##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 For the quarter ended September 30, 2006
 of
 ARRIS GROUP, INC.
 
 3871 Lakefield Drive
Suwanee, GA 30024
(678) 473-2000




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##### 



ARRIS GROUP, INC.
FORM 10-Q
For the Three and Nine Months Ended September 30, 2006
 Table of Contents
 PagePart I. Financial InformationItem 1. Financial Statementsa) Consolidated Balance Sheets as of September 30, 2006
and December 31, 2005
    
    1b) Consolidated Statements of Operations for the Three
and Nine Months Ended September 30, 2006 and 2005
    
    2c) Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2006 and 2005
    
    3d) Notes to the Consolidated Financial Statements
    
    4Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    11Item 3. Quantitative and Qualitative Disclosures on Market Risk
    
    22Item 4. Controls and Procedures
    
    23Part II. Other InformationItem 1A Risk Factors
    
    24Item 6. Exhibits
    
    27Signatures
    
    28EX-31.1 SECTION 302 CERTIFICATION OF CEOEX-31.2 SECTION 302 CERTIFICATION OF CFOEX-32.1 SECTION 906 CERTIFICATION OF CEOEX-32.2 SECTION 906 CERTIFICATION OF CFO




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##### Table of Contents



PART I. FINANCIAL INFORMATION
 
 Item 1. FINANCIAL STATEMENTS
 ARRIS GROUP, INC.
 
 CONSOLIDATED BALANCE SHEETS
 (in thousands, except share data)
 September 30,
    
    
    December 31,2006
    
    
    2005(unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    179,971
    
    
    $
    75,286Short-term investments, at fair value
    
    
    30,000
    
    
    
    54,250Total cash, cash equivalents and short-term investments
    
    
    209,971
    
    
    
    129,536Restricted cash
    
    
    6,126
    
    
    
    6,073Accounts receivable (net of allowances for doubtful
accounts of $2,832 in 2006 and $3,729 in 2005)
    
    
    120,740
    
    
    
    83,540Other receivables
    
    
    5,621
    
    
    
    286Inventories, net
    
    
    101,062
    
    
    
    113,909Prepaid assets
    
    
    3,751
    
    
    
    10,945Other current assets
    
    
    2,435
    
    
    
    4,331Total current assets
    
    
    449,706
    
    
    
    348,620Property, plant and equipment (net of accumulated
depreciation of $75,938 in 2006 and $69,309 in 2005)
    
    
    25,338
    
    
    
    25,557Goodwill
    
    
    150,569
    
    
    
    150,569Intangibles (net of accumulated amortization of $106,775
in 2006 and $106,200 in 2005)
    
    
    345
    
    
    
    920Investments
    
    
    3,438
    
    
    
    3,321Other assets
    
    
    641
    
    
    
    416$
    630,037
    
    
    $
    529,403LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    44,440
    
    
    $
    35,920Accrued compensation, benefits and related taxes
    
    
    19,630
    
    
    
    20,424Accrued warranty
    
    
    8,582
    
    
    
    8,479Other accrued liabilities
    
    
    28,371
    
    
    
    20,633Total current liabilities
    
    
    101,023
    
    
    
    85,456Accrued pension
    
    
    11,947
    
    
    
    12,636Other long-term liabilities
    
    
    5,589
    
    
    
    5,594Total liabilities
    
    
    118,559
    
    
    
    103,686Stockholders equity:Preferred stock, par value $1.00 per share, 5.0 million
shares authorized; none issued and outstanding
    
    
    
    
    
    
    Common stock, par value $0.01 per share, 320.0 million
shares authorized; 107.8 million and 105.6 million
shares issued and outstanding in 2006 and 2005,
respectively
    
    
    1,086
    
    
    
    1,069Capital in excess of par value
    
    
    747,721
    
    
    
    732,405Accumulated deficit
    
    
    (233,519
    )
    
    
    (305,555
    )Unrealized gain on marketable securities
    
    
    1,219
    
    
    
    1,077Unfunded pension losses
    
    
    (4,618
    )
    
    
    (4,618
    )Unrealized gain (loss) on derivatives
    
    
    (227
    )
    
    
    1,523Cumulative translation adjustments
    
    
    (184
    )
    
    
    (184
    )Total stockholders equity
    
    
    511,478
    
    
    
    425,717$
    630,037
    
    
    $
    529,403
  1




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##### Table of Contents



ARRIS
GROUP, INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited  (in thousands, except per share data and percentages)
 Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Net sales
    
    $
    228,646
    
    
    $
    200,957
    
    
    $
    656,980
    
    
    $
    499,082Cost of sales
    
    
    165,467
    
    
    
    145,979
    
    
    
    473,554
    
    
    
    366,230Gross margin
    
    
    63,179
    
    
    
    54,978
    
    
    
    183,426
    
    
    
    132,852Gross margin %
    
    
    27.6
    %
    
    
    27.4
    %
    
    
    27.9
    %
    
    
    26.6
    %Operating expenses:Selling, general and administrative expenses
    
    
    21,524
    
    
    
    20,070
    
    
    
    64,523
    
    
    
    53,803Research and development expenses
    
    
    16,066
    
    
    
    15,954
    
    
    
    50,460
    
    
    
    45,091Restructuring and impairment charges
    
    
    4
    
    
    
    34
    
    
    
    347
    
    
    
    430Amortization of intangibles
    
    
    138
    
    
    
    218
    
    
    
    575
    
    
    
    993Total operating expenses
    
    
    37,732
    
    
    
    36,276
    
    
    
    115,905
    
    
    
    100,317Operating income
    
    
    25,447
    
    
    
    18,702
    
    
    
    67,521
    
    
    
    32,535Other expense (income):Interest expense
    
    
    27
    
    
    
    11
    
    
    
    50
    
    
    
    2,033Loss on debt retirement
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,372Loss (gain) on investments
    
    
    32
    
    
    
    (60
    )
    
    
    29
    
    
    
    15Interest income
    
    
    (2,756
    )
    
    
    (777
    )
    
    
    (6,357
    )
    
    
    (2,099
    )Loss (gain) in foreign currency
    
    
    201
    
    
    
    288
    
    
    
    (943
    )
    
    
    145Other expense
    
    
    68
    
    
    
    83
    
    
    
    269
    
    
    
    366Income from continuing operations before income taxes
    
    
    27,875
    
    
    
    19,157
    
    
    
    74,473
    
    
    
    29,703Income tax expense
    
    
    1,328
    
    
    
    307
    
    
    
    2,562
    
    
    
    242Net income from continuing operations
    
    
    26,547
    
    
    
    18,850
    
    
    
    71,911
    
    
    
    29,461Income (loss) from discontinued operations
    
    
    15
    
    
    
    (30
    )
    
    
    124
    
    
    
    56Net income
    
    $
    26,562
    
    
    $
    18,820
    
    
    $
    72,035
    
    
    $
    29,517Net income per common share Basic:Income from continuing operations
    
    $
    0.25
    
    
    $
    0.18
    
    
    $
    0.67
    
    
    $
    0.31Income from discontinued operations
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00Net income
    
    $
    0.25
    
    
    $
    0.18
    
    
    $
    0.67
    
    
    $
    0.31Diluted:Income from continuing operations
    
    $
    0.24
    
    
    $
    0.18
    
    
    $
    0.66
    
    
    $
    0.31Income from discontinued operations
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00
    
    
    
    0.00Net income
    
    $
    0.24
    
    
    $
    0.18
    
    
    $
    0.66
    
    
    $
    0.31Weighted average common shares:Basic
    
    
    107,678
    
    
    
    104,434
    
    
    
    107,007
    
    
    
    93,768Diluted
    
    
    109,090
    
    
    
    107,049
    
    
    
    109,311
    
    
    
    95,368
  2




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##### Table of Contents



ARRIS GROUP, INC.
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 (unaudited
 (in thousands)
 Nine Months EndedSeptember 30,2006
    
    
    2005Operating activities:Net income
    
    $
    72,035
    
    
    $
    29,517Adjustments to reconcile net income to net cash provided by (used in) operating activities:Depreciation
    
    
    7,235
    
    
    
    7,941Amortization of intangibles
    
    
    575
    
    
    
    993Equity compensation expense
    
    
    7,068
    
    
    
    4,341Excess tax benefits from stock-based compensation plans
    
    
    (538
    )
    
    
    Amortization of deferred finance fees
    
    
    
    
    
    
    305Provision for doubtful accounts
    
    
    (248
    )
    
    
    (355
    )Gain related to previously written off receivables
    
    
    (1,573
    )
    
    
    Loss (gain) on disposal of fixed assets
    
    
    (2
    )
    
    
    131Loss on investments
    
    
    32
    
    
    
    75Loss on debt retirement
    
    
    
    
    
    
    2,372Impairment of long-lived assets
    
    
    
    
    
    
    291Gain on discontinued product lines
    
    
    (124
    )
    
    
    (56
    )Changes in operating assets and liabilities, net of effect of
acquisitions and dispositions:Accounts receivable
    
    
    (37,515
    )
    
    
    (39,525
    )Other receivables
    
    
    (5,335
    )
    
    
    (467
    )Inventory
    
    
    12,847
    
    
    
    2,824Accounts payable and accrued liabilities
    
    
    15,590
    
    
    
    (7,249
    )Other, net
    
    
    7,162
    
    
    
    (10,242
    )Net cash provided by (used in) operating activities
    
    
    77,209
    
    
    
    (9,104
    )Investing activities:Purchases of property, plant and equipment
    
    
    (7,080
    )
    
    
    (7,555
    )Cash proceeds from sale of property, plant and equipment
    
    
    22
    
    
    
    40Cash paid for acquisition, net of cash acquired
    
    
    
    
    
    
    (89
    )Purchases of short-term investments
    
    
    (51,900
    )
    
    
    (51,250
    )Disposals of short-term investments
    
    
    76,150
    
    
    
    83,032Purchases of equity investments
    
    
    
    
    
    
    (259
    )Net cash provided by investing activities
    
    
    17,192
    
    
    
    23,919Financing activities:Excess tax benefits from stock-based compensation plans
    
    
    538
    
    
    
    Proceeds from issuance of common stock and other
    
    
    9,746
    
    
    
    8,307Net cash provided by financing activities
    
    
    10,284
    
    
    
    8,307Net increase in cash and cash equivalents
    
    
    104,685
    
    
    
    23,122Cash and cash equivalents at beginning of period
    
    
    75,286
    
    
    
    25,072Cash and cash equivalents at end of period
    
    $
    179,971
    
    
    $
    48,194Noncash
investing and financing activitiesNet tangible
assets acquired, excluding cash
    
    $
    
    
    
    
    799Investment
in acquired company
    
    
    
    
    
    
    (1,325
    )Net
liabilities assumed
    
    
    
    
    
    
    (76
    )Intangible
assets acquired
    
    
    
    
    
    
    691Cash paid
for acquisition, net of cash acquired
    
    $
    
    
    
    
    89Equity
issued in exchange for 41⁄2%
 convertible subordinate notes due 2008
    
    $
    
    
    
    $
    75,000Equity
issued for make-whole interest payment 
41⁄2%
 convertible
subordinated notes due 2008
    
    $
    
    
    
    $
    2,372
  3




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ARRIS GROUP, INC.
 
 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
 (unaudited
 Note 1. Organization and Basis of Presentation
   Note 2. Impact of Recently Issued Accounting Standards
 Employers Accounting for Defined Benefit Pension and Other Postretirement Plans.
 Fair Value Measurements
 Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial
Statements
 Accounting for Uncertainty in
Income Taxes  an interpretation of FASB Statement No. 109, Accounting for Income Taxes,
 4




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How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income
Statement (That Is, Gross Versus Net Presentation).
 Note 3. Stock-Based Compensation
 Share-Based Payments Accounting for Stock Issued to Employees
  Nine Months Ended September 30,(in thousands, except per share data)(unaudited)2006
    
    
    2005Net income as reported
    
    $
    72,035
    
    
    $
    29,517Add: Stock-based employee compensation included in reported net income, net of taxes
    
    
    7,068
    
    
    
    4,341Deduct: Total stock-based employee compensation expense determined under fair value
based methods for all awards, net of taxes
    
    
    (7,068
    )
    
    
    (14,237
    )*Net income, pro forma
    
    $
    72,035
    
    
    $
    19,621Net income per common share:Basic  as reported
    
    $
    0.67
    
    
    $
    0.31Basic  pro forma
    
    $
    0.67
    
    
    $
    0.21Diluted  as reported
    
    $
    0.66
    
    
    $
    0.31Diluted  pro forma
    
    $
    0.66
    
    
    $
    0.21
 
 *
    
    Includes approximately $5.7 million of expense related to the acceleration of
out-of-the-money options in the second quarter of 2005. 5




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Note 4. Pension Benefits
 Components of Net Periodic Pension Benefit Cost
 Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)(unaudited)Service cost
    
    $
    130
    
    
    $
    114
    
    
    $
    390
    
    
    $
    344Interest cost
    
    
    370
    
    
    
    353
    
    
    
    1,108
    
    
    
    1,060Expected gain on plan assets
    
    
    (282
    )
    
    
    (261
    )
    
    
    (844
    )
    
    
    (784
    )Amortization of prior service cost
    
    
    120
    
    
    
    119
    
    
    
    358
    
    
    
    358Amortization of net (gain) loss
    
    
    2
    
    
    
    (34
    )
    
    
    6
    
    
    
    (103
    )Net periodic pension cost
    
    $
    340
    
    
    $
    291
    
    
    $
    1,018
    
    
    $
    875
 Employer Contributions
  Note 5. Guarantees
 Warranty
    Balance at December 31, 2005
    
    $
    8,479Accruals related to warranties (including changes in estimates)
    
    
    2,910Settlements made (in cash or in kind)
    
    
    (2,807
    )Balance at September 30, 2006 (unaudited)
    
    $
    8,582
 Note 6. Restructuring and Impairment Charges
  6




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(in thousands)Balance as of December 31, 2005
    
    $
    3,121First quarter payments
    
    
    (380
    )First quarter adjustments to accrual
    
    
    228Second quarter payments
    
    
    (404
    )Second quarter adjustments to accrual
    
    
    (5
    )Third quarter payments
    
    
    (395
    )Third quarter adjustments to accrual
    
    
    Balance as of September 30, 2006 (unaudited)
    
    $
    2,165
 Note 7. Inventories
   September 30,
    
    
    December 31,2006
    
    
    2005(unaudited)Raw material
    
    $
    904
    
    
    $
    788Finished goods
    
    
    100,158
    
    
    
    113,121Total net inventories
    
    $
    101,062
    
    
    $
    113,909
 Note 8. Property, Plant and Equipment
  September 30,
    
    
    December 31,2006
    
    
    2005(unaudited)Land
    
    $
    1,822
    
    
    $
    1,822Building and leasehold improvements
    
    
    11,388
    
    
    
    11,126Machinery and equipment
    
    
    88,066
    
    
    
    81,918101,276
    
    
    
    94,866Less: Accumulated depreciation
    
    
    (75,938
    )
    
    
    (69,309
    )Total property, plant and equipment, net
    
    $
    25,338
    
    
    $
    25,557
 Note 9. Goodwill and Intangible Assets
  7




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September 30, 2006 (unaudited)
    
    
    December 31, 2005Net
    
    
    
    
    
    
    
    
    
    
    NetGross
    
    
    Accumulated
    
    
    Book
    
    
    Gross
    
    
    Accumulated
    
    
    BookAmount
    
    
    Amortization
    
    
    Value
    
    
    Amount
    
    
    Amortization
    
    
    ValueExisting technology acquired:Arris Interactive L.L.C
    
    $
    51,500
    
    
    $
    (51,500
    )
    
    
    
    
    
    $
    51,500
    
    
    $
    (51,500
    )
    
    $
    Cadant, Inc.
    
    
    53,000
    
    
    
    (53,000
    )
    
    
    
    
    
    
    53,000
    
    
    
    (53,000
    )
    
    
    Com21
    
    
    1,929
    
    
    
    (1,929
    )
    
    
    
    
    
    
    1,929
    
    
    
    (1,527
    )
    
    
    402cXm Broadband
    
    
    691
    
    
    
    (346
    )
    
    
    345
    
    
    
    691
    
    
    
    (173
    )
    
    
    518Total
    
    $
    107,120
    
    
    $
    (106,775
    )
    
    $
    345
    
    
    $
    107,120
    
    
    $
    (106,200
    )
    
    $
    920
  2006
    
    $
    572007
    
    $
    2302008
    
    $
    582009
    
    $
    2010
    
    $
    
 Note 10. Long-Term Obligations
    8




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Note 11. Comprehensive Income
  Three Months Ended September 30,
    
    Nine Months Ended September 30,(unaudited)2006
    
    2005
    
    2006
    
    2005Net income
    
    $
    26,562
    
    
    $
    18,820
    
    
    $
    72,035
    
    
    $
    29,517Changes in the following equity accounts:Unrealized gain on marketable securities
    
    
    54
    
    
    
    137
    
    
    
    142
    
    
    
    269Unrealized gain (loss) on derivative
instruments
    
    
    616
    
    
    
    991
    
    
    
    (1,750
    )
    
    
    991Translation adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1
    )Comprehensive income
    
    $
    27,232
    
    
    $
    19,948
    
    
    $
    70,427
    
    
    $
    30,776
 Note 12. Sales Information
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(unaudited)2006
    
    2005
    
    2006
    
    2005Comcast
    
    $
    98,841
    
    
    $
    50,447
    
    
    $
    248,017
    
    
    $
    106,105% of sales
    
    
    43.2
    %
    
    
    25.1
    %
    
    
    37.8
    %
    
    
    21.3
    %Liberty Media International
    
    
    19,730
    
    
    
    25,930
    
    
    
    70,106
    
    
    
    74,480% of sales
    
    
    8.6
    %
    
    
    12.9
    %
    
    
    10.7
    %
    
    
    14.9
    %Cox Communications
    
    
    20,645
    
    
    
    33,953
    
    
    
    73,486
    
    
    
    88,328% of sales
    
    
    9.0
    %
    
    
    16.9
    %
    
    
    11.2
    %
    
    
    17.7
    %Time-Warner Cable
    
    
    17,087
    
    
    
    23,197
    
    
    
    57,765
    
    
    
    60,499% of sales
    
    
    7.5
    %
    
    
    11.5
    %
    
    
    8.8
    %
    
    
    12.1
    %
   9




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##### Table of Contents



Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited)2006
    
    
    2005
    
    
    2006
    
    
    2005Broadband
    
    $
    87,636
    
    
    $
    81,263
    
    
    $
    271,823
    
    
    $
    222,148Supplies & CPE
    
    
    141,010
    
    
    
    119,694
    
    
    
    385,157
    
    
    
    276,934Total sales
    
    $
    228,646
    
    
    $
    200,957
    
    
    $
    656,980
    
    
    $
    499,082
   Note 13. Earnings Per Share
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,(unaudited)2006
    
    
    2005
    
    
    2006
    
    
    2005Basic:Income from continuing operations
    
    $
    26,547
    
    
    $
    18,850
    
    
    $
    71,911
    
    
    $
    29,461Income (loss) from discontinued
operations
    
    
    15
    
    
    
    (30
    )
    
    
    124
    
    
    
    56Net income
    
    $
    26,562
    
    
    $
    18,820
    
    
    $
    72,035
    
    
    $
    29,517Weighted average shares outstanding
    
    
    107,678
    
    
    
    104,434
    
    
    
    107,007
    
    
    
    93,768Basic earnings per share
    
    $
    0.25
    
    
    $
    0.18
    
    
    $
    0.67
    
    
    $
    0.31Diluted:Income from continuing operations
    
    $
    26,547
    
    
    $
    18,850
    
    
    $
    71,911
    
    
    $
    29,461Income (loss) from discontinued
operations
    
    
    15
    
    
    
    (30
    )
    
    
    124
    
    
    
    56Net income
    
    $
    26,562
    
    
    $
    18,820
    
    
    $
    72,035
    
    
    $
    29,517Weighted average shares outstanding
    
    
    107,678
    
    
    
    104,434
    
    
    
    107,007
    
    
    
    93,768Net effect of dilutive equity awards
    
    
    1,412
    
    
    
    2,615
    
    
    
    2,304
    
    
    
    1,600Total
    
    
    109,090
    
    
    
    107,049
    
    
    
    109,311
    
    
    
    95,368Diluted earnings per share
    
    $
    0.24
    
    
    $
    0.18
    
    
    $
    0.66
    
    
    $
    0.31
 10




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##### Table of Contents



Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 Overview
  
    
    Transition to VoIP with an Everything IP, Everywhere philosophy and build on current
market successes;
    
    Leverage our current voice and data business;
    
    Strengthen and grow our supplies infrastructure distribution channel;
    
    Expand our existing product/services portfolio through internal developments,
partnerships and acquisitions; and
    
    Maintain and improve an already strong capital and expense structure.
  
    
    Our sales, net income, cash from operating activities, and
earnings per share have improved significantly as
compared to the same period in 2005.
 Nine Months Ended September 30,(in millions)2006
    
    2005
    
    IncreaseSales
    
    $
    657.0
    
    
    $
    499.1
    
    
    $
    157.9Net income
    
    $
    72.0
    
    
    $
    29.5
    
    
    $
    42.5Cash provided by (used in) operating activities
    
    $
    77.2
    
    
    $
    (9.1
    )
    
    $
    86.3
 
    
    The VoIP market continued to grow as MSOs continued their rollout of IP telephony. We
leveraged our existing market position in IP-based telephony with product offerings to
increase sales of both EMTA and CMTS products.
    
    We expect demand for CMTS products will continue to increase in future periods as new
services and competition between our customers and their competitors intensifies the need
to provide ever faster download speeds requiring added CMTS capacity and features.
    
    In the third quarter of 2006, we announced that we commenced shipping our C4 CMTS to
Time Warner, a key new account for this product.
    
    We experienced substantial growth in EMTA unit sales and revenues year over year and we
anticipate continued growth in the fourth quarter of 2006. The rate of future growth for
EMTA sales is expected to be lower than what we have experienced to date as many of our
customers have now passed through the initial launch stage. Our ultimate level of sales of
EMTAs will be affected by, but not limited to, such factors as the success our customers
have marketing IP telephony to their subscribers in the future, the success our customers
have retaining their IP telephony subscribers in the future, competitive factors affecting
our market share including price, and the timing and success of new product introductions.
    
    Sales of our CBR products, consistent with the expectation that we previously disclosed,
decreased significantly year over year and quarter over quarter as this product line nears
the end of its life. We anticipate sales of CBR products to further decline in 2007 as end
of life purchase orders are expected to be substantially fulfilled.
    
    Gross margin percentage in the third quarter of 2006 was 27.6%, which compares to 29.0%
in the second quarter of 2006. The decrease, consistent with the expectation that we
previously disclosed, reflects a change in product mix as we sold less CBR product (which
earns a higher than the company average gross margin) and more EMTAs (which earn a lower
than the company average gross margin). Partially offsetting the mix impact was an
increase in margins related to our EMTA products as we sold more of our new cost reduced
product. We anticipate that our gross margins as a percent of sales will improve in the
fourth quarter of 2006 as compared to the third quarter as we expect to sell
proportionately more of our cost reduced 500-series EMTAs (which earn higher gross margins than the
400-series). The ultimate result is
 11




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##### Table of Contents



dependent upon several factors including, but not limited to: product mix, attainment of
cost reductions, and competitive price pressure.
    
    We anticipate that we will utilize all, or the vast majority,
of our non-equity
compensation related federal and state net operating Losses (NOLs) in 2006. As a result,
we expect that in 2007 we will begin to record income tax expense at a full rate of
approximately 38.5%. Depending upon our actual results for 2006, it is possible we may
have insufficient non-equity compensation related NOLs to shelter all of our 2006 income.
As a result, we may incur a higher tax expense in the fourth quarter of 2006 than we have
predicted.
    
    In the fourth quarter of 2006, we will be further analyzing the valuation allowance we
have recorded to reduce our deferred tax assets to zero. We first recorded a valuation
allowance in 2001 and have continued to adjust it so that the current
value of our deferred
tax assets remains zero. At the end of 2005, we continued to be in a three year cumulative
loss position. Our projected income for the full year 2006 is expected to result in a
three year cumulative positive net income position entering 2007. As a result, we
anticipate that we may reverse a significant portion of our valuation allowance in the
fourth quarter of 2006. At the end of the third quarter 2006, the valuation allowance was
approximately $65.0 million. For further detail, see Income Taxes section below.
 Significant Customers
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,(unaudited)2006
    
    2005
    
    2006
    
    2005Comcast
    
    $
    98,841
    
    
    $
    50,447
    
    
    $
    248,017
    
    
    $
    106,105% of sales
    
    
    43.2
    %
    
    
    25.1
    %
    
    
    37.8
    %
    
    
    21.3
    %Liberty Media International
    
    
    19,730
    
    
    
    25,930
    
    
    
    70,106
    
    
    
    74,480% of sales
    
    
    8.6
    %
    
    
    12.9
    %
    
    
    10.7
    %
    
    
    14.9
    %Cox Communications
    
    
    20,645
    
    
    
    33,953
    
    
    
    73,486
    
    
    
    88,328% of sales
    
    
    9.0
    %
    
    
    16.9
    %
    
    
    11.2
    %
    
    
    17.7
    %Time-Warner Cable
    
    
    17,087
    
    
    
    23,197
    
    
    
    57,765
    
    
    
    60,499% of sales
    
    
    7.5
    %
    
    
    11.5
    %
    
    
    8.8
    %
    
    
    12.1
    %
  12




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##### Table of Contents



Comparison of Operations for the Three and Nine Months Ended September 30, 2006 and 2005
 Net Sales
  Net Sales
    
    
    Increase Between 2006 and 2005Three Months
    
    
    Nine Months
    
    
    Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,
    
    
    Ended September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    $
    
    
    %
    
    
    $
    
    
    %Product Category:Broadband
    
    $
    87.6
    
    
    $
    81.3
    
    
    $
    271.8
    
    
    $
    222.2
    
    
    $
    6.3
    
    
    
    7.7
    
    
    $
    49.6
    
    
    
    22.3Supplies & CPE
    
    
    141.0
    
    
    
    119.7
    
    
    
    385.2
    
    
    
    276.9
    
    
    
    21.3
    
    
    
    17.8
    
    
    
    108.3
    
    
    
    39.1Total sales
    
    $
    228.6
    
    
    $
    201.0
    
    
    $
    657.0
    
    
    $
    499.1
    
    
    $
    27.6
    
    
    
    13.7
    
    
    $
    157.9
    
    
    
    31.6
  Net Sales
    
    
    Increase Between 2006 and 2005Three Months
    
    
    Nine Months
    
    
    Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,
    
    
    Ended September 30
    
    
    Ended September 302006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    $
    
    
    %
    
    
    $
    
    
    %Domestic
    
    $
    174.2
    
    
    $
    148.6
    
    
    $
    493.5
    
    
    $
    366.8
    
    
    $
    25.6
    
    
    
    17.2
    
    
    $
    126.7
    
    
    
    34.5International
    
    
    54.4
    
    
    
    52.4
    
    
    
    163.5
    
    
    
    132.3
    
    
    
    2.0
    
    
    
    3.8
    
    
    
    31.2
    
    
    
    23.6Total sales
    
    $
    228.6
    
    
    $
    201.0
    
    
    $
    657.0
    
    
    $
    499.1
    
    
    $
    27.6
    
    
    
    13.7
    
    
    $
    157.9
    
    
    
    31.6
 Broadband Net Sales 2006 vs. 2005
  
    
    Sales of our CMTS product increased in the three and nine months ended September 30,
2006 as compared to the same periods in 2005; most notable was an increase in CMTS volume
to Comcast, among various other customers. It is also noteworthy that
we continued to gain
acceptance by new customers for our flagship C4 CMTS. In the third
quarter 2006, we began
shipping the C4 to Time Warner Cable.
    
    Sales of our CBR voice products were down in the third quarter of 2006 as compared to
the third quarter 2005 and also declined for the first nine months of 2006 as compared to
the same period in 2005 as customers migrate to our newer VoIP products.
  Supplies & CPE Net Sales 2006 vs. 2005
  
    
    Increased sales of our EMTA product as operators ramped up deployment of VoIP. In the
three and nine months ended September 30, 2006, we sold 1.3 million and 3.5 million EMTAs,
respectively, in comparison to approximately 0.9 million and 1.8 million in the three and
nine months 2005, respectively.
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##### Table of Contents



Consolidated Backlog and Book-to-Bill Ratio
  Gross Margin
  Gross Margin $
    
    
    Increase (Decrease) Between 2006 and 2005Three Months
    
    
    Nine Months
    
    
    Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,
    
    
    Ended September 30
    
    
    Ended September 302006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    $
    
    
    %
    
    
    $
    
    
    %Product Category:Broadband
    
    $
    40.5
    
    
    $
    28.4
    
    
    $
    124.8
    
    
    $
    81.9
    
    
    $
    12.1
    
    
    
    42.6
    
    
    $
    42.9
    
    
    
    52.4Supplies & CPE
    
    
    22.7
    
    
    
    26.6
    
    
    
    58.6
    
    
    
    51.0
    
    
    
    (3.9
    )
    
    
    (14.7
    )
    
    
    7.6
    
    
    
    14.9Total
    
    $
    63.2
    
    
    $
    55.0
    
    
    $
    183.4
    
    
    $
    132.9
    
    
    $
    8.2
    
    
    
    14.9
    
    
    $
    50.5
    
    
    
    38.0
  Gross Margin %
    
    Increase (Decrease) Between 2006 and 2005Three Months
    
    Nine Months
    
    Three Months
    
    Nine MonthsEnded September 30,
    
    Ended September 30,
    
    Ended September 30
    
    Ended September 302006
    
    2005
    
    2006
    
    2005
    
    Percentage PointsProduct Category:Broadband
    
    
    46.2
    %
    
    
    34.9
    %
    
    
    45.9
    %
    
    
    36.8
    %
    
    
    11.3
    
    
    
    9.1Supplies & CPE
    
    
    16.1
    %
    
    
    22.2
    %
    
    
    15.2
    %
    
    
    18.4
    %
    
    
    (6.1
    )
    
    
    (3.2
    )Total
    
    
    27.6
    %
    
    
    27.4
    %
    
    
    27.9
    %
    
    
    26.6
    %
    
    
    0.2
    
    
    
    1.3
 Broadband Gross Margin 2006 vs. 2005
  
    
    Gross margin dollars were affected by the quarter-over-quarter and year-over-year
increase in Broadband sales, in particular our CMTS sales.
    
    Gross margin percentages on Broadband products, in particular on CMTS products,
increased as a result of product cost reductions. In the first half of 2005, our next
generation DOCSIS 2.0 CMTS was in the process of being cost reduced. The initial margin
percentages for this product were lower than historical margins due to higher initial
product costs.
  Supplies & CPE Gross Margin 2006 vs. 2005
  
    
    Despite the increase in sales volume of EMTAs in the third quarter 2006 as compared to
2005, the gross margin dollars were negatively impacted by the mix of specific models of
EMTAs sold, resulting in a lower gross margin percentage year over year.
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##### Table of Contents




    
    The significant increase in sales of our EMTAs in the nine months ended September 30, 2006
as compared to the same period in 2005 resulted in the year-over-year increase in gross
margin dollars.
   Operating Expenses
  Operating Expenses
    
    
    Increase (Decrease) Between 2006 and 2005Three Months
    
    
    Nine Months
    
    
    Three Months
    
    
    Nine MonthsEnded September 30,
    
    
    Ended September 30,
    
    
    Ended September 30
    
    
    Ended September 302006
    
    
    2005
    
    
    2006
    
    
    2005
    
    
    $
    
    
    %
    
    
    $
    
    
    %SG&A
    
    $
    21.5
    
    
    $
    20.1
    
    
    $
    64.5
    
    
    $
    53.8
    
    
    $
    1.4
    
    
    
    7.0
    
    
    $
    10.7
    
    
    
    19.9Research &
development
    
    
    16.1
    
    
    
    16.0
    
    
    
    50.5
    
    
    
    45.1
    
    
    
    0.1
    
    
    
    0.6
    
    
    
    5.4
    
    
    
    12.0Restructuring &
impairment
    
    
    0.0
    
    
    
    0.0
    
    
    
    0.3
    
    
    
    0.4
    
    
    
    0.0
    
    
    
    0.0
    
    
    
    (0.1
    )
    
    
    (25.0
    )Amortization of
intangibles
    
    
    0.1
    
    
    
    0.2
    
    
    
    0.6
    
    
    
    1.0
    
    
    
    (0.1
    )
    
    
    (50.0
    )
    
    
    (0.4
    )
    
    
    (40.0
    )Total
    
    $
    37.7
    
    
    $
    36.3
    
    
    $
    115.9
    
    
    $
    100.3
    
    
    $
    1.4
    
    
    
    3.9
    
    
    $
    15.6
    
    
    
    15.6
 Selling, General, and Administrative, or SG&A, Expenses
  
    
    Equity compensation expense associated with the adoption of SFAS No. 123R beginning July
1, 2005.
    
    Higher variable compensation related to an increase in commissions, bonuses, slightly
higher staffing level, taxes and other fringe benefits.
    
    Higher legal and accounting professional fees.
    
    Partially offsetting these increases was a reduction in bad debt expense related to the
recovery of previously written off receivables. This contributed to
lower expenses of $1.6
million for the nine months ended September 30, 2006 as compared to the same period in
2005.
 Research & Development Expenses
  
    
    Previously disclosed technology licensing fees of $2.4 million during the second quarter
2006. As discussed below, this fee was related to a joint development project on Fixed
Mobile Convergence with UTStarcom.
    
    Higher variable compensation related to an increase in bonuses, slightly higher staffing
level, taxes and other fringe benefits.
    
    Included in the year-to-date 2005 expenses was a benefit of approximately $1.2 million
representing funding received from a customer related to development work that ARRIS
performed for the customer
 15




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over the preceding 18 months. The expense incurred to perform the work was charged to
research and development in the periods it was performed. The customer provided progress
payments over the time period. The payments were recorded as a liability until the work was
completed and no contingency existed for the potential return of the payments to the
customer. This occurred in the second quarter 2005, at which time the payments were
recognized as an offset to research and development expense.
   Ò
  Restructuring and Impairment Charges
  Amortization of Intangibles
  Other Expense (Income):
 Interest Expense
  16




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Loss on Debt Retirement
  Loss (Gain) in Foreign Currency
  Interest Income
  Other Expense
  Income Taxes
 Interim Financial
Reporting Accounting for Income Taxes in Interim Periods
 Accounting for Income Taxes
  17




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Financial Liquidity and Capital Resources
 Overview
  Liquidity & Capital Resources Data
 Nine Months Ended September 30,2006
    
    2005(in millions, except DSO and turns)Key Working Capital ItemsCash provided by (used in) operating activities
    
    $
    77.2
    
    
    $
    (9.1
    )Cash, cash equivalents, and short-term investments
    
    $
    210.0
    
    
    $
    94.4Accounts receivable, net
    
    $
    120.7
    
    
    $
    95.8Days Sales Outstanding (DSOs), annualized
    
    
    43
    
    
    
    42Inventory
    
    $
    101.1
    
    
    $
    90.1Inventory turns, annualized
    
    
    5.9
    
    
    
    5.3
 Inventory & Accounts Receivable
   Summary of Current Liquidity Position and Potential for Future Capital Raising
  18




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Commitments
  Cash Flow
  For the Nine Months EndedSeptember 30,2006
    
    
    2005Cash provided by (used in) operating activities
    
    $
    77.2
    
    
    $
    (9.1
    )Cash provided by investing activities
    
    
    17.2
    
    
    
    23.9Cash provided by financing activities
    
    
    10.3
    
    
    
    8.3Net increase in cash and cash equivalents
    
    $
    104.7
    
    
    $
    23.1
 Operating Activities:
  For the Nine Months EndedSeptember 30,2006
    
    
    2005Net income after non-cash adjustments
    
    $
    84.5
    
    
    $
    45.6(Increase)/Decrease in accounts receivable
    
    
    (37.5
    )
    
    
    (39.5
    )(Increase)/Decrease in inventory
    
    
    12.8
    
    
    
    2.8All other  net
    
    
    17.4
    
    
    
    (18.0
    )Cash provided by (used in) operating activities
    
    $
    77.2
    
    
    $
    (9.1
    )
 Investing Activities:
  For the Nine Months EndedSeptember 30,2006
    
    
    2005Capital expenditures
    
    $
    (7.1
    )
    
    $
    (7.6
    )Purchases of short-term investments
    
    
    (51.9
    )
    
    
    (51.3
    )Disposals of short-term investments
    
    
    76.2
    
    
    
    83.0Other
    
    
    
    
    
    
    (0.2
    )Cash provided by investing activities
    
    $
    17.2
    
    
    $
    23.9
 Capital Expenditures 
  Purchases/Disposals of Short-Term Investments 
  19




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Other 
  Financing Activities:
  For the Nine Months EndedSeptember 30,2006
    
    
    2005Excess tax benefits from stock-based compensation plans
    
    $
    0.5
    
    
    $
    Proceeds from issuance of stock and other
    
    
    9.8
    
    
    
    8.3Cash provided by financing activities
    
    $
    10.3
    
    
    $
    8.3
  Interest Rates
  Foreign Currency
    Financial Instruments
   Short-Term Investments
  20




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##### Table of Contents



Investments
 Accounting for
Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested
 Capital Expenditures
  Adoption of SFAS No. 123R, Share-Based Payment
 Share-Based Payment Accounting for Stock-Based Compensation Accounting for Stock Issued to
Employees, Statement of Cash Flows. Accounting for Stock Issued to Employees
  Share-Based Payment,
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Critical Accounting Estimates
  Forward-Looking Statements
  
 Item 3 . QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
     22




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Item 4. CONTROLS AND PROCEDURES
 Evaluation of Disclosure Controls and Procedures.
 Changes in Internal Control over Financial Reporting
 23




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Item 1A. Risk Factors
 Our business is dependent on customers capital spending on broadband communication systems, and
reductions by customers in capital spending would adversely affect our business.
  
    
    general economic conditions;
    
    availability and cost of capital;
    
    other demands and opportunities for capital;
    
    regulations;
    
    demands for network services;
    
    competition and technology;
    
    real or perceived trends or uncertainties in these factors; and
    
    acceptance of new services offered by our customers.
   The markets in which we operate are intensely competitive, and competitive pressures may adversely
affect our results of operations.
  
    
    Big Band Networks;
    
    Cisco Systems, Inc.;
    
    Motorola, Inc.; and
    
    TVC Communications, Inc.
   24




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##### Table of Contents



Acquisitions can involve significant risks.
  Our business has primarily come from several key customers. The loss of one of these customers or
a significant reduction in services to one of these customers would have a material adverse effect
on our business.
  The broadband products that we develop and sell are subject to technological change and a trend
towards open standards, which may impact our future sales and margins.
  We have anti-takeover defenses that could delay or prevent an acquisition of our company.
  Products currently under development may fail to realize anticipated benefits.
  
    
    are not cost-effective;
    
    are not brought to market in a timely manner;
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##### Table of Contents




    
    fail to achieve market acceptance; or
    
    fail to meet industry certification standards.
  Consolidations in the telecommunications industry could result in delays or reductions in purchases
of products, which would have a material adverse effect on our business.
   Our success depends in large part on our ability to attract and retain qualified personnel in all
facets of our operations.
  We are substantially dependent on contract manufacturers, and an inability to obtain adequate and
timely delivery of supplies could adversely affect our business.
  26




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Our international operations may be adversely affected by any decline in the demand for broadband
systems designs and equipment in international markets.
  Our international operations may be adversely affected by changes in the foreign laws in the
countries in which our manufacturers and assemblers have plants.
  We face risks relating to currency fluctuations and currency exchange.
   Our profitability has been, and may continue to be, volatile, which could adversely affect the
price of our stock.
  We may face higher costs associated with protecting our intellectual property.
  
 Item 6. EXHIBITS
 Exhibit No.
    
    Description of Exhibit31.1
    
    Section 302 Certification of Chief Executive Officer, filed herewith31.2
    
    Section 302 Certification of Chief Financial Officer, filed herewith32.1
    
    Section 906 Certification of Chief Executive Officer, filed herewith32.2
    
    Section 906 Certification of Chief Financial Officer, filed herewith
 27




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##### Table of Contents



SIGNATURES
  ARRIS GROUP, INC./s/ David B. PottsDavid B. PottsExecutive Vice President, Chief
Financial Officer, Chief Accounting
Officer, and Chief Information Officer  28