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ARRIS GROUP INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[November 07, 2014]

ARRIS GROUP INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) Overview On April 17, 2013 we acquired the Motorola Home business from General Instrument Holdings, Inc., a subsidiary of Google, Inc. for $2.4 billion in cash and equity, subject to certain adjustments as provided for in the acquisition agreement (the "Acquisition"). For more detail, see Note 3 Business Acquisitions to Notes to our Consolidated Financial Statements. We more than doubled in size as a result of the Acquisition, which had significant effects on virtually every aspect of our business and operations and which make comparisons in this discussion to our historical results difficult.



In addition, we have revised our segment disclosures to reflect changes in operating responsibilities that occurred during the first quarter of 2014. For more detail, see Note 14 Segment Information to Notes to our Consolidated Financial Statements. Readers should consider the size and transformative nature of the Acquisition when reviewing this "Management's Discussion and Analysis of Financial Condition and Results of Operations." Business and Financial Highlights Business Highlights • 32% year-over-year revenue growth as a result of increased demand across much of the company's product portfolio • Increased international sales, representing 27% of third quarter sales • Strong earnings and cash generation CPE Segment • Sales up 27% year-over-year with direct contribution dollars up 32% for the same time period. Sequential revenue and direct contribution dollars declined by 7%.

- Overall performance driven by strong cable and telco set-tops and DSL demand - Broadband device and accessory unit volumes improved 13% year-over-year. Unit volumes down slightly (3%) as compared to second quarter of 2014 record levels. Continued toexperience strong demand for advanced VDSL & DOCSIS 3.0 WiFi gateways - Announced upcoming trial with Comcast of a new RDK software solution on ARRIS broadband gateways. The trial is planned for fourth quarter of 2014 with general availability expected in first quarter of 2015.


- Introduced new broadband and telephony devices targeting latest DOCSIS & Wi-Fi technologies - Video CPE (set-tops and video gateways) unit volumesimproved 27% year-over-year and were consistent with second quarter of 2014 shipment levels - Announced latest evolution of set-top designs at IBC2014 trade show - Shipped one millionth video gateway device during third quarter of 2014 - Successfully integrated the Playcast Media solution for Portugal Telecom enabling cloud gaming services - Deployed high definition IPTV set top with TTNET (the largest internet service provider in Turkey ) enabling new & enhanced services N&C Segment • Sales up 42% year-over-year with direct contribution dollars up 117% for the same time period. Sequential revenue up by 13% and direct contribution dollars increased by 28%.

- Outstanding quarter as the industry momentum to expand bandwidth and video processing continues, and new services such as Network DVR take hold - Record level shipments of E6000 CCAP platform as operators re-fresh technology and expand capacity 24 -------------------------------------------------------------------------------- Table of Contents - Leading the industry in DOCSIS3.1 technology maturity - SCTE demo show casing early interoperability with CPE silicon development platforms - Strong demand for DOCSIS3.1-compatible CORWaveTM 3 Headend Optics platform - Continued strength in Video Systems portfolio including CherryPicker video processing platform and Network DVR products - Growing momentum and opportunity pipeline for ARRIS Professional Services Financial Highlights • Sales in the third quarter and nine months ended September 30, 2014 were $1,405.4 million and $4,059.5 million, respectively, as compared to $1,067.8 million and $2,421.8 million in the same periods in 2013, reflecting the acquisition of Motorola Home and strong demand.

• Gross margin percentage was 31.0% in the third quarter of 2014, which compares to 29.7% in the third quarter of 2013.

• Total operating expenses (excluding amortization of intangible assets, integration, acquisition, restructuring and other costs) in the third quarter of 2014 were $246.3 million, as compared to $228.4 million in the same period last year. As expected, operating expenses decreased from $256.5 million in the second quarter of 2014.

• We ended the third quarter of 2014 with $599.1 million of cash, cash equivalents, short-term and long-term marketable security investments. The Company generated $337.1 million of cash from operating activities through the first nine months of 2014, which compares to $380.2 million generated during the same period in 2013.

• We ended the third quarter 2014 with long-term debt of $1,561.3 million, at face value, the current portion of which is $68.8 million. We repaid $191.3 million of our Term Loans in the first nine months of 2014, including a $150 million optional prepayment.

• We ended the third quarter 2014 with an order backlog of $594.1 million and had a book-to-bill ratio of 0.86 in the quarter.

Non-GAAP Measures As part of our ongoing review of financial information related to our business, we regularly use non-GAAP measures, in particular non-GAAP earnings per share, as we believe they provide a meaningful insight into our business and trends. We also believe that these non-GAAP measures provide readers of our financial statements with useful information and insight with respect to the results of our business. However, the presentation of non-GAAP information is not intended to be considered in isolation or as a substitute for results prepared in accordance with GAAP. Below are tables for the three and nine months ended September 30, 2014 and 2013 which detail and reconcile GAAP and non-GAAP earnings per share (in thousands, except per share data): For the Three Months Ended September 30, 2014 Other Income Net Gross Operating Operating (Income) Tax Expense Income Sales Margin Expense Income Expense (Benefit) (Loss) Amounts in accordance with GAAP $ 1,405,445 $ 435,734 $ 313,625 $ 122,109 $ 22,976 $ 44,507 $ 54,626 Acquisition accounting impacts related to deferred revenue 780 47 - 47 - - 47 Stock compensation expense - 1,824 (11,671 ) 13,495 - - 13,495 Amortization of intangible assets - - (57,100 ) 57,100 - - 57,100 Integration, acquisition, restructuring and other costs - - (10,226 ) 10,226 - - 10,226 Impairment of investments - - - - (4,000 ) - 4,000 Net tax items - - - - - 19,375 (19,375 ) Non-GAAP amounts $ 1,406,225 $ 437,605 $ 234,628 $ 202,977 $ 18,976 $ 63,882 $ 120,119 GAAP net income per share - diluted $ 0.37 Non-GAAP net income per share - diluted $ 0.81 Weighted average common shares - basic 144,967 Weighted average common shares - diluted 148,753 25 -------------------------------------------------------------------------------- Table of Contents For the Nine Months Ended September 30, 2014 Other Income Operating Operating (Income) Tax Expense Net Income Sales Gross Margin Expense Income Expense (Benefit) (Loss) Amounts in accordance with GAAP $ 4,059,534 $ 1,201,921 $ 950,149 $ 251,772 $ 68,672 $ 48,649 $ 134,451 Acquisition accounting impacts related to deferred revenue 4,475 3,048 - 3,048 - - 3,048 Stock compensation expense - 4,934 (34,878 ) 39,812 - - 39,812 Amortization of intangible assets - - (179,835 ) 179,835 - - 179,835 Integration, acquisition, restructuring and other costs - - (34,246 ) 34,246 - - 34,246 Impairment of investments - - - - (7,000 ) - 7,000 Asset held for sale impairment - - - - (2,125 ) - 2,125 Net tax items - - - - - 107,428 (107,428 ) Non-GAAP amounts $ 4,064,009 $ 1,209,903 $ 701,190 $ 508,713 $ 59,547 $ 156,077 $ 293,089 GAAP net income per share - diluted $ 0.91 Non-GAAP net income per share - diluted $ 1.98 Weighted average common shares - basic 144,085 Weighted average common shares - diluted 147,996 For the Three Months Ended September 30, 2013 Other Income Operating Operating (Income) Tax Expense Net Income Sales Gross Margin Expense Income Expense (Benefit) (Loss) Amounts in accordance with GAAP $ 1,067,824 $ 316,895 $ 305,713 $ 11,182 $ 22,029 $ (28,016 ) $ 17,169 Acquisition accounting impacts related to deferred revenue 1,556 1,006 - 1,006 - - 1,006 Stock compensation expense - 1,248 (9,481 ) 10,729 - - 10,729 Amortization of intangible assets - - (65,053 ) 65,053 - - 65,053 Integration, acquisition, restructuring and other costs - - (12,278 ) 12,278 - - 12,278 Non-cash interest expense - - - - (3,374 ) - 3,374 Net tax items - - - - - 54,998 (54,998 ) Non-GAAP amounts $ 1,069,380 $ 319,149 $ 218,901 $ 100,248 $ 18,655 $ 26,982 $ 54,611 GAAP net income per share - diluted $ 0.12 Non-GAAP net income per share - diluted $ 0.39 Weighted average common shares - basic 138,478 Weighted average common shares - diluted 140,605 For the Nine Months Ended September 30, 2013 Other Income Operating Operating (Income) Tax Expense Net Income Sales Gross Margin Expense Income Expense (Benefit) (Loss) Amounts in accordance with GAAP $ 2,421,835 $ 656,377 $ 723,742 $ (67,365 ) $ 55,208 $ (76,630 ) $ (45,943 ) Reduction in revenue related to Comcast's investment in ARRIS 13,182 13,182 - 13,182 - - 13,182 Acquisition accounting impacts related to fair value of inventory - 57,600 - 57,600 - - 57,600 Acquisition accounting impacts related to deferred revenue 3,973 2,478 - 2,478 - - 2,478 Product Rationalization - 13,582 - 13,582 - - 13,582 Stock compensation expense - 2,945 (21,708 ) 24,653 - - 24,653 Amortization of intangible assets - - (128,571 ) 128,571 - - 128,571 Integration, acquisition, restructuring and other costs - - (71,126 ) 71,126 - - 71,126 Credit facility - ticking fees - - - (865 ) - 865 Mark-to-market FV adjustment related to Comcast's investment in ARRIS - - - - (13,189 ) - 13,189 Non-cash interest expense - - - (9,926 ) - 9,926 Net tax items - - - - - 143,034 (143,034 ) Non-GAAP amounts $ 2,438,990 $ 746,164 $ 502,337 $ 243,827 $ 31,228 $ 66,404 $ 146,195 GAAP net loss per share - diluted (1) $ (0.35 ) Non-GAAP net income per share - diluted $ 1.11 Weighted average common shares - basic 129,502 Weighted average common shares - diluted 132,169 (1) Basic shares used as losses were reported for those periods and the inclusion of dilutive shares would be anti-dilutive 26 -------------------------------------------------------------------------------- Table of Contents In managing and reviewing our business performance, we exclude a number of items required by GAAP. Management believes that excluding these items is useful in understanding the trends and managing our operations. We provide these supplemental non-GAAP measures in order to assist the investment community to see ARRIS through the "eyes of management," and therefore enhance understanding of ARRIS' operating performance. Non-GAAP financial measures should be viewed in addition to, and not as an alternative to, the Company's reported results prepared in accordance with GAAP. Our non-GAAP financial measures reflect adjustments based on the following items, as well as the related income tax effects: Reduction in Revenue Related to Comcast Investment in ARRIS: In connection with our acquisition of Motorola Home, Comcast was given an opportunity to invest in ARRIS. The accounting guidance requires that we record the implied fair value of benefit received by Comcast as a reduction in revenue. Until the closing of the deal, changes in the value of the investment were marked to market and flowed through other expense (income). We have excluded the effect of the implied fair value in calculating our non-GAAP financial measures. We believe it is useful to understand the effects of these items on our total revenues and other expense (income).

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

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

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

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

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

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

Restructuring expenses consist of employee severance, abandoned facilities, and other exit costs. We believe it is useful to understand the effects of these items on our total operating expenses.

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

Mark To Market Fair Value Adjustment Related To Comcast Investment in ARRIS: In connection with our acquisition of Motorola Home, Comcast was given an opportunity to invest in ARRIS. The accounting guidance requires we mark to market the changes in the value of the investment and flow through other expense (income). We have excluded the effect of the implied fair value in calculating our non-GAAP financial measures. We believe it is useful to understand the effects of these items on our total other expense (income).

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

Impairment of Investment: We have excluded the effect of an other-than-temporary 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).

Asset Held for Sale Impairment: In the second quarter of 2014, we entered into a contract to facilitate the sale of a building at less than its carrying value.

The asset has been reclassified as held for sale and was measured at the lower of its carrying amount or fair value less cost to sell. We have recorded an impairment charge to reduce the assets carrying amount to its estimated fair value less costs to sell in the period the held for sale criteria were met.

We have excluded the effect of the asset held for sale impairment in calculating our non-GAAP financial measures. We believe it is useful to understand the effect of this non-cash item in our other expense (income).

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

Comparison of Operations for the Three and Nine Months Ended September 30, 2014 and 2013 Net Sales The table below sets forth our net sales for the three and nine months ended September 30, 2014 and 2013, for each of our segments (in thousands): Net Sales Increase (Decrease) Between 2014 and 2013 For the Three Months Ended For the Nine Months Ended For the Three Months Ended For the Nine Months Ended September 30, September 30, September 30 September 30 2014 2013 2014 2013 $ % $ % Business Segment: CPE $ 945,386 $ 743,890 $ 2,861,912 $ 1,589,785 $ 201,496 27.1 % $ 1,272,127 80.0 % N&C 460,837 325,471 1,202,105 849,382 135,366 41.6 % 352,723 41.5 % Other (778 ) (1,537 ) (4,483 ) (17,332 ) 759 49.3 % 12,849 74.1 % Total sales $ 1,405,445 $ 1,067,824 $ 4,059,534 $ 2,421,835 $ 337,621 31.6 % $ 1,637,699 67.6 % 28 -------------------------------------------------------------------------------- Table of Contents The table below sets forth our domestic and international sales for the three and nine months ended September 30, 2014 and 2013 (in thousands): Net Sales Increase (Decrease) Between 2014 and 2013 For the Three Months Ended For the Nine Months Ended For the Three Months Ended For the Nine Months Ended September 30, September 30, September 30 September 30 2014 2013 2014 2013 $ % $ % Domestic $ 1,029,180 $ 731,439 $ 3,057,970 $ 1,631,083 $ 297,741 40.7 % $ 1,426,887 87.5 % International Americas, excluding U.S. 246,922 217,843 661,005 501,052 29,079 13.3 % 159,953 31.9 % Asia Pacific 38,584 48,869 113,674 108,102 (10,285 ) (21.0 )% 5,572 5.2 % EMEA 90,759 69,673 226,885 181,598 21,086 30.3 % 45,287 24.9 % Total International 376,265 336,385 1,001,564 790,752 39,880 11.9 % 210,812 26.7 % Total sales $ 1,405,445 $ 1,067,824 $ 4,059,534 $ 2,421,835 $ 337,621 31.6 % $ 1,637,699 67.6 % Customer Premises Equipment Net Sales 2014 vs. 2013 During the three months ended September 30, 2014 sales in our CPE segment increased by approximately 27.1% as compared to the same period in 2013. The increase was driven by strong cable and telco set-tops and DSL demand.

During the nine months ended September 30, 2014 sales in our CPE segment increased by approximately 80.0%, as compared to the same period in 2013. The sales increase reflects the inclusion of sales associated with our acquisition of Motorola Home as well as the introduction of new products, in particular the XG1 and Verizon Media Server (VMS) video gateways and a variety of new advanced broadband gateway devices in the second part of 2013.

Network and Cloud Net Sales 2014 vs. 2013 During the three months ended September 30, 2014, sales in N&C segment increased by approximately 41.6% as compared to the same period in 2013. The increase reflects strong sales across most product lines, led by our new CMTS platform, the E6000 CCAP, and video solutions.

During the nine months ended September 30, 2014, sales in N&C segment increased by approximately 41.5%, as compared to the same period in 2013. The increase reflects the inclusion of sales associated with our acquisition of Motorola Home, as well as sales of the E6000, which was introduced during 2013.

Gross Margin The table below sets forth our gross margin for the three and nine months ended September 30, 2014 and 2013 (in thousands, except percentages): Gross Margin Increase (Decrease) Between 2014 and 2013 For the Three Months Ended For the Nine Months Ended For the Three Months Ended For the Nine Months Ended September 30, September 30, September 30 September 30 2014 2013 2014 2013 $ % $ % Gross margin dollars $ 435,734 $ 316,895 $ 1,201,921 $ 656,377 $ 118,839 37.5 % $ 545,544 83.1 % Gross margin percentage 31.0 % 29.7 % 29.6 % 27.1 % 1.3 2.5 During the three months ended September 30, 2014, gross margin dollars and gross margin percentage increased as compared to the same period in 2013. The increase in gross margin dollar is the result of higher sales. The increase in gross margin percentage is the result of product mix, reflecting a higher percentage of N&C products which carry a higher gross margin percent.

29-------------------------------------------------------------------------------- Table of Contents During the nine months ended September 30, 2014, gross margin dollars and gross margin percentage increased as compared to the same period in 2013. The increase in gross margin dollars is primarily the result of the inclusion of sales associated with our acquisition of Motorola Home. The increase in gross margin is the result of product mix. In addition, the gross margin for the nine months ended September 30, 2013 includes a $57.6 million impact associated with writing up the historic cost of the Motorola Home inventory to fair value at the date of acquisition (subsequently increasing cost of goods sold) as well as $13.6 million of costs associated with the rationalization of certain products after the acquisition date.

Operating Expenses The table below provides detail regarding our operating expenses (in thousands): Operating Expenses Increase(Decrease) Between 2014 and 2013 For the Three Months Ended For the Nine Months Ended For the Three Months Ended For the Nine Months Ended September 30, September 30, September 30 September 30 2014 2013 2014 2013 $ % $ % Selling, general and administrative $ 103,497 $ 99,666 $ 314,991 $ 227,691 $ 3,831 3.8 % $ 87,300 38.3 % Research & development 142,802 128,716 421,077 296,354 14,086 10.9 % 124,723 42.1 % Amortization of intangible assets 57,100 65,053 179,835 128,571 (7,953 ) (12.2 )% 51,264 39.9 % Integration, acquisition, restructuring & other 10,226 12,278 34,246 71,125 (2,052 ) (16.7 )% (36,879 ) (51.9 )% Total $ 313,625 $ 305,713 $ 950,149 $ 723,741 $ 7,912 2.6 % $ 226,408 31.3 % Selling, General, and Administrative, or SG&A, Expenses During the three months ended September 30, 2014, SG&A expenses increased by approximately 3.8% as compared to the same period in 2013.

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

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. R&D expenses for the three months ended September 30, 2014 increased by approximately 10.9% as compared to the same period in 2013.

R&D expenses for the nine months ended September 30, 2014 increased as compared to the same period in 2013 due to the inclusion of expenses associated with the Motorola Home acquisition, as well as higher allocations of information technology and other costs.

Amortization of Intangible Assets Our intangible amortization expense relates to finite-lived intangible assets acquired in business combinations or acquired individually. Intangibles amortization expense for the three months ended September 30, 2014 and 2013 was $57.1 million and $65.1 million, respectively. For the nine months ended September 30, 2014 and 2013, intangible amortization expense was $179.8 million and $128.6 million, respectively.

30-------------------------------------------------------------------------------- Table of Contents Integration, Acquisition, Restructuring and Other Costs During the three months ending September 30, 2014 and 2013, we recorded acquisition-related expenses and integration expenses of $7.2 million and $6.2 million, respectively. Acquisition and integration related expenses declined $5.3 million compared to the prior quarter. During the nine months of 2014 and 2013, we recorded acquisition-related expenses and integration expenses of $31.6 million and $32.8 million, respectively. These expenses primarily related to the acquisition of Motorola Home and consisted primarily of integration related outside services and legal fees.

During the three months ended September 30, 2014 and 2013, we recorded restructuring charges of approximately $3.0 million and $6.1 million, respectively. Restructuring charges during the three months ended September 30, 2014 related primarily to facility rationalization initiatives, resulting in severance and employee termination benefits for 150 employees. During the nine months ended September 30, 2014 and 2013, we recorded restructuring (recovery) charges of approximately $2.6 million and $38.3 million, respectively. The charge recorded in 2014 was related to severance and employee termination benefits and the charges in 2013 were related to severance, employee termination benefits and facilities.

Direct Contribution The table below sets forth our direct contribution for the three and nine months ended September 30, 2014 and 2013, for each of our segments (in thousands): Direct Contribution Increase (Decrease) Between 2014 and 2013 For the Three Months Ended For the Nine Months Ended For the Three Months Ended For the Nine Months Ended September 30, September 30, September 30 September 30 2014 2013 2014 2013 $ % $ % Business Segment: CPE $ 208,163 $ 158,035 $ 624,732 $ 315,305 $ 50,128 31.7 % $ 309,427 98.1 % N&C 134,217 61,763 304,133 187,354 72,454 117.3 % 116,779 62.3 % Other (152,945 ) (131,285 ) (463,012 ) (370,327 ) (21,660 ) (16.5 )% (92,685 ) (25.0 )% Total $ 189,435 $ 88,513 $ 465,853 $ 132,332 $ 100,922 114.0 % $ 333,521 252.0 % Customer Premises Equipment Direct Contribution 2014 vs. 2013 During the three months ended September 30, 2014 direct contribution in our CPE segment increased by approximately 31.7% as compared to the same period in 2013.

The direct contribution is favorably impacted by product mix and higher sales.

During the nine months ended September 30, 2014 direct contribution in our CPE segment increased by approximately 98.1% as compared to the same period in 2013.

The increase is primarily attributable to the inclusion of direct contribution associated with our acquisition of Motorola Home. Further, the direct contribution is favorably impacted by product mix, given, that in the aggregate the contribution margin of former Motorola Home products is greater than that of former ARRIS products.

Network and Cloud Direct Contribution 2014 vs. 2013 During the three months ended September 30, 2014, direct contribution in our N&C segment increased by approximately 117.3% as compared to the same period in 2013. The increase is primarily attributable to the increase in E6000 CCAP and video solutions.

During the nine months ended September 30, 2014, direct contribution in our N&C segment increased by approximately 62.3% as compared to the same period in 2013.

The increase is primarily attributable to the inclusion of direct contribution associated with our acquisition of Motorola Home.

31-------------------------------------------------------------------------------- Table of Contents Other Expense (Income) Interest Expense Interest expense for the three months ended September 30, 2014 and 2013 was $14.2 million and $25.2 million respectively. For the nine months ended September 30, 2014 and 2013, interest expense was $49.0 million and $48.4 million respectively. During the nine months ended September 30, 2014, optional debt pre-payments were made resulting in the accelerated write-off of deferred financing fees and debt discount of $2.7 million. In addition, interest expense reflects the amortization of deferred finance fees, the debt discount for the term loans and interest paid on term loans and other debt obligations. The three and nine months ended September 30, 2013, interest expense also included the non-cash interest component of our convertible subordinated notes which were fully redeemed during the fourth quarter of 2013.

Interest Income Interest income during the three months ended September 30, 2014 and 2013 was $0.7 million and $0.8 million, respectively. During the nine months ended September 30, 2014 and 2013, interest income was $1.9 million and $2.3 million, respectively. The income reflects interest earned on cash, cash equivalents, short-term and long-term investments.

Loss on Foreign Currency During the three and nine months ended September 30, 2014, we recorded a foreign currency loss of approximately $3.1 million and $3.8 million, respectively.

During the three and nine months ended September 30, 2013, we recorded a foreign currency gain of approximately $3.8 million and $2.7 million, respectively. We have US dollar functional currency entities that bill certain international customers in their local currency and foreign functional currency entities that procure in U.S. dollars. Additionally, certain intercompany transactions are denominated in foreign currencies and subject to revaluation. To mitigate the volatility related to fluctuations in the foreign exchange rates, we have entered into various foreign currency contracts. The gain or loss on foreign currency is driven by the fluctuations in the foreign currency exchange rates.

Loss (Gain) on Investments During the three months ended September 30, 2014 and 2013, we recorded a net loss (gain) on investments, including impairment charges in 2014, of $6.4 million, and $(0.3) million, respectively. During the nine months ended September 30, 2014 and 2013, we recorded a net loss (gain) on investments, including impairment charges in 2014, related to these investments of $11.3 million, and $(1.5) million, respectively.

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

During the third quarter of 2014, the Company performed an evaluation of its investments and concluded that two private companies had indicators of impairment, and that their fair value had declined. This resulted in other-than-temporary impairment charges of $4.0 million during the quarter ended September 30, 2014. No impairment charges were recorded in 2013.

Other Expense (Income), net Other expense (income), net for the three months ended September 30, 2014 and 2013 was $(0.1) million and $1.7 million, respectively. For the nine months ended September 30, 2014 and 2013, other expense was $6.5 million and $13.4 million, respectively.

For the nine months ended September 30, 2014, we recorded a $2.1 million write-down in the carrying value of land and building reclassified as held for sale as a result of obtaining a letter of intent for its sale and is included in other expense (income), net.

32-------------------------------------------------------------------------------- Table of Contents In connection with Comcast's agreement in January 2013 to invest in ARRIS upon the acquisition of Motorola Home, accounting guidance requires that, since the agreed-upon purchase price was less than the market price on the date of agreement, the resulting forward arrangement be marked to market for the difference in fair value. This resulted in a mark-to-market adjustment of $13.2 million in the nine months ended September 30, 2013 and is recorded as Other expense (income), net.

Income Tax Expense For the three and nine month periods ended September 30, 2014, we recorded income tax expense of $44.5 million and $48.7 million, respectively as compared to a tax benefit of $28.0 million and $76.6 million, respectively in the same periods in 2013. The change in the income tax expense (benefit) for the three and nine month periods ended September 30, 2014 compared to the three and nine months period ended September 30, 2013, was due to the change in earnings from continuing operations, as a result of the Motorola Home acquisition that occurred on April 17, 2013 and its related significant, infrequent and unusual book charges. In addition, there were significant and unusual tax charges relating to an estimated increase in acquired net operating losses from the Motorola Home acquisition, less associated valuation allowances, a favorable change in state deferred tax rates due to supply chain related integration planning, an unfavorable accrual of uncertain tax positions relating to dual consolidated losses, a favorable impact of intangibles reattributed and an unfavorable impact from return to provision adjustments.

For the nine month period ended September 30, 2014, the Company recorded a pre-tax book loss of approximately $30.6 million relating to acquisition costs incurred on the Motorola Home acquisition, on which a tax benefit of $10.9 million was recorded. The company also recorded pre-tax book losses of $9.1 million on investments and available for sale assets, generating a tax benefit of $3.3 million during the nine month period ended September 30, 2014. Also during the nine month period ended September 30, 2014, the Company recorded a tax benefit of approximately $18.2 million relating to an estimated increase in acquired net operating losses from the Motorola Home acquisition, a tax expense of approximately $4.4 million on additional liabilities for uncertain tax positions, a $3.8 million benefit on changes in state deferred income tax rates, a $1.8 million benefit on changes to valuation allowances, a benefit of $4.0 million for reattributed intangibles, and an unfavorable charge of $6.2 million for provision to return adjustments. The Company has not yet recorded a favorable impact from research and development credits, as the credit has not yet been reenacted for the 2014 tax year.

During the third quarter of 2014, the Company identified and corrected an immaterial error in the accounting for income taxes related to the prior year ended December 31, 2013. The correction related to the Company's subsequent consideration of certain tax consequences related to a legal entity and tax restructuring completed in the fourth quarter of 2013. The impact of adjusting these amounts had a non-cash effect, increasing income tax expense and noncurrent income tax liabilities by $9.8 million. In accordance with ASC Topic 250, Accounting Changes and Error Corrections, the Company evaluated the impact on its financial statements for the year ended December 31, 2013 and the expected full year results for the year ending December 31, 2014 and concluded that the results of operations for these periods were not materially misstated.

In reaching its conclusion the Company considered both quantitative and qualitative factors. The quantitative factors included calculating the impact of the error on the effected financial statements and assessing materiality. The qualitative factors included, but were not limited to the absences of impact on debt covenants, management compensation and segment reporting. Based on its evaluation, the Company concluded that it is not probable that the judgment of a reasonable person relying on the financial statements would have been changed or influenced by the correction.

33 -------------------------------------------------------------------------------- Table of Contents Financial Liquidity and Capital Resources Overview Following completion of the Motorola Home acquisition, one of our key strategies remains maintaining and improving our capital structure. The key metrics we focus on are summarized in the table below: Liquidity & Capital Resources Data Nine Months Ended September 30, 2014 2013 (in thousands, except DSO and turns) Key Working Capital Items Cash provided by operating activities $ 337,091 $ 380,198 Cash, cash equivalents, and short-term investments $ 593,816 $ 666,501 Long-term U.S. corporate & government agency bonds $ 5,331 $ 28,477 Accounts receivable, net $ 703,566 $ 627,844 Days Sales Outstanding ("DSOs") 47 55 (1) Inventory $ 368,628 $ 350,919 Inventory turns 11.6 9.0 (1) Key Financing Items Convertible notes at face value $ - $ 231,972 Term loans at face value $ 1,561,313 $ 1,893,375 Cash used for debt repayment $ 195,903 $ 31,625 Capital Expenditures $ 41,759 $ 53,383 (1) Using annualized activity from the third quarter 2013, the first full quarter as a combined company following the Acquisition.

In managing our liquidity and capital structure, we have been and are focused on key goals, and we have and will continue in the future to implement actions to achieve them. They include: • Liquidity - ensure that we have sufficient cash resources or other short-term liquidity to manage day to day operations.

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

• Deleverage - reduce our debt obligation.

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

Accounts receivable increased during the first nine months of 2014 as compared to 2013, primarily as a result of higher sales. Looking forward, it is possible that DSOs may increase dependent upon our customer mix and payment patterns, particularly if international sales increase as customers internationally typically have longer payment terms.

Inventory increased in 2014 as compared to 2013. Inventory turns during the first nine months of 2014 were 11.6 as compared to 9.0 in the same period of 2013.

34 -------------------------------------------------------------------------------- Table of Contents Term Debt Repayments In the first nine months of 2014, we repaid $195.9 million of debt, of which $41.2 million is of our term debt, including a $150 million of optional prepayment and $4.7 million of debt assumed and settled in conjunction with the closing of the Seawell acquisition in April 2014.

In the first nine months of 2013, we repaid $31.6 million of our term debt.

Summary of Current Liquidity Position and Potential for Future Capital Raising We believe our current liquidity position, where we have approximately $593.8 million of cash, cash equivalents, and short-term investments and $5.3 million of long-term marketable securities on hand as of September 30, 2014, together with approximately $247.4 million in availability under our new Revolving Credit Facility, together with the prospects for continued generation of cash from operations are adequate for our short- and medium-term business needs. Our cash, cash-equivalents and short-term investments as of September 30, 2014 include approximately $167.9 million held by foreign subsidiaries whose earnings we expect to reinvest indefinitely outside of the United States. We do not expect to need the cash generated by those foreign subsidiaries to fund our domestic operations. However, in the unforeseen event that we repatriate cash from those foreign subsidiaries, in excess of what is owed to the United States parent, we may be required to provide for and pay U.S. taxes on permanently repatriated funds.

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

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

Senior Secured Credit Facilities In April 2013, we entered into senior secured credit facilities with Bank of America, N.A. and various other institutions, which are comprised of (i) a "Term Loan A Facility" of $1.1 billion, (ii) a "Term Loan B Facility" of $825 million and (iii) a "Revolving Credit Facility" of $250 million. The Term Loan A Facility and the Revolving Credit Facility have terms of five years. The Term Loan B Facility has a term of seven years. Interest rates on borrowings under the senior credit facilities are set forth in the table below. As of September 30, 2014, we had $1,561.3 million face value outstanding under the Term Loan A and Term Loan B Facilities and no amounts drawn under the Revolving Credit Facility and letters of credit totaling $2.6 million issued under the Revolving Credit Facility.

Rate As of September 30, 2014 Term Loan A LIBOR + 1.75 % 1.90 % Term Loan B LIBOR(1) + 2.50 % 3.25 % Revolving Credit Facility(2) LIBOR + 1.75 % Not Applicable (1) Includes LIBOR floor of 0.75% (2) Includes unused commitment fee of 0.35% and letter of credit fee of 1.75% not reflected in interest rate above.

Borrowings under the senior secured credit facilities are secured by first priority liens on substantially all of our assets and certain of our present and future subsidiaries who are or become parties to, or guarantors under, the credit agreement governing the senior secured credit facilities (the "Credit Agreement"). The Credit Agreement contains usual and customary limitations on indebtedness, liens, restricted payments, acquisitions and asset sales in the form 35 -------------------------------------------------------------------------------- Table of Contents of affirmative, negative and financial covenants, which are customary for financings of this type, including the maintenance of a minimum consolidated interest coverage ratio of not less than 3.5:1 and a maximum consolidated net leverage ratio of 3.75:1 (with an additional scheduled decreases to 3.5:1). As of September 30, 2014, we were in compliance with all covenants under the Credit Agreement.

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

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

Commitments Our contractual obligations are disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013. There has been no material change to our contractual obligations during the first nine months of 2014.

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

Cash Flow Below is a table setting forth the key line items of our Consolidated Statements of Cash Flows (in thousands): For the Nine Months Ended September 30, 2014 2013 Cash provided by Operating activities $ 337,091 $ 380,198 Investing activities (53,238 ) (1,972,719 ) Financing activities (199,292 ) 2,001,932 Net increase in cash and cash equivalents $ 84,561 $ 409,411 Operating Activities: Below are the key line items affecting cash provided by operating activities (in thousands): For the Nine Months Ended September 30, 2014 2013 Net income (loss) $ 134,451 $ (45,943 ) Adjustments to reconcile net income to cash provided by operating activities 274,773 181,716 Net income including adjustments 409,224 135,773 (Increase) decrease in accounts receivable (70,627 ) 17,793 (Increase) decrease in inventory (38,499 ) 60,345 Increase in accounts payable and accrued liabilities 2,592 155,264 All other - net 34,401 11,023 Cash provided by operating activities $ 337,091 $ 380,198 Net income including adjustments, increased $273.5 million during the first nine months of 2014 as compared to 2013.

Accounts receivable increased by $70.6 million during the first nine months of 2014. This increase was primarily a result of higher sales and payment patterns of our customers.

Inventory increased by $38.5 million during the first nine months of 2014, reflecting robust demand for certain products. The decrease in 2013 reflects the turnaround effect of inventory markup of $57.6 million to fair value in purchase accounting as a result of the Acquisition and the disposal of certain inventory as a result of product rationalization.

36-------------------------------------------------------------------------------- Table of Contents Accounts payable and accrued liabilities increased by $2.6 million during the first nine months of 2014. The increase of $155.3 million during the first nine months of 2013 was largely related the increase in accounts payable due to the acquisition of Motorola Home.

All other accounts, net, includes the changes in other receivables, income taxes payable (recoverable), and prepaids. The other receivables represent amounts due from our contract manufacturers for material used in the assembly of our finished goods. The change in our income taxes recoverable account is a result of the timing of the actual estimated tax payments during the year as compared to the actual tax liability for the year. The net change during the first nine months of 2014 was approximately $34.4 million.

Investing Activities: Below are the key line items affecting investing activities (in thousands): For the Nine Months Ended September 30, 2014 2013 Purchases of property, plant and equipment $ (41,759 ) $ (53,383 ) Sale of property, plant and equipment 19 90 Purchases of investments (40,901 ) (104,546 ) Sales of investments 29,319 393,234 Acquisitions, net of cash acquired 84 (2,208,114 ) Cash used in investing activities $ (53,238 ) $ (1,972,719 ) Purchases of Property, Plant and Equipment - This represents capital expenditures which are mainly for test equipment, laboratory equipment, and computing equipment.

Sale of Property, Plant and Equipment-This represents the cash proceeds we received from the sale of property, plant and equipment.

Purchases and Sales of Investments-This represents purchases and sales of securities Acquisitions, Net of Cash Acquired - This represents cash investments we have made in our acquisitions.

Financing Activities: Below are the key line items affecting our financing activities (in thousands): For the Nine Months Ended September 30, 2014 2013 Proceeds from issuance of debt $ - $ 1,925,000 Cash paid for debt discount - (9,853 ) Payment of debt obligations (195,903 ) (31,625 ) Early redemption of convertible notes - (79 ) Deferred financing costs paid - (42,356 ) Excess income tax benefits from stock-based compensation plans 14,651 6,416 Repurchase of shares to satisfy minimum tax withholdings (29,605 ) (12,522 ) Proceeds from issuance of common stock 11,565 166,951 Cash (used in) provided by financing activities $ (199,292 ) $ 2,001,932 Proceeds From Issuance of Debt - As part of the Motorola Home acquisition, we entered into senior secured credit facilities which include Term Loan A facility of $1.1 billion with a term of five years and Term Loan B facility of $0.8 billion with a term of seven years.

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

Payment of Debt Obligations - This represents the payment of the term loans under the senior secured credit facilities plus the payment of debt assumed and settled in conjunction with the closing of the SeaWell acquisition in April 2014.

Early Redemption of Convertible Notes - As a result of the holding company reorganization undertaken in connection with the Motorola Home acquisition, holders of the senior notes had the right to require us to repurchase the convertible senior notes for 100% of the principal amount plus accrued and unpaid interest or to convert the convertible senior notes for the consideration. This represents the portion of the convertible senior notes that were tendered pursuant to the repurchase right and surrendered pursuant to the conversion right.

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

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

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

Proceeds from Issuance of Common Stock - This represents cash proceeds related to the exercise of employee stock options, offset by expenses paid related to issuance of common stock. It also represents cash proceeds from shares issued to Comcast in relation to the Acquisition.

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

Foreign Currency A significant portion of our products are manufactured or assembled in China, Mexico and Taiwan, and we have research and development centers in Argentina, China, India, Ireland, Israel and Sweden. Our sales into international markets have been and are expected in the future to be an important part of our business. These foreign operations are subject to the usual risks inherent in conducting business abroad, including risks with respect to currency exchange rates, economic and political destabilization, restrictive actions and taxation by foreign governments, nationalization, the laws and policies of the United States affecting trade, foreign investment and loans, and foreign tax laws.

We have certain international customers that are billed in their local currency and certain international operations that procure in U.S. dollars. In addition, we have certain predicable 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 revenues and expenses. The percentage can vary, based on the predictability of the revenues denominated in the foreign currency.

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

We execute letters of credit and bank guarantees in favor of certain landlords, customers and vendors to guarantee performance on contracts. Certain financial instruments require cash collateral, and these amounts are reported as restricted cash. As of September 30, 2014 and December 31, 2013, we had approximately $1.0 million and $1.1 million outstanding, respectively, of restricted cash.

Cash, Cash Equivalents, and Short-Term Investments Our cash and cash equivalents (which are highly-liquid investments with an original maturity of three months or less) are primarily held in demand deposit and money market deposit accounts that pay taxable interest. We hold short-term investments consisting of debt securities classified as available-for-sale, which are stated at estimated fair value. These debt securities consist primarily of commercial paper, certificates of deposits, and U.S. government agency financial instruments.

We hold cost method investments in private companies. These investments are recorded at $10.3 million and $15.3 million as of September 30, 2014 and December 31, 2013, respectively. See Note 5 of Notes to the Consolidated Financial Statements for disclosures related to the fair value of our investments.

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

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

Capital Expenditures Capital expenditures are made at a level designed to support the strategic and operating needs of the business. ARRIS' capital expenditures were $41.8 million in the first nine months of 2014 as compared to $53.4 million in the first nine months of 2013. Management expects to invest approximately $55 million in capital expenditures for the fiscal year 2014.

Critical Accounting Policies and Estimates The accounting and financial reporting policies of ARRIS are in conformity with U.S. generally accepted accounting principles, which requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Management has discussed the development and selection of the Company's critical accounting estimates with the audit committee of the Company's Board of Directors and the audit committee has reviewed the Company's related disclosures.

Our critical accounting policies and estimates are disclosed in our Form 10-K for the year ended December 31, 2013, as filed with the SEC. Our critical accounting estimates have not changed in any material respect during the nine months ended September 30, 2014.

Forward-Looking Statements Certain information and statements contained in this Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report, including statements using terms such as "may," "expect," "anticipate," "intend," "estimate," "believe," "plan," "continue," "could be," or similar variations or the negative thereof, constitute forward-looking statements with respect to the financial condition, results of operations, and business of ARRIS, including statements that are based on current expectations, estimates, forecasts, and 39 -------------------------------------------------------------------------------- Table of Contents projections about the markets in which we operate and management's beliefs and assumptions regarding these markets. These and any other statements in this document that are not statements about historical facts are "forward-looking statements." We caution investors that forward-looking statements made by us are not guarantees of future performance and that a variety of factors could cause our actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements. Important factors that could cause results or events to differ from current expectations are described in the risk factors set forth in Item 1A, Part II, "Risk Factors." These factors are not intended to be an all-encompassing list of risks and uncertainties that may affect the operations, performance, development and results of our business.

In providing forward-looking statements, ARRIS expressly disclaims any obligation to update publicly or otherwise these statements, whether as a result of new information, future events or otherwise except to the extent required by law.

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