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[February 27, 2013]
ARRIS GROUP INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations
(Edgar Glimpses Via Acquire Media NewsEdge) Overview In recent years, the technology used in cable systems has evolved significantly.
Historically, cable systems offered only one-way analog video service. Due to technological advancements, these systems have evolved to become two-way broadband systems delivering high-volume, high-speed, interactive services. MSOs have over the years aggressively upgraded their networks to cost-effectively support and deliver enhanced voice, video and data services. As a result, MSOs have been able to use broadband systems to increase their revenues by offering enhanced interactive subscriber services, such as high-speed data, telephony, digital video and video on demand, and to effectively compete against other broadband communications technologies, such as DSL, local multiport distribution service, DBS, FTTH, and fixed wireless. Delivery of enhanced services also has helped MSOs offset slowing basic video subscriber growth, reduce their subscriber churn and compete against alternative video providers, in particular, DBS and the telephone companies.
A key factor driving the growth of broadband systems is the powerful growth of the Internet. Rapid growth in the number of Internet users, their desire for ever higher Internet access speeds, and more high-volume interactive services with growing customer control features have created demand for our products.
Another key factor driving the growth of broadband systems is the evolution of video services being offered to consumers. Video on demand, high definition television and switched digital video are three key video services expanding the use of MSOs' broadband systems. The increase in volume and complexity of the signals transmitted through the network and emerging competitive pressures from telephone companies with digital subscriber line and fiber to the premises offerings are spurring cable operators to rapidly deploy new technologies.
Further, cable operators are looking for products and technologies that are flexible, cost effective, easily deployable and scalable to meet future demand.
Because the technologies are evolving and the services delivered are growing in complexity and volume, cable operators need equipment that provides the necessary technical capability at a reasonable cost at the time of initial deployment and the flexibility later to accommodate technological advances and network expansion.
Within the past several years, the rise of wideband data services and improvements in server technology has enabled a new competitive threat. So called Over-the-Top ("OTT") entertainment, sports, and news video services such as those offered by Netflix, Hulu, NBC, ABC, CBS, FOX, ESPN and other content providers, now provide delivery of video programming directly to consumers via the Internet bypassing the traditional service provider Pay TV service and the attendant subscription and advertising revenue it generates for the service providers. In addition, Google and other Internet portals have made acquisitions and developed methods to provide advertising-supported video content which is linked directly to advertising buyers, increasing advertising effectiveness and reducing cost per impression. With the advent of these new OTT services, simple standalone devices which enable the viewing of OTT video on any television in the home have appeared on the retail shelves, thus moving the Internet viewing experience from the PC in the den to the big screen TV in the living room.
Recently consumer electronics manufacturers have begun to incorporate the network interfaces directly into their television sets and other entertainment devices. Further, there is a growing demand to be able to view video on multiple screens, for example tablets and PDAs.
OTT presents a new challenge to the MSOs, as consumers embrace these new services in lieu of the traditional linear programming provided by the service providers. OTT services provide the consumer with a new paradigm in entertainment: availability of a wide range of high quality, feature length programming specific to their tastes when they want to view it. In today's fast paced society, immediacy is a major factor in consumer preference. To address the challenge presented by OTT, the MSOs are moving to provide their content in a more compelling on-demand format, utilizing many of the technologies used by the OTT providers, but with a better managed, higher quality, more secure service, which will enable consumers to receive any content on any screen, anytime, anywhere. With the emergence of OTT programming, advertising revenues are moving from the traditional linear programming to these new services. A key factor in the migration is the economics of advertising in an on-demand format.
With the ability of advertisers to have immediate access to information regarding individual viewers' preferences, and to be able to correspond with that viewer in real time, the relevance of each 37-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements ad impression is substantially improved and the cost per relevant impression is dramatically reduced. The MSOs are addressing this opportunity, incorporating advertising insertion servers into their networks and building a system behind these servers to enable advertisers to mount campaigns directly to consumers via the MSOs' networks.
Over the past decade, United States cable operators have spent substantial investment to upgrade their networks to deliver digital video and two-way services such as high-speed data, video on demand, and telephony. As global cable operators maximize their investment in their networks, we believe that our business will be driven by the industry dynamics and trends outlined below.
Industry Conditions Competition Between Cable Operators and Telephone Companies Continues. Telephone companies are aggressively offering high-speed data services and are making progress in offering video services to the residential market. Counterbalancing these offerings, cable companies are providing IP-based telephone service and DOCSIS 3.0-based ultra high-speed data service.
Competition Between Cable Operators and Direct Broadcast Satellite Services Continues. Direct broadcast satellite services are aggressively offering many HDTV channels. DIRECTV and The Dish Network and multiple satellite services around the world are deploying significantly more HDTV channels including many local channels. Cable operators are responding by reclaiming spectrum through advanced technologies such as switched digital video, statistical multiplexing and upgrades of their networks to 1 GHz to make more spectrum available for additional HDTV channels.
Personalized Programming is Becoming More Readily Available Across Multiple Platforms. Demand for bandwidth by cable subscribers continues to grow as content providers (such as Google, Yahoo, YouTube, Hulu, MySpace, Facebook, Blockbuster, Netflix, ABC, CBS, NBC, movie and music studios, and gaming vendors) are offering personalized content across multiple venues. For example, broadcast network shows and user-generated (UG) content, such as streaming video, personalized web pages, and video and photo sharing, have become commonplace on the Internet. Likewise, certain cable operators are experimenting with offering more content through the use of network personal video recorders (nPVRs) which, once copyright issues are resolved, will add more traffic to the networks. Another bandwidth intensive service being offered by major cable operators allows cable video subscribers to re-start programs on demand if they miss the beginning of a television show (time-shifted television). Television today has thus become more interactive and personal, further increasing the demands on the network. In addition, the Internet has set the bar on personalization with viewers increasingly looking for "similar" experiences across multiple screens - television, PC, tablet, smart phone and PDA further increasing the challenges in delivering broadband content.
Emerging Competition Between Cable Operators and Internet-based Services is a Major Market Disruption. OTT video services enabled by wideband data services, is increasingly providing the same content provided by MSOs in an on-demand, location independent format. In our fast paced world such immediacy is finding favor with consumers. MSOs 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.
Advertisers are Exploring new Models To Better Leverage Advertising Investments Across All Media. Google, Yahoo, Facebook, Microsoft and others have introduced easy, interactive ways for advertisers to mount advertising campaigns, measure results in real time, target individual consumers with ads specific to their preferences, and provide consumers with a way to respond to ads in real time. Advertisers, Programmers, and Content Distributors including MSOs are evaluating ways to integrate this new advertising paradigm with existing linear television by incorporating next generation advertising insertion servers in their networks and jointly building an advanced advertising platform with consistent technologies, metrics and interfaces across a national footprint.
38 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Macroeconomic Factors Have and May Continue to Affect our Industry. The recent economic downturn continues to affect the global economy and the capital investment strategy of our customers. New household formations are just beginning to increase in 2013. This subdued climate is expected to result in low capital expenditure growth rates in 2013 and the foreseeable future.
Growth in Enhanced Broadband Services Requires Continued Upgrades and Maintenance by Domestic and International Cable Operators. Cable operators are offering enhanced broadband services, including high definition television, digital video, interactive and on demand video services, high-speed Internet and voice over Internet Protocol. As these enhanced broadband services continue to attract new subscribers, we expect that cable operators 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, operators will need to upgrade headends, hubs, nodes, and radio frequency distribution equipment. While many domestic cable operators have substantially completed initial network upgrades necessary to provide enhanced broadband services, they will need to take a scalable approach to continue upgrades as new services are deployed. In addition, many international cable operators have not yet completed the initial upgrades necessary to offer such enhanced broadband services. Finally, as more and more critical services are provided over the MSO 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.
Growing Demand for Bundled Services-Video, Voice, and Data. In response to increased competition from telecommunication service providers and direct broadcast satellite operators, cable operators have not only upgraded their networks to cost effectively support and deliver enhanced video, voice, and data, but continue to invest significantly to offer a "triple play" bundle of these services. The ability to cost-effectively provide personalized, bundled services helps cable operators reduce subscriber turnover and increase revenue per subscriber. As a result, the focus on such services is driving cable operators to continue to invest in network infrastructure, content management, digital advertising insertion, and back office automation tools.
Cable Operators 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, on demand network is causing cable operators to deploy new technologies. For example, transport technologies based on Internet Protocol allow cable operators to more cost effectively deliver video, voice, and data across a common network infrastructure. Cable operators 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, cable operators 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.
Digital Video Recorders are Impacting the Advertising Business. As the use of digital video recorders and other recording devices becomes more prevalent, advertisers face the need to develop new business models. Since personal recorders allow the viewer to skip over ads, network operators are looking for new ways to attract advertising dollars and deliver a meaningful ad experience to viewers. As a result, many network operators are implementing digital ad insertion, allowing them to transition from all analog to a mix of analog and digital and ultimately to all digital. One benefit is the ability to reallocate bandwidth. More importantly, digital advertising allows network operators to create a more dynamic and interactive experience between advertiser and viewer.
Telephone companies are also planning for this transition.
Cable Operators have Developed Strategies to Offer Business Services. Cable operators are leveraging their investment in existing fiber and coax networks by expanding beyond traditional residential customers to offer voice, video, and data services to commercial (small and medium size businesses), education, healthcare, and government clients. Using their experience in delivering data, cable operators can bundle both voice and data for commercial subscribers and effectively compete with the telephone companies who have typically focused on large enterprises. Business services are just one of several market segments where cable and telephone companies are trying to penetrate each other's markets.
39 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Consolidation of Vendors Has Occurred and May Continue. In February 2006, Cisco Systems, Inc. acquired Scientific-Atlanta, Inc. Both Cisco and Scientific-Atlanta are key competitors of ARRIS. In February 2007, Ericsson purchased Tandberg Television. In July 2007, Motorola acquired Terayon Communication Systems. In December 2007, ARRIS acquired C-COR. In 2009, ARRIS acquired Digeo and EGT. In November 2011, ARRIS acquired BigBand Networks. In May 2012, Google acquired Motorola Mobility. In December 2012, ARRIS announced its intention to purchase Motorola Home. It is also possible that other competitor consolidations may occur which could have an impact on future sales and profitability.
The impact of the above trends is difficult to predict and quantify, but generally: • 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 MSOs to expand their networks to meet the increased bandwidth and speed requirements their customers are demanding, driven by both the competition MSOs face and the proliferation of new services, in turn leads the MSOs to ask ARRIS, and ARRIS' competitors, for product innovations that decrease the cost per megabit of capacity required. This trend may have an impact on both revenues and margins, depending upon (amongst 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 development investment.
• The anticipated shift by MSOs to an all IP network is expected to increase ARRIS' revenue over time, as ARRIS is presently not a participant in the set top box market which is expected to be displaced by gateways. Gateways are expected to have lower than the current ARRIS average gross margin, as a result, it is possible that the Company's overall average gross margin may decline in the near term as gateway revenues ramp.
• Increased competition for the services of MSOs could result in pressure on the pricing of their services, which in turn could negatively impact the level of their capital expenditures and negatively impact their purchases from ARRIS.
• The contemplated acquisition of Motorola Home will significantly increase the revenue, scale, product offerings of ARRIS. Further, it is anticipated that ARRIS will incur significant debt and issue equity to complete the acquisition. See Risk Factors for potential impacts associated with the acquisition.
Our Strategy and Key Highlights Our long-term business strategy "Convergence Enabled" includes the following key elements: • Maintain a strong capital structure, mindful of our 2013 debt maturity, share repurchase opportunities and other capital needs including mergers and acquisitions.
• Grow our current business into a more complete portfolio including a strong video product suite.
• Continue to invest in the evolution toward enabling true network convergence onto an all IP platform.
• Continue to expand our product/service portfolio through internal developments, partnerships and acquisitions.
• Expand our international business and begin to consider opportunities in markets other than cable.
• Continue to invest in and evolve the ARRIS talent pool to implement the above strategies.
To fulfill our strategy, we develop technology, facilitate its implementation, and enable operators to put their subscribers in control of their entertainment, information, and communication needs. Through a set of business solutions that respond to specific market needs, we are integrating our products, software, and services solutions to work with our customers as they address Internet Protocol telephony deployment, high-speed data deployment, high definition television content expansion, on demand video rollout, operations management, network integration, and business services opportunities.
40-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements On December 19, 2012 we entered into an Acquisition Agreement with Motorola Mobility LLC, a Google Inc. subsidiary, pursuant to which, subject to the satisfaction or waiver of the conditions therein, we will acquire the Motorola Home business from Motorola Mobility for $2.35 billion in cash and equity, subject to certain adjustments as provided for in the Agreement. The transaction is expected to close in the second quarter of 2013. We believe acquiring Motorola Home will enhance our ability to provide next-generation consumer video products and services, supporting a more comprehensive product offering while also accelerating our ability to deliver a comprehensive set of industry-leading new products for broadband to a wide spectrum of customers. The acquisition adds expertise in video and a larger presence in the home to our core strengths in voice and data, ensuring we are even better positioned to capitalize on and manage the evolution toward multi-screen home entertainment. The transaction will increase our patent portfolio and provide a license to a wide array of Motorola Mobility patents.
Below are some key highlights and trends: Financial Highlights • Sales in 2012 were $1.354 billion as compared to $1.089 billion in 2011.
• Gross margin percentage was 34.2% in 2012, which compares to 37.7% in 2011.
The decline reflects a product mix shift with higher percentage of Customer Premise Equipment and HFC equipment sales (which have lower than average margins) and lower percentage of CMTS equipment sales (which have higher than average margins).
• We invested $170.7 million in research and development in 2012, up $24.2 million or approximately 16.5% from 2011.
• We ended 2012 with $584.0 million of cash, cash equivalents, short-term & long-term marketable security investments, which compares to $561.1 million at the end of 2011. We generated approximately $84.4 million of cash from operating activities in 2012 and $113.2 million during 2011.
• During 2012, we used $51.9 million of cash to repurchase 4.5 million shares of our common stock at an average price of $11.55 per share.
Product Line Highlights Broadband Communications Systems • CMTS • Downstream port shipments were approximately 349 thousand in 2012, as compared to 316 thousand in 2011.
• Continued capacity expansion with both new hardware sales (32D and 24U line cards) as well as license upgrades to existing deployed product.
• Neared completion of development of next generation E6000 Converged Edge Router CMTS product and started customer trials to enable smooth transition of legacy video networks to IP.
• CPE • Approximately 8.5 million CPE units were shipped in 2012 as compared to 5.3 million CPE units in 2011. Shipments of DOCSIS 3.0 CPEincreased to 81% of the total unit shipments in 2012 as compared to 40% in 2011.
• Significant increase in WiFi enabled devices as operaters extend their network deep into the consumers home to ensure high quality of service experience and simplify network management.
• Maintained number one EMTA market share for 32 consecutive quarters (source: Infonetics).
• Whole Home IP Video Solution 41 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements • Continued commercial deployment of a unique next generation hybrid whole home media solution, taking advantage of the technology andknow-how from the Digeo acquisition and the core technologies from our DOCSIS CPE products.
• Expanded portfolio to include additional 3rdparty middleware options such as NDS (Cisco) and Comcast RDK Access, Transport & Supplies • Selected as sole source optical node supplier with major MSOs.
• Growth in metro Wi-Fi deployments.
• Enhanced version of CHP COR Wave II platform.
Media & Communications Systems • Growing share of linear advertising back office and server in the North American market.
• Expanded deployments of ServAssure and WorkAssure in North and South America.
Non-GAAP Measures In addition to reviewing our financial results as determined under U.S. GAAP, ARRIS management also uses non-GAAP measures, in particular Adjusted ("non-GAAP") earnings per share, as we believe they provide a meaningful insight into our business and trends. We also believe that these non-GAAP measures provide readers of our financial statements with useful information and insight with respect to the results of our business. However, the presentation of non-GAAP information is not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. Below are tables for 2012, 2011 and 2010 which detail and reconcile GAAP and non-GAAP earnings per share: (in thousands, except per share data) For the Year Ended December 31, 2012 Income Other Tax Net Gross Operating Operating (Income) Expense Income Margin Expense Income Expense (Benefit) (Loss) Amounts in accordance with GAAP $ 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 Stock compensation expense 3,169 (24,737 ) 27,906 - - 27,906 Amortization of intangible assets - (30,294 ) 30,294 - - 30,294 Acquisition costs, restructuring, and integration costs - (12,631 ) 12,631 - - 12,631 Loss of sale of product line - (337 ) 337 - - 337 Settlement Charge - Pension - (3,064 ) 3,064 - - 3,064 Impairment of investment - - - (533 ) - 533 Non-cash interest expense - - (12,358 ) - 12,358 Adjustments of income tax valuation allowances and otherdiscrete tax items - - - - 4,658 (4,658 ) Tax related to items above - - - - 29,957 (29,957 ) Non-GAAP amounts $ 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 - diluted 116,514 42 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements (in thousands, except per share data) For the Year Ended December 31, 2011 Income Other Tax Net Gross Operating Operating (Income) Expense Income Margin Expense Income Expense (Benefit) (Loss) Amounts in accordance with GAAP $ 410,513 $ 425,121 $ (14,608 ) $ 13,903 $ (10,849 ) $ (17,662 ) Acquisition accounting impacts related to deferred revenue 3,126 3,126 - - 3,126 Stock compensation expense 2,040 (20,015 ) 22,055 - - 22,055 Acquisition costs, restructuring, and integration costs - (7,565 ) 7,565 - - 7,565 Amortization of intangible assets - (33,649 ) 33,649 - - 33,649 Impairment of goodwill and intangible assets - (88,633 ) 88,633 - - 88,633 Non-cash interest expense - - - (11,545 ) - 11,545 Impairment of investment - - - (3,000 ) - 3,000 Loss on retirement of debt - - - (19 ) - 19 Tax related to items above - - - - 26,642 (26,642 ) Adjustments of tax related to goodwill impairment and certain provision to return adjustments - - - - 25,584 (25,584 ) Non-GAAP amounts $ 415,679 $ 275,259 $ 140,420 $ (661 ) $ 41,377 $ 99,704 GAAP net income per share - diluted $ (0.15 ) Non-GAAP net income per share - diluted $ 0.81 GAAP weighted average common shares - diluted 120,157 (1) Non-GAAP weighted average common shares - diluted 122,555 (2) (1) Basic shares used for 2011 as losses were reported for those periods and the inclusion of dilutive shares would be antidilutive (2) Non-GAAP net income for 2011 is positive and, therefore, the diluted shares used in this calculation include the effect of options.
(in thousands, except per share data) For the Year Ended December 31, 2010 Income Other Tax Net Gross Operating Operating (Income) Expense Income Margin Expense Income Expense (Benefit) (Loss) Amounts in accordance with GAAP $ 424,089 $ 314,184 $ 109,905 $ 15,275 $ 30,502 $ 64,128 Stock compensation expense 1,897 (19,930 ) 21,827 - - 21,827 Acquisition costs, restructuring, and integration costs - (65 ) 65 - - 65 Amortization of intangible assets - (35,957 ) 35,957 - - 35,957 Non-cash interest expense - - - (11,325 ) - 11,325 Gain on retirement of debt - - - 373 - (373 ) Tax related to items above - - - - 24,311 (24,311 ) Adjustments of income tax valuation allowances, R&Dcredits, and other discrete tax items - - - - (889 ) 889 Non-GAAP amounts $ 425,986 $ 258,232 $ 167,754 $ 4,323 $ 53,924 $ 109,507 GAAP net income per share - diluted $ 0.50 Non-GAAP net income per share - diluted $ 0.85 GAAP weighted average common shares - diluted 128,271 Non-GAAP weighted average common shares - diluted 128,271 43 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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 our acquisition of BigBand, business combination rules require us to account for the fair values of deferred revenue arrangements for which acceptance has not been obtained, and post contract support in our purchase accounting. The non-GAAP adjustment to our sales and cost of sales is intended to include the full amounts of such revenues as if these purchase accounting adjustments had not been applied. We believe the adjustment to these revenues is useful as a measure of the ongoing performance of our business. We have historically experienced high renewal rates related to our support agreements and our objective is to increase the renewal rates on acquired post contract support agreements; however, we cannot be certain that our customers will renew our contracts.
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.
Acquisition Costs: We have excluded the effect of acquisition related expenses in calculating our non-GAAP operating expenses and net income (loss) measures.
We incurred significant expenses in connection with our pending acquisition of Motorola Home and our acquisition of BigBand, which we generally would not have otherwise incurred in the periods presented as part of our continuing operations. Acquisition related expenses consist of transaction costs, costs for transitional employees, other acquired employee related costs, and integration related outside services. We believe it is useful to understand the effects of these items on our total operating expenses.
Restructuring Costs: We have excluded the effect of restructuring charges in calculating our non-GAAP operating expenses and net income (loss) measures.
Restructuring expenses consist of employee severance, abandoned facilities, and other exit costs. We believe it is useful to understand the effects of these items on our total operating expenses.
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.
Impairment of Goodwill and Intangibles: We have excluded the effect of the estimated impairment of goodwill and intangible assets in calculating our non-GAAP operating expenses and net income (loss) measures. Although an impairment does not directly impact the Company's current cash position, such expense represents the declining value of the technology and other intangibles assets that were acquired. We exclude these impairments when significant and they are not reflective of ongoing business and operating results.
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.
44-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Impairment of Investment: We have excluded the effect of an other-than-temporary impairment of a cost method investment 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).
Loss (Gain) on Retirement of Debt: We have excluded the effect of the loss (gain) on retirement of debt in calculating our non-GAAP financial measures. We believe it is useful for investors to understand the effect of this non-cash item in our other expense (income).
Loss on Sale of Product Line: We have excluded the effect of a loss on the sale of a product line in calculating our non-GAAP operating expenses and net income measures. We believe it is useful to understand the effects of these items on our total operating expenses.
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 non-cash that is not considered by management in their review of financial results.
Income Tax Expense (Benefit): We have excluded the tax effect of the non-GAAP items mentioned above. Additionally, we have excluded the effects of certain tax adjustments related to state valuation allowances, research and development tax credits and provision to return differences.
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. These strategies were outlined in the Overview to the MD&A.
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, 2012 2011 2010 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 65.8 62.3 61.0 Gross margin 34.2 37.7 39.0 Operating expenses: Selling, general, and administrative expenses 12.4 14.0 12.7 Research and development expenses 12.6 13.5 12.9 Impairment of goodwill and intangibles - 8.1 - Amortization of intangible assets 2.2 3.1 3.3 Restructuring charges 0.5 0.4 - Operating income (loss) 6.5 (1.4 ) 10.1 Other expense (income): Interest expense 1.3 1.6 1.7 Loss (gain) on investments (0.1 ) 0.1 (0.1 ) Loss (gain) on foreign currency 0.1 (0.1 ) - Interest income (0.2 ) (0.3 ) (0.2 ) Other expense (income), net (0.1 ) (0.1 ) - Income (loss) before income taxes 5.5 (2.6 ) 8.7 Income tax expense 1.5 (1.0 ) 2.8 Net income (loss) 4.0 % (1.6 )% 5.9 % 45 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Comparison of Operations for the Three Years Ended December 31, 2012 Net Sales The table below sets forth our net sales for the three years ended December 31, 2012, 2011 and 2010 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, 2012 vs. 2011 2011 vs. 2010 2012 2011 2010 $ % $ % Business Segment: BCS $ 1,081,246 $ 824,008 $ 841,164 $ 257,238 31.2 % $ (17,156 ) (2.0 )% ATS 207,513 197,687 181,067 9,826 5.0 % 16,620 9.2 % MCS 64,904 66,990 65,275 (2,086 ) (3.1 )% 1,715 2.6 % Total $ 1,353,663 $ 1,088,685 $ 1,087,506 $ 264,978 24.3 % $ 1,179 0.1 % The table below sets forth our domestic and international sales for the three years ended December 31, 2012, 2011 and 2010 (in thousands, except percentages): Net Sales Increase (Decrease) Between Periods For the Years Ended December 31, 2012 vs. 2011 2011 vs. 2010 2012 2011 2010 $ % $ % Domestic $ 1,020,060 $ 748,167 $ 705,221 $ 271,893 36.3 % $ 42,946 6.1 % International: Americas, excluding U.S 202,887 195,500 222,185 7,387 3.8 % (26,685 ) (12.0 )% Asia Pacific 65,554 59,194 63,492 6,360 10.7 % (4,298 ) (6.8 )% EMEA 65,162 85,824 96,608 (20,662 ) (24.1 )% (10,784 ) (11.2 )% Total international 333,603 340,518 382,285 (6,915 ) (2.0 )% (41,767 ) (10.9 )% Total $ 1,353,663 $ 1,088,685 $ 1,087,506 $ 264,978 24.3 % $ 1,179 0.1 % Broadband Communications Systems Net Sales 2012 vs. 2011 During the year ended December 31, 2012, sales of our BCS segment increased $257.2 million or approximately 31.2%, as compared to 2011.
• This increase in sales is primarily attributable to high demand for our DOCSIS3.0 CPE equipment and video gateway products.
• The higher sales also reflect the full year sales associated with our late 2011 acquisition of BigBand.
Access, Transport & Supplies Net Sales 2012 vs. 2011 During the year ended December 31, 2012, Access, Transport & Supplies segment sales increased $9.8 million or approximately 5.0%, as compared to 2011.
• The increase in sales is a result of metro Wi-Fi wireless products, for which initial sales of this product began in the fourth quarter of 2011.
• This increase in metro Wi-Fi products was partially offset by a decline in optics products sales and the disposal of our ECCO product line.
46 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Media & Communications Systems Net Sales 2012 vs. 2011 During the year ended December 31, 2012, Media & Communications Systems segment sales decreased $2.1 million or 3.1%, as compared to the same period in 2011.
Broadband Communications Systems Net Sales 2011 vs. 2010 During the year ended December 31, 2011, sales of our BCS segment decreased $17.2 million or approximately 2.0%, as compared to 2010.
• This decline in sales is primarily the result of lower sales or our CMTS products. The introduction of the higher density downstream line cards and upgrade licenses for installed base of 16 channel cards enable us to be more competitive and sell bandwidth at a reduced price per downstream thus resulted in lower sales for comparable port shipments of our CMTS products.
• Offsetting these declines in CMTS sales was the introduction of our Moxi Gateway product, resulting in higher CPE sales. Additionally, we had $4.7 million of higher revenue related to sales of the BigBand product.
Access, Transport & Supplies Net Sales 2011 vs. 2010 During the year ended December 31, 2011, Access, Transport & Supplies segment sales increased $16.6 million or approximately 9.2%, as compared to the same period in 2010.
• The increase reflects growth in our professional and commercial services as well as several network upgrade projects.
Media & Communications Systems Net Sales 2011 vs. 2010 During the year ended December 31, 2011, Media & Communications Systems segment sales increased $1.7 million or 2.6%, as compared to the same period in 2010.
• The increase was primarily due to expansion of deployments for our Assurance product line as customers continue to focus on operating expense reductions and improving customer satisfaction.
Gross Margin The table below sets forth our gross margin for the three years ended December 31, 2012, 2011 and 2010 for each of our business segments (in thousands, except percentages): Gross Margin $ Increase (Decrease) Between Periods For the Years Ended December 31, 2012 vs. 2011 2011 vs. 2010 2012 2011 2010 $ % $ % Business Segment: BCS $ 373,493 $ 319,925 $ 343,884 53,568 16.7 % $ (23,959 ) (7.0 )% ATS 47,079 49,272 45,971 (2,193 ) (4.5 )% 3,301 7.2 % MCS 42,005 41,316 34,234 689 1.7 % 7,082 20.7 % Total $ 462,577 $ 410,513 $ 424,089 $ 52,064 12.7 % $ (13,576 ) (3.2 )% The table below sets forth our gross margin percentages for the three years ended December 31, 2012, 2011 and 2010 for each of our business segments: Gross Margin % Percentage Point Increase For the Years Ended December 31, (Decrease) Between Periods 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 Business Segment: BCS 34.5 % 38.8 % 40.9 % (4.3 ) (2.1 ) ATS 22.7 % 24.9 % 25.4 % (2.2 ) (0.5 ) MCS 64.7 % 61.7 % 52.4 % 3.0 9.3 Total 34.2 % 37.7 % 39.0 % (3.5 ) (1.3 ) 47 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Our overall gross margins are dependent upon, among other factors, achievement of cost reductions, product mix, customer mix, product introduction costs, and price reductions granted to customers.
Broadband Communications Systems Gross Margin 2012 vs. 2011 The increase in the BCS segment gross margin dollars and decrease in gross margin percentage in 2012 as compared to 2011 were related to the following factors: • The increase in gross margin dollars was the result of higher sales.
• The decrease in gross margin percentage was primarily reflects a product mix change as we had higher EMTA sales and lower CMTS sales. EMTA products have a lower gross margin than CMTS products.
Access, Transport & Supplies Gross Margin 2012 vs. 2011 The decrease in the ATS segment gross margin dollars and gross margin percentage in 2012 as compared to 2011 were related to the following factors: • The decrease in both gross margin dollar and percentage was driven by product mix, primarily resulting from lower gross margin for metro Wi-Fi products and lower volume of optics products Media & Communications Systems Gross Margin 2012 vs. 2011 The increase in the MCS segment gross margin dollars and gross margin percentage in 2012 as compared to 2011 are related to the following factors: • Higher year-over-year sales and product mix resulted in the increase in both gross margin dollars and percentage.
Broadband Communications Systems Gross Margin 2011 vs. 2010 The decrease in the BCS segment gross margin dollars and gross margin percentage in 2011 as compared to 2010 were related to the following factors: • The decrease primarily reflects a product mix change with more sales of CPE products, which have lower than average margins, and less sales of CMTS products, which have higher than average margins. The decrease also reflects competitive price pressure for our CMTS products.
Access, Transport & Supplies Gross Margin 2011 vs. 2010 The increase in the ATS segment gross margin dollars and decrease in gross margin percentage in 2011 as compared to 2010 were related to the following factors: • The increase in gross margin dollars was primarily the result of higher sales in 2011 as compared to 2010.
• The decrease in gross margin percentage was primarily the result of a change in product mix and pricing pressure associated with Supplies products.
Media & Communications Systems Gross Margin 2011 vs. 2010 The increase in the MCS segment gross margin dollars and gross margin percentage in 2011 as compared to 2010 are related to the following factors: • The increase in gross margin dollars and percentage was primarily due to higher Assurance sales which have higher gross margins.
48 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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, 2012 vs. 2011 2011 vs. 2010 2012 2011 2010 $ % $ % Selling, general, & administrative $ 161,338 $ 148,755 $ 137,694 $ 12,583 8.5 % $ 11,061 8.0 % Research & development 170,706 146,519 140,468 24,187 16.5 % 6,051 4.3 % Acquisition costs 5,870 3,205 - 2,665 83.2 % 3,205 100 % Restructuring 6,761 4,360 65 2,401 55.1 % 4,295 6607.7 % Impairment of goodwill & intangibles - 88,633 - (88,633 ) (100 )% 88,633 100 % Amortization of intangible assets 30,294 33,649 35,957 (3,355 ) 10.0 % (2,308 ) (6.4 )% Loss on sale of product line 337 - - 337 100 % - - Total $ 375,306 $ 425,121 $ 314,184 $ (49,815 ) (11.7 )% $ 110,937 35.3 % Selling, General, and Administrative, or SG&A, Expenses 2012 vs. 2011 The year over year increase of $12.6 million in SG&A expenses primarily reflects the addition of BigBand as well as $3.1 million expense associated with early pension settlements and higher legal expenses.
2011 vs. 2010 Several factors contributed to the $11.1 million increase year over year: • We acquired BigBand on November 21, 2011 and as a result incurred $3.1 million of incremental SG&A cost in 2011.
• We incurred higher legal expenses as a result of various patent and other litigation matters (see Part I, Item 3, "Legal Proceedings").
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.
2012 vs. 2011 The increase of $24.2 million year-over-year in research and development expense reflects the addition of BigBand and increased headcount, as we continued to aggressively invest in R&D.
2011 vs. 2010 The increase of $6.1 million year-over-year in research and development expense reflects: • $3.0 million incremental R&D expenses associated with BigBand, which were acquired in the fourth quarter of 2011.
• Higher prototype and incremental startup costs related to new product development.
Acquisition Costs 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 pending acquisition of Motorola Home and consisted of transaction costs and legal fees. During 2011, we recorded acquisition related expenses $3.2 million. These expenses were related to the acquisition of BigBand and consisted of transaction costs, employee related costs, and integration related outside services.
49-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Restructuring Charges During 2012, 2011 and 2010, we recorded restructuring charges of $6.8 million, $4.4 million and $0.1 million, respectively. 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. The majority of the charges recorded in 2011 relate to the restructuring initiative following the acquisition of BigBand. Charges in 2010 reflected changes in estimates related to real estate leases associated with the previous restructuring charges.
Impairment of Goodwill and Intangible Assets Goodwill relates to the excess of cost 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 most likely than not impaired. The annual tests were performed in the fourth quarters of 2012, 2011 and 2010, with an assessment date of October 1. No impairment resulted from the review in 2010 or 2012. As a result of the review in 2011, we recognized a total non-cash goodwill impairment loss of $41.2 in the MCS reporting unit. The Company determined that the fair values of the MCS reporting unit was less than its respective carrying amount, as a result of a decline in the expected future cash flows for the reporting unit. In making our assessment regarding MCS future cash flows, a number of specific factors arose from our annual strategic planning process in the fourth quarter, including an assessment of historical operating results, key customer inputs, and anticipated development expenditures required to migrate the product portfolio in line with the changing market dynamics, including the evolution from a proprietary to open standards IP architecture. As a result of these factors, the Company has decided to shift some investment from the MCS reporting unit to its BCS reporting unit. Given the decision to reduce our investment going forward, we correspondingly moderated our long-term projections for the MCS segment.
In 2011, indicators of impairment existed for long-lived assets associated with the MCS reporting unit due to changes in projected operating results and cash flows. As a result of the review in 2011, an impairment loss of $47.4 million before tax ($29.1 million after tax) related to MCS customer relationships was recorded. See Note 14 of Notes to the Consolidated Financial Statements for disclosures related to goodwill and intangible assets.
Amortization of Intangible Assets We recorded $30.3 million of intangibles amortization expense in 2012. Our intangibles amortization expenses in 2012, 2011 and 2010 are related to the acquisitions of BigBand Networks in November 2011, Digeo, Inc. in October 2009, EG Technology, Inc. in September 2009, Auspice Corporation in August 2008 and C-COR Incorporated in December 2007.
Loss on Sale of Product Line In March of 2012, the Company completed the sale of certain assets of its ECCO electronic connector product line to Eclipse Embedded Technologies, Inc. for approximately $3.9 million. The Company recorded a net loss of $(0.3) million on the sale, which included approximately $0.3 million of transaction related costs. The results of the ECCO product line were deemed immaterial to the overall financial results of the Company, and as such the Company has not reported the results in discontinued operations.
50-------------------------------------------------------------------------------- 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) For the Years Ended Increase (Decrease) December 31, Between Periods 2012 2011 2010 2012 vs. 2011 2011 vs. 2010 Interest expense $ 17,797 $ 16,939 $ 17,965 $ 858 $ (1,026 ) Loss (gain) on debt retirement - 19 (373 ) (19 ) 392 Loss (gain) on investments (1,404 ) 1,570 (414 ) (2,975 ) 1,984 Loss (gain) on foreign currency 786 (580 ) (44 ) 1,366 (536 ) Interest income (3,242 ) (3,154 ) (1,997 ) (87 ) (1,157 ) Other expense (income) (962 ) (891 ) 138 (71 ) (1,029 ) Total other expense $ 12,975 $ 13,903 $ 15,275 $ (928 ) $ (1,372 ) Interest Expense Interest expense reflects the amortization of deferred finance fees and the non-cash interest component of our convertible subordinated notes, interest paid on the notes, capital leases and other debt obligations.
Loss (Gain) on Debt Retirement During 2011, the Company acquired $5.0 million face value of the notes for approximately $5.0 million. The Company allocated $2 thousand to the reacquisition of the equity component of the notes. The Company also wrote off approximately $33 thousand of deferred finance fees associated with the portion of the notes acquired. As a result, the Company realized a loss of approximately $19 thousand on the retirement of the notes.
During 2010, we purchased $24.0 million of face value of the convertible notes for approximately $23.3 million. We allocated $0.1 million to the reacquisition of the equity component of the notes. We wrote off approximately $0.2 million of deferred finance fees associated with the portion of the notes acquired and realized a gain of approximately $0.4 million on the retirement of the convertible notes.
Loss (Gain) on Investments From time to time, we hold certain investments in the common stock of private and publicly-traded companies, a number of non-marketable equity securities, and investments in rabbi trusts associated with our deferred compensation plans.
During the years ended December 31, 2012, 2011 and 2010, we recorded net (gains) losses related to these investments of $(1.4) million, $1.6 million and $(0.4) million, respectively.
Loss (Gain) on Foreign Currency During 2012, 2011 and 2010, we recorded foreign currency (gains) losses related to our international customers whose receivables and collections are denominated in their local currency, primarily in euro. To mitigate the volatility related to fluctuations in the foreign exchange rates, we may enter into various foreign currency contracts. The (gain) loss on foreign currency is driven by the fluctuations in the foreign currency exchanges rates, primarily the euro.
Interest Income Interest income reflects interest earned on cash, cash equivalents, short-term and long-term marketable security investments. Interest income was $3.2 million in 2012, and $3.2 million in 2011 as compared to $2.0 million in 2010.
51-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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 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 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 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 will record the 2012 impact of the 2013 legislation as a favorable discrete tax event and will also include the impact of the 2013 credit in its effective income tax rate for 2013.
In 2011, we recorded $10.8 million of income tax benefit for U.S. federal and state taxes and foreign taxes, which was 38.1% of our pre-tax loss of $28.5 million. Pre-tax income was negatively impacted by $88.6 million as a result of our impairment of goodwill and intangibles, which generated an unfavorable permanent difference between book and taxable income of $22.3 million and an unfavorable timing difference between book and taxable income of $66.3 million.
The allocation of a portion of the total impairment of goodwill to tax deductible goodwill favorably impacted income tax expense by $7.3 million. The effective tax rate was favorably impacted by certain discrete tax events. The 2011 discrete tax events included the release of approximately $4.0 million of state valuation allowances in the first quarter of 2011 and the reversal of $2.7 million of tax liabilities from uncertain tax positions mostly attributable to the expiration of certain statutes of limitations in the third quarter of 2011, offset by approximately $3.8 million of tax increases primarily due to non-deductible acquisition costs, and increases in U.S. Federal valuation allowances / other. Exclusive of the impairments and the discrete tax events, the effective income tax rate would have been approximately 29.7%.
In 2010, we recorded $30.5 million of income tax expense for U.S. federal and state taxes and foreign taxes, which was 32.23% of our pre-tax income of $94.6 million. During the fourth quarter of 2010, approximately $4.1 million of research and development tax credits were recorded after Congress passed legislation retroactively extending the tax credits back to January 1, 2010. The research and development tax credit legislation was extended through December 31, 2011.
52 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Financial Liquidity and Capital Resources Overview As highlighted earlier, one of our key strategies is to maintain and improve our capital structure. The key metrics we focus on are summarized in the table below: Liquidity & Capital Resources Data Year Ended December 31, 2012 2011 2010 (in thousands, except DSO and Turns) Key Working Capital Items Cash provided by operating activities $ 84,401 $ 113,153 $ 118,509 Cash, cash equivalents, and short-term investments $ 530,117 $ 518,779 $ 620,102 Long-term U.S corporate bonds $ 53,914 $ 42,366 $ - Accounts Receivable, net $ 188,581 $ 152,437 $ 125,933 -Days Sales Outstanding 46 47 45 Inventory, net $ 133,848 $ 115,912 $ 101,763 - Turns 7.1 6.2 6.7 Key Financing Items Convertible notes at face value $ 232,050 $ 232,050 $ 237,050 Convertible notes at book value $ 222,124 $ 209,766 $ 202,615 Cash used for early redemption of convertible notes $ - $ 4,984 $ 23,287 Key Shareholder Equity Items Cash used for share repurchases $ 51,921 $ 109,123 $ 69,326 Capital Expenditures $ 21,507 $ 23,307 $ 22,645 In managing our liquidity and capital structure, we have been and are focused on key goals, and we have and will continue in the future to implement actions to achieve them. They include: • Liquidity - ensure that we have sufficient cash resources or other short term liquidity to manage day to day operations.
• Growth - implement a plan to ensure that we have adequate capital resources, or access thereto, fund internal growth and execute acquisitions while retiring our convertible notes in a timely fashion.
• Share repurchases - opportunistically repurchase our common stock.
Below is a description of key actions taken and an explanation as to their potential impact: Accounts Receivable & Inventory We use the number of times per year that inventory turns over (based upon sales for the most recent period, or turns) to evaluate inventory management, and days sales outstanding, or DSOs, to evaluate accounts receivable management.
Accounts receivable at the end of 2012 increased as compared to the end of 2011, primarily as a result of higher sales in the fourth quarter of 2012 as compared to the fourth quarter of 2011. DSOs decreased slightly from 2011 to 2012, primarily the result of payment patterns of our customers and timing of shipments to customers. Looking forward, it is possible that DSOs may increase dependent upon our customer mix and payment patterns, particularly if international sales increase.
Inventory increased in 2012 as compared to 2011. The increase in inventory was primarily related to an increase in BCS inventory level to ensure adequate supply. Inventory turns increased in 2012 as compared to 2011.
53-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Early Redemption of Convertible Notes In 2011 and 2010, we repurchased $5.0 million and $24.0 million of face value of our convertible notes for approximately $5.0 million and $23.3 million, respectively. No repurchases were made in 2012.
Common Share Repurchases During 2012, we repurchased 4.5 million shares of our common stock for $51.9 million at an average stock price of $11.55. During 2011, we repurchased 10.0 million shares of our common stock for $109.1 million at an average stock price of $10.95. During 2010, we repurchased 6.8 million shares of our common stock for $69.3 million at an average stock price of $10.24. The remaining authorized amount for stock repurchases under this program was $19.6 million as of December 31, 2012.
In the fourth quarter of 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. (As of December 31, 2012, the remaining authorized amount for future repurchases was $150.0 million) Unless terminated earlier by a Board resolution, this new plan will expire when ARRIS has used all authorized funds for repurchase Summary of Current Liquidity Position and Potential for Future Capital Raising We believe our current liquidity position, where we had approximately $530.1 million of cash, cash equivalents, and short-term investments and $53.9 million of long-term marketable securities on hand as of December 31, 2012, together with the prospects for continued generation of cash from operating activities are adequate for our short- and medium-term business needs. Upon the closing of the pending Motorola Home acquisition, we expect to be able to generate sufficient cash on a consolidated basis to make all of the principal and interest payments under the anticipated credit agreements, indentures and other instruments governing our indebtedness. We may in the future elect to repurchase additional shares of our common stock or additional principal amounts of our outstanding convertible notes. However, a key part of our overall long-term strategy may be implemented through additional acquisitions, and a portion of these funds may be used for that purpose. Should our available funds be insufficient for those purposes, it is possible that we will raise capital through private or public, share or debt offerings.
Contractual Obligations Following is a summary of our contractual obligations as of December 31, 2012: Payments due by period More than Contractual Obligations Less than 1 Year 1-3 Years 3-5 Years 5 Years Total (in thousands) Debt (1) $ 232,050 $ - $ - $ - $ 232,050 Operating leases, net of sublease income (2) 10,366 15,540 8,906 5,668 40,480 Purchase obligations (3) 214,399 - - - 214,399 Total contractual obligations (4) $ 456,815 $ 15,540 $ 8,906 $ 5,668 $ 486,929 (1) ARRIS may redeem the notes at any time on or after November 15, 2013, subject to certain conditions. In addition, the holders may require us to purchase all or a portion of their convertible notes on or after November 15, 2013.
Does not include interest, which is payable at the rate of 2% per annum.
(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) Approximately $25.4 million of uncertain tax position 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.
54 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements We are required to pay a termination fee of $117.5 million to Google if we terminate the Motorola Home acquisition under certain circumstances specified in the Acquisition Agreement.
Should the closing of the Motorola Home acquisition be delayed beyond March 19, 2013, which we currently expect, the Company will be subject to "ticking fees" under the commitment letter entered into with respect to the Credit Facility that will be used to partially finance the acquisition. For the first 30 days, the ticking fees for both the Term Loan A and the Term Loan B will be 0.50% per annum of the total amount committed for each term loan under the commitment letter. After 30 days, the ticking fee for the Term Loan A will remain 0.50% per annum, but the ticking fee for the Term Loan B will be calculated at 50% of the applicable margin for LIBOR advances as determined in accordance with the commitment letter. Ticking fees will accrue until the earlier of the termination of the commitment letter for the proposed Credit Facility and the closing of the transaction.
Off-Balance Sheet Arrangements We do not have any material off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.
Cash Flow Below is a table setting forth the key lines of our Consolidated Statements of Cash Flows (in thousands): 2012 2011 2010 Net cash provided by operating activities $ 84,401 $ 113,153 $ 118,509 Net cash used in investing (151,062 ) (134,613 ) (176,699 ) Net cash used in financing (37,511 ) (95,786 ) (89,254 ) Net decrease in cash and cash equivalents $ (104,172 ) $ (117,246 ) $ (147,444 ) Operating Activities: Below are the key line items affecting cash from operating activities (in thousands): 2012 2011 2010 Net income (loss) $ 53,459 $ (17,662 ) $ 64,128 Adjustments to reconcile net income (loss) to cash provided by operating activities 80,867 141,077 97,837 Net income including adjustments 134,326 123,415 161,965 Decrease (increase) in accounts receivable (37,139 ) (22,093 ) 18,058 Increase in inventory (21,491 ) (7,144 ) (5,912 ) Increase (decrease) in accounts payable and accrued liabilities (5,675 ) 433 (48,308 ) All other, net 14,380 18,542 (7,294 ) Net cash provided by operating activities $ 84,401 $ 113,153 $ 118,509 2012 vs. 2011 Net income including adjustments, as per the table above, increased $10.9 million during 2012 as compared to 2011 reflecting higher sales and lower operating expense as discussed above.
Accounts receivable increased $37.1 million in 2012. These increases were primarily related to higher sales in the fourth quarter of 2012 as compared to the fourth quarter of 2011, and also are impacted by 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.
55-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Inventory increased by $21.5 million in 2012 primarily as a result of the effort to increase our inventory to ensure adequate supply of our BCS product offerings.
Accounts payable and accrued liabilities decreased by $5.7 million in 2012.
Account payables increased due to increased purchases resulting from higher sales. Accrued liabilities decreased as a result over higher variable compensation payments made in 2012.
All other accounts, net, includes the changes in other receivables, income taxes payable (recoverable), and prepaids. The other receivables represent amounts due from our contract manufacturers for material used in the assembly of our finished goods. The change in our income taxes recoverable account is a result of the timing of the actual estimated tax payments during the year as compared to the actual tax liability for the year. The net change in 2012 was approximately $14.4 million as compared to $18.5 million in 2011.
2011 vs. 2010 Net income (loss), including adjustments, decreased $38.6 million during 2011 as compared to 2010 reflecting lower gross margin and higher operating expense as discussed above. In 2011, net loss included a goodwill & intangible impairment of $88.6 million and a related tax benefit of $25.6 million arising from the allocation of a portion of the total impairment of goodwill to tax deductible goodwill and the impairment of intangibles.
Accounts receivable increased $22.1 million in 2011 as a result of higher sales in the fourth quarter of 2011 as compared to fourth quarter of 2010 and payment patterns of our customers.
Inventory increased by $7.1 million in 2011. The increase in inventory was primarily related to an increase in BCS inventory level to ensure adequate supply.
Investing Activities: Below are the key line items affecting investing activities (in thousands): 2012 2011 2010 Capital expenditures $ (21,507 ) $ (23,307 ) $ (22,645 ) Acquisitions/other - (130, 227 ) (4,000 ) Purchases of investments (418,956 ) (277,937 ) (514,376 ) Sales of investments 286,013 296,774 364,077 Sale of property, plant and equipment 139 84 245 Sale of product line 3,249 - - Net cash used in investing activities $ (151,062 ) $ (134,613 ) $ (176,699 ) Capital Expenditures - Capital expenditures are mainly for test equipment, laboratory equipment, and computing equipment. We anticipate investing approximately $25 million in 2013.
Acquisitions/Other - This represents cash investments we have made in our various acquisitions. In 2011, we paid $ 162.4 million cash, or $53.1 million net of cash and marketable securities acquired, for the acquisition of BigBand Networks. In 2010, we paid $4.0 million related to a deferral of the purchase price of Digeo, Inc.
Purchases and Sales of Investments - This represents purchases and sales of securities.
Sale of Property, Plant and Equipment - This represents the cash proceeds we received from the sale of property, plant and equipment.
Sale of Product Line - This represents the cash proceeds we received from the sale of our ECCO product line.
56-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Financing Activities: Below are the key items affecting our financing activities (in thousands): 2012 2011 2010 Payment of debt obligations $ - $ - $ (124 ) Early retirement of long term debt - (4,984 ) (23,287 ) Repurchase of common stock (51,921 ) (109,123 ) (69,326 ) Proceeds from issuance of common stock 20,304 22,985 7,178 Repurchase of shares to satisfy minimum tax withholdings (9,443 ) (8,332 ) (6,447 ) Excess tax benefits from stock-based compensation plans 3,549 3,668 2,752 Net cash used in financing activities $ (37,511 ) $ (95,786 ) $ (89,254 ) Payment of Debt Obligation-This represents the payment of the short term loan to the Pennsylvania Industrial Development Authority (PIDA) for the cost of expansion of the facility in State College, Pennsylvania. The debt was repaid in 2010.
Early Retirement of Long -Term Debt - During 2011, the Company acquired $5.0 million face value of the notes for approximately $5.0 million. The Company allocated $2 thousand to the reacquisition of the equity component of the notes.
The Company also wrote off approximately $33 thousand of deferred finance fees associated with the portion of the notes acquired. As a result, the Company realized a loss of approximately $19 thousand on the retirement of the notes.
In 2010, we purchased $24.0 million of the face value of our convertible debt for approximately $23.3 million. We allocated $0.1 million to the reacquisition of the equity component of the notes. We also wrote off approximately $0.2 million of deferred finance fees associated with the portion of the notes retired. We realized a gain of approximately $0.4 million on the retirement of the convertible notes.
Repurchase of Common Stock - This represents the cash used to buy back the Company's common stock.
Proceeds from Issuance of Common Stock - This represents cash proceeds related to the exercise of stock options by employees, offset with expenses paid related to the issuance of common stock.
Repurchase of Shares to Satisfy Minimum Tax Withholdings - This represents the minimum shares withheld to satisfy the minimum tax withholding when restricted stock vests.
Excess Tax Benefits from Stock-Based Compensation Plans - This represents the cash that otherwise would have been paid for income taxes if increases in the value of equity instruments also had not been deductible in determining taxable income.
Income Taxes During 2012, approximately $2.7 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. During 2011, approximately $3.7 million of U.S. federal tax benefits were obtained from tax deductions arising from equity-based compensation deductions, all of which resulted from 2011 exercises of non-qualified stock options and lapses of restrictions on restricted stock rewards. In 2010, approximately $2.6 million of U.S. federal and state tax benefits were obtained from tax deductions arising from equity-based compensation deductions, all of which resulted from 2010 exercises of non-qualified stock options and lapses of restrictions on restricted stock awards.
Interest Rates As of December 31, 2012, we did not have any floating rate indebtedness or outstanding interest rate swap agreements.
57-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Foreign Currency A significant portion of our products are manufactured or assembled in China and Mexico, and we have research and development centers in China, Ireland and Israel. Our sales into international markets have been and are expected in the future to be an important part of our business. These foreign operations are subject to the usual risks inherent in conducting business abroad, including risks with respect to currency exchange rates, economic and political destabilization, restrictive actions and taxation by foreign governments, nationalization, the laws and policies of the United States affecting trade, foreign investment and loans, and foreign tax laws.
We have certain international customers who are billed in their local currency.
We use a hedging strategy and enter into forward or currency option contracts based on a percentage of expected foreign currency revenues. We have certain predictable expenditures for international operations in local currency. We use a hedging strategy and enter into forward or currency option contracts based on a percentage of expected foreign currency expenses. The percentage can vary, based on the predictability of the revenues and expenses denominated in the foreign currency.
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 in favor of certain landlords and vendors to guarantee performance on lease and insurance contracts. Additionally, we have cash collateral account agreements with our financial institutions as security against potential losses with respect to our foreign currency hedging activities. The letters of credit and cash collateral accounts are reported as restricted cash. As of December 31, 2012 and 2011, we had approximately $4.7 million and $4.1 million outstanding, respectively, of cash collateral.
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 money market funds that pay either taxable or non-taxable interest. 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.
From time to time, we hold certain investments in the common stock of publicly-traded companies, which were classified as available-for-sale. As of September 30, 2012, our holdings in these investments were $5.3 million. During the fourth quarter of 2012, we sold our holdings, resulting in a gain of approximately $1.0 million. As of December 31, 2012, we have no holdings in these investments. As of December 31, 2011, our holdings in these investments were $4.8 million. Changes in the market value of these securities typically are recorded in other comprehensive income and gains or losses on related sales of these securities are recognized in income (loss).
We hold cost method investments in private companies. Due to the fact the investments are in private companies, we are exempt from estimating the fair value on an interim and annual basis. It is not practical to estimate the fair value since the quoted market price is not available. Furthermore, the cost of obtaining an independent valuation appears excessive considering the materiality of the investments to the Company. However, we are required to estimate the fair value if there has been an identifiable event or change in circumstance that may have a significant adverse effect on the fair value of the investment. Each quarter, we evaluate our investments for any other-than-temporary impairment, by reviewing the current revenues, bookings and long-term plan of the private companies. During the evaluations perfomed in 2012, we concluded that two of the private companies had indicators of impairment, and that the fair value had declined. This resulted in other-than-temporary impairment charges of $1.5 million during the year ended December 31, 2012. Purchases of cost method investments were $7.2 million during 2012 and disposals were $0.7 million. These investments are recorded at $6.0 million and $1.0 million as of December 31, 2012 and 2011, respectively.
58 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements See Note 5 of Notes to the Consolidated Financial Statements for disclosures related to the fair value of our investments.
We have a deferred compensation plan that was available to certain current and former officers and key executives of C-COR. During 2008, this plan was merged into a new non-qualified deferred compensation plan which is also available to our key executives. Employee compensation deferrals and matching contributions are held in a rabbi trust, which is a funding vehicle used to protect the deferred compensation from various events (but not from bankruptcy or insolvency).
Additionally, we previously offered a deferred compensation arrangement to certain senior employees. As of December 31, 2004, the plan was frozen and no further contributions are allowed. The deferred earnings are invested in a rabbi trust.
We also have deferred retirement salary plans, which were limited to certain current or former officers of C-COR. We hold investments to cover the liability.
ARRIS also funds its nonqualified defined benefit plan for certain executives in a rabbi trust.
Capital Expenditures Capital expenditures are made at a level designed to support the strategic and operating needs of the business. Capital expenditures were $21.5 million in 2012 as compared to $23.3 million in 2011and $22.6 million in 2010. We had no significant commitments for capital expenditures at December 31, 2012.
Management expects to invest approximately $25.0 million in capital expenditures for the year 2013.
Deferred Income Tax Assets - Including Net Operating Loss Carryforwards and Research and Development Credit Carryforwards, 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 state deferred tax assets is dependent upon our future taxable income by legal entity. During 2012, we merged certain historical loss generating legal entities into a historically profitable legal entity, resulting in a release of approximately $1.2 million of state valuation allowances. A material portion of ARRIS' income tax filings are in the United States. In order to realize the $54.0 million of U.S. Federal deferred income tax assets in excess of liabilities that are reported at December 31, 2012, ARRIS will need to generate future U.S. Federal taxable income of approximately $154.2 million.
As of December 31, 2012, we had net operating loss, or NOL, carryforwards for U.S. federal, U.S. state, and foreign income tax purposes of approximately $47.0 million, $186.7 million, and $40.8 million, respectively. The U.S. federal NOLs expire through 2030. Foreign NOLs related to our Irish subsidiary in the amount of $19.9 million have an indefinite life. Other significant foreign NOLs arise from our Dutch subsidiaries ($6.8 million, expiring during the next 7 years), our French branch ($5.9 million, no expiration), and our U.K. branch ($7.1 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 $44.1 million of post-apportioned and $60.9 million of pre-apportioned U.S. state NOLs, and $3.2 million of the foreign NOLs are subject to valuation allowances because we do not believe the ultimate realization of the deferred tax assets associated with these U.S. federal and state NOLs is more-likely-than-not.
During 2012, we utilized approximately $3.3 million of U.S. federal NOLs, $10.8 million of post-apportioned and $21.9 million of pre-apportioned U.S. state NOLs to offset against taxable income. We used approximately $1.5 million of U.S.
federal NOLs and $14.7 million of U.S. state NOLs to reduce taxable income in 2011.
59 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements During the tax years ending December 31, 2012, and 2011, we utilized $1.2 million and $12.1 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, 2012, ARRIS has $5.6 million of available U.S.
federal research and development tax credits and $14.1 million of available U.S.
state research and development tax credits. The remaining unutilized U.S.
federal research and development tax credits can be carried back one year and carried forward twenty years. The U.S. state research and development tax credits carry forward and will expire pursuant to the various applicable state rules. Approximately $5.2 million of U.S. federal research and development tax credits and $9.2 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.
Since the acquisition of C-COR Incorporated in 2007, 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 the C-COR transaction.
Additionally, each tax year ARRIS includes in its taxable income all items of revenue that are deferred for financial reporting purposes. 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.
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. During December of 2010, Congress passed legislation that provides for an extension of these tax credits so that the Company can continue to calculate and claim research and development tax credits for the 2010 and 2011 tax years. The federal research and development credit expired on December 31, 2011. 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 will result in a tax benefit which will be recognized in the first quarter of 2013, which is the quarter in which the law was enacted.
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 ARRIS' 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. ARRIS 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. ARRIS' 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 2012, the plan assets were comprised of approximately 61% and 39% of equity and debt securities, respectively. For 2011, the plan assets were comprised of approximately 43%, 54%, and 3% of equity, debt securities, and money market funds, respectively. For 2013, the plan's current target allocations are 38% equity securities, 20% debt securities, and 42% money market funds. Liabilities or amounts in excess of these funding levels are accrued and reported in the consolidated balance sheets. ARRIS has 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.
60 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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.
The weighted-average actuarial assumptions used to determine the benefit obligations for the three years presented are set forth below: 2012 2011 2010 Assumed discount rate for non-qualified plan participants 3.75 % 4.50 % 5.50 % Assumed discount rate for qualified plan participants 3.75 % 4.50 % 5.50 % Rate of compensation increase 3.75 % 3.75 % 3.75 % The weighted-average actuarial assumptions used to determine the net periodic benefit costs are set forth below: 2012 2011 2010 Assumed discount rate for non-qualified plan participants 4.50 % 5.50 % 5.75 % Assumed discount rate for qualified plan participants 4.50 % 5.50 % 5.75 % Rate of compensation increase 3.75 % 3.75 % 3.75 % Expected long-term rate of return on plan assets 6.00 % 7.50 % 7.50 % 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 2013 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. ARRIS contributes to these plans based upon the dollar amount of each participant's contribution. ARRIS made matching contributions to these plans of approximately $5.7 million, $5.0 million, and $4.9 million in 2012, 2011 and 2010, respectively.
We have a deferred compensation plan that does not qualify under Section 401(k) of the Internal Revenue Code, that was available to certain current and former officers and key executives of C-COR. During 2008, this plan was merged into a new non-qualified deferred compensation plan which is also available to our key executives. Employee compensation deferrals and matching contributions are held in a rabbi trust. The total of net employee deferrals and matching contributions, which is reflected in other long-term liabilities, were $2.7 million and $2.6 million at December 31, 2012 and 2011, respectively. Total expenses included in continuing operations for the matching contributions were approximately $0.1 million in 2012 and $0.2 million in 2011.
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 $2.1 million and $2.6 million at December 31, 2012 and 2011, respectively.
We also have a deferred retirement salary plan, which was limited to certain current or former officers of C-COR. 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 $2.0 million and $2.2 million at December 31, 2012 and 2011, respectively. Total expense (income) included in continuing operations for the deferred retirement salary plan were approximately $0.1 million and $(0.2) million for 2012 and 2011, respectively.
61 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Our wholly-owned subsidiary located in Israel is required to fund future severance liabilities determined in accordance with Israeli severance pay laws.
Under these laws, employees are entitled upon termination to one month's salary for each year of employment or portion thereof. We record compensation expense to accrue for these costs over the employment period, based on the assumption that the benefits to which the employee is entitled, if the employee separates immediately. We fund the liability by monthly deposits in insurance policies and severance funds. The value of the severance fund assets are primarily recorded in other non-current assets on the Company's consolidated balance sheets, which was $3.8 million as of December 31, 2012. The liability for long-term severance accrued on the Company's consolidated balance sheets was $4.2 million as of December 31, 2012.
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 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. These are contained in the signed Contract, Purchase Order, or other documentation that shows scope, price and customer acceptance.
• 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.
62 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements • 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 cable system operators with equipment that can be placed within various stages of a broadband cable system that allows for the delivery of cable 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 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 revenues 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.
63-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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 multiple element arrangements that include software or have a software-related element that is more than incidental and does involve significant production, modification or customization, revenue is recognized using the contract accounting guidelines by applying the percentage-of-completion or completed-contract method. We recognize software license and associated professional services revenue for certain software license product installations using the percentage-of-completion method of accounting as we believe that our estimates of costs to complete and extent of progress toward completion of such contracts are reliable. For certain software license arrangements where professional services are being provided and are deemed to be essential to the functionality or are for significant production, modification, or customization of the software product, both the software and the associated professional service revenue are recognized using the completed-contract method. The completed-contract method is used for these particular arrangements because they are considered short-term arrangements and the financial position and results of operations would not be materially different from those under the percentage-of-completion method. Under the completed-contract method, revenue is recognized when the contract is complete, and all direct costs and related revenues are deferred until that time. The entire amount of an estimated loss on a contract is accrued at the time a loss on a contract is projected. Actual profits and losses may differ from these estimates.
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 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.
64-------------------------------------------------------------------------------- Table of Contents Index to Financial Statements b) Goodwill and Intangible Assets Goodwill Goodwill relates to the excess of cost 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 goodwill impairment testing date is 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, we have determined that our reporting units are the operating segments 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. The impairment testing is a two-step process. The first step is to identify a potential impairment by comparing the fair value of a reporting unit with its carrying amount. We concluded that a taxable transaction approach should be used. We determined the fair value of each reporting unit using a combination of an income approach using discounted cash flow analysis and a market approach comparing actual market transactions of businesses that are similar to our business. In addition, market multiples of publicly traded guideline companies also were considered. 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. 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. If necessary, the second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with the carrying amount of that goodwill. If the carrying amount of a reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount in excess of the carrying amount of goodwill over its implied fair value. The implied fair value of goodwill is determined in a similar manner as the determination of goodwill recognized in a business combination. We assign the fair value of a reporting unit to all of the assets and liabilities of that unit, including intangible assets, as if the reporting unit had been acquired in a business combination. Any excess of the fair value of a reporting unit over the amounts assigned to its assets and liabilities represents the implied fair value of goodwill.
The valuation methodologies described above have been consistently applied for all years discussed below.
2010 Impairment Analysis - There was no impairment of goodwill for our three reporting units from our annual goodwill impairment assessment performed as of October 1, 2010. The fair value of our MCS reporting unit exceeded its carrying value by 4.2% and thus was at risk of failing step one of the goodwill impairment test, and was therefore at risk of a future impairment in the event of significant unfavorable changes in the forecasted cash flows or the key assumptions used in our analysis, including the weighted average cost of capital (discount rate) and growth rates utilized in the discounted cash flow analysis.
2011 Impairment Analysis - There was no impairment of goodwill for our BCS and ATS reporting units from annual goodwill impairment assessment performed as of October 1, 2011. The fair value of our ATS reporting unit exceeded its carrying value by 7.6% and thus was at risk of failing step one of the goodwill impairment test, and was therefore at risk of a future impairment in the event of significant unfavorable changes in the forecasted cash flows or the key assumptions used in our analysis, including the weighted average cost of capital (discount rate) and growth rates utilized in the discounted cash flow analysis.
We determined during our step one of impairment testing that the fair value of the MCS reporting unit was less than its respective carrying value, as a result of a decline in the expected future cash flows for the reporting unit. In making our assessment regarding MCS future cash flows, a number of specific factors arose from our annual strategic planning process in the fourth quarter, including an assessment of historical operating results, key customer inputs, and anticipated development expenditures required to migrate the product portfolio in line with the changing market dynamics, including the evolution from a proprietary to open standards IP architecture. As a result of these factors, the 65 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements Company decided to shift some investment from the MCS reporting unit to its BCS reporting unit. Given the decision to reduce our investment going forward, we correspondingly moderated our long term projections for the MCS segment. The Company proceeded to step two of the goodwill impairment test to determine the implied fair value of the MCS goodwill. The Company concluded that the implied fair value of the goodwill was less than its carrying value, which resulted in a write off of all goodwill as of October 1, 2011 of $41.2 million before tax ($33.9 million after tax) for the MCS reporting unit. This expense was recorded in impairment of goodwill and intangibles line on the consolidated statements of operations.
2012 Impairment Analysis - There was no impairment of goodwill for our BCS and ATS reporting units from our annual goodwill impairment assessment performed as of October 1, 2012. The fair value of our ATS reporting unit exceeded its carrying value by $48.6 million, or 22.1%, and thus was at risk of failing step one of the goodwill impairment test, and was therefore at risk of a future impairment in the event of significant unfavorable changes in the forecasted cash flows or the key assumptions used in our analysis, including the weighted average cost of capital (discount rate) and growth rates utilized in the discounted cash flow analysis.
The following table sets forth the information regarding our ATS reporting unit as of October 1, 2012 (annual goodwill impairment testing date), including key assumptions (dollars in thousands): % Fair Value Exceeds Carrying Value as of Goodwill as of Key Assumptions October 1, 2012 October 1, 2012 Terminal Growth Percent of Discount Rate Rate Percentage Amount Total Assets ATS 13.0 % 3.0 % 22.1 % $ 35,027 11.2 % 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 the aforementioned reporting unit 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; 66 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements • new products and markets currently under development may fail to realize anticipated benefits; • 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. The table below provides sensitivity analysis related to the impact of each of the key assumptions, on a standalone basis, on the resulting percentage change in fair value of our ATS reporting unit as of October 1, 2012: Percentage Reduction in Fair Value (Income Approach) Assuming Hypothetical Assuming Hypothetical Assuming Hypothetical 10% Reduction in cash 1% increase in Discount 1% decrease in Terminal flows Rate Growth Rate ATS -6.6 % -7.0 % -2.8 % Intangible Assets We test our long-lived assets for 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. 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.
The carrying amount of a long-lived asset or an asset group is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset or asset group. 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.
If we determine that an asset or asset group is not recoverable, then we would record an impairment charge if the carrying value 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.
No review for impairment of long-lived assets was conducted in 2010 and 2012 as no indicators of impairment existed. In 2011, indicators of impairment existed for long-lived assets associated with the MCS reporting unit due to changes in projected operating results and cash flows. As such, we tested the MCS long-lived assets for recoverability by grouping assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. This was determined to be the MCS reporting unit level. We compared the undiscounted cash flows over the estimated useful life of the primary asset in the group. The estimated cash flows included revenues and expenses directly associated with and arise from the use of the asset group. Based upon the analysis, the undiscounted cash flows used in the recoverability test were less than the carrying amount of the asset group. We determined the fair value of the long-lived asset group and recognized an impairment loss for the amount the carrying amount of the long-lived asset group exceeded its fair value. In the fourth quarter of 2011, an impairment loss of $47.4 million before tax ($29.1 million after tax) related to MCS customer relationships was recorded.
67 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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 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 $1.6 million and $1.4 million as of December 31, 2012 and 2011, 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 its 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 68 -------------------------------------------------------------------------------- Table of Contents Index to Financial Statements 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.
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.
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