10-K 1 d825405d10k.htm FORM 10-K Form 10-K
Table of Contents
Index to Financial Statements

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

For the fiscal year ended December 31, 2014

of

ARRIS GROUP, INC.

A Delaware Corporation

IRS Employer Identification No. 46-1965727

SEC File Number 000-31254

3871 Lakefield Drive

Suwanee, GA 30024

(678) 473-2000

Securities registered pursuant to Section 12(b) of the Act:

Common Stock, $0.01 par value — NASDAQ Global Market System

ARRIS Group, Inc. is a well-known seasoned issuer.

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

Except as set forth in Item 10, ARRIS Group, Inc. is unaware of any delinquent filers pursuant to Item 405 of Regulation S-K.

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

ARRIS Group, Inc. is required to submit electronically and post on its corporate web site interactive data files required to be submitted and posted pursuant to Rule 405 of Regulation S-T.

The aggregate market value of ARRIS Group, Inc.’s Common Stock held by non-affiliates as of June 30, 2014 was approximately $4.6 billion (computed on the basis of the last reported sales price per share of such stock of $32.53 on the NASDAQ Global Market System). For these purposes, directors, officers and 10% shareholders have been assumed to be affiliates.

As of January 31, 2015, 145,161,490 shares of ARRIS Group, Inc.’s Common Stock were outstanding.

Portions of ARRIS Group, Inc.’s Proxy Statement for its 2015 Annual Meeting of Stockholders are incorporated by reference into Part III.

 

 

 


Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

          Page  
PART I   

ITEM 1.

   Business      1   

ITEM 1A.

   Risk Factors      12   

ITEM 1B.

   Unresolved Staff Comments      21   

ITEM 2.

   Properties      21   

ITEM 3.

   Legal Proceedings      21   

ITEM 4.

   Mine Safety Disclosures      25   

ITEM 4A.

   Executive Officers and Board Committees      25   
PART II   

ITEM 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters, Issuer Purchases of Equity Securities, and Stock Performance Graph      27   

ITEM 6.

   Selected Consolidated Historical Financial Data      29   

ITEM 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      30   

ITEM 7A.

   Quantitative and Qualitative Disclosures About Market Risk      62   

ITEM 8.

   Consolidated Financial Statements and Supplementary Data      63   

ITEM 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      63   

ITEM 9A.

   Controls and Procedures      63   

ITEM 9B.

   Other Information      63   
PART III   

ITEM 10.

   Directors, Executive Officers, and Corporate Governance      113   

ITEM 11.

   Executive Compensation      113   

ITEM 12.

   Security Ownership of Certain Beneficial Owners, Management and Related Stockholders Matters      113   

ITEM 13.

   Certain Relationships, Related Transactions, and Director Independence      113   

ITEM 14.

   Principal Accountant Fees and Services      113   
PART IV   

ITEM 15.

   Exhibits and Financial Statement Schedules      114   
   Signatures      118   

 

i


Table of Contents
Index to Financial Statements

PART I

 

Item 1. Business

As used in this Annual Report, unless the context requires otherwise, “we,” “our,” “us,” “the Company,” and “ARRIS” refer to ARRIS Group, Inc. (and its predecessors) and our consolidated subsidiaries.

General

Our principal executive offices are located at 3871 Lakefield Drive, Suwanee, Georgia 30024, and our telephone number is (678) 473-2000. We maintain a website at www.arris.com. The information contained on our website is not part of, and is not incorporated by reference into, this Form 10-K. On our website, we provide links to copies of the annual, quarterly and current reports that we file with the Securities and Exchange Commission (“SEC”), Section 16 reports that our officers and directors file with the SEC, any amendments to those reports, proxy materials for meetings of our shareholders, and all Company news releases. Investor presentations are also frequently posted on our website. Copies of our code of ethics and the charters of our standing board committees also are available on our website. We will provide investors copies of these documents in electronic or paper form upon request, free of charge. We will disclose on our website or on a Current Report on Form 8-K any waivers or amendments to our code of ethics made with respect to our directors and executive officers.

Glossary of Terms

Below are commonly used acronyms in our industry and their meanings:

 

Acronym

  

Terminology

AdVOD

   Linear and Demand Oriented Advertising

ARPU

   Average Revenue Per User

BEQ

   Broadband Edge QAM

BSR

   Broadband Services Router

Cable VoIP

   Cable Voice over Internet Protocol

CAM

   Cable Access Module

CBR

   Constant Bit Rate

CCAP

   Converged Cable Access Platform

CE

   Consumer Electronics

CMS

   Content Management System

CMTS

   Cable Modem Termination System

COTS

   Commercial Off the Shelf

CPE

   Customer Premises Equipment

CVeX

   Converged Video Exchange

CWDM

   Coarse Wave Division Multiplexing

DBS

   Digital Broadcast Satellite

DCT

   Digital Consumer Terminal

DOCSIS®

   Data Over Cable Service Interface Specification

DPI

   Digital Program Insertion

DRM

   Digital Rights Management

DSL

   Digital Subscriber Line

DTA

   Digital Television Adapter

DVB

   Digital Video Broadcasting

DVR

DWDM

  

Digital Video Recorder

Dense Wave Division Multiplexing

EMTA

   Embedded Multimedia Terminal Adapter

EPON

   Ethernet over Passive Optical Network

eQAM

   Edge Quadrature Amplitude Modulator

FPGA

   Field Programmable Gate Arrays

FTTH

   Fiber to the Home

FTTP

   Fiber to the Premises

GAAP

   Generally Accepted Accounting Principles

GHZ

   Gigahertz

GPA

   General Purchase Agreements

HD

   High Definition

 

1


Table of Contents
Index to Financial Statements

Acronym

  

Terminology

HD-DVR

   High Definition Digital Video Recorder

HDTV

   High Definition Television

HDR

   High Dynamic Range

HEVC

   High Efficiency Video Coding

HFC

   Hybrid Fiber-Coaxial

IFRS

   International Financial Reporting Standards

ILEC

   Incumbent Local Exchange Carrier

IoT

   Internet of Things

IP

   Internet Protocol

IPR

   Intellectual Property Rights

IPTV

   Internet Protocol Television

IRD

   Integrated Receiver / Decoder

LAN

   Local Area Network

Mbps

   Megabits per Second

MPEG

   Moving Picture Experts Group

MPEG-2

   Moving Picture Experts Group, Standard No. 2

MPEG-4

   Moving Picture Experts Group, Standard No. 4

M-CMTS

   Modular CMTS

MSO

   Multiple Systems Operator

MSP

   Media Services Platform

MTA

   Multimedia Terminal Adapter

MVPD

   Multichannel Video Programming Distributors

NGNA

   Next Generation Network Architecture

NDVR

   Network Digital Video Recorder

NPVR

   Network Personal Video Recorder

NSM

   Network Service Manager

NIU

   Network Interface Unit

OLT

   Optical Line Termination

ONU

   Optical Network Unit

OEM

   Original Equipment manufacturer

OSS

   Operations Support System

OTT

   Over-the-Top

PC

   Personal Computer

PCS

   Post Contract Support

PCT

   Patent Convention Treaty

PON

PSTN

  

Passive Optical Network

Public-Switched Telephone Network

PVR

QAM

  

Personal Video Recorder

Quadrature Amplitude Modulation

QoS

   Quality of Service

RDK

   Reference Design Kit

RF

   Radio Frequency

RFOG

   Radio Frequency over Glass

RGU

   Revenue Generating Unit

SCTE

   Society of Cable Telecommunication Engineers

SD

   Standard Definition

SDV

   Switched Digital Video

SLA

   Service Level Agreement

TVE

   TV Everywhere

UHD

   Ultra High Definition

Triple Play

   Bundled Offering of Internet, Telephone and TV

VAR

   Value-Added Reseller

VOD

   Video on Demand

VoIP

   Voice over Internet Protocol

VPN

   Virtual Private Network

VSP

   Video Services Platform / Video Service Provider

VSOE

   Vendor-Specific Objective Evidence

 

2


Table of Contents
Index to Financial Statements

Overview

ARRIS is a global provider of entertainment and communications solutions. We are headquartered in Suwanee, Georgia. We operate in two business segments: Customer Premises Equipment (“CPE”) and Network & Cloud (“N&C”). We enable service providers including cable, telephone, and digital broadcast satellite operators and media programmers to deliver media, voice, and IP data services to their subscribers. We are a leader in set-tops, digital video and Internet Protocol Television (“IPTV”) distribution systems, broadband access infrastructure platforms, and associated data and voice CPE, which we also sell directly to consumers through retail channels. Our solutions are complemented by a broad array of services including technical support, repair and refurbishment, and system design and integration.

Industry Overview

Entertainment and communications delivery is evolving rapidly as a result of a convergence of trends — including increased competition among service providers, industry consolidation, advances in technology, and shifts in global content consumption behaviors.

Consumers have embraced new forms of content as well as new vehicles for consumption. Across the board, consumers are watching more content, more often, and on more devices. Both content and content delivery are evolving to address the demand. User-generated, streaming, and on-demand content continues to grow in popularity, facilitated by a burgeoning ecosystem of connected devices, including tablets, smartphones, media players, gaming consoles, IP set-tops, and smart TVs. The intersection of consumer demand for personalized content, growing libraries of media, and a broadening device ecosystem has yielded a ripe environment for popular new services like Over-the-Top (“OTT”), TV Everywhere (“TVE”), and multiscreen.

On the technology front, Internet Protocol (“IP”) video distribution is further transforming how content is managed and consumed. IP is not only facilitating new forms of video — like Ultra High-Definition (“UHD”) TV — and the ways in which video is delivered, but it is also accelerating the evolution of communications services, like interactive media and broadband. As a result, service providers are compelled to continually invest in and upgrade their network and expand their video, voice, data, and mobile services. Additional, a recent focus on delivering gigabit broadband speeds increases the need to scale networks to the growing demand for bandwidth as new video services like multiscreen video and always-on services like Internet of Things (“IoT”) continue to increase in popularity.

Providing these advanced services to consumers is a highly competitive business. This environment is driving service providers to enhance and expand their offerings by adding more high-definition (“HD”) channels, and now UHD content (also referred to as 4K or 8K), increasing data speeds and expanding mobile services to provide converged media experiences that bridge conventional TV and Internet services. This, in turn, is creating a market for regular video and broadband network upgrades as well as technology investment cycles in CPE, such as set-tops, data modems, and gateways.

Service providers continue to advance their capabilities to differentiate and gain market share. U.S. Cable operators and telcos are investing extensively to deploy enhanced user interfaces, higher broadband speeds, additional programming, integrated home networking and monitoring services, all with higher reliability. These cycles, combined with associated consumer trends and innovation in entertainment and communications delivery continues to accelerate industry growth.

Motorola Home Integration

Following our acquisition of the Motorola Home business from General Instrument Holdings, Inc., a subsidiary of Google, Inc. in 2013, ARRIS experienced significant growth in global scale and customer base and benefitted from an augmented engineering capability and product portfolio. As a result of the acquisition, ARRIS more than doubled in size and capitalized on many of the synergies between the two companies. Since then, we’ve focused on streamlining the combined businesses and assets, recently completing the major tasks of integrating order management, supply chain, IT, and finance. Today the overall process is nearly complete. We have phased out our Transition Service Agreements with Google and are moving forward as a single, unified company.

 

3


Table of Contents
Index to Financial Statements

Current Operating Segments

The completion of the Motorola Home acquisition changed the way that we manage and review the performance of our business. As a result, beginning with the periods ended June 30, 2013, we report two operating segments, (1) Network & Cloud and (2) Customer Premises Equipment. Corporate and other expenses not included in the measure of segment contribution will be reported in an “All Other” category. See Note 10 to our financial statements for additional information.

Our Strategy

Our long-term business strategy is aimed at growth and expansion with the goal of transforming the future of consumer entertainment and connectivity. ARRIS is achieving that by:

 

   

Investing in global research and development

 

   

Advancing tomorrow’s consumer services and experiences

 

   

Deepening relationships with our customers

 

   

Gaining market share with new and existing service provider customers worldwide

 

   

Expanding the ARRIS product and solutions portfolio to serve satellite operators and grow retail channel sales

 

   

Enhancing the ARRIS brand

Specific aspects of our strategy include:

 

   

Leveraging ARRIS’ scale to drive profitable worldwide growth.     With the integration of the Motorola Home business, ARRIS has achieved a new level of scale to drive efficiencies. Our expanded portfolio, broader customer base, and larger sales team, expose us to a greater portion of worldwide spending on products in our markets.

 

   

Capitalizing on the evolution toward network convergence and all IP platforms to drive business growth.     New digital video services require IP-based infrastructure to reach consumers on their screen of choice. Service providers face a two-pronged challenge: meeting demand for these new services on legacy equipment, today, while transitioning equipment for tomorrow’s services to an all-IP model. ARRIS uniquely combines an end-to-end approach to the IP transition with an established footprint in the home and entrenched expertise in content delivery from the cloud to the home. Our end-to-end solutions give service providers a variety of choices for customizing their approach to the IP transition. They encompass network-based video transcoding, packaging, and compression technologies required to deliver new IP video formats; the cloud-based platforms to deliver robust and personalized user experiences; and a portfolio of video gateways that serve as the new hub for delivering IP-based entertainment to connected devices inside and outside the home.

 

   

Enabling differentiated and personalized multiscreen experiences through a holistic approach to content delivery.     The growth of connected consumer devices has created an opportunity for service providers to deliver new, more personalized content experiences to consumers across multiple screens. These experiences require control over content distribution as well as seamless integration into multiple touchpoints in the consumer experience. The challenge of supporting these differentiated experiences and monetizing them is the focus of ARRIS’ end-to-end content delivery strategy which leverages our expertise across hardware and software solutions in the cloud, network, and home to provide a holistic approach to personalization that can transform the entertainment experience.

 

   

Investing in our product and service portfolios through organic development, partnership and acquisition.     ARRIS has a comprehensive and robust development program designed to deliver new products to enhance our competitiveness and growth potential. We regularly evaluate opportunities to acquire capabilities that complement our internal research and development. We plan to continue targeting acquisition candidates that have complementary technology, products and talent.

 

4


Table of Contents
Index to Financial Statements
   

Expanding our international business and exploring adjacent market opportunities.     ARRIS continuously seeks and analyzes investments in opportunities that allow us to capitalize on the growth of video and data services in global markets. Some examples include the growth of digital video and HDTV in Latin America, Europe, the Middle East and Africa (“EMEA”) and Asia as well as the demand for increased data speeds that are driving infrastructure investment. We also are pursuing opportunities in new and adjacent markets, including satellite and Telco.

Our Principal Products

We provide cable network operators, telco service providers, content programmers and retailers with components of our broad product portfolio ranging from the cloud and headend solutions to CPE and global support services. A cross-section of our products in each of our two business segments Network & Cloud and Customer Premises Equipment are depicted below:

 

LOGO

Network & Cloud

 

   

CMTS/CCAP

 

   

The Cable Modem Termination System (“CMTS”) is cable operator headend equipment that communicates with cable modems to control the flow of data; allocates shared bandwidth and prioritizes and routes traffic. The Converged Cable Access Platform (“CCAP”) combines the functionality of a CMTS and an Edge QAM to enable voice, video and data in a converged IP network

 

   

Video Infrastructure

 

   

Multichannel Video Programming Distributors (“MVPD”) and Programmer Equipment that process and package video content for delivery over the service provider network to be received by a set-top or gateway. Includes encoding, compression, transcoding, storage, policy management, security and encryption, and signal modulation for HFC, DSL and/or fiber networks.

 

   

Ad Insertion Technologies supporting linear and on demand ad placement and substitution in MPEG and IP delivery environments.

 

5


Table of Contents
Index to Financial Statements
   

Access & Transport

 

   

Equipment in the ground or on transmission poles between service providers’ headend and subscribers’ premises, as well as equipment used to initiate the distribution of content-carrying signals. Includes optical transmission equipment, Fiber Nodes, RF Amplifiers and metro Wi-Fi wireless products.

 

   

Global Services

 

   

Technical support, professional services, and system integration offerings to enable solutions sales of our end-to-end product portfolio.

 

   

Cloud Solutions

 

   

Software products that enable providers to securely deliver rich user experiences; multiscreen recommendation, offer management, and advertising services.

 

   

Workforce management solutions enabling Service Providers to efficiently manage and dispatch field technicians. Network surveillance and issue correlation software and services.

Customer Premises Equipment

 

   

Set-Top

 

   

A device installed at the subscriber’s television set and connects to the service provider network to decode secure digital video signals and render them as video on the television set.

 

   

Gateway

 

   

A device that connects to the service provider network and delivers video, voice, and data services throughout the subscriber’s home.

 

   

DSL and Cable Modem

 

   

A device located at the subscriber’s home that connects to the cable or telco network to receive and transmit digital information between subscriber-owned devices (e.g. PC or tablet) and the service provider’s headend or central office, providing Internet connectivity.

 

   

E-MTA and Voice / Data Modem

 

   

A modem that also provides both data and telephone service from the service provider throughout the home.

Sales and Marketing

Our sales, sales engineering and technical services team serve our global customers through offices in the U.S. and many of our global markets. Our sales engineering team assists customers in system design and specification. Our technical services team provides professional services to help network operators to design and keep their networks operating at peak performance. Additionally, we provide 24x7 technical support, directly and through channel partners, as well as training, both at our facilities and at our customers’ sites.

We work with value added resellers (“VARs”), sales representatives and channel partners that extend our sales presence into operator markets where we do not have established sales offices. We also maintain an inside sales group that is responsible for regular phone contact with the customer, prompt order entry, timely and accurate delivery, and effective sales administration.

We achieve superior customer service through advanced customer relationship management programs combined with information systems that allow us to provide personalized and timely customer support on a range of subjects and to continually refine operations management.

 

6


Table of Contents
Index to Financial Statements

Our marketing organization promotes both the ARRIS brand and our solutions to customers, consumers, and partners throughout the world. It is complemented by a product management team, which works with our engineering bench to develop and market new products and product enhancements. These teams are responsible for inventory levels, pricing, delivery requirements, market demand analysis, as well as product positioning, communications and advertising.

Customers

The majority of our sales are to facilities-based cable and telco multi-channel video service providers worldwide. As the U.S. cable and telecommunications industries continues a trend toward consolidation, our sales to the largest service providers continues to be crucial to our success. Our sales are substantially dependent upon a system operator’s selection of ARRIS’ network equipment, demand for increased broadband services by subscribers, and general capital expenditure levels by system operators. Our three largest customers (including their affiliates, as applicable) are Comcast, Time Warner Cable and AT&T. From time to time, the affiliates included in our revenues from these customers have changed as a result of mergers and acquisitions. Therefore, the revenue for our customers for prior periods has been adjusted to include, on a comparable basis for all periods presented, the affiliates currently understood to be under common control. Our sales to these customers for the last three years were (in thousands, except percentages):

 

     Years ended December 31,  
     2014     2013     2012  

Comcast and affiliates

   $  1,012,367      $  674,977      $  421,177   

% of sales

     19.0     18.6     31.1

Time Warner Cable and affiliates

   $ 693,736      $ 359,516      $ 243,157   

% of sales

     13.0     9.9     18.0

AT&T and affiliates

   $ 614,601      $ 280,225      $ 1,661   

% of sales

     11.5     7.7     0.1

ARRIS utilizes standard terms of sale. These standard terms of sale apply to all purchases except those to a few of our large customers with whom we have executed general purchase agreements (“GPAs”). These GPAs do not obligate the customer to a specific volume of business. The vast majority of our sales, whether to customers with GPAs or otherwise, result from periodic purchase orders. We have multiple agreements with our largest customers, including Comcast and Time Warner Cable, based upon their needs or as a result of prior acquisitions. We maintain these agreements in the normal course of our business.

International Operations

Our international revenue is generated primarily from Asia-Pacific, Europe, Middle East and Africa (“EMEA”) and Americas. The Asia-Pacific market includes Australia, China, Hong Kong, India, Japan, Korea, Singapore, and Taiwan. The EMEA market includes Austria, Belgium, France, Germany, Great Britain, Hungary, Ireland, Israel, Netherlands, Norway, Poland, Portugal, Romania, Russia, Spain, Sweden, Switzerland and Turkey. The Americas market includes Argentina, Bahamas, Brazil, Canada, Chile, Colombia, Costa Rica, Ecuador, Honduras, Jamaica, Mexico, Panama, Peru and Puerto Rico. Revenues from international customers were approximately 25.7%, 32.1%, and 24.6% of total revenues for 2014, 2013 and 2012, respectively.

We continue to strategically invest in worldwide marketing and sales efforts. We currently maintain international sales offices in Argentina, Brazil, Chile, China, Great Britain, Japan, Korea, Mexico, Netherlands and Spain.

 

7


Table of Contents
Index to Financial Statements

Research and Development

We operate in an industry that is subject to rapid changes in technology and our success is largely contingent upon anticipating such changes. Accordingly, we invest significantly in research and development. This commitment to innovation has resulted in the development of many instrumental next-generation consumer solutions like HD-DVR, WholeHome DVR/media server, in-home and metro Wi-Fi, IoT, 4K/UHD, and more. We continue to innovate in response to both our customers’ needs and developing industry trends, including:

 

   

Transforming the Entertainment Experience — solving the complexity of delivering content to the burgeoning connected device ecosystem through scalable networking and connectivity solutions in the home.

 

   

Delivering Your Media, Your Way — anticipating demand for more personalized, relevant, and mobile experiences with end-to-end multiscreen solutions to personalize and monetize tomorrow’s content experiences.

 

   

Powering Smarter Networks — realizing the potential of today’s entertainment technology, enabling future services like UHD and multiscreen monetization, and transitioning to all-IP networks through powerful transcoding, bandwidth optimization, and video compression technologies.

 

   

Broadband Access — employing state-of-the-art computing and packet processing technologies to solve the last-mile bottleneck, providing ever higher residential speeds and bandwidth.

 

   

Cloud — the enablement of complex function to be performed in the “cloud” to simplify and streamline the in home network and the service providers’ network operations.

We have a significant engineering resources and employees in the U.S. dedicated to research and development through laboratories in Beaverton, Oregon; Horsham, Pennsylvania; Kirkland, Washington; Lisle, Illinois; San Diego, California; Santa Clara, California; Suwanee, Georgia; Wallingford, Connecticut; and Westborough and Lowell, Massachusetts, as well as internationally in Bangalore, India; Cordoba, Argentina; Cork, Ireland; Linkoping, Sweden; Shenzhen, China; and Tel Aviv, Israel.

Research and development expenses in 2014, 2013 and 2012 were approximately $556.6 million, $425.8 million and $170.7 million, respectively. Research and development expenses as a percent of sales in 2014, 2013 and 2012 were approximately 10.5%, 11.8% and 12.6%, respectively. These costs include allocated common costs associated with information technology and facilities.

Intellectual Property

We have an active patenting program for protecting our innovations. During 2014, we continued to enhance our patent portfolio. We were awarded 141 patents and filed 323 utility patent applications and 65 provisional patent applications. As of January 31, 2015, the patenting program consisted of maintaining our portfolio of approximately 1,482 issued patents (both U.S. and foreign) and pursuing patent protection on new inventions (currently approximately 955 U.S. and foreign patent applications). 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 based on criteria that includes: novelty, potential commercial value of the invention, and detectability of infringement. Patent applications are filed on the inventions that meet the criteria.

Although patents generally have a 20 year legal life, the relevant technologies to which the patents apply often have much shorter lives. As such, the economic useful life of the patents is often the same as that of the associated developed technology.

Our patents and patent applications generally are in the areas of telecommunications hardware, software and related technologies. For technology that is not owned by us, we have a program for obtaining appropriate licenses to ensure that we have the necessary license coverage for our products. In addition, we have formed strategic relationships with leading technology companies to provide us with early access to technology that we believe will help keep us at the forefront of our industry.

We also have a program for protecting and developing trademarks. As of January 31, 2015, ARRIS had 469 registered or pending trademark registrations. Our trademark program includes procedures for the use of current trademarks and for the development of new trademarks. This program is designed to ensure that our employees

 

8


Table of Contents
Index to Financial Statements

properly use our registered trademarks and any new trademarks that are expected to develop strong brand loyalty and name recognition. The design of our trademark program is intended to protect our trademarks from dilution or cancellation.

From time to time there are significant disputes with respect to the ownership of the technology used in our industry and patent infringements. See Part I, Item 3, “Legal Proceedings.”

Product Sourcing and Distribution

We maintain a balance of internal and external manufacturing providers to continue offering our customers a competitive combination of quality, cost and flexibility in meeting their needs. We operate manufacturing facilities in Taipei, Taiwan and Tijuana, Mexico. We also use contract manufacturers located in China, Thailand, Mexico, and the United States.

We provide our contract manufacturers with rolling, non-binding forecasts, and we typically have a minimum of 60 days of purchase orders placed with them for products. Purchase orders for delivery within 60 days generally are not cancelable. Purchase orders with delivery past 60 days generally may be cancelled with penalties in accordance with each vendor’s terms. Each contract manufacturer provides a minimum 15-month warranty.

We manufacture a significant portion of our video set-tops and gateways in our manufacturing facility in Taipei, Taiwan. The factory is 209,600 square feet, and, as of December 31, 2014, the facility employed approximately 1,100 people. Current outsourcing arrangements include set-tops, modems, DTAs and IP set-tops.

We manufacture a portion of our Network & Cloud products in our manufacturing facility in Tijuana, Mexico. The factory is 83,124 square feet, and, as of December 31, 2014, the facility employed approximately 410 people. Current outsourcing arrangements include CMTS, amplifiers, certain power supplies, accessories, optical modules, digital return modules, circuit boards, repair services, and video infrastructure equipment.

We distribute a substantial number of products that are not produced by us in order to provide our customers with a comprehensive portfolio offering. Domestically, we distribute hardware and installation products through regional warehouses in California, North Carolina, and Washington. Internationally, we distribute through regional warehouses in Japan, Germany and Netherlands, and through drop shipments from our contract manufacturers located throughout the world.

We obtain key components from numerous third-party suppliers. Our supply agreements include technology licensing and component purchase contracts. Several of our competitors have similar supply agreements for these components. In addition, we license software for operating network and security systems or sub-systems, and a variety of routing protocols from different suppliers.

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, 2014 was approximately $631.0 million, at December 31, 2013 was approximately $538.6 million, and at December 31, 2012 was approximately $222.6 million. We believe that all of the backlog existing at December 31, 2014 will be shipped in 2015.

Anticipated orders from customers may fail to materialize and delivery schedules may be deferred or cancelled for a number of reasons, including reductions in capital spending by network operators, shipping disruptions, customer financial difficulties, annual capital spending budget cycles, and construction delays.

 

9


Table of Contents
Index to Financial Statements

Competition

The markets in which we participate are dynamic and highly competitive, requiring companies to react quickly to capitalize on opportunity. We retain skilled and experienced personnel, and deploy substantial resources to meet the changing demands of the industry and to capitalize on change. We compete with international, national and regional manufacturers, distributors and wholesalers including companies that are larger than we are. Our major competitors include:

 

   

ADB Global;

 

   

Casa Systems, Inc.;

 

   

Cisco Systems, Inc.;

 

   

Commscope, Inc.;

 

   

Concurrent Computer Corporation;

 

   

Emcore Corporation;

 

   

Ericsson;

 

   

Harmonic, Inc.;

 

   

Hitron Technologies Americas Inc.;

 

   

Huawei;

 

   

Humax Co.;

 

   

Netgear;

 

   

Netgem;

 

   

Pace Plc;

 

   

RGB Networks;

 

   

Sagemcom;

 

   

Samsung;

 

   

SeaChange, Inc.;

 

   

SMC Networks;

 

   

Technicolor, Inc.;

 

   

Tivo Inc.;

 

   

Thomson Video Networks;

 

   

TOA Technologies (Oracle);

 

   

TVC Communications, Inc.;

 

   

Ubee Interactive, Inc.;

 

   

Vecima Networks, Inc.; and

 

   

ZTE

We distinguish our products on the basis of reliability and performance, differentiated features, flexibility, breadth, customer service, and availability of business solutions, while pricing our solutions competitively with those of other manufacturers.

The consumer demand for more broadband bandwidth is a fundamental driver behind the continued growth in CMTS and CCAP Edge Routing capacity deployed by cable operators worldwide. The CMTS/CCAP supplier

 

10


Table of Contents
Index to Financial Statements

space is highly competitive with strong historical players such as Cisco and announcements of new products from manufacturers such as Casa, Commscope and Harmonic. In the third quarter of 2014, according to Infonetics Research, CMTS, CCAP and Edge QAM Hardware and Subscribers Quarterly Worldwide and Regional Market Share, Size, and Forecasts, Third Quarter 2014, ARRIS secured 48% worldwide CMTS/CCAP share by revenue.

Through the acquisition of the Motorola Home business, ARRIS became a world leader in the supply of set-tops and video gateways. According to Infonetics Research, Set-Tops and Pay TV Subscribers Quarterly Worldwide Market Share and Forecasts for Third Quarter 2014, ARRIS was the leading provider of all cable video set-tops, gateways, and media players in the third quarter of 2014 with approximately 32% worldwide share of revenue. Infonetics tracks market share for 38 competitors in the very competitive set-tops market.

ARRIS has been a leader in the DOCSIS EMTA product category since its inception, and through the acquisition of the Motorola Home business, ARRIS is now a leader in the supply of all types of broadband CPE including DOCSIS, DSL, and FTTH. According to Infonetics Research, Broadband CPE Quarterly Worldwide Market Share and Forecasts for Third Quarter 2014, ARRIS was the leading worldwide provider of cable broadband CPE products in the third quarter of 2014 with approximately 36% worldwide share of revenues.

Our multi-screen content management and protection products compete with many vendors offering on-demand video and digital advertising insertion hardware and software, including Adobe, Cisco, Concurrent Computer Corporation, Ericsson Irdeto, SeaChange International Inc., Tivo, Verimatrix, and others. Our operations management systems compete with vendors offering network management, mobile workforce management, network configuration management, and network capacity management systems such as TOA Technologies, Click Software and others, some of which may currently have greater sales in these areas than ARRIS. In some instances, our customers internally develop their own software for these functions. However, we believe that we offer a more integrated solution that gives us a competitive advantage in supporting the requirements of both today’s distribution networks and the emerging all-digital, packet-based networks.

We also compete with companies such as Cisco, Harmonic, Huawei, Pace and ZTE for network distribution and access equipment. In recent periods, competition in this market has also increased from aftermarket suppliers, whose primary focus is on the refurbishment of OEM equipment, resulting in additional competition for new sales opportunities. In addition, because of the convergence of the cable and telecommunications and rapid technological development, new competitors may enter this space.

Lastly, some of our competitors are larger companies with greater financial resources and product breadth than us. This may enable them to bundle products or be able to market and price products more aggressively than we can.

Regulation and Corporate Responsibility

Our products and operations are subject to numerous U.S. and international regulations and requirements in the areas of labor, environmental compliance including energy efficiency standards, health and safety and ethics. Historically compliance with such regulations has not had a material impact on our business or results of operations.

We are committed to strong corporate responsibility and in 2014 took a number of steps to enhance this commitment. As part of this commitment, we became a member of the Electronic Industry Citizenship Coalition® (EICC®), a non-profit coalition of electronics companies committed to supporting the rights and wellbeing of workers and communities affected by the global electronics supply chain. In connection with joining the EICC, we adopted a number of new policies and initiated new programs relating to corporate responsibility. These included, among others, a Corporate Responsibility Policy and Corporate Responsibility Business Principles, a Supplier Code of Conduct and the establishment of sustainability goals. Additional information regarding these policies and programs is available under the “Investors” tab of our corporate website (www.arris.com).

With respect to energy efficiency, we are a signatory to both the Voluntary Agreement for Ongoing Improvement to the Energy Efficiency of Set-Top Boxes in the U.S. and the Voluntary Industry Agreement to Improve

 

11


Table of Contents
Index to Financial Statements

the Energy Consumption of Complex Set-Top Boxes in the European Union. As signatories to these agreements, we are committed to reducing our environmental impact through increasing the energy efficiency of our set-top boxes while still protecting our need to adapt to rapidly changing technology and the introduction of new features.

Employees

As of January 31, 2015, we had approximately 6,660 employees. ARRIS has no employees represented by unions within the United States. We believe that we have a strong relationship with our employees. Our future success depends, in part, on our ability to attract and retain key 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 long-term incentive programs that are intended to provide substantial incentives for our key employees to remain with us.

 

Item 1A. Risk Factors

Our business is dependent on customers’ capital spending on broadband communication systems, and reductions by customers in capital spending would adversely affect our business.

Our performance is primarily dependent on customers’ capital spending for constructing, rebuilding, maintaining or upgrading broadband communications systems. Capital spending in the broadband communications industry is cyclical and can be curtailed or deferred on short notice. A variety of factors affect capital spending, and, therefore, our sales and profits, including:

 

   

general economic conditions;

 

   

customer specific financial or stock market conditions;

 

   

availability and cost of capital;

 

   

foreign currency fluctuations;

 

   

governmental regulation;

 

   

demands for network services;

 

   

competition from other providers of broadband and high-speed services;

 

   

acceptance of new services offered by our customers; and

 

   

real or perceived trends or uncertainties in these factors.

Several of our customers have accumulated significant levels of debt. These high debt levels, coupled with the volatility in the capital markets, may impact their access to capital in the future. Even if the financial health of our customers remains intact, these customers may not purchase new equipment at levels we have seen in the past or expect in the future. While there has been improvement in the U.S. and global economy over the past year, we cannot predict the impact, if any, of any softening of the national of global economy or of specific customer financial challenges on our customer’s expansion and maintenance expenditures.

In addition, the Federal Communications Commission has publicly announced that it is considering adopting new regulations to mandate “net neutrality” by broadband Internet service providers and subjecting broadband providers to regulation as traditional telephone companies under Title II of the Communications Act. These and other changes in regulatory requirements with which many of our U.S. customers are required to comply could result in such customers reducing their investment in their broadband communications networks. A significant reduction in their capital expenditures as a result of any such regulations could adversely affect our business, operating results, and financial condition.

 

12


Table of Contents
Index to Financial Statements

The markets in which we operate are intensely competitive, and competitive pressures may adversely affect our results of operations.

The markets in which we participate are dynamic, highly competitive and require companies to react quickly and capitalize on change. We must retain skilled and experienced personnel, as well as deploy substantial resources to meet the changing demands of the industry and must be nimble to be able to capitalize on change. We compete with international, national and regional manufacturers, distributors and wholesalers including some companies that are larger than we are. We list our major competitors in Part I, Item 1, “Business”.

In some instances, our customers themselves may be our competition as they may develop their own software requiring support within our products or their own product design produced directly by the customer with a contract manufacturer. The rapid technological changes occurring in broadband may lead to the entry of new competitors, including those with substantially greater resources than our own. 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. 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, several of our larger competitors may be in a better position to withstand any significant, sustained reduction in capital spending by customers. They often have broader product lines and market focus and therefore are not as susceptible to downturns in a particular market. In addition, several of our competitors have been in operation longer than we have, and therefore have more established relationships with domestic and foreign broadband service providers.

Consolidations in the broadband communication systems industry could result in delays or reductions in purchases of products, which would have a material adverse effect on our business.

The broadband communication systems industry has historically experienced, and continues to experience, the consolidation of many industry participants. For example, in the first half of 2014 Comcast announced its proposed acquisition of Time Warner Cable and AT&T announced its proposed acquisition of DIRECTV and in February 2015, Verizon Communications Inc. announced that it is selling certain wireline businesses to Frontier Communications Corp. When consolidations occur, it is possible that the acquirer will not continue using the same suppliers, possibly resulting in an immediate or future elimination of sales opportunities for us or our competitors. Even if sales are not reduced, consolidation can also result in pressure from customers for lower prices or better terms, reflecting the increase in the total volume of products purchased or the elimination of a price differential between the acquiring customer and the company acquired. Consolidations also could result in delays in purchasing decisions by the affected companies prior to completion of the transaction and by the merged businesses. The purchasing decisions of the merged companies could have a material adverse effect on our business.

We may have difficulty in forecasting our sales.

Because a significant portion of the purchases by our customers are discretionary, accurately forecasting sales is difficult. In addition, in recent years our customers have submitted their purchase orders less evenly over the course of each quarter and year and with shorter lead times than they have historically. This, coupled with the size of our operations makes it difficult for us to forecast sales and other financial measures, which can result in us maintaining inventory levels that are too high or too low for our ultimate needs.

The broadband communications industry on which our business is focused is significantly impacted by technological change and open architecture solutions.

The broadband communication systems industry has gone through dramatic technological change resulting in service providers rapidly migrating their business from a one-way television service to a two-way communications network enabling multiple services, such as high-speed Internet access, residential telephony services, business telephony services and Internet access, digital television, video on demand and advertising services. New services, such as home security, power monitoring and control, HD television, 3-D television and 4K

 

13


Table of Contents
Index to Financial Statements

(UHD) television that are or may be offered by service providers, are also based on, and will be characterized by, rapidly evolving technology. The development of increasing transmission speed, density and bandwidth for Internet traffic has also enabled the provision of high quality, feature length video over the Internet. This so called over-the-top IP video service enables content providers such as Netflix and Hulu, programmers such as HBO and ESPN and portals like Google to provide video services on-demand, by-passing traditional video service providers. The Federal Communications Commission is also considering changes to its rules to facilitate the ability of over-the-top services to compete against traditional multichannel video programming providers. As these service providers enhance their quality and scalability, traditional providers are moving to match them and provide even more competitive services over their existing networks, as well as over-the-top IP video for delivery not only to televisions but to computers, tablets, and telephones in order to remain competitive. Our business is dependent on our ability to develop products that enable current and new customers to exploit these rapid technological changes. We believe the continued growth of over-the-top IP video represents a shift from the traditional video delivery paradigm. To the extent that we are unable to adapt our technologies to serve this emerging demand our business may be adversely affected.

The continued industry move to open standards may impact our future result.

The broadband communication systems industry has and will continue to demand products based on open standards. The move toward open standards is expected to increase the number of service providers that will offer new services. This trend is expected to increase the number of competitors and drive down the capital costs per subscriber deployed. These factors may adversely impact both our future revenues and margins. In addition, many of our customers participate in “technology pools” and increasingly request that we donate a portion of our source code used by the customer to these pools which may impact our ability to recapture the R&D investment made in developing such code.

We believe that we will be increasingly required to work with third party technology providers. As a result, we expect the shift to more open standards may require us to license software and other components from third parties, which licenses may not be available or may not continue to be available to us on commercially reasonable terms. In some circumstances, such technology may include technology or protocols developed by standards settings bodies or other industry forums. The terms of the licenses granted by such parties may limit our ability to commercialize products that utilize such technology, which could have a material adverse effect on our results.

The completion of the Motorola Home acquisition will continue to have a significant impact on our operations and financial statements going forward.

In April 2013, we completed our acquisition of the Motorola Home business, which was significantly larger than our business prior to the Acquisition. For the year ended December 31, 2012, Motorola Home had net sales of approximately $3.3 billion and total assets of approximately $2.5 billion, compared with our net sales of approximately $1.4 billion and total assets of $1.4 billion for the year ended December 31, 2012. In addition, we significantly increased our long-term debt in connection with the Acquisition. Given the significant increase in the size of our business as a result of the acquisition and the increase in our long-term debt, our historical results are not indicative of our combined operations going forward.

The anticipated benefits from acquisitions may not be realized.

Our growth strategy has historically included acquisitions, including our acquisition of the Motorola Home business, and we expect that we will continue to grow through additional strategic acquisitions in the future. We pursue acquisitions with the expectation that the transaction would result in various benefits, including, among other things, enhancing our current and future product offerings, strengthening our ability to capitalize on and manage changing industry trends and broadening our customer base.

An acquisition involves the combination of two companies that previously operated independently. The difficulties of combining the acquired company’s operations with ours include:

 

   

combining the best practices of two companies, including research and development and sales functions;

 

14


Table of Contents
Index to Financial Statements
   

the necessity of coordinating geographically separated organizations, systems and facilities;

 

   

integrating personnel with diverse business backgrounds and organizational cultures;

 

   

reducing the costs associated with each company’s operations; and

 

   

preserving important relationships of both ARRIS and the acquired company and resolving potential conflicts that may arise.

Integration of the operations of an acquired company could cause an interruption of, or loss of momentum in, our business and the possible loss of key personnel. The diversion of management’s attention and any delays or difficulties encountered in connection with the acquisition and the integration of the two companies’ operations could have an adverse effect on the business, results of operations, financial condition or prospects of the combined company after the acquisition. In addition, we may experience unexpected difficulties and/or delays in combining the acquired company’s systems with including the subsequent testing related to applicable internal controls, or the discovery of material weaknesses with such internal controls, in a timely fashion which could have an adverse effect on our operations. The integration process can be complex and take significant time to complete which may result in difficulties that could impact our operations or financial results not being discovered until well after the closing date of the acquisition. For example, while we completed the acquisition of the Motorola Home business in April 2013, we do not expect to complete the accounting system integration until the first quarter of 2015.

In addition, our ability to achieve the anticipated benefits of an acquisition is subject to a number of uncertainties discussed elsewhere, including:

 

   

our ability to take advantage of expected growth opportunities;

 

   

general market and economic conditions;

 

   

general competitive factors in the industry and marketplace; and

 

   

higher than expected costs required to achieve the anticipated benefits of the acquisition.

No assurance can be given that these benefits will be achieved or, if achieved, the timing of their achievement. Failure to achieve these anticipated benefits could result in increased costs and decreases in expected revenues and/or net income following an acquisition.

Our use of the “Motorola” brand name is limited.

In connection with our acquisition of Motorola Home, we were granted the right, as extended, subject to certain conditions, to continue to use the Motorola brand name on certain products for a period of two years after the acquisition. We sell those products in geographic regions and through distribution channels, especially retail, under the Motorola brand where the “ARRIS” brand is not as recognized.

Shelf space in retail outlets can also be impacted by how recognizable a brand is by customers. If we are unable to successfully rebrand those products, our sales in those regions and channels may decrease. Further, the loss of the use of the “Motorola” brand may result in a lower amount of shelf space, or space in less desirable areas, which may impact our sales.

Our business is concentrated in a few key customers. The loss of one of these customers or a significant reduction in sales to one of these customers would have a material adverse effect on our business.

For the year ended December 31, 2014, sales to our three largest customers (including their affiliates, as applicable) accounted for approximately 19.0%, 13.0% and 11.5%, respectively, of our total revenue. The loss of one of our large customers, or a significant reduction in the products or services provided to any of them would have a material adverse impact on our business. For many of these customers, we also are one of their largest suppliers. As a result, if from time-to-time customers elect to purchase products from our competitors in order to diversify their supplier base and to dual-source key products or to curtail purchasing due to budgetary or market

 

15


Table of Contents
Index to Financial Statements

conditions, such decisions could have material consequences to our business. In addition, because of the magnitude of our sales to these customers the terms and timing of our sales are heavily negotiated, and even minor changes can have a significant impact upon our business.

We may face higher costs associated with protecting our intellectual property or obtaining necessary access to the intellectual property of others.

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. Given the dependence within our industry on published specifications and technology, there are frequent claims and related litigation regarding patent and other intellectual property rights. We have received, directly or indirectly, and expect to continue to receive, from third parties, including some of our competitors, notices claiming that we, or our customers using our products, have infringed upon third-party patents or other proprietary rights. We are involved in several proceedings (and other proceedings have been threatened) in which our customers were sued for patent infringement. (See Item 3, “Legal Proceedings”) In these cases our customers have made claims against, us and other suppliers for indemnification. We may become involved in similar litigation involving these and other customers in the future. These claims, regardless of their merit, could result in costly litigation, divert the time, attention and resources of our management, delay our product shipments, and, in some cases, require us to enter into royalty or licensing agreements. If a claim of patent infringement against us or our customer is successful and we fail to obtain a license or develop non-infringing technology, we or our customer may be prohibited from marketing or selling products containing the infringing technology which could materially affect our business and operating results. In addition, the payment of any damages or any necessary licensing fees or indemnification costs associated with a patent infringement claim could be material and could also materially adversely affect our operating results.

We have significant indebtedness which could limit our operations and opportunities, make it more difficult for us to pay or refinance our debts and/or may cause us to issue additional equity in the future, which would increase the dilution of our stockholders or reduce earnings.

As of December 31, 2014, we had approximately $1.5 billion in total indebtedness. In addition, we have a $247.5 million available under our revolving line of credit to support our working capital needs. Our debt service obligations with respect to this indebtedness could have an adverse impact on our earnings and cash flows for as long as the indebtedness is outstanding.

This significant indebtedness could also have important consequences to stockholders. For example, it could:

 

   

make it more difficult for us to pay or refinance our debts as they become due during adverse economic and industry conditions because any decrease in revenues could cause us to not have sufficient cash flows from operations to make our scheduled debt payments;

 

   

limit our flexibility to pursue other strategic opportunities or react to changes in our business and the industry in which we operate and, consequently, place us at a competitive disadvantage to competitors with less debt;

 

   

require a substantial portion of our cash flows from operations to be used for debt service payments, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, acquisitions and other general corporate purposes; and

 

   

result in higher interest expense in the event of increases in interest rates since the majority of our debt is subject to variable rates.

Based upon current levels of operations, we expect to be able to generate sufficient cash on a consolidated basis to make all of the principal and interest payments when such payments are due under our senior secured credit facilities; but there can be no assurance that we will be able to repay or refinance such borrowings and obligations.

 

16


Table of Contents
Index to Financial Statements

We may consider it appropriate to reduce the amount of indebtedness currently outstanding. This may be accomplished in several ways, including issuing additional shares of common stock or securities convertible into shares of common stock, reducing discretionary uses of cash or a combination of these and other measures. Issuances of additional shares of common stock or securities convertible into shares of common stock would have the effect of diluting the ownership percentage that stockholders will hold in the company and may reduce our reported earnings per share.

We have substantial goodwill and amortizable intangible assets.

Our financial statements reflect substantial goodwill and intangible assets, approximately $936.1 million and $943.4 million, respectively, as of December 31, 2014, that was recognized in connection with acquisitions.

We annually (and more frequently if changes in circumstances indicate that the asset may be impaired) review the carrying amount of our goodwill in order to determine whether it has been impaired for accounting purposes. In general, if the fair value of the corresponding reporting unit is less that the carrying amount of the reporting unit, we record an impairment. The determination of fair value is dependent upon a number of factors, including assumptions about future cash flows and growth rates that are based on our current and long-term business plans. With respect to the amortizable intangible assets, we test recoverability when events or changes in circumstances indicate that their carrying amounts may not be recoverable. Examples of such circumstances include, but are not limited to, operating or cash flow losses from the use of such assets or changes in our intended uses of such assets. If we determine that an asset or asset group is not recoverable, then we would record an impairment charge if the carrying amount of the asset or asset group exceeds its fair value. Fair value is based on estimated discounted future cash flows expected to be generated by the asset or asset group. The assumptions underlying cash flow projections would represent management’s best estimates at the time of the impairment review.

While no goodwill or intangible asset impairments were recorded in 2014 and 2013, as the ongoing expected cash flows and carrying amounts of our remaining goodwill and intangible assets are assessed, changes in the economic conditions, changes to our business strategy, changes in operating performance or other indicators of impairment could cause us to realize impairment charges in the future. For additional information, see the discussion under “Critical Accounting Policies” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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 that we currently are developing may not ultimately be successful. Even if the products in development are successfully brought to market, they may not be widely used or we may not be able to capitalize successfully on their technology. 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 develop or introduce these products successfully if they:

 

   

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 technologies 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 relationship could have a material adverse effect on the progress of new products under development with that third party.

 

17


Table of Contents
Index to Financial Statements

Defects within our products could have a material impact on our results.

Many of our products are complex technology that include both hardware and software components. It is not unusual for software, especially in earlier versions, to contain bugs that can unexpectedly interfere with expected operations. While we employ rigorous testing prior to the shipment of our products, defects, including those resulting from components we purchase, may still occur from time to time. Product defects could impact our reputation with our customers which may result in fewer sales. In addition, depending on the number of products affected, the cost of fixing or replacing such products could have a material impact on our operating results.

We offer warranties of various lengths to our customers on many of our products and have established warranty reserves based on, among other things, our historic experience, failure rates and cost to repair. In the event of a significant non-recurring product failure, the amount of the warranty reserve may not be sufficient. From time to time we may also make repairs on defects that occur outside of the provided warranty period. Such costs would not be covered by the established reserves and, depending on the volume of any such repairs, may have a material adverse effect on our results from operations or financial condition.

Our success depends 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 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 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 dependent on contract manufacturers, and an inability to obtain adequate and timely delivery of supplies could adversely affect our business.

Many components, subassemblies and modules necessary for the manufacture or integration of our products are obtained from a sole supplier or a limited group of suppliers. Our reliance on sole or limited suppliers, particularly foreign suppliers, and our reliance on subcontractors involves several risks including a potential inability to obtain an adequate supply of required components, subassemblies or modules and reduced control over pricing, quality and timely delivery of components, subassemblies or modules. 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 ability to ship could be impacted by country laws and/or union labor disruptions. For example the recent labor dispute involving union dock workers at certain U.S. west coast port facilities has, in many cases, greatly increased the shipping times for our products arriving through the affected ports and has also increased our shipping costs as we have had to increase the number of products shipped using air freight which is significantly more expensive. Disputes of this nature may have a material impact on our financial results.

We are subject to the economic, political and social instability risks associated with doing business in certain foreign countries.

For the year ended December 31, 2014, approximately 25.7% of our sales were made outside of the United States. In addition, a significant portion of our products are manufactured or assembled in China, Mexico and Taiwan. As a result, we are exposed to risk of international operations, including:

 

   

the imposition of government controls;

 

   

compliance with United States and foreign laws concerning trade and employment practices;

 

   

difficulties in obtaining or complying with export license requirements;

 

   

labor unrest, including strikes, and difficulties in staffing;

 

18


Table of Contents
Index to Financial Statements
   

security concerns;

 

   

economic boycott for doing business in certain countries;

 

   

inflexible employee contracts or labor laws in the event of business downturns;

 

   

coordinating communications among and managing international operations;

 

   

fluctuations in currency exchange rates;

 

   

currency controls;

 

   

changes in tax and trade laws that increase our local costs;

 

   

exposure to heightened corruption risks; and

 

   

reduced protection for intellectual property rights.

Political instability and military and terrorist activities, including the continued unrest between the Ukraine and Russia and in Israel, may have significant impacts on our customers’ spending in these regions and can further enhance many of the risks identified above. In addition, a portion of our research and development operations and a portion of our contract manufacturing occur in Israel and we also have customer service, marketing and general and administrative employees at our Israeli facility. Most of our employees in Israel are obligated to perform annual reserve duty in the Israeli Defense Forces. In the past, several of these employees have been called for active military duty and, if hostilities increase again, we expect some will be called to active military duty.

Any of these risks could impact our sales, interfere with the operation of our facilities and result in reduced production, increased costs, or both, which could have an adverse effect on our financial results.

We face risks relating to currency fluctuations and currency exchange.

On an ongoing basis we are exposed to various changes in foreign currency rates because significant sales are denominated in foreign currencies. Additionally, certain intercompany transactions are denominated in foreign currencies and subject to revaluation. These changes can impact our 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 and option contracts. There can be no assurance that our risk management strategies will be effective.

In addition, many of our international customers make purchases from us that are denominated in U.S dollars. To the extent that the U.S. dollar strengthens, it may impact their ability to purchase products.

We also 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 depend on channel partners to sell our products in certain regions and are subject to risks associated with these arrangements.

We utilize distributors, value-added resellers, system integrators, and manufacturers’ representatives to sell our products to certain customers and in certain geographic regions to improve our access to these customers and regions and to lower our overall cost of sales and post-sales support. Our sales through channel partners are subject to a number of risks, including:

 

   

ability of our selected channel partners to effectively sell our products to end customers;

 

   

our ability to continue channel partner arrangements into the future since most are for a limited term and subject to mutual agreement to extend;

 

   

a reduction in gross margins realized on sale of our products; and

 

   

a diminution of contact with end customers which, over time, could adversely impact our ability to develop new products that meet customers’ evolving requirements.

 

19


Table of Contents
Index to Financial Statements

Our stock price has been and may continue to be volatile.

Our common stock is currently traded on The NASDAQ Global Select Market. The trading price of our common stock has been and may continue to be subject to large fluctuations. Our stock price may increase or decrease in response to a number of events and factors including:

 

   

future announcements concerning us, key customers or competitors;

 

   

quarterly variations in operating results;

 

   

changes in financial estimates and recommendations by securities analysts;

 

   

developments with respect to technology or litigation;

 

   

the operating and stock price performance of our competitors; and

 

   

acquisitions and financings.

Fluctuations in the stock market, generally, also impact the volatility of our stock price. General stock market movements may adversely affect the price of our common stock, regardless of our operating performance.

Cyber-security incidents, including data security breaches or computer viruses, could harm our business by disrupting our delivery of services, damaging our reputation or exposing us to liability.

We receive, process, store and transmit, often electronically, the confidential data of our clients and others. Unauthorized access to our computer systems or stored data could result in the theft or improper disclosure of confidential information, the deletion or modification of records or could cause interruptions in our operations. These cyber-security risks increase when we transmit information from one location to another, including transmissions over the Internet or other electronic networks. Despite implemented security measures, our facilities, systems and procedures, and those of our third-party service providers, may be vulnerable to security breaches, acts of vandalism, software viruses, misplaced or lost data, programming and/or human errors or other similar events which may disrupt our delivery of services or expose the confidential information of our clients and others. Any security breach involving the misappropriation, loss or other unauthorized disclosure or use of confidential information of our clients or others, whether by us or a third party, could (i) subject us to civil and criminal penalties, (ii) have a negative impact on our reputation, or (iii) expose us to liability to our clients, third parties or government authorities. Any of these developments could have a material adverse effect on our business, results of operations and financial condition. We have not experienced any such incidents that have had material consequences to date. Congress also is considering cyber-security legislation that, if enacted, could impose additional obligations upon us.

New regulations related to conflict minerals may adversely affect us

We are subject to recently adopted SEC disclosure obligations relating to our use of so-called “conflict minerals” — columbite-tantalite, cassiterite (tin), wolframite (tungsten) and gold. These minerals are present in a significant number of our products. We are required to file a report with the SEC annually covering our use of these materials and their source.

In preparing these reports, we are dependent upon information supplied by suppliers of products that contain, or potentially contain, conflict minerals. To the extent that the information that we receive from our suppliers is inaccurate or inadequate or our processes in obtaining that information do not fulfill the SEC’s requirements, we could face reputational risks. Further, if in the future we are unable to certify that our products are conflict mineral free, we may face challenges with our customers, which could place us at a competitive disadvantage.

 

20


Table of Contents
Index to Financial Statements

We do not intend to pay cash dividends in the foreseeable future.

We do not anticipate paying cash dividends on our common stock in the foreseeable future. In addition, our ability to pay dividends is limited by the terms of our senior secured credit facilities. Payment of dividends in the future will depend on, among other things, business conditions, our results of operations, cash requirements, financial condition, contractual restrictions, provisions of applicable law and other factors that our board of directors may deem relevant.

We have the ability to issue preferred shares without stockholder approval.

Our common stock may be subordinate to classes of preferred shares issued in the future in the payment of dividends and other distributions made with respect to common stock, including distributions upon liquidation or dissolution. Our Certificate of Incorporation permits our board of directors to issue preferred shares without first obtaining stockholder approval. If we issued preferred shares, these additional securities may have dividend or liquidation preferences senior to the common stock. If we issue convertible preferred shares, a subsequent conversion may dilute the current common stockholders’ interest. Also, the issuance of preferred shares or rights to acquire preferred shares may have an anti-takeover impact.

 

Item 1B. Unresolved Staff Comments

Not Applicable.

 

Item 2. Properties

Our corporate headquarters are located in Suwanee, Georgia. We own sites in Apodaca, Mexico; Cary, North Carolina; Horsham, Pennsylvania; San Diego, California and Hsin Tien, Taiwan. We operate manufacturing and warehouse facilities, research and development, administrative and sales offices in various locations in the United States and in many foreign countries. These properties are generally used by each of our operating segments.

As of December 31, 2014, we have approximately 35 principal leased facilities, 15 of which are located in North America and 20 of which are located in other countries. Larger leased sites include properties location in Bangalore, India, Beaverton, Oregon, Linkoping, Sweden, Lisle, Illinois, Lowell, Massachusetts, Ontario, California, Santa Clara, California, Suwanee, Georgia, Tel Aviv, Israel, Tijuana, Mexico, and Wallingford, Connecticut.

We believe that our existing facilities, including both owned and leased, are in good condition and suitable for the conduct of our business. We generally consider that the facilities are being appropriately utilized and that they have sufficient production capacity for their present intended purposes. The extent of utilization of such facilities varies from plant to plant and from time to time during the year. For additional information regarding our obligations under property leases, see Note 20 Commitments and Contingencies of Notes to the Consolidated Financial Statements.

 

Item 3. Legal Proceedings

We have been, and expect in the future to be a party to various legal proceedings, investigations or claims. In accordance with applicable accounting guidance, we record accruals for certain of our outstanding legal proceedings when it is probable that a liability will be incurred and the amount of loss can be reasonably estimated. We evaluate, at least on a quarterly basis, developments in our legal proceedings or other claims that could affect the amount of any accrual, as well as any developments that would result in a loss contingency to become both probable and reasonably estimable. When a loss contingency is not both probable and reasonably estimable, we do not record a loss accrual.

If the loss (or an additional loss in excess of any prior accrual) is reasonably possible and material, we disclose an estimate of the possible loss or range of loss, if such estimate can be made. The assessment whether a

 

21


Table of Contents
Index to Financial Statements

loss is probable or reasonably possible and whether the loss or a range of loss is estimable, involves a series of complex judgments about future events. Even if a loss is reasonably possible, we may not be able to estimate a range of possible loss, particularly where (i) the damages sought are substantial or indeterminate, (ii) the proceedings are in the early stages, or (iii) the matters involve novel or unsettled legal theories or a large number of parties. In such cases, there is considerable uncertainty regarding the ultimate resolution of such matters, including the amount of any possible loss. Accordingly, with respect to the proceedings described below, we are currently unable to reasonably estimate the possible loss or range of possible loss. However, because the results in litigation are unpredictable, an adverse resolution of one or more of such matters could have a material adverse effect on our business, financial position, results of operations or cash flows.

Due to the nature of our business, it is subject to patent infringement claims, including current suits against us or one or more of our wholly-owned subsidiaries or one or more of our customers who may seek indemnification from us. We believe that we have meritorious defenses to the allegation made in the pending cases and intend to vigorously defend these lawsuits; however, we are currently unable to determine the ultimate outcome of these or similar matters. In addition, we are a defendant in various litigation matters generally arising out of the normal course of business. Except as described below, ARRIS is not party (nor have indemnification claims been made with respect) to any proceedings that are, or reasonably are expected to be, material to its business, results of operations or financial condition. However, since it is difficult to predict the outcome of legal proceedings, it is possible that the ultimate outcomes could materially and adversely affect our business, financial position, results of operations or cash flows. Accordingly, with respect to these proceedings, we are currently unable to reasonably estimate the possible loss or range of possible loss.

AIP v. MSOs,     C.A. 12-cv-01690 et al., District of Delaware. On December 11, 2012, AIP filed several suits against service providers alleging infringement of four U.S. patents. The complaint requests unspecified damages for infringement and injunction against future infringement. This case has been stayed pending Inter Partes Review at the United States Patent and Trademark Office. The Patent Trial and Appeals Board has ruled all claims of the patent are invalid. An appeal may be filed. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify one or more of the MSOs and/or pay damages for utilizing certain technology.

AT&T v. Cox,     C.A. 14-cv-01106., District of Delaware. On August 28, 2014, AT&T sued Cox for infringement of eight U.S. patents. Cox has requested that we provide indemnification. The complaint requests unspecified damages for past and future infringement. To date, no evidence of damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify the MSOs and/or pay damages for utilizing certain technology.

Bear Creek Technologies v. MSOs,    C.A. 2:11-cv-00103, District of Delaware. In February 2011, Bear Creek sued MSOs, Telcos and other VoIP service providers for infringement of US Patent No. 7,889,722, relating to EMTAs. Certain of our customers have requested that we provide indemnification. The complaint requests unspecified damages for past infringement and injunction against future infringement. This case has been stayed pending reexamination of the patent by the United States Patent and Trademark Office. All claims of the patent have been rejected in the re-exam and that rejection is currently under appeal by the patent owner. To date, no evidence of damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify the MSOs and/or pay damages for utilizing certain technology.

Broadband iTV v. Time Warner Cable (TWC) et al.,    C.A. 1:14-cv-00169, District of Hawaii. On April 9, 2014, Broadband iTV filed suit against TWC alleging infringement of U.S. Patent No. 7,631,336 relating to media sharing. The complaint requests unspecified damages for past infringement and an injunction. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify TWC and/or pay damages for utilizing certain technology.

C-Cation v. ARRIS et al.,    C.A. 14-cv-00059, Eastern District of Texas. On February 4, 2014, C-Cation filed suit against TWC, ARRIS, Cisco and Casa alleging infringement of U.S. Patent No. 5,563,883 relating to

 

22


Table of Contents
Index to Financial Statements

channel management. The United States Patent and Trademark Office has instituted an Inter Partes Review proceeding on one claim of the asserted patent. The complaint requests unspecified damages for past and future infringement. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to pay damages for utilizing certain technology.

Custom Media Technologies v. MSOs,    C.A. 13-cv-01425, District of Delaware. On August 15, 2013, Custom Media Technologies LLC filed a claim against several MSOs alleging infringement of US Patent No. 6,269,275. The complaint requests damages for past and future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify one or more MSOs and/or pay damages for utilizing certain technology.

Dragon Intellectual Property v. MSOs,     C.A. 13-cv-02069; 13-cv-02063, etc., District of Delaware (RGA). Dragon IP filed suit against several MSOs alleging infringement of US Patent No. 5,930,444. The complaint requests unspecified damages for infringement and injunction against future infringement. A Petition for Inter Partes Review of the asserted patent has been filed with the United States Patent and Trademark Office. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify the MSOs and/or pay damages for utilizing certain technology.

FutureVision.com v. MSOs,     C.A. 13-cv-00855, District of Delaware. On May 16, 2013, FutureVision.com filed suit against several service providers alleging infringement of U.S. Patent No. 5,877,755 relating to an interactive broadband multimedia systems. FutureVision.com subsequently filed suit on July 2, 2014 against several additional service providers. The complaint requests unspecified damages for past and future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify one or more of the MSOs and/or pay damages for utilizing certain technology.

Intellectual Ventures I and II v. AT&T,     C.A. 12-cv-00193 and 13-cv-01631, District of Delaware. On February 16, 2012, Intellectual Ventures filed a claim against AT&T alleging infringement of several US patents. The complaint requests damages for past and future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify AT&T and/or pay damages for utilizing certain technology.

MediaTube et al v. Bell Canada et al,     C.A. T-705-13, Canadian Federal Court. On April 23, 2013, MediaTube Corp. filed a claim against Bell Canada entities alleging infringement of a Canadian patent. The complaint requests damages for past and future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify Bell Canada and/or pay damages for utilizing certain technology.

Motorola Mobility v. Microsoft,     C.A. 11-cv-01408, Western District of Washington. Motorola filed suit against Microsoft alleging infringement of multiple Motorola patents. Microsoft counterclaimed alleging infringement of several Microsoft patents, including two patents asserted against General Instrument products. It is premature to assess the likelihood of an unfavorable outcome. With respect to the liability attributable to Motorola Home products in this matter, a subsidiary of Google has agreed to indemnify ARRIS.

Spherix v. Verizon,     C.A. 14-cv-0721, Eastern District of Virginia. On June 11, 2014, Spherix filed suit against Verizon alleging infringement of four patents alleged to cover various Verizon products or services. The complaint requests unspecified damages for past infringement and injunction against future infringement. To date, no evidence of damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify the MSOs and/or pay damages for utilizing certain technology.

Sprint Communications v. MSOs,     C.A. 11-cv-2686, District of Kansas. On December 19, 2011, Sprint filed suit against several MSOs alleging infringement of several patents alleged to cover various aspects of voice services. The complaint requests unspecified damages for past infringement and injunction against future

 

23


Table of Contents
Index to Financial Statements

infringement. To date, no evidence of damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify the MSOs and/or pay damages for utilizing certain technology. With respect to the liability attributable to Motorola Home products in this matter, a subsidiary of Google has agreed to indemnify ARRIS.

Steelhead Licensing v. Comcast,     C.A. 13-cv-02076, District of Delaware (RGA). On December 20, 2013, Steelhead filed suit against Comcast alleging infringement of US Patent No. 8,082,318. The complaint requests unspecified damages for infringement and injunction against future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify Comcast and/or pay damages for utilizing certain technology.

TransVideo Electronics v. TWC,     C.A. 12-cv-01740, District of Delaware (RGA). On December 20, 2013, TransVideo filed suit against TWC alleging infringement of US Patent Nos. 5,594,936 and 5,991,801. The complaint requests unspecified damages for infringement and injunction against future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify TWC and/or pay damages for utilizing certain technology.

Two Way Media v. Bell Canada et al,    C.A. T-809-14, Canadian Federal Court. On April 2, 2014, Two Way Media filed a claim against Bell Canada entities alleging infringement of a Canadian patent. The complaint requests damages for past and future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify Bell Canada and/or pay damages for utilizing certain technology.

United Access Technologies v. AT&T,     C.A. 11-cv-00338, District of Delaware. On April 15, 2011, United Access Technologies filed suit against AT&T alleging infringement of three U.S. patents. The complaint requests unspecified damages for past and future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify AT&T and/or pay damages for utilizing certain technology.

Wireless Handover OY v. AT&T,     C.A. 13-cv-00507, Northern District of Texas. On January 31, 2013, Wireless Handover filed suit against AT&T alleging infringement of U.S. Patent No. 7,953,407. The complaint requests unspecified damages for infringement and injunction against future infringement. To date, no evidence of infringement or damages has been introduced. It is premature to assess the likelihood of an unfavorable outcome. In the event of an unfavorable outcome, ARRIS may be required to indemnify AT&T.

In the acquisition agreement entered into in connection with the acquisition of the Motorola Home business, a subsidiary of Google agreed to indemnify, defend and hold harmless ARRIS and various related parties with respect to, among other things, any losses suffered by ARRIS as a result of a court order involving, or the settlement of, certain agreed-upon litigation, including the two lawsuits described above that reference this indemnification obligation. There are various limitations upon this obligation, the most significant of which is that ARRIS was responsible for 50% of the first $50.0 million (i.e., $25.0 million) of losses attributable to past infringements as well as 50% of the first $50.0 million (i.e., $25.0 million) of future royalty payments and the costs of devising and implementing redesigns intended to avoid infringement. As a result of the settlement of Motorola Mobility’s litigation with TiVo in the third quarter of 2013, these particular obligations for contribution by ARRIS have been exhausted and ARRIS has made the payments for which it is responsible.

From time to time third parties demand that we or our customers enter into a license agreement with respect to patents owned, or allegedly owned, by the third parties. Such demands cause us to dedicate time to study the patents and enter into discussions with the third parties regarding the merits and value, if any, of the patents. These discussions, may materialize into license agreements or patent claims asserted against us or our customers. If asserted against our customers, our customers may request indemnification from us. It is not possible to determine the impact of any such demands and the related discussions on ARRIS’ business, results of operations or financial condition.

 

24


Table of Contents
Index to Financial Statements
Item 4. Mine Safety Disclosures

Not Applicable

 

Item 4A. Executive Officers and Board Committees

Executive Officers of the Company

The following table sets forth the name, age as of February 27, 2015, and position of our executive officers.

 

Name

   Age     

Position

Robert J. Stanzione

     67       Chief Executive Officer, Chairman of the Board

Lawrence A. Margolis

     67       Executive Vice President, Law and Administration and Secretary

David B. Potts

     57       Executive Vice President, Chief Financial Officer

Bruce W. McClelland

     48       President, Network & Cloud

Lawrence Robinson

     47       President, Customer Premises Equipment

Ronald M. Coppock

     60       President, Worldwide Sales

James R. Brennan

     53       Senior Vice President, Supply Chain & Quality

Robert J. Stanzione has been Chief Executive Officer since 2000. From 1998 through 1999, Mr. Stanzione was President and Chief Operating Officer of ARRIS and its predecessors. Mr. Stanzione has been a director of ARRIS since 1998 and has been the Chairman of the Board of Directors since 2003. From 1995 to 1997, he was President and Chief Executive Officer of Arris Interactive L.L.C. From 1969 to 1995, he held various positions with AT&T Corporation. Mr. Stanzione has served as a director of Symmetricom, Inc. since 2005. Mr. Stanzione also serves on the board of the National Cable Telecommunications Association and The Cable Center.

Lawrence A. Margolis has been Executive Vice President, Law and Administration since 2004 and has served as the Secretary of ARRIS and its predecessors since 1992. Mr. Margolis was the Chief Financial Officer from 1992 to 2004. Prior to joining ARRIS, Mr. Margolis 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.

David B. Potts has been the Chief Financial Officer since 2004. Prior to being named Chief Financial Officer in 2004, Mr. Potts was the Senior Vice President of Finance. Before joining ARRIS, he was Chief Financial Officer of Arris Interactive L.L.C. from 1995 to 2001. From 1984 to 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.

Bruce W. McClelland was appointed President of Network & Cloud in April 2013 and is responsible for overseeing the company’s portfolio of network technologies including CCAP, CMTS, QAM, Video Processing and Wireline technologies. Previously, Mr. McClelland was Group President, Products and Services after serving as the President of the Broadband Communications System Business Unit, and before that, as Vice President of Engineering for ARRIS Broadband. Prior to joining ARRIS in 1999 as Vice President of Engineering, he had eleven years of experience with Nortel Networks where he was responsible for development efforts on Nortel Networks’ Signaling System 7 and the Class 4/5 DMS switching product line.

Lawrence Robinson was appointed President of Customer Premises Equipment in April 2013 and is responsible for overseeing the company’s portfolio of digital cable set-tops, including DVB and IP Gateway platforms, IPTV solutions and broadband devices incorporating the latest DOCSIS and DSL technologies. Mr. Robinson assumed his current role after the ARRIS acquisition of Motorola Home business where he was responsible for its video, voice and data devices business, including set-tops, modems and gateways. In addition to his broadband and video industry experience, Mr. Robinson brings more than a decade of experience in large scale, aerospace communications systems, in addition to management consulting experience with PricewaterhouseCoopers, LLP.

 

25


Table of Contents
Index to Financial Statements

Ronald M. Coppock has been President of ARRIS Worldwide Sales since 2003. Prior to his current role, Mr. Coppock was President of International Sales since 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 and serves on the Cystic Fibrosis Foundation Board. Mr. Coppock is also a member of the Cable TV Pioneers.

James R Brennan was appointed Senior Vice President of Supply Chain and Quality in April 2013 and is responsible for leading the supply chain, quality and operation services and solutions that deliver financial results, customer satisfaction and industry leading practices. Prior to his current role, Mr. Brennan held a similar role as the Corporate Vice President of Supply Chain and Quality for the Motorola Home business. Prior to joining Motorola in 2000, Mr. Brennan held leadership positions at General Instrument in Operations and Northrop Grumman/Vought Aircraft in engineering development, manufacturing, and flight test operations and quality.

Board Committees

Our Board of Directors has three permanent committees: Audit, Compensation, and Nominating & Corporate Governance. The charters for all three committees are located on our website at www.arrisi.com. The Board believes that each of its members, with the exception of Mr. Stanzione, is independent, as defined by the SEC and NASDAQ rules. The Board has identified Harry Bosco as the lead independent director. Additionally, the Board has identified Matthew Kearney and Doreen Toben as an audit committee financial experts.

 

26


Table of Contents
Index to Financial Statements

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

ARRIS’ common stock is traded on the NASDAQ Global Select Market under the symbol “ARRS.” The following table reports the high and low trading prices per share of our common stock as listed on the NASDAQ Global Market System:

 

     High      Low  

2013

     

First Quarter

   $ 17.98       $ 15.09   

Second Quarter

     17.55         14.07   

Third Quarter

     17.23         14.15   

Fourth Quarter

     24.40         16.34   

2014

     

First Quarter

   $ 31.42       $ 23.38   

Second Quarter

     34.22         24.76   

Third Quarter

     35.83         28.22   

Fourth Quarter

     30.99         23.71   

We have not paid cash dividends on our common stock since our inception.

As of January 31, 2015, there were approximately 430 record holders of our common stock. This number excludes shareholders holding stock under nominee or street name accounts with brokers or banks.

Issuer Purchases of Equity Securities

The table below sets forth the purchases of ARRIS common stock for the quarter ended December 31, 2014:

 

Period

   Total
Number of
Shares
Purchased(1)
     Average
Price
Paid
Per
Share
     Total Number of
Shares
Purchased as
Part of Publicly
Announced Plans
or Programs
     Approximate
Dollar Value of
Shares That May
Yet Be  Purchased
Under the Plans
or Programs

(in thousands)
 

October 2014

     2,942       $ 27.96                 169,630   

November 2014

     699       $ 29.77                 169,630   

December 2014

     4,564       $ 30.06                 169,630   

 

(1) Includes approximately 8,205 shares repurchased to satisfy tax withholding obligations that arose on the vesting of shares of restricted stock and restricted stock units.

During the fiscal year 2012, we repurchased 4.5 million shares of our common stock for $51.9 million at an average stock price of $11.55. The remaining authorized amount for stock repurchases under this program was $19.6 million as of December 31, 2012, and will expire when we have used all authorized funds for repurchase.

In late 2012, the Company’s Board of Directors authorized a new plan for ARRIS to purchase up to an additional $150 million of common stock. No repurchases have been made under this plan. Unless terminated earlier by a Board resolution, this new plan will expire when ARRIS has used all authorized funds for repurchase.

Our board of directors previously authorized share repurchase plans, in May 2011 and October 2012, pursuant to which we could purchase up to an aggregate of $300.0 million of our common stock. In connection with our acquisition of Motorola Home in 2013, we suspended making any repurchases under the approved plans, but the plans were not terminated and have not expired. Accordingly, as of December 31, 2014, we had approximately $169.6 million remaining of repurchase authority under these plans that we may use from time to time to repurchase shares of our common stock.

 

27


Table of Contents
Index to Financial Statements

Stock Performance Graph

Below is a graph comparing total stockholder return on the Company’s stock from December 31, 2009 through December 31, 2014, with the Standard & Poor’s 500 and the Index of NASDAQ U.S. Stocks of entities in the industry of electronics and electrical equipment and components, exclusive of computer equipment (SIC 3600-3699), prepared by the Research Data Group, Inc.

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*

Among ARRIS Group Inc., the S&P 500 Index, and SIC Codes 3600 - 3699

 

LOGO

*$100 invested on 12/31/09 in stock or index, including reinvestment of dividends.

Fiscal year ending December 31.

Copyright© 2014 S&P, a division of The McGraw-Hill Companies Inc. All rights reserved.

 

     12/09     12/10     12/11     12/12     12/13     12/14  

ARRIS Group Inc.

    100.00          98.16          94.66          130.71          212.95          264.13     

S&P 500

    100.00          115.06          117.49          136.30          180.44          205.14     

SIC Codes 3600—3699

    100.00          115.80          110.47          117.37          161.29          195.21     
Copyright© 2014 Standard & Poor’s, a division of The McGraw-Hill Companies Inc. All rights reserved. (www.researchdatagroup.com/S&P.htm)     

Notwithstanding anything to the contrary set forth in any of our filings under the Securities Act of 1933, or the Securities Exchange Act of 1934 that might incorporate future filings, including this Annual Report on Form 10-K, in whole or in part, the Performance Graph presented above shall not be incorporated by reference into any such filings.

 

28


Table of Contents
Index to Financial Statements
Item 6. Selected Consolidated Historical Financial Data

The selected consolidated financial data as of December 31, 2014 and 2013 and for each of the three years in the period ended December 31, 2014 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, 2012, 2011, and 2010 and for the years ended December 31, 2011 and 2010 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.

On April 17, 2013, we completed our acquisition of Motorola Home and applied the acquisition method of accounting for the business combination. The selected balance sheet data as of December 31, 2013 represents the consolidated statement of financial position of the combined company. The consolidated operating data for the year ended December 31, 2013 include approximately eight months of operating results of the combined company.

See Note 21 of the Notes to the Consolidated Financial Statements for a summary of our quarterly consolidated financial information for 2014 and 2013 (in thousands, except per share data).

 

     2014     2013     2012     2011     2010  

Consolidated Operating Data:

          

Net sales

   $ 5,322,921      $ 3,620,902      $ 1,353,663      $ 1,088,685      $ 1,087,506   

Cost of sales

     3,740,425        2,598,154        891,086        678,172        663,417   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

     1,582,496        1,022,748        462,577        410,513        424,089   

Selling, general, and administrative expenses

     410,568        338,252        161,338        148,755        137,694   

Research and development expenses

     556,575        425,825        170,706        146,519        140,468   

Amortization of intangible assets

     236,521        193,637        30,294        33,649        35,957   

Integration, acquisition, restructuring and other costs

     37,498        83,047        12,968        7,565        65   

Impairment of goodwill & intangibles

                          88,633          
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating (loss) income

     341,334        (18,013     87,271        (14,608     109,905   

Interest expense

     62,901        67,888        17,797        16,939        17,965   

Loss (gain) on debt retirement

                          19        (373

Interest income

     (2,590     (2,936     (3,242     (3,154     (1,997

Other expense (income), net

     30,832        10,487        (176     (1,471     94   

Loss (gain) on investments and notes receivable

     10,961        2,698        (1,404     1,570        (414
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     239,230        (96,150     74,296        (28,511     94,630   

Income tax expense (benefit)

     (87,981     (47,390     20,837        (10,849     30,502   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ 327,211      $ (48,760   $ 53,459      $ (17,662   $ 64,128   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income per common share:

          

Basic

   $ 2.27      $ (0.37   $ 0.47      $ (0.15   $ 0.51   

Diluted

   $ 2.21      $ (0.37   $ 0. 46      $ (0.15   $ 0.50   

Selected Balance Sheet Data:

          

Total assets

   $ 4,365,645      $ 4,322,007      $ 1,405,894      $ 1,360,810      $ 1,424,087   

Long-term obligations

   $ 1,665,014      $ 1,907,992      $ 74,785      $ 286,749      $ 282,087   

 

29


Table of Contents
Index to Financial Statements
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

On April 17, 2013 we acquired the Motorola Home business from General Instrument Holdings, Inc., a subsidiary of Google, Inc. for $2.4 billion in cash and equity, subject to certain adjustments as provided for in the acquisition agreement (the “Acquisition”). As described above, we more than doubled in size as a result of the Acquisition, which had significant effects on virtually every aspect of our business and operations and which make comparisons in this discussion to our historical results difficult.

We have two reportable operating segments. For more detail, see Note 10 to Notes to our Consolidated Financial Statements. Readers should consider the size and transformative nature of the Acquisition when reviewing this “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Business and Financial Highlights:

Business Highlights

 

   

Completed Motorola Home integration.

 

   

Market share leadership.

 

   

Market leading E6000.

 

   

Video Gateway platform.

 

   

Broadband gateways, including advanced Wi-Fi solutions.

 

   

47% year-over-year revenue growth as a result of the Motorola Home acquisition and increased demand across much of the company’s product portfolio.

 

   

Strong earnings and cash generation.

Financial Highlights

 

   

Sales in 2014 were $5.323 billion as compared to $3.621 billion in 2013. This increase is primarily the result of the acquisition of Motorola Home, the introduction of new products and strong demand across various product lines.

 

   

Gross margin percentage improved to 29.7% in 2014, compared to 28.2% in 2013.

 

   

Total operating expenses (excluding amortization of intangible assets, integration, acquisition, restructuring and other costs) in the 2014 were $967.1 million, as compared to $764.1 million in the same period last year. The increase is the result of the inclusion of expenses associated with the Motorola Home business.

 

   

Intangible amortization increased from $193.6 million in 2013 to $236.5 million in 2014 as a result of the Acquisition.

 

   

We ended 2014 with $697.4 million of cash, cash equivalents, short-term & long-term marketable security investments, which compares to $513.4 million at the end of 2013. We generated approximately $459.3 million of cash from operating activities in 2014 and $562.7 million during 2013.

 

   

We ended 2014 with long-term debt of $1,547.6 million, at face value, the current portion of which is $75.6 million. We repaid $209.7 million of debt, of which $205.0 million related to term debt, including a $150 million optional prepayment and $4.7 million of debt assumed and settled in conjunction with the closing of the Seawell acquisition in April 2014.

 

   

We ended 2014 with a leverage ratio of 1.91 under our debt agreement, down from 2.77 at the end of 2013.

 

   

We recorded $162 million incremental tax assets associated with the Motorola Home acquisition which will reduce cash taxes in the future.

 

30


Table of Contents
Index to Financial Statements

Non-GAAP Measures

As part of our ongoing review of financial information related to our business, we regularly use non-GAAP measures, in particular non-GAAP net income per share, as we believe they provide a meaningful insight into our business and trends. We also believe that these non-GAAP measures provide readers of our financial statements with useful information and insight with respect to the results of our business. However, the presentation of non-GAAP information is not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. Below are tables for 2014, 2013 and 2012 which detail and reconcile GAAP and non-GAAP earnings per share (in thousands, except per share data):

 

(in thousands, except per share data)   For the Year Ended December 31, 2014  
    Sales     Gross
Margin
    Operating
Expense
    Operating
Income
    Other
(Income)
Expense
    Income
Tax
Expense
(Benefit)
    Net
Income
(Loss)
 

Amounts in accordance with GAAP

  $ 5,322,921      $ 1,582,496      $ 1,241,162      $ 341,334      $ 102,104      $ (87,981   $ 327,211   

Acquisition accounting impacts related to deferred revenue

    5,091        3,448               3,448                      3,448   

Stock compensation expense

           6,716        (47,084     53,800                      53,800   

Amortization of intangible assets

                  (236,521     236,521                      236,521   

Integration, acquisition, restructuring and other costs

                  (37,498     37,498                      37,498   

Impairment of investments

                                (7,050            7,050   

Liability related to foreign tax credit benefits

                                (20,492            20,492   

Asset held for sale impairment

                                (2,132            2,132   

Net tax items

                                       279,135        (279,135
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP amounts

  $ 5,328,012      $ 1,592,660      $ 920,059      $ 672,601      $ 72,430      $ 191,154      $ 409,017   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

GAAP net income per share —diluted

              $ 2.21   
             

 

 

 

Non-GAAP net income per share — diluted

              $ 2.76   
             

 

 

 

Weighted average common shares — basic

                144,387   
             

 

 

 

Weighted average common shares — diluted

                148,280   
             

 

 

 

 

(1) Basic shares used as losses were reported for those periods and the inclusion of dilutive shares would be anti-dilutive

 

31


Table of Contents
Index to Financial Statements
(in thousands, except per share data)   For the Year Ended December 31, 2013  
    Sales     Gross
Margin
    Operating
Expense
    Operating
Income
(Loss)
    Other
(Income)
Expense
    Income
Tax
Expense
(Benefit)
    Net
Income
(Loss)
 

Amounts in accordance with GAAP

  $ 3,620,902      $ 1,022,748      $ 1,040,761      $ (18,013   $ 78,137      $ (47,390   $ (48,760

Acquisition accounting impacts related to deferred revenue

    7,121        5,545               5,545                      5,545   

Reduction in revenue related to Comcast’s investment in ARRIS

    13,182        13,182               13,182                      13,182   

Product rationaliation

           16,473               16,473                      16,473   

Acquisition accounting impacts related to fair value of inventory

           53,782               53,782                      53,782   

Stock compensation expense

           4,269        (31,520     35,789                      35,789   

Amortization of intangible assets

                  (193,637     193,637                      193,637   

Integration, acquisition, restructuring and other costs

                  (83,047     83,047                      83,047   

Credit facility — ticking fees

                                (865            865   

Mark-to-market fair value adjustment related to Comcast’s investment in ARRIS

                                (13,189            13,189   

Non-cash interest expense

                                (9,926            9,926   

Net tax items

                                       152,883        (152,883
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP amounts

  $ 3,641,205      $ 1,115,999      $ 732,557      $ 383,442      $ 54,157      $ 105,493      $ 223,792   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

GAAP net income per share —diluted

              $ (0.37 )(1) 
             

 

 

 

Non-GAAP net income per share — diluted

              $ 1.66   
             

 

 

 

Weighted average common shares — basic

                131,980   
             

 

 

 

Weighted average common shares — diluted

                135,136   
             

 

 

 

 

(1) Basic shares used as losses were reported for those periods and the inclusion of dilutive shares would be anti-dilutive

 

32


Table of Contents
Index to Financial Statements
(in thousands, except per share data)   For the Year Ended December 31, 2012  
    Sales     Gross
Margin
    Operating
Expense
    Operating
Income
    Other
(Income)
Expense
    Income
Tax
Expense
(Benefit)
    Net
Income
(Loss)
 

Amounts in accordance with GAAP

  $ 1,353,663      $ 462,577      $ 375,306      $ 87,271      $ 12,975      $ 20,837      $ 53,459   

Acquisition accounting impacts related to deferred revenue

    2,899        2,899               2,899                      2,899   

Stock compensation expense

           3,169        (24,737     27,906                      27,906   

Amortization of intangible assets

                  (30,294     30,294                      30,294   

Integration, acquisition, restructuring and other costs

                  (12,968     12,968                      12,968   

Settlement charge — pension

                  (3,064     3,064                      3,064   

Impairment of investments

                                (533            533   

Non-cash interest expense

                                (12,358            12,358   

Net tax items

                                       34,615        (34,615
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-GAAP amounts

  $ 1,356,562      $ 468,645      $ 304,243      $ 164,402      $ 84      $ 55,452      $ 108,866   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

GAAP net income per share — diluted

              $ 0.46   
             

 

 

 

Non-GAAP net income per share — diluted

              $ 0.93   
             

 

 

 

Weighted average common shares — basic

                114,161   
             

 

 

 

Weighted average common shares — diluted

                116,514   
             

 

 

 

In managing and reviewing our business performance, we exclude a number of items required by GAAP. Management believes that excluding these items mentioned below is useful in understanding the trends and managing our operations. Historically, we have publicly presented these supplemental non-GAAP measures in order to assist the investment community to see ARRIS through the “eyes of management,” and therefore enhance understanding of ARRIS’ operating performance. Non-GAAP financial measures should be viewed in addition to, and not as an alternative to, the Company’s reported results prepared in accordance with GAAP. Our non-GAAP financial measures reflect adjustments based on the following items, as well as the related income tax effects:

Acquisition Accounting Impacts Related to Deferred Revenue:     In connection with the accounting related to our acquisitions, business combination rules require us to account for the fair values of deferred revenue arrangements for which acceptance has not been obtained, and post contract support in our purchase accounting. The non-GAAP adjustment to our sales and cost of sales is intended to include the full amounts of such revenues as if these purchase accounting adjustments had not been applied. We believe the adjustment to these revenues is useful as a measure of the ongoing performance of our business. We historically have experienced high renewal rates related to our support agreements, and our objective is to increase the renewal rates on acquired post contract support agreements. However, we cannot be certain that our customers will renew their contracts.

Acquisition Accounting Impacts Related to Inventory Valuation:     In connection with our acquisition of Motorola Home, business combinations rules require the inventory be recorded at fair value on the opening balance sheet. This is different from historical cost. Essentially we were required to write the inventory up to end customer price less a reasonable margin as a distributor. This resulted in an increase in the value of inventory and resulted in higher cost of goods sold as it was sold.

 

33


Table of Contents
Index to Financial Statements

Product Rationalization:     In conjunction with the integration of Motorola Home, we identified certain product lines which overlap. In the second quarter of 2013, we made the decision to eliminate certain products. As a result, we recorded expenses related to the elimination of inventory and certain vendor liabilities. We believe it is useful to understand the effects of this item on our total cost of goods sold.

Reduction in Revenue Related to Comcast Investment in ARRIS:     In connection with our acquisition of Motorola Home, Comcast was given an opportunity to invest in ARRIS. The accounting guidance requires that we record the implied fair value of benefit received by Comcast as a reduction in revenue. Until the closing of the deal, changes in the value of the investment were marked to market and flowed through other expense (income). We have excluded the effect of the implied fair value in calculating our non-GAAP financial measures. We believe it is useful to understand the effects of these items on our total revenues and other expense (income).

Stock-Based Compensation Expense:     We have excluded the effect of stock-based compensation expenses in calculating our non-GAAP operating expenses and net income (loss) measures. Although stock-based compensation is a key incentive offered to our employees, we continue to evaluate our business performance excluding stock-based compensation expenses. We record non-cash compensation expense related to grants of options and restricted stock. Depending upon the size, timing and the terms of the grants, the non-cash compensation expense may vary significantly but will recur in future periods.

Integration, Acquisition, Restructuring and Other Costs:     We have excluded the effect of integration, acquisition, restructuring and other costs and the effect of restructuring expenses in calculating our non-GAAP operating expenses and net income measures. We have and will incur significant expenses in connection with our recent acquisition of Motorola Home, which we generally would not otherwise incur in the periods presented as part of our continuing operations. Acquisition related expenses consist of transaction costs, costs for transitional employees, other acquired employee related costs, and integration related outside services. Restructuring expenses consist of employee severance, abandoned facilities, and other exit costs. We believe it is useful to understand the effects of these items on our total operating expenses.

Amortization of Intangible Assets:     We have excluded the effect of amortization of intangible assets in calculating our non-GAAP operating expenses and net income (loss) measures. Amortization of intangible assets is non-cash, and is inconsistent in amount and frequency and is significantly affected by the timing and size of our acquisitions. Investors should note that the use of intangible assets contributed to our revenues earned during the periods presented and will contribute to our future period revenues as well. Amortization of intangible assets will recur in future periods.

Non-Cash Interest on Convertible Debt:     We have excluded the effect of non-cash interest in calculating our non-GAAP operating expenses and net income (loss) measures. We record the accretion of the debt discount related to the equity component non-cash interest expense. We believe it is useful to understand the component of interest expense that will not be paid out in cash.

Impairment of Investment:     We have excluded the effect of an other-than-temporary impairments of cost method investments in calculating our non-GAAP financial measures. We believe it is useful to understand the effect of this non-cash item in our other expense (income).

Settlement Charge — Pension:     In an effort to reduce volatility and administrative expense in connection with the Company’s pension plan, we have offered certain participants an opportunity to voluntarily elect an early payout of their pension benefits. We exclude this charge in Non-GAAP measures, as this is a one-time charge that is not considered by management in their review of financial results.

Credit Facility — Ticking Fees:     In connection with our acquisition of Motorola Home, the cash portion of the consideration was funded through debt financing commitments. A ticking fee is a fee paid to our banks to compensate for the time lag between the commitment to make the loan and the actual funding. We have excluded the effect of the ticking fee in calculating our non-GAAP financial measures. We believe it is useful to understand the effect of these items in our other (income) expense.

Mark To Market Fair Value Adjustment Related To Comcast Investment in ARRIS:     In connection with our acquisition of Motorola Home, Comcast was given an opportunity to invest in ARRIS. The accounting guid-

 

34


Table of Contents
Index to Financial Statements

ance requires we mark to market the changes in the value of the investment and flow through other expense (income). We have excluded the effect of the implied fair value in calculating our non-GAAP financial measures. We believe it is useful to understand the effects of these items on our total other expense (income).

Asset Held for Sale Impairment:     In the second quarter of 2014, we entered into a contract to facilitate the sale of a building at less than its carrying amount. The asset has been reclassified as held for sale and was measured at the lower of its carrying amount or fair value less cost to sell. We have recorded an impairment charge to reduce the assets carrying amount to its estimated fair value less costs to sell in the period the held for sale criteria were met. We have excluded the effect of the asset held for sale impairment in calculating our non-GAAP financial measures. We believe it is useful to understand the effect of this non-cash item in our other expense (income).

Liability Related to Foreign Tax Credit Benefits:     In connection with our acquisition of Motorola Home, we have obtained certain foreign tax credit benefits for which we have recorded a liability to Google resulting from certain provisions in the acquisition agreement. The expense related to this liability has been recorded as part of other expense (income). We have excluded the effect of the expense in the calculation of our non-GAAP financial measures. We believe it is useful to understand the effects of this item on our total other expense (income).

Net Tax Items:     We have excluded the tax effect of the non-GAAP items mentioned above. Additionally, we have excluded the effects of certain tax adjustments related to tax and legal restructuring, state valuation allowances, research and development tax credits and provision to return differences.

Industry Conditions

Global macro-economic conditions continued to improve in 2014 over the historically low levels experienced since in 2007; although the U.S. and many other international markets we serve saw only modest growth. We expect to see further limited economic growth in many of our markets in 2015 notwithstanding the continuing global economic uncertainty. We believe this economic uncertainty will continue to influence the capital investment strategy of many of our customers and, as a result, we do not anticipate material growth in the overall capital expenditure markets we serve in 2015.

Consolidation of Customers Has Occurred and May Continue — In the first half of 2014 Comcast announced its intention to acquire Time Warner Cable; AT&T entered into an agreement to acquire DIRECTV; and in February 2015 Verizon announced its intention to sell certain properties to Frontier Communications. These announced transactions and other customer consolidations that may occur could have an impact on future sales and profitability. The impact of this customer M&A activity is difficult to estimate but may include:

 

   

a near-term delay in capital expenditures by the impacted customers until transactions are completed. Once the transactions are completed, we believe there is the potential for increased capital expenditure as acquiring operators work to standardize the purchased network to the acquirer’s existing systems and, in many cases, upgrade the acquired networks;

 

   

pressures from the resulting customers for lower prices or better terms, reflecting the increase in the total volume of products purchased or the elimination of a price differential between the acquiring customer and the company acquired; and

 

   

potential volatility in demand depending upon which technology, products and vendors each customer chooses to use post integration, including reductions in purchases from us in order to diversify their supplier base.

Capital Expenditures of Telcom Customers are Expected to be Lower in the Near Term — The U.S. Federal Communications Commission recently completed a wireless spectrum auction which raised a record amount for the acquired wireless spectrum licenses. Many of our telecom customers, including AT&T and Verizon, participated in this auction as they looked to expand their network capacity to meet increasing customer demand. As a result, capital expenditures at our existing and potential telecom customers are expected to be

 

35


Table of Contents
Index to Financial Statements

lower in the near term as a result of the costs associated with participating in the auction. Additional spectrum auctions, both in the U.S. (in 2016) and in some foreign markets are expected to occur which could further impact the capital expenditure strategies of telecom customers in the near term. Nevertheless, as described below, we still believe that the need for network expansion to meet customer demand presents potential opportunities for increased sales of our products to these customers.

Foreign Exchange Fluctuations May Impact Demand — The majority of our international sales are denominated in U.S. dollars and, as a result, the recent strengthening of the U.S. dollar has, and may continue to, impact our international customers who experience more cost to convert their local currency to US dollars in order to purchase our products. These customers may delay or reduce future purchases from us or we way experience pricing pressures in order to maintain or increase our market share in these international markets.

Competitive Market Regarding Communications and Entertainment Offerings from Non-Cable and Telecom Service Providers — OTT video services enabled by broadband data services is increasingly providing the same content provided by cable and telecom service providers in an on-demand, location independent format. Consumers are adopting this approach through offerings from providers such as Netflix and Hulu. Service providers are responding with enhanced on-demand location independent services of their own, providing immediate access to a wide array of content anytime, anywhere, on any screen. As a result, cable operators and Telecom companies are expected to increase the capacity of their networks to provide their customers with the bandwidth necessary to enable these services, which in turn may lead to greater demand for our products.

Growth of Connected Device Ecosystem — Consumers continue to add more connected devices to their home — including screens like smart TVs, tablets, laptops, and smartphones, but also connected appliances and health monitoring, security, and energy management devices. The proliferation of such devices is not only increasing the demand for bandwidth to keep them all concurrently connected, but creating new opportunities for services that take advantage of these new connections and the data they provide as a networked system. This ecosystem has taken on the moniker Internet of Things (“IoT”), and it poses both a significant monetization opportunity for service providers as well as a significantly complex environment for service delivery. The combination of different device interfaces, communications protocols, device management features and standards, privacy and security considerations, as well as an underlying need for wired and wireless connectivity poses its own unique set of challenges. However, the level of consumer engagement with these devices, as well as the unprecedented level of information they provide about users and their behaviors represent an opportunity for new, sticky services that service providers cannot deny. As a result, we expect to continue to invest in R&D to enable these services and create new products for the operators.

Content and Experience Personalization — As the connected device ecosystem and library of available media continues to grow, the ways in which content reaches consumers and how it is packaged is becoming paramount to providing relevant services. Consumers, increasingly, are engaging with more content and demanding that it be available anytime, anywhere, and on any device. This demand for personalization not only permeates the content delivery chain in the form of Multiscreen, TV Everywhere, DVR, and On-Demand services, but also affects content creation. User-generated, OTT, and direct-to-streaming content, for example, are becoming even more popular, giving way to new consumer trends like binge viewing and cord-cutting. And new interfaces, recommendation engines, and applications are creating opportunities for ad insertion and merchandising that are better targeted, device-specific, and more effective. Personalization, like the platform of connected devices on which it sits, continues to present a challenge of complexity and fragmentation in delivering content and experiences, but represents an unprecedented opportunity for service providers to achieve new levels of engagement and monetization. As a result, we expect to continue to invest in R&D to enable these services and create new products for the operators.

Monetization and Targeted Advertising in a Multiscreen World — The search and social media industries have introduced easy, interactive ways for advertisers to reach consumers while providing real-time results and responses and enabling content and ad-specific targeting. Advertisers, programmers, and content distributors including cable and telecom service providers are evaluating ways to integrate this new advertising paradigm with existing linear television by incorporating next-generation advertising insertion servers in their networks

 

36


Table of Contents
Index to Financial Statements

and jointly building an advanced advertising platform with consistent technologies, metrics, and interfaces across a national footprint. As a result, we expect to continue to invest in R&D to enable these services and create new products for the operators.

Network Optimization and Scaling Infrastructure to Keep Up with Growing Demand — Service providers are offering enhanced services, including high-definition television (and soon UHD/4K TV), digital video, interactive and VOD services, high-speed Internet and VoIP. As these enhanced broadband services continue to attract new subscribers, we expect that service providers will be required to invest in their networks to expand network capacity and support increased customer demand for personalized services. In the access portion, or “last-mile,” of the network, service providers will need to upgrade headends, hubs, nodes, and radio frequency distribution equipment. They will need to take a scalable approach to continue upgrades as new services are deployed. In addition, many international cable operators are still completing the initial upgrades necessary to offer such enhanced broadband services. Finally, as more and more critical services are provided over the service provider network, plant maintenance becomes a more important requirement. Operators must replace network components (such as amplifiers and lasers) as they approach the end of their useful lives. As a result we expect to continue to invest in R&D to enable these services and create new products for the operators.

Competition Between MSOs and Telecom Companies Continues and New Entrants are AppearingTelecom companies are offering high-speed data services and now also offer a strong suite of video services to the residential market. Counterbalancing these offerings, cable companies are providing IP-based telephone service and DOCSIS 3.0-based (and soon, DOCSIS 3.1-based) ultra high-speed data service. Recently Google has entered the market with fiber to the home services in several markets and has announced plans to expand further. As a result of this competition among service providers, we anticipate that our customers will continue to invest in products and services to provide improved service offerings to their subscribers which may lead to strong demand for our products.

Service providers are Demanding Advanced Network Technologies and Software Solutions.     The increase in volume and complexity of the signals transmitted over broadband networks as a result of the migration to an all-digital, all-IP, on demand network is causing service providers to deploy new technologies. Service providers also are demanding sophisticated network and service management software applications that minimize operating expenditures needed to support the complexity of two-way broadband communications systems. As a result, service providers are focusing on technologies and products that are flexible, cost-effective, compliant with open industry standards, and scalable to meet subscriber growth and effectively deliver reliable, enhanced services. As part of this evolution, some operators (for example Comcast with its Reference Design Kit (“RDK”) efforts) are choosing to design portions of the set-tops firmware internally. As a result we anticipate that over time operators will migrate to an all IP network and look to enable new platforms and technologies intended to accelerate the deployment of new services. As this occurs, which we believe will be over a multi-year period, we anticipate a decline in demand for our traditional set-tops and an increase in demand in new IP set-tops.

Consolidation of Vendors Has Occurred and May Continue — Our industry has seen, and is expected to continue to see, significant consolidation.

The specific impact of the above trend is difficult to predict and quantify, but in general we believe:

 

   

The pace of new service introduction will continue to increase as will the variety of connected consumer devices. This change will increase the consumption of bandwidth and the demand for ARRIS products.

 

   

The need for service providers to expand their networks to meet the increased bandwidth and speed requirements their customers are demanding will continue to grow, driven by both the competition each provider faces and the proliferation of new services and connected devices. This leads the service providers to ask ARRIS, and our competitors, for product innovations that decrease the cost per megabit of the capacity required. This trend may have an impact on both revenues and margins, depending upon (among other things), the life cycle of the technology being deployed and the price points associated with that technology at a point in time. Further, the requirement to continuously innovate is expected to require continued research and development investment.

 

37


Table of Contents
Index to Financial Statements

Results of Operations

Overview

As highlighted earlier, we have faced, and in the future will face, significant changes in our industry and business. These changes have impacted our results of operations and are expected to do so in the future. As a result, we have implemented strategies both in anticipation and in reaction to the impact of these dynamics.

Below is a table that shows our key operating data as a percentage of sales. Following the table is a detailed description of the major factors impacting the year-over-year changes of the key lines of our results of operations.

Key Operating Data (as a percentage of net sales)

 

     Years Ended December 31,  
         2014             2013             2012      

Net sales

     100.0     100.0     100.0

Cost of sales

     70.3        71.8        65.8   
  

 

 

   

 

 

   

 

 

 

Gross margin

     29.7        28.2        34.2   

Operating expenses:

      

Selling, general, and administrative expenses

     7.7        9.3        11.9   

Research and development expenses

     10.5        11.8        12.6   

Amortization of intangible assets

     4.4        5.3        2.2   

Integration, acquisition, restructuring and other costs

     0.7        2.3        1.0   
  

 

 

   

 

 

   

 

 

 

Operating income (loss)

     6.4        (0.5     6.5   

Other expense (income):

      

Interest expense

     1.2        1.9        1.3   

Loss (gain) on investments

     0.2        0.1        (0.1

Loss (gain) on foreign currency

     0.1        (0.1     0.1   

Interest income

     (0.1     (0.1     (0.2

Other expense (income), net

     0.5        0.4        (0.1
  

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     4.5        (2.7     5.5   

Income tax expense (benefit)

     (1.6     (1.3     1.5   
  

 

 

   

 

 

   

 

 

 

Net income (loss)

     6.1     (1.4 )%      4.0
  

 

 

   

 

 

   

 

 

 

 

38


Table of Contents
Index to Financial Statements

Comparison of Operations for the Three Years Ended December 31, 2014

Net Sales

The table below sets forth our net sales for the three years ended December 31, 2014, 2013 and 2012 for each of our business segments described in Item 1 of this Form 10-K (in thousands, except percentages):

 

    Net Sales      Increase (Decrease) Between Periods  
    For the Years Ended December 31,      2014 vs. 2013     2013 vs. 2012  
    2014     2013     2012      $      %     $     %  

Business Segment:

               

CPE

  $ 3,690,454      $ 2,448,381      $ 611,408       $ 1,242,073         50.7   $ 1,836,973        300.4

N&C

    1,637,544        1,193,001        742,255         444,543         37.3     450,746        60.7

Other

    (5,077     (20,480             15,403         75.2     (20,480     (100.0 )% 
 

 

 

   

 

 

   

 

 

    

 

 

      

 

 

   

Total sales

  $ 5,322,921      $ 3,620,902      $ 1,353,663       $ 1,702,019         47.0   $ 2,267,239        167.5
 

 

 

   

 

 

   

 

 

    

 

 

      

 

 

   

The table below sets forth our domestic and international sales for the three years ended December 31, 2014, 2013 and 2012 (in thousands, except percentages):

 

    Net Sales      Increase (Decrease) Between Periods  
    For the Years Ended December 31,      2014 vs. 2013     2013 vs. 2012  
    2014      2013      2012      $     %     $      %  

Domestic

  $ 3,957,203       $ 2,457,172       $ 1,020,060       $ 1,500,031        61.0   $ 1,437,112         140.9

International:

                 

Americas, excluding U.S

    900,822         746,146         202,887         154,676        20.7     543,259         267.8

Asia Pacific

    147,921         153,674         65,554         (5,753     (3.7 )%      88,120         134.4

EMEA

    316,975         263,910         65,162         53,065        20.1     198,748         305.0
 

 

 

    

 

 

    

 

 

    

 

 

     

 

 

    

Total international

    1,365,718         1,163,730         333,603         201,988        17.4     830,127         248.8
 

 

 

    

 

 

    

 

 

    

 

 

     

 

 

    

Total sales

  $ 5,322,921       $ 3,620,902       $ 1,353,663       $ 1,702,019        47.0   $ 2,267,239         167.5
 

 

 

    

 

 

    

 

 

    

 

 

     

 

 

    

Customer Premises Equipment Net Sales 2014 vs. 2013

During the year ended December 31, 2014, sales of our CPE segment increased by approximately $1,242.1 million or 50.7%, as compared to 2013. The increase is attributable to the inclusion of sales associated with our acquisition of Motorola Home as well as the introduction of new products, in particular the XG1 and Verizon Media Server (VMS) video gateways. The sales increase was also driven by strong cable and telco set-tops and broadband device demand.

Network & Cloud Net Sales 2014 vs. 2013

During the year ended December 31, 2014, sales in the N&C segment increased by approximately $444.5 million or 37.3%, as compared to 2013. The increase in sales is primarily the result of the inclusion of sales associated with our acquisition of Motorola Home as well as strong sales across most product lines, led by our new CMTS platform, the E6000 CCAP and video solutions.

Customer Premises Equipment Net Sales 2013 vs. 2012

During the year ended December 31, 2013, sales of our CPE segment increased by approximately $1,837.0 million or 300.4%, as compared to 2012. The increase is primarily attributable to the inclusion of sales associated with our acquisition of Motorola Home. The sales increase also reflects the introduction of new products, in particular the XG1 gateway.

 

39


Table of Contents
Index to Financial Statements

Network & Cloud Net Sales 2013 vs. 2012

During the year ended December 31, 2013, sales in the N&C segment increased by approximately $450.7 million or 60.7%, as compared to 2012. The increase in sales is primarily the result of the inclusion of sales associated with our acquisition of Motorola Home. During 2013, sales of our C4 CMTS declined as our new CMTS, the E6000, was introduced.

Gross Margin

The table below sets forth our gross margin for the three years ended December 31, 2014, 2013 and 2012 (in thousands, except percentages):

 

     Gross Margin     Increase (Decrease) Between Periods  
     For the Years Ended December 31,     2014 vs. 2013     2013 vs. 2012  
     2014     2013     2012     $      %     $      %  

Gross margin dollars

   $ 1,582,496      $ 1,022,748      $ 462,577        559,748         54.7     560,171         121.1

Gross margin percentage

     29.7     28.2     34.2        1.5           (6.0

During the year ended December 31, 2014, gross margin dollars and gross margin percentage increased as compared to 2013. The increase in gross margin dollars is primarily the result of the inclusion of sales associated with our acquisition of Motorola Home. In addition, the gross margin for the year ended December 31, 2013 includes a $53.8 million impact associated with writing up the historic cost of the Motorola Home inventory to fair value at the date of acquisition (subsequently increasing cost of goods sold) as well as $16.5 million of costs associated with the rationalization of certain products after the acquisition date.

During the year ended December 31, 2013, gross margin dollars increased and gross margin percentage decreased as compared to 2012. Increase in gross margin dollars was primarily the result of the inclusion of sales associated with our acquisition of Motorola Home. The decrease in gross margin percentage was the result of product mix, as the increased sales of CPE products, which carry a lower gross margin, were a higher percentage of total sales. The historic gross margin of Motorola Home products was lower than the average of the historic ARRIS business. Also leading to the mix impact was the relative proportion of legacy Motorola Home sales and ARRIS sales; volume of legacy Motorola Home sales were significantly higher. The gross margin for the year ended December 31, 2013 included a $53.8 million impact associated with writing up the historic cost of the Motorola Home inventory to fair value at the date of acquisition (subsequently increasing cost of goods sold) as well as $16.5 million of costs associated with the rationalization of certain products after the acquisition date. Also, the gross margins were impacted by $13.2 million associated with a reduction in sales associated with the accounting for Comcast’s investment in ARRIS. We do not expect these items to impact future quarters.

Operating Expenses

The table below provides detail regarding our operating expenses (in thousands, except percentages):

 

     Operating Expenses      Increase (Decrease) Between Periods  
     For the Years Ended December 31,      2014 vs. 2013     2013 vs. 2012  
     2014      2013      2012      $     %     $      %  

Selling, general & administrative

   $ 410,568       $ 338,252       $ 161,338       $ 72,316        21.4   $ 176,914         109.7

Research & development

     556,575         425,825         170,706         130,750        30.7     255,119         149.4

Amortization of intangible assets

     236,521         193,637         30,294         42,884        22.1     163,343         539.2

Integration, acquisition, restructuring & other

     37,498         83,047         12,968         (45,549     (54.8 )%      70,079         540.4
  

 

 

    

 

 

    

 

 

    

 

 

     

 

 

    

Total

   $ 1,241,162       $ 1,040,761       $ 375,306       $ 200,401        19.3   $ 665,455         177.3
  

 

 

    

 

 

    

 

 

    

 

 

     

 

 

    

 

40


Table of Contents
Index to Financial Statements

Selling, General, and Administrative, or SG&A, Expenses

2014 vs. 2013

The year over year increase in SG&A expenses primarily reflect the inclusion of expenses associated with the Motorola Home acquisition, as well as higher variable compensation costs and bad debt expense. The increase was partially offset as a result of certain information technology and other costs, formerly allocated to SG&A, which have been reclassified effective January 1, 2014 to cost of sales and research and development as a result of the way we review the business.

2013 vs. 2012

The year over year increase in SG&A expenses primarily reflect the inclusion of expenses associated with the Motorola Home acquisition.

Research & Development, or R&D, Expenses

Included in our R&D expenses are costs directly associated with our development efforts (people, facilities, materials, etc.) and reasonable allocations of our information technology and corporate facility costs.

2014 vs. 2013

The increase year-over-year in R&D expense reflects the inclusion of expenses associated with the Motorola Home acquisition, as well as, as well as higher variable compensation costs and allocations of information technology and other costs.

2013 vs. 2012

The increase year-over-year in R&D expense reflects the inclusion of expenses associated with the Motorola Home acquisition.

Amortization of Intangible Assets

Our intangible amortization expense relates to finite-lived intangible assets acquired in business combinations or acquired individually. Intangibles amortization expense was $236.5 million in 2014, as compared with $193.6 and $30.3 million in 2013 and 2012, respectively.

Integration, Acquisition, Restructuring and Other Costs

During 2014, we recorded acquisition related expenses and integration expenses of $34.1 million. These expenses primarily related to the acquisition of Motorola Home and consisted of integration related outside services and legal fees. The Company has substantially completed its integration of the Motorola Home business in 2014.

During 2013, we recorded acquisition related expenses and integration expenses of $18.6 million and $26.9 million, respectively. These expenses related to the acquisition of Motorola Home and consisted of transaction costs, integration related outside services and legal fees.

During 2012, we recorded acquisition-related expenses of $5.9 million. Approximately $0.8 million of these expenses were related to the acquisition of BigBand and $5.1 million were related to the acquisition of Motorola Home and consisted of transaction costs and legal fees. In addition, in March 2012, the Company completed the sale of certain assets of its ECCO electronic connector product line to Eclipse Embedded Technologies, Inc. for approximately $3.9 million. The Company recorded a net loss of $(0.3) million on the sale, which included approximately $0.3 million of transaction related costs. The results of the ECCO product line were deemed immaterial to the overall financial results of the Company, and as such the Company has not reported the results in discontinued operations.

 

41


Table of Contents
Index to Financial Statements

During 2014, 2013 and 2012, we recorded restructuring charges of $3.4 million, $37.6 million and $6.8 million, respectively. The charge recorded in 2014 related to rationalization of facilities resulting in costs related to severance and employee termination benefits and the charges in 2013 were related to severance, employee termination benefits and facilities. The charges recorded in 2012 related to severance and facilities associated with the continued implementation of the restructuring initiative following the acquisition of BigBand to align our workforce and operating costs with current business opportunities.

Direct Contribution

The table below sets forth our direct contribution for the three years ended December 31, 2014, 2013 and 2012 (in thousands, except percentages):

 

     Direct Contribution     Increase (Decrease) Between Periods  
     For the Years Ended December 31,     2014 vs. 2013     2013 vs. 2012  
     2014     2013     2012     $     %     $     %  

Operating Segment:

              

CPE

   $ 791,244      $ 509,473      $ 66,788      $ 281,771        55.3   $ 442,685        662.8

N&C

     430,943        264,589        228,798        166,354        62.9     35,791        15.6

Other

     (606,834     (515,391     (165,053     (91,443     (17.7 )%      (350,338     (212.3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Total

   $ 615,353      $ 258,671      $ 130,533      $ 356,682        137.9   $ 128,138        98.2
  

 

 

   

 

 

   

 

 

   

 

 

     

 

 

   

Customer Premises Equipment Direct Contribution 2014 vs. 2013

During 2014, direct contribution in our CPE segment increased by approximately 55.3% as compared to the same period in 2013. The increase is primarily attributable to the inclusion of direct contribution associated with our acquisition of Motorola Home. Further, the direct contribution is favorably impacted by mix, given, that in the aggregate the contribution margin of former Motorola Home products are greater than that of former ARRIS products.

Network & Cloud Direct Contribution 2014 vs. 2013

During 2014, direct contribution in our N&C segment increased by approximately 62.9% as compared to the same period in 2013. The increase is primarily attributable to the inclusion of direct contribution associated with our acquisition of Motorola Home and the success of our E6000 CMTS platform.

Customer Premises Equipment Direct Contribution 2013 vs. 2012

During 2013, direct contribution in our CPE segment increased by approximately 662.8% as compared to the same period in 2012. The increase is primarily attributable to the inclusion of direct contribution associated with our acquisition of Motorola Home as well as product mix and higher sales.

Network & Cloud Direct Contribution 2013 vs. 2012

During 2013, direct contribution in our N&C segment increased by approximately 15.6% as compared to the same period in 2012. Despite the higher sales, as a result of the Motorola Home acquisition, direct contribution did not increase proportionally. The contribution was impacted year over year by (1) higher operating expenses associated with investing in the acquired Cloud software portfolio, as well as overlapping investments in next generation CCAP; (2) the ramp-up of E6000 CMTS in 2013 resulted in higher shipments of new chassis and line cards, which have lower margin relative to license upgrades of deployed C4 CMTS products shipped in 2012.

 

42


Table of Contents
Index to Financial Statements

Other Expense (Income)

The table below provides detail regarding our other expense (income) (in thousands):

 

     Other Expense (Income)     Increase (Decrease)
Between Periods
 
     For the Years Ended
December 31,
   
     2014     2013     2012     2014 vs. 2013     2013 vs. 2012  

Interest expense

   $ 62,901      $ 67,888      $ 17,797      $ (4,987   $ 50,091   

Loss (gain) on investments

     10,961        2,698        (1,404     8,263        4,102   

Loss (gain) on foreign currency

     2,637        (3,502     786        6,139        (4,288

Interest income

     (2,590     (2,936     (3,242     346        306   

Other expense (income)

     28,195        13,989        (962     14,206        14,951   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

   $ 102,104      $ 78,137      $ 12,975      $ 23,967      $ 65,162   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest Expense

Interest expense reflects the amortization of deferred finance fees, the debt discount for the term loans and the non-cash interest component of our convertible subordinated notes which were fully redeemed during the fourth quarter of 2013, as well as interest paid on the notes and term loans and other debt obligations. Interest expense was $62.9 million in 2014, as compared with $67.9 million and $17.8 million in 2013 and 2012, respectively.

Loss (Gain) on Investments

From time to time, we hold certain investments in the common stock of private and publicly-traded companies, a number of non-marketable equity securities, and investments in rabbi trusts associated with our deferred compensation plans. In connection with the Motorola Home acquisition, we also acquired certain investments in limited liability companies and partnerships that are accounted for using the equity method of accounting. As such our equity portion in current earnings of such companies is included in the loss (gain) on investments.

During the years ended December 31, 2014, 2013 and 2012, we recorded net (gains) losses on investment, including impairment charges in 2014, related to these investments of $11.0 million, $2.7 million and $(1.4) million, respectively.

During 2014, the Company performed an evaluation of its investments and concluded that two private companies had indicators of impairment, and that their fair value had declined. This resulted in other-than-temporary impairment charges of $7.0 million. No impairment charges were recorded in 2013 and 2012.

Loss (Gain) on Foreign Currency

During the years ended December 31, 2014, 2013 and 2012, we recorded net (gains) losses on foreign currency of $2.6 million, $(3.5) million and $0.8 million, respectively. We have US dollar functional currency entities that bill certain international customers in their local currency and foreign functional currency entities that procure in U.S. dollars. We also have certain predictable expenditures for international operations in local currency. Additionally, certain intercompany transactions are denominated in foreign currencies and subject to revaluation. To mitigate the volatility related to fluctuations in the foreign exchange rates, we have entered into various foreign currency contracts. The gain or loss on foreign currency is driven by the fluctuations in the foreign currency exchange rates.

Interest Income

Interest income reflects interest earned on cash, cash equivalents, short-term and long-term marketable security investments. During the years ended December 31, 2014, 2013 and 2012, we recorded interest income of $2.6 million, $2.9 million and $3.2 million, respectively.

 

43


Table of Contents
Index to Financial Statements

Other Expense (Income)

Other expense (income) for the years ended December 31, 2014, 2013 and 2012 were $28.2 million, $14.0 million and $(1.0) million, respectively.

In connection with our acquisition of Motorola Home, we have obtained certain foreign tax credit benefits for which we have recorded a liability to Google resulting from certain provisions in the acquisition agreement. During the fourth quarter of 2014, we have recorded an expense of $20.5 million related to this liability.

For the year ended December 31, 2014, we recorded a $2.1 million write-down in the carrying amount of land and building reclassified as held for sale as a result of obtaining a letter of intent for its sale and is included in other expense (income), net.

In connection with Comcast’s agreement in January 2013 to invest in ARRIS upon the acquisition of Motorola Home, accounting guidance requires that, since the agreed-upon purchase price was less than the market price on the date of agreement, the resulting forward arrangement be marked to market for the difference in fair value. This resulted in a mark-to-market adjustment of $13.2 million in 2013 and was recorded as Other Expense (Income).

Income Tax Expense

Our annual provision for income taxes and determination of the deferred tax assets and liabilities require management to assess uncertainties, make judgments regarding outcomes, and utilize estimates. To the extent the final outcome differs from initial assessments and estimates, future adjustments to our tax assets and liabilities will be necessary.

In 2014, we recorded ($88.0) million of income tax benefit for U.S. federal and state taxes and foreign taxes, which was (36.8)% of our pre-tax income of $239.2 million. The Company’s effective income tax rate for 2014 was favorably impacted by $176.5 million of discrete tax benefit. The tax benefit was primarily due to the release of valuation allowances recorded for U.S. federal net operating losses and U.S. federal tax credits and from deferred tax assets recorded for state net operating losses and state research and development tax credits arising from the acquisition of the Motorola Home business from Google. In addition, $18.1 million of current tax benefit was recorded when the President signed legislation to approve the extension of the U.S. federal research and development tax credit through December 31, 2014. To assess the Company’s ability to remove the valuation allowances recorded against certain deferred tax assets acquired in the Motorola Home acquisition, the Company was required to analyze the impact of various tax rules which limit the Company’s ability to utilize net operating losses and tax credits. The Company was also required to assess tax planning strategies to best allow for the utilization of the tax attributes. During the fourth quarter of 2014, the Company completed the required tax analysis and received the final information from Google as to the amounts and types of acquired deferred tax assets. Exclusive of these discrete events, the effective income tax rate would have been approximately 29.6%.

In 2013, we recorded $47.4 million of income tax benefit for U.S. federal and state taxes and foreign taxes, which was 49.3% of our pre-tax loss of $96.2 million. The effective income tax rate was favorably impacted by $15.4 million of discrete tax benefit. The most significant 2013 discrete tax events were a reversal of $6.7 million of tax liabilities from uncertain tax positions, mostly attributable to the expiration of certain statutes of limitations in the third and fourth quarters of 2013, and a favorable impact of $8.7 million from global provision-to-return adjustments, including the 2012 U.S. federal credit for research and development, which was not reenacted until first quarter of 2013. Additionally, the Company recorded a pre-tax book loss on an investment in ARRIS by Comcast of approximately $26.4 million and a pre-tax book loss of approximately $10.0 million on certain foreign entities from the Motorola Home acquisition, on which no tax benefit was recorded. Exclusive of the discrete events, the effective income tax rate would have been approximately (17.9)%.

In 2012, we recorded $20.8 million of income tax expense for U.S. federal and state taxes and foreign taxes, which was 28.0% of our pre-tax income of $74.3 million. The effective income tax rate was favorably impacted

 

44


Table of Contents
Index to Financial Statements

by $4.7 million in discrete tax events. The most significant 2012 discrete tax events were a reversal of $3.4 million of tax liabilities from uncertain tax positions, mostly attributable to the expiration of certain statutes of limitations in the third quarter of 2012, a favorable impact of $0.7 million from global provision-to-return adjustments and $0.6 million from net valuation allowance decreases. Exclusive of the discrete tax events, the effective income tax rate would have been approximately 33.3%. The increase in the effective income tax rate from prior year, exclusive of discrete tax events and the prior year Goodwill impairment, was primarily attributable to the absence of research and development tax credits. While legislation was passed to extend the U.S. federal research and development tax credit in January of 2013, the passage was too late to allow the Company to record the benefit in 2012. However, 2012 tax expense was still favorably impacted by research and development tax credits as a result of the expiration of certain statute of limitations for prior years and certain adjustments for provision-to-return. During the first quarter of 2013, the Company recorded the 2012 impact of the 2013 legislation as a favorable discrete tax event and included the impact of the 2013 credit in its effective income tax rate for 2013.

Financial Liquidity and Capital Resources

Overview

Following completion of the Motorola Home acquisition, one of our key strategies remains maintaining and improving our capital structure. The key metrics we focus on are summarized in the table below:

Liquidity & Capital Resources Data

 

     Year Ended December 31,  
     2014      2013      2012  
     (in thousands, except DSO and Turns)  

Key Working Capital Items

        

Cash provided by operating activities

   $ 459,281       $ 562,716       $ 84,401   

Cash, cash equivalents, and short-term investments

   $ 692,538       $ 509,798       $ 530,117   

Long-term U.S corporate bonds

   $ 4,867       $ 3,577       $ 53,914   

Accounts Receivable, net

   $ 598,603       $ 619,571       $ 188,581   

-Days Sales Outstanding

     42         54         46   

Inventory, net

   $ 401,165       $ 330,129       $ 133,848   

- Turns

     10.2         10.1         7.1   

Key Financing Items

        

Convertible notes at face value

   $       $       $ 232,050   

Term loans at face value

   $ 1,547,563       $ 1,752,563       $   

Cash used for redemption of convertible notes

   $       $ 232,050       $   

Cash used for debt repayment

   $ 209,653       $ 172,437       $   

Key Financing Items

        

Cash used for share repurchases

   $       $       $ 51,921   

Capital Expenditures

   $ 56,588       $ 71,443       $ 21,507   

In managing our liquidity and capital structure, we have been and are focused on key goals, and we have and will continue in the future to implement actions to achieve them. They include:

 

   

Liquidity — ensure that we have sufficient cash resources or other short term liquidity to manage day to day operations.

 

   

Growth — implement a plan to ensure that we have adequate capital resources, or access thereto, fund internal growth and execute acquisitions.

 

   

Deleverage — reduce our debt obligation.

 

   

Share repurchases — opportunistically repurchase our common stock.

 

45


Table of Contents
Index to Financial Statements

Accounts Receivable & Inventory

We use the number of times per year that inventory turns over (based upon sales for the most recent period, or turns) to evaluate inventory management, and days sales outstanding, or DSOs, to evaluate accounts receivable management.

Accounts receivable at the end of 2014 decreased as compared to the end of 2013. DSOs decreased from 2014 to 2013, primarily the result of payment patterns of our customers and timing of shipments to customers.

Inventory increased in 2014 as compared to 2013, primarily as a result of higher CPE inventory levels to protect against potential supply chain disruptions with West Coast port of entry delays, as well as timing of customer requirements. In addition, the decision to in-source the manufacturing of certain product lines resulted in higher levels of component inventory previously held at contract manufacturers.

Accounts receivable at the end of 2013 increased as compared to the end of 2012, primarily as a result of the inclusion of receivables derived from sales associated with the Motorola Home products, which were not included in 2012. DSOs increased in 2013 as compared to 2012, reflecting a higher international mix of customers (which on average have longer payment terms) as a result of the Acquisition. As part of the Acquisition, we acquired approximately $462.2 million of accounts receivable. Looking forward, it is possible that DSOs may increase dependent upon our customer mix and payment patterns, particularly if international sales increase as customers internationally typically have longer payment terms.

Inventory increased in 2013 as compared to 2012. The increase in inventory was primarily as a result of the Motorola Home acquisition. We acquired approximately $270.4 million of inventory upon closing of the Motorola Home transaction in April 2013. Inventory turns were 10.1 in 2013 as compared to 7.1 in the same period of 2012. The turns increased reflecting the additions of inventory from the Motorola Home acquisition. Motorola Home had high inventory turns on average.

Common Share Repurchases

ARRIS did not repurchase any shares under the previously adopted share repurchase plan in 2014 and 2013. During 2012, we repurchased 4.5 million shares of our common stock for $51.9 million at an average stock price of $11.55.

Term Debt Repayments

In 2014, we repaid $209.7 million of debt, of which $205.0 million was related to term debt, including a $150 million optional prepayment and $4.7 million of debt assumed and settled in conjunction with the closing of the Seawell acquisition in April 2014.

In 2013, we repaid $172.4 million of our term debt, including $125 million optional repayment.

Redemption of 2.00% Convertible Senior Notes due 2026

In 2013, the Company redeemed its convertible notes, for $231.2 million in cash considerations and issued 3.1 million shares of common stock to Note holders.

Summary of Current Liquidity Position and Potential for Future Capital Raising

We believe our current liquidity position, where we had approximately $692.5 million of cash, cash equivalents, and short-term investments and $4.9 million of long-term marketable securities on hand as of December 31, 2014, together with approximately $247.5 million in availability under our new Revolving Credit Facility, and the prospects for continued generation of cash from operations, are adequate for our short- and medium-term business needs. Our cash, cash-equivalents and short-term investments as of December 31, 2014 include approximately $132.5 million held by foreign subsidiaries whose earnings we expect to reinvest indefinitely outside of the United States. We do not expect to need the cash generated by those foreign subsidiaries to

 

46


Table of Contents
Index to Financial Statements

fund our domestic operations. However, in the unforeseen event that we repatriate cash from those foreign subsidiaries, in excess of what is owed to the United States parent, we may be required to provide for and pay U.S. taxes on permanently repatriated funds.

We have subsidiaries in countries that maintain restrictions, such as legal reserves, with respect to the amount of dividends that the subsidiaries can distribute. Additionally, some countries impose restrictions or controls over how and when dividends can be paid by these subsidiaries. While we do not currently intend to repatriate earnings from entities in these countries, if we were to be required to distribute earnings from such countries, the timing of the distribution and the funds available to distribute, would be adversely impacted by these restrictions.

We expect to be able to generate sufficient cash on a consolidated basis to make all of the principal and interest payments under our senior secured credit facilities. Should our available funds be insufficient to support these initiatives or our operations, it is possible that we will raise capital through private or public, share or debt offerings.

Senior Secured Credit Facilities

In April 2013 we entered into senior secured credit facilities with Bank of America, N.A. and various other institutions, which are comprised of (i) a “Term Loan A Facility” of $1.1 billion, (ii) a “Term Loan B Facility” of $825 million and (iii) a “Revolving Credit Facility” of $250 million. The Term Loan A Facility and the Revolving Credit Facility have terms of five years. The Term Loan B Facility has a term of seven years. Interest rates on borrowings under the senior credit facilities are set forth in the table below. As of December 31, 2014, we had $1,547.6 million face value outstanding under the Term Loan A and Term Loan B Facilities, no borrowings under the Revolving Credit Facility and letters of credit totaling $2.5 million issued under the Revolving Credit Facility.

 

     Rate     As of December 31, 2014

Term Loan A

     LIBOR + 1.75    1.92%

Term Loan B

     LIBOR (1) + 2.50    3.25%

Revolving Credit Facility (2)

     LIBOR + 1.75    Not Applicable

 

(1) Includes LIBOR floor of 0.75%
(2) Includes unused commitment fee of 0.35% and letter of credit fee of 1.75% not reflected in interest rate above.

Borrowings under the senior secured credit facilities are secured by first priority liens on substantially all of our assets and certain of our present and future subsidiaries who are or become parties to, or guarantors under, the credit agreement governing the senior secured credit facilities (the “Credit Agreement”). The Credit Agreement contains usual and customary limitations on indebtedness, liens, restricted payments, acquisitions and asset sales in the form of affirmative, negative and financial covenants, which are customary for financings of this type, including the maintenance of a minimum 3.75:1 (with an additional scheduled decreases to 3.5:1). As of December 31, 2014, we were in compliance with all covenants under the Credit Agreement.

The Credit Agreement provides for certain step downs in the interest rates paid on the Term Loan A, Term Loan B and Revolving Credit Facility upon achievement of tiered lowered leverage ratios. As a result of our lowered leverage ratio at the end of the second quarter 2014, the interest rate paid on the Term Loan A, Term Loan B and Revolving Credit Facility decreased by 25 basis points. Since inception, we have realized a total 50 basis points decrease in the interest rate paid on the Term Loan A and Revolving Credit Facility and 25 basis points decrease in the interest paid rate on the Term Loan B. There are no further interest rate decreases available to us in the current Credit Agreement.

The Credit Agreement provides terms for mandatory prepayments and optional prepayments and commitment reductions. The Credit Agreement also includes events of default, which are customary for facilities of this type (with customary grace periods, as applicable), including provisions under which, upon the occurrence of an event of default, all amounts outstanding under the credit facilities may be accelerated.

 

47


Table of Contents
Index to Financial Statements

Commitments

Following is a summary of our contractual obligations as of December 31, 2014 (in thousands):

 

     Payments due by period  

Contractual Obligations

   Less than 1 Year      1-3 Years      3-5 Years      More than
5 Years
     Total  

Credit facilities (1)

   $ 75,625       $ 213,125       $ 715,000       $ 543,813       $ 1,547,563   

Operating leases, net of sublease income (2)

     21,434         32,104         16,863         20,457         90,858   

Purchase obligations (3)

     598,166         29,998                         628,164   

Patent license obligation (4)

     34,253                                 34,253   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations (5)

   $ 729,478       $ 275,227       $ 731,863       $ 564,270       $ 2,300,838   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Represents face values of Term Loan A and B which have terms of five years and seven years respectively.
(2) Includes leases which are reflected in restructuring accruals on the consolidated balance sheets.
(3) Represents obligations under agreements with non-cancelable terms to purchase goods or services. The agreements are enforceable and legally binding, and specify terms, including quantities to be purchased and the timing of the purchase.
(4) Represents a commitment to participate in a syndicate of approximately 30 companies, including certain customers of ARRIS, to fund RPX Corporation’s (“RPX”) purchase of 4,000 patent assets from Rockstar Consortium and its subsidiaries (“Rockstar”). As part of this transaction we will receive a non-exclusive license to the 4,000 patent assets purchased.
(5) Approximately $45.7 million of uncertain tax positions have been excluded from the contractual obligation table because we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities.

Off-Balance Sheet Arrangements

We do not have any material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

Sources and Uses of Cash

Below is a table setting forth the key line items of our Consolidated Statements of Cash Flows (in thousands):

 

     2014     2013     2012  

Cash provided by (used in)

      

Operating activities

     459,281      $ 562,716      $ 84,401   

Investing activities

     (124,586     (1,889,502     (151,062

Financing activities

     (211,343     1,637,521        (37,511
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

   $ 123,352      $ 310,735      $ (104,172
  

 

 

   

 

 

   

 

 

 

 

48


Table of Contents
Index to Financial Statements

Operating Activities:

Below are the key line items affecting cash from operating activities (in thousands):

 

     2014      2013      2012  

Net income (loss)

   $ 327,211       $ (48,760    $ 53,459   

Adjustments to reconcile net income (loss) to cash provided by operating activities

     229,213         284,738         80,867   
  

 

 

    

 

 

    

 

 

 

Net income including adjustments

     556,424         235,978         134,326   

Decrease (increase) in accounts receivable

     17,400         9,241         (37,139

Decrease (increase) in inventory

     (71,036      74,111         (21,491

Increase (decrease) in accounts payable and accrued liabilities

     (115,039      247,301         (5,675

All other, net

     71,532         (3,915      14,380   
  

 

 

    

 

 

    

 

 

 

Cash provided by operating activities

   $ 459,281       $ 562,716       $ 84,401   
  

 

 

    

 

 

    

 

 

 

2014 vs. 2013

Net income including adjustments, as per the table above, increased $320.4 million during 2014 as compared to 2013 reflecting higher sales and gross margin.

Accounts receivable decreased $17.4 million in 2014. These decreases were primarily related to the payment patterns of our customers. It is possible that both accounts receivable and DSOs may increase in future periods, particularly if we have an increase in international sales, which tend to have longer payment terms.

Inventory increased by $71.0 million in 2014, primarily as a result of higher CPE inventory levels to protect against potential supply chain disruptions with West Coast port of entry delays, as well as timing of customer requirements. In addition, the decision to in-source the manufacturing of certain product lines resulted in higher levels of component inventory previously held at contract manufacturers.

Accounts payable and accrued liabilities decreased by $115.0 million in 2014. The significant component of this change was a decrease in accounts payable reflecting timing of payments.

All other accounts, net, include the changes in other receivables, income taxes payable (recoverable), and prepaids. The other receivables represent amounts due from our contract manufacturers for material used in the assembly of our finished goods. The change in our income taxes recoverable account is a result of the timing of the actual estimated tax payments during the year as compared to the actual tax liability for the year. The net change during 2014 was approximately $71.5 million as compared to $3.9 million in 2013.

2013 vs. 2012

Net income including adjustments, increased $101.7 million during 2013 as compared to 2012 reflecting the inclusion of Motorola Home as discussed above.

Accounts receivable decreased $9.2 million in 2013.

Inventory decreased by $74.1 million in 2013. The reduction reflects the turnaround impact associated with writing up the historic cost of the Motorola Home inventory to fair value by $53.8 million and the disposal of certain inventory as a result of product rationalization.

Accounts payable and accrued liabilities increased by $247.3 million. The significant component of this change was an increase in accounts payable due to the acquisition of Motorola Home and timing of payments, coupled with higher variable compensation.

 

49


Table of Contents
Index to Financial Statements

All other accounts, net, include the changes in other receivables, income taxes payable (recoverable), and prepaids. The other receivables represent amounts due from our contract manufacturers for material used in the assembly of our finished goods. The change in our income taxes recoverable account is a result of the timing of the actual estimated tax payments during the year as compared to the actual tax liability for the year. The net change during 2013 was approximately $3.9 million as compared to $14.4 million in 2012.

Investing Activities:

Below are the key line items affecting investing activities (in thousands):

 

     2014      2013      2012  

Purchases of property, plant and equipment

   $ (56,588    $ (71,443    $ (21,507

Acquisitions/other

     84         (2,208,114        

Purchases of investments

     (127,780      (104,626      (418,956

Sales of investments

     59,679         479,781         286,013   

Proceeds from dividend equity investments

             14,780           

Other, net

     19         120         3,388   
  

 

 

    

 

 

    

 

 

 

Cash used in investing activities

   $ (124,586    $ (1,889,502    $ (151,062
  

 

 

    

 

 

    

 

 

 

Purchases of Property, Plant and Equipment — Represents capital expenditures which are mainly for test equipment, laboratory equipment, and computing equipment.

Acquisitions/Other — Represents cash investments we have made in our various acquisitions. In 2013, we paid $2,286 million cash for the acquisition of Motorola Home.

Purchases and Sales of Investments — Represents purchases and sales of securities and other investments.

Proceeds from dividend on equity investments — Represents the dividend proceeds we received from our equity investments.

Other, net — Represents the cash proceeds received sale of assets.

Financing Activities:

Below are the key items affecting our financing activities (in thousands):

 

     2014      2013      2012  

Proceeds from issuance of debt

   $       $ 1,925,000       $   

Cash paid for debt discount

             (9,853        

Payment of debt obligations

     (209,653      (404,488        

Deferred financing cost paid

             (42,724        

Repurchase of common stock

                     (51,921

Proceeds from issuance of common stock

     19,196         175,072         20,304   

Repurchase of shares to satisfy minimum tax withholdings

     (29,845      (12,664      (9,443

Excess tax benefits from stock-based compensation plans

     8,959         7,178         3,549   
  

 

 

    

 

 

    

 

 

 

Cash provided by (used in) financing activities

   $ (211,343    $ 1,637,521       $ (37,511
  

 

 

    

 

 

    

 

 

 

Proceeds From Issuance of Debt — As part of the Motorola Home acquisition, we entered into senior secured credit facility which comprised of Term Loan A facility of $1.1 billion with a term of five years and Term Loan B facilities of $0.8 billion with a term of seven years.

Cash Paid for Debt Discount — Represents amounts paid to lenders in the form of upfront fees, which have been treated as a reduction in the proceeds received by the Company and are considered a component of the discount on the Term Loans A and B.

 

50


Table of Contents
Index to Financial Statements

Payment of Debt Obligation — Represents the payment of the convertible debt and the term loans under the senior secured credit facilities plus the payment of debt assumed and settled in conjunction with the closing of the SeaWell acquisition in April 2014.

Deferred Financing Costs Paid — Represents the finance fees related to the issuance of the senior secured credit facilities. These costs will be amortized over the life of the term loans and revolving credit facility or written-off on an accelerated basis if optional prepayments are made on the debt.

Repurchase of Common Stock — Represents the cash used to buy back the Company’s common stock.

Proceeds from Issuance of Common Stock — Represents cash proceeds related to the exercise of stock options by employees, offset with expenses paid related to the issuance of common stock. It also represents cash proceeds from shares issued to Google and Comcast in relation to the Motorola Home acquisition.

Repurchase of Shares to Satisfy Minimum Tax Withholdings — Represents the minimum shares withheld to satisfy the minimum tax withholding when restricted stock vests.

Excess Tax Benefits from Stock-Based Compensation Plans — Represents the cash that otherwise would have been paid for income taxes if increases in the value of equity instruments also had not been deductible in determining taxable income.

Income Taxes Benefit Related to Equity Compensation

During 2014, approximately $17.2 million of U.S. federal tax benefits were obtained from tax deductions arising from equity-based compensation deductions, all of which resulted from 2014 exercises of non-qualified stock options and lapses of restrictions on restricted stock awards. During 2013, approximately $2.8 million of U.S. federal tax benefits were obtained from tax deductions arising from equity-based compensation deductions, all of which resulted from 2013 exercises of non-qualified stock options and lapses of restrictions on restricted stock awards. During 2012, approximately $2.9 million of U.S. federal tax benefits were obtained from tax deductions arising from equity-based compensation deductions, all of which resulted from 2012 exercises of non-qualified stock options and lapses of restrictions on restricted stock awards.

Interest Rates

As described above, all indebtedness under our senior secured credit facilities bears interest at variable rates based on LIBOR plus an applicable spread. We entered into interest rate swap arrangements to convert a notional amount of $600.0 million of our variable rate debt based on one-month LIBOR to a fixed rate. The objective of these swaps is to manage the variability of cash flows in the interest payments related to the portion of the variable rate debt designated as being hedged.

Foreign Currency

A significant portion of our products are manufactured or assembled in China, Mexico and Taiwan, and we have research and development centers in Argentina, China, India, Ireland, Israel and Sweden. 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 and certain international operations that procure in U.S dollars. We also have certain predictable expenditures for international operations in local currency. Additionally, certain intercompany transactions created in conjunction with the Motorola Home acquisition are denominated in foreign currencies and subject to revaluation. We use a hedging strategy and enter into forward or currency option contracts based on a percentage of expected foreign currency revenues and expenses. The percentage can vary, based on the predictability of exposures denominated in the foreign currency.

 

51


Table of Contents
Index to Financial Statements

Financial Instruments

In the ordinary course of business, we, from time to time, will enter into financing arrangements with customers. These financial arrangements include letters of credit, commitments to extend credit and guarantees of debt. These agreements could include the granting of extended payment terms that result in longer collection periods for accounts receivable and slower cash inflows from operations and/or could result in the deferral of revenue.

We execute letters of credit and bank guarantees in favor of certain landlords, customers and vendors to guarantee performance on contracts. Certain financial instruments require cash collateral, and these amounts are reported as restricted cash. As of December 31, 2014 and 2013, we had approximately $1.0 million and $1.1 million outstanding, respectively, of restricted cash.

Cash, Cash Equivalents, and Investments

Our cash and cash equivalents (which are highly-liquid investments with an original maturity of three months or less) are primarily held in demand deposit accounts and money market accounts. We hold short-term investments consisting of mutual funds and debt securities classified as available-for-sale, which are stated at estimated fair value. The debt securities consist primarily of commercial paper, certificates of deposits, short term corporate obligations and U.S. government agency financial instruments.

We hold cost method investments in private companies. These investments are recorded at $15.2 million and $15.3 million as of December 31, 2014 and 2013, respectively. See Note 7 of Notes to the Consolidated Financial Statements for disclosures related to the fair value of our investments.

We have two rabbi trusts that are used as funding vehicles for various deferred compensation plans that were available to certain current and former officers and key executives. We also have deferred retirement salary plans, which were limited to certain current or former officers of a business acquired in 2007. We hold investments to cover the liability.

ARRIS also funds its nonqualified defined benefit plan for certain executives in a rabbi trust.

Capital Expenditures

Capital expenditures are made at a level designed to support the strategic and operating needs of the business. ARRIS’ capital expenditures were $56.6 million in 2014 as compared to $71.4 million in 2013 and $21.5 million in 2012. We had no significant commitments for capital expenditures at December 31, 2014. Management expects to invest approximately $55.0 million in capital expenditures for the year 2015.

Deferred Income Tax Assets — Including Net Operating Loss Carryforwards and Research and Development Credit Carryforwards, and Capitalized Research and Experimentation Costs and Valuation Allowances

Deferred income tax assets represent amounts available to reduce income taxes payable on taxable income in future years. Such assets arise because of temporary differences between the financial reporting and tax bases of assets and liabilities, as well as from net operating loss and tax credit carryforwards. We evaluate the recoverability of these future tax deductions and credits by assessing the adequacy of future expected taxable income from all sources, including reversal of taxable temporary differences, forecasted operating earnings and available tax planning strategies. If we conclude that deferred tax assets are more-likely-than-not to not be realized, then we record a valuation allowance against those assets. We continually review the adequacy of the valuation allowances established against deferred tax assets. As part of that review, we regularly project taxable income based on book income projections by legal entity. Our ability to utilize our U.S. federal, state and foreign deferred tax assets is dependent upon our future taxable income by legal entity.

During the fourth quarter of 2014, Google provided information related to the acquired U.S. federal and state net operating losses (“NOLs”) and tax credits from their 2013 final income tax returns inclusive of all entities that were acquired by the Company in the acquisition of the Motorola Home business. After receiving the final NOL and tax credit information from Google and completing the tax planning required to best allow for

 

52


Table of Contents
Index to Financial Statements

utilization of the acquired tax attributes, the Company recorded a tax benefit arising from the acquired attributes and the reversal of valuation allowances previously recorded of $162.0 million for 2014, $18.2 million of which had been reversed in the first quarter of 2014.

As of December 31, 2014, ARRIS had net operating loss carryforwards for U.S. federal, state, and foreign income tax purposes of approximately $552.9 million, $417.3 million and $57.8 million, respectively. The U.S. federal NOLs expire through 2031. Foreign NOLs related to our Irish subsidiary in the amount of $18.5 million have an indefinite life. Other significant foreign NOLs arise from our Canadian subsidiary ($13.7 million, expiring within 20 years), Dutch subsidiaries ($3.3 million, expiring during the next eight years), and French branch ($5.4 million, no expiration), our U.K. branch ($6.4 million, no expiration), our U.K. subsidiary ($3.1 million, no expiration) and our Israeli subsidiary ($6.3 million, no expiration). The net operating losses are subject to various limitations on how and when the losses can be used to offset against taxable income. Approximately $178.2 million of U.S. federal, $228.5 million of state NOLs, and $18.8 million of the foreign NOLs are subject to valuation allowances because we do not believe the ultimate realization of that portion of the deferred tax assets associated with these U.S. federal and state and foreign NOLs is more-likely-than-not.

During 2014, we used approximately $75.2 million of U.S. federal NOLs to reduce taxable income. For state tax filing, we recorded the usage of $54.0 million of pre-apportioned and $375.6 million of post-apportioned U.S. state NOLs to reduce taxable income.

As of December 31, 2013, ARRIS had NOL carryforwards for U.S. federal, state, and foreign income tax purposes of approximately $435.6 million, $174.5 million, and $47.9 million, respectively. The U.S. federal NOLs expire through 2031. Foreign NOLs related to our Irish subsidiary in the amount of $20.9 million have an indefinite life. Other significant foreign NOLs arise from our Dutch subsidiaries ($5.0 million, expiring during the next 8 years), our French branch ($6.1 million, no expiration), our U.K. branch ($7.0 million, no expiration), and our Israeli subsidiary ($7.6 million, no expiration). The net operating losses were subject to various limitations on how and when the losses could be used to offset against taxable income. Approximately $73.8 million of post-apportioned and $78.7 million of pre-apportioned state NOLs, and $5.2 million of the foreign NOLs were subject to valuation allowances because we did not believe the ultimate realization of the deferred tax assets associated with these U.S. federal, state and foreign NOLs was more-likely-than-not.

During 2013, we used approximately $3.3 million of U.S. federal NOLs to reduce taxable income. We did not record the usage of any pre-apportioned or post-apportioned U.S. state NOLs to reduce taxable income.

During the tax year ending December 31, 2014, we utilized $17.6 million and $1.5 million, respectively of U.S. federal and state research and development tax credits, to offset against U.S. federal and state income tax liabilities. During the tax years ending December 31, 2013, and 2012, we utilized $5.5 million and $1.2 million, respectively of U.S. federal and state research and development tax credits, to offset against U.S. federal and state income tax liabilities. As of December 31, 2014, ARRIS has a deferred tax asset of $47.0 million for U.S. federal research and development tax credits and $29.4 million of for state research and development tax credits. We also have an additional $7.9 million of U.S. federal research and development credits, related to excess tax benefits recorded in additional paid in capital, which is also available to be utilized against future income tax liabilities of the Company. The remaining unutilized U.S. federal research and development tax credits can be carried back one year and carried forward twenty years. The state research and development tax credits carry forward and will expire pursuant to the various applicable state laws. Approximately $21.7 million of U.S. federal research and development tax credits and $11.7 million of state research and development tax credits are subject to valuation allowances because we do not believe the ultimate realization of the related deferred tax assets is more-likely-than-not.

ARRIS has generally reported taxable income in excess of its pre-tax net book income for financial reporting purposes. A significant reconciling item between the taxable income and the pre-tax net book income has been the book amortization expense relating to the separately stated intangible assets arising from acquisitions. Other significant reconciling items between taxable income and pre-tax net book income are certain reserves that are recorded as expenses for pre-tax net book income purposes which are not deductible for income tax purposes until they are paid. As of December 31, 2014, the Company reports $607.5 million of capitalized research and experimentation costs, which are available to reduce U.S. federal and state taxable income in future years, based

 

53


Table of Contents
Index to Financial Statements

on a straight-line method over a ten year life. The costs are amortized over the remaining lives on a straight-line basis, with the final amortization occurring in 2021.

The Company obtains significant benefits from U.S. federal research and development tax credits, which are used to reduce the Company’s U.S. federal income tax liability. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law. Under this act, the federal research and development credit was retroactively extended for amounts paid or incurred after December 31, 2011 and before January 1, 2014. The effects of these changes in the tax law resulted in a tax benefit which was recognized in the first quarter of 2013, the quarter in which the law was enacted. In December of 2014, this legislation was extended again through December 31, 2014. As a result of this legislation being extended, the company recorded a net benefit of $18.1 million in the fourth quarter of 2014. The U.S. federal research and development tax credit has yet to be extended for the 2015 tax year and, if extended, the tax law will have a material impact on our financial statements.

Defined Benefit Pension Plans

ARRIS sponsors a qualified and a non-qualified non-contributory defined benefit pension plan that cover certain U.S. employees. As of January 1, 2000, we froze the qualified defined pension plan benefits for its participants. These participants elected to enroll 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.

During the fourth quarter of 2012, in an effort to reduce the volatility and administration expense in connection with our pension obligation, we notified eligible employees of a limited opportunity to voluntarily elect an early payout of their pension benefits. These payouts were approximately $7.7 million and was funded from existing pension assets. We accounted for the lump-sum payments as a settlement and recorded a noncash pension settlement charge of approximately $3.1 million in the fourth quarter of 2012.

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. Our investment policy is to fund the qualified plan as required by the Employee Retirement Income Security Act of 1974 (“ERISA”) and to the extent that such contributions are tax deductible. For 2014, the plan assets were comprised of approximately 43%, 3% and 54% of equity securities, debt securities and money market funds, respectively. For 2013, the plan assets were comprised of approximately 43%, 3% and 54% of equity securities, debt securities and money market funds, respectively. For 2015, the plan’s current target allocations are 42% equity securities, 3% debt securities, and 55% money market funds. Liabilities or amounts in excess of these funding levels are accrued and reported in the consolidated balance sheets. We have established a rabbi trust to fund the pension obligations of the Chief Executive Officer under his Supplemental Retirement Plan including the benefit under our non-qualified defined benefit plan. In addition, we have established a rabbi trust for certain executive officers and certain senior management personnel to fund the pension liability to those officers under the non-qualified plan. Effective June 30, 2013, ARRIS amended the Supplemental Retirement Plan. This amendment effectively froze entry of any new participants into the Supplemental Plan and, for existing participants, a freeze on any additional benefit accrual after June 30, 2013. The participant’s benefit will continue to be distributed in accordance with the provisions of the Supplemental Plan but the final benefit accrual was frozen as of June 30, 2013. A curtailment gain of approximately $0.3 million, which represents the difference in the projected benefit obligation and the accumulated benefit obligation at June 30, 2013, offsets the existing plan loss and lowers future pension expense.

The investment strategies of the plans place a high priority on benefit security. The plans invest conservatively so as not to expose assets to depreciation in adverse markets. The plans’ strategy also places a high priority on earning a rate of return greater than the annual inflation rate along with maintaining average market results. The plan has targeted asset diversification across different asset classes and markets to take advantage of economic environments and to also act as a risk minimizer by dampening the portfolio’s volatility.

 

54


Table of Contents
Index to Financial Statements

The weighted-average actuarial assumptions used to determine the benefit obligations for the three years presented are set forth below:

 

     2014     2013     2012  

Assumed discount rate for plan participants

     3.75     4.50     3.75

Rate of compensation increase

     N/A        N/A        3.75

The weighted-average actuarial assumptions used to determine the net periodic benefit costs are set forth below:

 

     2014     2013     2012  

Assumed discount rate plan participants

     4.50     3.75     4.50

Rate of compensation increase

     N/A        3.75     3.75

Expected long-term rate of return on plan assets

     6.00     6.00     6.00

The expected long-term rate of return on assets is derived using the building block approach which includes assumptions for the long term inflation rate, real return, and equity risk premiums.

No minimum funding contributions are required in 2015 for the plan.

Other Benefit Plans

ARRIS has established defined contribution plans pursuant to the Internal Revenue Code Section 401(k) that cover all eligible U.S. employees. We contribute to these plans based upon the dollar amount of each participant’s contribution. We made matching contributions to these plans of approximately $15.3 million, $10.9 million, and $5.7 million in 2014, 2013 and 2012, respectively.

We have a deferred compensation plan that does not qualify under Section 401(k) of the Internal Revenue Code and is available to our key executives and certain other employees. Employee compensation deferrals and matching contributions are held in a rabbi trust. The total of net employee deferrals and matching contributions, which is reflected in other long-term liabilities, were $3.3 million and $2.9 million at December 31, 2014 and 2013, respectively. Total expenses included in continuing operations for the matching contributions were approximately $0.1 million in both 2014 and 2013.

We previously offered a deferred compensation arrangement that allowed certain employees to defer a portion of their earnings and defer the related income taxes. As of December 31, 2004, the plan was frozen and no further contributions are allowed. The deferred earnings are invested in a rabbi trust. The total of net employee deferral and matching contributions, which is reflected in other long-term liabilities, was $2.9 million and $2.6 million at December 31, 2014 and 2013, respectively.

We also have a deferred retirement salary plan, which was limited to certain current or former officers of a business acquired in 2007. The present value of the estimated future retirement benefit payments is being accrued over the estimated service period from the date of signed agreements with the employees. The accrued balance of this plan, the majority of which is included in other long-term liabilities, was $1.8 million at December 31, 2014 and 2013. Total expense (income) included in continuing operations for the deferred retirement salary plan were approximately $0.1 million and $(0.3) million for 2014 and 2013, respectively.

In connection with the Motorola Home acquisition, the Company assumed a pension liability related to a defined benefit plans in Taiwan, which had a balance of $27.5 million as of December 31, 2014.

Critical Accounting Policies

The accounting and financial reporting policies of ARRIS are in conformity with U.S. generally accepted accounting principles. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts

 

55


Table of Contents
Index to Financial Statements

of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management has discussed the development and selection of the critical accounting estimates discussed below with the audit committee of the Board of Directors and the audit committee has reviewed the related disclosures.

a)     Revenue Recognition

ARRIS generates revenue as a result of varying activities, including the delivery of stand-alone equipment, custom design and installation services, and bundled sales arrangements inclusive of equipment, software and services. The revenue from these activities is recognized in accordance with applicable accounting guidance and their related interpretations. Revenue is recognized when all of the following criteria have been met:

 

   

When persuasive evidence of an arrangement exists.     Contracts and customer purchase orders are used to determine the existence of an arrangement. For professional services evidence that an agreement exists includes information documenting the scope of work to be performed, price, and customer acceptance provisions. These are contained in the signed Contract, Purchase Order, or other documentation that shows scope, price and customer acceptance provisions.

 

   

Delivery has occurred.     Shipping documents, proof of delivery and customer acceptance (when applicable) are used to verify delivery.

 

   

The fee is fixed or determinable.     Pricing is considered fixed or determinable at the execution of a customer arrangement, based on specific products and quantities to be delivered at specific prices. This determination includes a review of the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment or future discounts.

 

   

Collectability is reasonably assured.     We assess the ability to collect from customers based on a number of factors that include information supplied by credit agencies, analyzing customer accounts, reviewing payment history and consulting bank references. Should a circumstance arise where a customer is deemed not creditworthy, all revenue related to the transaction will be deferred until such time that payment is received and all other criteria to allow us to recognize revenue have been met.

Revenue is deferred if any of the above revenue recognition criteria is not met as well as when certain circumstances exist for any of our products or services, including, but not limited to:

 

   

When undelivered products or services that are essential to the functionality of the delivered product exist, revenue is deferred until such undelivered products or services are delivered as the customer would not have full use of the delivered elements.

 

   

When required acceptance has not occurred.

 

   

When trade-in rights are granted at the time of sale, that portion of the sale is deferred until the trade-in right is exercised or the right expires. In determining the deferral amount, management estimates the expected trade-in rate and future value of the product upon trade-in. These factors are periodically reviewed and updated by management, and the updates may result in either an increase or decrease in the deferral.

Equipment — We provide operators with equipment that can be placed within various stages of a broadband system that allows for the delivery of telephony, video and high-speed data as well as outside plant construction and maintenance equipment. For equipment sales, revenue recognition is generally established when the products have been shipped, risk of loss has transferred, objective evidence exists that the product has been accepted, and no significant obligations remain relative to the transaction. Additionally, based on historical experience, ARRIS has established reliable estimates related to sales returns and other allowances for discounts. These estimates are recorded as a reduction to revenue at the time the revenue is initially recorded.

Software Sold Without Tangible Equipment — ARRIS sells internally developed software as well as software developed by outside third parties that does not require significant production, modification or customization. For arrangements that contain only software and the related post-contract support, we recognize revenue

 

56


Table of Contents
Index to Financial Statements

in accordance with the applicable software revenue recognition guidance. If the arrangement includes multiple elements that are software only, then the software revenue recognition guidance is applied and the fee is allocated to the various elements based on vendor-specific objective evidence (“VSOE”) of fair value. If sufficient VSOE of fair value does not exist for the allocation of revenue to all the various elements in a multiple element software arrangement, all revenue from the arrangement is deferred until the earlier of the point at which such sufficient VSOE of fair value is established or all elements within the arrangement are delivered. If VSOE of fair value exists for all undelivered elements, but does not exist for one or more delivered elements, the arrangement consideration is allocated to the various elements of the arrangement using the residual method of accounting. Under the residual method, the amount of the arrangement consideration allocated to the delivered elements is equal to the total arrangement consideration less the aggregate fair value of the undelivered elements. Under the residual method, if VSOE of fair value exists for the undelivered element, generally post contract support (“PCS”), the fair value of the undelivered element is deferred and recognized ratably over the term of the PCS contract, and the remaining portion of the arrangement is recognized as revenue upon delivery. If sufficient VSOE of fair value does not exist for PCS, revenue for the arrangement is recognized ratably over the term of support.

Standalone Services — Installation, training, and professional services are generally recognized as service revenue when performed or upon completion of the service when the final act is significant in relation to the overall service transaction. The key element for Professional Services in determining when service transaction revenue has been earned is determining the pattern of delivery or performance which determines the extent to which the earnings process is complete and the extent to which customers have received value from services provided. The delivery or performance conditions of our service transactions are typically evaluated under the proportional performance or completed performance model.

Incentives — Customer incentive programs that include consideration, primarily rebates/credits to be used against future product purchases and certain volume discounts, have been recorded as a reduction of revenue when the shipment of the requisite equipment occurs.

Value Added Resellers — ARRIS typically employs the sell-in method of accounting for revenue when using a Value Added Reseller (“VAR”) as our channel to market. Because product returns are restricted, revenue under this method is generally recognized at the time of shipment to the VAR provided all criteria for recognition are met. There are occasions, based on facts and circumstances surrounding the VAR transaction, where ARRIS will employ the sell-through method of recognizing revenue and defer that revenue until payment occurs.

Multiple Element Arrangements — Certain customer transactions may include multiple deliverables based on the bundling of equipment, software and services. When a multiple element arrangement exists, the fee from the arrangement is allocated to the various deliverables, to the extent appropriate, so that the proper amount can be recognized as revenue as each element is delivered. Based on the composition of the arrangement, we analyze the provisions of the accounting guidance to determine the appropriate model that is applied towards accounting for the multiple element arrangement. If the arrangement includes a combination of elements that fall within different applicable guidance, ARRIS follows the provisions of the hierarchal literature to separate those elements from each other and apply the relevant guidance to each.

For arrangements that fall within the software revenue recognition guidance, the fee is allocated to the various elements based on VSOE of fair value. If sufficient VSOE of fair value does not exist for the allocation of revenue to all the various elements in a multiple element arrangement, all revenue from the arrangement is deferred until the earlier of the point at which such sufficient VSOE of fair value is established or all elements within the arrangement are delivered. If VSOE of fair value exists for all undelivered elements, but does not exist for one or more delivered elements, the arrangement consideration is allocated to the various elements of the arrangement using the residual method of accounting. Under the residual method, the amount of the arrangement consideration allocated to the delivered elements is equal to the total arrangement consideration less the aggregate fair value of the undelivered elements. Using this method, any potential discount on the arrangement is allocated entirely to the delivered elements, which ensures that the amount of revenue recognized at any point in time is not overstated. Under the residual method, if VSOE of fair value exists for the undelivered element, generally PCS, the fair value of the undelivered element is deferred and recognized ratably over the term of the PCS

 

57


Table of Contents
Index to Financial Statements

contract, and the remaining portion of the arrangement is recognized as revenue upon delivery, which generally occurs upon delivery of the product or implementation of the system. Many of ARRIS’ products are sold in combination with customer support and maintenance services, which consist of software updates and product support. Software updates provide customers with rights to unspecified software updates that ARRIS chooses to develop and to maintenance releases and patches that we choose to release during the term of the support period. Product support services include telephone support, remote diagnostics, email and web access, access to on-site technical support personnel and repair or replacement of hardware in the event of damage or failure during the term of the support period. Maintenance and support service fees are recognized ratably under the straight-line method over the term of the contract, which is generally one year. We do not record receivables associated with maintenance revenues without a firm, non-cancelable order from the customer. VSOE of fair value is determined based on the price charged when the same element is sold separately and based on the prices at which our customers have renewed their customer support and maintenance. For elements that are not yet being sold separately, the price established by management, if it is probable that the price, once established, will not change before the separate introduction of the element into the marketplace is used to measure VSOE of fair value for that element.

Retail — Some of our product is sold through retail channels, which may include provisions involving a right of return. Upon shipment of the product, we reduce revenue for an estimate of potential future product returns related to the current period product revenue. Management analyzes historical returns, channel inventory levels, and current economic trends related to our products when evaluating the adequacy of the allowance for sales returns. When applicable, revenue on shipments is reduced for estimated price protection and sales incentives that are deemed to be contra-revenue under the authoritative guidance for revenue recognition.

b)     Goodwill and Intangible Assets

Goodwill

Goodwill relates to the excess of consideration transferred over the fair value of net assets resulting from an acquisition. Our goodwill is tested for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that the asset is more likely than not impaired. Our annual goodwill impairment test is performed in the fourth quarter, with a testing date of October 1, which aligns with the timing of the Company’s annual strategic planning process, which enables the Company to incorporate the reporting units’ long-term financial projections which are generated from the annual strategic planning process as a basis for performing our impairment testing. For purposes of impairment testing, our reporting units are based on our organizational structure, the financial information that is provided to and reviewed by segment management and aggregation criteria applicable to component businesses that are economically similar.

For goodwill, we perform a quantitative two-step impairment test. In the first step, we compare the fair value of each reporting unit to its carrying amount. We determine the fair value of each reporting unit using a weighting of fair values derived from an income approach using discounted cash flows and a market approach. Under the income approach, we calculate the fair value of a reporting unit based on the present value of estimated future cash flows. The discounted cash flow analysis requires us to make various judgmental assumptions, including assumptions about future cash flows, growth rates and weighted average cost of capital (discount rate). The assumptions about future cash flows and growth rates are based on the current and long-term business plans of each reporting unit. Discount rate assumptions are based on an assessment of the risk inherent in the future cash flows of the respective reporting units. Under the market approach, we estimate the fair value based upon Market multiples of revenue and earnings derived from publicly traded companies with similar operating and investment characteristics as the reporting unit. The weighting of the fair value derived from the market approach ranges from 0% to 50% depending on the level of comparability of these publicly-traded companies to the reporting unit. When market comparable are not meaningful or not available, we may estimate the fair value of a reporting unit using only the income approach. We considered the relative strengths and weaknesses inherent in the valuation methodologies utilized in each approach and consulted with a third party valuation specialist to assist in determining the appropriate weighting.

 

58


Table of Contents
Index to Financial Statements

In order to assess the reasonableness of the calculated fair values of our reporting units, we also compare the sum of the reporting units’ fair values to our market capitalization and calculate an implied control premium (the excess of the sum of the reporting units’ fair values over the market capitalization). We evaluate the control premium by comparing it to the fair value estimates of the reporting unit. If the implied control premium is not reasonable in light of the analysis, we will reevaluate the fair value estimates of the reporting unit by adjusting the discount rates and/or other assumptions. If the fair value of the reporting unit exceeds the carrying amount of the net assets assigned to that unit, goodwill is not impaired, and no further testing is required. If the fair value of the reporting unit is less than the carrying amount, we must perform the second step of the impairment test to measure the amount of impairment loss, if any. In the second step, the reporting unit’s fair value is assigned to all of the assets and liabilities of the reporting unit, including any unrecognized intangible assets, in a hypothetical analysis that calculates the implied fair value of goodwill in the same manner as if the reporting unit was being acquired in a business combination. If the implied fair value of the reporting unit’s goodwill is less than the carrying amount, the difference is recorded as an impairment loss.

The valuation methodologies described above have been consistently applied for all years discussed below.

The goodwill recorded in the Consolidated Balance Sheets as of December 31, 2014 and December 31, 2013 was $936.1 million and $940.4 million, respectively. There was no impairment of goodwill resulting from our annual impairment testing in 2014 and 2013. As of December 31, 2014, we have no reporting units that are at risk of failing step one of the goodwill impairment test.

Assumptions and estimates about future cash flows and discount rates are complex and often subjective. They are sensitive to changes in underlying assumptions and can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts. Our assessment includes significant estimates and assumptions including the timing and amount of future discounted cash flows, the discount rate and the perpetual growth rate used to calculate the terminal value.

Our discounted cash flow analysis included projected cash flows over a ten-year period, using our three-year business plans plus an additional seven years of projected cash flows based on the most recent three-year plan. These forecasted cash flows took into consideration management’s outlook for the future and were compared to historical performance to assess reasonableness. A discount rate was applied to the forecasted cash flows. The discount rate considered market and industry data, as well as the specific risk profile of the reporting unit. A terminal value was calculated, which estimates the value of annual cash flow to be received after the discrete forecast periods. The terminal value was based upon an exit value of annual cash flow after the discrete forecast period in year ten.

Examples of events or circumstances that could reasonably be expected to negatively affect the underlying key assumptions and ultimately impact the estimated fair value of our reporting units may include such items as the following:

 

   

a prolonged decline in capital spending for constructing, rebuilding, maintaining, or upgrading broadband communications systems;

 

   

rapid changes in technology occurring in the broadband communication markets which could lead to the entry of new competitors or increased competition from existing competitors that would adversely affect our sales and profitability;

 

   

the concentration of business we receive from several key customers, the loss of which would have a material adverse effect on our business;

 

   

continued consolidation of our customers base in the telecommunications industry could result in delays or reductions in purchases of our products and services, if the acquirer decided not to continue using us as a supplier;

 

   

new products and markets currently under development may fail to realize anticipated benefits;

 

59


Table of Contents
Index to Financial Statements
   

changes in business strategies affecting future investments in businesses, products and technologies to complement or expand our business could result in adverse impacts to existing business and products;

 

   

volatility in the capital (equity and debt) markets, resulting in a higher discount rate; and

 

   

legal proceeding settlements and/or recoveries, and its effect on future cash flows.

As a result, there can be no assurance that the estimates and assumptions made for purposes of the annual goodwill impairment test will prove to be accurate predictions of the future. Although management believes the assumptions and estimates made are reasonable and appropriate, different assumptions and estimates could materially impact the reported financial results.

Intangible Assets

We make judgments about the recoverability of acquired intangible assets with finite lives whenever events or changes in circumstances indicate that impairment may exist. Examples of such circumstances include, but are not limited to, operating or cash flow losses from the use of such assets or changes in our intended uses of such assets. Recoverability of purchased intangible assets with finite lives is measured by comparing the carrying amount of the asset to the future undiscounted cash flows the asset is expected to generate. In determining future undiscounted cash flows, we have made a “policy decision” to use pre-tax cash flows in our evaluation, which is consistently applied. To test for recovery, we group assets (an “asset group”) in a manner that represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities.

We review indefinite-lived assets for impairment annually or whenever events or changes in circumstances indicate the carrying amount may not be recoverable. Our indefinite-lived intangible assets relates to in-process research and development and were tested for impairment during the fourth quarter, as of October 1, 2014. Recoverability of indefinite-lived intangible assets is measured by comparing the carrying amount of the asset to the future discounted cash flows the asset is expected to generate. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying amount and the fair value of the indefinite-lived intangible asset. As of December 31, 2014, the carrying amount of in-process research and development was $5.1 million. Completion of the associated research and development efforts would cause the indefinite-lived in-process research and development asset to become a finite-lived asset. As such, prior to commencing amortization the assets will be tested for impairment. Because indefinite-lived intangible assets are initially recognized at fair value, any decrease in the fair value of the intangible asset will result in an impairment charge. The company uses discounted cash flows in the determination of the fair value of its indefinite-lived intangible assets. As such, a decrease in cash flows for the projects, as well as, an increase in interest rate changes affecting the discount rate used in the test without any offsetting increase in cash flows, could cause the discounted cash flows to decrease, resulting in an impairment charge.

Assumptions and estimates about future values and remaining useful lives of our acquired intangible assets are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends and internal factors such as changes in our business strategy and our internal forecasts.

There were no impairment charges related to acquired intangible assets during 2014 and 2013. Our ongoing consideration of all the factors described previously could result in additional impairment charges in the future, which could adversely affect our net income.

c)     Allowance for Doubtful Accounts and Sales Returns

We establish a reserve for doubtful accounts based upon our historical experience and leading market indicators 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. Unlike businesses with relatively small individual accounts receivable from a large number of customers, if we were to have a collection problem with one of our major customers, it is possible the reserve that we have established will not be sufficient. We calculate our reserve for uncollectible accounts

 

60


Table of Contents
Index to Financial Statements

using a model that considers customer payment history, recent customer press releases, bankruptcy filings, if any, Dun & Bradstreet reports, and financial statement reviews. Our calculation is reviewed by management to assess whether additional research is necessary, and if complete, whether there needs to be an adjustment to the reserve for uncollectible accounts. The reserve is established through a charge to the provision and represents amounts of current and past due customer receivable balances of which management deems a loss to be both probable and estimable. In the past several years, two of our major customers encountered significant financial difficulty due to the industry downturn and tightening financial markets.

In the event that we are not able to predict changes in the financial condition of our customers, resulting in an unexpected problem with collectability of receivables and our actual bad debts differ from estimates, or we adjust estimates in future periods, our established allowances may be insufficient and we may be required to record additional allowances. Alternatively, if we provided more allowances than are ultimately required, we may reverse a portion of such provisions in future periods based on our actual collection experience. In the event we adjust our allowance estimates, it could materially affect our operating results and financial position.

We also establish a reserve for sales returns and allowances. The reserve is an estimate of the impact of potential returns based upon historic trends.

Our reserves for uncollectible accounts and sales returns and allowances were $6.4 million and $1.9 million as of December 31, 2014 and 2013, respectively.

d)     Inventory Valuation

Inventory is reflected in our financial statements at the lower of average cost, approximating first-in, first-out, or market value.

We continuously evaluate future usage of product and where supply exceeds demand, we may establish a reserve. In reviewing inventory valuations, we also review for obsolete items. This evaluation 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. When we believe that we have overestimated our future usage, we adjust for that overstatement through an increase in cost of sales in the period identified as the inventory is written down to its net realizable value. Inherent in our valuations are certain management judgments and estimates, including markdowns, shrinkage, manufacturing schedules, possible alternative uses and future sales forecasts, which can significantly impact ending inventory valuation and gross margin. The methodologies utilized by ARRIS in its application of the above methods are consistent for all periods presented.

We conduct physical inventory counts at all ARRIS locations, either annually or through ongoing cycle-counts, to confirm the existence of our inventory.

e)     Warranty

We offer warranties of various lengths to our customers depending on product specifics and agreement terms with our customers. 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. The estimate is based upon historical experience. The embedded product base, failure rates, cost to repair and warranty periods are used as a basis for calculating the estimate. We also provide, via a charge to current cost of sales, estimated expected costs associated with non-recurring product failures. In the event of a significant non-recurring product failure, the amount of the reserve may not be sufficient. In the event that our historical experience of product failure rates and costs of correcting product failures change, our estimates relating to probable losses resulting from a significant non-recurring product failure changes, or to the extent that other non-recurring warranty claims occur in the future, we may be required to record additional warranty reserves. Alternatively, if we provided more reserves than we needed, we may reverse a portion of such provisions in future periods. In the event we change our warranty reserve estimates, the resulting charge against future cost of sales or reversal of previously recorded charges may materially affect our operating results and financial position.

 

61


Table of Contents
Index to Financial Statements

f)     Income Taxes

Considerable judgment must be exercised in determining the proper amount of deferred income tax assets to record on the balance sheet and also in concluding as to the correct amount of income tax liabilities relating to uncertain tax positions.

Deferred income tax assets must be evaluated quarterly and a valuation allowance should be established and maintained when it is more-likely-than-not that all or a portion of deferred income tax assets will not be realized. In determining the likelihood of realizing deferred income tax assets, management must consider all positive and negative evidence, such as the probability of future taxable income, tax planning, and the historical profitability of the entity in the jurisdiction where the asset has been recorded. Significant judgment must also be utilized by management in modeling the future taxable income of a legal entity in a particular jurisdiction. Whenever management subsequently concludes that it is more-likely-than-not that a deferred income tax asset will be realized, the valuation allowance must be partially or totally removed.

Uncertain tax positions occur, and a resulting income tax liability is recorded, when management concludes that an income tax position fails to achieve a more-likely-than-not recognition threshold. In evaluating whether or not an income tax position is uncertain, management must presume the income tax position will be examined by the relevant taxing authority that has full knowledge of all relevant information and management must consider the technical merits of an income tax position based on the statutes, legislative intent, regulations, rulings and case law specific to each income tax position. Uncertain income tax positions must be evaluated quarterly and, when they no longer fail to meet the more-likely-than-not recognition threshold, the related income tax liability must be derecognized.

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 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. Any other statements in this document that are not statements about historical facts also are forward-looking statements. We caution investors that forward-looking statements made by us are not guarantees of future performance and that a variety of factors could cause our actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. Important factors that could cause results or events to differ from current expectations are described in the risk factors set forth in Item 1A, “Risk Factors.” These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of our business, but instead are the risks that we currently perceive as potentially being material. 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.

 

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.

A significant portion of our products are manufactured or assembled in China, Mexico and Taiwan, and we have research and development centers in Argentina, China, India, Ireland, Israel and Sweden. 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.

 

62


Table of Contents
Index to Financial Statements

We have certain international customers who are billed in their local currency, and we have certain predictable expenditures for international operations in local currency. We also have certain predictable expenditures for international operations in local currency. Additionally, certain intercompany transactions created in conjunction with the Motorola Home acquisition are denominated in foreign currencies and subject to revaluation. 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 use a hedging strategy and 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 the customers who are billed in their local currency. Additionally, we face certain other working capital exposures related to both the euro and the British pound, and we are also subject to the revaluation of one of our long-term pension obligations denominated in the New Taiwan dollar. Taking into account the effects of foreign currency fluctuations of the euro, the British pound and the New Taiwan dollar versus the U.S. dollar, a hypothetical 10% appreciation or depreciation in the value of the U.S. dollar against these foreign currencies from the prevailing market rates would result in a corresponding decrease or increase, respectively, of $4.5 million in the underlying exposures as of December 31, 2014.

All indebtedness under our senior secured credit facilities bears interest at variable rates based on LIBOR plus an applicable spread. We entered into interest rate swap arrangements to convert a notional amount of $600.0 million of our variable rate debt based on one-month LIBOR to a fixed rate. This objective of these swaps is to manage the variability of cash flows in the interest payments related to the portion of the variable rate debt designated as being hedged.

 

Item 8. Consolidated Financial Statements and Supplementary Data

The report of our independent registered public accounting firm 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

Not Applicable

 

Item 9A. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures. Our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 as of the end of the period covered by this report (the “Evaluation Date”). Based on that evaluation, such officers concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective as contemplated by the Act.

(b) Changes in Internal Control over Financial Reporting. Our principal executive officer and principal financial officer evaluated the changes in our internal control over financial reporting that occurred during the most recent fiscal quarter. Based on that evaluation, our principal executive officer and principal financial officer concluded that, there had been no change in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Item 9B. Other Information

Not Applicable

 

63


Table of Contents
Index to Financial Statements

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

ARRIS’ management is responsible for establishing and maintaining an adequate system of internal control over financial reporting as required by the Sarbanes-Oxley Act of 2002 and as defined in Exchange Act Rule 13a-15(f). A control system can provide only reasonable, not absolute, assurance that the objectives of the control system are met.

Under management’s supervision, an evaluation of the design and effectiveness of ARRIS’ internal control over financial reporting was conducted based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework)(COSO). Based on this evaluation, management concluded that ARRIS’ internal control over financial reporting was effective as of December 31, 2014.

The effectiveness of ARRIS’ internal control over financial reporting as of December 31, 2014 has been audited by Ernst & Young LLP, an independent registered public accounting firm retained as auditors of ARRIS Group, Inc.’s financial statement, as stated in their report which is included herein.

 

/s/ R J STANZIONE

Robert J. Stanzione

Chief Executive Officer, Chairman

 

/s/ DAVID B, POTTS

David B. Potts

Executive Vice President, Chief Financial Officer and Chief Accounting Officer,

February 27, 2015

 

64


Table of Contents
Index to Financial Statements

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of ARRIS Group, Inc.

We have audited ARRIS Group, Inc. internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). ARRIS Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, ARRIS Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2014, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of ARRIS Group, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), cash flows, and stockholders’ equity for each of the three years in the period ended December 31, 2014, and our report dated February 27, 2015, expressed an unqualified opinion thereon.

/s/    Ernst & Young LLP

Atlanta, Georgia

February 27, 2015

 

65


Table of Contents
Index to Financial Statements

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page  

Report of Independent Registered Public Accounting Firm

     67   

Consolidated Balance Sheets at December 31, 2014 and 2013

     68   

Consolidated Statements of Operations for the years ended December 31, 2014, 2013 and 2012

     69   

Consolidated Statements of Comprehensive Income (Loss) for the years ended December  31, 2014, 2013 and 2012

     70   

Consolidated Statements of Cash Flows for the years ended December 31, 2014, 2013 and 2012

     71   

Consolidated Statements of Stockholders’ Equity for the years ended December  31, 2014, 2013 and 2012

     73   

Notes to the Consolidated Financial Statements

     74   

 

66


Table of Contents
Index to Financial Statements

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of ARRIS Group, Inc.

We have audited the accompanying consolidated balance sheets of ARRIS Group, Inc. as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), cash flows and stockholders’ equity for each of the three years in the period ended December 31, 2014. 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 the Company’s 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 the standards of the Public Company Accounting Oversight Board (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, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ARRIS Group, Inc. at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with U.S. generally accepted accounting principles. 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.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), ARRIS Group, Inc.’s internal control over financial reporting as of December 31, 2014, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 27, 2015 expressed an unqualified opinion thereon.

/s/    Ernst & Young LLP

Atlanta, Georgia

February 27, 2015

 

67


Table of Contents
Index to Financial Statements

ARRIS GROUP, INC.

CONSOLIDATED BALANCE SHEETS

 

    December 31,  
          2014                 2013 (1)        
   

(in thousands except

share and per share data)

 

ASSETS

   

Current assets:

   

Cash and cash equivalents

  $ 565,790      $ 442,438   

Short-term investments, at fair value

    126,748        67,360   
 

 

 

   

 

 

 

Total cash, cash equivalents and short-term investments

    692,538        509,798   

Restricted cash

    966        1,079   

Accounts receivable (net of allowances for doubtful accounts of $6,392 in 2014 and $1,887 in 2013)

    598,603        619,571   

Other receivables

    10,640        8,366   

Inventories (net of reserves of $62,359 in 2014 and $42,408 in 2013)

    401,165        330,129   

Prepaid income taxes

    11,023        13,034   

Prepaids

    27,497        61,482   

Current deferred income tax assets

    113,390        77,167   

Other current assets

    61,450        57,418   
 

 

 

   

 

 

 

Total current assets

    1,917,272        1,678,044   

Property, plant and equipment (net of accumulated depreciation of $265,811 in 2014 and $194,830 in 2013)

    366,431        396,152   

Goodwill

    936,067        940,402   

Intangible assets (net of accumulated amortization of $619,283 in 2014 and $427,143 in 2013)

    943,388        1,176,192   

Investments

    77,640        71,176   

Noncurrent deferred income tax assets

    71,686        7,678   

Other assets

    53,161        52,363   
 

 

 

   

 

 

 
  $ 4,365,645      $ 4,322,007   
 

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

   

Current liabilities:

   

Accounts payable

  $ 480,150      $ 606,340   

Accrued compensation, benefits and related taxes

    145,278        116,262   

Accrued warranty

    42,763        48,755   

Deferred revenue

    92,772        69,071   

Current portion of long-term debt

    73,956        53,254   

Income taxes payable

    10,610        3,068   

Other accrued liabilities

    164,341        198,278   
 

 

 

   

 

 

 

Total current liabilities

    1,009,870        1,095,028   

Long-term debt, net of current portion

    1,467,370        1,691,034   

Accrued pension

    64,917        58,657   

Noncurrent income tax liability

    41,082        21,048   

Noncurrent deferred income tax liabilities

    274        74,791   

Other noncurrent liabilities

    91,371        62,462   
 

 

 

   

 

 

 

Total liabilities

    2,674,884        3,003,020   
 

 

 

   

 

 

 

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; 145.1 million and 142.1 million shares issued and outstanding in 2014 and 2013, respectively

    1,796        1,766   

Capital in excess of par value

    1,739,700        1,688,782   

Treasury stock at cost, 34.2 million shares in 2014 and 2013

    (306,330     (306,330

Retained earnings (deficit)

    266,642        (60,569

Unrealized gain on marketable securities (net of accumulated tax effect of $14 in 2014 and $177 in 2013)

    25        306   

Unfunded pension liability (net of accumulated tax benefit of $3,428 in 2014 and $981 in 2013)

    (7,181     (2,416

Unrealized loss on derivative instruments (net of accumulated tax benefit of $1,832 in 2014 and $1,467 in 2013)

    (3,166     (2,541

Cumulative translation adjustments

    (725     (11
 

 

 

   

 

 

 

Total stockholders’ equity

    1,690,761        1,318,987   
 

 

 

   

 

 

 
  $ 4,365,645      $ 4,322,007   
 

 

 

   

 

 

 

 

(1) Certain amounts for December 31, 2013 have been recast to reflect results for business acquisitions.

 

See accompanying notes to the consolidated financial statements.

 

68


Table of Contents
Index to Financial Statements

ARRIS GROUP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     For the Years Ended December 31,  
           2014                 2013                   2012        
     (in thousands, except per share data)  

Net sales

   $ 5,322,921      $ 3,620,902      $ 1,353,663   

Cost of sales

     3,740,425        2,598,154        891,086   
  

 

 

   

 

 

   

 

 

 

Gross margin

     1,582,496        1,022,748        462,577   

Operating expenses:

      

Selling, general, and administrative expenses

     410,568        338,252        161,338   

Research and development expenses

     556,575        425,825        170,706   

Amortization of intangible assets

     236,521        193,637        30,294   

Integration, acquisition, restructuring and other costs

     37,498        83,047        12,968   
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     1,241,162        1,040,761        375,306   

Operating income (loss)

     341,334        (18,013     87,271   

Other expense (income):

      

Interest expense

     62,901        67,888        17,797   

Loss (gain) on investments

     10,961        2,698        (1,404

Loss (gain) on foreign currency

     2,637        (3,502     786   

Interest income

     (2,590     (2,936     (3,242

Other expense (income), net

     28,195        13,989        (962
  

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     239,230        (96,150     74,296   

Income tax expense (benefit)

     (87,981     (47,390     20,837   
  

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 327,211      $ (48,760   $ 53,459   
  

 

 

   

 

 

   

 

 

 

Net income (loss) per common share:

      

Basic

   $ 2.27      $ (0.37   $ 0.47   
  

 

 

   

 

 

   

 

 

 

Diluted

   $ 2.21      $ (0.37   $ 0.46   
  

 

 

   

 

 

   

 

 

 

Weighted average common shares:

      

Basic

     144,386        131,980        114,161   
  

 

 

   

 

 

   

 

 

 

Diluted

     148,280        131,980        116,514   
  

 

 

   

 

 

   

 

 

 

 

See accompanying notes to the consolidated financial statements.

 

69


Table of Contents
Index to Financial Statements

ARRIS GROUP, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

     For the Years Ended December 31,  
           2014                 2013                  2012        
     (in thousands)  

Net income (loss):

   $ 327,211      $ (48,760   $ 53,459   

Unrealized gain (loss) on marketable securities, net of tax (expense) benefit of $162, $(52) and $(244) in 2014, 2013 and 2012, respectively

     (281     100        473   

Unfunded pension liability, net of tax (expense) benefit of $2,447, $(1,291) and $(985) in 2014, 2013 and 2012, respectively

     (4,765     6,142        1,673   

Unrealized loss on derivative instruments, net of tax benefit of $365 and $1,467 in 2014 and 2013, respectively

     (625     (2,541     —     

Cumulative translation adjustments

     (714     173        —     
  

 

 

   

 

 

   

 

 

 

Comprehensive income (loss), net of tax

   $ 320,826      $ (44,886   $ 55,605   
  

 

 

   

 

 

   

 

 

 

 

See accompanying notes to the consolidated financial statements.

 

70


Table of Contents
Index to Financial Statements

ARRIS GROUP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Years Ended December 31,  
     2014     2013     2012  
     (in thousands)  

Operating activities:

      

Net income (loss)

   $ 327,211      $ (48,760   $ 53,459   

Depreciation

     78,988        61,516        27,953   

Amortization of intangible assets

     236,751        193,637        30,294   

Amortization of deferred finance fees and debt discount

     11,575        9,982        639   

Deferred income tax benefit

     (163,485     (55,763     (13,989

Stock compensation expense

     53,799        35,789        27,906   

Provision for doubtful accounts

     5,336        (658     240   

Revenue reduction related to Comcast’s investment in ARRIS

            13,182