including us, are expected to begin deliveries of
2
product compliant to this new standard in 2003. DOCSIS 2.0 builds upon the
capabilities of DOCSIS 1.0 and DOCSIS 1.1 and adds additional throughput in the
upstream portion of the cable plant -- from the consumer out to the Internet. In
addition to the DOCSIS standards which govern data transmission, CableLabs has
defined the PacketCable(R) standard for VoIP. This standard defines the
interfaces among network elements such as cable modem termination systems, or
CMTS, multi-media terminal adapters, or MTA, gateways and call management
servers to provide high quality IP telephony service over the HFC network.
OUR PRINCIPAL PRODUCTS
We provide cable system operators with a comprehensive product offering
that meets their end-to-end needs, from headend to subscriber premises. We
divide our product offerings into two categories:
<Table>
Broadband............................... - Cable telephony products, CBR telephony
products and VoIP telephony products,
including headend and subscriber
premises equipment;
- High speed data products, including
DOCSIS headend and subscriber premises
equipment;
- Operational support systems; and
- System integration services.
Supplies and Services................... Infrastructure products for fiber optic or
coaxial networks built under or above
ground, including cable and strand,
vaults, conduit, drop materials, tools,
and test equipment.
</Table>
BROADBAND
Voice over IP and Data Products
Headend -- The heart of a voice over IP headend is a cable modem
termination system, or CMTS. A CMTS, along with a call agent, a gateway, and
provisioning systems provide the ability to integrate the public-switched
telephone network and high-speed data services over an HFC network. The CMTS
provides the software and hardware to allow the IP traffic from the internet or
that used in VoIP telephony to be converted for use on HFC networks. It is also
responsible for initializing and monitoring all cable modems connected to the
HFC network. We provide two products that are used in the cable operator's
headend to provide VoIP and high-speed data services to residential or business
subscribers. These are the Cornerstone Data CMTS 1500 and the Cadant C4 CMTS:
- The Cadant C4 CMTS is a high density, chassis-based product that provides
the industry's most flexible built-in redundancy to ensure carrier-grade
performance. It is DOCSIS(TM) 1.1 and EuroDOCSIS 1.1 qualified and will
support recently released DOCSIS 2.0 and PacketCable standards. Each
chassis supports up to 32 downstream channels and 128 upstream channels
making it one of the highest density scaleable headend products currently
available. It will provide high-speed data and VoIP services in headends
that service thousands to hundreds of thousands of high-speed data and
VoIP subscribers.
- The Cornerstone CMTS 1500 is a DOCSIS 1.1 and EuroDOCSIS 1.1 qualified
CMTS. It is a scaleable headend solution, providing high-speed data and
VoIP services in headends that service several thousand to 50,000
subscribers. We also provide a modular redundant chassis to enable CMTS
1500's to be grouped together with a four-to-one redundant architecture
providing the requisite reliability for carrier-grade telephony
operation.
Subscriber Premises -- Subscriber premises equipment includes DOCSIS 1.0
and 1.1 certified cable modems for high-speed data applications and DOCSIS 1.1
and PacketCable certified cable modems with embedded multimedia terminal
adapters, or E-MTA, for PacketCable-compliant VoIP applications. The PacketCable
solution builds on DOCSIS 1.1 and its quality of service enhancements to support
lifeline
3
telephony deployed over HFC networks. The Touchstone product line provides
carrier-grade performance to enable operators to provide all IP and video
services on the same network using common equipment. We also are actively
involved with the new evolving DOCSIS 2.0 standard and are participating in
early interoperability testing with the Touchstone product family at CableLabs.
The Touchstone product line consists of the Touchstone 300-series and 450-series
Cable Modems, the Touchstone TM 202-series telephony modem for indoor
applications and the Touchstone TP 202-series telephony port for outdoor
deployments.
- The Touchstone CM300A Cable Modem is DOCSIS 1.1-certified enabling it to
be deployed in networks where advanced high-speed data features such as
tiered data services are planned. The Touchstone 300B Cable Modem
provides the same features as the CM300A but is EuroDOCSIS-certified for
use in European and similar systems. We plan to introduce the Touchstone
CM 450A/450C DOCSIS 2.0-based Cable Modems in the second quarter of 2003.
These advanced modems deliver higher upstream speeds enabling operators
to offer advanced services over HFC networks.
- The Touchstone TM 202A/B/C E-MTAs are PacketCable-certified indoor E-MTAs
that support enhanced services of high-speed data and up to two lines of
IP telephony on the same network for residential and business
subscribers. The Touchstone TM 202A is DOCSIS 1.1 certified for use in
North American and similar cable systems. The Touchstone TM 202B is
EuroDOCSIS 1.1 certified for use in European and similar cable systems.
The Touchstone TM 202C is DOCSIS 1.1-based and designed specifically for
the unique frequency plan of Japanese cable systems.
- The Touchstone TM 202P/R E-MTAs are PacketCable certified and provide all
of the features of the TM 202A/B/C series with the added benefit of an
integral battery back-up system enabling the service provider to offer
carrier-grade Telephony over IP, or ToIP(TM).
- The Touchstone TP 202A/C Telephony Port is a rugged, environmentally
hardened, ultra-reliable outdoor E-MTA that provides high-speed data
access and up to four lines of carrier-grade ToIP(TM) for service
providers wishing to compete by offering a service which is at parity
with the local telephone company.
Constant Bit Rate Products
Headend -- We market our headend equipment under the brand name Cornerstone
Voice. Cornerstone Voice products for the headend include host digital
terminals, or HDTs. An HDT is the device that provides the interfaces, controls
and communications channels between public-switched networks and the HFC
network. Because the Cornerstone Voice system is easy to implement, economical
and scaleable, network operators can offer telephony at low initial penetration
levels and expand as customer demand increases. We design this equipment to meet
the strict performance, reliability specifications, and demanding environmental
requirements expected of a lifeline, carrier-class residential telephone
service. This reliability and robust design enables our customers to compete
with the incumbent local telephone company with an equivalent, and often
superior, service offering.
Subscriber Premises -- The key equipment at subscriber premises is a
network interface unit, or NIU. We market our NIUs under the brand name
Cornerstone Voice Port(TM). The Cornerstone Voice Port is the most widely
deployed CBR NIU. Voice Port units operate in conjunction with the Cornerstone
HDT to provide cable telephony while also maintaining a subscriber's existing
video services. Operators who are also deploying high-speed data services, such
as our Cornerstone, Cadant and Touchstone brands, may deploy cable modems inside
the home or work premises and multiplex the data service signals on to the same
HFC network as the Cornerstone Voice application. This combination of solutions
provides subscribers with voice and high-speed data functionality from the same
operator. The Voice Port portfolio includes a two-line single-family residence
Voice Port NIU, a two-line indoor Voice Port NIU with an integrated backup
battery, a four-line Voice Port NIU, and a twenty-four-line Voice Port NIU for
multiple dwelling unit applications.
4
Operational Support Systems (OSS)
OSS stands for operational support systems. OSS are a group of networked
software suites that enable operators to automate many of the functions required
to install, provision, manage and grow a subscriber base while managing,
maintaining and upgrading the network for the multiple services offered. Without
OSS automation, operators cannot manage subscriber growth and network operations
effectively.
We are partnering with leading suppliers in the industry to provide
operators with the ability to automatically provision headend and subscriber
premises equipment to reflect subscribers' parameters, provide key data for
third-party billing software, and complete maintenance operations. We are an
authorized value added reseller of Alopa's MetaServ(TM), which provides
automated provisioning software for control of the CMTS and cable modems.
MetaServ works with various billing and middleware software programs. We have
strategic relationships with other equipment vendors to integrate existing
Cornerstone software for CMTS and cable modem OSS functions. Operators are able
to perform OSS functions across Cornerstone Voice and Cornerstone Data employing
the Cadant CMTS and Touchstone product lines using a common OSS solution. The
Cadant G2 IMS software supports configuration performance and fault management
of the Cadant C4 CMTS through easy to use graphical user interfaces. A single
Cadant G2 IM Server can support up to 100 Cadant C4 CMTS chassis and 20
simultaneous client applications.
System Integration Services
We are a full service system integrator for converged services over HFC
networks. We historically have been a pioneer in the voice and data over HFC
business and have the experience and infrastructure in place to help operators
launch these services. System integration offers the service provider a fully
integrated solution that has been tested for end-to-end interoperability,
performance, capacity, scalability, and reliability prior to ever being
installed at the customer facility. System solution verification can be followed
by complete headend and operations center design, installation, activation, and
traffic planning. We offer the operator coordination of the project management
for the suppliers and the overall program, and solution assurance services for
the long-term, including upgrade support, system audits, and configuration
management. Our systems integration service enables operators to rapidly deploy
new services on their networks with the assurance that all of the components of
the network will interoperate seamlessly.
SUPPLIES AND SERVICES
We offer a variety of supplies and services, including products and
value-added logistics programs, to support broadband network builds, rebuilds,
upgrades and maintenance. Our supplies and services are complemented by our
extensive channel-to-market infrastructure, which is focused on providing
efficient delivery of products from stocking or drop-ship locations.
We believe that the core strength of our products is our broad selection of
trusted name-brand products and strategic proprietary lines and our experience
in distribution. Our name-brand products are manufactured to our specifications
by manufacturing partners. These products include: taps, line passives, house
passives and premises installation equipment marketed under our Regal brand
name; MONARCH(TM) aerial and underground plant construction products and
enclosures; Digicon premium F-connectors; and FiberTel fiber optic connectivity
devices and accessories. Through our product selection, we are able to address
virtually every broadband infrastructure application, including fiber optics,
outside plant construction, drop and premises installation, and signal
acquisition and distribution.
We also resell products from hundreds of strategic supplier-partners, which
include widely recognized brands to small specialty manufacturers. Through our
strategic supplier-partners, we also supply ancillary products like tools and
safety equipment, testing devices and specialty electronics.
Our inventory management and logistics capabilities, which are critical to
our efficient and successful operation, are often leveraged to offer value-added
services to our customers. These services range from just-in-time delivery,
product "kitting," specialized electronic interfaces, and customized reporting,
to more complex and comprehensive supply chain management solutions. These
services complement our products
5
offerings with advanced channel-to-market and logistics capabilities, extensive
product bundling opportunities, and an ability to deliver carrier-grade
infrastructure solutions in the passive transmission portions of the network.
The depth and breadth of our inventory and service capabilities enable us to
provide our customers with single supplier flexibility.
SALES AND MARKETING
Our sales force is divided into two groups, North American and
International. Our North American sales force is also divided into two groups.
The first group focuses on the six largest multiple system operators, or MSOs.
The second group focuses on smaller system operators, overbuilders, regional
Bell telephone companies and major communications companies and competitive
local exchange carriers. Our North American sales force is headquartered in
Duluth, Georgia and Denver, Colorado. Our International sales force includes
sales offices in Argentina, Chile, Japan, Spain and the Netherlands.
We maintain an inside sales group that is responsible for regular phone
contact, prompt order entry, timely and accurate delivery and effective sales
administration for the many changes frequently required in any substantial
rebuild or upgrade activity. In addition, the sales structure includes sales
engineers and technicians that can assist customers in system design and
specification and can promptly be on site to "trouble shoot" any problems as
they arise during a project.
We also have marketing and product management teams that focus on each of
the various product categories and work with our engineers and various
technology partners on new products and product improvements. These teams are
responsible for inventory levels and pricing, delivery requirements, market
demand and product positioning and advertising.
We are committed to providing superior levels of customer service by
incorporating innovative customer-centric strategies and processes supported by
business systems designed to deliver differentiating product support and
value-added services. We have implemented advanced customer relationship
management programs to bring additional value to our customers and provide
significant value to our operations management. Through these information
systems, we can provide our customers with product information ranging from
operational manuals to the latest in order processing information. Through
on-going development and refinement, these programs will help to improve our
productivity and enable us to further improve our customer-focused services.
CUSTOMERS
The majority of our sales are to cable system operators, although we do
sell products to traditional telephone companies and our broadband products can
be deployed not only by cable system operators, but also by traditional
telephone companies, electric utilities and others. In 2002, as the US cable
industry continued a trend toward consolidation, the six largest MSOs controlled
over 90% of the US cable market, thereby making our sales to those MSOs critical
to our success. Internationally, the market is dominated by approximately ten
cable system operators, comprised of US-based MSOs, government entities, and
foreign-based multi-media owners. This group controls approximately 60% of the
total international "addressable" market.
Our sales are substantially dependent upon a system operator's selection of
our equipment, demand for increased broadband services by subscribers, and
general capital expenditure levels by system operators.
6
Our two largest customers are Comcast (including AT&T Broadband, which was
acquired by Comcast during 2002) and Cox Communications. Sales to these two
customers for 2002, 2001, and 2000 are set forth below:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
(IN MILLIONS)
Comcast (including AT&T Broadband)......................... $250.2 $245.6 $387.2
% of sales................................................. 38.4% 39.1% 51.6%
Cox Communications......................................... $106.7 $110.9 $116.5
% of sales................................................. 16.4% 17.7% 15.5%
</Table>
Other than Jupiter Telecom and Cabovisao, which accounted for approximately 7.6%
and 6.0% of our total sales for 2002, no other customer provided more than 5% of
our total sales for the year ended December 31, 2002.
In the fourth quarter of 2002, Comcast completed its purchase of AT&T
Broadband. AT&T Broadband was our largest customer in terms of revenue in the
first three quarters of 2002. AT&T Broadband, with the deployment of telephony
as part of its core strategy, had been using our CBR products in many of its
major markets. Comcast has announced that as an initial priority after its
purchase of AT&T Broadband, it will emphasize video and high-speed data services
and will focus on improving the profitability of its telephony operations at the
expense of subscriber growth. As a result, we have experienced a significant
decline in sales of our CBR telephony product to Comcast in the fourth quarter
of 2002, a trend we expect to continue into 2003.
There are uncertainties surrounding the level of any future transactions
with Cabovisao or Adelphia. Sales to these two customers for 2002, 2001 and 2000
are set forth below:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
(IN MILLIONS)
Adelphia Communications..................................... $25.9 $54.1 $48.7
% of sales.................................................. 4.0% 8.6% 6.5%
Cabovisao................................................... $39.1 $16.2 $ 2.5
% of sales.................................................. 6.0% 2.6% 0.3%
</Table>
Sales to Adelphia decreased during the second quarter of 2002 as a result
of Adelphia's financial troubles, which ultimately resulted in a bankruptcy
filing in June 2002. As a result, in June 2002, we established a bad debt
reserve of $20.2 million in connection with our accounts receivable from
Adelphia. In the third quarter of 2002, we sold a portion of our Adelphia
accounts receivable to an unrelated third party, resulting in a net gain of
approximately $4.3 million.
Cabovisao, a Portugal-based MSO, accounted for approximately 6% of our
total sales in 2002. As of March 10, 2003, Cabovisao owed us approximately 18.6
million euros in accounts receivable, a substantial portion of which was past
due. On October 17, 2002, the parent company of Cabovisao, CSii, issued an
announcement that suggested it may have difficulty in accessing or refinancing
its senior credit facility in the future. At that point, we suspended shipments
to them. In January 2003, Cabovisao senior management met with us and presented
a payment plan. In late January 2003, we received the first scheduled payment of
2.0 million euros. On the strength of the payment received and the payment plan
presented, we shipped 0.4 million euros of product to Cabovisao in February
2003. On January 29, 2003, the parent company of Cabovisao announced that it had
obtained access to bridge financing of 14.0 million euros and that it was
continuing negotiations with respect to a long-term financing solution. However,
Cabovisao failed to make the 2.5 million euros February payment to us by its due
date. On March 1, 2003, CSii announced that its bankers again extended the
waivers pertaining to the maturity date of its credit facility until March 26,
2003, but Csii would not make the scheduled March 3, 2003 interest payment on
its senior unsecured notes. The announcement also indicated the company had
formed a special board committee to consider alternatives to
7
meet its financial needs, including debt restructuring or a possible
court-supervised restructuring, among other alternatives. We will not deliver
further products to Cabovisao until we have a satisfactory payment plan with
Cabovisao and are considering what actions should be taken regarding the
situation. We cannot provide any assurance that Cabovisao will satisfy our
accounts receivable or that it will continue to place orders with us in the
future.
RESEARCH AND DEVELOPMENT
We are committed to the development of new technology and rapid innovation
in the evolving broadband market. New products are developed in our research and
development laboratories in Duluth, Georgia and Lisle, Illinois. We form
strategic alliances with world-class producers and suppliers of complementary
technology to provide "best-in-class" solutions focused on "time-to-revenue."
Research and development expenses in 2002, 2001, and 2000 were
approximately $64.8 million, $26.9 million, and $9.1 million, respectively. The
increase in 2002 and 2001 was directly attributable to the inclusion of the
research and development activities of Arris Interactive L.L.C. beginning with
the acquisition on August 3, 2001, and the development of new technology
following the acquisition of Cadant on January 8, 2002.
We believe that our future success depends on rapid adoption and
implementation of broadband local access industry specifications, as well as
rapid innovation and introduction of technologies that provide service and
performance differentiation. To that end, the Cadant C4 CMTS product line
continues to lead the industry in areas such as fault tolerance, wire-speed
throughput and routing, and density. The Touchstone(TM) product line boasts a
wide-range of DOCSIS 1.1 and PacketCable 1.0 certified products, including the
Touchstone Cable Modem 300, in addition to the Touchstone Telephony Modem Model
2E-MTA. We also have developed an outdoor E-MTA to support lifeline telephony
and data services.
The following trends are having a direct effect on our current product
development activities:
- Continued increase in peer-to-peer services are accelerating demand for
new services requiring intensive, high-touch processing and sophisticated
management techniques;
- Innovations in video encode/decode technology are making possible very
low bit rate, high quality video streaming;
- Continued silicon integration and chip fabrication technology innovations
are making possible very low cost, multi-functional broadband consumer
devices, integrating not only telephony but wireless and video
decompression and digital rights management functionality; and
- Continued field and market trials of PacketCable VoIP technology,
potentially leading to adoption and mass deployment beginning in 2004.
As a result, our product development activities are primarily directed at
the following areas:
- Rapid development and delivery of Cadant C4 CMTS features, including
DOCSIS 2.0 support, Layer 3 routing enhancements, packet inspection and
filtering features, and increased downstream/upstream density;
- Introduction of the fourth generation Touchstone Telephony Modem E-MTA,
including support for low maintenance, consumer-friendly lithium ion
battery technology;
- Expansion of the Touchstone product line to include support for DOCSIS
2.0 and wireless home networking capabilities;
- Definition of services and products that will exploit the video
compression innovations of H.264 and Windows Media(TM) Player 9; and
- Continued emphasis on product cost reduction.
8
INTELLECTUAL PROPERTY
We have an aggressive program for protecting our intellectual property. The
program consists of maintaining our portfolio of 45 issued patents (both U.S.
and foreign) and pursuing patent protection on new inventions (currently 133
patent applications are pending). In our effort to pursue new patents, we have
created a process whereby employees may submit ideas of inventions for review by
management. The review process evaluates each submission for novelty,
detectability, and commercial value, and patent applications are filed on the
inventions that meet the criteria. Our patents and patent applications generally
are in the areas of telecommunications hardware and software, and related
technologies. Recent research and development has led to a number of patent
applications in technology related to DOCSIS. The January 2002 purchase of the
assets of Cadant resulted in the acquisition of 19 US patent applications, 7
Patent Convention Treaty (PCT) applications, 5 trademark applications, 1 U.S.
registered trademark and 5 registered copyrights. The Cadant patents are in the
area of cable modems and CMTSs. The March 2003 purchase of the assets of Atoga
Systems resulted in the acquisition of 2 US patent applications, which also have
been filed as PCT applications. The Atoga patents are in the area of network
traffic flow.
For critical technology that is not owned by us, we have a program for
obtaining appropriate licenses with the industry leaders to ensure that the
strongest possible patents support the licensed technology. In addition, we have
formed strategic relationships with leading technology companies that will
provide us with early access to technology and will help keep us at the
forefront of our industry.
We have a program for protecting and developing trademarks. The program
consists of procedures for the use of current trademarks and for the development
of new trademarks. This program is designed to ensure that our employees
properly use those trademarks and any new trademarks that will develop strong
brand loyalty and name recognition. This is intended to protect our trademarks
from dilution or cancellation.
PRODUCT SOURCING AND DISTRIBUTION
Our product sourcing strategy centers on the use of contract manufacturers
to subcontract production. Our largest contract manufacturers are Solectron and
Mitsumi, located in the United States and Japan, respectively. The facilities
owned and operated by these contract manufacturers for the production of our
products are located in the United States, Mexico and the Philippines. We
distribute a substantial number of products that are not designed or trademarked
by us in order to provide our customers with a comprehensive product offering.
For instance, we distribute hardware and installation products. These products
are distributed through regional warehouses in North Carolina, California and
Rotterdam, Netherlands and through drop shipments from our contract
manufacturers located throughout the world.
Prior to 2002, we manufactured or assembled a substantial portion of our
products related to our Actives, Keptel and Power product lines. Manufacturing
operations ranged from electro-mechanical, labor-intensive assembly to
sophisticated electronic surface mount automated assembly lines. We operated
five major manufacturing facilities related to these product lines. During the
third quarter of 2001, we made the decision to outsource most of our
manufacturing and have since closed four facilities located in El Paso, Texas
and Juarez, Mexico. The remaining factory in Rock Falls, Illinois, was closed in
conjunction with the sale of the Keptel product line in April 2002.
BACKLOG
Our backlog consists of unfilled customer orders believed to be firm and
long-term contracts that have not been completed. With respect to long-term
contracts, we include in our backlog only amounts representing orders currently
released for production or, in specific instances, the amount we expect to be
released in the succeeding 12 months. The amount contained in backlog for any
contract or order may not be the total amount of the contract or order. The
amount of our backlog at any given time does not reflect expected revenues for
any fiscal period. Our backlog at December 31, 2002 was approximately $43.8
million, at December 31, 2001 was approximately $119.2 million and at December
31, 2000 was approximately $182.8 million.
9
We believe that substantially all of the backlog existing at December 31,
2002 will be shipped in 2003.
INTERNATIONAL OPPORTUNITIES
We sell our products primarily in North America. Our international revenue
is generated from Asia Pacific, Europe, Latin America and Canada. The Asia
Pacific market primarily includes China, Hong Kong, Japan, Korea, and Singapore.
The European market primarily includes Austria, Germany, France, Netherlands,
Poland, Portugal, Romania, Spain, and Switzerland. The Latin American market
primarily includes Argentina, the Bahamas, Chile, Colombia, Mexico, and Puerto
Rico. Sales to international customers were approximately 22.6%, 11.4% and 4.3%
of total sales for the years ended December 31, 2002, 2001 and 2000,
respectively. International sales for the years ended December 31, 2002, 2001
and 2000 were as follows:
<Table>
<Caption>
YEARS ENDED DECEMBER 31
----------------------------
2002 2001 2000
-------- ------- -------
(IN THOUSANDS)
Asia Pacific......................................... $ 51,328 $20,484 $ 2,721
Europe............................................... 67,363 31,613 6,592
Latin America........................................ 20,266 14,125 19,789
Canada............................................... 8,387 5,679 3,308
-------- ------- -------
Total.................................................. $147,344 $71,901 $32,410
======== ======= =======
</Table>
We believe that international opportunities exist and continue to
strategically invest in worldwide marketing efforts, which have yielded some
promising results in several regions. During 2001, our international group was
actively engaged in replacing the Nortel Networks sales and support
infrastructure that was in place with Arris Interactive We have made significant
operational and geographical changes in the international marketplace. We
consolidated our international offices and warehouses to the Netherlands (to
service northern Europe) and Spain (to service southern Europe). We also opened
a sales office in Chile to address the growing market in that region. In 2002,
we consolidated our international presence in the Far East by opening a sales
and warehouse facility in Japan. We currently maintain international sales
offices in Argentina, Chile, Japan, Spain and the Netherlands.
COMPETITION
All aspects of our business are highly competitive. The broadband
communications industry itself is dynamic, requiring companies to react quickly
and capitalize on change. We must retain skilled and experienced personnel, as
well as, deploy substantial resources to meet the ever-changing demands of the
industry. We compete with national, regional and local manufacturers,
distributors and wholesalers including some companies larger than us. Our major
competitors include:
- ADC Telecommunications, Inc.;
- Broadband Services, Inc.;
- Cisco Systems, Inc.;
- Juniper Networks, Inc.;
- Motorola, Inc.;
- Riverstone Networks, Inc.;
- Scientific-Atlanta, Inc.;
- Tellabs, Inc.;
- Terayon Communications Systems, Inc.; and
- TVC Communications, Inc.
10
Various manufacturers who are suppliers to us sell directly, as well as
through distributors, into the cable marketplace. In addition, because of the
convergence of the cable, telecommunications and computer industries and rapid
technological development, new competitors are entering the cable market. Many
of our competitors or potential competitors are substantially larger and have
greater resources than us.
Our products are marketed with emphasis on quality and are competitively
priced. Product reliability and performance, superior and responsive technical
and administrative support, and breadth of product offerings are key criteria
for competition. Technological innovations and speed to market are an additional
basis for competition.
EMPLOYEES
As of February 28, 2003, we had 959 full-time employees. We believe that we
have maintained an excellent relationship with our employees. Our future success
depends, in part, on our ability to attract and retain key executive, marketing,
engineering and sales personnel. Competition for qualified personnel in the
cable industry is intense, and the loss of certain key personnel could have a
material adverse effect on us. We have entered into employment contracts with
our key executive officers and have confidentiality agreements with
substantially all of our employees. We also have a stock option program that is
intended to provide substantial incentives for our key employees to remain with
us.
BACKGROUND AND HISTORY
ARRIS is the successor to ANTEC Corporation. From its inception until its
initial public offering in 1993, ANTEC was primarily a distributor of cable
television equipment and was owned and operated by Anixter, Inc. Subsequently
ANTEC completed several important strategic transactions and formed joint
ventures designed to expand significantly its product offerings. Most recently,
ANTEC formed a new holding company, ARRIS, and acquired Nortel Networks'
interest in Arris Interactive L.L.C., which previously had been a joint venture
between ANTEC and Nortel Networks.
A synopsis of ARRIS' evolution:
- 1969 -- Anixter entered the cable industry.
- 1987 -- Anixter acquired TeleWire Supply.
- 1988 -- Anixter and AT&T developed the first analog video laser
transmitter for the cable industry (Laser Link I).
- 1991 -- ANTEC was established.
- 1993 -- ANTEC's initial public offering.
- 1994 -- ANTEC completed the acquisition of the following companies, which
significantly expanded its product development and manufacturing
capabilities:
- Electronic System Products, Inc., or ESP, an engineering consulting firm
with core capabilities in digital design, RF design and application
specific integrated circuit development for the broadband communications
industry.
- Power Guard, Inc., a manufacturer of power supplies and high security
enclosures for broadband communications networks.
- Keptel, Inc., a designer, manufacturer and marketer of outside plant
telecommunications and transmission equipment for both residential and
commercial use, primarily by telephone companies.
- 1995 -- ANTEC and Nortel Networks formed Arris Interactive L.L.C.,
focused on the development, manufacture and sale of products that
enable the provision of a broad range of telephone and data
services over HFC architectures; ANTEC initially owned 25% and
Nortel Networks owned 75% of the Arris Interactive joint venture.
11
- 1997 -- ANTEC acquired TSX Corporation, which provided electronic
manufacturing capabilities and expanded the Company's product
lines to include amplifiers and line extenders and enhanced laser
transmitters and receivers and optical node product lines.
- 1998 -- ANTEC introduced the industry's first 1550 nm narrowcast
transmitter and dense wavelength division multiplexing, or DWDM,
optical transmission system.
- 1999 -- ANTEC completed the combination of the Broadband Technology
Division of Nortel Networks, which is known as LANcity, with
Arris Interactive, resulting in an increase in Nortel Networks'
interest in the joint venture to 81.25% while ANTEC's interest
was reduced to 18.75%.
ANTEC introduced the industry's first 18 band block converter
and combined that with the DWDM allowing 144 bands on a single
fiber.
- 2001 -- ARRIS acquired all of Nortel Networks' ownership interest in
Arris Interactive in exchange for approximately 49% of the common
stock of a newly formed holding company, ARRIS, and a Class B
membership interest in Arris Interactive.
ARRIS sold substantially all of its power product lines. During
2000, sales in those product lines were approximately $18.0
million, and during 2001 (through the date of the sale), sales
were approximately $8.1 million. ARRIS continues as an
authorized distributor and representative for these power
product lines.
- 2002 -- ARRIS acquired substantially all of the assets of Cadant, Inc., a
privately held designer and manufacturer of next- generation
cable modem termination systems.
ARRIS sold its Keptel product line. During 2001, sales in this
product line were approximately $44.8 million, and during 2002
(through the date of the sale), sales were approximately $7.5
million.
ARRIS sold its Actives product line. During 2001, sales in this
product line were approximately $68.2 million, and during 2002
(through the date of the sale), sales were approximately $58.8
million.
ARRIS closed its office in Andover, Massachusetts, which was
primarily a product development and repair facility.
- 2003 -- ARRIS acquired certain assets of Atoga Systems, a Fremont,
California-based developer of optical transport systems for
metropolitan area networks.
ITEM 2. PROPERTIES
We currently conduct our operations from 12 different locations; two of
which we own, while the remaining 10 are leased. These facilities consist of
sales and administrative offices and warehouses totaling approximately 600,000
square feet. Our long-term leases expire at various dates through 2009. We
believe that
12
our current properties are adequate for our operations. A summary of our
principal leased properties that are currently in use is as follows:
<Table>
<Caption>
LOCATION DESCRIPTION AREA (SQ. FT.) LEASE EXPIRATION
- -------- ----------- -------------- -----------------
Ontario, California.......... Warehouse 191,853 December 31, 2003
Duluth, Georgia.............. Office space 143,000 June 14, 2009
Suwanee, Georgia............. Office space 97,319 February 28, 2007
Andover, Massachusetts*...... Office space 75,037 July 7, 2004
Englewood, Colorado.......... Warehouse/Office space 42,880 March 30, 2006
Lisle, Illinois.............. Office space 35,249 March 31, 2005
Greenville, Mississippi...... Warehouse 30,000 May 31, 2003
Amsterdam.................... Office space 6,181 December 31, 2004
Barcelona.................... Office space 3,600 June 30, 2004
Tokyo........................ Office space 2,665 February 14, 2004
</Table>
* This location is in process of closing, and the closing should be
completed by June 30, 2003.
- ---------------
Our owned facilities have been pledged as collateral to secure payment of
our credit facility. We own the following properties:
<Table>
<Caption>
LOCATION DESCRIPTION AREA (SQ. FT.)
- -------- ----------- --------------
Cary, North Carolina............................. Warehouse 151,500
Chicago, Illinois................................ Warehouse/Office space 18,000
</Table>
ITEM 3. LEGAL PROCEEDINGS
We are not currently engaged in any litigation that we believe would have a
material adverse effect on our financial condition or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 2002, no matters were submitted to a vote of
our company's security holders.
EXECUTIVE OFFICERS OF THE COMPANY
The following table sets forth the name, age as of March 10, 2003, and
position with us of our executive officers.
<Table>
<Caption>
NAME AGE POSITION
- ---- --- --------
John M. Egan.............................. 55 Chairman of the Board
Robert J. Stanzione....................... 55 President and Chief Executive Officer
Lawrence A. Margolis...................... 55 Executive Vice President, Chief Financial Officer,
and Secretary
Gordon E. Halverson....................... 60 Corporate Executive Vice President, Domestic Sales
Ronald M. Coppock......................... 48 President, International
Bryant K. Isaacs.......................... 43 President, New Business Ventures
James D. Lakin............................ 59 President, Broadband
Robert Puccini............................ 41 President, TeleWire Supply
David B. Potts............................ 45 Senior Vice President, Finance and Chief Information
Officer
Leonard E. Travis......................... 40 Vice President and Controller
Marc Geraci............................... 50 Treasurer
</Table>
John M. Egan joined the Company in 1973 and has been Chairman of our board
of directors since 1997. Mr. Egan was President of ARRIS from 1980 to 1997 and
Chief Executive Officer of ARRIS and its
13
predecessors from 1980 through 1999. On January 1, 2000, Mr. Egan stepped down
from his role as Chief Executive Officer of ARRIS. He remained a full-time
employee until his retirement in May 2002. Currently, Mr. Egan serves on the
Executive Committee of the Company. Mr. Egan is on the Board of Directors of the
National Cable Television Association, or NCTA, the Walter Kaitz Foundation, an
association seeking to help the cable industry diversify its management
workforce to include minorities, and has been actively involved with the Society
of Cable Television Engineers and Cable Labs, Inc. Mr. Egan received the NCTA's
1990 Vanguard Award for Associates.
Robert J. Stanzione has been President and Chief Executive Officer since
January 1, 2000. From 1998 through 1999, Mr. Stanzione was President and Chief
Operating Officer of ARRIS. Mr. Stanzione has been a director of ARRIS since
1998 and serves on the Company's Executive Committee. From 1995 to 1997, he was
President and Chief Executive Officer of Arris Interactive. From 1969 to 1995,
he held various positions with AT&T Corporation. Mr. Stanzione also serves as a
director of Evolve Products, Inc., CoaXmedia, and Georgia CF Foundation.
Lawrence A. Margolis has been Executive Vice President, Chief Financial
Officer and Secretary of ARRIS since 1992 and was Vice President, General
Counsel and Secretary of Anixter, Inc., a global communications products
distribution company, from 1986 to 1992 and General Counsel and Secretary of
Anixter from 1984 to 1986. Prior to 1984, he was a partner at the law firm of
Schiff Hardin & Waite. Mr. Margolis serves as a director of Cabletel
Communications Corporation.
Gordon E. Halverson has been Corporate Executive Vice President, Domestic
Sales since August 2001. From April 1997 to August 2001, Mr. Halverson was
Executive Vice President and Chief Executive Officer of ARRIS TeleWire Supply.
From 1990 to April 1997, he was Executive Vice President, Sales of ARRIS. During
the period 1969 to 1990, he held various executive positions with predecessors
of ARRIS. He received the NCTA's 1993 Vanguard Award for Associates. Mr.
Halverson is a member of the NCTA, Society of Cable Television Engineers,
Illinois Cable Association, Cable Television Administration and Marketing
Society.
Ronald M. Coppock has been President of ARRIS International since January
1997 and was formerly Vice President International Sales and Marketing for TSX
Corporation. Mr. Coppock has been in the cable television and satellite
communications industry for over 20 years, having held senior management
positions with Scientific-Atlanta, Pioneer Communications and Oak
Communications. Mr. Coppock is an active member of the American Marketing
Association, Kappa Alpha Order, Cystic Fibrosis Foundation Board, and the Auburn
University Alumni Action Committee.
Bryant K. Isaacs has been President of ARRIS New Business Ventures since
December 2002. Prior to the sale of the Actives product line, Mr. Isaacs was
President of ARRIS Network Technologies since September 2000. Prior to joining
ARRIS, he was Founder and General Manager of Lucent Technologies' Wireless
Communications Networking Division in Atlanta from 1997 to 2000. From 1995
through 1997, Mr. Isaacs held the position of Vice President of Digital Network
Systems for General Instrument Corporation where he was responsible for
developing international business strategies and products for digital video
broadcasting systems.
James D. Lakin has been President of ARRIS Broadband since the acquisition
of Arris Interactive in August 2001. From October 2000 through August 2001, he
was President and Chief Operating Officer of Arris Interactive. From November
1995 until October 2000, Mr. Lakin was Chief Marketing Officer of Arris
Interactive. Prior to 1995, he held various executive positions with Compression
Labs, Inc. and its successor General Instrument Corporation.
Robert Puccini has been President of ARRIS TeleWire Supply since 1999 and
prior to that served as Chief Financial Officer of TeleWire for two years. Mr.
Puccini brings 20 years of experience in the cable television industry to ARRIS
TeleWire Supply. He has held various accounting and controller positions within
the former Anixter and ANTEC Corporations. Most recently, Mr. Puccini served as
Vice President, Project Management for ARRIS' AT&T account. Mr. Puccini is a
CPA.
14
David B. Potts has been the Senior Vice President of Finance and Chief
Information Officer since the acquisition of Arris Interactive in August 2001.
Prior to joining ARRIS, he was Chief Financial Officer of Arris Interactive from
1995 through 2001. From 1984 through 1995, Mr. Potts held various executive
management positions with Nortel Networks including Vice President and Chief
Financial Officer of Bell Northern Research in Ottawa and Vice President of
Mergers and Acquisitions in Toronto. Prior to Nortel Networks, Mr. Potts was
with Touche Ross in Toronto. Mr. Potts is a member of the Institute of Chartered
Accountants in Canada.
Leonard E. Travis has been Vice President and Controller of ARRIS since
March 2001. From 1998 through 2001, he was the Finance Director -- Europe of
RELTEC Corporation and the Vice President of Finance of Marconi
Services -- Americas, a division of RELTEC's successor, Marconi, Plc. Prior to
1998, Mr. Travis held various controller positions in finance and operations at
RELTEC Corporation. Prior to RELTEC, Mr. Travis was with Material Sciences and
Ernst & Whinney. Mr. Travis is a CPA and a CMA.
Marc Geraci has been Treasurer of ARRIS since January 2003 and has been
with ARRIS and the former ANTEC Corporation since 1994. He began with ARRIS as
Controller for the International Sales Group and in 1997 was named Chief
Financial Officer of that group. Prior to joining ARRIS, he was a broker/dealer
on the Pacific Stock Exchange in San Francisco for eleven years and, prior to
that, in public accounting in Chicago for four years.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Since August 6, 2001, ARRIS' common stock has traded on the Nasdaq National
Market System under the symbol "ARRS". Prior to the ARRIS reorganization, on
August 3, 2001, the Company's common stock traded on the Nasdaq National Market
System under the symbol "ANTC". (See Note 18 of Notes to the Consolidated
Financial Statements.) The following table reports the high and low trading
prices per share of the Company's common stock as listed on the Nasdaq National
Market System:
<Table>
<Caption>
HIGH LOW
------ -----
2001
First Quarter............................................... $14.38 $6.63
Second Quarter.............................................. 15.76 5.25
Third Quarter............................................... 13.59 2.68
Fourth Quarter.............................................. 11.65 3.18
2002
First Quarter............................................... $10.70 $7.71
Second Quarter.............................................. 9.90 3.13
Third Quarter............................................... 5.10 3.04
Fourth Quarter.............................................. 4.09 1.50
</Table>
We have not paid cash dividends on our common stock since our inception.
Our credit agreement contains covenants that prohibit us from paying such
dividends. On October 3, 2002, to implement our shareholder rights plan, our
board of directors declared a dividend consisting of one right for each share of
our common stock outstanding at the close of business on October 25, 2002. Each
right represents the right to purchase one one-thousandth of a share of our
Series A Participating Preferred Stock and becomes exercisable only if a person
or group acquires beneficial ownership of 15% or more of our common stock or
announces a tender or exchange offer for 15% or more of our common stock or
under other similar circumstances.
As of March 25, 2003, there were approximately 241 record holders of our
common stock. This number excludes shareholders holding stock under nominee or
street name accounts with brokers.
15
ITEM 6. SELECTED CONSOLIDATED HISTORICAL FINANCIAL DATA
Discontinued Operations. On April 24, 2002, we sold our Keptel product
line. Keptel designed and marketed network interface systems and fiber optic
cable management products primarily for traditional residential and commercial
telecommunications applications. The transaction generated cash proceeds of
$30.0 million. Additionally, we retained a potential earn-out over a twenty-four
month period based on sales achievements. The transaction also included a
distribution agreement whereby we will continue to distribute Keptel products.
The Keptel product line had approximately $51.1 million of revenue in 2001 and
approximately $6.3 million of revenue for the three months ended March 31, 2002.
Total assets of approximately $31.1 million were disposed of, which included
inventory, fixed assets, intangibles (formerly classified as goodwill), and
other assets. We incurred approximately $7.4 million of related closure costs,
including severance, vendor liabilities, outside consulting fees, and other
shutdown expenses. During the second quarter of 2002, a net loss of $8.5 million
was recorded in connection with the sale of the Keptel product line. This net
loss was reported in restructuring and other in the Consolidated Statement of
Operations during the second quarter due to the overall immateriality of
Keptel's results of operations and assets to the consolidated results and assets
of the company. During the fourth quarter of 2002, we reduced the loss by $2.4
million as a result of the resolution of certain estimated costs associated with
the sale.
On November 21, 2002, we sold our Actives product line to
Scientific-Atlanta for net proceeds of $31.8 million. The Actives product line
had approximately $68.2 million of revenue in 2001, and approximately $44.3
million of revenue for the nine months ended September 30, 2002. The agreement
provided for the transfer of inventory and equipment attributable to the product
line, plus the transfer of approximately 34 employees. Total assets of
approximately $20.3 million were disposed of, which included inventory, fixed
assets, and other assets attributable to the product line. Additionally, ARRIS
incurred approximately $9.3 million of related closure costs, including
severance, vendor liabilities, professional fees, and other shutdown expenses.
In connection with the sale, we recognized a gain of approximately $2.2 million
during the fourth quarter of 2002.
As the sale of Actives and Keptel product lines represented a majority of
the transmission, optical and outside plant product category, we have
reclassified the results of these product lines to discontinued operations for
all periods presented in accordance with Statement of Financial Accounting
Standards, or SFAS, No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets for all periods. The balance of the product lines previously
reported in transmission, optical, and outside plant product category have been
combined with our supplies and services category. All prior period revenues have
been aggregated to conform to the new product categories.
The selected consolidated financial data as of December 31, 2002 and 2001
and for each of the three years in the period ended December 31, 2002 set forth
below are derived from the accompanying audited consolidated financial
statements of ARRIS, and should be read in conjunction with such statements and
related notes thereto. The selected consolidated financial data as of December
31, 2000, 1999 and 1998 and for the years ended December 31, 1999 and 1998 is
derived from audited consolidated financial statements that have not been
included in this filing. The historical consolidated financial information is
not necessarily indicative of the results of future operations and should be
read in conjunction with ARRIS' historical consolidated financial statements and
the related notes thereto and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" included elsewhere in this document. See
Note 17 of the
16
Notes to the Consolidated Financial Statements for a summary of our quarterly
consolidated financial information.
<Table>
<Caption>
2002 2001 2000 1999 1998
--------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
CONSOLIDATED OPERATING DATA:
Net sales........................... $ 651,883 $ 628,323 $749,972 $587,439 $341,028
Cost of sales(1)(2)(3)(4)(5)(6)..... 425,231 479,663 624,720 479,252 266,654
--------- --------- -------- -------- --------
Gross profit........................ 226,652 148,660 125,252 108,187 74,374
Selling, general, administrative and
development
expenses(2)(3)(7)(8)............. 200,574 129,743 86,721 71,136 68,226
Impairment of goodwill(9)........... 70,209 -- -- -- --
Amortization of goodwill............ -- 3,256 3,300 3,324 3,293
Amortization of intangibles......... 34,494 7,012 -- -- --
In-process R&D write-off(10)........ -- 18,800 -- -- --
Restructuring and
other(1)(4)(11)(12)(13).......... 7,113 11,602 -- 1,421 6,896
--------- --------- -------- -------- --------
Operating income (loss)............. (85,738) (21,753) 35,231 32,306 (4,041)
Interest expense.................... 8,383 11,068 12,184 13,529 10,402
Membership interest................. 10,409 4,110 -- -- --
Loss on debt retirement(14)(20)..... 7,302 1,853 -- -- --
Other expense (income), net......... (5,513) 8,120 (1,271) (1,837) (2,123)
Loss on investments(15)............. 14,894 767 773 275 --
--------- --------- -------- -------- --------
Income (loss) from continuing
operations before income taxes... (121,213) (47,671) 23,545 20,339 (12,320)
Income tax expense
(benefit)(16)(17)................ (6,800) 35,588 9,622 9,202 (7,095)
--------- --------- -------- -------- --------
Net income (loss) from continuing
operations....................... (114,413) (83,259) 13,923 11,137 (5,225)
Discontinued Operations:
Income (loss) from discontinued
operations (including a net
loss on disposals of $4.0
million for the year ended
December 31, 2002)
(1)(4)(5)(8)(11)(18)(19)....... (18,794) (92,441) 11,409 10,177 26,056
Income tax expense (benefit)..... -- (7,969) 4,663 4,604 15,006
--------- --------- -------- -------- --------
Income (loss) from discontinued
operations....................... (18,794) (84,472) 6,746 5,573 11,050
--------- --------- -------- -------- --------
Net income (loss) before cumulative
effect of an accounting change... (133,207) (167,731) 20,669 16,710 5,825
Cumulative effect of an accounting
change (21)...................... 57,960 -- -- -- --
--------- --------- -------- -------- --------
Net income (loss)................... $(191,167) $(167,731) $ 20,669 $ 16,710 $ 5,825
========= ========= ======== ======== ========
</Table>
17
<Table>
<Caption>
2002 2001 2000 1999 1998
--------- --------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NET INCOME (LOSS) PER COMMON SHARE:
Basic:
Income (loss) from continuing
operations..................... $ (1.40) $ (1.55) $ 0.37 $ 0.30 $ (0.14)
Income (loss) from discontinued
operations..................... (0.23) (1.58) 0.18 0.15 0.30
Cumulative effect of accounting
change......................... (0.71) -- -- -- --
--------- --------- -------- -------- --------
Net income (loss)................ $ (2.33) $ (3.13) $ 0.54 $ 0.46 $ 0.16
========= ========= ======== ======== ========
Diluted:
Income (loss) from continuing
operations..................... $ (1.40) $ (1.55) $ 0.35 $ 0.29 $ (0.13)
Income (loss) from discontinued
operations..................... (0.23) (1.58) 0.17 0.14 0.29
Cumulative effect of accounting
change......................... (0.71) -- -- -- --
--------- --------- -------- -------- --------
Net income (loss)................ $ (2.33) $ (3.13) $ 0.52 $ 0.43 $ 0.15
========= ========= ======== ======== ========
</Table>
- ---------------
(1) In 1999, we recorded pre-tax charges of approximately $16.0 million in
conjunction with the closure of our New Jersey facility and the
discontinuance of certain products, of which approximately $10.7 million
relates to and is classified in discontinued operations. The charges
included approximately $2.6 million related to personnel costs and
approximately $3.0 million related to lease termination and other costs. Of
the total charge of $5.6 million, approximately $1.4 million is reflected
in restructuring and $4.2 million is classified in discontinued operations.
The charges also included an inventory write-down of approximately $10.4
million, of which $6.5 million is classified in discontinued operations and
$3.9 million is reflected in cost of sales. In 2000, we recorded an
additional $3.5 million pre-tax charge to cost of sales related to the 1999
reorganization.
(2) During 2001, we significantly reduced our overall employment levels. This
resulted in a pre-tax charge to cost of sales of approximately $1.3 million
for severance and related costs and a pre-tax charge of $3.7 million to
selling, general, administrative and development expenses.
(3) During 2002, we recorded severance charges related to general reductions in
force of approximately $5.1 million, of which $1.1 million is reflected in
cost of goods sold and $4.0 million is reflected in selling, general,
administrative and development expenses.
(4) In 2001, we recorded pre-tax restructuring and impairment charges of
approximately $66.2 million. Of this total charge, approximately $50.1
million is classified in discontinued operations, $8.5 million is reflected
in cost of goods sold, and $7.6 million is reflected in restructuring. Of
the $50.1 million classified in discontinued operations, approximately
$25.1 million related to the write-down of inventories, $14.8 million
related to the impairment of fixed assets, $4.5 million related to lease
termination and other shutdown expenses, and $5.7 million related to
severance and associated personnel costs. The remaining $16.1 million
related to continuing operations, of which approximately $8.5 million
related to the write-down of inventories and certain purchase order and
warranty obligations and was charged to cost of goods sold, and
approximately $7.6 million related to the impairment of goodwill and lease
termination expenses and was reflected in restructuring. In 2002, we
recorded an additional $2.4 million pre-tax charge to discontinued
operations related to the 2001 restructuring.
(5) Due to the economic disturbances in Argentina, we recorded a write-off of
$4.4 million related to unrecoverable inventory amounts due from a customer
in that region during the fourth quarter of 2001, of which approximately
$1.6 million relates to and is classified in discontinued operations, and
$2.8 million is reflected in cost of goods sold.
(6) During 2002, we wrote off the remaining $2.1 million of power inventories
that had not been transferred to the buyer. This charge is reflected in
cost of goods sold.
18
(7) In 2000, we recorded a pre-tax gain of $2.1 million as a result of the
curtailment of our defined benefit pension plan.
(8) During the first half of 2002, we established a reserve of $20.2 million in
connection with our Adelphia receivables of which approximately $1.3
million relates to and is classified in discontinued operations, and
approximately $18.9 million is reflected in selling, general,
administrative and development expenses. Adelphia filed for bankruptcy in
June 2002. During the third quarter of 2002, we sold a portion of our
Adelphia accounts receivables to an unrelated third party, resulting in a
net gain of approximately $4.3 million. Of this total gain, approximately
$0.3 million relates to and is classified in discontinued operations, and
$4.0 million is reflected in selling, general and administrative and
development expense.
(9) During the fourth quarter of 2002, based upon management's analysis
including an independent valuation, we recorded a goodwill impairment
charge of $70.2 million with respect to our supplies and services product
line.
(10) During 2001, we recorded a pre-tax write-off of in-process research and
development of $18.8 million in connection with the Arris Interactive
acquisition.
(11) In 1998, we recorded pre-tax charges of approximately $10.0 million in
conjunction with the consolidation of our corporate and administrative
functions, of which approximately $2.2 million relates to and is classified
in discontinued operations and $7.8 million is reflected in restructuring
expense. The charges included approximately $7.6 million related to
personnel costs and approximately $2.4 million related to lease termination
and other costs. Subsequently, during the fourth quarter of 1998 we reduced
this charge by $0.9 million as a result of the ongoing evaluation of the
estimated costs associated with these actions.
(12) During 2002, a restructuring charge of approximately $7.1 million was
recorded in connection with the closure of our development and repair
facility in Andover, Massachusetts.
(13) During 2001, we closed a research and development facility in Raleigh,
North Carolina and recorded a $4.0 million charge related to severance and
other costs associated with closing that facility.
(14) During 2002, we recorded a loss of $9.3 million associated with the 4 1/2%
note exchanges, in accordance with SFAS No. 84, Induced Conversions of
Convertible Debt. This loss was partially offset with a gain of
approximately $2.0 million related to cash repurchases of the 4 1/2% notes
in accordance with SFAS No. 145, Rescission of FASB Statements No. 4, 44,
and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
(15) We hold certain investments in the common stock of publicly traded
companies totaling approximately $0.1 million and $0.8 million at December
31, 2002 and 2001, respectively, which are classified as trading
securities. Changes in the market value of these securities and gains or
losses on related sales of these securities are recognized in income and
resulted in pre-tax losses of approximately $0.6 million and $0.8 million
during the years ended December 31, 2002 and 2001, respectively.
We recorded a $13.5 million charge to income during 2002 on our available
for sale securities as a result of market value declines considered by
management to be other than temporary.
(16) During 2002, we recognized a $6.8 million income tax benefit as a result of
a change in tax legislation, allowing us to carry back losses for five
years versus the previous limit of two years.
(17) During 2001, as a result of the restructuring and impairment charges during
that period, a valuation allowance of approximately $38.1 million against
deferred tax assets was recorded in accordance with SFAS No. 109,
Accounting for Income Taxes.
(18) During 2001, a one-time warranty expense relating to a specific product was
recorded, resulting in a pre-tax charge of $4.7 million for the expected
replacement cost of this product of which all relates to and is classified
in discontinued operations. We do not anticipate any further warranty
expenses to be incurred in connection with this product.
(19) During 2002, a loss of $6.2 million was recorded in connection with the
sale of the Keptel product line. Additionally, during 2002, a gain of $2.2
million was recorded in connection with the sale of the Actives product
line. The net loss of $4.0 million relates to and is classified in
discontinued operations.
(20) During 2001, we recorded pre-tax charges of $1.9 million on the
extinguishment of debt in accordance with EITF 96-19, Debtor's Accounting
for a Modification or Exchange of Debt Instruments. The amount
19
reflected unamortized deferred finance fees related to a loan agreement,
which was replaced in connection with the Arris Interactive acquisition. In
2002, this loss was reclassified to loss from continuing operations as a
result of the gain on cash repurchases recognized in the fourth quarter of
2002 in accordance with SFAS No. 145, Rescission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections.
(21) During 2002, we posted a loss of approximately $58.0 million due to the
cumulative effect of an accounting change. In accordance with SFAS No. 142,
Goodwill and Other Intangible Assets, and upon management's analysis of our
intangibles including an independent valuation, we recorded a reduction in
the value of our goodwill of approximately $58.0 million, primarily related
to our Keptel product line.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses ARRIS' Consolidated Financial Statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, management evaluates its
estimates and judgments, including those related to customer incentives, product
returns, bad debts, inventories, investments, intangible assets, income taxes,
financing operations, warranty obligations, restructuring costs, retirement
benefits, and contingencies and litigation. Management bases its estimates and
judgments on historical experience and on various other factors that are
believed to be reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ from
these estimates under different assumptions or conditions.
Discontinued Operations. On April 24, 2002, we sold our Keptel product
line. Keptel designed and marketed network interface systems and fiber optic
cable management products primarily for traditional residential and commercial
telecommunications applications. The transaction generated cash proceeds of
$30.0 million. Additionally, we retained a potential earn-out over a twenty-four
month period based on sales achievements. The transaction also includes a
distribution agreement whereby we will continue to distribute Keptel products.
The Keptel product line had approximately $51.1 million of revenue in 2001 and
approximately $6.3 million of revenue for the three months ended March 31, 2002.
Total assets of approximately $31.1 million were disposed of, which included
inventory, fixed assets, intangibles (formerly classified as goodwill), and
other assets. We incurred approximately $7.4 million of related closure costs,
including severance, vendor liabilities, outside consulting fees, and other
shutdown expenses. During the second quarter of 2002, a net loss of $8.5 million
was recorded in connection with the sale of the Keptel product line. This net
loss was reported in restructuring and other in the Consolidated Statement of
Operations during the second quarter due to the overall immateriality of
Keptel's results of operations and assets to the consolidated results and assets
of the company. During the fourth quarter of 2002, we reduced the loss by $2.4
million as a result of the resolution of certain estimated costs associated with
the sale.
On November 21, 2002, we sold our Actives product line to
Scientific-Atlanta for net proceeds of $31.8 million. The Actives product line
had approximately $68.2 million of revenue in 2001, and approximately $44.3
million of revenue for the nine months ended September 30, 2002. The agreement
provided for the transfer of inventory and equipment attributable to the product
line, plus the transfer of approximately 34 employees. Total assets of
approximately $20.3 million were disposed of, which included inventory, fixed
assets, and other assets attributable to the product line. Additionally, ARRIS
incurred approximately $9.3 million of related closure costs, including
severance, vendor liabilities, professional fees, and other shutdown expenses.
In connection with the sale, we recognized a gain of approximately $2.2 million
during the fourth quarter of 2002.
20
As the sale of Actives and Keptel product lines represent a majority
portion of the Transmission, Optical and Outside Plant product category, we have
reclassified the results of these product lines to discontinued operations for
all periods presented in accordance with Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets for all periods. The balance of the product lines previously reported in
Transmission, Optical and Outside Plant product category have been combined with
our Supplies and Services product category.
Management believes the following critical accounting policies, among
others, affect its more significant judgments and estimates used in the
preparation of its consolidated financial statements.
(a) Inventories
Our largest tangible asset is inventory, which net of reserves aggregated
$104.2 million as of December 31, 2002. Inventory is reflected in our financial
statements at the lower of average, approximating first-in, first-out cost or
market value. We continuously reevaluate future usage of product and where
supply exceeds demand, we establish a reserve. In reviewing inventory valuations
we also review for excess and obsolete items. This requires us to estimate
future usage, which, in an industry where rapid technological changes and
significant variations in capital spending by system operators are prevalent, is
difficult. As a result, to the extent that we have overestimated future usage of
inventory, the value of that inventory on our financial statements may be
overstated and when we recognize that overestimate we will have to adjust for
that overstatement through an increase in cost of sales in a future period.
(b) Accounts Receivable
We establish a reserve for doubtful accounts based upon our historical
experience in collecting accounts receivable. A majority of our accounts
receivable are from a few large cable system operators, either with investment
rated debt outstanding or with substantial financial resources, and have very
favorable payment histories. As a result, our reserve of approximately $10.7
million as of December 31, 2002 is small relative to our level of accounts
receivable. Unlike businesses with relatively small individual accounts
receivables from a large number of customers, if we were to have a
collectibility problem with one of our major customers, it is possible that the
reserve that we have established will not be sufficient. To the extent that
unexpected collectibility problems with any of our customers occur in the
future, the reserves that we have established may not be sufficient, and an
additional bad debt charge may be necessary. For example, we established a
reserve of $20.2 million during 2002 in connection with our Adelphia
receivables. Adelphia filed for bankruptcy in June 2002. As a result of selling
a portion of our Adelphia accounts receivables to an unrelated third party later
in 2002, this charge was reduced by approximately $4.3 million.
(c) Investments
We hold certain investments in the common stock of publicly traded
companies totaling approximately $0.1 million and $0.8 million at December 31,
2002 and 2001, respectively, which are classified as trading securities. Changes
in the market value of these securities and gains or losses on related sales of
these securities are recognized in income. We recorded pre-tax losses of
approximately $0.6 million and $0.8 million during the years ended December 31,
2002 and 2001, respectively, related to these investments.
We hold certain additional investments in the common stock of publicly
traded companies totaling approximately $1.8 million and $2.1 million at
December 31, 2002 and 2001, respectively, which are classified as available for
sale. In addition, we hold a number of non-marketable equity securities totaling
approximately $2.8 million and $12.0 million at December 31, 2002 and 2001,
respectively, which are classified as available for sale. At December 31, 2002
and 2001, we had unrealized losses related to these available for sale
securities of approximately $0 and $3.2 million, respectively, included in
comprehensive income. During the years ended December 31, 2002, 2001, and 2000,
we recorded impairment charges of approximately $13.5 million, $0, and $1.3
million on our available for sale securities as a result of market value
declines considered by management to be other than temporary.
We offer a deferred compensation arrangement, which allows certain
employees to defer a portion of their earnings and defer the related income
taxes. These deferred earnings are invested in a "rabbi trust", and are
21
accounted for in accordance with Emerging Issues Task Force 97-14, Accounting
for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi
Trust and Invested. A rabbi trust is a funding vehicle used to protect deferred
compensation benefits from events (other than bankruptcy). The investment in the
rabbi trust is classified as a current asset on our balance sheet. During the
year ended December 31, 2002, we recognized a loss of approximately $0.8 million
in connection with realized losses on the related investments.
(d) Goodwill and Long-Lived Assets
Goodwill relates to the excess of cost over net assets resulting from an
acquisition. Goodwill resulting from the 1986 acquisition of Anixter (ARRIS'
former owner) by Anixter International was allocated to ARRIS based on ARRIS'
proportionate share of total operating earnings of Anixter for the period
subsequent to the acquisition. Goodwill also has resulted from acquisitions of
business by Anixter and ARRIS subsequent to 1986 that now are owned by ARRIS.
Prior to January 1, 2002, we assessed the recoverability of goodwill and
other long-lived assets whenever events or changes in circumstances indicated
that expected future undiscounted cash flows might not be sufficient to support
the carrying amount of an asset. If expected future undiscounted cash flows from
operations were less than a business' carrying amount, an asset was determined
to be impaired, and a loss was recorded for the amount by which the carrying
value of the asset exceeded its fair value. Fair value was based on discounting
estimated future cash flows or using other valuation methods as appropriate.
Non-cash amortization expense was being recognized as a result of amortization
of goodwill on a straight-line basis over a period of 40 years from the
respective dates of acquisition. The estimation of future cash flows is critical
to the valuation of goodwill. Our industry is subject to rapid technological
changes and significant variations in capital spending by system operators. As a
result, estimations of future cash flows are difficult, and to the extent that
we have overestimated those cash flows we also may have underestimated the need
to reduce any attendant goodwill.
Effective January 1, 2002, we adopted SFAS No. 142, Goodwill and Other
Intangible Assets. In general, SFAS No. 142 requires that we assess the fair
value of the net assets underlying our acquisition related goodwill on a
business-by-business basis. Where that fair value is less than the related
carrying value, we are required to reduce the amount of the goodwill. In our
initial assessment of our goodwill in accordance with SFAS No. 142, we recorded
a transitional goodwill impairment loss of approximately $58.0 million,
primarily related to our Keptel product line, which was reflected in our
statement of operations as a cumulative effect of an accounting change as of
January 1, 2002. In addition, SFAS No. 142 requires that we assess the valuation
of goodwill on an annual basis. The Company's remaining goodwill was reviewed in
the fourth quarter of 2002, and based upon management's analysis including an
independent valuation, a charge of $70.2 million was taken with respect to our
supplies and services product category. SFAS No. 142 also requires that we
discontinue the amortization of our acquisition related goodwill. As of December
31, 2002, our financial statements included remaining acquisition related
goodwill of $151.3 million.
As of December 31, 2002, our financial statements included intangibles of
$64.8 million, net of accumulated amortization of $41.5 million. These
intangibles are primarily related to the existing technologies acquired from
Arris Interactive on August 3, 2001 and Cadant, Inc. on January 8, 2002, and are
amortized over a three-year period. Also included is an intangible pension asset
of $1.8 million, which is not being amortized. The valuation process to
determine the fair market value of the existing technologies by management
included valuations by an outside valuation service. The values assigned were
calculated using an income approach utilizing the cash flow expected to be
generated by these technologies.
(e) Warranty
We provide, by a current charge to cost of sales in the period in which the
related revenue is recognized, an estimate of future warranty obligations. This
estimate is based upon historical experience. In the event of an unusual
warranty claim, the amount of the reserve may not be sufficient. For instance,
in 2001 we had a warranty expense related to a single product and recorded a
charge of $4.7 million, now classified in discontinued operations. To the extent
that other unexpected warranty claims occur in the future, the reserves
22
that we have established may not be sufficient, cost of sales may have been
understated, and a charge against future costs of sales may be necessary.
(f) Income Taxes
We use the liability method of accounting for income taxes, which requires
recognition of temporary differences between financial statement and income tax
basis of assets and liabilities, measured by enacted tax rates.
We established a valuation allowance in accordance with the provisions of
SFAS No. 109, Accounting for Income Taxes. We continually review the adequacy of
the valuation allowance and recognize the benefits of deferred tax assets only
as reassessment indicates that it is more likely than not that the deferred tax
assets will be realized.
OVERVIEW
Over the past two years, we have significantly changed our business through
acquisitions, product line rationalizations and cost reduction actions, allowing
us to focus on our long-term business strategy. As a result of our acquisitions
and dispositions, our business has changed significantly and our historical
results of operations will not be as indicative of future results of operations
as they otherwise might suggest.
Acquisitions
During the third quarter of 2001, we acquired Nortel Networks' interest in
the joint venture Arris Interactive. In January 2002, we purchased substantially
all the assets and assumed certain liabilities of Cadant, Inc., a manufacturer
of cable modem termination systems that had developed a leading design in the
industry for enabling voice over IP telephony and high-speed data. In March
2003, we purchased certain assets of Atoga Systems, a developer of optical
transport systems for metropolitan area networks.
Product Line Rationalizations
Upon evaluation and review of our product portfolio, we concluded that the
Keptel product line was not core to our long-term strategy, thus we sold the
product line during the second quarter of 2002. The Keptel product line had
approximately $51.1 million of revenue in 2001 and approximately $6.3 million of
revenue for the three months ended March 31, 2002. In November 2002, upon
continued review and evaluation of our product portfolio, we sold our Actives
product line to Scientific-Atlanta. This product line had approximately $68.2
million of revenue in 2001, and approximately $44.3 million of revenue for the
nine months ended September 30, 2002. Both of these product lines were included
in our Transmission, Optical & Outside Plant product category and the results of
these operations for all periods have been reclassified to discontinued
operations.
Cost Reduction Actions
During 2001 and 2002, we implemented significant cost reduction actions. In
the third quarter of 2001, we concluded that it would be more cost effective to
outsource manufacturing of our Actives and Keptel product lines. This resulted
in the closure of four factories in Juarez, Mexico and El Paso, Texas. In
conjunction with the purchase of Cadant, we closed our facility in Raleigh,
North Carolina. The Raleigh location was a development facility where
duplicative work to that being done by the Cadant organization was being
performed. In 2001 and 2002, we continuously reviewed our cost structure with
the goal of improving both our effectiveness and efficiency of operations. As a
result, in October 2002, we announced the closure of our development and repair
facility in Andover, Massachusetts and implemented other expense reduction
actions including general reductions in force. These actions were in part
facilitated by the simplification of our business model as a result of the
closure of factories and product line rationalizations.
Debt Reduction and Refinancing Actions
Notes due 2003. In 1998, we issued $115.0 million of 4 1/2% convertible
subordinated notes due May 15, 2003. Between April 1, 2002 and December 31, 2002
we purchased approximately $75.7 million of the notes for an aggregate purchase
price of $73.7 million in cash and exchanged approximately 1.6 million shares of
our
23
common stock for $15.4 million of the notes. Between January 1, 2003 and March
10, 2003, we purchased approximately $12.4 million of the notes for cash. In
order for these transactions to be permitted under the terms of our credit
facility, we modified our credit facility on several occasions.
We recorded the exchanges in accordance with SFAS No. 84, Induced
Conversions of Convertible Debt, which requires the recognition of an expense
equal to the fair value of additional shares of common stock issued in excess of
the number of shares that would have been issued upon conversion under the
original terms of the notes. In connection with these exchanges, we recorded a
non-cash loss of approximately $8.7 million, based upon a weighted average
common stock value of $9.10 per share (as compared with a common stock value of
$24.00 per share in the original conversion ratio for the notes). We also
incurred associated fees of $0.6 million related to these exchanges, resulting
in an overall net loss of $9.3 million. We recorded a $2.0 million gain in 2002
on the notes purchased during the year in accordance with SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No.
13, and Technical Corrections. We anticipate recording neither a gain nor a loss
for the notes purchased in 2003.
We intend to repurchase or repay the remaining notes (approximately $11.5
million as of March 10, 2003) on or before their maturity on May 15, 2003. Our
credit facility imposes certain conditions on our ability to purchase or redeem
the notes, although we currently meet all of those conditions and expect to
continue to do so.
Notes due 2008. On March 18, 2003, we issued $125.0 million of 4 1/2%
convertible subordinated notes due March 15, 2008 under Rule 144A. These notes
are convertible at the option of the holder into our common stock at $5.00 per
share, subject to adjustment. We are entitled to call the notes for redemption
at any time, subject to our making a "make whole" payment if we call them for
redemption prior to March 15, 2006. In addition, we are required to repurchase
the notes in the event of a "change in control."
We used approximately $88.4 million of the proceeds, including the
reduction in the forgiveness of the Class B membership interest, of the notes
issuance to redeem the entire Class B membership interest in Arris Interactive
held by Nortel Networks. We used approximately $28.0 million of the proceeds of
the issuance to repurchase and retire 8 million shares of our common stock held
by Nortel Networks at a discount.
Credit Facility. As noted above, on several occasions during 2002 we
modified our credit facility in order to allow us to use existing cash reserves
and proceeds of asset sales to purchase or redeem our outstanding 4 1/2%
convertible subordinated notes due 2003. These modifications imposed certain
conditions on the use of such cash to purchase or redeem additional notes. On
March 11, 2003, we amended the credit facility to permit us to issue up to
$125.0 million of new convertible subordinated notes due 2008 and to use the
proceeds of the new notes to redeem the Class B membership interest in Arris
Interactive held by Nortel Networks and to purchase shares of the our common
stock held by Nortel Networks, subject to certain limitations. The amendment
also reduced the revolving loan commitments to $115.0 million.
Nortel Networks
Acquisition of Arris Interactive L.L.C. On August 3, 2001, we completed
the acquisition from Nortel of the portion of Arris Interactive that we did not
own. Arris Interactive was a joint venture formed by Nortel Networks and us in
1995, and immediately prior to the acquisition we owned 18.75% and Nortel
Networks owned the remainder. As part of this transaction:
- A new holding company, ARRIS, was formed;
- ANTEC, our predecessor, merged with our subsidiary and the outstanding
ANTEC common stock was converted, on a share-for-share basis, into ARRIS
common stock;
- Nortel Networks and our company contributed to Arris Interactive
approximately $131.6 million in outstanding indebtedness and adjusted
their ownership percentages in Arris Interactive to reflect these
contributions;
- Nortel Networks exchanged its remaining ownership interest in Arris
Interactive for 37 million shares of ARRIS common stock (approximately
49.2% of the total shares outstanding following the
24
transaction) and a subordinated redeemable Class B membership interest in
Arris Interactive with a face amount of $100 million;
- ANTEC, now our wholly-owned subsidiary, changed its name to Arris
International, Inc.;
- Nortel Networks designated two new members to our board of directors;
- We issued approximately 2.1 million options and 95,000 shares of
restricted stock to Arris Interactive employees.
In connection with this transaction, we entered into an agreement with
Nortel Networks whereby we pay Nortel Networks an agency fee of approximately,
on average, 10% for all sales of Arris Interactive legacy products made to
certain domestic and international customers. This agreement for domestic agency
fees expired December 31, 2001. The agreement for international agency fees was
terminated on December 6, 2002.
Membership Interest. In connection with the acquisition of Arris
Interactive in August 2001, Nortel Networks exchanged its remaining ownership
interest in Arris Interactive for 37 million shares of our common stock and a
subordinated redeemable Class B membership interest in Arris Interactive with a
face amount of $100.0 million. The Class B membership interest earned an
accreting non-cash return of 10% per annum, compounded annually, and was
redeemable in approximately four quarterly installments commencing February 3,
2002, provided that certain availability and other tests are met under our
revolving credit facility. Those tests were not met. The balance of the Class B
membership interest as of December 31, 2002 was approximately $114.5 million. In
June 2002, we entered into an option agreement with Nortel Networks that
permitted us to redeem the Class B membership interest in Arris Interactive at a
discount of 21% prior to June 30, 2003. To further induce us to redeem the Class
B membership interest, Nortel Networks offered to forgive approximately $5.9
million of the earnings on the Class B membership interest if we redeemed it
prior to March 31, 2003. As noted elsewhere, we used approximately $88.4 million
of the proceeds of the March 2003 convertible note offering to redeem the Class
B membership interest, including the reduction in the forgiveness of the
interest.
Common Stock. Of the 37 million shares of our common stock that Nortel
Networks received in 2001, it sold 15 million in a registered public offering in
June 2002. In order to reduce its holdings further, in March 2003 Nortel
Networks granted us an option to purchase up to 16 million shares at a 10%
discount to market, subject to a minimum purchase price of $3.50 per share for 8
million shares and $4.00 per share for the remainder. In addition, to the extent
that we purchased shares at a price of less than $4.00 per share, we were
obligated to return to Nortel Networks a portion of the return that was forgiven
with respect to the Class B membership interest, up to a maximum of $2.0
million. Pursuant to this option, on March 24, 2003, we purchased 8 million
shares for an aggregate purchase price of $28.0 million. Contemporaneously with
this transaction, we paid Nortel Networks $2.0 million, which represented the
reduction in the forgiveness of the Class B membership interest. We have not
decided when or whether we will exercise the option to repurchase the additional
8 million shares offered by Nortel Networks.
Amendment to Investor Rights Agreement. In connection with the sale of
shares of our common stock by Nortel Networks in June 2002, effective September
30, 2002, we agreed to relax certain restrictions in the Investor Rights
Agreement governing Nortel Networks' ownership and disposition of our stock that
will make it easier for Nortel Networks to sell its remaining shares of our
stock. Additionally, Nortel Networks and Liberty Media (our other large
shareholder), entered into a "standstill" agreement under which each of them has
agreed that it will not exercise its registration rights or, except under
certain circumstances, sell any shares of our common stock until July 31, 2003,
unless prior to then we both redeem our outstanding convertible notes and
repurchase at least 66% of Nortel Networks' Class B membership interest, in
which case the restrictions expire 30 days after the later of those two events.
As a result of the repurchase of the Class B membership interest, those
restrictions will expire on April 17, 2003.
25
ACQUISITION OF CADANT, INC.
On January 8, 2002, we acquired substantially all of the assets of Cadant,
Inc., a privately held designer and manufacturer of next generation CMTS. Under
the terms of the transaction, we issued 5.25 million shares of our common stock
and assumed approximately $16.5 million in liabilities in exchange for the
assets. We issued 2.0 million options to purchase our common stock and 250,000
shares of restricted stock to Cadant employees. We also agreed to issue up to
2.0 million additional shares of our common stock based upon the achievement of
future sales targets through 2003 for the CMTS product. These sales targets were
not achieved and no additional shares of our common stock will be issued.
ACQUISITION OF ATOGA SYSTEMS
-- On March 21, 2003, we purchased certain assets of Atoga Systems, a Fremont,
California-based developer of optical transport systems for metropolitan area
networks. Under the terms of the agreement, we obtained certain inventory, fixed
assets, and intellectual property in consideration for approximately $0.5
million of cash and the assumption of certain lease obligations. Further, we
retained approximately 30 employees and issued a total of 500,000 shares of
restricted stock to those employees. We anticipate the transaction to be
slightly dilutive to our earnings per share in 2003.
SALE OF KEPTEL PRODUCT LINE
-- On April 24, 2002, we sold our Keptel product line. Keptel designed and
marketed network interface systems and fiber optic cable management products
primarily for traditional telecommunications residential and commercial
applications. The transaction generated cash proceeds of $30.0 million.
Additionally, we retained a potential earnout over a twenty-four month period
based on sales achievements. The transaction also includes a distribution
agreement whereby we will continue to distribute Keptel products. The Keptel
product line had approximately $51.1 million of revenue in 2001 and
approximately $6.3 million of revenue for the three months ended March 31, 2002.
Total assets of approximately $31.1 million were disposed of, which included
inventory, fixed assets, intangibles (formerly classified as goodwill), and
other assets. We incurred approximately $7.4 million of related closure costs,
including severance, vendor liabilities, outside consulting fees, and other
shutdown expenses. The net result of the transaction was a loss on the sale of
the product line of approximately $8.5 million. During the fourth quarter of
2002, we reduced the loss by $2.4 million as a result of the resolution of
certain estimated costs associated with the sale.
SALE OF ACTIVES PRODUCT LINE
-- On November 21, 2002, we sold our Actives product line, excluding
receivables and payables, to Scientific-Atlanta for $31.8 million in net
proceeds. This product line had approximately $68.2 million of revenue in 2001
and approximately $44.3 million of revenue for the first nine months of 2002,
prior to the closing of the sale. The agreement provided for the transfer of
inventory and equipment attributable to the product lines, plus the transfer of
approximately 34 employees. Total assets of approximately $20.3 million were
disposed of, which included inventory, fixed assets, and other assets
attributable to the product line. Additionally, ARRIS incurred approximately
$9.3 million of related closure costs, including severance, vendor liabilities,
professional fees, and other shutdown expenses. In connection with the sale, we
recognized a gain of approximately $2.2 million.
INDUSTRY CONDITIONS
-- Our performance is largely dependent on capital spending for constructing,
rebuilding, maintaining and upgrading broadband communications systems. After a
period of intense consolidation and rapid capital expenditures within the
industry through the fourth quarter of 2000, there was a tightening of credit
availability throughout the telecommunications industry and a broad-based and
severe drop in market capitalization for the sector. This caused broadband
system operators to become more judicious in their capital spending, adversely
affecting us and other equipment providers.
26
-- Developments in the industry and in the capital markets over the past two
years have reduced access to funding for new and existing customers, causing
delays in the timing and scale of deployments of our equipment, as well as the
postponement or cancellation of certain projects by our customers. In addition,
during the same period, we and other vendors received notification that several
customers were canceling new projects or scaling back existing projects or
delaying new orders to allow them to reduce inventory levels which were in
excess of their current deployment requirements.
This industry downturn and other factors have adversely affected several of
our largest customers. In June 2002, Adelphia filed bankruptcy at a time when it
owed us approximately $20.2 million in accounts receivable. As a result, we
incurred a $20.2 million charge during the second quarter 2002. However, we sold
a portion of the Adelphia receivables during the third quarter 2002 to an
unrelated third party, resulting in net gain of approximately $4.3 million. For
the year ended December 31, 2002, the net result was a loss of $15.9 million
related to the Adelphia situation.
In addition, as of March 10, 2003, Cabovisao, a Portugal-based customer
owed us approximately 18.6 million euros in accounts receivable, a substantial
portion of which was past due. This customer accounted for approximately 6% of
our sales in 2002. On October 17, 2002, the parent company of Cabovisao, CSii,
issued an announcement that suggested it may have difficulty in accessing or
refinancing its senior credit facility in the future. On February 3, 2003, CSii
announced that it had obtained an extension of the maturity date of its credit
facility to February 28, 2003, and that it was continuing negotiations with
respect to a long term financing solution. On March 1, 2003, CSii announced that
it had formed a special committee of its board of directors to review and
evaluate alternatives to meet the financial needs of CSii and Cabovisao,
including: debt restructuring, recapitalization, capital infusion and court
supervised restructuring. We are uncertain what effect, if any, these
developments will have on our existing accounts receivable or future
relationship with Cabovisao.
Further, in the fourth quarter of 2002 Comcast completed its purchase of
AT&T Broadband. Historically, AT&T Broadband has been our largest customer. AT&T
Broadband, with the deployment of telephony as part of its core strategy, had
been using our CBR products in many of its major markets. Comcast has announced
that as its initial priority after its acquisition of AT&T Broadband, it will
emphasize video and high-speed data operations and focus on improving the
profitability of its telephony operations at the expense of subscriber growth.
As a result, we have experienced a significant decline in sales of our CBR
telephony product to Comcast in the fourth quarter of 2002, which we expect to
continue into 2003. On June 27, 2002, Comcast announced that it had chosen us to
provide an initial DOCSIS 1.1 C4 CMTS to be installed at the headend of a
Comcast cable system in the Philadelphia area. On January 13, 2003, we announced
that Comcast had ordered an additional fifty C4 CMTS chassis for immediate data
service deployment.
In response to this downturn, we have rationalized our product portfolio
and have significantly reduced expense levels through the actions previously
described.
27
RESULTS OF OPERATIONS
The following table sets forth ARRIS' key operating data as a percentage of
net sales:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
Net sales................................................... 100.0% 100.0% 100.0%
Cost of sales............................................... 65.2 76.3 83.3
----- ----- -----
Gross profit................................................ 34.8 23.7 16.7
Selling, general, administrative and development expenses... 30.8 20.6 11.6
In process R&D write-off.................................... -- 3.0 --
Restructuring and impairment charges........................ 1.1 1.8 --
Impairment of goodwill...................................... 10.8 -- --
Amortization of goodwill.................................... -- 0.5 0.4
Amortization of intangibles................................. 5.3 1.1 --
----- ----- -----
Operating income (loss)..................................... (13.2) (3.4) 4.7
Interest expense............................................ 1.3 1.8 1.6
Membership interest......................................... 1.6 0.7 --
Loss on debt retirement..................................... 1.1 0.3 --
Loss (gain) on investments.................................. 2.3 0.1 0.1
Other expense (income), net................................. (0.9) 1.3 (0.1)
----- ----- -----
Income (loss) from continuing operations.................... (18.6) (7.6) 3.1
Income tax expense (benefit)................................ (1.0) 5.7 1.3
----- ----- -----
Net income (loss) from continuing operations................ (17.6) (13.3) 1.9
Gain (loss) from discontinued operations.................... (2.9) (13.4) 0.9
----- ----- -----
Net income before cumulative effect of accounting change.... (20.4) (26.7) 2.8
Cumulative effect of an accounting change................... 8.9 -- --
----- ----- -----
Net income (loss)........................................... (29.3)% (26.7)% 2.8%
===== ===== =====
</Table>
SIGNIFICANT CUSTOMERS
Our two largest customers are Comcast (after giving effect to its
acquisition of AT&T Broadband) and Cox Communications. Sales to these two
customers for the years ended December 31, 2002, 2001, and 2000 were as follows
(in millions):
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
Comcast (including AT&T Broadband)......................... $250.2 $245.6 $387.2
% of sales................................................. 38.4% 39.1% 51.8%
Cox Communications......................................... $106.7 $110.9 $116.5
% of sales................................................. 16.4% 17.7% 15.6%
</Table>
28
As described above, we have uncertainties surrounding our future
transactions with Adelphia and Cabovisao. Sales to these two customers for the
years ended December 31, 2002, 2001, and 2000 were as follows (in millions):
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
Adelphia Communications..................................... $25.9 $54.1 $48.7
% of sales.................................................. 4.0% 8.6% 6.5%
Cabovisao................................................... $39.1 $16.2 $ 2.5
% of sales.................................................. 6.0% 2.6% 0.3%
</Table>
COMPARISON OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002 AND 2001
As the sale of our Actives and Keptel product lines represent a majority of
the transmission, optical and outside plant product category, we have
reclassified the results of these product lines to discontinued operations for
all periods presented in accordance with Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. Our products and services are summarized in the following two product
categories, broadband, and supplies and services, instead of the previous three
categories. The balance of the product lines previously reported in the former
transmission, optical and outside plant product category have been combined with
our supplies and services product category. All prior period amounts have been
aggregated to conform to the new product categories.
Net Sales. ARRIS' sales for 2002 increased by $23.6 million or 3.8% to
$651.9 million, as compared to sales of $628.3 million in 2001. The increase in
revenue is driven by an increase in international sales for the Broadband
product category, primarily in Europe and Asia Pacific. The increase
internationally was partially offset by reduced sales of supplies and services
products, partly due to the bankruptcy filing by Adelphia Communications.
- Broadband product revenues increased by approximately $81.2 million or
22.0% to $449.7 million in 2002, as compared to sales of $368.5 million
in 2001. Broadband product revenues accounted for approximately 69.0% of
2002 sales as compared to 58.7% for 2001. Broadband revenues for 2002
included a full year of international revenue for the Cornerstone product
line whereas 2001 included only five months of international revenues due
to the timing of the acquisition of Arris Interactive L.L.C. on August 3,
2001. Under the previous joint venture agreement, Nortel (not ARRIS) sold
the Cornerstone products internationally. This agreement terminated upon
our acquisition of Nortel's share of Arris Interactive L.L.C. on August
3, 2001. Additionally, sales in 2002 included a full year of Cadant
revenues following the acquisition in January 2002. However, these
increases in sales were partially offset with a reduction in broadband
sales to Comcast, following its acquisition of AT&T Broadband during the
fourth quarter of 2002. Historically, AT&T Broadband had been our largest
customer. AT&T Broadband, with the deployment of telephony as part of its
core strategy, had been using our CBR products in many of its major
markets. Comcast has announced that as its initial priority after its
acquisition of AT&T Broadband, it will emphasize video and high-speed
data operations and focus on improving the profitability of its telephony
operations at the expense of subscriber growth. As a result, we have
experienced a significant decline in sales of our CBR telephony product
to Comcast in the fourth quarter of 2002, which we expect to continue
into 2003.
- Supplies and services product revenues decreased by approximately $57.6
million or 22.2% to $202.2 million in 2002, as compared to $259.8 million
in 2001. Supplies and services product revenue accounted for
approximately 31.0% of 2002 sales as compared to 41.3% for 2001. The
bankruptcy filing by Adelphia and the resulting reduced sales to Adelphia
accounted for approximately 52.8% of the overall decrease in supplies and
services product revenue year over year. Additionally, a general slowdown
in MSO's infrastructure spending contributed to the decrease in supplies
and services sales year over year. We also experienced significantly
reduced sales of other product lines within this category, including
fiber optic cable, outside plant, and installation materials and tools,
which decreased by approximately 96.6%, 25.8%, and 25.9%, respectively.
29
International sales increased by approximately $75.4 million or 104.9% to
$147.3 million for the year ended December 31, 2002, as compared to sales of
$71.9 million during 2001. The Asia Pacific and Europe regions accounted for
approximately 88.3% of the overall increase. The overall increase was primarily
the result of the inclusion of a full year of international sales of the
Cornerstone product line for 2002, whereas 2001 included only five months of
Cornerstone international sales following our acquisition of Arris Interactive
L.L.C. Under a previous agreement with Nortel Networks, we had not been able to
sell Cornerstone products internationally. This agreement terminated upon our
acquisition of Nortel's share of Arris Interactive L.L.C. on August 3, 2001.
Gross Profit. Gross profit increased by $78.0 million or 52.5% to $226.7
million in 2002, as compared to $148.7 million in 2001. Gross profit margins for
the year ended December 31, 2002 increased 11.1 percentage points to 34.8% as
compared to 23.7% for 2001. The overall increase in gross margin is primarily
due to the fact that gross margins were positively impacted by the Arris
Interactive acquisition in August 2001. Prior to the acquisition, ANTEC, the
predecessor to ARRIS, was a distributor of Arris Interactive Cornerstone
products. Beginning in August 2001, the new ARRIS earned much higher margins as
the manufacturer of Cornerstone products on both domestic and international
sales. The year ended December 31, 2002 included a full year of this positive
impact, whereas 2001 included only five months. The increase in gross margin is
also attributable to the increased weighting of the broadband product, which
contribute higher margins, within the overall product mix. The broadband product
line accounted for 69% of total revenues in 2002, as compared to approximately
59% of total revenues in 2001.
Impacting the 2002 gross margin were charges of $2.1 million to write off
the balance of power product line inventory (this product line was sold in late
2001), and $1.1 million of severance costs related to employee reductions.
Impacting the 2001 gross margin were charges of $8.5 million related to
inventory write downs and $1.3 million related to severance, both as a result of
the planned restructuring of manufacturing operations. Also negatively impacting
gross margins in 2001 was a charge of approximately $2.8 million related to
unrecoverable amounts of inventory due from a customer in Argentina due to the
economic disturbances in that region.
Selling, General, Administrative, and Development, or SGA&D,
Expenses. SGA&D expenses increased by $70.9 million or 54.7% to $200.6 million
in 2002, as compared to $129.7 million in 2001. The primary reason for the
increase in SGA&D expenses year over year was the inclusion in 2002 of
additional expenses due to the acquisitions of Arris Interactive L.L.C. and
Cadant, Inc. Also impacting SGA&D for 2002 was approximately $4.0 million of
severance costs related to workforce reductions, and a net $14.9 million bad
debt write-off due to Adelphia's bankruptcy. SGA&D expenses for 2001 include
approximately $3.8 million of severance costs related to workforce reductions.
Write-off of in-process R&D. During the third quarter of the year ended
December 31, 2001, we wrote off acquired in-process research and development
totaling $18.8 million in connection with the Arris Interactive acquisition.
Restructuring and Impairment Charges. On October 30, 2002, we announced
the closure of our office in Andover, Massachusetts, which is primarily a
product development and repair facility. We decided to close the office in order
to reduce operating costs through consolidations of our facilities. The closure
affected approximately 75 employees and is expected to be completed during the
second quarter of 2003. In connection with this facility closure, we recorded a
charge of approximately $7.1 million in the fourth quarter of 2002. Included in
this restructuring charge was approximately $2.1 million related to remaining
lease payments, $2.7 million of fixed asset write-offs, $2.1 million of
severance, and $0.2 million of other costs associated with these actions.
In the fourth quarter of 2001, we closed a research and development
facility in Raleigh, North Carolina and recorded a $4.0 million charge. This
charge included termination expenses of $2.2 million related to the involuntary
dismissal of 48 employees, primarily engaged in engineering functions at that
facility. Also included was $0.7 million related to lease commitments, $0.2
million related to the impairment of fixed assets, and $0.9 million related to
other shutdown expenses.
30
In the third quarter of 2001, we recorded a charge of $5.9 million related
to the impairment of goodwill due to the sale of the power product lines.
Additionally, we recorded a restructuring charge of approximately $1.6 million
related to lease terminations of office space.
Impairment of Goodwill. We adopted SFAS No. 142, Goodwill and Other
Intangible Assets, on January 1, 2002. Under the new rules, goodwill and
indefinite lived intangible assets are no longer amortized but are reviewed
annually for impairment, or more frequently if impairment indicators arise. Upon
adoption of SFAS No. 142, we recorded a transitional goodwill impairment loss of
approximately $58.0 million, primarily related to our Keptel product line.
During the fourth quarter of 2002, our remaining goodwill was reviewed, and
based upon management's analysis including an independent valuation, an
impairment charge of $70.2 million was recorded with respect to our supplies and
services product category primarily due to a decline in current purchasing by
Adelphia, as well as the industry in general. The valuation was determined using
a combination of the income and market approaches on an invested capital basis,
which is the market value of equity plus interest-bearing debt.
Amortization of Goodwill. Total goodwill amortization expense for the year
ended December 31, 2001 was $3.3 million. Beginning January 1, 2002, in
accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill and
indefinite lived intangible assets are no longer amortized but are reviewed
annually for impairment, or more frequently if impairment indicators arise.
Amortization of Intangibles. Total intangibles amortization expense for
the years ended December 31, 2002 and 2001 was $34.5 million and $7.0 million,
respectively. The majority of our intangibles represent existing technology
acquired as a result of the Arris Interactive L.L.C. acquisition in the third
quarter 2001 and the Cadant, Inc. acquisition in the first quarter 2002.
Interest Expense. Interest expense for the years ended December 31, 2002
and 2001 was $8.4 million and $11.1 million, respectively. Interest expense for
all periods reflects the cost of borrowings on our revolving line of credit,
amortization of deferred finance fees, and the interest paid on the 4 1/2 %
convertible subordinated notes due 2003. During 2002, we did not have a balance
outstanding under our credit facility, and our outstanding convertible
subordinated notes were reduced by $91.1 million to $23.9 million, primarily in
the fourth quarter of 2002.
Membership Interest Expense. In conjunction with the acquisition of Arris
Interactive L.L.C. in August 2001, we issued to Nortel Networks a subordinated
redeemable Class B membership interest in Arris Interactive with a face amount
of $100.0 million. This membership interest earns a return of 10% per annum,
compounded annually. For the years ended December 31, 2002 and 2001, we recorded
membership interest expense of $10.4 million and $4.1 million, respectively.
Loss on Debt Retirement. In 2002, we exchanged 1,593,789 shares of our
common stock for approximately $15.4 million of the convertible subordinated
notes due 2003. The exchanges were recorded in accordance with SFAS No. 84,
Induced Conversions of Convertible Debt, which requires the recognition of an
expense equal to the fair value of additional shares of common stock issued in
excess of the number of shares that would have been issued upon conversion under
the original terms of the notes. As a result, in connection with these
exchanges, we recorded a non-cash loss of approximately $8.7 million, based upon
a weighted average common stock value of $9.10 (as compared with a common stock
value of $24.00 per share in the original conversion ratio for the notes). In
connection with the exchanges, we also incurred associated fees of $0.6 million,
resulting in an overall net loss of $9.3 million.
During 2002, we redeemed $75.7 million of the notes using cash from
operations and cash generated from the sale of our Actives product line. The
notes were redeemed at a discount, resulting in a gain on the debt retirement of
$2.0 million and was recorded in continuing operations in accordance with SFAS
No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. As of December 31, 2002, there were
approximately $23.9 million of the notes outstanding.
During 2001, we recorded pre-tax charges of $1.9 million on the
extinguishment of debt in accordance with EITF 96-19, Debtor's Accounting for a
Modification or Exchange of Debt Instruments. The amount reflected unamortized
deferred finance fees related to a loan agreement, which was replaced in
connection
31
with the Arris Interactive acquisition. In 2002, this loss was reclassified to
loss from continuing operations as a result of the gain on cash repurchases
recognized in the fourth quarter of 2002 in accordance with SFAS No. 145,
Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No.
13, and Technical Corrections.
Loss on Investments. We hold certain investments in the common stock of
publicly traded companies totaling approximately $0.1 million and $0.8 million
at December 31, 2002 and 2001, respectively, which are classified as trading
securities. Changes in the market value of these securities and gains or losses
on related sales of these securities are recognized in income and resulted in
pre-tax losses of approximately $0.6 million and $0.8 million during the years
ended December 31, 2002 and 2001, respectively.
We hold certain investments in the common stock of publicly traded
companies totaling approximately $1.8 million and $2.1 million at December 31,
2002 and 2001, respectively, which are classified as available for sale. Changes
in the market value of these securities are recorded in other comprehensive
income. These securities are also subject to a periodic impairment review;
however, and the impairment analysis requires significant judgment. As these
investments have been below their cost basis for a period greater than six
months, an unrealized loss of $3.5 million was considered "other than temporary"
and recognized through income in the fourth quarter of 2002.
In addition, we hold a number of non-marketable equity securities totaling
approximately $2.8 million and $12.0 million at December 31, 2002 and 2001,
respectively, which are classified as available for sale. These non-marketable
equity securities are subject to a periodic impairment review; however, there
are no open-market valuations, and the impairment analysis requires significant
judgment. During the second quarter 2002, we wrote off a $1.0 million investment
in a technology start-up company, as it was unable to raise further financing
and filed for bankruptcy during the second quarter. During the fourth quarter of
2002, we recorded a $3.0 million impairment for an investment in a technology
start-up, as its assets were sold to another company. An additional impairment
charge of $6.0 million was recorded in the fourth quarter of 2002 relating to
other non-marketable equity securities deemed to be impaired based on various
factors.
ARRIS offers a deferred compensation arrangement, which allows certain
employees to defer a portion of their earnings and defer the related income
taxes. These deferred earnings are invested in a "rabbi trust", and are
accounted for in accordance with Emerging Issues Task Force 97-14, Accounting
for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi
Trust and Invested. A rabbi trust is a funding vehicle used to protect deferred
compensation benefits from events (other than bankruptcy). The investment in the
rabbi trust is classified as a current asset on our balance sheet. During the
year ended December 31, 2002, we recognized a loss of approximately $0.8 million
in connection with realized losses on the related investments.
Loss (Gain) in Foreign Currency. During 2002, we recorded a foreign
currency gain of approximately $5.7 million, primarily related to the
strengthening of the euro as we have several European customers whose
receivables and collections are denominated in euros. During the third quarter
2002, we have evaluated and implemented a hedging strategy using forward
contracts.
Other Expense (Income). Other expense (income) for the years ended
December 31, 2002 and 2001 was $0.2 million and $8.1 million, respectively.
During 2002, we recorded bank charges of $0.6 million and a loss on disposal of
fixed assets of $0.3 million. These charges were partially offset with interest
income of $0.5 million and other miscellaneous income of $0.2 million. During
2001, we recorded an equity loss in Arris Interactive L.L.C. of $8.6 million.
The operations of Arris Interactive have been consolidated upon the acquisition
of Nortel Networks' interest in Arris Interactive in August 2001. Additionally,
bank charges of approximately $1.1 million were recorded during 2001. These
losses were offset with a gain on the disposal of fixed assets of approximately
$0.4 million, interest income of $0.9 million, and other miscellaneous income of
$0.3 million.
Income Tax Expense. We recognized an income tax benefit of $6.8 million
for the year ended December 31, 2002 as compared to income tax expense of
approximately $27.6 million for 2001. The income tax benefit in 2002 was due to
a change in the tax laws allowing NOL carry-backs for five years, which allowed
32
the company to record a tax benefit. The income tax expense in 2001 was
primarily the result of the restructuring and impairment charges during that
period, and a valuation allowance of approximately $38.1 million against
deferred tax assets was recorded in accordance with SFAS No. 109, Accounting for
Income Taxes. Of the net income tax expense of $27.6 million in 2001,
approximately $35.6 million expense related to continuing operations, and a
benefit of $8.0 million was reclassified to discontinued operations.
Discontinued Operations. We have adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, with respect to our Actives and
Keptel product line disposals. As a result, these two product lines have been
accounted for as discontinued operations and, where noted, current and
historical results have been reclassified accordingly. Revenues from the
discontinued operations were $68.8 million and $119.3 million for the years
ended December 31, 2002 and 2001, respectively. The income (loss) from
discontinued operations, net of taxes, for the years ending December 31, 2002
and 2001 was $(18.8) million and $(84.5) million, respectively. During 2002, we
recorded a net loss on disposals of $4.0 million.
Cumulative Effect of an Accounting Change -- Goodwill. We adopted SFAS No.
142, Goodwill and Other Intangible Assets, on January 1, 2002. Under the
transitional provisions of SFAS No. 142, we recorded a goodwill impairment loss
of approximately $58.0 million. The impairment loss has been recorded as a
cumulative effect of a change in accounting principle on the accompanying
Consolidated Statements of Operations for the year ended December 31, 2002.
Net Income (Loss). A net loss of $(191.2) million or $(2.33) per diluted
share was recorded for the year ended December 31, 2002. The net loss from
continuing operations was $(114.4) million or $(1.40) per diluted share, the net
loss from discontinued operations was $(18.8) million or $(0.23) per diluted
share, and the net loss from a cumulative effect of an accounting change was
$(58.0) million or $(0.71) per diluted share.
A net loss of $(167.7) million or $(3.13) per diluted share was recorded
for the year ended December 31, 2001. The net loss from continuing operations
was $(83.3) million or $(1.55) per diluted share and the net loss from
discontinued operations was $(84.5) million or $(1.58) per diluted share.
COMPARISON OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2001 AND 2000
Net Sales. Our consolidated sales for 2001 decreased by $121.7 million or
16.2% to $628.3 million as compared to 2000 sales of $750.0 million. The overall
reduction in sales was primarily due to the widespread slowdown in MSO's
infrastructure spending. The slowdown in spending began in the fourth quarter of
2000 and continued throughout 2001. However, broadband sales for the year were
up over 2000 due to the addition of international sales as a result of the
acquisition of Arris Interactive in August 2001. Supplies and services product
sales were down significantly from 2000, resulting in the overall sales
decreased year over year.
Our products and services are summarized in the following two product
categories, instead of the previous three categories: broadband; and supplies
and services. As the sale of Actives and Keptel product lines represents a
majority of the former transmission, optical and outside plant product category,
we have reclassified the results of these product lines to discontinued
operations for all periods presented in accordance with Statement of Financial
Accounting Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. The balance of the product lines previously reported in the
former transmission, optical and outside plant product category has been
combined with our supplies and services product category. All prior period
amounts have been aggregated to conform to the new product categories.
- Broadband product revenues increased by approximately $56.2 million or
18.0% to $368.5 million for the year ended December 31, 2001 as compared
to $312.3 million for 2000. Broadband product revenues accounted for
approximately 58.7% of sales for the year ended December 31, 2001 as
compared to 41.6% of sales for the year ended December 31, 2000. However,
revenues in 2001 included approximately $30.0 million of sales to AT&T
that were carried over from the fourth quarter of 2000. Further, 2001
included five months of additional international revenues due to the
acquisition of Arris Interactive L.L.C. on August 3, 2001.
33
- Supplies and services revenue decreased approximately $177.9 million or
40.6% to $259.8 million for the year ended December 31, 2001 as compared
to $437.7 million for 2000. We experienced reduced sales of all products
lines within this category, including engineering services, fiber optic
cable, outside plant, and installation materials and tools. Supplies and
service revenue accounted for approximately 41.3% of sales for year ended
December 31, 2001 as compared to 58.4% for 2000.
International sales increased approximately $39.5 million or 121.8% to
$71.9 million in 2001 from $32.4 million in 2000. This increase was primarily
the result of the addition of international sales of the Cornerstone product
line following our August 3, 2001 acquisition of Arris Interactive. Under a
previous agreement with Nortel Networks, we had not been able to sell
Cornerstone products internationally. This agreement terminated upon our
acquisition of Nortel's share of Arris Interactive L.L.C. on August 3, 2001.
International sales in 2001 represented approximately 11.4% of total sales, as
compared to international sales of 4.3% of our total revenue in 2000.
Gross Profit. Gross profit increased approximately $23.4 million or 18.7%
to $148.7 million for year ended December 31, 2001 from $125.3 million for 2000.
Gross profit margins for the year ended December 31, 2001 increased 7.0
percentage points to 23.7% as compared to 16.7% for 2000. The overall increase
in gross margin is primarily due to the fact that gross margins were positively
impacted by the Arris Interactive acquisition during the year ended December 31,
2001. For all of 2000 and for the first seven months of 2001, ANTEC, the
predecessor to ARRIS, was a distributor of Arris Interactive Cornerstone
products. Beginning in August 2001, the new ARRIS earned much higher margins as
the manufacturer of Cornerstone products on both domestic and international
sales. The increase in gross margin is also attributable to the increased
weighting of sales of the broadband product, which contribute higher margins,
within the overall product mix. The broadband product line accounted for
approximately 59% of total revenues in 2001, as compared to approximately 42% of
total revenues in 2000.
Impacting the 2001 gross margin were charges of $8.5 million related to
inventory write downs and $1.3 million related to severance, both as a result of
the planned restructuring of manufacturing operations. Also negatively impacting
gross margins in 2001 was a charge of approximately $2.8 million related to
unrecoverable amounts of inventory due from a customer in Argentina due to the
economic disturbances in that region. Impacting the 2000 gross margin was a
charge of $3.5 million related to product discontinuations.
Selling, General, Administrative and Development ("SGA&D") Expenses. SGA&D
expenses increased approximately $43.0 million or 49.6% to $129.7 million in
2001 from $86.7 million in 2000. As a percentage of sales, SGA&D was 20.6% in
2001 as compared with 11.6% in 2000. The increase year over year is primarily
the result of the additional expenses for five months following the acquisition
of Arris Interactive.
SGA&D expenses for 2001 include approximately $3.8 million of severance
costs related to workforce reductions. The SGA&D expenses for 2000 included a
pre-tax gain of $2.1 million as a result of employee elections associated with a
new and enhanced benefit plan and the resulting effect on our defined benefit
pension plan.
Restructuring. In the fourth quarter of 2001, we closed a research and
development facility in Raleigh, North Carolina and recorded a $4.0 million
charge related to severance and other costs associated with closing that
facility. This charge included termination expenses of $2.2 million related to
the involuntary dismissal of 48 employees, primarily engaged in engineering
functions at that facility. Also included in the $4.0 million charge was $0.7
million related to lease commitments, $0.2 million related to the impairment of
fixed assets, and $0.9 million related to other shutdown expenses.
In the third quarter of 2001, we announced a restructuring plan to
outsource the functions of most of our manufacturing facilities. This decision
to reorganize was due in part to the ongoing weakness in industry spending
patterns. The plan entailed the implementation of an expanded manufacturing
outsourcing strategy and the related closure of the four factories located in El
Paso, Texas and Juarez, Mexico. As a result, we recorded restructuring and
impairment charges of $66.2 million, of which approximately $50.1 million
relates to and is classified in discontinued operations. Included in these
charges was approximately $33.7 million related to the write-down of
inventories, and remaining warranty and purchase order commitments of which
34
approximately $8.6 million was reflected in cost of goods sold and $25.1 million
was reflected in discontinued operations. Additional charges incurred were
approximately $5.7 million related to severance and associated personnel costs,
$5.9 million related to the impairment of goodwill due to the sale of the power
product lines, $14.8 million related to the impairment of fixed assets, and
approximately $6.1 million related to lease terminations of factories and office
space and other shutdown expenses. Of these charges, approximately $7.5 million
is reflected in restructuring expense and $25.0 million is reflected in
discontinued operations. We offered terminated employees separation amounts in
accordance with our severance policy and provided the employees with specific
separation dates.
Write-off of in-process R&D. Acquired in-process research and development
totaling $18.8 million was written off in connection with the Arris Interactive
acquisition during the third quarter of 2001.
Amortization of Goodwill and Intangibles. Total goodwill amortization
expense for the years ended December 31, 2001 and 2000 was $3.3 million for each
year. Total intangibles amortization expense for the year ended December 31,
2001 was $7.0 million. The intangibles as of December 31, 2001 were acquired as
a result of the Arris Interactive acquisition in the third quarter 2001.
Interest Expense. Interest expense for the years ended December 31, 2001
and 2000 was $11.1 million and $12.2 million, respectively. Interest expense for
all periods reflects the cost of borrowings on our revolving line of credit,
amortization of deferred finance fees, and the interest paid on the 4 1/2%
convertible subordinated notes due 2003. As of December 31, 2001, we did not
have a balance outstanding under our credit facility, as compared to $89.0
million outstanding at December 31, 2000. For the year ended December 31, 2001,
the average interest rate on our outstanding line of credit borrowings was 7.2%
with an overall blended rate of approximately 5.2% including the subordinated
notes. For the year ended December 31, 2000, the average interest rate on the
company's outstanding line of credit borrowings was 7.9%, with an overall
blended rate of approximately 5.9% including the subordinated notes.
Membership Interest Expense. In conjunction with the acquisition of Arris
Interactive, we issued to Nortel Networks a subordinated redeemable Class B
membership interest in Arris Interactive with a face amount of $100.0 million.
This membership interest earns a return of 10% per annum, compounded annually.
For the year ended December 31, 2001, we recorded membership interest expense of
$4.1 million.
Loss on Debt Retirement. During 2001, we recorded pre-tax charges of $1.9
million on the extinguishment of debt in accordance with EITF 96-19, Debtor's
Accounting for a Modification or Exchange of Debt Instruments. The amount
reflected unamortized deferred finance fees related to a loan agreement, which
was replaced in connection with the Arris Interactive acquisition. In 2002, this
loss was reclassified to loss from continuing operations as a result of the gain
on cash repurchases recognized in the fourth quarter of 2002 in accordance with
SFAS No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections.
Loss on Investments. In 2000, we made a $1.0 million strategic investment
in Chromatis Networks, Inc., receiving shares of the company's preferred stock.
On June 28, 2000, Lucent Technologies acquired Chromatis. As a result of this
acquisition, our shares of Chromatis stock were converted into shares of Lucent
stock. Subsequently, as a result of Lucent's spin off of Avaya, Inc. during the
third quarter of 2000, we were issued shares of Avaya stock.
Because our investments in Lucent and Avaya stock are considered trading
securities held for resale, they are required to be carried at their fair market
value with any gains or losses being included in earnings. In calculating the
fair market value of the Lucent and Avaya investments and including $1.3 million
of impairment losses on investments available for sale in 2000, we recognized
pre-tax losses of $0.8 million for each year ended December 31, 2001 and 2000.
Loss (Gain) in Foreign Currency. During 2001, we recorded a foreign
currency gain of approximately $10 thousand, as compared to a loss of $(125)
thousand during 2000.
Other Expense (Income). Other expense (income) for the years ended
December 31, 2001 and 2000 was $8.1 million and $(1.4) million, respectively.
During 2001, we recorded an equity loss in Arris Interactive
35
of $8.6 million. The results of operations of Arris Interactive were
consolidated upon the acquisition of Nortel Networks' interest in Arris
Interactive in August 2001. Additionally, bank charges of approximately $1.1
million were recorded during 2001. These losses were offset with a gain on the
disposal of fixed assets of approximately $0.4 million, interest income of $0.9
million, and other miscellaneous income of $0.3 million. During 2000, we
recorded bank fees of $0.4 million. These expenses were offset with interest
income of $1.8 million during 2000.
Income Tax Expense. Income tax expense (benefit) for the year ended
December 31, 2001 was approximately $27.6 million, of which an expense of $35.6
million related to continuing operations and a benefit of $(8.0) related to
discontinued operations. For the year ended December 31, 2000, income tax
expense of approximately $14.3 million was recorded, of which $9.6 million
related to continuing operations and $4.7 million related to discontinued
operations. The increase in income tax expense in 2001 was due primarily to the
requirement to take a full valuation allowance against the deferred tax assets
as of the third quarter 2001.
Discontinued Operations. In accordance with SFAS No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets, our Actives and Keptel product
lines have been accounted for as discontinued operations and, where noted,
current and historical results have been reclassified accordingly. Revenues from
the discontinued operations were $119.3 million and $248.8 million for the years
ended December 31, 2001 and 2000, respectively. The income (loss) from
discontinued operations, net of taxes, for the years ending December 31, 2001
and 2000 was $(84.5) million and $6.8 million, respectively.
Net Income (Loss). A net loss of $(167.7) million or $(3.13) per diluted
share was recorded for the year ended December 31, 2001. The net loss from
continuing operations was $(83.3) million or $(1.55) per diluted share and the
net loss from discontinued operations was $(84.5) million or $(1.58) per diluted
share.
Net income of $20.7 million or $0.52 per diluted share was recorded for the
year ended December 31, 2000. The net income from continuing operations was
$13.9 million or $0.35 per diluted share and the net income from discontinued
operations was $6.8 million or $0.17 per diluted share.
MATERIAL COMMITMENTS
In the ordinary course of our business we enter into contracts with
landlords, suppliers and others that involve multi-year commitments on our part.
Note 13 to our Consolidated Financial Statements summarizes our commitments with
respect to real estate leases. Of those leases the most significant
(financially) is the lease for our headquarters in Duluth, Georgia. That lease
requires annual payments of $1.5 million, subject to adjustment, through 2009.
See Item 2, Properties for a discussion of other significant leases.
We also are party to various multi-year contracts with vendors. These
contracts generally do not require minimum purchases by us. The two most
significant of these are with Solectron and Mitsumi for contract manufacturing
and have been filed as exhibits to previous reports filed with the Securities
and Exchange Commission.
Lastly, we have several multi-year commitments that are not related to the
ordinary operation of our business. These include registration rights agreements
with Nortel Networks and Liberty Media as well as registration rights
obligations with Cadant. Although our monetary commitments under these
agreements may not be significant, they could impact our business in other ways
that investors might consider significant.
FINANCIAL LIQUIDITY AND CAPITAL RESOURCES
Overview
Our liquidity position is primarily the product of the cash flows that we
generate from operations and the funding available to us under our revolving
credit facility. During 2002, we continued to manage our inventory and other
current assets carefully and were able to generate substantial cash from our
business despite incurring an operating loss. In the future, we may not have the
same cash generating opportunities and may be more dependent upon cash generated
from operations and our revolving credit facility.
36
As discussed elsewhere, our operating results are dependent upon capital
expenditures by cable system operators, which were at reduced levels throughout
2001 and 2002. We believe industry capital spending for 2003 is likely to be
flat but concentrated in customers and products that should favor us to some
degree, and, as a result, we believe we will achieve more favorable results for
2003. If we are correct, we should generate sufficient funds from operations,
when combined with modest borrowing under our revolving credit facility, to meet
our operating liquidity needs. If not, we will need to borrow more funds.
As of December 31, 2002, we had outstanding $23.9 million of 4 1/2%
convertible subordinated notes due May 15, 2003, down from $115.0 million at
December 31, 2001. During the third and fourth quarters of 2002, we amended our
revolving credit facility to enable us to use our existing cash reserves to
retire these notes. We are continuing that process as the notes become available
in the market place. At the present time we have sufficient cash reserves to
retire these notes in full.
We have not paid cash dividends on our common stock since our inception.
Our credit agreement contains covenants that prohibit us from paying such
dividends. On October 3, 2002, to implement our shareholder rights plan, our
board of directors declared a dividend consisting of one right for each share of
our common stock outstanding at the close of business on October 25, 2002. Each
right represents the right to purchase one one-thousandth of a share of our
Series A Participating Preferred Stock and becomes exercisable only if a person
or group acquires beneficial ownership of 15% or more of our common stock or
announces a tender or exchange offer for 15% or more of our common stock or
under other similar circumstances.
Several key indicators of our liquidity are summarized in the following
table:
Liquidity Table
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
(DOLLARS IN MILLIONS)
Working capital............................................ $173.3 $250.0 $305.9
Current ratio.............................................. 2.4 3.1 2.7
Cash provided by operations................................ $117.3 $111.5 $ 4.7
Proceeds from issuance of common stock..................... $ 1.0 $ 1.1 $ 5.5
Capital expenditures....................................... $ (7.9) $ (9.6) $(15.5)
Borrowings (reductions) on debt obligations................ $(73.7) $(89.0) $ 20.5
Days sales outstanding..................................... 55.2 72.6 65.3
Inventory turnover......................................... 3.5 3.5 4.5
</Table>
Financing
In connection with the Arris Interactive acquisition in 2001, all of the
our existing bank indebtedness was refinanced. The facility, as subsequently
amended, is an asset-based revolving credit facility permitting us to borrow up
to $115.0 million, based upon availability under a borrowing base calculation.
In general, the borrowing base is limited to 85% of net eligible receivables
(with a cap of $5.0 million in relation to foreign receivables), subject to a
reserve of $10.0 million. In addition, upon obtaining appropriate asset
appraisals we may include in the borrowing base calculation 80% of the orderly
liquidation value of net eligible inventory (not to exceed $60.0 million). The
facility contains traditional financial covenants, including fixed charge
coverage, senior debt leverage, minimum net worth, and minimum inventory turns
ratios. The credit facility was amended in January 2003 to provide that the
minimum net worth covenant applied only to the period prior to December 31,
2002. The facility is secured by substantially all of our assets. The credit
facility has a maturity date of August 3, 2004. The commitment fee on unused
borrowings is 0.75%. The availability under the credit facility at December 31,
2002 was approximately $18.9 million, and we had no borrowings under the
facility.
37
The credit facility was modified in 2002 to allow the Company to use
existing cash reserves and proceeds of asset sales to purchase or redeem the
outstanding notes. These modifications imposed certain conditions on the use of
such cash to redeem additional notes including the requirement that, giving
effect to such purchase or redemption, (1) there must not be any event of
default, (2) no loans may be outstanding under the credit facility, and (3) the
Company must retain at least $50.0 million in cash on deposit in accounts
pledged as security for the credit facility. The Company met the applicable
conditions and was able to expend approximately $73.7 million in cash to redeem
approximately $75.7 million of notes. In order to redeem additional notes, the
Company must meet all of the conditions for such purchase. However, since the
Company had cash on hand of $98.4 million as of December 31, 2002, it
anticipates being able to meet such conditions.
On March 11, 2003, we amended our credit facility to permit the company to
issue up to $125.0 million of subordinated convertible notes due 2008, to use
the proceeds of such notes to redeem the Class B membership interest in Arris
Interactive held by Nortel Networks and to purchase shares of ARRIS common stock
held by Nortel Networks, subject to certain limitations. The amendment also
reduced the revolving loan commitments from $125.0 million to $115.0 million.
As of December 31, 2002, we had no borrowings outstanding under our credit
facility and $18.9 million of available capacity. We were in compliance with all
covenants contained in the credit facility.
Contractual Obligations and Commercial Commitments
Following is a summary of our contractual obligations and commercial
commitments, excluding routine items such as purchase orders, as of December 31,
2002:
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
----------------------------------------------
CONTRACTUAL OBLIGATIONS 1-3 YEARS 3-5 YEARS AFTER 5 YEARS TOTAL
- ----------------------- --------- --------- ------------- ------
(IN MILLIONS)
Current portion of long term debt(1).......... $23.9 $ -- $ -- $ 23.9
Operating leases.............................. 20.9 6.5 2.3 29.7
Sublease income............................... (2.2) -- -- (2.2)
Capital leases................................ 1.3 -- -- 1.3
Membership interest(2)........................ -- 114.5 -- 114.5
----- ------ ---- ------
Total contractual cash obligations............ $43.9 $121.0 $2.3 $167.2
===== ====== ==== ======
</Table>
- ---------------
(1) Between January 1, 2003 and March 10, 2003, we purchased approximately $12.4
million of our outstanding 4 1/2% convertible subordinated notes due 2003
for cash.
(2) In the first quarter of 2003, we raised $125.0 million from a convertible
note offering under Rule 144A. Approximately $88.4 million of the proceeds,
including the reduction in the forgiveness of the Class B membership
interest, were used to retire the Nortel Networks Class B membership
interest in Arris Interactive at a $28.5 million discount. We used
approximately $28.0 million of the proceeds of the issuance to repurchase
and retire 8 million shares of our common stock held by Nortel Networks at a
discount.
Cash Flow
Cash levels increased by approximately $93.1 million during 2002 as
compared to a decrease of approximately $3.5 million during 2001. Operating
activities in 2002 provided approximately $117.4 million in positive cash flow
and investing activities provided $51.2 million, while financing activities used
approximately $75.5 million in cash flow.
Operating activities provided cash of $117.4 million during the year ended
December 31, 2002. A net loss used $191.2 million in cash flow during this
period. Other non-cash items, including depreciation, amortization, provisions
for doubtful accounts, loss on investments, loss on debt retirement, a net loss
on sales of
38
product lines, loss on disposal of fixed assets, impairment of goodwill, and the
cumulative effect of an accounting change, accounted for positive adjustments of
approximately $244.0 million during 2002. Decreases in accounts receivable,
other receivables, inventory, and income taxes recoverable provided positive
cash flows of $91.8 million; and an increase in accrued membership interest
provided positive cash flows of $10.4 million. These net cash inflows were
offset by a decrease in accounts payable and accrued liabilities of $36.8
million, and an aggregate change in various other assets and liabilities of $0.9
million during the year ended December 31, 2002.
Operating activities provided cash of $111.5 million during the year ended
December 31, 2001. A net loss used $167.7 million in cash flow during this
period. Other non-cash items, including depreciation, amortization, provisions
for doubtful accounts, deferred income taxes, a loss on an equity investment, a
gain on the disposal of fixed assets, a write-off of in-process R&D, impairment
of fixed assets, a write-down of inventory, and a loss on investments accounted
for positive adjustments of approximately $147.5 million during 2001. Decreases
in accounts receivable, inventory, and income taxes recoverable provided
positive cash flows of $161.6 million; and an aggregate change in various other
assets and liabilities provided positive cash of $0.8 million. An increase in
accrued membership interest provided positive cash flows of $4.1 million. These
net cash inflows were offset by an increase in other receivables of $10.1
million and a decrease in accounts payable and accrued liabilities of $24.6
million through December 31, 2001.
Days sales outstanding ("DSO") was approximately 55 days during the year
ended December 31, 2002 as compared to 73 days during 2001.
Inventory at December 31, 2002 was $104.2 million, as compared to $137.1
million at December 31, 2001. Additionally, inventory related to discontinued
operations at December 31, 2001 was $53.8 million. The net inventory decrease,
including inventories of discontinued operations, was $86.7 million for the
twelve months ended December 31, 2002. Of this decrease, approximately $33.9
million related to inventory sold to the buyers of the Keptel and Actives
product lines, which was offset by an adjustment to Cadant purchase price of
$0.6 million. The net result was an inventory reduction of $53.4 million from
ongoing operations during the year ended December 31, 2002. Inventory levels
related to operating activities during 2001 decreased by approximately $125.9
million, net of the effects of the acquisition and the inventory write-downs in
the third quarter of 2001. This inventory decrease was reflective of the abrupt
slow down in our business late in 2000. Changes in both the financial markets in
general and in the telecommunications equipment market specifically, created a
slow down in capital spending by our customers late in 2000. With these events
unfolding during the fourth quarter, we were unable to adjust our inventory
levels to account for the delays in equipment spending from key customers.
Inventory turns remained level during 2002 and 2001, with 3.5 turns recorded for
each year.
A decrease in accounts payable and accrued liabilities used approximately
$36.8 million, while an increase in accrued membership interest provided $10.4
million in cash during 2002. Accounts payable and accrued liabilities used
approximately $24.6 million in cash while an increase in accrued membership
interest provided $4.1 million in cash during 2001.
Cash flows provided by investing activities were $51.2 million for the year
ended December 31, 2002, as compared to a net cash use of $19.3 million for the
same period in 2001. The investments made during 2002 included approximately
$7.9 million to purchase capital assets and $0.9 million in funds paid for the
Cadant acquisition, net of the cash acquired in the transaction. These outlays
were offset with cash proceeds of $60.0 million in connection with the disposals
of the Keptel and Actives product lines. The investments during 2001 included
$9.6 million spent on capital assets, $6.9 million in funds paid for the Arris
Interactive acquisition, and approximately $3.9 million spent in strategic
investments. These cash outflows were partially offset with cash proceeds of
$1.1 million from the sale of property and equipment.
Cash flows used in financing activities were $75.5 million for the year
ended December 31, 2002 as compared to a cash use of $95.7 million for the same
period in 2001. During 2002, we used approximately $73.7 million of cash to
purchase $75.7 million in 4 1/2% convertible subordinated notes. Also during
2002, we paid approximately $0.9 million in capital lease payments, $1.7 million
in deferred financing fees, and $0.1 million to repurchase director stock units.
During 2001, we paid down approximately $89.0 million on our
39
credit facility, whereas in 2002 we had no balance outstanding on our revolving
debt. Financing fees of $7.8 million were paid in 2001. The results for both
2002 and 2001 were affected by the issuance of common stock that provided
positive cash flows of approximately $1.0 million and $1.1 million,
respectively.
Interest Rates
As of December 31, 2002, we did not have any floating rate indebtedness. At
December 31, 2002, we did not have any outstanding interest rate swap
agreements.
Foreign Currency
A significant portion of our products are manufactured or assembled in
Mexico, the Philippines, and other countries outside the United States. Our
sales into international markets have been and are expected in the future to be
an important part of our business. These foreign operations are subject to the
usual risks inherent in conducting business abroad, including risks with respect
to currency exchange rates, economic and political destabilization, restrictive
actions and taxation by foreign governments, nationalization, the laws and
policies of the United States affecting trade, foreign investment and loans, and
foreign tax laws.
We have certain international customers who are billed in their local
currency. The monetary value of this business has increased since the
acquisition of Arris Interactive and its corresponding international customer
base formerly served through Nortel Networks. Since the acquisition of Arris
Interactive, the monetary exchange fluctuations from the time of invoice to the
time of payment have not been significant. However, during the second quarter of
2002, the euro increased in value relative to the US dollar enough to cause a
significant foreign exchange gain. Beginning in the third quarter of 2002, we
implemented a hedging strategy and entered into forward contracts based on a
percentage of expected foreign currency receipts. The percentage can vary, based
on the predictability of cash receipts. In July 2002, we entered into five
forward contracts for approximately 31.0 million euros with expirations from
August to December 2002. We will periodically review our accounts receivable in
foreign currency and purchase additional forward contracts when appropriate. As
of December 31, 2002, we had one foreign currency forward purchase contract
outstanding. The contract was entered into on December 26, 2002 for 250.0
million Yen and was due January 31, 2003. The contract was taken out in
anticipation of receiving a substantial yen payment from one of our customers,
which we received on a timely basis. The fair value adjustment at December 31,
2002 was not significant.
Financial Instruments
In the ordinary course of business, we, from time to time, will enter into
financing arrangements with customers. These financial instruments include
letters of credit, commitments to extend credit and guarantees of debt. These
agreements could include the granting of extended payment terms that result in
longer collection periods for accounts receivable and slower cash inflows from
operations and/or could result in the deferral of revenue. As of December 31,
2002, we had approximately $3.0 million outstanding under letters of credit with
our banks.
Investments
In the ordinary course of business, we may make strategic investments in
the equity securities of various companies, both public and private. We hold
certain investments in the common stock of publicly traded companies totaling
approximately $0.1 million and $0.8 million at December 31, 2002 and 2001,
respectively, which are classified as trading securities. Changes in the market
value of these securities and gains or losses on related sales of these
securities are recognized in income. We recorded pre-tax losses of approximately
$0.6 million and $0.8 million during the years ended December 31, 2002 and 2001,
respectively, related to these investments.
We hold certain additional investments in the common stock of publicly
traded companies totaling approximately $1.8 million and $2.1 million at
December 31, 2002 and 2001, respectively, which are classified as available for
sale. In addition, we hold a number of non-marketable equity securities totaling
approximately
40
$2.8 million and $12.0 million at December 31, 2002 and 2001, respectively,
which are classified as available for sale. At December 31, 2002 and 2001, we
had unrealized losses related to these available for sale securities of
approximately $0 and $3.2 million, respectively, included in comprehensive
income. During the years ended December 31, 2002, 2001, and 2000, we recorded
impairment charges of approximately $13.5 million, $0, and $1.3 million on its
available for sale securities as a result of market value declines considered by
management to be other than temporary.
We offer a deferred compensation arrangement, which allows certain
employees to defer a portion of their earnings and defer the related income
taxes. These deferred earnings are invested in a "rabbi trust", and are
accounted for in accordance with Emerging Issues Task Force 97-14, Accounting
for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi
Trust and Invested. A rabbi trust is a funding vehicle used to protect deferred
compensation benefits from events (other than bankruptcy). The investment in the
rabbi trust is classified as a current asset on our balance sheet. During the
year ended December 31, 2002, we recognized a loss of approximately $0.8 million
in connection with realized losses on the related investments.
Capital Expenditures
Capital expenditures are made at a level designed to support the strategic
and operating needs of the business. ARRIS' capital expenditures were $7.9
million in 2002 as compared to $9.6 million in 2001 and $15.5 million in 2000.
ARRIS had no significant commitments for capital expenditures at December 31,
2002. Management expects to invest approximately $8.0 million in capital
expenditures for the year 2003.
Net Operating Loss Carryforwards
As of December 31, 2002, ARRIS had net operating loss ("NOL") carryforwards
for domestic and foreign income tax purposes of approximately $78.2 million and
$6.9 million, respectively. We established a valuation allowance against
deferred tax assets in accordance with the provisions of SFAS No. 109,
Accounting for Income Taxes during 2001. We continually review the adequacy of
the valuation allowance and recognize the benefits only as reassessment
indicates that it is more likely than not that the benefits will be realized.
The availability of tax benefits of NOL carryforwards to reduce ARRIS'
federal and state income tax liability is subject to various limitations under
the Internal Revenue Code. The availability of tax benefits of NOL carryforwards
to reduce ARRIS' foreign income tax liability is subject to the various tax
provisions of the respective countries.
As of December 31, 2002, tax benefits arising from NOL carryforwards of
approximately $2.4 million, originating prior to TSX's quasi-reorganization,
will be credited directly to additional paid-in capital if and when realized.
FORWARD-LOOKING STATEMENTS
Certain information and statements contained in this Management's
Discussion and Analysis of Financial Condition and Results of Operations and
other sections of this report, including statements using terms such as "may,"
"expect," "anticipate," "intend," "estimate," "believe," "plan," "continue,"
"could be," or similar variations or the negative thereof, constitute
forward-looking statements with respect to the financial condition, results of
operations, and business of ARRIS, including statements that are based on
current expectations, estimates, forecasts, and projections about the markets in
which we operate and management's beliefs and assumptions regarding these
markets. These and any other statements in this document that are not statements
about historical facts are "forward-looking statements." We caution investors
that forward-looking statements made by us are not guarantees of future
performance and that a variety of factors could cause our actual results to
differ materially from the anticipated results or other expectations expressed
in our forward-looking statements. Important factors that could cause results or
events to differ from current expectations are described in the risk factors
below. These factors are not intended to be an all-encompassing list of risks
and uncertainties that may affect the operations, performance, development and
results of our
41
business. In providing forward-looking statements, ARRIS expressly disclaims any
obligation to update publicly or otherwise these statements, whether as a result
of new information, future events or otherwise except to the extent required by
law.
RISK FACTORS
OUR BUSINESS IS DEPENDENT ON CUSTOMERS' CAPITAL SPENDING ON BROADBAND
COMMUNICATION SYSTEMS, AND REDUCTIONS BY CUSTOMERS IN CAPITAL SPENDING COULD
ADVERSELY AFFECT OUR BUSINESS.
Our performance has been largely dependent on customers' capital spending
for constructing, rebuilding, maintaining or upgrading broadband communications
systems. Capital spending in the telecommunications industry is cyclical. A
variety of factors will affect the amount of capital spending, and therefore,
our sales and profits, including:
- general economic conditions;
- availability and cost of capital;
- other demands and opportunities for capital;
- regulations;
- demands for network services;
- competition and technology; and
- real or perceived trends or uncertainties in these factors.
Developments in the industry and in the capital markets over the past two
years have reduced access to funding for new and existing customers, causing
delays in the timing and scale of deployments of our equipment, as well as the
postponement or cancellation of certain projects by our customers. In addition,
during the same period, we and other vendors received notification from several
customers that they were canceling new projects or scaling back existing
projects or delaying new orders to allow them to reduce inventory levels which
were in excess of their current deployment requirements.
Further, several of our customers have accumulated significant levels of
debt and have recently announced, or are expected to announce, financial
restructurings, including bankruptcy filings. For example, Adelphia has been
operating under bankruptcy since the first half of 2002. Even if the financial
health of that company and other customers improve, we cannot assure you that
these customers will be in a position to purchase new equipment at levels we
have seen in the past. In addition, the bankruptcy filing of Adelphia in June
2002 has further heightened concerns in the financial markets about the domestic
cable industry. The concern, coupled with the current uncertainty and volatile
capital markets, has affected the market values of domestic cable operators and
may further restrict their access to capital.
DEVELOPMENTS RELATING TO CABOVISAO MAY ADVERSELY AFFECT OUR BUSINESS AND RESULTS
OF OPERATIONS.
Cabovisao, a Portugal-based MSO, accounted for approximately 6% of our
total sales in 2002. As of March 10, 2003, Cabovisao owed us 18.6 million euros
in accounts receivable. Cabovisao committed to a schedule of 2003 payments to us
for our products and services. Cabovisao made its January 2003 payment of 2.0
million euros to us according to the schedule. However, Cabovisao failed to make
the scheduled 2.5 million euros February payment to us by its due date. On March
1, 2003, Cabovisao's parent company, CSii, issued a press release that suggested
it may have difficulty in accessing or refinancing its senior credit facility
and that its bankers again extended the waivers pertaining to the maturity date
of its credit facility until March 26, 2003. CSii also indicated that it would
not make the scheduled March 3, 2003 interest payment on its senior unsecured
notes. The announcement further indicated that CSii had formed a special board
committee to consider alternatives to meet its financial needs, including debt
restructuring or a possible court-supervised restructuring, among other
alternatives. We will not deliver further products to Cabovisao until we have a
satisfactory payment plan with Cabovisao and are considering what actions should
be taken regarding
42
the situation. We cannot assure you that Cabovisao will pay us according to any
schedule or that it will continue to place orders with us in the future.
THE MARKETS IN WHICH WE OPERATE ARE INTENSELY COMPETITIVE, AND COMPETITIVE
PRESSURES MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.
The markets for broadband communication systems are extremely competitive
and dynamic, requiring the companies that compete in these markets to react
quickly and capitalize on change. This will require us to retain skilled and
experienced personnel as well as deploy substantial resources toward meeting the
ever-changing demands of the industry. We compete with national and
international manufacturers, distributors and wholesalers including many
companies larger than us. Our major competitors include:
- ADC Telecommunications, Inc.;
- Broadband Services, Inc.;
- Cisco Systems, Inc.;
- Juniper Networks, Inc.;
- Motorola, Inc.;
- Riverstone Networks, Inc.;
- Scientific-Atlanta, Inc.;
- Tellabs, Inc.;
- Terayon Communications Systems, Inc.; and
- TVC Communications, Inc.
The rapid technological changes occurring in the broadband markets may lead
to the entry of new competitors, including those with substantially greater
resources than ours. Because the markets in which we compete are characterized
by rapid growth and, in some cases, low barriers to entry, smaller niche market
companies and start-up ventures also may become principal competitors in the
future. Actions by existing competitors and the entry of new competitors may
have an adverse effect on our sales and profitability. The broadband
communications industry is further characterized by rapid technological change.
In the future, technological advances could lead to the obsolescence of some of
our current products, which could have a material adverse effect on our
business.
Further, many of our larger competitors are in a better position to
withstand any significant reduction in capital spending by customers in these
markets. They often have broader product lines and market focus and therefore
will not be as susceptible to downturns in a particular market. In addition,
several of our competitors have been in operation longer than we have been, and
therefore they have more long-standing and established relationships with
domestic and foreign broadband service users. We may not be able to compete
successfully in the future, and competition may harm our business.
OUR BUSINESS HAS PRIMARILY COME FROM SEVERAL KEY CUSTOMERS. THE LOSS OF ONE OF
THESE CUSTOMERS OR A SIGNIFICANT REDUCTION IN SERVICES TO ONE OF THESE CUSTOMERS
WOULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS.
Our two largest customers are Comcast (primarily through the recently
acquired AT&T Broadband business) and Cox Communications. For the year ended
December 31, 2002, sales to Comcast (including AT&T Broadband) accounted for
approximately 38.4% of our total revenues, while sales to Cox Communications
accounted for approximately 16.4%. We currently are the exclusive provider of
telephony products for both Cox Communications and, in eight metro areas,
Comcast, as successor to AT&T Broadband. In addition, we have two other
customers who accounted for more than 5% each of our total revenues for the year
ended December 31, 2002, one of which is Cabovisao. The loss of Comcast, Cox
Communications or one of our other large customers, or a significant reduction
in the services provided to any of them would have a material
43
adverse impact on our business. In addition, as a result of the merger of
Comcast with AT&T Broadband in late 2002, we may experience possible
interruptions in purchasing by the resulting Comcast company in 2003.
OUR CREDIT FACILITY IMPOSES FINANCIAL COVENANTS THAT MAY ADVERSELY AFFECT THE
REALIZATION OF OUR STRATEGIC OBJECTIVES.
We and certain of our subsidiaries have entered into a revolving credit
facility providing for borrowing up to a committed amount of $115.0 million, as
amended in March 2003, with borrowing also limited by a borrowing base
determined by reference to eligible accounts receivable and, subject to certain
conditions, eligible inventory. As of December 31, 2002, the borrowing base was
$18.9 million. The credit facility imposes, among other things, covenants
limiting the incurrence of additional debt and liens and requires us to meet
certain financial objectives. The credit facility has a maturity date of August
3, 2004. As of March 16, 2003, we had no borrowings outstanding under the credit
facility, and our borrowing base was $15.9 million. Any acceleration of the
maturity date of the credit facility could have a material adverse effect on our
business.
The credit facility was modified on several occasions during 2002 to allow
us to use existing cash reserves and proceeds of asset sales to purchase or
redeem the outstanding 4 1/2% convertible subordinated notes. These
modifications imposed certain conditions on the use of such cash to purchase or
redeem additional 4 1/2% notes. We recently amended our credit facility to
permit the redemption of the Nortel Networks' membership interest and to
repurchase a limited number of shares of our common stock from Nortel Networks,
subject to certain conditions.
WE HAVE SIGNIFICANT STOCKHOLDERS THAT MAY NOT ACT CONSISTENTLY WITH THE
INTERESTS OF OUR OTHER STOCKHOLDERS.
As of March 25, 2003, Nortel Networks owned approximately 18.8% of our
common stock and Liberty Media Group beneficially owned approximately 10.3% of
our common stock. These respective ownership interests result in both Nortel
Networks and Liberty Media having a significant influence over us. Nortel
Networks and Liberty Media may exert their respective influences or sell their
respective shares at a time or in a manner that is inconsistent with the
interests of our other stockholders.
Any sales of substantial amounts of our common stock in the public market,
or the perception that such sales might occur, could have a depressive effect on
the market price of our common stock.
WE HAVE ANTI-TAKEOVER DEFENSES THAT COULD DELAY OR PREVENT AN ACQUISITION OF OUR
COMPANY.
On October 3, 2002, our board of directors approved the adoption of a
shareholder rights plan (commonly known as a "poison pill"). This plan is not
intended to prevent a takeover, but is intended to protect and maximize the
value of shareholders' interests. This poison pill could make it more difficult
for a third party to acquire us or may delay that process.
WE MAY DISPOSE OF EXISTING PRODUCT LINES OR ACQUIRE NEW PRODUCT LINES IN
TRANSACTIONS THAT MAY ADVERSELY IMPACT US AND OUR FUTURE RESULTS.
On an ongoing basis, we evaluate our various product offerings in order to
determine whether any should be sold or closed and whether there are businesses
that we should pursue acquiring. Future acquisitions and divestitures entail
various risks, including:
- the risk that acquisitions will not be integrated or otherwise perform as
expected;
- the risk that we will not be able to find a buyer for a product line
while product line sales and employee morale will have been damaged
because of general awareness that the product line is for sale; and
- the risk that the purchase price obtained will not be equal to the book
value of the assets for the product line that we sell.
44
PRODUCTS CURRENTLY UNDER DEVELOPMENT MAY FAIL TO REALIZE ANTICIPATED BENEFITS.
Rapidly changing technologies, evolving industry standards, frequent new
product introductions and relatively short product life cycles characterize the
markets for our products. The technology applications currently under
development by us may not be successfully developed. Even if the developmental
products are successfully developed, they may not be widely used or we may not
be able to successfully exploit these technology applications. To compete
successfully, we must quickly design, develop, manufacture and sell new or
enhanced products that provide increasingly higher levels of performance and
reliability. However, we may not be able to successfully develop or introduce
these products if our products:
- are not cost-effective;
- are not brought to market in a timely manner;
- fail to achieve market acceptance; or
- fail to meet industry certification standards.
Furthermore, our competitors may develop similar or alternative new
technology applications that, if successful, could have a material adverse
effect on us. Our strategic alliances are based on business relationships that
have not been the subject of written agreements expressly providing for the
alliance to continue for a significant period of time. The loss of a strategic
partner could have a material adverse effect on the progress of new products
under development with that partner.
CONSOLIDATIONS IN THE TELECOMMUNICATIONS INDUSTRY COULD RESULT IN DELAYS OR
REDUCTIONS IN PURCHASES OF PRODUCTS, WHICH WOULD HAVE A MATERIAL ADVERSE EFFECT
ON OUR BUSINESS.
The telecommunications industry has experienced the consolidation of many
industry participants, and this trend is expected to continue. We and one or
more of our competitors may each supply products to businesses that have merged,
such as AT&T Broadband and Comcast, or will merge in the future. Consolidations
could result in delays in purchasing decisions by the merged businesses, and we
could play either a greater or lesser role in supplying the communications
products to the merged entity. These purchasing decisions of the merged
companies could have a material adverse effect on our business. For example, we
experienced delays while the Comcast and AT&T Broadband deal was pending.
Mergers among the supplier base also have increased, and this trend may
continue. The larger combined companies with pooled capital resources may be
able to provide solution alternatives with which we would be put at a
disadvantage to compete. The larger breadth of product offerings by these
consolidated suppliers could result in customers electing to trim their supplier
base for the advantages of one-stop shopping solutions for all of their product
needs. Consolidation of the supplier base could have a material adverse effect
on our business.
OUR SUCCESS DEPENDS IN LARGE PART ON OUR ABILITY TO ATTRACT AND RETAIN QUALIFIED
PERSONNEL IN ALL FACETS OF OUR OPERATIONS.
Competition for qualified personnel is intense, and we may not be
successful in attracting and retaining key executives, marketing, engineering
and sales personnel, which could impact our ability to maintain and grow our
operations. Our future success will depend, to a significant extent, on the
ability of our management to operate effectively. In the past, competitors and
others have attempted to recruit our employees and in the future, their attempts
may continue. The loss of services of any key personnel, the inability to
attract and retain qualified personnel in the future or delays in hiring
required personnel, particularly engineers and other technical professionals,
could negatively affect our business.
WE ARE SUBSTANTIALLY DEPENDENT ON CONTRACT MANUFACTURERS, AND AN INABILITY TO
OBTAIN ADEQUATE AND TIMELY DELIVERY OF SUPPLIES COULD ADVERSELY AFFECT OUR
BUSINESS.
Many components, subassemblies and modules necessary for the manufacture or
integration of our products are obtained from a sole supplier or a limited group
of suppliers. Our reliance on sole or limited suppliers, particularly foreign
suppliers, and our reliance on subcontractors involves several risks including a
45
potential inability to obtain an adequate supply of required components,
subassemblies or modules and reduced control over pricing, quality and timely
delivery of components, subassemblies or modules. Historically, we have not
generally maintained long-term agreements with any of our suppliers or
subcontractors. An inability to obtain adequate deliveries or any other
circumstance that would require us to seek alternative sources of supply could
affect our ability to ship products on a timely basis. Any inability to reliably
ship our products on time could damage relationships with current and
prospective customers and harm our business.
OUR INTERNATIONAL OPERATIONS MAY BE ADVERSELY AFFECTED BY ANY DECLINE IN THE
DEMAND FOR BROADBAND SYSTEMS DESIGNS AND EQUIPMENT IN INTERNATIONAL MARKETS.
Sales of broadband communications equipment into international markets are
an important part of our business. The entire line of our products is marketed
and made available to existing and potential international customers. In
addition, United States broadband system designs and equipment are increasingly
being employed in international markets, where market penetration is relatively
lower than in the United States. While international operations are expected to
comprise an integral part of our future business, international markets may no
longer continue to develop at the current rate, or at all. We may fail to
receive additional contracts to supply equipment in these markets.
OUR INTERNATIONAL OPERATIONS MAY BE ADVERSELY AFFECTED BY CHANGES IN THE FOREIGN
LAWS IN THE COUNTRIES IN WHICH WE HAVE MANUFACTURING OR ASSEMBLY PLANTS.
A significant portion of our products are manufactured or assembled in
Mexico and the Philippines and other countries outside of the United States. The
governments of the foreign countries in which our products are manufactured may
pass laws that impair our operations, such as laws that impose exorbitant tax
obligations or nationalize these manufacturing facilities.
WE FACE RISKS RELATING TO CURRENCY FLUCTUATIONS AND CURRENCY EXCHANGE.
We may encounter difficulties in converting our earnings from international
operations to U.S. dollars for use in the United States. These obstacles may
include problems moving funds out of the countries in which the funds were
earned and difficulties in collecting accounts receivable in foreign countries
where the usual accounts receivable payment cycle is longer.
We are exposed to various market risk factors such as fluctuating interest
rates and changes in foreign currency rates. These risk factors can impact
results of operations, cash flows and financial position. We manage these risks
through regular operating and financing activities and periodically use
derivative financial instruments such as foreign exchange forward contracts.
There can be no assurance that our risk management strategies will be effective.
OUR PROFITABILITY HAS BEEN, AND MAY CONTINUE TO BE, VOLATILE, WHICH COULD
ADVERSELY AFFECT THE PRICE OF OUR STOCK.
We have experienced several years with significant operating losses.
Although we have been profitable in the past, we may not be profitable or meet
the level of expectations of the investment community in the future, which could
have a material adverse impact on our stock price. In addition, our operating
results may be adversely affected by timing of sales or a shift in our product
mix.
WE MAY FACE HIGHER COSTS ASSOCIATED WITH PROTECTING OUR INTELLECTUAL PROPERTY.
Our future success depends in part upon our proprietary technology, product
development, technological expertise and distribution channels. We cannot
predict whether we can protect our technology or whether competitors can develop
similar technology independently. We have received and may continue to receive
from third parties, including some of our competitors, notices claiming that we
have infringed upon third-party patents or other proprietary rights. Any of
these claims, whether with or without merit, could result in costly litigation,
divert the time, attention and resources of our management, delay our product
shipments, or require us to enter into royalty or licensing agreements. If a
claim of product infringement against us is successful and we fail to obtain a
license or develop non-infringing technology, our business and operating results
could be adversely affected.
46
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including interest rates and
foreign currency rates. The following discussion of our risk-management
activities includes "forward-looking statements" that involve risks and
uncertainties. Actual results could differ materially from those projected in
the forward-looking statements.
In the past, we have used interest rate swap agreements, with large
creditworthy financial institutions, to manage our exposure to interest rate
changes. These swaps would involve the exchange of fixed and variable interest
rate payments without exchanging the notional principal amount. During the year
ended December 31, 2002, we did not have any outstanding interest rate swap
agreements.
A significant portion of our products are manufactured or assembled in
Mexico, the Philippines, and other countries outside the United States. Our
sales into international markets have been and are expected in the future to be
an important part of our business. These foreign operations are subject to the
usual risks inherent in conducting business abroad, including risks with respect
to currency exchange rates, economic and political destabilization, restrictive
actions and taxation by foreign governments, nationalization, the laws and
policies of the United States affecting trade, foreign investment and loans, and
foreign tax laws.
We have certain international customers who are billed in their local
currency. The monetary value of this business has increased since the
acquisition of Arris Interactive and its corresponding international customer
base formerly served through Nortel Networks. Changes in the monetary exchange
rates may adversely affect our results of operations and financial condition. To
manage the volatility relating to these typical business exposures, we may enter
into various derivative transactions, when appropriate. We do not hold or issue
derivative instruments for trading or other speculative purposes. The euro is
the predominant currency of those customers who are billed in their local
currency. Taking into account the effects of foreign currency fluctuations of
the euro versus the dollar, a hypothetical 10% weakening of the U.S. dollar (as
of December 31, 2002) would provide a gain on foreign currency of approximately
$2.7 million. Conversely, a hypothetical 10% strengthening of the U.S. dollar
would provide a loss on foreign currency of approximately $2.7 million. As of
December 31, 2002, we had no material contracts, other than accounts receivable,
denominated in foreign currencies.
We will periodically review our accounts receivable in foreign currency and
purchase additional forward contracts when appropriate. As of December 31, 2002,
we had one foreign currency forward purchase contract outstanding. The contract
was entered into on December 26, 2002 for 250.0 million Yen and was due January
31, 2003. The contract was taken out in anticipation of receiving a substantial
yen payment from one of our customers, which we received on a timely basis. The
fair value adjustment at December 31, 2002 was not significant.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The report of independent auditors and consolidated financial statements
and notes thereto for the Company are included in this Report and are listed in
the Index to Consolidated Financial Statements.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
N/A
47
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<Table>
<Caption>
PAGE
----
Report of Ernst & Young LLP, Independent Auditors........... 49
Consolidated Balance Sheets at December 31, 2002 and 2001... 50
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000.......................... 51
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000.......................... 52
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2002, 2001 and 2000.............. 53
Notes to the Consolidated Financial Statements.............. 54
</Table>
48
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
To the Board of Directors and Stockholders
ARRIS Group, Inc.
We have audited the accompanying consolidated balance sheets of ARRIS
Group, Inc. as of December 31, 2002 and 2001 and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2002. Our audits also included the
financial statement schedule listed in the Index at Item 15(a). These financial
statements and schedule are the responsibility of ARRIS' management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, based on our audits, the consolidated financial statements
referred to above present fairly, in all material respects, the consolidated
financial position of ARRIS Group, Inc. at December 31, 2002 and 2001, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein.
As discussed in Note 3 of the Notes to the Consolidated Financial
Statements, the Company adopted Statement of Financial Accounting Standards No.
142, Goodwill and Other Intangible Assets, Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, and Statement of Financial Accounting Standards No. 146, Accounting for
Costs Associated with Exit or Disposal Activities in 2002.
/s/ ERNST & YOUNG LLP
Atlanta, Georgia
February 4, 2003, except for Note 19,
as to which the date is March 24, 2003
49
ARRIS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
<Table>
<Caption>
DECEMBER 31,
--------------------
2002 2001
--------- --------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 98,409 $ 5,337
Accounts receivable (net of allowances for doubtful
accounts of $10,698 in 2002 and $9,409 in 2001)......... 78,743 118,264
Accounts receivable from Nortel Networks.................. 2,212 18,857
Other receivables......................................... 3,154 10,049
Inventories............................................... 104,203 137,132
Income taxes recoverable.................................. -- 5,066
Investments held for resale............................... 137 795
Current assets -- discontinued operations................. -- 64,835
Other current assets...................................... 14,834 19,185
--------- --------
Total current assets............................... 301,692 379,520
Property, plant and equipment (net of accumulated
depreciation of $44,810 in 2002 and $19,600 in 2001)...... 34,540 41,623
Goodwill (net of accumulated amortization of $0 in 2002 and
$56,430 in 2001).......................................... 151,265 259,062
Intangibles (net of accumulated amortization of $41,506 in
2002 and $7,012 in 2001).................................. 64,843 44,488
Investments................................................. 4,594 14,037
Other assets................................................ 6,478 13,385
--------- --------
$ 563,412 $752,115
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 24,253 $ 18,620
Accrued compensation, benefits and related taxes.......... 23,423 32,747
Accounts payable and accrued expenses -- Nortel
Networks................................................ 11,303 25,411
Current portion of long-term debt......................... 23,887 --
Current portion of capital lease obligations.............. 1,120 --
Other accrued liabilities................................. 44,360 41,684
--------- --------
Total current liabilities.......................... 128,346 118,462
Capital lease obligations, net of current portion........... 158 --
Long-term debt.............................................. -- 115,000
--------- --------
Total liabilities.................................. 128,504 233,462
Membership interest -- Nortel Networks...................... 114,518 104,110
--------- --------
Total liabilities & membership interest............ 243,022 337,572
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; 82.5 million and 75.2 million shares
issued and outstanding in 2002 and 2001, respectively... 831 755
Capital in excess of par value............................ 603,563 507,650
Accumulated deficit....................................... (281,329) (90,162)
Unrealized holding gain (loss) on marketable securities... 227 (3,211)
Unearned compensation..................................... (1,649) (577)
Unfunded pension losses................................... (1,219) --
Cumulative translation adjustments........................ (34) 88
--------- --------
Total stockholders' equity......................... 320,390 414,543
--------- --------
$ 563,412 $752,115
========= ========
</Table>
See accompanying notes to the consolidated financial statements.
50
ARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
2002 2001 2000
----------- ----------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net sales (includes sales to Nortel Networks of $3.2
million, $23.4 million and $1.6 million for the years
ended December 31, 2002, 2001, and 2000, respectively)... $ 651,883 $ 628,323 $749,972
Cost of sales.............................................. 425,231 479,663 624,720
--------- --------- --------
Gross profit............................................. 226,652 148,660 125,252
Operating expenses:
Selling, general, administrative and development
expenses.............................................. 200,574 129,743 86,721
In-process R&D write-off................................. -- 18,800 --
Restructuring and impairment charges..................... 7,113 11,602 --
Impairment of goodwill................................... 70,209 -- --
Amortization of goodwill................................. -- 3,256 3,300
Amortization of intangibles.............................. 34,494 7,012 --
--------- --------- --------
312,390 170,413 90,021
--------- --------- --------
Operating income (loss).................................... (85,738) (21,753) 35,231
Other expense (income):
Interest expense......................................... 8,383 11,068 12,184
Membership interest...................................... 10,409 4,110 --
Loss on debt retirement.................................. 7,302 1,853 --
Loss on investments...................................... 14,894 767 773
(Gain) loss on foreign currency.......................... (5,739) (10) 125
Other expense (income), net.............................. 226 8,130 (1,396)
--------- --------- --------
Income (loss) from continuing operations before income
taxes.................................................... (121,213) (47,671) 23,545
Income tax expense (benefit)............................... (6,800) 35,588 9,622
--------- --------- --------
Net income (loss) from continuing operations............... (114,413) (83,259) 13,923
Discontinued Operations:
Income (loss) from discontinued operations (including a
net loss on disposals of $4.0 million for the year
ended December 31, 2002).............................. (18,794) (92,441) 11,409
Income tax expense (benefit)............................. -- (7,969) 4,663
--------- --------- --------
Income (loss) from discontinued operations............ (18,794) (84,472) 6,746
--------- --------- --------
Net income (loss) before cumulative effect of an accounting
change................................................... (133,207) (167,731) 20,669
Cumulative effect of an accounting change -- goodwill...... 57,960 -- --
--------- --------- --------
Net income (loss)................................... $(191,167) $(167,731) $ 20,669
========= ========= ========
Net income (loss) per common share:
Basic:
Income (loss) from continuing operations.............. $ (1.40) $ (1.55) $ 0.37
Income (loss) from discontinued operations............ (0.23) (1.58) 0.18
Cumulative effect of an accounting change............. (0.71) -- --
--------- --------- --------
Net income (loss)................................... $ (2.33) $ (3.13) $ 0.54
========= ========= ========
Diluted:
Income (loss) from continuing operations.............. $ (1.40) $ (1.55) $ 0.35
Income (loss) from discontinued operations............ (0.23) (1.58) 0.17
Cumulative effect of an accounting change............. (0.71) -- --
--------- --------- --------
Net (loss) income................................... $ (2.33) $ (3.13) $ 0.52
========= ========= ========
Weighted average common shares:
Basic.................................................... 81,934 53,624 37,965
========= ========= ========
Diluted.................................................. 81,934 53,624 39,571
========= ========= ========
</Table>
See accompanying notes to the consolidated financial statements.
51
ARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
---------------------------------
2002 2001 2000
--------- --------- ---------
(IN THOUSANDS)
Operating activities:
Net (loss) income.......................................... $(191,167) $(167,731) $ 20,669
Adjustments to reconcile net (loss) income to net cash
provided by (used in) operating activities:
Depreciation............................................. 20,400 18,089 13,551
Amortization of goodwill................................. -- 4,872 4,917
Amortization of intangibles.............................. 34,494 7,012 --
Amortization of deferred finance fees.................... 2,859 1,772 1,163
Amortization of unearned compensation.................... 1,850 1,076 950
Loss from equity investment.............................. -- 8,607 --
Provision for doubtful accounts.......................... 29,744 5,820 1,117
Loss (gain) on disposal of fixed assets.................. 322 (448) --
Deferred income taxes.................................... -- 19,273 30
Loss on investments...................................... 14,894 788 773
Cash proceeds from sale of trading securities............ 60 -- --
Write-off of acquired in-process R&D..................... -- 18,800 --
Impairment of goodwill................................... 70,209 5,877 --
Impairment of fixed assets............................... -- 14,722 --
Write-down of inventories................................ -- 31,970 --
Loss on debt retirement.................................. 7,302 -- --
Loss on sale of power product line....................... -- 9,225 --
Loss on sale of discontinued product lines............... 3,959 -- --
Cumulative effect of an accounting change -- goodwill.... 57,960 -- --
Changes in operating assets and liabilities, net of
effect of acquisitions and dispositions:
(Increase) decrease in accounts receivable............. 26,422 17,771 36,034
(Increase) decrease in other receivables............... 6,895 (10,049) --
(Increase) decrease in inventories..................... 53,431 125,891 (48,467)
(Increase) decrease in income taxes recoverable........ 5,066 17,895 (7,492)
Increase (decrease) in accounts payable and accrued
liabilities........................................... (36,820) (24,644) (21,629)
Increase (decrease) in accrued Class B membership
interest.............................................. 10,409 4,110 --
Increase (decrease) in other, net...................... (897) 795 3,106
--------- --------- ---------
Net cash provided by (used in) operating activities......... 117,392 111,493 4,722
Investing activities:
Purchases of property, plant and equipment................. (7,923) (9,556) (15,498)
Cash proceeds from sale of property & equipment............ -- 1,061 --
Cash proceeds from sale of Keptel product line............. 30,000 -- --
Cash proceeds from sale of Actives product line............ 30,000 -- --
Cash paid for acquisition, net of cash acquired............ (874) (6,852) --
Other...................................................... (50) (3,930) (8,198)
--------- --------- ---------
Net cash provided by (used in) investing activities......... 51,153 (19,277) (23,696)
--------- --------- ---------
Financing activities:
Borrowings under credit facilities......................... -- 302,726 352,000
Reductions in borrowings under credit facilities........... -- (391,726) (331,500)
Payments on capital lease obligations...................... (903) -- --
Payments on debt obligations............................... (73,737) -- --
Deferred financing costs paid.............................. (1,725) (7,813) (1,163)
Repurchase of stock units.................................. (115) -- --
Proceeds from issuance of common stock..................... 1,007 1,146 5,454
--------- --------- ---------
Net cash provided by (used in) financing activities......... (75,473) (95,667) 24,791
Net increase (decrease) in cash and cash equivalents........ 93,072 (3,451) 5,817
Cash and cash equivalents at beginning of year.............. 5,337 8,788 2,971
--------- --------- ---------
Cash and cash equivalents at end of year.................... $ 98,409 $ 5,337 $ 8,788
========= ========= =========
Noncash investing and financing activities:
Net tangible assets acquired, excluding cash............... $ 5,063 $ 55,284 $ --
Net liabilities assumed.................................... (14,955) -- --
Intangible assets acquired, including goodwill............. 79,339 195,193 --
Noncash purchase price, including 5,250,000 shares of
common stock in 2002 and 37,000,000 shares of common
stock in 2001, and fair market value of stock options
issued................................................... (68,573) (243,625) --
--------- --------- ---------
Cash paid for acquisition, net of cash acquired............ $ 874 $ 6,852 $ --
========= ========= =========
Equity received in exchange for services provided.......... $ -- $ 1,000 $ --
========= ========= =========
Equity issued in exchange for 4 1/2% convertible
subordinated notes due 2003.............................. $ 14,497 $ -- $ --
========= ========= =========
Supplemental cash flow information:
Interest paid during the year.............................. $ 1,131 $ 8,952 $ 10,966
========= ========= =========
Income taxes paid during the year.......................... $ 2,831 $ 465 $ 15,286
========= ========= =========
</Table>
See accompanying notes to the consolidated financial statements.
52
ARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<Table>
<Caption>
CAPITAL IN RETAINED UNREALIZED
EXCESS OF EARNINGS LOSS ON UNFUNDED CUMULATIVE
COMMON PAR (ACCUMULATED MARKETABLE UNEARNED PENSION TRANSLATION
STOCK VALUE DEFICIT) SECURITIES COMPENSATION LOSSES ADJUSTMENTS TOTAL
------ ---------- ------------ ---------- ------------- -------- ----------- ---------
(IN THOUSANDS)
Balance, December 31,
1999...................... $378 $252,245 $ 56,900 $ -- $ (184) $ -- $ (1) $ 309,338
Comprehensive income:
Net income................ -- -- 20,669 -- -- -- -- 20,669
Unrealized loss on
marketable securities... -- -- -- (1,668) -- -- -- (1,668)
Translation adjustment.... -- -- -- -- -- -- 81 81
---------
Comprehensive income...... 19,082
Shares granted under stock
award plan.............. -- 1,444 -- -- (1,444) -- -- --
Compensation under stock
award plan.............. -- -- -- -- 950 -- -- 950
Issuance of common stock
and other............... 5 5,449 -- -- -- -- -- 5,454
Tax benefit related to
exercise of stock
options................. -- 7,078 -- -- -- -- -- 7,078
---- -------- --------- ------- ------- ------- ----- ---------
Balance, December 31,
2000...................... 383 266,216 77,569 (1,668) (678) -- 80 341,902
Comprehensive (loss)
Net (loss)................ -- -- (167,731) -- -- -- -- (167,731)
Unrealized loss on
marketable securities... -- -- -- (1,543) -- -- -- (1,543)
Translation adjustment.... -- -- -- -- -- -- 8 8
---------
Comprehensive (loss)...... (169,266)
Shares granted under stock
award plan.............. -- 975 -- -- (975) -- -- --
Compensation under stock
award plan.............. -- -- -- -- 1,076 -- -- 1,076
Issuance of common stock
to acquire Arris
Interactive L.L.C. ..... 370 226,810 -- -- -- -- -- 227,180
Issuance of stock options
in acquisition of Arris
Interactive L.L.C. ..... -- 12,531 -- -- -- -- -- 12,531
Issuance of common stock
and other............... 2 1,118 -- -- -- -- -- 1,120
---- -------- --------- ------- ------- ------- ----- ---------
Balance, December 31,
2001...................... 755 507,650 (90,162) (3,211) (577) -- 88 414,543
Comprehensive (loss)
Net (loss)................ -- -- (191,167) -- -- -- -- (191,167)
Unrealized loss on
marketable securities... -- -- -- (86) -- -- -- (86)
Recognized unrealized loss
on marketable
securities.............. -- -- -- 3,524 -- -- -- 3,524
Minimum liability on
unfunded pension........ -- -- -- -- -- (1,219) -- (1,219)
Translation adjustment.... -- -- -- -- -- -- (122) (122)
---------
Comprehensive (loss)...... (189,070)
Shares granted under stock
award plan.............. 1 3,139 -- -- (3,140) -- -- --
Compensation under stock
award plan.............. -- -- -- -- 1,850 -- -- 1,850
Repurchase of stock
units................... -- (237) -- -- 122 -- -- (115)
Forfeiture of restricted
stock................... -- (96) -- -- 96 -- -- --
Issuance of common stock
in acquisition of
Cadant, Inc. ........... 53 55,760 -- -- -- -- -- 55,813
Issuance of stock options
in acquisition of
Cadant, Inc. ........... -- 12,760 -- -- -- -- -- 12,760
Issuance of common stock
in conversion of 4 1/2%
notes................... 16 24,042 -- -- -- -- -- 24,058
Issuance of common stock
and other............... 6 545 -- -- -- -- -- 551
---- -------- --------- ------- ------- ------- ----- ---------
Balance, December 31,
2002...................... $831 $603,563 $(281,329) $ 227 $(1,649) $(1,219) $ (34) $ 320,390
==== ======== ========= ======= ======= ======= ===== =========
</Table>
See accompanying notes to the consolidated financial statements.
53
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION
ARRIS Group, Inc., the successor to ANTEC Corporation (together with its
consolidated subsidiaries, except as the context otherwise indicates, "ARRIS" or
the "Company"), is an international communications technology company,
headquartered in Duluth, Georgia. ARRIS specializes in the design and
engineering of hybrid fiber-coax architectures and the development and
distribution of products for these broadband networks. The Company provides its
customers with products and services that enable reliable, high-speed, two-way
broadband transmission of video, telephony, and data.
ARRIS operates in one business segment, Communications, providing a range
of customers with network and system products and services, primarily hybrid
fiber-coax networks and systems for the communications industry. This segment
accounts for 100% of consolidated sales, operating profit and identifiable
assets of the Company. ARRIS provides a broad range of products and services to
cable system operators and telecommunication providers. ARRIS is a leading
developer, manufacturer and supplier of telephony, data, construction, rebuild
and maintenance equipment for the broadband communications industry. ARRIS
supplies most of the products required in a broadband communication system,
including headend, distribution, drop and in-home subscriber products.
On November 21, 2002, ARRIS sold the Actives portion of its transmission,
optical and outside plant product lines, which included laser transmitters,
optical nodes and RF amplifiers, to Scientific-Atlanta for net proceeds of $31.8
million. The Actives product line had approximately $68.2 million of revenue in
2001, and approximately $44.3 million of revenue for the nine months ended
September 30, 2002. Total assets of approximately $20.3 million were disposed
of, which included inventory, fixed assets, and other assets attributable to the
product line. Additionally, ARRIS incurred approximately $9.3 million of related
closure costs, including severance, vendor liabilities, professional fees, and
other shutdown expenses. In connection with the sale, the Company recognized a
gain of approximately $2.2 million during the fourth quarter of 2002. As of
December 31, 2002, approximately $1.8 million of the proceeds are receivable. As
of December 31, 2002, approximately $1.1 million related to severance, $7.5
million related to vendor liabilities, $0.2 million related to professional
fees, and $0.9 million related to other shutdown expenses remained in an accrual
to be paid. The remaining payments are expected to be complete by the end of
2003.
On April 24, 2002, ARRIS sold its Keptel product line. Keptel designed and
marketed network interface systems and fiber optic cable management products
primarily for traditional telco residential and commercial applications. The
transaction generated cash proceeds of $30.0 million. Additionally, the Company
retained a potential earnout over a twenty-four month period based on sales
achievements. The transaction also includes a distribution agreement whereby
ARRIS will continue to distribute Keptel products. The Keptel product line had
approximately $51.1 million of revenue in 2001 and approximately $6.3 million of
revenue for the three months ended March 31, 2002. Total assets of approximately
$31.1 million were disposed of, which included inventory, fixed assets,
intangibles (formerly classified as goodwill), and other assets. The Company
incurred approximately $7.4 million of related closure costs, including
severance, vendor liabilities, outside consulting fees, and other shutdown
expenses. The net result of the transaction was a loss on the sale of the
product line of approximately $8.5 million in the second quarter of 2002. During
the fourth quarter of 2002, the loss was reduced by $2.4 million as a result of
the resolution of certain estimated costs associated with the sale. As of
December 31, 2002, approximately $0.1 million related to severance, $0.9 million
related to vendor liabilities, $1.0 million related to outside consulting fees,
and $0.1 million related to other shutdown expenses remained in an accrual to be
paid. The remaining payments are expected to be complete by the end of 2003.
The Company has adopted Statement of Financial Accounting Standards
("SFAS") No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, with respect to its Actives and Keptel product line disposals. As a
result, these two product lines have been accounted for as discontinued
operations and current and historical results have been reclassified accordingly
for all periods presented. Revenues from the discontinued operations were $68.8
million, $119.3 million, and $248.7 million for the years ended December 31,
2002, 2001, and 2000, respectively. The income (loss) from discontinued
operations, net of taxes, for
54
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the years ending December 31, 2002, 2001, and 2000 was $(18.8) million, $(84.5)
million, and $6.7 million, respectively. During 2002, the Company recorded a net
loss on disposals of $4.0 million.
On October 30, 2002, ARRIS announced that it would close its office in
Andover, Massachusetts, which is primarily a product development and repair
facility. The Company decided to close the office in order to reduce operating
costs through consolidations of its facilities. The closure affected
approximately 75 employees and is expected to be completed during the second
quarter of 2003. In connection with these actions, the Company recorded a charge
of approximately $7.1 million in the fourth quarter of 2002. Included in this
restructuring charge was approximately $2.1 million related to remaining lease
payments, $2.7 million of fixed asset write-offs, $2.1 million of severance, and
$0.2 million of other costs associated with these actions.
Further, in November 2002, ARRIS implemented other cost reduction actions,
including a reduction in force at various locations affecting an additional 113
employees. These actions were prompted by the change in scale and complexity of
the business as a result of the Actives sale and the Company's desire to lower
its expense overhead to be in line with the revenue forecast.
On January 8, 2002, ARRIS completed the acquisition of substantially all of
the assets of Cadant, Inc., a privately held designer and manufacturer of next
generation cable modem termination systems ("CMTS"). The Company issued 5.25
million shares of ARRIS common stock for the purchase of substantially all of
Cadant's assets and certain liabilities. Additionally, ARRIS agreed to pay up to
2.0 million shares based upon future sales targets of the CMTS product through
January 8, 2003. These targets were not met as of January 8, 2003, and
therefore, no further shares were issued. As of December 31, 2002, Cadant, Inc.
shareholders owned approximately 6.1% of the Company's outstanding common stock.
On August 3, 2001, the Company acquired Nortel Networks' portion of Arris
Interactive L.L.C., which was a joint venture formed by Nortel and the Company
in 1995. Nortel exchanged its ownership interest in Arris Interactive L.L.C. for
a subordinated redeemable Class B membership interest in Arris Interactive
L.L.C. with a face amount of $100 million and 37 million shares of ARRIS common
stock. Following the Arris Interactive L.L.C. acquisition, Nortel designated two
new members to ARRIS' Board of Directors. In June 2002, Nortel sold 15 million
of its shares of ARRIS through a public offering. As of December 31, 2002,
Nortel owned approximately 26.7% of the Company's outstanding common stock.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Consolidation
The consolidated financial statements include the accounts of ARRIS after
elimination of intercompany transactions.
(b) Use of Estimates
The preparation of the consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.
(c) Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year's financial statement presentation.
(d) Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of
three months or less to be cash equivalents. The carrying amount reported in the
consolidated balance sheets for cash and cash equivalents approximates fair
value.
55
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(e) Inventories
Inventories are stated at the lower of average, approximating first-in,
first-out, cost or market. The cost of finished goods is comprised of material,
labor, and manufacturing overhead.
(f) Investments
The Company holds certain investments in the common stock of publicly
traded companies totaling approximately $0.1 million and $0.8 million at
December 31, 2002 and 2001, respectively, which are classified as trading
securities. Changes in the market value of these securities and gains or losses
on related sales of these securities are recognized in income. The Company
recorded pre-tax losses of approximately $0.6 million and $0.8 million during
the years ended December 31, 2002 and 2001, respectively, related to these
investments.
The Company holds certain additional investments in the common stock of
publicly traded companies totaling approximately $1.8 million and $2.1 million
at December 31, 2002 and 2001, respectively, which are classified as available
for sale. In addition, ARRIS holds a number of non-marketable equity securities
totaling approximately $2.8 million and $12.0 million at December 31, 2002 and
2001, respectively, which are classified as available for sale. At December 31,
2002 and 2001, ARRIS had unrealized losses related to these available for sale
securities of approximately $0 and $3.2 million, respectively, included in
comprehensive income. During the years ended December 31, 2002, 2001, and 2000,
the Company recorded impairment charges of approximately $13.5 million, $0, and
$1.3 million, respectively, on its available for sale securities as a result of
market value declines considered by management to be other than temporary.
ARRIS offers a deferred compensation arrangement, which allows certain
employees to defer a portion of their earnings and defer the related income
taxes. These deferred earnings are invested in a "rabbi trust", and are
accounted for in accordance with Emerging Issues Task Force 97-14, Accounting
for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi
Trust and Invested. A rabbi trust is a funding vehicle used to protect deferred
compensation benefits from events (other than bankruptcy). The investment in the
rabbi trust is classified as a current asset on the consolidated balance sheet.
During the year ended December 31, 2002, the Company recognized a loss of
approximately $0.8 million in connection with realized losses on the related
investments.
(g) Revenue Recognition
ARRIS' revenue recognition policies are in compliance with Staff Accounting
Bulletin No. 101, Revenue Recognition in Financial Statements, as issued by the
Securities and Exchange Commission. Sales and related cost of sales are
recognized at the time products are shipped or title passes pursuant to the
terms of the agreement with the customer, the amount due from the customer is
fixed and collectibility of the related receivable is reasonably assured. Sales
of services are recognized at the time of performance. ARRIS resells software
developed by outside third parties as well as internally developed software.
Software sold by ARRIS does not require significant production, modification or
customization. Software revenue is generally recognized when shipment is made,
no significant vendor obligations remain and collection is considered probable.
(h) Shipping and Handling Fees
Shipping and handling costs for the years ended December 31, 2002, 2001,
and 2000 were approximately $5.3 million, $7.3 million and $18.0 million,
respectively, and are classified in net sales and cost of sales.
(i) Depreciation of Property, Plant and Equipment
The Company provides for depreciation of property, plant and equipment
principally on the straight-line basis over estimated useful lives of 25 to 40
years for buildings and improvements, 3 to 10 years for machinery and equipment,
and the term of the lease or useful life for leasehold improvements.
Depreciation expense for the years ended December 31, 2002, 2001, and 2000 was
approximately $20.4 million, $18.1 million and $13.6 million, respectively.
56
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(j) Goodwill and Long-Lived Assets
Goodwill relates to the excess of cost over net assets resulting from an
acquisition. Goodwill resulting from the 1986 acquisition of Anixter (ARRIS'
former owner) by Anixter International was allocated to ARRIS based on ARRIS'
proportionate share of total operating earnings of Anixter for the period
subsequent to the acquisition. Goodwill also has resulted from acquisitions of
businesses by Anixter and ARRIS subsequent to 1986 that now are owned by ARRIS.
ARRIS adopted SFAS No. 142, Goodwill and Other Intangible Assets, on
January 1, 2002. Under the new rules, goodwill and indefinite lived intangible
assets are no longer amortized but are reviewed annually for impairment, or more
frequently if impairment indicators arise. Separable intangible assets that are
not deemed to have an indefinite life will continue to be amortized over their
useful lives. Upon adoption of SFAS No. 142, the Company recorded a goodwill
impairment loss of approximately $58.0 million, based on management's analysis
including an independent valuation. The resulting impairment loss has been
recorded as a cumulative effect of a change in accounting principle on the
accompanying Consolidated Statements of Operations for the year ended December
31, 2002. The valuation was determined using a combination of the income and
market approaches on an invested capital basis, which is the market value of
equity plus interest-bearing debt. The Company's remaining goodwill was reviewed
in the fourth quarter of 2002, and based upon management's analysis including an
independent valuation, an impairment charge of $70.2 million was recorded with
respect to its supplies and services product category.
As of December 31, 2002, the financial statements included intangibles of
$64.8 million, net of amortization of $41.5 million. These intangibles are
primarily related to the existing technology acquired from Arris Interactive
L.L.C. on August 3, 2001 and from Cadant, Inc. on January 8, 2002, and are being
amortized over a three year period. The valuation process to determine the fair
market values of the existing technology by management included valuations by an
outside valuation service. The values assigned were calculated using an income
approach utilizing the cash flow expected to be generated by these technologies.
(k) Advertising and Sales Promotion
Advertising and sales promotion costs are expensed as incurred. Advertising
expense, predominantly from continuing operations, was approximately $0.6
million, $1.3 million and $1.2 million for the years ended December 31, 2002,
2001 and 2000, respectively.
(l) Research and Development
Research and development ("R&D") costs are expensed as incurred. ARRIS'
research and development expenditures for the years ended December 31, 2002,
2001 and 2000 were approximately $64.8 million, $26.9 million and $9.1 million,
respectively. Additionally, acquired in-process research and development in the
amount of $18.8 million was written off in connection with the Arris Interactive
acquisition during the third quarter of 2001.
(m) Warranty
ARRIS provides, by a current charge to income in the period, an amount it
estimates will be needed to cover future warranty obligations related to
embedded base, failure rate, and costs to repair of its products already
deployed in the field.
(n) Income Taxes
ARRIS uses the liability method of accounting for income taxes, which
requires recognition of temporary differences between financial statement and
income tax bases of assets and liabilities, measured by enacted tax rates. The
Company continually reviews the adequacy of the valuation allowance and
recognizes the benefits of deferred tax assets only as reassessment indicates
that it is more likely than not that the deferred tax assets will be realized.
57
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(o) Foreign Currency
The financial position and operating results of ARRIS' foreign operations
are consolidated using the local currency as the functional currency. All
balance sheet accounts of foreign subsidiaries are translated at the current
exchange rate at the end of the accounting period with the exception of fixed
assets, which are translated at historical cost. Income statement items are
translated at average currency exchange rates. The resulting translation
adjustment is recorded as a separate component of stockholders' equity.
The Company has certain international customers who are billed in their
local currency. The monetary value of this business has increased since the
acquisition of Arris Interactive and its corresponding international customer
base formerly served through Nortel Networks. Since the acquisition of Arris
Interactive, the monetary exchange fluctuations from the time of invoice to the
time of payment have not been significant. However, during the second quarter of
2002, the euro increased in value relative to the US dollar enough to cause a
significant foreign exchange gain. During 2002, the Company recorded a foreign
currency gain of approximately $5.7 million, primarily related to the
strengthening of the euro as it has several European customers whose receivables
and collections are denominated in euros. During the third quarter 2002, the
Company have evaluated and implemented a hedging strategy using forward
contracts. During 2001, the Company recorded a foreign currency gain of
approximately $10 thousand.
(p) Stock-Based Compensation
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation -- Transition and Disclosure. This Statement amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition for a voluntary change to the fair value based method of accounting
for stock-based employee compensation. In addition, this Statement amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in both
annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results.
The Company uses the intrinsic value method for valuing its awards of stock
options and restricted stock and recording the related compensation expense, if
any, in accordance with APB Opinion No. 25, Accounting for Stock Issued to
Employees and related interpretations. No stock-based employee or director
compensation cost for stock options is reflected in net income, as all options
granted have exercise prices equal to the market value of the underlying common
stock on the date of grant. The Company records compensation expense related to
its restricted stock awards and director stock units. The following table
illustrates the effect on net income and earnings per share as if the Company
had applied the fair value recognition provisions of SFAS No. 123 to stock-based
employee compensation.
<Table>
<Caption>
2002 2001 2000
--------- --------- -------
Net income (loss), as reported...................... $(191,167) $(167,731) $20,669
Add: Stock-based employee compensation included in
reported net income, net of taxes................. 1,850 1,076 950
Deduct: Total stock-based employee compensation
expense determined under fair value based methods
for all awards, net of taxes...................... (26,770) (15,710) (7,165)
--------- --------- -------
Net income (loss), pro forma........................ $(216,087) $(182,365) $14,454
========= ========= =======
Net income (loss) per common share:
Basic -- as reported.............................. $ (2.33) $ (3.13) $ 0.54
========= ========= =======
Basic -- pro forma................................ $ (2.64) $ (3.40) $ 0.38
========= ========= =======
Diluted -- as reported............................ $ (2.33) $ (3.13) $ 0.52
========= ========= =======
Diluted -- pro forma.............................. $ (2.64) $ (3.40) $ 0.37
========= ========= =======
</Table>
58
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(q) Interest Rate Agreements
As of December 31, 2002, the Company had no outstanding floating rate
indebtedness or interest rate swap agreements.
(r) Concentrations of Credit
Financial instruments that potentially subject ARRIS to concentrations of
credit risk consist principally of temporary cash investments and accounts
receivable. ARRIS places its temporary cash investments with high credit quality
financial institutions in accordance with debt agreements. Concentrations with
respect to accounts receivable occur as the Company sells primarily to large,
well-established companies including companies outside of the United States,
however, the credit quality of these customers generally significantly
diminishes the risk of loss from extension of credit. The Company's credit
policy generally does not require collateral from its customers. ARRIS closely
monitors extensions of credit to other parties and, where necessary, utilizes
common financial instruments to mitigate risk or requires cash on delivery
terms. Overall financial strategies and the effect of using a hedge are reviewed
periodically. When deemed uncollectible, accounts receivable balances are
written off.
Due to the economic disturbances in Argentina, the Company recorded a
write-off of $4.4 million related to unrecoverable amounts of inventory due from
a customer in that region during 2001. Of this total charge, approximately $2.8
million is reflected in cost of sales and $1.6 million is reflected in
discontinued operations. In 2002, the industry downturn and other factors have
adversely affected several of our largest customers. As a result, the Company
incurred a $20.2 million charge related to its Adelphia receivable during the
second quarter 2002. However, the Company sold a portion of the Adelphia
receivables during the third quarter 2002 to an unrelated third party, resulting
in net gain of approximately $4.3 million. For the year ended December 31, 2002,
the net result was a loss of $15.9 million related to Adelphia, of which
approximately $14.9 million is reflected in selling, general, administrative,
and development expenses and $1.0 million is reflected in discontinued
operations.
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
- Cash and cash equivalents: The carrying amount reported in the balance
sheet for cash and cash equivalents approximates its fair value.
- Accounts receivable and accounts payable: The carrying amounts reported
in the balance sheet for accounts receivable and accounts payable
approximate their fair values. We establish a reserve for doubtful
accounts based upon our historical experience in collecting accounts
receivable.
- Marketable securities: The fair values for trading and available-for-sale
equity securities are based on quoted market prices.
- Non-marketable securities: Non-marketable equity securities are subject
to a periodic impairment review; however, there are no open-market
valuations, and the impairment analysis requires significant judgment.
This analysis includes assessment of the investee's financial condition,
the business outlook for its products and technology, its projected
results and cash flow, recent rounds of financing, and the likelihood of
obtaining subsequent rounds of financing.
- Long-term debt: The carrying amounts of the Company's borrowings under
its long-term revolving credit arrangements approximate their fair value.
The fair value of the Company's convertible subordinated debt is based on
its quoted market price and totaled approximately $16.7 million and $89.7
million at December 31, 2002 and 2001, respectively.
- Foreign exchange contracts and interest rate swaps: The fair values of
the Company's foreign currency contracts and interest rate swaps are
estimated based on dealer quotes, quoted market prices of comparable
contracts adjusted through interpolation where necessary, maturity
differences or if there are no relevant comparable contracts on pricing
models or formulas using current assumptions. As of December 31, 2002,
the Company had one foreign exchange contract; the Company sold 250.0
million
59
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Japanese yen (US$2.1 million) for delivery on January 31, 2003. The
contract was taken out in anticipation of receiving a substantial yen
payment from one of ARRIS' customers. The Company received the yen needed
to close the contract on a timely basis. The fair value adjustment at
December 31, 2002 was not significant. The Company had no interest rate
swap agreements outstanding as of December 31, 2002.
(s) Accounting for Derivative Instruments
ARRIS uses various derivative financial instruments, including foreign
exchange contracts, and in the past, interest rate swap agreements to enhance
the Company's ability to manage risk. Derivative instruments are entered into
for periods consistent with related underlying exposures and do not constitute
positions independent of those exposures. ARRIS' derivative financial
instruments are for purposes other than trading. ARRIS' non-derivative financial
instruments include letters of credit, commitments to extend credit and
guarantees of debt. ARRIS generally does not require collateral to support its
financial instruments.
It is the Company's policy to recognize all derivative financial
instruments, such as interest rate swap contracts and foreign exchange
contracts, in the consolidated financial statements at fair value regardless of
the purpose or intent for holding the instrument. Changes in the fair value of
derivative financial instruments are either recognized periodically in income or
in shareholders' equity as a component of comprehensive income depending on
whether the derivative financial instrument qualifies for hedge accounting, and
if so, whether it qualifies as a fair value hedge or cash flow hedge. Generally,
changes in fair values of derivatives accounted for as fair value hedges are
recorded in income along with the portions of the changes in the fair values of
the hedged items that relate to the hedged risk(s). Changes in fair values of
derivatives accounted for as cash flow hedges, to the extent they are effective
as hedges, are recorded in comprehensive income net of applicable deferred
taxes. Changes in fair values of derivatives, not qualifying as hedges, are
reported in income. These amounts were immaterial for the years ended December
31, 2002, 2001 and 2000, respectively.
NOTE 3. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force No. 94-3, Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring). The provisions of SFAS No. 146 are effective
for exit or disposal activities that are initiated after December 31, 2002, with
early application encouraged. The Company has adopted SFAS No. 146 in connection
with the closure of its facility in Andover, Massachusetts during the fourth
quarter of 2002. See Note 5 of Notes to Consolidated Financial Statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections. This Statement relates to accounting for debt extinguishments,
leases, and intangible assets of motor carriers. The provisions of SFAS No. 145
related to the rescission of SFAS No. 4 are effective for fiscal years beginning
after May 15, 2002 with earlier adoption encouraged. The Company has adopted
SFAS No. 145 in connection with the $2.0 million gain on the retirement of debt
(see Note 9 of Notes to the Consolidated Financial Statements) resulting in the
classification of this gain in other expense (income) on the Consolidated
Statements of Operations. In accordance with provisions of SFAS No. 145, the
$1.9 million loss on debt retirement recorded as an extraordinary item in 2001
has been reclassified to other expense (income) on the Consolidated Statements
of Operations for comparative purposes.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. The Statement supercedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of, however it retains the fundamental provisions of that
statement related to the recognition and measurement of the impairment of
long-lived assets to be "held and used." The Statement is effective for
year-ends beginning after December 15, 2001. The Company has adopted SFAS No.
144, and as a result, the Actives and Keptel product lines, which were sold in
2002, have been accounted
60
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
for as discontinued operations and current and historical results have been
reclassified for all periods presented. See Note 4 of Notes to Consolidated
Financial Statements for further discussion.
In June 2001, the FASB issued SFAS No. 141, Business Combinations, and SFAS
No. 142, Goodwill and Other Intangible Assets. The Company adopted SFAS No. 142
on January 1, 2002. See Note 8 of Notes to Consolidated Financial Statements.
NOTE 4. DISCONTINUED OPERATIONS
Upon evaluation and review of the ARRIS product portfolio, the Company
concluded that the Keptel product line was not core to its long-term strategy
and thus sold the product line on April 24, 2002. Keptel designed and marketed
network interface systems and fiber optic cable management products primarily
for traditional residential and commercial telecommunications applications. The
transaction generated cash proceeds of $30.0 million. Additionally, ARRIS
retained a potential earn-out over a twenty-four month period based on sales
achievements. The transaction also includes a distribution agreement whereby the
Company will continue to distribute Keptel products. The Keptel product line had
approximately $51.1 million of revenue in 2001 and approximately $6.3 million of
revenue for the three months ended March 31, 2002. Total assets of approximately
$31.1 million were disposed of, which included inventory, fixed assets,
intangibles (formerly classified as goodwill), and other assets. ARRIS incurred
approximately $7.4 million of related closure costs, including severance, vendor
liabilities, outside consulting fees, and other shutdown expenses. During the
second quarter of 2002, a net loss of $8.5 million was recorded in connection
with the sale of the Keptel product line. This net loss was previously reported
in restructuring and other expense in the Consolidated Statement of Operations
during the second quarter due to the overall immateriality of Keptel's results
of operations and assets to the consolidated results and assets of the Company.
During the fourth quarter of 2002, the loss was reduced by $2.4 million as a
result of the resolution of certain estimated costs associated with the sale. As
of December 31, 2002, approximately $0.1 million related to severance, $0.9
million related to vendor liabilities, $1.0 million related to outside
consulting fees, and $0.1 million related to other shutdown expenses remained in
an accrual to be paid. The remaining payments are expected to be complete by the
end of 2003.
Upon continued review of ARRIS' product portfolio, the Company sold its
Actives product line to Scientific-Atlanta on November 21, 2002, for net
proceeds of $31.8 million. The Actives product line had approximately $68.2
million of revenue in 2001, and approximately $44.3 million of revenue for the
nine months ended September 30, 2002. Total assets of approximately $20.3
million were disposed of, which included inventory, fixed assets, and other
assets attributable to the product line. Additionally, ARRIS incurred
approximately $9.3 million of related closure costs, including severance, vendor
liabilities, professional fees, and other shutdown expenses. In connection with
the sale, the Company recognized a gain of approximately $2.2 million during the
fourth quarter of 2002. As of December 31, 2002, approximately $1.8 million of
the proceeds are receivable. As of December 31, 2002, approximately $1.1 million
related to severance, $7.5 million related to vendor liabilities, $0.2 million
related to professional fees, and $0.9 million related to other shutdown
expenses remained in an accrual to be paid. The remaining payments are expected
to be complete by the end of 2003.
The Company's Actives and Keptel product lines, as a whole, constituted the
majority of its transmission, optical and outside plant product category and
qualified as discontinued operations in accordance with SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets. Accordingly, the results of
these product lines have been reclassified to discontinued operations for all
periods presented.
Revenues from discontinued operations were $68.8 million, $119.3 million,
and $248.7 million for the years ended December 31, 2002, 2001, and 2000,
respectively. The income (loss) from discontinued operations, net of taxes, for
the years ending December 31, 2002, 2001, and 2000 was $(18.8) million, $(84.5)
million, and $6.7 million, respectively. During 2002, the Company recorded a net
loss on these disposals of $4.0 million.
61
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The balance sheet as of December 31, 2001 includes $64.8 million of current
assets of discontinued operations, comprised of approximately $11.1 million of
fixed assets and $53.7 million of inventory.
NOTE 5. RESTRUCTURING AND OTHER CHARGES
On October 30, 2002, the Company announced that it would close its office
in Andover, Massachusetts, which is primarily a product development and repair
facility. The Company decided to close the office in order to reduce operating
costs through consolidations of its facilities. The closure affected
approximately 75 employees and is expected to be completed during the second
quarter of 2003. In connection with these actions, the Company recorded a charge
of approximately $7.1 million in the fourth quarter of 2002. Included in this
restructuring charge was approximately $2.1 million related to remaining lease
payments, $2.7 million of fixed asset write-offs, $2.1 million of severance, and
$0.2 million of other costs associated with these actions. The remaining
payments are expected to be complete by the second quarter of 2006 (end of
lease). The estimated savings as a result of the Andover, Massachusetts closure
is approximately $8.6 million annually, primarily related to employee costs.
During the second quarter of 2002, ARRIS established a bad debt reserve in
connection with its Adelphia accounts receivable. Adelphia declared bankruptcy
in June 2002. The reserve resulted in a charge of approximately $20.2 million in
the second quarter of 2002, of which $18.9 million is classified in selling,
general, administrative, and development and $1.3 million is classified in
discontinued operations. In the third quarter of 2002, ARRIS sold a portion of
its Adelphia accounts receivable to an unrelated third party, resulting in a net
gain of approximately $4.3 million, of which approximately $4.0 million was
recorded as a reduction of the provision for doubtful accounts included in
selling, general and administrative and development expenses, and the remaining
gain of $0.3 million is classified in discontinued operations.
In the fourth quarter of 2001, ARRIS closed a research and development
facility in Raleigh, North Carolina and recorded a $4.0 million charge related
to severance and other costs associated with closing that facility. This charge
included termination expenses of $2.2 million related to the involuntary
dismissal of 48 employees, primarily engaged in engineering functions at that
facility. Also included in the $4.0 million charge was $0.7 million related to
lease commitments, $0.2 million related to the impairment of fixed assets, and
$0.9 million related to other shutdown expenses. As of December 31, 2002,
approximately $0.6 million related to lease commitments, and $0.1 million
related to other shutdown costs remained in an accrual to be paid. Due to a
change in estimate, the original liability was reduced by approximately $0.4
million. The remaining payments are expected to be complete by the third quarter
of 2004 (end of lease). The estimated savings as a result of the Raleigh, North
Carolina closure is approximately $5.5 million annually, primarily related to
employee costs.
In the third quarter of 2001, the Company announced a restructuring plan to
outsource the functions of most of its manufacturing facilities. This decision
to reorganize was due in part to the ongoing weakness in industry spending
patterns. The plan entailed the implementation of an expanded manufacturing
outsourcing strategy and the related closure of the four factories located in El
Paso, Texas and Juarez, Mexico. As a result, the Company recorded restructuring
and impairment charges of $66.2 million, of which approximately $50.1 million
relates to and is classified in discontinued operations. Included in these
charges was approximately $33.7 million related to the write-down of
inventories, and remaining warranty and purchase order commitments of which
approximately $8.6 million was reflected in cost of goods sold and $25.1 million
was reflected in discontinued operations. Additional charges incurred were
approximately $5.7 million related to severance and associated personnel costs,
$5.9 million related to the impairment of goodwill due to the sale of the power
product lines, $14.8 million related to the impairment of fixed assets, and
approximately $6.1 million related to lease terminations of factories and office
space and other shutdown expenses. Of these charges, approximately $7.5 million
is reflected in restructuring expense and $25.0 million is reflected in
discontinued operations. The personnel-related costs included termination
expenses for the involuntary dismissal of 807 employees, primarily engaged in
production and assembly functions performed at the facilities. ARRIS offered
terminated employees separation amounts in accordance with the Company's
severance policy and provided the employees with specific separation dates. Due
to unforeseen delays in
62
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exiting the facility after the shutdown, during the fourth quarter of 2002 the
Company recorded an additional charge of $2.4 million to discontinued
operations. As of December 31, 2002, of the remaining $2.8 million balance in
the restructuring reserve, approximately $0.6 million related to severance and
associated personnel costs, and $2.2 million related to lease terminations of
factories and office space and other shutdown costs. The remaining costs are
expected to be expended by the end of 2003.
During the second quarter of 2000, ARRIS recorded a pre-tax charge of $3.5
million to cost of sales related to the 1999 consolidation of the New Jersey
facility to Georgia and the Southwest, coupled with the discontinuance of
certain product offerings.
NOTE 6. INVENTORIES
Inventories are stated at the lower of average, approximating first-in,
first-out, cost or market. The components of inventory are as follows, net of
reserves (in thousands):
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Raw material............................................ $ 3,941 $ 17,627
Finished goods.......................................... 100,262 119,505
-------- --------
Total inventories............................. $104,203 $137,132
======== ========
</Table>
NOTE 7. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, at cost, consisted of the following (in
thousands):
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Land.................................................... $ 1,822 $ 1,964
Buildings and leasehold improvements.................... 7,295 10,120
Machinery and equipment................................. 70,233 49,139
-------- --------
79,350 61,223
Less: Accumulated depreciation.......................... (44,810) (19,600)
-------- --------
Total property, plant and equipment, net...... $ 34,540 $ 41,623
======== ========
</Table>
NOTE 8. GOODWILL AND INTANGIBLE ASSETS
ARRIS adopted SFAS No. 142, Goodwill and Other Intangible Assets, on
January 1, 2002. Under the new rules, goodwill and indefinite lived intangible
assets are no longer amortized but are reviewed annually for impairment, or more
frequently if impairment indicators arise. Separable intangible assets that are
not deemed to have an indefinite life will continue to be amortized over their
useful lives. Upon adoption of SFAS No. 142, the Company recorded a goodwill
impairment loss of approximately $58.0 million, primarily related to the Keptel
product line, based upon management's analysis including an independent
valuation. The resulting impairment loss has been recorded as a cumulative
effect of a change in accounting principle on the accompanying Consolidated
Statements of Operations for the year ended December 31, 2002. The valuation was
determined using a combination of the income and market approaches on an
invested capital basis, which is the market value of equity plus
interest-bearing debt. The Company's remaining goodwill was reviewed in the
fourth quarter of 2002, and based upon management's analysis including an
independent valuation, an impairment charge of $70.2 million was recorded with
respect to our supplies and services product category primarily due to a decline
in current purchasing by Adelphia, as well as the industry in general.
Application of the non-amortization provision of SFAS No. 142 resulted in the
elimination of approximately $10.5 million of amortization expense in fiscal
2002.
63
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following sets forth a reconciliation of net income and earnings per
share information for the years ended December 31, 2002, 2001, and 2000, as
adjusted for the non-amortization provisions of SFAS No. 142:
<Table>
<Caption>
YEAR ENDED DECEMBER 31,
--------------------------------
2002 2001 2000
--------- --------- --------
Net income (loss):
Net income (loss)........................ $(191,167) $(167,731) $ 20,669
Add: Goodwill amortization from
continuing operations................. -- 3,256 3,300
Add: Goodwill amortization from
discontinued operations............... -- 1,616 1,617
--------- --------- --------
Adjusted net income (loss)............... $(191,167) $(162,859) $ 25,586
========= ========= ========
Diluted earnings per share:
Adjusted net income (loss)............... $ (2.33) $ (3.04) $ 0.65
========= ========= ========
</Table>
The changes in the carrying amount of goodwill for the years ended December
31, 2001 and 2002 are as follows (in thousands):
<Table>
Balance as of December 31, 2000............................. $144,919
Goodwill acquired from Arris Interactive L.L.C.
acquisition............................................... 124,892
Goodwill written off related to sale of power product
line...................................................... (5,877)
Amortization................................................ (4,872)
--------
Balance as of December 31, 2001............................. $259,062
Transitional impairment charge.............................. (57,960)
Purchase price allocation adjustment -- Arris Interactive
L.L.C. ................................................... 33
Goodwill acquired from Cadant, Inc. acquisition............. 26,339
Transferred to intangible asset upon adoption of SFAS No.
142....................................................... (6,000)
Goodwill impairment charge, October 1, 2002................. (70,209)
--------
Balance as of December 31, 2002............................. $151,265
========
</Table>
The gross carrying amount and accumulated amortization of the Company's
intangible assets, other than goodwill, as of December 31, 2002 and December 31,
2001 are as follows (in thousands):
<Table>
<Caption>
DECEMBER 31, 2002 DECEMBER 31, 2001
---------------------------------- ---------------------------------
GROSS ACCUMULATED NET BOOK GROSS ACCUMULATED NET BOOK
AMOUNT AMORTIZATION VALUE AMOUNT AMORTIZATION VALUE
-------- ------------ -------- ------- ------------ --------
Existing technology
acquired:
Arris Interactive
L.L.C. ......... $ 51,500 $(24,178) $27,322 $51,500 $(7,012) $44,488
Cadant, Inc........ 53,000 (17,328) 35,672 -- -- --
Pension asset........ 1,849 -- 1,849 -- -- --
-------- -------- ------- ------- ------- -------
Total...... $106,349 $(41,506) $64,843 $51,500 $(7,012) $44,488
======== ======== ======= ======= ======= =======
</Table>
Amortization expense recorded on the intangible assets listed in the above
table for the years ended December 31, 2002 and 2001 was $34.5 million and $7.0
million, respectively. The estimated total amortization expense for each of the
next five fiscal years is as follows (in thousands):
<Table>
2003........................................................ $34,833
2004........................................................ $27,822
2005........................................................ $ 339
2006........................................................ $ --
2007........................................................ $ --
</Table>
64
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9. LONG-TERM OBLIGATIONS
Debt, capital lease obligations and membership interest consist of the
following (in thousands):
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Revolving credit facility................................... $ -- $ --
Capital lease obligations................................... 1,278 --
Membership interest -- Nortel Networks...................... 114,518 104,110
4 1/2% convertible subordinated notes....................... 23,887 115,000
-------- --------
Total debt, capital lease obligations and membership
interest............................................... 139,683 219,110
Less current portion...................................... (25,007) --
-------- --------
Total long term debt, capital lease obligations and
membership interest.................................... $114,676 $219,110
======== ========
</Table>
In 1998, the Company issued $115.0 million of 4 1/2% Convertible
Subordinated Notes ("Notes") due May 15, 2003. The Notes are convertible, at the
option of the holder, at any time prior to maturity, into the Company's common
stock at a conversion price of $24.00 per share. In 2002, ARRIS exchanged
1,593,789 shares of its common stock for approximately $15.4 million of the
Notes. The Company recorded the exchanges in accordance with SFAS No. 84,
Induced Conversions of Convertible Debt, which requires the recognition of an
expense equal to the fair value of additional shares of common stock issued in
excess of the number of shares that would have been issued upon conversion under
the original terms of the Notes. As a result, in connection with these
exchanges, ARRIS recorded a non-cash loss of approximately $8.7 million, based
upon a weighted average common stock value of $9.10 (as compared with a common
stock value of $24.00 per share in the original conversion ratio for the Notes).
In connection with the exchanges, the Company also incurred associated fees of
$0.6 million, resulting in an overall loss of approximately $9.3 million.
During the fourth quarter of 2002, the Company redeemed $75.7 million of
the Notes using cash from operations and cash generated from the sale of its
Actives product line. The Notes were redeemed at a discount, resulting in a gain
on the debt retirement of $2.0 million recorded in continuing operations in
accordance with SFAS 145. As of December 31, 2002, there were approximately
$23.9 million of the Notes outstanding.
In connection with the Arris Interactive L.L.C. acquisition in 2001, all of
the Company's existing bank indebtedness was refinanced. The facility, as
subsequently amended, is an asset-based revolving credit facility (the "Credit
Facility") permitting the Company to borrow up to $125.0 million (which can be
increased under certain conditions by up to $25.0 million), based upon
availability under a borrowing base calculation. In general, the borrowing base
is limited to 85% of net eligible receivables (with a cap of $5.0 million in
relation to foreign receivables), subject to a reserve of $10.0 million. In
addition, upon obtaining appropriate asset appraisals the Company may include in
the borrowing base calculation 80% of the orderly liquidation value of net
eligible inventory (not to exceed $60.0 million). The Credit Facility was
modified in 2002 to allow the Company to use existing cash reserves and proceeds
of asset sales to purchase or redeem the outstanding Notes. These modifications
imposed certain conditions on the use of such cash to redeem additional Notes
including the requirement that, giving effect to such purchase or redemption,
(1) there must not be any event of default, (2) no loans may be outstanding
under the Credit Facility, and (3) the Company must retain at least $50.0
million in cash on deposit in accounts pledged as security for the Credit
Facility. During the fourth quarter of 2002, the Company met the applicable
conditions imposed by these modifications and was able to expend approximately
$73.7 million in cash to redeem approximately $75.7 million of Notes. In order
to redeem additional Notes, the Company must continue to meet all of the
conditions for such purchase. Since the Company had cash of $98.4 million as of
December 31, 2002, it anticipates being able to meet such conditions. The Credit
Facility contains traditional financial covenants, including fixed charge
coverage, senior debt leverage, minimum net worth, and minimum inventory turns
ratios. The Credit Facility was amended in January 2003 to provide that the
minimum net worth covenant applied only to the period prior to
65
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 2002. The facility is secured by substantially all of the Company's
assets. The Credit Facility has a maturity date of August 3, 2004. The
commitment fee on unused borrowings is 0.75%. The availability under the Credit
Facility at December 31, 2002 was approximately $18.9 million, and the Company
had no borrowings under the facility.
In conjunction with the acquisition of Arris Interactive L.L.C., the
Company issued to Nortel Networks a subordinated redeemable Class B membership
interest in Arris Interactive L.L.C. with a face amount of $100.0 million. This
membership interest earns an accreting non-cash return of 10% per annum,
compounded annually, and is due six months after the maturity date of the
Company's Credit Facility, as amended or extended. The Class B membership
interest is redeemable in approximately four quarterly installments commencing
February 3, 2002, provided that certain availability and other tests are met
under the Credit Facility. Those tests were not met in 2002. No amounts were
redeemed during the year ended December 31, 2002. In June 2002, the Company
entered into an option agreement with Nortel Networks that permits Arris
Interactive L.L.C. to redeem Nortel Networks' membership interest in Arris
Interactive at a discount of 21% prior to June 30, 2003. The balance of the
Class B membership interest as of December 31, 2002 was approximately $114.5
million. For the year ended December 31, 2002, the Company recorded membership
interest expense of approximately $10.4 million, as compared to membership
interest of approximately $4.1 million for the year ended December 31, 2001.
In conjunction with the acquisition of Cadant, Inc. in January 2002, the
Company assumed approximately $2.3 million in capital lease obligations related
to machinery and equipment. The leases require future rental payments until
2004. The balance of the capital lease obligations at December 31, 2002 was
approximately $1.3 million.
ARRIS has not paid cash dividends on its common stock since its inception.
The Company's credit agreement contains covenants that prohibit them from paying
such dividends. On October 3, 2002, to implement its shareholder rights plan,
its board of directors declared a dividend consisting of one right for each
share of its common stock outstanding at the close of business on October 25,
2002. Each right represents the right to purchase one one-thousandth of a share
of its Series A Participating Preferred Stock and becomes exercisable only if a
person or group acquires beneficial ownership of 15% or more of its common stock
or announces a tender or exchange offer for 15% or more of its common stock or
under other similar circumstances.
NOTE 10. COMMON STOCK
The following shares of Common Stock have been reserved for future
issuance:
<Table>
<Caption>
DECEMBER 31,
------------------------------------
2002 2001 2000
---------- ---------- ----------
Convertible subordinated notes................... 995,292 4,791,667 4,791,667
Stock options, stock units, and restricted
stock.......................................... 16,545,445 14,711,306 7,292,275
Employee stock purchase plan..................... 419,841 727,165 448,298
Liberty Media options............................ 854,341 854,341 854,341
---------- ---------- ----------
Total............................................ 18,814,919 21,084,479 13,386,581
========== ========== ==========
</Table>
66
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11. EARNINGS PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations for the periods indicated (in
thousands except per share data):
<Table>
<Caption>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
2002 2001 2000
---------- ---------- --------
Basic:
Income (loss) from continuing operations.......... $(114,413) $ (83,259) $13,923
Income (loss) from discontinued operations........ (18,794) (84,472) 6,746
Cumulative effect of an accounting change......... (57,960) -- --
--------- --------- -------
Net income (loss).............................. $(191,167) $(167,731) $20,669
Weighted average shares outstanding............ 81,934 53,624 37,965
========= ========= =======
Basic earnings (loss) per share................ $ (2.33) $ (3.13) $ 0.54
========= ========= =======
Diluted:
Income (loss) from continuing operations.......... $(114,413) $ (83,259) $13,923
Income (loss) from discontinued operations........ (18,794) (84,472) 6,746
Cumulative effect of an accounting change......... (57,960) -- --
--------- --------- -------
Net income (loss).............................. $(191,167) $(167,731) $20,669
Weighted average shares outstanding............ 81,934 53,624 37,965
Net effect of dilutive stock options........... -- -- 1,606
--------- --------- -------
Total.......................................... 81,934 53,624 39,571
========= ========= =======
Diluted earnings (loss) per share.............. $ (2.33) $ (3.13) $ 0.52
========= ========= =======
</Table>
The 4 1/2% Convertible Subordinated Notes were antidilutive for all periods
presented. The effects of the options and warrants were not presented for the
years ended December 31, 2002 and 2001 as the Company incurred net losses during
those periods and inclusion of these securities would be antidilutive.
NOTE 12. INCOME TAXES
Income tax expense (benefit) consisted of the following (in thousands):
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------------
2002 2001 2000
-------- -------- --------
Current -- Federal................................... $ (6,800) $ (4,636) $ 12,496
State..................................... -- (430) 1,759
-------- -------- --------
(6,800) (5,066) 14,255
-------- -------- --------
Deferred -- Federal.................................. -- 29,908 26
State.................................... -- 2,777 4
-------- -------- --------
-- 32,685 30
-------- -------- --------
$ (6,800) $ 27,619 $ 14,285
======== ======== ========
</Table>
67
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation of the Statutory Federal tax rate of 35% and the effective
rates is as follows:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
----- ----- ----
Statutory Federal income tax expense (benefit).............. (35.0)% (35.0)% 35.0%
Effects of:
Amortization of goodwill.................................. 0.0% 1.1% 4.4%
Goodwill impairment....................................... 23.3% 0.0% 0.0%
State income taxes, net of Federal benefit................ (3.3)% (3.3)% 2.1%
Meals and entertainment................................... 0.2% 0.3% 1.1%
Write-off of acquired in-process R&D...................... 0.0% 4.7% 0.0%
Change in valuation allowance............................. 4.4% 50.1% (2.8)%
Amortization of intangibles............................... 6.9% 1.8% 0.0%
Other, net................................................ (0.1)% 0.0% 1.1%
----- ----- ----
(3.6)% 19.7% 40.9%
===== ===== ====
</Table>
Deferred income taxes reflect the net tax effects of temporary differences
between carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes.
Significant components of ARRIS' net deferred tax assets (liabilities) were
as follows (in thousands):
<Table>
<Caption>
DECEMBER 31,
-------------------
2002 2001
-------- --------
Current deferred tax assets:
Inventory costs....................................... $ 5,706 $ 16,853
Merger, disposal and restructuring related reserves... 10,270 6,481
Allowance for uncollectible accounts.................. 4,092 3,599
Accrued pension....................................... 3,591 4,707
Other, principally operating expenses................. 22,711 14,274
-------- --------
Total current deferred tax assets............. 46,370 45,914
Long-term deferred tax assets:
Federal/state net operating loss carryforwards........ 31,367 19,521
Foreign net operating loss carryforwards.............. 2,358 2,358
Plant and equipment, depreciation and basis
differences........................................ (1,854) 7,687
-------- --------
Total long-term deferred tax assets........... 31,871 29,566
-------- --------
Long-term deferred tax liabilities:
Purchased technology.................................. (24,095) (17,017)
Goodwill and other.................................... 3,665 (2,040)
-------- --------
Total long-term deferred tax liabilities...... (20,430) (19,057)
Net deferred tax assets................................. 57,811 56,423
Valuation allowance on deferred tax assets............ (57,811) (56,423)
-------- --------
Net deferred tax assets....................... $ -- $ --
======== ========
</Table>
As of December 31, 2002, ARRIS has estimated federal and foreign tax loss
carryforwards of $78.2 million and $6.9 million, respectively. The federal and
foreign tax loss carryforwards expire through 2022 and 2005, respectively. Tax
benefits arising from loss carryforwards of approximately $2.4 million,
originating prior to TSX's quasi-reorganization on November 22, 1985, will be
credited directly to additional paid in capital if and when realized.
ARRIS established a valuation allowance in accordance with the provisions
of SFAS No. 109, Accounting for Income Taxes. The Company continually reviews
the adequacy of the valuation allowance and
68
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
recognizes the benefits of deferred tax assets only as reassessment indicates
that it is more likely than not that the deferred tax assets will be realized.
The Company had U.S. and foreign net operating loss carryforwards at December
31, 2002 expiring as follows (in thousands):
<Table>
<Caption>
U.S. FOREIGN
EXPIRATION IN CALENDAR YEAR AMOUNT AMOUNT
- --------------------------- ------- -------
2004....................................................... $ 501 $ --
2005....................................................... 1,967 6,935
2007....................................................... 2,745 --
2008....................................................... 1,605 --
2021....................................................... 42,587 --
2022....................................................... 28,760 --
------- ------
$78,165 $6,935
======= ======
</Table>
NOTE 13. COMMITMENTS
ARRIS leases office, distribution, and manufacturing facilities as well as
equipment under long-term leases expiring at various dates through 2009. The
cost of equipment that is acquired under terms of leases, which substantially
transfer all of the rights and risks of ownership, is capitalized by the
Company. Assets acquired under capital leases are depreciated principally on the
same basis as other similar assets or over the lease term, if shorter. The
original cost and related accumulated depreciation on equipment under capital
leases included in property, plant and equipment on the balance sheet are
approximately $2.0 million and $1.0 million, respectively, at December 31, 2002.
The Company had no assets under capital leases as of December 31, 2001. Future
minimum lease payments under non-cancelable leases at December 31, 2002 were as
follows (in thousands):
<Table>
<Caption>
CAPITAL LEASES OPERATING LEASES
-------------- ----------------
2003..................................... $1,178 $ 8,940
2004..................................... 162 6,725
2005..................................... -- 5,273
2006..................................... -- 4,197
2007..................................... -- 2,309
Thereafter............................... -- 2,265
Less sublease income..................... -- (2,192)
------ -------
Total minimum lease payments............. $1,340 $27,517
=======
Less interest included in lease
payments............................... (62)
------
Principal amount of lease payments....... $1,278
======
</Table>
Total rental expense for all operating leases amounted to approximately
$11.0 million, $7.8 million and $5.3 million for the years ended December 31,
2002, 2001 and 2000, respectively. We currently lease approximately 75,000
square feet of office space from Nortel Networks with an annual rental charge of
approximately $675,000 expiring July 2004.
As of December 31, 2002, the Company had approximately $3.0 million
outstanding under letters of credit with its banks.
NOTE 14. STOCK-BASED COMPENSATION
ARRIS grants stock options for a fixed number of shares to employees and
directors with an exercise price equal to the market price of the shares at the
date of grant. ARRIS accounts for stock option grants in accordance with APB
Opinion No. 25, Accounting for Stock Issued to Employees and, accordingly, does
not recognize compensation expense for the stock option grants. The Company has
elected to follow APB Opinion No. 25 because, as discussed below, the
alternative fair value accounting provided for under SFAS No. 123,
69
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Accounting for Stock-Based Compensation, requires use of option valuation models
that were not developed for use in valuing employee stock options.
ARRIS grants stock options under its 2002 Stock Incentive Plan ("2002 SIP")
as well as from its 2001 Stock Incentive Plan ("2001 SIP") and issues stock
purchase rights under its Employee Stock Purchase Plan ("ESPP"). In connection
with the Company's reorganization on August 3, 2001, the Company froze
additional grants under its prior plans, which are the 2000 Stock Incentive Plan
("2000 SIP"), the 2000 Mid-Level Stock Option Plan ("MIP"), the 1997 Stock
Incentive Plan ("SIP"), the 1993 Employee Stock Incentive Plan ("ESIP"), the
Director Stock Option Plan ("DSOP"), and the TSX Long-Term Incentive Plan
("LTIP"). All options granted under the previous plans are still exercisable.
These plans are described below.
As required by SFAS No. 123, ARRIS presents supplemental information
disclosing pro forma net (loss) income and net (loss) income per common share as
if ARRIS had recognized compensation expense on stock options granted subsequent
to December 31, 1994 under the fair value method of that statement. The fair
value for these options was estimated using a Black-Scholes option-pricing
model. The weighted average assumptions used in this model to estimate the fair
value of options granted under the 2002 SIP, 2001 SIP, 2000 SIP, MIP, SIP, ESIP,
DSOP and LTIP for 2002, 2001 and 2000 were as follows: risk-free interest rates
of 3.97%, 4.27% and 5.03%, respectively; a dividend yield of 0%; volatility
factor of the expected market price of ARRIS' common stock of .83, .71 and .64,
respectively; and a weighted average expected life of 5, 4, and 5 years,
respectively. The weighted average assumptions used to estimate the fair value
of purchase rights granted under the ESPP for 2002, 2001, and 2000 were as
follows: risk-free interest rates of 1.88%, 2.70% and 5.52% respectively; a
dividend yield of 0%; volatility factor of the expected market price of ARRIS'
common stock of .83, .71 and .64, respectively; and a weighted average expected
life of .5, .5 and 1 year, respectively. See Note 2 of Notes to Consolidated
Financial Statements for pro forma presentation.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions, including the expected stock price
volatility. Because ARRIS' employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
In 2002, the Board of Directors approved the 2002 SIP to facilitate the
retention and continued motivation of key employees, consultants and directors,
and to align more closely their interests with those of the Company and its
stockholders. Awards under the 2002 SIP may be in the form of incentive stock
options, non-qualified stock options, stock grants, stock units, restricted
stock, stock appreciation rights, performance shares and units, dividend
equivalent rights and reload options. A total of 2,500,000 shares of the
Company's common stock may be issued pursuant to this plan. The vesting
requirements for issuance under this plan may vary.
In 2001, the Board of Directors approved the 2001 SIP to facilitate the
retention and continued motivation of key employees, consultants and directors,
and to align more closely their interests with those of the Company and its
stockholders. Awards under the 2001 SIP may be in the form of incentive stock
options, non-qualified stock options, stock grants, stock units, restricted
stock, stock appreciation rights, performance shares and units, dividend
equivalent rights and reload options. A total of 9,580,000 shares of the
Company's common stock may be issued pursuant to this plan. The vesting
requirements for issuance under this plan may vary.
In 2001, the Board of Directors approved a proposal to grant truncated
options to employees and board members having previous stock options with
exercise prices more than 33% higher than the market price of the Company's
stock at $10.20 per share. The truncated options to purchase stock of the
Company pursuant to the Company's 2001 SIP, have the following terms: (a) one
fourth of each option shall be exercisable immediately and an additional one
fourth shall become exercisable or vest on each anniversary of this grant;
70
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(b) each option shall be exercisable in full after the closing price of the
stock has been at or above the target price as determined by the agreement for
twenty consecutive trading days (the "Accelerated Vesting Date"); (c) each
option shall expire on the earliest of (i) the tenth anniversary of grant, (ii)
six months and one day from the accelerated vesting date, (iii) the occurrence
of an earlier expiration event as provided in the terms of the options granted
by 2000 stock option plans. No compensation was recorded in relation to these
options.
In 2000, the Board of Directors approved the 2000 SIP to facilitate the
retention and continued motivation of key employees, consultants and directors,
and to align more closely their interests with those of the Company and its
stockholders. Awards under the 2000 SIP may be in the form of incentive stock
options, non-qualified stock options, stock grants, stock units, restricted
stock, stock appreciation rights, performance shares and units, dividend
equivalent rights and reload options. A total of 2,500,000 shares of the
Company's common stock were originally reserved for issuance under this plan.
Options granted under this plan vest in fourths on the anniversary date of the
grant beginning with the first anniversary and terminate ten years from the date
of grant.
In 2000, the Board of Directors approved the 2000 MIP established to
facilitate the retention and continued motivation of key mid-level employees and
to align more closely their interests with those of the Company and its
stockholders. Awards under this plan were in the form of non-qualified stock
options. A total of 500,000 shares of ARRIS' common stock were originally
reserved for issuance under this plan. As only mid-level employees of the
Company are eligible to receive grants under this plan, no options under this
plan were granted to officers of ARRIS. No mid-level employee received more than
7,500 options to purchase shares of the Company's stock under this plan and no
option may be granted under this plan after the date of the 2000 annual meeting
of stockholders. Options granted under this plan vest in fourths on the
anniversary date of the grant beginning with the first anniversary and terminate
ten years from the date of grant.
In 1997, the Board of Directors approved the SIP to facilitate the hiring,
retention and continued motivation of key employees, consultants and directors
and to align more closely their interests with those of the Company and its
stockholders. Awards under the SIP were in the form of incentive stock options,
non-qualified stock options, stock grants, stock units, restricted stock, stock
appreciation rights, performance shares and units, dividend equivalent rights
and reload options. A total of 3,750,000 shares of the Company's common stock
were originally reserved for issuance under this plan. Vesting requirements for
issuance under the SIP may vary as may the related date of termination.
Approximately three-fourths of the SIP options granted were tied to a vesting
schedule that would accelerate if ARRIS' stock closed above specified prices
($15, $20 and $25) for 20 consecutive days and the Company's diluted earnings
per common share (before non-recurring items) over a period of four consecutive
quarters exceed $1.00 per common share. As of March 31, 1999 the $1.00 per
diluted share trigger for the vesting of these grants was met. The $15 and $20
stock value targets had already been met. Accordingly two-thirds of these
options were vested. Further, on May 26, 1999, the final third was vested upon
meeting the $25 per share value target. Under the terms of the options, one half
of the vested options became exercisable when the target was reached and the
remaining options become exercisable one year later. A portion of all other
options granted under this plan vest each year on the anniversary of the date of
grant beginning with the second anniversary and terminate seven years from the
date of grant. The remaining portion of options granted under the SIP plan vest
in fourths on the anniversary of the date of grant beginning with the first
anniversary and have an extended life of ten years from the date of grant.
In 1993, the Board of Directors approved the ESIP that provides for
granting key employees and consultants options to purchase up to 1,925,000
shares of ARRIS common stock. In 1996, an amendment to the ESIP was approved
increasing the number of shares of ARRIS common stock that may be issued
pursuant to that plan from 1,925,000 shares to 3,225,000 shares. One-third of
these options vests each year on the anniversary of the date of grant beginning
with the second anniversary. The options terminate seven years from the date of
grant.
In 1993, the Board of Directors also approved the DSOP that provides for
the granting, to each director of the Company who has not been granted any
options under the ESIP each January 1, commencing
71
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
January 1, 1994, an option to purchase 2,500 shares of ARRIS common stock for
the average closing price for the ten trading days preceding the date of grant.
A total of 75,000 shares of ARRIS common stock were originally reserved for
issuance under this plan. These options vest six months from the date of grant
and terminate seven years from the date of grant. No options have been issued
pursuant to this plan after 1997.
In connection with ARRIS' acquisition of TSX in 1997, each option to
purchase TSX common stock under the LTIP was converted to a fully vested option
to purchase ARRIS common stock. A total of 883,900 shares of ARRIS common stock
have been allocated to this plan. The options under the LTIP terminate ten years
from the original grant date.
A summary of activity of ARRIS' options granted under its 2002 SIP, 2001
SIP, 2000 SIP, MIP, SIP, ESIP, DSOP, and LTIP is presented below:
<Table>
<Caption>
2002 2001 2000
---------------------------- --------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
----------- -------------- ---------- -------------- ---------- --------------
Beginning balance.......... 8,912,226 $13.34 5,378,727 $16.27 3,940,717 $14.34
Grants..................... 7,359,432 $ 6.76 4,169,778 $10.17 2,389,017 $21.11
Exercises.................. (11,925) $ 8.00 (59,328) $11.80 (490,337) $10.71
Terminations............... (1,421,471) $ 9.38 (535,227) $17.45 (460,003) $30.85
Expirations................ (405,049) $18.43 (41,724) $22.22 (667) $15.88
----------- ---------- ----------
Ending balance............. 14,433,213 $10.24 8,912,226 $13.34 5,378,727 $16.27
=========== ========== ==========
Vested at period end....... 4,929,486 $13.40 3,605,738 $13.64 2,261,708 $12.46
=========== ========== ==========
Weighted average fair value
of options granted during
year..................... $ 4.64 $ 5.71 $ 21.11
=========== ========== ==========
</Table>
The following table summarizes information about 2002 SIP, 2001 SIP, 2000
SIP, MIP, SIP, ESIP, DSOP, and LTIP options outstanding at December 31, 2002.
<Table>
<Caption>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- ------------------------------
NUMBER WEIGHTED AVERAGE WEIGHTED NUMBER WEIGHTED
RANGE OF OUTSTANDING REMAINING AVERAGE EXERCISABLE AVERAGE
EXERCISE PRICES AT 12/31/02 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/02 EXERCISE PRICE
--------------- ----------- ---------------- -------------- ----------- --------------
$ 2.00 to $ 4.00..... 2,402,069 9.86 years $ 2.52 20,000 $ 2.00
$ 5.00 to $ 8.68..... 3,081,737 8.70 years $ 8.08 574,599 $ 8.00
$ 8.88 to $10.32..... 6,605,628 7.79 years $10.05 2,371,808 $ 9.72
$10.50 to $15.88..... 1,024,103 1.32 years $12.70 1,021,853 $12.70
$16.60 to $19.75..... 153,001 2.89 years $16.99 153,001 $16.99
$22.88 to $59.31..... 1,166,675 6.66 years $29.90 788,225 $28.93
---------- ---------
$ 2.00 to $59.31..... 14,433,213 7.73 years $10.24 4,929,486 $13.40
========== =========
</Table>
Additionally, ARRIS has an ESPP that initially enabled its employees to
purchase a total of 300,000 shares of ARRIS common stock over a period of time.
In 1999, an amendment to the ESPP was approved increasing the number of shares
of ARRIS common stock that may be issued pursuant to that plan to 800,000
shares. The Company accounts for the ESPP in accordance with APB Opinion No. 25,
Accounting for Stock Issued to Employees, and accordingly recognizes no
compensation expense. Participants can request that up to 10% of their base
compensation be applied toward the purchase of ARRIS common stock under ARRIS'
ESPP. Purchases by any one participant are limited to $25,000 in any one year.
The exercise price is the lower of 85% of the fair market value of the ARRIS
common stock on either the first day of the purchase period or the last day of
the purchase period. Under the ESPP, employees of ARRIS purchased 18,709 shares
of ARRIS common stock in 2000. In connection with the Company's reorganization
on August 3, 2001, the existing plan was frozen and a new plan was authorized
under which 800,000 shares were available. Under the
72
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
new plan, employees of ARRIS purchased 307,324 and 72,835 shares of ARRIS common
stock in 2002 and 2001, respectively. At December 31, 2002, approximately
198,957 shares are subject to purchase under the new ESPP at a price of no more
than $3.15 per share, to be settled March 31, 2003.
In 2002, 2001, and 2000, ARRIS paid its non-employee directors annual
retainer fees of $50,000 in the form of stock units. These stock units, which
are granted out of the various stock option plans, convert to Common Stock of
the Company at the prearranged time selected by each director. The Company
amortizes the compensation expense related to these stock units on a
straight-line basis over a period of one year. At December 31, 2002, 2001, and
2000 there were 123,800 units, 71,200 units and 40,300 units issued and
outstanding, respectively. In conjunction with the acquisitions of Arris
Interactive L.L.C. and Cadant, Inc., the Company issued approximately 345,000
shares of restricted stock, which are being amortized to compensation expense
over two-year periods. In 2002, the Company issued a total of 30,000 shares of
restricted stock to members of its newly formed Technical Advisory Board, which
are being amortized to compensation expense over a two-year period. Compensation
expense for the stock units and restricted stock discussed above was
approximately $1.9 million, $1.1 million, and $1.0 million for the years ending
December 31, 2002, 2001, 2000, respectively.
NOTE 15. EMPLOYEE BENEFIT PLANS
The Company sponsors two non-contributory defined benefit pension plans
that cover the Company's U.S. employees. As of January 1, 2000, the Company
froze the defined pension plan benefits for 569 participants. These participants
elected to participate in ARRIS' enhanced 401(k) plan. Due to the cessation of
plan accruals for such a large group of participants, a curtailment was
considered to have occurred. As a result of the curtailment, as outlined under
SFAS No. 88, Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits, the Company recorded a $2.1
million pre-tax gain on the curtailment during the first quarter 2000. In
addition, during the year ended December 31, 2001, the Company recognized
approximately $3.6 million in pension expense related to supplemental pension
plan benefits.
The U.S. pension plan benefit formulas generally provide for payments to
retired employees based upon their length of service and compensation as defined
in the plans. ARRIS' policy is to fund the plans as required by the Employee
Retirement Income Security Act of 1974 ("ERISA") and to the extent that such
contributions are tax deductible. Liabilities for amounts in excess of these
funding levels are accrued and reported in the consolidated balance sheet.
Summary data for the non-contributory defined benefit pension plans is as
follows:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001
---------- ----------
(IN THOUSANDS)
Change in Benefit Obligation:
Benefit obligation at the beginning of year.......... $ 28,973 $ 17,851
Service cost......................................... 898 431
Interest cost........................................ 1,587 1,269
Plan amendment....................................... -- 3,955
Actuarial (gain) loss................................ (3,423) 2,207
Benefit payments..................................... (310) (329)
Settlements.......................................... (6,485) --
Curtailment.......................................... (483) 3,589
-------- --------
Benefit obligation at end of year.................... $ 20,757 $ 28,973
======== ========
</Table>
73
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001
---------- ----------
(IN THOUSANDS)
Change in Plan Assets:
Fair value of plan assets at beginning of year....... $ 11,140 $ 11,513
Actual return on plan assets......................... (1,371) (56)
Company contributions................................ 6,585 11
Settlements.......................................... (6,485) --
Benefits paid from plan assets....................... (310) (328)
-------- --------
Fair value of plan assets at end of year............. $ 9,559 $ 11,140
======== ========
Funded Status:
Funded status of plan................................ $(11,198) $(17,833)
Unrecognized actuarial loss.......................... 1,279 1,486
Unamortized prior service cost....................... 3,584 4,106
Minimum pension liability............................ (1,849) --
Unfunded pension loss................................ (1,219) --
-------- --------
(Accrued) benefit cost............................... $ (9,403) $(12,241)
======== ========
</Table>
The settlement in 2002 represents the payment of the accrued benefit to a
former participant of the plan. The plans' assets consist of corporate and
government debt securities and equity securities. Net periodic pension cost for
2002, 2001 and 2000 for pension and supplemental benefit plans includes the
following components (in thousands):
<Table>
<Caption>
2002 2001 2000
------ ------ -------
Service cost.............................................. $ 898 $ 431 $ 597
Interest cost............................................. 1,587 1,269 1,143
Return on assets (expected)............................... (882) (914) (901)
Recognized net actuarial (gain) loss...................... (198) (23) (141)
Amortization of prior service cost........................ 550 313 308
------ ------ -------
Net periodic pension cost................................. 1,955 1,076 1,006
Additional pension (income) due to curtailment............ (483) 3,589 (2,108)
------ ------ -------
Net periodic pension cost (income)........................ $1,472 $4,665 $(1,102)
====== ====== =======
</Table>
The assumptions used in accounting for the Company's defined benefit plans
for the three years presented are set forth below:
<Table>
<Caption>
2002 2001 2000
---- ---- ----
Assumed discount rate for active participants............... 6.75% 7.25% 7.75%
Assumed discount rate for inactive participants............. 6.5% 6.5% 6.5%
Rates of compensation increase.............................. 6.0% 6.0% 6.0%
Expected long-term rate of return on plan assets............ 8.0% 8.0% 8.0%
</Table>
Additionally, ARRIS has established defined contribution plans pursuant to
the Internal Revenue Code Section 401(a) that cover all eligible U.S. employees.
ARRIS contributes to these plans based upon the dollar amount of each
participant's contribution. ARRIS made contributions to these plans of
approximately $2.0 million, $1.1 million and $1.1 million in 2002, 2001, and
2000, respectively. In conjunction with the Company's reorganization in August
2001, all the terms and conditions of the plan remain the same.
74
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 16. SALES INFORMATION
A significant portion of ARRIS' revenue is derived from sales to Comcast
(including AT&T Broadband) and Cox Communications. Sales to these two customers
for 2002, 2001, and 2000 are set forth below:
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------
2002 2001 2000
------ ------ ------
Comcast (including AT&T Broadband)......................... $250.2 $245.6 $387.2
% of sales................................................. 38.4% 39.1% 51.8%
Cox Communications......................................... $106.7 $110.9 $116.5
% of sales................................................. 16.4% 17.7% 15.6%
</Table>
In the fourth quarter of 2002, Comcast completed its purchase of AT&T
Broadband. AT&T Broadband was the Company's largest customer in terms of
revenues in the first three quarters of 2002. AT&T Broadband, with the
deployment of telephony as part of its core strategy, had been using ARRIS' CBR
products in many of its major markets. Comcast has announced that as its initial
priority after its acquisition of AT&T Broadband, it will emphasize video and
high-speed data operations and focus on improving the profitability of its
telephony operations at the expense of subscriber growth.
ARRIS operates globally and offers products and services that are sold to
cable system operators and telecommunications providers. ARRIS' products and
services are focused in two product categories instead of the previous three
categories: Broadband, and Supplies and Services. As a result of the sale of the
Company's Keptel and Actives product lines in 2002, revenues from the remaining
product lines within the former Transmission, Optical, and Outside Plant product
category are now reported with the Supplies and Services product revenues. All
prior period revenues have been aggregated to conform to the new product
categories. Consolidated revenues by principal products and services for the
years ended December 31, 2002, 2001 and 2000, respectively were as follows (in
thousands):
<Table>
<Caption>
SUPPLIES AND
BROADBAND SERVICES TOTAL
--------- ------------ --------
Annual sales
December 31, 2002................................... $449,703 $202,180 $651,883
December 31, 2001................................... $368,511 $259,812 $628,323
December 31, 2000................................... $312,310 $437,662 $749,972
</Table>
The Company sells its products primarily in the United States with its
international revenue being generated from Asia Pacific, Europe, Latin America
and Canada. The Asia Pacific market primarily includes China, Hong Kong, Japan,
Korea, and Singapore. The European market primarily includes Austria, Germany,
France, Netherlands, Poland, Portugal, Romania, Spain, and Switzerland. The
Latin American market primarily includes Argentina, the Bahamas, Chile,
Colombia, Mexico, and Puerto Rico. Sales to international customers were
approximately 22.6%, 11.4% and 4.3% of total sales for the years ended December
31, 2002, 2001 and 2000, respectively. International sales for the years ended
December 31, 2002, 2001 and 2000 were as follows (in thousands):
<Table>
<Caption>
DECEMBER 31, DECEMBER 31, DECEMBER 31,
2002 2001 2000
------------ ------------ ------------
International region
Asia Pacific.................................. $ 51,328 $ 20,484 $ 2,721
Europe........................................ 67,363 31,613 6,592
Latin America................................. 20,266 14,125 19,789
Canada........................................ 8,387 5,679 3,308
-------- -------- --------
Total international sales.................. 147,344 71,901 32,410
Total domestic sales....................... 504,539 556,422 717,562
-------- -------- --------
Total sales........................... $651,883 $628,323 $749,972
======== ======== ========
</Table>
Total identifiable international assets were immaterial.
75
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 17. SUMMARY QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
The following table summarizes ARRIS' quarterly consolidated financial
information (in thousands, except share data). Quarters in 2002 and 2001 ended
March 31, June 30, and September 30 are restated to comply with the reporting
requirements of SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets.
<Table>
<Caption>
QUARTERS IN 2002 ENDED
---------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
Net sales.............................. $172,397 $176,502 $180,577 $122,407
Gross profit(10)(11)................... 58,231 60,479 65,217 42,725
Operating income
(loss)(10)(12)(13)(14)............... 2,678 (16,491) 10,403 (82,328)
Income (loss) from continuing
operations((7)(17)(18)............... 3,443 (27,032) 4,893 (95,717)
Income (loss) from discontinued
operations(3)(12)(15)(16)............ (5,377) (13,682) (1,406) 1,671
Net income (loss) before cumulative
effect of accounting change.......... (1,934) (40,714) 3,487 (94,046)
Net income (loss)(19).................. $(59,894) $(40,714) $ 3,487 $(94,046)
======== ======== ======== ========
Net (loss) per basic and diluted share:
Income (loss) from continuing
operations........................ $ 0.04 $ (0.33) $ 0.06 $ (1.16)
Income (loss) from discontinued
operations........................ (0.07) (0.17) (0.02) 0.02
Cumulative effect of accounting
change............................ (0.72) -- -- --
-------- -------- -------- --------
Net income (loss)................. $ (0.75) $ (0.50) $ 0.04 $ (1.14)
======== ======== ======== ========
</Table>
<Table>
<Caption>
QUARTERS IN 2001 ENDED
---------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
--------- -------- ------------- ------------
Net sales.............................. $178,248 $141,423 $ 146,521 $162,131
Gross profit(1)(3)(9).................. 31,350 25,413 38,374 53,523
Operating income (loss)(1)(3)(4)(8).... 6,162 (1,059) (28,484) 1,628
Income (loss) from continuing
operations(5)(6)(7).................. 145 (5,150) (75,137) (3,116)
Income (loss) from discontinued
operations(2)(3)(9).................. (7,363) (9,338) (57,328) (10,444)
Net income (loss) before cumulative
effect of accounting change.......... (7,218) (14,488) (132,465) (13,560)
Net income (loss)...................... $ (7,218) $(14,488) $(132,465) $(13,560)
======== ======== ========= ========
Net (loss) per basic and diluted share:
Income (loss) from continuing
operations........................ $ 0.00 $ (0.13) $ (1.21) $ (0.04)
Income (loss) from discontinued
operations........................ (0.19) (0.24) (0.92) (0.14)
Cumulative effect of accounting
change............................ -- -- -- --
-------- -------- --------- --------
Net income (loss)................. $ (0.19) $ (0.38) $ (2.13) $ (0.18)
======== ======== ========= ========
</Table>
- ---------------
(1) During the second quarter of 2001, a workforce reduction program was
implemented which significantly reduced the Company's overall employment
levels. This action resulted in a pre-tax charge to cost of goods sold of
approximately $1.3 million for severance and related costs incurred at the
factory level. Additionally, a pre-tax charge of $3.7 million was recorded
to operating expenses.
(2) During the second quarter of 2001, a warranty expense relating to a
specific product was recorded, resulting in a pre-tax charge of $4.7
million for the expected replacement cost of this product of which
76
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
all relates to and is classified in discontinued operations. The Company
does not anticipate any further warranty expenses to be incurred in
connection with this product.
(3) In the third quarter of 2001, in connection with the outsourcing of most of
our manufacturing functions, the Company recorded pre-tax restructuring and
impairment charges of approximately $66.2 million, of which approximately
$50.1 million relates to and is classified in discontinued operations.
Included in these charges was approximately $33.7 million related to the
write-down of inventories and remaining warranty and purchase order
commitments, of which approximately $8.6 million was reflected in cost of
goods sold and $25.1 million was reflected in discontinued operations.
Additional charges incurred were approximately $5.7 million related to
severance and associated personnel costs, $5.9 million related to the
impairment of goodwill due to the sale of the power product lines, $14.8
million related to the impairment of fixed assets, and approximately $6.1
million related to lease terminations of factories and office space and
other shutdown expenses. Of these charges, approximately $7.5 million is
reflected in restructuring expense and $25.0 million is reflected in
discontinued operations. In 2002, the Company recorded an additional $2.4
million pre-tax charge to discontinued operations related to the 2001
restructuring.
(4) During the third quarter 2001, the Company wrote off in-process R&D of
$18.8 million in connection with the Arris Interactive L.L.C. acquisition.
(5) During the third quarter of 2001, unamortized deferred finance fees of $1.9
million were recorded as a loss on the extinguishment of debt. These fees
related to a revolving credit facility, which was replaced in connection
with the Arris Interactive L.L.C. acquisition. This charge was originally
recorded as an extraordinary loss, but was reclassified to income (loss)
from continuing operations in connection with the adoption in 2002 of SFAS
No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections.
(6) As a result of the restructuring and impairment charges during the third
quarter 2001, a valuation allowance of approximately $38.1 million against
deferred tax assets was recorded in accordance with SFAS No. 109,
Accounting for Income Taxes. (See Note 4 of Notes to the Consolidated
Financial Statements.)
(7) The Company recorded pre-tax losses of approximately $0.6 million and $0.8
million during the years ended December 31, 2002 and 2001, respectively,
related to changes in market value of its trading securities.
The Company recorded a $1.0 million and $12.5 million charge to income
during the second quarter of 2002 and fourth quarter of 2002, respectively,
on its available for sale securities as a result of market value declines
considered by management to be other than temporary.
(8) In the fourth quarter of 2001, ARRIS closed a research and development
facility in Raleigh, North Carolina and recorded a $4.0 million charge
related to severance and other costs associated with closing that facility.
(9) Due to the economic disturbances in Argentina, the Company recorded a
write-off of $4.4 million related to unrecoverable inventory amounts due
from a customer in that region during the fourth quarter of 2001, of which
approximately $1.6 million relates to and is classified in discontinued
operations, and $2.8 million is reflected in cost of goods sold.
(10) During 2002, the Company recorded severance charges related to general
reductions in force of approximately $5.1 million, of which $1.1 million is
reflected in cost of goods sold and $4.0 million is reflected in selling,
general, administrative and development expenses.
(11) During 2002, ARRIS wrote off the remaining $2.1 million of power
inventories that had not been transferred to the buyer. This charge is
reflected in cost of goods sold.
(12) During the second quarter of 2002, the Company established a reserve of
$20.2 million in connection with its Adelphia receivables of which
approximately $1.3 million relates to and is classified in discontinued
operations, and approximately $18.9 million is reflected in selling,
general, administrative and development expenses. Adelphia filed for
bankruptcy in June 2002. During the third quarter of
77
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2002, the Company sold a portion of its Adelphia accounts receivables to an
unrelated third party, resulting in a net gain of approximately $4.3
million. Of this total gain, approximately $0.3 million relates to and is
classified in discontinued operations, and $4.0 million is reflected in
selling, general and administrative and development expense.
(13) During the fourth quarter of 2002, based upon management's analysis
including an independent valuation, the Company recorded a goodwill
impairment charge of $70.2 million with respect to our supplies and
services product line.
(14) During the fourth quarter of 2002, a restructuring charge of approximately
$7.1 million was recorded in connection with the closure of our development
and repair facility in Andover, Massachusetts.
(15) During the second quarter of 2002, a loss of $8.5 million was recorded in
connection with the sale of the Keptel product line and is classified in
discontinued operations. During the fourth quarter of 2002, the Company
reduced this loss by $2.4 million as a result of the resolution of certain
estimated costs associated with the sale.
(16) During the fourth quarter of 2002, a gain of $2.2 million was recorded in
connection with the sale of the Actives product line and is classified in
discontinued operations.
(17) During the second quarter of 2002, the Company recorded a loss of
approximately $9.3 million associated with the 4 1/2% note exchanges, in
accordance with SFAS No. 84. This loss was partially offset with a gain of
$2.0 million recorded in the fourth quarter of 2002, related to cash
repurchases of the 4 1/2% notes, which was classified in continuing
operations in accordance with SFAS No. 145.
(18) During the first quarter of 2002, the Company recorded a $6.8 million
income tax benefit as a result of a change in tax legislation, allowing
ARRIS to carry back losses for five years versus the previous limit of two
years.
(19) The Company posted a goodwill impairment loss of approximately $58.0
million in the first quarter of 2002, due to the cumulative effect of an
accounting change in accordance with SFAS No. 142 and upon management's
analysis of its intangibles including an independent valuation.
NOTE 18. BUSINESS ACQUISITIONS
ACQUISITION OF ARRIS INTERACTIVE L.L.C.
On August 3, 2001, ARRIS completed the acquisition from Nortel Networks of
the portion of Arris Interactive that it did not own. Arris Interactive was a
joint venture formed by Nortel Networks and the Company in 1995, that developed
products for delivering voice and data services over hybrid fiber coax-
networks. The Company decided to complete this transaction because it believes
that the growth prospects for conveyed telecommunications networks offering
cable telephony and high speed are significant, and that the transaction enables
the combined company to acquire new products or technology to expand ARRIS'
total product offering. Immediately prior to the acquisition the Company owned
18.75% and Nortel Networks owned the remainder. As part of this transaction:
- A new holding company, ARRIS, was formed;
- ANTEC, its predecessor, merged with its subsidiary and the outstanding
ANTEC common stock was converted, on a share-for-share basis, into ARRIS
common stock;
- Nortel Networks and the Company contributed to Arris Interactive
approximately $131.6 million in outstanding indebtedness and adjusted
their ownership percentages in Arris Interactive to reflect these
contributions;
- Nortel Networks exchanged its remaining ownership interest in Arris
Interactive for 37.0 million shares of ARRIS common stock (approximately
49.2% of the total shares outstanding following the transaction) and a
subordinated redeemable Class B interest in Arris Interactive with a face
amount of $100 million;
- ANTEC, now the Company's wholly-owned subsidiary, changed its name to
Arris International, Inc.;
78
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- Nortel Networks designated two new members to the Company's board of
directors;
- The Company issued approximately 2.1 million options and 95,000 shares of
restricted stock to Arris Interactive employees
In connection with this transaction, the Company entered into an agreement
with Nortel Networks whereby it paid Nortel Networks an agency fee of
approximately, on average, 10% for all sales of Arris Interactive legacy
products made to certain domestic and international customers. This agreement
for domestic agency fees expired December 31, 2001. The agreement for
international agency fees was terminated on December 6, 2002.
The Class B membership interest is redeemable in approximately four
quarterly installments commencing February 3, 2002, provided that certain
availability and other tests are met under the Company's revolving credit
facility as described in Note 9 of the Notes to the Consolidated Financial
Statements.
The following is a summary of the purchase price allocation to record the
Company's purchase of Nortel Networks' ownership interest in Arris Interactive
for 37,000,000 shares of ARRIS Group, Inc. common stock on August 3, 2001 at
$6.14 per share as of April 9, 2001 (date of definitive agreement):
<Table>
<Caption>
(IN THOUSANDS)
--------------
37,000,000 shares of ARRIS' $0.01 par value common stock at
$6.14 per share........................................... $227,180
Acquisition costs (banking fees, legal and accounting fees,
printing
costs).................................................... 7,616
Write-off of abandoned leases and related leasehold
improvements.............................................. 2,568
Fair value of stock options to Arris Interactive L.L.C
employees................................................. 12,531
Other....................................................... 1,346
--------
Adjusted Purchase Price........................... $251,241
========
Allocation of Purchase Price:
Net tangible assets acquired.............................. $ 56,048
Existing technology (to be amortized over 3 years)........ 51,500
In-process research and development....................... 18,800
Goodwill (not deductible for income tax purposes)......... 124,893
--------
Total Allocated Purchase Price.................... $251,241
========
</Table>
The value assigned to in-process research and development, in accordance
with accounting principles generally accepted in the United States, was written
off at the time of acquisition. The $18.8 million of in-process research and
development valued for the transaction related to two projects that were
targeted at the carrier-grade telephone and high-speed data markets. The value
of the in-process research and development was calculated separately from all
other acquired assets. The projects included:
- Multi-service Access System ("MSAS"), a high-density multiple stream
cable modem termination system providing carrier-grade availability and
high-speed routing technology on the same headend targeted at the
carrier-grade telephone and high-speed data market. There were specific
risks associated with this in-process technology. As the MSAS had a
unique capability to perform hardware sparing through its functionality
via use of a radio frequency switching matrix, there was risk involved in
being able to achieve the isolation specifications related to this type
of technology. Subsequent to December 31, 2001 the MSAS project was
discontinued because of a product overlap with Cadant, Inc.
- Packet Port II, an outside voice over internet protocol terminal targeted
at the carrier-grade telephone market. There were specific risks
associated with this in-process technology. Based on the key product
objectives of the Packet Port II, from a hardware perspective, the
product is required to achieve power supply performance capable of
meeting a wide range of input power, operating conditions and loads. From
a software perspective, the Company was dependent on a third party for
reference design software critical to this product. Since development of
this reference design software was currently in
79
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
process at the time of valuation, the ordinary risks associated with the
completion and timely delivery of the software were inherent to this project.
Additionally, there are sophisticated power management techniques required
to meet the target power consumption of this product. There are
technical/schedule risks associated with implementing processor power down
that can simultaneously meet power consumption targets without affecting
the voice or data functionality of this technology application. The Packet
Port II project was completed in 2002.
The following table identifies specific assumptions for the projects, at
the acquisition date, in millions:
<Table>
<Caption>
FAIR VALUE AT ESTIMATED EXPECTED
DATE OF PERCENTAGE OF COST TO EXPECTED DATE DISCOUNT
PROJECT VALUATION COMPLETION COMPLETE TO COMPLETE RATE
- ------- ------------- ------------- -------- ------------- --------
MSAS................. $16.9 68.9% $ 9.9 July 2002 32%
Packet Port II....... $ 1.9 41.5% $11.3 March 2002 32%
</Table>
Valuation of in-process research and development
The fair values assigned to each developed technology as related to this
transaction were valued using an income approach based upon the current stage of
completion of each project in order to calculate the net present value of each
in-process technology's cash flows. The cash flows used in determining the fair
value of these projects were based on projected revenues and estimated expenses
for each project. Revenues were estimated based on relevant market size and
growth factors, expected industry trends, individual product sales cycles, the
estimated life of each product's underlying technology, and historical pricing.
Estimated expenses include cost of goods sold, selling, general and
administrative and research and development expenses. The estimated research and
development expenses include costs to maintain the products once they have been
introduced into the market, and costs to complete the in-process research and
development. It was anticipated that the acquired in-process technologies would
yield similar prices and margins that had been historically recognized by Arris
Interactive and expense levels consistent with historical expense levels for
similar products.
A risk-adjusted discount rate was applied to the cash flows related to each
existing products' projected income stream for the years 2002 through 2006. This
discount rate assumes that the risk of revenue streams from new technology is
higher than that of existing revenue streams. The discount rate used in the
present value calculations was generally derived from a weighted average cost of
capital, adjusted upward to reflect the additional risks inherent in the
development life cycle, including the useful life of the technology,
profitability levels of the technology, and the uncertainty of technology
advances that are known at the assumed transaction date. Product-specific risk
includes the stage of completion of each product, the complexity of the
development work completed to date, the likelihood of achieving technological
feasibility, and market acceptance.
ACQUISITION OF CADANT, INC.
On January 8, 2002, ARRIS completed the acquisition of all of the assets of
Cadant, Inc., a privately held designer and manufacturer of next generation
Cable Modem Termination Systems ("CMTS"). The Company decided to complete this
transaction because it provides significant product and technology extensions to
complement its broadband product offerings and would have a positive impact on
future results of the Company.
- ARRIS issued 5.25 million shares of ARRIS common stock for the purchase
of substantially all of Cadant's assets and certain liabilities.
- ARRIS agreed to pay up to 2.0 million shares based upon future sales of
the CMTS product through January 8, 2003. These targets were not met as
of January 8, 2003, and therefore, no further shares were issued.
The following is a summary of the purchase price allocation to record
ARRIS' purchase price of the assets and certain liabilities of Cadant Inc. for
5,250,000 shares of ARRIS Group, Inc. common stock based
80
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
on the average closing price of ARRIS' common stock for 5 days prior and 5 days
after the date of the transaction as quoted on the Nasdaq National Market
System. The excess of the purchase price over the fair value of the net tangible
and intangible assets acquired has been allocated to goodwill.
<Table>
<Caption>
(IN THOUSANDS)
--------------
5,250,000 shares of ARRIS Group, Inc.'s $0.01 par value
common stock at $10.631 per common share.................. $55,813
Acquisition costs (banking fees, legal and accounting fees,
printing costs)........................................... 874
Fair value of stock options to Cadant, Inc. employees....... 12,760
Assumption of certain liabilities of Cadant, Inc............ 14,955
-------
Adjusted purchase price................................... $84,402
=======
Allocation of Purchase Price:
Net tangible assets acquired.............................. $ 5,063
Existing technology (to be amortized over 3 years)........ 53,000
Goodwill (not deductible for income tax purposes)......... 26,339
-------
Total allocated purchase price............................ $84,402
=======
</Table>
SUPPLEMENTAL PRO FORMA INFORMATION
Presented below is summary unaudited pro forma combined financial
information for the Company, Arris Interactive L.L.C. and Cadant, Inc. to give
effect to the transactions. This summary unaudited pro forma combined financial
information is derived from the historical financial statements of the Company,
Arris Interactive L.L.C. and Cadant, Inc. This information assumes the
transactions were consummated at the beginning of the applicable period. This
information is presented for illustrative purposes only and does not purport to
represent what the financial position or results of operations of the Company,
Arris Interactive L.L.C., Cadant, Inc., or the combined entity would actually
have been had the transactions occurred at the applicable dates, or to project
the Company's, Arris Interactive L.L.C.'s, Cadant, Inc.'s or the combined
entity's results of operations for any future period or date. The actual results
of Arris Interactive L.L.C. are included in the Company's operations from August
4, 2001 to December 31, 2002. The actual results of Cadant, Inc. are included in
the Company's operations from January 8, 2002 to December 31, 2002.
<Table>
<Caption>
(UNAUDITED)
YEARS ENDED DECEMBER 31,
------------------------
2002 2001
---------- ----------
(IN THOUSANDS,
EXCEPT FOR EARNINGS PER
SHARE DATA)
Net sales................................................... $ 651,883 $ 670,174
Gross profit................................................ 226,652 173,927
Operating income (loss) (1)................................. (86,475) (112,148)
Income (loss) before income taxes........................... (121,950) (140,408)
Income (loss) from continuing operations.................... (115,150) (175,996)
Income (loss) from discontinued operations.................. (18,794) (84,472)
Net income (loss) before cumulative effect of accounting
change.................................................... (133,944) (260,468)
Net income (loss)........................................... (191,904) (260,468)
Net income (loss) per common share:
Basic and diluted......................................... $ (2.34) $ (3.23)
========= =========
Weighted average common shares:
Basic and diluted......................................... 82,049 80,669
========= =========
</Table>
(1) In accordance with SFAS No. 142, Goodwill and Other Intangible Assets,
goodwill is no longer amortized, but reviewed annually for impairment. The
provisions of SFAS No. 142 state that goodwill and indefinite lived
intangible assets acquired after June 30, 2001 will not be amortized. The
information presented above, therefore, does not include amortization
expense on the goodwill acquired in these transactions.
81
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table represents the amount assigned to each major asset and
liability caption of Arris Interactive L.L.C. as of August 3, 2001 and Cadant,
Inc. as of January 8, 2002, as adjusted:
<Table>
<Caption>
AS OF ACQUISITION DATE
(IN THOUSANDS)
--------------------------
ARRIS
INTERACTIVE
L.L.C. CADANT, INC.
----------- ------------
Total current assets........................................ $179,909 $ 782
Property, plant and equipment, net.......................... $ 23,209 $ 4,281
Goodwill.................................................... $124,926 $26,339
Intangible assets (existing technology)..................... $ 51,500 $53,000
Total assets................................................ $379,544 $84,402
Total current and long-term liabilities..................... $ 67,208 $14,955
Total liabilities and membership interest................... $167,208 $14,955
</Table>
NOTE 19. SUBSEQUENT EVENTS
REDEMPTION OF CONVERTIBLE SUBORDINATED NOTES DUE 2003
Between January 1, 2003 and March 10, 2003, the Company purchased
approximately $12.4 million of its 4 1/2% convertible subordinated notes due
2003 in exchange for cash. No gain or loss was recognized on these purchases. As
of March 10, there were approximately $11.5 million of the 4 1/2% convertible
subordinated notes due 2003 outstanding.
CABOVISAO DEVELOPMENTS
As of March 10, 2003, Cabovisao, a Portugual-based customer owed ARRIS
approximately 18.6 million euros in accounts receivable, a substantial portion
of which was past due. On October 17, 2002, the parent company of Cabovisao,
CSii, issued an announcement that suggested it may have difficulty in accessing
or refinancing its senior credit facility in the future. On February 3, 2003,
CSii announced that it had obtained an extension of the maturity date of its
credit facility to February 28, 2003, and that it was continuing negotiations
with respect to a long term financing solution. On March 1, 2003, CSii announced
that it had formed a special committee of its board of directors to review and
evaluate alternatives to meet the financial needs of CSii and Cabovisao,
including: debt restructuring, recapitalization, capital infusion, court
supervised restructuring. The Company is uncertain what effect, if any, these
developments will have on its existing accounts receivable or future
relationship with Cabovisao.
AMENDMENT TO CREDIT FACILITY
On March 11, 2003, ARRIS amended its credit facility to permit the Company
to issue up to $125.0 million of subordinated convertible notes due 2008, to use
the proceeds of such notes to redeem the Class B membership interest in Arris
Interactive held by Nortel Networks and to purchase shares of the ARRIS common
stock held by Nortel Networks, subject to certain limitations. The amendment
also reduced the revolving loan commitments to $115.0 million.
CONVERTIBLE SUBORDINATED NOTE OFFERING
On March 18, 2003, the Company issued a $125.0 million of convertible
subordinated notes due 2008. The convertible subordinated notes will pay
interest semi-annually based on an annual rate of 4.5%. The conversion rate is
equivalent to $5.00 per share. The Company used approximately $88.4 million of
the proceeds from the issuance, including the reduction in the forgiveness of
the Class B membership interest, to redeem the Class B membership interest in
Arris Interactive held by Nortel Networks. On March 24, 2003, the Company used
approximately $28.0 million of the proceeds of the issuance to repurchase and
retire 8 million shares of our common stock held by Nortel Networks at a
discount.
82
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
REDEMPTION OF CLASS B MEMBERSHIP INTEREST HELD BY NORTEL NETWORKS
In connection with the acquisition of Arris Interactive in August 2001,
Nortel Networks exchanged its remaining ownership interest in Arris Interactive
for 37 million shares of ARRIS common stock and a subordinated redeemable Class
B membership interest in Arris Interactive with a face amount of $100.0 million.
The Class B membership interest earned an accreting non-cash return of 10% per
annum, compounded annually, and was redeemable in approximately four quarterly
installments commencing February 3, 2002, provided that certain availability and
other tests are met under the Company's Credit Facility. Those tests were not
met. The balance of the Class B membership interest as of December 31, 2002 was
approximately $114.5 million. In June 2002, ARRIS entered into an option
agreement with Nortel Networks that permitted ARRIS to redeem the Class B
membership interest in Arris Interactive at a discount of 21% prior to June 30,
2003. To further induce the Company to redeem the Class B membership interest,
Nortel Networks offered to forgive approximately $5.9 million of the earnings on
the Class B membership interest if ARRIS redeemed it prior to March 31, 2003.
The Company used approximately $88.4 million, including the reduction in the
forgiveness of the Class B membership interest, of the proceeds of the March
2003 offering of its 4 1/2% convertible subordinated notes due 2008 to redeem
the Class B membership interest, at a $28.5 million discount.
REPURCHASE OF SHARES HELD BY NORTEL NETWORKS
Of the 37 million shares of ARRIS common stock that Nortel Networks
received in 2001, it sold 15 million in a registered public offering in June
2002. In order to reduce its holdings further, in March 2003 Nortel Networks
granted the Company an option to purchase up to 16 million shares at a 10%
discount to market, subject to a minimum purchase price of $3.50 per share for 8
million shares and $4.00 per share for the remainder. In addition, to the extent
that the Company purchases shares at a price of less than $4.00 per share, it is
obligated to return to Nortel Networks a portion of the return that was forgiven
with respect to the Class B membership interest, up to a maximum of $2.0
million. Pursuant to this option, on March 24, 2003, the Company purchased and
retired 8 million shares for an aggregate purchase price of $28.0 million. The
Company has not decided when or whether it will exercise the remainder of the
option.
ACQUISITION OF ATOGA SYSTEMS
On March 21, 2003, the Company purchased certain assets of Atoga Systems, a
Fremont, California-based of optical transport systems for metropolitan area
networks. Under the terms of the agreement, ARRIS obtained certain inventory,
fixed assets, and intellectual property in consideration for approximately $0.5
million of cash and the assumption of certain lease obligations. Further, the
Company retained approximately 30 employees and issued a total of 500,000 shares
of restricted stock to those employees.
83
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to directors and officers of ARRIS is set forth under
the captions entitled "Election of Directors" and "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Company's Proxy Statement for the 2003
Annual Meeting of Stockholders and is incorporated herein by reference. Certain
information concerning the executive officers of the Company is set forth in
Part I of this document under the caption entitled "Executive Officers of the
Company".
ITEM 11. EXECUTIVE COMPENSATION
Information regarding compensation of officers and directors of ARRIS is
set forth under the captions entitled "Executive Compensation", "Compensation of
Directors", and "Employment Contracts and Termination of Employment and
Change-In-Control Arrangements" in the Proxy Statement incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of ARRIS common stock is set forth under
the captions entitled "Security Ownership of Management" and "Security Ownership
of Principal Stockholders" in the Proxy Statement and is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions with
ARRIS is set forth under the captions entitled "Compensation of Directors" and
"Certain Relationships and Related Transactions" in the Proxy Statement and is
incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of our
disclosure controls and procedures (as such term is defined in Rules 13a-14(c)
and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the
"Exchange Act") as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"). Based on such evaluation, such
officers have concluded that, as of the Evaluation Date, our disclosure controls
and procedures are effective in alerting them on a timely basis to material
information relating to our company (including our consolidated subsidiaries)
required to be included in our reports filed or submitted under the Exchange
Act.
(b) Changes in Internal Controls. Since the Evaluation Date, there have
not been any significant changes in our internal controls or in other factors
that could significantly affect such controls.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) EXHIBITS.
The exhibits listed below in Item 15(a) 1, 2 and 3 are filed as part of
this document. Each management contract or compensatory plan required to be
filed as an exhibit is identified by an asterisk (*).
(B) REPORTS ON FORM 8-K.
On October 3, 2002, we filed a report on Form 8-K relating to Item 5, Other
Events and Item 7, Financial Statements, Pro Forma Financial Information and
Exhibits, to describe the Rights Agreement, dated October 3, 2002.
On October 10, 2002, we filed a report on Form 8-K relating to Item 5,
Other Events and Item 7, Financial Statements, Pro Forma Financial Information
and Exhibits, to disclose the fifth amendment to our credit agreement, dated
September 30, 2002.
84
On November 15, 2002, we filed a report on Form 8-K relating to Item 5, Other
Events and Item 7, Financial Statements, Pro Forma Financial Information and
Exhibits, to announce the definitive agreement to sell our transmission,
optical, and outside plant product lines.
ITEM 15(A) 1 & 2. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL
STATEMENT SCHEDULES
FINANCIAL STATEMENTS
The following Consolidated Financial Statements of ARRIS Group, Inc. and
Report of Independent Auditors are filed as part of this Report.
<Table>
<Caption>
PAGE
----
Report of Independent Auditors.............................. 49
Consolidated Balance Sheets at December 31, 2002 and 2001... 50
Consolidated Statements of Operations for the years ended
December 31, 2002, 2001 and 2000.......................... 51
Consolidated Statements of Cash Flows for the years ended
December 31, 2002, 2001 and 2000.......................... 52
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 2002, 2001 and 2000.............. 53
Notes to the Consolidated Financial Statements.............. 54
</Table>
85
FINANCIAL STATEMENT SCHEDULES
The following consolidated financial statement schedule of ARRIS is
included in Item 15(a) 2 pursuant to paragraph (d) of Item 15:
Schedule II -- Valuation and Qualifying Accounts
All other schedules for which provision is made in the applicable
accounting regulation of the Securities and Exchange Commission are not required
under the related instructions or are not applicable, and therefore have been
omitted.
SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS
<Table>
<Caption>
BALANCE AT RESERVES BALANCE AT
BEGINNING FROM CHARGE TO END OF
DESCRIPTION OF PERIOD ACQUISITION EXPENSES DEDUCTIONS(1) PERIOD
- ----------- ---------- ----------- --------- ------------- ----------
(IN THOUSANDS)
YEAR ENDED DECEMBER 31, 2002
Reserves and allowance deducted from
asset accounts:
Allowance for uncollectible
accounts........................ $ 9,409 $ -- $29,744 $28,455 $10,698
Reserve for obsolescence and
excess inventory(2)............. $23,373 $ -- $10,697 $19,152 $14,918
YEAR ENDED DECEMBER 31, 2001
Reserves and allowance deducted
from asset accounts:
Allowance for uncollectible
Accounts........................ $ 6,686 $ 2,046 $ 5,820 $ 5,143 $ 9,409
Reserve for obsolescence and
excess inventory(2)............. $20,000 $14,704 $16,540 $27,871 $23,373
YEAR ENDED DECEMBER 31, 2000
Reserves and allowance deducted from
asset accounts:
Allowance for uncollectible
Accounts........................ $ 7,505 $ -- $ 1,117 $ 1,936 $ 6,686
Reserve for obsolescence and
excess inventory(2)............. $20,852 $ -- $18,480 $19,332 $20,000
</Table>
- ---------------
(1) Uncollectible accounts written off, net of recoveries
(2) The reserve for obsolescence and excess inventory is included in inventories
ITEM 15(A)3. EXHIBIT LIST
Each management contract or compensation plan required to be filed as an
exhibit is identified by an asterisk (*).
<Table>
<Caption>
THE FILINGS REFERENCED FOR
INCORPORATION BY REFERENCE ARE
ARRIS (FORMERLY KNOWN AS
EXHIBIT BROADBAND PARENT, INC.) FILINGS
NUMBER DESCRIPTION OF EXHIBIT UNLESS OTHERWISE NOTED
- ------- ---------------------- -------------------------------
3.1 Amended and Restated Certificate of
Incorporation...................................... Registration Statement
#333-61524, Exhibit 3.1.
3.2 Certificate of Amendment to Amended and Restated
Certificate of Incorporation....................... August 3, 2001 Form 8-A,
Exhibit 3.2.
3.3 By-laws............................................ Registration Statement
#333-61524, Exhibit 3.2, filed
by Broadband Parent Corporation
</Table>
86
<Table>
<Caption>
THE FILINGS REFERENCED FOR
INCORPORATION BY REFERENCE ARE
ARRIS (FORMERLY KNOWN AS
EXHIBIT BROADBAND PARENT, INC.) FILINGS
NUMBER DESCRIPTION OF EXHIBIT UNLESS OTHERWISE NOTED
- ------- ---------------------- -------------------------------
4.1 Form of Certificate for Common Stock............... Registration Statement
#333-61524, Exhibit 4.1.
4.2 Rights Agreement dated October 3, 2002............. October 3, 2002 Form 8-K
Exhibit 4.1
4.3 Indenture dated March 18, 2003..................... Filed herewith.
10.1 Credit Agreement, dated August 3, 2001............. August 3, 2001 Form 8-K,
Exhibit 10.1.
10.1(a) First Amendment to Credit Agreement dated January
8, 2002............................................ December 31, 2001 Form 10-K,
Exhibit 10.1(a).
10.1(b) Second Amendment to Credit Agreement dated April
19, 2002........................................... March 31, 2002 Form 10-Q,
Exhibit 10.1(b).
10.1(c) Third Amendment to Credit Agreement dated April 24,
2002............................................... March 31, 2002 Form 10-Q,
Exhibit 10.1(c).
10.1(d) Fourth Amendment to Credit Agreement dated May 31,
2002............................................... June 7, 2002 Form 8-K, Exhibit
10.1.
10.1(e) Acknowledgment from Lenders, dated June 25 2002.... June 30, 2002 Form 10-Q,
Exhibit 10.1(e).
10.1(f) Fifth Amendment to Credit Agreement dated September
30, 2002........................................... September 30, 2002 Form 8-K,
Exhibit 10.1.
10.1(g) Sixth Amendment to Credit Agreement dated November
21, 2002........................................... November 21, 2002 Form 8-K,
Exhibit 10.1.
10.1(i) Limited Waiver to Credit Agreement dated December
5, 2002............................................ November 21, 2002 Form 8-K,
Exhibit 10.2.
10.1(h) Seventh Amendment to Credit Agreement dated January
2, 2003............................................ November 21, 2002 Form 8-K,
Exhibit 10.3.
10.1(j) Eighth Amendment to Credit Agreement dated March
11, 2003........................................... March 11, 2003 Form 8-K,
Exhibit 10.1
10.2 Second Amended and Restated Investor Rights
Agreement Dated June 7, 2002....................... June 7, 2002 Form 8-K Exhibit
10.3.
10.2(a) Option Agreement Dated June 7, 2002................ June 7, 2002 Form 8-K Exhibit
10.2.
10.2(b) Letter Agreement with Nortel Networks dated March
11, 2003........................................... March 11, 2003 Form 8-K,
Exhibit 10.2.
10.3 (Nortel Networks) Registration Rights Agreement.... August 3, 2001 Form 8-K,
Exhibit 10.3.
</Table>
87
<Table>
<Caption>
THE FILINGS REFERENCED FOR
INCORPORATION BY REFERENCE ARE
ARRIS (FORMERLY KNOWN AS
EXHIBIT BROADBAND PARENT, INC.) FILINGS
NUMBER DESCRIPTION OF EXHIBIT UNLESS OTHERWISE NOTED
- ------- ---------------------- -------------------------------
10.3(a) Letter Agreement with Nortel Networks dated March
11, 2003........................................... March 11, 2003 Form 8-K,
Exhibit 10.4.
10.4 (Liberty Media) Registration Rights Agreement...... Filed herewith.
10.5 (Cadant, Inc.) Asset Purchase Agreement dated
December 8, 2001................................... February 8, 2002 Form S-3,
Exhibit 2.
10.6(a)* Agreement with Robert J. Stanzione for the
conversion of special 2001 bonus to stock units.... December 31, 1999 Form 10-K,
Exhibit 10.10(b), filed by
ANTEC Corporation.
10.6(b)* Amended and Restated Employment Agreement, dated
August 6, 2001, with Robert J Stanzione............ September 30, 2001 Form 10-Q,
Exhibit 10.10(c).
10.6(c)* Supplemental Executive Retirement Plan for Robert J
Stanzione.......................................... September 30, 2001 Form 10-Q,
Exhibit 10.10(d).
10.7(a)* Amended and Restated Employment Agreement dated
April 29, 1999, with John M. Egan.................. June 30, 1999 Form 10-Q,
Exhibit 10.31(a).
10.7(b)* Consulting Agreement, dated April 27, 1999 with
John M. Egan....................................... June 30, 1999 Form 10-Q,
Exhibit 10.31(b), filed by
ANTEC Corporation.
10.7(c)* Supplemental Executive Retirement Plan for John M.
Egan............................................... June 30, 1999 Form 10-Q,
Exhibit 10.31(c), filed by
ANTEC Corporation.
10.8* Amended and Restated Employment Agreement, dated
April 29, 1999, with Lawrence A. Margolis.......... June 30, 1999 Form 10-Q,
Exhibit 10.33, filed by ANTEC
Corporation.
10.9* Form of Employment Agreement with Gordon E.
Halverson.......................................... March 31, 2002, Form 10-Q,
Exhibit 10.9.
10.10* Consulting Agreement dated February 1, 1998 for
James L. Faust..................................... December 31, 1998 Form 10-K,
Exhibit 10.14, filed by ANTEC
Corporation.
10.11* Stock Option Agreement with William H. Lambert
dated March 14, 1994............................... April 30, 1994 TSX Corporation
Form 10-K, Exhibit 10(A)(1)(3)
</Table>
88
<Table>
<Caption>
THE FILINGS REFERENCED FOR
INCORPORATION BY REFERENCE ARE
ARRIS (FORMERLY KNOWN AS
EXHIBIT BROADBAND PARENT, INC.) FILINGS
NUMBER DESCRIPTION OF EXHIBIT UNLESS OTHERWISE NOTED
- ------- ---------------------- -------------------------------
10.12* 2001 Stock Incentive Plan.......................... July 2, 2001 Appendix III of
Proxy Statement filed as part
of, Registration Statement
#333-61524, filed by Broadband
Parent Corporation.
10.13* Management Incentive Plan.......................... July 2, 2001 Appendix IV of
Proxy Statement filed as part
of Registration Statement
#333-61524, filed by Broadband
Parent Corporation.
10.14 Solectron Manufacturing Agreement and Addendum..... December 31, 2001 Form 10-K,
Exhibit 10.15.
10.15 Mitsumi Agreement.................................. December 31, 2001 Form 10-K,
Exhibit 10.16.
10.16* Form of Employment Agreement with Ronald M.
Coppock............................................ December 31, 2001 Form 10-K,
Exhibit 10.17.
10.17 Keptel, Inc. Asset Purchase Agreement.............. March 31, 2002 Form 10-Q,
Exhibit 10.18.
10.18 Actives Purchase Agreement dated November 13,
2002............................................... Filed herewith.
10.19* Employment Agreement with James D. Lakin and
Supplement dated August 5, 2001.................... Filed herewith.
10.20* Employment Agreement with David B. Potts dated
August 5, 2001..................................... Filed herewith.
10.21 Settlement and Release Agreement dated March 11,
2003 March 11, 2003 Form 8-K,
Exhibit 10.3
21 Subsidiaries of the Registrant..................... Filed herewith.
23 Consent of Ernst & Young LLP....................... Filed herewith.
24 Powers of Attorney................................. Filed herewith.
</Table>
89
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
ARRIS GROUP, INC.
/s/ LAWRENCE A. MARGOLIS
--------------------------------------
Lawrence A. Margolis
Executive Vice President,
Chief Financial Officer
Dated: March 26, 2003
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
<Table>
Chairman and Director
- ---------------------------------------------------
John M. Egan
/s/ ROBERT J. STANZIONE President, Chief Executive March 26, 2003
- --------------------------------------------------- Officer and Director
Robert J. Stanzione
/s/ LAWRENCE A. MARGOLIS Executive Vice President, Chief March 26, 2003
- --------------------------------------------------- Financial Officer
Lawrence A. Margolis
/s/ DAVID B. POTTS Senior Vice President of Finance, March 26, 2003
- --------------------------------------------------- Chief Information Officer
David B. Potts
/s/ ALEX B. BEST* Director March 26, 2003
- ---------------------------------------------------
Alex B. Best
/s/ HARRY L. BOSCO* Director March 26, 2003
- ---------------------------------------------------
Harry L. Bosco
/s/ JOHN IAN ANDERSON CRAIG* Director March 26, 2003
- ---------------------------------------------------
John Ian Anderson Craig
Director
- ---------------------------------------------------
Randy K. Dodd
/s/ JAMES L. FAUST* Director March 26, 2003
- ---------------------------------------------------
James L. Faust
/s/ MATTHEW B. KEARNEY* Director March 26, 2003
- ---------------------------------------------------
Matthew B. Kearney
Director
- ---------------------------------------------------
William H. Lambert
/s/ JOHN R. PETTY* Director March 26, 2003
- ---------------------------------------------------
John R. Petty
</Table>
90
<Table>
/s/ LARRY ROMRELL* Director March 26, 2003
---------------------------------------------------
Larry Romrell
Director
---------------------------------------------------
Bruce Van Wagner
*By: /s/ LAWRENCE A. MARGOLIS
---------------------------------------------
Lawrence A. Margolis
(as attorney in fact for each
person indicated)
</Table>
91
CERTIFICATION PURSUANT TO SEC. 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Robert J. Stanzione, certify that:
1. I have reviewed this annual report on Form 10-K of ARRIS Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
<Table>
Date: March 26, 2003 /s/ ROBERT J. STANZIONE
-----------------------------------------------------
Robert J. Stanzione
President and Chief Executive Officer
</Table>
92
CERTIFICATION PURSUANT TO SEC. 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Lawrence A. Margolis, certify that:
1. I have reviewed this annual report on Form 10-K of ARRIS Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
<Table>
Date: March 26, 2003 /s/ LAWRENCE A. MARGOLIS
-----------------------------------------------------
Lawrence A. Margolis
Executive Vice President, Chief Financial
Officer and Secretary
</Table>
93